Feb 10, 2015
Executives
Loren Hanson - Manager of Investor Relations Jim McIntyre - CEO Chuck MacFarlane - President and COO Kevin Moug - Senior Vice President and Chief Financial Officer
Analysts
Matt Tucker - Key Banc Capital Markets
Operator
Good morning, and welcome to the Otter Tail Corporation’s 2014 Earnings Conference Call. Today’s call is being recorded and there will be a question-and-session after the prepared remarks.
I will like to turn the call over to Mr. Loren Hanson at Otter Tail.
Please go ahead.
Loren Hanson
Well good morning, everyone, and welcome to our call. My name is Loren Hanson and I manage the Investor Relations area at Otter Tail.
Last night, we announced our 2014 results and also increased 2015 earnings guidance. Our complete earnings release and slides accompanying this earnings call are available on our website at www.ottertail.com.
A replay of the call will be available on our website later today. With me on the call today is Jim McIntyre, Otter Tail Corporation’s CEO; Chuck MacFarlane, Otter Tail Corporation’s President and Chief Operating Officer; and Kevin Moug, Otter Tail Corporation’s Senior Vice President and Chief Financial Officer.
Before we begin, I would like to remind you that during the course of this call, we will be making forward-looking statements. These forward-looking statements are covered under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, and includes statements regarding Otter Tail Corporation’s future financial and operating results, or other statements that are not historical facts.
Please be advised that actual results could differ materially from those stated or implied by our forward-looking statements, due to certain risks and uncertainties, including those described in our most recent Form 10-K and subsequent quarterly reports on Form 10-Q. Otter Tail Corporation disclaims any duty to update or revise our forward-looking statements, as a result of new information, future events, developments or otherwise.
For opening remarks, I would now like to turn the call over to Otter Tail Corporation’s CEO, Mr. Jim McIntyre.
Jim?
Jim McIntyre
Thank you for joining us on the call this morning. We’ve had a very good 2014 and are eager to talk about it with you.
Chuck will give some of the high points of the year and he will explain how the pending divestiture of our construction companies is consistent with our strategy. Kevin, of course will address the financials.
I would like to use my time to talk about the pride I have in this corporation and my belief in its future. As you know, I will be retiring as CEO in April.
This is the last time I will join you on an earnings call in this capacity. So I would like to use the time to summarize something I’ve talked with you about in prior calls, our strategic journey.
It may be helpful to refer to slide 4 as a strong reminder of what our strategy entails. When I came aboard as CEO in late 2011, Otter Tail Corporation was dealing with a very slowly improving national economy after a widespread downturn, as were most companies.
We had identified a strategy that would narrow our portfolio of businesses, tighten and enhance oversight in our operations, and allow us to pursue investment opportunities in our electric utility. In the three years that followed, I had the privilege of working with an engaged board, a talented leadership team, and committed employees throughout the company to bring this strategy to fruition.
We reduced risk by divesting companies that no longer fit our strategy. We invested in power plant environmental upgrades and reasonable transmission projects.
We worked through the legislative and regulatory processes to achieve approval for environmental upgrade and transmission cost recovery riders that provide more certainty for investors and lower cost for customers. We removed unnecessary debt, stabilized and increased earnings, and saw an upgrade in all our corporate credit ratings.
We supplemented operations and talent management resources at our companies and we implemented a corporate wide leadership development program including a robust succession planning process. Our commitment to shareholders never waned.
We maintained a dividend through the dark days. And in February 2014 following strong financial results in 2013, our Board of Directors increased the annual dividend by $0.02 a share, the first increase since 2008.
Last week, the board again increased the annualized dividend $0.02 a share to an indicated annual rate of $1.23 a share, the 305th consecutive quarter we paid dividends on common stock. In 2014, the dividend and stock appreciation combined to provide a total shareholder return of approximately 10%.
That's a good return on a utility-based investment. Otter Tail Corporation is well positioned for sustainable success.
Internal and external clarity and transparency exists as to its strategic plan. Enhanced management systems and practices are in place to support more predictable results.
The corporation has an engaged workforce and strong leaders and is intentionally taking actions to expand overall leadership. The incoming CEO is battle tested, both in the Utility and in the Varistar businesses and the supportive board has strong governance practices in place.
Well challenges will always exist. Otter Tail Corporation’s people and systems are more than capable of successfully meeting them.
I appreciate the time I've had with this organization. And now I will turn it over to Chuck for specific comments in 2014 and for his insight into 2015.
Chuck?
Chuck MacFarlane
Jim won’t say it, but of course that he has had a strong hand in achieving the results we're reviewing with you today. We thank him for that and we're not letting him go just yet.
He is CEO through the first quarter and will serve as a consultant for our strategic planning process in the second quarter. So no goodbyes just yet and he will be available to take your questions at the conclusion of the call.
I do appreciate Jim's confidence in our organization and I share it. The 2014 results demonstrate we are delivering shareholder value.
Consolidated revenues increased 8%. Consolidated net income and diluted earnings per share from continuing operations both improved more than 16%.
And utility net income was 14% higher than in 2013. The improvement in utility net income is primarily related to cost recovery riders with the environmental upgrade project at Big Stone Plant and major transmission projects.
All three states, the utility serves approved or implemented riders in 2014. Just a quick update on the environmental project.
It's nearly 90% complete. It's maintaining an excellent safety record and will begin the four-month process of putting the environmental controls into service at the end of this month.
You’ll recall that we now expect the project to cost $384 million, which is 22% less than the original estimate used in our advanced determination of prudence proceedings. Our share of the project is $207 million.
Utility is also earning a return during the development, and construction of the midcontinent independent system operator multi-value in CapX2020 transmission projects. Two of the four projects in which we are participating will be completed in 2015.
The remaining two will be completed in the 2017 to 2019 timeframe. Those two projects, Big Stone South to Brookings and Big Stone South to Ellendale have received their South Dakota State permits and Otter Tail Power has assumed project management duties with the Ellendale Project.
Slide 5 shows all of our current rate-base projects and the percent of completion. And slide 6 shows the various cost recovery mechanisms we have for each of them in the states we serve.
Now before I turn my attention to our manufacturing and infrastructure companies, I would like to provide an update on three other utility items. First Coyote Station, the jointly owned 427 MW mine-mouth plant we operate in North Dakota suffered a major mechanical failure in one of its steam-driven boiler feed pumps and tripped offline on December 4.
Lube oil lines ruptured resulting in a fire. Thankfully no one was hurt, but the plant sustained major damage to the failed pump as well as damage to the roof, cabling and other nearby equipment.
Crews had plant back online at half load 18 days later, but it will take some months before we can rebuild the failed pump and return the plant to full service. A vast majority of the equipment repairs will be covered by insurance.
Until then, Otter Tail Power has made alternative arrangements for energy. I also want to update you on the rail delivery of coal to our power plants.
Since our last call train cycle times have improved. So the Big Stone Plant lifted the coal conservation mode on January 1st.
Deliveries are keeping up with the use. The last time is an update on our discussion of the EPA’s proposed rule to reduce carbon dioxide emissions from existing power plants.
You’ll recall that the EPA proposed state-by-state emissions reduction targets. And that the South Dakota targets were concerning because Big Stone Plant is the only coal plant in the state.
This is a concern because under the proposed rule, South Dakota’s only combined-cycle natural gas plant which was brought on line in August of 2012 is assumed to increase to a 70% capacity factor resulting in a corresponding decrease in the output at the only coal-fired plant in the state, Big Stone. We continue to work with the South Dakota agencies and other stakeholders as we reported in the third quarter, including the Congressional delegations from Minnesota, North Dakota, South Dakota, Montana to file comments in December.
We also filed comments as a company and in reading the various filings we're gratified to see the support for our specific concern. We're seeing a modification to the final rule which is expected some time this summer.
Now to the manufacturing and infrastructure companies. As you know we’ve moved the construction companies, Aevenia and Foley to discontinued operations.
The two companies performed very well in 2014, but as Jim explained during our third quarter call we continually assess the companies fit with our portfolio criteria and strategic plan. Through that assessment, we determined that we would best be able to strengthen our overall diversified operations by investing exclusively in manufacturing-based companies.
It will allow us to focus on a similar set of businesses. Also some aspects of the Construction segment did not align with our investors’ expectations for predictable earnings based on a moderate risk profile.
We now have signed letters of intent for Aevenia and Foley and expect to close on the respected transactions by the end of the first quarter of this year. We recorded a goodwill impairment on Foley at the end of 2014 based on Foley’s indicated market price.
And we expect to record a gain on Aevenia when the transaction closes in 2015. These sales will conclude our migration of companies under Varistar from a highly-diversified platform to one that is composed entirely of manufacturing companies.
Sufficient diversity remains in the end-use markets within the platform to provide a measure of protection against specific market downturns. During the next several years, we will concentrate on organic growth and acquisition within these companies or alongside them.
The other companies are doing well. T.O.
Plastics strengthened its management and sales team in 2014 and saw a 12% increase in sales of horticulture containers. Horticulture is the company’s primary market and now accounts for more than 50% of T.O’s total sales.
Continuing to emphasize this market T.O. launched a new line of products, specialized plug trays called SureRoots ELITE.
The company designed them in collaboration with distributors and growers and makes them with a 100% reclaimed material. BTD revenues were up.
But because the increased sales didn't translate to improve net income, BTD has initiated several actions to help reduce cost and improve margins. We’ve hired a new Chief Operating Officer, a new Human Resources Officer and a new manager at the Washington Illinois plant.
These strategic hires will help focus on efficiency. In addition to the facility’s expansion plan we discussed in the third quarter call, we will put Lakeville operations under one roof, significantly reducing logistics cost.
The PVC pipe companies, Vinyltech and Northern Pipe products had a strong year in 2014. Their earnings were affected by increased resin prices throughout the year.
So results aren’t as strong as in 2013, but sales were excellent. In fact Northern Pipe products had a record year shipping its most pounds ever.
The pipe companies are very competitive with low conversion and fixed costs, their outlook is solid. I'm pleased with the progress of all of our companies.
I’ve had the operating company presidents report directly to me since last spring. This has given me a better opportunity to assess their businesses and best determine how to proceed.
To that end, we're pleased to announce that John Abbott has accepted the role of Varistar President and he begins work tomorrow. John has strong sales, marketing and operating experience.
He has successfully overseen multiple P&L presidents in his previous roles. And he has significant manufacturing company acquisition and integration experience.
This is another strategic hire to further enhance the performance of our Manufacturing segment. I’ll summarize by saying that Utility had a strong 2014, both financially and operationally.
It had an excellent OSHA safety record, good electric service reliability, and a customer satisfaction rating among the top in the nation. Our decision to invest in utility rate base projects has improved the income.
And this will continue for the foreseeable future as demonstrated on slide 7. The manufacturing and infrastructure companies under Varistar also had a strong year financially and operationally.
Northern Pipe and Vinyltech have low capital costs and operating costs. They are agile and able and provide excellent customer service.
They have strong earnings, strong cash flow and are highly competitive. T.O.
Plastics is growing its horticulture container business. It has a more focused strategy and has enhanced talent with good earnings in 2014.
BTD is a high quality full service, fast growing metal fabricator serving a highly desirable base of household name customers. The combination of continued growth in BTD sales, a focus on increasing the return on sales and the addition of talent provides confidence for BTD.
Together they exceeded the return on invested capital targets. And under the guidance of John Abbott, the new Varistar President I anticipate an even stronger 2015.
Slide 8 shows our remaining businesses have provided shareholder value. And we’ll continue to target a compounded annual growth rate of 4 to 7%.
Now I will turn it over to Kevin for the financial perspective.
Kevin Moug
Well, good morning. Please move to slide 9 for an overview of 2014.
As part of discussing our financial results for 2014, it's important to know we signed letters of intent to sell Aevenia and Foley companies in our Construction segment. The segment meets the criteria to be classified as held for sale and as such is being reported as discontinued operations as of December 31, 2014.
I will discuss this later in my comments, but with that backdrop let me move on to our results from continuing operations. 2014 was another year of executing on our strategies.
Our consolidated revenues increased across the Electric, Manufacturing and Plastics segments. We raised $25.6 million in equity under our at-the-market dividend reinvestment and other employee stock plans.
And we expect to continue to use these programs as equity financing is needed during the 2015-2019 timeframe. Our strong 2014 performance and 2015 outlook allowed the Board of Directors to increase our indicated annualized dividend rate from $1.21 a common share to a $1.23 a common share in 2015.
Now I will move to slide 10 for an overview of 2014 earnings from continuing operations. The Electric segment had strong performance in 2014 earning a $1.19 per share.
Revenue increased 9.2% primarily due to continued rate base investments in transmission and environmental upgrade to our Big Stone Plant, and from increased pipeline and commercial sales. A $5.4 million increase in net earnings is reflective of our continued execution of the rate base growth strategies.
Our Manufacturing segment’s earnings were $0.25 a share in 2014 compared with $0.32 a share in 2013. BTD’s revenues increased nearly 12% year-over-year due to higher sales to energy-related, recreational, and lawn and garden end markets.
Earnings at BTD were down year-over-year due to one, an after-tax charge of $1.7 million or $0.05 a share related to the exit of leased facilities at our [indiscernible] location. Two; increased product handling costs, freight inventory reserves and tooling costs to repair and refurbish dies.
These costs reduced gross margins by 2%. And three; increased operating expenses.
T.O. Plastics’ revenues and earnings decreased in 2014 mainly as a result of reduced sales of packaging products produced for a customer prior to 2014.
And while the revenues declined related to this, T.O. Plastics’ product mix improved resulting in higher gross margin percentages year-over-year.
Our Plastics segment earned $0.33 a share in 2014 compared to $0.38 a share in 2013. Revenues increased based on stronger sales volumes and higher prices for pipes sold.
However earnings were down year-over-year due to an increase in cost per pound of pipes sold, primarily related to higher PVC resin costs. The increase in resin costs could not be fully recovered through increased pipe prices due to competitive market conditions.
Corporate costs were $0.22 a share compared with $0.42 a share in 2013. The components to this change are discussed in the press release.
Our earnings per share from continuing operations on a GAAP basis was $1.55 in 2014. This reflects $0.09 a share of infrequent charges.
Our 2014 earnings per share from continuing operations on a non-GAAP basis is a $1.64 adjusting for this amount. The $1.64 a share reflects the base earnings capability of our Electric and Manufacturing platforms.
Let's move to slide 11 to discuss discontinued operations. We’ve been successful in marketing the Construction segment and have signed letters of intent to sell these businesses by the end of the first quarter of 2015.
We did recognize an impairment loss in the fourth quarter for Foley based on the indicated market price we’ve agreed to sell the company for. And we do expect to recognize a gain on the sale of Aevenia at closing.
Please move to slide 13 for a discussion of our 2015 business outlook. Our 2015 earnings guidance is expected to be in the range of a $1.65 to a $1.80 of earnings per share.
This guidance reflects the current mix of businesses owned by the corporation. This guidance also considers the cyclical nature of some of the operating companies and strategies for improving future results.
Our Electric segment earnings per share is expected to increase in 2015 based on the following items. One; rider recovery increases including riders in Minnesota and North Dakota related to the Big Stone AQCS environmental upgrade.
Two; increased volumes from pipeline and commercial customers. And three; a decrease in plant overall costs.
These items are offset by an increase in pension costs as a result of an increase in projected benefit expenses based on a decrease in the discount rate from 5.3% to 4.35% and the adoption of new mortality tables with longer life expectancy assumptions. Higher depreciation and property taxes, a tax expense due to large transmission projects being put into service, and higher short-term interest costs to fund major projects being worked on.
We expect earnings from both BTD and T.O. Plastics, our Manufacturing segment to increase in 2015.
At BTD, revenues are expected to increase as follows, growth and market share and breadth of services with existing customers. Our paint line capabilities are expected to be in service by June of 2015 and will also contribute to additional revenues and earnings growth.
We also expect earnings to improve as a result of our facilities expansion and optimization plan and expected cost reductions at our Illinois facility. T.O.
Plastics is also expected to increase earnings in 2015 based on expected volume increases in its horticulture business line through market share growth and product line expansion, as well as growth in the various industrial end markets it serves. Backlog for this segment is approximately a $140 million for 2015 compared with a $136 million one year ago.
We expect Plastics’ net income to be down from 2014. Sales volumes are projected to be slightly up over 2014.
Operating margins are expected to be lower due to tighter spreads between resin costs and sales prices along with increased labor and freight. And we expect corporate costs to be flat in 2015 compared to 2014.
Let me provide an overview as shown on slide 14 of our capital expenditure plans. We expect capital expenditures for 2015 to be a $183 million compared with a $164 million last year.
We continue to invest in various transmission projects as well as the completion of the Big Stone AQCS project. The investments in these environmental and transmission projects positively impacted corporation’s earnings and returns on capital.
Also contributing to the increase in planned expenditures for 2015 is the BTD expansion at its two Minnesota locations, Lakeville and Detroit Lakes. A five-year capital expenditure plan calls for $665 million in utility projects and also includes a $110 million for the manufacturing and plastics businesses.
We believe our 2015 guidance further positions us to achieve a 47% compounded annual growth rate and earnings per share using 2013 $1.50 a share as adjusted for the base year. This is driven largely by the approved projects and related rider recovery of rate base investments at the utility, and capacity available in our manufacturing and plastics companies.
2015 presents opportunities and challenges as we grow our business. We’ll continue to perform on our rate base expansion projects for the utility.
Success at BTD will be dependent on successful execution of the paint line and facility expansion along with operational improvements needed to further improve our return on sales margins. And T.O.
Plastics must be successful in its strategies to grow revenues across all the end markets it serves. And while there is volatility in our Plastics segment’s earnings from year to year, this segment can be relied on to provide stronger earnings, cash flows and returns on invested capital.
After the Q&A, Jim will return with closing comments and we're now ready to take your questions.
Question-and
Operator
[Operator Instructions] Our first question comes from the line of Matt Tucker with Key Banc Capital Markets. Your line is now open.
Please proceed with your question.
Matt Tucker
First question, would you guys be able to give us the amounts you are receiving or any evaluation metrics on the sale of the construction businesses?
Kevin Moug
Yeah Matt, this is Kevin. We're not closed.
We're continuing to work on the agreements and towards closing. So we're not yet able to disclose any metrics or expected prices on the transactions.
Matt Tucker
Okay, looking at your guidance for the Manufacturing segment. I think at the midpoint, it implies earnings growth of about 30% excluding the charge at BTD in the fourth quarter.
And you’ve talked today and in the past about some of the things you're doing internally to expand the paint services. You talked a lot about market share today, gaining market share.
What gives you the confidence that you will be able to do that this year?
Chuck MacFarlane
Matt, this is Chuck. Just a couple of and on the changes of the increase I think in manufacturing or year-over-year to go to the midpoint.
We’ve approximately 14% -- or $0.14 improvement. And what we see in that is the [indiscernible] lease writedown should improve $0.05 of that.
We’ve logistics improvements of $0.03. And then with the paint line and returning to more historic return on sales numbers for BTD, we would envision another $0.06 to sort of walk you from one to the other.
The logistics cost, just to give you a feel we had three sites in Minnesota. The one facility at [indiscernible] was not near either our Lakeville or our Detroit Lakes’ locations.
And we were hauling finished parts and child parts and whatnot to and from that location. In our optimization plan, we're going to you know eliminate that facility and we’ve already leased it out and we’ll be expanding at both the Lakeville and DL sites to cover that.
So you know it’s not hugely dependent on a large amount of new revenues coming in to BTD. It is more a function of improving the return on sales to a more historic numbers or levels.
Matt Tucker
Are you seeing growth in end-market demand for the manufacturing segments or is it really as you kind of said you know the growth is going to be more driven by what you're doing internally?
Chuck MacFarlane
We're seeing growth in certain end markets and we're seeing certain end markets contract a little bit. The energy and ag markets are soft, the law and garden, RV horticulture and others are improving.
Matt Tucker
And do you guys have the weather impact on the fourth quarter or the degree days versus normal at electric?
Kevin Moug
For just the fourth quarter or for the year, because the year is in there.
Matt Tucker
Well, the year is in there. The fourth quarter would be helpful and then if also for the full year do you have an estimate for the impact on earnings or margin versus normal weather?
Kevin Moug
You know in terms of from 13 to 14 you know right now I think there is -- the weather is relatively neutral in terms of planning for normal weather compared to where we were at slightly below that. And I am just trying to look at something here on your fourth quarter.
Yeah man, it is in the press release in terms of fourth quarter as well on page 4.
Matt Tucker
Okay thanks, sorry I missed that. One more from me.
You cited strong growth from pipeline and commercial customers in electric in 14. Are you seeing any impact on demand from your pipeline customers in particular since the decline in energy prices began?
Chuck MacFarlane
Matt, this Chuck. The majority of our pipeline sales are associated with you know Canadian oil.
While we think the production is maintaining its level, but one thing we watch is the differential between the Brent and the West Texas pricing. And if there is a significant premium to the Brent, that will allow us more real flexibility if you will.
And as those have come closer together, we're seeing strong or continued load on the pipeline company.
Operator
[Operator Instructions]. And we’ve a follow-up from the line of Matt Tucker.
Your line is now open. Please proceed with your follow-up.
Matt Tucker
Hey guys, just a couple of more. It looks like the 2014 electric CapEx came in a little bit lower than anticipated and I think 2015 moved up a bit.
Could you just touch on the movement there?
Chuck MacFarlane
The 2014 was primarily driven by the projects coming in lower than expected. We had contingencies built into that capital budget and that has been lower.
We’ve not seen a significant delay in any of those. We’ll be starting the large Big Stone to Ellendale, and Big Stone South to Brookings projects are slightly behind, but there hasn't been a lot of capital expended.
If you see that slide, it’s percent complete. I think you would look, we didn’t mention a number in there because they are still in development.
But those are probably in the area of 5% of the capital dollars have been spent on those two. But primarily the reduction in 14 is projects coming in lower than expected cost.
Matt Tucker
And could you please comment on 2014 utility customer growth and your expectations for customer growth going forward?
Chuck MacFarlane
Yeah, the expectations going forward is we’ve approximately 2.5% revenue growth. That is largely or almost all driven by known industrial and commercial additions.
The year-over-year residential growth is essentially flat. It was up slightly in 14, but we don't expect a lot of growth sort of in the base amount.
It is just known industrial and commercial customers in ‘15.
Matt Tucker
And then just in terms of your plastics outlook. And you talked about you know seeing some margin pressure, and I think you’ve been talking about that for a while.
Does your guidance assume that margins continue to get squeezed or is it kind of assumed the current margins for the rest of the year?
Kevin Moug
Yeah Matt, I mean this is the Kevin. And as we head into ’15, you know we certainly will expect that there is, kind of where we're at to slightly declining as we head into ‘15.
Matt Tucker
How do you see the decline in energy prices impacting the plastic segment either from a demand perspective or from a cost perspective?
Chuck MacFarlane
Yeah you know from a demand perspective, we do see slightly increased volumes here in 2015 as we head into the year. From a pricing perspective either you know as we head into the year, there has been some announcements around potential increases in resin prices again.
Whether you know there looks to be that they may not fully take effect. But you know, so there is really you know we're expecting you know increased volumes, slightly increased volumes year-over-year.
And then kind of given where we finish the year in terms of our resin pricing, and as we head into the year we expect those margins as we said to kind of continue to be tightened like we finished the year. And potentially there is additional risk, they could tighten up further.
Operator
[Operator Instructions]. And with no further questions in the queue, I would like to turn the call over to you, Jim McIntyre for closing remarks.
Jim McIntyre
Well thank you, Nicholas. Planning, people, processes and operational excellence drive over performance.
Over the last three plus years, we successfully executed our strategy, and accomplished what we said we're going to do and more. We’ve rationalized our business strategy and made it simpler, easier to understand with far less risk and have successfully delivered increasing shareholder value for each of those years.
The lessons learned from the past server Otter Tail Corporation well and will not be easily displaced or forgotten. I am optimistic about Otter Tail’s performance not only in 2015, but in the years to follow.
I’ve confidence in Chuck MacFarlane’s leadership as the incoming CEO and then the organization based on the strength of its people and commitment to excellence. While this is my last call on behalf of the corporation, we appreciate your continued interest and look forward to your joining us for our second quarter call.
Thank you very much.
Operator
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect.
Have a good day, everyone.