Otter Tail Corporation (OTTR) Q1 2017 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to Otter Tail First Quarter 2017 Earnings Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions]. As a reminder, this conference call is being recorded. I will now like to turn the call over to Otter Tail.

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 first quarter 2017 results. 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 Chuck MacFarlane, Otter Tail Corporation’s President and CEO; and Kevin Moug, Otter Tail Corporation’s Senior Vice President and Chief Financial Officer. Before we begin today’s call, I’d like to remind you that during the course of the call, we will be making forward-looking statements. As noted on Slide 2, these statements represent our current judgment or opinion of what the future holds. They are subject to risks and uncertainties that may cause actual results to differ materially from forward-looking statements made today. So please be advised about placing undue reliance on any of these statements. Our forward-looking statements are described in more detail in our filings with the Securities and Exchange Commission, which we encourage you to review. 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 President and CEO, Mr. Chuck MacFarlane. Chuck?

Thank you, Loren and good morning everyone. For the quarter net income was $19.5 million or $0.49 a share. This was better than planned and $0.11 better than last year. As pointed out in the press release, although all of the operating segments improved net income. Minnesota interim rate revenue at the utility drove the overall improvement. Weather was also slightly more favorable for the utility this year although mild winter weather did negatively impact Otter Tail Power's first quarter earnings per share by $0.02 compared to normal. Improvement in the manufacturing platform was largely a result of improving prices on scrap metal sales, lower operating costs and lower interest costs, which Kevin will describe in a few moments. I credit our employees. They are dedicated to cost management and they work toward operational excellence. Their retention helps us manage events such as unfavorable weather at the utility and difficult economic factors that continue to effect our manufacturing platform. We are confident in our business model that combines a strong regulated electric utility with the portfolio of manufacturing businesses to enhance long-term returns. My remarks today will focus on continuing execution of our strategy to grow rate base, which includes the utilities rate case decision, the Minnesota Commission decision on the utility's resource plan; and transmission investment that is underway. I will also update you on each of our manufacturing companies. On March 2, a year after Otter Tail Power filed its rate case, the Minnesota Public Utilities Commission granted a revenue increase of 6.3%. This compares with the utilities modified request of 7.4% submitted during rebuttal testimony. The Minnesota Commission set the return on equity at 9.41% on an equity layer of 52.5%. The Commissioners complemented the utility's operational performance and we believe, we received more favorable treatment as a result. Because the rate case decision will result in revenue increase less than the Company collected during interim rates, Otter Tail Power will refund customers the difference with interest. Otter Tail Power will implement the approved rates approximately 120 days after the order becomes effective, likely November. Otter Tail Power's rates continue to be among the lowest in the nation and region. Two weeks after the rate case hearing, the Minnesota Commission approved the Otter Tail Power's 2017 to 2031 resource plan. Key ordering points include a 5-year action plan with the addition of up to 200 megawatts of wind, 30 megawatts of solar and up to 250 megawatts of peaking capacity in 2021. All of these projects are included in the list of rate-based projects on Slide 8. The order also included an additional 100 to 200 megawatts of wind energy in the 2022 to 2023 time frame. Overall, the order was favorable and supported our buildout strategy. We will file our next resource plan in June of 2019. On March 27, we announced our plan to construct a 250-megawatt natural gas plant near Astoria, South Dakota. We submitted the notice of intent for the South Dakota permitting efforts on April 3, and filed the request for advanced determination of prudence in North Dakota on April 10. If approved, this natural gas project will be simple-cycle plant near the intersection of the northern border pipeline in the Big Stone South-Brookings 345 kV transmission line, which is scheduled to be completed by the end of this year. We chose this site to avoid significant costs for extending gas to transmission facilities and to minimize landlord impact. We expect the project to cost approximately $165 million and to be online in 2021 with three to five full time employees. Combined with a 150 megawatt, Merricourt wind project, we announced in November, it will replace expiring purchase power agreements and prepare for the retirement of the aging Hoot Lake Plant in 2021. You will recall that we executed project agreements in November for a 150-megawatt wind farm that EDF Renewal Energy will build in southeast North Dakota in 2019, near the small town of Merricourt. It will cost approximately $250 million and Otter Tail will take a 100% ownership when complete. This will boost our renewable resources to nearly 30%. We continue to be pleased with the performance of our exiting wind farm and this new wind farm will have a very low delivered energy price. We filed a request for advanced determination of prudence in North Dakota for the Merricourt wind project on April 10 and will submit a renewable writer eligibility filing in Minnesota soon. Our resource plan and related projects are not impacted by changes to the implementation of the Clean Power Plan. The Clean Power Plan has been hold since the Supreme Court issued a stay last year. And President Trump signed an executive order in March directing the Environmental Protection Agency to review and repeal or replace the Clean Power Plan and other greenhouse gas regulations for the power sector. With or without federal carbon regulation, we continue with our renewable energy and natural gas projects because they are part of a least-cost resource plan. We will also provide for a diverse energy mix. And we will continue to proceed with retiring Hoot Lake Plant by 2021 based on economics. Allow me, to update you on the transmission side of our rate base growth strategy. Before we made progress on two 345-kV transmission projects we discussed on past calls, Big Stone South-Brookings and Big Stone South-Ellendale. The map on Slide 7 shows their relative locations. Both are designated as Multi-Value Projects within MISO, allowing recovery of project costs from all customers in MISO’s upper mid-west footprint. Both remain on budget and on schedule. We are a 50% owner in the Brookings project with Xcel Energy, with the project manager. All structures are set, line stringing began in 2016 and will continue through this summer and we expect the project to be energized, later this year. We are 50% owner in the line portion of the Ellendale project with MDU. Otter Tail Power is the project manager and contractors have completed nearly half of the 750 pole foundations and have set 106 structures. We expect the project to be energized in 2019. These two transmission projects have a combined Otter Tail investment of approximately $250 million. As shown on Slide 8, the Wind, Natural Gas and transmission projects are part of our Electric platforms plan to grow rate base by an annual growth rate of 7.5%, using 2015 as a base year. As shown on Slide 9, Otter Tail power plans to make capital investments of $862 million during the 2017 to 2021 timeframe. Slide 10, shows our regulatory framework, which continues to be constructive. As noted on the slide, the majority of future projects are eligible for rider recovery while under construction. The balance of capital spend is at current depreciation levels and effectively covered in base rates. Our manufacturing companies all increased net income quarter-over-quarter. BTD, our custom metal fabricator, that serves some of the top OEMs in the nation, continues to be impacted by economic challenges including a soft power sport recreational vehicle market. But the Company was able to increase net income quarter-over-quarter, even with lower sales. Key factors are improved scrap metal pricing, lower operating expense and lower interest costs. BTD expanded facilities, including the Georgia facility acquired in 2015, should put it in a good position to enhance earnings when markets improve. Strategically speaking, BTD needed to establish a presence in the Southeast. Many of its customers have expanded there and want suppliers nearby. This is the right location for future growth. Improved operations also drove year-over-year net income growth for T.O. Plastics, our thermoforming manufacturer. The company increased sales and its major end markets, horticulture containers and life science products. Horticulture containers account for 63% of the company's total sales in 2016. The PVC pipe companies, Vinyltech and Northern Pipe Products, continued their solid performance. The companies have low capital costs and low operating costs. They provide excellent customer service, they have strong earnings, strong cash flow and are highly competitive. Early in the quarter, the rain and subsequent flooding in North California, which is Vinyltech's largest market, halted construction and curtailed pipe shipments to the state. Northern Pipe Products also had inclement weather over much of its trade area. Later in the quarter, both companies shipped record amounts of pipe as distributors saw to build inventory prior to an announced resin price increase throughout the industry. Overall, the first quarter was positive and included excellent operational performance across all of our companies. Now I'll turn it over to Kevin for the financial perspective.

Well, good morning, everyone. Please refer to Slides 11 and 12 as I discuss our first quarter results. Utility net earnings increased $3 million quarter-over-quarter. Key drivers of the 24% increase in net earnings were, an increase in retail revenues of $2.8 million net of an estimated refund related to interim rates that went into effect in mid-April of 2016; increased retail revenue related to colder weather in the first quarter of 2017 compared to the first quarter last year; heating-degree days increased by 10% between the quarters; weather positively impacted earnings per share by approximately $0.02 quarter-over-quarter. Compared to normal, weather negatively impacted earnings per share by $0.02. Increased MISO transmission tariff revenue related to increased investment in regional transmission projects and lower operating and maintenance expenses. These items were offset in part by lower kilowatt-hour sales as well as lower prices to industrial customer as a result of a customer opting for market base pricing in July of 2016; lower environmental rider revenues due to increased investment balances; and lower conservation improvement program incentive revenues. Our manufacturing segment net earnings increased $319,000 quarter-over-quarter. Revenues decreased quarter-over-quarter for BTD by $2.2 million mainly due to reduced sales of transportation fixtures for wind turbine blades and tooling sales, offset in part by higher scrap metal sales due to more favorable pricing. Also contributing to BTD's higher net income were lower operating expenses and lower interest costs. At T.O. Plastics, revenues and earnings increased quarter-over-quarter. Horticultural sales increased driven by unit volume growth, offset by lower selling prices. The lower selling prices were impacted by increased competition in the marketplace. Life sciences, which includes medical packaging and research products had a $200,000 revenue increase quarter-over-quarter. Earnings also benefited from lower operating expenses and lower interest costs. Our Plastics segment's revenues increased between the quarters as a result of an 11.2% increase in the amount of pound sold. Increased sales were offset by a higher cost per pound of pipe sold stemming from higher resin prices. The increase in resin costs could not be fully recovered through increased sales per pound pipe prices. They remain flat between the quarters. This resulted in a 9.4% decrease in gross margin per pound of pipe sold. Earnings increased between the quarters primarily due to lower operating expenses along with lower interest costs. Our corporate expenses net of taxes decreased $4.1 million quarter-over-quarter, primarily due to a reduction in income tax expense related to a tax benefit from the accounting treatment of stock performance awards. Lower labor and benefit costs resulting from a lower employee headcount also contributed to the lower corporate costs. Moving to our business outlook, we are reaffirming our consolidated earnings per share guidance of $1.60 to $1.75, as shown on Slide 13. Our 2017 guidance is dependent on the business and economic challenges our two platforms are facing. Our Electric segment's 2017 net income is expected to be higher than 2016 net income based on normal weather for the remainder of 2017; a full year of increased rates from the Minnesota rate case compared to 8.5 months in 2016; rider recovery increases related to increased investments in MVP transmission projects; and increased sales to industrial and commercial customer. These items are offset by increased operating and maintenance expenses related to increased medical, workers compensation and retiree medical benefits. Also, increased pension costs due to a decrease in the discount rate as well as lowering the assumed long-term rate of return. Higher depreciation and property tax expense due to large transmission projects being put into service; lower CIP incentives in Minnesota as a result of a new state initiated program; and increased costs related to certain capacity agreements. We expect increased earnings from our manufacturing segment in 2017. Items driving this for BTD are: flat year-over-year sales with lower recreational vehicles sales offset by higher lawn and garden, scrap and tooling sales; and improved levels of operating costs and lower interest costs. We are also expecting increased earnings at T.O. Plastics primarily due to increased sales, along with lower interest costs. Backlog for this segment is approximately $105 million for 2017 compared with $102 million a year ago. And we expect Plastics net income to be in line with 2016. Sales volumes are projected to be slightly lower compared to 2016, but look for improved sales prices resulting in improved operating margins. And segment net income will also benefit from lower interest expense. And our corporate costs are expected to be in line with 2016. We are pleased with our strong first quarter. First quarter results were largely impacted by having interim rates in effect in the first quarter of 2017, which weren’t in effect in the first quarter of 2016; and the lower costs at corporate, which were largely driven by the tax benefit related to the accounting treatment of stock performance awards. Key initiatives that remain for this year include continued rate-based growth from our investments in the Electric segment; continued improvement in profitability at BTD over 2016; and while earnings per share are expected to be similar in 2017 compared with 2016 for our Plastics segment, we are encouraged by the outlook for improved pipe pricing which should improve operating margins. This ongoing effort positions us to meet our long-term goal of 4% to 7% compounded growth rate in earnings per share, using 2016's $1.60 a share from continuing operations. We are now ready to take your questions. And after the Q&A, Chuck will return with a few closing remarks.

Thank you. [Operator Instructions] And our first question comes from Paul Ridzon from KeyBanc. Your line is now open.

Good morning, congratulations on the quarter.

Thank you, Paul.

Are there any – are you caught up with your refunds or could we see some more refunds from interim rates flowing to the second quarter?

Hey, Paul. This is Kevin. As of the end of the quarter, our estimated refund is trued up to the – as the result of the oral arguments and deliberations that occurred in the March timeframe, the final order was issued yesterday. And so we're in line and trued up with, as we review that order, we were relatively trued up against the order. There is one item that we have outstanding related to a private letter ruling that we agreed to go get with the Department of Commerce. That's – it has to do with treatment of accumulated deferred income taxes to the extent that that comes back differently than where we're at, that could have some impact on the estimated refund. But we're pretty well trued up now.

Thank you. And then the tax benefit you've had from the stock comp, is that ongoing or what should we expect in the coming quarters?

There will be no more of that this year. So it's really a – the result of – we switch the accounting for those performance share awards in the fourth quarter to the equity method. And when those – it was the 2014 awards that we're in the money through based on the three-year return ending 2016. That was paid out in the first quarter of 2017. And given that the fair value of the awards were higher than what the grant date fair value was, then we get this tax benefit that benefited lower corporate costs. But it won't happen again because our performance share awards are, to the extent they're in the money. They're issued and awarded annually based on the performance, the three-year performance. So the next time we could see something would be in February of 2018.

Got it. And then depreciation at the utility was down a little bit. Did that impact net income or was your dollar-for-dollar revenue offset?

It impacted net income some, but there was also, the offset as you suggest but we did have an order that came out of the commission that related to assets at Hoot Lake and the orders said we should extend the life over which those assets are depreciated. So we did have some pick up there as a result of that order.

Because your revenue was still based on – but that would be trued up with when you implemented new rates, is that fair?

I don't think so.

Okay. Thank you very much.

Thank you. And our next question comes from Tate Sullivan from Sidoti. Your line is now open.

Hi, thank you and good morning. If I may start with the Plastics division, you mentioned, first, why – why, what do you see that makes you think you have the lower sales volume of PVC pipe?

Tate, this is Kevin. Just as we look at the forecast for the rest of the year in terms of demand. We're seeing lower forecasted sales compared to last year somewhere in that kind of 1% to 2% range. And there was a – as Chuck mentioned in his comments, we did see a real burst of volume in March related to, I would say, pent-up demand that was out there because of some of the issues that occurred with inclement weather in our regions that we sell into. So there was a real pick up there in March relating to buying pipe in advance of announced increases. And now as we look out through the rest of the year, we're seeing kind of what we would expect to be normal volumes of pipe to be sold through the rest of the year such that we don't expect it to get back to the same levels last year. But having said that, we are starting to see a uplift in sales pipe prices that are kind of coincide with these resin increases that are occurring as well. So we are looking to see some improved margins there but we aren't seeing a pickup to last year's volume yet.

What does it normally entail? I mean is it residential development that may point to 2016 is a near term peak in the sales of your PVC pipe or the whole industries are? Is it government or can you just give me some macro reasons that maybe in 2016?

Sure. I think that certainly, residential development or construction and housing starts is an indicator that we look at – construction starts in general, ex-residential is another indicator. And then just in terms of interest rates that can be an indicator as well in terms of what could happen with volumes.

Okay. Thank you and…

We believe the fourth quarter of 2016, a lot of these large distributors were holding off on major purchases. So take into consideration that Q4 of 2016 was probably a low volume accounts this quarter and a lot of that sort of rollover into the first quarter of 2017.

Okay. And then manufacturing, I think – have you indicated before a net profit margin goal for that business? And I may have missed your comments when you're talking about your outlook for 2017. Do you see higher sales in that business in 2017?

Yes, we have – Tate, Kevin here. We have publicly stated that we have a goal of getting the Manufacturing segment to a return on sales of 5%. Now as it relates to 2017 forecasted sales for BTD, we expect flat sales year-over-year for the reasons that were indicated in our script comments. We're seeing some volume growth a bit at T.O. Plastics. But we don't, we're still on a, call it, a glide path to get to the 5% return on sales. We don't expect that, our guidance does not anticipate getting to a 5% return on sales of this year. There's still headwinds that we continue to work through, primarily at BTD, in terms of our three locations that will take us a while to get back to the 5%.

We do anticipate being at or above 5% in the other manufacturing companies. It would be BTD that would be under that target in 2017.

Okay understood. Okay thank you very much.

And our next question comes from Chris Ellinghaus from Williams Capital. Your line is now open.

Good morning guys, how are you.

Good.

Good.

Chuck if I heard you correctly, you said that the first quarter results were better than planned. Given – well I suppose it depends what the magnitude is but any reason not to adjust the guidance given better than expected first quarter.

Thanks Chris. They were slightly better. And I think that the main issue – we had planned this. We knew that there would be one quarter, where we would have interim rates in affecting in 2017 and not in 2016, for the remaining three quarters, you are going to have with interim rates very – year-over-year comparables will be much closer. So we anticipated that when we set guidance and it has effectively has come out that way and we are still a little bit behind on weather.

As far as and the PVC volumes being at record levels in the first quarter, and given your sort of overall slightly lower expectations for volumes, where will the sort of delta come from throughout the rest of the year? Is that volumetric sort of benefit in the first quarter is going to come out in the second quarter? Is that sort of throughout the rest of the year? Have you got any insight into that.

Yeah, Chris, in general that volume comes out through the rest of the year as we look out in the forecast, we expect that welcome to come out throughout the rest of the year is where we're seeing it.

Okay, Kevin you said something about electric sales volumes can you just repeat that.

Oh, sure, we had a reference to lower industrial kilowatt-hour sales quarter-over-quarter. And it was due to reduced, we saw some reduced volumes in our industrial base and then we saw some lower pricing in the first quarter with our major pipeline customer. There was different pricing metrics that kicked in, in July of 2016 with our major pipeline customer that weren't in place in the first quarter of a year ago. And, so we saw lower revenues as a result of that. We don't expect, I said differently, we do expect that the pipeline customer is going to continue on their current levels of forecast, with us for 2017. So we aren’t seeing any erosion there but it was just this one – the pricing change that occurred and then some lower volumes across the industrial base.

Okay.

And in addition to that, I mean the large pumping loads are on forecast. We had, what I would consider, an abnormally high first quarter in 2016 of pipeline load just by some of the projects that they had undergoing and constraints they had in their system across additional pumping load if you will.

Okay, that is good. Steel scrap for manufacturing, can you just give us some directional numbers there, sort of what was the increase and what sort of proportionality for the improvement in manufacturing earnings was the scrap pricing.

And Chris it is Kevin, so on a quarter-over-quarter basis scrap revenues were up about $760,000 quarter-over-quarter. And so that ultimately just drops straight through your tax effect, drops straight through to the bottom line and so that really helped offset the lower revenues that we experienced quarter-over-quarter.

What kind of percent increase in prices was that?

It was pretty much all driven by pipe – metal scrap metal, increases. The volumes were relatively consistent between the quarters. So it was pretty much driven by prices and that is just an improving, there has been an improving market, for pricing in scrap metal over the last year.

Okay great thanks for the details guys.

[Operator Instructions] And I am not showing any further questions at this moment. I would like to turn the call back over to Chuck MacFarlane for any further remarks.

Thank you. Well to summarize, net earnings increased $0.11 quarter-over-quarter from continuing operations. Otter Tail Power completed it’s first general rate case in Minnesota in six years and received an overall 6.3% rate increase. The Minnesota Commission approved Otter Tail Power’s resource plan that supports our buildout strategy. And our manufacturing segment has improved earnings. And we are reaffirming our 2017 earnings guidance of $1.60 to $1.75 per share. Thank you for joining our call and for your interest in Otter Tail Corporation. We look forward to speaking with you next quarter.

Ladies and gentlemen, thanks you for participating in today’s conference. This concludes today’s program you may all disconnect. Everyone have a great day.