Otter Tail Corp (OTTR) 2016 Q4 法說會逐字稿

Good morning, and welcome to Otter Tail Corporation fourth quarter 2016 Earnings Conference Call.

(Operator Instructions)

Today's call is being recorded and there will be a question-and-answer session after the prepared remarks. I will now turn the call over to the Company.

Good morning, everyone, and welcome to our call. My name is Loren Hansen and I manage the Investor Relations area at Otter Tail. Last night, we announced our 2016 results and issued 2017 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. Commenting this morning will be Chuck MacFarlane, Otter Tail Corporation's President and Chief Executive Officer; and Kevin Moug, Otter Tail Corporation's Senior Vice President and Chief Financial Officer.

Before we begin today's call, I would 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 our President and CEO, Mr. Chuck MacFarlane. Chuck?

Thanks, Loren, and good morning everyone. Last night we released our 2016 results. Earnings per share from continuing operations for the year were $1.60, a 2.6% increase over 2015 earnings per share of $1.56. We accomplished this despite weather challenges in our electric platform and difficult market conditions in our manufacturing platform. Employees across the organization remain focused on driving results and we appreciate the leadership they demonstrate.

Our stock performed well compared to major utility and broad market indexes. The total return was 57.9% and our year-end dividend yield is 3.1%. Otter Tail Power employees had a number of accomplishments in 2016. In addition to overcoming a negative weather impact to net income of $2.4 million compared to normal, we had record safety year, achieving the lowest OSHA rate in Company history. They again achieved the top electric utility residential satisfaction score in the nation, as measured by the American Customer Satisfaction Index.

They battled tough conditions for more than five days to restore power to customers in North and South Dakota after a Christmas ice storm broke more than 250 poles. They continue to manage several large projects including a general rate case in Minnesota, project agreements for a new wind farm, a resource plan filing, and two regional transmission projects.

Here is a brief update on each. As we have discussed on previous calls, Otter Tail Power filed a Minnesota general rate case in February of last year. The Public Utilities Commission granted interim rates in April. The administrative law judge issued his report a month ago, recommending a return on equity of 9.54%. While that is lower than we requested, the judge agreed with the majority of our positions and he supported an ROE at the high end of the Minnesota Department of Commerce's recommended range. The judge cited Otter Tail Power's continued strong customer satisfaction and existing low rates.

Although the Minnesota Public Utilities Commission isn't bound by his recommendation, they will rely on in it in reaching their final decision in March. Meanwhile, the accrual we have recorded for any potential refunds of revenue collected under interim rates is reasonable based on the ALJ report.

In November, we executed project agreements for 150 megawatt wind project that EDF Renewable Energy will build in Southeast North Dakota in 2019. When complete, Otter Tail Power will take 100% ownership, boosting its renewable resources to 28%. Before construction can begin, Otter Tail Power and EDF will seek required approvals from state regulatory agencies and MISO will need to authorize interconnection to the transmission system. This project will combine with the proposed 250 megawatt natural gas project to replace expiring purchase power agreements and prepare for the retirement of the aging Hoot Lake plant in 2021.

Hoot Lake is a two-unit 140 megawatt coal-fired plant. One unit has been online since 1959 and the other since 1964. Two years ago, the Minnesota Public Utilities Commission approved Otter Tail Power's 2014 to 2028 resource plan that included the wind and natural gas fired generation additions. The Company again identified these additions in its purposed 2017 to 2031 resource plan filed last June. We expect a ruling on that plan in March.

Employees also made progress on two 345 KB transmission projects we have discussed on past calls; Big Stone South to Brookings, and Big Stone South to Ellendale. The map on slide 8 shows the relative locations. Both are designated as multi-value projects within MISO, allowing recovery of project costs from all customers in MISO's upper midwest footprint. Both remain on budget and on schedule.

We are a 50% owner in the Brookings project with Xcel Energy, who is he project manager. Pole foundations are complete, structures are being set, and we expect the project to be energized later this year. We are 50% owner in the lions portion of the Ellendale project with MDU.

Otter Tail Power is the project manager, contractors have poured 42% of the 750 pole foundations, and have set 40 structures. We expect the project to be energized in 2019.

These projects have a combined Otter Tail investment of approximately $230 million. As shown on slide 9, the wind, natural gas transmission projects are part of our electric platform's plan to grow rate base by an annual growth rate of 7.5%, using 2015 as a base year. During the 2017 to 2021 timeframe, Otter Tail Power plans to make capital investments of $862 million.

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, which means it is effectively covered in existing base rates.

Our manufacturing companies also experienced a number of accomplishments in 2016. Safety performance in all businesses was below the target OSHA incident rate, and T.O Plastics reached a milestone with 324 days without a reportable OSHA incident. Vinyltech and Northern Pipe products, our plastics segment, had an approximate 11% increase in pounds of pipe sold. This was not enough to offset narrowing sales to resin price margins, but is evidence of a nimble management team and engaged employees.

BTD completed its facility expansion in Detroit Lakes and Lakeville, Minnesota. The project has reduced logistics costs and added complex assembly and in-house painting capabilities. All OEMs had given paint system approval by the end of the year. BTD Illinois experienced strong sales to GE, primarily associated with the transportation fixtures for wind turbine blades.

BTD Georgia converted to BTD's enterprise resource planning software. We are now better able to collect, manage and interpret information system wide. Our manufacturing companies continue to be impacted by economic challenges, especially BTD, which serves some of the top OEMs in the nation, but we continue to position for future growth. BTD nearly doubled earnings year-over-year in 2016, and although BTD is still working to regain the earnings level achieved prior to 2015, we expect increased sales in 2017 primarily from the lawn and garden end market.

Overall, 2016 included a number of important events for Otter Tail Corporation. We have captured some of the highlights in slide 5. We will continue to watch the new presidential administration's major initiatives, specifically environmental and tax policy changes.

We had already developed compliance plans to meet the intent of the Clean Power Plan even though the US Supreme Court had stayed the rule. The future of the Clean Power Plan rests on the DC circuit ruling, the new EPA, and ultimately the future of the Supreme Court. We are also taking steps to address outcomes to our businesses from a potential tax reform. Kevin will describe this further, so I will turn it over to him for the financial discussion at this time.

Good morning. Let me cover with you the following items: A review of 2016 financial results, our liquidity position, strength of our balance sheet, secured and unsecured credit ratings, our view of potential tax reform, and a preview of our 2017 business outlook.

First, based on our solid 2016 performance and our 2017 outlook, the Board of Directors increased our indicated annualized dividend rate from $1.25 a common share to $1.28. We have paid dividends on our common stock for 78 years, or 313 consecutive quarters.

2016's strong results represent another year of executing on our strategies, despite continued challenges with soft end markets, phase fire manufacturing companies, and milder than normal weather impacting our electric utility, our consolidated net income from continuing operations was up 5.8% and our earnings per share from continuing operations increased 2.6%.

Now I will provide a detailed review of 2016 earnings as shown on slides 11 through 14. The electric segment increased earnings in 2016 despite being adversely impacted by milder weather. Key items of the $1.5 million increase in net earnings were increased retail revenues of $7.4 million, which is net of an estimated refund related to interim rates that went into effect in April of 2016, increased environmental and transmission riders, increased conservation improvement program incentive revenue, increased MISO transmission tariff revenue related to increased investments in regional transmission projects, and also positively impacting earnings were increased sales to pipeline customers.

These items were offset by lower retail revenue due to milder weather in 2016. Year-over-year weather was a drag on earnings per share of $0.02, and $0.07 compared to normal. Other items negatively impacting earnings were higher operating and maintenance expenses, and higher depreciation and amortization expense related to our increased rate base investments.

Our manufacturing segments earnings increased year-over-year, driven by a $2 million increase in earnings at BTD. Contributing factors include a $15.4 million increase in revenues as a result of owning BTD Georgia for all of 2016, compared to four months in 2015, a $9.6 million increase in revenues related to the production of wind tower components. These increases were offset in part by a $15.2 million decrease in revenues related to continued softness in sales to customers served by BTD in the recreational vehicle, agriculture, and oil and gas end markets.

T.O. Plastics revenues and earnings decreased year-over-year, primarily due to lower sales in horticulture, industrial and custom sales, as well as changes in their product mix. Our plastics segments revenues and earnings were down year-over-year. Revenues decreased $2.9 million, primarily due to an 11.2% decrease in the price per pound of pipes sold, despite a 10.5% increase in the pounds of pipes sold.

Earnings were lower, primarily due to compressed margins, as lower raw material prices did not decline as much as sales prices. Our corporate expense, net of tax, decreased $2 million between the years. The reduction in cost is primarily due to an increase in non taxable death benefit proceeds and cash value of corporate-owned life insurance policies, as well as lower operating costs and income taxes.

Moving to slide 15, let's consider our capital structure. We raised over $44 million in equity under our aftermarket dividend reinvestment and other employee equity plans to support our capital expenditure program. While we don't expect to use the aftermarket program in 2017, we will continue to use these programs as equity financing will be needed in the future to help fund the utilities rate base growth initiatives.

On December 13, 2016, we issued an $80 million tenure 3.55% note in a private placement transaction. These proceeds were used to repay existing debt including the remaining $52.3 million of the 9% senior notes that were due on December 15, 2016.

We have ample liquidity under our two credit facilities to support our two platforms. Both facilities are in place until October 29 of 2021. Management is committed to maintaining investment-grade credit ratings and will manage our operations to reflect that commitment.

Let's move to slide 17 and I will share our current views on the hot topic of tax reform. This slide presents our expected position on the key areas of tax reform, split between our two business platforms. First, in terms of lower tax rates, this could result in a revaluation of our deferred tax liabilities for our electric platform, which exposes us to a potential immediate refund to our customers. We have $343 million in deferred taxes related to property items. We would expect the reduction that would occur would need to flow back to customers over some negotiated period of time.

Lower tax rates at our manufacturing platform is favorable to us given our deferred liabilities would be revalued at a lower tax rate, resulting in an immediate pick-up of earnings. Also, lower effective tax rates respectively would result in higher cash flows and earnings for these businesses. These benefits clearly inure to the shareholder.

We view ourselves to be in a good position as a relates to the potential elimination of interest expense deductibility. First, we have only $80 million of long-term debt at the parent, which has been used solely to finance our manufacturing platform. No debt at the parent has been pushed down to the utility in the form of equity.

Second, the rest of our long-term debt is held at Otter Tail Power Company level, where the elimination of deductibility would be mitigated through our rate making process. The full expensing of capital expenditures would lead to large net operating losses given our large capital expenditure plans.

There's also discussion of repealing the Section 199 deduction. The loss of this deduction for the electric platform would ultimately be passed back to customers through the rate making process and would increase our tax expense for the manufacturing platform.

We believe we are competitively positioned for tax reform with our low risk balance sheet. We will certainly need legislative support for our regulated utility to receive normalization treatment related to potential refunds to customers based on a lower effective tax rate. We are supportive of the efforts that EEI is making to shape legislation that is positive for both our business platforms.

Please move to slide 18 for a discussion of our 2017 business outlook. Our 2017 earnings guidance is in the range of $1.60 to $1.75 of earnings per share. This guidance reflects the current mix of the 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 segments 2017 net income is expected to be higher than 2016 net income based on normal weather for 2017, a constructive outcome of the Minnesota rate case with a full year of increased rates in 2017, compared to 8.5 months in 2016, rider recovery increases related to increased investments in MVP transmission projects, and increased sales to pipeline and commercial customers.

These items are offset by increased operating and maintenance expenses related to increased medical, worker's comp 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 SIP incentives in Minnesota as a result of a new state initiated program, and increased cost related to certain capacity agreements.

We expect increased earnings from our manufacturing segment in 2017 due to increased sales at BTD from the lawn and garden end markets. And we continue to see soft end markets in agriculture, oil and gas, and energy.

Our scrap revenues are expected to be flat between years, and we also look for improved margins from productivity across all of BTD's locations, and lower interest cost. Increased earnings at T.O. Plastics are primarily due to increased horticulture and custom sales along with lower interest cost. Our backlog for this segment is approximately $118 million for 2017 compared with $134 million a year ago.

We expect plastics net income to be in line with 2016. Sales volumes are projected to be down compared to 2016, but look for improved sales prices resulting in improved operating margins. Segment net income will also benefit from lower interest expense. And corporate costs are expected to be in line with 2016.

Let me provide an overview as shown on slide 19 of our capital expenditure plans. We expect capital expenditures for 2017 to be $149 million. We continue to invest in transmission projects designated by MISO as multi-value projects, which continue to positively impact the corporation's earnings and returns on capital. The five-year capital expenditure plan calls for $862 million in utility projects. The plan also include $74 million for the manufacturing and plastics businesses. Our updated compounded annual growth rate and rate base are projected to be 7.5% using 2015 as the base year.

We believe our 2017 guidance further positions us to achieve a 4% to 7% compounded annual growth rate in earnings per share, using 2016, $1.60 per share from continuing operations. Our 2017 guidance has depended on the business and economic challenges our two platforms will face this year. Key initiatives include the constructive outcome in the Minnesota rate case, BTD's successful growth in sales from strategic investments that have been made over the last two years, along with continued operational improvements across all locations to further improve return on sales margins.

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, we are encouraged by the outlook for improved pipe pricing, which should enhance operating margins. We continue to look to this segment to provide strong earnings, cash flows and returns on invested capital.

We are now ready to take your questions. And after the Q&A, Chuck will return with a few closing remarks.

(Operator Instructions)

Chris Ellinghaus, Williams Capital.

Looking at the CapEx slide, this should encompass the wind farm purchase, the combustion turbine, and the solar, right? So, if I look across the years for the renewables in natural gas generation, it doesn't necessarily appear that it totals to their remainder if you back out the wind farm. So have you spend significant dollars on development of the solar and the gas plant at this point that are not included in these numbers?

No, we have not.

Okay, so it's about $460 million-ish. So if you back out the $250 million for the wind, do you really get to the $250 million, plus $200 million for the gas plant, plus $50 million - $60 million for the solar? Does that total? It looks a little short.

Do you have the transmission projects in there, Chris?

I am just looking at the generation line.

Okay.

So, it looks like, not adding it up completely, it's about $460 million, so I would expect it would be closer to $500 million if I took those three generation projects. Is there a reason there is a discrepancy there? Or are you coming in under budget on something?

You know, Chris, I'm not sure I am following where you are looking at, here.

I will follow up with Loren on that one.

All right.

Can we assume that in 2019, you will be making progress payments on the wind farm?

Yes.

Okay. And can you just walk us through the three quarters with the interim reserve in it? I didn't see anything about a fourth-quarter reserve.

Yes, Chris, this is Kevin.

At the end of the year for 2016, we did book additional reserves for the potential estimated refund in Q4. The effect on the year for the total year was $0.06 a share. We have $3.6 million of reserves on our books for an estimated refund at the end of the year.

So that would make the fourth quarter something like $1.4 million?

Right.

Okay. Kevin, can you just discuss after 2017, what your thoughts on equity are?

Sure. When we look out now in terms of our financing plans over the 2020/2021 timeframe, we're looking to see a pretty healthy growth in retained earnings based on growing earnings across the respective Companies and our current financing plans would put us in a range of equity from probably $90 million to $110 million right now. That assumes that we would be just using our current programs available to us: the aftermarket dividend reinvestment, employee stock purchase plans. We will have to redo the aftermarket shelf in May of 2018 to continue on with that, and then we do have long-term debt needs as well, solely for the utility during this timeframe to support the capital structure and to [be relate the] maintain at the utility that 51% to 53% equity to total cap range.

Okay, I'm sorry. I didn't catch what term was that? 2021 or 2020?

2021.

Okay. One more question and then I will jump back in the queue.

Can you just discuss how you were booking the interim in 2016? Were you using a volumetric approach? Was it more of a straight-line approach?

In terms of how we booked it?

Yes.

Yes, Chris, what we did was, at the end of the second quarter, we booked the reserves specific to a correction we had to make in our original filing; that there was an error related to one of the components of the rate case, so it was a pretty small amount. I think it was $200,000.

Yes.

In the third quarter is when we received all of the intervenor testimonies. And so, based on the feedback from the intervenor testimonies, then we recorded an additional, I think, $2.1 million of accrual to reflect where we were at with our rebuttal testimony, and then how the direct intervenor testimonies had come in. And then we continued to book in the fourth quarter along those lines and then the ALJ report was issued in early January. We then made a comparison of our positions of where we had been occurring compared to where the ALJ report came out, and felt that our accrual, that $3.6 million I referred to, felt that was a pretty appropriate place to be, based on the ALJ's report.

Okay, great. Thanks.

Chris, just to follow up on your initial question on the capital budget on the natural gas and renewable generation, I think probably that line is misleading. That is our total generation CapEx. And you can assume about $10 million a year of maintenance CapEx on the plants and existing wind farms in that line.

Okay, great. Thank you.

That should balance it out.

Paul Ridzon, KeyBanc.

Just a clarification: did you say you have a $343 million deferred tax at the utility? And that would all be refunded to customers under tax reform?

No, Paul; this is Kevin.

I was just trying to give you a scope. We have $343 million of property-related deferred tax items for the utility at the end of the year. So, I'm just trying to give you a scope of how big the number is. I mean, if you had a revaluation of that reserve based on a lower effective tax rate, based on the change in your effective tax rates, that would be the impact to the revaluing of that amount of the liabilities.

Got it, got it. Okay. Just wasn't clear on that.

And then, you had, it looks like about $0.065, $0.07 of weather versus normal headwind, but you are assuming normal weather for 2017, I presume. But you are not getting that picked up. Where the big headwinds there in 2017? Or were you doing some cost-cutting during the year to help offset that'll come back in 2017?

Well, we certainly, there was lots of efforts in 2016 despite the weather to help deliver the earnings we had, so there was certainly cost reductions that were made. We have stronger than expected CIP revenue that we had in 2016. And also as you look at headwinds into 2017, we are seeing some higher O&Ms given the change in the Minnesota program for CIPs. There's a reduction there that we are expecting that we're not going to have the same levels of CIP incentives in 2017 as we did in 2016. We have got some capacity purchases that are going to, costs that are going to increase, so there is headwinds there as well to offset the $0.07 normal that's in our plan.

How much was the CIP in 2016?

Hang on. We had $1.7 million increase in CIP incentives year over year and the impact for 2017 is expected to be about $0.04 a share from 2016 to 2017. Negative.

Got it.

It's called out in the press release.

Are you seeing any pickup in the end markets for energy at manufacturing? Or has that just not gotten any traction yet? We hear a lot of talk about increased drilling activity after the OPEC cut? Did it take a while to trickle down?

Paul, this is Chuck.

You know, it's very slight increase. I would not say that we would call it any sort of a step change in the type of equipment that we were selling two or three years ago. Those vendors likely have their own inventory that they have to work through before bringing in new.

Okay, thank you very much.

(Operator Instructions)

Chris Ellinghaus, Williams Capital.

Guys, versus the guidance at the end of the year for manufacturing, it looks like the fourth quarter was a little weaker than you expected. Can you talk about that a little bit?

Sure. In Q4, Chris -- this is Kevin.

We did see soft, softer than expected [hort] sales at T.O. Plastics. We did see some softer continued softness in the end markets at BTD that certainly impacted where we thought the fourth quarter was going to finish up for them. We did get some pickup offsetting that at BTD as it related to shipping these wind power components out of our Illinois facility. We had stronger than expected shipments that helped offset some of the end-market softness that continued in the fourth quarter with recreational vehicle, ag, oil and gas.

You have the heating degree days versus normal for the fourth quarter?

Just for the fourth quarter?

Yes, just the fourth quarter.

Chris, it's on page 4 of the press release in the table. The heating degrees in -- I'm sorry, that's for the full year. We're going to have to get you that. We don't have that here in front of us.

Okay, I will talk to Loren about that.

Can I also gather that, versus the number that you show in the table for the year, in terms of the weather impact, that, that means that the fourth quarter was $0.015 or $0.02?

Yes.

Okay. And as far as the guidance, I just want to make sure I understand: you are assuming in the guidance that you get the interim as it stood?

Yes.

Okay. And your comment in the guidance about normal weather, does that include what looks to be like maybe a pretty weak January as well?

It doesn't. The $0.07 was based off of the actual results compared to our budget. Weather, you are right; in weather started out as favorable in the first part of January, but then turned unfavorable the last half. But that is one month. Doesn't make the year.

Great. Just want to make sure that hadn't taken effect for what looked to be a pretty miserable January, really.

Right.

So, as far as numbers, looking at Fargo as sort of the benchmark for your service territory, looks like it was down slightly. There really was no net pickup versus last year's January?

I think that's fair, yes.

Okay. The fourth quarter in plastics actually looked like it was maybe a little better than you were expecting. Can you give us a little color on that?

Sure. So, in terms of the fourth quarter, to the quarter-over-quarter comparison, we did have about 6% more pounds that were shipped in the fourth quarter of 2016 compared to 2015. However, that was offset by about a 6% decline in the price of pipes sold between the quarters. So margins were down slightly, and where we saw pickup was, we ended up with higher than forecasted taxable earnings and so we had a stronger Section 199 deduction that came through in the fourth quarter of 2016 compared to the fourth quarter of 2015. We didn't get the Section 199 deduction and that helped drive the stronger quarter as well.

And what were the benefits in Texas and California at plastics for 2016 that you don't expect to recur?

Well, the Texas markets, we had some opportunities we were able to take advantage of, to ship pipe into favorably in 2016 that, as we head into 2017 we're not expecting to have the same types of opportunities to move volume into Texas that we had in 2016. If the markets change, we will certainly be able to take advantage of that. And then, in terms of we look at our customers in California, we are expecting that we will see some lower volumes from some of our customers that had bigger years in 2016 than what they are saying in 2017.

Okay. One more thing, Kevin.

You have had occasion to talk about what you think normal earnings levels should look like at manufacturing in plastics. And now that you have added the capacity and you have worked on cost and efficiency, have you got a new base level that you can talk about in those two segments?

Sure. In terms of manufacturing, we certainly believe that we should consolidated basis, and most of this is driven by BTD, that we should be able to return to a return on sales level of 5%.

Okay.

And plastics, we typically believe we should be able to make $0.045 a pound in that business. And we were a little bit below that here in 2016, and so that is our metric that we keep holding the business accountable to. And we were off a little bit in 2016 but as we look at planning for the business, we certainly will look to make a $0.045 a pound number.

Okay, great. Thanks for the color, guys. I appreciate it.

I am showing no further questions at this time, so I would like to turn the call back over to Chuck MacFarlane for closing remarks.

Thank you. During the last several years, Otter Tail Corporation has been moving toward a business model with two platforms. The result is a focused manufacturing platform combined with the core utility plan. All of our operating Companies focus on our long-term compound annual earnings-per-share growth goal that Kevin has just described. While we're currently below this goal, we're confident we will be back in the range given our pipeline of rate-based projects and our efforts to return our Companies to historic return on sales levels when the current down cycle in manufacturing segment improves. We expect 2017 earnings to be in the range of $1.60 to $1.75 per share as we execute on our objectives to grow all the businesses, achieve operational excellence, and develop our employees.

We want to thank all of our employees for their hard work and we want to 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, this concludes today's conference. thanks for your participation. Have a wonderful day.