Otter Tail Corp (OTTR) 2017 Q2 法說會逐字稿

Good morning, and welcome to the Otter Tail Corporation Second Quarter 2017 Earnings Conference Call. (Operator Instructions)

I will now turn the call over to the company for the opening remarks.

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 second 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 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.

Thank you, Loren, and good morning, everyone. For the quarter, net income was $16.7 million or $0.42 a share. This is a $0.01 better than last year and follows a quarter that was $0.11 better than the first quarter last year. Consequently, we are raising our earnings guidance by $0.05 on both ends of the range, $1.65 to $1.80.

Operations improved across all operating segments. The second quarter numbers almost masked the story. As we pointed out in the press release, BTD had a favorable product mix in 2016, and we did not expect nor did it repeat in 2017. And we recognized a gain from life insurance proceeds in 2016 that we couldn't expect again this year, yet we improved net income by $0.01 a share. The utility at higher transmission service revenues reflecting our investment in regional transmission projects, and lower generating plant operating and maintenance costs reflecting a major scheduled outage at Coyote Station last year that was not necessary this year.

Improvement in the manufacturing platform was largely due to strong results in our Plastics segment. The Plastics segment companies are effectively retaining sales volumes at improved margins. BTD is showing strength in its Minnesota operations with improved flat flow and added paint capabilities, and T.O. Plastics' increased sales in all of its major end markets.

I credit our employees' operational excellence as one of our strategic objectives. Our employees know the companies who are leaders in their fields, standardize in the automate processes, train employees and communicate regularly and ultimately. They are dedicated to cost management and customer service. We remain confident in our business model that combines a stable regulated electric utility with the portfolio manufacturing businesses to enhance long-term returns. My remarks today will focus on the continuing execution of our strategy to grow rate base, which includes both generation and transmission investment. I will also update you on operational improvement at our manufacturing companies.

As we described during our call last quarter, the Minnesota Public Utilities Commission granted Otter Tail Power a revenue increase of 6.2%, concluding the rate case we filed last year. This compares to the utilities modified request of 7.4% submitted during rebuttal testimony. The commission set return on equity at 9.41% on an equity layer of 52.5%. Otter Tail Power will implement the improved rates -- approved rates and an interim refund in the fourth quarter of this year. Even with this increase, Otter Tail Power rates continue to be among the lowest in the nation and the region.

Last quarter, we also discussed the Minnesota Commission's approval of Otter Tail Power's 2017 to 2031 resource plan. Key ordering points included a 5-year action plan with the addition of up to 200 megawatts of wind, 30 megawatts of solar and 250 megawatts of peaking capacity in 2021. These generation projects are included in the list of rate-based projects on Slide 6.

On March 27, we announced our plan to construct a 250-megawatt natural gas plant near Astoria, South Dakota. Please see the map on Slide 7. We submitted the notice of intent for the South Dakota permitting efforts on April 4, and we expect to file for the South Dakota site permit in October. We filed the request for Advanced Determination of Prudence in North Dakota on April 10 and expect a hearing in October with final decision by the end of the year. This natural gas project will be a simple cycle plant near the intersection of the Northern Border Pipeline and the Big Stone South to 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 or transmission facilities and to minimize landowner impact. We expect the project to cost $165 million and to be online in 2021 with 3 to 5 full-time employees. Combined with the 150-megawatt Merricourt wind project in November, it will replace expiring purchase power agreements and prepare for the retirement of the aging Hoot Lake Plant in 2021. When we filed our request for Advanced Determination of Prudence for Astoria, we included a request for Advanced Determination of Prudence for the Merricourt wind project. We expect both -- we expect the North Dakota Commission to rule on both of these projects by the end of the year.

We also filed a generator interconnection request with MISO, the Midcontinent Independent System Operator, and have submitted a renewable rider eligibility filing in Minnesota. EDF Renewable Energy, the developer of the Merricourt wind project, has filed for modifications to the existing site permit in North Dakota with a hearing scheduled for September 13. EDF will build a 150-megawatt wind project in Southeast North Dakota in 2019, we see the map on Slide 8. It will cost approximately $250 million, and Otter Tail Power will take 100% ownership when it's complete. This will reboost our renewable resources to nearly 30%. We continue to be pleased with the performance of our existing wind farms and this new wind farm will have a very low delivered energy price.

Our Renewable Energy and natural gas projects are part of a least cost resource plan and provide for a diverse energy mix. On July 27, the Minnesota PUC raised the externality cost of carbon dioxide from the current range of $0.44 to $4.53 per short ton to a range of $9 to $43 by 2020. Because Otter Tail Power used a range of $9 to $34 in its recently approved resource plan, we anticipate very limited impact on our future resource plans.

Next, I'll update you on the transmission side of our rate base growth strategy. The two 345 kV transmissions projects, Big Stone South, the Brookings, and Big Stone South to Ellendale, remain on scheduled and slightly below budget. The map on Slide 9 shows the relative locations. Both are designated as multi-value projects within MISO, allowing recovery of construction work in progress from all customers in MISO's upper Midwest footprint. We are 50% owner in the Brookings project with Xcel Energy who is the project manager. All structures are set, line stringing is 95% complete, 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 we have obtained all easements and contractors have completed nearly 2/3 of the 750 foundations and have set 1/3 of the structures. We expect the project to be energized in 2019. These 2 transmission projects have a combined Otter Tail investment of approximately $250 million. 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 10, Otter Tail Power plans to make capital investments of $862 million during the 2017 through 2021 time frame.

Slide 11 shows our regulatory framework, which continues to be constructive. As noted on the slide, 50% of future projects are eligible for rider recovery, while under construction. The balance of our capital spend, except for Astoria, is at current depreciation levels and effectively covered in base rates. Our Manufacturing segment showed a slight decline in net income quarter-over-quarter. But as I said earlier, each company demonstrated improved operations. BTD, our custom metal fabricator, serves some of the top OEMs in the nation and met our expectations for the quarter. Key factors included improved scrap metal pricing and lower interest costs. The company continues to be impacted by soft agriculture, recreational vehicle and oil and gas end markets. The BTD's Minnesota plants are making steady improvement with plant flow, reduced logistics costs and added paint type capabilities.

Having completed the company's Minnesota optimization plan, and BTD Illinois plant saw increased volume for oil and gas extraction components. Improved operations drove year-over-year net income growth for the second consecutive quarter at T.O. Plastics, our thermoforming business. And as I said earlier, the company increased sales in all of its major end markets, horticulture containers, life science and industrial packaging.

The PVC pipe companies, Vinyltech and Northern Pipe Products, continued their solid performance. They experienced slightly lower volumes, but better margins this quarter. As we pointed out in the past, these companies have low capital costs, low operating costs. They provide excellent customer service. They have strong earnings, strong cash flow and are highly competitive. Overall, we are pleased with the second quarter results, which included improved operational performance across all of our companies and it followed an excellent first quarter.

Now I'll turn it over to Kevin for the financial perspective.

Good morning, everyone. Please refer to Slides 12 and 13 as I discuss our second quarter results.

Utility net earnings increased nearly $1 million quarter-over-quarter. Key drivers contributing to this were a $3.3 million increase in MISO transmission tariff revenue related to increased investment and Big Stone area transmission projects: increased kilowatt-hour sales, mainly to industrial and commercial customers; lower operations and maintenance expense, primarily from the reduction in external service costs related to our Coyote plants maintenance shutdown in the second quarter of 2016.

These items were offset in part by a $1.5 million net decrease in retail revenues, primarily due to an increase in the interim rate refund accrual in the second quarter of 2017, lower environmental rider revenues from declining rate base due to depreciation on these investments, increased sales to customers with lower tariff rates, lower transmission rider revenues due to a reduction in services and costs from another regional transmission provider, and decreased revenues related to milder weather in the second quarter of 2017. Weather negatively impacted earnings per share by approximately $0.01 quarter-over-quarter as well as compared to normal.

Our net earnings for the Manufacturing segment were basically flat quarter-over-quarter, which was in line with our second quarter 2017 expectations for this segment. BTD had improved revenues, primarily driven by an increase in scrap metal sales based on better scrap metal pricing. These items were offset by lower operating margins due to a different product mix in the second quarter of 2017 compared to the second quarter of 2016 as well as increased costs for scrap parts and obsolete inventory. Second quarter results were also positively impacted by lower interest costs. The effect of these items resulted in a $400,000 decrease in net earnings between the quarters for BTD.

At T.O. Plastics, revenues and earnings increased quarter-over-quarter as a result of improved sales in all end markets. The earnings also benefited from improved margins due to lower material costs and lower interest expense.

Our Plastics segment's revenues and earnings increased between the quarters as a result of a 9.4% increase in PVC pipe sales prices, despite a 1.9% decrease in pounds of pipe sold. The 33% increase in earnings also benefited from lower interest costs.

Our corporate expenses net of taxes increased $900,000, primarily due to a nontaxable corporate-owned life insurance benefit received in the second quarter of 2016, which did not occur in the second quarter of 2017.

Moving onto our business outlook. We are raising our consolidated earnings per share guidance to $1.65 to $1.80 from $1.60 to $1.75 as shown on Slide 15. Our Electric segment's 2017 net income is expected to be higher than 2016 based on normal weather for the remainder of the year; milder than normal weather has negatively impacted earnings per share by $0.03 for the 6 months ended June 30, 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 pipeline and commercial customers.

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 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 earnings -- we expect increased earnings from our Manufacturing segment in 2017 due to a slight decrease -- I'm sorry, a slight increase in sales due to higher lawn and garden, scrap and capturing new business with existing customers, offset by lower recreational vehicle sales; improved margins on parts and tooling sales, combined with lower interest costs; and increased earnings at T.O. Plastics, primarily driven by increased sales along with lower interest costs.

The backlog for this segment is approximately $84 million for the balance of 2017 compared with $81 million a year ago. And we now expect Plastics 2017 net income to increase over 2016 due to strong second quarter results along with continued improvement in sales prices, resulting in higher operating margins. This segment's net income will also benefit from lower interest expense, and we expect our corporate costs to be in line with 2016.

We are pleased with our second quarter and strong year-to-date performance. This represents a mix of earnings from our Electric and manufacturing platforms that is consistent with our moderate risk profile and reflects our efforts to remain focused on our strategic initiatives. Key initiatives for 2017 include: continued rate-based growth from our investments in the Electric segment; continued improvement in profitability over 2016 at BTD; and as I mentioned, we now expect our Plastics segment revenues to be higher in 2017 driven by stronger sales prices on similar volumes, resulting in higher operating margins.

This ongoing effort positions us to raise our 2017 consolidated diluted earnings per share guidance range to $1.65 to $1.80. It also further 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're now ready to take your questions. And after the Q&A, Chuck will return with a few closing remarks.

(Operator Instructions) Our first question comes from Paul Ridzon of KeyBanc.

Just a quick question on the improved outlook in Plastics. You said you've had higher margins on similar volumes, is there any customer behavior, are people pre-buying in the face of anticipated higher pricing? Or what's the dynamic there? Are you just burning off lower cost inventory to -- and selling at higher prices?

We -- I mean, there is no particular customer dynamic or anything going on, Paul. We did see an uplift in sales prices in the second quarter, and somewhat, I suppose, an expectation that maybe resin prices will be increasing. And so there is some buying that's occurring, but nothing significant in terms of customer dynamics. We were able to deliver certain types of PVC pipe to customers in the second quarter that some of our competitors didn't have available. And so we were able to take advantage of those opportunities. But we are just, in general, now, in the last half of the year, seeing a strengthening in pipe prices as we look to the last 6 months.

And what are the primary end markets you're seeing the strength in?

Well, I just -- remember, we sell -- our pipe is sold to distributors like Ferguson and HD Supply and so forth, and then they in turn are delivering and selling the pipe to the end users, the construction market. I mean, we've seen -- just kind of general good sales across all -- both of the regions that Northern pipe and Vinyltech serve.

Our next question comes from Tate Sullivan of Sidoti.

To follow-up the questions about the Plastics and PVC pipe. When they go -- when you deliver the pipe to your distributors, is it a construction companies building residential developments buying them or who's the ultimate buyer of the PVC, the diameter of pipe that you make?

I mean, it's going across a number of end markets, Tate. I mean, its residential, its construction markets across our footprint. We certainly are delivering product to the rural water market in North Dakota. There is still some work being done in the Bakken in terms of water infrastructure. But it's a, I would say, pretty good mix of its residential, its construction, its rural water across the regions that we serve.

Okay. And did you say on Plastics that the volumes were similar in the most recent quarter to year ago level?

From quarter-to-quarter, they are down not quite 2% but sales pipe prices were up little over 9% quarter-over-quarter. And so that really drove the increase in earnings quarter-over-quarter. We did say though as it relates to the outlook for the year that we expect our volumes for '17 to be similar to what they are for '16.

For all the '17, okay. That's nice.

So really, again, similar volumes to last year and really driven by strong -- the improvement in the earnings is driven by stronger sales pipe prices.

Can you -- last on Plastics. What's the lag between -- is it the suppliers pricing based on a resin-based index? And is there a delay between change in the oil price to the change in the resin price?

Tate, this is Kevin. Maybe can you repeat that again?

What's driving the higher prices? I mean, is it mostly resin prices? And doesn't that link mostly to what's happening in the oil price?

I mean, oil is a component, but -- I mean, the bigger driver for the components of the PVC resin is certainly natural gas prices, chlorine, ethylene. I mean, there haven't been any significant increases in those ingredients in terms of the price of the PVC resin. Sales prices were just -- we're starting to see -- we've been through a period of time the last '16 for sure, where sales prices were soft. And we're starting to see an increase in the sales price, and we've been able to capture that with not as large of increases coming on the resin side.

Great. Okay. Can you talk a little bit -- moving on to the Manufacturing, can you talk a little bit about -- when you have various customers in different end markets, can you talk about the feedback you are getting from them on volumes and their outlook, in general, for your Manufacturing business?

Yes. I mean, I'll take a start at it. Certainly, we're seeing good opportunities in growth in our lawn and garden end markets. We continue to see challenges in ag and recreational vehicle. I mean, both, whether it's John Deere, Polaris, and other customers in those end markets, those end markets are certainly soft right now. And so we're not necessarily seeing increases in revenues from those -- in those end markets. We are starting to be able to as we've come through the kind of the softness in some of these end markets, and there was certainly pressure by customers on pricing that suppliers were providing to them. We have seen work come back to us because of other competitors -- smaller competitors not being able to effectively deliver on the product that they were engaged to make for our -- some of our customers. And so my comment about capturing new business with existing customers relates to our ability, one, BTD's financial strength, we've been able to weather some difficult times here as customers have been putting pressure on suppliers for reduced prices, and the customers are now starting to see some of these -- while these smaller competitors were said they could do it at lower prices, when push came to shove, they have had difficulties delivering product to the customer, and now the customers have started to come back to BTD and ask us if we can do the work at the prices we originally quoted to them. And so we have seen additional opportunities in revenue as a result of that.

Okay. I think that all very helpful. And then you mentioned, I think, more volumes for oil and gas related equipment out of your Illinois plant. Did I capture that right? And what are you making for oil and gas?

Tate, this is Chuck. We did mention that, and we build frac pump components, whether it's transmission housings or machining some of the pumps. And I think, effectively, we've not seen it return to previous levels, of course. But I think, some of the OEMs have worked through their inventory. We are now seeing sort of a steady increase in the amount of those components that we built a lot of in the 2013-2014 time frame.

Okay. And last for me is dividend -- the drip, not the drip, but the stock on the ATM plan. Can you give an update on what your plans are for issuing shares to fund on the wind farm in part?

Yes. I mean, our -- currently, Tate, we are not issuing any shares this year under the ATM. We did do some original issue of shares here in the first half of 2017. You will see us shut that down here now in the last half of 2017. And we'll just -- any demands under the dividend reinvestment plan, we will just satisfy by doing open market purchases. And so our equity ratios and -- the balance sheet is strong. The equity ratio is healthy. As we look out over the 2007 -- I'll call it 2018 to 2021 time frame, we're going to be looking to issue a balanced mix of debt and equity, most of the debt -- well, all the debt will be issued at of the power company for its respective projects. And from an ATM perspective, we need to renew the ATM shelf and the dividend reinvestment plan shelf in May of '18 as they expire at that time, so we expect to renew them. In terms of a range of equity needs, I'd tell you right now, over that time frame, we're probably looking at, call it, $70 million to kind of an $85 million range, and we continue to fine-tune those as we go through the time frame as we get closer to when those projects are going to be experiencing the big part of their cash flows, but that would be the current view.

(Operator Instructions) I'm showing no further questions at this time. I'll turn the call back over to Chuck MacFarlane for any closing remarks.

Thank you. To summarize, net earnings increased $0.01 quarter-over-quarter following $0.11 first quarter year-over-year improvement. Operations across the organization have improved, and we credit our employees for their attention to cost control and customer service. Given our strong first half, we are raising our 2017 earnings guidance to $1.65 to $1.80 per share. We thank all of our employees for their hard work. And we thank you for joining our call and for your interest in Otter Tail Corporation. We look forward to speaking with you next quarter.

Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.