Otter Tail Corp (OTTR) 2018 Q2 法說會逐字稿

Good morning, and welcome to Otter Tail Corporation's 2018 Second Quarter Earnings Conference Call. Today's call is being recorded and we will host a question and answer session after the prepared remarks. I will now turn the call over to the company for their opening comments.

Good morning, everyone, and welcome to our call. My name is Loren Hanson, and I manage Otter Tail's Investor Relations area.

Last night, we announced our second quarter results and increased our 2018 earnings per share guidance range. Our complete earnings release and slides accompanying this call are available on our website at ottertail.com. A replay of the call will be available on our website later today.

With me on the call today are 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, I want to remind you that we will be making forward-looking statements during this call. 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. 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 due to new information, future events, developments or otherwise.

For opening remarks, I will now turn the call over to Otter Tail Corporation's President and CEO, Mr. Chuck MacFarlane.

Thanks, Loren. Good morning, everyone. Last night, we released our second quarter results. For the quarter, net income from continuing operations was $18.7 million or $0.47 a share compared with $16.7 million from continuing operations or $0.42 a share last year. All operating segments improved net income quarter-over-quarter.

Contributing to positive results, our Electric segment had favorable weather across the service area and interim rates in place in North Dakota. Our Manufacturing segment experienced increased revenue and our Plastics segment delivered improved operating margins. Lower tax rates also contributed to earnings increases in both Manufacturing and Plastics.

Allow me to briefly discuss each segment. We mentioned during our last call that Otter Tail Power received authority to reduce interim rates in North Dakota effective March 1 to accommodate lower federal tax rates. This decreased our overall request from $13.1 million to $7.1 million. In July, we reached a proposed settlement agreement with the North Dakota Public Service Commission staff and intervenors in the case. The proposed settlement results in an annual revenue increase of $5.4 million and allowed return on equity of 9.77%, and future eligibility for costs associated with the natural gas generation project -- Astoria natural gas generation project to be covered in riders. We expect the North Dakota Commission to decide on the case by the end of the third quarter.

The South Dakota Public Utilities Commission established Otter Tail's current rates in 2011 based on 2009 costs. Since then, costs we incur to serve customers have increased. On April 20, we requested a rate review in South Dakota. As a result of tax reform, we were able to reduce the overall rate request by more than $1 million. This is a multi-year request, the first step would be to increase nonfuel rates by approximately $3.3 million or 10%. If the commission approves the request as filed, a typical residential customer's bill would increase by approximately $11 a month. The second step would be a 1.7% increase to recover costs for the Merricourt wind generation project, when that facility goes into service. We anticipate the commission will make a final determination on our overall request in October. Even with the combined increase, we expect our South Dakota rates to continue to be among the lowest in the nation.

In Minnesota, we're part of an ongoing docket with other Minnesota utilities regarding the handling of tax reform in that state. Otter Tail Power also continues to manage the Big Stone South to Ellendale 345 kV transmission project. The map on Slide 8 shows its relative location. We are 50% owner in this 163-mile line with MDU. The project has obtained all easements, completed all 750 foundations, set 85% of the structures and remains on schedule to be completed in 2019. Our share of the project will be approximately $125 million. This is a Midcontinent Independent System Operator Multi-Value Project, allowing formula rate recovery from all customers in MISO's Upper Midwest footprint. Otter Tail Power customers will pay about 1% of the cost.

Otter Tail Power is also working its way through the MISO generator interconnection process for both the Merricourt wind and Astoria natural gas generation projects. These 2 projects are included in the list of rate-based projects on Slide 11. Both are included in the approved Minnesota integrated resource plan and have received North Dakota Advanced Determination of Prudence and have their major permits. These projects are part of our Electric segment's plan to grow rate base by an annual growth rate of approximately 9% from 2017 to 2022.

Customer satisfaction continues to be a key performance indicator at Otter Tail Power. In July, J.D. Power released its 2018 Electric Utility Residential Customer Satisfaction results, indicating Otter Tail Power's overall score of 733 on a 1000 point scale. Our target is to be among the top 3 of 10 utilities in our neighboring peer group. We thank our dedicated employees for achieving that goal in 2018.

Now turning to the Manufacturing segment. Earnings per share were up $0.02 compared with second quarter last year, primarily due to the impact of tax reform. BTD, our custom metal fabricator, is our largest manufacturing business. BTD's quarter-over-quarter revenue was up $8.3 million due to increased sales in its primary markets. Well, the second quarter steel tariffs did not greatly impact our product prices in large part because BTD secured contract prices for steel before tariffs took effect. Looking forward, we do not anticipate higher steel prices from tariffs having a significant impact on BTD's margins as steel costs are largely passed through to customers. BTD is working to enhance productivity in a period of increased volume and tight labor markets. Our investment in the company's Minnesota facilities has provided additional capabilities and capacity, and BTD's expansion to the Southeast has created new opportunities.

Vinyltech and Northern Pipe Products, our PVC pipe companies continue to have strong financial performance with a $0.04 earnings improvement quarter-over-quarter. Market conditions continue to support strong sales prices and operating margins, which primarily drove this segment's earning improvement. As we pointed out in the past, these companies have low capital and operating costs. They provide excellent customer service. They have strong earnings, strong cash flows and are highly competitive. Overall, we are pleased with the second quarter results, which include improved operational and commercial performance across all companies.

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

Thanks, Chuck, and good morning, everyone. All of our businesses delivered another solid quarter, resulting in increased revenues and earnings. Please refer to Slide 16 through 18, as I discuss our second quarter results.

The Electric segment net earnings increased $466,000 quarter-over-quarter. Key drivers contributing to this 4.6% increase were $2.5 million as a result of an increase in kilowatt hour sales due to colder weather in April and warmer weather in May and June compared to the same time frame a year ago. Weather positively impacted earnings per share by approximately $0.05 quarter-over-quarter, and compared to normal, weather also positively impacted earnings by approximately $0.04 per share for the quarter. $1.9 million as a result of increased megawatt hour sales to an industrial customer and $1.4 million increase in retail revenues, net of an estimated refund related to interim rates that went into effect in January of 2018 in conjunction with the 2017 North Dakota general rate increase request.

Also positively impacting earnings were increased Renewable Resource rider revenues in Minnesota and North Dakota along with Conservation Improvement Program incentives in Minnesota. These items were offset in part by a $2.4 million reduction in revenues related to a provision for refunds to recognize that current retail rates in Minnesota and South Dakota are recovering federal income taxes, which are more than the reduced tax rate from tax reform. $1.3 million reduction in revenues related to final rates implemented in Minnesota that were lower than interim rates in effect during the second quarter of 2017. Lower North Dakota and South Dakota Environmental Cost Recovery rider revenue due to the impact from the lower tax rate and the lower investment balance subject to recovery resulting from depreciation.

Also impacting earnings were higher O&M and depreciation expenses. And income tax expense decreased $1.8 million, mainly due to the reduced tax rate from tax reform.

Net earnings for the Manufacturing segment increased $628,000 quarter-over-quarter. Key items contributing to this improvement were: BTD revenues grew $8.3 million from increased product sales of recreational vehicle, agricultural and heavy construction equipment, as well as increased scrap metal revenues caused both by higher volume and improved prices. These increases were offset by higher cost of goods and operating expenses. And although BTD's income before taxes decreased quarter-over-quarter, lower tax expense of $500,000 due to the impact of reduced tax rate resulted in a $400,000 increase in BTD's net earnings.

At T.O. Plastics, revenues improved $600,000, mainly due to increased sales of horticultural containers and industrial products. Earnings were also positively impacted by reduced tax expense from the lower tax rate, resulting in improved earnings of $200,000.

Our Plastics segment's earnings increased $1.6 million quarter-over-quarter, primarily due to a 12.3% increase in PVC pipe sales prices. Increased pipe prices more than offset a 4% decrease in pounds of pipes sold and a 10.6% increase in the cost per pound of pipes sold, resulting in a $1.5 million increase in gross margins.

Lower income tax expense from the lower federal tax rate also positively impacted net earnings. And our corporate expenses, net of taxes increased approximately $700,000 quarter-over-quarter, primarily due to increased employee benefit costs as well as a reduction in income tax savings due to the reduced federal tax rate.

Moving on to our business outlook on Slide 19. We are raising our 2018 consolidated earnings per share guidance range to $1.95 to $2.10 from $1.90 to $2.05 based on our Plastics segment's stronger-than-expected year-to-date results.

Our Electric segment's 2018 net income is expected to be higher than 2017 based on normal weather for the remainder of the year. Milder-than-normal weather in 2017 caused a reduction in earnings per share of $0.04 compared to normal. Weather is favorable to normal by $0.06 a share for the first 6 months of this year.

A constructive outcome of the rate cases filed in North Dakota last November and this past April in South Dakota and increased transmission investments. These items are offset by increased operating and maintenance expenses related to a planned outage at Big Stone Plant during the last half of 2018 and higher pension, medical, workers' compensation and retiree medical benefits. The increase in pension costs is a result of a decrease in the discount rate from 4.6% to 3.9%.

Higher depreciation due to large transmission projects being put into service and increased interest expense related to replacing short-term debt with long-term debt carrying a higher interest rate, combined with increased borrowings to fund capital expenditures.

We expect increased earnings from our Manufacturing segment in 2018 due to increased sales and improved operating margins at BTD through cost reductions and improved productivity; increased earnings at T.O. Plastics, primarily driven by increased sales in horticultural, life science and industrial end markets; and lower income taxes due to lower federal tax rates implemented as part of the new tax law. The backlog for this segment is approximately $107 million for 2018 compared with $84 million a year ago.

We are also raising Plastics' 2018 net income expectations based on continued strong performance through the second quarter. Higher-than-expected operating margins along with favorable business conditions have driven the strong performance. With solid business conditions forecasted for the remainder of the year, we now expect 2018 earnings to be in line with 2017. Earnings in 2017 included an estimated impact of $0.09 per share due to market reaction to hurricanes in the Gulf region of the United States.

In Plastics, 2018 net income continues to be positively affected by lower tax rates. And corporate costs, net of tax, are expected to be higher in 2018, primarily due to the impact of the lower tax rate. The change in the guidance range for corporate costs is primarily driven by increased employee benefit costs resulting from increasing the company's overall guidance range.

We have also updated our 2018 through 2022 anticipated capital expenditures. The update primarily relates to the expected timing of capital spend for the Merricourt wind generation facility, because of a change in the expected timing of the MISO interconnection approval. We also have accelerated the exercise of a purchase option on the Ashtabula III wind farm project from 2023 to 2022. Of the $980 million in the capital expenditures anticipated for the Electric segment over the next 5 years, approximately 38% is earmarked towards renewable projects.

Our current earnings guidance for 2018 reflects 66% of our earnings per share from our Electric segment and 34% from our Manufacturing and Plastics segments net of unallocated corporate costs. This current mix is primarily impacted by the strong financial performance of our Plastics segment. We expect the long-term earnings mix to be back in line with the 75% of earnings from our Electric segment and 25% from our Manufacturing, Plastics segments net of unallocated corporate costs. This will be driven by the capital plan, which calls for approximately 93% of our capital spend over the 2018 to 2022 time frame to be in the Electric segment. This will continue to drive our approximate 9% compounded annual growth rate in rate base and move our earnings contribution back in the 75% to 25% mix and continue to maintain our moderate risk profile.

We are pleased with our second quarter and strong year-to-date financial performance. Achieving our 2018 earnings per share guidance remains dependent on the business and economic challenges our 2 platforms will face. Key initiatives include constructive outcomes in the North Dakota and South Dakota rate cases, BTD's continued operational improvements across all locations to further improve our return on sales margins and increased sales that are resulting from an improved economy, and continued strong earnings, cash flows and returns on invested capital from the Plastics segment.

We continue to be well positioned to achieve a 4% to 7% compounded annual growth rate and earnings per share based on 2017's $1.81 per share.

We are 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 the line of Paul Ridzon with KeyBanc.

You mentioned the Tax Cuts and Jobs Act a couple of times in your utility commentary. Did that all flush to 0 from an EPS standpoint when it worked its way through your income statement?

Yes, I mean, there is -- Paul, this is Kevin. And we're seeing, obviously, a reduction in revenues as we anticipate the amount of dollars that go back from the benefit of the taxes, but then that is offset down in the tax expense line. So they're netting to 0.

And is the strength in Plastics, is any of that related to follow on from the hurricanes, or is that well behind us?

No, Paul. Kevin again. There's -- the impact of the hurricanes have pretty well subsided back in the -- probably by November or so of '17. And then we've just continued to see strong sales prices hold and continuing through into 2018, and some of the announced resin increases that were expected during the first 3, 4 months of '18 haven't fully materialized. And so we've been benefiting by the strong prices and not as high as expected resin costs, which are really driving the performance of the segment.

And then lastly, because they are competitive businesses, have we started to get any sense that the benefit of tax reform is going to get competed away?

Paul, we've not seen any pressure at all to date from customers asking to get that benefit of tax reform passed through to them in the form of pricing. From that perspective, I think, we probably just would worry more about, particularly in Plastics, competitors doing something to just reduce prices, but I don't think it would necessarily be related to anything having to do with tax reform. And that's just based on historical experience in the business, where some competitors will, from time to time, take a different strategy with pricing and reduce their prices, which could then certainly impact our margins. On the Manufacturing -- and I would say the same thing would be similar for T.O. Plastics and at BTD. We had not seen any pressure to give that back. And then the other thing that of course is driving, particularly BTD, is the labor market. The labor market has certainly -- is positive in terms of unemployment. There is lots of jobs available for people. And of course, we're seeing wage pressure on the expense side at BTD. So that too, is something we're cognizant of in trying to make sure that we're able to get that wage rate pressure passed on into our prices as well.

And then at PVC, is it just housing starts that's kind of the volume there?

That tends to be the best indicator, Paul. This is Chuck. So there are other major infrastructure projects, or road and highway, that type of deal. But the best indicator we look at is new home starts and they have to be in our regions that we serve.

And how much of that business is residential?

A large percentage of it.

(Operator Instructions) I'm showing no further questions at this time. And I would like to turn the conference back over to Mr. Chuck MacFarlane for any further remarks.

Thank you. Well, to summarize, earnings per share increased $0.05 or 12% quarter-over-quarter in part due to favorable weather at Otter Tail Power service area and the interim rate revenues in North Dakota, increased volumes and lower taxes at BTD and T.O. Plastics and improved sales margins and lower taxes at Vinyltech and Northern Pipe Products. I want to extend our appreciation to employees across our organization for their hard work and the second quarter results. Looking ahead, we have the right long-term strategy in place, supported by a solid capital growth plan. We remain on track to deliver shareholder value in 2018 and have increased our full year guidance range. Thank you for joining our call. We appreciate your interest in Otter Tail Corporation and look forward to speaking with you next quarter.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.