Otter Tail Corp

NASDAQ:OTTR

Earnings Call Transcript 2018-Q1

[Operator]

Good morning, and welcome to Otter Tail Corporation's 2018 First Quarter Earnings Conference Call. [Operator Instructions] I'll now turn the call over to the company for their opening comments.

[Loren Hanson, executive]

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 2018 first 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 future 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.

[Chuck MacFarlane, executive]

Thank you, Loren. Good morning, everyone. Last night, we released our first quarter results. For the quarter, net income was $26 million or $0.66 a share compared with $0.49 a share last year. As pointed out in the press release, although all 5 operating companies improved net income, the PVC pipe companies drove most of the improvement.

Customers continue to order more PVC pipe to get ahead of forecast raw material price increases. Continued strong prices, combined with sales volume and the benefits of tax reform, resulted in a $4.4 million increase in the Plastics segment's net income quarter-over-quarter.

In addition, the Manufacturing segment showed nearly $2 million in net income improvement, and the Electric segment improved net income by more than $1 million. Allow me to briefly discuss each.

The Electric segment earnings per share were up $0.03 compared with the first quarter last year. We had $0.05 of colder weather and $0.03 of North Dakota interim rate impact. This was offset by $0.05 of 2017 Minnesota interim rates being higher than 2018 final rates. We mentioned during our last call that we anticipate an adjustment to our North Dakota general rate case related to tax reform. We filed that adjustment in February and received authority to reduce interim rates effective March 1 to accommodate the lower federal tax rates. Our overall request to North Dakota decreased from $13.1 million to $7.1 million. The North Dakota commission has scheduled hearings for mid-July and we expect a decision on our overall request in the third quarter.

We are working with Minnesota regulators to bring the benefits of tax reform to our utility customers in that state, and we were able to reduce our April 20 South Dakota rate request by more than $1 million because of tax reform. The South Dakota Commission established Otter Tail Power's currency rates in 2011 based on 2009 costs. Since then, the costs we incur to serve our customers have increased, and we made infrastructure investments, such as improved transmission and the required environmental technologies that we finished installing at the Big Stone Plant in late 2015. The new customer information system scheduled to go-live later this year is also driving our rate review. This is a multiyear request. The first step would be to increase nonfuel rates by approximately 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 an additional 1.7% increase in 2020 to recover costs for the Merricourt wind generation project, which is scheduled to be in service by the end of 2019. If the commission approved this portion of the request, a typical residential customer's bill would increase by approximately $1.75 a month. Even with the combined increase, we expect our South Dakota rates to continue to be among the lowest in the nation. We have asked to increase rates on an interim basis beginning May 21. The rates would remain in effect until the South Dakota Commission makes a final determination on our overall request, which we expect within 12 months.

Otter Tail Power 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 750 foundations and set approximately 75% of the structures and remains to be on schedule to be completed in 2019. The project will cost between $200 million and $240 million and 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 we've discussed on past calls.

As part of implementing our resource plan, Otter Tail Power has entered into definitive agreements to purchase a 150-megawatt wind farm to be built in Southeastern North Dakota near Merricourt in 2019. At approximately $270 million, it will be the largest capital project in the company's history. It's important to note that our existing wind farms don't generate PTCs after mid-2018. So we expect to efficiently use PTCs for Merricourt even with the lower tax rate.

With the Merricourt addition, nearly 30% of the electricity to supply Otter Tail Power customers will come from renewable energy. We will also construct a 250-megawatt simple cycle natural gas plant near Astoria, South Dakota. We expect the project to cost $165 million and to be in service in 2021. These 2 generation projects are included in the list of rate-based projects on Slide 11. Both projects are included in the approved Minnesota integrated resource plan and have received North Dakota Advanced Determination of Prudence. Both projects have their major permits, except for the South Dakota site permit for Astoria, which is on track for the third quarter. These projects are part of our electric platforms planned to grow rate base by an annual growth rate of 9% from 2017 to 2022.

Otter Tail Power plans to make capital investments of approximately $900 million between 2018 and 2022, as shown on Slide 12.

Slide 13 shows our regulatory framework, which continues to be constructive. As noted on the slide, 35% of our future project investments are eligible for rider recovery, while under construction.

Turning to our Manufacturing segment. Earnings per share were up $0.05 compared with the first quarter last year. Approximately $0.03 was due to improved sales volume and productivity gains and $0.02 was due to the impact of tax reform. BTD, our custom metal fabricator, is our largest manufacturing business. 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. We are seeing growth now that the company's customer base in agriculture, construction and recreational utility vehicles has begun to show economic recovery. But as I said earlier, the story this quarter belongs to our Plastics segment companies, Vinyltech and Northern Pipe Products. Their contribution to earnings per share was up $0.11 quarter-over-quarter, $0.08 from continued strong sales prices and volumes and $0.03 from the tax reform. 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. I applaud the management and the employees of our Plastics segment for driving operational excellence and customer satisfaction, while handling very strong demand.

Overall, we are very pleased with the first quarter results, which included improved operational and commercial performance across all of our companies.

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

[Kevin Moug, executive]

Well, thanks, Chuck. Good morning, everyone. We are extremely pleased with our first quarter results. Each of our 3 reporting segments delivered increased earnings, mostly from improved business conditions in the markets they serve and, as expected, from tax reform. Please refer to Slide 16 through 17 as I discuss our first quarter results.

The Electric segment net earnings increased $1.1 million quarter-over-quarter. Key drivers contributing to these increases were a $2.7 million increase in kilowatt-hour sales due to colder weather in the first quarter of 2018 compared to the first quarter last year. Weather positively impacted earnings per share by approximately $0.05 quarter-over-quarter. And compared to normal, weather impacted earnings by approximately $0.02 a share. A $1.6 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 our North Dakota general rate increase request. Also positively impacting earnings were increased renewable resource adjustment rider revenues in Minnesota and North Dakota, along with increased Conservation Improvement Program incentives in Minnesota. These items were offset in part by a $2.4 million reduction in revenues due to implementation of final retail rates in Minnesota that were lower than the interim rates that were in effect in the first quarter of 2017. A $2.4 million reduction in revenues for a provision of refunds related to recovery of federal income taxes in current retail rates in Minnesota and South Dakota that are in excess of lower federal income taxes under the new tax law.

Lower North Dakota and South Dakota environmental cost recovery rider revenues due to the impact from the lower tax rate and an adjustment of the return on equity component of the rider to the level requested in the North Dakota general rate case. Lower transmission rider revenue in North Dakota related to general rate case and the lower federal tax rate, and impacting earnings were higher operating and maintenance and depreciation expenses. And income tax expense decreased $4 million mainly due to the reduced tax rate from tax reform, along with lower earnings before taxes.

We believe we have an appropriate amount of accruals recorded for the estimated refunds related to expected rate case outcomes and for the effect of tax reform as of the end of the first quarter.

Net earnings for the Manufacturing segment increased $2 million quarter-over-quarter. Key items contributing to this improvement were: At BTD, revenues increased $9.6 million from increased product sales of industrial and construction equipment, recreational vehicle and lawn and garden equipment, as well as an increase in scrap metal revenues. Of the $500,000 increase in scrap metal revenues, approximately 75% is due to increased volumes related to increased production and the balance from improved scrap metal prices. These increases were offset in part by higher cost of goods sold and operating expenses. And although overall income tax expense increased quarter-over-quarter, BTD did realize lower tax expense of $600,000 due to the reduced tax rate. These items resulted in a $1.8 million increase in BTD's net earnings.

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

Our Plastics segment earnings increased $4.4 million quarter-over-quarter, due to a 10.7% increase in pounds of pipes sold as well as an approximate 20.7% increase in PVC pipe sales prices. Increased pipe prices more than offset increased resin prices, resulting in a $6 million increase in margins. Lower income tax expense from the lower federal tax rate also positively impacted Plastics net earnings.

In our corporate expenses, net of taxes increased $800,000 quarter-over-quarter, primarily due to increased professional service and 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 18. We are raising our 2018 consolidated earnings per share guidance range to $1.90 to $2.05 from $1.80 to $1.95, primarily based on the Plastics segment's stronger-than-expected first quarter results. Our Electric segment's 2018 net income is expected to be higher than 2017 based on: One, normal weather -- milder than normal weather in 2017 caused a reduction in earnings per share of $0.04 compared to normal. And weather is favorable to normal by $0.02 a share in the first quarter of '18. Constructive outcome of the rate case filed in North Dakota last November and most recently 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, higher pension, medical, workers' compensation and retiree medical benefits. The increase in pension costs was a result of a decrease in the discount rate from 4.6% to 3.9%.

Higher depreciation and property tax expense 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 $142 million for 2018 compared with $105 million at the same time a year ago. We are raising our Plastics segment 2018 net income expectations based on their strong first quarter results. Business conditions in the first quarter saw continued strong sales prices resulting in higher-than-forecasted operating margins. While announced resin price increases will lower operating margins through the remainder of the year, overall business conditions are expected to remain solid. Earnings in 2017 included an estimated impact of $0.09 a share due to the market reaction to hurricanes in the Gulf region of the United States. Our Plastics' 2018 net income will also be positively affected by lower tax rates and the new tax law. And the change in our -- in the guidance range for corporate costs is primarily due to additional increases in employee benefit costs due to the increase in the company's overall guidance range.

Our first quarter results reflect our continued commitment to delivering shareholder value. The Plastics segment's performance, in particular, was outstanding. We continue to be well positioned to achieve a 4% to 7% compounded annual growth rate in earnings per share based on 2017's $1.81 per share. Achieving our 2018 earnings per share guidance is 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 are encouraged by the favorable outlook for business conditions for the remainder of the year.

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

[Operator]

[Operator Instructions] And our first question comes from Paul Ridzon of KeyBanc.

[Paul Ridzon, analyst]

Can you hear me?

[Kevin Moug, executive]

We sure can, Paul.

[Paul Ridzon, analyst]

Just on the Plastics, how much of this is -- this quarter is business-related construction starts versus customers accelerating, trying to build up inventory ahead of resin price increases?

[Kevin Moug, executive]

Paul, this is Kevin. I think the first quarter results are a reflection of all of those that you mentioned. We clearly saw sales prices continue to be strong as we headed into the first quarter. The tailwinds from the fourth quarter after the hurricane, sales prices were strong and they've continued to be strong. And we saw increased volumes based on both business conditions, and then there was some announced resin price increases here that was expected to occur in the March, April time frame, which certainly drove orders as well. As we look to the rest of the year, we certainly believe that sales prices will continue to be strong, but we would expect volumes to taper off because of some of that early or, I should say, advanced ordering that occurred in the first quarter.

[Paul Ridzon, analyst]

Do you think -- how far out do you think customers were buying? I mean, could this -- did you possibly cannibalize any '19 sales? Or do you think it's all contained in '18?

[Kevin Moug, executive]

No, there is no cannibalization that far out. I mean, certainly, our reflection of softer volumes in the last 9 months of the year is due to some of that being accelerated into the first quarter, but there wouldn't be any impact on '19.

[Operator]

And our next question comes from Chris Ellinghaus of Williams Capital.

[Christopher Ellinghaus, analyst]

As far as the forward purchasing on PVC pipe, is there any chance that not only does it reflect sort of the announced resin price increases, but also some acceleration of the economy? So how do you strip out, when you're thinking about what the first quarter looked like, what might have been economic impact versus pricing?

[Chuck MacFarlane, executive]

Well, in terms of pricing, Chris, the first quarters had very strong sales prices that those conditions carried over from the fourth quarter of '17, once the effect of the hurricane was pretty well done by early November. And we expected that sales prices would start to soften, but they did not. March sales prices continued to be strong through the remainder of '17. And then they continued to stay strong here in '18 as well. And that certainly had, in terms of our original expectations for the year and the guidance, that we expected softening in sales prices and that hasn't occurred. The other thing that did occur was there was some level of advanced orders purchased by distributors because of expected resin price increases that were to occur in February, March, April time frame. A lot of it, I would tell you, is -- I think a fair amount is driven by the overall business conditions that we're seeing in the markets that we serve. But we recognize that there will be some softening in volumes for the last 9 months of the year because of the advanced purchases that occurred until they work through that inventory.

[Christopher Ellinghaus, analyst]

Okay. Can you give us a little bit more color about what improved other than those scrap prices and volumes at BTD in your different end market?

[Chuck MacFarlane, executive]

Well, in terms of end market improvements, I mean, I think we mentioned in the release that we saw certainly industrial and construction equipment, our lawn and garden and ag markets were certainly stronger than first quarter last year, and we've continue -- particularly lawn and garden has continued to perform well. Recreational vehicles were certainly performing well quarter-over-quarter. And then, I guess, a part too that we probably wasn't as significant that we didn't mention was we did see some improvement in the energy part of the business as well -- not wind, but from the oil and gas part of the business, the heat pumps and those things that we make for customers in that end market, certainly, were good in the first quarter as well.

[Kevin Moug, executive]

And energy revenue was neutral, oil and gas was up and wind was down.

[Christopher Ellinghaus, analyst]

That's interesting. Why would you expect wind to see some weakness?

[Chuck MacFarlane, executive]

Well, we make primarily fixtures to transport blades and they are reusable. I think they are something that, while there is more facilities going to go in, in the next 2 years, those were built in preparation for those -- that 2 years of probably pretty strong wind blade and wind power installation.

[Christopher Ellinghaus, analyst]

Got you. And what are you seeing at T.O. Plastics? I mean, there does seem to be some tailwinds in the economy from a little bit of a housing boom. Seems like maybe you're seeing that in the lawn and garden market. Wouldn't that seem to suggest a little bit more strength in T.O. Plastics, as there is some plant work to be done associated with new housing construction?

[Kevin Moug, executive]

Yes, Chris, this is Kevin. We are seeing certainly stronger horticultural market here as we started the year out with T.O., both in the quarter and then as we look out for the rest of the year. We certainly are expecting strong hort markets as well. So I think to the extent that there has something to do with housing, that certainly is part of it. But we did announce a price increase in the hort side of the business here on March 1. So that's certainly driving part of the expectations, but we are seeing some growth with 2 of our larger customers year-over-year, and then we're also seeing growth in kind of the Southeast and South Central regions that we serve for hort.

[Chuck MacFarlane, executive]

I would tell you that probably in general, most of it is just due to the business conditions that are in place in the economy. And then the growth with the large customers would be driven in large part by that as well.

[Operator]

[Operator Instructions] And I'm showing no further questions at this time. I'd like to turn the conference back over to Chuck MacFarlane for any closing remarks.

[Chuck MacFarlane, executive]

Thank you. To summarize, net earnings increased $0.17 quarter-over-quarter. Vinyltech and Northern Pipe Products drove most of the improvement with exceptionally strong sales prices and volume. BTD also continued with volume and productivity improvements, and Otter Tail Power benefited from colder weather, began collecting interim rates in North Dakota, filed a rate case in South Dakota and is working with regulators in all 3 states we serve to bring the benefits of tax reform to all of our utility customers.

I want to extend our appreciation to employees across our organization for their hard work and excellent first 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.

[Operator]

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.