Otter Tail Corp

NASDAQ:OTTR

Earnings Call Transcript 2018-Q3

[Operator]

Good morning, and welcome to Otter Tail Corporation's 2018 Third Quarter Earnings Conference Call. Today's call is being recorded and we will hold a question-and-answer session after the prepared remarks.

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

[Loren Hanson, Manager of IR]

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 third quarter results and revised 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 two, 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.

[Charles MacFarlane, President and CEO]

Thank you, Loren. Good morning, everyone. Last night we released the third quarter results. For the quarter, net income was $23.3 million or $0.58 a share, compared with $17.7 million or $0.45 a share last year. This is a 29% earnings per share increase year-over-year.

All operating segments improved net income quarter-over-quarter, contributing to the positive results, our Electric segment have interim rates in place in North Dakota, increased transmission investments and favorable weather. Our Manufacturing segment experienced increased revenue and earnings growth both our Manufacturing and Plastic segments received a benefit of lower tax rates.

Before I discuss these segment, allow me to share that Otter Tail Corporation is the member of the Edison Electric Institute joined in the third quarter with member companies to provide environmental, social and government information that gives investors and other inside into our commitment to being a good corporate citizen.

On slide six through eight, you see the highlights from our ESG sustainability report and a glimpse into how our electric utilities, plant and service and resource mix are evolving due to the significant investments in low cost renewable energy and transmission that enables regional wind development. You can find our full ESG's sustainability report on our website at ottertail.com.

Now allow me to briefly discuss each segment. We mentioned during our last call with Otter Tail Power reached a proposed settlement agreement with the North Dakota Public Utility Service Commission staff and interveners in the North Dakota rate case.

As you'll see on slide 10, in the September hearing, the North Dakota Public Service Commission approved an overall revenue increase of $4.6 million or 3.1% and a return on equity of 9.77% on a 52.5% equity layer. This compares with our March 2018 adjusted increase request of $7.1 million or 4.8% and a return on equity of 10.3%.

The approval results in no rate based adjustments from our original request and allows for future rider recovery of the planned Astoria natural gas generating facility. Final rates will be effective January 1, 2019 with interim rate refunds applied to customers' bills in March.

On October 28th, we implemented South Dakota interim rates while the Public Utilities Commission works through our two part rate request. The first part of our request is to increase non-fuel rates by approximately 10%. The second part is to recover cost for the Merricourt wind project when it goes into service, which would result in a 1.7% increase. We expect the PUC to issue a final decision in February of 2019.

Otter Tail Power continues to manage the Big Stone South-Ellendale 345 kV transmission project. The map on slide 12 show its relative location. We are 50% owner in this 163 mile line with a partnering utility. All structures have been set, over 85% of the conductor has been strung and the project remains on schedule for 2019 completion.

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 two projects are included in the list of rate based projects on slide 15.

As indicated on the next slide, they are important to our Electric segment's plan to grow rate base by an annual growth rate of approximately 9% from 2017 to 2022. We continue to benefit from a constructive regulatory environment, providing timely cost recovery.

Turning to our Manufacturing segment. Earnings per share were up $0.04 compared to third quarter of last year, primarily due to BTD Manufacturing's Georgia plant achieving a significant year-over-year revenue improvement and profitability for the quarter. BTD continues to enhance further activity in a period of increased volume and tight labor market. Our investment in the company's Minnesota facilities has provided additional capabilities and capacity, BTD's expansion to the Southeast has also created new opportunities.

Our PVC pipe companies Vinyltech and Northern Pipe Products continue to show improved financial performance, with favorable market conditions supporting strong sales prices. These companies have low capital and operating cost, provide excellent customer service and outstanding returns on capital, while remaining highly competitive.

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

Now, I will turn it over to Kevin for the financial perspective.

[Kevin Moug, SVP and CFO]

Thanks, Chuck and good morning, everyone. In the third quarter, our three operating segments delivered increased earnings from improved market conditions and continued positive impacts from tax reform.

Please refer slide 20 through 22, as I discuss the third quarter results. The Electric segment net earnings increased $3.7 million quarter-over-quarter. The press release describes all the items impacting our quarterly results with key items worth mentioning are the third quarter of 2017 reflected additional accruals in our estimated rate refund liability related to the final order in the 2016 Minnesota general rate case. There were no similar items in the third quarter of 2018.

Interim rates, net of estimated refunds related to our North Dakota general rate case have been in effects since January of 2018. Weather positively impact earnings per share by approximately $0.01 quarter-over-quarter and increased transmission tariff and service revenues. These items were offset in part with higher property taxes and depreciation expenses. Net earnings for the manufacturing segment increased $1.4 million quarter-over-quarter.

Key elements of this improvement are BTD revenues increased $11.8 million from increased product sales to all its major end markets. $4.2 million of this increase relates to higher material costs that are pass through to customers. We also improved our revenue mix by reducing our low margin work quarter-over-quarter.

BTD's Georgia plant in particular had a strong quarter due to increased sales and productivity improvements. And in addition, BTD's scrap metal revenues increased due to higher scrap volume and higher scrap sales prices. These increases were offset impart by higher cost of goods sold and operating expenses. And lower income taxes also contributed to BTD's increase in net earnings.

At T.O. Plastics, revenues improved $900,000 mainly due to increased sales of horticultural containers. These increased revenues were offset impart by lower sales of industrial and life science products, as well as higher cost of goods sold and operating expenses. And all our earnings before taxes were flat quarter-over-quarter reduced tax expense from the lower tax rate resulted in improved earnings for T.O. Plastics.

Our Plastics segment's earnings increased $340,000 quarter-over-quarter, however [ph] pipe sold decreased 12.5% this was partially offset by a 7.5% increase in pipe sales prices. Our operating income was lower in the third quarter of 2018 compared with the third quarter 2017, primarily due to hurricane related impacts in 2017, which positively impacted our third quarter 2017 earnings by $0.04 a share.

The lower operating income was more than offset with reduced income tax expense due to lower tax rates in 2018. Our corporate expenses net of taxes decreased slightly primarily due to non-taxable life insurance benefits, offset impart by lower income tax savings due to the lower tax rates in 2018.

Moving on to our business outlook on slide 23, we are narrowing our 2018 consolidated earnings per share guidance range to $2 and $2.10 from $1.95 to $2.10. 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. And weather is favorable to normal by $0.06 a share for the first nine months of 2018.

Impact from the settlement of our North Dakota rate case and the interim rates from the South Dakota rate case and increased transmission investments. These items were offset by increased operating and maintenance expenses related to the planned outage at Big Stone plant that began in September of 2018 and higher pension, medical, workers compensation and retiree medical benefits. The increase in pension cost 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, cost reductions and improved productivity, increased earnings in T.O. Plastics, primarily driven by improved sales in horticultural markets and lower income taxes due to lower federal tax rates implemented as part of the new tax law. The backlog for this segment for the remainder of 2018 is approximately $62 million compared with $53 million a year ago.

We are raising Plastics 2018 net income expectations based on year to date performance combined with fourth quarter business conditions. Earnings in 2017 included an estimated impact of $0.09 per share due to the market reaction to hurricanes in the Gulf region of the United States. And Plastics 2018 net income continues to be positively affected by lower tax rates.

In corporate costs net of tax are expected to be higher in 2018, primarily due to the impact of the lower tax rates, increased employee benefit costs resulting from increased earnings and expected contributions made to Otter Tail Corporation's Foundation, which was established in 2018.

Our current earnings guidance for 2018 is 65% from our Electric segment and 35% from our Manufacturing and Plastics segments. While this 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 75% of earnings from our Electric segment and 25% from our Manufacturing, Plastics segments net of unallocated corporate cost.

This will be driven by the capital plan, which calls for approximately 93% of our capital spend over the 2018 through 2022 timeframe to be in the Electric segment. This will continue to drive our approximate 9% compounded annual growth rate and rate base and bring our earnings mix back in line with our 75% to 25% expectations.

2018 is shaping up to be an outstanding year of financial performance. We see growth in earnings per share driven by improved results across all of our operating segments and strong returns on equity and cash flows from operations. Our balance sheet is strong and we have ample liquidity in place to support our businesses as we head into 2019. We continue to be well-positioned to achieve a 4% to 7% compounded annual growth rate and earnings per share based on 2017 $1.81 per share.

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

[Operator]

Thank you. [Operator Instructions] Our first question comes from the line of Paul Ridzon with KeyBanc. Your line is now open.

[Paul Ridzon, KeyBanc Capital Markets]

Good morning.

[Charles MacFarlane, President and CEO]

Good morning, Paul.

[Paul Ridzon, KeyBanc Capital Markets]

Could you just repeat the weather impacts 2017 and year-to-date?

[Kevin Moug, SVP and CFO]

The weather quarter-over-quarter was favorable by a penny a share. Year-to-date weather is favorable by this is year-over-year is $0.10 a share and compared to normal in 2018 at $0.06.

[Paul Ridzon, KeyBanc Capital Markets]

So last year was $0.04 below normal year-to-date.

[Kevin Moug, SVP and CFO]

Yes.

[Paul Ridzon, KeyBanc Capital Markets]

And then just - I know I ask every quarter, but kind of whether you are seeing any of your customers wanting to share in your tax savings.

[Charles MacFarlane, President and CEO]

Paul, we have not had any requests from customers to share the tax savings and that's been across the manufacturing and plastics companies, we just haven't had that pressure. Suppose over time, one would expect that some of that wouldn't get baked into pricing on a - over a longer term basis, but certainly in 2018 we've not had any pressure for that.

[Paul Ridzon, KeyBanc Capital Markets]

Okay. Where are we in the PVC pricing cycle?

[Charles MacFarlane, President and CEO]

Well, I think when we look historically we would say we were in the order probably in the upper end of the pricing cycle. When we look back over this last few years, I know that this year certainly we've seen stronger prices in 2018 and even what we saw in the last half of 2017. Those conditions weren't expected to continue as we headed into 2018. But I think that there was certainly the market for whatever reasons adjusted to the higher prices that were in driven in part by the hurricane effect those continued into this year, and they've continued strong for the year.

I think certainly as we go forward, we recognize we're at the higher end of the cycle and when we look out longer term that that's probably not normal, but that's going to - would expect to continue.

[Paul Ridzon, KeyBanc Capital Markets]

Thank you for the color. Appreciate it.

[Operator]

Thank you. [Operator Instructions] I'm not seeing any further questions. I'd now like to turn the call back to Mr. Chuck MacFarlane for any closing remarks.

[Charles MacFarlane, President and CEO]

Thank you. To summarize, earnings per share increased $0.13 or 29% quarter-over-quarter in part due to interim rate revenues from North Dakota, increased revenue from transmission investments and favorable weather in Otter Tail Power service area. Increased volumes and lower taxes at BTD and T.O. Plastics and improved sales margin 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 improved third quarter results.

Looking ahead, we have the right long-term strategy in place supported by a targeted capital growth plan. We remain on track to deliver shareholder value in 2018 and have raised the lower end and narrowed our full year guidance to a $2 to $2.10 range. Thank you for joining our call. We appreciate your interest in Otter Tail Corporation and look forward to speaking with you next year.

[Operator]

Thank you. Ladies and gentlemen, this concludes today's call. You may all disconnect. And everyone have a great day.