Otter Tail's (OTTR) CEO Chuck MacFarlane on Q2 2016 Results - Earnings Call Transcript

| About: Otter Tail (OTTR)

Otter Tail Corp. (NASDAQ:OTTR)

Q2 2016 Earnings Call

August 9, 2016 11:00 AM ET

Executives

Loren Hanson - Manager, Investor Relations

Chuck MacFarlane - President and Chief Executive Officer

Kevin Moug - SVP and Chief Financial Officer

Analysts

Operator

Good morning, and welcome to Otter Tail Corporation's Second Quarter 2016 Earnings Conference Call. 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.

Loren Hanson

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 2016 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.

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'd like to remind you that during the course of this call, we will be making forward-looking statements as noted on slide two of our presentation. These forward-looking statements represent our current judgment or opinion of what the future holds. These statements are subject to risks and uncertainties that may cause actual results to differ materially from forward-looking statements made today. So pleased by advised by 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 incurred 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?

Chuck MacFarlane

Thanks, Loren. Good morning, and thanks for joining our call. For the quarter, net income from continuing operations was $15.6 million or $0.41 a share. We’re pleased with this result and is stronger than the second quarter last year and can be largely attributed to improving margins in our manufacturing segment.

Accordingly we are reaffirming our guidance for the remainder of 2016. To enhance long-term returns, our strategy continues to focus on maintaining a solid regulative electric utility supplemented with the portfolio of manufacturing businesses. Today I will reaffirm our plans to grow rate base and review our recently filed Minnesota rate case. I will also update you on our manufacturing platform.

Slide six shows our planned rate base growth. It calls for capital investment of $858 million from 2016 through 2020. Slide seven shows our regulatory recovery mechanisms. We have positive regulatory constructs and relationships in each jurisdiction. Our rate based growth plans include two large regional transmission projects and several generation investments for projected compound annual growth rate of 8% in utility rate base using 2014 as the base year.

We have discussed the two large transmission projects Big Stone South-Brookings and Big Stone South-Ellendale on past earnings calls. To recap, the midcontinent independent system operator approved both as multi value projects which means the cost will be allocated across all customers in MISO's 15 state Midwest footprint, with limited rate increases to our retail customers.

The map on slide eight shows the relative location and length of these lines. The first will run from Brookings South Dakota 70 miles north to a new substation near Big Stone plant. It is the next leg of the recently completed CapEx 2020 line from the twin cities to Brookings. Otter Tail Power is a 50% owner in the line portion of this project with Xcel Energy. Our investment is $97 million; Xcel began construction last year and has the line on schedule be in service in 2017.

The second line will run from a new substation near the plant a 170 miles northwest to Ellendale North Dakota and it is scheduled to be in service in 2019. Otter Tail Power manages the project and is a 50% owner in the line portion of this project with MDU. Our investment is $153 million. Construction started in June. The steel tower vendor has begun producing transmission structures and contractors have set 6% of the more than 700 pole foundations we expect to be complete with the project in 2019.

Otter Tail Power filed an integrated resource plan with the Minnesota Public Utilities Commission on June 1, and filed copies with North Dakota and South Dakota commissions in July.

Slide 10 shows how our 2016 filing compares with our 2013 commission [approved] [ph] plan. The resource plan identifies the most cost effective combination of resources for meeting our customer’s needs for reliable service during the next 15 years. Otter Tail Power selected its proposed plan based on reliability, affordability and environmental responsibility. It includes adding 200 megawatts of wind resources, a 100 megawatts in 2018 and a 100 megawatts in 2020, and authorized to add another 100 megawatts and at a later time.

Today wind resources serve approximately 19% of Otter Tail Power customers’ energy needs. If all three of the projects were put into service, wind would serve approximately 34% of our retail load. Our plans also include adding 30 megawatts of solar resources by 2020 to comply with Minnesota’s solar energy standard. With the exception of solar, our proposed resource plan is the lowest cost for our customers, but we anticipate the price of solar will continue to decline, and if it does, it should be part of a least cost plan scenario in 2020.

The plan also includes adding 240 megawatt simple cycle natural gas plant in 2021. While we won’t formally announce our preferred natural gas plant site or begin permitting until this fall, we can say it’s in a close proximity to a high voltage transmission line and a large natural gas pipeline within Otter Tail Power service area.

We expect a ruling on our resource plan in 2017. If the plan is approved, the natural gas combustion turbine and a portion of the additional wind energy would replace capacity from the Hoot Lake Coal Plant which we planned to retire in 2021, as well as expiring long-term purchase power agreements.

I also want to mention that stakeholder engagement was an important step in our resource planning process because Otter Tail Power service area stretches across three states with differing regulatory policies. It was important for us to meet with regulators and organizations in all three states to gain perspective. The meetings were helpful to all parties and have led to a solid resource plan that balances needs and resources.

Turning to our rate case as shown on slide 11, Otter Tail Power filed with the Minnesota Public Utilities Commission in February 16, requesting a 9.8% rate increase or approximately $19.3 million annually. As we mentioned last quarter, this reflects a 10.4% return on equity and a 52.5% equity ratio. The PUC granted interim rates of 9.56% which went into effect on April 16. They are subject to refund and will remain in place while the commission considers the overall request. We expect to recognize 8.5 months of interim rates in 2016.

Interveners will file a testimony in mid-August and the PUC will make a final determination in 2017. See slide 12 for a complete rate case timeline.

At the time of this call last quarter, we were half way through a schedule 10 week maintenance outage at Coyote Station. We were replacing the lower boiler walls, installing a separated over fire air system to reduce NOX emissions and tying into the new mine’s coal conveyor system. This is a $35 million project and our share is 35%. Coyote came back online in June and has been running well. In fact, because it’s a low cost unit, MISO has dispatched it to run nearly every hour of every day this summer.

Last quarter I also mentioned implementation of a new customer information system at Otter Tail Power. The well-staffed implementation team officially kicked off this $15 million project this spring. They completed the planning and analysis phase and moved into the design phase at the end of July.

One more item you might be interested in is that two weeks ago Otter Tail Power working with the City of Bemidji and Bemidji State University in Minnesota, announced the installation of three electric vehicle charging stations in Bemidji. This was close on the heels of Otter Tail Power’s July 1 implementation of a new rate for customers and charge plug-in vehicles in the garages at night. Today electric vehicles make only – up only a small fraction in the cars on the road, about 3,000 in Minnesota.

Moving on to our manufacturing platform, BTD completed its $33 million facilities expansion in Detroit Lakes and Lakeville, Minnesota. The expansion increased capabilities including in-house painting and complex assembly services. Reduced logistics costs and enhanced margins. BTD also experienced increased sales at its Illinois plant and continues to integrate the Georgia plant. BTD acquired the Georgia plant in late 2015 as part of a strategy to expand to the Southeast to better serve customers.

Improved productivity across the company translated into improved net income in the second quarter of 2016 compared to the second quarter of 2015. Northern Pipe Products and Vinyltech experienced the 19.2% increase in pipe sales quarter-over-quarter, which is a significant and is attribute to our sales teams. But the narrowed spread between sales and raw material prices has reduced margins. We expect margins to be compressed for the remainder of the year.

I will now turn it over to Kevin for financial perspective.

Kevin Moug

Thanks Chuck, and good morning. Please bear with me this morning as I do have a cold and my voice could be challenged as I speak with you on the results of the quarter.

Please refer to slides 13 and 14 as I discuss our second quarter results. Our electric segment net earnings increased $896,000 quarter-over-quarter. They key elements of this increase in earnings were an increase in retail revenue of $2.8 million related to a 9.65% interim rate increase and went into effect in April of 2016. Those rates which are subject to refund or expected to be finalized in 2017.

Increased environmental and transmission cost recovery riders increased conservation incentives. Warmer weather in the second quarter compared to the second quarter of 2015 positively impacted earnings per share by a penny. Weather was neutral for the quarter when compared to normal, also positively impacting earnings for increased sales to pipeline customers. These positive impacts to earnings were offset impart by higher operating and maintenance expenses as well as higher depreciation expense due to increased rate base investments.

Our manufacturing segment revenues and earnings increased quarter-over-quarter BTD’s performance. Revenues increased $7.8 million quarter-over-quarter at BTD due to the September 1, 2015 acquisition of impulse manufacturing located in Georgia. Impulse contributed $6.5 million in revenues. Our Illinois plant had an increase in revenues of $3.8 million driven by demand for wind tower components. These increases were offset by a $2.5 million decrease in sales at our Minnesota plants related to reduced volumes in agricultural, oil and gas, and recreational vehicle end markets.

The key drivers to BTD’s improved quarter-over-quarter profitability is the increased volume in the Illinois plant, improved gross margins due to change in product mix and improved productivity and cost reduction efforts in the Illinois and Minnesota plants. Our Georgia plant contributed a net loss during the quarter and we continue to work on the integration process.

T.O. Plastics experienced a decrease in revenues and net earnings quarter-over-quarter primarily due to changes in the product mix, offset in part by increased sales on horticulture containers.

Our Plastics segments revenues increased between the quarters as a result of a 19.2% increase in the amount of pounds sold, despite a 14% decrease in the price per pound of pipes sold. These increased sales came primarily from the Western and Southwest regions of the United States where construction activity remained strong. Their earnings decreased $780,000 between the quarters due to compressed operating margins from declining PVC pipe prices resulting from low raw material costs. And our corporate expenses net of tax decreased $700,000 as a result of receiving a $700,000 non-taxable benefit proceeds from corporate owned life insurance.

We are reaffirming our consolidated earnings per share guidance of $1.50 to $1.65 per share as shown on slide 16. Our 2016 guidance reflects our current mix of business and the overall challenges facing our respective platforms. As a result, we are updating our segment guidance. We now expect 2016 Electric segment net income to be comparable with 2015.

2016 results are dependent on a constructive outcome of the rate case we filed in Minnesota in February of 2016. We are currently receiving interim rates subject to refund. These rates are subject to review and determination by the Minnesota Public Utilities Commission. Our ability to obtain final rates similar to interim rate and reasonable rates of return depends on regulatory action under applicable statutes and regulation. We cannot provide assurance our interim rates will become final and our requested ROE will ultimately be approved.

Other key factors I want to mention impacting 2016 compared with 2015 are: normalized weather for the remainder of the year, rider recovery increases, increase in forecasted sales to pipeline and commercial customers offset [indiscernible] the effect of the 2015 adoption of bonus depreciation for income taxes which reduces our projected earnings per share by $0.06. The higher depreciation and property tax expense due to large CapEx projects being put into service.

The press release fully explains additional reasons driving 2016 expected results. We are increasing the expected earnings per share range for the manufacturing segment by $0.02 of share on both ends of the range. This is based on positive year-to-date performance and continued focus on improved productivity and cost reductions to challenge – to address challenges with softening end markets at BTD Manufacturing.

Our backlog for the manufacturing segment is $81 million for the remainder of the year, this compares with $85 million for the same time a year ago. We are maintaining our earnings per share guidance range for the Plastic segment. We expect lower corporate cost than originally estimated for 2016 due to continued cost reduction efforts.

We remain focused on our strategic initiatives for the year and are off to a strong start to the first half of 2016. Our year-to-date performance reflects the balance mix of earnings from our electric and manufacturing platforms. The reminder of 2016 presents opportunities and challenges as we continue to manage the business.

Key initiatives we continue to focus on are; a constructive outcome of our Minnesota rate case, successful growth in sales at BTD from its new paint line along with continued focus on operational improvements, needed to improve our return on sales as well as full integration of BTD Georgia to better serve our customers in the Southeast. These initiatives are especially important in light of the continued market softness and agriculture, oil, gas and recreational vehicle end markets that BTD serves. And we are well positioned for a rebound at end markets served by BTD with the strategic investments we have made over the last two years.

While the plastics segment expected 2016 net earnings are currently down from 2015, this segment will still provide strong earnings, cash flows and returns on invested capital in 2016. As we continue to execute on our strategies, we remain confident in the future ability of our two platforms which further positions us to meet our long-term goal of 4% to 7% compounded growth rate in earnings per share using 2013’s $1.50 a share as adjusted for the base year.

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

Question-and-Answer Session

[Operator Instructions] And I’m showing no questions at this time. I would now like to turn the call back over to Chuck MacFarlane for any further remarks.

Chuck MacFarlane

Thank you. To summarize, we are pleased with the second quarter results which reflect not only interim rates at Otter Tail Power but also operational improvement at BTD during 2016. Net earnings increased quarter-over-quarter from continuing operations and we reaffirm our 2016 earnings guidance of a $1.50 to a $1.65 per share.

Thank you for joining our call and for your interest in Otter Tail Corporation. We look forward to speaking with you next quarter.

Operator

Ladies and gentlemen, thank you for participating on today’s conference. This concludes today’s program. You may all disconnect. Everyone, have a great day.

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