Otter Tail Corporation (NASDAQ:OTTR) Q3 2016 Earnings Conference Call November 3, 2016 11:00 AM ET
Loren Hanson - Investor Relations
Chuck MacFarlane - President and CEO
Kevin Moug - Senior Vice President and CFO
Paul Ridzon - KeyBanc
Stephanie Tsao - S&P Global
Good morning. And welcome to Otter Tail Corporation Third 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 for 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 Corporation. Last night, we announced our third quarter 2016 results. Our complete earnings release and the slides accompanying this 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 the call, we will be making forward-looking statements. 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 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 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?
Good morning and thanks for joining our call. Our third quarter results reflect current business conditions, operating companies continue to execute on strategic initiatives and we remain confident that 2016 will meet our expectations.
Third quarter results from continuing operations were down from last year’s third quarter by $0.05 a share and can be largely attributed to three items, cooler weather resulting in fewer degree days negatively impacted results by penny a share, providing for an estimated potential refund in our Minnesota rate case negatively impacted results by $0.03 a share and narrowed margins in our Plastic segment negatively impacted results by $0.03 a share.
This was partly offset by $0.02 a share of lower corporate costs. We are managing through the impacts of the $0.05 reduction by further tightening our expenses and we are reaffirming our guidance for the remainder of 2016. Continued to maintain two platform company with the solid regulated Utility and Manufacturing businesses enhance long-term returns. Allow me to provide a brief update on both platforms.
We are investing $850 million from 2016 through 2020 in utility rate base growth as shown on slide six. Slide seven shows our regulatory recovery mechanisms. We have positive regulatory constructs and relationships in each jurisdiction. Our utility rate base growth plan includes two regional transmission projects and several generation projects producing a compounded annual growth rate of 8% using 2014 as the base year.
Work continues on two large transmission projects, Big Stone South to Brookings and Big Stone South to Ellendale. The map on slide eight shows a relative locations and length, both are designated as multi-value projects within the Midcontinent Independent System Operator or MISO footprint.
We are 50% owner in the first project with Xcel Energy, who is the project manager. This is the 70-mile project, only 25 pole foundations are left to complete and the structure setting has begin. The line is on budget and on schedule to be in service in 2017.
We are 50% owner in the line portion of the second project with MDU, Otter Tail Power project manager. The line will run from the new substation near Big Stone, 170 miles Northwest to Ellendale, North Dakota. More than 90% of the easements are executed, contractors have set 25% of the 750 foundations and steel towers began arriving in October. We expect to complete the project in 2019.
Turning to our planned generation investments, in our June 1st resource plan filing with the Minnesota Public Utilities Commission, we proposed adding 200 megawatts of wind, 30 megawatts of solar and 248 megawatts of natural gas during the next five years to reliably serve our customers.
Stakeholders submitted their comments on the filing in October. Minnesota Department of Commerce supports our plan and recommends even more wind energy in the out years. They recommend an additional 200 megawatts of wind in the 2023 timeframe. Required comments on the resource plan are due December 5th. We expect the commission hearing to take place in February or March next year.
Now just a note on each resource, wind resources serve approximately 19% of our customers’ energy needs today. If all wind projects in our resource plan are put into service, wind would serve more than a third of our retail world. We will need to have 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 to continue to decline and if it does as anticipated, it should be part of a lease cost plan in 2020.
Minnesota solar energy legislation also requires us to provide 1/10 of 1.5% of the Minnesota retail electric energy sales with solar projects that are less than 20 kW by 2020. An example of how we are working toward that goal occurred last month. The University of Minnesota Crookston held a grand opening of its new $15 million wellness center. The new building has a 20 kW rooftop solar system estimated to produce 23,000 kilowatt hours annually. This is 6% to 10% of the building’s electric needs.
The Crookston campus took advantage of Otter Tail’s POP solar program to receive a $25,000 rebate in addition to other incentives. POP stands for publicly owned property. POP solar is a valuable program for tax exempt public entities because they typically don’t qualify for the 30% federal tax credit for installing solar projects.
Finally a comment on our natural gas generation project, our resource plan includes adding a 248 megawatts simple cycle natural gas plant in 2021. We are finalizing our preferred natural gas plant site. It will be in close proximity to a high-voltage transmission line and a large natural gas pipeline within Otter Tail Power service area.
If our resource plan is approved, the natural gas combustion turbine and additional wind energy would replace expiring long-term purchase power agreements and capacity from the Hoot Lake coal plant, which we plan to retire in 2021.
Turning to our rate case as shown on slide 10, Otter Tail Power filed with the Minnesota Public Utilities Commission on February 16th, requesting a 9.8% rate increase or approximately $19.3 million annually. This reflected 10.4% return on equity and a 52.5% equity ratio. The PUC granted interim rates of 9.56%, which went into effect in April of ‘16. They are subject to refund and will remain in place while the commission considers the overall request.
As we worked through our rate case process with updated inputs, we lowered our ROE request to 10.05%, public hearings took place in October, followed by evidentiary hearings in October. The administrative law judge’s report is due in January and the commission is expected to issue its final order in March of 2017. Slide 11 shows the complete rate case timeline.
Moving on to our Manufacturing platform, last quarter we announced that BTD had completed its $33 million facilities expansion in Detroit Lakes in Lakeville, Minnesota. The expansion increased capabilities, including in-house painting and complex assembly services, and reduced logistics costs.
Margins at the Minnesota and Illinois plants have improved over the last year, with better on time delivery and inventory levels. This is somewhat offset by BTD Georgia plant, where integration is ongoing and profitability is lower than expected due to soft markets and productivity challenges. BTD acquired the Georgia plant in September of 2015 as part of its strategy to expand to the Southeast to better serve customers.
Recreational vehicle, agriculture, and oil and gas extraction equipment end markets, which BTD serves, continue to be soft in 2016. However, BTD’s net income was stable quarter-over-quarter and BTD earnings are on pace to double year-over-year. We believe BTD is in a good position to enhance earnings when market conditions improve.
T.O. Plastics, our other company in the Manufacturing segment, saw lower than anticipated growth in its primary market, thermoformed horticulture containers. Net earnings were down quarter-over-quarter. We expect fourth quarter horticulture sales to be stronger this year than last year. Sales volumes at Northern Pipe Products and Vinyltech were essentially unchanged quarter-over-quarter, but lower raw material costs were not enough to offset lower pipe prices.
Customers in this market are aware when resin prices decline and they expect similar or similar rate of reductions in pipe prices. Pipe prices have fallen faster than raw material prices, resulting in compressed margins again this quarter. We anticipated margin compression year-over-year. Both of the companies are in good position, however, they have low capital costs, low operating costs and excellent customer service.
Now, I’ll turn it over to Kevin for financial perspective.
Well, good morning. Please refer to slides 12 and 13 as I discuss our third quarter results. Our net earnings decreased $408,000 quarter-over-quarter for the Electric segment. Key items contributing to this change are, an increase in retail revenues of $3.8 million related to the 9.56% interim rate increase that went into effect in April 2016 in conjunction with the rate case we filed in Minnesota, increased environmental and transmission cost recovery riders, increased conservation incentives and increased weather-normalized sales to all customer classes.
These items were offset by, interim rate revenues were reduced by $2.1 million for a provision for an estimated refund in third quarter, this estimate reflects a modification in our original request and other expected outcomes from our previously mentioned Minnesota rate case.
For the nine months ended September 30, 2016, a $2.3 million provision has been established for an estimated refund on interim rate revenues of $6.9 million. Milder weather in the third quarter of 2016 negatively impacted earnings per share by a penny and weather has negatively impacted earnings per share by $0.04 year-to-date. Higher operating and maintenance expenses, as well as higher depreciation and amortization expenses increased rate base investments.
Other items impacting the utility’s third quarter performance are noted in our press release. Our Manufacturing segment revenues and earnings decreased quarter-over-quarter. Revenues at BTD increased by $3.7 million as a result of owning BTD Georgia for the three months in the third quarter of 2016 compared with one month in the third quarter of 2015.
This was offset in part by a $2.1 million decrease in revenues at BTD’s Minnesota and Illinois plants, as they continue to be impacted by softening demand from the recreational vehicle, agricultural, and oil and gas end markets.
BTD had an $800,000 increase in net income at its Minnesota and Illinois plants related to ongoing productivity improvements, cost reduction efforts and improved gross margins. That increase was offset by a $700,000 increase in net losses at our Georgia plant. The Georgia plant has been impacted by softness in end markets they serve, as well as productivity challenges.
T.O. Plastics’ revenues and net earnings decreased quarter-over-quarter. This is due to lower volumes in horticulture, industrial, and custom sales and changes in product mix. Our Plastics segment revenues decreased quarter-over-quarter primarily due to a 10.4% decline in the price per pound of PVC pipe sold. This was caused by lower quarter-over-quarter resin prices.
Despite lower cost of goods sold and lower operating expenses, net earnings decreased $1.2 million between the quarters due to margin compression that occurred with a large drop in pipe selling prices. Historically, when resin prices are rising or stable, margins and sales volumes have been higher, and when resin prices are falling, sales volumes and margins have been lower.
Our corporate expenses net of tax decreased to $900,000 due to lower insurance costs at our captive insurance company, as well as lower legal fees, as well as an increase in the cash value of corporate-owned life insurance policies.
We had third quarter financing activities that I would like to share with you. We raised $16.1 million by issuing 467,000 common shares under our at the market program offering and we also entered into an $80 million 3.55% delay draw note purchase agreement. These notes are expected to be issued on December 13, 2016 and will be used in part to pay down the $52 million 9% notes that are due on December 15, 2016.
Now, moving on to our updated business outlook, we are reaffirming our consolidated earnings per share guidance of $1.50 per share to $1.65 per share as shown on slide 15. We now expect 2016 Electric segment net income to be comparable to 2015 net income, due to normalized whether for the remainder of the year.
Mild weather has had a negative impact on year-to-date earnings per share of approximately $0.05 compared to projected earnings under normal temperatures and $0.04 compared to the nine months ended September 30, 2015. It is important to keep in mind that Otter Tail Power is a winter peaking utility in a summer peaking pool.
Constructive outcome of the rate case we filed in Minnesota in February 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 file rates similar to interim rates and reasonable rates of return depends on regulatory action under applicable statute and regulation.
Interim rate revenue of $6.9 million has been reduced for an estimated refund of $2.3 million, as previously mentioned. This is based on modifications to our original request and other expected outcomes. This has negatively impacted year-to-date results by $0.04 per share and the expected negative impact for the year is $0.06.
Other key factors impacting 2016 results compared with 2015 are, rider recovery increases, an increase in forecasted sales to pipeline and commercial customers, offset by the effect of the 2015 adoption of bonus depreciation for income tax, reducing projected earnings by $0.06 a share, higher depreciation and property tax expense due to large CapEx projects being put into service, higher operating and maintenance expenses and higher post-retirement medical costs than initially expected for 2016.
We are increasing the expected earnings per share range for the Manufacturing segment by $0.02 on each end of the range. This is based on positive year-to-date performance and continued focus on improved productivity and cost reductions to address challenges with softening end markets at BTD.
Despite these softening end markets, we expect 2016 net income to increase over 2015 by $3 million. This is due to improved margins on product mix in the second quarter and improved productivity from lower expediting costs, cost of quality and maintenance expenses in our Minnesota and Illinois plants, offset in part by continued challenges of on-time deliveries, low productivity and end market softness at BTD Georgia, higher facility costs from BTD’s expansion project in Minnesota and lower earnings at T.O. Plastics due to lower margins from a shift in their product mix.
Our backlog for the Manufacturing segment is $42 million for the remainder of the year. This compares with $45 million for the same time a year ago. We are maintaining our earnings per share guidance range for the Plastics segment and we expect lower corporate costs than originally estimated for 2016 due to continued cost reduction efforts.
The first nine months of the year reflect the efforts of focusing on our key initiatives. We continue to see the earnings growth we expect from our rate base investments in our Electric segment and while continued softness in end markets served by our manufacturing companies has negatively impacted 2016 revenues, net earnings are benefiting improved productivity and cost reductions and strategic investments made by BTD over the last two years positions them well for a rebound when market conditions improve. While the Plastics segment continues to face challenges from compressed margins, this segment continues to provide strong earnings, cash flows and returns on invested capital.
Key initiatives we remain focused on for the year are, constructive outcome of our Minnesota rate case, successful growth in sales in BTD from its new paint line along with continued focus on operational improvements needed to enhance our return on sales, as well as full integration of BTD Georgia to better serve our customers in the Southeast, and lower costs and improved overall performance across all of our companies.
We remain confident in the future earnings ability of our two platforms, opportunities to invest in utility rate base and organic growth in our Manufacturing platform positions us well to meet our long-term goal of 4% to 7% compounded growth rate in earnings per share, using 2015’s $1.56 a share from continuing operations.
We are now ready to take your comments and after the Q&A, Chuck will return with a few closing remarks.
[Operator Instructions] And our first question comes from the line of Paul Ridzon from KeyBanc. Your line is now open.
You indicated that horticultural should have an up fourth quarter?
And what is driving that?
Well, typically, Paul, this is Kevin and thanks for the question. We -- the fourth quarter for hort typically is the strong quarter for that business as customers look to get their pre-season orders out in advance of the upcoming season sales for the following year. And so there were a number of trade shows that occurred later in the third quarter this year that we were at and based on the traditional seasonality of when hort orders come in we expect that they should be stronger in the fourth quarter.
Okay. The weakness in the PVC pipe, is that leading over into the fourth quarter from what you can see?
Yeah. We would expect that these compressed margins would continue on into the fourth quarter as well.
Is it stabilizing, is it continuing to decline or do you have a read on that?
Yes, Paul, we would, I think it’s, there’s probably more downside pressure to sales prices, but we -- as we looked at the third quarter and where sales prices were compared to a year ago, and as they head into the fourth quarter they look to be holding flat or stabilized. But I would tell you that just with a declining resin market there certainly could be more downside pressure on them. But we attempted to kind of address that and bake that into the risks as we finish the year as we look into our guidance as well.
And then at the Electric segment, what -- how the weather in the fourth quarter of 2015, as I recall it was mild.
I believe that’s, the, we had a pretty mild winter overall in 2015 and into the first quarter of 2016.
In the fourth quarter you should continue to collect income rates, offset by -- offset partially by refund, is that the way -- right way to look at it?
Okay. Thank you very much for your answers.
Thanks for the questions, Paul.
[Operator Instructions] And our next question comes from the line Stephanie Tsao from S&P Global. Your line is now open.
Hi. Good morning.
I had some questions just on your comments on wind and solar. You mentioned that the Chamber of Commerce actually requested more wind capacity. Could you just go into a little bit more color on that? And then you mentioned that a solar cost, which you do expect to drop further, can you just talk about how low do you or what range do you expect solar costs to be?
Okay. Thanks for the questions, Stephanie. The first, it is not the Chamber of Commerce, it was the Minnesota Department of Commerce who acts as the consumer advocate and to a certain degree the analytical arm of the Minnesota Public Utilities Commission.
So the -- and they indicate, they run the same capacity planning models that we run and they anticipate -- their system selected an additional amount of wind over what we believe in our or put in our resource plan, indicating they anticipate lower cost energy from wind in the out years, beyond the five-year plan and so they recommended that we included an additional 200 megawatts in the time frame after the initial five years starting in 2023.
And on the solar question, we don’t expect them to come -- the cost come down as rapidly as they have in the past. But we do believe that they will come on parity, possibly in the 2020 timeframe with other resources, particularly wind, if there is not a PTC renewal for wind.
I am seeing no further questions in the queue at this time. I would like to turn the call back over to Mr. Chuck MacFarlane.
Well, thank you. To summarize, the Manufacturing segment earnings were in line with expectations, given continued market softness in the agriculture, oil and gas, and recreational vehicle end markets. And we believe BTD is in a good position to enhance earnings when market conditions improve.
Pipe sales volumes remain strong and the utility remains solid, and is working through its growth plan. It continues to focus on transmission build out, a constructive outcome for the Minnesota rate case and the opportunity to build wind, solar and natural gas generation as outlined in our 2016 resource plan. We reaffirm our 2016 earnings guidance of $1.50 per share to $1.65 per share. Thank you for joining our call and for your interest in Otter Tail Corporation and we look forward to speaking with you next quarter.
Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program. You may now disconnect. Everyone have a great day