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Otter Tail Corp (NASDAQ:OTTR)
Q2 2019 Earnings Call
Aug 6, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to Otter Tail Corporation's Second Quarter 2019 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 the opening comments.

Loren Hanson -- Assistant Secretary

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 2019 earnings results. 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 judgement 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 S. MacFarlane -- President and Chief Executive Officer

Thank you, Loren. Good morning, everyone. Last night, we released our second quarter results, please refer to slide 5 as I begin my comments. Operating revenues increased slightly quarter-over-quarter, while net income and earnings per share decreased compared to second quarter 2018. Our financial performance is in line with our expectations and we are reaffirming our 2019 guidance range of $2.10 to $2.25.

Our Electric segment quarter-over-quarter earnings decreased mainly due to the planned outage at Coyote Station, unexpected turbine repairs at our Hoot Lake Plant and milder weather. As anticipated, our Plastics segment's second quarter results were lower than 2018, due to lower sales prices on slightly higher volumes. We expect our financial performance for the second half of 2019 to remain in line with our forecast.

Recall, the last half of 2018, included a planned outage at Big Stone Plant, costs associated with the establishment of foundations at Otter Tail Corporation and Otter Tail Power, and the increased expense related to certain tax matters. We don't expect these costs to reoccur in the second half of 2019.

Let's take a closer look at Otter Tail Power. Investments on slide 11, including the Merricourt Wind Energy Center and Astoria Station, along with our Dakota Transmission Reliability project will produce an annual rate base growth of 8.6% between 2018 and 2023, in a constructive regulatory environment. I'll touch briefly on a few of these projects.

On slide 14, you'll see that July 16th marked a significant milestone for the Merricourt Wind Energy Center, when Otter Tail Power closed on the purchase of development assets and issued a notice to proceed for construction. The project has received Minnesota Renewable Resource Rider and North Dakota Advance Determination of Prudence approvals. We estimate the project will cost approximately $270 million, and will generate enough energy to power more than 65,000 homes. This is the largest capital project in Otter Tail Power history.

Construction of Astoria Station began in May. Astoria will be a highly efficient 245-megawatt natural gas combustion turbine. It will complement our wind generation by providing a reliable backstop when the wind isn't blowing, and it will have flexible operating options and low CO2 emissions. We will invest $158 million in the project, which during the peak of its construction period, will create approximately 70 construction jobs. It is eligible for cost recovery in North Dakota and South Dakota during construction. We expect the Astoria Station to be online in 2021.

We have the opportunity to add $30 million to $55 million of rate base associated with new generator interconnection upgrades as proposed by the MISO Generator Interconnection process. Self-fund is an election by the MISO transmission owner, in this case, Otter Tail Power, to fund the network upgrades associated with new generator interconnections. If approved, Otter Tail will fund and earn a return on and return of the capital costs of the network upgrades over a 20-year period from these interconnection customers.

MISO submitted its tariff modifications to provide the self-fund option to FERC last year, after the D.C. Circuit Court of Appeals had vacated prior FERC orders, which had denied transmission owners the right to self-fund certain interconnection network upgrades. We anticipate this will create additional investment opportunity from generator interconnection projects over the long term.

In May, the South Dakota Public Utilities Commission approved a return on equity of 8.75% and a revenue increase of approximately $2.6 million or about 7.7%. Interim rates have begin -- been in place since October of 2018. Because final rates, which began in August, are less than interim rates, customers will receive a refund in October.

Now turning to our Manufacturing segment. BTD, our contract metal fabricator, improved return on sales on a consolidated basis, and again improved financial results at the Georgia facility where we added stamping capability in Q2. This was done to improve logistics and better serve existing and new customers in the Southeast. Quote volumes remain steady and operations continue to balance production output and costs to build the right level of inventory to ensure on-time delivery remains strong. BTD employee accounts are mainly static for 2019, after a 15% increase in 2018.

T.O Plastics earnings remained essentially unchanged between the quarters. In anticipation of the horticulture Q4, Q1 primary buying season, T.O. Plastics is strategically building product inventory. In Q2, we experienced growth in the plug tray sales to certain horticulture markets, and we expect we will increase production capacity in Q4 to serve those markets. We continue to improved factory output, despite tight labor markets at the Otsego and Clearwater facilities.

In our Plastics segment, Northern Pipe Products and Vinyltech had lower quarter-over-quarter results primarily due to lower sales price on slightly higher volumes. We continue to monitor resin costs and evaluate potential volatility throughout the remainder of the year. Hurricane Barry did not interrupt any of our resin supply. Both companies are implementing continuous improvement projects to enhance efficiency and capacity, and they continue to improve in the markets they serve by demonstrating responsiveness to customer needs.

On a final note, we continue to enhance our balanced generation mix. As shown on slide 6, we anticipate that by 2022, Otter Tail Power customers will receive 30% of their energy from renewable resources and our carbon emissions will be at least 30% below 2005 levels, all while keeping rates nearly 30% below the national average. Merricourt and Astoria, which I discussed earlier, are catalysts in these 30% trajectories.

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

Kevin G. Moug -- Chief Financial Officer and Senior Vice President

Thanks, Chuck and good morning. Consolidated earnings per share for the quarter were in line with our expectations, despite the extended planned outage at Coyote Station, the unplanned outage at Hoot Lake Plant and milder weather compared with the second quarter last year. Our Manufacturing segment had another solid quarter with net earnings up 11%. In our Plastics segment, earnings were in line with expectations. Please refer to slide 22 and 23, as I discuss our second quarter results.

Electric segment net earnings decreased $3 million quarter-over-quarter. The key items causing this decline were higher O&M expenses, primarily related to the $2.6 million increase in maintenance and material costs associated with the extended outage at our Coyote Station and an unplanned outage at our Hoot Lake Plant related to turbine repairs; lower revenues related to milder weather quarter-over-quarter. Weather negatively impacted earnings by $0.03 a share compared to the second quarter of 2018 and compared to normal, weather had a positive impact of a $0.01 a share.

Other items affecting the quarter are increased retail revenues in Minnesota, due to a reduction in expected refunds associated with the Tax Cut and Jobs Act. The effect of lower tax expense recovery requirement was rolled into base rates starting in June of '19.

Interim rates, net of estimated refunds associated with our South Dakota rate case, they went into effect in October of 2018, increased renewable resource, transmission and conservation improvement cost recovery revenues in Minnesota and increased revenues due to the establishment of a generation cost recovery rider in North Dakota related to the Astoria Station, while under construction. These items were offset in part by increased property and depreciation expense and income tax expense increased, despite lower pre-tax earnings due to the decrease in federal Production Tax Credits, which expired in November of 2018.

Net earnings for the Manufacturing segment increased $407,000 or 11%. At BTD, net revenues increased $3.9 million. This was driven by a $4.5 million increase in product sales to agricultural, construction and recreational vehicle end markets. $4.2 million of this increase relates to higher material costs passed through to customers with the balance due to increase value-add sales.

BTD's scrap metal revenues decreased $600,000 primarily due to lower scrap metal prices, and the overall increase in revenues at BTD were offset in part by higher cost of goods sold and higher operating and income tax expenses resulting in a $400,000 increase in earnings.

T.O. Plastics earnings were basically unchanged. Increased revenues related to increased horticultural sales, driven by an early order program offered to customers during the second quarter, the catch up on shipments that were delayed due to inclement weather during the first quarter of the year, and growth of plug tray sales associated with certain horticulture end markets. This was partially offset by lower sales of industrial products. And also impacting earnings were increased cost of goods sold and higher operating expenses.

Our Plastics segment earnings decreased $437,000 due to a 3.6% decrease in pipe prices, offset in part by a 2% increase in pounds of pipes sold. Although we anticipate lower overall sales volumes in 2019 compared to 2018, quarter-over-quarter, sales volumes were higher due to a stronger demand in the South Central and South Western regions of the United States, offset by lower sales volumes to certain customers in the Northern region of our sales territory.

Cost of goods sold decreased, despite the increased sales volumes, due to a 2% decrease in cost per pound sold. The impact of the lower pipe sales prices exceeded the decrease in the cost per pound sold, resulting in a 9% decrease in gross margins.

Our Corporate pre-tax expense and net of tax losses increased primarily due to increased employee benefit expense.

Slide 25 reflects an updated 2019 to 2023 capital expenditure plan from $1.07 billion to $1.1 billion based on the need for additional wind and other technology and transmission investments. We now expect capital expenditures to be $233 million for 2019, which includes $79 million for Merricourt and $46 million for Astoria. With this revision, our compounded annual growth rate in rate base is now projected to be 8.6% over the 2018 through 2023 timeframe. These investments will continue to positively impact the Corporation's earnings and returns on capital.

Moving to our business outlook on slide 26. We are reaffirming our 2019 consolidated earnings per share guidance of $2.10 to $2.25 , which equates to a return on equity of 11.5% to 12.3%, based on an estimated equity to total cap ratio of 54%. We expect a strong second half of 2019, driven in large part by increased earnings in our Electric segment. This is a result of the expected increase in revenues from South Dakota final rates being in place for the entire six months of 2019 compared with two-and-a-half months of 2018, increased earnings from our planned capital projects, including our Merricourt and Astoria Station projects.

Astoria Station started construction in May and Merricourt will begin construction in August. Additional transmission investments related to our South Dakota Transmission Reliability project and decreased O&M expenses due to a decrease in pension, medical, workers' compensation and retiree medical benefits. Our discount rate for the pension plan increased in 2019 to 4.5% from 3.9%, driven by higher interest rates.

Also, we incurred $0.07 a share of costs in the last half of 2018 related to the planned Big Stone Plant outage in Q3 and Q4 and the contribution to Otter Tail Power's foundation that are not expected to occur in the last half of 2019.

We expect increased earnings from our Manufacturing segment in 2019, primarily driven by increased sales at BTD. However, we have lowered both ends of the 2019 guidance range due to an expected decrease in scrap metal revenue in the remainder -- for the remainder of the year, resulting from lower scrap metal prices. And as noted last quarter, we expect lower earnings at T.O. Plastics mainly due to first quarter volume softness and the expected impact on business operations from the partial collapse and replacement of the warehouse roof, which was damaged in March during a winter storm. The backlog for this segment is approximately $115 million for 2019 compared with $107 million a year ago.

We expect Plastics' 2019 net income to be lower than 2018 due to lower operating margins resulting from increased resin prices on lower sales volumes and slightly lower sales prices compared to last year. We have increased both ends of the 2019 guidance range for this segment. As expected price increases for resin have moderated.

In Corporate costs, net of tax, are expected to be lower in 2019. This is due in large part to an $0.08 share of expenses incurred in the fourth quarter of 2019 related to a contribution to establish the Otter Tail Corporation foundation and accruals related to certain tax matters. These costs are not expected to occur in the last half of 2019, and are highlighted on page 27 of the earnings call presentation.

Our second quarter earnings per share results are in line with our expectations, and we are well positioned to achieve our 2019 earnings guidance as we enter the second half of the year. As noted earlier, Astoria started construction in May and Merricourt will start construction in August. Otter Tail Power Company continues to execute on major construction projects safely on-time and within budget. We remained well positioned to grow our rate base in support of regulatory environments at 8.6% compounded annual growth rate over the next five years. Over time, the electric utility will provide approximately 75% of our overall earnings.

The Manufacturing and Plastics segments continue to provide organic growth through new products and services, market expansion, and increased efficiencies. The Manufacturing and Plastics segments are expected to provide around 25% of our earnings over time. We expect to be able to deliver total shareholder return of 8% to 10%. Our earnings per share are expected to increase at a 5% to 7% growth rate of 2018 results and our dividend yield is approximately 3%.

Looking forward, we would expect to grow the dividend in line with our earnings-per-share growth rate, while maintaining a dividend payout ratio of 60% to 70%. And our Company is on solid footings with strong balance sheet and corporate credit ratings.

We are now ready to take your questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from Tate Sullivan of Maxim Group. Your line is open.

Tate Sullivan -- Maxim Group -- Analyst

Hi, thank you. Thank you. Good morning and thank you for those comments. Real quickly, I have a couple of follow-ups on utility. Could -- Kevin, I'm sorry, if you went over a little earlier, the higher capex guidance for materials, what causes the estimate revision in that and I assume it's all rate based?

Kevin G. Moug -- Chief Financial Officer and Senior Vice President

Yeah, thanks for the question, Tate. The revision in the capex is additional wind related. We have an option to purchase the Ashtabula wind farm that is now included in our 2022 timeframe of capex. That's been moved forward from 2023. And then also, there is additional technology kind of related investments that we are looking at, that have been included in the up -- revised capex as well.

Tate Sullivan -- Maxim Group -- Analyst

Okay. Thank you. And then Manufacturing, Chuck, did I hear you earlier say that you added employees in 2Q or did I hear later that it was a stable headcount in the Atlanta region facility in BTD?

Charles S. MacFarlane -- President and Chief Executive Officer

Yeah, Tate. In BTD, the reference was to BTD. And in 2018, we increased employee levels about 15% and that varies by location. But it was primarily the Georgia and one of the Minnesota locations. And the comment was that in '19, we are at sort of static employee levels. We have not increased or decreased employee levels through the first half of 2019.

Tate Sullivan -- Maxim Group -- Analyst

Okay. And then I don't think I missed it early. I saw your comments and heard about the lower scrap prices in BTD. What are the drivers behind that in general?

Kevin G. Moug -- Chief Financial Officer and Senior Vice President

Yeah, I mean there has been lower steel pricing in the market, Tate.

Tate Sullivan -- Maxim Group -- Analyst

Okay.

Kevin G. Moug -- Chief Financial Officer and Senior Vice President

And so, then as a result, as those lower steel prices have come down and scrap metal prices have come down as well.

Tate Sullivan -- Maxim Group -- Analyst

And is that dynamic still in place for this current quarter to --?

Kevin G. Moug -- Chief Financial Officer and Senior Vice President

The dynamic -- we expect the dynamic to be in place for the rest of the year like we said in our comments.

Tate Sullivan -- Maxim Group -- Analyst

Okay.

Kevin G. Moug -- Chief Financial Officer and Senior Vice President

It was in place in the second quarter and we continue to expect -- and our guidance, our forecast reflect those lower scrap prices through the rest of the year.

Tate Sullivan -- Maxim Group -- Analyst

Okay, thank you. And last for me, on Plastics and the pricing versus the volumes, and I understand. Is it consistent to how it -- how has it worked in the last couple of years? Was it a delayed factor in lower resin prices on the pricing side for the PVC, please?

Kevin G. Moug -- Chief Financial Officer and Senior Vice President

Sorry, maybe just to clarify, are you referring to sales prices, resin prices, or both?

Tate Sullivan -- Maxim Group -- Analyst

Sales prices, excuse me. Yeah. What drove the lower sales prices or [Speech Overlap].

Kevin G. Moug -- Chief Financial Officer and Senior Vice President

I think that -- there -- 2018 was our record year for us in terms of earnings and sales prices and operating margins. And as we headed into 2019, Tate, we -- based on where we expected resin prices to move up and we were seeing some softening in sales prices, we just didn't expect that the sales price levels in '18 could hold through all of '19 and that's -- you've seen a softening in sales prices in the first six months of the year and they are slightly lower throughout '19 compared to '18.

On the resin price, we -- as we headed into the year, we expected that there were going to be increased resin prices coming from our suppliers. And while we've seen some increases, we now think that there is going to be moderation in those increases the rest of the year. And so as a result, that uplift in the guidance from the first quarter and the second quarter is being driven by that moderation and expected resin price increases.

Tate Sullivan -- Maxim Group -- Analyst

Okay. Thank you for that, and have a good rest of the day.

Kevin G. Moug -- Chief Financial Officer and Senior Vice President

Thanks, Tate.

Charles S. MacFarlane -- President and Chief Executive Officer

Thanks, Tate.

Operator

Thank you. And our next question comes from Chris Ellinghaus of Williams Capital. Your line is open.

Christopher R. Ellinghaus -- The Williams Capital Group, L.P -- Analyst

Hey guys, Good afternoon.

Kevin G. Moug -- Chief Financial Officer and Senior Vice President

Hi, Chris.

Christopher R. Ellinghaus -- The Williams Capital Group, L.P -- Analyst

Kevin, I appreciate slide 27, but it kind of ruined half of my question. The...

Kevin G. Moug -- Chief Financial Officer and Senior Vice President

I don't think you did [Phonetic], Chris.

Christopher R. Ellinghaus -- The Williams Capital Group, L.P -- Analyst

I knew you were. How do we think about the foundation and win, and sort of future contribution timing?

Kevin G. Moug -- Chief Financial Officer and Senior Vice President

Yeah, we had a -- it was a $2 million contribution to the parent company foundation last year to -- and to get it on good footing and establish it on a go-forward basis. We -- every year, we -- in our budget plans, we anticipate that we would contribute to the foundation, and as we go throughout the year, we look at where we're at in terms of the foundation and how it's proceeding with its activities and its needs. And -- so we will evaluate that on an annual basis this year. We think we're in good shape with the $2 million contribution that we've made to it and don't see a need to put any additional funds into it this year.

Christopher R. Ellinghaus -- The Williams Capital Group, L.P -- Analyst

Okay, great. Chuck, you were talking about the interconnection opportunity. Can you just make or clarify, is there -- is that money in the capex now, and is it completely in the capex?

Charles S. MacFarlane -- President and Chief Executive Officer

It would be in the $1.1 billion estimate. The range I gave of the 30% to 55% is in there. There could be future. Each time a interconnection customer, which is generally not Otter Tail Power, it's somebody else hooking up a wind farm that interconnects or has network upgrade implications to our system, adds that. So as renewables grow in our region, we anticipate there could more in future years, but we have not included anything other than known projects in the $37 million estimate that's on page 12 over the deck.

Christopher R. Ellinghaus -- The Williams Capital Group, L.P -- Analyst

Okay. So that's your best current guess?

Charles S. MacFarlane -- President and Chief Executive Officer

Correct. But we anticipate there'll be more to show, but we don't -- some of these customers haven't even made interconnection request that could show up within the 2023 -- 2018 to 2023 timeframe. But we haven't included anything on projects where we aren't aware of it, I guess.

Christopher R. Ellinghaus -- The Williams Capital Group, L.P -- Analyst

Okay. PVC, the Plastics segment, your guidance is still suggesting that you would be at a level that's consistent with or slightly higher than 2017. That was -- it got the hurricane benefit. Is this sort of your thought process, is 2019 sort of the new normal for the Plastics segment? If this will be, maybe the second best year ever, down from the spike in 2018, but is this the new normal?

Kevin G. Moug -- Chief Financial Officer and Senior Vice President

Chris, this is Kevin. I think we're still not expecting that, call it, the $20 million range. It might be, I'd say, the high end of the new normal. I think we still -- as we look and see the dynamics in the industry, a range of normal I would say is -- I'm going to say in that $16 million to $20 million range.

Christopher R. Ellinghaus -- The Williams Capital Group, L.P -- Analyst

Okay. The Hoot Lake outage. Can you give us a number for what that cost?

Kevin G. Moug -- Chief Financial Officer and Senior Vice President

It was a $0.01 a share. So roughly above a little -- not little over $300,000.

Christopher R. Ellinghaus -- The Williams Capital Group, L.P -- Analyst

And lastly, with the Merricourt scheduled to start construction this month, would -- have you got any update or change in thought process on when you think it will be complete?

Charles S. MacFarlane -- President and Chief Executive Officer

No real change. We continue to believe it will be in, in the late third or fourth quarter of '20. It's a fully 100% PTC Safe Harbored project. So it has to be in and operational before the end of 2020.

Christopher R. Ellinghaus -- The Williams Capital Group, L.P -- Analyst

Great. Okay, great. Thanks for the details, guys.

Kevin G. Moug -- Chief Financial Officer and Senior Vice President

Thanks, Chris.

Operator

Thank you. [Operator Instructions] And at this time, I'm showing no other callers in the queue for questions. I'd like to turn the call back over to Mr. MacFarlane for closing remarks.

Charles S. MacFarlane -- President and Chief Executive Officer

Thank you. Our financial performance continues to demonstrate the value, employee actions to grow our business, achieve operational and commercial excellence, and develop talent. We are excited to have Astoria and Merricourt projects moving to construction, and we are reaffirming our 2019 earnings per share guidance range of $2.10 to $2.25.

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

Operator

[Operator Closing Remarks]

Duration: 32 minutes

Call participants:

Loren Hanson -- Assistant Secretary

Charles S. MacFarlane -- President and Chief Executive Officer

Kevin G. Moug -- Chief Financial Officer and Senior Vice President

Tate Sullivan -- Maxim Group -- Analyst

Christopher R. Ellinghaus -- The Williams Capital Group, L.P -- Analyst

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