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Operator
Good morning and welcome to Otter Tail Corporation's Q3 2021 earnings conference call. Today's call is being recorded and we will hold the question and answer session after the prepared remarks. I will now turn the call over to the company for their opening comments.
spk03
Good morning everyone and welcome to our call. My name is Tyler Ackerman and I manage Otter Tail's investor relations area. Last night we announced our third quarter 2021 earnings results. Our complete earnings release and slides accompanying this call are available on our website at ottertail.com. A recording of the call will be available on our website later today. With me on the call today are Chuck McFarland, Otter Tail Corporation's President and CEO, and Kevin Moog, Otter Tail Corporation's Senior Vice President and Chief Financial Officer. Before I 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. 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 turn the call over to Otter Tail Corporation's President and CEO, Mr. Chuck McFarland.
Tyler Ackerman
Thank you, Tyler. Good morning, everyone. Welcome to our third quarter 2021 earnings call. Otter Tail Corporation continues to support all the locations we serve with collective efforts to mitigate the spread of COVID-19. Most of our employees have returned to the office from working remotely. As of today, 5% of our employees continue to work remotely. We continue to monitor case activity along with vaccination rates in the communities we operate. We also continue to monitor and follow guidance and recommendations from the CDC, our states, local public health officials, and OSHA. Additionally, we are making plans to meet the executive order guidance for federal contractors or OSHA ETS requirements for all of our operating companies related to COVID vaccination or testing requirements. Throughout the course of the past year and a half, Our companies have done an excellent job managing COVID-related impacts, including creating safe work environments, adjustments to staffing levels, navigating supply chain constraints, managing commodity pricing, and supporting increased customer demand. Please refer to slide four as I begin my comments on Q3 results. Autotel Corporation achieved outstanding financial results during the third quarter of 2021. We earned $1.26 per share for the quarter, which was a 145% increase over the 87 cents per share earned in Q3 of 2020. The increase was led by our plastic segment, which had another record quarter driven by continued strong PVC pipe demand and PVC resin supply constraints, which were exacerbated in the third quarter due to impacts from Hurricane Ida. Kevin will provide more detailed discussion of our financial performance in his comments, but a brief overview of Q3 is as follows. Electric segment quarter-over-quarter earnings were down with earnings per share decreasing six cents. This was primarily driven by increased costs arising from this year's planned major maintenance at Big Stone Plant and a Q3 2020 positive earnings impact from a MISO MVP order. Our manufacturing segment earnings per share increased two cents due to increased sales volumes at BTD and TO Plastics and scrap metal revenues at BTD. Our plastic segment had a record-breaking quarter with earnings per share increasing 43 cents. This was driven by higher PVC pipe prices and improved operating margins resulting from positive unique market conditions. These increased results started with the unusual and infrequent impact resulting from the extreme cold weather in February that caused resin suppliers to temporarily close petrochemical plants in the Gulf Coast region. We expect these supply and demand conditions to persist for the remainder of 2021 and continuing in the first half of 2022. Based on our strong year-to-date performance, especially in our plastic segment, In our updated view for the remainder of the year, we are increasing our 2021 diluted earnings per share guidance to be in the range of $4.05 to $4.20 from our previously announced guidance of $3.50 to $3.65. This is a 73% to 79% increase over last year's $2.34 per share. Turning to some highlights for the quarter, Otter Tail Power filed its integrated resource plan in September. The requests in the five-year action plan include the addition of dual fuel capability to our storage station natural gas plant, the addition of 150 megawatts of solar generation in the 2025 timeframe, and the commencement of the process to withdraw from our 35% ownership in Coyote Station by year-end 2028. After incorporating the requests from the integrated resource plan, we now anticipate capital expenditures in our electric segment of nearly $1 billion over the next five years, which will result in a compound annual growth rate and rate base of 7.2% from the end of 2020 to the end of 2026. We continue to make progress on the development of Otter Tail Power's 49-megawatt Boot Lake solar project which will be constructed on and near the retired Hoot Lake plant property. The project is expected to be completed in 2023 and has received renewable rider eligibility approval in Minnesota, allocating 100% of the costs and benefits of the project to Minnesota customers. The location of Hoot Lake Solar offers us a unique opportunity to utilize our existing Hoot Lake transmission rights, substation, and land. We continue to work through supply chain challenges, including inflationary costs and potential increased solar tariff issues associated with the project. Our investments in Hoot Lake Solar, those identified in our integrated resource plan, and other capital expenditures will allow us to improve our customers' experience, reduce operating and maintenance expenses, reduce emissions, and improve reliability and safety. As shown on slide 8, we are targeting to reduce carbon emissions from our own generation resources approximately 50% from 2005 levels by 2025 and 97% by 2050. Otter Tail Power announced in the third quarter the addition of a new load with a business focused on the delivery of high-performance crypto mining and infrastructure solutions to customers which engage in direct mining of Ethereum, Bitcoin, and other crypto assets. Demand from the customer's facilities could approach 100 megawatts with a high load factor and the ability to be curtailed. The North Dakota PSC has approved our electric service agreement with this customer, and we expect this load to be fully online by the end of the first quarter of 2022. Given the increases we've seen in natural gas prices, we are planning to update our 2022 Minnesota fuel clause adjustment forecast. We submitted our original forecast for 2022 in April of this year. The Minnesota PUC has yet to approve the forecast that will go into effect on January 1st, 2022. As a result, we have an opportunity to provide an updated forecast and will seek to have the revised forecast approved. Fuel cost recovery in North Dakota and South Dakota are based on actual costs incurred. The favorable regulatory environments we operate in provide opportunities to mitigate risks in fuel price changes. We filed our Minnesota general rate case on November 2, 2020, As shown on slide 14. Our last Minnesota rate review was filed in 2026. Excuse me 2016. The primary driver for this request is to place Astoria Station. Into our base rates in Minnesota. In September of 2021, the administrative law judge provided recommendations on our Minnesota rate case. The recommendations include a revenue decoupling mechanism for residential, and commercial customers, a return on equity of 9.48% on a 52.5% equity layer, and full recovery of the recently completed Maricourt Wind and Astoria natural gas generation projects in base rates. Based on the ALJ recommendations, we are anticipating final rates will reflect only a moderate increase over our current rates. This is due to operating expense reductions achieved during the rate case period and other regulatory proceedings approved following our original filing in November of 2020. Recognizing the economic impact to customers of the ongoing pandemic and with input from Commission staff, we agreed to reduce our interim rate request by approximately half to $6.9 million, or 3.2%. This was done in conjunction with approval of our annual depreciation filing, which extended our wind asset lives from 25 to 35 years. This change in depreciation expense and reduction in pension expense drove the decrease in the interim rate request. In December, the Commission approved our interim rate request beginning in January of 2021. In late April, we filed a substantial reduction to our original request, Incorporating the lower depreciation rates approved by the Commission, lower borrowing rates, lower pension and benefit costs, and other refinements identified during the discovery phase of the case, the new request was for $8.2 million, or a 3.8% increase, versus the original request of $14.5 million, or 6.8%. As reflected on slide 15, the ALJ is recommending an approximate $0.5 million overall increase. The Minnesota Public Utilities Commission will have deliberations in early November with a written order projected to be issued by the end of January 2022. We expect final rates to be implemented by mid-2022. At the conclusion of this case, Otter Tail Power residential customers will continue to have some of the lowest rates in the country. Turning to our manufacturing segment, BTD, our contract metal fabricator, continues to be challenged by labor and recruitment costs as we focus on hiring to meet customer demand. We have made progress on hiring new employees during the quarter after increasing starting wages, off-ship premiums, and offering sign-on incentives. BTD is at its highest employee count level of all time. We are focusing on getting these new employees to full productivity. Steel prices remain at historically high levels, but lead times have started to improve. We remain focused on managing our steel supplies to ensure we continue to receive material on time. Also, BTD continues to experience increased customer demand driven by OEMs' improved sales and the desire to rebuild depleted inventories. Teoplastics had a solid performance driven by strong horticulture and market sales. Our plastic segment continues to deliver extraordinary results in a tight pipe market, which experienced further resin supply constraints in the third quarter due to disruptions caused by Hurricane Ida. Resin shortages and low PVC pipe inventories negatively impacted our volume of pipe sold in the quarter. However, demand for PVC pipe remains strong and sales prices continue to increase because of these conditions, resulting in record third quarter earnings. Again, I would like to thank employees within Otter Tail for their commitment and dedication and for navigating the economic swings and safety concerns presented with COVID. Now I'll turn it over to Kevin for the financial perspective.
Tyler
Well, thank you, Chuck, and good morning, everyone. The third quarter revenues were up 34% and net earnings increased 47%. These results continue to be driven by the unique market conditions we've been experiencing in our plastic segment during the second and third quarters of 2021. Let me provide a detailed review of the quarter results as shown on slides 26 and 27. The electric segment net earnings decreased $2.2 million quarter over quarter, driven by a $3.2 million decrease in net retail revenues due primarily to a $2.6 million of Minnesota transmission rider revenue recognized in the third quarter of 2020. This resulted from a favorable judicial decision regarding the state jurisdictional treatment of federally approved transmission projects. In addition to the decreased retail revenues, there were increased operating expenses related to the Maricourt Wind Farm and Astoria Station being commercially operational, and increased big stone plant planned outage maintenance expenses. Other items impacting earnings were higher depreciation and property tax expense due to recent capital additions, higher interest expense due to new long-term debt issuances in 2020, higher short-term borrowings in 2021, and a lower level of capitalized interest resulting from placing the Astoria Station in service in the first quarter. There was also a reduction in other income due to lower amounts of equity funds used during construction due to the completion of the Astoria Station. And income taxes were favorably impacted mainly due to production tax credits earned on Maricourt in 2021. Net earnings for the manufacturing segment increased $900,000. Segment revenues increased $30.1 million, primarily due to higher material costs at VTD as steel prices have increased significantly from the previous year. Steel prices increased as steel mill production has not matched customer demand. As mill capacity continues to recover from the shutdowns in 2020, that resulted from the COVID-19 pandemic. These material costs are passed through to customers. Higher scrap metal prices continued in the third quarter of 2021, which contributed to an increase in operating revenues. In addition to favorable scrap metal prices, a 4% increase in sales volumes also contributed to the increase in operating revenues. The increase in operating revenues at BTD were largely offset by lower gross profit margins. This was a result of increased labor related to time required for new employees to be trained. This in turn caused lower productivity levels during the quarter. Operating expenses also increased in the third quarter of 2021 due to incentive-based compensation and other costs necessary to support higher business volumes. Manufacturing segment operating revenues and net income also benefited from increased product pricing and higher levels of horticultural sales at TO Plastics, along with increased gross profit margins resulting from higher production volumes. The increase in net income for the plastic segment was driven by the sales price per pound of PVC pipe sold continuing to increase. It increased 103.6% in the third quarter of 2021 compared to the same quarter last year and exceeded the 91.7% increase in the cost of PVC resin and other input materials. The increases in sales prices was largely due to the combination of PVC resin supply constraints, which has led to limited PVC pipe inventory and strong demand for PVC pipe products. Resin supply in the third quarter of 2021 was negatively impacted by disruptions caused by Hurricane Ida in the Gulf Coast region. This compounded supply constraints that began in the first quarter of 2021. Pounds of pipes sold in the third quarter of 2021 decreased 13% from the same period last year as resin supply constraints limited our production. Our corporate costs, net of tax, were basically unchanged between the quarters. On September 30th, 2021, Otter Tail Corporation entered into a fourth amended and restated credit agreement, and Otter Tail Power Company entered into a third amended and restated credit agreement, amending and restating the previously existing credit agreements to extend the maturity date of each agreement to September 30th, 2026. The borrowing capacity and other significant terms of the agreements remain unchanged from our previous credit agreements. We continue to generate strong cash flows and have the appropriate levels of liquidity under our credit facilities to support our business operations. We expect operating cash flows in 2021 will be much stronger than originally anticipated, resulting from our plastic segment performance. These strong cash flows allows us to look at investment opportunities such as additional contributions to our pension plan to improve funded status and opportunities for additional capital investments to continue to grow organically in all three of our segments. Moving on to our business outlook, we are increasing our 2021 diluted earnings per share guidance range to $4.05 to $4.20 considering the third quarter results and forecasts for the remainder of 2021. The uplift in the guidance is again driven by the continued strong performance in our plastic segment. The midpoint of our revised 2021 earnings per share guidance of $4.13 reflects a 76% growth rate from the 2020 diluted earnings per share of $2.34. We are increasing our previous 2021 guidance for our plastic segment, as operating income margins during the first nine months have been higher than expected, driven by the unique market conditions resulting from PVC resin supply constraints that began in the first quarter. These unexpected conditions arose from the extreme cold weather in February, which caused resin suppliers to temporarily close various petrochemical plants. The market conditions created by this event continued into the second quarter. Supply constraints were further exacerbated in the third quarter due to the impacts from Hurricane Ida, which caused resident suppliers to again declare force majeure contract provisions. This further contributed to continuing increases in PVC pipe prices and operating income margins at levels not previously experienced. Pounds of pipes sold in 2021 are now expected to be slightly higher than 2020 by strong construction and municipal markets. Resin suppliers continue to enforce resin allocations to customers and increase prices for raw materials due to market conditions such as availability constraints related to feedstock supplies for resin. and a strong export market that has higher resin prices than the domestic market. We currently expect the supply constraints to continue for the remainder of 2021 and into 2022. We currently expect these conditions could moderate during the last half of 2022. We continue to maintain our manufacturing guidance from our August 2, 2021 earnings release. Steel lead times have improved somewhat during the third quarter and supply has become less of an issue. Despite these positive indicators, we remain focused on managing our steel supply to ensure we continue to receive material on time. Steel prices remain elevated above historic levels and are expected to continue into 2022. We continue to work on improving staffing levels to keep up with strong demand and to mitigate the impact of increasing expedited freight costs while maintaining or improving labor efficiencies. The backlog for the manufacturing companies is approximately $90 million for 2021 compared with $59 million one year ago. And we continue to maintain our electric segment guidance from our May 3rd, 2021 earnings release and continue to maintain our corporate cost center guidance from our August 2, 2021 earnings release. The management teams of our operating companies have done an excellent job of managing the business through challenging times, delivering impressive financial results. These results have positively positioned us from several perspectives. Increased earnings and cash flows over our original 2021 financial plan. results in stronger financial metrics such as equity to total capitalization ratio, returns on equity, and FFO to debt metrics. The increased cash flows allow for additional investment in organic growth opportunities across all of our segments and allows for improved funding of our pension plan. Our expected 2021 financial results show 42% of our consolidated earnings per share come from the electric segment. This is a departure from our 70% expected earnings from this segment. The 2021 results are clearly driven by the economic recovery in our non-electric businesses and most significantly by the unique market conditions in our plastic segment, which are not expected to continue over the long term. Our electric segment is expected to contribute 70% of our overall earnings over the long term. It will continue to deliver reliable performance along with rate-based investment opportunities over the next five years to allow for growing revenues, earnings, and cash flows. The manufacturing and plastic segments will also provide organic growth over the long term, and these two segments are expected to provide around 30% of our earnings over time. We expect to deliver total shareholder return of 8% to 10% over the long term consisting of our expected 5% to 7% compounded annual growth rate in earnings per share, using 2020 as the base year, along with our current dividend yield. Looking forward, we would expect to grow the dividend consistent with our long-term earnings per share growth rate of 5% to 7%. Our business model continues to service well. We remain positioned to fund our rate-based growth opportunities at the utility, with our strong balance sheet, ample liquidity to support our businesses, and our strong investment-grade corporate credit ratings. We're now ready to take questions.
Operator
Thank you. Ladies and gentlemen, if you have a question, please press star, then 1 on your touchstone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. After the question and answer, Chuck will return with a few closing remarks. Your first question comes from the line of Brian Russo from Siloti. Please proceed with your question.
Chuck
Hi, good morning.
Tyler Ackerman
Good morning, Brian.
Chuck
Hey, so first on the utility, what are the major regulatory milestones in regards to the IRP that... supports your increased and updated CapEx. Will you issue RFPs or just file for CPCNs?
Tyler Ackerman
Hi, Brian. This is Chuck. Well, first we'll go through a discovery process and answer questions. It's generally a contested case in Minnesota. And from that point, then, the plan will generally indicate a resource requirement with a cost. It doesn't generally specify the requirement to use a PPA or whatnot. We'll go out and get price estimates, both self-billed and a PPA estimate. and then we'll go from there, you know, selecting the least cost resource.
Chuck
Okay. Got it. And it seems like a lot of these investments are at existing sites. I suppose just like the HOOT solar project, you have some access to transmission and other related infrastructure. Sure.
Tyler Ackerman
We do. When we do our integrated resource plan, if you've looked into it, we do differentiate interconnection costs and types by a new regular MISO interconnection, a replacement, which is what we're doing at Hoot Lake, and then the ability at times you can add different resources. You can pair up an existing gas resource, for instance, with solar or wind.
Chuck
And given the strength in cash flows from the plastic cell performance, I know you had no plans to issue equity, you know, given the prior capital budget, but are you still able to finance it with debt and cash flow and no significant amount of equity through the 2026 period?
Tyler
Yeah, Brian, this is Kevin. We will be updating our financing plans here as a part of our coming out with the 2022 guidance in February. But we certainly would continue to expect that there should be kind of minimal amounts of equity that would have to be issued.
Chuck
Okay, got it. And then just to switch topics to the plastics. segment, the supply constraints and high prices and attractive margins are now forecast to continue into the first half of next year. Is it all because of Hurricane Ida and the temporary shutdowns of the petrochemical plants that have pushed this out? Or is there other market trends that that these margins may be not as high as they currently are recorded in the third quarter, but that there is a sustainable higher level of margins in the plastic segment.
Tyler
Brian, Kevin, again, I would agree with your comment that AIDA certainly has if you will, compounded, exacerbated the supply constraint issue. That certainly wasn't expected. The resin suppliers are continuing to struggle to get back to higher levels of production of the PVC resin. And that, as we said in our prepared remarks, is expected to continue into that first half of 2022. We currently... expect that those conditions could start to change in the last half of 2022. Certainly fluid and subject to updates as we continue to go through the year. But I think basically that's the conditions we're seeing today and we're expecting those based on today's conditions, we're expecting those to continue into that first part of 2022.
Chuck
And you mentioned resin supplier adjusting allocations due to the dynamics you just discussed. Are you facing allocation supply shortages as well, or given that you're only like 2% of the market, you know, you're able to get what you need to, you know, hit your targets?
Tyler
Brian, we're getting what we need to meet current demands, but we're not getting anything in addition to build existing inventory levels.
Tyler Ackerman
We are on allocation.
Tyler
So the allocations continue, but basically the resin that comes into the plant, converted to pipe, and it's moved right out on a truck to be sold. So we're not getting any extra resin, if you will, to be able to build our inventories back up to kind of what we typically have in the business.
Chuck
Got it. Understood. And then just real quickly on the manufacturing side, some of the large end market customers, you know, obviously are facing their own supply issues and raw material inflation. But are you sensing that this is And, I mean, are you meeting their demand or, you know, is their demand exceeding what's actually available in the marketplace right now?
Tyler
From our perspective, Brian, you know, we're meeting what our customers need. You know, steel supply has certainly improved here over the last, you know, handful of months. And so we're able to meet their needs, but I think Polaris and others are still having other supply constraints in their supply chain that is causing them to still have difficulties to get their inventory levels built back up to where they would like them to be. But we continue to monitor the steel supply to make sure we're getting what we need need to meet customer demand, certainly impacted by all the new hires that we've had into the business and having some productivity challenges there as we bring those people up to full speed.
Chuck
Okay, so is it fair to say that there's pent-up demand from your end market customers, you know, going forward and into 2022 as they look to replenish dealer inventory?
Tyler
Yes.
Chuck
Okay, got it. Thank you very much. Thanks.
Operator
Thank you. The next question comes from the line of Sophie Karp from KeyBank. Your line is open.
Chuck
Hi, good morning. Congrats on this drunk water and thank you for taking my question. So can I maybe ask you about that cryptocurrency mining customer that you added? And I guess I'm just kind of curious if you plan to add more, if you have any visibility, if that's something that's going to grow in your territory. And is there any kind of impact on margins that is different from a typical electric customer that you add?
Tyler Ackerman
Hi, Sophie. This is Chuck. We do have interest as I'm sure most utilities do now with these types of loads. We did in a couple years ago establish a super large general rate in North Dakota and it allows us to you know it's a tariff rate but each each individual installation. And there's requirements on how the minimum megawatts, the minimum capacity factor, and those types of things. Each one has to be individually approved by the commission. So we continue to look at those. But there's only a certain number of sites and certain available resources, not personnel, but resources in terms of generating facilities and market purchases and those types of things to meet that. So we continue to have interest. We do have a filed rate. And we continue to meet and work with these customers.
Chuck
So is there any differentiated impact on your margin, or is it pretty much the same as any other customer?
Tyler Ackerman
No, they are a lower margin customer. They just take a lot of energy and have the ability to curtail, so we don't necessarily have to provide for a capacity requirement.
Chuck
Understood. Thank you. And then my other question was about your IRP and sort of how you will be determining the low-cost resource, right, during that process. Can you maybe get a little bit more granular and walk us through how exactly that is determined, for example, when you compare, you know, a PPA versus something you would build on your own? and own, right? So is that based on the levelized cost of energy or is that based on just total cost to build because, you know, clearly it's a different financial structure, something that would be in rates versus just a straight up PPA agreement. So any color on that would be helpful in how you generally approach or how your commissions rather require you to approach that cost comparison.
Tyler Ackerman
Sure, we use our capacity planning model, which we put in both the upfront capital costs or a PPA price and escalation. But to answer your question, it generally drives on the levelized cost of energy, whether the resource is a PPA or self-built. And we utilize that and come up with a least cost overall plan And the Commission generally approves a requirement, because a lot of these, it's a 15-year plan, so the costs or the projects or the additional resource changes could be, you know, five to ten years out. And generally, it's a 15-year plan and there's a five-year action plan or five-year plan that the Minnesota Commission would work on approving. And many times those approvals are generic requests because they are four to five years out. And from that point, then we go out and try to find, say it's a solar resource or a wind resource. We would go out and try to find the least cost resource of that category after the plan is approved.
Chuck
Right, so some of your peers discussed that they are having a difficult time owning those assets, renewable assets specifically due to the tax normalization issue within the regulatory construct. And they actually discussed informing an affiliate, non-regulated affiliate to be able to build and own some of those resources. Did you find that it is also a challenge for you or are you able to work through those issues?
Tyler Ackerman
From a tax perspective, we have been able to have a good tax appetite, somewhat beneficial from our non-utility companies having a tax creation. To date, we have not needed to look for outside tax equity sponsors, and we are watching the reconciliation bill and the ability to use, that maintains a longer ITC or PTC window. Our IRP is filed, assume that the ramp down that's in the current law goes forward and then the ability to have direct pay credits would change that dynamic also.
Chuck
Thank you. I appreciate the comments. I'll jump back into the queue.
Operator
Once again, if you have a question, just press star and then the number one on your telephone keypad. If there are no further questions on queue, I will now turn the call back to Chuck.
Tyler Ackerman
Thank you for your questions and interest in Otter Tail Corporation. Our outstanding year-to-date results reflect the collective efforts of the people of Otter Tail Corporation and unique market conditions. Our long-term focus remains on executing our growth strategies. For the utility, our strategy is to continue to invest in rate-based growth opportunities over the long term and drive efficiency in our operating and maintenance expenses, which will lower our overall risk, create more predictable earnings stream, and maintain our credit quality. The utility is complemented by well-run strategic manufacturing and plastic pipe businesses, which provide organic growth opportunities from new products and services, market expansion, and increased efficiencies. Based on our strong year-to-date results and our updated view of the remainder of the year, we are raising our 2021 diluted earnings per share to $4.05 to $4.20 from our previous guidance of $3.50 to $3.65. Thank you for joining our call. We appreciate your interest in Autotill Corporation, and we look forward to speaking with you next quarter.
Operator
Thank you. This concludes today's conference call. Thank you all for participating. You may now disconnect.
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