Otter Tail Corp quarterly report, Q3 FY2014

Business context and reporting period

Otter Tail Corporation’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2014, with comparisons to 2013. Its four segments are Electric, Manufacturing, Plastics and Construction.

Financial results and position

Metric	Q3 2014	Q3 2013	Nine months 2014	Nine months 2013
Operating revenue	$242.4 million	$229.8 million	$717.5 million	$660.1 million
Operating income	$28.3 million	$25.1 million	$81.0 million	$68.2 million
Net income	$15.8 million	$15.1 million	$47.2 million	$38.2 million
Diluted EPS, continuing operations	$0.43	$0.41	$1.28	$1.02
Operating margin	11.7%	10.9%	11.3%	10.3%

For the nine months, continuing-operations income before tax was $62.2 million and income tax expense was $15.3 million; the effective tax rate was 24.5%, down from 25.9%. Dividends declared were $0.3025 per share for Q3 and $0.9075 for the nine months.

Cash flow: Operating cash flow from continuing operations was $47.4 million for the nine months, versus $95.8 million in 2013. The filing attributes the decline mainly to increased working-capital use and a $10 million larger discretionary pension contribution. Capital expenditures were $125.2 million versus $109.7 million; investing cash outflow was $124.1 million. Financing cash inflow was $75.6 million, including $150 million of new long-term notes. Cash at September 30 was zero.

Debt and liquidity: Short- and long-term debt, including current maturities, totaled $537.7 million at September 30, compared with $441.0 million at December 31, 2013. Long-term debt, net of current maturities, was $498.5 million; short-term debt was $39.0 million. The company reported $280.0 million available under its $320 million revolving credit facilities and stated it was in covenant compliance. Consolidated interest-bearing debt to capitalization was 0.49:1.00. The quarterly filing notes the credit facilities were extended to October 2029 in an amendment dated November 3, 2014.

Material changes versus the prior comparable period

Nine-month revenue rose 8.7% and operating income rose 18.8%; diluted continuing-operations EPS increased from $1.02 to $1.28.
Electric segment operating income increased 27.9% for the nine months, supported by higher retail sales and recovery through environmental and transmission riders. Retail electricity sales volume rose 6.5%.
Manufacturing revenue grew, but nine-month segment operating income fell 5.3%, reflecting higher costs at BTD and product-mix changes at T.O. Plastics.
Plastics revenue increased 8.8%, while operating income declined 13.5% as PVC resin and labor costs outpaced selling-price increases.
Construction segment operating income rose to $5.6 million from $1.6 million, despite mixed revenue trends, reflecting improved project margins and cost control.
Interest expense rose $1.5 million for the nine months, chiefly reflecting the 2014 note issuance and reduced capitalized interest, partly offset by lower expense following the 2013 retirement of high-coupon debt.

Guidance, outlook, risks and unusual items

Management maintained 2014 consolidated diluted EPS guidance of $1.65–$1.80. Segment guidance was revised: Electric and Manufacturing expectations were reduced; Plastics, Construction and Corporate expectations were adjusted upward or improved. Management said successful execution of strategic alternatives for Construction would still leave the company within its original February guidance.
Management cited the extended Hoot Lake outage and milder-than-normal Q3 weather as constraints on Electric results. Hoot Lake was offline for much of Q2 and Q3; maintenance issues and delayed coal shipments also affected generation. OTP decided to end energy trading not directly related to retail customers by year-end 2014.
OTP’s Big Stone Plant air-quality control system was projected to cost about $384 million, of which OTP’s share was $207 million; OTP had incurred $143 million of its share by September 30. Commercial operation was expected in October 2015. The project is a significant capital commitment, with recovery dependent on regulatory mechanisms.
In November 2014, after the quarter, the company announced a review of strategic alternatives for its Construction businesses. The filing does not state an outcome.
Regulatory uncertainty includes a FERC proceeding challenging the 12.38% MISO transmission return on equity and unresolved implementation details for the Cross-State Air Pollution Rule. The potential effect of proposed federal carbon-emissions rules was not yet determinable.
Known environmental, litigation and open-tax contingencies could total up to $2.0 million if all identified matters resulted in liabilities; management said pending legal matters were not expected to have a material adverse effect. The company retained warranty obligations for divested wind-tower and waterfront businesses, with a $2.9 million warranty reserve at September 30; additional remediation claims could exceed reserves.
Other notable items: a $2.4 million airplane-lease termination charge in Q2; a $20 million discretionary pension contribution in January; and a $150 million long-term debt issuance used partly to refinance debt and fund construction.

Important facts for investors to verify

Whether 2014 EPS guidance was achieved and how the Hoot Lake outage, weather and power-purchase costs affected full-year Electric results.
Construction strategic-alternatives progress, potential proceeds or costs, and implications for the company’s business mix and guidance.
Big Stone AQCS project cost, schedule, remaining funding needs and regulatory cost recovery.
Cash conversion and working-capital trends, given the sharp year-over-year decline in operating cash flow alongside higher capital spending.
Debt levels, refinancing and covenant headroom, plus exposure to rate changes and the FERC MISO return-on-equity proceeding.
PVC resin cost pass-through and Plastics margins, and the extent of any additional legacy-product warranty or remediation exposure.