Otter Tail Corporation — Q2 2013 Form 10-Q
Business context and period. Unaudited quarterly report for the three and six months ended June 30, 2013. The company operates Electric, Manufacturing, Construction and Plastics businesses. Comparisons below are with the corresponding 2012 periods; financial statement amounts are in millions unless noted.
Financial performance and position
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Operating revenue | $212.4 | $211.4 | $430.3 | $431.3 |
| Operating income | $15.8 | $15.2 | $43.0 | $33.5 |
| Operating margin | 7.4% | 7.2% | 10.0% | 7.8% |
| Income from continuing operations | $7.5 | $6.9 | $22.7 | $17.1 |
| Net income (loss) | $7.7 | $(17.4) | $23.1 | $(10.1) |
| Diluted EPS, continuing operations | $0.21 | $0.19 | $0.61 | $0.46 |
| Total diluted EPS | $0.21 | $(0.48) | $0.62 | $(0.29) |
- Q2 electric revenue rose 4.9% to $82.9 million, while nonelectric revenue was $129.6 million, down from $132.5 million. For the first half, electric revenue increased 8.8% to $183.9 million; nonelectric revenue declined to $246.5 million from $262.4 million.
- Q2 operating income improved modestly; first-half operating income rose substantially despite nearly unchanged revenue. Continuing-operations earnings improved in both comparisons. Total net income comparisons also reflect discontinued operations: 2012 included significant impairment and disposition losses.
- Cash flow: Six-month operating cash flow was $46.9 million ($48.8 million from continuing operations), versus $45.5 million total in 2012. Capital expenditures were $51.2 million, down from $65.0 million. Cash ended June 30 at $42.3 million, versus $52.4 million at year-end 2012.
- Liquidity and debt: Total debt including current maturities was approximately $438.7 million, versus $421.9 million at year-end. The company reported $317.0 million available under $320 million of revolving facilities, net of borrowings and letters of credit. It said it was in compliance with debt covenants; consolidated interest-bearing debt to capitalization was 0.46 to 1.00.
- Balance sheet and dividends: Total assets were $1.591 billion. Common dividends declared were $0.2975 per share for Q2 and $0.5950 for the first half. The filing notes that dividends have exceeded net income in each of the prior five years and future payments depend on financial and business conditions.
Material changes and management commentary
- Electric segment Q2 revenue increased with higher retail usage, transmission rider recovery and wholesale generation sales. Colder spring weather lifted retail kilowatt-hour sales 6.0%; electric operating income nevertheless fell 24.6%, mainly due to higher operating and maintenance costs, including benefits and transmission charges.
- Manufacturing Q2 revenue fell 6.1% and operating income fell 15.6%, reflecting softer demand in several customer end markets. Plastics revenue grew 7.9% in Q2 and 7.6% for the first half, supported by higher PVC pipe volumes, but higher costs constrained margins.
- Construction revenue declined 7.8% in Q2 and 16.5% for the first half, partly because weather delayed work and certain prior-year projects were nearing completion. The segment returned to slight Q2 operating income from a loss, and its first-half operating loss narrowed, aided by lower cost overruns at Foley. Management cited disappointing Aevenia results.
- The company completed the sale of substantially all waterfront-equipment business assets in February 2013 for about $13.0 million and received a $2.4 million working-capital true-up in June. Wind-tower assets had been sold in 2012. Results of these businesses are reported as discontinued operations.
Outlook, capital plans, risks and contingencies
- 2013 guidance: Management narrowed continuing-operations EPS guidance to $1.30–$1.50 from $1.30–$1.55. It reduced the Construction and Manufacturing outlook, citing Aevenia performance, softer manufacturing demand and a customer’s plan to bring work in-house; Plastics guidance increased based on first-half performance. Electric guidance was narrowed due to benefit and administrative costs.
- Management revised 2013 capital expenditure expectations to $165–$175 million, from $200–$210 million. The change reflects lower estimated Big Stone Plant air-quality-control-system costs and revised timing of some transmission spending. The company expects significant electric investment to grow rate base, while noting estimates and schedules can change.
- OTP reported $154.3 million of construction-program commitments at June 30, up from $79.4 million at year-end, mainly related to the Big Stone air-quality-control system. Recovery of related costs depends on regulatory processes. Minnesota legislation enabling an emissions-reduction rider was enacted; OTP filed for rider recovery after quarter-end. North Dakota’s rider request remained under review, with a hearing scheduled for September 2013.
- OTP entered a 25-year wind-power purchase agreement, but had no financial commitment as of August 9, 2013 because required Minnesota regulatory approval had not been received.
- OTP borrowed $40.9 million under a variable-rate term loan due June 2014, partly to redeem pollution-control bonds and fund redemption of the company’s preferred shares. A $150 million senior unsecured debt placement was priced, with funding scheduled for February 2014, to support construction and retire the term loan.
- Known environmental, litigation and open-tax matters could result in losses up to $2.9 million, according to the filing. Separately, a $3.9 million warranty reserve remained for products of the divested wind-tower and waterfront businesses; additional remediation or warranty claims could exceed current reserves.
- Other risks include project cost and schedule changes, construction contract estimates, weather and seasonal demand, fuel and energy-market conditions, PVC resin prices and availability, pension costs, capital-market access, regulatory recovery delays, environmental requirements and potential goodwill impairment. The filing says earnings for the first half should not be taken as indicative of the rest of the year.
Important facts for investors to verify
- Whether OTP obtains timely regulatory cost recovery for the Big Stone air-quality-control system and transmission investments, and whether project costs remain within revised estimates.
- Whether the announced debt placement funds as scheduled and the term loan is retired as planned; monitor variable-rate exposure and leverage.
- Whether Construction and Manufacturing performance supports updated EPS guidance, including Aevenia execution, Foley contract margins and customer demand.
- Whether the wind-power agreement receives the required regulatory approval and creates a future purchase commitment.
- Whether warranty or remediation claims on divested businesses exceed the $3.9 million reserve, and whether other contingent losses exceed management’s stated estimate.
- Whether cash generation, capital spending and regulatory or financing restrictions support the dividend, given management’s disclosure that dividends have exceeded earnings in recent years.