Otter Tail Corporation — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Financial statements are unaudited. Otter Tail operates Electric, Manufacturing and Plastics businesses; management cautions that seasonal factors mean interim earnings should not be taken as a reliable indication of full-year results.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Operating revenue | $227.7 million | $216.5 million | $695.3 million | $642.7 million |
| Operating income | $38.3 million | $33.0 million | $106.0 million | $98.2 million |
| Net income | $23.3 million | $17.7 million | $68.2 million | $54.1 million |
| Diluted EPS | $0.58 | $0.45 | $1.71 | $1.36 |
| Operating margin | 16.8% | 15.3% | 15.2% | 15.3% |
Q3 diluted EPS increased 29%; nine-month EPS increased 26%. Electric segment net income was $14.6 million in Q3 and $41.8 million year to date; Manufacturing contributed $3.0 million and $10.8 million, respectively; Plastics contributed $6.4 million and $19.5 million. Corporate results were losses of $0.7 million in Q3 and $3.9 million year to date.
Revenue growth reflected stronger Manufacturing sales, higher electric sales and wholesale generation, and higher Plastics pricing year to date. Q3 Plastics revenue fell 6% as pipe volume declined 12.5%; segment operating income fell 12.3%. Nine-month Plastics revenue rose 8.8% on higher prices despite a 3.3% decline in volume. Manufacturing revenue rose 23% in Q3 and 18.5% year to date, with higher costs accompanying increased sales.
Cash flow and investment: Nine-month operating cash flow was $100.9 million, down from $114.1 million. Capital expenditures were $74.5 million versus $94.5 million, leaving operating cash flow less capital expenditures of approximately $26.4 million. The operating cash flow decline principally reflected a $20 million discretionary pension contribution, partly offset by higher net income. Cash and equivalents were $0.6 million at September 30, versus $16.2 million at year-end.
Liquidity and debt: Current assets were $241.4 million and current liabilities $163.5 million; the reported current ratio was approximately 1.48. The company had $284.2 million available under $300 million of revolving credit facilities, net of $0.3 million restricted for letters of credit. Short-term debt was $15.5 million; long-term debt, net of issuance costs, was $590.0 million. Total short- and long-term debt including current maturities was $605.6 million, compared with $602.9 million at December 31, 2017. The company reported compliance with debt covenants; consolidated debt to capitalization was 0.46. In February, OTP issued $100 million of 4.07% senior notes due 2048, using proceeds to repay credit-line borrowings.
Dividends declared were $0.335 per share for Q3, compared with $0.320 in Q3 2017; $1.005 per share was declared for the first nine months. Cash dividends paid year to date were $39.9 million.
Material changes and notable items
- Operating income rose in Q3, led by Electric and Manufacturing. Electric Q3 operating income increased 23.4%, supported by lower purchased-power costs, higher wholesale sales and reduced operating costs; nine-month Electric operating income was nearly flat despite higher revenues and demand.
- Weather supported year-to-date electric demand: retail kilowatt-hour sales rose 4.1%. Management estimated weather added $0.10 to nine-month diluted EPS versus the prior-year period; Q3 weather had an estimated $0.01 year-over-year EPS benefit.
- The federal tax-rate reduction contributed to lower income taxes. The effective tax rate was 24.0% in Q3 versus 28.4%, and 17.2% for nine months versus 26.3%. IRS guidance on bonus depreciation also generated a $2.7 million tax adjustment; OTP recorded an offsetting regulatory asset for expected future recovery.
- OTP made a $20 million discretionary pension contribution. Pension benefit liability declined to $89.1 million from $109.7 million at year-end, while the company’s total pension and postretirement benefit liabilities were significant.
- Gross plant increased to $2.41 billion from $2.34 billion at year-end, including construction work in progress of $183.4 million. Major work includes the Big Stone South–Ellendale transmission project and a customer information system expected to be implemented in Q1 2019.
Outlook, regulation and risks
2018 outlook: On November 5, 2018, the company narrowed its consolidated diluted EPS guidance to $2.00–$2.10, from the August range of $1.95–$2.10. It expected 2018 capital expenditures of approximately $106 million. Management cited expected gains in Manufacturing and Plastics and a higher Electric contribution, partly offset by plant maintenance, benefit costs, depreciation and higher interest expense. The outlook assumes normal weather for the remainder of the year and depends on regulatory outcomes and business conditions.
- North Dakota regulators approved a $4.6 million annual revenue increase, effective January 1, 2019; OTP accrued $2.3 million of interim-rate refunds for customers. South Dakota interim rates took effect October 18, 2018 on a requested $3.3 million annual increase; final recovery is not assured.
- TCJA-related customer refund liabilities at September 30 totaled $6.0 million in Minnesota, $0.8 million in North Dakota and $1.1 million in South Dakota. The Minnesota Public Utilities Commission had determined that tax benefits should be refunded and rates adjusted, but implementation details and timing were not yet known.
- A Minnesota appellate court reversed a rate treatment affecting recovery of OTP’s Big Stone South–Brookings and Big Stone South–Ellendale transmission investments. The Minnesota Supreme Court agreed to review the matter; a decision was expected in Q2 2019. Approximately $2.5 million credited to Minnesota customers through September was potentially recoverable depending on the outcome.
- OTP carried a $1.6 million estimated liability for potential refunds related to FERC proceedings on MISO transmission return on equity. Further regulatory decisions could change the estimate.
- The five-year 2018–2022 capital plan totaled approximately $1.05 billion, including renewable and natural-gas generation investment. The company projected about 9% compounded annual growth in Electric rate base from 2017 to 2022 and stated that financing would be needed for expansion plans. Projects include the 150-MW Merricourt wind farm and the planned Astoria natural-gas facility, intended to replace Hoot Lake when it retires in 2021.
- Risks include regulatory recovery and rate decisions, environmental rules and potential plant requirements, generation outages and fuel costs, interest rates and capital-market access, pension funding, weather and energy-market volatility, and dependence on key customers and PVC resin suppliers. Management stated that pending legal matters were not expected to have a material adverse effect; it estimated other specified known contingencies, excluding the MISO refund liability, could reach $1.0 million if all resulted in losses.
Important facts for investors to verify
- Whether the company achieves the $2.00–$2.10 2018 EPS guidance, including the assumptions for weather, segment performance and costs.
- Final outcomes and timing for Minnesota and South Dakota rates, TCJA-related customer refunds, and the Minnesota transmission-cost appeal.
- FERC’s resolution of MISO return-on-equity proceedings and whether OTP’s $1.6 million refund estimate changes.
- Capital-project costs, schedules, regulatory approvals and financing needs, particularly for Merricourt, Astoria and the Big Stone South–Ellendale line.
- Manufacturing and Plastics margins, customer concentration, PVC resin availability and prices, and the effect of any change in demand or material costs.