Otter Tail Corp quarterly report, Q1 FY2017

Otter Tail Corporation — Q1 2017 Form 10-Q

Reporting period: Three months ended March 31, 2017. Unaudited consolidated results. Otter Tail operates Electric, Manufacturing and Plastics businesses; management cautions that first-quarter results are seasonal and should not be taken as an indication of full-year earnings.

Financial results and position

Unless otherwise noted, amounts are in millions of dollars.

Metric	Q1 2017	Q1 2016
Operating revenue	$214.1	$206.2
Operating income	$32.8	$27.6
Income from continuing operations	$19.5	$14.5
Net income	$19.6	$14.5
Diluted EPS from continuing operations	$0.49	$0.38
Cash provided by operating activities	$21.2	$22.6
Capital expenditures	$30.1	$24.9
Dividends declared per share	$0.32	$0.3125

Revenue increased 3.8%; operating income rose 18.9%, and net income increased 34.9%. Operating margin was approximately 15.3%, versus 13.4% a year earlier.
Electric revenue rose 4.9% to $118.6 million, and segment operating income increased 19.4% to $27.7 million. Manufacturing revenue fell 2.3% to $58.4 million and operating income fell 2.6% to $3.8 million. Plastics revenue increased 11.1% to $37.2 million, while operating income rose 5.6% to $4.0 million.
Operating cash flow was $1.4 million below prior year, reflecting greater working-capital use, partly offset by higher earnings and no comparable $10 million discretionary pension contribution made in Q1 2016. Investing used $30.0 million; financing provided $8.8 million.
At March 31, total assets were $1.931 billion and common equity was $679.1 million. Cash and cash equivalents were reported as zero. Short-term debt was $59.2 million; long-term debt, including current maturities, was approximately $535.6 million. Total debt including short-term borrowings was about $594.7 million.
Available revolving credit was $240.8 million of $300 million in combined facilities. The company reported compliance with debt covenants; consolidated interest-bearing debt to total capitalization was 0.47:1, against a 0.60:1 limit.

Material changes and management commentary

Electric results benefited from higher retail rates, colder weather versus Q1 2016, and increased transmission revenues. Higher purchased-power costs and lower industrial pricing partly offset these gains. Actual heating degree days were 90.1% of normal, compared with 81.8% in Q1 2016; weather was estimated to add $0.02 per diluted share year over year.
Plastics sales volumes increased 11.2%, but higher PVC resin costs reduced gross margin per pound by 9.4%. Manufacturing results reflected lower BTD sales, partly offset by growth at T.O. Plastics.
The Minnesota regulator’s March decision authorized an approximately $12.3 million annual base-rate increase, a 6.27% increase versus the prior interim increase of 9.56%, and a 9.41% allowed return on equity. The written order was issued May 1, 2017. Otter Tail had accrued an estimated $5.2 million interim-rate refund, including interest, at March 31.
Interest expense declined $0.5 million, principally following refinancing that replaced higher-cost debt with 3.55% senior notes. The effective tax rate fell to 24.6% from 27.5%, including stock-award tax benefits and increased production tax credits.

Outlook, commitments and risks

Management reaffirmed 2017 diluted EPS guidance of $1.60–$1.75 and forecast approximately $149 million in 2017 capital expenditures. It expects Electric and Manufacturing earnings to increase from 2016 and Plastics earnings to be similar, with lower sales volumes. Guidance assumes normal weather for the remainder of 2017.
The five-year 2017–2021 capital plan totals approximately $936 million, including transmission, renewable generation and a planned natural-gas facility to replace Hoot Lake Plant, expected to retire in 2021. Management expects equity or debt financing will be needed during 2017–2021.
Major prospective projects include the 150-MW Merricourt wind project and a 250-MW natural-gas facility near Astoria, each subject to regulatory review. The planned Astoria facility is estimated at $165 million; the Merricourt construction contract is approximately $200.5 million, in addition to a $34.7 million development-asset purchase price, subject to adjustments and approvals.
Construction and other purchase commitments were approximately $114.6 million at quarter-end, up from $84.8 million at year-end. Otter Tail Power’s coal supply agreement for Coyote Station extends through 2040; its potential exposure to unrecovered costs under the related mining arrangement could reach $59.7 million if specified early-termination circumstances occur.
A pending FERC/MISO Revenue Sufficiency Guarantee dispute could produce a material adverse effect if relevant FERC orders are reversed; the company cannot estimate its exposure. Other contingencies include environmental remediation, former-business warranties and regulatory refunds. Known contingencies excluding RSG were estimated at up to $1.0 million if all resulted in liabilities.
Other risks include regulatory rate recovery, environmental rules, weather and energy-market conditions, interest rates and capital-market access, pension costs, cybersecurity and generation outages, manufacturing demand, and PVC resin price and supply volatility. The filing reports no material change in risk factors from the 2016 Form 10-K.

Key facts for investors to verify

Track final implementation and any reconsideration or refund consequences of the Minnesota rate-case order.
Assess whether the reaffirmed $1.60–$1.75 EPS guidance and $149 million 2017 capital plan remain achievable as project costs, weather and segment margins develop.
Monitor working-capital cash use, borrowing levels, upcoming debt maturities and the company’s financing needs for its capital program.
Follow the FERC/MISO RSG proceedings and other regulatory or environmental exposures; RSG liability is not quantifiable in the filing.
Check PVC resin costs and margins, manufacturing backlog and the approval, schedule and economics of the Merricourt and Astoria projects.