Otter Tail Corporation — Q1 2016 Form 10-Q
Business context and reporting period
Unaudited results cover the three months ended March 31, 2016, compared with Q1 2015. Otter Tail operates Electric, Manufacturing and Plastics businesses. Management cautions that seasonality and other factors mean first-quarter earnings should not be taken as indicative of the full year.
Key financial metrics
| Metric | Q1 2016 | Q1 2015 / prior date |
|---|---|---|
| Operating revenue | $206.2 million | $202.8 million |
| Operating income | $27.6 million; 13.4% margin | $25.0 million; 12.3% margin |
| Income from continuing operations | $14.5 million | $13.8 million |
| Net income | $14.5 million | $17.9 million |
| Diluted EPS, continuing / total | $0.38 / $0.38 | $0.37 / $0.48 |
| Cash from operating activities | $22.6 million | $(8.4) million total; $(2.1) million continuing operations |
| Capital expenditures | $24.9 million | $35.7 million |
| Total assets | $1.833 billion | $1.819 billion at Dec. 31, 2015 |
| Short-term debt | $42.9 million | $80.7 million at Dec. 31, 2015 |
| Long-term debt, net of issuance costs | $493.8 million | $443.8 million at Dec. 31, 2015 |
| Available revolving credit | $277.1 million | $239.0 million at Dec. 31, 2015 |
| Quarterly dividend declared | $0.3125 per share | $0.3075 per share |
Cash and cash equivalents were zero at March 31. Current assets were $209.9 million versus current liabilities of $232.9 million. The company reported $589.2 million of total short- and long-term debt including current maturities, and said it was in compliance with debt covenants. Consolidated interest-bearing debt to capitalization was 0.49 to 1.00.
Material changes versus Q1 2015
- Revenue increased 1.7% and operating income increased 10.2%. Continuing-operations EPS improved to $0.38 from $0.37.
- Total net income and EPS declined because Q1 2015 included a $7.2 million after-tax gain on the sale of discontinued operations. Q1 2016 discontinued-operations income was $0.03 million.
- Electric revenue was nearly flat and segment operating income was $23.2 million. Milder weather reduced retail sales revenue, while lower purchased-power costs, rider recoveries and higher MISO transmission revenue partly offset that effect.
- Manufacturing revenue rose 5.4% and operating income rose 52.4%; the September 2015 BTD-Georgia acquisition contributed $7.8 million of Q1 revenue. Plastics revenue rose 2.7%, but operating income increased only 3.7% as higher sales volume was partly offset by lower PVC pipe prices.
- Continuing-operations operating cash flow improved by $24.7 million year over year, primarily reflecting lower working-capital cash use. The company made a $10 million discretionary pension contribution in both Q1 2016 and Q1 2015.
- Depreciation and amortization increased to $18.3 million from $14.5 million, notably reflecting the Big Stone Plant air-quality control system entering service in December 2015.
Guidance, outlook and management commentary
- Management reaffirmed 2016 consolidated diluted EPS guidance of $1.50–$1.65 and expected 2016 capital expenditures of $175 million, versus $160 million in 2015.
- The five-year 2016–2020 capital plan totals $858 million, including electric transmission, renewable generation and a planned natural-gas plant expected to replace Hoot Lake when retired in 2021. Management expects an 8.0% compounded annual rate-base growth rate.
- Electric earnings are expected to be slightly above 2015, supported by rate and rider recovery and planned investment, but offset by bonus depreciation, higher depreciation, property taxes, interest and operating costs.
- Manufacturing EPS guidance was raised: management cited strong first-quarter productivity, while noting soft end markets. BTD-Georgia full-year sales are now estimated at $30 million versus an original $33 million; manufacturing backlog was approximately $102 million versus $106 million a year earlier.
- Plastics EPS guidance was lowered because announced resin price increases may not be fully passed through to customers; management expects tighter margins and higher labor and freight costs.
- On February 16, 2016, OTP filed for a Minnesota annual revenue increase of approximately $19.3 million, or 9.8%. Interim rates, approved after quarter-end, provided a modified annualized increase of $16.8 million effective April 16, 2016.
Risks, contingencies and unusual items
- A FERC proceeding challenges the 12.38% return on equity used in MISO transmission rates. OTP recorded a $1.4 million estimated refund liability at quarter-end; further FERC decisions were pending.
- OTP’s 35% share of Coyote Creek mine development costs was $60.3 million. The filing states potential loss could be as high as that amount if regulation or legislation makes coal burning cost-prohibitive and the mine assets worthless.
- Environmental rules, potential changes to carbon-emissions requirements, generation outages, regulatory rate recovery, market access and interest rates could affect results or funding needs. The Supreme Court had stayed the federal existing-plant CO2 guidelines pending review.
- The company retains warranty responsibility for products from divested businesses; the warranty reserve was $2.1 million. Management noted that additional remediation costs could be substantial.
- Known environmental, divestiture-indemnity and litigation matters, if all resulted in liabilities, could reach $1.0 million; the company separately reported the FERC refund estimate. Management did not expect pending legal matters to have a material overall effect.
- OTP construction and other purchase commitments were approximately $102.9 million, extending into 2019. Management said equity or debt financing would be needed during 2016–2020 to support planned investment and other potential corporate needs.
- Management stated that disclosure controls were effective and that there was no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Track the outcome and timing of OTP’s Minnesota rate case and the pending MISO transmission return-on-equity proceedings and any resulting customer refunds.
- Monitor execution of the $858 million capital plan, financing requirements, debt maturities and the effect of added borrowing on interest expense and covenants.
- Assess whether the reaffirmed $1.50–$1.65 EPS guidance remains achievable given manufacturing end-market weakness and Plastics margin pressure.
- Verify that planned rate-base growth and project spending translate into authorized, timely rate recovery and earnings growth.
- Review coal, environmental and legacy warranty exposures, including the conditional $60.3 million Coyote Creek exposure and potential divested-business remediation costs.