Otter Tail Corporation — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparisons are with Q1 2018 unless otherwise noted. Otter Tail operates Electric, Manufacturing and Plastics businesses. The unaudited results are subject to seasonal factors; management cautions they should not be taken as an indication of results for the rest of 2019.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Operating revenue | $246.0 million | $241.3 million | Up 2.0% |
| Operating income | $39.6 million | $37.6 million | Up 5.2% |
| Operating margin | 16.1% | 15.6% | Up 0.5 percentage points |
| Net income | $26.3 million | $26.2 million | Up 0.4% |
| Diluted EPS | $0.66 | $0.66 | Unchanged |
| Cash from operating activities | $17.2 million | $4.6 million | Up $12.5 million |
| Capital expenditures | $24.7 million | $23.6 million | Up $1.1 million |
Revenue and operating income rose, but net income was nearly flat as income tax expense increased to $5.6 million from $3.8 million. The effective tax rate was 17.6%, compared with 12.6%, partly reflecting the expiration of federal production tax credits for the Ashtabula wind farm. Interest charges increased $0.5 million to $7.8 million. Net margin was approximately 10.7%, versus 10.9%.
Segment net income: Electric $18.7 million (up from $16.7 million); Manufacturing $4.8 million (up from $4.2 million); Plastics $3.7 million (down from $6.8 million); Corporate loss $0.9 million (improved from $1.5 million loss).
Balance sheet, debt and liquidity
- Total assets were $2.105 billion at March 31, up from $2.053 billion at December 31, 2018; common equity was $740.5 million, versus $728.9 million.
- Cash was $0.9 million. Short-term debt was $43.6 million, up from $18.6 million at year-end; long-term debt, net, was $590.0 million. Total debt including current maturities was $633.8 million.
- Of $300 million in revolving credit facilities, $256.1 million was available at quarter-end, compared with $281.1 million at year-end. Management said liquidity was adequate and the company was in compliance with debt covenants.
- Operating cash flow benefited from a $10 million pension contribution, half the $20 million contribution in Q1 2018. The increase was partly offset by higher receivables, which used $37.1 million of cash in Q1 2019. Cash dividends paid were $13.9 million; the quarterly dividend had been raised to $0.35 per share.
Material changes and operating drivers
- Electric: Revenue rose 4.2% and segment operating income increased 19.6%. Colder weather (heating degree days 13.3% above Q1 2018 and 19.5% above normal) lifted retail consumption; management estimated weather added $0.05 to year-over-year EPS. South Dakota rate-case effects and higher rider recovery also contributed. Lower transmission revenue partly offset these gains.
- Manufacturing: Revenue grew 13.3% and operating income grew 15.7%, mainly from higher BTD parts sales. T.O. Plastics sales weakened amid lower customer demand, a customer shift to a competitor, and weather and production disruption after part of a warehouse roof collapsed under heavy snow.
- Plastics: Revenue fell 19.3% and operating income fell 44.9%. Pipe volume sold declined 16.8%, prices fell 3.1%, and cost per pound rose 2.5%, reducing gross margin per pound by 19.0%.
- Q1 included a $1.0 million South Dakota revenue benefit from reversal of a tax-related refund accrual under a rate-case settlement. The company also adopted lease accounting (ASC 842), recognizing about $20 million of net lease assets and liabilities at adoption, with no material income, cash-flow, liquidity or covenant impact.
Outlook, projects and risks
- Management reaffirmed 2019 diluted EPS guidance of $2.10–$2.25. The Electric segment outlook improved, while Manufacturing guidance was reduced because of first-quarter softness and the T.O. Plastics roof damage. Plastics earnings are expected to decline, principally because of higher resin costs and lower expected margins.
- Planned 2019 capital expenditures are $203 million; the 2019–2023 plan totals approximately $1.07 billion. Management projects electric rate base growth of 7.9% compounded annually from 2018 to 2023 and expects the investment program to support utility earnings growth. It anticipates equity or debt financing will be required during 2019–2023.
- Major projects include the $158 million, 245-MW Astoria natural-gas plant, intended to replace capacity and prepare for Hoot Lake’s planned 2021 retirement, and the 150-MW Merricourt wind project, with construction expected to begin after an anticipated second-half 2019 closing and completion targeted for 2020. The Big Stone South–Ellendale transmission line was energized in February 2019.
- Key uncertainties include regulatory rate and rider proceedings; a pending FERC review of MISO transmission return-on-equity methodology, for which OTP carried a $1.6 million estimated refund liability; and a Minnesota Supreme Court decision affecting recovery of transmission investment. The company had accrued $10.4 million of Minnesota TCJA-related customer refunds at quarter-end; further rate changes and refunds were expected in 2019, subject to regulatory approval.
- Other disclosed exposures include a potential maximum $53.1 million OTP share of unrecovered Coyote Creek mining costs under specified early-termination circumstances; construction and purchase commitments, including $70.5 million for OTP; plant outage and operating risks; environmental regulation; manufacturing customer concentration; and PVC resin price and supply volatility. Management said it was not aware of contingencies expected to exceed established reserves and considered pending litigation’s effect not material.
Important facts for investors to verify
- Whether 2019 EPS guidance remains achievable given the Plastics margin outlook, Manufacturing softness and Electric project execution.
- Regulatory outcomes and timing for Minnesota TCJA refunds, the Minnesota transmission rider dispute, South Dakota’s final allowed return on equity, and FERC’s MISO ROE proceedings.
- Capital spending, financing needs and rate-base recovery milestones for Astoria, Merricourt and transmission projects.
- Whether higher receivables convert to cash as management expects, and the company’s ability to maintain liquidity and covenant headroom as short-term borrowing rises.
- Developments in the Coyote Creek supply agreement exposure, the T.O. Plastics warehouse repair, and customer concentration and resin-cost risks.