Otter Tail Corporation — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing also reports unaudited fourth-quarter results. Otter Tail operates regulated electric utility, manufacturing and PVC pipe businesses.
Financial results and liquidity
| Metric | 2018 | 2017 |
|---|---|---|
| Operating revenue | $916.4 million | $849.4 million |
| Operating income | $129.4 million | $132.3 million |
| Net income | $82.3 million | $72.4 million |
| Diluted EPS | $2.06 | $1.82 |
| Operating cash flow | $143.4 million | $173.6 million |
| Capital expenditures | $105.4 million | $132.9 million |
| Long-term debt, net | $590.0 million | $490.4 million |
Consolidated operating margin was approximately 14.1%, down from 15.6%; net margin was approximately 9.0%, up from 8.5%. Income tax expense fell to $14.6 million from $27.3 million, primarily reflecting the reduction in the federal corporate tax rate to 21%. The effective tax rate was 15.0%, versus 27.3%.
Net income by segment was $54.4 million Electric, $12.8 million Manufacturing, and $23.8 million Plastics; corporate costs were $8.7 million. Electric income rose 10.1%, Manufacturing 16.2%, and Plastics 9.8%.
Cash and cash equivalents were $0.9 million at year-end. The company had $18.6 million drawn on $300 million of revolving facilities, leaving $281.1 million available. Total debt including short-term borrowings was approximately $608.8 million; debt to total capitalization was 0.46, and the company reported compliance with covenants. The $100 million 4.07% utility notes issued in 2018 funded repayment of revolving borrowings. Dividends paid were $53.2 million; the annual dividend was $1.34 per share, and the board raised the quarterly rate to $0.35 in February 2019.
Fourth-quarter results
For the three months ended December 31, 2018, revenue was $221.2 million versus $206.7 million in 2017; operating income was $23.4 million versus $33.9 million; net income was $14.2 million versus $18.3 million; and diluted EPS was $0.35 versus $0.46. The filing does not provide a single explanation for the full year-over-year quarterly operating-income decline.
Material changes and management commentary
- Full-year revenue increased 7.9%. Manufacturing growth reflected higher sales across BTD locations, including pass-through of higher steel costs. Plastics revenue rose on higher pipe prices, despite lower volume. Electric retail kWh sales increased 3.4%, aided by colder winter and warmer summer weather.
- Operating income declined despite higher revenue, reflecting higher electric fuel, purchased power, maintenance, depreciation and other costs. Net income nevertheless increased, helped principally by lower income taxes.
- Operating cash flow declined $30.1 million, largely because of a $20 million discretionary pension contribution and changes in deferred liabilities and taxes. Cash used for financing included repayment of short-term debt, the new long-term notes and dividends.
- Management targets 5%–7% annual EPS growth over the next several years, using 2018 diluted EPS as the base. Its long-term desired earnings mix is 75%–85% Electric and 15%–25% Manufacturing and Plastics; actual 2018 mix was 66% and 34%, respectively.
Outlook, risks and contingencies
- 2019 outlook: Diluted EPS guidance is $2.10–$2.25. Management expects higher Electric and Manufacturing earnings, partly offset by lower Plastics earnings from anticipated resin-cost pressure. The outlook assumes normal weather; favorable weather added an estimated $0.07 to 2018 EPS versus normal.
- Investment plan: Estimated 2019–2023 capital spending is about $1.07 billion, including $973 million for Electric. Major projects include the 150-MW Merricourt wind project, targeted for completion in 2020, and the 250-MW Astoria gas plant, intended to replace capacity as Hoot Lake retires in 2021. Forecast Electric rate base grows from $1.11 billion in 2018 to $1.63 billion in 2023.
- Regulation and refunds: The Minnesota regulator directed prospective rate reductions and a one-time refund of tax savings from the tax-law change; $8.4 million of Minnesota-related refund liabilities was accrued at year-end. North Dakota’s rate case approved a $4.6 million annual increase, with final rates effective February 2019 and a $3.0 million interim-rate refund accrued. South Dakota’s rate case remained pending, with a partial settlement subject to approval.
- Regulatory uncertainty: A Minnesota Supreme Court review of transmission cost recovery for two MISO projects could affect about $2.3 million credited to customers and potentially recoverable. A FERC transmission-return complaint is reflected in a $1.6 million refund liability; further regulatory action could change the estimate.
- Environmental exposure: Future Regional Haze requirements at Coyote Station remain uncertain and could require material controls or costs. The company reported approximately 3.7 million tons of power-plant CO2 emissions in 2018. Environmental rules, carbon regulation, plant reliability and recovery of capital costs in rates could affect results.
- Other business risks: Two suppliers represented over 99% of PVC resin purchases. Major customer concentration includes one customer at 11% of Electric segment revenue, the top two at 33% of Manufacturing revenue, and two customers at 39% of Plastics revenue. Steel, resin and scrap prices, economic cycles, cybersecurity, pension assumptions and access to capital are also risks.
- Commitments and unusual items: Contractual cash obligations totaled $2.06 billion, including $619 million of coal contracts and $592 million of debt obligations. Under certain early-termination scenarios involving the Coyote coal supplier, OTP’s disclosed potential exposure could reach $53.9 million. The filing states ordinary-course litigation and other known contingencies, excluding the recognized FERC refund liability, could result in losses up to $1.0 million; management did not expect pending matters to have a material consolidated effect.
Important facts for investors to verify
- Whether 2019 EPS guidance and planned capital projects proceed on schedule, with expected regulatory approvals and rate recovery.
- Final outcomes and timing of Minnesota, North Dakota and South Dakota rate matters, including customer refunds and the Minnesota transmission cost-recovery appeal.
- Whether operating cash flow can support the large capital program, dividends and pension funding while maintaining covenant and credit metrics.
- Whether Plastics margins withstand resin-price changes and whether concentrated suppliers and customers remain stable.
- Potential costs of environmental rules, particularly Regional Haze requirements for Coyote Station, and plans for Hoot Lake’s 2021 retirement.
The independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting; management also concluded disclosure controls were effective at December 31, 2018.