Otter Tail Corporation — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015. Financial statements are unaudited. Otter Tail operates Electric, Manufacturing and Plastics segments; Foley and AEV were reported as discontinued operations following their sales.
Key financial results
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Operating revenue | $188.2 million | $194.4 million | $391.0 million | $409.3 million |
| Operating income | $24.8 million | $14.8 million | $49.8 million | $50.2 million |
| Net income from continuing operations | $13.7 million | $7.9 million | $27.4 million | $29.7 million |
| Net income, including discontinued operations | $11.4 million | $10.0 million | $29.4 million | $31.4 million |
| Diluted EPS, continuing operations | $0.36 | $0.21 | $0.73 | $0.81 |
| Diluted EPS, total | $0.30 | $0.27 | $0.78 | $0.86 |
Operating margin was approximately 13.2% in Q2 2015 versus 7.6% a year earlier; for the first half it was approximately 12.7% versus 12.3%. Q2 improvement came despite lower revenue, principally from better Electric segment operating income and lower corporate expenses. First-half total earnings were lower, and included a $7.0 million after-tax gain on the AEV sale.
- Revenue and segment trends: Q2 revenue declined 3.2%. Electric revenue fell 2.1%, Manufacturing 3.9%, and Plastics 4.4%. Lower electric sales reflected milder weather, lower retail usage and reduced wholesale sales; manufacturing weakness included reduced oil-and-gas equipment demand. Plastics revenue was pressured by lower PVC prices. For the first half, revenue declined 4.5%; Electric operating income increased 3.9%, while Manufacturing operating income fell 34.7% and Plastics operating income fell 6.4%.
- Profit and margins: Q2 operating income rose 68% year over year, while first-half operating income was essentially flat. Q2 continuing-operations net income increased to $13.7 million from $7.9 million; first-half continuing-operations net income decreased to $27.4 million from $29.7 million. Q2 tax expense was $4.0 million versus $0.1 million, with effective tax rates of 22.7% and 1.1%, respectively.
- Cash flow and investment: First-half operating cash flow was $41.8 million, versus $4.2 million; continuing-operations operating cash flow was $52.7 million versus $20.5 million. Investing cash outflow was $55.6 million, including $83.4 million of capital expenditures, partly offset by $32.8 million of discontinued-operation sale proceeds. Financing cash inflow was $13.9 million. Cash was zero at both period-end dates.
- Balance sheet and liquidity: At June 30, total assets were $1.81 billion; net plant was $1.33 billion. Short-term debt was $43.0 million and long-term debt, including current maturities, was approximately $498.6 million. Total debt including short-term borrowing was approximately $541.6 million, compared with $509.5 million at year-end. Revolving credit availability was $276.5 million of $320 million in total commitments. The company reported compliance with debt covenants; consolidated interest-bearing debt to total capitalization was 0.48:1.00.
- Capital returns: The quarterly dividend increased to $0.3075 per share in February 2015. Dividends declared were $0.615 per share for the first half. A May 2015 at-the-market program permits up to $75 million of common-share sales; no shares were sold under it in Q2.
Material changes and notable items
- AEV was sold in February for $22.3 million cash plus estimated adjustments; the company recorded an estimated $7.0 million after-tax gain. Foley was sold in April for $12.0 million cash plus an estimated $5.7 million working-capital and other adjustment. Final sale adjustments remained unresolved.
- Electric generation was constrained: Big Stone Plant was offline for an extended outage and turbine repairs, while Coyote Station operated at reduced load following a boiler-feed-pump failure and fire. Replacement power cost approximately $4.0 million. These conditions reduced wholesale sales and increased purchased-power requirements.
- Big Stone Plant air-quality-control construction was projected to cost approximately $384 million overall; Otter Tail Power’s 53.9% share was $207 million. Its share of expenditures through June 30 was $193.4 million, excluding allowance for funds used during construction. Commercial operation was expected in December 2015.
- The company made a $10 million discretionary pension contribution in January and did not expect to make another contribution in 2015. Pension expense increased, and the pension benefit liability was $93.5 million at June 30.
Guidance, outlook and risks
Management maintained 2015 diluted EPS guidance of $1.50–$1.65 and expected results in the middle to upper end. Segment guidance anticipated higher Electric earnings than in 2014, Manufacturing earnings near or slightly below 2014, and Plastics earnings flat to slightly lower. Management cited rider recoveries and pipeline-customer sales as Electric positives, offset by mild weather, pension and operating costs, and possible lower MISO transmission returns. Manufacturing faced soft end markets; Plastics expected lower sales partly offset by improved margins. Management cautioned that seasonal and other factors mean first-half results are not necessarily indicative of full-year results.
- Regulatory exposure: Two FERC complaints sought reductions in the MISO transmission return on equity from 12.38% to 9.15% and 8.67%. Otter Tail recorded a $0.8 million estimated refund liability through June 30, net of anticipated state-rider recovery. Outcomes remained pending.
- Environmental and project exposure: EPA coal-combustion-residual rules could require future monitoring, retrofits or reclamation. The company identified a future reclamation obligation at Big Stone and recorded an approximately $0.5 million asset-retirement obligation. The potential cost of broader environmental compliance was not clearly quantified.
- Other contingencies: The filing estimated known environmental, divestiture-indemnity and litigation matters could result in losses up to $2.7 million if all resulted in liabilities. Separate legacy product warranties remained with the company; the reserve was $2.4 million, and additional remediation costs could be material.
- Coyote Creek mine agreement: Otter Tail Power’s 35% share of development costs and fees was $35.9 million. If the contract were terminated because regulation made coal burning cost prohibitive and the assets worthless, the filing stated exposure could be as high as that amount.
- Funding and market risks: Management expected equity or debt financing to be needed during 2015–2019 for Electric expansion. Risks include interest-rate changes on variable-rate borrowings, access to capital, generating-plant outages, environmental regulation, pension funding, and cyclical manufacturing and PVC-resin markets.
Most important facts for investors to verify
- Whether Big Stone and Coyote returned to planned operating levels, and the resulting replacement-power, repair and capital costs.
- Final working-capital and other sale adjustments for Foley and AEV, and any remaining indemnity or warranty exposure.
- Progress and final outcomes of the MISO ROE proceedings, including any change to transmission revenue or refund estimates.
- Whether 2015 EPS guidance of $1.50–$1.65 was achieved, particularly given weather, segment demand, rider recovery and pension-cost assumptions.
- Capital-spending and financing needs through 2019, available credit, leverage and dividend capacity.
- Potential costs and regulatory treatment of environmental compliance, including coal-ash requirements and Big Stone project recovery.