Otter Tail Corporation — Q2 2014 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and six months ended June 30, 2014. Otter Tail operates in Electric, Manufacturing, Plastics and Construction. The Electric utility is the largest segment; the other businesses include manufacturing, PVC pipe and construction services. Results are seasonal and management cautions that first-half earnings are not necessarily indicative of full-year results.
Financial performance
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Operating revenue | $234.6 million, up 10.5% from $212.4 million | $475.1 million, up 10.4% from $430.3 million |
| Operating income | $18.2 million, versus $15.8 million | $52.7 million, versus $43.0 million |
| Net income | $10.0 million, versus $7.7 million | $31.4 million, versus $23.1 million |
| Diluted EPS from continuing operations | $0.27, versus $0.21 | $0.86, versus $0.61 |
| Operating margin | 7.8%, versus 7.4% | 11.1%, versus 10.0% |
| Cash provided by operating activities | Not presented for the quarter | $4.2 million, versus $46.9 million |
| Capital expenditures | Not presented for the quarter | $80.7 million, versus $51.2 million |
For the six-month period, cash from continuing operations was $4.4 million, down from $48.8 million. Management attributed the decline mainly to a $32.0 million greater use of cash for working capital and a $10.0 million increase in discretionary pension contributions. Investing activities used $79.2 million; financing activities provided $73.9 million. Cash and cash equivalents were zero at June 30, 2014, compared with $1.2 million at year-end.
Debt and liquidity. Total short- and long-term debt, including current maturities, was $526.9 million at June 30, versus $441.0 million at December 31, 2013. Long-term debt, net of current maturities, was $498.6 million; short-term debt was $28.1 million. OTP issued $150 million of long-dated notes in February, using proceeds in part to repay a $40.9 million term loan and $82.5 million of short-term debt. The company reported $289.2 million available under its revolving credit facilities and compliance with debt covenants. Consolidated interest-bearing debt to capitalization was 49%.
Material changes and segment performance
- Electric: Six-month revenue rose 15.3% and operating income increased to $36.7 million from $27.0 million. Retail sales growth, rate riders and transmission revenues contributed; purchased-power costs and maintenance expenses also rose. Hoot Lake Plant was offline for most of Q2 for extended maintenance, increasing power purchases.
- Manufacturing: Six-month revenue grew 5.7%, but operating income fell 7.1% to $9.8 million as increased BTD sales and costs, including tooling, offset lower T.O. Plastics activity.
- Plastics: Six-month revenue rose 7.8%, while operating income declined 14.4% to $11.6 million. Higher PVC resin costs were not fully recovered in pipe prices amid competitive conditions.
- Construction: Revenue increased 7.1%; the segment moved to $2.0 million operating income from a $1.6 million loss, with improved project cost control and increased North Dakota work cited.
- Corporate Q2 expenses included a $2.5 million charge to terminate an airplane lease early. Six-month other income included gains of $0.8 million on an investment sale and $0.3 million on the sale of Aevenia’s data communications business.
Outlook, risks and contingencies
Management narrowed 2014 diluted EPS guidance to $1.65–$1.80, from $1.60–$1.80. The Electric outlook improved on strong first-quarter results and rider recovery, partly offset by debt interest and planned maintenance. Plastics guidance was reduced because resin costs were expected to remain difficult to pass through; Construction guidance increased on improved cost control and more selective bidding. Manufacturing was expected to be broadly in line with 2013. Management projects 2014 capital expenditures of $185 million and substantial electric investment through 2018.
- The Big Stone Plant air-quality control system was projected to cost approximately $384 million in total, of which OTP’s 53.9% share was approximately $207 million. OTP had incurred $128 million of its share by June 30; commercial operation was expected in October 2015.
- A FERC complaint sought to reduce the MISO transmission return on equity from 12.38% to 9.15%; the matter was pending. Future requirements and costs from federal carbon-emissions rules and the reinstated Cross-State Air Pollution Rule remained uncertain.
- OTP’s share of Coyote Creek mine development costs was $13.0 million; that was also its stated maximum exposure to loss if specified regulatory or legislative conditions made coal burning uneconomic and the mine assets worthless.
- Management estimated known environmental, litigation and open-tax contingencies could result in losses of up to $2.0 million. The company separately retained warranty responsibility for sold wind-tower and waterfront businesses; related reserves were $2.9 million, and additional remediation or warranty claims could be substantially higher than anticipated.
- Other cited risks include capital-market access and borrowing costs, utility outages and power costs, regulatory recovery delays, pension funding, PVC resin supply and pricing, and construction contract cost overruns. Management said pending legal matters were not expected to have a material adverse effect. No material change to the prior annual report’s risk factors was reported.
Important facts for investors to verify
- Whether working-capital demands and elevated capital spending improve into the second half, and how they affect operating cash flow and borrowing needs.
- Progress, final cost, schedule and regulatory cost recovery for the Big Stone AQCS and major transmission projects.
- Whether the company achieves its $1.65–$1.80 EPS guidance, particularly given PVC resin margins, Hoot Lake maintenance and construction execution.
- Developments in the FERC return-on-equity complaint, environmental rules, and retained warranty and remediation obligations.
- Debt, dividend and pension funding capacity: the quarterly dividend was raised to $0.3025 per share, and management noted dividends exceeded net income in four of the previous five years.