Otter Tail Corporation — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. The financial statements are unaudited. The company operates Electric, Manufacturing and Plastics businesses. Management cautions that seasonal factors mean interim earnings are not necessarily indicative of full-year results.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Operating revenue | $226.3 million | $212.1 million | $467.6 million | $426.2 million |
| Operating income | $30.1 million | $31.0 million | $67.7 million | $65.2 million |
| Net income | $18.7 million | $16.8 million | $44.9 million | $36.4 million |
| Diluted EPS | $0.47 | $0.42 | $1.13 | $0.92 |
- Revenue rose 6.7% in Q2 and 9.7% in the first half. Manufacturing and Plastics drove much of the increase. Operating income declined 2.9% in Q2 but increased 3.9% year to date.
- Q2 operating margin was approximately 13.3%, versus 14.6% a year earlier; first-half operating margin was approximately 14.5%, versus 15.3%. The lower effective tax rate—14.0% in Q2 and 13.2% year to date, compared with 26.1% and 25.3%—helped net income and EPS rise despite weaker Q2 operating income. Management attributed the lower rate primarily to federal tax reform.
- Segment changes: Q2 Electric operating income fell 7.0% to $18.4 million, reflecting higher fuel and operating costs; Manufacturing operating income was nearly flat at $5.1 million; Plastics operating income rose 12.1% to $8.6 million. First-half segment net income increased to $27.3 million in Electric, $7.7 million in Manufacturing and $13.1 million in Plastics.
- Cash flow, first half: Operating cash flow was $53.4 million, down from $69.3 million. Capital expenditures were $49.1 million, versus $56.4 million; financing cash outflow was $18.9 million. Cash declined to $1.0 million from $16.2 million at year-end. The $20 million discretionary pension contribution and working-capital movements weighed on operating cash flow.
- Debt and liquidity, June 30: Short-term debt was $21.0 million and long-term debt, net, was $590.0 million; total debt including current maturities was approximately $611.1 million, compared with $602.9 million at December 31, 2017. The company issued $100 million of 4.07% notes due 2048, primarily to repay credit-line borrowings. Of $300 million in revolving credit facilities, $278.7 million was available. Management said liquidity was adequate and reported compliance with debt covenants.
- Total assets were $2.01 billion; common equity was $714.6 million. The quarterly dividend increased to $0.335 per share from $0.32 in 2017.
Material changes and management outlook
- Plastics’ first-half revenue increased 18.7% and operating income increased 54.4%, supported by higher PVC pipe prices and sales volume. Manufacturing revenue rose 16.2% and operating income 25.0%, with stronger BTD sales, partly offset by higher costs.
- Electric results were affected by weather-related demand, higher generation and fuel costs, increased transmission investment depreciation, storm repairs, and customer refunds associated with lower taxes and rate adjustments. Management estimated weather contributed $0.09 per diluted share to the first-half year-over-year comparison.
- Management raised 2018 diluted EPS guidance for the second time, from the May range of $1.90–$2.05 to $1.95–$2.10, citing stronger-than-expected Plastics results. The company expected 2018 capital expenditures of $106 million and forecast $1.05 billion for 2018–2022. It projected approximately 9% annualized Electric rate-base growth from 2017 through 2022.
- Major plans include the Merricourt 150-MW wind project, with construction anticipated to begin in 2019 and targeted completion in 2020, and the approximately $165 million Astoria natural-gas generation project. Astoria is intended to replace Hoot Lake Plant when it retires in 2021. Both projects remain subject to approvals and execution risks.
Regulatory, contingency and other risks
- OTP’s North Dakota rate case remained pending. A proposed settlement would provide a $5.4 million annual revenue increase; OTP had accrued a $1.8 million interim-rate refund, and the filing said a decision was expected by the end of Q3. A South Dakota rate case sought a first-step annual increase of approximately $3.3 million, with interim rates scheduled to begin October 2018.
- The Minnesota Court of Appeals reversed a state regulator’s treatment of two MISO multi-value transmission projects in the Minnesota transmission rider. The regulator sought state Supreme Court review. Approximately $2.0 million credited to customers could become recoverable if the appellate decision stands.
- Tax-reform-related refund liabilities were $4.1 million in Minnesota, $0.8 million in North Dakota and $0.7 million in South Dakota. The ultimate rate treatment and tax effects remain subject to regulatory action and estimates.
- OTP’s estimated maximum exposure tied to the Coyote Station lignite supply arrangement was $55.7 million if specified early-termination conditions occur. Other identified contingencies, excluding the already-recorded MISO return-on-equity refund liability, could total up to $1.0 million if all result in losses. Management said pending legal matters were not expected to have a material adverse effect.
- Risks include regulatory decisions and delayed cost recovery, environmental rules, fuel and commodity-price volatility, access to capital and interest rates, pension costs, generation outages, cyber and physical security, and reliance on significant customers and limited PVC resin suppliers. A Minnesota fuel-cost recovery mechanism planned for 2019 could increase earnings variability if actual costs exceed forecast levels.
Investor verification priorities
- Track the final North Dakota rate-case decision, interim refund, and the South Dakota rate-case outcome.
- Verify the Minnesota Supreme Court’s treatment of the transmission-rider appeal and any resulting recovery or customer refunds.
- Assess whether Plastics’ unusually strong margins and the raised $1.95–$2.10 EPS guidance are sustained in the second half.
- Monitor capital spending, financing needs and project milestones for Merricourt, Astoria and the transmission program.
- Review cash conversion, the pension contribution’s effects, debt growth, and the company’s remaining credit availability.
- Follow tax-related refund estimates, MISO transmission return-on-equity proceedings and other recorded or unrecorded contingencies.