Otter Tail Corporation — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015. Financial statements are unaudited. Otter Tail operates Electric, Manufacturing and Plastics businesses; construction companies being sold are reported as discontinued operations. Results are seasonal and the company cautions against treating the quarter as indicative of the full year.
Key financial results
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Operating revenue | $202.8 million | $215.0 million | Down 5.6% |
| Operating income | $25.0 million | $35.4 million | Down 29.3% |
| Operating margin | 12.3% | 16.5% | Down 4.2 percentage points |
| Income from continuing operations | $13.8 million | $21.8 million | Down 36.7% |
| Net income | $17.9 million | $21.4 million | Down 16.3% |
| Diluted EPS, continuing operations | $0.37 | $0.60 | |
| Total diluted EPS | $0.48 | $0.59 | |
| Dividends declared per share | $0.3075 | $0.3025 |
Net income included $4.2 million of income from discontinued operations, including a $7.2 million after-tax gain on the AEV asset sale, partly offset by a $3.1 million operating loss that included a $1.0 million goodwill impairment. Continuing-operations net income is the clearer indicator of the quarter’s underlying earnings trend.
Cash flow: Net cash used in operating activities was $8.4 million, versus $19.1 million used in Q1 2014. Continuing operations used $2.1 million, compared with $12.2 million used; the improvement principally reflected a $10.0 million smaller discretionary pension contribution. Capital expenditures were $35.7 million. Cash ended at $0.2 million.
Balance sheet and liquidity: Total assets were $1.82 billion at March 31, up from $1.79 billion at year-end. Short-term debt was $48.7 million; long-term debt, including current maturities, was $498.6 million, for total debt of $547.3 million. Total unused revolving credit availability was $270.6 million, net of letters-of-credit restrictions. The company reported debt-to-total-capitalization ratios of 0.48 consolidated and 0.49 for OTP, and stated it was compliant with debt covenants. Its interest and dividend coverage ratios were 3.24 consolidated and 3.04 for OTP under specified agreements.
Material changes and operating drivers
- Electric: Revenue fell 4.7% to $113.5 million and operating income fell 13.9% to $23.2 million. Milder winter weather reduced retail sales and wholesale market demand; retail kWh sales declined 2.6%. Coyote Station’s reduced output after a boiler-feed-pump failure and fire, and Big Stone’s planned outage, reduced generation and increased purchased-power needs. Fuel expense fell, but utility operating and maintenance costs, purchased power and property taxes increased.
- Manufacturing: Revenue rose 2.4% to $56.8 million, but operating income declined 53.1% to $2.5 million as product and operating costs rose faster than sales. Management cited weaker agriculture, energy, mining and oil-and-gas equipment markets at BTD, lower productivity and higher benefit costs.
- Plastics: Revenue declined 19.6% to $32.6 million and operating income declined 37.4% to $3.6 million. PVC pipe volume fell 20.6%, partly as customers delayed purchases amid falling resin prices; lower volume reduced costs but unit costs rose.
- Consolidated interest expense increased $1.1 million, chiefly reflecting a full-quarter impact of OTP’s 2014 note issuance. The continuing-operations effective tax rate was 22.8%, versus 28.2%.
Outlook, capital plans and risks
- On May 4, 2015, management reduced 2015 diluted EPS guidance to $1.50–$1.65 from $1.65–$1.80. The segment guidance table presents this as continuing-operations EPS. Electric guidance was lowered for weaker first-quarter results, higher disability-plan claims and unrecovered reagent costs in Minnesota; Manufacturing guidance was reduced, while Plastics guidance increased. Expected Plastics sales volumes were slightly below 2014.
- Management’s 2015–2019 capital plan shows total annual capital expenditures of $183 million in 2015, $151 million in 2016, $114 million in 2017, $164 million in 2018 and $163 million in 2019. Electric rate base is projected to grow from $957 million in 2015 to $1.196 billion in 2019. Management expects utility investment to support earnings growth, but says equity or debt financing will be needed during 2015–2019.
- Big Stone’s air-quality control system was projected to cost approximately $384 million overall, with OTP’s share approximately $207 million; OTP had incurred $174.9 million of its share through March 31, excluding AFUDC. Commercial operation was expected in October 2015.
- FERC proceedings seek reductions in the MISO transmission return on equity. OTP recorded a $0.6 million estimated refund liability; outcomes and any further financial effects remain uncertain. Minnesota regulators denied OTP’s request to recover reagent and emissions-allowance costs through its fuel adjustment rider; North Dakota and South Dakota approved recovery mechanisms.
- OTP’s reduced Coyote Station generation required approximately $2.9 million of replacement-power purchases for April–June 2015. OTP’s share of development-period costs, fees and capital charges for the Coyote Creek mine was $28.5 million; the filing identifies that amount as potential maximum exposure in a specified coal-regulation termination scenario.
- Coal-ash rule compliance costs were not yet known; OTP had not completed its assessment of required actions or determined whether remediation or additional asset-retirement obligations would be necessary. The filing says known significant contingencies, if all resulted in liabilities, could total as much as $5.0 million, excluding the separately discussed Coyote Creek exposure.
- AEV’s assets were sold February 28, 2015; Foley was sold April 30, 2015 for $12.0 million plus working-capital and other adjustments. Foley’s final proceeds and any sale loss were not yet known. The company retained certain legacy warranty responsibilities.
- Management cited access to capital markets, interest rates, pension costs, environmental rules, utility plant outages, regulatory recovery, commodity prices, PVC resin supply and demand, and retained warranty claims among relevant risks. The board increased the quarterly dividend to $0.3075 per share; future dividends remain subject to financial and regulatory constraints.
Important facts for investors to verify
- Whether the reduced 2015 EPS guidance is achieved, particularly in Electric and Manufacturing, and whether the stated segment guidance is understood as continuing operations.
- Resolution and potential customer-refund effects of the FERC MISO return-on-equity proceedings, including the basis for OTP’s $0.6 million accrual.
- Progress, final cost and in-service timing for Big Stone AQCS and other capital projects, and the related financing and rate-recovery assumptions.
- Final Foley sale adjustments and AEV sale adjustments, as well as continuing liabilities for legacy warranties and discontinued operations.
- Costs and required actions under coal-ash rules, plus the status of the Coyote Station repair and associated replacement-power costs.
- Cash generation, short-term borrowing, available credit and covenant headroom as capital spending proceeds; management’s reported liquidity includes substantial unused facilities but very little quarter-end cash.