Business context and reporting period
Otter Tail Corporation’s Form 10-K covers the fiscal year ended December 31, 2015; it is an annual report, not a standalone fourth-quarter filing. The company operates regulated electric utility, manufacturing and plastics businesses. In 2015, the Electric segment generated 83% of continuing-operations earnings.
During 2015, the company sold AEV and Foley, eliminating its Construction segment, and acquired Georgia metal fabricator Impulse for $30.8 million, now operated as BTD-Georgia. Deloitte issued an unqualified audit opinion and concluded internal control over financial reporting was effective.
Financial results and position
| Metric | 2015 | 2014 |
|---|---|---|
| Operating revenue | $779.8 million | $799.3 million |
| Operating income | $109.2 million | $99.5 million |
| Net income from continuing operations | $58.6 million | $56.9 million |
| Total net income | $59.3 million | $57.7 million |
| Diluted EPS, continuing operations | $1.56 | $1.55 |
| Operating cash flow, continuing operations | $131.5 million | $125.8 million |
| Capital expenditures, continuing operations | $160.1 million | $163.6 million |
- Operating margin was approximately 14.0%, up from 12.4%. Continuing-operations income tax expense increased to $21.6 million from $16.6 million; the effective rate rose to 27.0% from 22.5%.
- Cash used in investing activities from continuing operations was $193.6 million, including the $30.8 million acquisition. Continuing-operations financing provided $38.1 million; dividends paid were $46.2 million. Cash and cash equivalents were reported as zero at year-end.
- At December 31, total debt, including short-term borrowings and current maturities, was approximately $579.2 million, versus $509.5 million a year earlier. Long-term debt, net of current maturities, was $445.9 million. Debt-to-capitalization was 0.49; the company reported compliance with debt covenants.
- Revolving credit facilities totaled $320 million, with $239.0 million available at year-end. Current liabilities were $271.2 million and current assets $206.7 million.
- Annual dividends declared were $1.23 per share, with a 78% payout ratio. In January 2016, the board raised the quarterly dividend to $0.3125 per share.
Fourth-quarter reference: Continuing-operations revenue was $188.8 million versus $193.4 million in Q4 2014; operating income was $29.8 million versus $24.9 million. Continuing-operations net income was $15.4 million versus $14.0 million; diluted EPS from continuing operations was $0.41 versus $0.38.
Material changes versus 2014
- Revenue declined 2.4%, mainly due to lower PVC pipe prices and volumes and weaker Manufacturing sales. Plastics revenue fell 8.3%; Manufacturing revenue fell 2.1%; Electric revenue was nearly flat.
- Electric net income rose 10.7% to $48.4 million, aided by transmission and environmental rider revenues and lower fuel and operating costs. Milder weather reduced retail electricity sales 2.2% and negatively affected EPS by about $0.08 year over year.
- Manufacturing net income fell 54.6% to $4.2 million, with weakness in oil-and-gas, agricultural and recreational equipment markets and lower scrap prices; the Impulse acquisition contributed $8.8 million of revenue but recorded a $0.8 million net loss in 2015.
- Plastics net income was approximately unchanged at $12.1 million, while lower resin costs reduced sales prices and revenue. Corporate expenses declined, partly because 2014 included airplane lease exit costs.
- The company completed the Big Stone Plant air-quality control system and two major CapX2020 transmission projects. Electric plant additions contributed to higher assets and continuing investment.
Outlook, risks and unusual items
- Management guided to 2016 diluted EPS of $1.50–$1.65, compared with 2015 continuing-operations EPS of $1.56. It expected Electric earnings to be slightly higher, Manufacturing earnings to improve, Plastics earnings to decline and corporate costs to fall.
- Planned 2016 capital expenditures are $175 million; the 2016–2020 plan totals approximately $972 million, including $858 million for Electric. Major electric investments include $213 million for MISO transmission projects, $162 million for natural-gas generation to replace Hoot Lake capacity, and $190 million for wind and solar. Management projected 8.0% compounded annual rate-base growth over the period.
- OTP filed a Minnesota general rate case in February 2016 seeking $19.3 million, or 9.8%, in additional annual revenue; the outcome was pending. The plan assumes a constructive result and continued recovery through riders.
- Environmental regulation remains a material uncertainty. The Big Stone AQCS cost approximately $367 million in total, of which OTP’s share was approximately $198 million. The Clean Power Plan was stayed by the U.S. Supreme Court in February 2016 while litigation proceeds. Hoot Lake is expected to stop burning coal by May 2021, with replacement generation planned.
- FERC proceedings could reduce MISO transmission returns. An administrative law judge recommended a 10.32% return on equity versus the then-current 12.38%; a second complaint sought 8.67%. OTP recorded a $1.1 million estimated refund liability, net of expected state rider recovery.
- Other key risks include power-plant outages and fuel/purchased-power costs; weather and wholesale-market conditions; rate recovery and major-project execution; pension funding and interest rates; cyber incidents; and manufacturing-market cyclicality. Two vendors supplied approximately 96% of Plastics resin purchases in 2015.
- Unusual items include a $7.1 million after-tax gain on the AEV sale, offset by losses from discontinued operations; Foley incurred $4.4 million of pretax charges on a large fixed-price construction job. Warranty reserves of $2.1 million remain for products from former businesses, with potential remediation costs described as uncertain. OTP also disclosed a potential $56.1 million exposure under the Coyote mine agreement if specified coal-regulation termination conditions occur.
Important facts for investors to verify
- Progress and final outcome of the Minnesota rate case, and whether environmental and transmission rider recoveries remain timely and sufficient.
- Execution, financing and returns on the $972 million capital program, including planned replacement generation and renewable projects.
- FERC decisions on MISO transmission ROE and any resulting refunds or changes to future transmission revenue.
- Whether 2016 guidance is achieved given weak end markets, Plastics margins, weather assumptions and the effects of tax depreciation.
- Debt maturity and refinancing plans, liquidity needs, dividend coverage and the extent of further equity or debt financing.
- Potential costs from environmental rules, coal-supply arrangements, legacy warranties and other contingencies.