Otter Tail Corporation — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014. Financial statements are unaudited. Otter Tail operates Electric, Manufacturing, Plastics and Construction businesses, primarily in the United States. Management cautions that seasonal and other factors mean first-quarter earnings are not necessarily indicative of results for the rest of the year.
Financial performance
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Operating revenue | $240.5 million | $218.0 million |
| Operating income | $34.4 million | $27.2 million |
| Net income | $21.4 million | $15.4 million |
| EPS, diluted | $0.59 | $0.41 |
| Operating cash flow | $(19.1) million | $7.8 million |
| Capital expenditures | $37.7 million | $23.3 million |
| Dividends declared per common share | $0.3025 | $0.2975 |
Operating margin was approximately 14.3%, compared with 12.5% a year earlier. Revenue rose about 10%; operating income rose about 26%. Electric revenue increased 17.9%, helped by colder weather, higher retail sales, rider recoveries and improved generating-plant availability. Manufacturing revenue grew 4.3%, while operating income fell 15.1%. Plastics revenue increased 8.2%, but operating income declined 14.1% as costs and operating expenses rose. Construction revenue decreased 3.5%; its operating loss narrowed to $1.2 million from $1.7 million.
- Electric segment operating income increased 31.8% to $26.9 million. Retail electricity sales volume rose 6.7%; colder weather supported demand and wholesale prices. Fuel and purchased-power costs also increased.
- Continuing-operations income before tax was $29.7 million, versus $21.1 million. The effective tax rate was 28.0%, broadly unchanged from 27.9%.
- Other income included approximately $0.8 million from selling a tax-credit-qualified housing investment and $0.3 million from the sale of Aevenia’s data-services business.
Cash, debt and liquidity
- Cash was $6.6 million at March 31, versus $1.2 million at year-end. Operating cash flow from continuing operations was negative $18.9 million, compared with positive $10.2 million a year earlier. Management attributed the shift principally to higher working-capital use and a $20 million discretionary pension contribution, compared with $10 million in Q1 2013.
- Total debt, including current maturities, was approximately $510.7 million, up from $441.0 million at December 31, 2013. Long-term debt net of current maturities was $498.6 million; short-term debt was $11.9 million. The company issued $150 million of fixed-rate OTP notes in February, using part of the proceeds to retire a $40.9 million term loan and repay short-term borrowings.
- Available capacity under revolving credit facilities was $303.6 million at quarter-end. The company reported compliance with debt covenants; consolidated interest-bearing debt to capitalization was 0.48, and OTP’s was 0.53.
- Total assets were $1.656 billion and common equity was $549.7 million at March 31. Management said liquidity and capital resources were adequate, while noting that equity or debt financing will be needed during 2014–2018 to support planned investment.
Material changes and investment plans
- 2014 capital expenditures were forecast at $195 million, including $172 million for the Electric segment. The five-year plan projects total expenditures of $195 million in 2014 and $164–$167 million annually in 2015–2016, then $117 million in 2017 and $126 million in 2018.
- The Big Stone Plant air-quality control system was projected to cost approximately $384 million in total; OTP’s 53.9% share was about $207 million, of which $113 million had been spent by March 31. Commercial operation was expected in October 2015.
- Net regulatory assets were $21.4 million, down from $26.5 million at year-end. Rate riders and regulatory recovery are important to the Electric segment’s revenue and investment returns.
Outlook, risks and contingencies
- Management raised 2014 diluted EPS guidance to $1.60–$1.80 from $1.55–$1.75. The company cited strong first-quarter Electric and Plastics results, including the benefit of colder-than-normal weather. Segment guidance: Electric $1.21–$1.25; Manufacturing $0.29–$0.33; Plastics $0.27–$0.31; Construction $0.07–$0.11; Corporate costs $(0.24)–$(0.20).
- Expected Electric segment pressures include higher interest and operating costs and planned Hoot Lake maintenance; expected offsets include rider recoveries and lower pension costs. Manufacturing guidance was unchanged, with backlog of about $115 million versus $97 million a year earlier. Construction backlog was $85 million versus $100 million.
- Key risks include weather and energy-market volatility, generating-plant outages, regulatory decisions and the timing of cost recovery, environmental requirements, interest rates and access to capital, pension funding, raw-material prices and supply, and construction-contract cost or performance risk. The company also identifies potential excess warranty and remediation costs tied to products of sold wind-tower and waterfront-equipment businesses; the related warranty reserve was $3.0 million.
- Known environmental, litigation and open-tax contingencies could produce losses up to $2.0 million, according to the filing; management said resolution of pending legal matters was not expected to be material. OTP’s share of Coyote Creek mine development costs was $10.9 million; the filing describes potential exposure up to that amount in a specified contract-termination scenario.
- A FERC complaint sought to reduce the MISO transmission return on equity from 12.38% to 9.15%; it remained pending. Following the Supreme Court’s April 2014 decision concerning the Cross-State Air Pollution Rule, implementation timing remained uncertain because the rule was still stayed pending further proceedings.
Most important facts for investors to verify
- Whether the raised $1.60–$1.80 EPS outlook is achieved, and how much first-quarter weather benefits reverse or persist.
- Electric-sector cost recovery, approvals and schedule for the Big Stone AQCS and major transmission projects, including the effect of regulatory proceedings.
- Working-capital conversion and operating cash flow after the Q1 outflow and pension contribution; the funding mix for the multi-year capital program.
- Debt, interest costs, covenant headroom and dividend sustainability. Management noted dividends exceeded net income in four of the previous five years.
- Exposure to legacy product warranties and remediation, construction-contract estimates, and the Coyote Creek mine agreement.