Otter Tail Corporation (Nasdaq: OTTR) — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Unaudited consolidated results. Otter Tail operates electric utility, manufacturing and plastics businesses. Management cautions that seasonality means interim earnings should not be taken as an indication of full-year results.
Key financial results
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Operating revenue | $229.2m | $226.3m | $475.2m | $467.6m |
| Operating income | $26.8m | $30.1m | $66.4m | $67.7m |
| Net income | $15.4m | $18.7m | $41.8m | $44.9m |
| Diluted EPS | $0.39 | $0.47 | $1.05 | $1.13 |
| Operating margin | 11.7% | 13.3% | 14.0% | 14.5% |
Cash flow, six months: Operating cash flow was $69.3m, versus $53.4m; capital expenditures were $54.0m, versus $49.1m. Operating cash flow less capital expenditures was approximately $15.3m, versus $4.3m. Financing cash outflow was $13.8m, including $27.9m of dividends paid. Cash at June 30 was $1.0m.
Debt and liquidity at June 30: Short-term borrowings were $36.6m; long-term debt, net, was $590.1m, with $0.2m of current maturities. Total debt including current maturities was approximately $626.8m. Of $300m in revolving credit facilities, $254.6m was available after borrowings and letters of credit. The company reported compliance with debt covenants; debt-to-capitalization was 0.46 consolidated and 0.47 for OTP. Quarterly dividend was raised to $0.35 per share in February 2019.
Material changes and operating drivers
- Q2 revenue rose 1.3%, while operating income fell 10.9% and net income fell 17.5%. For the first half, revenue increased 1.6%, but operating income declined 2.0% and net income declined 7.0%.
- Electric: Q2 segment operating income declined to $15.5m from $18.4m. Coyote Station was offline for an extended maintenance outage, and Hoot Lake had an unplanned turbine-repair outage. Lower generation and replacement-power purchases increased costs; milder Q2 weather also reduced retail demand. First-half electric segment operating income was $45.9m, up from $43.9m.
- Manufacturing: Q2 operating income increased to $5.8m from $5.1m; first-half income rose to $12.6m from $11.0m, with higher BTD sales in several end markets. Higher material costs were largely passed through to customers.
- Plastics: Q2 operating income decreased to $8.0m from $8.6m. First-half operating income fell to $13.2m from $17.9m as PVC pipe sales volumes and prices declined; lower prices outpaced cost reductions and compressed gross margin.
- Q2 electric operating results were affected by reduced wholesale sales and lower fuel costs, offset by higher purchased-power and maintenance costs. The company attributed the Coyote and Hoot Lake outages to maintenance issues.
Outlook, investments and notable items
- Management reaffirmed 2019 diluted EPS guidance of $2.10–$2.25 in its August 5 update. Expected 2019 capital expenditures were $233m, including $79m for Merricourt and $46m for Astoria Station. The five-year 2019–2023 capital plan was increased to $1.105bn; management projects 8.6% compound annual growth in electric rate base from 2018 to 2023.
- Astoria Station, a planned 245-MW gas-fired facility, is expected to cost approximately $158m and be completed before the planned 2021 Hoot Lake retirement. Merricourt, a 150-MW wind project, is expected to cost approximately $270m and be completed in October 2020. OTP closed on Merricourt development assets on July 16, 2019; construction was expected to begin in August.
- The Big Stone South–Ellendale transmission line entered service in February 2019. OTP’s capitalized costs on the project were approximately $106m at June 30.
- Minnesota customers were to receive an $11.5m one-time refund in August 2019 for prior-period Tax Cuts and Jobs Act savings. Management cited expiration of federal wind production tax credits as a factor increasing tax expense and utility revenue-recovery needs.
- South Dakota’s rate settlement set an authorized ROE of 8.75% and includes an earnings-sharing mechanism. A North Dakota generation-cost recovery rider for Astoria took effect on customer bills after July 1, 2019.
- Management said liquidity and financial condition were adequate for operations and planned investment, while noting that equity or debt financing would be needed during 2019–2023 to support utility expansion and other funding needs.
Risks, contingencies and unusual items
- OTP estimated potential exposure of up to $52.2m, its 35% share of unrecovered costs, if the Coyote Station lignite supply arrangement were terminated under specified circumstances involving coal regulation or uneconomic operation.
- A $1.6m liability was recorded for possible refunds related to pending FERC proceedings on MISO transmission return on equity. The amount remains subject to regulatory outcomes.
- Regulatory proceedings include a Minnesota Supreme Court review involving transmission-cost recovery and the outcome of FERC proceedings over MISO transmission ROE. Rate decisions could affect recovery of investments and revenues.
- Environmental regulation, plant outages, energy-market conditions, interest rates, pension and benefit costs, customer concentration, and the availability and price of PVC resin and manufacturing raw materials are identified risks. The EPA’s final Affordable Clean Energy rule was scheduled to take effect September 6, 2019.
- The company adopted lease accounting guidance in 2019, recognizing $19.9m of operating lease liabilities at June 30; adoption did not materially affect income, cash flows, liquidity or covenant compliance. Management reported effective disclosure controls and no material change in internal control over financial reporting.
- Management stated pending litigation and regulatory matters were not expected to materially affect consolidated results, financial position or cash flows; outcomes remain uncertain.
Important facts for investors to verify
- Whether 2019 EPS guidance of $2.10–$2.25 remained achievable given the Coyote and Hoot Lake outages, weather variability, and segment trends.
- Actual project spending, schedule and regulatory cost recovery for Astoria Station and Merricourt, and funding needs under the $1.105bn five-year capital plan.
- Resolution of Minnesota transmission-cost recovery and FERC MISO ROE proceedings, including any changes to the $1.6m refund accrual.
- Whether Plastics pricing, volume and resin-cost trends, and Manufacturing customer demand and scrap prices, develop as management expected.
- Liquidity and leverage as short-term borrowing rises to finance capital expenditures, including compliance with debt covenants and the timing and terms of future financing.