OTTR

Otter Tail Corp. Q1 2010 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2010. Otter Tail Corporation operates as a diversified holding company with segments including Electric (regulated utility), Plastics, Manufacturing, Health Services, Food Ingredient Processing, and Other Business Operations. The company is headquartered in Fergus Falls, Minnesota.

Key Financial Metrics

Note: Operating cash flow turned negative due to significant increases in working capital requirements, specifically costs in excess of billings and accounts receivable.

Material Changes vs. Prior Period

• Revenue Decline: Total revenues decreased 5.4% to $262.2 million, driven primarily by a 18.2% drop in the Manufacturing segment and a 17.5% drop in Other Business Operations due to economic conditions and weather.
• Profitability Improvement: Despite lower revenues, Operating Income increased 85.7% to $16.0 million. This was driven by a 141.4% surge in the Plastics segment (due to higher PVC prices and volume) and a 439.7% improvement in the Manufacturing segment (due to the absence of $1.8 million in product recall costs incurred in Q1 2009).
• Electric Segment: Revenues increased 2.9% due to rate increases in South Dakota and Minnesota, and higher energy trading gains, offset by a 9.6% reduction in heating-degree-days.
• Debt Management: The company retired $58.4 million of long-term debt in Q1 2010 using lower-cost short-term borrowings, increasing short-term debt from $7.6 million to $110.5 million.

Guidance, Outlook, and Risks

• 2010 Guidance: Management reaffirms diluted EPS guidance of $1.00 to $1.40. Consolidated capital expenditures are expected to range from $75 million to $85 million.
• Segment Outlook:
  • Electric: Lower net income expected due to soft wholesale markets and higher O&M costs, partially offset by interim rate increases in Minnesota.
  • Manufacturing: Earnings expected to improve due to better backlog ($217 million) and productivity gains.
  • Health Services: Increased net income expected as the company rightsizes its imaging asset fleet, reducing rental costs.
• Regulatory Risks:
  • Big Stone II: The company withdrew from the Big Stone II project in 2009. $13.2 million in costs are deferred as regulatory assets pending recovery approval from state commissions. If denied, these costs would be expensed immediately.
  • Rate Cases: A general rate case was filed in Minnesota (April 2010) requesting an 8.0% increase. Decisions on renewable resource riders in Minnesota and North Dakota are pending.
• Goodwill Impairment: Management reviewed goodwill for ShoreMaster and BTD. No impairment was recorded in Q1 2010, but continued economic weakness could trigger future charges if cash flow projections are not met.
• Legal Proceedings: The Sierra Club appeal regarding the Big Stone Generating Station is pending oral arguments. A FERC complaint regarding interconnection access was settled in May 2010 with no material financial impact.

Investor Verification Checklist

• Working Capital Trends: Verify the sustainability of the $21 million increase in "Costs and Estimated Earnings in Excess of Billings" and the $20.5 million increase in receivables, which drove the negative operating cash flow.
• Big Stone II Recovery: Monitor regulatory decisions in Minnesota, North Dakota, and South Dakota regarding the recoverability of the $13.2 million in deferred project costs.
• ShoreMaster Performance: Track revenue and margin trends at ShoreMaster to ensure they meet the assumptions used in the goodwill impairment test (40% to 70% capacity utilization).
• Debt Structure: Assess the impact of the shift from long-term to short-term debt on interest rate exposure and liquidity, given the $110.5 million in short-term borrowings.
• Minnesota Rate Case: Follow the outcome of the April 2010 Minnesota general rate case filing, which seeks a $10.6 million annual revenue increase.