Otter Tail Corporation — Q2 2012 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and six months ended June 30, 2012. Otter Tail operates electric utility and diversified non-electric businesses across Electric, Wind Energy, Manufacturing, Construction and Plastics. Comparisons below are year over year unless stated otherwise. The company cautions that seasonal factors mean interim results are not necessarily indicative of full-year results.
Financial performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Operating revenue | $283.7 million | $283.3 million | $561.3 million | $532.4 million |
| Operating income (loss) | $(23.6) million | $13.4 million | $(6.2) million | $29.0 million |
| Continuing-operations net income (loss) | $(16.9) million | $5.1 million | $(7.4) million | $10.3 million |
| Net income (loss), including discontinued operations | $(17.4) million | $18.8 million | $(10.1) million | $24.5 million |
| Diluted EPS, continuing operations | $(0.48) | $0.14 | $(0.22) | $0.28 |
| Total diluted EPS | $(0.49) | $0.51 | $(0.29) | $0.66 |
Margins. Operating margin was approximately (8.3)% in Q2 2012 versus 4.7% a year earlier; for the first half it was approximately (1.1)% versus 5.4%. The Q2 and first-half operating losses principally reflect a $45.6 million noncash impairment charge for DMI Industries’ assets. The six-month comparison also reflects weaker Construction results and changes in discontinued operations.
Cash flow and capital spending. Six-month operating cash flow was $45.5 million, including $44.1 million from continuing operations, versus $40.7 million total in 2011. Continuing-operations capital expenditures were $69.4 million versus $39.8 million, largely reflecting electric transmission construction. Investing cash flow was $(51.6) million overall, including $24.3 million net proceeds from discontinued-operation sales. Financing cash flow was $(7.9) million. Cash and cash equivalents were zero at June 30, down from $14.7 million at year-end.
Balance sheet, debt and liquidity. Total assets were $1.634 billion, down from $1.701 billion at December 31, 2011. Current assets were $369.5 million and current liabilities $233.4 million. At June 30, short-term debt was $11.3 million, current maturities of long-term debt $50.2 million, and long-term debt net of current maturities $421.8 million. Total debt including current maturities and short-term borrowings was approximately $483.3 million. Common equity was $540.0 million. The company reported $354.8 million available under its $370 million combined credit facilities, after borrowings and letter-of-credit restrictions, and said it was in compliance with debt covenants. Its June 30 long-term debt carrying amount, including current maturities, was approximately $472.0 million versus estimated fair value of $532.9 million.
Dividends declared were $0.2975 per common share in Q2 and $0.5950 for the first half, unchanged from 2011. The indicated annual dividend was $1.19 per share. Management noted that dividends had exceeded net income in each of the prior four years and said future dividends depend on financial condition, earnings, cash flows, capital needs and other factors.
Material changes and segment performance
- Electric: Revenue was nearly flat for the first half at $169.0 million, while segment earnings available for common shares declined to $16.2 million from $18.5 million. Milder weather reduced retail sales volumes; scheduled Coyote and Big Stone outages reduced generation and increased purchased-power needs. Transmission tariff revenues rose with investment, including CapX2020 projects.
- Wind Energy: First-half revenue rose to $114.7 million from $102.0 million, but the segment recorded an operating loss of $38.4 million, including the DMI impairment. Reduced industry demand, the idling of DMI’s Canadian plant and uncertainty over renewal of the federal Production Tax Credit (PTC) affected the business.
- Manufacturing: First-half revenue increased 15% to $129.6 million, but operating income declined to $10.4 million from $11.2 million as costs and operating expenses rose. Management cited improved BTD demand, but weaker ShoreMaster commercial sales and relocation costs.
- Construction: First-half revenue fell 15% to $73.6 million and the segment recorded a $9.3 million operating loss, versus $0.2 million operating income. Foley’s lower work volume and cost overruns on major projects were key factors; Aevenia’s electrical work increased.
- Plastics: First-half revenue increased 21.5% to $76.4 million and operating income rose to $12.9 million from $5.6 million, supported by higher PVC pipe volumes and prices.
- Dispositions: Aviva’s assets were sold in January 2012 and DMS was sold in February 2012. The 2011 comparative results were reclassified for discontinued operations. In June, Otter Tail entered a nonbinding letter of interest to sell DMI’s fixed assets for $20 million and retain its working capital, approximately $66 million at June 30. DMI was still reported in continuing operations pending completion of its 2012 backlog.
Outlook, commentary and risks
- Management reduced 2012 continuing-operations diluted EPS guidance to $0.84–$1.09 from $1.05–$1.40. The revised range includes a $0.22-per-share after-tax charge for the July debt retirement. Management expected Electric earnings to remain within prior guidance, lower Manufacturing and Construction results, and improved Plastics results. DMI was expected to be classified as discontinued operations after its backlog is completed; DMI’s remaining-2012 backlog was $70 million.
- Expected 2012 capital expenditures were $125–$135 million, compared with $74 million in 2011, including Big Stone air-quality controls, MISO multi-value transmission projects and CapX2020 investments. These projects entail regulatory, execution and funding risks.
- On July 13, 2012, the company repaid a $50 million, 8.89% note using its revolving credit facility. The $63.0 million payment included principal, accrued interest and a $12.5 million negotiated premium. The premium and $0.6 million of unamortized debt expense were expected to reduce 2012 diluted EPS by $0.22; management expects lower interest costs in future periods. Available corporate credit-facility capacity fell to $139.3 million at July 31.
- Management identified the wind industry’s dependence on incentives, particularly the PTC scheduled to expire December 31, 2012, as a risk to DMI demand and asset value. If the proposed DMI sale does not close, the company plans to finish the backlog, close its West Fargo and Tulsa plants and sell the fixed assets.
- Other disclosed risks include construction overruns and possible liquidated damages, product warranty and remediation claims, environmental requirements and related capital spending, utility rate-recovery and permitting outcomes, pension funding, commodity-price volatility, PVC resin supply, interest and foreign-exchange exposure, and access to capital. The filing states that significant listed contingencies, if all incurred, could reach $7.0 million; management considers pending litigation resolution not material.
- The company reported a $10 million discretionary pension contribution in January. It also said additional equity or debt financing may be needed during 2012–2016 for utility investment or other corporate purposes. Management asserted that liquidity was adequate for operations and planned expenditures, while noting that future dividends depend on earnings and other financial conditions.
Most important facts for investors to verify
- Whether the DMI asset sale closes on the anticipated terms and timing, whether DMI completes its backlog, and whether further impairment or closure costs arise.
- Whether the PTC is extended and how any change affects wind-tower demand, DMI’s value and the company’s updated guidance.
- Construction-segment project performance, especially Foley cost overruns, and whether management’s revised segment outlook is achieved.
- Funding and execution of the $125–$135 million 2012 capital program, including Big Stone AQCS and transmission projects, and resulting rate recovery.
- Post-July debt and liquidity: the note repayment was funded with revolver borrowings; verify subsequent debt levels, facility availability, covenant headroom and refinancing needs.
- Operating cash generation, the sustainability of the $1.19 indicated annual dividend, and whether earnings and cash flows support it.
- Potential additional warranty, environmental, litigation, tax or pension liabilities, and collection of regulatory and contract-related receivables.