Otter Tail Corporation — FY2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011. This is an annual report, not a standalone fourth-quarter filing. Figures below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise. Comparative results were recast to present businesses sold or held for sale as discontinued operations.
Business context
Otter Tail operates a regulated electric utility serving Minnesota, North Dakota and South Dakota, alongside Wind Energy, Manufacturing, Construction and Plastics businesses. Its strategy is to reduce portfolio risk and direct more resources to the utility; management expects the utility to contribute 75%–85% of earnings over time. The company sold food ingredients processor IPH and trucking business Wylie in 2011, sold Aviva assets in January 2012, and agreed in February 2012 to sell DMS Health Technologies, subject to closing conditions.
Financial performance and position
| Metric | FY2011 | FY2010 |
|---|---|---|
| Operating revenue | $1,077.9 million | $892.2 million |
| Operating income | $52.3 million | $24.1 million |
| Continuing-operations net income (loss) | $17.1 million | ($10.8 million) |
| Net income (loss), including discontinued operations | ($13.2 million) | ($1.3 million) |
| Diluted EPS from continuing operations | $0.45 | ($0.32) |
| Diluted EPS, total | ($0.40) | ($0.06) |
| Operating cash flow, continuing operations | $79.7 million | $94.1 million |
| Capital expenditures, continuing operations | $73.7 million | $61.5 million |
Revenue rose 20.8%, driven by higher sales in Wind Energy, Manufacturing, Construction and Plastics; electric revenue was nearly flat. Operating margin was approximately 4.9%, versus 2.7% in 2010. Continuing-operations net margin was approximately 1.6%, compared with a loss in 2010. The company’s total net loss chiefly reflects discontinued operations, including a $56.4 million pretax impairment of DMS; discontinued operations recorded a net loss of $30.4 million overall.
Segment highlights: Electric net income increased 12.5% to $38.9 million; Manufacturing swung to $7.6 million net income from a $14.0 million loss, which included a 2010 impairment; Plastics net income rose 131.1% to $5.8 million. Wind Energy recorded a $21.9 million net loss, including a $3.1 million pretax impairment for its idled Fort Erie plant. Construction reported a $2.2 million net loss, compared with a $0.6 million loss.
Cash from continuing operations fell $14.4 million, primarily because 2010 included $54.3 million in income-tax refunds, versus $0.3 million in 2011. Year-end cash was $14.7 million. Long-term debt was $471.9 million, with no short-term debt outstanding; unused credit availability was $364.7 million. Interest-bearing debt was 45% of total capitalization on a consolidated basis. The company reported compliance with debt covenants. Common dividends remained $1.19 per share, despite losses in total reported earnings.
Material changes and unusual items
- In December 2011, OTP issued $140 million of 4.63% senior notes due 2021. Proceeds helped refinance $90 million of 6.63% notes and retire $10.4 million of pollution-control bonds, repay short-term debt and fund a $10 million pension contribution made in January 2012.
- 2011 sales proceeds included approximately $87 million for IPH and $25 million for Wylie. IPH proceeds were used to reduce borrowings; Wylie proceeds were designated for general corporate purposes. The DMS sale agreement contemplated $30 million in cash and triggered the impairment noted above.
- The 2011 effective tax rate on continuing operations was 10.9%; federal production tax credits of $7.3 million reduced tax expense. Canadian operating losses at DMI did not produce recognized tax savings.
- The pension plan’s funded status weakened: its deficit increased to $77.5 million from $45.7 million, largely reflecting actuarial losses and a lower year-end discount rate. Management made a $10 million discretionary contribution in January 2012.
Outlook, risks and contingencies
Management forecast 2012 diluted EPS of $1.00–$1.40 and expects modestly higher Electric earnings, a significant Wind Energy improvement, improved Manufacturing and Construction earnings, and slightly lower Plastics earnings. The outlook assumes an economic recovery and execution of planned cost and operating improvements; DMI still faced pricing pressure, and potential warranty, remediation or liquidated-damages exposure remained.
Planned 2012–2016 capital expenditures are approximately $846 million, including $730 million for Electric. Major utility investments include an estimated $265 million OTP share of the Big Stone air-quality control system and $226 million for transmission projects. The filing gives 2012 capital expenditure estimates of $125–$135 million in the outlook, $137 million in the capital-requirements discussion and $137 million in the segment forecast table; these figures are not reconciled in the provided text.
- Environmental and regulatory exposure: Big Stone’s required air-quality controls were estimated at about $490 million total, or $265 million OTP share. Final EPA approval of South Dakota’s regional-haze plan and a North Dakota prudence determination were pending. Other uncertain rules involve power-plant air toxics, water intake and coal ash; the filing cites a possible $5.75 million annual Big Stone cost under the most costly coal-ash option.
- Transmission cost allocation: MISO’s multi-value project cost allocation was under appeal. A change could leave OTP bearing a disproportionate share of costs that might not be recoverable.
- Fuel and supply: OTP had about 75% of 2012 Big Stone and Hoot Lake coal needs contracted, but no coal contracts for 2013 and beyond at year-end. Coal, rail transport and wholesale power costs, plant outages and market prices could affect results.
- Business concentration and execution: Two customers accounted for over 85% of Wind Energy segment revenue. Plastics relied on two vendors for approximately 97% of resin purchases. Fixed-price contract overruns, warranty claims, volatile input costs and weak demand are additional risks.
- Liquidity and dividends: Management considered liquidity adequate, but expects debt or equity financing may be required for the capital plan. Dividends exceeded earnings in each of the prior four years; future payments depend on earnings, cash flow, investment needs and credit restrictions.
- The company disclosed ordinary-course litigation and other contingencies, including warranty, environmental, tax and liquidated-damages matters; management said currently pending litigation was not expected to have a material consolidated effect. It cited a potential loss range as high as $9 million for specified contingencies.
The independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting; management also concluded disclosure controls were effective.
Most important facts for investors to verify
- Whether the DMS transaction closed on the expected timetable and the final proceeds, adjustments and discontinued-operations impact.
- How the $39.1 million after-tax DMS impairment and other discontinued-operation results affect normalized earnings and the continuing business.
- The actual 2012 capital budget and reconciliation of the filing’s differing $125–$135 million and $137 million estimates, plus financing needs and rate recovery for major utility projects.
- Final environmental requirements, Big Stone control-system cost and schedule, and the outcome of MISO transmission-cost allocation litigation.
- Whether 2012 EPS guidance is achieved, particularly DMI’s recovery, backlog conversion and exposure to customer concentration, warranty and remediation claims.
- The sustainability of the $1.19 annual common dividend given the loss history, capital program, pension funding and reliance on subsidiary cash flows.