Business context and reporting period
Otter Tail Corporation filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2010. The diversified company operates an electric utility and businesses in plastics, manufacturing, health services, food ingredient processing and other operations. Amounts below are in millions of dollars unless stated otherwise.
Financial performance and position
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Revenue | $280.7 | $257.4 | $813.0 | $781.5 |
| Operating income | $14.8 | $17.5 | $17.7 | $32.3 |
| Operating margin | 5.3% | 6.8% | 2.2% | 4.1% |
| Net income (loss) | $6.1 | $10.6 | $(3.4) | $17.7 |
| Diluted EPS | $0.16 | $0.29 | $(0.11) | $0.48 |
| Dividends per common share | $0.2975 | $0.2975 | $0.8925 | $0.8925 |
- Nine-month operating cash flow was $60.9, down from $140.6; capital expenditures were $62.9, versus $150.1. Investing cash outflow was $61.8. Financing cash outflow was $3.3.
- Cash and cash equivalents were zero at September 30, 2010, compared with $4.4 at year-end 2009. Current assets were $361.3 and current liabilities $246.2.
- Short-term debt was $94.0; long-term debt including current maturities was approximately $436.2, for total short- and long-term debt of $530.2. Total capitalization was $1,088.3. The company had $273.9 of availability under its $370.0 revolving facilities, net of outstanding letters of credit.
- Debt increased primarily through short-term borrowing used for capital needs, a $20.0 pension contribution and early retirement of long-term debt. The $20.0 pension contribution is expected to generate an additional approximately $8.0 tax refund; the refund had not been received by the report date.
Material changes versus the prior comparable period
- Revenue grew 9.0% in Q3 and 4.0% year to date, but operating income and earnings declined. Year-to-date results include a $19.7 ShoreMaster impairment charge; management attributed approximately $15.6 of the year-to-date net loss to the impairment’s after-tax effect.
- Electric segment earnings improved: retail and wholesale revenues increased with higher electric sales, rate adjustments and greater generation. Higher fuel, operating and depreciation costs partly offset the gains.
- Manufacturing was the largest pressure point. Its nine-month operating loss was $28.1, including the impairment; lower DMI and ShoreMaster revenues and additional DMI tower production costs weighed on performance.
- Health Services revenue fell 12.3% for nine months as scans declined, but the segment returned to a small operating profit as it reduced equipment rental costs and resized its imaging fleet. Other Business Operations revenue rose 21.7%, while the segment remained loss-making year to date.
- Interest expense increased to $27.7 for nine months from $20.3, reflecting higher average debt and rates and lower capitalized interest. Operating cash flow fell largely because receivables increased by $49.0, compared with a $30.0 decrease in the prior-year period.
Guidance, outlook, risks and contingencies
- Management narrowed 2010 diluted EPS guidance to $0.70–$0.85, excluding $0.49 per share of first-half impairment and health-care-reform charges; the corresponding GAAP range is $0.21–$0.36. Management expected results below the midpoint of the narrowed range. The prior adjusted guidance range was $0.70–$1.00.
- Management cited near-term challenges at DMI, including extra costs to meet a customer’s new tower specifications, deferred deliveries into 2011 and lower-than-expected wind-tower demand. Manufacturing backlog for the remainder of 2010 was about $56, versus $61 a year earlier.
- OTP’s Minnesota rate case requested an 8.0% final increase, or about $10.6 annual revenue; an interim 3.8% increase was in effect pending a decision expected by May 2011. OTP also filed a South Dakota case seeking about $2.8 annual revenue. Rate outcomes and potential refunds remain relevant.
- OTP had $8.0 of Big Stone II costs not yet approved for recovery and deferred their expense recognition pending regulatory decisions. North Dakota approved recovery of its share; Minnesota and South Dakota recovery remained pending. Denial could result in expense recognition.
- New regulatory and project exposures include EPA-required air-control equipment at Big Stone, CapX2020 transmission commitments and construction, and ongoing exposure to environmental rules, energy-market volatility, commodity costs, customer concentration, pension funding, and access to financing. The filing states the company was in compliance with debt covenants; consolidated interest coverage was 1.61x, near the 1.50x minimum.
- The Sierra Club Big Stone lawsuit was dismissed and the dismissal affirmed on appeal; the deadline for seeking U.S. Supreme Court review was November 10, 2010. The filing says the ultimate outcome could not then be determined. Other ordinary-course legal matters were not expected to have a material adverse effect.
- The company said it had adequate liquidity and resources for operations and planned capital spending, but anticipated that equity or debt financing could be needed during 2011–2014 for electric expansion and other purposes. Its current indicated annual dividend was $1.19 per share; future dividends depend on financial condition, cash flow, capital spending and other factors.
Most important facts for investors to verify
- Whether DMI’s customer delivery delays, added production costs and lower wind-tower demand persist, and whether results meet the revised EPS guidance.
- Final outcomes and timing of the Minnesota and South Dakota rate cases, including any interim-rate refunds.
- Regulatory recovery of remaining Big Stone II costs and the scale and recoverability of Big Stone air-control spending.
- Working-capital conversion, cash generation, short-term borrowing levels and covenant headroom, particularly against the 1.50x coverage threshold.
- Whether ShoreMaster’s impairment signals continued weakness and whether further impairment at BTD or other businesses becomes necessary.
- Capital needs, pension funding, dividend sustainability and access to financing amid planned electric investments and regulatory or market risks.