Otter Tail Corporation — Form 10-Q Summary
Business context and period. This unaudited filing covers the three and nine months ended September 30, 2011. Otter Tail operates an electric utility and businesses in wind energy, manufacturing, construction, plastics and health services. Results are seasonal and the company cautions that interim earnings are not necessarily indicative of the remainder of the year.
Financial performance and position
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Operating revenue | $315.8 million | $259.7 million | $914.1 million | $754.0 million |
| Operating income | $17.2 million | $12.0 million | $47.7 million | $11.1 million |
| Operating margin | 5.4% | 4.6% | 5.2% | 1.5% |
| Continuing-operations net income (loss) | $6.9 million | $4.1 million | $18.5 million | $(8.8) million |
| Net income (loss), including discontinued operations | $6.4 million | $6.1 million | $30.9 million | $(3.4) million |
| Diluted EPS, continuing operations / total | $0.18 / $0.17 | $0.11 / $0.16 | $0.50 / $0.83 | $(0.26) / $(0.11) |
Revenue growth was concentrated in nonelectric businesses: nine-month nonelectric revenue rose to $659.5 million from $495.9 million, while electric revenue declined to $254.6 million from $258.1 million. The prior-year comparison includes a $19.7 million manufacturing asset impairment charge; its absence materially helped the year-to-date operating-income improvement. Nine-month discontinued-operations income included a $12.8 million after-tax gain on the Idaho Pacific Holdings (IPH) sale.
- Cash flow: Nine-month operating cash flow was $80.4 million, compared with $60.9 million; continuing operations provided $78.0 million. Capital expenditures were $71.3 million. Investing activities provided net cash of $10.2 million, including $84.3 million of net proceeds from discontinued operations, principally the IPH sale. Financing activities used $83.7 million.
- Liquidity: September 30 cash was $6.6 million; current assets were $371.7 million and current liabilities $215.9 million. Of $370 million in revolving credit facilities, $328.6 million was available after borrowings and letter-of-credit restrictions. Management said liquidity was adequate and reported compliance with debt covenants.
- Debt and equity: Short-term debt was $39.1 million; current maturities of long-term debt were $3.3 million; long-term debt, net of current maturities, was $433.5 million. Total short- and long-term debt including current maturities was $475.8 million, down from $514.9 million at December 31, 2010. Consolidated interest-bearing debt to total capitalization was 0.43:1. The quarterly common dividend remained $0.2975 per share; the filing notes the dividend payout ratio exceeded 100% in each of the prior three years.
Material changes and management commentary
- Q3 consolidated revenue increased 21.6% year over year, mainly from higher wind-tower, construction, manufacturing and plastics activity. Electric revenue fell 4.6%; retail kilowatt-hour sales declined 1.0% and wholesale sales were lower.
- For the first nine months, manufacturing returned to operating income of $13.7 million from a $17.2 million loss, partly reflecting the absence of the prior-year impairment. Construction revenue grew 65.0%, but operating income was only $0.1 million; Foley recorded $0.8 million of Q3 cost overruns on one large project. Plastics operating income increased to $9.3 million. Health Services revenue fell 7.9%, while operating income improved to $2.6 million partly through lower equipment rental costs.
- Wind Energy remained loss-making: its nine-month operating loss widened to $15.2 million from $9.8 million, despite higher tower production and revenue. Management cited rework, underused capacity, higher quality-control and steel costs, and trucking cost increases. Wind Energy backlog was $33 million for 2011, versus $23 million a year earlier.
- IPH was sold in May 2011 for approximately $87 million cash; net proceeds were used to reduce borrowings. Wylie exited its wind-heavy-haul business, which is reported as discontinued operations. Management described the IPH sale as part of a strategy to shift the business mix toward the utility and fund utility investment.
- Otter Tail Power’s Minnesota rate order took effect October 1, 2011. The authorized base-revenue increase was approximately $5 million, with an overall customer increase of about 1.6%; a $3.9 million interim-rate refund, including interest, was issued October 31. South Dakota final rates provided an increase of approximately $643,000.
Outlook, risks and unusual items
- Updated 2011 EPS guidance: Continuing operations $0.48–$0.85 per share; total including discontinued operations $0.77–$1.19. Previous total guidance was $0.72–$1.30. Updated segment ranges include Electric $1.05–$1.10, Wind Energy loss of $0.70–$0.55, Manufacturing $0.23–$0.28, Construction $0.00–$0.03, Plastics $0.12–$0.15, Health Services $0.01–$0.05 and Corporate loss of $0.23–$0.21.
- Management expects utility earnings to benefit from rate recovery, sales growth and investment. Planned total capital expenditures are $107 million in 2011, rising to $267 million in 2013, including significant transmission and environmental spending. Average electric rate base is projected to increase from $651 million in 2011 to $1.299 billion in 2015.
- OTP agreed to issue $140 million of 4.63% senior notes due 2021, expected to close December 1, 2011. Proceeds are intended in part to refinance $90 million of 6.63% notes due December 2011 and $10.4 million of pollution-control bonds, and to repay short-term debt.
- The Big Stone Plant air-quality-control project was estimated at approximately $490 million, with OTP’s share about $264 million. Regulatory prudence proceedings were pending, and the plant was reported to meet then-current emissions standards. The project is a significant capital and regulatory exposure.
- Management warned of possible future goodwill impairment for Wylie’s continuing trucking operations and Health Services, though neither was included in current guidance. DMI continues to face pricing pressure and potential liquidated damages, warranty and remediation claims. Warranty remediation costs could be substantial; the filing says the range of loss for significant contingencies could be as high as $9 million, while also noting that larger or undiscovered claims are possible.
- Other risks include access to capital and borrowing costs, environmental regulation, utility cost recovery, energy-market and counterparty exposure, commodity prices, construction-contract overruns, and uncertainty in wind and health-services markets. Management reported no material adverse effect expected from pending ordinary-course litigation.
Important facts for investors to verify
- Whether the 2021 notes closed as planned and whether refinancing reduced near-term debt and interest costs.
- Actual 2011 results versus the updated EPS guidance, especially wind losses, construction project costs and discontinued-operation items.
- Progress, final cost allocation and regulatory recovery for the Big Stone environmental project and planned utility transmission investments.
- Whether DMI warranty, remediation or liquidated-damages exposure, or possible Wylie and Health Services goodwill impairment, results in additional charges or cash outflows.
- Dividend sustainability given the history of payout ratios above 100%, planned capital spending and reliance on external financing.