Otter Tail Corporation — Q1 2011 Form 10-Q
Business context and period. Unaudited results cover the three months ended March 31, 2011, compared with Q1 2010. Otter Tail operates an electric utility and diversified businesses across wind energy, manufacturing, construction, plastics and health services. Food Ingredient Processing was presented as discontinued operations following the subsequent sale of Idaho Pacific Holdings (IPH), completed May 6, 2011.
Financial performance and position
| Metric | Q1 2011 | Q1 2010 |
|---|---|---|
| Operating revenue | $286.7 million | $243.7 million |
| Operating income | $13.2 million | $14.0 million |
| Income from continuing operations | $3.9 million | $3.3 million |
| Net income | $5.7 million | $4.7 million |
| EPS from continuing operations, diluted | $0.10 | $0.09 |
| Total diluted EPS | $0.15 | $0.13 |
| Operating cash flow | $7.0 million | $(22.7) million |
| Capital expenditures | $24.0 million | $17.7 million |
Revenue increased 17.6%, led by nonelectric businesses; operating income declined as expense growth outpaced revenue growth. Net income included $1.8 million from discontinued operations. The continuing-operations effective tax rate was 9.5%, versus 33.3%, reflecting prior-year tax legislation charges and higher wind production tax credits, partly offset by deferred Canadian wind-tower tax benefits.
At March 31, total assets were $1.80 billion; short-term debt was $117.0 million and long-term debt, net of current maturities, was $436.1 million. Cash was $0.2 million. Revolving credit facilities totaled $370 million, with $250.3 million available after borrowings and letters of credit. The company reported $553.7 million of total short- and long-term debt, including current maturities. Interest-bearing debt-to-capitalization was 0.46 for the consolidated company; management reported compliance with debt covenants. Common dividends were $0.2975 per share, unchanged year over year.
Material changes and segment results
- Electric operating income rose to $18.5 million from $17.5 million. Colder weather lifted retail sales, while lower wholesale prices and reduced energy-trading gains offset some growth. A $2.3 million estimated Minnesota interim-rate refund was accrued in Q1.
- Wind Energy moved to an $8.8 million operating loss from $1.6 million of income. Tower production constraints, inefficiencies and quality costs at DMI, plus cost overruns on a major trucking contract, materially weakened results.
- Manufacturing operating income improved to $5.1 million from a $0.1 million loss, mainly on higher customer demand and sales volume. Construction’s operating loss narrowed to $0.3 million from $2.4 million as project activity increased.
- Plastics shifted to a $0.3 million operating loss from $1.6 million of income, with PVC pipe volume down 18.1%. Health Services returned to $1.1 million of operating income from a $0.9 million loss, aided by lower equipment rental costs following fleet reductions.
- Operating cash flow from continuing operations improved to $4.2 million from cash use of $21.2 million, principally due to more favorable working-capital movements, including lower growth in DMI costs in excess of billings. Investing cash use rose to $23.6 million, largely reflecting utility transmission construction.
Outlook, commentary and key risks
Management’s updated 2011 diluted EPS guidance is $1.00–$1.40 from continuing operations, plus $0.06–$0.07 from discontinued operations through the IPH sale and an estimated $0.35–$0.38 gain on sale, for total EPS guidance of $1.41–$1.85. The filing cautions that first-quarter results are seasonal and are not necessarily indicative of full-year results.
Guidance was raised for Electric and Manufacturing but reduced substantially for Wind Energy. Management expects utility earnings to benefit from sales growth, rate recovery and planned investment; it expects continued improvement in Manufacturing, Construction and Health Services. Wind Energy guidance reflects DMI production and cost challenges and Wylie project overruns. Backlogs were $134 million for Wind Energy, $87 million for Manufacturing and $105 million for Construction.
The May 6 IPH sale generated $83.8 million of cash net of escrow, and proceeds were used to reduce short-term borrowings. Management described the divestiture as a portfolio and liquidity decision, with utility investment expected to replace the divested earnings over time. The company disclosed planned capital expenditures of $107 million in 2011, $171 million in 2012 and $267 million in 2013; electric utility average rate base was projected to rise from $651 million in 2011 to $876 million in 2013.
- Major investment and regulatory exposure: Big Stone Plant air-quality controls were estimated at approximately $490 million in total, with Otter Tail’s share about $264 million. Timing, cost recovery and regulatory approvals remain important.
- Rate matters: Minnesota’s April 2011 rate-case order followed the quarter-end and included an estimated interim-rate refund; OTP expected to distribute refunds in Q4 2011 and intended to seek reconsideration on certain issues. South Dakota interim rates were approved, with final rates expected June 1, 2011.
- Project and contract risks: Wind tower production constraints, fixed-price contract execution, input-cost volatility and potential warranty or remediation claims could affect results. Wind towers depend substantially on a few significant customers.
- Liquidity and capital needs: Management said liquidity was adequate, but noted expected equity or debt financing needs during 2011–2015 for utility investment and other purposes. The dividend payout ratio exceeded 100% in each of the prior three years; future dividends depend on earnings, cash flow, capital spending and covenant restrictions.
- Other exposures: Variable-rate borrowings, energy-market and counterparty risks, environmental regulation, pension and postretirement obligations, and uncertain recovery of regulatory assets are disclosed risks. A Leech Lake Band petition sought suspension or revocation of a transmission-project route permit; the project owners opposed the request and filed a federal declaratory judgment action.
Management concluded disclosure controls were effective as of March 31, 2011 and reported no material change in internal control over financial reporting during the quarter. The company stated that pending ordinary-course litigation was not expected to have a material adverse effect.
Important facts for investors to verify
- Whether the Minnesota rate order, refund estimate and any reconsideration change the timing or amount of utility revenue and customer refunds.
- Whether DMI resolves production and quality constraints and whether Wind Energy can meet its revised loss guidance and backlog commitments.
- Actual IPH sale proceeds after post-closing adjustments and escrow claims, and the amount of debt reduction achieved with the proceeds.
- Funding, regulatory recovery and schedule for planned electric capital spending, especially the Big Stone air-quality project and CapX2020 transmission projects.
- Whether operating cash flow, available credit and covenant headroom remain sufficient to fund investment plans and support the dividend.