Otter Tail Corp annual report, FY2010

Otter Tail Corporation — FY 2010 Form 10-K

Reporting period: Fiscal year ended December 31, 2010; the filing also reports unaudited fourth-quarter results. Otter Tail is a diversified holding company with a regulated electric utility and six nonutility business segments. Segment reporting was realigned in the fourth quarter; prior-period segment figures were revised for comparability. Financial statements received an unqualified audit opinion, and the auditor and management concluded internal control over financial reporting was effective.

Financial performance

Metric	FY 2010	FY 2009
Operating revenue	$1,119.1 million	$1,039.5 million
Operating income	$34.5 million	$45.4 million
Net income (loss)	$(1.3) million	$26.0 million
Diluted EPS	$(0.06)	$0.71
Operating cash flow	$105.0 million	$162.8 million
Capital expenditures	$85.6 million	$177.1 million

• Revenue increased 7.7%, but operating income declined about 24%; operating margin was approximately 3.1% versus 4.4% in 2009. The net loss reflected weaker nonutility results, higher interest expense and tax charges.
• FY segment earnings available for common shares: Electric $34.6 million; Wind Energy loss $21.2 million; Manufacturing loss $14.8 million; Construction loss $0.6 million; Plastics $2.5 million; Health Services $0.2 million; and Food Ingredient Processing $8.0 million.
• Fourth-quarter revenue was $306.0 million versus $258.0 million in Q4 2009; operating income was $16.9 million versus $13.1 million. Net income was $2.1 million versus $8.3 million, and diluted EPS was $0.05 versus $0.23. The filing attributes a $6.6 million increase in income tax expense at DMI’s Canadian operations in Q4 to a deferred-tax valuation allowance and a Canadian tax-rate change.
• Cash from operations fell $57.7 million, reflecting lower deferred-tax-related cash effects, a $20 million pension contribution (versus $4 million in 2009), and working-capital changes. Cash and cash equivalents were zero at year-end; current assets were $369.4 million and current liabilities $264.6 million.
• At year-end, short-term borrowings were $79.5 million and long-term debt was $435.4 million; total debt was approximately $515 million before current-maturity and other presentation details. Available capacity under credit lines was $288.8 million. Consolidated debt-to-capitalization was 0.44; the company reported compliance with debt covenants.
• The common dividend remained $1.19 per share. The dividend payout ratio exceeded 100% in each of the last three years; the company reported a FY 2010 loss.

Material changes and management commentary

• Electric revenue rose on rate and rider recoveries, higher retail commercial sales and greater generation availability. Electric segment earnings increased 2.6% to $34.6 million.
• Wind Energy lost $21.2 million. DMI incurred $16.6 million of additional production costs to meet a customer’s new tower design and delivery schedule; Wylie trucking revenue increased substantially, but associated costs also rose.
• Manufacturing recorded a $19.7 million pretax impairment at ShoreMaster, including full impairment of goodwill and intangible assets and partial impairment of long-lived assets. The company reported the impairment as $15.6 million net of tax.
• Construction revenue increased 29% as activity recovered, but higher costs resulted in a small segment loss. Plastics earnings improved with higher pipe prices and volume; Health Services returned to a small profit after reducing its imaging fleet; Food Ingredient Processing reported record earnings available for common shares.
• Interest expense increased $8.5 million, principally due to the $100 million 9% notes issued in December 2009. Income taxes shifted from a $4.6 million benefit in 2009 to $4.0 million expense in 2010, including a $5.5 million valuation allowance for DMI Canadian loss carryforwards and a healthcare-law-related tax charge.

Outlook, risks and contingencies

• Management forecast 2011 diluted EPS of $1.00–$1.40 and capital expenditures of $100–$110 million. It expected improved Wind Energy, Manufacturing, Construction and Health Services results, with lower Food Ingredient Processing earnings than the 2010 record.
• Planned 2011–2015 capital expenditures total approximately $956 million, including $724 million for Electric. Major items include $264 million for Otter Tail’s share of a Big Stone Plant air-quality control system and $188 million for transmission projects, including $130 million for CapX2020. Future financing is expected to be needed.
• The projected Big Stone air-quality project cost is approximately $490 million overall, or $264 million for Otter Tail. Final regulatory requirements, project cost, timing and recovery through rates remain uncertain. Coyote Station NOx controls are currently estimated at $6 million overall, or $2.1 million for Otter Tail.
• $7.9 million of Big Stone II project costs remained unapproved for recovery at year-end; the North Dakota share was approved for recovery, while Minnesota and South Dakota recovery remained pending. Denial of recovery could require an expense charge.
• Other key risks include environmental rules and costs (including coal ash and greenhouse-gas regulation), utility rate decisions, fuel and purchased-power availability and cost, wholesale market exposure, and large capital needs. Nonutility risks include fixed-price project overruns, customer concentration in wind towers, PVC resin supplier concentration, healthcare reimbursement and compliance changes, and potato supply and foreign-exchange exposure.
• Otter Tail remained involved in FERC proceedings over Revenue Sufficiency Guarantee charges but reported no known liability and could not predict the outcome. The Sierra Club Big Stone lawsuit was dismissed and the dismissal became final in 2010. Management stated other ordinary-course legal matters were not expected to have a material consolidated effect.
• Management stated the company was financially positioned to fund operations, but the dividend’s coverage by earnings, reliance on subsidiary cash flows, and the need for future financing are relevant constraints. The $200 million corporate revolver expires in 2013; OTP’s credit agreement was due for renewal in 2011, with a term sheet signed for a proposed five-year facility.

Important facts for investors to verify

• Progress and final decisions in Minnesota and South Dakota rate cases, including interim-rate refunds and recovery of Big Stone II costs.
• Regulatory approval, final scope, cost, schedule and rate recovery for the Big Stone air-quality system and planned transmission investments.
• Whether 2011 guidance is achieved, particularly the assumed recovery in Wind Energy, Manufacturing and Construction and the expected segment-level performance.
• Cash generation, borrowing levels, covenant headroom and financing required for the $956 million five-year capital program; also assess the sustainability of the $1.19 dividend.
• Whether DMI’s production execution improves and its customer backlog converts to profitable revenue; monitor customer concentration and receivable-funding arrangements.
• Effects of healthcare reimbursement changes on Health Services and supply, pricing and margin volatility in plastics and food processing.