SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-368
OTTER TAIL POWER COMPANY
(Exact name of registrant as specified in its charter)
Minnesota 41-0462685
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
215 South Cascade Street, Box 496, Fergus Falls, Minnesota 56538-0496
(Address of principal executive offices) (Zip Code)
218-739-8200
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES X NO
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date:
July 30, 1999 - 11,924,123 Common Shares ($5 par value)
OTTER TAIL POWER COMPANY
------------------------
INDEX
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Part I. FINANCIAL INFORMATION Page No.
Item 1. Financial Statements
Consolidated Balance Sheets - June 30, 1999 (Unaudited)
and December 31, 1998 2 & 3
Consolidated Statements of Income - Three and Six Months
Ended June 30, 1999 and 1998 (Unaudited) 4
Consolidated Statements of Cash Flows - Six Months
Ended June 30, 1999 and 1998 (Unaudited) 5
Notes to Consolidated Financial Statements (Unaudited) 6-8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9-16
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 16
Part II. OTHER INFORMATION
Item 2. Changes in Securities 16
Item 3. Legal Proceedings 16
Item 4. Submission of Matters to a Vote of Security Holders 16-17
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURES 17
PART I. FINANCIAL INFORMATION
------------------------------
ITEM 1. FINANCIAL STATEMENTS
--------------------
OTTER TAIL POWER COMPANY
CONSOLIDATED BALANCE SHEETS
-ASSETS-
JUNE 30, DECEMBER 31,
1999 1998
----------- ------------
(Unaudited)
(Thousands of dollars)
PLANT:
Electric plant in service $ 768,818 $ 770,887
Subsidiary companies 92,562 89,094
---------- ----------
TOTAL 861,380 859,981
Less accumulated depreciation and amortization 379,627 370,290
---------- ----------
481,753 489,691
Construction work in progress 15,973 10,495
---------- ----------
NET PLANT 497,726 500,186
INVESTMENTS 25,360 20,612
---------- ----------
INTANGIBLES -- net 20,421 21,176
---------- ----------
OTHER ASSETS 5,456 3,968
---------- ----------
Current assets:
Cash and cash equivalents 14,651 3,919
Accounts receivable:
Trade - net 40,650 41,249
Other 3,566 6,845
Materials and supplies:
Fuel 2,897 3,418
Inventory, materials and operating supplies 27,511 23,138
Deferred income taxes 3,026 2,730
Accrued utility revenues 7,264 11,179
Other 6,487 6,310
---------- ----------
TOTAL CURRENT ASSETS 106,052 98,788
---------- ----------
DEFERRED DEBITS:
Unamortized debt expense and reacquisition premiums 3,494 3,737
Regulatory assets 3,518 3,774
Other 1,415 3,371
---------- ----------
TOTAL DEFERRED DEBITS 8,427 10,882
---------- ----------
TOTAL $ 663,442 $ 655,612
========== ==========
See accompanying notes to consolidated financial statements
-2-
OTTER TAIL POWER COMPANY
CONSOLIDATED BALANCE SHEETS
-LIABILITIES-
JUNE 30, DECEMBER 31,
1999 1998
---------- -----------
(Unaudited)
(Thousands of dollars)
CAPITALIZATION
Common shares, par value $5 per share - authorized
50,000,000 shares; outstanding 1999 -- 11,924,123
and 1998 -- 11,879,504 shares $ 59,621 $ 59,398
Premium on common shares 41,406 39,919
Retained earnings 128,893 125,462
Accumulated other comprehensive income 610 297
---------- ----------
TOTAL 230,530 225,076
Cumulative preferred shares - authorized 1,500,000
shares without par value; outstanding 1999
and 1998, 388,311 shares
Subject to mandatory redemption 18,000 18,000
Other 15,500 20,831
Cumulative preference shares - authorized 1,000,000
shares without par value; outstanding - none - -
Long-term debt 181,326 181,046
---------- ----------
TOTAL CAPITALIZATION 445,356 444,953
---------- ----------
CURRENT LIABILITIES
Short-term debt - 824
Sinking fund requirements and current maturities 15,062 5,794
Accounts payable 30,055 32,411
Accrued salaries and wages 3,506 3,946
Federal and state income taxes accrued 6,624 2,192
Other taxes accrued 8,696 11,119
Interest accrued 3,099 3,120
Other 3,818 3,826
---------- ----------
TOTAL CURRENT LIABILITIES 70,860 63,232
---------- ----------
NONCURRENT LIABILITIES 24,695 22,842
---------- ----------
DEFERRED CREDITS
Accumulated deferred income taxes 89,813 90,964
Accumulated deferred investment tax credit 16,899 17,481
Regulatory liabilities 11,312 11,692
Other 4,507 4,448
---------- ----------
TOTAL DEFERRED CREDITS 122,531 124,585
---------- ----------
TOTAL $ 663,442 $ 655,612
========== ==========
See accompanying notes to consolidated financial statements
-3-
OTTER TAIL POWER COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1999 1998 1999 1998
-------------- ------------- ------------- -------------
(in thousands, except share and per share amounts)
OPERATING REVENUES
Electric $ 55,232 $ 53,078 $ 117,951 $ 109,624
Manufacturing 25,305 24,674 43,900 42,805
Health services 16,049 17,773 33,564 33,072
Other business operations 14,972 11,421 27,482 18,354
------------- ------------- ------------- -------------
Total operating revenues 111,558 106,946 222,897 203,855
OPERATING EXPENSES
Production fuel 9,487 9,311 19,251 18,179
Purchased power 11,473 8,730 23,365 16,987
Other electric operation and maintenance expenses 17,042 17,318 34,793 36,288
Special charges - - - 9,522
Cost of goods sold 41,864 38,799 78,576 67,405
Other nonelectric expenses 8,769 8,980 17,193 16,747
Depreciation and amortization 6,269 6,353 12,509 12,841
Property taxes 2,803 2,770 5,658 5,643
------------- ------------- ------------- -------------
Total operating expenses 97,707 92,261 191,345 183,612
OPERATING INCOME
Electric 8,986 9,455 24,022 14,523
Manufacturing 2,222 2,858 3,196 4,123
Health services 1,357 1,672 3,263 3,799
Other business operations 1,286 700 1,071 (2,202)
------------- ------------- ------------- -------------
Total operating income 13,851 14,685 31,552 20,243
OTHER INCOME AND DEDUCTIONS - NET 1,070 1,265 1,412 1,707
INTEREST CHARGES 3,728 4,098 7,347 8,047
------------- ------------- ------------- -------------
INCOME BEFORE INCOME TAXES 11,193 11,852 25,617 13,903
INCOME TAXES 4,047 3,837 9,222 3,949
------------- ------------- ------------- -------------
Income before cumulative effect of change in accounting principle 7,146 8,015 16,395 9,954
Cumulative effect of change in accounting principle - net-of-tax - - - 3,819
------------- ------------- ------------- -------------
NET INCOME 7,146 8,015 16,395 13,773
Preferred dividend requirements 589 589 1,179 1,179
------------- ------------- ------------- -------------
EARNINGS AVAILABLE FOR COMMON SHARES $ 6,557 $ 7,426 $ 15,216 $ 12,594
============= ============= ============= =============
Basic and diluted earnings per average common share:
Before cumulative effect of change in accounting principle $ 0.55 $ 0.63 $1.28 $ 0.75
Cumulative effect of change in accounting principle - - - 0.32
------------- ------------- ------------- -------------
Basic and diluted earnings per average common share - net $ 0.55 $ 0.63 $ 1.28 $ 1.07
============= ============= ============= =============
Average number of common shares outstanding 11,922,596 11,777,247 11,906,252 11,758,856
Dividends per common share $0.495 $0.480 $0.990 $0.960
See accompanying notes to consolidated financial statements
-4-
OTTER TAIL POWER COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
SIX MONTHS ENDED
JUNE 30
1999 1998
---------- ---------
(Thousands of dollars)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 16,395 $ 13,773
Adjustments to reconcile net income to net cash
Provided by operating activities:
Depreciation and amortization 17,719 17,802
Deferred investment tax credit - net (582) (588)
Deferred income taxes (1,762) (6,285)
Change in deferred debits and other assets 536 (367)
Change in noncurrent liabilities and deferred credits 1,911 865
Allowance for equity (other) funds used during constructio (29) (61)
(Gains)/Losses from investments and disposal of noncurrent 36 315
Voluntary early retirement program charges - 6,305
Cumulative effect of change in accounting principle - (3,819)
Asset impairment losses - 3,217
Cash provided by (used for) current assets & current liabilities:
Change in receivables, materials and supplies 50 (3,012)
Change in other current assets 3,715 (1,809)
Change in payables and other current liabilities (5,225) (6,324)
Change in interest and income taxes payable 4,411 (1,954)
---------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 37,175 18,058
CASH FLOWS FROM INVESTING ACTIVITIES:
Gross capital expenditures (14,400) (11,026)
Proceeds from disposal of noncurrent assets 314 1,359
Purchase of businesses, net of cash acquired - (1,354)
Change in other investments (4,438) (1,372)
---------- ---------
NET CASH USED IN INVESTING ACTIVITIES (18,524) (12,393)
CASH FLOWS FROM FINANCING ACTIVITIES:
Change in short-term debt - net (824) 2,200
Proceeds from issuance of common stock 1,710 2,756
Proceeds from issuance of long-term debt 6,576 5,722
Payments for debt and common stock issuance expense - (81)
Payments for retirement of long-term debt (2,416) (5,135)
Dividends paid (12,965) (12,462)
---------- ---------
NET CASH USED IN FINANCING ACTIVITIES (7,919) (7,000)
NET CHANGE IN CASH AND CASH EQUIVALENTS 10,732 (1,335)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 3,919 5,301
---------- ---------
CASH AND CASH EQUIVALENTS AT JUNE 30 $ 14,651 $ 3,966
========== =========
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest and income taxes:
Interest (net of amount capitalized) $ 6,867 $ 7,695
Income taxes $ 7,153 $ 12,566
See accompanying notes to consolidated financial statements
-5-
OTTER TAIL POWER COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
(Unaudited)
The Company, in its opinion, has included all adjustments (including normal
recurring accruals) necessary for a fair presentation of the results of
operations for the periods. The financial statements for 1999 are subject to
adjustment at the end of the year when they will be audited by independent
accountants. The financial statements and notes thereto should be read in
conjunction with the financial statements and notes for the years ended
December 31, 1998, 1997, and 1996 included in the Company's 1998 Annual
Report to the Securities and Exchange Commission on Form 10-K. Certain
prior year amounts have been reclassified to conform to 1999 presentation.
Because of seasonal and other factors, the earnings for the three-month and
six-month periods ended June 30, 1999, should not be taken as an indication
of earnings for all or any part of the balance of the year.
Common shares and earnings per share
- ------------------------------------
On February 23, 1999, the Company granted options that would allow the
purchase of 219,000 shares of common stock to eligible employees under the
Company's 1999 Stock Incentive Plan (the "Plan") approved by shareholders on
April 12, 1999. A total of 1,300,000 shares of the Company's common stock
are available for granting of awards under the Plan. The exercise price of
the stock options is equal to the fair market value per share at the date of
the grant. The options vest over a four-year period at the rate of 25% per
year and will expire ten years after the date of the grant. The Company
accounts for the Plan under Accounting Principles Board Opinion No. 25,
which does not require recording of compensation expense. The effects of the
common stock options on the computation of diluted earnings per share were
immaterial for the quarter and six-months ended June 30, 1999.
On April 12, 1999 the shareholders approved the Company's 1999 Employee
Stock Purchase Plan ("Purchase Plan"). The Purchase Plan allows eligible
employees to purchase the Company's common stock at 85% of the lower market
price at either the beginning or the end of each six-month purchase period.
A total of 200,000 shares of the Company's common stock are available for
purchase by employees under the Purchase Plan.
The Company issued 7,102 common shares in the second quarter of 1999 and
44,619 common shares for the six months ended June 30, 1999 under its
Automatic Dividend Reinvestment and Share Purchase Plan. Starting in June
1999, the Company began purchasing the common shares needed for this plan
from the open market instead of issuing new shares. During 1998, the
Company issued 42,319 and 76,839 common shares for the three and six-month
periods ending June 30, respectively, under the Automatic Dividend
Reinvestment and Share Purchase Plan.
Comprehensive Income
- --------------------
Elements of comprehensive income for the three-month period ended June 30,
1999, include net income of $7,146,000 and other comprehensive income of
$222,000 (net of $157,000 in deferred taxes) related to the recognition of
$379,000 in unrealized gains on "available-for-sale" securities held by a
Company subsidiary. Comprehensive income for the six-month period ended
June 30, 1999, includes net income of $16,395,000 and other comprehensive
income of $313,000 (net of $191,000 in deferred taxes) related to the
recognition of $504,000 in unrealized gains on "available-for-sale"
securities held by a Company subsidiary.
Elements of comprehensive income for the three-month period ended June 30,
1998, include net income of $8,015,000 along with a reduction in accumulated
other comprehensive income of $33,000 (net of $23,000 in deferred taxes)
related to a $56,000 reduction in the market value of securities held as
"available-for-sale".
Comprehensive income for the six-month period ended June 30, 1998, includes
net income of $13,773,000 and other comprehensive income of $116,000 (net of
$81,000 in deferred taxes) related to the recognition of an additional
$197,000 in unrealized gains on "available-for-sale" securities held by a
Company subsidiary.
Rate Matters
- ------------
As previously disclosed, due to the ongoing review of demand-side management
programs and related incentives by the Minnesota Public Utilities Commission
("MPUC"), the Company has chosen not to record any 1999 conservation program
incentives until approved by the MPUC. On June 24, 1999, the MPUC approved
the Company's request for recovery of 1998 Conservation Improvement Program
("CIP") financial incentives totaling $1.8 million (which had been accrued for
in 1998) along with a 1.5% CIP surcharge effective July 1, 1999 through
June 30, 2000. The conservation-related costs being recovered through the
surcharge and in base rates include CIP expenditures, carrying costs on CIP
expenditures until they are recovered through rates, lost margins on avoided
kilowatt-hour sales, and bonus incentives related to energy savings.
On May 26, 1999, the Company reached a settlement with the staff of the
North Dakota Public Service Commission ("NDPSC") following an audit of the
Company's electric operations in North Dakota. The NDPSC's decision on this
settlement is expected in the third quarter. The effect of this settlement
on the Company for 1999 is estimated to be $441,000 after taxes or $0.037
per share. In addition, the Company would be allowed to retain all
1999 earnings from North Dakota regulated electric operations up to a 12.5%
return on equity and refund to North Dakota customers any earnings over the
12.5% return. The Company would also file a proposal for a
performance-based ratemaking plan by year-end.
Segment Information
- -------------------
The Company's business operations, which are based mainly in Minnesota,
North Dakota and South Dakota, are broken down into four segments based upon
products and services. Electric operations include the electric utility
only. Manufacturing operations includes production of agricultural
equipment, plastic pipe, automobile and truck frame-straightening equipment
and accessories, and fabricated metal parts. Health services operations
consists of businesses involved in the sale, service, rental, refurbishing
and operations of medical imaging equipment and the sale of related supplies
and accessories to various medical institutions located primarily in the
Midwestern United States. Other business operations consists of businesses
diversified in such areas as electrical and telephone construction
contracting, entertainment, energy services, natural gas marketing, and
telecommunications. The Company evaluates the performance of its business
segments and allocates resources to them based on earnings contribution and
return on investment. Substantially all sales and long-lived assets of the
Company are within the United States.
Operating Income
----------------
Three months ended Six months ended
June 30, June 30,
------------------ ----------------
(in thousands) 1999 1998 1999 1998
- --------------------------------------------------------------------------
Electric $ 8,986 $ 9,455 $24,022 $14,523
Manufacturing 2,222 2,858 3,196 4,123
Health Services 1,357 1,672 3,263 3,799
Other Business Operations 1,286 700 1,071 (2,202)
------- ------- ------- --------
Total $13,851 $14,685 $31,552 $20,243
------- ------- ------- --------
Identifiable Assets
-------------------
As of As of
June 30, December 31,
(in thousands) 1999 1998
- -----------------------------------------------------------------
Electric $ 523,985 $ 525,226
Manufacturing 51,894 41,579
Health Services 31,042 36,241
Other Business Operations 56,521 52,566
-------- ----------
Total $ 663,442 $ 655,612
---------- ----------
Special charges
- ---------------
In the first quarter of 1998, the Company recorded special charges that
reflected three items: (1) a voluntary early retirement offer was accepted
by 55 of the 67 eligible employees resulting in a one-time noncash charge of
$6,305,000 ($3,783,000 net-of-tax or $0.32 per share); (2) an impairment
loss of $2,500,000 ($1,500,000 net-of-tax or $0.13 per share) was recorded
on the write-down of Quadrant's Co. waste incineration plant to an
undepreciated carrying value of $0 under the requirements of SFAS 121; and
(3) as a result of an unfavorable court decision related to the construction
of a rail spur intended to serve Big Stone Plant, the Company wrote off
$717,000 ($430,000 net-of-tax or $0.04 per share) in project related costs.
Cumulative effect of change in accounting principle
- ---------------------------------------------------
In the first quarter of 1998, the Company changed its method of revenue
recognition from sales of electricity in Minnesota and South Dakota from
meter-reading dates to energy-delivery dates, resulting in the recognition
of $6,364,000 ($3,819,000 net-of-tax or $0.32 per share) in unbilled
revenue.
Forward Looking Information - Safe Harbor Statement Under the Private
Securities Litigation Reform Act of 1995
- ----------------------------------------
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995 (the "Act"), the Company has filed cautionary
statements identifying important factors that could cause the Company's
actual results to differ materially from those discussed in forward-looking
statements made by or on behalf of the Company. When used in this Form 10-Q
and in future filings by the Company with the Securities and Exchange
Commission, in the Company's press releases and in oral statements, words
such as "may", "will", "expect", "anticipate", "continue", "estimate",
"project", "believes" or similar expressions are intended to identify
forward-looking statements within the meaning of the Act. Factors that
might cause such differences include, but are not limited to, governmental
and regulatory action, the competitive environment, economic factors,
weather conditions, the Company's ability to identify and address all year
2000 issues and other factors discussed under "Factors affecting future
earnings" on pages 22-25 of the Company's 1998 Annual Report to
Shareholders, which is incorporated by reference in the Company's Form 10-K
for the fiscal year ended December 31, 1998. These factors are in addition
to any other cautionary statements, written or oral, which may be made or
referred to in connection with any such forward-looking statement or
contained in any subsequent filings by the Company with the Securities and
Exchange Commission.
Item 2. Management's Discussion and Analysis of Condition and
Results of Operations
- ---------------------
MATERIAL CHANGES IN FINANCIAL POSITION
- --------------------------------------
Cash provided by operating activities of $37.2 million as shown on the
Consolidated Statement of Cash Flows for the six months ended June 30, 1999
allowed the Company to pay dividends, finance its capital expenditures and
contribute to the increase in cash and cash equivalents. At June 30, 1999,
the Company and its subsidiaries had $31.2 million available in unused lines
of credit, which could be used to supplement cash needs. Cash paid for
income taxes as shown on the Consolidated Statement of Cash Flows under
supplemental cash flow information decreased significantly for the six
months ended June 30, 1999, as compared to the same period in 1998, due to a
change in the method of calculating estimated income tax payments.
The Company estimates that funds internally generated, combined with funds
on hand, will be sufficient to meet all sinking fund payments for First
Mortgage Bonds in the next five years and to provide for its estimated
1999-2003 consolidated capital expenditures. During the third quarter of
1999, the Company's $9.00 exchangeable cumulative preferred shares will be
either exchanged for common stock purchased on the open market or redeemed
for cash at a total aggregate cost of $5.3 million using funds on hand.
Additional short-term or long-term financing will be required in the period
1999-2003 in connection with the maturity of First Mortgage Bonds and other
long-term debt and in the event the Company decides to refund or retire
early any of its presently outstanding debt or cumulative preferred shares
or for other corporate purposes.
The $2.5 million decrease in net plant is due to the normal increase in
accumulated depreciation offset by an increase in transmission and
distribution construction projects in the electric utility and expansion of
plant within the manufacturing segment. Investments increased $4.7 million
as a result of increased investment at the Company's subsidiaries. The
decrease in other accounts receivable of $3.3 million is mainly due to the
timing of payments from the joint owners for the operation of Big Stone
Plant and Coyote Station where the Company serves as operating agent. The
$4.4 million increase in inventory, materials and operating supplies
reflects increases at the Company's health services and manufacturing
companies due to increased sales and work in progress. The $3.9 million
decrease in accrued utility revenues reflects the reduction in unbilled
revenues due to the seasonal change in weather. Other deferred debits
decreased $1.9 million primarily as a result of timing differences in the
recording of the costs of conservation programs compared to the recovery of
these costs.
The combined increase in common shares, par value and premium on common
shares of $1.7 million is due to the issuance of 44,619 shares of common
stock under the Company's Automatic Dividend Reinvestment and Share Purchase
Plan. The decrease in other cumulative preferred shares and part of the
increase in sinking fund requirements and current maturities relates to the
exchange or redemption of the Company's $9.00 exchangeable cumulative
preferred shares that will take place during the third quarter. The remaining
increase of $3.9 million in sinking fund requirements and current maturities
reflects a normal seasonal increase in credit line usage at the Company's
manufacturing and construction subsidiaries. The increase in federal and
state income taxes accrued of $4.4 million is related to the timing and
amount of estimated tax payments due to a change in the method of determining
estimated tax payments. The $2.4 million decrease in other taxes accrued is
the result of the timing of property tax payments due in the second quarter,
most of which are paid to the State of Minnesota.
MATERIAL CHANGES IN RESULTS OF OPERATIONS
- -----------------------------------------
Comparison of the Quarters Ended June 30, 1999 and 1998
-------------------------------------------------------
Electric Operations
-------------------
Three months ended
June 30,
------------------ Percentage
(in thousands) 1999 1998 Change
- --------------------------------------------------------------------------
Operating revenues $55,232 $53,078 4.1
Production fuel 9,487 9,311 1.9
Purchased power 11,473 8,730 31.4
Other operation and maintenance expenses 17,042 17,318 (1.6)
Depreciation and amortization 5,442 5,504 (1.1)
Property taxes 2,802 2,760 1.5
------- ------- -------
Operating income $ 8,986 $ 9,455 (5.0)
------- ------- -------
The increase in electric operating revenues for the quarter is due to a $3.2
million (33%) increase in revenues from power pool sales offset by decreases
of $155,000 (0.4%) in retail revenue and $913,000 (34%) in other electric
revenue. Power pool sales were up significantly due to increased demand in
the pool combined with a high level of availability from the Company's
generating plants. The slight decrease in retail revenue is the result of an
overall 2.1% decrease in retail kwh sales offset by a 1.7% increase in
revenue per kwh sold. Increases in sales to residential and commercial
customers were offset by decreased sales to industrial customers. Decreases
in electrical contract work done for other utilities combined with the
Company's decision not to record 1999 conservation program incentives until
approved by the MPUC are the primary reasons for the decrease in other
electric revenue.
During the second quarter production fuel expenses increased due to a 4.4%
increase in kwh generated offset by a slight reduction in fuel costs per kwh
generated. The increase in purchased power expense is commensurate with the
increase in power pool sales. The decrease in other electric operation and
maintenance expenses is due to a reduction in materials and supplies
expenses partially offset by increased labor expenses.
Manufacturing Operations
------------------------
Three months ended
June 30,
--------------------- Percentage
(in thousands) 1999 1998 change
- ---------------------------------------------------------------
Operating revenues $25,305 $24,674 2.6
Cost of goods sold 19,664 18,313 7.4
Operating expenses 3,419 3,503 (2.4)
------- ------- -------
Operating income $ 2,222 $ 2,858 (22.3)
------- ------- -------
Four of the Company's seven manufacturing subsidiaries had increased sales
for the quarter. The reason for the decline in operating income for the
manufacturing segment is primarily due to lower gross margins on new product
lines at one of the manufacturing subsidiaries.
Health Services Operations
--------------------------
Three months ended
June 30,
------------------ Percentage
(in thousands) 1999 1998 change
- ---------------------------------------------------------------
Operating revenues $16,049 $17,773 (9.7)
Cost of goods sold 12,725 14,211 (10.5)
Operating expenses 1,967 1,890 4.1
------- ------- -------
Operating income $ 1,357 $ 1,672 (18.8)
------- ------- -------
The decrease in operating revenues for the quarter is due to decreases in
sales volumes and a decrease in the average fee per imaging scan. The
decrease in cost of goods sold reflects the decrease in sales volumes.
Other Business Operations
-------------------------
Three months ended
June 30,
------------------ Percentage
(in thousands) 1999 1998 change
- ----------------------------------------------------------------
Operating revenues $14,972 $11,421 31.1
Cost of goods sold 9,475 6,275 51.0
Operating expenses 4,211 4,446 (5.3)
------- ------- --------
Operating income $ 1,286 $ 700 83.7
------- ------- --------
Higher volumes of contracted work at the Company's construction subsidiaries
is the primary reason for the increases in operating revenues, cost of goods
sold and operating income during the second quarter. The other subsidiaries
within this segment also recorded increases in operating income.
Other Income and Deductions - net
---------------------------------
The $195,000 (15.4%) reduction for the quarter in other income and
deductions is due to decreases in demand-side management incentives offset
by increased interest income due to the increase in short-term investments.
Interest Charges and Income Taxes
---------------------------------
Interest charges decreased $370,000 (9.0%) during the second quarter due to
the payment of interest during 1998 on the settlement of the 1996 Federal
income tax audit combined with a reduction in outstanding debt and lower
interest rates during 1999. Even though income before income taxes
decreased, income taxes increased $210,000 (5.5%) due to minor adjustments
made for book and tax timing differences.
Comparison of the Six Months Ended June 30, 1999 and 1998
---------------------------------------------------------
Electric Operations
-------------------
Six months ended
June 30,
-------------------- Percentage
(in thousands) 1999 1998 Change
- --------------------------------------------------------------------------
Operating revenues $117,951 $109,624 7.6
Production fuel 19,251 18,179 5.9
Purchased power 23,365 16,987 37.5
Other operation and maintenance expenses 34,793 36,288 (4.1)
Special charges - 7,022 -
Depreciation and amortization 10,864 11,005 (1.3)
Property taxes 5,656 5,620 0.6
-------- -------- ------
Operating income $ 24,022 $ 14,523 65.4
-------- -------- ------
The increase year-to-date in electric operating revenues is due to a $8.9
million (64%) increase in revenues from power pool sales combined with a
$664,000 (0.7%) increase in retail revenue offset by a $1.3 million (27%)
decrease in other electric revenue. The increase in power pool sales is
related to an increase in energy available for sale, increased demand in the
power pool and increased power marketing sales efforts. The increase in
retail revenue is the result of an increase in cost-of-energy revenues and
an increase in the conservation improvement surcharge revenues offset by a
2.6% decrease in retail kwh sales. The recovery of fuel and purchased power
costs through the cost-of-energy adjustment mechanism in retail rates lags
two to four months behind the incurrance of those costs which gave rise to
the increase in cost-of-energy revenues. Decreases in electrical contract
work done for other utilities combined with the Company's decision not to
record 1999 conservation program incentives until approved by the MPUC are
the primary reasons for the decrease in other electric revenue.
Production fuel expenses for the six months increased as a direct result of
an 8.5% increase in kwh generated offset by a slight decrease in the fuel
costs per kwh generated. Purchased power expense increased as a result of
a 64% increase in power pool sales, partially offset by a 10% decrease in
kwh purchased for system use. The reduction in purchased power for system
use was due to greater plant availability during the first quarter of 1999
coincidental with a reduction in demand for retail sales.
The decrease in other electric operation and maintenance expenses year-to-
date is primarily related to a reduction in expense due to the early
retirement program in 1998 and a reduction in material and supplies expenses
due to less contracted work for other utilities during 1999.
The special charges recorded under electric operations in the first quarter
of 1998, represent two items: (1) a noncash charge of $6,305,000 associated
with a voluntary early retirement program offered by the Company and, (2)
the write-off of $717,000 in accumulated costs related to a rail spur
project at Big Stone Plant. (See "Special charges" in notes to consolidated
financial statements on page 8 for further information including the net-of-
tax and earnings per share impact of these charges.) Excluding the special
charges, this business segment would have shown an increase of $2.5 million
(11.5%) in operating income for the six months ended June 30.
Manufacturing Operations
------------------------
Six months ended
June 30,
--------------------- Percentage
(in thousands) 1999 1998 change
- --------------------------------------------------------------
Operating revenues $43,900 $42,805 2.6
Cost of goods sold 34,138 32,356 5.5
Operating expenses 6,566 6,326 3.8
------- ------- ------
Operating income $ 3,196 $ 4,123 (22.5)
------- ------- ------
Four of the Company's seven manufacturing subsidiaries had increased sales
year-to-date. The reason for the decline in operating income for the
manufacturing segment is primarily due to lower gross margins on new product
lines at one of the manufacturing subsidiaries.
Health Services Operations
--------------------------
Six months ended
June 30,
--------------------- Percentage
(in thousands) 1999 1998 change
- ------------------------------------------------------------
Operating revenues $33,564 $33,072 1.5
Cost of goods sold 26,261 25,468 3.1
Operating expenses 4,040 3,805 6.2
------- ------- ------
Operating income $ 3,263 $ 3,799 (14.1)
------- ------- ------
The increase in operating revenues for the six months reflects overall
increases in sales volumes and an increase in the number of medical imaging
scans performed offset by a decrease in the average fee per scan. Cost of
goods sold and operating expenses increased as a result of the increased
sale volumes combined with increases in the costs of repair and maintenance
on equipment used to serve customers. These increased operating costs offset
the increase in revenues and resulted in a $536,000 decrease in health
services operating income.
Other Business Operations
-------------------------
Six months ended
June 30,
--------------------- Percentage
(in thousands) 1999 1998 change
- ----------------------------------------------------------------------
Operating revenues $27,482 $18,354 49.7
Cost of goods sold 18,177 9,581 89.7
Special charges - 2,500 -
Operating expenses 8,234 8,475 (2.8)
------- -------- -----
Operating income (loss) $ 1,071 $(2,202) -
------- -------- -----
There are two primary reasons for the increases in operating revenues and
cost of goods sold: (1) larger volume of work contracted at the Company's
construction subsidiaries and (2) the PAM Natural Gas acquisition that
occurred on May 1, 1998. The special charges recorded during the first
quarter of 1998 represent an impairment loss associated with the Quadrant
Co. waste incineration plant. (See "Special charges" in notes to
consolidated financial statements on page 8 for further information
including the net-of-tax and earnings per share impact of these charges.)
Excluding the Quadrant Co. impairment loss, this business segment would have
shown an increase of $773,000 (259%) in operating income for the six months
ended June 30.
Other Income and Deductions - net
---------------------------------
The $295,000 (17%) reduction in other income and deductions year-to-date is
due to decreases in demand-side management incentives offset by increased
interest income and reduced donation expenses.
Interest Charges and Income Taxes
---------------------------------
The $700,000 (8.7%) decrease in interest charges is due to a reduction in
outstanding debt and lower average interest rates during 1999 combined with
the payment of interest during 1998 on the settlement of the 1996 Federal
income tax audit. The $5.3 million (134%) increase in income taxes is
primarily due to the increase in income before taxes.
Year 2000 Readiness Disclosure
- ------------------------------
Many computer software systems, as well as certain hardware and equipment
containing date-sensitive data, were structured to utilize a two-digit year
field meaning that they may not be able to properly recognized dates in the
year 2000. The Company recognizes that the year 2000 occurrence puts all of
its electronic systems on all platforms at risk. Application systems,
information technology systems and technology that includes embedded systems
are being reviewed, in order, from highly critical to less critical. These
systems include the Company's financial software, customer-information
system, energy-management system, power plant control systems, manufacturing
processes and diagnostic medical imaging equipment. In order to address the
year 2000 issue from a total business perspective, the Company is working
with its major vendors, customers, banks, regulatory and government
agencies, and utility alliances.
In order to improve business information systems, the Company's operating
businesses began replacing major financial computer systems in 1996. The
electric utility has replaced its major in-house developed financial
computer systems with financial applications from Oracle Corporation, while
at the same time, replacing the hardware on which these applications reside.
Because of the recent implementation, these systems should require minimal
remediation efforts. The costs of replacing these major financial computer
systems are not included in the cost estimates discussed below.
The Company's plan to resolve the year 2000 issues involves three phases:
inventory, assessment and remediation/testing. The inventory phase was
completed in December 1998 for the electric utility and as of June 30, 1999
is 99% complete for the other companies. The assessment phase was completed
in February 1999 for the electric utility and is 98% complete for the other
companies as of June 30, 1999. The remediation and testing phase was
completed in June 1999 for the electric utility and is 85% complete for the
other companies as of June 30, 1999. The other companies are on schedule to
complete the inventory, assessment and remediation/ testing phases by
October 31, 1999. The electric utility will continue to refine its
contingency plans for January 1, 2000.
In addition, the Company's operating businesses are communicating with
critical external parties in order to determine the extent of vulnerability
to such parties' failure to resolve their own year 2000 issues. The
subsidiary companies have completed 85% of their third party assessments and
expect to have the remaining work completed by September 30, 1999. The
Company is developing plans to alter business relationships in the event
certain third parties fail to become year 2000 compliant. There can be no
guarantee that the third parties of business importance to the Company will
successfully reprogram or replace and test all of their own computer
hardware, software, and process control systems in a timely manner. While
the failure of a single third party to achieve year 2000 readiness should not
have a material adverse effect on the Company's financial results or
operations, the failure of several key third parties could have such an
effect.
The electric utility industry is unique in its dependence upon a complex
network of interrelated systems of the power pool grid in order to support
and maintain reliable, efficient operations. The Company's year 2000
readiness effort is linked to the readiness efforts of other utilities, as
well as those of major customers whose loads support the integrity of the
power pool grid. The Company is coordinating its year 2000 effort with that
of the Mid-Continent Area Power Pool and with plans established by the North
America Electric Reliability Council ("NERC") under the direction of the
U. S. Department of Energy. The Company successfully participated in the
April 9, 1999 NERC drill to simulate loss of multiple voice and data
communications systems. The Company also plans to participate in the
September 1999 NERC drill. The goal of this drill is to simulate as
realistically as is practical the implementation of administrative,
operating, communications and contingency response plans for the year 2000
transition. While the Company is supporting these cooperative efforts, it
cannot guarantee the successful implementation of solutions of third
parties. A failure of a system within the power pool grid could have a
material impact on the Company and its customers.
The costs of the Company's year 2000 readiness effort are being funded with
cash flows from operations. These costs are not expected to be substantially
different from the normal, ongoing costs that are incurred for systems
development, implementation and maintenance due in part to the use of
internal resources and the deferral of other projects. Total expenditures
related to the Company's year 2000 readiness effort is expected to range
from $975,000 to $1,350,000 for 1997 to 2000. Expenditures incurred through
June 30, 1999, most of which have occurred at the electric utility, are
estimated at $625,000. The Company does not track year 2000 costs in a
separate account.
The Company's medical subsidiary owns diagnostic imaging equipment which has
computer software that is vulnerable to year 2000 issues. While the medical
subsidiary will negotiate to have its vendors pay the costs to solve the
year 2000 issues, there can be no assurances the vendors will absorb the
costs. In the event the vendors do not pay all or some portion of the costs,
the medical subsidiary would have to absorb the majority of the costs.
These costs are included in the estimates shown above.
As part of its normal business practice, the electric utility maintains
emergency backup and recovery procedures to be followed in the event of
failure of a business-critical system. These procedures were expanded to
include specific procedures for potential year 2000 issues. The business
critical processes contingency plans were approved in April of 1999. The
Company's electrical system contingency plan, which was completed and
approved in June 1999, used templates provided by the NERC. This plan
includes meeting with large customers to determine their operating plans
during critical dates. The Company also has plans to provide for additional
staffing at critical locations to respond to any year 2000 situations that
might arise. Contact is ongoing with neighboring utilities to coordinate
contingency plans, operating plans, and the year 2000 backup communications
drill.
At this time, the Company believes its worst case scenario is that key
customers could experience significant reductions in their power needs due
to their own year 2000 issues. Although the Company does not believe that
this scenario is likely to occur, the Company expects that such a scenario
would not have a material adverse affect on the Company's consolidated
financial position. The Company believes a more probable worst case scenario
is a temporary disruption of service to its electric customers, including
the effect of cascading disruptions caused by other entities whose
electrical systems are connected to the Company's. The Company has assessed
the risk of this scenario, and believes that contingency plans would mitigate
the long-term effect of such a scenario. In the event that a temporary
disruption in service does occur, the Company does not expect that it would
have a material adverse effect on its consolidated financial position.
While the Company believes it will be able to resolve its year 2000 issues
in a timely manner, if it is unable to complete the required changes to
existing critical systems, or if those with whom the Company conducts
business are unsuccessful in implementing timely solutions, the year 2000
issue could have a material adverse effect upon the Company's consolidated
results of operations.
The costs of the project and the completion dates are based on management's
best estimates, which were derived from assumptions of future events
including the availability of resources, third party modification plans, and
other factors. There can be no guarantee that these estimates will be
achieved and actual results could vary due to uncertainties.
The forward looking statements contained in this section under the heading
"Year 2000 Readiness Disclosure" should be read in conjunction with the
Company's disclosure above under the heading "Forward Looking Information-
Safe Harbor Statement Under the Private Securities Litigation Reform Act of
1995."
Item 3. Quantitative and Qualitative Disclosures About Market Risk
----------------------------------------------------------
The Company does not have material market risk exposure related to foreign
currency exchange rate risk, commodity price risk or interest rate risk.
PART II. OTHER INFORMATION
--------------------------
Item 2. Changes in Securities
---------------------
During May 1999, the Company sold 6,490 shares of common stock,
acquired in the open market, as part of the final payment in
connection with the acquisition of PAM Natural Gas, Inc. to some of
the former owners. The sale of such shares did not involve a public
offering and therefore was exempt from registration pursuant to
section 4(2) of the Securities Act of 1933, as amended.
Item 3. Legal Proceedings
-----------------
During June 1999, Quadrant and the Company reached a settlement with
the Minnesota Pollution Control Agency (MPCA) regarding the 1998
claimed violations of emission limits, operational requirements and
reporting requirements applicable to Quadrant under Minnesota law.
Under the settlement, Quadrant admitted no wrongdoing and agreed to
pay $80,000 in fines to the MPCA and $70,000 to the City of Perham,
Minnesota. These payments were fully covered by reserves previously
established by Quadrant. In addition, Quadrant agreed to transfer all
of its assets to the City of Perham and agreed not to operate or
manage a waste incinerator facility in the future.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
The annual meeting of Shareholders of the Company was held on April 12,
1999, for the purpose of electing three nominees to the Board of
Directors with terms expiring in 2002, approving the appointment of
auditors, voting on an Amendment to the Articles of Incorporation to
increase the authorized number of Common Shares to 50,000,000 shares,
and voting on proposals to approve two new stock-based benefit plans,
the 1999 Employee Stock Purchase Plan and the 1999 Stock Incentive
Plan. Proxies for the meeting were solicited pursuant to Section
14(a) of the Securities Exchange Act of 1934, as amended, and there
was no solicitation in opposition to management's solicitations. All
nominees for directors as listed in the proxy statement were elected.
The voting results were as follows:
Shares Shares Voted
Election of Directors Voted For Withheld Authority
- --------------------- --------- ------------------
Dennis R. Emmen 10,011,911 120,548
Kenneth L. Nelson 10,012,057 120,402
Nathan I. Partain 10,000,801 131,658
Shares Shares Shares
Voted For Voted Against Voted Abstain
--------- ------------- -------------
Increase in Shares Authorized 8,930,964 1,012,678 188,817
- -----------------------------
1999 Employee Stock Purchase Plan 8,295,700 334,225 1,502,534
- ---------------------------------
1999 Stock Incentive Plan 7,160,525 1,355,491 1,616,443
- -------------------------
Approval of Auditors
- --------------------
Deloitte & Touche LLP 9,891,945 81,127 159,387
Item 6. Exhibits and Reports on Form 8-K.
--------------------------------
a) Exhibits:
3 Restated Articles of Incorporation, as amended.
27 Financial Data Schedule
b) Reports on Form 8-K.
No reports on Form 8-K were filed during the fiscal quarter ended
June 30, 1999.
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OTTER TAIL POWER COMPANY
By: John Erickson
---------------------
John Erickson
Vice President, Finance
(Chief Financial Officer/Authorized Officer)
Dated: August 13, 1999
---------------