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 SEPTEMBER 30, 1998
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:
August 1, 1998 - 11,848,241 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 - September 30, 1998 (Unaudited)
and December 31, 1997 2 & 3
Consolidated Statements of Income - Three and Nine Months
Ended September 30, 1998 and 1997 (Unaudited) 4
Consolidated Statements of Cash Flows - Nine Months
Ended September 30, 1998 and 1997 (Unaudited) 5
Notes to Consolidated Financial Statements (Unaudited) 6-8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9-14
Part II. Other Information
Item 3. Legal Proceedings 15
Item 6. Exhibits and Reports on Form 8-K 15
Signatures 15
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Part I. Financial Information
------------------------------
Item 1. Financial Statements
- ----------------------------
Otter Tail Power Company
Consolidated Balance Sheets
-Assets-
September 30, December 31,
1998 1997
------------- ------------
(Unaudited)
(Thousands of dollars)
<S> <C> <C>
Plant:
Electric plant in service $766,013 $758,551
Subsidiary companies 87,130 89,716
-------- --------
Total 853,143 848,267
Less accumulated depreciation and amortization 364,400 350,647
-------- --------
488,743 497,620
Construction work in progress 12,195 12,146
-------- --------
Net plant 500,938 509,766
-------- --------
Investments 20,391 20,048
-------- --------
Intangibles -- net 21,918 20,911
-------- --------
Other assets 3,736 5,932
-------- --------
Current assets:
Cash and cash equivalents 3,798 5,301
Temporary cash investments - -
Accounts receivable:
Trade - net 39,333 33,304
Other 7,070 6,796
Materials and supplies:
Fuel 2,930 3,425
Inventory, materials and operating supplies 28,455 24,160
Deferred income taxes 2,277 4,738
Accrued utility revenues 8,578 4,271
Other 8,607 3,795
-------- --------
Total current assets 101,048 85,790
-------- --------
Deferred debits:
Unamortized debt expense and reacquisition premiums 3,854 4,187
Regulatory assets 6,332 5,060
Other 2,610 3,747
-------- --------
Total deferred debits 12,796 12,994
-------- --------
Total $660,827 $655,441
======== ========
See accompanying notes to consolidated financial statements
- 2 -
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Otter Tail Power Company
Consolidated Balance Sheets
-Liabilities-
September 30, December 31,
1998 1997
------------- ------------
(Unaudited)
(Thousands of dollars)
<S> <C> <C>
Capitalization
Common shares, par value $5 per share - authorized
25,000,000 shares; outstanding 1998 -- 11,846,090
and 1997 -- 11,731,078 shares $ 59,230 $ 58,655
Premium on common shares 38,744 35,196
Retained earnings 120,869 115,942
Accumulated other comprehensive income 347 363
--------- ---------
Total 219,190 210,156
Cumulative preferred shares - authorized 1,500,000
shares without par value; outstanding 1998
and 1997, 388,311 shares
Subject to mandatory redemption 18,000 18,000
Other 20,831 20,831
Cumulative preference shares - authorized 1,000,000
shares without par value; outstanding - none - -
Long-term debt 185,554 189,973
--------- ---------
Total capitalization 443,575 438,960
--------- ---------
Current liabilities
Short-term debt - 2,100
Sinking fund requirements and current maturities 10,576 12,324
Accounts payable 38,355 28,427
Accrued salaries and wages 2,765 3,835
Federal and state income taxes accrued 336 2,572
Other taxes accrued 10,403 11,122
Interest accrued 2,161 3,339
Other 3,345 2,980
--------- ---------
Total current liabilities 67,941 66,699
--------- ---------
Noncurrent liabilities 22,150 17,805
--------- ---------
Deferred credits
Accumulated deferred income taxes 94,208 97,583
Accumulated deferred investment tax credit 17,785 18,666
Regulatory liabilities 11,549 12,121
Other 3,619 3,607
--------- ---------
Total deferred credits 127,161 131,977
--------- ---------
Total $ 660,827 $ 655,441
========= =========
See accompanying notes to consolidated financial statements
-3-
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<CAPTION>
Otter Tail Power Company
Consolidated Statements of Income
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
1998 1997 1998 1997
------ ------ ------ ------
(in thousands, except share and per share amounts)
<S> <C> <C> <C> <C>
Operating revenues
Electric $ 54,958 $ 47,418 $ 164,582 $ 151,244
Manufacturing 24,463 22,088 67,268 57,273
Health services 16,664 17,868 49,736 48,277
Other business operations 16,086 14,484 34,440 30,449
---------- ---------- ----------- ----------
Total operating revenues 112,171 101,858 316,026 287,243
Operating expenses
Production fuel 8,052 7,900 26,231 22,522
Purchased power 10,480 4,543 27,467 17,584
Other electric operation and maintenance expenses 16,435 18,115 52,723 53,323
Special charges - - 9,522 -
Cost of goods sold 36,945 35,729 95,624 89,200
Other nonelectric expenses 13,330 12,658 38,803 33,896
Depreciation and amortization 6,398 6,380 19,239 19,064
Property taxes 2,675 2,780 8,318 8,363
---------- ---------- ----------- ----------
Total operating expenses 94,315 88,105 277,927 243,952
Operating income
Electric 11,756 8,747 26,279 33,436
Manufacturing 3,286 2,857 7,409 6,420
Health services 1,424 1,095 5,223 2,592
Other business operations 1,390 1,054 (812) 843
---------- ---------- ----------- ----------
Total operating income 17,856 13,753 38,099 43,291
Other income and deductions - net 880 2,572 2,587 5,397
Interest charges 3,828 4,729 11,875 13,867
---------- ---------- ----------- ----------
Income before income taxes 14,908 11,596 28,811 34,821
Income taxes 5,031 3,811 8,980 10,953
---------- ---------- ----------- ----------
Income before cumulative effect of
change in accounting principle 9,877 7,785 19,831 23,868
Cumulative effect of change in
accounting principle - net-of-tax - - 3,819 -
---------- ---------- ----------- ----------
Net income 9,877 7,785 23,650 23,868
Preferred dividend requirements 590 590 1,769 1,769
---------- ---------- ----------- ----------
Earnings available for common shares $ 9,287 $ 7,195 $ 21,881 $ 22,099
Basic and diluted earnings per average common share:
Before cumulative effect of
change in accounting principle $ 0.79 $ 0.62 $ 1.54 $ 1.90
Cumulative effect of change in
accounting principle - - 0.32 -
---------- ---------- ----------- ----------
Basic and diluted earnings
per average common share - net $ 0.79 $ 0.62 $ 1.86 $ 1.90
========== ========== =========== ==========
Average number of common shares outstanding 11,818,460 11,660,523 11,778,724 11,616,861
Dividends per common share $0.480 $0.465 $1.440 $1.395
See accompanying notes to consolidated financial statements
-4-
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Otter Tail Power Company
Consolidated Statements of Cash Flows
(Unaudited)
Nine months ended
September 30,
1998 1997
------ ------
(Thousands of dollars)
<S> <C> <C>
Cash flows from operating activities:
Net income $ 23,650 $ 23,867
Adjustments to reconcile net income to net cash
Provided by operating activities:
Depreciation and amortization 26,592 29,937
Deferred investment tax credit - net (881) (882)
Deferred income taxes (2,777) (2,331)
Change in deferred debits and other assets 5 491
Change in noncurrent liabilities and deferred credits 608 682
Allowance for equity (other) funds used during construction (82) -
(Gains)/Losses from investments and disposal of noncurrent assets 432 (1,445)
Voluntary early retirement program charges 6,305 -
Asset impairment losses 3,217 -
Cash provided by (used for) current assets & current liabilities:
Change in receivables, materials and supplies (9,013) (5,632)
Change in other current assets (9,048) 1,603
Change in payables and other current liabilities 6,561 (1,587)
Change in interest and income taxes payable (3,416) (1,831)
------- -------
Net cash provided by operating activities 42,153 42,872
Cash flows from investing activities:
Gross capital expenditures (19,795) (33,849)
Proceeds from disposal of noncurrent assets 1,645 3,664
Purchase of businesses, net of cash acquired (1,354) -
Purchases of marketable securities - (5)
Proceeds from sales of marketable securities - 786
Change in other investments (1,042) (578)
--------- --------
Net cash used in investing activities (20,546) (29,982)
Cash flows from financing activities:
Change in short-term debt - net (2,100) 3,500
Proceeds from issuance of common stock 4,123 4,933
Proceeds from issuance of long-term debt 2,943 72,597
Payments for debt and common stock issuance expense (82) -
Payments for retirement of long-term debt (9,272) (71,801)
Dividends paid (18,722) (18,239)
-------- --------
Net cash used in financing activities (23,110) (9,010)
Net change in cash and cash equivalents (1,503) 3,880
Cash and cash equivalents at beginning of year 5,301 2,130
-------- --------
Cash and cash equivalents at September 30 $ 3,798 $ 6,010
======== ========
Supplemental cash flow information
Cash paid for interest and income taxes:
Interest (net of amount capitalized) $ 12,376 $ 15,096
Income taxes $ 17,331 $ 14,439
See accompanying notes to consolidated financial statements
- 5 -
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OTTER TAIL POWER COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Otter Tail Power Company (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 1998 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, 1997, 1996, and 1995
included in the Company's 1997 Annual Report to the Securities and Exchange
Commission on Form 10-K. Because of seasonal and other factors, special
charge items and the cumulative effect of a change in accounting principle
related to the initial recording of unbilled revenue for the states of
Minnesota and South Dakota, the earnings for the three-month and nine-month
periods ended September 30, 1998, should not be taken as an indication of
earnings for all or any part of the balance of the year.
Special charges
- ---------------
In March 1998, an offer of voluntary early retirement was accepted by 55 of
67 eligible employees. Most of the costs of the early retirement offer
will be funded through the Company's pension plan. The Company recorded a
noncash charge to operating expenses of $6,305,000 ($3,783,000 net-of-tax or
$0.32 per share) for special termination benefits and the recognition of
previously unrecognized prior service costs related to pension and
postretirement benefits. As a result of the reduction in the number of
utility employees through this program, the electric utility company will
experience a reduction in ongoing payroll costs in 1998 and future years.
In March 1998, the Company recorded a noncash accounting charge related to
the impairment of its Quadrant Co. ("Quadrant") waste incineration plant.
The impaired assets include buildings, machinery and equipment used to burn
waste. The revised carrying value of this group of assets was calculated on
the basis of discounted estimated future cash flows and resulted in a pre-
tax noncash charge of $2,500,000 ($1,500,000 net-of-tax or $0.13 per share).
The recognition of this impairment is in accordance with the provisions of
Statement of Financial Accounting Standards No. 121 - Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
The $2,500,000 impairment loss is included in operating expenses under the
caption of special charges and in operating income from other business
operations on the Company's Statement of Income for the nine months ended
September 30, 1998. In early July 1998, Quadrant's waste incinerators were
shut down because they were not in compliance with Minnesota Pollution
Control Agency ("MPCA") particulate emissions regulations. Quadrant is
cooperating with the MPCA to resolve the issue. Quadrant and the Company
have received from the MPCA a Notice of Violation dated October 15, 1998.
The Notice of Violation outlines claimed violations of emission limits,
operating requirements, and reporting requirements applicable to Quadrant
under Minnesota law. Quadrant and the MPCA are in the process of
negotiating a penalty settlement and intend to negotiate the terms and
conditions of a stipulation agreement involving a compliance schedule, a
civil penalty for past alleged violations, and stipulated penalties for any
future violations of the stipulation agreement. The outcome of the
negotiations is not known at this time, however, it is not expected to have
a material financial impact on the Company.
In the first quarter of 1998, 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 in the States of Minnesota and South Dakota from meter reading
dates to energy delivery dates, resulting in the accrual of estimated
unbilled revenue from sales of electricity through the end of the accounting
period. This change results in better matching of revenues and expenses and
is consistent with predominant industry practice. The change is also
consistent with the way the Company has been recording electric revenue from
its North Dakota customers since 1995 under an order from the North Dakota
Public Service Commission. The cumulative effect of recording Minnesota and
South Dakota unbilled revenue as of January 1, 1998, increased 1998 net
income by $3,819,000 (net of income taxes of $2,545,000) or $0.32 per share.
If the Company had been recording Minnesota and South Dakota unbilled
revenue in previous accounting periods, its reported electric revenue for
the third quarter of 1997 would have been reduced by $731,000 and its
reported net income would have been reduced by $439,000 or $0.038 per share.
Also, the Company's reported electric revenue for the nine months ended
September 30, 1997 would have been reduced by $3,323,000 and its reported
net income would have been reduced by $1,994,000 or $0.172 per share.
Comprehensive income
- --------------------
Comprehensive income for the three month period ended September 30, 1998,
includes net income of $9,877,000 along with a reduction in accumulated
other comprehensive income of $132,000 (net of $93,000 in deferred taxes)
related to a $225,000 reduction in the market value of securities held as
"available-for-sale". Comprehensive income for the nine month period ended
September 30, 1998, includes net income of $23,650,000 along with a $16,000
reduction in accumulated other comprehensive income (net of $12,000 in
deferred taxes) related to a $28,000 reduction in the market value of
securities held as "available-for-sale".
Net income of $7,785,000 is the only element of comprehensive income for the
three month period ended September 30, 1997. Elements of comprehensive
income for the nine month period ended September 30, 1997, include net
income of $23,868,000 along with a $359,000 reduction in accumulated other
comprehensive income related to the reversal of previously recorded
unrealized gains on "available-for-sale" securities which were sold or
reclassified in the first quarter of 1997.
Common shares
- -------------
The Company issued 38,173 common shares in the third quarter of 1998 and
115,012 common shares for the nine months ended September 30, 1998 under its
Automatic Dividend Reinvestment and Share Purchase Plan. During 1997, the
Company issued 42,127 common shares for the three months ended September 30,
1997 and 123,060 common shares for the nine months ended September 30, 1997
under its Automatic Dividend Reinvestment and Share Purchase Plan.
Acquisitions
- ------------
On May 1, 1998, the Company acquired PAM Natural Gas, Inc. ("PAM"), for
approximately $1.8 million in stock purchased on the open market and an earn
out amount to be paid over seven years contingent upon the achievement of
certain financial results. PAM is a Sioux Falls, South Dakota based
marketer of natural gas to commercial and institutional customers in Iowa,
South Dakota, North Dakota and Minnesota. Upon acquisition PAM's name was
changed to Otter Tail Energy Management, Inc.
Rate Matters
- ------------
On July 1, 1998, the Company increased its Conservation Improvement Project
Rider surcharge to all Minnesota customers from 1.75% to 2.75% based upon
approval by the Minnesota Public Utilities Commission ("MPUC"). The
conservation-related costs being recovered through the surcharge and in base
rates include Conservation Improvement Program expenditures, carrying costs
on costs incurred in excess of costs currently being recovered, lost margins
on avoided kilowatt-hour sales, and bonus incentives related to energy
savings. The Minnesota Department of Public Service has recommended to the
MPUC that the awarding of lost margin recovery and bonus incentives to
regulated utilities be discontinued. The Company's annual electric revenues
include approximately $2 million for lost margin recovery and incentives.
The MPUC has opened a docket to review this issue. The Company has filed
comments urging the MPUC to continue to allow the lost margin recovery and
bonus incentives.
Contingency
- -----------
The University of Minnesota ("University") has notified the Company that it
intends to seek contribution for expenditures made by the University for the
remediation of soil contaminated by polychlorinated biphenyls ("PCBs") at
the Rosemount Research Center Superfund site, which is owned by the
University. The Minnesota Pollution Control Agency and the University assert
that some of the Company's used electrical equipment was a source of
contamination at the site. The Company and the University have agreed to a
settlement of $450,000, which is being finalized by legal counsel. The
Company recognized a liability for $450,000 during the quarter ended
September 30, 1998 and included the expense under other electric operation
and maintenance expenses.
Subsequent Event
- ----------------
On November 1, 1998, Mid-States Development, Inc. a subsidiary of the
Company since 1989, changed its name to Varistar Corporation.
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 28-30 of the Company's 1997 Annual Report to
Shareholders, which is incorporated by reference in the Company's Form 10-K
for the fiscal year ended December 31, 1997. 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
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
Material Changes in Financial Position
- --------------------------------------
Cash provided by operating activities of $42.2 million as shown on the
Consolidated Statement of Cash Flows for the nine months ended September 30,
1998, combined with cash provided by the issuance of $4.1 million in common
stock and funds on hand of $5.3 million at December 31, 1997, allowed the
Company to pay dividends, finance its capital expenditures, retire short and
long-term debt, and acquire an additional business. The $14.1 million
reduction in gross capital expenditures, in the first nine months of 1998,
as compared to the same period in 1997, primarily relates to the timing of
construction expenditures, higher construction expenditures due to the
massive winter storm in the spring of 1997 and the Company's ongoing
initiative to control capital expenditures. At September 30, 1998, the
Company and its subsidiaries had total lines of credit of $35.5 million of
which $30.7 million was available to supplement cash needs. 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 1998-2002 consolidated
capital expenditures.
Additional short-term or long-term financing will be required in the period
1998-2002 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.
Although the Company continues to make capital investments to improve and
enhance system reliability and customer service, the small increases in
electric plant in service and construction work in progress reflect the
Company's ongoing initiative to reduce capital expenditures. The decrease in
subsidiary companies plant is mainly due to the $7.2 million ($2.25 million
net of accumulated depreciation) impairment write-down of the Quadrant Co.
waste incineration plant in the first quarter of 1998. Other changes in
subsidiary companies plant as of September 30, 1998 include capital
additions of $4.3 million in the manufacturing segment and $1.8 million in
the other business operations segment and a net decrease in equipment of
$1.4 million in the health services segment.
The $1 million increase in intangibles--net is primarily a result of goodwill
related to the PAM acquisition. The $2.2 million decrease in other assets
reflects a $2.5 million reduction in net pension assets related to the
Company's voluntary early retirement program in the first quarter of 1998.
The $6 million increase in trade accounts receivable primarily reflects
increased sales in the manufacturing segment. The $4.3 million increase in
inventory, materials and operating supplies is primarily due to the large
number of medical equipment installations that are in process at the medical
subsidiaries. The $2.5 million decrease in deferred income taxes and the
$4.3 million increase in accrued utility revenues are related to the
recording of Minnesota and South Dakota unbilled revenues, initiated in
January 1998. The increase in other current assets of $4.8 million
primarily reflects an increase in costs in excess of billings on projects
that are still in process at the Company's construction and manufacturing
subsidiaries. These projects are scheduled to be completed and billed
during fourth quarter 1998. The write-off of $717,000 in costs related to
the Big Stone Plant rail spur project is reflected in the reduction in other
deferred debits.
The combined increase in common shares, par value and premium on common
shares of $4.1 million is due to the issuance of 115,012 shares of common
stock under the Company's Automatic Dividend Reinvestment and Share Purchase
Plan. The decrease in sinking fund requirements and current maturities
reflects the July 1, 1998 retirement at maturity of the 5.625% pollution
control revenue bonds in the amount of $2.2 million. The $9.9 million
increase in accounts payable is primarily due to the increase in uncompleted
work in progress and medical equipment installations occurring at the
Company's construction, manufacturing and medical subsidiaries at the end of
the third quarter 1998 as compared to year end 1997. Accrued salaries and
wages decreased $1 million primarily as a result of the payment of 1997
accrued employee incentives and the reduction in accrued benefits to
voluntary early retirement program participants. The decrease in federal and
state taxes accrued of $2.2 million is related to the timing of estimated
tax payments made in September. The decrease in other taxes accrued of
$719,000 is a result of the timing of property tax payments. Interest
accrued decreased $1.2 million due to the timing of bond interest payments,
the majority of which are due in the first and third quarters of the
calendar year.
The increase in noncurrent liabilities of $4.3 million is primarily due to
the recognition of special termination benefits and unrecognized prior
service costs related to pension and postretirement benefits as a result of
the Company's voluntary early retirement program. The $3.3 million decrease
in accumulated deferred income taxes is mainly due to the $6.3 million
expense accrual for the Company's voluntary early retirement program and the
reversal of $1.0 million in deferred taxes related to the Quadrant Co. waste
incineration plant.
Material Changes in Results of Operations
- -----------------------------------------
The 15.9% increase in electric operating revenue for the quarter ended
September 30, 1998, as compared to the same period in 1997, is due to a $4.4
million increase in power pool revenues, combined with a $2 million increase
in retail electric revenues and a $1.1 million increase in other electric
revenues. Power pool kwh sales increased 112%, while revenue per power pool
kwh sold increased almost 50%. The increase in power pool sales was the
result of a 3.6% increase in demand in the power pool along with increased
emphasis within the Company on wholesale sales. The ongoing transition to a
competitive wholesale market has caused the revenue per power pool kwh sold
along with the cost per kwh of purchased power to increase. The increase in
retail electric revenues is the result of a 3.9% increase in retail kwh
sales. The increase in other electric revenues reflects increased electrical
contract work done for other utilities.
The 8.8% increase in electric operating revenues for the nine months ended
September 30, 1998, as compared to the same period in 1997, is due to a
$13.8 million increase in power pool sales, combined with a $2.5 million
increase in other electric revenue, offset by a $3 million decrease in
retail revenue. Power pool kwh sales increased 134% and revenue per power
pool kwh sold increased 31%. The increase in the power pool sales is
related to an increase in energy available for sale, along with an increase
in demand. During the first six months of 1997, the Company had less energy
to market as a result of delayed coal shipments caused by blizzards and the
shutdown of Coyote Plant for a lengthy scheduled major overhaul. Increases
in wheeling revenues, Mid-Continent Area Power Pool transmission service
charges, Minnesota conservation improvement program incentives, integrated
transmission system deficiency payments and an increase in electrical
contract work done for other utilities contributed to the increase in other
electric revenue. The decrease in retail revenue was caused by a .8%
decline in retail kwh sales primarily as a result of significantly milder
weather, particularly during the first quarter of 1998. Heating degree-days
were down 22% for 1998 as compared to 1997. Revenue per retail kwh
decreased 1.3%. This decrease was due primarily to a reduction in cost-of-
energy revenues, which were $3 million lower than those recorded in 1997
primarily as a result of the Company having to purchase replacement power
during the overhaul shut down of Big Stone Plant in November 1996. The
recovery of fuel and purchase power costs through the cost-of-energy
adjustment mechanism in retail electric rates lags two to four months behind
the actual incurrance of those costs resulting in higher cost-of-energy
revenue recovery in the first quarter of 1997.
Production fuel expenses increased 1.9% and fuel costs per kwh generated
increased 4.4% in the three months ended September 30, 1998, as compared to
the three months ended September 30, 1997, as a result of increased
generation at a higher cost plant. The Company's Big Stone plant was offline
from September 11, 1998 until October 30, 1998 for a scheduled overhaul.
Total Company generation was down 1.9% for the quarter ended September 30,
1998 as compared to the three months ended September 30, 1997. Production
fuel expenses increased 16.5% for the nine month period ended September 30,
1998 as compared to the same period in 1997, with an 18% increase in kwhs
generated as a result of greater plant availability and increased demand in
the power pool. The shutdown of the Coyote Plant from March 27, 1997 until
June 6, 1997 was the primary reason for the increase in generation at the
steam plants in 1998 for nine-month period as compared to the same period in
1997.
Purchased power costs increased 131% for the three months ended September
30, 1998 as compared to the three months ended September 30, 1997 due to a
$2.2 million increase in power purchased for system use and a $3.7 million
increase in power purchased for resale. The $2.2 million increase in power
purchased for system use was the result of a 37% increase in kwh purchased
combined with a 30% increase in the cost per kwh purchased for the quarter
as compared to the same period in the prior year. More kwhs were purchased
for system use due to a 3.9% increase in retail sales and a 1.9% reduction
in Company generation. For the nine months ended September 30, 1998,
purchased power costs increased 56% as compared to the nine months ended
September 30, 1997. Purchased power for system use decreased $1.5 million
for the nine months of 1998 as compared to the same period in 1997 due to
increased generation at the Company's plants. Purchased power costs for
resale increased $11.3 million for the nine months ended September 30, 1998
as compared to the nine months ended September 30, 1997 due to an increase
in power pool sales.
Other electric operation and maintenance expenses for the quarter ended
September 30, 1998, as compared to the same period in 1997, decreased 9.3%.
This decrease is primarily due to an increase in capitalized costs and a
reduction in labor expenses mainly related to the early retirement program
and a reduction in pension expense. The decrease was offset by the
recording of a $450,000 settlement liability to the University of Minnesota
for the Rosemount site contamination settlement. (See "Contingency" in notes
to financial statements on page 8 for further information.) The reduction in
other electric operation and maintenance expenses for the quarter ended
September 30, 1998 offset increases in this category during the first six
months of 1998, resulting in a 1.1% decrease for the nine month period ended
September 30, 1998 as compared to the prior year.
Special charges of $9.5 million that were recorded in the first quarter of
1998, represent three items: (1) a noncash charge of $6.3 million associated
with a voluntary early retirement program offered by the Company, (2) a $2.5
million impairment loss associated with the Quadrant Co. waste incineration
plant, and (3) 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
financial statements on page 6 for further information including the net-of-
tax and earnings per share impact of these charges.)
The breakdown of cost of goods sold and other nonelectric expenses by
business segments other than electric are as follows:
Three months ended September 30
Cost of goods sold Other nonelectric expenses
------------------ --------------------------
1998 1997 1998 1997
------ ------ ------ ------
(in thousands)
Manufacturing $17,812 $15,963 $3,238 $3,169
Health services 8,683 10,916 6,426 5,679
Other business operations 10,450 8,850 3,666 3,810
------- ------- ------- -------
Total $36,945 $35,729 $13,330 $12,658
======= ======= ======= =======
Nine months ended September 30
Cost of goods sold Other nonelectric expenses
------------------ --------------------------
1998 1997 1998 1997
------ ------ ------ ------
(in thousands)
Manufacturing $50,168 $42,784 $ 9,309 $ 7,672
Health services 25,425 28,744 18,689 16,498
Other business operations 20,031 17,672 10,805 9,726
------- ------- -------- --------
Total $95,624 $89,200 $38,803 $33,896
======= ======= ======= =======
Operating income for the manufacturing segment increased $429,000 and
$989,000 for the three- and nine-month periods ended September 30, 1998,
respectively, as compared to the same periods in the prior year. The
increase in manufacturing operating revenue of 10.8% for the three months
ended September 30, 1998 as compared to the same period in 1997 is due to
increased sales volumes at three of the Company's six manufacturing
subsidiaries. Sales volume increases at all but one of the six manufacturing
subsidiaries contributed to the 17.5% increase in manufacturing operating
revenue for the nine month period ended September 30, 1998 as compared to
the same period in 1997. Increases in manufactured cost of goods sold are
directly related to the increases in the sales. The increase in
manufacturing other nonelectric expenses is due to increased sales volumes,
increased incentive compensation and increased marketing expenditures.
Operating income for the health services segment increased $329,000 and $2.6
million for the three- and nine-month periods ended September 30, 1998 as
compared to the same periods in the prior year. Health services operating
revenues decreased 6.7% and increased 3% for the three- and nine-month ended
periods ended September 30, 1998, respectively, as compared to the same
period in 1997. The decrease in health services operating revenues during
the third quarter of 1998 is due to the large number of medical equipment
installations that are in process. These installations are not billed until
completed. The number of medical imaging scans performed during the three
and nine months ended September 30, 1998 as compared to the same period in
1997 has increased 6.4% and 12.9% respectively. The decrease in health
services cost of goods sold for the three months ended September 30, 1998 is
a result of the decrease in medical equipment sold. The decrease for the
nine months ended in health services cost of goods sold as compared to the
same period in 1997, is primarily due to inventory write downs recorded
during the nine months ended September 30, 1997. The increase in health
services other nonelectric expenses for the three and nine-months ended
September 30, 1998 is related to the increase in medical imaging services
delivered.
In other business operations, operating income increased $336,000 for the
three month period ended September 30, 1998 as compared to the same period
in 1997. For the nine months ended September 30, 1998 other business
operations operating income decreased $1.7 million. This decrease reflects
the $2.5 million Quadrant impairment loss recorded in the first quarter of
1998. The increase in operating revenues and cost of goods sold for the
three- and nine- month periods ended September 30, 1998, were primarily a
result of the PAM acquisition. Expenses recorded in 1997 related to the
Peoples Telephone acquisition was the primary reason for the decrease in
other nonelectric expenses for the three months ended September 30, 1998.
The increase in other nonelectric expenses for the nine months ended
September 30, 1998 is due to the PAM acquisition and increased operating
expenses in the construction companies and radio stations.
The decrease in other income and deductions - net for the quarter ended
September 30, 1998, as compared to the third quarter in 1997, primarily
relates to a $1.8 million gain on the sale of a Direct Broadcast Satellite
franchise recorded in the third quarter of 1997. The remainder of the
decrease in other income and deductions - net for the nine months ended
September 30, 1998, as compared to the nine months ended September 30, 1997,
is related to the sale and reclassification of investments held by the
Company's telecommunications subsidiary in 1997 and the recognition of
$880,000 in compensation for the abandonment of certain microwave
frequencies in 1997.
The decrease in interest charges for the three- and nine-month periods ended
September 30, 1998, as compared to the same periods in 1997, is primarily a
result of the reduction of debt related to a $16 million sale/leaseback
transaction entered into by the medical imaging services subsidiary in
November 1997, refinancing of various subsidiary fixed and variable interest
rate debt with $22.5 million in 7.8% fixed rate debt in November 1997 and
lower interest rates on the subsidiaries' line of credit borrowings.
Interest rates paid under the subsidiaries' line of credit averaged 7.4%
during the nine months ended September 30, 1998 as compared to 8.5% during
the nine months ended September 30, 1997.
The increase in income taxes for the three months ended September 30, 1998,
and the decrease for the nine months ended September 30, 1998 as compared to
the three- and nine- month periods ended September 30, 1997, primarily
relate to the increase and decrease in income before taxes for the same
comparable periods.
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 field
meaning that they may not be able to properly recognize 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 ensure that
the year 2000 issue is addressed from a total business perspective, the
Company is working with its major vendors, customers, banks, regulatory and
government agencies, and utility alliances. Contingency plans are also
being developed for certain critical business processes and should be fully
developed by June 1999.
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. 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. As of September 30, 1998,
90% of the material systems have been inventoried. The inventory phase is
expected to be completed by December 1, 1998. The assessment phase is 70%
complete as of September 30, 1998, with an estimated completion date of
December 31, 1998. Remediation and testing is 25% complete as of September
30, 1998. The Company expects to complete remediation and testing by
June 1, 1999.
In addition, the Company's operating businesses are in the process of
initiating communications with critical external parties in order to
determine the extent of vulnerability to such parties failure to resolve
their own year 2000 issues. 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 compliance should not have a material adverse
effect on the Company's results of operations, the failure of several key
third parties could have such an effect. The Company expects to have third
party assessments completed by March 1999. The Company is developing
contingency plans to alter business relationships in the event certain third
parties fail to become year 2000 compliant.
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
compliance effort is linked to the compliance 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 under the direction of the U. S.
Department of Energy. 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 compliance effort are being funded with
cash flows from operations. These costs are not expected to be substantially
different from the normal, recurring costs that are incurred for systems
development and implementation, due in part to the use of internal resources
and the deferral of other projects. Total expenditures related to inventory,
assessment, remediation, testing, conversion replacement and upgrading
system applications are expected to range from $750,000 to $950,000 for 1997
to 2000. Expenditures incurred through September 30, 1998 were $250,000.
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. The costs of solving the year 2000 issue on the diagnostic imaging
equipment is expected to range from $450,000 to $600,000. 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.
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."
PART II. OTHER INFORMATION
--------------------------
Item 3. Legal Proceedings
-----------------
Quadrant and the Company have received from the Minnesota Pollution
Control Agency a Notice of Violation dated October 15, 1998 claiming
violations of emission limits, operational requirements and reporting
requirements applicable to Quadrant under Minnesota law. See
discussion under "Special Charges" in the Notes to Consolidated
Financial Statements. The Company does not expect this proceeding to
have a material impact on the Company's consolidated financial
position or consolidated results of operations.
Item 6. Exhibits and Reports on Form 8-K.
---------------------------------
a) Exhibits:
27 Financial Data Schedule
b) Reports on Form 8-K.
A report on Form 8-K was filed on September 29, 1998, related to
Amendment No. 1 to the Rights Agreement dated as of January 27, 1997,
between the Company and Norwest Bank Minnesota, National Association.
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: Jeff Legge
---------------------
Jeff Legge
Controller
(Chief Accounting Officer/Authorized Officer)
Dated: November 13, 1998
---------------------
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This schedule contains summary financial information extracted from the
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