-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, A7IgvVN/k2wr6/Hb457sg2U3pd+E/ESWwfwUt5ZRXnVlTSCPjQHOMTnX/TdUyD0V BRegpBbzZRejp4CATX/UvA== 0000075129-99-000016.txt : 19990330 0000075129-99-000016.hdr.sgml : 19990330 ACCESSION NUMBER: 0000075129-99-000016 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990329 FILER: COMPANY DATA: COMPANY CONFORMED NAME: OTTER TAIL POWER CO CENTRAL INDEX KEY: 0000075129 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 410462685 STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-00368 FILM NUMBER: 99575716 BUSINESS ADDRESS: STREET 1: 215 S CASCADE ST STREET 2: PO BOX 496 CITY: FERGUS FALLS STATE: MN ZIP: 56538-0496 BUSINESS PHONE: 2187398200 10-K405 1 10-K FOR 1998 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) (X) Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 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 Identification No.) incorporation or organization) 215 S. CASCADE ST., BOX 496, FERGUS FALLS, MN 56538-0496 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (218) 739-8200 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered NONE NONE Securities registered pursuant to Section 12(g) of the Act: COMMON SHARES, par value $5.00 per share PREFERRED SHARE PURCHASE RIGHTS CUMULATIVE PREFERRED SHARES, without par value (Title of class) 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 by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. (X) State the aggregate market value of the voting stock held by nonaffiliates of the registrant. $438,363,131 as of February 26, 1999 Indicate the number of shares outstanding of each of the registrant's classes of Common Stock, as of the latest practicable date: 11,884,855 Common Shares ($5 par value) as of February 26, 1999 Documents Incorporated by Reference: 1998 Annual Report to Shareholders-Portions incorporated by reference into Parts I and II Proxy Statement dated March 12, 1999-Portions incorporated by reference into Part III PART I Item 1. BUSINESS -------- (a) General Development of Business ------------------------------- Otter Tail Power Company (the Company) is an operating public utility incorporated in 1907 under the laws of the State of Minnesota. The Company's principal executive office is located at 215 South Cascade Street, Box 496, Fergus Falls, Minnesota 56538-0496; its telephone number is (218)739-8200. Historically, the Company's primary business has been the production, transmission, distribution and sale of electric energy. During the last decade the Company, through its subsidiaries, has made significant investments in other businesses which are referred to as Manufacturing Operations, Health Services Operations and Other Business Operations. Manufacturing Operations includes businesses involved in the production of agricultural equipment, automobile and truck frame-straightening equipment, plastic pipe extrusion, and metal parts stamping and fabrication. Health Services Operations consists of certain businesses which are involved in the sale, service, rental, refurbishing, and operation of medical imaging equipment and the sale of related supplies and accessories to various medical institutions. Other Business Operations include businesses involved in such areas as electrical and telephone construction contracting, energy services, natural gas marketing, entertainment, waste incinerating, and telephone/cable TV utility. Substantially all of these businesses are owned by the Company's wholly-owned subsidiary Varistar Corporation (Varistar)(formerly Mid-States Development, Inc.). The Company continues to investigate acquisitions of additional non- electric businesses and expects continued growth in this area. On May 1, 1998, the Company's energy services subsidiary, Otter Tail Energy Services, acquired PAM Natural Gas, Inc. (PAM) a 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 Company. In December 1998, Varistar entered into a definitive agreement to sell certain assets of the radio stations and video production company owned by KFGO, Inc. and the radio stations owned by Western Minnesota Broadcasting Company. Disposition of the Quadrant Co. municipal waste burning facility is also being considered following its shut down in July 1998 due to alleged noncompliance with the Minnesota Pollution Control Agency (MPCA) particulate emissions regulations. See "Other Business Operations" for additional information regarding these subsidiaries. For a discussion of the Company's results of operations, see "Management's discussion and analysis of financial condition and results of operations," which is incorporated by reference to pages 18 through 25 of the Company's 1998 Annual Report to Shareholders, filed as an Exhibit hereto. (b) Financial Information About Industry Segments --------------------------------------------- The Company and its subsidiaries are engaged in businesses that have been classified into four segments: Electric Operations, Manufacturing Operations, Health Services Operations, and Other Business Operations. Financial information about the Company's industry segments is incorporated by reference to note 4 of "Notes to consolidated financial statements" on pages 35 and 36 of the Company's 1998 Annual Report to Shareholders, filed as an Exhibit hereto. (c) Narrative Description of Business --------------------------------- ELECTRIC OPERATIONS ------------------- General - ------- The Company derived 53% of its consolidated operating revenues from the electric segment during 1998; 52% during 1997; and 54% during 1996. During 1998 the Company derived approximately 52.1% of its retail electric revenues from Minnesota, 40.2% from North Dakota, and 7.7% from South Dakota. The territory served by the Company is predominantly agricultural, including a part of the Red River Valley. Although there are relatively few large customers, sales to commercial and industrial customers are significant. By customer category, 32.6% of 1998 electric revenue was derived from commercial customers, 29.9% from residential customers, 20.1% from industrial customers, and 17.4% from other sources, including municipalities, farms and power pools. No customer accounted for more than 10% of electric revenues in 1998. Power pool sales to other utilities, which accounted for 25.5% of total 1998 kwh sales, increased from 14.5% in 1997. An increase in the Company's energy available for sale combined with unusually high wholesale market demands led to this increase in power pool sales to other utilities. Activity in short- term energy sales is subject to change based on a number of factors and the Company is unable to predict the 1999 level of activity. The aggregate population of the Company's retail electric service area is approximately 230,000. In this service area of 423 communities and adjacent rural areas and farms, approximately 123,600 people live in communities having a population of more than 1,000, according to the 1990 census. The only communities served which have a population in excess of 10,000 are Jamestown, North Dakota (15,571); Fergus Falls, Minnesota (12,362); and Bemidji, Minnesota (11,245). Since 1990 when the customer count was at a low of 121,277, the Company has experienced an increase in customers. By year end 1998 total customers had increased to 125,712. During 1998, the Company experienced a net increase of 521 customers, with the majority of growth in residential customers. Competition - ----------- The Company's electric sales are subject to competition in some areas from municipally owned systems, rural electric cooperatives and, in certain respects, from on-site generators and cogenerators. The Company's electricity also competes with other forms of energy. The degree of competition may vary from time to time depending on relative costs and supplies of other forms of energy. The Company may also face competition as the restructuring of the electric industry evolves. Proposals that are being considered by various states and at the federal level, along with the National Energy Policy Act of 1992 (NEPA), are expected to bring more competition into the electric industry. NEPA reduces restrictions on operation and ownership of independent power producers (IPPs). It also allows IPPs and other wholesale suppliers and purchasers increased access to transmission lines. NEPA prohibits retail wheeling ordered by the Federal Energy Regulatory Commission (FERC), but it does not address the states' authority to order retail wheeling. In 1996, FERC issued two closely related final rules. FERC Order No. 888 opened wholesale power sales to competition by requiring public utilities who own, control, or operate transmission lines, to file nondiscriminatory pro forma open access tariffs that offer others the same transmission service they provide themselves. FERC Order No. 889 requires utilities to post or make available information about their transmission system for their own wholesale power transactions, such as capacity availability, by the same means as their competitors would via an Open Access Same-time Information System (OASIS), as well as separate their wholesale marketing and transmission operation functions. As the electric industry moves towards deregulation, the Company expects the industry to become more competitive. The Company is taking a number of steps to position itself for success in a competitive marketplace. It has initiated the process of functionally unbundling its energy supply, energy delivery, and energy services operations by setting up distinct separate business units in each of these areas. The Company is developing the necessary accounting systems to capture costs and determine the profitability of each of these units and to identify areas for improvement and opportunities for increased profitability. The Company has established an energy services business unit to promote the energy-related products and services traditionally offered to the Company's customers and to develop new products and services to be offered to current and potential customers in order to distinguish the Company from the competition. Furthermore, with the goal of alleviating state tax inequities in the electric industry, the Company is working with other utilities to develop tax reform proposals and testimony for legislative committees developed in the states of Minnesota and North Dakota to study competition. In order to facilitate the move to competition and to control costs, the Company announced a voluntary early retirement program in January 1998 for all nonunion electric utility employees age 55 and over. The offer of early retirement was accepted by 55 of the 67 eligible utility employees during the enrollment period. The Company anticipates that most of the staff reduction will be permanent, resulting in enhanced competitive positioning and earnings potential. As the electric industry evolves and become more competitive, the Company believes it is well positioned to maintain its customer base and may have opportunities to increase its market share. The Company's generation capacity appears poised for competition due to unit heat rate improvements and reductions in fuel and freight costs at most of its generating plants. A comparison of the Company's electric retail rates to the rates of other investor-owned utilities, cooperatives, and municipals in the states the Company serves indicates that the Company's rates are competitive. In addition, the Company plans to attempt more flexible pricing strategies under an open, competitive environment. For the status of other regulatory initiatives relating to competition, see "General Regulation". Capability and Demand - --------------------- At December 31, 1998, the Company had base load net plant capability totaling 565,381 kw, consisting of 254,731 kw from the jointly-owned Big Stone Plant (constituting the Company's 53.9% share of the plant's total capability), 155,550 kw from the Hoot Lake Plant, 149,450 kw from the jointly-owned Coyote Station (constituting the Company's 35% share of the station's total capability), and, under contract, 5,650 kw from a co- generation plant near Bemidji, Minnesota. In addition to its base load capability, the Company has combustion turbine and small diesel units, used chiefly for peaking and standby purposes, with a total capability of 90,634 kw, and hydroelectric capability of 4,109 kw. During 1998, the Company generated about 66% of its total kwh sales and purchased the balance. The Company has made arrangements to help meet its future base load requirements, and continues to investigate other means for meeting such requirements. The Company has an agreement with another utility for the annual exchange of 75,000 kw of seasonal diversity capacity which runs through October 2004. The Company also has agreements to purchase 75,000 kw of capacity for the summer of 1999 and 50,000 kw of year-round capacity which extends through April 30, 2005. The Company has a direct control load management system, which provides some flexibility to the Company to effect reductions of peak load. The Company, in addition, offers rates to customers which encourage off-peak usage. The Company is a member of the Mid-Continent Area Power Pool (MAPP). The objective of MAPP is to coordinate the planning and operation of generation and interconnecting transmission facilities to provide reliable and economic electric service to members' customers. Customers served by MAPP members may, therefore, benefit from the regional high voltage interconnections, which are capable of transferring large blocks of energy between systems. Also, high voltage interconnections permit companies to engage in power transactions with each other. The operating agreement for MAPP was restated in 1996 to open membership to organizations outside the original Upper Midwest boundaries, to establish a Regional Transmission Group and to add energy market functions. The Company traditionally experiences its peak system demand during the winter season. For the calendar year 1998, the Company experienced a system peak demand of 635,174 kw on January 13, 1998. The Company's highest sixty- minute peak demand ever was 635,529 kw on January 7, 1997. Taking into account additional capacity available to it in January 1998 under power purchase contracts (including short-term arrangements), as well as its own generating capacity, the Company's capability of then meeting system demand, including reserve requirements computed in accordance with accepted industry practice, amounted to 782,983 kw. The Company expects moderate load growth in peak demand in 1999 as compared to 1998. The Company's additional capacity available under power purchase contracts (as described above), combined with the Company's generating capability and load management control capabilities, is expected to meet 1999 system demand, including industry reserve requirements. Fuel Supply - ----------- Coal is the principal fuel burned by the Company at its Big Stone, Coyote, and Hoot Lake generating plants. Coyote, a mine-mouth facility, burns North Dakota lignite coal. Hoot Lake and Big Stone plants burn western subbituminous coal. The following table shows, for 1998, the sources of energy used to generate the Company's net output of electricity: Net Kilowatt % of Total Hours Kilowatt Generated Hours Sources (Thousands) Generated ------- ----------- --------- Subbituminous Coal. . . . . . . . . . . 2,184,413 68.2% Lignite Coal. . . . . . . . . . . . . . 985,281 30.8 Hydro . . . . . . . . . . . . . . . . . 25,249 .8 Oil . . . . . . . . . . . . . . . . . . 7,200 .2 --------- ----- Total . . . . . . . . . . . . . . . . . 3,202,143 100.0% ========= ===== The Company has a coal supply agreement with Westmoreland Resources, Inc. of Billings, Montana, for the supply of subbituminous coal to the Big Stone Plant from mid-1995 through the end of 1999. The coal comes from the Absaloka Mine near Hardin, Montana. Negotiations are underway for the supply of subbituminous coal for 2000 and 2001. Based on current market conditions, the Company expects to execute a new subbituminous coal contract near current contract prices. The Company is in final negotiations for the supply of subbituminous coal as needed for the Hoot Lake Plant. A lignite coal contract with Knife River Coal Mining Company for the Coyote Station expires in 2016, with a 15-year renewal option subject to certain contingencies, and is expected to provide the plant's lignite coal requirements during the term of the contract. Knife River Coal Mining Company is an affiliate of Montana-Dakota Utilities Co., which is a co-owner of the Big Stone Plant and Coyote Station. In September 1996, three of the four co-owners of the Coyote Station filed a Demand and Notice of Arbitration complaint against Knife River Coal Mining Company and MDU Resources Group, Inc. The three co-owners contend that the 15-year-old pricing mechanism outlined in the original coal supply contract has been abandoned by all parties over the past 8 years and no longer results in fair, equitable, and competitive prices for the lignite coal used to generate electricity at the plant. The case was remanded to arbitration in 1997. The co-owners anticipate resolution of this case in 1999. It is the Company's practice to maintain minimum 30-day inventory (at full output) of coal at the Big Stone Plant, a 20-day inventory at the Coyote Station, and a 10-day inventory at the Hoot Lake Plant. The Company has a coal transportation agreement with Burlington Northern and Santa Fe Railroad for transportation services to the Big Stone Plant. This contract began in 1995 and runs through 1999. The Company has begun negotiations on a new coal transportation agreement for the Big Stone Plant. The average cost of coal consumed (including handling charges to the plant sites) per million BTU for each of the three years 1998, 1997, and 1996, was $.956, $.958, and $.944, respectively. The Company is permitted by the State of South Dakota to burn some alternative fuels, including tire and refuse derived fuel, at the Big Stone Plant. The quantity of alternative fuel burned at the Big Stone Plant is insignificant when compared to the total annual coal consumption at the Big Stone Plant. Rate Regulation - --------------- The Company is subject to electric rate regulation as follows: Year Ended December 31, 1998 ----------------- % of Electric % of kwh Rates Regulation Revenues Sales ----- ---------- -------- -------- MN retail sales MN Public Utilities Commission 44.8% 40.4% ND retail sales ND Public Service Commission 34.5 28.7 SD retail sales SD Public Utilities Commission 6.6 5.4 Transmission & sales FERC for resale 14.1 25.5 ----- ----- 100.0% 100.0% ===== ===== The following table summarizes the electric rate proceedings with the Minnesota Public Utilities Commission (MPUC), the South Dakota Public Utilities Commissions (SDPUC), the North Dakota Public Service Commission (NDPSC) and FERC since January 1, 1994: Commission Date - ---------- ---- Minnesota Last Proceeding was July 1, 1987 North Dakota Last Proceeding was September 22, 1993 South Dakota Last Proceeding was November 1, 1987 FERC On March 25, 1997, FERC issued an order approving a settlement agreement in the Company's Open Access Transmission Tariff filing of July 9, 1996. This settlement sets the rates the Company can charge under its Open Access Transmission Tariff. On May 29, 1997, FERC issued an order approving a request for the waiver of the standards of conduct under Order 889. Since 1995, the Company has recovered demand-side management related costs, under Minnesota's Conservation Improvement Programs, through the use of an annual recovery mechanism approved by the MPUC. In 1998, the MPUC approved the Company's 1997 financial incentives filing along with a 2.75 percent surcharge on all Minnesota customers' bills starting on July 1, 1998, for the recovery of conservation-related costs over and above those being recovered in current rates. The approved surcharge in effect from July 1, 1997 through June 30, 1998 was 1.75 percent and the approved surcharge in effect from July 1, 1996 through June 30, 1997 was 1.25 percent. The current surcharge rate will be in place until June 30, 1999 when it will be revised for subsequent years' program results. During 1998, the Minnesota Department of Public Service (DPS) recommended to the MPUC that demand-side management incentives for all Minnesota electric utilities be terminated as of January 1, 1998. At a hearing held November 19, 1998, the MPUC did not accept the DPS recommendation, however, the MPUC put electric and gas utilities on notice that the ability to earn demand-side management incentives could end as early as January 1, 1999. Incentives accrued by the Company for 1998 totaled $1,750,000. A MPUC Chair's Round Table has been convened to examine demand-side management programs and related incentives. A report from the Round Table to the MPUC is due by May 1, 1999. Under Minnesota law, the MPUC must allow implementation of an interim rate increase, subject to refund with interest, sixty days after the initial filing date of a rate increase request, except that the MPUC is not required to allow implementation of the interim rate increase until four months after the effective date of a previous rate order. The amount of the interim rate increase will be calculated using the proposed test year cost of capital, the rate of return on common equity most recently granted to the Company by the MPUC, and rate base and expense items allowed by a currently effective MPUC order. In addition, if the MPUC fails to make a final determination regarding any rate request within ten months after the initial request is filed, then the requested rate is deemed to be approved, except if (I) an extension of the procedural schedule (in case of a contested rate increase request) has been granted, in which case the schedule of rates will be deemed to have been approved by the MPUC on the last day of the extended period of suspension of the rate increase, or (II) a settlement has been submitted to and rejected by the MPUC, and the MPUC does not make a final determination concerning the schedule of rates, in which case the schedule of rates will be deemed to have been approved sixty days after the initial or, if applicable, the extended period of suspension of the rate increase. Rate requests filed with the NDPSC become effective thirty days after the date of filing unless suspended by the NDPSC. Within seven months after the date of suspension, the NDPSC must act on the request, and during the period of consideration by the NDPSC a suspended rate can be implemented only with the approval of the NDPSC. The NDPSC periodically performs audits of gas and electric utilities over which it has rate setting jurisdiction to determine reasonability of overall rate levels. In the past, these audits have occasionally resulted in settlement agreements adjusting rate levels. While the Company has begun preliminary discussions with the NDPSC staff regarding the current audit, it is too early to predict whether any rate adjustment will be made. South Dakota law provides that a requested rate increase can be implemented thirty days after the date of filing, unless its effectiveness is suspended by the SDPUC. The SDPUC may suspend the effectiveness of the proposed rate change for a period not longer than ninety days beyond the time when the rate change would otherwise go into effect, unless the SDPUC finds that a longer time is required, in which case the SDPUC may extend the suspension for a period not to exceed a total of twelve months. A public utility may not put a proposed rate change into effect until at least forty- five days after the SDPUC has made a determination concerning any previously filed rate change. In the event that a requested rate change is suspended by the SDPUC, such requested rate change may be implemented by the public utility six months after the date of filing (unless previously authorized by the SDPUC), subject to refund with interest. The Company's wholesale power sales and transmission rates are subject to the jurisdiction of the FERC under the Federal Power Act of 1935, as amended (FPA). Filed rates are effective after a one-day suspension period, subject to ultimate approval by the FERC. Power pool sales are conducted continuously through MAPP on the basis of generating costs, in accordance with schedules filed by MAPP with the FERC. In rate cases, a forward test year procedure enables cost increases to be recovered more promptly than use of an historic test year. The MPUC has established by regulation a forward test year. North Dakota law allows a forward test year. The SDPUC uses an historic test year with adjustments for known and measurable changes occurring within twenty-four months of the last month of the test year. The Company has obtained approval from the regulatory commissions in all three states which it serves for lower rates for residential demand control and controlled service, in Minnesota and North Dakota for real-time pricing, and in North Dakota and South Dakota for bulk interruptible rates. Each of these special rates is designed to improve efficient use of Company facilities, while encouraging use of electricity instead of other fuels and giving customers more control over the size of their electric bill. All of the Company's electric rate schedules now in effect, except for wheeling, certain municipal and area lighting services and certain interruptible rates, provide for adjustments in rates based upon the cost of fuel delivered to the Company's generating plants, as well as for adjustments based upon the cost of electric power energy purchased by the Company. Such adjustments are presently based upon a two-month moving average in Minnesota and under FERC regulation, a three-month moving average in South Dakota, and a four-month moving average in North Dakota and are applied to the next billing after becoming applicable. General Regulation - ------------------ Minnesota: Under the Minnesota Public Utilities Act, the Company is subject to the jurisdiction of the MPUC with respect to rates, issuance of securities, depreciation rates, public utility services, construction of major utility facilities, establishment of exclusive assigned service areas, contracts and arrangements with subsidiaries and other affiliated interests, and other matters. The MPUC has the authority to assess the need for large energy facilities and to issue or deny certificates of need, after public hearings, within six months of an application to construct such a facility. The DPS is responsible for investigating all matters subject to the jurisdiction of the DPS or the MPUC, and for the enforcement of MPUC orders. Among other things, the DPS is authorized to collect and analyze data on energy and the consumption of energy, develop recommendations as to energy policies for the governor and the legislature of Minnesota and evaluate policies governing the establishment of rates and prices for energy as related to energy conservation. The DPS acts as a state advocate in matters heard before the MPUC. The DPS also has the power to prepare and adopt regulations to conserve and allocate energy in the event of energy shortages and on a long-term basis. Under Minnesota law, every public utility that furnishes electric service must make annual investments and expenditures in energy conservation improvements, or make a contribution to the state's energy and conservation account, in an amount equal to at least 1.5% of its gross operating revenues from service provided in Minnesota. The DPS may require the Company to make investments and expenditures in energy conservation improvements whenever it finds that the improvement will result in energy savings at a total cost to the utility less than the cost to the utility to produce or purchase an equivalent amount of a new supply of energy. Such DPS orders are appealable to the MPUC. Investments made pursuant to such orders generally are recoverable costs in rate cases, even though ownership of the improvement may belong to the property owner rather than the utility. In 1995, the MPUC approved an automatic recovery mechanism which allows the Company to begin collecting from customers any conservation-related expenditures not included in base rates. The MPUC requires the submission of a 15-year advance integrated resource plan by utilities serving at least 10,000 customers, either directly or indirectly, and having at least 100 megawatts of load. The MPUC's findings and orders with respect to these submissions is binding for jurisdictional utilities. The Company's most recent plan was submitted to the MPUC in 1996, and was approved as submitted in its entirety. During 1998, the MPUC granted the Company a one year waiver in submitting its next plan, which will be completed in 1999. The Minnesota legislature has enacted a statute that favors conservation over the addition of new resources. In addition, it has mandated the use of renewable resources where new supplies are needed, unless the utility proves that a renewable energy facility is not in the public interest. It has effectively prohibited the building of new nuclear facilities. The environmental externality law requires the MPUC, to the extent practicable, to quantify the environmental costs of each type of generation, and to use such monetized values in evaluating resource plans. The MPUC must disallow any nonrenewable rate base additions (whether within or outside of the state) or any rate recovery therefrom, and may not approve any nonrenewable energy facility in an integrated resource plan, unless the utility proves that a renewable energy facility is not in the public interest.The state has prioritized the acceptability of new generation with wind and solar ranked first and coal and nuclear ranked fifth, the lowest ranking. Pursuant to the Minnesota Power Plant Siting Act, the Minnesota Environmental Quality Board (EQB) has been granted the authority to regulate the siting in Minnesota of large electric power generating facilities in an orderly manner compatible with environmental preservation nd the efficient use of resources. To that end, the EQB is empowered, after study, evaluation, and hearings, to select or designate in Minnesota sites for new electric power generating plants (50,000 kw or more) and routes for transmission lines (200 kv or more) and to certify such sites and routes as to environmental compatibility. North Dakota: The Company is subject to the jurisdiction of the NDPSC with respect to rates, services, certain issuances of securities and other matters. The North Dakota Energy Conversion and Transmission Facility Siting Act grants the NDPSC the authority to approve sites in North Dakota for large electric generating facilities and high voltage transmission lines. This Act is similar to the Minnesota Power Plant Siting Act described above and affects new electric power generating plants of 50,000 kw or more and new transmission lines of more than 115 kv. The Company is required to submit a ten-year plan to the NDPSC annually. South Dakota: The South Dakota Public Utilities Act subjects the Company to the jurisdiction of the SDPUC with respect to rates, public utility services, establishment of assigned service areas, and other matters. The Company is currently exempt from the jurisdiction of the SDPUC with respect to the issuance of securities. Under the South Dakota Energy Facility Permit Act, the SDPUC has the authority to approve sites in South Dakota for large energy conversion facilities (100,000 kw or more) and transmission lines of 115 kv or more. FERC: The Company is also subject to regulation by the FERC, successor to the Federal Power Commission, created pursuant to the FPA. The FERC is an independent agency which has jurisdiction over rates for sales for resale, transmission and sale of electric energy in interstate commerce, interconnection of facilities, and accounting policies and practices. General: The United States Congress ended its 1998 legislative session without taking action on proposed electric industry restructuring legislation. Federal restructuring legislation in 1999 is not anticipated due to the complexities of issues involved with federal intervention. The MPUC issued its Wholesale Competition Report in 1996 and its Retail Competition Report in 1997 and continues to work on specific topics in the areas of potential stranded costs, unbundled rates and affiliated transactions. The Minnesota legislature did not take any significant legislative action on electric utility restructuring in 1998, and no significant action is expected during 1999. In 1997, the North Dakota legislature created a subcommittee to investigate the impact of electric utility industry restructuring on North Dakota. The North Dakota legislature plans to deal with tax issues surrounding restructuring first. Currently, South Dakota is not undertaking any legislative activity regarding electric utility restructuring. The Company is subject to various federal and state laws, including the Federal Public Utility Regulatory Policies Act and the Energy Policy Act of 1992, which are intended to promote the conservation of energy and the development and use of alternative energy sources. The Company is unable to predict the impact on its operations resulting from future regulatory activities by any of the above agencies, from any future legislation or from any future tax which may be imposed upon the source or use of energy. Environmental Regulation - ------------------------ Impact of Environmental Laws: The Company's existing generating plants are subject to stringent federal and state standards and regulations regarding, among other things, air, water and solid waste pollution. The Company estimates that it has expended in the five years ended December 31, 1998, approximately $2,238,000 for environmental control facilities. Included in the 1999-2003 construction budget are approximately $2,757,000 for environmental equipment for existing and new facilities, including $677,000 for 1999. Air Quality: Pursuant to the Federal Clean Air Act of 1970 as amended (the Act), the United States Environmental Protection Agency (EPA) has promulgated national primary and secondary standards for certain air pollutants. All primary fuel burned by the Company at its steam generating plants is North Dakota lignite or western subbituminous coal with sulfur content averaging less than one percent. Electrostatic precipitators have been installed at the principal units at the Hoot Lake Plant and at the Big Stone Plant. A fabric filter to collect particulates from stack gases has been installed on a smaller unit at Hoot Lake Plant. As a result, the units at the Big Stone Plant and the Hoot Lake Plant currently meet all presently applicable federal and state air quality and emission standards. The Coyote Station is substantially the same design as the Big Stone Plant, except for site-related items and the inclusion of sulfur dioxide removal equipment. The removal equipment--referred to as a dry scrubber-- consists of a spray dryer, followed by a fabric filter, and is designed to desulfurize hot gases from the stack without producing sludge, an unwanted by-product of the conventional wet scrubber system. The Coyote Station is currently operating within all presently applicable federal and state air quality and emission standards. The Act, in addressing acid deposition, will impose new requirements on power plants in an effort to reduce national emissions of sulfur dioxide (SO2) and nitrogen oxide (NOx). The national SO2 emission reduction goals are to be achieved through a new market-based system under which power plants are to be allocated "emissions allowances" that will require plants to either reduce their emissions or acquire allowances from others to achieve compliance. The SO2 emission reduction requirements are being imposed in two phases. Phase one was imposed in 1995 and phase two will be imposed in 2000. The phase one requirements did not apply to any of the Company's plants. The phase two requirements will apply to the Company's plants. The Company believes that its current use of low sulfur coal at the Hoot Lake Plant and the dry scrubbers installed at the Coyote Station will enable the facilities to comply with anticipated phase two limitations on SO2 emissions. The subbituminous coal burned at the Big Stone Plant replaced lignite, which had been used since inception of plant operation in 1975 as the primary fuel. The Company intends that the Big Stone Plant will maintain current levels of operation and meet phase two requirements by burning low sulfur subbituminous coal. The national NOx emission reduction goals are to be achieved by imposing mandatory emissions standards on individual sources. The NOx emissions regulations that were issued by the EPA in 1995 apply to phase one boilers of the same design as those used at the Hoot Lake Plant units 2 and 3. The Act allowed the EPA to retain the standard as it currently applies to phase one boilers or adopt more stringent standards for phase two boilers by January 1, 1997. More stringent standards were adopted by the EPA on December 19, 1996. The Company had the option of complying with the phase one standards beginning on January 1, 1997, under EPA's early opt-in provision, or complying with any revised standard for phase two boilers. The Company elected the early opt-in provision for Hoot Lake Plant unit 2. The unit is governed by the phase one standard until January 1, 2008. The Company did not elect the early opt-in provision for Hoot Lake Plant unit 3. Minor modifications have been completed on Hoot Lake Plant unit 3 to meet the NOx emission requirements by 2000. On December 19, 1996, the EPA also adopted NOx emissions regulations that would be applicable to cyclone-fired boilers such as those used at the Big Stone Plant and Coyote Station. The regulations require that the emission standard be met by cyclone boilers beginning on January 1, 2000. The Company has evaluated the Big Stone Plant and Coyote Station NOx emissions with respect to the December 19, 1996 rules. Existing emissions monitoring data indicate that the Coyote Station meets the emissions requirements. During 1997, the Company conducted tests at the Big Stone Plant to determine if emissions can be reduced through modifications to existing equipment. The results of the tests were positive and modifications have been completed. As a result of the modifications, the Company believes the NOx emissions regulations have been met. The Act contains a list of regulated toxic air pollutants, which includes certain substances believed to be emitted by the Company's plants. The Act calls for EPA studies of the effects of emissions of the listed pollutants by electric utility steam generating plants. The EPA has completed the studies and sent reports to Congress. Because promulgation of rules by the EPA has not been completed, it is not possible to assess at this time whether, or to what extent, this legislation will ultimately impact the Company. Water Quality: The Federal Water Pollution Control Act Amendments of 1972, and amendments thereto, provide for, among other things, the imposition of effluent limitations to regulate discharges of pollutants, including thermal discharges, into the waters of the United States, and the EPA has established effluent guidelines for the steam electric power generating industry. Discharges must also comply with state water quality standards. The Company has all federal and state water permits presently necessary for the operation of the Big Stone Plant. Water discharge permits for the Hoot Lake Plant and Coyote Station were renewed in 1997 and 1998, respectively, each for a five-year term. The Company owns five small dams on the Otter Tail River which are subject to FERC licensing requirements. A license for all five dams was issued on December 5, 1991. Total nameplate rating of the five dams is 3,450 kw (net unit capability of 3,539 kw at December 31, 1998). Solid Waste: Permits for disposal of ash and other solid wastes have been issued for the Big Stone Plant and Coyote Station. A renewal permit is pending for the Hoot Lake Plant, and the Company anticipates that it will obtain this renewal in due course. The Company estimates that the current ash disposal site at the Hoot Lake Plant will be filled to capacity within three to four years. The Company is evaluating its options, including increased marketing of the ash for construction purposes and building a new ash disposal site adjacent to the current site within the same permitted area. Although an estimate of the engineering costs required to construct a new facility has not been completed, the Company believes that the investment required will not have a significant impact on future plant operating costs. The EPA has promulgated various solid and hazardous waste regulations and guidelines pursuant to, among other laws, the Resource Conservation and Recovery Act of 1976, the Solid Waste Disposal Act Amendments of 1980, and the Hazardous and Solid Waste Amendments of 1984, which provide for, among other things, the comprehensive control of various solid and hazardous wastes from generation to final disposal. The states of Minnesota, North Dakota and South Dakota have also adopted rules and regulations pertaining to solid and hazardous waste. The total impact on the Company of the various solid and hazardous waste statutes and regulations enacted by the federal government or the states of Minnesota, North Dakota and South Dakota is not certain at this time. To date, the Company has incurred no significant costs as a result of these laws. In 1980, the United States enacted the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as the Federal Superfund law, which was reauthorized and amended in 1986. In 1983, Minnesota adopted the Minnesota Environmental Response and Liability Act, commonly known as the Minnesota Superfund law. In 1988, South Dakota enacted the Regulated Substance Discharges Act, commonly known as the South Dakota Superfund law. In 1989, North Dakota enacted the Environmental Emergency Cost Recovery Act. Among other requirements the federal and state acts establish environmental response funds to pay for remedial actions associated with the release or threatened release of certain regulated substances into the environment. These federal and state Superfund laws also establish liability for cleanup costs and damage to the environment resulting from such release or threatened release of regulated substances. The Minnesota Superfund law also creates liability for personal injury and economic loss under certain circumstances. The Company is unable to determine the total impact of the Superfund laws on its operations at this time but has not incurred any significant costs to date related to these laws. The Federal Toxic Substances Control Act of 1976 regulates, among other things, polychlorinated byphenyls (PCBs). The EPA has enacted regulations concerning the use, storage and disposal of PCBs. The Company completed a program for the removal of all PCB-filled transformers and capacitors by the end of 1987 and received Certificates of Disposal in 1989. The Company completed removal of PCB-contaminated mineral oil dielectric fluid from all substation transformers and voltage regulators and continues to remove such oil from other electrical equipment. The University of Minnesota (University) notified the Company during 1998 that it intended to seek contribution for expenditures made by the University for the remediation of soil contaminated by PCBs at the Rosemount Research Center Superfund site, which is owned by the University. The MPCA and the University asserted that some of the Company's used electrical equipment shipped to the site for disposal 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. The Company recognized a liability for $450,000 related to this settlement during the third quarter of 1998. Health Effects of Electric and Magnetic Fields (EMF): In 1996, the National Research Council of the National Academy of Sciences, after evaluating more than 500 studies on the effects of EMF, found insufficient evidence to consider electric and magnetic fields a threat to human health. Although research conducted to date has found no conclusive evidence that electric and magnetic fields affect health, a few studies have suggested a possible connection with cancer. The utility industry continues to fund studies. The ultimate impact, if any, of this issue on the Company and the utility industry is impossible to predict. Capital Expenditures - -------------------- The Company is continually expanding, replacing and improving its electric utility facilities. During 1998, the Company invested approximately $18,174,000 for additions to its electric utility properties. During the five years ended December 31, 1998, the Company had gross electric property additions, including construction work in progress, of approximately $134,511,000 and gross retirements of approximately $42,329,000. The Company estimates that during the five years 1999 through 2003 it will invest approximately $105 million for electric utility construction. The Company continuously reviews options for increasing its generating capacity, but at this time has no firm plans for additional base load generating plant construction. The majority of electric utility expenditures for the five-year period 1999 through 2003 will be for work related to the Company's transmission and distribution system. Franchises - ---------- At December 31, 1998, the Company had franchises in all but one of the 371 incorporated municipalities which it serves. All franchises are nonexclusive and generally were obtained for 20-year terms, with varying expiration dates. No franchises are required to serve unincorporated communities in any of the three states which the Company serves. MANUFACTURING OPERATIONS ------------------------ General - ------- Manufacturing Operations consists of businesses involved in the following manufacturing activities: PVC pipe, sugar beet processing equipment, metal stamping, contract machining, and frame-straightening racks and accessories used by the auto body industry. The Company derived 20% of its consolidated operating revenues from this segment in 1998, 21% in 1997, and 17% in 1996. The following is a brief description of each of these businesses: Precision Machine of North Dakota, Inc., located in West Fargo, ND, uses computer controlled lathes and milling machines to produce precision parts for industrial equipment manufacturers. Dakota Machine, Inc., located in West Fargo, ND, is primarily engaged in the metal fabrication of large equipment that handles or processes sugar beets. Glendale Machining, Inc., located in Pelican Rapids, MN, uses computer controlled lathes and milling machines to produce parts for farm implement and industrial manufacturers. BTD Manufacturing, Inc. (BTD), located in Detroit Lakes, MN, is a metal stamping and tool and die manufacturer. BTD stamps, machines, and assembles metal parts according to manufacturers' specifications primarily for the recreation vehicle industry and industrial manufacturers. Northern Pipe Products, Inc., located in Fargo, ND, manufactures poly- vinyl-chloride (PVC) pipe for municipal, rural water, irrigation and other uses in a sixteen-state area. Chassis Liner Corporation, located in Alexandria and Lucan, MN, manufactures and sells vehicle frame-straightening equipment and accessories used by the auto body shop industry. Competition - ----------- The various markets in which the Company's manufacturing entities compete are characterized by intense competition. These markets have many established manufacturers with broader product lines, greater distribution capabilities, greater capital resources and larger marketing, research and development staffs and facilities than the Company's manufacturing entities. The Company believes the principal competitive factors in its manufacturing segment are product performance, quality, price, ease of use, technical innovation, cost effectiveness, customer service and breadth of product line. The Company's manufacturing entities intend to continue to compete on the basis of their high performance products, innovative technologies, cost effective manufacturing techniques, close customer relations and support and their strategy of increasing product offerings. Some of the products sold by the companies in the manufacturing segment are purchased by companies in the recreational vehicle market, sugar beet industry, auto body shop industry and PVC pipe market. The growth in these markets has provided strong growth for the Company's manufacturing segment. A downturn in these markets could have an adverse impact on the financial results of the Company's manufacturing segment. In addition, Northern Pipe Products' gross margin percentage is related to PVC resin prices. Due to the commodity nature of PVC resin and the dynamic supply and demand factors worldwide, it is difficult to predict gross margin percentages or assume that historical trends will continue. Capital Expenditures - -------------------- During 1998, capital expenditures of approximately $5.5 million were made in Manufacturing Operations. Total capital expenditures for Manufacturing Operations during the five-year period 1999-2003 are estimated to be approximately $19 million. HEALTH SERVICES OPERATIONS -------------------------- General - ------- Health Services Operations consists of businesses involved in the sale, service, rental, refurbishing and operation of medical imaging equipment and the sale of related supplies and accessories to various medical institutions, primarily in the midwestern United States. The Company derived 16% of its consolidated operating revenues from this segment in 1998, and 17% in both 1997 and 1996. Subsidiaries comprising Health Services Operations include the following: Diagnostic Medical Systems, Inc. (DMS), located in Fargo, ND, sells, services and refurbishes diagnostic medical imaging equipment and associated supplies and accessories. DMS sells radiology equipment manufactured by several entities, including Philips Medical Systems (Philips) a large multi-national company based in the Netherlands. Philips manufacturers fluoroscopic, radiographic and mammography equipment, along with ultrasound, computerized tomography (CT) scanners, magnetic resonance imaging (MRI) scanners, cardiac cath labs, and radiation therapy equipment for the treatment of cancer. In 1994, DMS entered into a five-year dealer agreement with Philips. This agreement expired at the end of 1998. A new dealer agreement is currently being negotiated with Philips. DMS is also a supplier of medical film and related accessories. DMS markets mainly to hospitals, clinics and mobile service companies in North Dakota, South Dakota, Minnesota, Montana and Wyoming. DMS subsidiaries are DMS Imaging, Inc. and DMS Leasing, Inc. DMS Imaging, Inc., a subsidiary of DMS located in Bemidji MN, provides CT, MRI, nuclear medicine services and other similar radiology services to health care providers in a twenty-one state area. Combined, the Health Services subsidiaries cover the three basics of the medical imaging industry: (1) operating technologists who do the imaging of patients of hospitals and clinics; (2) the equipment function that sells, owns, rents, refurbishes and maintains the imaging machines; and (3) central office specialists who provide scheduling, billing and administrative support. Each of the subsidiaries described above under Health Services Operations and Manufacturing Operations is owned by Varistar. Competition - ----------- The market for selling, servicing and operating diagnostic imaging services and imaging systems is highly competitive. In addition to direct competition from other contract providers, the companies within the health services segment compete with free-standing imaging centers and health care providers that have their own diagnostic imaging systems and with equipment manufacturers that sell imaging equipment to health care providers for full- time installation. Some of their direct competitors which provide contract MRI services have access to greater financial resources than the health services companies. In addition, some of the health services companies' customers are capable of providing the same services to their patients directly, subject only to their decision to acquire a high-cost diagnostic imaging system, assume the financial and technology risk, and employ the necessary technologies. The companies within this segment compete against other contract providers on the basis of quality of services, quality and magnetic field strength of imaging systems, price, availability and reliability. Capital Expenditures - -------------------- During 1998 capital expenditures of approximately $3.1 million were made in Health Services. Total capital expenditures during the five-year period 1999-2003 are estimated to be $42 million. OTHER BUSINESS OPERATIONS General - ------- The Company's Other Business Operations consists of businesses that are diversified in such areas as electrical and telephone construction contracting, entertainment, energy services, natural gas marketing, waste incinerating, and telephone/cable TV utility. The Company derived 11% of its consolidated operating revenues from these diversified businesses during 1998, 10% in 1997, and 12% during 1996. The following is a brief description of each of these businesses: Moorhead Electric, Inc., located in Moorhead, MN, provides electrical wiring in residential, commercial and industrial settings; installs data cable for commercial and industrial computer networks; and installs underground fiber-optic and copper cable for the telecommunications industry. Aerial Contractors, Inc., located in West Fargo, ND, builds and repairs overhead and underground electric distribution and transmission lines and substations; and installs underground fiber-optic, copper and coaxial cable for the telecommunciations industry. KFGO, Inc. (KFGO), located in Fargo, ND, operates two AM and four FM commercial radio stations along with a video production facility. Varistar has entered into an agreement to sell certain assets owned by KFGO. See below for more information. Western Minnesota Broadcasting Company (Western), located in Morris, MN, operates an AM and FM commercial radio station. Varistar has entered into an agreement to sell the radio stations owned by Western. See below for more information. Quadrant Co. (Quadrant) owns a municipal waste burning facility located in Perham, MN. In March 1998, the Company recorded a noncash accounting charge related to the impairment of the Quadrant plant. The impaired assets included building, machinery and equipment used to burn waste. For a further discussion on the impairment, see note 3, in "Notes to consolidated financial statements" on page 35 of the Company's 1998 Annual Report to Shareholders, filed as an Exhibit hereto. In July 1998, the plant ceased operations due to alleged noncompliance with MPCA particulate emissions regulations. See "Environmental Regulation" below for more information. Midwest Information Systems, Inc. (MIS), headquartered in Parkers Prairie, MN, owns three operating telephone companies serving over 6,300 customers and two cable television companies serving approximately 1,200 customers. MIS is also involved in long-distance telephone, fiber-optic transmission facilities, and the sale of direct broadcast satellite television equipment. Otter Tail Energy Services Company (OTESCO), headquartered in Fergus Falls, MN was established in 1997 to pursue opportunities in the natural gas and electricity markets. It offers technical services, engineering services, performance-based service contracting and financial services related to these products. OTESCO has one subsidiary, Otter Tail Energy Management Company (OTEMCO), which was formed as a result of the acquisition of PAM Natural Gas, Inc. OTEMCO is a marketer of natural gas to commercial and institutional customers in Iowa, South Dakota, North Dakota and Minnesota. With the exception of Quadrant and OTESCO, each of the subsidiaries described above is owned by Varistar. Quadrant and OTESCO are wholly-owned subsidiaries of Minnesota-Dakota Generating Company, which in turn is a wholly-owned subsidiary of the Company. In December 1998, Varistar entered into a definitive agreement to sell certain assets of the radio stations and video production company owned by KFGO and the radio stations owned by Western Minnesota Broadcasting Company. The agreement provides for a sale price of $24 million in cash, which would result in an after-tax gain of approximately $8 million. Net cash proceeds from the sale may be used to fund future acquisitions, to expand existing businesses, to reduce outstanding debt or for other corporate purposes. The sale is subject to approval by the Federal Communications Commission (FCC) and other governmental authorities and is expected to close in late 1999. General Regulation - ------------------ The Company's operating telephone subsidiaries are subject to the regulatory authority of the MPUC regarding rates and charges for telephone services, as well as other matters. The operating telephone subsidiaries must keep on file with the MPUC schedules of such rates and charges, and any requests for changes in such rates and charges must be filed for approval by the MPUC. The telephone industry is also subject generally to rules and regulations promulgated by the FCC. The Company's operating cable television subsidiary is regulated by federal and local authorities. The Company's radio broadcasting subsidiaries are regulated by the FCC. Environmental Regulation - ------------------------ In July 1998, Quadrant's waste incinerators were shut down for alleged noncompliance with MPCA particulate emissions regulations. Quadrant and the Company received from the MPCA a Notice of Violation dated October 15, 1998, outlining 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. The Company does not expect any further costs related to the plant's disposition to have a material effect upon future consolidated earnings. Competition - ----------- Each of the businesses in Other Business Operations is subject to competition, as well as the effects of general economic conditions, in their respective industries. Capital Expenditures - -------------------- During 1998, capital expenditures of approximately $2.7 million were made in Other Business Operations. Capital expenditures during the five-year period 1999-2003 are estimated to be approximately $9 million for Other Business Operations. FINANCING --------- The Company estimates that funds internally generated net of forecasted dividend payments, 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. Additional short-term or long-term financing will be required in the period 1999-2003 for the maturity of First Mortgage Bonds and other long-term debt, 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 foregoing estimates of capital expenditures and funds internally generated may be subject to substantial changes due to unforeseen factors, such as changed economic conditions, interest rates, demand for energy, competitive conditions, technological changes, new environmental and other governmental regulations, tax law changes, and rate regulation. As of December 31, 1998, the Company had unutilized net fundable property available for the issuance of more than $38 million principal amount of additional First Mortgage Bonds and also was entitled to issue in excess of $131 million principal amount of additional First Mortgage Bonds on the basis of First Mortgage Bonds theretofore retired. The Company's operating subsidiaries have been responsible for obtaining their own financing after the Company's initial equity investment and have developed financing arrangements with various banks. Historically, the Company has not made or guaranteed loans to its subsidiaries, or cosigned on any subsidiary's borrowing. The Company has access to short-term borrowing resources. As of December 31, 1998, the Company and its subsidiaries had unused credit lines totaling $35,439,000. The Company had $824,000 in short-term borrowings as of December 31, 1998. EMPLOYEES --------- The Company and its subsidiaries had approximately 1,783 full-time employees at December 31, 1998. A total of 559 employees are represented by local unions of the International Brotherhood of Electrical Workers, of which 409 are employees of the Electric Operations segment and are covered by a three-year labor contract that was renewed in 1999 and expires November 1, 2002. The Company has never experienced any strike, work stoppage, or strike vote, and considers its present relations with employees as very good. 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-K 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 through 25 of the Company's 1998 Annual Report to Shareholders, filed as an Exhibit hereto. 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. PROPERTIES ---------- The Coyote Station, which commenced operation in 1981, is a 414,000 kw (nameplate rating) mine-mouth plant located in the lignite coal fields near Beulah, North Dakota and is jointly owned by the Company, Northern Municipal Power Agency, Montana-Dakota Utilities Co. and Northwestern Public Service Company. The Company has a 35% interest in the plant and was the project manager in charge of construction. On July 1, 1998, the Company became the operating agent of the Coyote Station. The Company, jointly with Northwestern Public Service Company and Montana-Dakota Utilities Co., owns the 414,000 kw (nameplate rating) Big Stone Plant in northeastern South Dakota which commenced operation in 1975. The Company, for the benefit of all three utilities, was in charge of construction and is now in charge of operations. The Company owns 53.9% of the plant. Located near Fergus Falls, Minnesota, the Hoot Lake Plant is comprised of three separate generating units with a combined rating of 127,000 kw. The oldest Hoot Lake Plant generating unit was constructed in 1948 (7,500 kw nameplate rating) and a subsequent unit was added in 1959 (53,500 kw nameplate rating). A third unit was added in 1964 (66,000 kw nameplate rating) and later modified during 1988 to provide cycling capability, allowing this unit to be more efficiently brought on-line from a standby mode. At December 31, 1998, the Company's transmission facilities, which are interconnected with lines of other public utilities, consisted of 48 miles of 345 kv lines; 363 miles of 230 kv lines; 636 miles of 115 kv lines; and 4,228 miles of lower voltage lines, principally 41.6 kv. The Company owns the uprated portion of the 48 miles of the 345 kv line, with Minnkota Power Cooperative retaining title to the original 230 kv construction. All of the Company's electric utility properties, with minor exceptions, are subject to the lien of the Company's Indenture of Mortgage dated July 1, 1936, as amended and supplemented, securing its First Mortgage Bonds. All of the common shares of the companies owned by Varistar are pledged to secure indebtedness of Varistar. Item 3. LEGAL PROCEEDINGS ----------------- Quadrant and the Company received from the MPCA a Notice of Violation dated October 15, 1998 outlining 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 Company does not expect this proceeding to have a material impact on the Company's consolidated financial position or consolidated results of operations. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS --------------------------------------------------- No matters were submitted to a vote of security holders during the three months ended December 31, 1998. Item 4A. EXECUTIVE OFFICERS OF THE REGISTRANT (AS OF MARCH 1, 1999) ---------------------------------------------------------- Set forth below is a summary of the principal occupations and business experience during the past five years of executive officers of the Company: DATES ELECTED ------------- NAME AND AGE TO OFFICE PRESENT POSITION AND BUSINESS EXPERIENCE - ------------ --------- ----------------------------- John C. MacFarlane (59) 4/8/91 Present: Chairman, President and Chief Executive Officer John D. Erickson (40) 10/26/98 Present: Vice President, Finance and Chief Financial Officer Prior to 10/26/98 Director, Market Strategies & Regulation Marlowe E. Johnson (54) 4/12/93 Present: Vice President, Customer Service, North Dakota Douglas L. Kjellerup (57) 4/12/93 Present: Vice President, Marketing and Development LeRoy S. Larson (53) 4/12/93 Present: Vice President, Customer Service, Minnesota and South Dakota Jay D. Myster (60) 10/1/98 Present: Corporate Secretary Prior to 10/1/98 Senior Vice President, Governmental and Legal, and Corporate Secretary Rodney C.H. Scheel (49) 4/10/95 Present: Vice President, Electrical Prior to 4/10/95 Director, Information Services Ward L. Uggerud (49) 4/10/89 Present: Vice President, Operations Jeffrey J. Legge (42) 4/10/95 Present: Controller Prior to 4/10/95 Manager, Tax Department The term of office of each of the officers is one year, and there are no arrangements or understanding between individual officers or any other persons pursuant to which he was selected as an officer. No family relationships exist between any officers of the Company. PART II Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER ----------------------------------------------------------------- MATTERS ------- The information required by this Item is incorporated by reference to the first sentence under "Otter Tail Power Company stock listing" on Page 48, to "Selected consolidated financial data" on Page 17 and to "Quarterly information" on Page 41 of the Company's 1998 Annual Report to Shareholders, filed as an Exhibit hereto. Item 6. SELECTED FINANCIAL DATA ----------------------- The information required by this Item is incorporated by reference to "Selected consolidated financial data" on Page 17 of the Company's 1998 Annual Report to Shareholders, filed as an Exhibit hereto. Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS --------------------- The information required by this Item is incorporated by reference to "Management's discussion and analysis of financial condition and results of operations" on Pages 18 through 25 of the Company's 1998 Annual Report to Shareholders, filed as an Exhibit hereto. Item 7A. 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. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ------------------------------------------- The information required by this Item is incorporated by reference to "Quarterly information" on Page 41 and the Company's audited financial statements on Pages 26 through 41 of the Company's 1998 Annual Report to Shareholders excluding "Report of Management" on Page 26, filed as an Exhibit hereto. Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND --------------------------------------------------------------- FINANCIAL DISCLOSURE -------------------- None. PART III Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT -------------------------------------------------- The information required by this Item regarding Directors is incorporated by reference to the information under "Nominees for Election as Directors" in the Company's definitive Proxy Statement dated March 12, 1999. The information regarding executive officers is set forth in Item 4A hereto. The information regarding Section 16 reporting is incorporated by reference to the information under "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's definitive Proxy Statement dated March 12, 1999. Item 11. EXECUTIVE COMPENSATION ---------------------- The information required by this Item is incorporated by reference to the information under "Summary Compensation Table," "Pension and Supplemental Retirement Plans," "Severance Agreements," and "Directors' Compensation" in the Company's definitive Proxy Statement dated March 12, 1999. Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT -------------------------------------------------------------- The information required by this Item is incorporated by reference to the information under "Outstanding Voting Shares" and "Security Ownership of Management" in the Company's definitive Proxy Statement dated March 12, 1999. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ---------------------------------------------- None. PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K --------------------------------------------------------------- (a) List of documents filed: (1) and (2) See Table of Contents on Page 22 hereof. (3) See Exhibit Index on Pages 23 through 28 hereof. Pursuant to Item 601(b)(4)(iii) of Regulation S-K, copies of certain instruments defining the rights of holders of certain long-term debt of the Company are not filed, and in lieu thereof, the Company agrees to furnish copies thereof to the Securities and Exchange Commission upon request. (b) Reports on Form 8-K: None SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 /s/John D. Erickson ------------------- John D. Erickson Vice President, Finance and Chief Financial Officer Dated: March 24, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated: Signature and Title - ------------------- John C. MacFarlane ) Chairman, President and ) Chief Executive Officer ) (principal executive officer) ) and Director ) ) John D. Erickson ) Vice President, Finance and ) Chief Financial Officer ) (principal financial officer) ) ) Jeffrey J. Legge ) By /s/John D. Erickson Controller ) ------------------- (principal accounting officer) ) John D. Erickson ) Pro Se and Attorney-in-Fact ) Dated March 24, 1999 Thomas M. Brown, Director ) ) Dayle Dietz, Director ) ) Dennis R. Emmen, Director ) ) Maynard D. Helgaas, Director ) ) Arvid R. Liebe, Director ) ) Kenneth L. Nelson, Director ) ) Nathan I. Partain, Director ) ) Robert N. Spolum, Director ) OTTER TAIL POWER COMPANY TABLE OF CONTENTS ----------------- FINANCIAL STATEMENTS, SUPPLEMENTARY FINANCIAL DATA, SUPPLEMENTAL FINANCIAL SCHEDULES INCLUDED IN ANNUAL REPORT (FORM 10-K) FOR THE YEAR ENDED DECEMBER 31, 1998 The following items are included in this annual report by reference to the registrant's Annual Report to Shareholders for the year ended December 31, 1998: Page in Annual Report to Shareholders ------------ Financial Statements: Independent Auditors' Report........................................26 Consolidated Balance Sheets, December 31, 1998 and 1997........28 & 29 Consolidated Statements of Income for the Three Years Ended December 31, 1998.............................................27 Consolidated Statements of Changes in Equity for the Three Years Ended December 31, 1998.................................30 Consolidated Statements of Cash Flows for the Three Years Ended December 31, 1998.............................................31 Consolidated Statements of Capitalization, December 31, 1998 and 1997............................................................32 Notes to Consolidated Financial Statements.......................33-41 Selected Consolidated Financial Data for the Five Years Ended December 31, 1998.............................................17 Quarterly Data for the Two Years Ended December 31, 1998...................................................41 Schedules are omitted because of the absence of the conditions under which they are required or because the information required is included in the financial statements or the notes thereto. EX-99 2 Exhibit Index to Annual Report on Form 10-K For Year Ended December 31, 1998 Previously Filed ---------------- As Exhibit File No. No. -------- -------- 3-A 10-K for year 3-A --Restated Articles of ended 12/31/96 Incorporation, as amended (including resolutions creating outstanding series of Cumulative Preferred Shares). 3-C 33-46071 4-B --Bylaws as amended through April 11, 1988. 4-D-1 2-14209 2-B-1 --Twenty-First Supplemental Indenture from the Company to First Trust Company of Saint Paul and Russel M. Collins, as Trustees, dated as of July 1, 1958. 4-D-2 2-14209 2-B-2 --Twenty-Second Supplemental Indenture dated as of July 15, 1958. 4-D-3 33-32499 4-D-7 --Thirty-Second Supplemental Indenture dated as of January 18, 1974. 4-D-4 33-46070 4-D-12 --Forty-Third Supplemental Indenture dated as of February 1, 1991. 4-D-5 33-46070 4-D-13 --Forty-Fourth Supplemental Indenture dated as of September 1, 1991. 4-D-6 8-K dated 4-D-15 --Forty-Fifth Supplemental 7/24/92 Indenture dated as of July 1, 1992. 4-D-7 8-A dated 1 --Rights Agreement, dated as of 1/28/97 January 28, 1997 (the Rights Agreement), between the Company and Norwest Bank Minnesota, National Association. 4-D-8 8-A/A dated 1 --Amendment No. 1, dated as of 9/29/98 August 24, 1998, to the Rights Agreement. 10-A 2-39794 4-C --Integrated Transmission Agreement dated August 25, 1967, between Cooperative Power Association and the Company. Previously Filed ---------------- As Exhibit File No. No. -------- -------- 10-A-1 10-K for year 10-A-1 --Amendment No. 1, dated as ended 12/31/92 of September 6, 1979, to Integrated Transmission Agreement, dated as of August 25, 1967, between Cooperative Power Association and the Company. 10-A-2 10-K for year 10-A-2 --Amendment No. 2, dated as of ended 12/31/92 November 19, 1986, to Integ- rated Transmission Agreement between Cooperative Power Association and the Company. 10-C-1 2-55813 5-E --Contract dated July 1, 1958, between Central Power Electric Corporation, Inc., and the Company. 10-C-2 2-55813 5-E-1 --Supplement Seven dated November 21, 1973. (Supplements Nos. One through Six have been super- seded and are no longer in effect.) 10-C-3 2-55813 5-E-2 --Amendment No. 1 dated December 19, 1973, to Supplement Seven. 10-C-4 10-K for year 10-C-4 --Amendment No. 2 dated ended 12/31/91 June 17, 1986, to Supplement Seven. 10-C-5 10-K for year 10-C-5 --Amendment No. 3 dated ended 12/31/92 June 18, 1992, to Supplement Seven. 10-C-6 10-K for year 10-C-6 --Amendment No. 4 dated ended 12/31/93 January 18, 1994, to Supple- ment Seven. 10-D 2-55813 5-F --Contract dated April 12, 1973, between the Bureau of Reclamation and the Company. 10-E-1 2-55813 5-G --Contract dated January 8, 1973, between East River Electric Power Cooperative and the Company. 10-E-2 2-62815 5-E-1 --Supplement One dated February 20, 1978. 10-E-3 10-K for year 10-E-3 --Supplement Two dated ended 12/31/89 June 10, 1983. 10-E-4 10-K for year 10-E-4 --Supplement Three dated ended 12/31/90 June 6, 1985. Previously Filed ---------------- As Exhibit File No. No. -------- -------- 10-E-5 10-K for year 10-E-5 --Supplement No. Four, dated ended 12/31/92 as of September 10, 1986. 10-E-6 10-K for year 10-E-6 --Supplement No. Five, dated ended 12/31/92 as of January 7, 1993. 10-E-7 10-K for year 10-E-7 --Supplement No. Six, dated ended 12/31/93 as of December 2, 1993. 10-F 10-K for year 10-F --Agreement for Sharing ended 12/31/89 Ownership of Generating Plant by and between the Company, Montana-Dakota Utilities Co., and North- western Public Service Company (dated as of January 7, 1970). 10-F-1 10-K for year 10-F-1 --Letter of Intent for pur- ended 12/31/89 chase of share of Big Stone Plant from Northwestern Public Service Company (dated as of May 8, 1984). 10-F-2 10-K for year 10-F-2 --Supplemental Agreement No. 1 ended 12/31/91 to Agreement for Sharing Ownership of Big Stone Plant (dated as of July 1, 1983). 10-F-3 10-K for year 10-F-3 --Supplemental Agreement No. 2 ended 12/31/91 to Agreement for Sharing ownership of Big Stone Plant (dated as of March 1, 1985). 10-F-4 10-K for year 10-F-4 --Supplemental Agreement No. 3 ended 12/31/91 to Agreement for Sharing ownership of Big Stone Plant (dated as of March 31, 1986). 10-F-5 10-K for year 10-F-5 --Amendment I to Letter of ended 12/31/92 Intent dated May 8, 1984, for purchase of share of Big Stone Plant. 10-G 10-Q for quarter 10-A --Big Stone Plant Coal Agreement ended 9/30/94 by and between the Company, Montana-Dakota Utilities Co., Northwestern Public Service Company, and Westmoreland Resources, Inc. (dated as of June 30, 1994). 10-G-1 10-Q for quarter 10-B --Big Stone Coal Transportation ended 9/30/94 Agreement by and between the Company, Montana-Dakota Utilities, Northwestern Public Service Co., and Burlington Northern Railroad Company (dated as of July 18, 1994). Previously Filed ---------------- As Exhibit File No. No. -------- -------- 10-G-2 10-K for year 10-G-2 --Amendment No. 1, dated as of ended 12/31/95 December 27, 1995, to Big Stone Coal Transportation Agreement (dated as of July 18, 1994). 10-H 2-61043 5-H --Agreement for Sharing Owner- ship of Coyote Station Generating Unit No. 1 by and between the Company, Minnkota Power Cooperative, Inc., Montana-Dakota Utilities Co., Northwestern Public Service Company, and Minnesota Power & Light Company (dated as of July 1, 1977). 10-H-1 10-K for year 10-H-1 --Supplemental Agreement No. ended 12/31/89 One dated as of November 30, 1978, to Agreement for Sharing Ownership of Coyote Generating Unit No. 1. 10-H-2 10-K for year 10-H-2 --Supplemental Agreement No. ended 12/31/89 Two dated as of March 1, 1981, to Agreement for Sharing Ownership of Coyote Generating Unit No. 1 and Amendment No. 2 dated March 1, 1981, to Coyote Plant Coal Agreement. 10-H-3 10-K for year 10-H-3 --Amendment dated as of ended 12/31/89 July 29, 1983, to Agreement for Sharing Ownership of Coyote Generating Unit No. 1. 10-H-4 10-K for year 10-H-4 --Agreement dated as of Sept. ended 12/31/92 5, 1985, containing Amendment No. 3 to Agreement for Sharing Ownership of Coyote Generating Unit No.1, dated as of July 1, 1977, and Amendment No. 5 to Coyote Plant Coal Agreement, dated as of January 1, 1978. 10-I 2-63744 5-I --Coyote Plant Coal Agreement by and between the Company, Minnkota Power Cooperative, Inc., Montana-Dakota Utilities Co., Northwestern Public Service Company, Minnesota Power & Light Company, and Knife River Coal Mining Company (dated as of January 1, 1978). 10-I-1 10-K for year 10-I-1 --Addendum, dated as of March ended 12/31/92 10, 1980, to Coyote Plant Coal Agreement. Previously Filed ---------------- As Exhibit File No. No. -------- -------- 10-I-2 10-K for year 10-I-2 --Amendment (No. 3), dated as ended 12/31/92 of May 28, 1980, to Coyote Plant Coal Agreement. 10-I-3 10-K for year 10-I-3 --Fourth Amendment, dated as ended 12/31/92 of August 19, 1985, to Coyote Plant Coal Agreement. 10-I-4 10-Q for quarter 19-A --Sixth Amendment, dated as of ended 6/30/93 February 17, 1993, to Coyote Plant Coal Agreement. 10-K 10-K for year 10-K --Diversity Exchange Agreement ended 12/31/91 by and between the Company and Northern States Power Company, (dated as of May 21, 1985) and amendment thereto (dated as of August 12, 1985). 10-L 10-K for year 10-L --Integrated Transmission ended 12/31/91 Agreement by and between the Company, Missouri Basin Municipal Power Agency and Western Minnesota Municipal Power Agency (dated as of March 31, 1986). 10-L-1 10-K for Year 10-L-1 --Amendment No. 1, dated as ended 12/31/88 of December 28, 1988, to Integrated Transmission Agreement (dated as of March 31, 1986). 10-M-1 10-K for year 10-M-1 --Hoot Lake Plant Coal ended 12/31/89 Agreement dated as of October 1, 1980, by and between the Company and Knife River Coal Mining Company. 10-M-2 10-K for year 10-M-2 --First Amendment dated as of ended 12/31/89 August 14, 1985, to Hoot Lake Plant Coal Agreement. 10-M-3 10-K for year 10-M-10 --Hoot Lake Coal Transportation ended 12/31/92 Agreement dated January 15, 1993 by and between the Company and Northern Coal Transportation Co. 10-M-4 10-Q for quarter 19-C --First Amendment dated as of ended 6/30/93 January 20, 1993 to Hoot Lake Coal Transportation Agreement dated January 15, 1993. 10-M-5 10-K for year 10-M-5 --Second Amendment dated as of ended 12/31/96 May 21, 1996 to Hoot Lake Coal Transportation Agreement dated January 15, 1993. Previously Filed ---------------- As Exhibit File No. No. -------- -------- 10-N-1 10-K for year 10-N --Deferred Compensation Plan ended 12/31/91 for Directors, dated April 9, 1984.* 10-N-2 10-K for year 10-N-2 --Executive Survivor and Sup- ended 12/31/94 plemental Retirement Plan, as amended.* 10-N-3 10-K for year 10-P --Form of Severance ended 12/31/92 Agreement.* 10-N-4 10-K for year 10-N-5 --Nonqualified Profit Sharing ended 12/31/93 Plan.* 10-N-5 10-K for year 10-N-6 --Nonqualified Retirement ended 12/31/93 Savings Plan.* 10-N-6 --1999 Employee Stock Purchase Plan. 10-N-7 --1999 Stock Incentive Plan.* 13-A --Portions of 1998 Annual Report to Shareholders incorporated by reference in this Form 10-K. 18 --Report of Independent Accountants - Accounting Change. 21-A --Subsidiaries of Registrant. 23 --Consent of Deloitte & Touche LLP. 24-A --Powers of Attorney. 27 --Financial Data Schedule. - -------- * Management contract or compensatory plan or arrangement required to be filed pursuant to Item 601(b)(10)(iii)(A) of Regulation S-K. EX-10 3 Exhibit 10-N-6 OTTER TAIL POWER COMPANY 1999 EMPLOYEE STOCK PURCHASE PLAN ARTICLE I. INTRODUCTION Section 1.01 Purpose. The purpose of the plan is to provide employees of the Company and certain related corporations with an opportunity to share in the ownership of the Company by providing them with a convenient means for regular and systematic purchases of Common Stock and, thus, to develop a stronger incentive to work for the continued success of the Company. Section 1.02 Rules of Interpretation. It is intended that the Plan be an "employee stock purchase plan" as defined in Section 423(b) of the Code and Treasury Regulations promulgated thereunder. Accordingly, the Plan shall be interpreted and administered in a manner consistent therewith if so approved. All Participants in the Plan will have the same rights and privileges consistent with the provisions of the Plan. Section 1.03 Definitions. For purposes of the Plan, the following terms will have the meanings set forth below: (a) "Acceleration Date" means the earlier of the date of shareholder approval or approval by the Company's Board of Directors of (i) any consolidation or merger of the Company in which the Company is not the continuing or surviving corporation or pursuant to which shares of Company Common Stock would be converted into cash, securities or other property, other than a merger of the Company in which shareholders of the Company immediately prior to the merger have substantially the same proportionate ownership of stock in the surviving corporation immediately after the merger; (ii) any sale, exchange or other transfer (in one transaction or a series of related transactions) of all or substantially all of the assets of the Company; or (iii) any plan of liquidation or dissolution of the Company. (b) "Affiliate" means any subsidiary corporation of the Company, as defined in Section 424(f) of the Code, whether now or hereafter acquired or established. (c) "Code" means the Internal Revenue Code of 1986, as amended. (d) "Committee" means the committee described in Section 10.01 of the Plan. (e) "Common Stock" means the Company's Common Shares, $5 par value per share, as such stock may be adjusted for changes in the stock or the Company as contemplated by Article XI of the Plan. (f) "Company" means Otter Tail Power Company, a Minnesota corporation, and its successors by merger or consolidation as contemplated by Section 11.02 of the Plan (g) "Current Compensation" means all regular wage, salary and commission payments paid by the Company to a Participant in accordance with the terms of his or her employment, but excluding annual bonus payments and all other forms of special compensation. (h) "Fair Market Value" as of a given date means the fair market value of the Common Stock determined by such methods or procedures as shall be established from time to time by the Committee, but shall not be less than, if the Common Stock is then quoted on the NASDAQ National Market System, the average of the high and low sales price as reported on the NASDAQ National Market System on such date or, if the NASDAQ National Market System is not open for trading on such date, on the most recent preceding date when it is open for trading. If on a given date the Common Stock is not traded on an established securities market, the Committee shall make a good faith attempt to satisfy the requirements of this Section 1.03(h) and in connection therewith shall take such action as it deems necessary or advisable. (i) "Participant" means a Regular Employee who is eligible to participate in the Plan under Section 2.01 of the Plan and who has elected to participate in the Plan. (j) "Participating Affiliate" means an Affiliate which has been designated by the Committee in advance of the Purchase Period in question as a corporation whose eligible Regular Employees may participate in the Plan. (k) "Plan" means the Otter Tail Power Company 1999 Employee Stock Purchase Plan, as it may be amended, the provisions of which are set forth herein. (l) "Purchase Period" means the period beginning on May 1, 1999 and ending on the last business day in December, 1999 and thereafter each approximate six-month period beginning on January 1st and July 1st of each year and ending on the last business day in June and December of each year; provided, however, that the then current Purchase Period will end upon the occurrence of an Acceleration Date. (m) "Regular Employee" means an employee of the Company or a Participating Affiliate as of the first day of a Purchase Period, including an officer or director who is also an employee, but excluding an employee whose customary employment is less than 20 hours per week. (n) "Stock Purchase Account" means the account maintained on the books and records of the Company recording the amount received from each Participant through payroll deductions made under the Plan. ARTICLE II. ELIGIBILITY AND PARTICIPATION Section 2.01 Eligible Employees. All Regular Employees shall be eligible to participate in the Plan beginning on the first day of the first Purchase Period to commence after such person becomes a Regular Employee. Subject to the provisions of Article VI of the Plan, each such employee will continue to be eligible to participate in the Plan so long as he or she remains a Regular Employee. Section 2.02 Election to Participate. An eligible Regular Employee may elect to participate in the Plan for a given Purchase Period by filing with the Company, in advance of that Purchase Period and in accordance with such terms and conditions as the Committee in its sole discretion may impose, a form provided by the Company for such purpose (which authorizes regular payroll deductions from Current Compensation beginning with the first payday in that Purchase Period and continuing until the employee withdraws from the Plan or ceases to be eligible to participate in the Plan). Section 2.03 Limits on Stock Purchase. No employee shall be granted any right to purchase Common Stock hereunder if such employee, immediately after such a right to purchase is granted, would own, directly or indirectly, within the meaning of Section 423(b)(3) and Section 424(d) of the Code, Common Stock possessing 5% or more of the total combined voting power or value of all the classes of the capital stock of the Company or of all Affiliates. Section 2.04 Voluntary Participation. Participation in the Plan on the part of a Participant is voluntary and such participation is not a condition of employment nor does participation in the Plan entitle a Participant to be retained as an employee. ARTICLE III. PAYROLL DEDUCTIONS AND STOCK PURCHASE ACCOUNT Section 3.01 Deduction from Pay. The form described in Section 2.02 of the Plan will permit a Participant to elect payroll deductions of any multiple of $10 but not less than $10 or more than $2,000 of such Participant's Current Compensation for each pay period during such Purchase Period, subject to such other limitations as the Committee in its sole discretion may impose. A Participant may cease making payroll deductions at any time, subject to such limitations as the Committee in its sole discretion may impose. In the event that during a Purchase Period the entire credit balance in a Participant's Stock Purchase Account exceeds the product of (a) 85% of the Fair Market Value of the Common Stock on the first business day of that Purchase Period and (b) 2,000, then payroll deductions for such Participant shall automatically cease, and shall resume on the first pay period of the next Purchase Period. Section 3.02 Credit to Account. Payroll deductions will be credited to the Participant's Stock Purchase Account on each payday. Section 3.03 Interest. No interest will be paid on payroll deductions or on any other amount credited to, or on deposit in, a Participant's Stock Purchase Account. Section 3.04 Nature of Account. The Stock Purchase Account is established solely for accounting purposes, and all amounts credited to the Stock Purchase Account will remain part of the general assets of the Company or the Participating Affiliate (as the case may be). Section 3.05 No Additional Contributions. A Participant may not make any payment into the Stock Purchase Account other than the payroll deductions made pursuant to the Plan. ARTICLE IV. RIGHT TO PURCHASE SHARES Section 4.01 Number of Shares. Each Participant will have the right to purchase on the last business day of the Purchase Period all, but not less than all, of the number of whole and fractional shares, computed to four decimal places, of Common Stock that can be purchased at the price specified in Section 4.02 of the Plan with the entire credit balance in the Participant's Stock Purchase Account, subject to the limitations that (a) no more than 2000 shares of Common Stock may be purchased under the Plan by any one Participant for a given Purchase Period, and (b) in accordance with Section 423(b)(8) of the Code, no more than $25,000 in Fair Market Value (determined at the beginning of each Purchase Period) of Common Stock and other stock may be purchased under the Plan and all other employee stock purchase plans (if any) of the Company and the Affiliates by any one Participant for any calendar year. If the purchases for all Participants for any Purchase Period would otherwise cause the aggregate number of shares of Common Stock to be sold under the Plan to exceed the number specified in Section 10.04 of the Plan, each Participant shall be allocated a pro rata portion of the Common Stock to be sold for such Purchase Period. Section 4.02 Purchase Price. The purchase price for any Purchase Period shall be that price as announced by the Committee prior to the first business day of that Purchase Period, which price may, in the discretion of the Committee, be a price which is not fixed or determinable as of the first business day of that Purchase Period; provided, however, that in no event shall the purchase price for any Purchase Period be less than the lesser of (a) 85% of the Fair Market Value of the Common Stock on the first business day of that Purchase Period or (b) 85% of the Fair Market Value of the Common Stock on the last business day of that Purchase Period, in each case rounded up to the next higher full cent. ARTICLE V. EXERCISE OF RIGHT Section 5.01 Purchase of Stock. On the last business day of a Purchase Period, the entire credit balance in each Participant's Stock Purchase Account will be used to purchase the number of whole shares and fractional shares, computed to four decimal places, of Common Stock purchasable with such amount (subject to the limitations of Section 4.01 of the Plan), unless the Participant has filed with the Company, in advance of that date and subject to such terms and conditions as the Committee in its sole discretion may impose, a form provided by the Company which requests the distribution of the entire credit balance in cash. Section 5.02 Notice of Acceleration Date. The Company shall use its best efforts to notify each Participant in writing at least ten days prior to any Acceleration Date that the then current Purchase Period will end on such Acceleration Date. ARTICLE VI. WITHDRAWAL FROM PLAN; SALE OF STOCK Section 6.01 Voluntary Withdrawal. A Participant may, in accordance with such terms and conditions as the Committee in its sole discretion may impose, withdraw from the Plan and cease making payroll deductions by filing with the Company a form provided for this purpose. In such event, the entire credit balance in the Participant's Stock Purchase Account will be paid to the Participant in cash within 30 days. A Participant who withdraws from the Plan will not be eligible to reenter the Plan until the beginning of the next Purchase Period following the date of such withdrawal. Section 6.02 Death. Subject to such terms and conditions as the Committee in its sole discretion may impose, upon the death of a Participant, no further amounts shall be credited to the Participant's Stock Purchase Account. Thereafter, on the last business day of the Purchase Period during which such Participant's death occurred and in accordance with Section 5.01 of the Plan, the entire credit balance in such Participant's Stock Purchase Account will be used to purchase Common Stock, unless such Participant's estate has filed with the Company, in advance of that day and subject to such terms and conditions as the Committee in its sole discretion may impose, a form provided by the Company which elects to have the entire credit balance in such Participant's Stock Account distributed in cash within 30 days after the end of that Purchase Period or at such earlier time as the Committee in its sole discretion may decide. Each Participant, however, may designate one or more beneficiaries who, upon death, are to receive the Common Stock or the amount that otherwise would have been distributed or paid to the Participant's estate and may change or revoke any such designation from time to time. No such designation, change or revocation will be effective unless made by the Participant in writing and filed with the Company during the Participant's lifetime. Unless the Participant has otherwise specified the beneficiary designation, the beneficiary or beneficiaries so designated will become fixed as of the date of the death of the Participant so that, if a beneficiary survives the Participant but dies before the receipt of the payment due such beneficiary, the payment will be made to such beneficiary's estate. Section 6.03 Termination of Employment. Subject to such terms and conditions as the Committee in its sole discretion may impose, upon a Participant's normal or early retirement with the consent of the Company under any pension or retirement plan of the Company or Participating Affiliate, no further amounts shall be credited to the Participant's Stock Purchase Account. Thereafter, on the last business day of the Purchase Period during which such Participant's approved retirement occurred and in accordance with Section 5.01 of the Plan, the entire credit balance in such Participant's Stock Purchase Account will be used to purchase Common Stock, unless such Participant has filed with the Company, in advance of that day and subject to such terms and conditions as the Committee in its sole discretion may impose, a form provided by the Company which elects to receive the entire credit balance in such Participant's Stock Purchase Account in cash within 30 days after the end of that Purchase Period, provided that such Participant shall have no right to purchase Common Stock in the event that the last day of such a Purchase Period occurs more than three months following the termination of such Participant's employment with the Company or Participating Affiliate by reason of such an approved retirement. In the event of any other termination of employment (other than death) with the Company or a Participating Affiliate, participation in the Plan will cease on the date the Participant ceases to be a Regular Employee for any reason. In such event, the entire credit balance in such Participant's Stock Purchase Account will be paid to the Participant in cash within 30 days. For purposes of this Section 6.03, a transfer of employment to any Participating Affiliate or to the Company, or a leave of absence which has been approved by the Committee, will not be deemed a termination of employment as a Regular Employee. ARTICLE VII. NONTRANSFERABILITY Section 7.01 Nontransferable Right to Purchase. The right to purchase Common Stock hereunder may not be assigned, transferred, pledged or hypothecated (whether by operation of law or otherwise), except as provided in Section 6.02 of the Plan, and will not be subject to execution, attachment or similar process. Any attempted assignment, transfer, pledge, hypothecation or other disposition or levy of attachment or similar process upon the right to purchase will be null and void and without effect. Section 7.02 Nontransferable Account. Except as provided in Section 6.02 of the Plan, the amounts credited to a Stock Purchase Account may not be assigned, transferred, pledged or hypothecated in any way, and any attempted assignment, transfer, pledge, hypothecation or other disposition of such amounts will be null and void and without effect. Section 7.03 Nontransferable Shares. Except as the Committee shall otherwise permit, prior to the second anniversary of the beginning of any Purchase Period, the Common Stock purchased at the end of such Purchase Period by a Participant pursuant to Section 5.01 of the Plan together with any additional Common Stock acquired pursuant to Section 8.04 of the Plan upon the reinvestment of dividends may not be assigned, transferred, pledged, hypothecated or otherwise disposed of in any way other than by will or by the laws of descent and distribution, and any other attempted assignment, transfer, pledge, hypothecation or other disposition of such share or shares will be null and void and without effect. ARTICLE VIII. COMMON STOCK ISSUANCE AND DIVIDEND REINVESTMENT Section 8.01 Issuance of Purchased Shares. Promptly after the last day of each Purchase Period and subject to such terms and conditions as the Committee in its sole discretion may impose, the Company will cause the Common Stock then purchased pursuant to Section 5.01 of the Plan to be issued for the benefit of the Participant and held in the Plan pursuant to Section 8.03 of the Plan. Section 8.02 Completion of Issuance. A Participant shall have no interest in the Common Stock purchased pursuant to Section 5.01 of the Plan until such Common Stock is issued for the benefit of the Participant pursuant to Section 8.03 of the Plan. Section 8.03 Form of Ownership. The Common Stock issued under Section 8.01 of the Plan will be held in the Plan in the name of the Participant or jointly in the name of the Participant and another person, as the Participant may direct on a form provided by the Company, until such time as certificates for such shares of Common Stock are delivered to or for the benefit of the Participant pursuant to Section 8.05 of the Plan. Section 8.04 Automatic Dividend Reinvestment. Prior to the delivery of certificates to or for the benefit of the Participant under Section 8.05 of the Plan, any and all cash dividends paid on full and fractional shares of Common Stock issued under either Section 8.01 of the Plan or this Section 8.04 shall be reinvested to acquire either new issue Common Stock or shares of Common Stock purchased on the open market, as determined by the Committee in its sole discretion. Purchases of Common Stock under this Section 8.04 will be (a) with respect to shares newly issued by the Company, invested on the dividend payment date, or, if that date is not a trading day, the immediately preceding trading day, or (b) with respect to shares purchased on the open market, normally purchased on the open market within ten business days of the dividend payment date, depending upon market conditions. The price per share of the Common Stock issued under this Section 8.04 shall be (x) with respect to shares newly issued by the Company, the Fair Market Value of the Common Stock on the applicable investment date, or (y) with respect to shares purchased on the open market, the weighted average price per share at which the Common Stock is actually purchased on the open market for the relevant period on behalf of all participants in the Plan. All shares of Common Stock acquired under this Section 8.04 will be held in the Plan in the same name as the Common Stock upon which the cash dividends were paid. Section 8.05 Delivery. At any time following the conclusion of the nontransferability period set forth in Section 7.03 of the Plan and subject to such terms and conditions as the Committee in its sole discretion may impose, by filing with the Company a form provided by the Company for such purpose, the Participant may elect to have the Company cause to be delivered to or for the benefit of the Participant a certificate for the number of whole shares and cash for the number of fractional shares representing the Common Stock purchased pursuant to Section 5.01 of the Plan together with any additional Common Stock acquired pursuant to Section 8.04 of the Plan upon the reinvestment of dividends. The election notice will be processed as soon as practicable after receipt. A certificate for whole shares normally will be mailed to the Participant within five business days after receipt of the election notice; provided, however, that if the notice is received between a dividend record date and a dividend payment date, a certificate will generally not be sent out until the declared dividends have been reinvested pursuant to Section 8.04 of the Plan. Any fractional shares normally will be sold on the first trading day of each month and a check for the fractional shares sent to the Participant promptly thereafter. ARTICLE IX. EFFECTIVE DATE, AMENDMENT AND TERMINATION OF PLAN Section 9.01 Effective Date. The Plan was approved by the Board of Directors on December 14, 1998, subject to approval by the shareholders of the Company within twelve (12) months thereafter. Section 9.02 Plan Commencement. The initial Purchase Period under the Plan will commence May 1, 1999. Thereafter, each succeeding Purchase Period will commence and terminate in accordance with Section 1.03(l) of the Plan. Section 9.03 Powers of Board. The Board of Directors may amend or discontinue the Plan at any time. No amendment or discontinuation of the Plan, however, shall be made without shareholder approval that requires shareholder approval under any rules or regulations of the NASDAQ National Market System or any securities exchange that are applicable to the Company. Section 9.04 Automatic Termination. The Plan shall automatically terminate when all of the shares of Common Stock provided for in Section 10.04 of the Plan have been sold, provided that such termination shall in no way affect the terms of the Plan pertaining to any Common Stock then held under the Plan. ARTICLE X. ADMINISTRATION Section 10.01 The Committee. The Plan shall be administered by a committee (the "Committee") established by the Board of Directors. The members of the Committee need not be directors of the Company and shall be appointed by and serve at the pleasure of the Board of Directors. Section 10.02 Powers of Committee. Subject to the provisions of the Plan, the Committee shall have full authority to administer the Plan, including authority to interpret and construe any provision of the Plan, to establish deadlines by which the various administrative forms must be received in order to be effective, and to adopt such other rules and regulations for administering the Plan as it may deem appropriate. The Committee shall have full and complete authority to determine whether all or any part of the Common Stock acquired pursuant to the Plan shall be subject to restrictions on the transferability thereof or any other restrictions affecting in any manner a Participant's rights with respect thereto but any such restrictions shall be contained in the form by which a Participant elects to participate in the Plan pursuant to Section 2.02 of the Plan. Decisions of the Committee will be final and binding on all parties who have an interest in the Plan. Section 10.03 Power and Authority of the Board of Directors. Notwithstanding anything to the contrary contained herein, the Board of Directors may, at any time and from time to time, without any further action of the Committee, exercise the powers and duties of the Committee under the Plan. Section 10.04 Stock to be Sold. The Common Stock to be issued and sold under the Plan may be authorized but unissued shares or shares acquired in the open market or otherwise. Except as provided in Section 11.01 of the Plan, the aggregate number of shares of Common Stock to be sold under the Plan will not exceed 200,000 shares. Section 10.05 Notices. Notices to the Committee should be addressed as follows: Otter Tail Power Company 215 South Cascade Street, Box 496 Fergus Falls, MN 56538-0496 Attn: Corporate Secretary ARTICLE XI. ADJUSTMENT FOR CHANGES IN STOCK OR COMPANY Section 11.01 Stock Dividend or Reclassification. If the outstanding shares of Common Stock are increased, decreased, changed into or exchanged for a different number or kind of securities of the Company, or shares of a different par value or without par value, through reorganization, recapitalization, reclassification, stock dividend, stock split, amendment to the Company's Articles of Incorporation, reverse stock split or otherwise, an appropriate adjustment shall be made in the maximum numbers and kind of securities to be purchased under the Plan with a corresponding adjustment in the purchase price to be paid therefor. Section 11.02 Merger or Consolidation. If the Company is merged into or consolidated with one or more corporations during the term of the Plan, appropriate adjustments will be made to give effect thereto on an equitable basis in terms of issuance of shares of the corporation surviving the merger or of the consolidated corporation, as the case may be. ARTICLE XII. APPLICABLE LAW Rights to purchase Common Stock granted under the Plan shall be construed and shall take effect in accordance with the laws of the State of Minnesota. EX-10 4 Exhibit 10-N-7 OTTER TAIL POWER COMPANY 1999 STOCK INCENTIVE PLAN Section 1. Purpose. The purpose of the Plan is to promote the interests of the Company and its shareholders by aiding the Company in attracting and retaining employees, officers, consultants, independent contractors and non-employee directors capable of assuring the future success of the Company, to offer such persons incentives to put forth maximum efforts for the success of the Company's business and to afford such persons an opportunity to acquire a proprietary interest in the Company. Section 2. Definitions. As used in the Plan, the following terms shall have the meanings set forth below: (a) "Affiliate" shall mean (i) any entity that, directly or indirectly through one or more intermediaries, is controlled by the Company and (ii) any entity in which the Company has a significant equity interest, in each case as determined by the Committee. (b) "Award" shall mean any Option, Stock Appreciation Right, Restricted Stock, Restricted Stock Unit, Performance Award, Other Stock Grant or Other Stock-Based Award granted under the Plan. (c) "Award Agreement" shall mean any written agreement, contract or other instrument or document evidencing any Award granted under the Plan. (d) "Board" shall mean the Board of Directors of the Company. (e) "Code" shall mean the Internal Revenue Code of 1986, as amended from time to time, and any regulations promulgated thereunder. (f) "Committee" shall mean a committee of Directors designated by the Board to administer the Plan. The Committee shall be comprised of not less than such number of Directors as shall be required to permit Awards granted under the Plan to qualify under Rule 16b-3, and each member of the Committee shall be a "Non-Employee Director" within the meaning of Rule 16b-3 and an "outside director" within the meaning of Section 162(m) of the Code. The Company expects to have the Plan administered in accordance with the requirements for the award of "qualified performance-based compensation" within the meaning of Section 162(m) of the Code. (g) "Company" shall mean Otter Tail Power Company, a Minnesota corporation, and any successor corporation. (h) "Director" shall mean a member of the Board. (i) "Eligible Person" shall mean any employee, officer, consultant, independent contractor or Director providing services to the Company or any Affiliate whom the Committee determines to be an Eligible Person. (j) "Fair Market Value" shall mean, with respect to any property (including, without limitation, any Shares or other securities), the fair market value of such property determined by such methods or procedures as shall be established from time to time by the Committee. Notwithstanding the foregoing, unless otherwise determined by the Committee, the Fair Market Value of Shares as of a given date shall be, if the Shares are then quoted on the NASDAQ National Market System, the average of the high and low sales price as reported on the NASDAQ National Market System on such date or, if the NASDAQ National Market System is not open for trading on such date, on the most recent preceding date when it is open for trading. (k) "Incentive Stock Option" shall mean an option granted under Section 6(a) of the Plan that is intended to meet the requirements of Section 422 of the Code or any successor provision. (l) "Non-Qualified Stock Option" shall mean an option granted under Section 6(a) of the Plan that is not intended to be an Incentive Stock Option. (m) "Option" shall mean an Incentive Stock Option or a Non-Qualified Stock Option, and shall include Reload Options. (n) "Other Stock Grant" shall mean any right granted under Section 6(e) of the Plan. (o) "Other Stock-Based Award" shall mean any right granted under Section 6(f) of the Plan. (p) "Participant" shall mean an Eligible Person designated to be granted an Award under the Plan. (q) "Performance Award" shall mean any right granted under Section 6(d) of the Plan. (r) "Person" shall mean any individual, corporation, partnership, association or trust. (s) "Plan" shall mean the Otter Tail Power Company 1999 Stock Incentive Plan, as amended from time to time, the provisions of which are set forth herein. (t) "Reload Option" shall mean any Option granted under Section 6(a)(iv) of the Plan. (u) "Restricted Stock" shall mean any Shares granted under Section 6(c) of the Plan. (v) "Restricted Stock Unit" shall mean any unit granted under Section 6(c) of the Plan evidencing the right to receive a Share (or a cash payment equal to the Fair Market Value of a Share) at some future date. (w) "Rule 16b-3" shall mean Rule 16b-3 promulgated by the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, or any successor rule or regulation. (x) "Shares" shall mean Common Shares, $5 par value per share, of the Company or such other securities or property as may become subject to Awards pursuant to an adjustment made under Section 4(c) of the Plan. (y) "Stock Appreciation Right" shall mean any right granted under Section 6(b) of the Plan. Section 3. Administration. (a) Power and Authority of the Committee. The Plan shall be administered by the Committee. Subject to the express provisions of the Plan and to applicable law, the Committee shall have full power and authority to: (i) designate Participants; (ii) determine the type or types of Awards to be granted to each Participant under the Plan; (iii) determine the number of Shares to be covered by (or with respect to which payments, rights or other matters are to be calculated in connection with) each Award; (iv) determine the terms and conditions of any Award or Award Agreement; (v) amend the terms and conditions of any Award or Award Agreement and accelerate the exercisability of Options or the lapse of restrictions relating to Restricted Stock, Restricted Stock Units or other Awards; (vi) determine whether, to what extent and under what circumstances Awards may be exercised in cash, Shares, other securities, other Awards or other property, or canceled, forfeited or suspended; (vii) determine whether, to what extent and under what circumstances cash, Shares, promissory notes, other securities, other Awards, other property and other amounts payable with respect to an Award under the Plan shall be deferred either automatically or at the election of the holder thereof or the Committee; (viii) interpret and administer the Plan and any instrument or agreement, including an Award Agreement, relating to the Plan; (ix) establish, amend, suspend or waive such rules and regulations and appoint such agents as it shall deem appropriate for the proper administration of the Plan; and (x) make any other determination and take any other action that the Committee deems necessary or desirable for the administration of the Plan. Unless otherwise expressly provided in the Plan, all designations, determinations, interpretations and other decisions under or with respect to the Plan or any Award shall be within the sole discretion of the Committee, may be made at any time and shall be final, conclusive and binding upon any Participant, any holder or beneficiary of any Award and any employee of the Company or any Affiliate. (b) Delegation. The Committee may delegate its powers and duties under the Plan to one or more Directors or a committee of Directors, subject to such terms, conditions and limitations as the Committee may establish in its sole discretion. (c) Power and Authority of the Board of Directors. Notwithstanding anything to the contrary contained herein, the Board may, at any time and from time to time, without any further action of the Committee, exercise the powers and duties of the Committee under the Plan. Section 4. Shares Available for Awards. (a) Shares Available. Subject to adjustment as provided in Section 4(c) of the Plan, the aggregate number of Shares that may be issued under all Awards under the Plan shall be 1,300,000. Shares to be issued under the Plan may be either authorized but unissued Shares or Shares acquired in the open market or otherwise. Any Shares that are used by a Participant as full or partial payment to the Company of the purchase price relating to an Award, or in connection with the satisfaction of tax obligations relating to an Award, shall again be available for granting Awards (other than Incentive Stock Options) under the Plan. In addition, if any Shares covered by an Award or to which an Award relates are not purchased or are forfeited, or if an Award otherwise terminates without delivery of any Shares, then the number of Shares counted against the aggregate number of Shares available under the Plan with respect to such Award, to the extent of any such forfeiture or termination, shall again be available for granting Awards under the Plan. Notwithstanding the foregoing, the number of Shares available for granting Incentive Stock Options under the Plan shall not exceed 1,300,000, subject to adjustment as provided in the Plan and subject to the provisions of Section 422 or 424 of the Code or any successor provision. (b) Accounting for Awards. For purposes of this Section 4, if an Award entitles the holder thereof to receive or purchase Shares, the number of Shares covered by such Award or to which such Award relates shall be counted on the date of grant of such Award against the aggregate number of Shares available for granting Awards under the Plan. (c) Adjustments. In the event that the Committee shall determine that any dividend or other distribution (whether in the form of cash, Shares, other securities or other property), recapitalization, stock split, reverse stock split, reorganization, merger, consolidation, split-up, spin-off, combination, repurchase or exchange of Shares or other securities of the Company, issuance of warrants or other rights to purchase Shares or other securities of the Company or other similar corporate transaction or event affects the Shares such that an adjustment is determined by the Committee to be appropriate in order to prevent dilution or enlargement of the benefits or potential benefits intended to be made available under the Plan, then the Committee shall, in such manner as it may deem equitable, adjust any or all of (i) the number and type of Shares (or other securities or other property) that thereafter may be made the subject of Awards, (ii) the number and type of Shares (or other securities or other property) subject to outstanding Awards and (iii) the purchase or exercise price with respect to any Award; provided, however, that the number of Shares covered by any Award or to which such Award relates shall always be a whole number. (d) Award Limitations Under the Plan. No Eligible Person may be granted any Award or Awards under the Plan, the value of which Award or Awards is based solely on an increase in the value of the Shares after the date of grant of such Award or Awards, for more than 50,000 Shares (subject to adjustment as provided for in Section 4(c) of the Plan), in the aggregate in any calendar year. The foregoing annual limitation specifically includes the grant of any Award or Awards representing "qualified performance-based compensation" within the meaning of Section 162(m) of the Code. Section 5. Eligibility. Any Eligible Person shall be eligible to be designated a Participant. In determining which Eligible Persons shall receive an Award and the terms of any Award, the Committee may take into account the nature of the services rendered by the respective Eligible Persons, their present and potential contributions to the success of the Company or such other factors as the Committee, in its discretion, shall deem relevant. Notwithstanding the foregoing, an Incentive Stock Option may only be granted to full or part-time employees (which term as used herein includes, without limitation, officers and Directors who are also employees), and an Incentive Stock Option shall not be granted to an employee of an Affiliate unless such Affiliate is also a "subsidiary corporation" of the Company within the meaning of Section 424(f) of the Code or any successor provision. Section 6. Awards. (a) Options. The Committee is hereby authorized to grant Options to Participants with the following terms and conditions and with such additional terms and conditions not inconsistent with the provisions of the Plan as the Committee shall determine: (i) Exercise Price. The purchase price per Share purchasable under an Option shall be determined by the Committee; provided, however, that such purchase price shall not be less than 100% of the Fair Market Value of a Share on the date of grant of such Option. (ii) Option Term. The term of each Option shall be fixed by the Committee. (iii) Time and Method of Exercise. The Committee shall determine the time or times at which an Option may be exercised in whole or in part and the method or methods by which, and the form or forms (including, without limitation, cash, Shares, promissory notes, other securities, other Awards or other property, or any combination thereof, having a Fair Market Value on the exercise date equal to the relevant exercise price) in which, payment of the exercise price with respect thereto may be made or deemed to have been made. (iv) Reload Options. The Committee may grant Reload Options, separately or together with another Option, pursuant to which, subject to the terms and conditions established by the Committee, the Participant would be granted a new Option when the payment of the exercise price of a previously granted option is made by the delivery of Shares owned by the Participant pursuant to Section 6(a)(iii) of the Plan or the relevant provisions of another plan of the Company, and/or when Shares are tendered or withheld as payment of the amount to be withheld under applicable income tax laws in connection with the exercise of an Option, which new Option would be an Option to purchase the number of Shares not exceeding the sum of (A) the number of Shares so provided as consideration upon the exercise of the previously granted option to which such Reload Option relates and (B) the number of Shares, if any, tendered or withheld as payment of the amount to be withheld under applicable tax laws in connection with the exercise of the option to which such Reload Option relates pursuant to the relevant provisions of the plan or agreement relating to such option. Reload Options may be granted with respect to Options previously granted under the Plan or any other stock option plan of the Company or may be granted in connection with any Option granted under the Plan or any other stock option plan of the Company at the time of such grant. Such Reload Options shall have a per share exercise price equal to the Fair Market Value of one Share as of the date of grant of the new Option. Any Reload Option shall be subject to availability of sufficient Shares for grant under the Plan. (b) Stock Appreciation Rights. The Committee is hereby authorized to grant Stock Appreciation Rights to Participants subject to the terms of the Plan and any applicable Award Agreement. A Stock Appreciation Right granted under the Plan shall confer on the holder thereof a right to receive upon exercise thereof the excess of (i) the Fair Market Value of one Share on the date of exercise (or, if the Committee shall determine, at any time during a specified period before or after the date of exercise) over (ii) the grant price of the Stock Appreciation Right as specified by the Committee, which price shall not be less than 100% of the Fair Market Value of one Share on the date of grant of the Stock Appreciation Right. Subject to the terms of the Plan and any applicable Award Agreement, the grant price, term, methods of exercise, dates of exercise, methods of settlement and any other terms and conditions of any Stock Appreciation Right shall be as determined by the Committee. The Committee may impose such conditions or restrictions on the exercise of any Stock Appreciation Right as it may deem appropriate. (c) Restricted Stock and Restricted Stock Units. The Committee is hereby authorized to grant Restricted Stock and Restricted Stock Units to Participants with the following terms and conditions and with such additional terms and conditions not inconsistent with the provisions of the Plan as the Committee shall determine: (i) Restrictions. Shares of Restricted Stock and Restricted Stock Units shall be subject to such restrictions as the Committee may impose (including, without limitation, a waiver by the Participant of the right to vote or to receive any dividend or other right or property with respect thereto), which restrictions may lapse separately or in combination at such time or times, in such installments or otherwise as the Committee may deem appropriate. (ii) Stock Certificates. Any Restricted Stock granted under the Plan shall be registered in the name of the Participant and shall bear an appropriate legend referring to the terms, conditions and restrictions applicable to such Restricted Stock. In the case of Restricted Stock Units, no Shares shall be issued at the time such Awards are granted. (iii) Forfeiture. Except as otherwise determined by the Committee, upon termination of employment (as determined under criteria established by the Committee) during the applicable restriction period, all Shares of Restricted Stock and all Restricted Stock Units at such time subject to restriction shall be forfeited and reacquired by the Company; provided, however, that the Committee may, when it finds that a waiver would be in the best interest of the Company, waive in whole or in part any or all remaining restrictions with respect to Shares of Restricted Stock or Restricted Stock Units. Upon the lapse or waiver of restrictions and the restricted period relating to Restricted Stock Units evidencing the right to receive Shares, such Shares shall be issued and delivered to the holders of the Restricted Stock Units. (d) Performance Awards. The Committee is hereby authorized to grant Performance Awards to Participants subject to the terms of the Plan and any applicable Award Agreement. A Performance Award granted under the Plan (i) may be denominated or payable in cash, Shares (including, without limitation, Restricted Stock and Restricted Stock Units), other securities, other Awards or other property and (ii) shall confer on the holder thereof the right to receive payments, in whole or in part, upon the achievement of such performance goals during such performance periods as the Committee shall establish. Subject to the terms of the Plan and any applicable Award Agreement, the performance goals to be achieved during any performance period, the length of any performance period, the amount of any Performance Award granted, the amount of any payment or transfer to be made pursuant to any Performance Award and any other terms and conditions of any Performance Award shall be determined by the Committee. (e) Other Stock Grants. The Committee is hereby authorized, subject to the terms of the Plan and any applicable Award Agreement, to grant to Participants Shares without restrictions thereon as are deemed by the Committee to be consistent with the purpose of the Plan. (f) Other Stock-Based Awards. The Committee is hereby authorized to grant to Participants subject to the terms of the Plan and any applicable Award Agreement, such other Awards that are denominated or payable in, valued in whole or in part by reference to, or otherwise based on or related to, Shares (including, without limitation, securities convertible into Shares), as are deemed by the Committee to be consistent with the purpose of the Plan. Shares or other securities delivered pursuant to a purchase right granted under this Section 6(f) shall be purchased for such consideration, which may be paid by such method or methods and in form or forms (including, without limitation, cash, Shares, promissory notes, other securities, other Awards or other property or any combination thereof), as the Committee shall determine, the value of which consideration, as established by the Committee, shall not be less than 100% of the Fair Market Value of such Shares or other securities as of the date such purchase right is granted. (g) General. (i) No Cash Consideration for Awards. Awards shall be granted for no cash consideration or for such minimal cash consideration as may be required by applicable law. (ii) Awards May Be Granted Separately or Together. Awards may, in the discretion of the Committee, be granted either alone or in addition to, in tandem with or in substitution for any other Award or any award granted under any plan of the Company or any Affiliate other than the Plan. Awards granted in addition to or in tandem with other Awards or in addition to or in tandem with awards granted under any such other plan of the Company or any Affiliate may be granted either at the same time as or at a different time from the grant of such other Awards or awards. (iii) Forms of Payment under Awards. Subject to the terms of the Plan and of any applicable Award Agreement, payments or transfers to be made by the Company or an Affiliate upon the grant, exercise or payment of an Award may be made in such form or forms as the Committee shall determine (including, without limitation, cash, Shares, promissory notes, other securities, other Awards or other property or any combination thereof), and may be made in a single payment or transfer, in installments or on a deferred basis, in each case in accordance with rules and procedures established by the Committee. Such rules and procedures may include, without limitation, provisions for the payment or crediting of reasonable interest on installment or deferred payments or the grant or crediting of dividend equivalents with respect to installment or deferred payments. (iv) Limits on Transfer of Awards. No Award (other than Other Stock Grants) and no right under any such Award shall be transferable by a Participant otherwise than by will or by the laws of descent and distribution; provided, however, that, if so determined by the Committee, a Participant may, in the manner established by the Committee, transfer Options (other than Incentive Stock Options) or designate a beneficiary or beneficiaries to exercise the rights of the Participant and receive any property distributable with respect to any Award upon the death of the Participant. Each Award or right under any Award shall be exercisable during the Participant's lifetime only by the Participant or, if permissible under applicable law, by the Participant's guardian or legal representative. No Award or right under any such Award may be pledged, alienated, attached or otherwise encumbered, and any purported pledge, alienation, attachment or encumbrance thereof shall be void and unenforceable against the Company or any Affiliate. (v) Term of Awards. The term of each Award shall be for such period as may be determined by the Committee. (vi) Restrictions; Securities Exchange Listing. All Shares or other securities delivered under the Plan pursuant to any Award or the exercise thereof shall be subject to such restrictions as the Committee may deem advisable under the Plan, applicable federal or state securities laws and regulatory requirements, and the Committee may cause appropriate entries to be made or legends to be affixed to reflect such restrictions. If any securities of the Company are traded on a securities exchange, the Company shall not be required to deliver any Shares or other securities covered by an Award unless and until such Shares or other securities have been admitted for trading on such securities exchange. Section 7. Amendment and Termination; Adjustments. (a) Amendments to the Plan. The Board may amend, alter, suspend, discontinue or terminate the Plan at any time; provided, however, that, notwithstanding any other provision of the Plan or any Award Agreement, without the approval of the shareholders of the Company, no such amendment, alteration, suspension, discontinuation or termination shall be made that, absent such approval: (i) would violate the rules or regulations of the NASDAQ National Market System or any securities exchange that are to the Company; or (ii) would cause the Company to be unable, under the Code, to grant Incentive Stock Options under the Plan. (b) Amendments to Awards. The Committee may waive any conditions of or rights of the Company under any outstanding Award, prospectively or retroactively. Except as otherwise provided herein or in the Award Agreement, the Committee may not amend, alter, suspend, discontinue or terminate any outstanding Award, prospectively or retroactively, if such action would adversely affect the rights of the holder of such Award, without the consent of the Participant or holder or beneficiary thereof. (c) Correction of Defects, Omissions and Inconsistencies. The Committee may correct any defect, supply any omission or reconcile any inconsistency in the Plan or any Award in the manner and to the extent it shall deem desirable to carry the Plan into effect. Section 8. Income Tax Withholding; Tax Bonuses. (a) Withholding. In order to comply with all applicable federal or state income tax laws or regulations, the Company may take such action as it deems appropriate to ensure that all applicable federal or state payroll, withholding, income or other taxes, which are the sole and absolute responsibility of a Participant, are withheld or collected from such Participant. In order to assist a Participant in paying all or a portion of the federal and state taxes to be withheld or collected upon exercise or receipt of (or the lapse of restrictions relating to) an Award, the Committee, in its discretion and subject to such additional terms and conditions as it may adopt, may permit the Participant to satisfy such tax obligation by (i) electing to have the Company withhold a portion of the Shares otherwise to be delivered upon exercise or receipt of (or the lapse of restrictions relating to) such Award with a Fair Market Value equal to the amount of such taxes or (ii) delivering to the Company Shares other than Shares issuable upon exercise or receipt of (or the lapse of restrictions relating to) such Award with a Fair Market Value equal to the amount of such taxes. The election, if any, must be made on or before the date that the amount of tax to be withheld is determined. (b) Tax Bonuses. The Committee, in its discretion, shall have the authority, at the time of grant of any Award under this Plan or at any time thereafter, to approve cash bonuses to designated Participants to be paid upon their exercise or receipt of (or the lapse of restrictions relating to) Awards in order to provide funds to pay all or a portion of federal and state taxes due as a result of such exercise or receipt (or the lapse of such restrictions). The Committee shall have full authority in its discretion to determine the amount of any such tax bonus. Section 9. General Provisions. (a) No Rights to Awards. No Eligible Person, Participant or other Person shall have any claim to be granted any Award under the Plan, and there is no obligation for uniformity of treatment of Eligible Persons, Participants or holders or beneficiaries of Awards under the Plan. The terms and conditions of Awards need not be the same with respect to any Participant or with respect to different Participants. (b) Award Agreements. No Participant will have rights under an Award granted to such Participant unless and until an Award Agreement shall have been duly executed on behalf of the Company and, if requested by the Company, signed by the Participant. (c) No Limit on Other Compensation Arrangements. Nothing contained in the Plan shall prevent the Company or any Affiliate from adopting or continuing in effect other or additional compensation arrangements, and such arrangements may be either generally applicable or applicable only in specific cases. (d) No Right to Employment. The grant of an Award shall not be construed as giving a Participant the right to be retained in the employ of the Company or any Affiliate, nor will it affect in any way the right of the Company or an Affiliate to terminate such employment at any time, with or without cause. In addition, the Company or an Affiliate may at any time dismiss a Participant from employment free from any liability or any claim under the Plan or any Award, unless otherwise expressly provided in the Plan or in any Award Agreement. (e) Governing Law. The validity, construction and effect of the Plan or any Award, and any rules and regulations relating to the Plan or any Award, shall be determined in accordance with the laws of the State of Minnesota. (f) Severability. If any provision of the Plan or any Award is or becomes or is deemed to be invalid, illegal or unenforceable in any jurisdiction or would disqualify the Plan or any Award under any law deemed applicable by the Committee, such provision shall be construed or deemed amended to conform to applicable laws, or if it cannot be so construed or deemed amended without, in the determination of the Committee, materially altering the purpose or intent of the Plan or the Award, such provision shall be stricken as to such jurisdiction or Award, and the remainder of the Plan or any such Award shall remain in full force and effect. (g) No Trust or Fund Created. Neither the Plan nor any Award shall create or be construed to create a trust or separate fund of any kind or a fiduciary relationship between the Company or any Affiliate and a Participant or any other Person. To the extent that any Person acquires a right to receive payments from the Company or any Affiliate pursuant to an Award, such right shall be no greater than the right of any unsecured general creditor of the Company or any Affiliate. (h) No Fractional Shares. No fractional Shares shall be issued or delivered pursuant to the Plan or any Award, and the Committee shall determine whether cash shall be paid in lieu of any fractional Shares or whether such fractional Shares or any rights thereto shall be canceled, terminated or otherwise eliminated. (i) Headings. Headings are given to the Sections and subsections of the Plan solely as a convenience to facilitate reference. Such headings shall not be deemed in any way material or relevant to the construction or interpretation of the Plan or any provision thereof. Section 10. Effective Date of the Plan. The Plan was approved by the Board on December 14, 1998, subject to approval by the shareholders of the Company within twelve (12) months thereafter. Any Award granted under the Plan prior to shareholder approval of the Plan shall be subject to shareholder approval of the Plan. Section 11. Term of the Plan. No Award shall be granted under the Plan after December 13, 2008 or any earlier date of discontinuation or termination established pursuant to Section 7(a) of the Plan. However, unless otherwise expressly provided in the Plan or in an applicable Award Agreement, any Award theretofore granted may extend beyond such date. EX-13 5 Exhibit 13-A Selected consolidated financial data - ----------------------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 1993 1988 ------ ------ ------ ------ ------ ------ ------ (thousands except per-share data) Revenues Electric $227,477 $205,121 $199,345 $203,925 $198,812 $192,290 $178,221 Manufacturing 86,030 81,543 64,568 38,690 13,083 8,473 - Health services 68,728 66,185 61,697 50,896 45,555 32,068 - Other business operations 48,843 41,430 45,323 32,818 29,276 32,396 - -------- -------- -------- -------- -------- -------- -------- Total operating revenues $431,078 $394,279 $370,933 $326,329 $286,726 $265,227 $178,221 Special charges $ 9,522 $ - $ - $ - $ - $ - $ - Cumulative change in accounting principle (1) $ 3,819 $ - $ - $ - $ - $ - $ - Net income $ 34,520 $ 32,346 $ 30,624 $ 28,945 $ 28,475 $ 27,369 $ 25,317 Cash flow from operations $ 63,959 $ 69,398 $ 68,611 $ 58,077 $ 51,832 $ 53,255 $ 47,675 Total assets $655,612 $655,441 $669,704 $609,196 $578,972 $563,905 $476,363 Long-term debt $181,046 $189,973 $163,176 $168,261 $162,196 $166,563 $121,815 Redeemable preferred $ 18,000 $ 18,000 $ 18,000 $ 18,000 $ 18,000 $ 18,000 $ 15,925 Common shares outstanding (2) (thousands) 11,880 11,731 11,536 11,180 11,180 11,180 11,968 Number of common shareholders (3) 13,699 13,753 13,829 13,933 14,115 13,634 14,595 Basic and diluted earnings per share (4) (5) $ 2.73 $ 2.58 $ 2.46 $ 2.38 $ 2.34 $ 2.23 $ 1.92 Dividends per common share $ 1.92 $ 1.86 $ 1.80 $ 1.76 $ 1.72 $ 1.68 $ 1.48 - ------------------------------------------------------------------------------------------------- Notes: (1) In the first quarter of 1998 the Company changed its method of electric revenue recognition in the states of Minnesota and South Dakota from meter-reading dates to energy-delivery dates. The amount presented is net of income tax of $2,545. (2) Number of shares outstanding at year-end. (3) Holders of record at year-end. (4) Based on average number of shares outstanding. (5) 1998 includes cumulative effect of change in accounting principle of 32 cents per share
Management's discussion and analysis of financial condition and results of operations Management's major financial objective is to increase shareholder value by earning returns for shareholders that exceed returns available from comparable risk investments. This objective can be met by earning the returns allowed by regulators in electric operations combined with successfully growing diversified operations. Meeting this objective enables the Company to preserve and enhance its financial capability by maintaining optimal capitalization ratios and a strong interest coverage position, providing excellent returns to the common shareholder in the form of capital appreciation and dividends, and preserving strong credit ratings on outstanding securities, which in the form of lower interest rates benefits both the Company's customers and shareholders. Liquidity: Liquidity is the ability to generate adequate amounts of cash to meet the Company's needs, both short-term and long-term. Historically, the Company's liquidity has been a function of its capital expenditures and debt service requirements, its net internal funds generation, and its access to long-term securities markets and credit facilities for external capital. Over the years the Company has achieved a high degree of long-term liquidity by maintaining desired capitalization ratios through timely stock and debt issuances or repurchases, maintaining strong bond ratings, implementing cost-containment programs, evaluating operations and projects on a cost-benefit approach, investing in projects that enhance shareholder value, and implementing sound tax reduction strategies. Cash provided by operating activities of $64 million, as shown on the Consolidated Statement of Cash Flows for the year ended December 31, 1998, combined with cash provided by the issuance of $5.5 million in common stock and funds on hand of $5.3 million at December 31, 1997, allowed the Company to pay dividends, retire short- and long-term debt, meet sinking fund payment requirements on its outstanding First Mortgage Bonds, acquire an additional business, and finance its consolidated capital expenditures in 1998. In 1998 the Company issued 148,426 common shares under its Automatic Dividend Reinvestment and Share Purchase Plan, generating proceeds of $5.5 million. In 1999 the Company plans to purchase shares on the open market to fulfill the requirements of the Plan. The Company estimates that funds internally generated net of forecasted dividend payments, 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 through 2003 consolidated capital expenditures. Additional short-term or long-term financing will be required in the period 1999 through 2003 for 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. Capital requirements: The Company's consolidated capital requirements include periodic and timely replacement of technically obsolete or worn out equipment, new equipment purchases, and plant upgrades to accommodate anticipated growth. The electric segment has a construction and capital investment program to provide facilities necessary to meet forecasted customer demands and provide reliable service. The construction program is subject to continuing review and is revised annually in light of changes in demands for energy, environmental laws, regulatory changes, technology, the costs of labor, materials and equipment, and the Company's financial condition (including cash flow and earnings). Consolidated capital expenditures for the years 1998, 1997, and 1996 were $29 million, $42 million, and $65 million, respectively. The reduction in capital expenditures since 1996 reflects an initiative started by the Company in 1997 to more closely evaluate capital expenditures. The estimated capital expenditures for 1999 are $33 million and the total expenditures for the five-year period 1999 through 2003 are expected to be approximately $175 million. The breakdown of 1998 actual and 1999 through 2003 estimated capital project expenditures by segment is as follows: 1998 1999 1999-2003 ------ ------ ----------- (in millions) Electric utility $ 18 $ 20 $105 Manufacturing 5 7 19 Health services 3 4 42 Other business operations 3 2 9 ---- ---- ---- Total $ 29 $ 33 $175 In addition to these capital requirements, funds totaling approximately $49 million will be needed during the five-year period 1999 through 2003 to retire First Mortgage Bonds and other long-term obligations, including subsidiary long-term obligations, at maturity and through sinking fund payments. Capital resources: Financial flexibility is provided by unused lines of credit, financial coverages in excess of the minimum levels required for issuance of securities, strong credit ratings, the pledging of assets owned by the Company, and alternative financing arrangements such as leasing. As of December 31, 1998, the Company had $3.9 million in cash and cash equivalents and $35.4 million in unused lines of credit available. Bank lines of credit are a key source of operating capital and can provide interim financing of working capital and other capital requirements, if needed. The Company had $824,000 of credit lines in use at December 31, 1998. Borrowing rates on the Company's bank line of credit averaged 6.65 percent for 1998. The notes and credit lines of the subsidiaries are secured by a pledge of all of the common stock of the subsidiaries. (See note 11 to consolidated financial statements for further information.) The Company's coverage ratios improved in 1998 compared to 1997 as a result of a decreased level of debt and lower interest rates. The fixed charge coverage ratio after taxes was 4.0 for 1998 as compared to 3.0 for 1997 and the long-term debt interest coverage ratio before taxes was 4.3 for 1998, as compared to 4.0 for 1997. The Company expects these coverages to remain stable during 1999. The Company's credit ratings affect its access to the capital market. The current credit ratings for the Company's First Mortgage Bonds at December 31, 1998, which remain unchanged from 1997, are as follows: Moody's Investors Service Aa3 Duff and Phelps AA Standard and Poor's AA- The Company's disclosure of these security ratings is not a recommendation to buy, sell, or hold the Company's securities. As of December 31, 1998, the Company had the capacity under its Indenture of Mortgage to issue an additional $170 million principal amount of First Mortgage Bonds. (See note 9 to consolidated financial statements for further information.) Results of operations: Electric operations - ------------------- (bar graph of information in following table) Electric operating income (millions) ------------------------- 1996 $45.3 1997 $45.0 1998 $42.2 (end of graph) Otter Tail Power Company provides electrical service to over 125,000 customers in a service territory of over 50,000 square miles. 1998 1997 1996 ------ ------ ------ (in thousands) Operating revenues $227,477 $205,121 $199,345 Production fuel 34,234 31,362 27,913 Purchased power 40,609 24,420 28,378 Other operation and maintenance expenses 70,584 72,112 66,401 Special charges 7,022 -- -- Depreciation and amortization 22,128 21,442 19,880 Property taxes 10,684 10,819 11,494 -------- -------- -------- Operating income $ 42,216 $ 44,966 $ 45,279 The 10.9 percent increase in electric operating revenues in 1998, as compared to 1997, is due to a $17.9 million increase in power pool revenues, combined with increases of $2.7 million in other electric revenue and $1.7 million in retail revenue. Power pool kilowatt-hour (kwh) sales increased 96 percent and revenue per power pool kwh sold increased 33 percent. An increase in energy available for sale enabled the Company to respond to unusually high wholesale market demands, resulting in the increase in power pool sales in 1998. The evolution of a competitive wholesale electricity market is reflected in market-based increases in revenue per power pool kwh sold and the cost per kwh of purchased power. Other electric revenue increased as a result of more electrical contract work done for other utilities and an increase in payments from other utilities for the use of shared transmission facilities. Retail revenue increased 0.9 percent despite a 0.3 percent decline in retail kwh sales. Revenue per retail kwh increased 1.2 percent in 1998, as compared to 1997, as a result of increases in the Minnesota Conservation Improvement Program (CIP) surcharge rate and an increase in cost-of-energy revenues. Significantly milder weather during the first quarter of 1998 was the main contributing factor to the decline in retail kwh sales as heating degree days were down 18.7 percent for 1998 as compared to 1997. Heating degree days, which generally correlate to increases or decreases in the use of electricity by residential customers, were 7,827 for 1998, 9,628 for 1997, and 10,349 for 1996. The 2.9 percent increase in electric operating revenues in 1997, as compared to 1996, reflects increases of 1.0 percent in revenue from retail kwh sales, 56.5 percent in other electric revenue, and 8.6 percent in revenue from power pool sales. The increase in retail revenue is mainly due to increases in kwh sales to industrial customers and increases in cost-of-energy revenue related to power purchased for sale to retail customers in the first half of 1997. The increase in other electric revenue in 1997, as compared to 1996, reflects Minnesota CIP lost margins recovery approved by the Minnesota Public Utilities Commission (MPUC). Increases in transmission service charge revenue and electric property rental income also contributed to the increase in other electric revenue in 1997, as compared to 1996. Power pool sales increased as a result of strong sales in the fourth quarter of 1997, which offset lower sales earlier in the year. Increases or decreases in fuel and purchased power costs arising from changing prices results in adjustments to the Company's rate schedules through the cost of energy adjustment clause. Over the last five years this has resulted in savings of nearly $42 million to the Company's customers. Greater plant availability in 1998, which allowed the Company to sell more wholesale power, resulted in a 9.1 percent increase in kwhs generated and a 9.2 percent increase in production fuel expense in 1998 as compared to 1997. The 66.3 percent increase in purchased power costs in 1998 as compared to 1997 is due to a 161 percent increase in cost of power purchased for resale combined with a 6.8 percent increase in cost of power purchased for system use. The cost of power purchased for system use increased despite a 5.1 percent decrease in the volume of energy purchased for system use as a result of generally higher market prices for purchased power during 1998. Power purchased for resale increased due to a 96 percent increase in power pool sales combined with a 40 percent increase in cost per kwh purchased for resale. Production fuel expense increased 12.4 percent in 1997, as compared to 1996, while purchased power expense decreased 13.9 percent over the comparable periods for a net decrease in production fuel and purchased power expenses of 0.9 percent. The net reduction in production fuel and purchased power expenses in 1997, as compared to 1996, was achieved despite a slight increase in total kwh sales of 0.4 percent mainly as a result of having Big Stone Plant, the Company's lowest-cost generating unit, available for generation during all of 1997, as compared to 1996, when it was shut down two months for a major overhaul. In 1997 Big Stone Plant generated a record net output of 3,166,398 mwh for a single year exceeding its previous record output by 515,627 mwh. The increase in generation at Big Stone Plant contributed to a decrease in purchased power in 1997 and helped alleviate a shortage in available generation caused by the scheduled maintenance shutdown of Coyote Station in the Spring of 1997. Other electric operation and maintenance expenses for 1998 as compared to 1997, decreased 2.1 percent. This decrease, in part, reflects the effect of the Company's early retirement program, which resulted in a workforce reduction of 55 employees by June 1, 1998. Maintenance expenses were higher in 1997 than in 1998 due to the 10- week overhaul of Coyote Station in 1997. The primary contributors to the 8.6 percent increase in other electric operation and maintenance expense in 1997 were the overhaul of the Coyote Station in the second quarter of 1997 and increased expenditures for outside and contracted services in 1997. Special charges incurred in 1998 of $7 million represent two items related to electric operations: (1) a noncash charge of $6.3 million 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 note 3 to consolidated financial statements for further information including the net-of-tax and earnings per share impact of these charges.) The Company incurred insignificant additional costs related to the early retirement offer after the first quarter. Depreciation and amortization expense for 1998 as compared to 1997, increased 3.2 percent due to a slight increase in electric plant in service. The 7.9 percent increase in depreciation and amortization expense in 1997 is the result of property additions including upgrades made to Big Stone Plant in the latter part of 1996. The decrease in property taxes of 5.9 percent in 1997 compared to 1996 reflects reductions in Minnesota property taxes as a result of legislative action affecting Minnesota commercial and industrial property class rates for 1997 and lower assessed values on Minnesota utility property. Manufacturing operations - ------------------------ (bar graph of information in following table) Manufacturing operating income (millions) ----------------------- 1996 $6.5 1997 $7.9 1998 $8.7 (end of graph) Manufacturing operations is made up of businesses involved in the production of agricultural equipment, automobile and truck frame- straightening equipment and accessories, plastic pipe extrusion, and metal parts stamping and fabrication. 1998 1997 1996 ------ ------ ------ (in thousands) Operating revenues $86,030 $81,543 $64,568 Cost of goods sold 64,390 61,361 48,269 Operating expenses 12,979 12,237 9,795 ------- ------- ------- Operating income $ 8,661 $ 7,945 $ 6,504 Manufacturing operating revenue increased 5.5 percent in 1998 as a result of increased sales volumes of 15 percent within the manufacturing companies that produce agricultural equipment and metal parts stamping. These increases were offset by a reduction in sales of automobile and truck frame-straightening equipment and a decrease in revenues from the sales of PVC pipe. The increase in manufacturing operating revenue of 26.3 percent in 1997 reflects increased sales at all six of the Company's manufacturing subsidiaries. During 1998 manufacturing cost of goods sold increased 4.9 percent as a result of the increased sales volumes, offset by a decrease in prices for resins used in the manufacture of PVC pipe. The increase in operating expenses for 1998 of 6.1 percent was primarily due to increased labor costs and the use of outside professional services. The increases of 27.1 percent in manufacturing cost of goods sold and 24.9 percent in manufacturing operating expenses in 1997, as compared to 1996, correspond to the increase in sales over the same comparable periods. The increase in cost of goods sold in 1997 also reflects increases in prices for resins used in the manufacture of PVC pipe. Health services operations - -------------------------- (bar graph of information in following table) Health services operating income (millions) ----------------- 1996 $5.1 1997 $4.3 1998 $6.5 (end of graph) Health services operations include businesses involved in the sale, service, rental, refurbishing, and operation of medical imaging equipment and the sale of related supplies and accessories to various medical institutions primarily in the Midwest. 1998 1997 1996 ------ ------ ------ (in thousands) Operating revenues $68,728 $66,185 $61,697 Cost of goods sold 35,913 38,922 34,032 Operating expenses 26,305 22,968 22,528 ------- ------- ------- Operating income $ 6,510 $ 4,295 $ 5,137 The 3.8 percent increase in health services operating revenue in 1998, as compared to 1997, is due to an increase in sales volumes of diagnostic medical equipment combined with an increase in the number of medical imaging scans performed offset by a decrease in the average fee per scan. Health services cost of goods sold decreased 7.7 percent in 1998, as compared to 1997 due to the recording of equipment valuation adjustments in 1997. The 14.5 percent increase in health services operating expense in 1998 as related to 1997 reflects the increase in rental costs of diagnostic imaging equipment and increased repairs and maintenance expense on mobile imaging equipment. The increase in health services operating revenue of 7.3 percent in 1997 and the increase in health services operating expenses of 2 percent in 1997 is related to the 1996 acquisitions of two medical imaging services companies. The increase in health services cost of goods sold in 1997, as compared to 1996, is due to valuation adjustments related to equipment held for sale and increased costs associated with customer service contracts. Other business operations - ------------------------- (bar graph of information in following table) Other business operations operating income (millions) -------------------------- 1996 $2.5 1997 $1.8 1998 ($0.2) The Company's other business operations include telephone utilities and businesses involved in electrical and telephone construction contracting, entertainment, and waste incinerating. On May 1, 1998, the Company acquired PAM Natural Gas, Inc. (PAM), a marketer of natural gas to commercial and institutional customers. Upon acquisition, PAM's name was changed to Otter Tail Energy Management, Inc. (See note 4 to consolidated financial statements for more information.) In December 1998 Varistar Corporation (formerly Mid-States Development, Inc.) entered into a definitive agreement to sell certain assets of the radio stations and video production company owned by KFGO, Inc., and the radio stations owned by Western Minnesota Broadcasting Company to an unrelated party. (See additional discussion under "Factors affecting future earnings" on page 25.) 1998 1997 1996 ------ ------ ------ (in thousands) Operating revenues $48,843 $41,430 $45,323 Cost of goods sold 29,133 23,393 28,297 Special charges 2,500 -- -- Operating expenses 17,367 16,210 14,574 ------ ------- ------- Operating income $ (157) $ 1,827 $ 2,452 Other business operations operating revenues, cost of goods sold, and operating expenses increased 17.9 percent, 24.5 percent and 7.1 percent, respectively, in 1998, as compared to 1997, primarily as a result of the PAM acquisition. Special charges of $2.5 million recorded during the first quarter of 1998 represent an impairment loss associated with the Quadrant Co. (Quadrant) waste incineration plant. Substantially all of the first quarter charge was used to reduce the plant book value to zero. The plant ceased operations during the third quarter of 1998. During the fourth quarter of 1998, an additional provision of $250,000 was included in operating expenses for plant disposition costs. Pro forma operating income for other business operations without Quadrant would have been $3,016,000, $2,426,000, and $2,237,000 in 1998, 1997, and 1996, respectively. (See note 3 to consolidated financial statements and discussion under "Factors affecting future earnings" on page 25 for further information on the Quadrant waste incineration plant, including the net-of-tax and earnings per share impact of this special charge.) The 8.6 percent decrease in other business operations operating revenue in 1997, as compared to 1996, is due to a decline in revenue and reductions in material cost pass-through billings at the Company's construction subsidiaries, offset slightly by increases in media and telecommunications revenue due to the acquisition of several radio stations in 1996. The decrease in construction activity and material cost pass-through billings are the main factors contributing to the 17.3 percent decrease in cost of goods sold in 1997. The increase in operating expenses from other business operations of 11.2 percent in 1997 reflects the acquisitions of four radio stations during 1996. Consolidated other income and deductions--net - --------------------------------------------- (bar graph of information in following table) Other income and deductions (millions) --------------------------- 1996 $2.1 1997 $6.1 1998 $4.2 (end of graph) The 32 percent decrease in other income and deductions--net for 1998, as compared to 1997, reflects the 1997 sale of a Direct Broadcast Satellite franchise for $1.8 million. Included in other income and deductions for 1998 is $839,000 of dividend income and a $500,000 increase in revenue recognition relating to Minnesota CIP financial incentives. A gain on the sale of the Direct Broadcast Satellite franchise, in which the Company's telecommunications subsidiary, Midwest Information Systems, Inc., held a one-third ownership interest, accounted for $1.8 million of the increase in other income and deductions--net in 1997, as compared to 1996. Realized gains on sales of investments of $751,000 and an increase of $1,322,000 in miscellaneous nonoperating income, including compensation for the abandonment of certain microwave frequencies licensed to the Company, also contributed to the 1997 increase in other income and deductions--net. The remainder of the increase in other income and deductions--net for 1997 reflects an increase in revenue recognition related to Minnesota CIP financial incentives of $307,000. Consolidated interest charges - ----------------------------- (bar graph of information in following table) Interest charges (millions) ---------------- 1996 $16.9 1997 $18.5 1998 $15.6 (end of graph) The 15.9 percent decrease in interest charges in 1998 as compared to 1997 is a result of a lower average interest rate on line of credit borrowings and refinancing of various subsidiary companies' fixed and variable interest rate debt with lower fixed rate debt in November 1997. In addition, the decrease can be attributed to the implementation of a consolidated cash management function within the subsidiaries that allowed excess cash to be used to reduce outstanding borrowings. Also the medical imaging subsidiary reduced debt by entering into a $16 million sale/leaseback transaction in November 1997. Interest charges increased 9.8 percent in 1997 as a result of increased debt at the Company's subsidiaries due to acquisitions and growth and increased use of short-term debt at the parent-company level. Consolidated income taxes - ------------------------- (bar graph of information in following table) Income taxes (millions) ------------ 1996 $14.0 1997 $14.3 1998 $15.1 (end of graph) The 5.8 percent increase in income taxes in 1998 as compared to 1997 reflects the use of a capital loss carryforward in 1997 combined with an increase in net income before tax for 1998. The increase of 2.1 percent in 1997 income taxes over 1996 income taxes mainly is due to an increase in income before income taxes for the same comparable periods. Part of the increase in taxes on increased operating income was offset by an increase in affordable housing tax credits earned in 1997 over 1996. (See note 14 and "Investments" under note 1 to consolidated financial statements for more information.) 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. This change results in better matching of revenues and expense and is consistent with predominant industry practice. The change is also consistent with the way the Company has been recording electric revenue for its North Dakota customers since 1993 under an order from the North Dakota Public Service Commission. The cumulative effect of this change was $3,819,000 (net of income taxes of $2,545,000) or $0.32 per share. (See note 2 to consolidated financial statements for more information.) Impact of inflation - ------------------- The Company operates under regulatory provisions that allow price increases in the cost of fuel and purchased power to be passed to customers through automatic adjustments to its rate schedules under the cost of energy adjustment clause. Other increases in the cost of electric service must be recovered through timely filings for rate relief with the appropriate regulatory agency. The Company's health services, manufacturing and other business operations consist almost entirely of unregulated businesses. Increased operating costs are reflected in product or services pricing with any limitations on price increases determined by the marketplace. The impact of inflation upon these segments has been less significant during the past few years because of the relatively low rates of inflation experienced in the United States. Raw material costs, labor costs, and interest rates are important components of costs for companies in these segments. Any or all of these components could be impacted by inflation, with a possible adverse effect on the Company's profitability. Factors affecting future earnings Growth of electric revenue - -------------------------- The results of operations discussed above are not necessarily indicative of future earnings. Anticipated higher operating costs and carrying charges on increased investment in plant, if not offset by proportionate increases in operating revenues and other income (either by appropriate rate increases, increases in unit sales, or increases in nonelectric operations), will affect future earnings. Growth in electric sales will be subject to a number of factors, including the volume of power pool sales to other utilities, the effectiveness of demand-side management programs, weather, competition, and the rate of economic growth or decline in the Company's service area. The Company's electric business is primarily dependent upon the use of electricity by customers in our service area. Percentage changes in the Company's electric kwh sales to retail customers over the prior year for the last three years showed a decrease of 0.3 percent in 1998 and increases of 1.4 percent in 1997, and 4.0 percent in 1996. Market factors beyond the Company's control such as mergers and acquisitions, geographical location, transmission costs and the effects of deregulation could have a negative impact on noncontractual power pool sales. Rates of return earned on utility operations are subject to review by the various state commissions that have jurisdiction over the electric rates charged by the Company. These reviews may result in future revenue reductions when actual rates of return are deemed by regulators to be in excess of allowed rates of return. Demand-side management - ---------------------- Demand-side management (DSM) efforts will continue in all jurisdictions served by the Company. The goal of DSM is to encourage the wise and efficient use of electricity by customers. Currently, Minnesota is the only jurisdiction that mandates investments in DSM. In 1998 the Minnesota Public Utility Commission (MPUC) approved the Company's 1997 financial incentive filing along with a 2.75 percent surcharge on all Minnesota customers' bills starting on July 1, 1998, for the recovery of conservation-related costs over and above those being recovered in current rates. The approved surcharge in effect from July 1, 1997 through June 30, 1998 was 1.75 percent and the approved surcharge from July 1, 1996, through June 30, 1997, was 1.25 percent. The current surcharge rate will be in place until June 30, 1999, when it will be revised for subsequent years' program results. During 1998 the Minnesota Department of Public Service (MDPS) recommended to the MPUC that demand-side management incentives for all Minnesota electric utilities be terminated as of January 1, 1998. At a hearing held November 19, 1998, the MPUC did not accept the MDPS recommendation, however, the MPUC put electric and gas utilities on notice that the ability to earn demand-side management incentives could end as early as January 1, 1999. Incentives accrued for 1998 totaled $1,750,000. A MPUC Chair's Round Table has been convened to examine demand-side management programs and related incentives. A report from the Round Table is due to the MPUC by May 1, 1999. (See note 5 to consolidated financial statements for more information.) Fuel Costs - ---------- The Company began purchasing subbituminous coal for Big Stone Plant in August 1995 under a contract that runs through December 1999. The Company expects to execute a new coal contract in 2000 near current contract prices. In November 1995 the Company and two other Coyote Station owners initiated a lawsuit against Knife River Coal Mining Company and its parent, MDU Resources Group Inc., in an attempt to resolve disputes over pricing in the Coyote coal agreement. The case was remanded to arbitration in 1997 and a resolution is still pending. Any fuel cost savings that may result from resolution of this dispute will be passed on to customers through the cost of energy adjustment clause. Environmental - ------------- Current regulations under the Federal Clean Air Act (the Act) are not expected to have a significant impact on future capital requirements or operating costs. However, proposed or future regulations under the Act, changes in the future coal supply market, and/or other laws and regulations could impact such requirements or costs. It is anticipated that, under current regulatory principles, any such costs could be recovered through rates. The Company's plants are not subject to the Act's phase one requirements. Phase two standards of the Act must be met by the year 2000. The Company intends that Big Stone Plant will maintain current levels of operation and meet phase two requirements for sulfur dioxide emissions by burning subbituminous coal. Based on current market conditions, the Company expects to execute a new coal contract in 2000 near current contract prices. Under EPA regulations, modifications would be required at Big Stone Plant by 2000 to satisfy nitrogen oxide emission standards. During 1997 the Company conducted tests at Big Stone Plant to determine if nitrogen oxide emissions could be reduced through modifications to existing equipment. The results of the tests were positive and modifications have been completed. The Company is a member of the Utility Air Regulatory Group (UARG). In 1998, the Federal Court rejected a petition filed by the UARG for reconsideration of the standards based on inconsistencies in current laws. The Company's Coyote Station is equipped with sulfur dioxide removal equipment. Compliance with the phase two requirements is not expected to significantly impact operations at that plant. Hoot Lake Plant already uses low-sulfur subbituminous coal. Minor modifications have been completed at Hoot Lake Plant to meet the phase two nitrogen oxide emission requirements by 2000. Regulation and legislation - -------------------------- In 1995 the Federal Energy Regulatory Commission (FERC) issued a Notice of Proposed Rulemaking (NOPR) to promote competition and deregulation in wholesale electric markets by requiring owners of transmission facilities to offer nondiscriminatory open-access transmission and ancillary services to wholesale sellers and purchasers of electric energy in interstate commerce. On April 24, 1996, the FERC issued two final rules, Order Nos. 888 and 889, which may have a potentially significant impact on wholesale markets. Order No. 888, effective July 9, 1996, requires electric utilities and other transmission providers to abide by, and to offer to other transmission users, terms, conditions and pricing comparable to those they use for themselves in transmitting power. The Company filed its initial transmission tariff on July 9, 1996, as required by Order No. 888. A revised rate schedule became effective in the first quarter of 1997. Order No. 889, which became effective January 3, 1997, requires public utilities to implement Standards of Conduct and an Open Access Same-Time Information System (OASIS). These rules require transmission personnel to provide information about their transmission systems to all customers, including their marketing associates within their respective companies, through the OASIS. The FERC issued orders after rehearing, 888A and B, further clarifying its intent to prevent any discriminatory abuse of market power by utilities controlling both transmission and generation assets. The U.S. Congress ended its 1998 legislative session without taking action on proposed electric industry restructuring legislation. Federal restructuring legislation in 1999 is not anticipated due to the complexity of issues involved with federal intervention. The Minnesota Public Utilities Commission issued its Wholesale Competition Report in 1996 and its Retail Competition Report in 1997 and continues to work on specific topics in the areas of potential stranded costs, unbundled rates, and affiliated transactions. The Minnesota Legislature did not take any significant legislative action on electric utility restructuring in 1998, and no significant action is expected during 1999. In 1997 the North Dakota Legislature created a subcommittee to investigate the impact of electric utility industry restructuring on North Dakota. The North Dakota Legislature plans to deal with tax issues surrounding restructuring first. The South Dakota Public Utility Commission has not taken any action with regards to industry restructuring or retail competition. Competition - ----------- As the electric industry moves towards deregulation the Company expects the industry to become more competitive. The Company is taking a number of steps to position itself for success in a competitive marketplace. It has initiated the process of functionally unbundling its energy supply, energy delivery, and energy services operations. The Company is developing the necessary accounting systems to capture costs and determine the profitability of each of these business units and to identify areas for improvement and opportunities for increased profitability. The Company has established an energy services business unit to promote the energy- related products and services traditionally offered to the Company's customers and to develop new products and services to be offered to current and potential customers in order to distinguish the Company from the competition. In January 1998 the Company announced a voluntary early retirement program for all nonunion electric utility employees age 55 and over. The offer of early retirement was accepted by 55 of the 67 eligible utility employees during the enrollment period. (See note 3 to consolidated financial statements for further information regarding this voluntary early retirement program.) The Company anticipates that most of the staff reductions will be permanent, resulting in enhanced future earnings through reduced payroll expenses. As the electric industry evolves and becomes more competitive, the Company believes it is well positioned to maintain its customer base and may have opportunities to increase its market share. The Company's generation capacity appears poised for competition due to unit heat rate improvements and reductions in fuel and freight costs. A comparison of the Company's electric retail rates to the rates of other investor-owned utilities, cooperatives, and municipals in the states the Company serves indicates that its rates are competitive. In addition, the Company would attempt more flexible pricing strategies under an open, competitive environment. The markets in which the Company's manufacturing companies, health services companies, and other businesses compete are characterized by intense competition and are subject to the effects of general economic conditions in each of their respective industries. The various markets the companies compete in have many established manufacturers with broader product lines, greater distribution capabilities, greater capital resources, and larger marketing, research and development staffs and facilities. 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 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 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 software applications in 1996. The electric utility has replaced its major in-house developed financial software applications with financial applications from Oracle Corporation, while at the same time, replacing the hardware (platforms) 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. As of December 31, 1998, the inventory phase is complete within the electric utility and ranges from 88 percent to 100 percent complete for the other companies. The assessment phase is 95 percent complete for the electric utility as of December 31, 1998 and will be completed by the end of February 1999. Within the other companies the assessment phase completion ranges from 50 percent to 100 percent. Remediation and testing for the electric utility is 55 percent complete and ranges from 25 percent to 98 percent complete for the other companies as of December 31, 1998. The Company is on schedule to complete remediation and testing by June 1, 1999. In addition, the Company's operating businesses are in the process of communicating with critical external parties in order to determine how vulnerable the Company may be to these 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 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 Company expects to have third party assessments completed by March 1999. The Company is developing 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 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 contacting its large customers to assess their level of year 2000 readiness and to discuss their operating plans for January 1, 2000. 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. In April and September of 1999 the Company will participate in NERC defined readiness drills. These drills will be carried out at the power pool level. 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 vary substantially from normal ongoing costs incurred for systems development, implementation, and maintenance due to the use of internal resources and the deferral of other projects. Total expenditures related to remediation, testing, conversion, replacement, and upgrading of system applications are expected to range from $975,000 to $1,350,000 for 1997 to 2000. Expenditures incurred through December 31, 1998 were $350,000. The Company's medical subsidiary owns diagnostic imaging equipment that has computer software 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 may have to absorb the majority of the costs. These costs are included in the estimates shown above. Contingency plans are also being developed for certain critical business and electrical processes. The business critical processes contingency plans will be approved during the first quarter of 1999. The Company's electrical system contingency plan uses templates provided by the NERC and are to be completed by June 30, 1999. 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 below under the heading "Cautionary Statements for Purposes of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995." Diversification - --------------- In March 1998 the Company recorded a $2.5 million noncash accounting charge related to the impairment of its Quadrant Co. waste incineration plant. (See note 3 to consolidated financial statements for further information.) In July 1998, Quadrant's waste incinerators were shut down for alleged noncompliance with Minnesota Pollution Control Agency (MPCA) particulate emissions regulations. Quadrant and the Company received from the MPCA a Notice of Violation dated October 15, 1998, outlining 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. The Company does not expect any further costs related to the plant's disposition to have a material effect upon future consolidated earnings. In December 1998 Varistar entered into a definitive agreement to sell certain assets of the radio stations and video production company owned by KFGO, Inc., and the radio stations owned by Western Minnesota Broadcasting Company to an unrelated party. The sale is subject to approval by the Federal Communications Commission and other governmental authorities. Operating income related to these radio stations did not have a significant effect on consolidated operating income for 1998, 1997, and 1996. When regulatory approvals are received, the Company will recognize a one-time gain on the sale of the radio stations. The Company continues to investigate acquisitions of additional businesses (both utility and nonutility) and expects continued growth in this area. The success of these businesses and any future business purchases will affect future earnings. Increased revenues from the Company's nonregulated businesses could result in greater earnings and stock price volatility. Accounting pronouncements In June 1998 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) 133 - Accounting for Derivative Instruments and Hedging Activities, effective for financial statements issued for periods beginning after June 15, 1999. SFAS 133 establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires that all derivatives be recognized as either assets or liabilities and that those financial instruments be measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative. The adoption of this statement is not expected to have a material impact on the Company's financial position as presently reported. In 1998 the Company adopted SFAS 131 -- Disclosures about Segments of an Enterprise and Related Information and SFAS 132 -- Employers' Disclosures about Pensions and Other Postretirement Benefits. The adoption of SFAS 131 and 132 did not affect the Company's 1998 operations or financial position. (See note 1 to consolidated financial statements for further information.) Cautionary Statements for Purposes of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995 The information in this annual report includes forward-looking statements. Important risks and uncertainties that could cause actual results to differ materially from those discussed in such forward-looking statements are set forth above under "Factors affecting future earnings." Other risks and uncertainties may be presented from time to time in the Company's future Securities and Exchange Commission filings. Otter Tail Power Company Consolidated Statements of Income For the Years Ended December 31 1998 1997 1996 - ----------------------------------------------------------------------------- (in thousands, except per-share amounts) Operating revenues Electric $227,477 $205,121 $199,345 Manufacturing 86,030 81,543 64,568 Health services 68,728 66,185 61,697 Other business operations 48,843 41,430 45,323 -------- ------- -------- Total operating revenues 431,078 394,279 370,933 Operating expenses Production fuel 34,234 31,362 27,913 Purchased power 40,609 24,420 28,378 Electric operation and maintenance expenses 70,584 72,112 66,401 Special charges 9,522 - - Cost of goods sold 129,436 123,676 110,598 Other nonelectric expenses 52,926 47,275 43,351 Depreciation and amortization 25,813 25,536 23,387 Property taxes 10,724 10,865 11,533 -------- -------- -------- Total operating expenses 373,848 335,246 311,561 Operating Income Electric 42,216 44,966 45,279 Manufacturing 8,661 7,945 6,504 Health services 6,510 4,295 5,137 Other business operations (157) 1,827 2,452 -------- -------- -------- Total operating income 57,230 59,033 59,372 Other income and deductions -- net 4,177 6,140 2,125 Interest charges 15,566 18,519 16,863 -------- -------- -------- Income before income taxes 45,841 46,654 44,634 Income taxes 15,140 14,308 14,010 -------- -------- -------- Income before cumulative effect of change in accounting principle 30,701 32,346 30,624 Cumulative effect of change in accounting principle (net-of-tax of $2,545) 3,819 - - -------- -------- -------- Net income 34,520 32,346 30,624 Preferred dividend requirements 2,358 2,358 2,358 -------- -------- -------- Earnings available for common shares $ 32,162 $ 29,988 $ 28,266 ======== ======== ======== Average number of common shares outstanding 11,798 11,639 11,503 Basic and diluted earnings per share Before cumulative effect of change in accounting principle $2.41 $2.58 $2.46 Cumulative effect of change in accounting principle 0.32 - - -------- -------- -------- Basic and diluted earnings per share $2.73 $2.58 $2.46 Dividends per common share $1.92 $1.86 $1.80 See accompanying notes to consolidated financial statements.
Otter Tail Power Company Consolidated Balance Sheets, December 31 1998 1997 - ----------------------------------------------------------------------------- (in thousands) Assets Plant Electric plant in service $ 770,887 $ 758,551 Diversified operations 89,094 89,716 --------- --------- Total 859,981 848,267 Less accumulated depreciation and amortization 370,290 350,647 --------- --------- Plant-net of accumulated depreciation and amortization 489,691 497,620 Construction work in progress 10,495 12,146 --------- --------- Net plant 500,186 509,766 --------- --------- Investments 20,612 20,048 --------- --------- Intangibles--net 21,176 20,911 --------- --------- Other assets 3,968 5,932 --------- --------- Current assets Cash and cash equivalents 3,919 5,301 Accounts receivable: Trade (less accumulated provision for uncollectible accounts: 1998, $1,444,000; 1997, $1,026,000) 40,029 33,304 Other 8,065 6,796 Materials and supplies: Fuel 3,418 3,425 Inventory, materials, and operating supplies 23,138 24,160 Deferred income taxes 2,730 4,738 Accrued utility revenues 11,179 4,271 Other 6,310 3,795 --------- --------- Total current assets 98,788 85,790 --------- --------- Deferred debits Unamortized debt expense and reacquisition premiums 3,737 4,187 Regulatory assets 3,774 5,060 Other 3,371 3,747 --------- --------- Total deferred debits 10,882 12,994 --------- --------- Total $ 655,612 $ 655,441 ========= ========= See accompanying notes to consolidated financial statements.
Otter Tail Power Company Consolidated Balance Sheets, December 31 1998 1997 - ----------------------------------------------------------------------------- (in thousands) Liabilities and Equity Capitalization (page 32) Common shares, par value $5 per share -- authorized, 25,000,000 shares; outstanding, 1998 -- 11,879,504 shares; 1997 -- 11,731,078 shares $ 59,398 $ 58,655 Premium on common shares 39,919 35,196 Retained earnings 125,462 115,942 Accumulated other comprehensive income 297 363 --------- --------- Total common equity 225,076 210,156 Cumulative preferred shares 38,831 38,831 Long-term debt: Electric utility 153,389 154,279 Diversifed operations 27,657 35,694 --------- --------- Total capitalization 444,953 438,960 --------- --------- Current liabilities Short-term debt 824 2,100 Sinking fund requirements and current maturities 5,794 12,324 Accounts payable 32,411 28,427 Accrued salaries and wages 3,946 3,835 Federal and state income taxes accrued 2,192 2,572 Other taxes accrued 11,119 11,122 Interest accrued 3,120 3,339 Other 3,826 2,980 --------- --------- Total current liabilities 63,232 66,699 --------- --------- Noncurrent liabilities 22,842 17,805 --------- --------- Commitments (note 8) - - --------- --------- Deferred credits Accumulated deferred income taxes 90,964 97,583 Accumulated deferred investment tax credit 17,481 18,666 Regulatory liabilities 11,692 12,121 Other 4,448 3,607 --------- --------- Total deferred credits 124,585 131,977 --------- --------- Total $ 655,612 $ 655,441 ========= ========= See accompanying notes to consolidated financial statements.
Independent Auditors' Report To the Shareholders of Otter Tail Power Company: We have audited the accompanying consolidated balance sheets and statements of capitalization of Otter Tail Power Company and its subsidiaries (the Company) as of December 31, 1998, and 1997, and the related consolidated statements of income, changes in equity, and cash flows for each of the three years in the period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 1998, and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. As disclosed in note 2 to the consolidated financial statements, the Company changed its method of accounting for unbilled revenues in 1998. DELOITTE & TOUCHE LLP February 1, 1999 Minneapolis, Minnesota Otter Tail Power Company Consolidated Statements of Changes in Equity - ---------------------------------------------------------------------------------------------------------- Par Premium Accumulated Common value, on other shares common common Retained comprehensive Total outstanding shares shares earnings income equity ----------- ---------------------------------------------------- (in thousands, except common shares outstanding) Balance, December 31, 1995 11,180,136 $55,901 $30,335 $ 98,006 $ - $184,242 Effects of pooling transactions, January 1, 1996: Peoples Telephone 163,758 819 (798) 2,058 216 2,295 Chassis Liner 157,646 788 (588) 381 581 Common stock issuances 34,516 172 936 1,108 Comprehensive income: Net income 30,624 30,624 Unrealized gains on available- for-sale securities 403 403 ------- Total comprehensive income 31,027 Cumulative preferred dividends at required annual rates (2,358) (2,358) Common dividends (20,124) (20,124) Distributions by pooled entities (723) (723) ---------- ----------------------------------------------------- Balance, December 31, 1996 11,536,056 $57,680 $29,885 $107,864 $ 619 $196,048 Cash portion of Peoples pooling transaction, January 1, 1997 (209) (209) Common stock issuances 195,022 975 5,520 6,495 Comprehensive income: Net income 32,346 32,346 Unrealized gains on available -for-sale securities 103 103 Reversal of previously recorded unrealized gains on available-for-sale securities sold in 1997 (359) (359) ------- Total comprehensive income 32,090 Cumulative preferred dividends at required annual rates (2,358) (2,358) Common dividends (21,496) (21,496) Distributions by pooled entities (414) (414) ---------- ----------------------------------------------------- Balance, December 31, 1997 11,731,078 $58,655 $35,196 $115,942 $ 363 $210,156 Common stock issuances 148,426 743 4,723 5,466 Comprehensive income: Net income 34,520 34,520 Unrealized loss on available- for-sale securities (66) (66) ------- Total comprehensive income 34,454 Cumulative preferred dividends at (2,358) (2,358) required annual rates Common dividends (22,642) (22,642) ---------- ----------------------------------------------------- Balance, December 31, 1998 11,879,504 $59,398 $39,919 $125,462 $ 297 225,076 - ---------------------------------------------------------------------------------------------------------- See accompanying notes to consolidated financial statements.
Otter Tail Power Company Consolidated Statements of Cash Flows For the Years Ended December 31 1998 1997 1996 - ------------------------------------------------------------------------------------------------------ (in thousands) Cash flows from operating activities Net income $ 34,520 $ 32,346 $ 30,624 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 34,965 39,302 35,305 Deferred investment tax credit--net (1,186) (1,186) (1,186) Deferred income taxes (6,253) (3,155) (5,277) Change in deferred debits and other assets 99 1,204 3,679 Change in noncurrent liabilities and deferred credits 2,129 1,960 3,389 Allowance for equity (other) funds used during construction (103) - (325) Loss/(Gain) on investments in and disposal of noncurrent assets 607 (1,722) 555 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 and current liabilities: Change in receivables, materials, and supplies (5,765) (2,270) 396 Change in other current assets (2,962) 1,752 (922) Change in payables and other current liabilities 2,804 908 867 Change in interest and income taxes payable (599) 259 1,506 ------- ------- ------- Net cash provided by operating activities 63,959 69,398 68,611 ------- ------- ------- Cash flows from investing activities Gross capital expenditures (29,289) (41,973) (64,823) Proceeds from disposal of noncurrent assets 3,359 20,802 4,734 Proceeds from the sales of marketable securities - 785 - Purchase of subsidiaries, net of cash acquired (1,372) - (10,006) Change in temporary cash investments - - 2,208 Change in other investments (1,585) (470) (10,640) ------- ------- ------- Net cash used in investing activities (28,887) (20,856) (78,527) ------- ------- ------- Cash flows from financing activities Change in short-term debt--net issuances (1,276) (23,500) 25,600 Proceeds from issuance of long-term debt 1,559 178,272 118,083 Proceeds from issuance of common stock 5,466 6,286 1,719 Payments for debt and common stock issuance expense (82) (244) (22) Payments for retirement of long-term debt (17,121) (181,917) (111,957) Dividends paid (25,000) (24,268) (23,244) ------- ------- ------- Net cash (used in)/provided by financing activities (36,454) (45,371) 10,179 ------- ------- ------- Net change in cash and cash equivalents (1,382) 3,171 263 Cash and cash equivalents at beginning of year 5,301 2,130 1,867 ------- ------- ------- Cash and cash equivalents at end of year $ 3,919 $ 5,301 $ 2,130 ======== ======== ======== Supplemental disclosures of cash flow information Cash paid during the year for: Interest (net of amount capitalized) $ 15,189 $ 18,203 $ 16,650 Income taxes $ 22,966 $ 18,057 $ 18,832 See accompanying notes to consolidated financial statements.
Otter Tail Power Company Consolidated Statements of Capitalization, December 31 1998 1997 - ------------------------------------------------------------ ------------------------ (in thousands) Total common shareholders' equity $ 225,076 $ 210,156 --------- --------- Cumulative preferred shares -- without par value (stated and liquidating value $100 a share) -- authorized 1,500,000 shares; outstanding: Series subject to mandatory redemption: $6.35, 180,000 shares; 9,000 shares due 2002-06; 135,000 shares due 2007 18,000 18,000 --------- --------- Other series: $3.60, 60,000 shares 6,000 6,000 $4.40, 25,000 shares 2,500 2,500 $4.65, 30,000 shares 3,000 3,000 $6.75, 40,000 shares 4,000 4,000 $9.00, 53,311 shares 5,331 5,331 --------- --------- Total other preferred 20,831 20,831 --------- --------- Cumulative preference shares -- without par value, authorized 1,000,000 shares; outstanding: none Long-term debt First mortgage bond series: 7.25%, due August 1, 2002 18,800 19,000 8.75%, due September 15, 2021 18,600 18,800 8.25%, due August 1, 2022 28,200 28,500 Pollution control series: 6.30-6.80%, due February 1, 2006, Big Stone project 5,307 5,367 6.30-6.90%, due February 1, 2019, Coyote project 21,264 21,499 --------- --------- Total first mortgage bond series 92,171 93,166 Senior debentures 6.375%, due December 1, 2007 50,000 50,000 Long-term lease obligation (5.625% pollution control revenue bonds due July 1, 1998) - 2,200 Industrial development refunding revenue bonds 5.00% due December 1, 2002 3,010 3,010 Pollution control refunding revenue bonds variable 3.85% at December 31, 1998, due December 1, 2012 10,400 10,400 Obligations of Varistar Corporation: 7.80% ten-year term note 18,169 22,500 Various at 1.9% to 9% at December 31, 1998 4,112 10,775 Obligations of Midwest Information Systems, Inc. variable 6.7% to 7.27% at December 31, 1998 10,169 11,542 Other 6 6 --------- --------- Total 188,037 203,599 Less: Current maturity 4,799 11,329 Sinking fund requirement 995 995 Unamortized debt discount and premium -- net 1,197 1,302 --------- --------- Total long-term debt 181,046 189,973 --------- --------- Total capitalization $ 444,953 $ 438,960 ========= ========= See accompanying notes to consolidated financial statements.
Otter Tail Power Company Notes to consolidated financial statements For the three years ended December 31, 1998 1. Summary of accounting policies System of accounts--In 1997 the Company implemented an activity based costing system along with an entirely new account code structure that will enable it to capture costs to facilitate decision-making in a less regulated and more competitive electric industry. For regulatory reporting purposes, all new account code combinations can be translated into the accounts of the Uniform System of Accounts prescribed by the Federal Energy Regulatory Commission (FERC), the Public Service Commission of North Dakota, and the Public Utilities Commissions of Minnesota and South Dakota. Principles of consolidation--The consolidated financial statements include the accounts of the Company and all wholly owned subsidiaries. Profits on sales from the regulated electric utility company to nonregulated affiliates are eliminated. However, profits on sales to the regulated electric utility company from nonregulated affiliates are not eliminated, in accordance with the requirements of Statement of Financial Accounting Standards (SFAS) No. 71 - Accounting for the Effects of Certain Types of Regulation. Plant, retirements, and depreciation--Utility plant is stated at original cost. The cost of additions includes contracted work, direct labor and materials, allocable overheads, and allowance for funds used during construction. The cost of depreciable units of property retired plus removal costs less salvage is charged to the accumulated provision for depreciation. Maintenance, repairs, and replacement of minor items of property are charged to operating expenses. Repairs to property made necessary by storm damage are charged to the reserve therefor. The provisions for utility depreciation for financial reporting purposes are made on the straight-line method based on the estimated service lives of the properties. Such provisions as a percent of the average balance of depreciable electric utility property were 3.12 percent in 1998, 3.08 percent in 1997, and 3.00 percent in 1996. Property and equipment of nonutility and subsidiary operations are carried at historical cost, or at the current appraised value if acquired in a business combination accounted for under the purchase method of accounting, and are depreciated on a straight-line basis over the useful lives (3 to 40 years) of the related assets. Upon sale or retirement of property and equipment, the cost and related accumulated depreciation are eliminated from the respective accounts and the resulting gain or loss is included in the consolidated financial statements. Jointly owned plants--The consolidated financial statements include the Company's 53.9 percent and 35 percent ownership interests in the assets, liabilities and expenses of Big Stone Plant and Coyote Station, respectively. Amounts at December 31, 1998 and 1997 included in electric plant in service for Big Stone were $111,754,000 and $108,273,000, respectively, and the accumulated provision for depreciation and amortization was $63,635,000 and $61,650,000, respectively. Amounts at December 31, 1998 and 1997 included in electric plant in service for Coyote were $145,899,000 and $145,720,000, respectively, and the accumulated provision for depreciation and amortization was $63,463,000 and $61,820,000, respectively. The Company's share of direct expenses of the jointly owned plants in service is included in the corresponding operating expenses in the statement of income. Allowance for funds used during construction (AFC)--AFC, a noncash item, is included in construction work in progress. In 1998 and 1996 AFC was based on a composite rate that assumes funds used for construction were provided by borrowed funds and equity funds. In 1997 the average level of short-term borrowing exceeded the average level of construction work in progress; consequently, 1997 AFC was based entirely on the year's average short-term debt borrowing rate. The AFC included in construction work in progress will ultimately be included in the rate base used in establishing rates for utility services. The rate for AFC was 10.25 percent for 1998, 5.67 percent for 1997, and 8.50 percent for 1996. Recoverability of long-lived assets--The Company reviews its long- lived assets whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable. The Company determines potential impairment by comparing the carrying value of the assets with net cash flows expected to be provided by operating activities of the business or related assets. Should the sum of the expected future net cash flows be less than the carrying values, the Company would determine whether an impairment loss should be recognized. An impairment loss would be quantified by comparing the amount by which the carrying value exceeds the fair value of the asset where fair value is based on the discounted cash flows expected to be generated by the asset. Income taxes--Comprehensive interperiod income tax allocation is used for substantially all book and tax temporary differences. Deferred income taxes arise for all temporary differences between the book and tax basis of assets and liabilities. Deferred taxes are recorded using the tax rates scheduled by tax law to be in effect when the temporary differences reverse. The Company amortizes the investment tax credit over the estimated lives of the related property. Operating revenues--Electric customers' meters are read and bills are rendered on a cycle basis. 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 is consistent with the way the Company has been recording electric revenue from its North Dakota customers since 1993 under an order from the North Dakota Public Service Commission. See note 2 for the cumulative effect of recording Minnesota and South Dakota unbilled revenue as of January 1, 1998. The Company's rate schedules applicable to substantially all customers include a cost of energy adjustment clause under which the rates are adjusted to reflect changes in average cost of fuels and purchased power. Since July 1, 1995, rate schedules applicable to Minnesota customers also include a surcharge for recovery of conservation-related expenses: 2.75 percent as of July 1, 1998, 1.75 percent from July 1, 1997 through June 30, 1998, and 1.25 percent from July 1, 1996, through June 30, 1997, and .503 percent from July 1, 1995, through June 30, 1996. (See further discussion under note 5.) Health services' operating revenues on major equipment and installation contracts are recorded using the percentage-of- completion method. Amounts received in advance under customer service contracts are deferred and recognized on a straight-line basis over the contract period. Manufacturing operating revenues are recorded when products are shipped, when services are rendered, and on a percentage-of- completion basis for large items that are assembled over several months. Other business operations' operating revenues are recorded when services are rendered or products are shipped. In the case of construction contracts, the percentage-of-completion method is used. Storm damage provision--The Company is required under its Indenture of Mortgage to make annual provisions for storm damage of not less than 0.5 percent gross electric operating revenues. Provisions for loss have been used in determining rates approved by the applicable regulatory commissions. Provisions for 1998, 1997, and 1996 were $1,354,000, $1,423,000, and $1,247,000, respectively. Employee incentive plan--The Company has incentive plans covering employees that are based upon certain performance measures. Total amounts of accrued compensation for these incentive plans in 1998, 1997, and 1996 were $3,083,000, $3,826,000, and $2,810,000, respectively. Use of estimates--In recording transactions and balances resulting from business operations, the Company uses estimates based on the best information available. Estimates are used for such items as plant depreciable lives, tax provisions, uncollectible accounts, workers' compensation claims, injuries and damages reserve, unbilled revenues, service contract maintenance costs and actuarially determined benefit costs. As better information becomes available (or actual amounts are determinable) the recorded estimates are revised. Consequently, operating results can be affected by revisions to prior accounting estimates. Reclassifications--Certain prior year amounts have been reclassified to conform to 1998 presentation. Such reclassification had no impact on net income and shareholders' equity. Cash equivalents--The Company considers all highly liquid debt instruments purchased with a maturity of 90 days or less to be cash equivalents. Debt reacquisition premiums--In accordance with regulatory treatment, the Company defers utility debt redemption premiums and amortizes such costs over the original life of the reacquired bonds. The unamortized balance was $2,490,000 on December 31, 1998. Investments--At December 31, 1998 and 1997, the Company had noncurrent investments of $7,540,000 and $6,761,000, respectively, in limited partnerships that invest in tax-credit qualifying affordable housing projects. These investments, accounted for under the equity method, provided the Company with tax credits of $1,330,000 and $1,057,000, in 1998 and 1997, respectively. At December 31, 1998 and 1997, the Company had $590,000 and $703,000 respectively, invested in marketable equity securities classified as available-for-sale and recorded at market value. The balance of investments at December 31, 1998 consists of $1,911,000 in additional investments accounted for under the equity method, and $10,571,000 in financial instruments, with $1,515,000 related to participation in economic development loan pools. The balance of investments at December 31, 1997 consists of $2,071,000 in additional investments accounted for under the equity method, and $10,513,000 in financial instruments, with $2,070,000 related to participation in economic development loan pools. (See further discussion under note 12.) Inventories--The electric operation inventories are reported at average cost. The health service, manufacturing, and other business operation inventories are stated at the lower of cost (first-in, first-out) or market. Short-term debt--The composite interest rate on short-term debt outstanding as of December 31, 1998 and 1997, was 8.75 percent and 6.15 percent, respectively. The average interest rate paid on short- term debt during 1998 and 1997 was 6.65 percent and 5.67 percent, respectively. Intangible assets--The majority of the Company's intangible assets consist of goodwill associated with the acquisition of subsidiaries. Intangible assets are amortized on a straight-line basis over periods of 40 years for the telephone company and 15 years or less for all other intangibles. The Company periodically evaluates the recovery of intangible assets based on an analysis of undiscounted future cash flows. Total intangibles as of December 31 are as follows: 1998 1997 --------- --------- (in thousands) Goodwill on telephone company $ 7,749 $ 7,749 Other intangible assets 21,808 20,594 --------- --------- Total 29,557 28,343 Less accumulated amortization 8,381 7,432 --------- --------- Intangibles-net $21,176 $20,911 Adoption of new accounting pronouncements--In 1998 the Company adopted Statement of Financial Accounting Standards (SFAS) 131 - Disclosures about Segments of an Enterprise and Related Information. SFAS 131 supersedes SFAS 14, Financial Reporting for Segments of a Business Enterprise, replacing the "industry segment" approach with the "management" approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company's reportable segments. SFAS 131 also requires disclosures about products and services, geographic areas, and major customers. The adoption of SFAS 131 did not change the Company's reportable segments or affect results of operations or financial position. In February 1998 the Financial Accounting Standards Board (FASB) issued SFAS 132 -- Employers' Disclosures about Pensions and Other Postretirement Benefits, which was effective for the Company on January 1, 1998. SFAS 132 revises employers' disclosures about pension and other postretirement benefit plans. The adoption of SFAS 132 did not affect the Company's 1998 results of operations or financial position. Note 10 reflects the adoption of SFAS 132. In 1997 the Company adopted SFAS 128 - Earnings Per Share. SFAS 128 requires certain public companies to present both basic and diluted earnings per share (EPS) on the face of their income statements. Diluted EPS reflects the dilution that could occur if securities or other contracts to issue common stock (options, warrants, convertible debt or preferred stock, contingent share arrangements, etc.) were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Other than the Company's outstanding $9.00 exchangeable cumulative preferred shares, which are not redeemable or exchangeable until after August 9, 1999, the Company has no financial instruments outstanding similar to those mentioned above. Additionally, if the outstanding $9.00 preferred shares were exchanged for shares of the Company's common stock, the effect on the Company's 1998 EPS would be antidilutive. Therefore, the Company's basic and diluted EPS are the same and are effectively disclosed on the face of the Company's 1998, 1997, and 1996 consolidated statements of income included in this report. In June 1997 the FASB issued SFAS 130 - Reporting Comprehensive Income, which was adopted by the Company in 1997. SFAS 130 establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general purpose financial statements and requires that all items required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. The Consolidated Statements of Changes in Equity reflects the adoption of SFAS 130. New accounting pronouncement--In June 1998 the FASB issued Statement of Financial Accounting Standards (SFAS) 133 -- Accounting for Derivative Instruments and Hedging Activities, effective for financial statements issued for periods beginning after June 15, 1999. SFAS 133 establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires that all derivatives be recognized as either assets or liabilities and that those financial instruments be measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative. The adoption of this statement is not expected to have a material impact on the Company's financial position as presently reported. 2. Change in accounting principle Effective January 1, 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 is consistent with the way the Company has been recording electric revenue from its North Dakota customers since 1993 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. The effect on 1998 income of this accounting change, not including the cumulative effect, was an increase in net income of approximately $193,000 or $0.02 per share. If the Company had been recording Minnesota and South Dakota unbilled revenue in previous accounting periods, its reported electric revenue for 1997 and 1996 would have been $203,778,000 and $200,640,000, respectively, and its reported net income would have been $31,540,000 or $2.51 per share and $31,401,000 or $2.52 per share, for 1997 and 1996, respectively. 3. Special charges In January 1998 the Company announced a voluntary early retirement program for all nonunion electric utility employees age 55 and over. The offer of early retirement was accepted by 55 of 67 eligible utility employees during the enrollment period that ended March 23, 1998. Most of the cash costs of the program 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) in 1998 for special termination benefits and the recognition of previously unrecognized prior service costs related to pension and postretirement benefits. The electric utility will experience a reduction in payroll costs as a result of the voluntary early retirement program. In March 1998 the Company recorded a noncash accounting charge related to the impairment of its Quadrant Co. (Quadrant) waste incineration plant. Quadrant operates a municipal waste burning facility located in Perham, Minnesota. The facility processed solid waste for three Minnesota counties. Quadrant is included in the other business operations segment. Due to developments which may have required additional capital investment in the plant to be in compliance with current air-pollution rules, reductions in waste flows and related revenue, and increased costs associated with repairs and maintenance due to the age of the facility, it was determined that future cash flows from this facility were less than the carrying value of the assets requiring the recognition of an impairment loss. The impaired assets include buildings, machinery, and equipment used to burn waste. The revised carrying value of this group of assets was determined to be zero, which was calculated on the basis of discounted estimated future cash flows. The pre-tax noncash charge of $2,500,000 ($1,500,000 net-of-tax or $0.13 per share) pertaining to the write down includes $248,000 for selling or disposal costs. 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 year ended December 31, 1998. In the fourth quarter of 1998 an additional provision of $250,000 was recorded under other nonelectric expenses for plant disposition costs. 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 capitalized project related costs. 4. Business combinations and segment information Effective November 1998 Mid-States Development, Inc., a subsidiary of the Company since 1989, changed its name to Varistar Corporation (Varistar). On January 1, 1999 the Company's telecommunications subsidiary, North Central Utilities, Inc. (NCU) merged with Varistar. Subsidiaries previously owned by NCU became wholly owned subsidiaries of Varistar. 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. The PAM acquisition was accounted for as a purchase. The pro forma effect of the PAM acquisition on 1998 and 1997 revenue, net income, or earnings per share was not significant. On January 2, 1997, the Company acquired all of the outstanding common stock of The Peoples Telephone Co. of Bigfork (Peoples), a telephone company with 1,903 access lines serving five communities in Northern Minnesota, in exchange for 163,758 newly issued shares of the Company's common stock and $209,000 in cash. On June 30, 1997, the Company's subsidiary, Varistar acquired all of the outstanding common stock of Chassis Liner Corporation (Chassis Liner), a manufacturer of auto and truck frame-straightening equipment with facilities in Alexandria and Lucan, Minnesota, in exchange for 157,646 newly issued shares of the Company's common stock. These acquisitions have been accounted for under the pooling of interests method of accounting. There were no transactions between the Company, Peoples, and Chassis Liner prior to the acquisitions. Costs incurred to effect these mergers were not significant. The Company's 1996 consolidated financial statements were restated to include both Peoples and Chassis Liner. In 1996 Varistar purchased a Montana-based supplier of X-ray supplies and accessories in February, a mobile medical diagnostic services company located in Minnesota in April, and four radio stations located in the Fargo, North Dakota/ Moorhead, Minnesota, market area: two in June, one in October, and one in December. NCU acquired two small cable TV systems in 1996. In the 1996 acquisitions, the purchase method of accounting was used and the acquisitions would have had no significant pro forma effect on the Company's operating revenues, net income, or earnings per share for 1996. The total price for the businesses acquired was $11,060,000 in 1996. Segment information--The accounting policies of the segments are the same as those described in the note 1 -- Summary of accounting policies. 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 includes the electric utility only. 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. Manufacturing operations includes production of agricultural equipment, plastic pipe, automobile and truck frame-straightening equipment and accessories, and fabricated metal parts. Other business operations consists of businesses diversified in such areas as electrical and telephone construction contracting, entertainment, waste incinerating, and telecommunications. The Company evaluates the performance of its business segments and allocates resources to them based on earnings contribution and return on investment. Information for the business segments for 1998, 1997 and 1996 is presented in the table below. 1998 1997 1996 -------- -------- -------- (in thousands) Operating revenue Electric $227,477 $205,121 $199,345 Manufacturing 86,030 81,543 64,568 Health services 68,728 66,185 61,697 Other business operations 48,843 41,430 45,323 -------- -------- -------- Total $431,078 $394,279 $370,933 Operating income Electric $ 42,216 $ 44,966 $ 45,279 Manufacturing 8,661 7,945 6,504 Health services 6,510 4,295 5,137 Other business operations (157) 1,827 2,452 -------- -------- -------- Total $ 57,230 $ 59,033 $ 59,372 Depreciation and amortization Electric $ 22,128 $ 21,442 $ 19,880 Manufacturing 510 542 594 Health services 541 638 585 Other business operations 2,634 2,914 2,328 -------- -------- -------- Total $ 25,813 $ 25,536 $ 23,387 Capital expenditures Electric $ 17,939 $ 26,603 $ 38,224 Manufacturing 5,536 6,264 4,787 Health services 3,101 3,800 16,230 Other business operations 2,713 5,306 5,582 -------- -------- -------- Total $ 29,289 $ 41,973 $ 64,823 Identifiable assets Electric $525,226 $526,679 $523,509 Manufacturing 41,579 40,814 34,354 Health services 36,241 35,738 65,140 Other business operations 52,566 52,210 46,701 -------- -------- -------- Total $655,612 $655,441 $669,704 No single external customer accounts for 10 percent or more of the Company's revenues. Substantially all sales and long-lived assets of the Company are within the United States. 5. Rate matters On July 1, 1995, the Company began charging all Minnesota customers a .5030 percent surcharge on their electric service statements for recovery of conservation-related costs exceeding the amount already included in base rates. On July 1, 1996, the rate was increased to 1.25 percent, on July 1, 1997, the rate was increased to 1.75 percent and on July 1, 1998 the rate was increased to 2.75 percent. The conservation-related costs being recovered through the surcharge and in base rates include Conservation Improvement Program (CIP) expenditures, carrying charges 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 MPUC approved recovery of 1997, 1996, and 1995 lost margins and bonus incentives in 1998, 1997, and 1996, respectively. The Company recorded revenues related to 1998, 1997, and 1996 lost margins and bonus incentives of $1,750,000, $1,931,000, and $1,266,000, respectively. As these costs are recovered through the monthly billing process, the amounts billed are offset by the amortization of deferred CIP charges. During 1998 the Minnesota Department of Public Service (MDPS) recommended to the Minnesota Public Utilities Commission (MPUC) that demand-side management incentives for all Minnesota electric utilities be terminated as of January 1, 1998. At a hearing held November 19, 1998, the MPUC did not accept the MDPS recommendation, however, the MPUC put electric and gas utilities on notice that the ability to earn demand-side management incentives could end as early as January 1, 1999. A MPUC Chair's Round Table has been convened to examine demand-side management programs and related incentives. A report from the Round Table is due to the MPUC by May 1, 1999. 6. Common shares New issuances--On August 30, 1996, the Company filed a shelf registration statement with the Securities and Exchange Commission for the issuance of up to 1,000,000 common shares pursuant to the Company's Automatic Dividend Reinvestment and Share Purchase Plan (the Plan), which will permit shares purchased by shareholders, employees, or customers who participate in the Plan to be either new issue common shares or common shares purchased on the open market. In December 1996 the Company began issuing newly issued common shares under the Plan: 148,426 shares were issued in 1998, 161,831 shares were issued in 1997 and 34,516 shares were issued in 1996. In 1999 the Company plans to purchase shares on the open market for the Plan. Additional common stock issuances in 1997 included 321,404 unregistered shares to effect the pooling acquisitions, 30,561 shares to the Company's leveraged employee stock ownership plan and 2,630 shares issued as a bonus to a consultant. Shareholder rights plan--On January 27, 1997, the Company's Board of Directors declared a dividend of one preferred share purchase right (Right) for each outstanding common share held of record as of February 10, 1997. One Right was also issued with respect to each common share issued after February 10, 1997. Each Right entitles the holder to purchase from the Company one one-hundredth of a share of newly created Series A Junior Participating Preferred Stock at a price of $70, subject to certain adjustment. The Rights are exercisable when, and are not transferable apart from the Company's common shares until, a person or group has acquired 15 percent or more, or commenced a tender or exchange offer for 15 percent or more, of the Company's common shares. If the specified percentage of the Company's common shares is acquired, each Right will entitle the holder (other than the acquiring person or group) to receive, upon exercise, common shares of either the Company or the acquiring company having value equal to two times the exercise price of the Right. The Rights are redeemable by the Company's Board of Directors in certain circumstances and expire on January 27, 2007. 7. Retained earnings restriction The Company's Indenture of Mortgage and Articles of Incorporation, as amended, contain provisions that limit the amount of dividends that may be paid to common shareholders. Under the most restrictive of these provisions, retained earnings at December 31, 1998, were restricted by $10,008,000. 8. Commitments At December 31, 1998, the Company had commitments under contracts in connection with construction programs aggregating approximately $2,973,000. For capacity requirements the Company has agreements extending through April 2005, at annual costs of approximately $5,340,000 in 1999, $2,300,000 in each year of 2000 through 2004, and $760,000 in 2005. The Company also has several long-term coal contracts in which it is responsible for making payment only upon the delivery of the coal. The risk of loss from nonperformance of the contracts is considered nominal because of the availability of other suppliers and the expected continued reliability of the current fuel suppliers. Furthermore, the cost of energy adjustment provision in the rate- making process lessens the risk of loss (in the form of increased costs) from market price changes because it assures recovery of almost all fuel costs. In 1996 the Big Stone Plant joint owners entered into operating leases for 250 new aluminum coal cars for transporting coal to Big Stone Plant. The terms of the leases are 15 years. The new cars began transporting coal in October 1996. In November 1997 Varistar's medical imaging services subsidiary entered into a sale/leaseback transaction whereby $16,000,000 of diagnostic medical equipment was sold and leased back under two operating leases with terms of three and four years. The amounts of future operating lease payments are as follows: Electric Subsidiary utility companies Total -------- ---------- -------- (in thousands) 1999 $939 $10,315 $11,254 2000 939 9,771 10,710 2001 939 8,008 8,947 2002 939 4,079 5,018 2003 939 919 1,858 Later years 3,912 557 4,469 Rent expense was $13,016,000, $6,714,000, and $6,288,000 for 1998, 1997, and 1996, respectively. 9. Long-term obligations Preferred shares--The $6.35 cumulative preferred shares are redeemable in whole or in part at the option of the Company after December 1, 1998, at $102.540, declining linearly to $100.00 at December 31, 2002. The $9.00 exchangeable cumulative preferred shares are redeemable in whole or in part at the option of the Company after August 9, 1999, for $100.00 per share payable in cash or, at the holder's election, common shares. Subject to certain conditions, such shares are exchangeable at the option of the holder after August 9, 1999, for $100.00 per share in cash or common shares. Long-term debt--All utility property, with certain minor exceptions, is subject to the lien of the Indenture of Mortgage of the Company securing its First Mortgage Bonds. The Company is required by the Indenture to make annual payments (exclusive of redemption premiums) for sinking fund purposes, except that the requirement with respect to certain series may be satisfied by the delivery of bonds of such series of equal principal amount. The Company issued First Mortgage Bonds of its pollution control series to secure payment of a like principal amount of revenue bonds that were issued by local governmental units to finance facilities leased or purchased and that the Company has capitalized. Varistar's ten-year term note and credit line borrowings are secured by a pledge of all of the common stock of the companies owned by Varistar. The aggregate amounts of maturities and sinking fund requirements on bonds outstanding and other long- term obligations at December 31, 1998, for each of the next five years are $5,794,000 for 1999, $5,618,000 for 2000, $5,189,000 for 2001, $26,026,000 for 2002, and $4,304,000 for 2003. 10. Pension plan and other postretirement benefits The utility company's noncontributory funded pension plan covers substantially all electric utility employees. The plan provides 100 percent vesting after 5 vesting years of service and for retirement compensation at age 65, with reduced compensation in cases of retirement prior to age 62. The utility company reserves the right to discontinue the plan, but no change or discontinuance may affect the pensions theretofore vested. The utility company's policy is to fund pension costs accrued. All past service costs have been provided for. The total pension cost was $3,670,000 for 1998, $1,104,000 for 1997, and $1,292,000 for 1996. The pension plan has a trustee who is responsible for pension payments to retirees. Five investment managers are responsible for managing the plan's assets. In addition, an independent actuary performs the necessary actuarial valuations for the plan. Net periodic pension cost for 1998, 1997, and 1996 includes the following components: 1998 1997 1996 ------- ------- ------- (in thousands) Service cost--benefit earned during the period $ 2,319 $ 2,385 $ 2,273 Interest cost on projected benefit obligation 7,823 7,131 6,754 Expected return on assets (10,988) (9,036) (8,443) Amortization of transition asset (235) (235) (235) Amortization of prior-service cost 1,069 980 943 Amortization of net gain (344) (121) -- ------- ------- ------- Net periodic pension cost $ (356) $ 1,104 $ 1,292 1998 early retirement and curtailment 4,026 -- -- ------- ------- ------- Total expense $ 3,670 $ 1,104 $ 1,292 ======= ======= ======= The plan assets consist of common stock and bonds of public companies, U.S. Government Securities, cash, and cash equivalents. The following tables provide a reconciliation of the changes in the plan's benefit obligations and fair value of assets over the two-year period ending December 31, 1998 and a statement of the funded status as of December 31 of both years: 1998 1997 -------- -------- (in thousands) Reconciliation of benefit obligation: Obligation at January 1 $107,357 $100,664 Service cost 2,319 2,385 Interest cost 7,823 7,131 Plan amendments -- 1,658 Actuarial loss 13,924 807 Benefit payments (6,813) (5,288) 1998 early retirement and curtailment 3,895 -- -------- -------- Obligation at December 31 $128,505 $107,357 ======== ======== Reconciliation of fair value of plan assets: Fair value of plan assets at January 1 $137,560 $121,506 Actual return on plan assets 19,054 21,119 Pension purchase options rollovers 225 223 Benefit payments (6,813) (5,288) -------- -------- Fair value of plan assets at December 31 $150,026 $137,560 ======== ======== Funded status: Funded status at December 31 $ 21,521 $ 30,203 Unrecognized transition asset (780) (1,015) Unrecognized prior-service cost 9,393 10,594 Unrecognized net actuarial gain (31,174) (37,152) -------- -------- Net amount recognized $ (1,040) $ 2,630 ======== ======== The following table provides the amounts recognized in the statement of financial position as of December 31 of both years: 1998 1997 -------- -------- (in thousands) Prepaid benefit cost $ -- $ 2,630 Accrued benefit liability 1,040 -- -------- -------- Net amount recognized $ (1,040) $ 2,630 ======== ======== The assumptions used for actuarial valuations were: 1998 1997 -------- -------- Discount rate 6.50% 7.25% Rate of increase in future compensation level 4.25% 4.25% Long-term rate of return on assets 9.50% 8.50% In addition to providing pension benefits to all electric utility employees, the Company has an unfunded, nonqualified benefit plan for executive officers and certain key management employees. This plan provides defined benefit payments to these employees upon their retirements or to their beneficiaries upon their deaths for a 15-year period. Life insurance carried on the plan participants is payable to the Company upon the employee's death. There are no plan assets in this nonqualified benefit plan due to the nature of the plan. The net periodic pension cost of this program in 1998, 1997, and 1996 was $562,000, $482,000, and $485,000, respectively. Net periodic pension cost for 1998, 1997, and 1996 includes the following components: 1998 1997 1996 -------- ------- ------- (in thousands) Service cost--benefit earned during the period $ (88) $ (140) $ (132) Interest cost on projected benefit obligation 521 475 467 Amortization of transition obligation 18 20 20 Amortization of prior service cost 111 127 130 ------- ------ ----- Net periodic pension cost $ 562 $ 482 $ 485 1998 early retirement and curtailment 1,413 -- -- ------- ------ ----- Total expense $ 1,975 $ 482 $ 485 ======= ====== ===== The following tables provide a reconciliation of the changes in the plan's benefit obligations over the two-year period ending December 31, 1998 and a statement of the funded status as of December 31 of both years: 1998 1997 -------- -------- (in thousands) Reconciliation of benefit obligation: Obligation at January 1 $ 6,964 $ 6,636 Service cost (88) (140) Interest cost 521 475 Actuarial loss 807 128 Benefit payments (273) (135) 1998 early retirement and curtailment 1,140 -- ------- ------- Obligation at December 31 $ 9,071 $ 6,964 ======= ======= Funded status: Funded status at December 31 $ (9,071) $ (6,964) Unrecognized transition obligation 34 62 Unrecognized prior-service cost 1,273 1,647 Unrecognized net actuarial loss 1,422 615 ------- ------- Net amount recognized $ (6,342) $ (4,640) ========= ========= The following table provides the amounts recognized in the statement of financial position as of December 31 of both years: 1998 1997 -------- -------- (in thousands) Accrued benefit liability $ (7,649) $ (5,355) Intangible asset 1,307 715 ------- ------- Net amount recognized $ (6,342) $ (4,640) ========= ========= The assumptions used for actuarial valuations were: 1998 1997 ------ ------ Discount rate 6.50% 7.25% Rate of increase in future compensation level 5.00% 5.00% In addition to providing pension benefits, the electric utility provides a portion of health insurance benefits for retired electric utility employees. Substantially all of the Company's electric utility employees may become eligible for health insurance benefits if they reach age 55 and have 10 years of service. Upon adoption of SFAS 106 - Employers' Accounting for Postretirement Benefits Other Than Pensions - in January 1993, the Company elected to recognize its transition obligation related to postretirement benefits earned of approximately $14,964,000 over a period of 20 years. There are no plan assets. The net postretirement benefit cost for 1998, 1997, and 1996 includes the following components: 1998 1997 1996 -------- -------- -------- (in thousands) Service cost - benefit earned during the period $ 563 $ 578 $ 484 Interest cost on accumulated postretirement benefit obligation 1,281 1,159 1,132 Amortization of transition obligation 748 748 748 Amortization of net gain (209) (251) (210) Life insurance curtailment gain -- -- (749) ------ ------ ------ Net periodic postretirement benefit cost $2,383 $2,234 $1,405 1998 early retirement and curtailment 954 -- -- ------ ------ ------ Total expense $3,337 $2,234 $1,405 ====== ====== ====== The following tables provide a reconciliation of the changes in the plan's benefit obligations over the two-year period ending December 31, 1998 and a statement of the funded status as of December 31 of both years: 1998 1997 -------- -------- (in thousands) Reconciliation of benefit obligation: Obligation at January 1 $ 17,707 $ 16,323 Service cost 563 578 Interest cost 1,281 1,159 Actuarial loss 4,726 337 Benefit payments (1,412) (1,057) Participant premium payments 492 367 1998 early retirement and curtailment 271 -- -------- -------- Obligation at December 31 $ 23,628 $ 17,707 ======== ======== Funded status: Funded status at December 31 $ (23,628) $ (17,707) Unrecognized transition obligation 10,474 11,223 Unrecognized loss (gain) 802 (3,449) --------- --------- Net amount recognized $ (12,352) $ (9,933) ========= ========= The following table provides the amounts recognized in the statement of financial position as of December 31 of both years: 1998 1997 -------- -------- (in thousands) Accrued benefit liability $(12,352) $ (9,933) The assumed health-care cost-trend rate used in measuring the accumulated postretirement benefit obligation as of December 31, 1998, was 7.5 percent for 1999, decreasing linearly each successive year until it reaches 5.0 percent in 2003, after which it remains constant. The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation as of December 31, 1997, was 8.0 percent for 1998, decreasing linearly each successive year until it reaches 5.0 percent in 2003, after which it remains constant. The assumed discount rate used in determining the accumulated postretirement benefit obligation as of December 31, 1998 and 1997, was 6.50 percent and 7.25 percent, respectively. Assumed health-care cost-trend rates have a significant effect on the amounts reported for health care plans. A one-percentage-point change in assumed health-care cost-trend rates for 1998 would have the following effects: 1 percent 1 percent increase decrease --------- --------- Effect on total of service and interest (in thousands) cost components $ 304 $ (261) Effect on the postretirement benefit obligation $ 2,525 $ (2,281) The Company has a leveraged employee stock ownership plan (ESOP) for the benefit of all its electric utility employees. Contributions made by the Company were $1,078,000 for 1998, $1,055,000 for 1997, and $1,010,000 for 1996. 11. Compensating balances and short-term borrowings The Company maintains formal bank lines of credit for its electric utility operations separate from lines and letters of credit maintained by the subsidiary companies. They make available to the Company bank loans for short-term financing and provide backup financing for commercial paper notes. At December 31, 1998, the Company maintained no compensating balances to support formal bank lines of credit. The Company's bank lines of credit for electric utility operations totaled $18,000,000, none of which was used at December 31, 1998. The subsidiary companies' bank lines and letters of credit, which require no compensating balances, totaled $18,263,000 of which $824,000 was used at December 31, 1998. 12. Fair value of financial instruments The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: Cash and short-term investments--The carrying amount approximates fair value because of the short-term maturity of those instruments. Other investments--The carrying amount approximates fair value. A portion of other investments is in financial instruments that have variable interest rates that reflect fair value. The remainder of other investments is accounted for by the equity method which, in the case of operating losses, results in a reduction of the carrying amount. Redeemable preferred stock--The fair value is estimated based on the current rates available to the Company for the issuance of redeemable preferred stock. Long-term debt--The fair value of the Company's long-term debt is estimated based on the current rates available to the Company for the issuance of debt. About $20 million of the Company's long-term debt, which is subject to variable interest rates, approximates fair value. 1998 1997 --------------------- --------------------- (in thousands) Carrying Fair Carrying Fair amount value amount value --------- --------- --------- --------- Cash and short-term investments $ 3,919 $ 3,919 $ 5,301 $ 5,301 Other investments 20,612 20,612 20,048 20,048 Redeemable preferred stock (18,000) (19,252) (18,000) (19,619) Long-term debt (181,046) (203,789) (189,973) (207,063) The Company's marketable securities are included in investments on the balance sheet and are classified as available for sale. These securities are recorded at fair value with any unrealized gain or loss included in accumulated other comprehensive income in the equity section of the balance sheet net of deferred income taxes of $210,000 at year-end 1998 and $257,000 at year-end 1997. Realized gains and losses are computed on each specific investment sold. The amounts recognized on the balance sheet as of December 31, 1998 and 1997, and amounts sold for each year are as follows: 1998 1997 -------- -------- Available for sale - securities (in thousands) Cost $ 83 $ 83 Gross unrealized gain 507 620 ------- ------- Fair value $ 590 $ 703 ======= ======= Proceeds from sale $ -- $ 785 Gross realized gains -- 707 13. Property, plant, and equipment 1998 1997 -------- -------- (December 31, in thousands) Electric plant: Production 309,109 $305,147 Transmission 143,822 141,956 Distribution 234,671 227,463 General 83,285 83,985 -------- -------- Electric plant 770,887 758,551 Less accumulated depreciation and amortization 332,315 315,011 ------- -------- Electric plant net of accumulated depreciation 438,572 443,540 Construction work in progress 10,495 12,146 -------- -------- Net electric plant $449,067 $455,686 -------- -------- Diversified operations plant $ 89,094 $ 89,716 Less accumulated depreciation and amortization 37,975 35,636 -------- -------- Net diversified operations plant $ 51,119 $ 54,080 -------- -------- Net plant $500,186 $509,766 ======== ======== 14. Income taxes The total income tax expense differs from the amount computed by applying the federal income tax rate (35 percent in 1998, 1997 and 1996) to net income before total income tax expense for the following reasons: 1998 1997 1996 -------- -------- -------- (in thousands) Tax computed at federal statutory rate $18,272 $16,329 $15,378 Increases (decreases) in tax from: State income taxes net of federal income tax benefit 2,665 2,224 1,835 Investment tax credit amortization (1,186) (1,186) (1,186) Depreciation differences--flow-through method reversal 1,133 408 (138) Differences reversing in excess of federal rates (1,639) (994) (1,030) Dividend received/paid deduction (643) (620) (604) Affordable housing tax credits (1,330) (1,057) (593) Permanent and other differences 413 (796) 348 ------- ------- ------- Total income tax expense $17,685 $14,308 $14,010 ======= ======= ======= Overall effective federal and state income tax rate 33.9% 30.7% 31.4% Income tax expense includes the following: Charges (credits) related to operations: Current federal income taxes $20,198 $17,123 $18,014 Current state income taxes 4,182 3,300 3,608 Deferred federal income taxes (4,085) (3,410) (4,657) Deferred state income taxes (206) (205) (480) Investment tax credit amortization (1,186) (1,186) (1,186) ------- ------- ------- Total $18,903 $15,622 $15,299 ------- ------- ------- Charges (credits) related to other income and deductions: Current federal income taxes (280) (645) (430) Affordable housing tax credits (1,330) (1,057) (593) Current state income taxes (9) 19 (103) Deferred federal and state income taxes 401 369 (163) ------- ------- ------- Total income tax expense $17,685 $14,308 $14,010 ======= ======= ======= The Company's deferred tax assets and liabilities were composed of the following on December 31, 1998 and 1997: 1998 1997 ------- ------- (in thousands) Deferred tax assets Amortization of tax credits $ 11,497 $ 12,258 Vacation accrual 1,202 1,121 Unearned revenue 1,844 4,105 Operating reserves 10,026 7,890 Differences related to property 2,209 936 Transfer to regulatory asset 124 (61) Other 991 811 --------- --------- Total deferred tax assets $ 27,893 $ 27,060 Deferred tax liabilities Differences related to property (108,968) (111,300) Excess tax over book - pensions -- (1,043) Transfer to regulatory asset (3,744) (4,999) Transfer to regulatory liability -- (188) Other (3,415) (2,375) --------- --------- Total deferred tax liabilities $(116,127) $(119,905) --------- --------- Deferred income taxes $ (88,234) $ (92,845) ========= ========= 15. Quarterly information (unaudited) The quarterly data shown below reflects seasonal and timing variations that are common in the utility industry. Three Months Ended March 31 June 30 September 30 December 31 -------------- --------------- --------------- --------------- 1998 1997 1998 1997 1998 1997 1998 1997 ------ ------ ------ ------ ------ ------ ------ ------ (in thousands except per share data) Operating revenues $96,909 $94,289 $106,946 $91,096 $112,171 $101,858 $115,052 $107,036 Operating income $ 5,558 $19,741 $ 14,685 $ 9,798 $ 17,856 $ 13,753 $ 19,131 $ 15,742 Income before cumulative effect of change in accounting principle $ 1,939 -- -- -- -- -- -- -- Cumulative effect of change in accounting principle -- net-of-tax $ 3,819 -- -- -- -- -- -- -- ------- Net income $ 5,758 $10,690 $ 8,015 $ 5,393 $ 9,877 $ 7,785 $ 10,870 $ 8,478 Earnings available for common shares $ 5,168 $10,101 $ 7,426 $ 4,803 $ 9,287 $ 7,195 $ 10,281 $ 7,889 Basic and diluted earnings per share Before cumulative effect of change in accounting principle $ .12 -- -- -- -- -- -- -- Cumulative effect of change in accounting principle $ .32 -- -- -- -- -- -- -- ------ Basic and diluted earnings per share $ .44 $ .87 $ .63 $ .41 $ .79 $ .62 $ .87 $ .67 Dividends paid per common share $ .48 $ .465 $ .48 $ .465 $ .48 $ .465 $ .48 $ .465 Price range: High $38 3/4 $34 3/4 $37 3/4 $34 1/4 $40 3/4 $34 1/2 $42 3/4 $38 3/8 Low $36 $31 1/2 $30 1/8 $30 $35 $31 1/2 $37 $32 1/8 Average number of common shares outstanding 11,740 11,569 11,777 11,621 11,818 11,661 11,855 11,704
In the first quarter of 1998 the Company changed its method of electric revenue recognition in the states of 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) in unbilled revenue. The first quarter of 1998 also reflects the recording of special charges related to the voluntary early retirement program, Quadrant Co. asset impairment and the write-off of the Big Stone plant rail spur project. - ----------------------------------------------------------------------------- Stock listing - ------------- Otter Tail common stock is traded on The Nasdaq Stock Market. (Nasdaq: National Association of Securities Dealers Automated Quotation.) EX-18 6 Exhibit 18 REPORT OF INDEPENDENT ACCOUNTANTS - ACCOUNTING CHANGE Otter Tail Power Company We have audited the consolidated balance sheets of Otter Tail Power Company and its subsidiaries (the Company) as of December 31, 1998 and 1997, and the related consolidated statements of income, retained earnings, and cash flows for each of the three years in the period ended December 31, 1998, included in your Annual Report on Form 10-K to the Securities and Exchange Commission and have issued our report thereon dated February 1, 1999. Note 2 to such consolidated financial statements contains a description of the Company's change in its method of accounting for unbilled revenues in the States of Minnesota and South Dakota during 1998. In our judgement, such change is to an alternative accounting principle that is preferable under the circumstances. Deloitte & Touche LLP Minneapolis, Minnesota February 1, 1999 EX-21 7 Exhibit 21-A OTTER TAIL POWER COMPANY Subsidiaries of the Registrant March 1, 1999 Company State of Organization Minnesota-Dakota Generating Company Minnesota Otter Tail Realty Company Minnesota Otter Tail Management Corporation* Minnesota ORD Corporation* Minnesota Quadrant Co. Minnesota Midwest Information Systems, Inc. Minnesota Midwest Telephone Co. Minnesota Osakis Telephone Company Minnesota Peoples Telephone Company of Bigfork Minnesota Data Video Systems, Inc. Minnesota Otter Tail Communications SD, Inc. South Dakota MIS Investments, Inc. Minnesota Varistar Corporation Minnesota Glendale Machining, Inc. Minnesota Precision Machine of North Dakota, Inc. North Dakota Dakota Machine, Inc. North Dakota Dakota Engineering, Inc. North Dakota Aerial Contractors, Inc. North Dakota Moorhead Electric, Inc. Minnesota KFGO, Inc. North Dakota Western Minnesota Broadcasting Company Minnesota Diagnostic Medical Systems, Inc. North Dakota DMS Imaging, Inc. North Dakota DMS Leasing Corporation North Dakota BTD Manufacturing, Inc. Minnesota Northern Pipe Products, Inc. North Dakota Northern Micro, Inc. North Dakota Fargo Baseball, LLC Minnesota Fargo Sports Concession LLC Minnesota Chassis Liner Corporation Minnesota Otter Tail Energy Services Company, Inc. Minnesota Mid-States Testing Company Minnesota Otter Tail Energy Management Company Minnesota *Inactive EX-23 8 Exhibit 23 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement Nos. 333-11145 on Form S-3 and 333-25261, 333-73041, 333-73075 on Form S-8 of Otter Tail Power Company of our report dated February 1, 1999, incorporated by reference in this Annual Report on Form 10-K of Otter Tail Power Company for the year ended December 31, 1998. Deloitte & Touche LLP Minneapolis, Minnesota March 24, 1999 EX-24 9 Exhibit 24-A POWER OF ATTORNEY __________ I, JEFFREY J. LEGGE, do hereby constitute and appoint JOHN C. MAC FARLANE, JOHN D. ERICKSON, and C. E. BRUNKO, and or any one of them, my Attorney-in-Fact for the purpose of signing, in my name and on my behalf as Controller and Principal Accounting Officer of Otter Tail Power Company, the Annual Report of Otter Tail Power Company on Form 10-K for its fiscal year ended December 31, 1998, and any and all amendments to said Annual Report, and to deliver on my behalf said Annual Report and any and all amendments thereto, as each thereof is so signed, for filing with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended. Date: February 12, 1999. ___________Jeffrey J. Legge_______ Jeffrey J. Legge In Presence of: Anita Anderson ______________ Becky Luhning ______________ POWER OF ATTORNEY __________ I, JOHN C. MAC FARLANE, do hereby constitute and appoint JOHN D. ERICKSON, and C. E. BRUNKO, or any one of them, my Attorney-in-Fact for the purpose of signing, in my name and on my behalf as President and Chief Executive Officer, Principal Executive Officer and Director of Otter Tail Power Company, the Annual Report of Otter Tail Power Company on Form 10-K for its fiscal year ended December 31, 1998, and any and all amendments to said Annual Report, and to deliver on my behalf said Annual Report and any and all amendments thereto, as each thereof is so signed, for filing with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended. Date: February 11, 1999. ________John C. MacFarlane_______ John C. MacFarlane In Presence of: Deborah A. Kleven ___________________ Penny Mosher ___________________ POWER OF ATTORNEY __________ I, ROBERT N. SPOLUM, do hereby constitute and appoint JOHN C. MAC FARLANE, JOHN D. ERICKSON, and C. E. BRUNKO, or any one of them, my Attorney-in-Fact for the purpose of signing, in my name and on my behalf as Director of Otter Tail Power Company, the Annual Report of Otter Tail Power Company on Form 10-K for its fiscal year ended December 31, 1998, and any and all amendments to said Annual Report, and to deliver on my behalf said Annual Report and any and all amendments thereto, as each thereof is so signed, for filing with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended. Date: February 17, 1999 ___________Robert N. Spolum_____ Robert N. Spolum In Presence of: Dwight Fredricson ___________________ Francine C. Johnson ___________________ POWER OF ATTORNEY __________ I, NATHAN I. PARTAIN, do hereby constitute and appoint JOHN C. MAC FARLANE, JOHN D. ERICKSON, and C. E. BRUNKO, or any one of them, my Attorney-in-Fact for the purpose of signing, in my name and on my behalf as Director of Otter Tail Power Company, the Annual Report of Otter Tail Power Company on Form 10-K for its fiscal year ended December 31, 1998, and any and all amendments to said Annual Report, and to deliver on my behalf said Annual Report and any and all amendments thereto, as each thereof is so signed, for filing with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended. Date: February 19, 1999. _________Nathan I. Partain________ Nathan I. Partain In Presence of: Eric Elveberg _____________ Ellen Rembert _____________ POWER OF ATTORNEY __________ I, DAYLE DIETZ, do hereby constitute and appoint JOHN C. MAC FARLANE, JOHN D. ERICKSON, and C. E. BRUNKO, or any one of them, my Attorney-in-Fact for the purpose of signing, in my name and on my behalf as Director of Otter Tail Power Company, the Annual Report of Otter Tail Power Company on Form 10-K for its fiscal year ended December 31, 1998, and any and all amendments to said Annual Report, and to deliver on my behalf said Annual Report and any and all amendments thereto, as each thereof is so signed, for filing with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended. Date: March 1, 1999. ___________Dayle Dietz___________ Dayle Dietz In Presence of: Eleanor Zakala ________________ Steve Stroh ________________ POWER OF ATTORNEY __________ I, ARVID R. LIEBE, do hereby constitute and appoint JOHN C. MAC FARLANE, JOHN D. ERICKSON, and C. E. BRUNKO, or any one of them, my Attorney-in-Fact for the purpose of signing, in my name and on my behalf as Director of Otter Tail Power Company, the Annual Report of Otter Tail Power Company on Form 10-K for its fiscal year ended December 31, 1998, and any and all amendments to said Annual Report, and to deliver on my behalf said Annual Report and any and all amendments thereto, as each thereof is so signed, for filing with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended. Date: February 16, 1999. ___________Arvid R. Liebe ______ Arvid R. Liebe In Presence of: Renee Thomas _________________ Susan J. DeJong _________________ POWER OF ATTORNEY __________ I, THOMAS M. BROWN, do hereby constitute and appoint JOHN C. MAC FARLANE, JOHN D. ERICKSON, and C. E. BRUNKO, or any one of them, my Attorney-in-Fact for the purpose of signing, in my name and on my behalf as Director of Otter Tail Power Company, the Annual Report of Otter Tail Power Company on Form 10-K for its fiscal year ended December 31, 1998, and any and all amendments to said Annual Report, and to deliver on my behalf said Annual Report and any and all amendments thereto, as each thereof is so signed, for filing with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended. Date: February 22, 1999. ___________Thomas M. Brown _____ Thomas M. Brown In Presence of: Donna M. Hull _________________ Diane Rundlbade _________________ POWER OF ATTORNEY __________ I, C. E. BRUNKO, do hereby constitute and appoint JOHN C. MAC FARLANE, and JOHN D. ERICKSON, or any one of them, my Attorney-in-Fact for the purpose of signing, in my name and on my behalf as Assistant Treasurer and Assistant Secretary of Otter Tail Power Company, the Annual Report of Otter Tail Power Company on Form 10-K for its fiscal year ended December 31, 1998, and any and all amendments to said Annual Report, and to deliver on my behalf said Annual Report and any and all amendments thereto, as each thereof is so signed, for filing with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended. Date: February 12, 1999. __________C. E. Brunko____________ C. E. Brunko In Presence of: LeAnn Dornburg ____________________ Desdemona B. Norgren ____________________ POWER OF ATTORNEY __________ I, MAYNARD D. HELGAAS, do hereby constitute and appoint JOHN C. MAC FARLANE, JOHN D. ERICKSON, and C. E. BRUNKO, or any one of them, my Attorney-in-Fact for the purpose of signing, in my name and on my behalf as Director of Otter Tail Power Company, the Annual Report of Otter Tail Power Company on Form 10-K for its fiscal year ended December 31, 1998, and any and all amendments to said Annual Report, and to deliver on my behalf said Annual Report and any and all amendments thereto, as each thereof is so signed, for filing with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended. Date: February 14, 1999. _________Maynard D. Helgaas_______ Maynard D. Helgaas In Presence of: Julie Dunwoodie ___________________ Ronald Hurour ___________________ POWER OF ATTORNEY __________ I, KENNETH L. NELSON, do hereby constitute and appoint JOHN C. MAC FARLANE, JOHN D. ERICKSON, and C. E. BRUNKO, or any one of them, my Attorney-in-Fact for the purpose of signing, in my name and on my behalf as Director of Otter Tail Power Company, the Annual Report of Otter Tail Power Company on Form 10-K for its fiscal year ended December 31, 1998, and any and all amendments to said Annual Report, and to deliver on my behalf said Annual Report and any and all amendments thereto, as each thereof is so signed, for filing with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended. Date: February 15, 1999 __________Kenneth L. Nelson____ Kenneth L. Nelson In Presence of: Kim M. Nelson _________________ Penny Mosher _________________ POWER OF ATTORNEY __________ I, DENNIS R. EMMEN, do hereby constitute and appoint JOHN C. MAC FARLANE, JOHN D. ERICKSON, and C. E. BRUNKO, or any one of them, my Attorney-in-Fact for the purpose of signing, in my name and on my behalf as Director of Otter Tail Power Company, the Annual Report of Otter Tail Power Company on Form 10-K for its fiscal year ended December 31, 1998, and any and all amendments to said Annual Report, and to deliver on my behalf said Annual Report and any and all amendments thereto, as each thereof is so signed, for filing with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended. Date: February 16, 1999 _________Dennis R. Emmen_______ Dennis R. Emmen In Presence of: Becky Luhning ________________ Penny Mosher ________________ POWER OF ATTORNEY __________ I, JOHN D. ERICKSON, do hereby constitute and appoint JOHN C. MAC FARLANE, and C. E. BRUNKO, or any one of them, my Attorney-in-Fact for the purpose of signing, in my name and on my behalf as Vice President, Finance of Otter Tail Power Company, the Annual Report of Otter Tail Power Company on Form 10-K for its fiscal year ended December 31, 1998, and any and all amendments to said Annual Report, and to deliver on my behalf said Annual Report and any and all amendments thereto, as each thereof is so signed, for filing with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended. Date: February 24, 1999. _________John D. Erickson______ John D. Erickson In Presence of: Penny Mosher _________________ Lori D. Dawkins _________________ EX-27 10
UT Exhibit 27 This schedule contains summary financial information extracted from the Consolidated Balance Sheet as of December 31, 1998, and the Consolidated Statement of Income for the twelve months ended December 31, 1998, and is qualified in its entirety by reference to such financial statements. 1,000 12-MOS DEC-31-1998 DEC-31-1998 PER-BOOK 449,067 96,875 98,788 10,882 0 655,612 59,398 39,919 125,759 225,076 18,000 20,831 181,046 824 0 0 5,794 0 0 0 204,041 655,612 431,078 15,140 373,848 388,988 42,090 4,177 46,267 15,566 34,520 2,358 32,162 22,642 14,823 63,959 2.73 2.73
-----END PRIVACY-ENHANCED MESSAGE-----