RESULTS OF OPERATIONS
Following is an analysis of the operating results of
Otter Tail Corporation(the Company, we, us and our) by business segment for the three months ended March 31, 2014and 2013, followed by a discussion of changes in our consolidated financial position during the three months ended March 31, 2014and our business outlook for the remainder of 2014.
Comparison of the Three Months Ended
Consolidated operating revenues were
$240.5 millionfor the three months ended March 31, 2014compared with $218.0 millionfor the three months ended March 31, 2013. Operating income was $34.4 millionfor the three months ended March 31, 2014compared with $27.2 millionfor the three months ended March 31, 2013. The Company recorded diluted earnings per share from continuing operations and total diluted earnings per share of $0.59for the three months ended March 31, 2014compared to $0.41for the three months ended March 31, 2013. Amounts presented in the segment tables that follow for operating revenues, cost of products sold and construction revenues earned and other nonelectric operating expenses for the three month periods ended March 31, 2014and 2013 will not agree with amounts presented in the consolidated statements of income due to the elimination of intersegment transactions. The amounts of intersegment eliminations by income statement line item are listed below: Intersegment Eliminations (in thousands) March 31, 2014 March 31, 2013 Operating Revenues: Electric $ 40 $ 34 Nonelectric -- 13 Cost of Products Sold 2 12 Cost of Construction Revenues Earned -- 1 Other Nonelectric Expenses 38 34 Electric Three Months Ended March 31, %
(in thousands) 2014 2013 Change Change Retail Sales Revenues
$ 105,504 $ 92,323 $ 13,18114.3 Wholesale Revenues - Company Generation 4,900 1,633 3,267 200.1 Net Revenue - Energy Trading Activity (269 ) 345
(614 ) (178.0 ) Other Revenues 8,953 6,709 2,244 33.4 Total Operating Revenues
$ 119,088 $ 101,010 $ 18,07817.9 Production Fuel 22,030 17,953 4,077 22.7 Purchased Power - System Use 21,785 16,639 5,146 30.9
Other Operation and Maintenance Expenses 34,622 32,447
2,175 6.7 Depreciation and Amortization 10,763 10,631 132 1.2 Property Taxes 2,971 2,916 55 1.9 Operating Income
$ 26,917 $ 20,424 $ 6,49331.8 Electric kilowatt-hour (kwh) Sales (in thousands) Retail kwh Sales 1,397,891 1,310,312 87,579 6.7 Wholesale kwh Sales - Company Generation 73,305 64,345 8,960 13.9 Wholesale kwh Sales - Purchased PowerResold 1,611 13,789 (12,178 ) (88.3 ) Heating Degree Days 4,089 3,671 418 11.4
Retail sales revenue increased
purchased power costs recovered in base rates, driven by an 8.2% increase in
fuel costs per kwh generated at
generating units and a 43.2% increase in prices for power purchased to serve
retail customers as a result of higher demand due to colder weather in the
first quarter of 2014 compared to the first quarter of 2013,
sales, of which:
million is related to increased sales to a pipeline customer and approximately
due, in part, to improved economic conditions and customer growth in OTP's
to earning a return in
invested in the Air Quality Control System (AQCS) under construction at Big
Stone Plant, and
from increased investment in transmission lines,
due to depreciation and (2) reduced RRA revenue requirements related to
earning more federal Production Tax Credits (PTCs) as a result of a 33.0%
increase in kwhs generated by OTP's wind turbines eligible for PTCs. Net revenue from energy trading activities, including net mark-to-market gains and losses on forward energy contracts, decreased
$0.6 millionmainly as a result of decreased trading activity and the incurrence of losses on contracts entered into and settled in the first quarter of 2014. Wholesale electric revenues from company-owned generation increased $3.3 millionas a result of a 163% increase in revenue per wholesale kwh sold and a 13.9% increase in wholesale kwhs sold. The increase in wholesale kwh sales and prices was driven by increased wholesale market demand resulting from colder weather in the first quarter of 2014. OTP was able to serve the higher demand of both wholesale and retail customers as a result of improved availability of Coyote Station, which was shut down for generator repairs during the first seven weeks of 2013, and as a result of the 30.9% increase in kwhs generated from OTP's wind turbines.
Other electric operating revenues increased
(MISO) tariff revenues resulting from increased investment in regional
transmission lines and returns on and recovery of CapX2020 and MISO-designated
million increase in transmission related revenue under an integrated
transmission agreement and a
at Big Stone Plant. Production fuel costs increased
$4.1 millionas a result of a 13.4% increase in kwhs generated from OTP's steam-powered and combustion turbine generators in combination with an 8.2% increase in the cost of fuel per kwh generated. The increase in kwh generation was facilitated by the improved availability of Coyote Station. The cost of purchased power to serve retail customers increased $5.1 milliondue to a 43.2% increase in costs per kwh purchased, partially offset by an 8.5% decrease in kwhs purchased. The increase in costs per kwh purchased was driven by increased wholesale market demand resulting from colder weather.
Electric operating and maintenance expenses increased
increasing investments in regional CapX2020 projects and MISO-designated MVPs,
and accrued incentives related to OTP's improved performance quarter over
? increases of
of expense: generating plant material and supplies, electric grid software
maintenance, travel expenses, regulatory assessment charges and insurance
premiums, offset by:
pension and postretirement benefit costs related to an increase in discount
rates and pension fund contributions.
36 Manufacturing Three Months Ended March 31, % (in thousands) 2014 2013 Change Change Operating Revenues
$ 55,435 $ 53,166 $ 2,2694.3 Cost of Products Sold 42,199 39,326 2,873 7.3 Operating Expenses 5,225 4,498 727 16.2 Depreciation and Amortization 2,620 2,993 (373 ) (12.5 ) Operating Income $ 5,391 $ 6,349 $ (958 )(15.1 )
The increase in revenues in our Manufacturing segment relates to the following:
? Revenues at
fabrication company, increased
sales to manufacturers of recreational equipment. ? Revenues at
T.O. Plastics, Inc.( T.O. Plastics), our manufacturer of
thermoformed plastic and horticultural products, decreased
mainly due to a significant reduction in sales of a high volume product that a
customer began producing on its own in 2014.
The increase in cost of products sold in our Manufacturing segment relates to the following:
? Cost of products sold at BTD increased
material costs related to an increase in sales volume and increases in support
salaries, wages and product handling costs to support anticipated sales growth
? Cost of products sold at
decreased material costs related to
The increase in operating expenses in our Manufacturing segment is mainly due to the following:
? Operating expenses at BTD increased
administrative and general expenses related to increased labor and benefit
? Operating expenses at
Depreciation expense decreased
Plastics Three Months Ended March 31, % (in thousands) 2014 2013 Change Change Operating Revenues
$ 40,483 $ 37,400 $ 3,0838.2 Cost of Products Sold 31,742 28,473 3,269 11.5 Operating Expenses 2,117 1,436 681 47.4 Depreciation and Amortization 853 774 79 10.2 Operating Income $ 5,771 $ 6,717 $ (946 )(14.1 )
The increase in Plastics segment revenue is the result of a 10.3% increase in pounds of polyvinyl chloride (PVC) pipe sold, partially offset by a 1.8% decrease in the price per pound of pipe sold. States with significant increases in sales were
Colorado, California, Arizona, Nevada, Texasand Minnesota. Cost of products sold increased by $3.3 million, mostly due to the increase in sales volume, but also due to a 1.1% increase in the cost per pound of pipe sold related to higher PVC resin costs. A $0.7 millionincrease in operating expenses, mainly related to increased wage and benefit costs, in combination with the $0.2 millionreduction in gross margins resulted in the $0.9 milliondecline in Plastics segment operating income between the quarters. 37 Construction Three Months Ended March 31, % (in thousands) 2014 2013 Change Change Operating Revenues $ 25,506 $ 26,425 $ (919 )(3.5 )
Cost of Construction Revenues Earned 22,362 24,276 (1,914 ) (7.9 )
Operating Expenses 3,850 3,386
Depreciation and Amortization 512 462 50 10.8 Operating Loss
$ (1,218 ) $ (1,699 ) $ 48128.3
The decrease in revenues in our Construction segment relates to the following:
? Revenues at
industrial projects, decreased
in work volume between the quarters, but Foley's profitability and performance
improved on jobs in progress in the first quarter of 2014.
? Revenues at
services company, increased
higher volume of electrical transmission, distribution, substation and underground work in 2014, despite challenging weather conditions.
The decrease in cost of construction revenues earned in our Construction segment relates to the following:
? Cost of construction revenues earned at Foley decreased
a result of the reduction in material costs and lower work volume.
? Cost of construction revenues earned at
the quarters as a result of increased material and labor costs related to an
increase in construction activity at
Foley's operating expenses for wages and benefits increased
$0.5 millionbetween the quarters, due in part to bonuses and in part to severance payments related to workforce reductions. Corporate Corporate includes items such as corporate staff and overhead costs, the results of our captive insurance company and other items excluded from the measurement of operating segment performance. Corporate is not an operating segment. Rather it is added to operating segment totals to reconcile to totals on our consolidated statements of income. Three Months Ended March 31, % (in thousands) 2014 2013 Change Change Operating Expenses $ 2,407 $ 4,492 $ (2,085 )(46.4 ) Depreciation and Amortization 32 60 (28 ) (46.7 )
Corporate operating expenses decreased
compensation costs which were higher in the first quarter of 2013 as a result
of a 24% increase in the market value of the Company's common stock in that
charged to the corporation's operating segments, and
38 Interest Charges
2013, offset by:
Senior Unsecured Notes due
principal amount of OTP's 5.47% Series B Senior Unsecured Notes due February
27, 2044. Other Income The
$1.0 millionincrease in other income in the three months ended March 31, 2014compared with the three months ended March 31, 2013includes a $0.8 milliongain on the sale of an investment in tax-credit-qualified low income housing rental property, and a $0.3 milliongain on the sale of Aevenia'sdata communication installation and services business, both sold in the first quarter of 2014. Income Taxes - Continuing Operations Income taxes - continuing operations increased $2.4 millionin the first quarter of 2014 compared with the first quarter of 2013. The following table provides a reconciliation of income tax expense calculated at the Company's net composite federal and state statutory rate on income from continuing operations before income taxes and income tax expense for continuing operations reported on the Company's consolidated statements of income for the three month periods ended March 31, 2014and 2013: Three Months Ended March 31, (in thousands) 2014 2013 Income Before Income Taxes - Continuing Operations $
11,563 8,237 Increases (Decreases) in Tax from: Federal Production Tax Credits (PTCs) (2,252 ) (1,589 ) Section 199 Domestic Production Activities Deduction (358 ) --
North Dakota Wind Tax Credit Amortization - Net of Federal Taxes
(212 ) (223 ) Employee Stock Ownership Plan Dividend Deduction (189 ) (190 ) AFUDC Equity (133 ) (115 ) Corporate Owned Life Insurance (112 ) (302 ) Other Items - Net (19 ) 68 Income Tax Expense - Continuing Operations
$ 8,288 $ 5,886Effective Income Tax Rate - Continuing Operations 28.0 % 27.9 % Federal PTCs are recognized as wind energy is generated based on a per kwh rate prescribed in applicable federal statutes. OTP's kwh generation from its wind turbines eligible for PTCs increased 33.0% in the three months ended March 31, 2014compared with the three months ended March 31, 2013. North Dakotawind energy credits are based on dollars invested in qualifying facilities and are being recognized on a straight-line basis over 25 years. 39 Discontinued Operations On February 8, 2013we completed the sale of substantially all the assets of our former waterfront equipment manufacturing company, formerly included in our Manufacturing segment, for approximately $13.0 millionin cash and received a working capital true up of approximately $2.4 millionin June 2013. On November 30, 2012we completed the sale of the assets of our former wind tower manufacturing company and on February 29, 2012we completed the sale of DMS Health Technologies, Inc.(DMS) and recorded an additional $0.2 milliongain on the sale in the first quarter of 2013 related to a working capital true up. Following are summary presentations of the results of discontinued operations for the three-month periods ended March 31, 2014and 2013, which mainly includes residual revenues and expenses from our former wind tower and waterfront equipment manufacturers and the additional $0.2 milliongain on the sale of DMS in the first quarter of 2013: For the Three Months Ended March 31, (in thousands) 2014 2013 Operating Revenues $ -- $ 2,009Operating Expenses (117 ) 2,707 Operating Income (Loss) 117 (698 ) Other Income -- 412 Income Tax Benefit (49 ) (205 ) Net Income (Loss) from Operations 68 (81 ) Gain on Disposition Before Taxes -- 216 Income Tax Expense on Disposition -- 6 Net Gain on Disposition -- 210 Net Income $ 68$ 129 FINANCIAL POSITION
The following table presents the status of our lines of credit as of
Restricted due to In Use on Outstanding Available on Available on March 31, Letters of March 31, December 31, (in thousands) Line Limit 2014 Credit 2014 2013 Otter Tail Corporation Credit Agreement
$ 150,000 $ 11,899$ 659 $ 137,442 $ 149,341OTP Credit Agreement 170,000 -- 3,830 166,170 116,975 Total $ 320,000 $ 11,899 $ 4,489 $ 303,612 $ 266,316
We believe we have the necessary liquidity to effectively conduct business operations for an extended period if needed. Our balance sheet is strong and we are in compliance with our debt covenants. Financial flexibility is provided by operating cash flows, unused lines of credit, strong financial coverages, investment grade credit ratings and alternative financing arrangements such as leasing. We believe our financial condition is strong and our cash, other liquid assets, operating cash flows, existing lines of credit, access to capital markets and borrowing ability because of investment-grade credit ratings, when taken together, provide adequate resources to fund ongoing operating requirements and future capital expenditures related to expansion of existing businesses and development of new projects. On
May 11, 2012we filed a shelf registration statement with the Securities and Exchange Commissionunder which we may offer for sale, from time to time, either separately or together in any combination, equity, debt or other securities described in the shelf registration statement, which expires on May 10, 2015. On May 14, 2012, we entered into a Distribution Agreement with J.P. Morgan Securities(JPMS) under which we may offer and sell our common shares from time to time through JPMS, as our distribution agent, up to an aggregate sales price of $75 million. Equity or debt financing will be required in the period 2014 through 2018 given the expansion plans related to our Electric segment to fund construction of new rate base investments, in the event we decide to reduce borrowings under our lines of credit or refund or retire early any of our presently outstanding debt, to complete acquisitions or for other corporate purposes. Also, our operating cash flow and access to capital markets can be impacted by macroeconomic factors outside our control. In addition, our borrowing costs can be impacted by changing interest rates on short-term and long-term debt and ratings assigned to us by independent rating agencies, which in part are based on certain credit measures such as interest coverage and leverage ratios. 40
Our common stock dividend payments have exceeded our net income (losses) in four of the last five years. The determination of the amount of future cash dividends to be declared and paid will depend on, among other things, our financial condition, improvement in earnings per share, cash flows from operations, the level of our capital expenditures and our future business prospects. As a result of certain statutory limitations or regulatory or financing agreements, restrictions could occur on the amount of distributions that are allowed to be made by our subsidiaries. See note 8 to condensed consolidated financial statements for more information. The decision to declare a dividend is reviewed quarterly by the Board of Directors. On
February 3, 2014our Board of Directors increased the quarterly dividend from $0.2975to $0.3025per common share. Cash used in operating activities of continuing operations was $18.9 millionfor the three months ended March 31, 2014compared with cash provided by operating activities of continuing operations of $10.2 millionfor the three months ended March 31, 2013. Contributing to the $29.1 millionshift in cash provided by operating activities in the first quarter of 2013 to cash used in operating activities in the first quarter of 2014 was a $21.2 millionincrease in cash used for working capital items from $22.9 millionin the first quarter of 2013 to $44.1 millionin the first quarter of 2014, and a $10.0 millionincrease in discretionary contributions to our pension plan between the quarters. Accounts receivable and inventories in the Plastics segment increased $19.3 millionin the first quarter of 2014 compared with an increase of $9.2 millionin the first quarter of 2013. The greater increase in receivables and inventories in the Plastic segment in 2014 corresponds with a 10.3% increase in sales volume, 8.2% increase in revenues and higher material and labor costs between the quarters. Foley's accounts payable and billings in excess of costs decreased $9.2 millionin the first quarter of 2014 compared with a $1.3 millionincrease in accounts payable and billings in excess of costs in the first quarter of 2013. Net cash used in investing activities of continuing operations was $37.2 millionfor the three months ended March 31, 2014compared to $23.5 millionfor the three months ended March 31, 2013due to a $14.4 millionincrease in cash used for capital expenditures in the Electric segment between the quarters, as construction of the Big Stone Plant AQCS remains on pace and OTP continues to invest in major transmission grid upgrades and improvements. Net proceeds from the sale of discontinued operations of $10.5 millionin the first quarter of 2013 reflect $12.2 millionin net proceeds from the sale of the assets of our former waterfront equipment manufacturer net of a $1.7 millionworking capital settlement paid to the buyer of DMS, which we sold in the first quarter of 2012. Net cash provided by financing activities in the three months ended March 31, 2014of $61.7 millioncompares with net cash used in investing activities in the three months ended March 31, 2014of $8.6 million. Net cash provided by financing activities in the first quarter of 2014 mainly reflects the issuance by OTP of $150 millionin privately placed unsecured notes in two series on February 27, 2014, and the use of a portion of the proceeds of the notes to retire OTP's $40.9 millionunsecured term loan and to repay short-term debt outstanding under the OTP Credit Agreement which was being used to finance OTP's construction activities. First quarter 2014 financing activities also reflect the payment of $11.0 millionin common stock dividends, OTP's repayment of $51.2 millionin short-term debt outstanding under the OTP Credit Agreement on December 31, 2013and the borrowing of $11.9 millionunder the Otter Tail Corporation Credit Agreement to fund the working capital needs of our manufacturing and infrastructure companies. First quarter 2014 financing cash flows also include $3.7 millionin cash proceeds from the issuance of common stock. In the first quarter of 2014, we began issuing common shares to meet the requirements of our dividend reinvestment and share purchase plan, employee stock ownership plan, and employee stock purchase plan, rather than purchasing shares in the open market. Net cash used in financing activities of continuing operations in the three months ended March 31, 2013of $8.6 millionreflects $2.5 millionin proceeds from short-term borrowings and the issuance of common stock offset by $11.3 millionin common and preferred stock dividend payments. On March 1, 2013OTP used proceeds from a $40.9 millionunsecured term loan to fund the redemption of all $25.1 millionof the then outstanding 4.65% Grant County, South DakotaPollution Control Refunding Revenue Bonds and 4.85% Mercer County, North DakotaPollution Control Refunding Revenue Bonds, and to pay off an intercompany note to the Company that mirrored the Company's $15.5 millionin outstanding cumulative preferred shares, which were also redeemed on March 1, 2013. 41 CAPITAL REQUIREMENTS 2014-2018 Capital Expenditures The following table shows our 2013 capital expenditures and 2014 through 2018 anticipated capital expenditures and electric utility average rate base: 2013 (in millions) Actual 2014 2015 2016 2017 2018 Capital Expenditures: Electric Segment: Transmission $ 53 $ 46 $ 97 $ 52 $ 56Environmental 82 61 -- -- -- Other 37 38 44 45 46 Total Electric Segment $ 149 $ 172 $ 145 $ 141 $ 97 $ 102Manufacturing and Infrastructure Segments 15 23 19 26 20 24 Total Capital Expenditures $ 164 $ 195 $ 164 $ 167 $ 117 $ 126Total Electric Utility Average Rate Base $ 885 $ 991 $ 1,062 $ 1,120 $ 1,152
Execution on the currently anticipated electric utility capital expenditure plan is expected to grow rate base and be a key driver in increasing utility earnings over the 2014 through 2018 timeframe.
Ashtabula III Wind FarmOTP has a purchased wind power agreement with the owner of the Ashtabula III wind farm. In connection with this agreement, OTP has the option to purchase the wind farm for approximately $50 millionin the 2023 timeframe. Contractual Obligations Our contractual obligations reported in the table on page 53 of our Annual Report on Form 10-K for the year ended December 31, 2013increased $340 millionin the first quarter of 2014. Our long-term debt obligations increased $150 millionfor the years beyond 2018 and our interest obligations on long-term debt increased by $3.9 millionfor 2014, $15.5 millionfor 2015 and 2016, $15.5 millionfor 2017 and 2018 and $155 millionfor the years beyond 2018 as a result of OTP's February 27, 2014borrowings under OTP's 2013 Note Purchase Agreement. Our purchase obligations did not increase and OTP entered into no new coal, capacity or energy purchase agreements in the first quarter of 2014.
Short-Term Debt On
October 29, 2012we entered into a Third Amended and Restated Credit Agreement (the Otter Tail Corporation Credit Agreement), which is an unsecured $150 millionrevolving credit facility that may be increased to $250 millionon the terms and subject to the conditions described in the Otter Tail CorporationCredit Agreement. On October 29, 2013the Otter Tail Corporation Credit Agreement was amended to extend its expiration date by one year from October 29, 2017to October 29, 2018. We can draw on this credit facility to refinance certain indebtedness and support our operations and the operations of our subsidiaries. Borrowings under the Otter Tail Corporation Credit Agreement bear interest at LIBORplus 1.75%, subject to adjustment based on our senior unsecured credit ratings. The interest rate being charged under the Second Amended and Restated Credit Agreement prior to the renewal was LIBORplus 3.25%. We are required to pay commitment fees based on the average daily unused amount available to be drawn under the revolving credit facility. The Otter Tail Corporation Credit Agreement contains a number of restrictions on us and the businesses of the Company's wholly-owned subsidiary, Varistar Corporation, and its material subsidiaries, including restrictions on our and their ability to merge, sell assets, make investments, create or incur liens on assets, guarantee the obligations of certain other parties and engage in transactions with related parties. The Otter Tail Corporation Credit Agreement also contains affirmative covenants and events of default, and financial covenants as described below under the heading "Financial Covenants." The Otter Tail Corporation Credit Agreement does not include provisions for the termination of the agreement or the acceleration of repayment of amounts outstanding due to changes in our credit ratings. Our obligations under the Otter Tail Corporation Credit Agreement are guaranteed by certain of our material subsidiaries. Outstanding letters of credit issued by us under the Otter Tail Corporation Credit Agreement can reduce the amount available for borrowing under the line by up to $40 million. 42 On October 29, 2012OTP entered into a Second Amended and Restated Credit Agreement (the OTP Credit Agreement), providing for an unsecured $170 millionrevolving credit facility that may be increased to $250 millionon the terms and subject to the conditions described in the OTP Credit Agreement. On October 29, 2013the OTP Credit Agreement was amended to extend its expiration date by one year from October 29, 2017to October 29, 2018. OTP can draw on this credit facility to support the working capital needs and other capital requirements of its operations, including letters of credit in an aggregate amount not to exceed $50 millionoutstanding at any time. Borrowings under this line of credit bear interest at LIBORplus 1.25%, subject to adjustment based on the ratings of OTP's senior unsecured debt. OTP is required to pay commitment fees based on the average daily unused amount available to be drawn under the revolving credit facility. The OTP Credit Agreement contains a number of restrictions on the business of OTP, including restrictions on its ability to merge, sell assets, make investments, create or incur liens on assets, guarantee the obligations of any other party, and engage in transactions with related parties. The OTP Credit Agreement also contains affirmative covenants and events of default, and financial covenants as described below under the heading "Financial Covenants." The OTP Credit Agreement does not include provisions for the termination of the agreement or the acceleration of repayment of amounts outstanding due to changes in OTP's credit ratings. OTP's obligations under the OTP Credit Agreement are not guaranteed by any other party.
2016 Notes On
December 4, 2009we issued $100 millionof our 9.000% notes due 2016 (the 2016 Notes) under the indenture (for unsecured debt securities) dated as of November 1, 1997, as amended by the First Supplemental Indenture dated as of July 1, 2009, between us and U.S. Bank National Association(formerly First Trust National Association), as trustee. The 2016 Notes are senior unsecured indebtedness and bear interest at 9.000% per year, payable semi-annually in arrears on June 15and December 15of each year. In November 2013we purchased and retired, in two separate transactions, $12,933,000and $34,737,000, respectively, of our outstanding 2016 Notes. The remaining $52,330,000principal amount of the 2016 Notes outstanding, unless previously redeemed or otherwise repaid, will mature and become due and payable on December 15, 2016. 2013 Note Purchase Agreement On August 14, 2013OTP entered into a Note Purchase Agreement (the 2013 Note Purchase Agreement) with the Purchasers named therein, pursuant to which OTP agreed to issue to the Purchasers, in a private placement transaction, $60 millionaggregate principal amount of OTP's 4.68% Series A Senior Unsecured Notes due February 27, 2029(the Series A Notes) and $90 millionaggregate principal amount of OTP's 5.47% Series B Senior Unsecured Notes due February 27, 2044(the Series B Notes and, together with the Series A Notes, the Notes). On February 27, 2014OTP issued all $150 millionaggregate principal amount of the Notes. The 2013 Note Purchase Agreement states that OTP may prepay all or any part of the Notes (in an amount not less than 10% of the aggregate principal amount of the Notes then outstanding in the case of a partial prepayment) at 100% of the principal amount prepaid, together with accrued interest and a make-whole amount, provided that if no default or event of default under the 2013 Note Purchase Agreement exists, any optional prepayment made by OTP of (i) all of the Series A Notes then outstanding on or after November 27, 2028or (ii) all of the Series B Notes then outstanding on or after November 27, 2043, will be made at 100% of the principal prepaid but without any make-whole amount. In addition, the 2013 Note Purchase Agreement states OTP must offer to prepay all of the outstanding Notes at 100% of the principal amount together with unpaid accrued interest in the event of a change of control of OTP. The 2013 Note Purchase Agreement contains a number of restrictions on the business of OTP, including restrictions on OTP's ability to merge, sell assets, create or incur liens on assets, guarantee the obligations of any other party, and engage in transactions with related parties. The 2013 Note Purchase Agreement also contains affirmative covenants and events of default, as well as certain financial covenants as described below under the heading "Financial Covenants." The 2013 Note Purchase Agreement does not include provisions for the termination of the agreement or the acceleration of repayment of amounts outstanding due to changes in OTP's credit ratings. The 2013 Note Purchase Agreement includes a "most favored lender" provision generally requiring that in the event OTP's existing credit agreement or any renewal, extension or replacement thereof, at any time contains any financial covenant or other provision providing for limitations on interest expense and such a covenant is not contained in the 2013 Note Purchase Agreement under substantially similar terms or would be more beneficial to the holders of the Notes than any analogous provision contained in the 2013 Note Purchase Agreement (an "Additional Covenant"), then unless waived by the Required Holders (as defined in the 2013 Note Purchase Agreement), the Additional Covenant will be deemed to be incorporated into the 2013 Note Purchase Agreement. The 2013 Note Purchase Agreement also provides for the amendment, modification or deletion of an Additional Covenant if such Additional Covenant is amended or modified under or deleted from the OTP credit agreement, provided that no default or event of default has occurred and is continuing. 43 2007 and 2011 Note Purchase Agreements On December 1, 2011, OTP issued $140 millionaggregate principal amount of its 4.63% Senior Unsecured Notes due December 1, 2021(the 2021 Notes) pursuant to a Note Purchase Agreement dated as of July 29, 2011(2011 Note Purchase Agreement). OTP used a portion of the proceeds of the 2021 Notes to retire $90 millionaggregate principal amount of OTP's 6.63% Senior Notes due December 1, 2011at maturity and to retire early $10.4 millionaggregate principal amount of outstanding pollution control refunding revenue bonds due December 1, 2012. No penalty was paid for the early retirement. The remaining proceeds of the 2021 Notes were used to repay short-term debt of OTP which was issued to fund capital expenditures, to pay fees and expenses related to the debt issuance and to fund a $10 millioncontribution to the Company's pension plan in January 2012. OTP also has outstanding its $155 millionsenior unsecured notes issued in four series consisting of $33 millionaggregate principal amount of 5.95% Senior Unsecured Notes, Series A, due 2017; $30 millionaggregate principal amount of 6.15% Senior Unsecured Notes, Series B, due 2022; $42 millionaggregate principal amount of 6.37% Senior Unsecured Notes, Series C, due 2027; and $50 millionaggregate principal amount of 6.47% Senior Unsecured Notes, Series D, due 2037 (collectively, the 2007 Notes). The 2007 Notes were issued pursuant to a Note Purchase Agreement dated as of August 20, 2007(the 2007 Note Purchase Agreement). The 2011 Note Purchase Agreement and the 2007 Note Purchase Agreement each states that OTP may prepay all or any part of the notes issued thereunder (in an amount not less than 10% of the aggregate principal amount of the notes then outstanding in the case of a partial prepayment) at 100% of the principal amount prepaid, together with accrued interest and a make-whole amount. The 2011 Note Purchase Agreement states in the event of a transfer of utility assets put event, the noteholders thereunder have the right to require OTP to repurchase the notes held by them in full, together with accrued interest and a make-whole amount, on the terms and conditions specified in the 2011 Note Purchase Agreement. The 2011 Note Purchase Agreement and the 2007 Note Purchase Agreement each also states that OTP must offer to prepay all of the outstanding notes issued thereunder at 100% of the principal amount together with unpaid accrued interest in the event of a change of control of OTP. The note purchase agreements contain a number of restrictions on OTP, including restrictions on OTP's ability to merge, sell assets, create or incur liens on assets, guarantee the obligations of any other party, and engage in transactions with related parties. The note purchase agreements also include affirmative covenants and events of default, and certain financial covenants as described below under the heading "Financial Covenants." Financial Covenants We were in compliance with the financial covenants in our debt agreements as of March 31, 2014. No Credit or Note Purchase Agreement contains any provisions that would trigger an acceleration of the related debt as a result of changes in the credit rating levels assigned to the related obligor by rating agencies.
Our borrowing agreements are subject to certain financial covenants. Specifically:
? Under the Otter Tail Corporation Credit Agreement, we may not permit the ratio
of our Interest-bearing Debt to Total Capitalization to be greater than 0.60
to 1.00 or permit our Interest and Dividend Coverage Ratio to be less than
1.50 to 1.00 (each measured on a consolidated basis), as provided in the Otter
Tail Corporation Credit Agreement. As of
Dividend Coverage Ratio calculated under the requirements of the Otter Tail
Corporation Credit Agreement was 4.24 to 1.00. ? Under the OTP Credit Agreement, OTP may not permit the ratio of its
Interest-bearing Debt to Total Capitalization to be greater than 0.60 to 1.00.
? Under the 2007 Note Purchase Agreement and 2011 Note Purchase Agreement, OTP
may not permit the ratio of its Consolidated Debt to Total Capitalization to
be greater than 0.60 to 1.00 or permit its Interest and Dividend Coverage
Ratio to be less than 1.50 to 1.00, in each case as provided in the related
borrowing agreement, and OTP may not permit its Priority Debt to exceed 20% of
its Total Capitalization, as provided in the related agreement. As of March
31, 2014 OTP's Interest and Dividend Coverage Ratio and Interest Charges
Coverage Ratio, calculated under the requirements of the 2007 Note Purchase
Agreement and 2011 Note Purchase Agreement, was 4.04 to 1.00. ? Under the 2013 Note Purchase Agreement, OTP may not permit its
Interest-bearing Debt to exceed 60% of Total Capitalization and may not permit
its Priority Indebtedness to exceed 20% of its Total Capitalization, each as
provided in the 2013 Note Purchase Agreement.
We and our subsidiary companies have outstanding letters of credit totaling
$9.9 million, but our line of credit borrowing limits are only restricted by $4.5 millionof the outstanding letters of credit. We do not have any other off-balance-sheet arrangements or any relationships with unconsolidated entities or financial partnerships. These entities are often referred to as structured finance special purpose entities or variable interest entities, which are established for the purpose of facilitating off-balance-sheet arrangements or for other contractually narrow or limited purposes. We are not exposed to any financing, liquidity, market or credit risk that could arise if we had such relationships.
2014 BUSINESS OUTLOOK
We are increasing our consolidated diluted earnings per share guidance for 2014 to be in the range of
$1.60to $1.80from our previously announced range of $1.55to $1.75. This updated guidance reflects the current mix of businesses owned by us. It considers the cyclical nature of some of our businesses and reflects challenges, as well as our plans and strategies for improving future operating results. Segment components of our 2014 earnings per share guidance range are as follows: Previous 2014 EPS Guidance Current 2014 EPS Guidance Low High Low High Electric $1.19 $1.23 $1.21 $1.25Manufacturing $0.29 $0.33 $0.29 $0.33Plastics $0.25 $0.29 $0.27 $0.31Construction $0.07 $0.11 $0.07 $0.11Corporate ( $0.25) ( $0.21) ( $0.24) ( $0.20)
Total - Continuing Operations
Contributing to our updated earnings guidance for 2014 are the following items:
? We expect 2014 net income for our Electric segment to increase from our
previously issued guidance primarily as a result of the strong first quarter
results driven in part by colder than normal weather. Items affecting our 2014
Electric segment earnings guidance compared with 2013 earnings include:
o Rider recovery increases, including environmental riders in
o A decrease in pension costs of approximately
increase in the discount rate from 4.5% to 5.3%, offset by
o An increase in interest costs as a result of
term debt put in place in the first quarter of 2014 to finance the
Plant AQCS and transmission projects, and
o An increase in operating and maintenance costs primarily for increased labor
and a planned outage for maintenance at Hoot Lake Plant. ? We are maintaining our original 2014 earnings expectations for our
Manufacturing segment, which we expect to be unchanged from 2013 results due
to the following factors:
o An increase at BTD due to increased order volume as a result of expanded
relationships with customers in recreational vehicle, lawn and garden, industrial and commercial end markets BTD serves, offset by
o A decrease in earnings from
product the customer will be producing on its own in 2014.
o Backlog for the manufacturing companies of approximately
$97 millionone year ago.
? We are raising our expectations for 2014 net income for our Plastics segment
from our original guidance due to a stronger than expected first quarter.
? We are maintaining our original 2014 guidance for our Construction segment.
Net income is expected to be higher in 2014 than in 2013 as a result of
improved cost control processes in construction management and more selective
bidding on projects with the potential for higher margins. Backlog in place
for the construction businesses is
million one year ago. 45
? Corporate costs are expected to be slightly lower than original guidance as a
result of the sale of an investment in tax-credit-qualified low income housing
rental property, which was not expected when our original guidance was given,
and improved performance in our self-insured health plan.
We review our portfolio of companies at least annually to see where additional opportunities exist to improve our risk profile, improve credit metrics and generate additional sources of cash to support the future capital expenditure plans of our Electric segment.
Critical Accounting Policies Involving Significant Estimates
The discussion and analysis of the financial statements and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in
the United States of America. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We use estimates based on the best information available in recording transactions and balances resulting from business operations. Estimates are used for such items as depreciable lives, asset impairment evaluations, tax provisions, collectability of trade accounts receivable, self-insurance programs, unbilled electric revenues, accrued renewable resource and transmission rider revenues, valuations of forward energy contracts, percentage-of-completion, warranty and actuarially determined benefits costs and liabilities. As better information becomes available or actual amounts are known, estimates are revised. Operating results can be affected by revised estimates. Actual results may differ from these estimates under different assumptions or conditions. Management has discussed the application of these critical accounting policies and the development of these estimates with the Audit Committee of the Board of Directors. A discussion of critical accounting policies is included under the caption "Critical Accounting Policies Involving Significant Estimates" on pages 60 through 64 of our Annual Report on Form 10-K for the year ended December 31, 2013. There were no material changes in critical accounting policies or estimates during the quarter ended March 31, 2014.
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), we have filed cautionary statements identifying important factors that could cause our actual results to differ materially from those discussed in forward-looking statements made by or on behalf of the Company. When used in this Form 10-Q and in future filings by the Company with the
Securities and Exchange Commission, in our 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 and are included, along with this statement, for purposes of complying with the safe harbor provision of the Act. These forward-looking statements involve risks and uncertainties. Actual results may differ materially from those contemplated by the forward-looking statements due to, among other factors, the risks and uncertainties described in the section entitled "Risk Factors" in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, as well as the various factors described below:
? Federal and state environmental regulation could require us to incur
substantial capital expenditures and increased operating costs.
? Volatile financial markets and changes in our debt ratings could restrict our
ability to access capital and could increase borrowing costs and pension plan
and postretirement health care expenses.
? We rely on access to both short- and long-term capital markets as a source of
liquidity for capital requirements not satisfied by cash flows from operations.
If we are not able to access capital at competitive rates, our ability to
implement our business plans may be adversely affected.
? Disruptions, uncertainty or volatility in the financial markets can also
adversely impact our results of operations, the ability of our customers to
finance purchases of goods and services, and our financial condition, as well
as exert downward pressure on stock prices and/or limit our ability to sustain
our current common stock dividend level.
? We made
pension plan in
capital to the pension plan in the future if the market value of pension plan
assets significantly declines, plan assets do not earn in line with our
long-term rate of return assumptions or relief under the Pension Protection Act
is no longer granted.
? Any significant impairment of our goodwill would cause a decrease in our asset
values and a reduction in our net operating income.
? Declines in projected operating cash flows at any of our reporting units may
result in goodwill impairments that could adversely affect our results of
operations and financial position, as well as financing agreement covenants.
? We currently have
trade name recorded on our consolidated balance sheet related to the
between 2012 and 2013. If future expected operating profits do not meet the
corporation's projections, the reductions in anticipated cash flows from Foley
may indicate its fair value is less than its book value, resulting in an
impairment of some or all of the goodwill and indefinite-lived intangible
assets associated with Foley along with a corresponding charge against
? The inability of our subsidiaries to provide sufficient earnings and cash flows
to allow us to meet our financial obligations and debt covenants and pay
dividends to our shareholders could have an adverse effect on us.
? Economic conditions could negatively impact our businesses.
? If we are unable to achieve the organic growth we expect, our financial
performance may be adversely affected.
? Our plans to grow and realign our business mix through capital projects,
acquisitions and dispositions may not be successful, which could result in poor
? We may, from time to time, sell assets to provide capital to fund investments
in our electric utility business or for other corporate purposes, which could
result in the recognition of a loss on the sale of any assets sold and other
potential liabilities. The sale of any of our businesses could expose us to
additional risks associated with indemnification obligations under the
applicable sales agreements and any related disputes.
? Our plans to grow and operate our manufacturing and infrastructure businesses
could be limited by state law.
? Significant warranty claims and remediation costs in excess of amounts normally
reserved for such items could adversely affect our results of operations and
financial condition. ? We are subject to risks associated with energy markets.
? We are subject to risks and uncertainties related to the timing and recovery of
deferred tax assets which could have a negative impact on our net income in
? We rely on our information systems to conduct our business, and failure to
protect these systems against security breaches or cyber-attacks could
adversely affect our business and results of operations. Additionally, if these
systems fail or become unavailable for any significant period of time, our
business could be harmed.
? We may experience fluctuations in revenues and expenses related to our electric
operations, which may cause our financial results to fluctuate and could impair
our ability to make distributions to our shareholders or scheduled payments on
our debt obligations, or to meet covenants under our borrowing agreements.
? Actions by the regulators of our electric operations could result in rate
reductions, lower revenues and earnings or delays in recovering capital
? OTP's electric generating facilities are subject to operational risks that
could result in unscheduled plant outages, unanticipated operation and
maintenance expenses and increased power purchase costs.
? Changes to regulation of generating plant emissions, including but not limited
to carbon dioxide (CO2) emissions, could affect OTP's operating costs and the
costs of supplying electricity to its customers.
? Competition from foreign and domestic manufacturers, the price and availability
of raw materials and general economic conditions could affect the revenues and
earnings of our manufacturing businesses.
? Our Plastics segment is highly dependent on a limited number of vendors for PVC
resin, many of which are located in the
supply of resin. The loss of a key vendor, or an interruption or delay in the
supply of PVC resin, could result in reduced sales or increased costs for this
? Our plastic pipe companies compete against a large number of other
manufacturers of PVC pipe and manufacturers of alternative products. Customers
may not distinguish the pipe companies' products from those of its competitors.
? Reductions in PVC resin prices can negatively impact PVC pipe prices, profit
margins on PVC pipe sales and the value of PVC pipe held in inventory.
? A significant failure or an inability to properly bid or perform on projects or
contracts by our construction businesses could lead to adverse financial
results and could lead to the possibility of delay or liquidated damages.
? Our construction subsidiaries enter into contracts which could expose them to
unforeseen costs and costs not within their control, which may not be
recoverable and could adversely affect our results of operations and financial