News Column

OTTER TAIL CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 11, 2014

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 and six month periods ended June 30, 2014 and 2013, followed by a discussion of changes in our consolidated financial position during the six months ended June 30, 2014 and our business outlook for the remainder of 2014.



Comparison of the Three Months Ended June 30, 2014 and 2013

Consolidated operating revenues were $234.6 million for the three months ended June 30, 2014 compared with $212.4 million for the three months ended June 30, 2013. Operating income was $18.2 million for the three months ended June 30, 2014 compared with $15.8 million for the three months ended June 30, 2013. The Company recorded diluted earnings per share from continuing operations of $0.27 for the three months ended June 30, 2014 compared to $0.21 for the three months ended June 30, 2013. Amounts presented in the segment tables that follow for operating revenues, cost of goods sold and other nonelectric operating expenses for the three month periods ended June 30, 2014 and 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) June 30, 2014 June 30, 2013 Operating Revenues: Electric $ 8 $ 24 Nonelectric (1 ) (3 ) Cost of Products Sold 5 -- Cost of Construction Revenues Earned -- 1 Other Nonelectric Expenses 2 20 Electric Three Months Ended June 30, % (in thousands) 2014 2013 Change Change Retail Sales Revenues $ 83,360$ 72,263$ 11,097 15.4 Wholesale Revenues - Company Generation 1,762 3,432 (1,670 ) (48.7 ) Net Revenue - Energy Trading Activity 408 596

(188 ) (31.5 ) Other Revenues 7,381 6,571 810 12.3 Total Operating Revenues $ 92,911$ 82,862$ 10,049 12.1 Production Fuel 12,603 15,603 (3,000 ) (19.2 ) Purchased Power - System Use 16,476 11,245 5,231 46.5

Other Operation and Maintenance Expenses 39,774 35,805

3,969 11.1 Depreciation and Amortization 10,926 10,672 254 2.4 Property Taxes 3,387 3,009 378 12.6 Operating Income $ 9,745$ 6,528$ 3,217 49.3 Electric kilowatt-hour (kwh) Sales (in thousands) Retail kwh Sales 1,064,115 962,006 102,109 10.6 Wholesale kwh Sales - Company Generation 57,025 110,912 (53,887 ) (48.6 ) Wholesale kwh Sales - Purchased Power Resold 15,612 36,065 (20,453 ) (56.7 ) Heating Degree Days 673 839 (166 ) (19.8 ) Cooling Degree Days 113 116 (3 ) (2.6 ) 37



Retail electric revenues increased $11.1 million as a result of:

? a $3.9 million increase in revenue due to a 10.6% increase in retail kwh sales

mainly related to increased sales to pipeline and commercial customers,



? a $3.7 million increase in fuel clause adjustment (FCA) revenues and fuel and

purchased power costs recovered in base rates, driven by increased power

purchases to meet higher retail kwh sales demand and higher purchased power

prices,



? a $3.5 million increase in Environmental Costs Recovery (ECR) rider revenue

related to earning a return in Minnesota and North Dakota on increasing

amounts invested in the air quality control system (AQCS) under construction

at Big Stone Plant, and



? a $1.5 million increase in Transmission Cost Recovery (TCR) rider revenues

related to recovering costs and returns earned on increasing investments in

transmission plant, offset by:



? an estimated $0.7 million decrease in revenues related to milder weather in

the second quarter of 2014 compared with the second quarter of 2013,



? a $0.4 million reduction in Big Stone II cost recovery rider revenues as the

North Dakota share of abandoned plant costs were fully recovered by the end of

March 2014, and



? a $0.3 million decrease in accrued conservation improvement program incentives

and cost recovery revenues.

Wholesale electric revenues from company-owned generation decreased $1.7 million as a result of a 49% reduction in wholesale kwh sales. The decrease in wholesale kwh sales was related to a 12.4% decrease in kwhs generated by Otter Tail Power Company (OTP) generating units, mainly as a result of the extended maintenance shutdown of Hoot Lake Plant, which was offline for most of the second quarter of 2014.



Net revenue from energy trading activities, including net marked-to-market losses and gains on forward energy contracts, decreased $0.2 million as a result of decreased trading activity.

Other electric operating revenues increased $0.8 million mainly due to an increase in Midcontinent Independent System Operator, Inc. (MISO) tariff revenues resulting from increased investment in regional transmission lines and returns on and recovery of Capacity Expansion 2020 (CapX2020) and MISO-designated Multi-Value Project (MVP) investment costs and operating expenses.

Production fuel costs decreased $3.0 million as a result of a 14.7% decrease in kwhs generated from OTP's steam-powered and combustion turbine generators in combination with a 5.3% decrease in the cost of fuel per kwh generated. The decreases in kwh generation and the cost of fuel per kwh generated were mainly due to the extended maintenance shutdown of Hoot Lake Plant in the second quarter of 2014. The cost of purchased power to serve retail customers increased $5.2 million due to a 42.8% increase in kwhs purchased and a 2.6% increase in the cost per kwh purchased. The increase in kwhs purchased was driven by the need to make up for the reduction in generation from Hoot Lake Plant and increased demand from retail-mainly pipeline-customers.



Electric operating and maintenance expenses increased $4.0 million as a result of:

? a $3.4 million increase in contracted maintenance and material and supply

costs at Hoot Lake Plant related to its extended maintenance shutdown in the

second quarter of 2014, ? a $1.0 million increase in MISO transmission tariff charges related to increasing investments in regional CapX2020 and MISO-designated MVP transmission projects,



? a $0.6 million increase in costs for wind turbine, transformer, and Coyote

Station maintenance, and ? a $0.5 million increase in expenditures for vegetation maintenance and control, offset by:



? a $1.1 million reduction in labor and benefit expenses mainly due to decreases

in pension and retirement health benefit costs resulting from higher discount

rates on projected benefit obligations, and



? a $0.4 million decrease in amortization of the North Dakota share of Big Stone

II abandoned plant costs in conjunction with final recovery of those costs by

the end of March 2014. The $0.4 million increase in property tax expense is due to higher property valuations for transmission and distribution property in Minnesota and South Dakota. 38 Manufacturing Three Months Ended June 30, % (in thousands) 2014 2013 Change Change Operating Revenues $ 53,370$ 49,793$ 3,577 7.2 Cost of Products Sold 41,185 37,447 3,738 10.0 Operating Expenses 5,100 5,321 (221 ) (4.2 ) Depreciation and Amortization 2,650 2,793 (143 ) (5.1 ) Operating Income $ 4,435$ 4,232$ 203 4.8



The increase in revenues in our Manufacturing segment relates to the following:

? Revenues at BTD Manufacturing, Inc. (BTD), our metal parts stamping and

fabrication company, increased $6.0 million mainly as a result of increased

sales to manufacturers of energy-related, recreational, and lawn and garden

equipment. ? Revenues at T.O. Plastics, Inc. (T.O. Plastics), our manufacturer of



thermoformed plastic and horticultural products, decreased $2.4 million,

mainly due to discontinuing a product packing process performed for a customer

prior to 2014.



The increase in cost of products sold in our Manufacturing segment relates to the following:

? Cost of goods sold at BTD increased $5.8 million due in part to the increase

in sales but also due to the incurrence of additional tooling costs to repair

and refurbish several dies.



? Cost of goods sold at T.O. Plastics decreased $2.1 million as a result of

decreased material costs related to the product packaging process that was

discontinued in 2014.



The decrease in operating expenses in our Manufacturing segment is mainly due to the following:

? Operating expenses at BTD decreased $0.3 million mainly as a result of gains

recorded on the sale of fixed assets in the second quarter of 2014.



? Operating expenses at T.O. Plastics were flat between the quarters.

Depreciation expense decreased $0.1 million at BTD as a result of certain assets reaching the end of their depreciable lives between the quarters.

Plastics Three Months Ended June 30, % (in thousands) 2014 2013 Change Change Operating Revenues $ 48,090$ 44,761$ 3,329 7.4 Cost of Products Sold 38,998 34,890 4,108 11.8 Operating Expenses 2,425 2,241 184 8.2 Depreciation and Amortization 866 822 44 5.4 Operating Income $ 5,801$ 6,808$ (1,007 ) (14.8 )

The increase in Plastics segment revenues is the result of a 6.8% increase in pounds of polyvinyl chloride (PVC) pipe sold combined with a 0.6% increase in the price per pound of pipe sold. States with significant increases in sales were California, Minnesota, North Dakota, Montana, New Mexico, Nevada and Colorado. Cost of products sold increased by $4.1 million due to the increase in sales volume and a 4.6% increase in the cost per pound of pipe sold related to higher PVC resin costs. The increased resin costs could not be fully recovered through increased pipe prices due to competitive market conditions. 39 Construction Three Months Ended June 30, % (in thousands) 2014 2013 Change Change Operating Revenues $ 40,247$ 34,994$ 5,253 15.0



Cost of Construction Revenues Earned 33,881 31,601 2,280

7.2 Operating Expenses 2,622 2,748



(126 ) (4.6 )

Depreciation and Amortization 498 496 2 0.4 Operating Income $ 3,246$ 149$ 3,097 2,078.5



The increase in revenues in our Construction segment relates to the following:

? Revenues at Foley Company (Foley), a mechanical and prime contractor on

industrial projects, increased $2.6 million between the quarters as a result

of increased construction activity in the second quarter of 2014 compared with

the second quarter of 2013.



? Revenues at Aevenia, Inc. (Aevenia), our electrical design and construction

services company, increased $2.7 million between the quarters mainly due to

increased electric transmission and distribution work in western North Dakota.

The increase in cost of construction revenues earned in our Construction segment relates to the following:

? Cost of construction revenues earned at Foley increased $1.5 million as a

result of increased construction activity between the quarters.

? Cost of construction revenues earned at Aevenia increased $0.8 million as a

result of the increase in electric transmission and distribution work.

Aevenia's operating expenses decreased $0.1 million mainly as a result of a decrease in labor expense due to having fewer employees than the same period last year.

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 June 30, % (in thousands) 2014 2013 Change Change Operating Expenses $ 4,959$ 1,886$ 3,073 162.9 Depreciation and Amortization 29 52 (23 ) (44.2 )



The increase in Corporate operating expenses between the quarters includes:

? a $2.5 million charge related to the early termination of an airplane lease in

the second quarter of 2014, as recent divestitures reduced the need for the

airplane,



? a $0.3 million increase in contracted services related to employee development

programs, and ? a $0.2 million increase in accrued performance incentive costs. 40 Interest Charges



The $0.8 million increase in interest charges in the second quarter of 2014 compared with the second quarter of 2013 reflects:

? a $1.9 million increase in interest expense related to the February 27, 2014

issuance of $60 million aggregate principal amount of OTP's 4.68% Series A

Senior Unsecured Notes due February 27, 2029 and $90 million aggregate

principal amount of OTP's 5.47% Series B Senior Unsecured Notes due February

27, 2044. offset by:



? a $1.1 million reduction in interest expense related to the early retirement,

in November 2013, of $47.7 million of our 9.0% unsecured notes due December 15, 2016. Income Taxes - Continuing Operations Income taxes - continuing operations decreased $0.6 million in the second quarter of 2014 compared with the second 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 June 30, 2014 and 2013: Three Months Ended June 30, (in thousands) 2014 2013 Income Before Income Taxes - Continuing Operations $



11,470 $ 9,598 Tax Computed at Company's Net Composite Federal and State Statutory Rate (39%)

4,473 3,743 Increases (Decreases) in Tax from: Federal Production Tax Credits (PTCs) (1,864 ) (1,841 ) Section 199 Domestic Production Activities Deduction (349 ) --



North Dakota Wind Tax Credit Amortization - Net of Federal Taxes

(212 ) (216 ) Employee Stock Ownership Plan Dividend Deduction (189 ) (188 ) Allowance for Funds Used During Construction (AFUDC) Equity (164 ) (106 ) Investment Tax Credits (127 ) (140 ) Deferred Tax Asset Reduction - North Dakota due to Tax Rate Decrease -- 365 Other Items - Net (82 ) 477 Income Tax Expense - Continuing Operations $ 1,486$ 2,094 Effective Income Tax Rate - Continuing Operations 13.0 % 21.8 % 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 6.9% in the three months ended June 30, 2014 compared with the three months ended June 30, 2013. North Dakota wind energy credits are based on dollars invested in qualifying facilities and are being recognized on a straight-line basis over 25 years. 41 Discontinued Operations On February 8, 2013 we 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 million in cash and received a working capital true up of approximately $2.4 million in June 2013. On November 30, 2012 we completed the sale of the assets of our former wind tower manufacturing company and on February 29, 2012 we completed the sale of DMS Health Technologies, Inc. (DMS) and recorded an additional $0.2 million gain on the sale of DMS 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 June 30, 2014 and 2013, which mainly includes residual revenues and expenses from our former wind tower and waterfront equipment manufacturers and the additional $0.2 million gain on the sale of DMS in the first quarter of 2013: For the Three Months Ended June 30, (in thousands) 2014 2013 Operating Revenues $ -- $ 7 Operating Expenses (10 ) (161 ) Operating Income 10 168 Other Income -- 160 Income Tax Expense 1 131 Net Income $ 9 $ 197



Comparison of the Six Months Ended June 30, 2014 and 2013

Consolidated operating revenues were $475.1 million for the six months ended June 30, 2014 compared with $430.3 million for the six months ended June 30, 2013. Operating income was $52.7 million for the six months ended June 30, 2014 compared with $43.0 million for the six months ended June 30, 2013. The Company recorded diluted earnings per share from continuing operations of $0.86 for the six months ended June 30, 2014 compared to $0.61 for the six months ended June 30, 2013 and total diluted earnings per share of $0.86 for the six months ended June 30, 2014 compared to $0.62 for the six months ended June 30, 2013. Amounts presented in the segment tables that follow for operating revenues, cost of goods sold and other nonelectric operating expenses for the six month periods ended June 30, 2014 and 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) June 30, 2014 June 30, 2013 Operating Revenues: Electric $ 48 $ 58 Nonelectric (1 ) 10 Cost of Products Sold 7 12 Cost of Construction Revenues Earned -- 2 Other Nonelectric Expenses 40 54 42 Electric Six Months Ended June 30, %

(in thousands) 2014 2013 Change Change Retail Sales Revenues $ 188,864$ 164,586$ 24,278 14.8 Wholesale Revenues - Company Generation 6,662 5,065 1,597 31.5 Net Revenue - Energy Trading Activity 139 941

(802 ) (85.2 ) Other Revenues 16,334 13,280 3,054 23.0 Total Operating Revenues $ 211,999$ 183,872$ 28,127 15.3 Production Fuel 34,633 33,556 1,077 3.2 Purchased Power - System Use 38,261 27,884 10,377 37.2

Other Operation and Maintenance Expenses 74,396 68,252

6,144 9.0 Depreciation and Amortization 21,689 21,303 386 1.8 Property Taxes 6,358 5,925 433 7.3 Operating Income $ 36,662$ 26,952$ 9,710 36.0 Electric kwh Sales (in thousands) Retail kwh Sales 2,462,006 2,272,318 189,688 8.3 Wholesale kwh Sales - Company Generation 130,330 175,257 (44,927 ) (25.6 ) Wholesale kwh Sales - Purchased Power Resold 17,223 49,854

(32,631 ) (65.5 ) Heating Degree Days 4,762 4,510 252 5.6 Cooling Degree Days 113 116 (3 ) (2.6 )



Retail sales revenue increased $24.3 million as a result of:

? a $9.4 million increase in retail revenue related to increases in FCA revenues

and fuel and purchased power costs recovered in base rates, driven by

increased kwh generation from OTP's higher-fuel-cost natural gas and fuel-oil

fired combustion turbines and by purchases to meet higher retail kwh sales

demand along with higher prices for purchased power,



? a $6.0 million increase in ECR rider revenue related to earning a return in

Minnesota and North Dakota on increasing amounts invested in the AQCS under

construction at Big Stone Plant,



? a $5.4 million increase in revenue mainly related to increased kwh sales to

pipeline and commercial customers,



? a $3.8 million increase in TCR rider revenues related to recovering costs and

earning returns on increased investment in transmission plant, and



? a $1.1 million increase in revenues mainly related to colder winter weather in

2014, evidenced by an 11.4% increase in heating-degree days in the first

quarter of 2014 compared with the first quarter of 2013,

offset by:

? a $1.0 million decrease in Renewable Resource Adjustment (RRA) rider revenues

in North Dakota as a result of declining book values of renewable assets due

to depreciation and reduced RRA requirements related to earning more PTCs as a

result of a 19.7% increase in kwhs generated by OTP's wind turbines eligible

for PTCs, and



? a $0.4 million reduction in Big Stone II cost recovery rider revenues as the

North Dakota share of abandoned plant costs were fully recovered by the end of

March 2014. Wholesale electric revenues from company-owned generation increased $1.6 million as a result of a 76.9% increase in revenue per wholesale kwh sold, partially offset by a 25.6% reduction in wholesale kwh sales. The increase in wholesale prices was driven by increased wholesale market demand resulting from colder weather in the first quarter of 2014. The decrease in wholesale kwh sales was the result of dedicating more company-owned generation to serve the increase in retail kwh demand while having less generation available for sale in the second quarter of 2014 as a result of the extended maintenance shutdown of Hoot Lake Plant, which was offline for most of the second quarter of 2014. Net revenue from energy trading activities, including net marked-to-market gains and losses on forward energy contracts, decreased $0.8 million mainly as a result of decreased trading activity and the incurrence of losses on contracts entered into and settled in the first half of 2014. 43



Other electric operating revenues increased $3.1 million as a result of:

? a $2.4 million increase in MISO tariff revenues related to increased

investment in regional transmission lines and returns on and recovery of

CapX2020 and MISO designated MVP investment costs and operating expenses,

? a $0.3 million increase in transmission related revenue under an integrated

transmission agreement,



? a $0.2 million increase in revenue from steam sales to an ethanol producer

adjacent to OTP's Big Stone Plant site, and



? $0.2 million from the sale of renewable energy credits in the first quarter of

2014. Production fuel costs increased $1.1 million as a result of a 3.0% increase in fuel costs per kwh of generation driven by a 105% increase in kwh generation from OTP's higher-fuel-cost natural gas and fuel-oil fired combustion turbines, partially offset by a 3.0% reduction in fuel costs from OTP's steam-powered generators mainly related to a 38.6% reduction in kwh generation at Hoot Lake Plant due to its extended maintenance outage in the second quarter of 2014. The cost of purchased power to serve retail customers increased $10.4 million due to an 11.0% increase in kwhs purchased in combination with a 23.6% increase in costs per kwh purchased. The increase in kwhs purchased was driven by the need to make up for the reduction in generation from Hoot Lake Plant and increased demand from retail customers. The increase in costs per kwh purchased was driven by increased wholesale market demand resulting from colder weather in the first quarter of 2014.



Electric operating and maintenance expenses increased $6.1 million as a result of:

? a $3.4 million increase in contracted maintenance and material and supply

costs at Hoot Lake Plant related to its extended maintenance shutdown in the

second quarter of 2014, ? a $2.2 million increase in MISO transmission tariff charges related to increasing investments in regional CapX2020 and MISO-designated MVP transmission projects,



? a $0.9 million increase in material and supply and contractor costs related to

required generation plant maintenance at Big Stone Plant, Coyote Station and

two of OTP's wind farms, ? a $0.4 million increase in expenditures for vegetation maintenance and control, and



? a $0.2 million increase in office expense related to the timing of necessary

filings, offset by:



? a $1.0 million reduction in labor and benefit expenses mainly due to decreases

in pension and retirement health benefit costs resulting from higher discount

rates on projected benefit obligations.

The $0.4 million increase in property tax expense is due to higher property valuations for transmission and distribution property in Minnesota and South Dakota. Manufacturing Six Months Ended June 30, % (in thousands) 2014 2013 Change Change Operating Revenues $ 108,805$ 102,959$ 5,846 5.7 Cost of Products Sold 83,384 76,773 6,611 8.6 Operating Expenses 10,325 9,819 506 5.2 Depreciation and Amortization 5,270 5,786 (516 ) (8.9 ) Operating Income $ 9,826$ 10,581$ (755 ) (7.1 )



The increase in revenues in our Manufacturing segment reflects the following:

? Revenues at BTD increased $10.9 million mainly as a result of increased sales

to manufacturers of energy-related, recreational, and lawn and garden equipment.



? Revenues at T.O. Plastics decreased $5.0 million, mainly due to discontinuing

a product packing process performed for a customer prior to 2014.

44



The increase in cost of products sold in our Manufacturing segment reflects the following:

? Cost of products sold at BTD increased $10.7 million as a result of increased

material and labor costs related to an increase in sales volume, increased

product handling costs and the incurrence of additional tooling costs to

repair and refurbish several dies in 2014.

? Cost of products sold at T.O. Plastics decreased $4.1 million mainly as a

result of decreased material costs related to the product packaging process

that was discontinued in 2014.

The increase in operating expenses in our Manufacturing segment is mainly due to the following:

? Operating expenses at BTD increased $0.4 million due to increases in

administrative and general expenses related to increased labor and contracted

service costs.



? Operating expenses at T.O. Plastics increased $0.1 million mainly due to

additional sales and marketing personnel.

Depreciation expense decreased $0.4 million at BTD and $0.1 million at T.O. Plastics as a result of certain assets reaching the end of their depreciable lives. Plastics Six Months Ended June 30, % (in thousands) 2014 2013 Change Change Operating Revenues $ 88,573$ 82,161$ 6,412 7.8 Cost of Products Sold 70,740 63,363 7,377 11.6 Operating Expenses 4,542 3,677 865 23.5 Depreciation and Amortization 1,719 1,596 123 7.7 Operating Income $ 11,572$ 13,525$ (1,953 ) (14.4 )

The increase in Plastics segment revenue is the result of an 8.4% increase in pounds of PVC pipe sold, partially offset by a 0.6% decrease in the price per pound of pipe sold. States with significant increases in sales were Minnesota, California, North Dakota, Colorado and Nevada. Cost of products sold increased by $7.4 million due to the increase in sales volume and a 3.0% increase in the cost per pound of pipe sold related to higher PVC resin costs. The $1.0 million reduction in gross margins combined with a $0.9 million increase in operating expenses related to an increase in allocated corporate costs and increased wage and benefit costs and a $0.1 million increase in depreciation expense resulted in the $2.0 million decline in Plastics segment operating income between the periods. Construction Six Months Ended June 30, % (in thousands) 2014 2013 Change Change Operating Revenues $ 65,753$ 61,419$ 4,334 7.1

Cost of Construction Revenues Earned 56,243 55,877 366 0.7 Operating Expenses 6,472 6,134 338 5.5 Depreciation and Amortization 1,010 958 52 5.4 Operating Income (Loss) $ 2,028$ (1,550 )$ 3,578 230.8



The increase in revenues in our Construction segment relates to the following:

? Revenues at Foley increased $0.8 million mainly as a result of increased

construction activity in 2014.



? Revenues at Aevenia increased $3.6 million mainly due to increased electric

transmission and distribution work in western North Dakota.

45



The increase in cost of construction revenues earned in our Construction segment reflects the following:

? Cost of construction revenues earned at Foley decreased $1.2 million mainly as

a result of a $4.9 million decrease in material costs related to a reduction

in material intensive jobs, partially offset by a $3.6 million increase in

subcontractor and labor costs related to an increase in work volume in 2014.

? Cost of construction revenues earned at Aevenia increased $1.6 million mainly

as a result of increased material costs related to the increase in electric

transmission and distribution work in western North Dakota.

The increase in operating expenses in our Construction segment reflects the following:

? Foley's wage expenses increased $0.5 million between the periods, due in part

to incentive compensation and in part to severance costs related to workforce

reductions.



? Aevenia's operating expenses decreased $0.2 million as a result of a decrease

in labor expense due to having fewer employees than the same period last year.

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. Six Months Ended June 30, % (in thousands) 2014 2013 Change Change Operating Expenses $ 7,366$ 6,378$ 988 15.5 Depreciation and Amortization 61 112 (51 ) (45.5 )



Corporate operating expenses decreased $1.0 million reflecting:

? a $2.5 million charge related to the early termination of an airplane lease in

the second quarter of 2014, as recent divestitures reduced the need for the

airplane, offset by:



? a $1.6 million increase in corporate operating expenses allocated to the

corporation's operating segments. Interest Charges



The $0.4 million increase in interest charges in the first six months of 2014 compared with the first six months of 2013, primarily reflects:

? a $2.6 million increase in interest expense related to the February 27, 2014

issuance of $60 million aggregate principal amount of OTP's 4.68% Series A

Senior Unsecured Notes due February 27, 2029 and $90 million aggregate

principal amount of OTP's 5.47% Series B Senior Unsecured Notes due February

27, 2044. offset by:



? a $2.1 million reduction in interest expense related to the early retirement

of $47.7 million of our 9.0% unsecured notes due December 15, 2016, in November 2013. Other Income

The $1.1 million increase in other income in the six months ended June 30, 2014 compared with the six months ended June 30, 2013 includes a $0.8 million gain on the sale of an investment in tax-credit-qualified low income housing rental property, and a $0.3 million gain on the sale of Aevenia's data communication installation and services business, both sold in the first quarter of 2014.

46 Income Taxes - Continuing Operations Income taxes - continuing operations increased $1.8 million in the first six months of 2014 compared with the first six months 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 six month periods ended June 30, 2014 and 2013: Six Months Ended June 30, (in thousands) 2014 2013 Income Before Income Taxes - Continuing Operations $



41,120 $ 30,718 Tax Computed at Company's Net Composite Federal and State Statutory Rate (39%)

16,037 11,980 Increases (Decreases) in Tax from: Federal PTCs (4,116 ) (3,430 ) Section 199 Domestic Production Activities Deduction (707 ) --



North Dakota Wind Tax Credit Amortization - Net of Federal Taxes

(425 ) (439 ) Employee Stock Ownership Plan Dividend Deduction (379 ) (378 ) AFUDC Equity (297 ) (221 ) Investment Tax Credits (254 ) (280 )



Deferred Tax Asset Reduction - North Dakota due to Tax Rate Decrease

-- 365 Other Items - Net (85 ) 383 Income Tax Expense - Continuing Operations $ 9,774$ 7,980 Effective Income Tax Rate - Continuing Operations 23.8 % 26.0 % 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 19.7% in the six months ended June 30, 2014 compared with the six months ended June 30, 2013. North Dakota wind energy credits are based on dollars invested in qualifying facilities and are being recognized on a straight-line basis over 25 years. Discontinued Operations On February 8, 2013 we 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 million in cash and received a working capital true up of approximately $2.4 million in June 2013. On November 30, 2012 we completed the sale of the assets of our former wind tower manufacturing company and on February 29, 2012 we completed the sale of DMS and recorded an additional $0.2 million gain on the sale of DMS 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 six month periods ended June 30, 2014 and 2013, which mainly includes residual revenues and expenses from our former wind tower and waterfront equipment manufacturers and the additional $0.2 million gain on the sale of DMS in the first quarter of 2013: For the Six Months Ended June 30, (in thousands) 2014 2013 Operating Revenues $ -- $ 2,016 Operating Expenses (127 ) 2,546 Operating Income (Loss) 127



(530 )

Other Income --



572

Income Tax Expense (Benefit) 50



(74 )

Net Income from Operations 77



116

Gain on Disposition Before Taxes --



216

Income Tax Expense on Disposition -- 6 Net Gain on Disposition -- 210 Net Income $ 77 $ 326 47 FINANCIAL POSITION



The following table presents the status of our lines of credit as of June 30, 2014 and December 31, 2013:

Available Restricted due to on In Use on Outstanding Available on December (in thousands) Line Limit June 30, 2014 Letters of Credit June 30, 2014 31, 2013 Otter Tail Corporation Credit Agreement $ 150,000$ 25,273 $ 309 $ 124,418$ 149,341 OTP Credit Agreement 170,000 2,870 2,330 164,800 116,975 Total $ 320,000$ 28,143 $ 2,639 $ 289,218$ 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, 2012 we filed a shelf registration statement with the Securities and Exchange Commission under 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. In the second quarter of 2014 we received net proceeds of $2.5 million from the issuance of 86,909 shares under this program. 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. Our common stock dividend payments 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, 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. In 2014 our Board of Directors increased the quarterly dividend from $0.2975 to $0.3025 per common share. Cash provided by operating activities of continuing operations was $4.4 million for the six months ended June 30, 2014 compared with $48.8 million for the six months ended June 30, 2013. The major contributing factors to the $44.4 million decrease in cash provided by operating activities between the periods was a $32.0 million increase in cash used for working capital items from $16.7 million in the first six months of 2013 to $48.7 million in the first six months of 2014, and a $10.0 million increase in discretionary contributions to our pension plan between the periods. The following major items contributed $34.7 million to the increase in cash used for working capital between the periods:



? In the Plastics segment, accounts receivable and inventories increased

$18.7 million in the first six months of 2014 compared with an increase of

$11.0 million in the first six months of 2013. The greater increase in

receivables and inventories in the Plastic segment in 2014 corresponds with an

8.4% increase in sales volume, a 7.8% increase in revenues, higher material,

freight, labor and utility costs and a greater build-up of inventory compared

with the first six months of 2013.



? Foley's accounts payable and billings in excess of costs decreased $12.9

million in the first six months of 2014 compared with a $1.1 million increase

in accounts payable and billings in excess of costs in the first six months of

2013 and Foley's accounts receivable and costs in excess of billings increased

$5.2 million in the first six months of 2014 compared with a $1.0 million

increase in the first six months of 2013, as accelerated cash payments

received on certain jobs at Foley at the end of 2013 enabled them to pay for

increased costs incurred on a higher level of construction activity in the

first half of 2014 compared with the first half of 2013.

48



? In the electric segment, accounts payable related to operating activities

decreased $5.3 million in the first six months of 2014 compared to an increase

of $3.5 million in the first six months of 2013.

Net cash used in investing activities of continuing operations was $79.2 million for the six months ended June 30, 2014 compared with $49.6 million for the six months ended June 30, 2013 due to a $30.5 million increase in cash used for capital expenditures in the Electric segment, as construction of the Big Stone Plant AQCS remains on pace and OTP continues to invest in major transmission grid upgrades and improvements, offset by a $0.9 million reduction in capital expenditures at Foley. Net proceeds from the sale of discontinued operations of $12.8 million in the first six months of 2013 reflect $14.5 million in net proceeds from the sale of the assets of our former waterfront equipment manufacturer net of a $1.7 million working capital settlement paid to the buyer of DMS, which was sold in the first quarter of 2012. Net cash provided by financing activities in the six months ended June 30, 2014 of $73.9 million compares with net cash used in financing activities in the six months ended June 30, 2014 of $19.6 million. Net cash provided by financing activities in the first six months of 2014 mainly reflects the issuance by OTP of $150 million in 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 million unsecured term loan and to repay short-term debt outstanding under the OTP Credit Agreement which was being used to finance OTP's construction activities. Financing activities in the first six months of 2014 also reflect: (1) the payment of $22.0 million in common stock dividends, (2) OTP's repayment of $51.2 million in short-term debt under the OTP Credit Agreement outstanding on December 31, 2013, (3) the borrowing of $25.3 million under the Otter Tail Corporation Credit Agreement to fund the working capital needs of our manufacturing and infrastructure companies and (4) the borrowing of $2.9 million under the OTP Credit Agreement to fund a portion of OTP's 2014 capital expenditures. Financing cash flows for the first six months of 2014 also include $8.5 million in cash proceeds from the issuance of common stock. In 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. In the second quarter of 2014 we began issuing common shares using our At-the-Market offering program under our Distribution Agreement with JPMS. Net cash used in financing activities of continuing operations in the six months ended June 30, 2013 of $19.6 million reflects $2.6 million in proceeds from short-term borrowings and the issuance of common stock offset by $22.1 million in common and preferred stock dividend payments. On March 1, 2013 OTP used proceeds from a $40.9 million unsecured term loan to fund the redemption of all $25.1 million of the then outstanding 4.65% Grant County, South Dakota Pollution Control Refunding Revenue Bonds and 4.85% Mercer County, North Dakota Pollution Control Refunding Revenue Bonds, and to pay off an intercompany note to the Company that mirrored the Company's $15.5 million in outstanding cumulative preferred shares, which were also redeemed on March 1, 2013.



CAPITAL REQUIREMENTS

2014-2018 Capital Expenditures The following table shows our 2013 capital expenditures, 2014-2018 projected electric utility average rate base and updated 2014-2018 anticipated capital expenditures reflecting additional expenditures in 2018 for a generation facility to replace Hoot Lake Plant, expected reductions in costs for the Big Stone Plant AQCS and an acceleration of expenditures for transmission line

construction: 2013 (in millions) Actual 2014 2015 2016 2017 2018

Capital Expenditures: Electric Segment: Transmission $ 55$ 55$ 98$ 63$ 63 Environmental 73 50 -- -- -- Other 34 43 45 41 80 Total Electric Segment $ 149$ 162$ 148$ 143$ 104$ 143

Manufacturing and Infrastructure Segments 15 23 19 26 20 24 Total Capital Expenditures $ 164$ 185$ 167$ 169$ 124$ 167 Total 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. 49 Ashtabula III Wind Farm OTP 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 million in 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, 2013 increased $340 million in the first half of 2014. Our long-term debt obligations increased $150 million for the years beyond 2018 and our interest obligations on long-term debt increased by $3.9 million for 2014, $15.5 million for 2015 and 2016, $15.5 million for 2017 and 2018 and $155 million for the years beyond 2018 as a result of OTP's February 27, 2014 borrowings 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 half of 2014.



CAPITAL RESOURCES

Short-Term Debt On October 29, 2012 we entered into a Third Amended and Restated Credit Agreement (the Otter Tail Corporation Credit Agreement), which is an unsecured $150 million revolving credit facility that may be increased to $250 million on the terms and subject to the conditions described in the Otter Tail Corporation Credit Agreement. On October 29, 2013 the Otter Tail Corporation Credit Agreement was amended to extend its expiration date by one year from October 29, 2017 to 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 LIBOR plus 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 LIBOR plus 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. On October 29, 2012 OTP entered into a Second Amended and Restated Credit Agreement (the OTP Credit Agreement), providing for an unsecured $170 million revolving credit facility that may be increased to $250 million on the terms and subject to the conditions described in the OTP Credit Agreement. On October 29, 2013 the OTP Credit Agreement was amended to extend its expiration date by one year from October 29, 2017 to 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 million outstanding at any time. Borrowings under this line of credit bear interest at LIBOR plus 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. 50 Long-Term Debt 2016 Notes On December 4, 2009 we issued $100 million of 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 15 and December 15 of each year. In November 2013 we purchased and retired, in two separate transactions, $12,933,000 and $34,737,000, respectively, of our outstanding 2016 Notes. The remaining $52,330,000 principal 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, 2013 OTP 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 million aggregate principal amount of OTP's 4.68% Series A Senior Unsecured Notes due February 27, 2029 (the Series A Notes) and $90 million aggregate 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, 2014 OTP issued all $150 million aggregate principal amount of the Notes. OTP used a portion of the proceeds of the Notes to retire its $40.9 million unsecured term loan under a Credit Agreement with JPMorgan Chase Bank, N.A., and to repay $82.5 million of short-term debt then outstanding under the OTP Credit Agreement. Remaining proceeds of the Notes have been used to fund OTP construction program expenditures. 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, 2028 or (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. 2007 and 2011 Note Purchase Agreements On December 1, 2011, OTP issued $140 million aggregate 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 million aggregate principal amount of OTP's 6.63% Senior Notes due December 1, 2011 at maturity and to retire early $10.4 million aggregate 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 million contribution to the Company's pension plan in January 2012. 51

OTP also has outstanding its $155 million senior unsecured notes issued in four series consisting of $33 million aggregate principal amount of 5.95% Senior Unsecured Notes, Series A, due 2017; $30 million aggregate principal amount of 6.15% Senior Unsecured Notes, Series B, due 2022; $42 million aggregate principal amount of 6.37% Senior Unsecured Notes, Series C, due 2027; and $50 million aggregate 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 and OTP were in compliance with the financial covenants in our respective debt agreements as of June 30, 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 June 30, 2014 our Interest and

Dividend Coverage Ratio calculated under the requirements of the Otter Tail

Corporation Credit Agreement was 4.21 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 June 30,

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 3.84 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.

As of June 30, 2014 our interest-bearing debt to total capitalization was 0.49 to 1.00 on a consolidated basis and 0.53 to 1.00 for OTP.

OFF-BALANCE-SHEET ARRANGEMENTS

We and our subsidiary companies have outstanding letters of credit totaling $8.1 million, but our line of credit borrowing limits are only restricted by $2.6 million of 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. 52 2014 BUSINESS OUTLOOK We are narrowing our consolidated diluted earnings per share guidance for 2014 to be in the range of $1.65 to $1.80 from our previously announced range of $1.60 to $1.80. This 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 2013 earnings per share and 2014 earnings per share guidance ranges are as follows:

2013 February 2014 EPS May 2014 EPS Current 2014 EPS EPS by Guidance Guidance Guidance Segment Low High Low High Low High Electric $1.05$1.19$1.23$1.21$1.25$1.23$1.26 Manufacturing $0.32$0.29$0.33$0.29$0.33$0.30$0.33 Plastics $0.38$0.25$0.29$0.27$0.31$0.26$0.29 Construction $0.04$0.07$0.11$0.07$0.11$0.10$0.13 Corporate ($0.25) ($0.25) ($0.21) ($0.24) ($0.20) ($0.24) ($0.21) Subtotal - Continuing Operations $1.54$1.55$1.75$1.60$1.80$1.65$1.80 Corporate - Loss on Debt Extinguishment ($0.17) Total - Continuing Operations $1.37$1.55$1.75$1.60$1.80$1.65$1.80



Contributing to our updated earnings guidance for 2014 are the following items:

? We are raising our 2014 net income expectations for our Electric segment from

our previously issued guidance primarily from strong first quarter results

driven in part by colder than normal weather. Items affecting our 2014 Electric segment earnings guidance compared with 2013 segment earnings include:



o Rider recovery increases, including environmental riders in Minnesota and

North Dakota related to the Big Stone AQCS environmental upgrades while under

construction, and



o A decrease in pension costs of approximately $2.0 million as a result of an

increase in the discount rate from 4.5% to 5.3%, offset by



o An increase in interest costs as a result of $150 million of fixed rate long

term debt put in place in the first quarter of 2014 to finance the Big Stone

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 narrowing our 2014 earnings expectations for our Manufacturing segment,

which are expected 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 T.O. Plastics due to a reduction in sales of a

product the customer will be producing on its own in 2014, and



o Backlog for the manufacturing companies of approximately $86 million for 2014

compared with $76 million one year ago.



? We are lowering our previous 2014 net income guidance for our Plastics segment

due to an expected continued increase in PVC resin costs which, based on

current market conditions, are not expected to be fully recovered through

higher sales prices for PVC pipe due to current competitive market conditions.

? We are raising our previous 2014 net income guidance for our Construction

segment. Segment net income for 2014 is expected to be higher than previous

guidance and 2013 net income 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 $64 million for 2014 compared with $74 million one year ago.



? We are narrowing our previous range for corporate costs for 2014. Corporate

costs for 2014 are still expected to be lower than 2013 costs, despite the

charge recorded to exit the airplane lease early, as a result of lower

interest costs, the 2014 sale of an investment in tax-credit-qualified low

income housing rental property and improved performance in our self-insured

health plan. 53 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 June 30, 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 $20.0 million in discretionary contributions to our defined benefit

pension plan in January 2014. We could be required to contribute additional

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.

54



? We currently have $7.3 million of goodwill and a $1.1 million indefinite-lived

trade name recorded on our consolidated balance sheet related to the

acquisition of Foley Company in 2003. Foley net earnings improved $10.4 million

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

earnings.

? 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

financial performance.



? 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

future periods.



? 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

expenditures.

? 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 Gulf Coast regions, and a limited

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

segment.



? 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.

? Changes 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

condition.



55


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Source: Edgar Glimpses


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