Otter Tail Corp - Quarter Report: 2022 March (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☒ Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2022 or
☐ Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number 0-53713
OTTER TAIL CORPORATION
(Exact name of registrant as specified in its charter)
Minnesota (State or other jurisdiction of incorporation or organization) | 27-0383995 (I.R.S. Employer Identification No.) | ||||
215 South Cascade Street, Box 496, Fergus Falls, Minnesota (Address of principal executive offices) | 56538-0496 (Zip Code) | ||||
Registrant's telephone number, including area code: 866-410-8780
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||||||
| Common Shares, par value $5.00 per share | OTTR | The Nasdaq Stock Market LLC | ||||||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer ☑ | Accelerated Filer ☐ | ||||||||||||||||
Non-Accelerated Filer ☐ | Smaller Reporting Company ☐ | Emerging Growth Company ☐ | |||||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑
Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date:
41,630,655 Common Shares ($5 par value) as of April 27, 2022.
| TABLE OF CONTENTS | |||||||||||
| Description | Page | |||||||
| ITEM 1. | ||||||||
| ITEM 2. | ||||||||
| ITEM 3. | ||||||||
| ITEM 4. | ||||||||
| ITEM 1. | ||||||||
| ITEM 1A. | ||||||||
| ITEM 6. | ||||||||
1
| DEFINITIONS | |||||||||||
| AFUDC | Allowance for Funds Used During Construction | MISO | Midcontinent Independent System Operator, Inc. | |||||||||||
| ARP | Alternative Revenue Program | MPUC | Minnesota Public Utilities Commission | |||||||||||
| BTD | BTD Manufacturing, Inc. | OTC | Otter Tail Corporation | |||||||||||
| CIP | Conservation Improvement Program | OTP | Otter Tail Power Company | |||||||||||
| EPA | Environmental Protection Agency | PTCs | Production tax credits | |||||||||||
| ESSRP | Executive Survivor and Supplemental Retirement Plan | PVC | Polyvinyl chloride | |||||||||||
| FERC | Federal Energy Regulatory Commission | RHR | Regional Haze Rule | |||||||||||
| GCR | Generation Cost Recovery Rider | ROE | Return on equity | |||||||||||
| ISO | Independent System Operator | RRR | Renewable Resource Rider | |||||||||||
| IRP | Integrated Resource Plan | SEC | Securities and Exchange Commission | |||||||||||
| kwh | kilowatt-hour | T.O. Plastics | T.O. Plastics, Inc. | |||||||||||
| Merricourt | Merricourt Wind Energy Center | TCR | Transmission Cost Recovery Rider | |||||||||||
| FORWARD-LOOKING INFORMATION | ||
PART I. FINANCIAL INFORMATION
| ITEM 1. | FINANCIAL STATEMENTS | ||||
2
OTTER TAIL CORPORATION
CONSOLIDATED BALANCE SHEETS (unaudited)
| (in thousands, except share data) | March 31, 2022 | December 31, 2021 | |||||||||
| Assets | |||||||||||
| Current Assets | |||||||||||
| Cash and Cash Equivalents | $ | 1,371 | $ | 1,537 | |||||||
| Receivables, net of allowance for credit losses | 218,896 | 174,953 | |||||||||
| Inventories | 145,857 | 148,490 | |||||||||
| Regulatory Assets | 21,770 | 27,342 | |||||||||
| Other Current Assets | 14,497 | 17,032 | |||||||||
| Total Current Assets | 402,391 | 369,354 | |||||||||
| Noncurrent Assets | |||||||||||
| Investments | 57,893 | 56,690 | |||||||||
| Property, Plant and Equipment, net of accumulated depreciation | 2,128,344 | 2,124,605 | |||||||||
| Regulatory Assets | 124,413 | 125,508 | |||||||||
| Intangible Assets, net of accumulated amortization | 8,768 | 9,044 | |||||||||
| Goodwill | 37,572 | 37,572 | |||||||||
| Other Noncurrent Assets | 32,360 | 32,057 | |||||||||
| Total Noncurrent Assets | 2,389,350 | 2,385,476 | |||||||||
| Total Assets | $ | 2,791,741 | $ | 2,754,830 | |||||||
| Liabilities and Shareholders' Equity | |||||||||||
| Current Liabilities | |||||||||||
| Short-Term Debt | $ | 97,770 | $ | 91,163 | |||||||
| Current Maturities of Long-Term Debt | 29,990 | 29,983 | |||||||||
| Accounts Payable | 119,022 | 135,089 | |||||||||
| Accrued Salaries and Wages | 19,846 | 31,704 | |||||||||
| Accrued Taxes | 21,879 | 19,245 | |||||||||
| Regulatory Liabilities | 27,211 | 24,844 | |||||||||
| Other Current Liabilities | 57,437 | 55,671 | |||||||||
| Total Current Liabilities | 373,155 | 387,699 | |||||||||
| Noncurrent Liabilities | |||||||||||
| Pension Benefit Liability | 53,153 | 73,973 | |||||||||
| Other Postretirement Benefits Liability | 66,383 | 66,481 | |||||||||
| Regulatory Liabilities | 233,989 | 234,430 | |||||||||
| Deferred Income Taxes | 203,877 | 188,268 | |||||||||
| Deferred Tax Credits | 16,475 | 16,661 | |||||||||
| Other Noncurrent Liabilities | 63,497 | 62,527 | |||||||||
| Total Noncurrent Liabilities | 637,374 | 642,340 | |||||||||
| Capitalization | |||||||||||
| Long-Term Debt, net of current maturities | 734,074 | 734,014 | |||||||||
| Shareholders' Equity | |||||||||||
Common Shares: 50,000,000 shares authorized, $5 par value; 41,605,884 and 41,551,524 outstanding at March 31, 2022 and December 31, 2021 | 208,029 | 207,758 | |||||||||
| Additional Paid-In Capital | 421,449 | 419,760 | |||||||||
| Retained Earnings | 424,605 | 369,783 | |||||||||
| Accumulated Other Comprehensive Loss | (6,945) | (6,524) | |||||||||
| Total Shareholders' Equity | 1,047,138 | 990,777 | |||||||||
| Total Capitalization | 1,781,212 | 1,724,791 | |||||||||
| Total Liabilities and Shareholders' Equity | $ | 2,791,741 | $ | 2,754,830 | |||||||
See accompanying notes to consolidated financial statements.
3
OTTER TAIL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (unaudited)
| Three Months Ended March 31, | |||||||||||
| (in thousands, except per-share amounts) | 2022 | 2021 | |||||||||
| Operating Revenues | |||||||||||
| Electric | $ | 130,416 | $ | 123,699 | |||||||
| Product Sales | 244,488 | 138,011 | |||||||||
| Total Operating Revenues | 374,904 | 261,710 | |||||||||
| Operating Expenses | |||||||||||
| Electric Production Fuel | 14,853 | 14,714 | |||||||||
| Electric Purchased Power | 20,529 | 19,260 | |||||||||
| Electric Operating and Maintenance Expenses | 44,278 | 41,421 | |||||||||
| Cost of Products Sold (excluding depreciation) | 151,759 | 101,977 | |||||||||
| Other Nonelectric Expenses | 17,206 | 13,693 | |||||||||
| Depreciation and Amortization | 23,548 | 22,126 | |||||||||
| Electric Property Taxes | 4,432 | 4,320 | |||||||||
| Total Operating Expenses | 276,605 | 217,511 | |||||||||
| Operating Income | 98,299 | 44,199 | |||||||||
| Other Income and Expense | |||||||||||
| Interest Charges | 8,948 | 9,398 | |||||||||
| Nonservice Cost Components of Postretirement Benefits | (22) | 383 | |||||||||
| Other Income (Expense), net | 260 | 1,160 | |||||||||
| Income Before Income Taxes | 89,633 | 35,578 | |||||||||
| Income Tax Expense | 17,630 | 5,249 | |||||||||
| Net Income | $ | 72,003 | $ | 30,329 | |||||||
| Weighted-Average Common Shares Outstanding: | |||||||||||
| Basic | 41,548 | 41,455 | |||||||||
| Diluted | 41,871 | 41,700 | |||||||||
| Earnings Per Share: | |||||||||||
| Basic | $ | 1.73 | $ | 0.73 | |||||||
| Diluted | $ | 1.72 | $ | 0.73 | |||||||
See accompanying notes to consolidated financial statements.
4
OTTER TAIL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)
| Three Months Ended March 31, | |||||||||||
| (in thousands) | 2022 | 2021 | |||||||||
| Net Income | $ | 72,003 | $ | 30,329 | |||||||
| Other Comprehensive (Loss) Income: | |||||||||||
Unrealized (Loss) on Available-for-Sale Securities, net of tax benefit of $61 and $10 | (231) | (35) | |||||||||
Pension and Other Postretirement Benefits, net of tax benefit (expense) of $67 and $(53) | (190) | 150 | |||||||||
| Total Other Comprehensive (Loss) Income | $ | (421) | $ | 115 | |||||||
| Total Comprehensive Income | $ | 71,582 | $ | 30,444 | |||||||
See accompanying notes to consolidated financial statements.
5
OTTER TAIL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (unaudited)
| (in thousands, except common shares outstanding) | Common Shares Outstanding | Par Value, Common Shares | Additional Paid-In Capital | Retained Earnings | Accumulated Other Comprehensive Income (Loss) | Total Shareholders' Equity | |||||||||||||||||||||||||||||
| Balance, December 31, 2021 | 41,551,524 | $ | 207,758 | $ | 419,760 | $ | 369,783 | $ | (6,524) | $ | 990,777 | ||||||||||||||||||||||||
| Stock Issued Under Share-Based Compensation Plans, net of shares withheld for employee taxes | 54,360 | 271 | (3,215) | — | — | (2,944) | |||||||||||||||||||||||||||||
| Net Income | — | — | — | 72,003 | — | 72,003 | |||||||||||||||||||||||||||||
| Other Comprehensive Loss | — | — | — | — | (421) | (421) | |||||||||||||||||||||||||||||
| Stock Compensation Expense | — | — | 4,904 | — | — | 4,904 | |||||||||||||||||||||||||||||
Common Dividends ($0.4125 per share) | — | — | — | (17,181) | — | (17,181) | |||||||||||||||||||||||||||||
| Balance, March 31, 2022 | 41,605,884 | $ | 208,029 | $ | 421,449 | $ | 424,605 | $ | (6,945) | $ | 1,047,138 | ||||||||||||||||||||||||
| Balance, December 31, 2020 | 41,469,879 | $ | 207,349 | $ | 414,246 | $ | 257,878 | $ | (8,507) | $ | 870,966 | ||||||||||||||||||||||||
| Stock Issued Under Share-Based Compensation Plans, net of shares withheld for employee taxes | 40,576 | 203 | (1,710) | — | — | (1,507) | |||||||||||||||||||||||||||||
| Stock Issued Under Dividend Reinvestment and Stock Purchase Plans, net of expenses and repurchased shares | — | — | (25) | — | — | (25) | |||||||||||||||||||||||||||||
| Net Income | — | — | — | 30,329 | — | 30,329 | |||||||||||||||||||||||||||||
| Other Comprehensive Income | — | — | — | — | 115 | 115 | |||||||||||||||||||||||||||||
| Stock Compensation Expense | — | — | 4,197 | — | — | 4,197 | |||||||||||||||||||||||||||||
Common Dividends ($0.39 per share) | — | — | — | (16,208) | — | (16,208) | |||||||||||||||||||||||||||||
| Balance, March 31, 2021 | 41,510,455 | $ | 207,552 | $ | 416,708 | $ | 271,999 | $ | (8,392) | $ | 887,867 | ||||||||||||||||||||||||
See accompanying notes to consolidated financial statements.
6
OTTER TAIL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
| Three Months Ended March 31, | |||||||||||
| (in thousands) | 2022 | 2021 | |||||||||
| Operating Activities | |||||||||||
| Net Income | $ | 72,003 | $ | 30,329 | |||||||
| Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: | |||||||||||
| Depreciation and Amortization | 23,548 | 22,126 | |||||||||
| Deferred Tax Credits | (186) | (186) | |||||||||
| Deferred Income Taxes | 14,342 | 5,697 | |||||||||
| Discretionary Contribution to Pension Plan | (20,000) | (10,000) | |||||||||
| Allowance for Equity Funds Used During Construction | (260) | (45) | |||||||||
| Stock Compensation Expense | 4,904 | 4,197 | |||||||||
| Other, Net | 866 | (1,407) | |||||||||
| Changes in Operating Assets and Liabilities: | |||||||||||
| Receivables | (43,943) | (20,431) | |||||||||
| Inventories | 3,403 | (261) | |||||||||
| Regulatory Assets | 4,468 | 703 | |||||||||
| Other Assets | 3,729 | (6,421) | |||||||||
| Accounts Payable | (12,533) | 2,245 | |||||||||
| Accrued and Other Liabilities | (7,859) | (8,890) | |||||||||
| Regulatory Liabilities | 2,812 | (3,850) | |||||||||
| Pension and Other Postretirement Benefits | 122 | 1,464 | |||||||||
| Net Cash Provided by Operating Activities | 45,416 | 15,270 | |||||||||
| Investing Activities | |||||||||||
| Capital Expenditures | (28,710) | (50,076) | |||||||||
| Proceeds from Disposal of Noncurrent Assets | 878 | 3,244 | |||||||||
| Cash Used for Investments and Other Assets | (3,617) | (2,188) | |||||||||
| Net Cash Used in Investing Activities | (31,449) | (49,020) | |||||||||
| Financing Activities | |||||||||||
| Net Borrowings on Short-Term Debt | 6,608 | 53,854 | |||||||||
| Payments for Retirement of Long-Term Debt | — | (169) | |||||||||
| Dividends Paid | (17,181) | (16,208) | |||||||||
| Payments for Shares Withheld for Employee Tax Obligations | (2,942) | (1,507) | |||||||||
| Other, net | (618) | (2,171) | |||||||||
Net Cash (Used in) Provided by Financing Activities | (14,133) | 33,799 | |||||||||
| Net Change in Cash and Cash Equivalents | (166) | 49 | |||||||||
| Cash and Cash Equivalents at Beginning of Period | 1,537 | 1,163 | |||||||||
| Cash and Cash Equivalents at End of Period | $ | 1,371 | $ | 1,212 | |||||||
| Supplemental Disclosure of Noncash Investing Activities | |||||||||||
| Accrued Property, Plant and Equipment Additions | $ | 9,165 | $ | 18,962 | |||||||
See accompanying notes to consolidated financial statements
7
OTTER TAIL CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
1. Summary of Significant Accounting Policies
Overview
Otter Tail Corporation (OTC) and its subsidiaries (collectively, the "Company", "us", "our" or "we") form a diverse, multi-platform business consisting of a vertically integrated, regulated utility with generation, transmission and distribution facilities complemented by manufacturing businesses providing metal fabrication for custom machine parts and metal components, manufacturing of extruded and thermoformed plastic products, and manufacturing of polyvinyl chloride (PVC) pipe products. We classify our business into three segments: Electric, Manufacturing and Plastics.
Basis of Presentation
The unaudited consolidated financial statements included herein have been prepared pursuant to the rules and regulations of the SEC for interim reporting. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles. In the opinion of management, we have included all adjustments, including normal recurring accruals, necessary for a fair presentation of the consolidated financial statements for the periods presented. The consolidated financial statements and condensed notes thereto should be read in conjunction with the consolidated financial statements and notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021.
Because of the seasonality of our businesses and other factors, the earnings for the three months ended March 31, 2022 should not be taken as an indication of earnings for all or any part of the balance of the current year or as an indication of earnings for future years.
Use of Estimates
We use estimates based on the best information available in recording transactions and balances resulting from business operations. As better information becomes available or actual amounts are known, the recorded estimates are revised. Consequently, operating results can be affected by revisions to prior accounting estimates.
Reclassifications
Certain reclassifications of amounts previously reported have been made to the accompanying consolidated statements of shareholders' equity and consolidated statements of cash flows to maintain consistency and comparability between periods presented. The reclassifications had no impact on previously reported shareholders' equity, net cash provided by operating activities, net cash used in investing activities, net cash (used in) provided by financing activities, or cash and cash equivalents.
2. Segment Information
We classify our business into three segments, Electric, Manufacturing and Plastics, consistent with our business strategy, organizational structure and our internal reporting and review processes used by our chief operating decision maker to make decisions regarding allocation of resources, to assess operating performance and to make strategic decisions.
Certain assets and costs are not allocated to our operating segments. Corporate operating costs include 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 assets consist primarily of cash, prepaid expenses, investments and fixed assets. Corporate is not an operating segment, rather it is added to operating segment totals to reconcile to consolidated amounts.
Information for each segment and our unallocated corporate costs for the three months ended March 31, 2022 and 2021 are as follows:
| Three Months Ended March 31, | ||||||||||||||
| (in thousands) | 2022 | 2021 | ||||||||||||
| Operating Revenue | ||||||||||||||
| Electric | $ | 130,416 | $ | 123,699 | ||||||||||
| Manufacturing | 104,957 | 75,825 | ||||||||||||
| Plastics | 139,531 | 62,186 | ||||||||||||
| Total | $ | 374,904 | $ | 261,710 | ||||||||||
| Net Income (Loss) | ||||||||||||||
| Electric | $ | 19,233 | $ | 17,587 | ||||||||||
| Manufacturing | 4,084 | 5,385 | ||||||||||||
| Plastics | 50,846 | 9,147 | ||||||||||||
| Corporate | (2,160) | (1,790) | ||||||||||||
| Total | $ | 72,003 | $ | 30,329 | ||||||||||
8
The following provides the identifiable assets by segment and corporate assets as of March 31, 2022 and December 31, 2021:
| (in thousands) | March 31, 2022 | December 31, 2021 | |||||||||
| Identifiable Assets | |||||||||||
| Electric | $ | 2,278,337 | $ | 2,283,776 | |||||||
| Manufacturing | 269,833 | 251,044 | |||||||||
| Plastics | 184,865 | 162,565 | |||||||||
| Corporate | 58,706 | 57,445 | |||||||||
| Total | $ | 2,791,741 | $ | 2,754,830 | |||||||
3. Revenue
We present our operating revenues to external customers, in total and by amounts arising from contracts with customers and alternative revenue program (ARP) arrangements, disaggregated by revenue source and segment for the three months ended March 31, 2022 and 2021:
| Three Months Ended March 31, | |||||||||||
| (in thousands) | 2022 | 2021 | |||||||||
| Operating Revenues | |||||||||||
| Electric Segment | |||||||||||
| Retail: Residential | $ | 40,561 | $ | 37,485 | |||||||
| Retail: Commercial and Industrial | 71,171 | 66,403 | |||||||||
| Retail: Other | 1,907 | 1,818 | |||||||||
| Total Retail | 113,639 | 105,706 | |||||||||
| Transmission | 12,556 | 11,944 | |||||||||
| Wholesale | 2,463 | 4,507 | |||||||||
| Other | 1,758 | 1,542 | |||||||||
| Total Electric Segment | 130,416 | 123,699 | |||||||||
| Manufacturing Segment | |||||||||||
| Metal Parts and Tooling | 89,573 | 62,673 | |||||||||
| Plastic Products and Tooling | 12,445 | 10,295 | |||||||||
| Scrap Metal Sales | 2,939 | 2,857 | |||||||||
| Total Manufacturing Segment | 104,957 | 75,825 | |||||||||
| Plastics Segment | |||||||||||
| PVC Pipe | 139,531 | 62,186 | |||||||||
| Total Operating Revenue | 374,904 | 261,710 | |||||||||
| Less: Non-contract Revenues Included Above | |||||||||||
| Electric Segment - ARP Revenues | (2,460) | (975) | |||||||||
| Total Operating Revenues from Contracts with Customers | $ | 377,364 | $ | 262,685 | |||||||
4. Select Balance Sheet Information
Receivables and Allowance for Credit Losses
Receivables as of March 31, 2022 and December 31, 2021 are as follows:
| (in thousands) | March 31, 2022 | December 31, 2021 | |||||||||
| Receivables | |||||||||||
| Trade | $ | 192,315 | $ | 142,297 | |||||||
| Other | 8,139 | 10,591 | |||||||||
| Unbilled Receivables | 20,229 | 23,901 | |||||||||
| Total Receivables | 220,683 | 176,789 | |||||||||
| Less: Allowance for Credit Losses | (1,787) | (1,836) | |||||||||
| Receivables, net of allowance for credit losses | $ | 218,896 | $ | 174,953 | |||||||
9
The following is a summary of activity in the allowance for credit losses for the three months ended March 31, 2022 and 2021:
| March 31, | March 31, | ||||||||||
| (in thousands) | 2022 | 2021 | |||||||||
| Beginning Balance, January 1 | $ | 1,836 | $ | 3,215 | |||||||
| Additions Charged to Expense | 210 | 211 | |||||||||
| Reductions for Amounts Written Off, Net of Recoveries | (259) | (443) | |||||||||
| Ending Balance, March 31 | $ | 1,787 | $ | 2,983 | |||||||
Inventories
Inventories consist of the following as of March 31, 2022 and December 31, 2021:
| (in thousands) | March 31, 2022 | December 31, 2021 | |||||||||
| Finished Goods | $ | 37,195 | $ | 39,903 | |||||||
| Work in Process | 33,962 | 35,705 | |||||||||
| Raw Material, Fuel and Supplies | 74,700 | 72,882 | |||||||||
| Total Inventories | $ | 145,857 | $ | 148,490 | |||||||
Investments
The following is a summary of our investments as of March 31, 2022 and December 31, 2021:
| (in thousands) | March 31, 2022 | December 31, 2021 | |||||||||
| Corporate-Owned Life Insurance Policies | $ | 40,722 | $ | 41,078 | |||||||
| Debt Securities | 8,959 | 9,202 | |||||||||
| Money Market Funds | 1,893 | 949 | |||||||||
| Mutual Funds | 6,285 | 5,432 | |||||||||
| Other Investments | 34 | 29 | |||||||||
| Total Investments | $ | 57,893 | $ | 56,690 | |||||||
The amount of unrealized gains and losses on debt securities as of March 31, 2022 and December 31, 2021 was not material and no unrealized losses were deemed to be other-than-temporary. In addition, the amount of unrealized gains and losses on marketable equity securities still held as of March 31, 2022 and December 31, 2021 was not material.
Property, Plant and Equipment
Major classes of property, plant and equipment as of March 31, 2022 and December 31, 2021 include:
| (in thousands) | March 31, 2022 | December 31, 2021 | |||||||||
| Electric Plant | |||||||||||
| Electric Plant in Service | $ | 2,776,778 | $ | 2,758,445 | |||||||
| Construction Work in Progress | 72,347 | 74,926 | |||||||||
| Total Gross Electric Plant | 2,849,125 | 2,833,371 | |||||||||
| Less Accumulated Depreciation and Amortization | 829,499 | 817,302 | |||||||||
| Net Electric Plant | 2,019,626 | 2,016,069 | |||||||||
| Nonelectric Property, Plant and Equipment | |||||||||||
| Nonelectric Property, Plant and Equipment in Service | 278,729 | 273,950 | |||||||||
| Construction Work in Progress | 14,365 | 16,611 | |||||||||
| Total Gross Nonelectric Property, Plant and Equipment | 293,094 | 290,561 | |||||||||
| Less Accumulated Depreciation and Amortization | 184,376 | 182,025 | |||||||||
| Net Nonelectric Property, Plant and Equipment | 108,718 | 108,536 | |||||||||
| Net Property, Plant and Equipment | $ | 2,128,344 | $ | 2,124,605 | |||||||
10
5. Regulatory Matters
Regulatory Assets and Liabilities
The following presents our current and long-term regulatory assets and liabilities as of March 31, 2022 and December 31, 2021 and the period we expect to recover or refund such amounts:
| Period of | March 31, 2022 | December 31, 2021 | |||||||||||||||||||||||||||
| (in thousands) | Recovery/Refund | Current | Long-Term | Current | Long Term | ||||||||||||||||||||||||
| Regulatory Assets | |||||||||||||||||||||||||||||
Pension and Other Postretirement Benefit Plans1 | Various | $ | 7,791 | $ | 113,663 | $ | 7,791 | $ | 114,961 | ||||||||||||||||||||
Alternative Revenue Program Riders2 | Up to 2 years | 9,280 | 5,713 | 11,889 | 5,564 | ||||||||||||||||||||||||
Asset Retirement Obligations1 | Asset lives | — | 1,098 | — | 742 | ||||||||||||||||||||||||
ISO Cost Recovery Trackers1 | Up to 2 years | 220 | 950 | — | 1,342 | ||||||||||||||||||||||||
Unrecovered Project Costs1 | Up to 5 years | 1,086 | 1,456 | 2,136 | 1,455 | ||||||||||||||||||||||||
Deferred Rate Case Expenses1 | Various | 542 | 1,037 | 607 | 1,131 | ||||||||||||||||||||||||
Debt Reacquisition Premiums1 | Up to 11 years | 68 | 234 | 100 | 240 | ||||||||||||||||||||||||
Fuel Clause Adjustments1 | Up to 1 year | 2,767 | — | 4,819 | — | ||||||||||||||||||||||||
Other1 | Various | 16 | 262 | — | 73 | ||||||||||||||||||||||||
| Total Regulatory Assets | $ | 21,770 | $ | 124,413 | $ | 27,342 | $ | 125,508 | |||||||||||||||||||||
| Regulatory Liabilities | |||||||||||||||||||||||||||||
| Deferred Income Taxes | Asset lives | $ | — | $ | 128,042 | $ | — | $ | 129,437 | ||||||||||||||||||||
| Plant Removal Obligations | Asset lives | 8,561 | 101,850 | 8,306 | 101,595 | ||||||||||||||||||||||||
| Fuel Clause Adjustments | Up to 1 year | 5,386 | — | 1,554 | — | ||||||||||||||||||||||||
| Alternative Revenue Program Riders | Various | 6,215 | 3,986 | 5,772 | 3,336 | ||||||||||||||||||||||||
| Pension and Other Postretirement Benefit Plans | Up to 1 year | 2,603 | — | 2,603 | — | ||||||||||||||||||||||||
| Derivative Instruments | Various | 4,179 | — | 6,214 | — | ||||||||||||||||||||||||
| Other | Various | 267 | 111 | 395 | 62 | ||||||||||||||||||||||||
| Total Regulatory Liabilities | $ | 27,211 | $ | 233,989 | $ | 24,844 | $ | 234,430 | |||||||||||||||||||||
1Costs subject to recovery without a rate of return. | |||||||||||||||||||||||||||||
2Amount eligible for recovery includes an incentive or rate of return. | |||||||||||||||||||||||||||||
6. Short-Term and Long-Term Borrowings
The following is a summary of our outstanding short- and long-term borrowings by borrower, OTC or Otter Tail Power (OTP), as of March 31, 2022 and December 31, 2021:
Short-Term Debt
The following is a summary of our lines of credit as of March 31, 2022 and December 31, 2021:
| March 31, 2022 | December 31, 2021 | ||||||||||||||||||||||||||||
| (in thousands) | Line Limit | Amount Outstanding | Letters of Credit | Amount Available | Amount Available | ||||||||||||||||||||||||
| OTC Credit Agreement | $ | 170,000 | $ | 43,281 | $ | — | $ | 126,719 | $ | 147,363 | |||||||||||||||||||
| OTP Credit Agreement | 170,000 | 54,489 | 7,844 | 107,667 | 88,315 | ||||||||||||||||||||||||
| Total | $ | 340,000 | $ | 97,770 | $ | 7,844 | $ | 234,386 | $ | 235,678 | |||||||||||||||||||
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Long-Term Debt
The following is a summary of outstanding long-term debt by borrower as of March 31, 2022 and December 31, 2021:
| (in thousands) | ||||||||||||||||||||||||||||||||
| Entity | Debt Instrument | Rate | Maturity | March 31, 2022 | December 31, 2021 | |||||||||||||||||||||||||||
| OTC | Guaranteed Senior Notes | 3.55% | 12/15/26 | $ | 80,000 | $ | 80,000 | |||||||||||||||||||||||||
| OTP | Series 2007B Senior Unsecured Notes | 6.15% | 08/20/22 | 30,000 | 30,000 | |||||||||||||||||||||||||||
| OTP | Series 2007C Senior Unsecured Notes | 6.37% | 08/02/27 | 42,000 | 42,000 | |||||||||||||||||||||||||||
| OTP | Series 2013A Senior Unsecured Notes | 4.68% | 02/27/29 | 60,000 | 60,000 | |||||||||||||||||||||||||||
| OTP | Series 2019A Senior Unsecured Notes | 3.07% | 10/10/29 | 10,000 | 10,000 | |||||||||||||||||||||||||||
| OTP | Series 2020A Senior Unsecured Notes | 3.22% | 02/25/30 | 10,000 | 10,000 | |||||||||||||||||||||||||||
| OTP | Series 2020B Senior Unsecured Notes | 3.22% | 08/20/30 | 40,000 | 40,000 | |||||||||||||||||||||||||||
| OTP | Series 2021A Senior Unsecured Notes | 2.74% | 11/29/31 | 40,000 | 40,000 | |||||||||||||||||||||||||||
| OTP | Series 2007D Senior Unsecured Notes | 6.47% | 08/20/37 | 50,000 | 50,000 | |||||||||||||||||||||||||||
| OTP | Series 2019B Senior Unsecured Notes | 3.52% | 10/10/39 | 26,000 | 26,000 | |||||||||||||||||||||||||||
| OTP | Series 2020C Senior Unsecured Notes | 3.62% | 02/25/40 | 10,000 | 10,000 | |||||||||||||||||||||||||||
| OTP | Series 2013B Senior Unsecured Notes | 5.47% | 02/27/44 | 90,000 | 90,000 | |||||||||||||||||||||||||||
| OTP | Series 2018A Senior Unsecured Notes | 4.07% | 02/07/48 | 100,000 | 100,000 | |||||||||||||||||||||||||||
| OTP | Series 2019C Senior Unsecured Notes | 3.82% | 10/10/49 | 64,000 | 64,000 | |||||||||||||||||||||||||||
| OTP | Series 2020D Senior Unsecured Notes | 3.92% | 02/25/50 | 15,000 | 15,000 | |||||||||||||||||||||||||||
| OTP | Series 2021B Senior Unsecured Notes | 3.69% | 11/29/51 | 100,000 | 100,000 | |||||||||||||||||||||||||||
| Total | $ | 767,000 | $ | 767,000 | ||||||||||||||||||||||||||||
| Less: | Current Maturities, Net of Unamortized Debt Issuance Costs | 29,990 | 29,983 | |||||||||||||||||||||||||||||
| Unamortized Long-Term Debt Issuance Costs | 2,936 | 3,003 | ||||||||||||||||||||||||||||||
| Total Long-Term Debt, Net of Unamortized Debt Issuance Costs | $ | 734,074 | $ | 734,014 | ||||||||||||||||||||||||||||
On June 10, 2021, OTP entered into a Note Purchase Agreement pursuant to which OTP agreed to issue, in a private placement transaction, $230.0 million of senior unsecured notes consisting of (a) $40.0 million of 2.74% Series 2021A Senior Unsecured Notes due November 29, 2031, (b) $100.0 million of 3.69% Series 2021B Senior Unsecured Notes due November 29, 2051 and (c) $90.0 million of 3.77% Series 2022A Senior Unsecured Notes due May 20, 2052. During the year ended December 31, 2021, OTP issued its Series 2021A and Series 2021B notes for aggregate proceeds of $140.0 million, which were used to repay the Series 2011A notes. The issuance of the Series 2022A notes is scheduled to close, subject to the satisfaction of certain customary conditions to closing, in May 2022.
Financial Covenants
Certain of OTC's and OTP's short- and long-term debt agreements require the borrower, whether OTC or OTP, to maintain certain financial covenants, including a maximum debt to total capitalization ratio of 0.60 to 1.00, a minimum interest and dividend coverage ratio of 1.50 to 1.00, and a maximum level of priority indebtedness. As of March 31, 2022, OTC and OTP were in compliance with these financial covenants.
7. Employee Postretirement Benefits
Pension Plan and Other Postretirement Benefits
The Company sponsors a noncontributory funded pension plan (the "Pension Plan"), an unfunded, nonqualified Executive Survivor and Supplemental Retirement Plan, both accounted for as defined benefit pension plans, and a postretirement healthcare plan accounted for as an other postretirement benefit plan.
The following table includes the components of net periodic benefit cost of our defined benefit pension plans and other postretirement benefits for the three months ended March 31, 2022 and 2021:
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| Pension Benefits (Pension Plan) | Pension Benefits (ESSRP) | Postretirement Benefits | |||||||||||||||||||||||||||||||||
| (in thousands) | 2022 | 2021 | 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||||||||||||
| Service Cost | $ | 1,644 | $ | 1,866 | $ | 49 | $ | 47 | $ | 335 | $ | 430 | |||||||||||||||||||||||
| Interest Cost | 3,086 | 2,915 | 335 | 307 | 510 | 473 | |||||||||||||||||||||||||||||
| Expected Return on Assets | (5,921) | (5,590) | — | — | — | — | |||||||||||||||||||||||||||||
| Amortization of Prior Service Cost | — | — | — | — | (1,433) | (1,433) | |||||||||||||||||||||||||||||
| Amortization of Net Actuarial Loss | 1,966 | 2,728 | 142 | 155 | 766 | 943 | |||||||||||||||||||||||||||||
| Net Periodic Benefit Cost | $ | 775 | $ | 1,919 | $ | 526 | $ | 509 | $ | 178 | $ | 413 | |||||||||||||||||||||||
The following table includes the impact of regulation on the recognition of periodic benefit cost arising from pension and other postretirement benefits for the three months ended March 31, 2022 and 2021:
| (in thousands) | 2022 | 2021 | |||||||||
| Net Periodic Benefit Cost | $ | 1,479 | $ | 2,841 | |||||||
| Net Amount Amortized (Deferred) Due to the Effect of Regulation | 527 | (115) | |||||||||
| Net Periodic Benefit Cost Recognized | $ | 2,006 | $ | 2,726 | |||||||
We had no minimum funding requirements for our pension plan or any other postretirement benefit plans as of December 31, 2021, but made a discretionary contribution of $20.0 million to our pension plan in February 2022.
8. Income Taxes
The reconciliation of the statutory federal income tax rate to our effective tax rate for each of the three months ended March 31, 2022 and 2021 is as follows:
| Three Months Ended March 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Federal Statutory Rate | 21.0 | % | 21.0 | % | |||||||
| Increases (Decreases) in Tax from: | |||||||||||
| State Taxes on Income, Net of Federal Tax | 5.0 | 5.0 | |||||||||
| Production Tax Credits (PTCs) | (4.4) | (7.6) | |||||||||
| Amortization of Excess Deferred Income Taxes | (1.3) | (2.9) | |||||||||
| Excess Tax Deduction on Stock Awards | (0.5) | (0.1) | |||||||||
| North Dakota Wind Tax Credit Amortization, Net of Federal Tax | (0.2) | (0.4) | |||||||||
| Corporate-Owned Life Insurance | 0.2 | (0.5) | |||||||||
| Other, Net | (0.1) | 0.3 | |||||||||
| Effective Tax Rate | 19.7 | % | 14.8 | % | |||||||
9. Commitments and Contingencies
Contingencies
FERC ROE. In November 2013 and February 2015, customers filed complaints with Federal Energy Regulatory Commission (FERC) seeking to reduce the return on equity (ROE) component of the transmission rates that Midcontinent Independent System Operator, Inc. (MISO) transmission owners, including OTP, may collect under the MISO tariff rate. FERC's most recent order, issued on November 19, 2020, adopted a revised ROE methodology and set the base ROE at 10.02% (10.52% with an adder) effective for the fifteen-month period from November 2013 to February 2015 and on a prospective basis beginning in September 2016. The order also dismissed any complaints covering the period from February 2015 to May 2016. The November 2020 opinion is subject to judicial review. We have deferred recognition and recorded a refund liability of $2.4 million as of March 31, 2022. This refund liability reflects our best estimate of required refunds to customers once all regulatory and judicial proceedings are completed.
Regional Haze Rule (RHR). The RHR was adopted in an effort to improve visibility in national parks and wilderness areas. The RHR requires states, in coordination with the Environmental Protection Agency (EPA) and other governmental agencies, to develop and implement plans to achieve natural visibility conditions. The second RHR implementation period covers the years 2018-2028. States are required to submit a state implementation plan to assess reasonable progress with the RHR and determine what additional emission reductions are appropriate, if any.
Coyote Station, OTP's jointly owned coal-fired power plant in North Dakota, is subject to assessment in the second implementation period under the North Dakota state implementation plan. In September 2021, the North Dakota Department of Environmental Quality (NDDEQ) made public a draft of its state implementation plan. The plan concluded it is not reasonable to require additional emission controls during this planning period. In January 2022, prior to the submission to the EPA by the NDDEQ, the EPA provided preliminary comments on the draft North Dakota state
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implementation plan in which it expressed disagreement with the NDDEQ's recommendation to forgo additional emission controls. Following a consultation and public comment period, and any subsequent modifications to the plan, the NDDEQ will submit its state implementation plan to the EPA for approval.
We cannot predict with certainty the impact the state implementation plan may have on our business until the state implementation plan has been approved or otherwise acted on by the EPA. However, significant emission control investments could be required and the recovery of such costs from customers would require regulatory approval. Alternatively, investments in emission control equipment may prove to be uneconomic and result in the early retirement of or the sale of our interest in Coyote Station, subject to regulatory approval. We cannot estimate the ultimate financial effects such a retirement or sale may have on our consolidated operating results, financial position or cash flows, but such amounts could be material and the recovery of such costs in rates would be subject to regulatory approval.
Other Contingencies. We are party to litigation and regulatory matters arising in the normal course of business. We regularly analyze relevant information and, as necessary, estimate and record accrued liabilities for legal, regulatory enforcement and other matters in which a loss is probable of occurring and can be reasonably estimated. We believe the effect on our consolidated operating results, financial position and cash flows, if any, for the disposition of all matters pending as of March 31, 2022, other than those discussed above, will not be material.
10. Stockholders' Equity
Registration Statements
On May 3, 2021, we filed a shelf registration statement with the SEC 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. No new debt or equity has been issued pursuant to the registration statement. The registration statement expires in May 2024.
On May 3, 2021, we filed a second registration statement with the SEC for the issuance of up to 1,500,000 common shares under an Automatic Dividend Reinvestment and a Share Purchase Plan, which provides shareholders, retail customers of OTP and other interested investors methods of purchasing our common shares, by reinvesting their dividends or making optional cash investments. Shares purchased under the plan may be newly issued common shares or common shares purchased on the open market. During the three months ended March 31, 2022, we issued 36,104 shares under this program. We repurchased a sufficient number of shares on the open market to satisfy issuance under the plan; accordingly no proceeds from the issuance were received. As of March 31, 2022, there was 1,348,716 shares available for purchase or issuance under the plan. The registration statement expires in May 2024.
Dividend Restrictions
OTC is a holding company with no significant operations of its own. The primary source of funds for payments of dividends to our shareholders is from dividends paid or distributions made by our subsidiaries. As a result of certain statutory limitations or regulatory or financing agreements, restrictions could occur on the amount of distributions allowed to be made by our subsidiaries. Both the OTC Credit Agreement and OTP Credit Agreement contain restrictions on the payment of cash dividends upon a default or event of default, including failure to maintain certain financial covenants. As of March 31, 2022, we were in compliance with these financial covenants.
Under the Federal Power Act, a public utility may not pay dividends from any funds properly included in a capital account. What constitutes “funds properly included in a capital account” is undefined in the Federal Power Act or the related regulations; however, the FERC has consistently interpreted the provision to allow dividends to be paid as long as i) the source of the dividends is clearly disclosed, ii) the dividend is not excessive and iii) there is no self-dealing on the part of corporate officials.
The Minnesota Public Utilities Commission (MPUC) indirectly limits the amount of dividends OTP can pay to the Company by requiring an equity-to-total-capitalization ratio between 48.0% and 58.7% based on OTP’s most recent capital structure petition effective by order of the MPUC on January 26, 2022. As of March 31, 2022, OTP’s equity-to-total-capitalization ratio including short-term debt was 53.2% and its net assets restricted from distribution totaled approximately $682.0 million. Under the MPUC order relating to the Company's 2021 capital structure petition, total capitalization for OTP cannot exceed $1.7 billion.
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11. Accumulated Other Comprehensive Income (Loss)
The following shows the changes in accumulated other comprehensive loss for the three months ended March 31, 2022 and 2021:
| (in thousands) | Pension and Other Postretirement Benefits | Net Unrealized Gain (Losses) on Available-for-Sale Securities | Total | ||||||||||||||
Balance, December 31, 2021 | $ | (6,537) | $ | 13 | $ | (6,524) | |||||||||||
| Other Comprehensive Loss Before Reclassifications, net of tax | — | (231) | (231) | ||||||||||||||
| Amounts Reclassified from Accumulated Other Comprehensive Income (Loss) | (190) | (1) | — | (2) | (190) | ||||||||||||
| Total Other Comprehensive Income (Loss) | (190) | (231) | (421) | ||||||||||||||
Balance, March 31, 2022 | $ | (6,727) | $ | (218) | $ | (6,945) | |||||||||||
Balance, December 31, 2020 | $ | (8,716) | $ | 209 | $ | (8,507) | |||||||||||
| Other Comprehensive Loss Before Reclassifications, net of tax | — | (32) | (32) | ||||||||||||||
| Amounts Reclassified from Accumulated Other Comprehensive Income (Loss) | 150 | (1) | (3) | (2) | 147 | ||||||||||||
| Total Other Comprehensive Income (Loss) | 150 | (35) | 115 | ||||||||||||||
Balance, March 31, 2021 | $ | (8,566) | $ | 174 | $ | (8,392) | |||||||||||
(1) Included in the computation of net periodic pension and other postretirement benefit costs. See Note 7. | |||||||||||||||||
(2) Included in other income (expense), net on the accompanying consolidated statements of income. | |||||||||||||||||
12. Share-Based Payments
Stock Compensation Expense
Stock-based compensation expense arising from our employee stock purchase plan and share-based compensation plans, recognized within operating expenses in the consolidated statements of income, amounted to $4.9 million and $4.2 million for the three months ended March 31, 2022 and 2021, respectively.
Restricted Stock Awards. We grant restricted stock awards to members of our Board of Directors and restricted stock units to certain key employees. The awards vest, depending on award type and recipient, either ratably over periods of or four years or cliff vest after four years. Vesting is accelerated in certain circumstances, including on retirement.
The following is a summary of stock award activity for the three months ended March 31, 2022:
| Shares | Weighted Average Grant-Date Fair Value | ||||||||||
Nonvested, January 1, 2022 | 138,093 | $ | 44.48 | ||||||||
| Granted | 15,842 | 61.39 | |||||||||
| Vested | (18,969) | 46.49 | |||||||||
| Forfeited | — | — | |||||||||
Nonvested, March 31, 2022 | 134,966 | $ | 46.18 | ||||||||
The fair value of vested awards was $1.2 million and $0.7 million during the three months ended March 31, 2022 and 2021, respectively.
Stock Performance Awards. Stock performance awards are granted to executive officers and certain other key employees. The awards vest at the end of a three year performance period. The number of common shares awarded, if any, at the end of the performance period ranges from zero to 150% of the target amount based on two performance measures: i) total shareholder return relative to a peer group and ii) return on equity. Vesting of the awards is accelerated in certain circumstances, including on retirement. The amount of common shares awarded on an accelerated vesting is based either on actual performance at the end of the performance period or the amount of common shares earned at target.
The grant date fair value of stock performance awards granted during the three months ended March 31, 2022 and 2021 was determined using a Monte Carlo fair value simulation model incorporating the following assumptions:
| 2022 | 2021 | ||||||||||
| Risk-free interest rate | 1.52 | % | 0.18 | % | |||||||
| Expected term (in years) | 3.00 | 3.00 | |||||||||
| Expected volatility | 32.00 | % | 32.00 | % | |||||||
| Dividend yield | 2.90 | % | 3.60 | % | |||||||
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The risk-free interest rate was derived from yields on U.S. government bonds of a similar term. The expected term of the award is equal to the three-year performance period. Expected volatility was estimated based on actual historical volatility of our common stock. Dividend yield was estimated based on historic and future yield estimates.
The following is a summary of stock performance award activity for the three months ended March 31, 2022 (share amounts reflect awards at target):
| Shares | Weighted Average Grant-Date Fair Value | ||||||||||
Nonvested, January 1, 2022 | 189,600 | $ | 42.54 | ||||||||
| Granted | 55,800 | 54.91 | |||||||||
| Vested | (55,600) | 43.30 | |||||||||
| Forfeited | — | — | |||||||||
Nonvested, March 31, 2022 | 189,800 | $ | 45.95 | ||||||||
The fair value of vested awards was $5.1 million and $2.5 million during the three months ended March 31, 2022 and 2021, respectively.
13. Earnings Per Share
The numerator used in the calculation of both basic and diluted earnings per common share is net income. The denominator used in the calculation of basic earnings per common share is the weighted average number of common shares outstanding during the period. The denominator used in the calculation of diluted earnings per common share is derived by adjusting basic shares outstanding for the dilutive effect of potential common shares outstanding, which consist of time and performance based stock awards and employee stock purchase plan shares.
The following includes the computation of the denominator for basic and diluted weighted-average shares outstanding for the three months ended March 31, 2022 and 2021:
| Three Months Ended March 31, | |||||||||||
| (in thousands) | 2022 | 2021 | |||||||||
| Weighted Average Common Shares Outstanding – Basic | 41,548 | 41,455 | |||||||||
| Effect of Dilutive Securities: | |||||||||||
| Stock Performance Awards | 219 | 143 | |||||||||
| Restricted Stock Awards | 102 | 85 | |||||||||
| Employee Stock Purchase Plan Shares and Other | 2 | 17 | |||||||||
| Dilutive Effect of Potential Common Shares | 323 | 245 | |||||||||
| Weighted Average Common Shares Outstanding – Diluted | 41,871 | 41,700 | |||||||||
The amount of shares excluded from diluted weighted-average common shares outstanding because such shares were anti-dilutive was not material for the three months ended March 31, 2022 and 2021.
14. Derivative Instruments
OTP enters into derivative instruments to manage its exposure to future price variability and reduce volatility in prices for our retail customers. These derivative instruments are not designated as qualifying hedging transactions but provide for an economic hedge against future price variability. The instruments are recorded at fair value on the consolidated balance sheets. In accordance with rate-making and cost recovery processes, we recognize a regulatory asset or liability to defer losses or gains from derivative activity until settlement of the associated derivative instrument.
As of March 31, 2022, OTP had outstanding pay-fixed, receive-variable swap agreements with an aggregate notional amount of 156,800 megawatt-hours of electricity, which will be settled periodically throughout 2022 and 2023. As of March 31, 2022, the fair value of these derivative instruments was $4.2 million, which is included in other current assets, and $0.2 million, which is included in other noncurrent liabilities, on the consolidated balance sheets. As of December 31, 2021, the fair value of these types of derivative contracts was $6.2 million, which is included in other current assets. During the three months ended March 31, 2022, contracts matured and were settled in an aggregate amount of $2.8 million.
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15. Fair Value Measurements
The following tables present our assets and liabilities measured at fair value on a recurring basis as of March 31, 2022 and December 31, 2021 classified by the input method used to measure fair value:
| Level 1 | Level 2 | Level 3 | |||||||||||||||
| March 31, 2022 | |||||||||||||||||
| Assets: | |||||||||||||||||
| Investments: | |||||||||||||||||
| Money Market Funds | $ | 1,893 | $ | — | $ | — | |||||||||||
| Mutual Funds | 6,285 | — | — | ||||||||||||||
| Corporate Debt Securities | — | 1,367 | — | ||||||||||||||
| Government-Backed and Government-Sponsored Enterprises’ Debt Securities | — | 7,592 | — | ||||||||||||||
| Derivative Instruments | — | 4,179 | — | ||||||||||||||
| Total Assets | $ | 8,178 | $ | 13,138 | $ | — | |||||||||||
| Liabilities: | |||||||||||||||||
| Derivative Instruments | $ | — | $ | 198 | $ | — | |||||||||||
| Total Liabilities | $ | — | $ | 198 | $ | — | |||||||||||
| December 31, 2021 | |||||||||||||||||
| Assets: | |||||||||||||||||
| Investments: | |||||||||||||||||
| Money Market Funds | $ | 949 | $ | — | $ | — | |||||||||||
| Mutual Funds | 5,432 | — | — | ||||||||||||||
| Corporate Debt Securities | — | 1,333 | — | ||||||||||||||
| Government-Backed and Government-Sponsored Enterprises’ Debt Securities | — | 7,869 | — | ||||||||||||||
| Derivative Instruments | — | 6,214 | — | ||||||||||||||
| Total Assets | $ | 6,381 | $ | 15,416 | $ | — | |||||||||||
Level 1 fair value measurements are based on quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access at the measurement date.
The level 2 fair value measurements for government-backed and government-sponsored enterprises and corporate debt securities are determined on the basis of valuations provided by a third-party pricing service which utilizes industry accepted valuation models and observable market inputs to determine valuation. Some valuations or model inputs used by the pricing service may be based on broker quotes.
The level 2 fair value measurements for derivative instruments are determined by using inputs such as forward electric commodity prices, adjusted for location differences. These inputs are observable in the marketplace throughout the full term of the instrument, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace.
In addition to assets recorded at fair value on a recurring basis, we also hold financial instruments that are not recorded at fair value in the consolidated balance sheets but for which disclosure of the fair value of these financial instruments is provided. The following reflects the carrying value and estimated fair value of these assets and liabilities as of March 31, 2022 and December 31, 2021:
| March 31, 2022 | December 31, 2021 | ||||||||||||||||||||||
| (in thousands) | Carrying Amount | Fair Value | Carrying Amount | Fair Value | |||||||||||||||||||
| Assets: | |||||||||||||||||||||||
| Cash and Cash Equivalents | $ | 1,371 | $ | 1,371 | $ | 1,537 | $ | 1,537 | |||||||||||||||
| Total | 1,371 | 1,371 | 1,537 | 1,537 | |||||||||||||||||||
| Liabilities: | |||||||||||||||||||||||
| Short-Term Debt | 97,770 | 97,770 | 91,163 | 91,163 | |||||||||||||||||||
| Long-Term Debt | 764,064 | 781,531 | 763,997 | 878,272 | |||||||||||||||||||
| Total | $ | 861,834 | $ | 879,301 | $ | 855,160 | $ | 969,435 | |||||||||||||||
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The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash Equivalents: The carrying amount approximates fair value because of the short-term maturity of those instruments.
Short-Term Debt: The carrying amount approximates fair value because the debt obligations are short-term and the balances outstanding are subject to variable rates of interest which reset frequently, a Level 2 fair value input.
Long-Term Debt: The fair value of long-term debt is estimated based on current market indications for borrowings of similar maturities, a Level 2 fair value input.
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| ITEM 2. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | ||||
You should read the following discussion and analysis of our financial condition and results of operations together with our interim financial statements and the related notes appearing under Item 1 of this Quarterly Report on Form 10-Q, and our annual financial statements and the related notes along with the discussion and analysis of our financial condition and results of operations contained in our Annual Report on Form 10-K for the year ended December 31, 2021.
Otter Tail Corporation and its subsidiaries form a diverse group of businesses with operations classified into three segments: Electric, Manufacturing and Plastics. Our Electric business is a vertically integrated, regulated utility with generation, transmission and distribution facilities to serve our customers in western Minnesota, eastern North Dakota and northeastern South Dakota. Our Manufacturing segment provides metal fabrication for custom machine parts and metal components and manufactures extruded and thermoformed plastic products. Our Plastics segment manufactures PVC pipe for use in, among other applications, municipal and rural water, wastewater, and water reclamation projects.
COVID-19
We continue to monitor the progression of COVID-19 and its impact on our business. As this pandemic continues, we are following the directives and advice of government leaders and medical professionals and have adopted practices to help curtail the spread of the virus and mitigate its impact on our employees, customers, vendors and other business partners, and communities in which we live and work.
While the impact of COVID-19 did not materially impact our operating results in 2021 or the first quarter of 2022, uncertainty remains regarding the magnitude and duration of the pandemic and the resulting potential future financial effects. Increased infection rates and any future responses to mitigate the spread of the virus, including any potential vaccination mandates that would apply to our employees, could impact our business and our financial results in future periods. We continue to monitor developments involving our workforce, customers, construction contractors, suppliers and vendors, and the financial effects on our business. However, due to the unprecedented and evolving nature of this pandemic, we cannot predict the full extent of the impact COVID-19 will have on our operating results, financial condition and liquidity.
RESOURCE MATERIAL AVAILABILITY AND PRICING
The cost of steel and PVC resin, two key material inputs to our Manufacturing and Plastics segments, respectively, significantly impacted our operating results in the first quarter of 2022.
Steel prices increased rapidly throughout 2021 and remained elevated in the first quarter of 2022. The increase in steel prices has led to increased sale prices for our products at BTD Manufacturing, Inc. (BTD), our metal fabrication business within our Manufacturing segment, as we passed along material cost increases to our customers. Consistent with steel prices, scrap metal prices also increased throughout 2021 and remained elevated in the first quarter of 2022. Steel costs remain elevated as mill prices and supply chain costs remain significantly higher than historical levels. While steel costs are expected to moderate through 2022, they are expected to remain historically high through the year. Scrap metal prices are also expected to moderate throughout the year.
PVC resin is the primary material input of the PVC pipe manufactured by our Plastics segment businesses. Resin supply disruptions throughout 2021, along with robust domestic and global demand for PVC resin, led to significantly increased resin prices. Resin supply disruptions also resulted in reduced manufacturing of PVC pipe and low pipe inventories across the industry. The combination of disrupted PVC resin supply and the resulting low PVC pipe inventories along with robust demand for PVC pipe led to rapidly increasing sale prices for PVC pipe throughout 2021, which continued in the first quarter of 2022. The increase in sale prices has outpaced the increase in PVC resin costs, leading to expanding gross profit margins and a significant increase in earnings in our Plastics segment. While PVC resin supplies have improved, the price of PVC resin is now increasing again, driven by rising feedstock prices from energy supply disruptions resulting from the conflict in Ukraine. This has created an environment for U.S. resin producers to raise domestic prices and a strengthening of the export markets for PVC resin. In addition, beginning in the second half of 2021 and continuing in the first quarter of 2022, supply constraints for additives and other ingredients aside from PVC resin used to manufacture PVC pipe prevented PVC pipe manufacturers from being able to build inventory levels.
We currently expect the unique market dynamics we experienced in 2021 and the first quarter of 2022 to continue through the second quarter of 2022, but begin to subside in the second half of 2022 due to anticipated resin price declines and slowing demand, thus impacting our gross profit margins. Should current market conditions continue through the second half of 2022, our Plastics segment financial results could exceed current expectations.
The marketplace dynamics impacting both our Manufacturing and Plastics segments are fluid and subject to change which may impact our operating results prospectively.
| RESULTS OF OPERATIONS – QUARTER TO DATE | |||||
Provided below is a summary and discussion of our operating results on a consolidated basis followed by a discussion of the operating results of each of our segments: Electric, Manufacturing and Plastics. In addition to the segment results, we provide an overview of our Corporate costs. Our Corporate costs do not constitute a reportable segment but rather consist of unallocated general corporate expenses, such as corporate staff and overhead costs, the results of our captive insurance company and other items excluded from the measurement of segment performance. Corporate costs are added to operating segment totals to reconcile to totals on our consolidated statements of income.
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CONSOLIDATED RESULTS
The following table summarizes consolidated operating results for the three months ended March 31, 2022 and 2021:
| (in thousands) | 2022 | 2021 | $ change | % change | |||||||||||||||||||
| Operating Revenues | $ | 374,904 | $ | 261,710 | $ | 113,194 | 43.3 | % | |||||||||||||||
| Operating Expenses | 276,605 | 217,511 | 59,094 | 27.2 | |||||||||||||||||||
| Operating Income | 98,299 | 44,199 | 54,100 | 122.4 | |||||||||||||||||||
| Interest Charges | 8,948 | 9,398 | (450) | (4.8) | |||||||||||||||||||
| Nonservice Cost Components of Postretirement Benefits | (22) | 383 | (405) | (105.7) | |||||||||||||||||||
| Other Income | 260 | 1,160 | (900) | (77.6) | |||||||||||||||||||
| Income Before Income Taxes | 89,633 | 35,578 | 54,055 | 151.9 | |||||||||||||||||||
| Income Tax Expense | 17,630 | 5,249 | 12,381 | 235.9 | |||||||||||||||||||
| Net Income | $ | 72,003 | $ | 30,329 | $ | 41,674 | 137.4 | % | |||||||||||||||
Operating Revenues increased $113.2 million primarily due to rising PVC pipe prices within our Plastics segment and increased material costs leading to increased sales prices in our Manufacturing segment. Increased retail revenues partially offset by decreased wholesales revenues within our Electric segment also contributed to higher operating revenues in the first quarter of 2021 compared to the same period last year. See our segment disclosures below for additional discussion of items impacting operating revenues.
Operating Expenses increased $59.1 million primarily due to increased costs of products sold in our Plastics and Manufacturing segments due to increased raw material costs. Operating expenses in our Electric segment increased primarily due to higher operating and maintenance expenses and increased purchased power costs. See our segment disclosures below for additional discussion of items impacting operating expenses.
Interest Charges decreased $0.5 million due to a decrease in the interest rate on our $140.0 million of fixed-rate long-term debt that was refinanced in December 2021, and a lower level of average short-term borrowings outstanding in 2022 compared to 2021.
Nonservice Cost Components of Postretirement Benefits decreased $0.4 million primarily due to the amortization of actuarial gains resulting from the increase in the discount rates used to measure our pension benefit and postretirement benefit liabilities as of December 31, 2021.
Other Income decreased $0.9 million primarily due to investment losses on our corporate-owned life insurance policies during the first quarter of 2022 compared to investment gains in the same period of the previous year.
Income Tax Expense increased $12.4 million primarily due to increased income before income taxes. Our effective tax rate was 19.7% in the first quarter of 2022 and 14.8% in the first quarter of 2021. The increase in our effective tax rate was driven by an increase in our income before income taxes without a corresponding increase in tax credits and other permanent differences that impact our effective tax rate. See Note 8 to our consolidated financial statements included in this Quarterly Report on Form 10-Q for additional information regarding factors impacting our effective tax rate in 2022 and 2021.
ELECTRIC SEGMENT RESULTS
The following table summarizes Electric segment operating results for the three months ended March 31, 2022 and 2021:
| (in thousands) | 2022 | 2021 | $ change | % change | |||||||||||||||||||
| Retail Revenues | $ | 113,639 | $ | 105,706 | $ | 7,933 | 7.5 | % | |||||||||||||||
| Transmission Services Revenues | 12,556 | 11,944 | 612 | 5.1 | |||||||||||||||||||
| Wholesale Revenues | 2,463 | 4,507 | (2,044) | (45.4) | |||||||||||||||||||
| Other Electric Revenues | 1,758 | 1,542 | 216 | 14.0 | |||||||||||||||||||
| Total Operating Revenues | 130,416 | 123,699 | 6,717 | 5.4 | |||||||||||||||||||
| Production Fuel | 14,853 | 14,714 | 139 | 0.9 | |||||||||||||||||||
| Purchased Power | 20,529 | 19,260 | 1,269 | 6.6 | |||||||||||||||||||
| Operating and Maintenance Expenses | 44,278 | 41,421 | 2,857 | 6.9 | |||||||||||||||||||
| Depreciation and Amortization | 18,382 | 17,308 | 1,074 | 6.2 | |||||||||||||||||||
| Property Taxes | 4,432 | 4,320 | 112 | 2.6 | |||||||||||||||||||
| Operating Income | $ | 27,942 | $ | 26,676 | $ | 1,266 | 4.7 | % | |||||||||||||||
| 2022 | 2021 | change | % change | ||||||||||||||||||||
Electric kilowatt-hour (kwh) Sales (in thousands) | |||||||||||||||||||||||
| Retail kwh Sales | 1,515,297 | 1,348,519 | 166,778 | 12.4 | % | ||||||||||||||||||
| Wholesale kwh Sales – Company Generation | 66,187 | 80,423 | (14,236) | (17.7) | |||||||||||||||||||
| Heating Degree Days | 3,821 | 3,078 | 743 | 24.1 | |||||||||||||||||||
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The operating results of our Electric segment are impacted by fluctuations in weather conditions and the resulting demand for electricity for heating and cooling. The following table shows heating degree days as a percent of normal for the three months ended March 31, 2022 and 2021.
| 2022 | 2021 | ||||||||||
| Heating Degree Days | 111.8 | % | 89.5 | % | |||||||
The following table summarizes the estimated effect on diluted earnings per share of the difference in retail kwh sales under actual weather conditions and expected retail kwh sales under normal weather conditions in 2022 and 2021, and between years.
2022 vs Normal | 2022 vs 2021 | 2021 vs Normal | |||||||||||||||
| Effect on Diluted Earnings Per Share | $ | 0.04 | $ | 0.08 | $ | (0.04) | |||||||||||
Retail Revenues increased $7.9 million primarily due to the following:
•A $4.4 million increase in revenues from the favorable impact of weather in the first quarter of 2022 compared to the same period last year.
•A $3.6 million increase in fuel recovery revenues primarily due to increased production fuel and purchase power costs and a decrease in credits provided to retail customers from decreased margins recognized on wholesale sales.
•A $2.3 million increase in retail sales volumes from commercial and industrial customers.
•A $2.4 million decrease in interim rate revenue in Minnesota as a result of our April 2021 filing with the MPUC in which we lowered our requested net annual revenue increase, primarily due to a reduction in operating costs from amounts included in our original filing.
Wholesale Revenues decreased $2.0 million as a result of a 18% decrease in wholesale sales volumes and a 34% decrease in wholesale prices. Wholesale energy sales in the first quarter of 2021 were comparatively higher due to high prices driven by high market demand and availability constraints caused by winter storm activity, which drove up spot market prices for electricity.
Production Fuel costs increased $0.1 million as a result of increased fuel cost per kwh, which was largely offset by a 15% decrease in kwhs generated from our fuel-burning plants due to the retirement of our coal-burning Hoot Lake Plant in May 2021.
Purchased Power costs to serve retail customers increased $1.3 million primarily due to a 59% increase in the volume of purchased power resulting from the retirement of Hoot Lake Plant and increased demand due to cold weather, partially offset by a decrease in the price of purchased power.
Operating and Maintenance Expense increased $2.9 million due to increased operating and maintenance costs as a result of Merricourt and Astoria Station because the facilities were fully operational in the first quarter of 2022 and were ramping up in the previous year because they had recently been placed into service; increased incentive compensation costs related to current year financial and operational performance; increased travel costs resulting from eased COVID restrictions; and increased insurance costs. These increased costs were partially offset by a decrease in CIP expenses as CIP spending decreased compared to the previous year.
Depreciation and Amortization expense increased $1.1 million primarily due to Astoria Station being placed in service in February of 2021.
MANUFACTURING SEGMENT RESULTS
The following table summarizes Manufacturing segment operating results for the three months ended March 31, 2022 and 2021:
| (in thousands) | 2022 | 2021 | $ change | % change | |||||||||||||||||||
| Operating Revenues | $ | 104,957 | $ | 75,825 | $ | 29,132 | 38.4 | % | |||||||||||||||
| Cost of Products Sold (excluding depreciation) | 86,161 | 56,311 | 29,850 | 53.0 | |||||||||||||||||||
| Other Operating Expenses | 8,847 | 8,212 | 635 | 7.7 | |||||||||||||||||||
| Depreciation and Amortization | 4,014 | 3,757 | 257 | 6.8 | |||||||||||||||||||
| Operating Income | $ | 5,935 | $ | 7,545 | $ | (1,610) | (21.3) | % | |||||||||||||||
Operating Revenues increased $29.1 million primarily due to a $29.3 million increase in material costs at BTD, which are passed through to customers, as a result of higher steel prices. Steel prices increased rapidly throughout 2021 and remained elevated in the first quarter of 2022, which resulted in increased revenues as we sell through high-priced inventory. Operating revenues also increased slightly due to price increases related to inflationary costs being experienced across the business. The increase in operating revenues was partially offset by a 5% decrease in sales volumes. End market demand has remained strong, however, supply chain disruptions experienced by our OEM customers have led to unpredictable shipments of products as customers have delayed or adjusted their shipment timing in response to other supply chain challenges they are experiencing, which has negatively impacted our sales volumes. Increases in sales prices and volumes at T.O. Plastics, due to strong customer demand in the horticulture sector, also contributed to the segment increase in operating revenues.
Cost of Products Sold increased $29.9 million primarily due to higher material, labor and freight costs at BTD. The increase in material cost was largely driven by increased steel prices as mentioned above. The increases in labor and freight costs, and lower productivity resulted in lower gross profit margins compared to the same period in 2021. Aligning labor with unpredictable demand led to lower production efficiency which had a
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negative impact on gross profit margins. Increases in sales volumes at T.O. Plastics also impacted costs of products sold, and gross profit margins were negatively impacted by product mix and increased maintenance and freight costs.
Other Operating Expenses increased $0.6 million due to increases in various cost categories including salaries and wages, due to increases in headcount compared to the previous year, and software and service provider costs, partially offset by lower incentive compensation.
PLASTICS SEGMENT RESULTS
The following table summarizes Plastics segment operating results for the three months ended March 31, 2022 and 2021:
| (in thousands) | 2022 | 2021 | $ change | % change | |||||||||||||||||||
| Operating Revenues | $ | 139,531 | $ | 62,186 | $ | 77,345 | 124.4 | % | |||||||||||||||
| Cost of Products Sold (excluding depreciation) | 65,598 | 45,666 | 19,932 | 43.6 | |||||||||||||||||||
| Other Operating Expenses | 3,964 | 2,944 | 1,020 | 34.6 | |||||||||||||||||||
| Depreciation and Amortization | 1,107 | 990 | 117 | 11.8 | |||||||||||||||||||
| Operating Income | $ | 68,862 | $ | 12,586 | $ | 56,276 | 447.1 | % | |||||||||||||||
Operating Revenues increased $77.3 million primarily due to a 125% increase in the price per pound of PVC pipe sold. The increase in sale prices was primarily due to continued strong demand for PVC pipe products and limited PVC pipe inventories. The unique supply and demand market conditions in the first quarter of 2022 were a continuation of the market dynamics experienced throughout 2021. In the first quarter of 2022, we, along with other PVC pipe manufacturers, experienced supply constraints of additives and other ingredients used to make PVC pipe, which prevented us and others from being able to build inventory levels. PVC resin supply disruptions improved during the quarter. Expected declines in the price of PVC resin did not materialize and resin prices continued to increase in March due to increasing feedstock prices and stronger than expected export markets. Sales volumes in the first quarter of 2022 were consistent with sales volumes in the first quarter of 2021.
Cost of Products Sold increased $19.9 million primarily due to increased PVC resin and other input material costs, which increased 52% due to the market conditions described above. Labor, freight and various non-resin material costs also increased from the previous year.
Other Operating Expenses increased $1.0 million due to increases in various cost categories including compensation costs and sales commissions.
CORPORATE COSTS
The following table summarizes Corporate operating results for the three months ended March 31, 2022 and 2021:
| (in thousands) | 2022 | 2021 | $ change | % change | |||||||||||||||||||
| Other Operating Expenses | $ | 4,395 | $ | 2,537 | $ | 1,858 | 73.2 | % | |||||||||||||||
| Depreciation and Amortization | 45 | 71 | (26) | (36.6) | |||||||||||||||||||
| Operating Loss | $ | 4,440 | $ | 2,608 | $ | 1,832 | 70.2 | % | |||||||||||||||
Other Operating Expenses increased $1.9 million primarily due to increased compensation expenses, including stock and incentive compensation, in the first quarter of 2022 which were higher than the amount recognized in the same period in the previous year due to our current year financial performance.
| REGULATORY RATE MATTERS | |||||
The following provides a summary of general rate case filings, rate rider filings and other regulatory filings that have or are expected to have a material impact on our operating results, financial position or cash flows.
GENERAL RATES
Minnesota Rate Case: On November 2, 2020, OTP filed a request with the MPUC for an increase in revenue recoverable through base rates in Minnesota. In its filing, OTP requested a net increase in annual revenue of approximately $14.5 million, or 6.77%, based on an allowed rate of return on rate base of 7.59% and an allowed rate of return on equity of 10.20% on an equity ratio of 52.5% of total capital. Through this proceeding, OTP had proposed changes to the mechanism of cost recovery, with some costs moving from riders into base rates and fuel, purchased power, and conservation program costs moving out of base rates and into riders. The filing also included a revenue decoupling mechanism proposal. Such mechanisms are designed to separate a utility's revenue from changes in energy sales. The decoupling mechanism uses a tracker balance through which authorized customer margins are subject to a true-up mechanism to maintain or cap a given level of revenues.
On December 3, 2020, the MPUC approved an interim annual rate increase of $6.9 million, or 3.2%, effective January 1, 2021. This approval was provided after an alternative recovery proposal was submitted by OTP which, among other changes, requested the extension of depreciable lives of certain wind-related assets and proposed deferral of certain cost recovery decisions to the final rate determination. In the aggregate, this alternative recovery proposal reduced operating costs and delayed recovery of certain other costs by approximately $7.0 million to lessen the interim rate impact on customers.
In a filing submitted to the MPUC on April 30, 2021, OTP lowered its initially requested net annual revenue increase from $14.5 million to $8.2 million, primarily due to a reduction in operating costs from amounts included in its November 2020 filing. Among other items, the cost reductions included lower depreciation expense on our wind generation assets due to the extension of depreciable lives from 25 to 35 years and a reduction in postretirement benefit costs.
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On February 1, 2022, the MPUC issued its written order. The key provisions of the order include a revenue requirement of $209.0 million, based on a return on rate base of 7.18% and an allowed return on equity of 9.48% on an equity ratio of 52.5%. The order also authorizes recovery of our remaining Hoot Lake Plant net asset over a five-year period, and approves the requested decoupling mechanism for most residential and commercial customer rate groups with a cap of 4% of annual base revenues.
On March 8, 2022, OTP filed its final rate case compliance filing, which included final revenue calculations, rate design and resulting tariff revisions, along with a proposal for interim rate refunds. The final calculations included a revision to the calculation of interim rates. If approved by the MPUC, this revision could increase interim revenues in the period the filing is approved by an amount of approximately $4.0 million. We expect the MPUC will issue its order and implement final rates in mid-2022.
RATE RIDERS
The following table includes a summary of pending and recently concluded rate rider proceedings:
| Recovery | Filing | Amount | Effective | |||||||||||||||||||||||||||||||||||
| Mechanism | Jurisdiction | Status | Date | (in millions) | Date | Notes | ||||||||||||||||||||||||||||||||
| CIP - 2022 | MN | Requested | 04/01/22 | $ | 10.8 | 10/01/22 | Includes recovery of energy conservation improvement costs as well as a demand side management financial incentive. | |||||||||||||||||||||||||||||||
| CIP - 2021 | MN | Approved | 04/01/21 | 9.4 | 12/01/21 | Includes recovery of energy conservation improvement costs as well as a demand side management financial incentive. | ||||||||||||||||||||||||||||||||
| TCR - 2021 | MN | Requested | 11/23/21 | 7.2 | 07/01/22 | Includes recovery of two new transmission projects. | ||||||||||||||||||||||||||||||||
| RRR - 2021 | MN | Requested | 12/06/21 | 7.0 | 07/01/22 | Includes return on Hoot Lake Solar construction costs and costs associated with the acquisition of the Ashtabula III wind farm. | ||||||||||||||||||||||||||||||||
| RRR - 2021 | ND | Approved | 03/07/21 | 11.8 | 04/01/21 | Includes recovery of Merricourt investment and operating costs. | ||||||||||||||||||||||||||||||||
| RRR - 2022 | ND | Approved | 01/05/22 | 7.8 | 04/01/22 | Includes Merricourt recovery, the proposed purchase of Ashtabula III and credits related to deferred taxes and production tax credits. | ||||||||||||||||||||||||||||||||
| TCR - 2021 | ND | Approved | 09/15/21 | 6.1 | 01/01/22 | Includes recovery of three new transmission projects/programs. | ||||||||||||||||||||||||||||||||
| TCR - 2020 | ND | Approved | 11/18/20 | 5.6 | 01/01/21 | Includes recovery of eight new transmission projects. | ||||||||||||||||||||||||||||||||
| GCR - 2021 | ND | Approved | 03/01/21 | 5.2 | 07/01/21 | Includes recovery of Astoria Station, net of anticipated savings associated with the retirement of Hoot Lake Plant. | ||||||||||||||||||||||||||||||||
| GCR - 2022 | ND | Requested | 03/01/22 | 3.3 | 07/01/22 | Annual update to generation cost recovery rider. | ||||||||||||||||||||||||||||||||
| TCR - 2020 | SD | Approved | 01/29/20 | 2.3 | 03/02/20 | Annual update to transmission cost recovery rider. | ||||||||||||||||||||||||||||||||
| TCR - 2021 | SD | Approved | 10/29/21 | 2.2 | 03/01/22 | Annual update to transmission cost recovery rider. | ||||||||||||||||||||||||||||||||
| TCR - 2021 | SD | Approved | 02/19/21 | 2.2 | 03/01/21 | Includes recovery of two new transmission projects. | ||||||||||||||||||||||||||||||||
INTEGRATED RESOURCE PLAN
On September 1, 2021, OTP filed its 2022 Integrated Resource Plan (IRP) concurrently with regulators in the three states where OTP operates, Minnesota, North Dakota and South Dakota. The 2022 IRP includes OTP’s preferred plan for meeting customers’ anticipated capacity and energy needs while maintaining system reliability and low electric service rates.
The components of OTP's preferred plan include:
–the addition of dual fuel capability at our Astoria Station natural gas plant;
–the addition of 150 megawatts of solar generation in 2025;
–the addition of 100 megawatts of wind generation in 2027;
–the commencement of the process of withdrawing from our 35 percent ownership interest in Coyote Station, a jointly owned, coal-fired generation plant, by December 31, 2028; and
–the addition of 50 megawatts of solar generation in 2033.
Although the 2022 IRP includes planned actions beyond 2026, regulators will not act upon or approve planned actions in periods beyond 2026 as part of our 2022 IRP filing.
Subject to regulatory approval, the preferred plan proposes to create a regulatory asset as a vehicle to recover costs related to a future withdrawal from Coyote Station, including the net book value of the plant on the withdrawal date, anticipated decommissioning costs and any required costs incurred as a result of an early termination of the existing lignite sales agreement, under which Coyote Station acquires all of its lignite coal from a nearby mine. As part of the filing, OTP developed an estimate of the reasonably foreseeable costs of withdrawing from Coyote Station at the end of 2028 of $68.5 million. These costs may differ from actual results due to the uncertainty and timing of future events associated with the terms and conditions of a withdrawal.
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We currently anticipate the MPUC, barring any delays in the procedural schedule, will hold deliberations and render a decision on the IRP by the end of 2022. There currently is no procedural schedule established for this IRP by the North Dakota Public Service Commission.
| LIQUIDITY | |||||
LIQUIDITY OVERVIEW
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 us ample liquidity to conduct our business operations, fund our short-term and long-term capital expenditure plans and satisfy our obligations as they become due. Our liquidity, including our operating cash flows and access to capital markets, can be impacted by macroeconomic factors outside of our control. In addition, our liquidity could be impacted by non-compliance with covenants under our various debt instruments. As of March 31, 2022, we were in compliance with all financial covenants (see the Financial Covenants section under Capital Resources below).
The following table presents the status of our lines of credit as of March 31, 2022 and December 31, 2021:
| 2022 | 2021 | ||||||||||||||||||||||||||||
| (in thousands) | Line Limit | Amount Outstanding | Letters of Credit | Amount Available | Amount Available | ||||||||||||||||||||||||
| OTC Credit Agreement | $ | 170,000 | $ | 43,281 | $ | — | $ | 126,719 | $ | 147,363 | |||||||||||||||||||
| OTP Credit Agreement | 170,000 | 54,489 | 7,844 | 107,667 | 88,315 | ||||||||||||||||||||||||
| Total | $ | 340,000 | $ | 97,770 | $ | 7,844 | $ | 234,386 | $ | 235,678 | |||||||||||||||||||
We have an internal risk tolerance metric to maintain a minimum of $50 million of liquidity under the OTC Credit Agreement. Should additional liquidity be needed, this agreement includes an accordion feature allowing us to increase the amount available to $290 million, subject to certain terms and conditions. The OTP Credit Agreement also includes an accordion feature allowing OTP to increase that facility to $250 million, subject to certain terms and conditions.
CASH FLOWS
The following is a discussion of our cash flows for the three months ended March 31, 2022 and 2021:
| (in thousands) | 2022 | 2021 | |||||||||
| Net Cash Provided by Operating Activities | $ | 45,416 | $ | 15,270 | |||||||
Net Cash Provided by Operating Activities increased $30.1 million for the three months ended March 31, 2022 compared to the three months ended March 31, 2021. The increase in cash provided by operating activities was primarily the result of increased earnings during the year, which was partially offset by increased working capital needs. Our level of working capital increased year over year and was impacted by increased accounts receivables within our Manufacturing and Plastics segments, due to strong sales volumes and significantly increased sales prices in 2022, partially offset by increased accounts payable due to increased material costs in our Manufacturing and Plastics segments in 2022. Operating cash flows were also reduced by a discretionary contribution to our pension plan of $20.0 million during the three months ended March 31, 2022, compared to a contribution of $10.0 million in 2021.
| (in thousands) | 2022 | 2021 | |||||||||
| Net Cash Used in Investing Activities | $ | 31,449 | $ | 49,020 | |||||||
Net Cash Used in Investing Activities decreased $17.6 million for the three months ended March 31, 2022 compared to the three months ended March 31, 2021. The decrease in capital expenditures was primarily related to costs incurred in 2021 by OTP to complete our Astoria Station project, and other one-time projects. Capital investment spending in our Manufacturing and Plastics segments also decreased from the previous year.
| (in thousands) | 2022 | 2021 | |||||||||
| Net Cash (Used in) Provided by Financing Activities | $ | (14,133) | $ | 33,799 | |||||||
Net Cash (Used in) Provided by Financing Activities decreased $47.9 million for the three months ended March 31, 2022 compared to the three months ended March 31, 2021, primarily as a result of a decrease in financing needs given the lower level of capital spending in our Electric segment and the increase in cash provided by operating activities. Financing activities for the three months ended March 31, 2022 included net proceeds from short-term borrowings of $6.6 million and dividend payments of $17.2 million. Financing activities for the three months ended March 31, 2021 included net proceeds from short-term borrowings of $53.9 million, primarily incurred to fund major construction projects, and dividend payments of $16.2 million.
| CAPITAL REQUIREMENTS | |||||
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CAPITAL EXPENDITURES
We have a capital expenditure program for expanding, upgrading and improving our plants and operating equipment. Typical uses of cash for capital expenditures in our electric segment are investments in electric generation facilities, including wind and solar investments, environmental upgrades, transmission lines and distribution systems, and computer hardware and information systems. Our electric segment capital expenditure program is subject to review and regulatory approval and is revised in light of changes in demands for energy, technology, environmental laws, regulatory changes, business expansion opportunities, the costs of labor, materials and equipment and our financial condition. Our future capital expenditure plans also include investments in manufacturing facilities and facility upgrades, manufacturing equipment additions and upgrades and additional technology assets to be used in our manufacturing operations. Refer to Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, of our Form 10-K for the year ended December 31, 2021 for our capital expenditure plan for the five year period from 2022 through 2026.
CONTRACTUAL OBLIGATIONS
Our contractual obligations primarily include principal and interest payments due under our outstanding debt obligations, commitments to acquire coal, energy and capacity commitments, payments to meet our postretirement benefit obligations, and payment obligations under land easement and leasing arrangements. Our contractual obligations as of December 31, 2021 are included in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the year ended December 31, 2021. There were no material changes in our contractual obligations outside of the ordinary course of our business during the three months ended March 31, 2022.
Off-Balance Sheet Arrangements
As of March 31, 2022, we have outstanding letters of credit totaling $11.0 million, a portion of which reduces our borrowing capacity under our lines of credit. No outstanding letters of credit are reflected in outstanding short-term debt on our consolidated balance sheets. We do not have any other off-balance-sheet arrangements or any relationships with unconsolidated entities or financial partnerships that have, or are reasonably likely to have, a material current or future effect on our financial condition. 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.
COMMON STOCK DIVIDENDS
We paid dividends to our common stockholders totaling $17.2 million, or $0.4125 per share, in the first three months of 2022. The determination of the amount of future cash dividends to be 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 allowed to be made by our subsidiaries. See Note 10 to our consolidated financial statements included in this Quarterly Report on Form 10-Q for additional information. The decision to declare a dividend is reviewed quarterly by our Board of Directors.
| CAPITAL RESOURCES | |||||
Financial flexibility is provided by operating cash flows, unused lines of credit and access to capital markets, which is aided by strong financial coverages and investment grade credit ratings. Debt financing will be required in the five-year period from 2022 through 2026 to refinance maturing debt and to finance our capital investments. Our financing plans are subject to change and are impacted by our planned level of capital investments, decisions to reduce borrowings under our lines of credit, to refund or retire early any of our presently outstanding debt, to complete acquisitions, or to use capital for other corporate purposes.
REGISTRATION STATEMENTS
On May 3, 2021, we filed a shelf registration statement with the SEC 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. No new debt or equity has been issued pursuant to the registration statement. The registration statement expires in May 2024.
On May 3, 2021, we filed a second registration statement with the SEC for the issuance of up to 1,500,000 common shares under an Automatic Dividend Reinvestment and a Share Purchase Plan, which provides shareholders, retail customers of OTP and other interested investors methods of purchasing our common shares, by reinvesting their dividends or making optional cash investments. Shares purchased under the plan may be newly issued common shares or common shares purchased on the open market. As of March 31, 2022, there was 1,348,716 shares available for purchase or issuance under the plan. The registration statement expires in May 2024.
SHORT-TERM DEBT
OTC and OTP are each party to a credit agreement (the OTC Credit Agreement and OTP Credit Agreement, respectively) which each provide for unsecured revolving lines of credit. The following is a summary of key provisions and borrowing information as of, and for the three months ended, March 31, 2022:
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| (in thousands, except interest rates) | OTC Credit Agreement | OTP Credit Agreement | |||||||||
| Borrowing Limit | $ | 170,000 | $ | 170,000 | |||||||
Borrowing Limit if Accordion Exercised1 | 290,000 | 250,000 | |||||||||
Amount Restricted Due to Outstanding Letters of Credit as of March 31, 2022 | — | 7,844 | |||||||||
Amount Outstanding as of March 31, 2022 | 43,281 | 54,489 | |||||||||
Average Amount Outstanding During the Three Months Ended March 31, 2022 | 35,493 | 66,098 | |||||||||
Maximum Amount Outstanding During the Three Months Ended March 31, 2022 | 58,715 | 74,519 | |||||||||
Interest Rate as of March 31, 2022 | 1.92 | % | 1.64 | % | |||||||
| Maturity Date | September 30, 2026 | September 30, 2026 | |||||||||
1Each facility includes an accordion featuring allowing the borrower to increase the borrowing limit if certain terms and conditions are met. | |||||||||||
LONG-TERM DEBT
At March 31, 2022, we had $767.0 million of principal outstanding under long-term debt arrangements. These instruments generally provide for unsecured borrowings at fixed rates of interest with maturities ranging from 2022 to 2051. Pursuant to a Note Purchase Agreement executed in June 2021, OTP intends to issue its Series 2022A notes due May 20, 2052, in May 2022 for aggregate proceeds of $90.0 million, subject to the satisfaction of certain customary conditions to closing, and use a portion of the proceeds to repay the $30.0 million Series 2007B Notes which are maturing in August 2022.
Note 6 to our consolidated financial statements included in this Quarterly Report on Form 10-Q includes additional information regarding these short-term and long-term debt instruments.
Financial Covenants
Certain of our short- and long-term debt agreements require OTC and OTP to maintain certain financial covenants. As of March 31, 2022, we were in compliance with these financial covenants as further described below:
OTC, under its financial covenants, may not permit its ratio of interest-bearing debt to total capitalization to exceed 0.60 to 1.00, may not permit its interest and dividend coverage ratio to be less than 1.50 to 1.00, and may not permit its priority indebtedness to exceed 10% of our total capitalization. As of March 31, 2022, our interest-bearing debt to total capitalization was 0.45 to 1.00, our interest and dividend coverage ratio was 8.35 to 1.00, and we had no priority indebtedness outstanding.
OTP, under its financial covenants, may not permit its ratio of debt to total capitalization to exceed 0.60 to 1.00, may not permit its interest and dividend coverage ratio to be less than 1.50 to 1.00, and may not permit its priority debt to exceed 20% of its total capitalization. As of March 31, 2022, OTP's interest-bearing debt to total capitalization was 0.47 to 1.00, its interest and dividend coverage ratio was 3.33 to 1.00, and OTP had no priority indebtedness outstanding.
| CRITICAL ACCOUNTING POLICIES INVOLVING SIGNIFICANT ESTIMATES | |||||
The discussion and analysis of our results of operations are based on financial statements prepared in accordance with accounting principles generally accepted in the United States of America. Certain of our accounting policies require 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 in the preparation of our consolidated financial statements. We have disclosed in our Annual Report on Form 10-K for the year ended December 31, 2021 the critical accounting policies that affect our most significant estimates and assumptions used in preparing our consolidated financial statements. There have been no material changes to our critical accounting policies and estimates from those disclosed in the most recent Annual Report on Form 10-K.
| ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | ||||
There have been no material changes in our market risk from those disclosed in Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in our Annual Report on Form 10-K for the year ended December 31, 2021.
| ITEM 4. | CONTROLS AND PROCEDURES | ||||
Evaluation of Disclosure Controls and Procedures. Under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)) as of March 31, 2022, the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2022.
Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) under the Exchange Act) during the quarter ended March 31, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
| ITEM 1. | LEGAL PROCEEDINGS | ||||||||||
We are the subject of various legal and regulatory proceedings in the ordinary course of our business. Such matters are subject to many uncertainties and to outcomes that are not predictable with assurance. We record a liability in our consolidated financial statements for costs related to claims, including future legal costs, settlements and judgments, where we have assessed that a loss is probable, and an amount can be reasonably estimated. Material proceedings are described under Note 9, Commitments and Contingencies, to the consolidated financial statements, and in Management's Discussion and Analysis of Financial Condition and Results of Operations, Regulatory Rate Matters.
| ITEM 1A. | RISK FACTORS | |||||||||||||
There have been no material changes from the risk factors disclosed in Item 1A, Risk Factors, of our Annual Report on Form 10-K for the year ended December 31, 2021.
| ITEM 6. | EXHIBITS | |||||||||||||
The following Exhibits are filed as part of, or incorporated by reference into, this report.
| No. | Description | ||||
| 31.1 | |||||
| 31.2 | |||||
| 32.1 | |||||
| 32.2 | |||||
| 101.SCH | —Inline XBRL Taxonomy Extension Schema Document | ||||
| 101.CAL | —Inline XBRL Taxonomy Extension Calculation Linkbase Document | ||||
| 101.LAB | —Inline XBRL Taxonomy Extension Label Linkbase Document | ||||
| 101.PRE | —Inline XBRL Taxonomy Extension Presentation Linkbase Document | ||||
| 101.DEF | —Inline XBRL Taxonomy Extension Definition Linkbase Document | ||||
| 104 | —Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) | ||||
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| OTTER TAIL CORPORATION | ||||||||
| By: | /s/ Kevin G. Moug | |||||||
| Kevin G. Moug Chief Financial Officer and Senior Vice President (duly authorized officer and principal financial officer) | ||||||||
| Dated: May 4, 2022 | ||||||||
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