Otter Tail Corp - Quarter Report: 2023 June (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 June 30, 2023 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:
41,710,521 Common Shares ($5 par value) as of July 28, 2023.
| TABLE OF CONTENTS | |||||||||||
| Description | Page | |||||||
| ITEM 1. | ||||||||
| ITEM 2. | ||||||||
| ITEM 3. | ||||||||
| ITEM 4. | ||||||||
| ITEM 1. | ||||||||
| ITEM 1A. | ||||||||
| ITEM 5. | ||||||||
| ITEM 6. | ||||||||
1
| DEFINITIONS | |||||||||||
| AMDT | Advanced Meter and Distribution Technology | MISO | Midcontinent Independent System Operator, Inc. | |||||||||||
| ARP | Alternative Revenue Program | MPUC | Minnesota Public Utilities Commission | |||||||||||
| BTD | BTD Manufacturing, Inc. | NDDEQ | North Dakota Department of Environmental Quality | |||||||||||
| CCS | Carbon Capture and Sequestration | OTC | Otter Tail Corporation | |||||||||||
| CIP | Conservation Improvement Program | OTP | Otter Tail Power Company | |||||||||||
| EGU | Electric Generating Units | PIR | Phase-In Rider | |||||||||||
| EITE | Energy Intensive, Trade Exposed Rider | PSLRA | Private Securities Litigation Reform Act of 1995 | |||||||||||
| EPA | Environmental Protection Agency | PTC | Production Tax Credits | |||||||||||
| ESSRP | Executive Survivor and Supplemental Retirement Plan | PVC | Polyvinyl chloride | |||||||||||
| EUIC | Electric Utility Infrastructure Cost Recovery Rider | RHR | Regional Haze Rule | |||||||||||
| FERC | Federal Energy Regulatory Commission | ROE | Return on equity | |||||||||||
| GCR | Generation Cost Recovery Rider | RRR | Renewable Resource Rider | |||||||||||
| GHG | Greenhouse Gas | SEC | Securities and Exchange Commission | |||||||||||
| ISO | Independent System Operator | T.O. Plastics | T.O. Plastics, Inc. | |||||||||||
| kwh | kilowatt-hour | TCR | Transmission Cost Recovery Rider | |||||||||||
| Merricourt | Merricourt Wind Energy Center | |||||||||||||
| FORWARD-LOOKING INFORMATION | ||
PART I. FINANCIAL INFORMATION
| ITEM 1. | FINANCIAL STATEMENTS | ||||
2
OTTER TAIL CORPORATION
CONSOLIDATED BALANCE SHEETS (unaudited)
| (in thousands, except share data) | June 30, 2023 | December 31, 2022 | |||||||||
| Assets | |||||||||||
| Current Assets | |||||||||||
| Cash and Cash Equivalents | $ | 150,578 | $ | 118,996 | |||||||
| Receivables, net of allowance for credit losses | 194,951 | 144,393 | |||||||||
| Inventories | 144,441 | 145,952 | |||||||||
| Regulatory Assets | 19,058 | 24,999 | |||||||||
| Other Current Assets | 15,084 | 18,412 | |||||||||
| Total Current Assets | 524,112 | 452,752 | |||||||||
| Noncurrent Assets | |||||||||||
| Investments | 59,882 | 54,845 | |||||||||
| Property, Plant and Equipment, net of accumulated depreciation | 2,316,246 | 2,212,717 | |||||||||
| Regulatory Assets | 96,128 | 94,655 | |||||||||
| Intangible Assets, net of accumulated amortization | 7,393 | 7,943 | |||||||||
| Goodwill | 37,572 | 37,572 | |||||||||
| Other Noncurrent Assets | 52,653 | 41,177 | |||||||||
| Total Noncurrent Assets | 2,569,874 | 2,448,909 | |||||||||
| Total Assets | $ | 3,093,986 | $ | 2,901,661 | |||||||
| Liabilities and Shareholders' Equity | |||||||||||
| Current Liabilities | |||||||||||
| Short-Term Debt | $ | 50,197 | $ | 8,204 | |||||||
| Accounts Payable | 104,661 | 104,400 | |||||||||
| Accrued Salaries and Wages | 26,029 | 32,327 | |||||||||
| Accrued Taxes | 31,900 | 19,340 | |||||||||
| Regulatory Liabilities | 41,743 | 17,300 | |||||||||
| Other Current Liabilities | 46,032 | 56,065 | |||||||||
| Total Current Liabilities | 300,562 | 237,636 | |||||||||
| Noncurrent Liabilities | |||||||||||
| Pension Benefit Liability | 33,198 | 33,210 | |||||||||
| Other Postretirement Benefits Liability | 47,364 | 46,977 | |||||||||
| Regulatory Liabilities | 245,935 | 244,497 | |||||||||
| Deferred Income Taxes | 231,910 | 221,302 | |||||||||
| Deferred Tax Credits | 15,544 | 15,916 | |||||||||
| Other Noncurrent Liabilities | 67,093 | 60,985 | |||||||||
| Total Noncurrent Liabilities | 641,044 | 622,887 | |||||||||
| Capitalization | |||||||||||
| Long-Term Debt | 823,941 | 823,821 | |||||||||
| Shareholders' Equity | |||||||||||
Common Shares: 50,000,000 shares authorized, $5 par value; 41,710,521 and 41,631,113 outstanding at June 30, 2023 and December 31, 2022 | 208,553 | 208,156 | |||||||||
| Additional Paid-In Capital | 425,867 | 423,034 | |||||||||
| Retained Earnings | 693,138 | 585,212 | |||||||||
| Accumulated Other Comprehensive Income | 881 | 915 | |||||||||
| Total Shareholders' Equity | 1,328,439 | 1,217,317 | |||||||||
| Total Capitalization | 2,152,380 | 2,041,138 | |||||||||
| Total Liabilities and Shareholders' Equity | $ | 3,093,986 | $ | 2,901,661 | |||||||
See accompanying notes to consolidated financial statements.
3
OTTER TAIL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (unaudited)
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| (in thousands, except per-share amounts) | 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||
| Operating Revenues | |||||||||||||||||||||||
| Electric | $ | 113,763 | $ | 130,949 | $ | 265,671 | $ | 261,365 | |||||||||||||||
| Product Sales | 223,953 | 269,091 | 411,126 | 513,579 | |||||||||||||||||||
| Total Operating Revenues | 337,716 | 400,040 | 676,797 | 774,944 | |||||||||||||||||||
| Operating Expenses | |||||||||||||||||||||||
| Electric Production Fuel | 14,833 | 14,714 | 26,326 | 29,567 | |||||||||||||||||||
| Electric Purchased Power | 5,212 | 24,162 | 47,037 | 44,691 | |||||||||||||||||||
| Electric Operating and Maintenance Expenses | 45,522 | 42,379 | 91,070 | 86,659 | |||||||||||||||||||
| Cost of Products Sold (excluding depreciation) | 120,658 | 152,466 | 233,027 | 304,225 | |||||||||||||||||||
| Other Nonelectric Expenses | 16,870 | 17,252 | 35,568 | 34,457 | |||||||||||||||||||
| Depreciation and Amortization | 24,232 | 23,566 | 48,089 | 47,113 | |||||||||||||||||||
| Electric Property Taxes | 4,336 | 4,435 | 8,957 | 8,866 | |||||||||||||||||||
| Total Operating Expenses | 231,663 | 278,974 | 490,074 | 555,578 | |||||||||||||||||||
| Operating Income | 106,053 | 121,066 | 186,723 | 219,366 | |||||||||||||||||||
| Other Income and (Expense) | |||||||||||||||||||||||
| Interest Expense | (9,696) | (8,991) | (19,111) | (17,939) | |||||||||||||||||||
| Nonservice Components of Postretirement Benefits | 2,421 | 751 | 4,833 | 772 | |||||||||||||||||||
| Other Income (Expense), net | 3,253 | (889) | 5,370 | (629) | |||||||||||||||||||
| Income Before Income Taxes | 102,031 | 111,937 | 177,815 | 201,570 | |||||||||||||||||||
| Income Tax Expense | 20,062 | 26,000 | 33,365 | 43,630 | |||||||||||||||||||
| Net Income | $ | 81,969 | $ | 85,937 | $ | 144,450 | $ | 157,940 | |||||||||||||||
| Weighted-Average Common Shares Outstanding: | |||||||||||||||||||||||
| Basic | 41,678 | 41,597 | 41,655 | 41,573 | |||||||||||||||||||
| Diluted | 42,053 | 41,944 | 42,035 | 41,907 | |||||||||||||||||||
| Earnings Per Share: | |||||||||||||||||||||||
| Basic | $ | 1.97 | $ | 2.07 | $ | 3.47 | $ | 3.80 | |||||||||||||||
| Diluted | $ | 1.95 | $ | 2.05 | $ | 3.44 | $ | 3.77 | |||||||||||||||
See accompanying notes to consolidated financial statements.
4
OTTER TAIL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| (in thousands) | 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||
| Net Income | $ | 81,969 | $ | 85,937 | $ | 144,450 | $ | 157,940 | |||||||||||||||
| Other Comprehensive Income (Loss): | |||||||||||||||||||||||
Unrealized Gain (Loss) on Available-for-Sale Securities, net of tax (expense) benefit of $16, $20, $(5) and $81 | (61) | (74) | 19 | (305) | |||||||||||||||||||
Pension and Other Postretirement Benefits, net of tax benefit (expense) of $9, $(37), $19 and $29 | (27) | 106 | (53) | (84) | |||||||||||||||||||
| Total Other Comprehensive Income (Loss) | (88) | 32 | (34) | (389) | |||||||||||||||||||
| Total Comprehensive Income | $81,881 | $85,969 | $144,416 | $157,551 | |||||||||||||||||||
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, March 31, 2023 | 41,684,526 | $ | 208,423 | $ | 424,948 | $ | 629,437 | $ | 969 | $ | 1,263,777 | ||||||||||||||||||||||||
| Stock Issued Under Share-Based Compensation Plans, net of shares withheld for employee taxes | 25,995 | 130 | (130) | — | — | — | |||||||||||||||||||||||||||||
| Stock Issued Under Stock Purchase Plan, net of expenses | — | — | (167) | — | — | (167) | |||||||||||||||||||||||||||||
| Net Income | — | — | — | 81,969 | — | 81,969 | |||||||||||||||||||||||||||||
| Other Comprehensive Loss | — | — | — | — | (88) | (88) | |||||||||||||||||||||||||||||
| Stock Compensation Expense | — | — | 1,216 | — | — | 1,216 | |||||||||||||||||||||||||||||
Common Dividends ($0.4375 per share) | — | — | — | (18,268) | — | (18,268) | |||||||||||||||||||||||||||||
| Balance, June 30, 2023 | 41,710,521 | $ | 208,553 | $ | 425,867 | $ | 693,138 | $ | 881 | $ | 1,328,439 | ||||||||||||||||||||||||
| Balance, March 31, 2022 | 41,605,884 | $ | 208,029 | $ | 421,449 | $ | 424,605 | $ | (6,945) | $ | 1,047,138 | ||||||||||||||||||||||||
| Stock Issued Under Share-Based Compensation Plans, net of shares withheld for employee taxes | 24,915 | 125 | (105) | — | — | 20 | |||||||||||||||||||||||||||||
| Net Income | — | — | — | 85,937 | — | 85,937 | |||||||||||||||||||||||||||||
| Other Comprehensive Income | — | — | — | — | 32 | 32 | |||||||||||||||||||||||||||||
| Stock Compensation Expense | — | — | 607 | — | — | 607 | |||||||||||||||||||||||||||||
Common Dividends ($0.4125 per share) | — | — | — | (17,191) | — | (17,191) | |||||||||||||||||||||||||||||
| Balance, June 30, 2022 | 41,630,799 | $ | 208,154 | $ | 421,951 | $ | 493,351 | $ | (6,913) | $ | 1,116,543 | ||||||||||||||||||||||||
| Balance, December 31, 2022 | 41,631,113 | $ | 208,156 | $ | 423,034 | $ | 585,212 | $ | 915 | $ | 1,217,317 | ||||||||||||||||||||||||
| Stock Issued Under Share-Based Compensation Plans, net of shares withheld for employee taxes | 79,408 | 397 | (3,485) | — | — | (3,088) | |||||||||||||||||||||||||||||
| Stock Issued Under Stock Purchase Plan, net of expenses | — | — | (166) | — | — | (166) | |||||||||||||||||||||||||||||
| Net Income | — | — | — | 144,450 | — | 144,450 | |||||||||||||||||||||||||||||
| Other Comprehensive Loss | — | — | — | — | (34) | (34) | |||||||||||||||||||||||||||||
| Stock Compensation Expense | — | — | 6,484 | — | — | 6,484 | |||||||||||||||||||||||||||||
Common Dividends ($0.875 per share) | — | — | — | (36,524) | — | (36,524) | |||||||||||||||||||||||||||||
| Balance, June 30, 2023 | 41,710,521 | $ | 208,553 | $ | 425,867 | $ | 693,138 | $ | 881 | $ | 1,328,439 | ||||||||||||||||||||||||
| 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 | 79,275 | 396 | (3,320) | — | — | (2,924) | |||||||||||||||||||||||||||||
| Net Income | — | — | — | 157,940 | — | 157,940 | |||||||||||||||||||||||||||||
| Other Comprehensive Loss | — | — | — | — | (389) | (389) | |||||||||||||||||||||||||||||
| Stock Compensation Expense | — | — | 5,511 | — | — | 5,511 | |||||||||||||||||||||||||||||
Common Dividends ($0.825 per share) | — | — | — | (34,372) | — | (34,372) | |||||||||||||||||||||||||||||
| Balance, June 30, 2022 | 41,630,799 | $ | 208,154 | $ | 421,951 | $ | 493,351 | $ | (6,913) | $ | 1,116,543 | ||||||||||||||||||||||||
See accompanying notes to consolidated financial statements.
6
OTTER TAIL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
| Six Months Ended June 30, | |||||||||||
| (in thousands) | 2023 | 2022 | |||||||||
| Operating Activities | |||||||||||
| Net Income | $ | 144,450 | $ | 157,940 | |||||||
| Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: | |||||||||||
| Depreciation and Amortization | 48,089 | 47,113 | |||||||||
| Deferred Tax Credits | (372) | (373) | |||||||||
| Deferred Income Taxes | 8,708 | 25,160 | |||||||||
| Discretionary Contribution to Pension Plan | — | (20,000) | |||||||||
| Investment (Gains) Losses | (4,295) | 4,440 | |||||||||
| Stock Compensation Expense | 6,484 | 5,511 | |||||||||
| Other, Net | 161 | (164) | |||||||||
| Changes in Operating Assets and Liabilities: | |||||||||||
| Receivables | (50,558) | (50,885) | |||||||||
| Inventories | 2,396 | 2,889 | |||||||||
| Regulatory Assets | 7,320 | 5,604 | |||||||||
| Other Assets | 3,561 | 3,240 | |||||||||
| Accounts Payable | 1,037 | 1,933 | |||||||||
| Accrued and Other Liabilities | (4,271) | (3,394) | |||||||||
| Regulatory Liabilities | 27,169 | (3,859) | |||||||||
| Pension and Other Postretirement Benefits | (5,382) | 475 | |||||||||
| Net Cash Provided by Operating Activities | 184,497 | 175,630 | |||||||||
| Investing Activities | |||||||||||
| Capital Expenditures | (151,516) | (70,791) | |||||||||
| Proceeds from Disposal of Noncurrent Assets | 2,970 | 2,840 | |||||||||
| Cash Used for Investments and Other Assets | (5,079) | (5,944) | |||||||||
| Net Cash Used in Investing Activities | (153,625) | (73,895) | |||||||||
| Financing Activities | |||||||||||
| Net Borrowings (Repayments) of Short-Term Debt | 41,993 | (91,163) | |||||||||
| Proceeds from Issuance of Long-Term Debt | — | 90,000 | |||||||||
| Dividends Paid | (36,524) | (34,372) | |||||||||
| Payments for Shares Withheld for Employee Tax Obligations | (3,088) | (2,942) | |||||||||
| Other, net | (1,671) | (2,806) | |||||||||
| Net Cash Provided by (Used in) Financing Activities | 710 | (41,283) | |||||||||
| Net Change in Cash and Cash Equivalents | 31,582 | 60,452 | |||||||||
| Cash and Cash Equivalents at Beginning of Period | 118,996 | 1,537 | |||||||||
| Cash and Cash Equivalents at End of Period | $ | 150,578 | $ | 61,989 | |||||||
| Supplemental Disclosure of Noncash Investing Activities | |||||||||||
| Accrued Property, Plant and Equipment Additions | $ | 13,149 | $ | 11,116 | |||||||
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, 2022.
Because of the seasonality of our businesses and other factors, the earnings for the three and six months ended June 30, 2023 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 cash flows to maintain consistency and comparability between periods presented. Other, net operating cash flows previously reported for the six months ended June 30, 2022, included $4.4 million of investment losses, which are presented separately in the current period, and excluded $0.6 million of allowance for equity funds used during construction, which were previously presented separately. The reclassifications had no impact on previously reported 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.
Concentration of Deposits and Investments
The Company has financial instruments that potentially subject us to a concentration risk, including cash and cash equivalents held in deposit and money market accounts with various financial institutions. These deposits are guaranteed by the Federal Deposit Insurance Corporation up to an insurance limit of $250,000. Currently, our cash and cash equivalents significantly exceed federally insured levels.
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 and cash equivalents, 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.
8
Information for each segment and our unallocated corporate costs for the three and six months ended June 30, 2023 and 2022 are as follows:
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||
| (in thousands) | 2023 | 2022 | 2023 | 2022 | ||||||||||||||||||||||
| Operating Revenue | ||||||||||||||||||||||||||
| Electric | $ | 113,763 | $ | 130,949 | $ | 265,671 | $ | 261,365 | ||||||||||||||||||
| Manufacturing | 102,475 | 103,196 | 209,257 | 208,154 | ||||||||||||||||||||||
| Plastics | 121,478 | 165,895 | 201,869 | 305,425 | ||||||||||||||||||||||
| Total | $ | 337,716 | $ | 400,040 | $ | 676,797 | $ | 774,944 | ||||||||||||||||||
| Net Income (Loss) | ||||||||||||||||||||||||||
| Electric | $ | 19,634 | $ | 18,858 | $ | 42,854 | $ | 38,091 | ||||||||||||||||||
| Manufacturing | 5,969 | 7,555 | 12,831 | 11,639 | ||||||||||||||||||||||
| Plastics | 55,392 | 63,959 | 89,078 | 114,806 | ||||||||||||||||||||||
| Corporate | 974 | (4,435) | (313) | (6,596) | ||||||||||||||||||||||
| Total | $ | 81,969 | $ | 85,937 | $ | 144,450 | $ | 157,940 | ||||||||||||||||||
The following provides the identifiable assets by segment and corporate assets as of June 30, 2023 and December 31, 2022:
| (in thousands) | June 30, 2023 | December 31, 2022 | |||||||||
| Identifiable Assets | |||||||||||
| Electric | $ | 2,446,293 | $ | 2,351,961 | |||||||
| Manufacturing | 260,050 | 245,869 | |||||||||
| Plastics | 177,470 | 126,318 | |||||||||
| Corporate | 210,173 | 177,513 | |||||||||
| Total | $ | 3,093,986 | $ | 2,901,661 | |||||||
3. Revenue
Presented below are 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 and six months ended June 30, 2023 and 2022:
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| (in thousands) | 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||
| Operating Revenues | |||||||||||||||||||||||
| Electric Segment | |||||||||||||||||||||||
| Retail: Residential | $ | 26,974 | $ | 33,011 | $ | 70,951 | $ | 73,743 | |||||||||||||||
| Retail: Commercial and Industrial | 64,989 | 78,521 | 155,474 | 149,527 | |||||||||||||||||||
| Retail: Other | 1,752 | 2,071 | 3,743 | 3,972 | |||||||||||||||||||
| Total Retail | 93,715 | 113,603 | 230,168 | 227,242 | |||||||||||||||||||
| Transmission | 14,829 | 11,697 | 26,936 | 24,254 | |||||||||||||||||||
| Wholesale | 2,670 | 3,537 | 4,508 | 6,000 | |||||||||||||||||||
| Other | 2,549 | 2,112 | 4,059 | 3,869 | |||||||||||||||||||
| Total Electric Segment | 113,763 | 130,949 | 265,671 | 261,365 | |||||||||||||||||||
| Manufacturing Segment | |||||||||||||||||||||||
| Metal Parts and Tooling | 89,396 | 88,296 | 179,463 | 177,869 | |||||||||||||||||||
| Plastic Products and Tooling | 10,068 | 11,416 | 24,211 | 23,860 | |||||||||||||||||||
| Scrap Metal Sales | 3,011 | 3,484 | 5,583 | 6,425 | |||||||||||||||||||
| Total Manufacturing Segment | 102,475 | 103,196 | 209,257 | 208,154 | |||||||||||||||||||
| Plastics Segment | |||||||||||||||||||||||
| PVC Pipe | 121,478 | 165,895 | 201,869 | 305,425 | |||||||||||||||||||
| Total Operating Revenue | 337,716 | 400,040 | 676,797 | 774,944 | |||||||||||||||||||
| Less: Non-contract Revenues Included Above | |||||||||||||||||||||||
| Electric Segment - ARP Revenues | (334) | (4,928) | (1,545) | (7,388) | |||||||||||||||||||
| Total Operating Revenues from Contracts with Customers | $ | 338,050 | $ | 404,968 | $ | 678,342 | $ | 782,332 | |||||||||||||||
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4. Select Balance Sheet Information
Receivables and Allowance for Credit Losses
Receivables as of June 30, 2023 and December 31, 2022 are as follows:
| (in thousands) | June 30, 2023 | December 31, 2022 | |||||||||
| Receivables | |||||||||||
| Trade | $ | 166,267 | $ | 112,126 | |||||||
| Other | 11,183 | 9,983 | |||||||||
| Unbilled Receivables | 19,715 | 23,932 | |||||||||
| Total Receivables | 197,165 | 146,041 | |||||||||
| Less: Allowance for Credit Losses | 2,214 | 1,648 | |||||||||
| Receivables, net of allowance for credit losses | $ | 194,951 | $ | 144,393 | |||||||
The following is a summary of activity in the allowance for credit losses for the six months ended June 30, 2023 and 2022:
| (in thousands) | 2023 | 2022 | |||||||||
| Beginning Balance, January 1 | $ | 1,648 | $ | 1,836 | |||||||
| Additions Charged to Expense | 1,001 | 382 | |||||||||
| Reductions for Amounts Written Off, Net of Recoveries | (435) | (461) | |||||||||
| Ending Balance, June 30 | $ | 2,214 | $ | 1,757 | |||||||
Inventories
Inventories consist of the following as of June 30, 2023 and December 31, 2022:
| (in thousands) | June 30, 2023 | December 31, 2022 | |||||||||
| Raw Material, Fuel and Supplies | $ | 73,314 | $ | 70,374 | |||||||
| Work in Process | 29,326 | 31,766 | |||||||||
| Finished Goods | 41,801 | 43,812 | |||||||||
| Total Inventories | $ | 144,441 | $ | 145,952 | |||||||
Investments
The following is a summary of our investments as of June 30, 2023 and December 31, 2022:
| (in thousands) | June 30, 2023 | December 31, 2022 | |||||||||
| Corporate-Owned Life Insurance Policies | $ | 39,352 | $ | 38,991 | |||||||
| Corporate and Government Debt Securities | 8,926 | 8,761 | |||||||||
| Money Market Funds | 4,069 | 1,560 | |||||||||
| Mutual Funds | 7,505 | 5,503 | |||||||||
| Other Investments | 30 | 30 | |||||||||
| Total Investments | $ | 59,882 | $ | 54,845 | |||||||
The amount of unrealized gains and losses on debt securities as of June 30, 2023 and December 31, 2022 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 June 30, 2023 and December 31, 2022 was not material.
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Property, Plant and Equipment
Major classes of property, plant and equipment as of June 30, 2023 and December 31, 2022 include:
| (in thousands) | June 30, 2023 | December 31, 2022 | |||||||||
| Electric Plant | |||||||||||
| Electric Plant in Service | $ | 2,933,603 | $ | 2,844,379 | |||||||
| Construction Work in Progress | 141,249 | 113,932 | |||||||||
| Total Gross Electric Plant | 3,074,852 | 2,958,311 | |||||||||
| Less Accumulated Depreciation and Amortization | 888,374 | 859,988 | |||||||||
| Net Electric Plant | 2,186,478 | 2,098,323 | |||||||||
| Nonelectric Property, Plant and Equipment | |||||||||||
| Nonelectric Property, Plant and Equipment in Service | 297,908 | 293,928 | |||||||||
| Construction Work in Progress | 34,147 | 15,170 | |||||||||
| Total Gross Nonelectric Property, Plant and Equipment | 332,055 | 309,098 | |||||||||
| Less Accumulated Depreciation and Amortization | 202,287 | 194,704 | |||||||||
| Net Nonelectric Property, Plant and Equipment | 129,768 | 114,394 | |||||||||
| Net Property, Plant and Equipment | $ | 2,316,246 | $ | 2,212,717 | |||||||
On January 3, 2023, we purchased the Ashtabula III wind farm, located in eastern North Dakota, which consists of 39 wind turbines and the related infrastructure, adding 62.4 megawatts of nameplate capacity to our owned generation assets. The total purchase price of the acquisition was $50.6 million. In addition to the acquired assets, we also recognized a $3.3 million asset retirement obligation liability associated with the wind farm and became party to the land easement agreements with the landowners of the wind farm.
5. Regulatory Matters
Regulatory Assets and Liabilities
The following presents our current and long-term regulatory assets and liabilities as of June 30, 2023 and December 31, 2022 and the period we expect to recover or refund such amounts:
| Period of | June 30, 2023 | December 31, 2022 | |||||||||||||||||||||||||||
| (in thousands) | Recovery/Refund | Current | Long-Term | Current | Long-Term | ||||||||||||||||||||||||
| Regulatory Assets | |||||||||||||||||||||||||||||
Pension and Other Postretirement Benefit Plans1 | Various | $ | — | $ | 90,602 | $ | — | $ | 88,354 | ||||||||||||||||||||
Alternative Revenue Program Riders2 | Up to 2 years | 6,563 | 79 | 5,679 | 2,508 | ||||||||||||||||||||||||
Asset Retirement Obligations1 | Asset lives | — | 2,327 | — | 1,467 | ||||||||||||||||||||||||
| Deferred Income Taxes | Asset lives | — | 847 | — | — | ||||||||||||||||||||||||
ISO Cost Recovery Trackers1 | Up to 2 years | 288 | 207 | 575 | 314 | ||||||||||||||||||||||||
Unrecovered Project Costs1 | Up to 4 years | 349 | 1,048 | 320 | 990 | ||||||||||||||||||||||||
Deferred Rate Case Expenses1 | Up to 3 years | 377 | 566 | 377 | 754 | ||||||||||||||||||||||||
Fuel Clause Adjustments1 | Up to 1 year | 9,935 | — | 10,893 | — | ||||||||||||||||||||||||
Derivative Instruments1 | Up to 2 years | 1,521 | 207 | 7,130 | — | ||||||||||||||||||||||||
Other1 | Various | 25 | 245 | 25 | 268 | ||||||||||||||||||||||||
| Total Regulatory Assets | $ | 19,058 | $ | 96,128 | $ | 24,999 | $ | 94,655 | |||||||||||||||||||||
| Regulatory Liabilities | |||||||||||||||||||||||||||||
| Deferred Income Taxes | Asset lives | $ | — | $ | 129,567 | $ | — | $ | 131,480 | ||||||||||||||||||||
| Plant Removal Obligations | Asset lives | 8,474 | 106,393 | 8,509 | 105,733 | ||||||||||||||||||||||||
| Fuel Clause Adjustments | Up to 1 year | 22,358 | — | 365 | — | ||||||||||||||||||||||||
| Alternative Revenue Program Riders | Up to 1 year | 4,560 | — | 2,504 | — | ||||||||||||||||||||||||
| North Dakota PTC Refunds | Asset lives | — | 9,512 | — | 7,136 | ||||||||||||||||||||||||
| Pension and Other Postretirement Benefit Plans | Up to 1 year | 5,589 | — | 5,589 | — | ||||||||||||||||||||||||
| Other | Various | 762 | 463 | 333 | 148 | ||||||||||||||||||||||||
| Total Regulatory Liabilities | $ | 41,743 | $ | 245,935 | $ | 17,300 | $ | 244,497 | |||||||||||||||||||||
1Costs subject to recovery without a rate of return. | |||||||||||||||||||||||||||||
2Amount eligible for recovery includes an incentive or rate of return. | |||||||||||||||||||||||||||||
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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 Company (OTP), as of June 30, 2023 and December 31, 2022:
Short-Term Debt
The following is a summary of our lines of credit as of June 30, 2023 and December 31, 2022:
| June 30, 2023 | December 31, 2022 | ||||||||||||||||||||||||||||
| (in thousands) | Borrowing Limit | Amount Outstanding | Letters of Credit | Amount Available | Amount Available | ||||||||||||||||||||||||
| OTC Credit Agreement | $ | 170,000 | $ | — | $ | — | $ | 170,000 | $ | 170,000 | |||||||||||||||||||
| OTP Credit Agreement | 170,000 | 50,197 | 9,573 | 110,230 | 152,223 | ||||||||||||||||||||||||
| Total | $ | 340,000 | $ | 50,197 | $ | 9,573 | $ | 280,230 | $ | 322,223 | |||||||||||||||||||
Long-Term Debt
The following is a summary of outstanding long-term debt by borrower as of June 30, 2023 and December 31, 2022:
| (in thousands) | ||||||||||||||||||||||||||||||||
| Borrower | Debt Instrument | Rate | Maturity | June 30, 2023 | December 31, 2022 | |||||||||||||||||||||||||||
| OTC | Guaranteed Senior Notes | 3.55% | 12/15/26 | $ | 80,000 | $ | 80,000 | |||||||||||||||||||||||||
| 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 | |||||||||||||||||||||||||||
| OTP | Series 2022A Senior Unsecured Notes | 3.77% | 05/20/52 | 90,000 | 90,000 | |||||||||||||||||||||||||||
| Total | $ | 827,000 | $ | 827,000 | ||||||||||||||||||||||||||||
| Less: | Unamortized Long-Term Debt Issuance Costs | 3,059 | 3,179 | |||||||||||||||||||||||||||||
| Total Long-Term Debt, Net of Unamortized Debt Issuance Costs | $ | 823,941 | $ | 823,821 | ||||||||||||||||||||||||||||
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 June 30, 2023, 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 (the "ESSRP"), both accounted for as defined benefit pension plans, and a postretirement healthcare plan accounted for as an other postretirement benefit plan.
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The following table includes the components of net periodic benefit cost (income) related to our defined benefit pension plans and other postretirement benefits for the three and six months ended June 30, 2023 and 2022:
| Three Months Ended June 30, | |||||||||||||||||||||||||||||||||||
| Pension Benefits (Pension Plan) | Pension Benefits (ESSRP) | Postretirement Benefits | |||||||||||||||||||||||||||||||||
| (in thousands) | 2023 | 2022 | 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||||||||||||
| Service Cost | $ | 924 | $ | 1,644 | $ | 18 | $ | 49 | $ | 153 | $ | 334 | |||||||||||||||||||||||
| Interest Cost | 4,109 | 3,086 | 473 | 336 | 669 | 511 | |||||||||||||||||||||||||||||
| Expected Return on Assets | (6,478) | (5,921) | — | — | — | — | |||||||||||||||||||||||||||||
| Amortization of Prior Service Cost | — | — | — | — | (1,434) | (1,434) | |||||||||||||||||||||||||||||
| Amortization of Net Actuarial Loss | — | 1,967 | — | 142 | — | 766 | |||||||||||||||||||||||||||||
| Net Periodic Benefit Cost (Income) | $ | (1,445) | $ | 776 | $ | 491 | $ | 527 | $ | (612) | $ | 177 | |||||||||||||||||||||||
| Six Months Ended June 30, | |||||||||||||||||||||||||||||||||||
| Pension Benefits (Pension Plan) | Pension Benefits (ESSRP) | Postretirement Benefits | |||||||||||||||||||||||||||||||||
| (in thousands) | 2023 | 2022 | 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||||||||||||
| Service Cost | $ | 1,849 | $ | 3,288 | $ | 36 | $ | 98 | $ | 306 | $ | 669 | |||||||||||||||||||||||
| Interest Cost | 8,218 | 6,172 | 945 | 671 | 1,338 | 1,021 | |||||||||||||||||||||||||||||
| Expected Return on Assets | (12,957) | (11,842) | — | — | — | — | |||||||||||||||||||||||||||||
| Amortization of Prior Service Cost | — | — | — | — | (2,867) | (2,867) | |||||||||||||||||||||||||||||
| Amortization of Net Actuarial Loss | — | 3,933 | — | 284 | — | 1,532 | |||||||||||||||||||||||||||||
| Net Periodic Benefit Cost (Income) | $ | (2,890) | $ | 1,551 | $ | 981 | $ | 1,053 | $ | (1,223) | $ | 355 | |||||||||||||||||||||||
The following table includes the impact of regulation on the recognition of periodic benefit cost (income) arising from pension and other postretirement benefits for the three and six months ended June 30, 2023 and 2022:
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| (in thousands) | 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||
| Net Periodic Benefit Cost (Income) | $ | (1,566) | $ | 1,480 | $ | (3,132) | $ | 2,959 | |||||||||||||||
| Net Amount Amortized (Deferred) Due to the Effect of Regulation | 240 | (204) | 490 | 324 | |||||||||||||||||||
| Net Periodic Benefit Cost (Income) Recognized | $ | (1,326) | $ | 1,276 | $ | (2,642) | $ | 3,283 | |||||||||||||||
We had no minimum funding requirements for our Pension Plan or any other postretirement benefit plans as of December 31, 2022. We did not make any contributions to our Pension Plan during the six months ended June 30, 2023. We made a discretionary contribution to our Pension Plan of $20.0 million during the six months ended June 30, 2022.
8. Income Taxes
The reconciliation of the statutory federal income tax rate to our effective tax rate for each of the three and six months ended June 30, 2023 and 2022 is as follows:
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||||||||||||||
| 2023 | 2022 | 2023 | 2022 | ||||||||||||||||||||||||||||||||
| Income Taxes at Federal Statutory Rate | $ | 21,426 | 21.0 | % | $ | 23,507 | 21.0 | % | $ | 37,341 | 21.0 | % | $ | 42,330 | 21.0 | % | |||||||||||||||||||
| Increases (Decreases) in Tax from: | |||||||||||||||||||||||||||||||||||
| State Taxes on Income, Net of Federal Tax | 5,104 | 5.0 | 5,596 | 5.0 | 8,893 | 5.0 | 10,078 | 5.0 | |||||||||||||||||||||||||||
| Production Tax Credits (PTCs) | (4,574) | (4.5) | (4,719) | (4.2) | (9,229) | (5.2) | (8,686) | (4.3) | |||||||||||||||||||||||||||
| Amortization of Excess Deferred Income Taxes | (622) | (0.6) | 99 | — | (1,420) | (0.8) | (1,078) | (0.5) | |||||||||||||||||||||||||||
| North Dakota Wind Tax Credit Amortization, Net of Federal Tax | (146) | (0.1) | (155) | (0.1) | (310) | (0.2) | (355) | (0.2) | |||||||||||||||||||||||||||
| Corporate-Owned Life Insurance | (460) | (0.5) | 965 | 0.8 | (878) | (0.5) | 1,142 | 0.6 | |||||||||||||||||||||||||||
| Other, Net | (666) | (0.6) | 707 | 0.7 | (1,032) | (0.5) | 199 | — | |||||||||||||||||||||||||||
| Income Tax Expense / Effective Tax Rate | $ | 20,062 | 19.7 | % | $ | 26,000 | 23.2 | % | $ | 33,365 | 18.8 | % | $ | 43,630 | 21.6 | % | |||||||||||||||||||
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9. Commitments and Contingencies
Commitments
Land Easements. Since 2013, OTP had purchased the wind-generated electricity from the Ashtabula III wind farm pursuant to a power purchase agreement. That agreement granted us the option to purchase the wind farm and on January 3, 2023, we completed the purchase for $50.6 million. In connection with the purchase, we assumed 51 land easements, not classified as leases, which require annual payments. As of June 30, 2023, the remaining payments to be made under the easements total $4.1 million and the remaining terms of the agreements extend into 2034.
Contingencies
FERC Return on Equity (ROE). In November 2013 and February 2015, customers filed complaints with the Federal Energy Regulatory Commission (FERC) seeking to reduce the return on equity 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. On August 9, 2022, the U.S. Court of Appeals for the District of Columbia Circuit vacated the FERC order citing a lack of reasoned explanation by FERC in its adoption of its revised ROE methodology as outlined in its November 2020 order. The U.S. Court of Appeals remanded the matter to FERC to reopen the proceedings.
Significant uncertainty exists as to how FERC will proceed upon remand and there is no prescribed timeline under which FERC must act. We have deferred recognition and recorded a refund liability of $2.7 million as of June 30, 2023. This refund liability reflects our best estimate of amounts previously collected from customers under the MISO tariff rate that may be required to be refunded to customers once all regulatory and judicial proceedings are complete and a final ROE is established for the periods outlined above.
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. The North Dakota Department of Environmental Quality (NDDEQ) submitted its state implementation plan to the EPA for approval in August, 2022. In its plan, the NDDEQ concluded it is not reasonable to require additional emission controls during this planning period. The EPA has previously expressed disagreement with the NDDEQ's recommendation to forgo additional emission controls and has indicated that such a plan is not likely to be accepted.
We cannot predict with certainty the impact the state implementation plan may have on our business until the 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.
Self-Funding of Transmission Upgrades. The FERC has granted transmission owners within MISO the unilateral authority to determine the funding mechanism for interconnection transmission upgrades that are necessary to accommodate new generation facilities connecting to the electrical grid. Under existing FERC orders, transmission owners can unilaterally determine whether the generator pays the transmission owner in advance for the transmission upgrade or, alternatively, the transmission owner can elect to fund the upgrade and recover over time from the generator the cost of and a return on the upgrade investment (a self-funding). FERC’s orders granting transmission owners this unilateral funding authority has been judicially contested on the basis that transmission owners may be motivated to discriminate among generators in making funding determinations. In the most recent judicial proceedings, the petitioners argued to the U.S. Court of Appeals for the District of Columbia that FERC did not comply with a previous judicial order to fully develop a record regarding the risk of discrimination and the financial risk absorbed by transmission owners for generator-funded upgrades. On December 2, 2022, the Court of Appeals ruled in favor of the petitioners remanding the matter to FERC, instructing the agency to adequately explain the basis of its orders. The Court of Appeals decision did not vacate transmission owners’ unilateral funding authority.
OTP, as a transmission owner in MISO, has exercised its authority and elected to self-fund previous transmission upgrades necessary to accommodate new system generation. Under such an election, OTP is recovering the cost of the transmission upgrade and a return on that investment from the generator over a contractual period of time. Should FERC, on remand from the Court of Appeals, eliminate transmission owners’ unilateral funding authority, on either a prospective or retrospective basis, our financial results would be impacted. We cannot at this time reasonably predict the outcome of this matter given the uncertainty as to how and when FERC may respond to the judicial remand.
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 June 30, 2023, other than those discussed above, will not be material.
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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 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 six months ended June 30, 2023, we issued 56,311 shares under this plan. 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 June 30, 2023, there were 1,194,682 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 OTC's shareholders is from dividends paid or distributions made by OTC's subsidiaries. As a result of certain statutory limitations or regulatory or financing agreements, the amount of distributions allowed to be made by OTC's subsidiaries or the amount of dividends paid by OTC could be restricted. 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 June 30, 2023, 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 OTC by requiring an equity-to-total-capitalization ratio between 47.5% and 58.0% based on OTP’s capital structure petition effective by order of the MPUC on November 8, 2022. As of June 30, 2023, OTP’s equity-to-total-capitalization ratio, including short-term debt, was 53.8% and its net assets restricted from distribution totaled approximately $778.6 million. Under the MPUC order, total capitalization for OTP cannot exceed $1.8 billion.
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11. Accumulated Other Comprehensive Income (Loss)
The following presents the changes in accumulated other comprehensive loss for the three and six months ended June 30, 2023 and 2022:
| Three Months Ended June 30, | |||||||||||||||||||||||||||||||||||
| 2023 | 2022 | ||||||||||||||||||||||||||||||||||
| (in thousands) | Pension and Other Postretirement Benefits | Net Unrealized Gains (Losses) on Available-for-Sale Securities | Total | Pension and Other Postretirement Benefits | Net Unrealized Gains (Losses) on Available-for-Sale Securities | Total | |||||||||||||||||||||||||||||
| Balance, Beginning of Period | $ | 1,308 | $ | (339) | $ | 969 | $ | (6,727) | $ | (218) | $ | (6,945) | |||||||||||||||||||||||
| Other Comprehensive Loss Before Reclassifications, net of tax | — | (62) | (62) | — | (75) | (75) | |||||||||||||||||||||||||||||
| Amounts Reclassified from Accumulated Other Comprehensive Income (Loss) | (27) | (1) | 1 | (2) | (26) | 106 | (1) | 1 | (2) | 107 | |||||||||||||||||||||||||
| Total Other Comprehensive Income (Loss) | (27) | (61) | (88) | 106 | (74) | 32 | |||||||||||||||||||||||||||||
| Balance, End of Period | $ | 1,281 | $ | (400) | $ | 881 | $ | (6,621) | $ | (292) | $ | (6,913) | |||||||||||||||||||||||
| Six Months Ended June 30, | |||||||||||||||||||||||||||||||||||
| 2023 | 2022 | ||||||||||||||||||||||||||||||||||
| (in thousands) | Pension and Other Postretirement Benefits | Net Unrealized Gains (Losses) on Available-for-Sale Securities | Total | Pension and Other Postretirement Benefits | Net Unrealized Gains (Losses) on Available-for-Sale Securities | Total | |||||||||||||||||||||||||||||
| Balance, Beginning of Period | $ | 1,334 | $ | (419) | $ | 915 | $ | (6,537) | $ | 13 | $ | (6,524) | |||||||||||||||||||||||
| Other Comprehensive Income (Loss) Before Reclassifications, net of tax | — | 18 | 18 | — | (306) | (306) | |||||||||||||||||||||||||||||
| Amounts Reclassified from Accumulated Other Comprehensive Income (Loss) | (53) | (1) | 1 | (2) | (52) | (84) | (1) | 1 | (2) | (83) | |||||||||||||||||||||||||
| Total Other Comprehensive Income (Loss) | (53) | 19 | (34) | (84) | (305) | (389) | |||||||||||||||||||||||||||||
| Balance, End of Period | $ | 1,281 | $ | (400) | $ | 881 | $ | (6,621) | $ | (292) | $ | (6,913) | |||||||||||||||||||||||
(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 $1.2 million and $0.6 million for the three months ended June 30, 2023 and 2022, respectively, and $6.5 million and $5.5 million for the six months ended June 30, 2023 and 2022, 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 six months ended June 30, 2023:
| Shares | Weighted-Average Grant-Date Fair Value | ||||||||||
Nonvested, January 1, 2023 | 141,551 | $ | 49.83 | ||||||||
| Granted | 55,205 | 68.03 | |||||||||
| Vested | (45,493) | 50.02 | |||||||||
| Forfeited | (1,300) | 50.00 | |||||||||
Nonvested, June 30, 2023 | 149,963 | $ | 56.47 | ||||||||
The fair value of vested awards was $3.1 million and $3.0 million during the six months ended June 30, 2023 and 2022.
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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 number of common shares awarded on an accelerated vesting is based either on actual performance at the end of the performance period or the number of common shares earned at target.
The grant date fair value of stock performance awards granted during the six months ended June 30, 2023 and 2022 was determined using a Monte Carlo fair value simulation model incorporating the following assumptions:
| 2023 | 2022 | ||||||||||
| Risk-free interest rate | 4.15 | % | 1.52 | % | |||||||
| Expected term (in years) | 3 | 3 | |||||||||
| Expected volatility | 34.00 | % | 32.00 | % | |||||||
| Dividend yield | 2.50 | % | 2.90 | % | |||||||
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 historical and future yield estimates.
The following is a summary of stock performance award activity for the six months ended June 30, 2023 (share amounts reflect awards at target):
| Shares | Weighted-Average Grant-Date Fair Value | ||||||||||
Nonvested, January 1, 2023 | 189,800 | $ | 45.95 | ||||||||
| Granted | 59,400 | 61.97 | |||||||||
| Vested | (55,000) | 47.79 | |||||||||
| Forfeited | — | — | |||||||||
Nonvested, June 30, 2023 | 194,200 | $ | 50.33 | ||||||||
The fair value of vested awards was $5.3 million and $5.1 million during the six months ended June 30, 2023 and 2022, 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 and six months ended June 30, 2023 and 2022:
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| (in thousands) | 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||
| Weighted-Average Common Shares Outstanding – Basic | 41,678 | 41,597 | 41,655 | 41,573 | |||||||||||||||||||
| Effect of Dilutive Securities: | |||||||||||||||||||||||
| Stock Performance Awards | 281 | 259 | 281 | 239 | |||||||||||||||||||
| Restricted Stock Awards | 92 | 85 | 97 | 94 | |||||||||||||||||||
| Employee Stock Purchase Plan Shares and Other | 2 | 3 | 2 | 1 | |||||||||||||||||||
| Dilutive Effect of Potential Common Shares | 375 | 347 | 380 | 334 | |||||||||||||||||||
| Weighted-Average Common Shares Outstanding – Diluted | 42,053 | 41,944 | 42,035 | 41,907 | |||||||||||||||||||
The number of shares excluded from diluted weighted-average common shares outstanding because such shares were anti-dilutive was not material for the three and six months ended June 30, 2023 and 2022.
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14. Derivative Instruments
OTP enters into derivative instruments to manage its exposure to future market energy 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 market energy 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 June 30, 2023, OTP had multiple outstanding pay-fixed, receive-variable swap agreements with an aggregate notional amount of 195,400 megawatt-hours of electricity, with various settlement dates extending to December 31, 2024. As of June 30, 2023, the fair value of these derivative instruments was $1.7 million, of which $1.5 million is included in other current liabilities and $0.2 million is included in other noncurrent liabilities, on the consolidated balance sheets. As of December 31, 2022, the fair value of these types of derivative contracts was $7.1 million, which is included in other current liabilities. There were no contracts which matured during the three months ended June 30, 2023 or 2022. During the six months ended June 30, 2023 and 2022, contracts matured and were settled in an aggregate amount of a $16.0 million loss and a $2.8 million gain, respectively. Gains and losses recognized on the settlement of derivative instruments are recorded in electric purchased power in the consolidated statements of income. Such settlement gains and losses are returned to or recovered from our electric customers through fuel recovery mechanisms in each state.
15. Fair Value Measurements
The following tables present our assets and liabilities measured at fair value on a recurring basis as of June 30, 2023 and December 31, 2022 classified by the input method used to measure fair value:
| (in thousands) | Level 1 | Level 2 | Level 3 | ||||||||||||||
| June 30, 2023 | |||||||||||||||||
| Assets: | |||||||||||||||||
| Investments: | |||||||||||||||||
| Money Market Funds | $ | 4,069 | $ | — | $ | — | |||||||||||
| Mutual Funds | 7,505 | — | — | ||||||||||||||
| Corporate Debt Securities | — | 1,456 | — | ||||||||||||||
| Government-Backed and Government-Sponsored Enterprises’ Debt Securities | — | 7,470 | — | ||||||||||||||
| Total Assets | $ | 11,574 | $ | 8,926 | $ | — | |||||||||||
| Liabilities: | |||||||||||||||||
| Derivative Instruments | $ | — | $ | 1,728 | $ | — | |||||||||||
| Total Liabilities | $ | — | $ | 1,728 | $ | — | |||||||||||
| December 31, 2022 | |||||||||||||||||
| Assets: | |||||||||||||||||
| Investments: | |||||||||||||||||
| Money Market Funds | $ | 1,560 | $ | — | $ | — | |||||||||||
| Mutual Funds | 5,503 | — | — | ||||||||||||||
| Corporate Debt Securities | — | 1,434 | — | ||||||||||||||
| Government-Backed and Government-Sponsored Enterprises’ Debt Securities | — | 7,327 | — | ||||||||||||||
| Total Assets | $ | 7,063 | $ | 8,761 | $ | — | |||||||||||
| Liabilities: | |||||||||||||||||
| Derivative Instruments | — | 7,130 | — | ||||||||||||||
| Total Liabilities | $ | — | $ | 7,130 | $ | — | |||||||||||
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 based on 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.
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The following reflects the carrying value and estimated fair value of these assets and liabilities as of June 30, 2023 and December 31, 2022:
| June 30, 2023 | December 31, 2022 | ||||||||||||||||||||||
| (in thousands) | Carrying Amount | Fair Value | Carrying Amount | Fair Value | |||||||||||||||||||
| Assets: | |||||||||||||||||||||||
| Cash and Cash Equivalents | $ | 150,578 | $ | 150,578 | $ | 118,996 | $ | 118,996 | |||||||||||||||
| Total | 150,578 | 150,578 | 118,996 | 118,996 | |||||||||||||||||||
| Liabilities: | |||||||||||||||||||||||
| Short-Term Debt | 50,197 | 50,197 | 8,204 | 8,204 | |||||||||||||||||||
| Long-Term Debt | 823,941 | 698,831 | 823,821 | 681,615 | |||||||||||||||||||
| Total | $ | 874,138 | $ | 749,028 | $ | 832,025 | $ | 689,819 | |||||||||||||||
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, 2022.
Otter Tail Corporation and its subsidiaries form a diverse group of businesses with operations classified into three segments: Electric, Manufacturing and Plastics. Our Electric segment 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.
PVC PIPE SUPPLY AND DEMAND CONDITIONS
Extraordinary supply and demand conditions in the PVC industry beginning in 2021 have led to a significant expansion in operating margins and elevated earnings in our Plastics segment. Periodic disruptions in the supply of resin, the primary material input used in the manufacturing of PVC pipe, coupled with robust demand for resin, led to a significant increase in the cost of resin over the last two years. Low industry volumes of PVC pipe and robust end market demand for the product led to a rapid and significant increase in sales prices for PVC pipe, significantly outpacing the increase in resin input costs, leading to widening margins within our Plastics segment.
Demand for PVC pipe began to soften in the second half of 2022 and softening demand continued through the first half of 2023 as distributors and contractors have reduced purchase volumes in response to uncertain and competitive market conditions. Resin prices have declined over this time frame but sales prices for PVC pipe remain elevated, continuing to produce expanded operating margins.
These unique market dynamics impacting our Plastics segment resulted in a significant increase in earnings in 2022 compared to prior periods. We currently expect earnings of our Plastics segment to remain elevated in 2023 compared to pre-2021 levels, but as the industry supply and demand conditions normalize, we expect segment earnings to normalize in the last half of 2024.
STEEL PRICING
Volatility in the price of steel, a key material input to our Manufacturing segment, significantly impacted our operating results in the last two years. Steel prices were elevated at the beginning of 2022 but began to steadily decline at the end of the second quarter and returned to near historical levels by the end of the year. Elevated steel prices led to increased sales prices in 2022 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. Steel prices in the first half of 2023 had significantly declined from the same period in the previous year, impacting our comparative operating results.
The marketplace dynamics impacting both our Manufacturing and Plastics segments are fluid and subject to change and 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.
CONSOLIDATED RESULTS
The following table summarizes consolidated operating results for the three months ended June 30, 2023 and 2022:
| (in thousands) | 2023 | 2022 | $ change | % change | |||||||||||||||||||
| Operating Revenues | $ | 337,716 | $ | 400,040 | $ | (62,324) | (15.6) | % | |||||||||||||||
| Operating Expenses | 231,663 | 278,974 | (47,311) | (17.0) | |||||||||||||||||||
| Operating Income | 106,053 | 121,066 | (15,013) | (12.4) | |||||||||||||||||||
| Interest Expense | (9,696) | (8,991) | (705) | 7.8 | |||||||||||||||||||
| Nonservice Components of Postretirement Benefits | 2,421 | 751 | 1,670 | 222.4 | |||||||||||||||||||
| Other Income (Expense) | 3,253 | (889) | 4,142 | (465.9) | |||||||||||||||||||
| Income Before Income Taxes | 102,031 | 111,937 | (9,906) | (8.8) | |||||||||||||||||||
| Income Tax Expense | 20,062 | 26,000 | (5,938) | (22.8) | |||||||||||||||||||
| Net Income | $ | 81,969 | $ | 85,937 | $ | (3,968) | (4.6) | % | |||||||||||||||
Operating Revenues decreased $62.3 million primarily due to decreased sales volumes within our Plastics segment, decreased fuel recovery revenues in our Electric segment and decreased steel prices in our Manufacturing segment. These decreases were partially offset by increased transmission services revenue, increased rider revenue, and higher commercial and industrial sales in our Electric segment and increased sales volumes in our Manufacturing segment. In our Plastics segment, PVC pipe sale volumes decreased as customer demand softened from the same
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period a year ago amid changing market conditions. Decreased sales prices in our Manufacturing segment were primarily due to decreased steel prices, which are passed through to customers. In our Electric segment, decreased fuel recovery revenues were driven by lower purchased power costs and volumes. See our segment disclosures below for additional discussion of items impacting operating revenues.
Operating Expenses decreased $47.3 million primarily due to lower sales volumes in our Plastics segment, lower purchased power costs in our Electric segment and lower material costs in our Manufacturing segment, as discussed above. See our segment disclosures below for additional discussion of items impacting operating expenses.
Interest Expense increased $0.7 million due to increased interest rates on our short-term variable rate debt and a higher level of average borrowings.
Nonservice Components of Postretirement Benefits improved by $1.7 million, having a positive impact on net income, primarily due to a change in actuarial assumptions used to measure our pension benefit and postretirement benefit obligations, including an increase in the discount rate applied and an increase in the expected return on assets assumption.
Other Income increased $4.1 million primarily due to gains on our corporate-owned life insurance policies during the second quarter of 2023 compared to investment losses in the previous year and investment income earned on our short-term cash equivalent investments.
Income Tax Expense decreased $5.9 million primarily due to decreased income before income taxes. Our effective tax rate was 19.7% in the second quarter of 2023 and 23.2% in the second quarter of 2022. The decrease in our effective tax rate was primarily due to non-taxable gains on our corporate-owned life insurance policy investments. 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 2023 and 2022.
ELECTRIC SEGMENT RESULTS
The following table summarizes Electric segment operating results for the three months ended June 30, 2023 and 2022:
| (in thousands) | 2023 | 2022 | $ change | % change | |||||||||||||||||||
| Retail Revenues | $ | 93,715 | $ | 113,603 | $ | (19,888) | (17.5) | % | |||||||||||||||
| Transmission Services Revenues | 14,829 | 11,697 | 3,132 | 26.8 | |||||||||||||||||||
| Wholesale Revenues | 2,670 | 3,537 | (867) | (24.5) | |||||||||||||||||||
| Other Electric Revenues | 2,549 | 2,112 | 437 | 20.7 | |||||||||||||||||||
| Total Operating Revenues | 113,763 | 130,949 | (17,186) | (13.1) | |||||||||||||||||||
| Production Fuel | 14,833 | 14,714 | 119 | 0.8 | |||||||||||||||||||
| Purchased Power | 5,212 | 24,162 | (18,950) | (78.4) | |||||||||||||||||||
| Operating and Maintenance Expenses | 45,522 | 42,379 | 3,143 | 7.4 | |||||||||||||||||||
| Depreciation and Amortization | 18,672 | 18,390 | 282 | 1.5 | |||||||||||||||||||
| Property Taxes | 4,336 | 4,435 | (99) | (2.2) | |||||||||||||||||||
| Operating Income | $ | 25,188 | $ | 26,869 | $ | (1,681) | (6.3) | % | |||||||||||||||
| 2023 | 2022 | change | % change | ||||||||||||||||||||
Electric kilowatt-hour (kwh) Sales (in thousands) | |||||||||||||||||||||||
| Retail kwh Sales | 1,345,830 | 1,286,419 | 59,411 | 4.6 | % | ||||||||||||||||||
| Wholesale kwh Sales – Company Generation | 87,032 | 56,514 | 30,518 | 54.0 | |||||||||||||||||||
| Heating Degree Days | 639 | 716 | (77) | (10.8) | |||||||||||||||||||
| Cooling Degree Days | 254 | 154 | 100 | 64.9 | |||||||||||||||||||
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 and cooling degree days as a percent of normal for the three months ended June 30, 2023 and 2022.
| 2023 | 2022 | ||||||||||
| Heating Degree Days | 120.6 | % | 135.1 | % | |||||||
| Cooling Degree Days | 215.3 | % | 129.4 | % | |||||||
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 2023 and 2022, and between years.
2023 vs Normal | 2023 vs 2022 | 2022 vs Normal | |||||||||||||||
| Effect on Diluted Earnings Per Share | $ | 0.04 | $ | 0.01 | $ | 0.03 | |||||||||||
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Retail Revenues decreased $19.9 million primarily due to a $19.2 million decrease in fuel recovery revenues, due to decreased purchased power costs and volumes, as described below. Also, our Minnesota rate case was finalized in the second quarter of 2022, which included a determination of the final interim rate refund and resulted in an additional $4.1 million of retail revenue in the second quarter of 2022. These decreases, were partially offset by:
•A $1.6 million increase in retail revenues from increased sales volumes to commercial and industrial customers.
•A $2.1 million increase in renewable resource rider revenue, including recovery of costs related to our Hoot Lake Solar project and the Ashtabula III wind farm.
Transmission Services Revenue increased $3.1 million primarily due to increased sales volumes compared to same period in the prior year.
Purchased Power costs to serve retail customers decreased $19.0 million due to a 72% decrease in the price of purchased power per kwh, primarily due to decreased market energy costs, and a 23% decrease in the volume of purchased power, primarily due to the planned outage at Coyote Station in the second quarter of 2022, which resulted in higher purchase volumes last year, as well as the acquisition of the Ashtabula III wind farm in the current year. Prior to the acquisition of Ashtabula III, OTP purchased the wind generated electricity from the facility under the terms of a power purchase agreement.
Operating and Maintenance Expenses increased $3.1 million primarily due to increased labor costs, increased maintenance and transmission service activities at our wind farm facilities, including the incremental costs associated with the Ashtabula III facility that was purchased during the year, maintenance expenses related to an outage at Big Stone Plant, increased vegetative management expenses, and increased MISO tariff expenses. These increases were partially offset by decreased maintenance and other expenses related to Coyote Station, as the second quarter of 2022 includes costs associated with a planned outage at Coyote Station.
MANUFACTURING SEGMENT RESULTS
The following table summarizes Manufacturing segment operating results for the three months ended June 30, 2023 and 2022:
| (in thousands) | 2023 | 2022 | $ change | % change | |||||||||||||||||||
| Operating Revenues | $ | 102,475 | $ | 103,196 | $ | (721) | (0.7) | % | |||||||||||||||
| Cost of Products Sold (excluding depreciation) | 79,154 | 78,515 | 639 | 0.8 | |||||||||||||||||||
| Other Operating Expenses | 10,470 | 9,890 | 580 | 5.9 | |||||||||||||||||||
| Depreciation and Amortization | 4,531 | 4,091 | 440 | 10.8 | |||||||||||||||||||
| Operating Income | $ | 8,320 | $ | 10,700 | $ | (2,380) | (22.2) | % | |||||||||||||||
Operating Revenues decreased $0.7 million primarily due to decreased steel prices, which impacted revenues at BTD Manufacturing, as well as decreased sales volumes at T.O. Plastics. Steel prices declined compared to the second quarter of 2022, resulting in a 15% decrease in material costs, which are passed through to customers. The impact of decreased steel prices was offset by a 14% increase in sales volumes, driven by strong customer and end market demand in the construction, agriculture, and energy markets, as well as sales price increases which were implemented in response to labor and non-steel material cost inflation. Lower scrap metal prices also impacted operating revenues as scrap metal revenues decreased $0.5 million from the previous year. Operating revenues at T.O. Plastics decreased primarily due to decreased sales volumes of horticulture products in response to changing market conditions as order and delivery lead times began to normalize.
Cost of Products Sold increased $0.6 million primarily due to increased sales volumes, as described above, largely offset by decreased material costs, as well as unfavorable cost absorption at BTD. Increased labor costs and lower productivity contributed to unfavorable cost absorption and lower profit margins. The increase in labor costs and the lower level of productivity during the quarter resulted from increased incentives and overtime wages combined with increased staffing levels to meet higher business volumes and the time required for new employees to achieve peak productivity.
Other Operating Expenses increased $0.6 million primarily due to increased salaries, benefits, and other compensation costs.
PLASTICS SEGMENT RESULTS
The following table summarizes Plastics segment operating results for the three months ended June 30, 2023 and 2022:
| (in thousands) | 2023 | 2022 | $ change | % change | |||||||||||||||||||
| Operating Revenues | $ | 121,478 | $ | 165,895 | $ | (44,417) | (26.8) | % | |||||||||||||||
| Cost of Products Sold (excluding depreciation) | 41,504 | 73,951 | (32,447) | (43.9) | |||||||||||||||||||
| Other Operating Expenses | 3,936 | 4,340 | (404) | (9.3) | |||||||||||||||||||
| Depreciation and Amortization | 1,003 | 1,043 | (40) | (3.8) | |||||||||||||||||||
| Operating Income | $ | 75,035 | $ | 86,561 | $ | (11,526) | (13.3) | % | |||||||||||||||
Operating Revenues decreased $44.4 million primarily due to a 26% decrease in sales volumes compared to the same period last year. Sales volume decreases in the second quarter were driven by general end market softness and distributors continuing to manage inventory levels. Sales prices declined 1% from the second quarter of 2022 but remained elevated compared to pre-2021 levels.
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Cost of Products Sold decreased $32.4 million due to decreased sales volumes, as described above, and decreased PVC resin costs. PVC resin and other input material costs decreased 37% compared to the same period in the previous year as the unique supply and demand conditions, which caused significant increases in resin costs, have subsided and resin costs have stabilized.
CORPORATE COSTS
The following table summarizes Corporate operating results for the three months ended June 30, 2023 and 2022:
| (in thousands) | 2023 | 2022 | $ change | % change | |||||||||||||||||||
| Other Operating Expenses | $ | 2,464 | $ | 3,022 | $ | (558) | (18.5) | % | |||||||||||||||
| Depreciation and Amortization | 26 | 42 | (16) | (38.1) | |||||||||||||||||||
| Operating Loss | $ | 2,490 | $ | 3,064 | $ | (574) | (18.7) | % | |||||||||||||||
Other Operating Expenses decreased $0.6 million primarily due to decreased employee benefit expenses related to decreases in our employee health insurance claim costs.
| RESULTS OF OPERATIONS – YEAR TO DATE | |||||
CONSOLIDATED RESULTS
The following table summarizes consolidated operating results for the six months ended June 30, 2023 and 2022:
| (in thousands) | 2023 | 2022 | $ change | % change | |||||||||||||||||||
| Operating Revenues | $ | 676,797 | $ | 774,944 | $ | (98,147) | (12.7) | % | |||||||||||||||
| Operating Expenses | 490,074 | 555,578 | (65,504) | (11.8) | |||||||||||||||||||
| Operating Income | 186,723 | 219,366 | (32,643) | (14.9) | |||||||||||||||||||
| Interest Expense | (19,111) | (17,939) | (1,172) | 6.5 | |||||||||||||||||||
| Nonservice Components of Postretirement Benefits | 4,833 | 772 | 4,061 | 526.0 | |||||||||||||||||||
| Other Income (Expense) | 5,370 | (629) | 5,999 | (953.7) | |||||||||||||||||||
| Income Before Income Taxes | 177,815 | 201,570 | (23,755) | (11.8) | |||||||||||||||||||
| Income Tax Expense | 33,365 | 43,630 | (10,265) | (23.5) | |||||||||||||||||||
| Net Income | $ | 144,450 | $ | 157,940 | $ | (13,490) | (8.5) | % | |||||||||||||||
Operating Revenues decreased $98.1 million primarily due to lower sales volumes within our Plastics segment and decreased steel prices in our Manufacturing segment. These decreases were partially offset by increased sales volumes, due to strong customer demand, in our Manufacturing segment and increased retail and transmission services revenues, due to increased sales volumes and rider revenues, within our Electric segment. See our segment disclosures below for additional discussion of items impacting operating revenues.
Operating Expenses decreased $65.5 million primarily due to lower sales volumes within our Plastics segment, as discussed above. In addition to lower sales volumes, operating expenses in our Plastics segment also decreased due to decreased PVC resin and other input costs. Decreased operating expenses in our Manufacturing segment primarily due to lower material costs at BTD, driven by lower steel prices, were largely offset by higher sales volumes and increases in other operating expenses. Operating expenses in our Electric segment increased primarily due to higher labor costs, maintenance expenses related to an outage at Big Stone Plant, increased maintenance expenses associated with our wind generation assets, and increased vegetative management expenses. See our segment disclosures below for additional discussion of items impacting operating expenses.
Interest Expense increased $1.2 million due to increased interest rates on our short-term variable rate debt, partially offset by a lower level of average borrowings.
Nonservice Components of Postretirement Benefits improved by $4.1 million, having a positive impact on net income, primarily due to a change in actuarial assumptions used to measure our pension benefit and postretirement benefit obligations, including an increase in the discount rate applied and an increase in the expected return on assets assumption.
Other Income increased $6.0 million primarily due to gains on our corporate-owned life insurance policies during the second quarter of 2023 compared to investment losses in the same period of the previous year and investment income earned on our short-term cash equivalent investments.
Income Tax Expense decreased $10.3 million primarily due to decreased income before income taxes. Our effective tax rate was 18.8% for the six months ended June 30, 2023 and 21.6% for the same period in the previous year. The decrease in our effective tax rate was driven by non-taxable gains on our corporate-owned life insurance policy investments and an increase in production tax credits from our wind generation assets in the current period. See Note 8 to our consolidated financial statements included in the report on Form 10-Q for additional information regarding factors impacting our effective tax rate.
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ELECTRIC SEGMENT RESULTS
The following table summarizes Electric segment operating results for the six months ended June 30, 2023 and 2022:
| (in thousands) | 2023 | 2022 | $ change | % change | |||||||||||||||||||
| Retail Revenues | $ | 230,168 | $ | 227,242 | $ | 2,926 | 1.3 | % | |||||||||||||||
| Transmission Services Revenues | 26,936 | 24,254 | 2,682 | 11.1 | |||||||||||||||||||
| Wholesale Revenues | 4,508 | 6,000 | (1,492) | (24.9) | |||||||||||||||||||
| Other Electric Revenues | 4,059 | 3,869 | 190 | 4.9 | |||||||||||||||||||
| Total Operating Revenues | 265,671 | 261,365 | 4,306 | 1.6 | |||||||||||||||||||
| Production Fuel | 26,326 | 29,567 | (3,241) | (11.0) | |||||||||||||||||||
| Purchased Power | 47,037 | 44,691 | 2,346 | 5.2 | |||||||||||||||||||
| Operating and Maintenance Expenses | 91,070 | 86,659 | 4,411 | 5.1 | |||||||||||||||||||
| Depreciation and Amortization | 36,997 | 36,772 | 225 | 0.6 | |||||||||||||||||||
| Property Taxes | 8,957 | 8,866 | 91 | 1.0 | |||||||||||||||||||
| Operating Income | $ | 55,284 | $ | 54,810 | $ | 474 | 0.9 | % | |||||||||||||||
| 2023 | 2022 | change | % change | ||||||||||||||||||||
Electric kilowatt-hour (kwh) Sales (in thousands) | |||||||||||||||||||||||
| Retail kwh Sales | 2,981,076 | 2,801,716 | 179,360 | 6.4 | % | ||||||||||||||||||
| Wholesale kwh Sales – Company Generation | 148,886 | 122,701 | 26,185 | 21.3 | |||||||||||||||||||
| Heating Degree Days | 4,371 | 4,537 | (166) | (3.7) | |||||||||||||||||||
| Cooling Degree Days | 254 | 154 | 100 | 64.9 | |||||||||||||||||||
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 and cooling degree days as a percent of normal for the six months ended June 30, 2023 and 2022.
| 2023 | 2022 | ||||||||||
| Heating Degree Days | 109.9 | % | 114.9 | % | |||||||
| Cooling Degree Days | 215.3 | % | 129.4 | % | |||||||
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 2023 and 2022, and between years.
2023 vs Normal | 2023 vs 2022 | 2022 vs Normal | |||||||||||||||
| Effect on Diluted Earnings Per Share | $ | 0.07 | $ | — | $ | 0.07 | |||||||||||
Retail Revenues increased $2.9 million primarily due to the following:
•A $4.3 million increase in retail revenues from increased sales volumes from commercial and industrial customers, including the impact of a new commercial customer load in North Dakota that came online during the first quarter of 2022.
•A $3.4 million increase in renewable resource rider revenue, including recovery of costs related to our Hoot Lake Solar project and the Ashtabula III wind farm.
These increases were partially offset by a decrease in fuel recovery revenues, primarily due to decreased fuel and market energy costs, as described below. Also, our Minnesota rate case was finalized in the second quarter of 2022, which included a determination of the final interim rate refund and resulted in an additional $4.1 million of retail revenue in 2022.
Production Fuel costs decreased $3.2 million primarily due to a 10% decrease in fuel cost per kwh resulting from decreases in natural gas prices.
Purchased Power costs to serve retail customers increased $2.3 million due to a 13% increase in the volume of purchased power due to increased customer demand and favorable market energy prices, partially offset by a 7% decrease in the price of purchased power per kwh, resulting from decreased natural gas and market energy prices.
Operating and Maintenance Expense increased $4.4 million, primarily due to increased labor costs, maintenance expenses related to an outage at Big Stone Plant, increased maintenance and transmission service activities at our wind farm facilities, including the incremental costs associated with the Ashtabula III facility that was purchased during the year, increased vegetative management expenses, higher insurance expenses, and increased MISO tariff expenses. These increases were partially offset by decreased maintenance and other expenses related to Coyote Station, as the second quarter of 2022 included costs associated with a planned outage at the facility.
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MANUFACTURING SEGMENT RESULTS
The following table summarizes Manufacturing segment operating results for the six months ended June 30, 2023 and 2022:
| (in thousands) | 2023 | 2022 | $ change | % change | |||||||||||||||||||
| Operating Revenues | $ | 209,257 | $ | 208,154 | $ | 1,103 | 0.5 | % | |||||||||||||||
| Cost of Products Sold (excluding depreciation) | 161,381 | 164,676 | (3,295) | (2.0) | |||||||||||||||||||
| Other Operating Expenses | 21,047 | 18,736 | 2,311 | 12.3 | |||||||||||||||||||
| Depreciation and Amortization | 9,000 | 8,105 | 895 | 11.0 | |||||||||||||||||||
| Operating Income | $ | 17,829 | $ | 16,637 | $ | 1,192 | 7.2 | % | |||||||||||||||
Operating Revenues increased $1.1 million primarily due to a 17% increase in sales volumes at BTD, as well as sales price increases which were implemented in response to labor and non-steel material cost inflation. Increased sales volumes and pricing were largely offset by a 18% decrease in material costs, which are passed through to customers, as a result of lower steel prices. Increased sales prices at T.O. Plastics, partially offset by a decrease in sales volumes of horticulture products, also contributed to the increase in operating revenues.
Cost of Products Sold decreased $3.3 million primarily due to lower material costs at BTD, as discussed above, largely offset by increased sales volumes and unfavorable cost absorption. Unfavorable cost absorption was primarily due to increased labor costs and lower productivity. The increase in labor costs and the lower level of productivity during the current year resulted from increased incentives and overtime wages combined with increased staffing levels to meet higher production volumes, and the time required for new employees to achieve peak productivity. Decreased sales volumes at T.O. Plastics, as discussed above, also contributed to the decrease in cost of products sold.
Other Operating Expenses increased $2.3 million due to variable costs associated with increased business activity and financial performance during the period.
PLASTICS SEGMENT RESULTS
The following table summarizes Plastics segment operating results for the six months ended June 30, 2023 and 2022:
| (in thousands) | 2023 | 2022 | $ change | % change | |||||||||||||||||||
| Operating Revenues | $ | 201,869 | $ | 305,425 | $ | (103,556) | (33.9) | % | |||||||||||||||
| Cost of Products Sold (excluding depreciation) | 71,646 | 139,549 | (67,903) | (48.7) | |||||||||||||||||||
| Other Operating Expenses | 7,465 | 8,304 | (839) | (10.1) | |||||||||||||||||||
| Depreciation and Amortization | 2,040 | 2,150 | (110) | (5.1) | |||||||||||||||||||
| Operating Income | $ | 120,718 | $ | 155,422 | $ | (34,704) | (22.3) | % | |||||||||||||||
Operating Revenues decreased $103.6 million, primarily due to a 36% decrease in sales volumes compared to the same period last year, partially offset by a 3% increase in sales price per pound of PVC pipe sold. Sales volume decreases continue to be attributable to distributor customer inventory management as distributors continue to closely manage their inventory levels and make strategic purchasing decisions amid uncertain and competitive market conditions.
Cost of Products Sold decreased $67.9 million due to decreased sales volumes, as discussed above, as well as a 30% decrease in PVC resin and other input costs.
CORPORATE COSTS
The following table summarizes Corporate operating results for the six months ended June 30, 2023 and 2022:
| (in thousands) | 2023 | 2022 | $ change | % change | |||||||||||||||||||
| Other Operating Expenses | $ | 7,056 | $ | 7,417 | $ | (361) | (4.9) | % | |||||||||||||||
| Depreciation and Amortization | 52 | 86 | (34) | (39.5) | |||||||||||||||||||
| Operating Loss | $ | 7,108 | $ | 7,503 | $ | (395) | (5.3) | % | |||||||||||||||
Other Operating Expenses decreased $0.4 million primarily due to decreased employee benefit expenses related to decreases in our employee health insurance claim costs.
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| REGULATORY MATTERS | |||||
The following provides a summary of 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.
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 | Description | ||||||||||||||||||||||||||||||||
| RRR - 2022 | MN | Approved | 11/01/22 | $ | 17.5 | 07/01/23 | Recovery of Hoot Lake Solar costs, Ashtabula III costs, and true up for PTCs from Merricourt. | |||||||||||||||||||||||||||||||
| CIP - 2022 | MN | Approved | 04/01/22 | 10.8 | 10/01/22 | Recovery of energy conservation improvement costs as well as a demand side management financial incentive. | ||||||||||||||||||||||||||||||||
| CIP - 2023 | MN | Approved | 04/03/23 | 9.7 | 10/01/23 | Recovery of energy conservation improvement costs as well as a demand side management financial incentive. | ||||||||||||||||||||||||||||||||
| TCR - 2021 | MN | Approved | 11/23/21 | 7.2 | 08/01/22 | Recovery of transmission project costs. | ||||||||||||||||||||||||||||||||
| RRR - 2021 | MN | Approved | 12/06/21 | 7.0 | 08/01/22 | Recovery of Hoot Lake Solar and Ashtabula III costs. | ||||||||||||||||||||||||||||||||
| EITE - 2023 | MN | Approved | 04/14/23 | 2.2 | 01/01/24 | Biennial update to Energy-Intensive, Trade-Exposed rider. | ||||||||||||||||||||||||||||||||
| EUIC - 2023 | MN | Requested | 03/20/23 | 1.3 | 07/01/23 | Recovery of advanced metering infrastructure, outage management and demand response system projects. | ||||||||||||||||||||||||||||||||
| RRR - 2023 | ND | Approved | 12/30/22 | 12.2 | 05/01/23 | Recovery of Merricourt, Ashtabula III and other costs. | ||||||||||||||||||||||||||||||||
| RRR - 2022 | ND | Approved | 01/05/22 | 7.8 | 04/01/22 | Recovery of Merricourt costs, Ashtabula III costs, and deferred taxes and production tax credits. | ||||||||||||||||||||||||||||||||
| TCR - 2022 | ND | Approved | 09/15/22 | 7.5 | 01/01/23 | Recovery of transmission project costs. | ||||||||||||||||||||||||||||||||
| TCR - 2021 | ND | Approved | 09/15/21 | 6.1 | 01/01/22 | Recovery of transmission project costs. | ||||||||||||||||||||||||||||||||
| GCR - 2022 | ND | Approved | 03/01/22 | 3.3 | 07/01/22 | Annual update to generation cost recovery rider. | ||||||||||||||||||||||||||||||||
| AMDT - 2022 | ND | Approved | 07/08/22 | 3.1 | 01/01/23 | Recovery of advanced metering infrastructure, outage management system and demand response projects. | ||||||||||||||||||||||||||||||||
| GCR - 2023 | ND | Approved | 03/03/23 | 2.2 | 07/01/23 | Recovery of Astoria Station, net of anticipated savings associated with the retirement of Hoot Lake Plant. | ||||||||||||||||||||||||||||||||
| PIR - 2022 | SD | Approved | 06/01/22 | 3.0 | 09/01/22 | Recovery of Ashtabula III, Merricourt, Astoria Station, Advanced Grid Infrastructure project costs, and impact of load growth credits. | ||||||||||||||||||||||||||||||||
| TCR - 2022 | SD | Approved | 11/01/22 | 3.0 | 03/01/23 | Recovery of transmission project costs. | ||||||||||||||||||||||||||||||||
| PIR - 2023 | SD | Requested | 06/01/23 | 2.6 | 09/01/23 | Recovery of Ashtabula III, Merricourt, Astoria Station, Advanced Grid Infrastructure project costs, and impact of load growth credits. | ||||||||||||||||||||||||||||||||
| TCR - 2021 | SD | Approved | 10/29/21 | 2.2 | 03/01/22 | Recovery of transmission project costs. | ||||||||||||||||||||||||||||||||
INTEGRATED RESOURCE PLAN
On March 31, 2023, OTP submitted a supplemental resource plan filing to the MPUC, the NDPSC, and the South Dakota Public Utilities Commission. The supplemental filing updates OTP’s original 2022 Integrated Resource Plan (2022 IRP), which was filed on September 1, 2021. In the supplemental filing, OTP outlined its updated plan for meeting customers’ anticipated capacity and energy needs while maintaining system reliability and low electric service rates, in light of several changes that have occurred since the original filing, including significant winter and spring reserve planning margins adopted by MISO, tax credits made available for renewable energy projects under the Inflation Reduction Act, the enactment of the Clean Energy Bill in Minnesota, and recent volatility in energy and capacity markets.
The major requests in OTP's supplemental filing include:
•the addition of on-site liquefied natural gas fuel storage at our Astoria Station natural gas plant in 2026;
•the addition of approximately 200 megawatts of solar generation in 2027-2028;
•undertaking the initial steps necessary to add approximately 200 megawatts of wind generation in 2029; and
•a withdrawal from our 35 percent ownership interest in Coyote Station, a jointly-owned coal-fired generation plant, in the event we are required to make a major, non-routine capital investment in the plant.
Consistent with the original 2022 IRP, the supplemental filing proposes to, subject to regulatory approval, create a regulatory asset to recover costs related to any future withdrawal from Coyote Station. Should such a withdrawal occur, we anticipate the regulatory asset would include the net
26
book value of the plant on the withdrawal date, anticipated decommissioning costs, and any costs incurred if the existing lignite sales agreement, under which Coyote Station acquires all of its lignite coal, must be terminated. As part of an economic analysis included in the filing, OTP developed an estimate of the reasonably foreseeable costs of withdrawing from Coyote Station, which was determined to be $68.5 million, assuming a withdrawal at the end of 2028. These costs may differ from actual results due to the uncertainty and timing of future events which could result in a withdrawal from Coyote Station.
ENVIRONMENTAL REGULATION
Climate Change and Greenhouse Gas Regulation
In May 2023, the EPA proposed new regulations under Section 111 of the Clean Air Act to regulate greenhouse gas (GHG) emissions from existing and new fossil fuel-based electric generating units (EGU). The proposal provides requirements for different types of fossil fuel-based EGUs with various compliance dates.
For existing coal-fired steam generating units that were in operation before January 8, 2014 and that plan to operate past December 31, 2039, the proposal would (subject to certain exceptions) set emissions standards that reflect the use of carbon capture and sequestration (CCS) with 90% capture of carbon dioxide emissions beginning in 2030.
For existing coal-fired steam generating units that are scheduled to be retired between January 1, 2032 and December 31, 2039, the proposed rule would, in general, set emissions standards that reflect the use of co-firing 40% natural gas with coal beginning in 2030.
For existing coal-fired steam generating units that will either (a) retire by January 1, 2032, or (b) retire between 2032 and December 21, 2034 and will operate at a 20% annual capacity factor limit in the meantime, the proposed rule would simply require routine maintenance and no increase in emission rate.
The proposal also includes emission standards for existing large (greater than 300 mega-watt), frequently-used (those that operate at a capacity factor over 50%) natural gas combustion turbines, including the use of CCS or co-firing with low-GHG hydrogen. Under the proposed rule, each state must submit a plan to the EPA to implement standards that are at least as stringent as the EPA’s emission guidelines. The EPA is proposing to require states to submit their plans within 24 months of the effective date of the regulation.
We continue to review and evaluate the proposal and its impact, if adopted as proposed, on our EGUs and the potential impact to our operating results, financial condition and liquidity. Coyote Station and Big Stone Plant, our two co-owned coal-fired power plants, would be within the scope of the proposed regulations. We do not believe our combustion turbines would be within the scope of the regulation given their size and operating frequency.
| LIQUIDITY | |||||
LIQUIDITY OVERVIEW
We believe our financial condition is strong and our cash and cash equivalents, 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, could be impacted by macroeconomic factors outside of our control, including higher interest rates and debt capital costs and diminished credit availability. In addition, our liquidity could be impacted by non-compliance with certain financial covenants under our various debt instruments. As of June 30, 2023, 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 June 30, 2023 and December 31, 2022:
| 2023 | 2022 | ||||||||||||||||||||||||||||
| (in thousands) | Borrowing Limit | Amount Outstanding | Letters of Credit | Amount Available | Amount Available | ||||||||||||||||||||||||
| OTC Credit Agreement | $ | 170,000 | $ | — | $ | — | $ | 170,000 | $ | 170,000 | |||||||||||||||||||
| OTP Credit Agreement | 170,000 | 50,197 | 9,573 | 110,230 | 152,223 | ||||||||||||||||||||||||
| Total | $ | 340,000 | $ | 50,197 | $ | 9,573 | $ | 280,230 | $ | 322,223 | |||||||||||||||||||
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.
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CASH FLOWS
The following is a discussion of our cash flows for the six months ended June 30, 2023 and 2022:
| (in thousands) | 2023 | 2022 | |||||||||
| Net Cash Provided by Operating Activities | $ | 184,497 | $ | 175,630 | |||||||
Net Cash Provided by Operating Activities increased $8.9 million for the six months ended June 30, 2023 compared to the six months ended June 30, 2022, primarily due to the absence of a pension plan contribution in 2023 due to the plan's funded status, whereas a $20.0 million discretionary contribution was made in February 2022, as well as increases to certain regulatory liabilities for fuel cost recovery due to increased customer collections that will be returned to customers in future periods. Increases to operating cash flows were partially offset by lower earnings and higher working capital.
| (in thousands) | 2023 | 2022 | |||||||||
| Net Cash Used in Investing Activities | $ | 153,625 | $ | 73,895 | |||||||
Net Cash Used in Investing Activities increased $79.7 million for the six months ended June 30, 2023 compared to the six months ended June 30, 2022. The increase in cash used in investing activities was primarily due to a higher amount of Electric segment capital investment compared to last year, including the purchase of the Ashtabula III wind farm for $50.6 million in January 2023. Capital expenditures in our Manufacturing and Plastics segments increased $14.0 million as a result of investments in additional equipment and a facility expansion project at our Plastics segment facility in Phoenix, Arizona.
| (in thousands) | 2023 | 2022 | |||||||||
| Net Cash Provided by (Used in) Financing Activities | $ | 710 | $ | (41,283) | |||||||
Net Cash Provided by (Used in) Financing Activities increased $42.0 million for the six months ended June 30, 2023 compared to the six months ended June 30, 2022. Financing activities for the six months ended June 30, 2023 included net proceeds from short-term borrowings of $42.0 million under the OTP credit agreement, which were primarily used to fund the acquisition of Ashtabula III and other capital investments, and dividend payments of $36.5 million. Financing activities for the six months ended June 30, 2022 included net repayments of short-term borrowings of $91.2 million, the issuance of $90.0 million of long-term debt, and dividend payments of $34.4 million.
| CAPITAL REQUIREMENTS | |||||
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 are investments in electric generation facilities and environmental upgrades, transmission and distribution lines, manufacturing facilities and upgrades, equipment used in the manufacturing process, and computer hardware and information systems. Our capital expenditure program is subject to review and regulatory approval and is revised in light of changes in demands for energy, technology, environmental laws, tax laws, regulatory changes, business expansion opportunities, the costs of labor, materials and equipment, and our financial condition.
The following provides a summary of actual capital expenditures for the year ended December 31, 2022, anticipated annual capital expenditures for the current year ending December 31, 2023, and the subsequent four years, along with electric utility average rate base and annual rate base growth:
| (in millions) | 2022 | 2023(1) | 2024 | 2025 | 2026 | 2027 | Total 2023 - 2027 | ||||||||||||||||||||||||||||||||||||||||
| Electric Segment | |||||||||||||||||||||||||||||||||||||||||||||||
| Renewables and Natural Gas Generation | $ | 88 | $ | 119 | $ | 88 | $ | 85 | $ | 49 | $ | 429 | |||||||||||||||||||||||||||||||||||
| Technology and Infrastructure | 33 | 30 | 6 | 5 | 1 | 75 | |||||||||||||||||||||||||||||||||||||||||
| Distribution Plant Replacements | 33 | 37 | 38 | 38 | 43 | 189 | |||||||||||||||||||||||||||||||||||||||||
| Transmission (includes replacements) | 34 | 36 | 46 | 87 | 78 | 281 | |||||||||||||||||||||||||||||||||||||||||
| Other | 26 | 25 | 30 | 24 | 23 | 128 | |||||||||||||||||||||||||||||||||||||||||
| Total Electric Segment | $ | 148 | $ | 214 | $ | 247 | $ | 208 | $ | 239 | $ | 194 | $ | 1,102 | |||||||||||||||||||||||||||||||||
| Manufacturing and Plastics Segments | 23 | 48 | 53 | 29 | 25 | 24 | 179 | ||||||||||||||||||||||||||||||||||||||||
| Total Capital Expenditures | $ | 171 | $ | 262 | $ | 300 | $ | 237 | $ | 264 | $ | 218 | $ | 1,281 | |||||||||||||||||||||||||||||||||
| Total Electric Utility Average Rate Base | $ | 1,624 | $ | 1,748 | $ | 1,851 | $ | 1,990 | $ | 2,111 | $ | 2,230 | |||||||||||||||||||||||||||||||||||
| Annual Rate Base Growth | 3.1 | % | 7.6 | % | 5.9 | % | 7.5 | % | 6.1 | % | 5.6 | % | |||||||||||||||||||||||||||||||||||
(1) Includes actual results for the six months ended June 30, 2023, and anticipated capital expenditures for the remaining six months of 2023. | |||||||||||||||||||||||||||||||||||||||||||||||
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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 easements and leasing arrangements.
Our contractual obligations as of December 31, 2022 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, 2022. Except for the obligations arising from new land easements assumed in connection with the purchase of Ashtabula III, there were no material changes in our contractual obligations outside of the ordinary course of business during the six months ended June 30, 2023.
In connection with the purchase of the Ashtabula III wind farm in January 2023, we assumed 51 land easements not classified as leases, which require annual payments. As of June 30, 2023, the remaining payments to be made under the easements were $4.1 million and the remaining terms of the agreements extend into 2034.
COMMON STOCK DIVIDENDS
We paid dividends to our common stockholders totaling $36.5 million, or $0.875 per share, in the first six months of 2023. The determination of the amount of future cash dividends to be paid will depend on, among other things, our financial condition, our actual or expected level of earnings and 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, the amount of dividends we are allowed to pay could be restricted. See Note 10 to our consolidated financial statements included in this Quarterly Report on Form 10-Q for additional information. The decision to declare dividends 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, and is aided by strong financial coverages and investment grade credit ratings. Debt financing will be required in the five-year period from 2023 through 2028 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, and decisions to reduce borrowings under our lines of credit, to refund or retire early any of our 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 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 June 30, 2023, there were 1,194,682 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 the 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 six months ended, June 30, 2023:
| (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 June 30, 2023 | — | 9,573 | |||||||||
Amount Outstanding as of June 30, 2023 | — | 50,197 | |||||||||
Average Amount Outstanding During the Six Months Ended June 30, 2023 | — | 48,846 | |||||||||
Maximum Amount Outstanding During the Six Months Ended June 30, 2023 | — | 61,006 | |||||||||
Interest Rate as of June 30, 2023 | 6.64 | % | 6.48 | % | |||||||
| Maturity Date | October 29, 2027 | October 29, 2027 | |||||||||
1Each facility includes an accordion featuring allowing the borrower to increase the borrowing limit if certain terms and conditions are met. | |||||||||||
LONG-TERM DEBT
As of June 30, 2023, we had $827.0 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 2026 to 2052. 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.
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Financial Covenants
Certain of our short- and long-term debt agreements require OTC and OTP to maintain certain financial covenants. As of June 30, 2023, 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 percent of its total capitalization. As of June 30, 2023, OTC's interest-bearing debt to total capitalization was 0.40 to 1.00, OTC's interest and dividend coverage ratio was 10.18 to 1.00, and OTC had no priority indebtedness outstanding.
OTP, 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 20 percent of its total capitalization. As of June 30, 2023, OTP's interest-bearing debt to total capitalization was 0.46 to 1.00, OTP's interest and dividend coverage ratio was 3.65 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 generally accepted accounting principles 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 disclosures 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, 2022 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, 2022.
| 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 June 30, 2023, 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 June 30, 2023.
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 June 30, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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 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, 2022.
| ITEM 5. | OTHER INFORMATION | |||||||||||||
Securities Trading Plans of Directors and Executive Officers. During the three months ended June 30, 2023, none of our directors or executive officers adopted, amended, or terminated any contract, instruction or written plan for the purchase or sale of our securities that was intended to satisfy the affirmative defense conditions of Rule 10b5-1(c) or any “non-Rule 10b5-1 trading arrangement.”
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| ITEM 6. | EXHIBITS | |||||||||||||
The following Exhibits are filed as part of, or incorporated by reference into, this report.
| No. | Description | ||||
| 10.1 | |||||
| 10.2 | |||||
| 10.3 | |||||
| 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: August 2, 2023 | ||||||||
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