☒Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2021 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:
41,539,984CommonShares ($5 par value) asof October 29, 2021.
The following abbreviations or acronyms are used in the text.
AFUDC
Allowance for Funds Used During Construction
MPUC
Minnesota Public Utilities Commission
ARP
Alternative Revenue Program
NDPSC
North Dakota Public Service Commission
BTD
BTD Manufacturing, Inc.
Northern Pipe
Northern Pipe Products, Inc.
CIP
Conservation Improvement Program
OTC
Otter Tail Corporation
ECR
Environmental Cost Recovery Rider
OTP
Otter Tail Power Company
EEP
Energy Efficiency Plan
PACE
Partnership in Assisting Community Expansion
EPA
Environmental Protection Agency
PIR
Phase-In Rider
ESSRP
Executive Survivor and Supplemental Retirement Plan
PTCs
Production tax credits
EUIC
Electric Utility Infrastructure Cost Recovery Rider
PVC
Polyvinyl chloride
FCA
Fuel Clause Adjustment
RHR
Regional Haze Rule
FERC
Federal Energy Regulatory Commission
ROE
Return on equity
GCR
Generation Cost Recovery Rider
RRR
Renewable Resource Rider
ISO
Independent System Operator
SDPUC
South Dakota Public Utilities Commission
IRP
Integrated Resource Plan
SEC
Securities and Exchange Commission
kW
kiloWatt
T.O. Plastics
T.O. Plastics, Inc.
kwh
kilowatt-hour
TCR
Transmission Cost Recovery Rider
Merricourt
Merricourt Wind Energy Center
Vinyltech
Vinyltech Corporation
MISO
Midcontinent Independent System Operator, Inc.
FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the Act). When used in this Form 10-Q and in future filings by the Company with the SEC, in the Company’s press releases and in oral statements, words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “outlook,” “plan,” “possible,” “potential,” “should,” “will,” “would” or similar expressions are intended to identify forward-looking statements within the meaning of the Act. Such statements are based on current expectations and assumptions and entail various risks and uncertainties that could cause actual results to differ materially from those expressed in such forward-looking statements. The Company’s risks and uncertainties include, among other things, uncertainty of the impact and duration of the COVID-19 pandemic, uncertainty of future investments and capital expenditures, rate base levels and rate base growth, long-term investment risk, seasonal weather patterns and extreme weather events, counterparty credit risk, future business volumes with key customers, reductions in our credit ratings, our ability to access capital markets on favorable terms, assumptions and costs relating to funding our employee benefit plans, our subsidiaries’ ability to make dividend payments, cyber security threats or data breaches, the impact of government legislation and regulation, including foreign trade policy and environmental laws and regulations, the impact of climate change, including compliance with legislative and regulatory changes to address climate change, operational and economic risks associated with our electric generating and manufacturing facilities, risks associated with energy markets, the availability and pricing of resource materials, attracting and maintaining a qualified and stable workforce, expectations regarding regulatory proceedings, and changing macroeconomic and industry conditions. These and other risks and uncertainties are more fully described in our filings with the Securities and Exchange Commission, including our most recently filed Annual Report on Form 10-K. Forward-looking statements speak only as of the date they are made, and we expressly disclaim any obligation to update any forward-looking information.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
1. Summary of Significant Accounting Policies
Overview
Otter Tail Corporation 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 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, 2020.
Because of the coronavirus (COVID-19) pandemic, the seasonality of our businesses and other factors, the earnings for the three and nine months ended September 30, 2021 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.
2. Segment Information
We classify our business into three segments, Electric, Manufacturing and Plastics, consistent with our business strategy, organizational structure and our internal reporting and review processes used by our chief operating decision maker to make decisions regarding allocation of resources, to assess operating performance and to make strategic decisions.
Certain assets and costs are not allocated to our operating segments. Corporate operating costs include items such as corporate staff and overhead costs, the results of our captive insurance company and other items excluded from the measurement of operating segment performance. Corporate assets consist primarily of cash, prepaid expenses, investments and fixed assets. Corporate is not an operating segment, rather it is added to operating segment totals to reconcile to consolidated amounts.
Information for each segment and our unallocated corporate costs for the three and nine months ended September 30, 2021 and 2020 are as follows:
Three Months Ended September 30,
Nine Months Ended September 30,
(in thousands)
2021
2020
2021
2020
Operating Revenue1
Electric
$
118,775
$
115,213
$
348,629
$
333,213
Manufacturing
89,977
59,849
250,085
174,276
Plastics
107,542
60,693
264,898
155,769
Total
$
316,294
$
235,755
$
863,612
$
663,258
Net Income (Loss)
Electric
$
22,528
$
24,737
$
55,547
$
54,225
Manufacturing
4,200
3,311
15,290
8,476
Plastics
28,410
10,343
60,102
20,922
Corporate
(2,384)
(2,457)
(5,787)
(6,440)
Total
$
52,754
$
35,934
$
125,152
$
77,183
1Amounts reflect operating revenues to external customers. Intersegment operating revenues are not material for any period presented.
The following provides the identifiable assets by segment and corporate assets as of September 30, 2021 and December 31, 2020:
(in thousands)
September 30, 2021
December 31, 2020
Identifiable Assets
Electric
$
2,271,636
$
2,233,399
Manufacturing
242,414
191,005
Plastics
143,615
99,767
Corporate
55,483
54,183
Total
$
2,713,148
$
2,578,354
3. Revenue
We present our operating revenues to external customers, in total and by amounts arising from contracts with customers and alternative revenue program (ARP) arrangements, disaggregated by revenue source and segment for the three and nine months ended September 30, 2021 and 2020:
Three Months Ended September 30,
Nine Months Ended September 30,
(in thousands)
2021
2020
2021
2020
Operating Revenues
Electric Segment
Retail: Residential
$
33,902
$
32,734
$
100,067
$
96,440
Retail: Commercial and Industrial
60,557
64,918
185,376
189,771
Retail: Other
1,979
1,953
5,687
5,550
Total Retail
96,438
99,605
291,130
291,761
Transmission
13,300
12,288
37,085
32,802
Wholesale
6,944
1,500
14,711
3,141
Other
2,093
1,820
5,703
5,509
Total Electric Segment
118,775
115,213
348,629
333,213
Manufacturing Segment
Metal Parts and Tooling
76,455
50,957
210,141
145,435
Plastic Products and Tooling
10,198
7,600
30,624
25,323
Scrap Metal Sales
3,324
1,292
9,320
3,518
Total Manufacturing Segment
89,977
59,849
250,085
174,276
Plastics Segment
PVC Pipe
107,542
60,693
264,898
155,769
Total Operating Revenue
316,294
235,755
863,612
663,258
Less: Non-contract Revenues Included Above
Electric Segment - ARP Revenues
(33)
2,778
(2,790)
2,900
Total Operating Revenues from Contracts with Customers
$
316,327
$
232,977
$
866,402
$
660,358
4. Select Balance Sheet Information
Receivables and Allowance for Credit Losses
Receivables as of September 30, 2021 and December 31, 2020 are as follows:
The following is a summary of activity in the allowance for credit losses for the nine months ended September 30, 2021 and 2020:
(in thousands)
2021
2020
Beginning Balance, January 1
$
3,215
$
1,339
Additions Charged to Expense
177
1,845
Reductions for Amounts Written Off, Net of Recoveries
(1,060)
(923)
Ending Balance, September 30
$
2,332
$
2,261
Inventories
Inventories consist of the following as of September 30, 2021 and December 31, 2020:
(in thousands)
September 30, 2021
December 31, 2020
Finished Goods
$
25,727
$
22,046
Work in Process
29,932
16,210
Raw Material, Fuel and Supplies
58,956
53,909
Total Inventories
$
114,615
$
92,165
Investments
The following is a summary of our investments as of September 30, 2021 and December 31, 2020:
(in thousands)
September 30, 2021
December 31, 2020
Corporate-Owned Life Insurance Policies
$
40,096
$
36,825
Debt Securities
9,208
9,260
Money Market Funds
953
4,075
Mutual Funds
5,170
1,662
Other Investments
29
34
Total Investments
$
55,456
$
51,856
The amount of unrealized gains and losses on debt securities as of September 30, 2021 and December 31, 2020 are 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 September 30, 2021 and December 31, 2020 are not material.
Property, Plant and Equipment
Major classes of property, plant and equipment as of September 30, 2021 and December 31, 2020 include:
(in thousands)
September 30, 2021
December 31, 2020
Electric Plant in Service
Electric Plant in Service
$
2,705,778
$
2,531,352
Construction Work in Progress
100,495
203,078
Total Gross Electric Plant
2,806,273
2,734,430
Less Accumulated Depreciation and Amortization
822,441
778,988
Net Electric Plant
1,983,832
1,955,442
Nonelectric Property, Plant and Equipment
Nonelectric Property, Plant and Equipment in Service
263,880
258,730
Construction Work in Progress
15,564
9,290
Total Gross Nonelectric Property, Plant and Equipment
The following presents our current and long-term regulatory assets and liabilities as of September 30, 2021 and December 31, 2020 and the period we expect to recover or refund such amounts:
Period of
September 30, 2021
December 31, 2020
(in thousands)
Recovery/Refund
Current
Long-Term
Current
Long Term
Regulatory Assets
Pension and Other Postretirement Benefit Plans1
Various
$
11,037
$
139,467
$
11,037
$
146,071
Alternative Revenue Program Riders2
Up to 3 years
7,229
8,225
8,871
9,373
Asset Retirement Obligations1
Asset lives
—
7,065
—
8,462
ISO Cost Recovery Trackers1
Up to 2 years
270
1,027
1,079
867
Unrecovered Project Costs1
Up to 3 years
3,227
1,456
361
2,989
Deferred Rate Case Expenses1
Various
637
936
360
230
Debt Reacquisition Premiums1
Up to 12 years
117
262
192
341
Other1
Various
—
77
—
62
Total Regulatory Assets
$
22,517
$
158,515
$
21,900
$
168,395
Regulatory Liabilities
Deferred Income Taxes
Asset lives
$
—
$
130,555
$
—
$
134,719
Plant Removal Obligations
Asset lives
5,893
96,734
—
98,707
Fuel Clause Adjustments
Up to 1 year
5,692
—
10,947
—
Alternative Revenue Program Riders
Various
5,265
2,507
3,581
470
Pension and Other Postretirement Benefit Plans
Up to 1 year
1,959
—
1,959
—
Derivative Instruments
Various
6,136
787
—
—
Other
Various
378
150
176
77
Total Regulatory Liabilities
$
25,323
$
230,733
$
16,663
$
233,973
1Costs subject to recovery without a rate of return.
2Amount eligible for recovery includes an incentive or rate of return.
6. Short-Term and Long-Term Borrowings
The following is a summary of our outstanding short and long-term borrowings by borrower, Otter Tail Corporation (OTC) or Otter Tail Power Company (OTP), as of September 30, 2021 and December 31, 2020:
Short-Term Debt
The following is a summary of our lines of credit as of September 30, 2021 and December 31, 2020:
September 30, 2021
December 31, 2020
(in thousands)
Line Limit
Amount Outstanding
Letters of Credit
Amount Available
Amount Available
OTC Credit Agreement
$
170,000
$
36,624
$
—
$
133,376
$
104,834
OTP Credit Agreement
170,000
61,233
13,159
95,608
140,068
Total
$
340,000
$
97,857
$
13,159
$
228,984
$
244,902
On September 30, 2021, OTC entered into a Fourth Amended and Restated Credit Agreement (the OTC Credit Agreement) and OTP entered into a Third Amended and Restated Credit Agreement (the OTP Credit Agreement) amending and restating the previously existing credit agreements to extend the maturity date of each agreement to September 30, 2026. The agreements both provide for $170 million revolving lines of credit to support operations, and borrowings which may be used for working capital needs and other capital requirements, to refinance certain indebtedness and for the issuance of letters of credit in an aggregate not to exceed $40 million for the OTC Credit Agreement and $50 million for the OTP Credit Agreement. Each credit facility includes an accordion provision allowing the borrower to increase the available borrowing capacity, subject to certain terms and conditions. The borrowing capacity of the OTC Credit Agreement can be increased to $290 million and the OTP Credit Agreement can be increased to $250 million. Borrowings under each credit facility are subject to a variable rate of interest on outstanding balances and a commitment fee is applied based on the average unused amount available to be drawn under the respective facility. The variable rate of interest to be charged is based on either LIBOR or a Base Rate, as defined in the agreement, selected by the borrower at the time of an advance, subject to the conditions of each agreement, plus an applicable credit spread. The credit spread ranges from 0.125% to 2.00% for the OTC Credit Agreement and from zero to 1.75% for the OTP Credit Agreement, depending on the benchmark interest rate selected and is subject to adjustment
based on the credit ratings of the borrower. As of September 30, 2021, the weighted-average LIBOR Rate based interest rate was 1.59% and 1.33% under the OTC Credit Agreement and OTP Credit Agreement, respectively.
Each credit facility contains a number of restrictions on the borrower, including restrictions on their ability to merge, sell assets, make investments, create or incur liens on assets, guarantee the obligations of any other party and engage in transactions with related parties. The agreements also contain certain financial and non-financial covenants and defined events of default, and include provisions for the replacement of the LIBOR benchmark rate in the event that LIBOR is no longer available.
Long-Term Debt
The following is a summary of outstanding long-term debt by borrower as of September 30, 2021 and December 31, 2020:
(in thousands)
Entity
Debt Instrument
Rate
Maturity
September 30, 2021
December 31, 2020
OTC
Guaranteed Senior Notes
3.55%
12/15/26
$
80,000
$
80,000
OTP
Series 2011A Senior Unsecured Notes
4.63%
12/01/21
140,000
140,000
OTP
Series 2007B Senior Unsecured Notes
6.15%
08/20/22
30,000
30,000
OTP
Series 2007C Senior Unsecured Notes
6.37%
08/02/27
42,000
42,000
OTP
Series 2013A Senior Unsecured Notes
4.68%
02/27/29
60,000
60,000
OTP
Series 2019A Senior Unsecured Notes
3.07%
10/10/29
10,000
10,000
OTP
Series 2020A Senior Unsecured Notes
3.22%
02/25/30
10,000
10,000
OTP
Series 2020B Senior Unsecured Notes
3.22%
08/20/30
40,000
40,000
OTP
Series 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
OTC
PACE Note
2.54%
03/18/21
—
169
Total
$
767,000
$
767,169
Less:
Current Maturities Net of Unamortized Debt Issuance Costs
169,962
140,087
Unamortized Long-Term Debt Issuance Costs
2,419
2,650
Total Long-Term Debt Net of Unamortized Debt Issuance Costs
$
594,619
$
624,432
On June 10, 2021, OTP entered into a Note Purchase Agreement pursuant to which OTP agreed to issue, in a private placement transaction, $230 million aggregate principal amount of senior unsecured notes consisting of (a) $40 million of 2.74% Series 2021A Senior Unsecured Notes due November 29, 2031, (b) $100 million of 3.69% Series 2021B Senior Unsecured Notes due November 29, 2051 and (c) $90 million of 3.77% Series 2022A Senior Unsecured Notes due May 20, 2052. As of September 30, 2021, there were no amounts outstanding. The funding of the notes will occur in two issuances, $140 million in November 2021 and $90 million in May 2022. The issuance of the notes is subject to the satisfaction of certain customary conditions to closing.
Financial Covenants
Certain of OTC's and OTP's short-term 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 September 30, 2021, OTC and OTP were in compliance with these financial covenants.
The reconciliation of the statutory federal income tax rate to our effective tax rate for each of the three and nine months ended September 30, 2021 and 2020 is as follows:
Three Months Ended September 30,
Nine Months Ended September 30,
2021
2020
2021
2020
Federal Statutory Rate
21.0
%
21.0
%
21.0
%
21.0
%
Increases (Decreases) in Tax from:
State Taxes on Income, Net of Federal Tax
5.0
5.0
5.0
5.0
Production Tax Credits (PTCs)
(5.0)
—
(6.0)
—
Amortization of Excess Deferred Income Taxes
(1.6)
(2.9)
(2.0)
(3.4)
North Dakota Wind Tax Credit Amortization, Net of Federal Tax
(0.2)
(0.6)
(0.3)
(0.8)
Excess Tax Deduction on Stock Awards
—
0.3
—
(0.4)
Allowance for Equity Funds Used During Construction
(0.1)
(0.7)
(0.1)
(0.8)
Other, Net
(0.8)
(1.9)
(0.7)
(1.2)
Effective Tax Rate
18.3
%
20.2
%
16.9
%
19.4
%
We began generating PTCs from our Merricourt wind farm placed in service in the fourth quarter of 2020. No PTCs were generated during the nine months ended September 30, 2020. Income tax benefits arising from PTCs are offset by corresponding operating revenue reductions.
9. Commitments and Contingencies
Commitments
Construction and Other Purchase Commitments. OTP has commitments under contracts, including its share of construction program and other commitments associated with its jointly-owned facilities, extending into 2046.
Electric Utility Capacity and Energy Requirements and Coal Purchase and Delivery Contracts. OTP has commitments for the purchase of capacity and energy requirements under agreements extending into 2044. OTP also has contracts providing for the purchase and delivery of a significant portion of its current coal requirements, with expiration dates ranging from 2022 through 2040. Certain contracts do not include minimum purchase requirements but do require all coal necessary for the operation of the respective plant to be purchased from the counterparty.
Land Easements. OTP has commitments to make future payments under land easements extending into 2050.
Contingencies
FERC ROE. In November 2013 and February 2015, customers filed complaints with FERC seeking to reduce the ROE component of the transmission rates that MISO transmission owners, including OTP, may collect under the MISO tariff rate. FERC's most recent order, issued on November 19, 2020, adopted a revised ROE methodology and set the base ROE at 10.02% (10.52% with an adder) effective for the fifteen-month period from November 2013 to February 2015 and on a prospective basis beginning in September 2016. The order also dismissed any complaints covering the period from February 2015 to May 2016. The November 2020 opinion is subject to judicial review. We have deferred recognition and recorded a refund liability of $3.0 million as of September 30, 2021. This refund liability reflects our best estimate of required refunds to customers once all regulatory and judicial proceedings are completed.
Regional Haze Rule (RHR). The RHR was adopted in an effort to improve visibility in national parks and wilderness areas. The RHR requires states, in coordination with the EPA and other governmental agencies, to develop and implement plans to achieve natural visibility conditions. The second RHR implementation period covers the years 2018-2028. States are required to submit a state implementation plan to assess reasonable progress with the RHR and determine what additional emission reductions are appropriate, if any.
Coyote Station, OTP's jointly owned coal-fired power plant in North Dakota, is subject to assessment in the second implementation period under the North Dakota state implementation plan. In September 2021, the North Dakota Department of Environmental Quality (NDDEQ) made public a draft of its state implementation plan. The plan concluded it is not reasonable to require additional emission controls during this planning period. Following a consultation and public comment period, and any subsequent modifications to the plan, the NDDEQ will submit its state implementation plan to the EPA for approval.
We cannot predict with certainty the impact the state implementation plan may have on our business until the state implementation plan has been approved or otherwise acted on by the EPA. However, significant emission control investments could be required and the recovery of such costs from customers would require regulatory approval. Alternatively, investments in emission control equipment may prove to be uneconomic and result in an early retirement of, or the sale of our interest in, Coyote Station, subject to regulatory approval. We cannot estimate the 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 from customers would be subject to regulatory approval.
Westmoreland Coal Company (Westmoreland) Arbitration. In December 2018, insurers for Westmoreland, Westmoreland and its affiliated companies filed an arbitration demand against the co-owners of Coyote Station, including OTP, a 35% co-owner. The claimant insurers are pursuing recovery in the amount of $5.5 million, plus prejudgment interest to recover business interruption insurance proceeds paid to Westmoreland or its affiliates arising from a boiler feed pump explosion in December 2014 at the facility. The explosion and ensuing repairs reduced the amount of coal purchased from a Westmoreland affiliate under an existing coal purchase agreement. The Westmoreland insurers claim the co-owners breached the minimum purchase obligations in the coal purchase agreement. As of September 30, 2021, we have recorded an estimated liability for losses to be incurred related to this matter based upon the most recent information available, however, ultimate losses could be in excess of the amount recorded. Any losses incurred from this matter could be eligible for recovery through typical cost recovery processes of our electric utility business. The potential cost recovery would be subject to regulatory approval.
Other Contingencies. We are party to litigation and regulatory matters arising in the normal course of business. We regularly analyze relevant information and, as necessary, estimate and record accrued liabilities for legal, regulatory enforcement and other matters in which a loss is probable of occurring and can be reasonably estimated. We believe the effect on our consolidated operating results, financial position and cash flows, if any, for the disposition of all matters pending as of September 30, 2021, other than those discussed above, will not be material.
10. Stockholders' Equity
Registration Statements
On May 3, 2021 we filed a shelf registration statement with the Securities and Exchange Commission (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. 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 a method of purchasing our common shares by reinvesting their dividends and/or making optional cash investments. Shares purchased under the plan may be new issue common shares or common shares purchased on the open market. The registration statement expires in May 2024.
Dividend Restrictions
Otter Tail Corporation is a holding company with no significant operations of its own. The primary source of funds for payments of dividends to our shareholders is from dividends paid or distributions made by our subsidiaries. As a result of certain statutory limitations or regulatory or financing agreements, restrictions could occur on the amount of distributions allowed to be made by our subsidiaries. Both the OTC Credit Agreement and OTP Credit Agreement contain restrictions on the payment of cash dividends upon a default or event of default, including failure to maintain certain financial covenants. As of September 30, 2021, 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 MPUC indirectly limits the amount of dividends OTP can pay to the Company by requiring an equity-to-total-capitalization ratio between 47.5% and 58.1% based on OTP’s 2020 capital structure petition effective by order of the MPUC on July 15, 2020. As of September 30, 2021, OTP’s equity-to-total-capitalization ratio including short-term debt was 52.6% and its net assets restricted from distribution totaled approximately $674.9 million. Under the 2020 capital structure petition, total capitalization for OTP cannot exceed $1.7 billion.
11. 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 $0.8 million and $1.3 million for the three months ended September 30, 2021 and 2020, respectively, and $6.4 million and $5.3 million for the nine months ended September 30, 2021 and 2020, respectively.
Stock Awards. We grant restricted stock awards to members of our Board of Directors and restricted stock units to our employees. The awards vest, depending on award type and recipient, either ratably over periods of three and four years or cliff vest after four years. Vesting is accelerated in certain circumstances, including on retirement. Restricted stock awards granted to members of the Board of Directors are issued and outstanding on grant and carry the same voting and dividend rights of unrestricted outstanding common stock. Restricted stock units are not issued or outstanding on grant and do not provide for voting or dividend rights. Certain restricted stock unit award recipients are eligible to receive dividend equivalent payments during the vesting period, subject to forfeiture under the terms of the agreement.
The grant date fair value of each stock award is determined based on the market price of our common stock on the date of grant adjusted to exclude the value of dividends for those awards that do not receive dividend or dividend equivalent payments during the vesting period.
The following is a summary of stock award activity for the nine months ended September 30, 2021:
Shares
Weighted Average Grant-Date Fair Value
Nonvested, January 1, 2021
128,664
$
44.30
Granted
57,650
43.10
Vested
(47,646)
42.98
Forfeited
(2,075)
40.95
Nonvested, September 30, 2021
136,593
$
44.30
The fair value of vested awards was $2.1 million and $2.8 million during the nine months ended September 30, 2021 and 2020.
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. The awards have no voting or dividend rights during the vesting period. Vesting of the awards is accelerated in certain circumstances, including on retirement. The amount of common shares awarded on an accelerated vesting is based either on actual performance at the end of the performance period or the amount of common shares earned at target.
The grant date fair value of stock performance awards granted during the nine months ended September 30, 2021 and 2020 was determined using a Monte Carlo fair value simulation model incorporating the following assumptions:
2021
2020
Risk-free interest rate
0.18
%
1.42
%
Expected term (in years)
3.00
3.00
Expected volatility
32.00
%
19.00
%
Dividend yield
3.60
%
2.80
%
The risk-free interest rate was derived from yields on U.S. government bonds of a similar term. The expected term of the award is equal to the three-year performance period. Expected volatility was estimated based on actual historical volatility of our common stock. Dividend yield was estimated based on historic and future yield estimates.
The following is a summary of stock performance award activity for the nine months ended September 30, 2021 (share amounts reflect awards at target):
Shares
Weighted Average Grant-Date Fair Value
Nonvested, January 1, 2021
164,600
$
42.32
Granted
79,000
38.34
Vested
(54,000)
35.73
Forfeited
—
—
Nonvested, September 30, 2021
189,600
$
42.54
The fair value of vested awards was $2.5 million and $3.4 million during the nine months ended September 30, 2021 and 2020.
12. 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 nine months ended September 30, 2021 and 2020:
Three Months Ended September 30,
Nine Months Ended September 30,
(in thousands)
2021
2020
2021
2020
Weighted Average Common Shares Outstanding – Basic
41,504
40,914
41,487
40,548
Effect of Dilutive Securities:
Stock Performance Awards
262
98
209
107
Stock Awards
88
49
82
53
Employee Stock Purchase Plan Shares and Other
15
17
17
25
Dilutive Effect of Potential Common Shares
365
164
308
185
Weighted Average Common Shares Outstanding – Diluted
41,869
41,078
41,795
40,733
The amount of shares excluded from diluted weighted-average common shares outstanding because such shares were anti-dilutive was not material for the three and nine months ended September 30, 2021 and 2020.
13. Derivative Instruments
OTP enters into derivative instruments to manage its exposure to future price variability and reduce volatility in prices for our retail customers. These derivative instruments are not designated as qualifying hedging transactions but provide for an economic hedge against future price variability. The instruments are recorded at fair value on the consolidated balance sheets, with changes in fair value recorded in the consolidated statements of income. However, 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 September 30, 2021, OTP had outstanding pay-fixed, receive-variable swap agreements with an aggregate notional amount of 356,200 megawatt-hours of electricity, which will be settled periodically through 2022. As of September 30, 2021, the aggregate fair value of these contracts was $6.9 million, of which $6.1 million is included in other current assets and $0.8 million is included in other noncurrent assets on the consolidated balance sheets.
14. Fair Value Measurements
The following tables present our assets measured at fair value on a recurring basis as of September 30, 2021 and December 31, 2020 classified by the input method used to measure fair value:
Level 1
Level 2
Level 3
September 30, 2021
Investments:
Money Market Funds
$
953
$
—
$
—
Mutual Funds
5,170
—
—
Corporate Debt Securities
—
2,377
—
Government-Backed and Government-Sponsored Enterprises’ Debt Securities
—
6,831
—
Derivative Instruments
—
6,923
—
Total Assets
$
6,123
$
16,131
$
—
December 31, 2020
Investments:
Money Market Funds
$
4,075
$
—
$
—
Mutual Funds
1,662
—
—
Corporate Debt Securities
—
2,627
—
Government-Backed and Government-Sponsored Enterprises’ Debt Securities
—
6,633
—
Total Assets
$
5,737
$
9,260
$
—
The level 2 fair value measurements for government-backed and government-sponsored enterprises and corporate debt securities are determined on the basis of valuations provided by a third-party pricing service which utilizes industry accepted valuation models and observable market inputs to determine valuation. Some valuations or model inputs used by the pricing service may be based on broker quotes.
The level 2 fair value measurements for derivative instruments are determined by using inputs such as forward electric commodity prices, adjusted for location differences. These inputs are observable in the marketplace throughout the full term of the instrument, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace.
In addition to assets recorded at fair value on a recurring basis, we also hold financial instruments that are not recorded at fair value in the consolidated balance sheets but for which disclosure of the fair value of these financial instruments is provided. The following reflects the carrying value and estimated fair value of these assets and liabilities as of September 30, 2021 and December 31, 2020:
September 30, 2021
December 31, 2020
(in thousands)
Carrying Amount
Fair Value
Carrying Amount
Fair Value
Assets:
Cash and Cash Equivalents
$
1,272
$
1,272
$
1,163
$
1,163
Total
1,272
1,272
1,163
1,163
Liabilities:
Short-Term Debt
97,857
97,857
80,997
80,997
Long-Term Debt
764,581
873,632
764,519
858,455
Total
$
862,438
$
971,489
$
845,516
$
939,452
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.
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, 2020.
Otter Tail Corporation and its subsidiaries form a diverse group of businesses with operations classified into three segments: Electric, Manufacturing and Plastics. Our Electric business is a vertically integrated, regulated utility with generation, transmission and distribution facilities to serve our customers in western Minnesota, eastern North Dakota and northeastern South Dakota. Our Manufacturing segment provides metal fabrication for custom machine parts and metal components and manufactures extruded and thermoformed plastic products. Our Plastics segment manufactures PVC pipe for use in, among other applications, municipal and rural water, wastewater, and water reclamation projects.
COVID-19
We continue to monitor the progression of the novel coronavirus (COVID-19) and its impact on our businesses, employees, customers, construction contractors and vendors. As this pandemic continues, we are following the directives and advice of government leaders and medical professionals and have adopted practices to help curtail the spread of the virus and mitigate its impact on our communities, employees, construction contractors, customers and business operations.
Beginning in March 2020, COVID-19 and the resulting economic conditions negatively impacted operating results of our Manufacturing segment as customer demand declined significantly in the second quarter of 2020. Sales volumes strengthened in the third and fourth quarters of 2020 due to strong recreational vehicle and lawn and garden end-market demand. Our Electric and Plastics segments operating results were also impacted in 2020. Within our Electric segment, we experienced reduced demand from commercial and industrial customers and increased costs for bad debts. In our Plastics segment, we experienced lower sales volumes in the second quarter of 2020 as distributors of our products reduced inventory levels given the uncertainty of the potential impact of COVID-19. Sales volumes recovered and gross profit margins increased in the third and fourth quarters of 2020, and have continued to increase in 2021, due to increased demand and supply disruptions.
The impact of COVID-19 and the resulting macroeconomic conditions on our business and financial results began to ease in the first quarter of 2021 and continued to do so through the third quarter of 2021. However, uncertainty remains regarding the magnitude and duration of the pandemic and resulting financial effects. Increased infection rates and any future responses to mitigate the spread of the virus, including any potential vaccination mandates that would apply to our employees, could impact our business and our financial results in future periods.
Recently, the Department of Labor’s Occupational Safety and Health Administration (“OSHA”) drafted an emergency temporary standard requiring all employers with at least 100 employees to ensure their employees are fully vaccinated or require weekly testing for unvaccinated employees. On October 12, 2021, OSHA sent a draft of the standard to the White House regulatory office for approval and it is anticipated to be acted upon soon. Additionally, President Biden issued an executive order on September 9, 2021, which requires employees of certain federal contractors and covered subcontractors to be vaccinated, with no weekly testing option, unless they have an approved disability or religious exemption. We expect one, or both, of these new regulations will apply to at least some, and possibly all, of our businesses. The exact impact the new regulations could have on our companies is uncertain at this time. However, it could result in employee attrition, difficulty fulfilling future labor needs, additional costs related to compliance and may have an adverse effect on our future operating results.
We continue to monitor developments involving our workforce, customers, construction contractors, suppliers and vendors and the financial effects on our business. However, due to the unprecedented and evolving nature of this pandemic, we cannot predict the full extent of the impact COVID-19 will have on our operating results, financial condition and liquidity.
RESOURCE MATERIAL AVAILABILITY AND PRICING
Supply shortages of steel and resin, two key material inputs to our Manufacturing and Plastics segments, respectively, have impacted our operating results in 2021.
Steel supply shortages arose primarily due to steel mill capacity reductions in 2020 in response to lower steel demand due to COVID-19. Production and availability of steel have begun to improve as steel mill facilities have increased production capacities in response to strong market demand for steel products. The combination of steel supply shortages and strong demand has led to significantly increased steel prices. The increase in steel prices has led to increased sale prices for our products at BTD, our metal fabrication business within our Manufacturing segment, as we pass along material cost increases to our customers. In addition, limited steel availability has led to increased complexity in managing our business, including our production schedules, and other increased costs. We anticipate increased steel prices will continue throughout the remainder of 2021 and into 2022.
Resin shortages initially arose as a result of production plant shutdowns due to abnormally low temperatures and ice storms in the Gulf Coast region of the United States in the first quarter of 2021 and have been exacerbated by hurricane activity in the third quarter of the year. These supply constraints, along with robust domestic and global demand for PVC resin, have led to significantly increased resin prices. The increase in the price of resin, the primary material input into the PVC pipe manufactured by our Plastics segment businesses, along with strong customer demand for PVC pipe and low pipe inventories, due to the resin supply constraints, have led to rapidly increased sales prices for PVC pipe. The increase in sale prices has outpaced the increase in resin costs, leading to expanding gross profit margins and a significant increase in net earnings in our Plastics segment. We anticipate these market dynamics will persist through the remainder of 2021 and continue during the first half of 2022. We currently expect these conditions to subside beginning in the second half of 2022.
The marketplace dynamics impacting both our Manufacturing and Plastics segments are fluid and subject to change which may impact our operating results prospectively.
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.
Intersegment transactions were not material in 2021 or 2020 and amounted to less than $0.1 million of operating revenues and operating expenses for each period.
CONSOLIDATED RESULTS
The following table summarizes consolidated operating results for the three months ended September 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Operating Revenues
$
316,294
$
235,755
$
80,539
34.2
%
Operating Expenses
241,766
183,026
58,740
32.1
Operating Income
74,528
52,729
21,799
41.3
Interest Charges
9,648
8,568
1,080
12.6
Nonservice Cost Components of Postretirement Benefits
505
842
(337)
(40.0)
Other Income
203
1,712
(1,509)
(88.1)
Income Before Income Taxes
64,578
45,031
19,547
43.4
Income Tax Expense
11,824
9,097
2,727
30.0
Net Income
$
52,754
$
35,934
$
16,820
46.8
%
Operating Revenues increased $80.5 million primarily due to rising PVC pipe prices and increased sales volumes within our Plastics segment and increased volumes and material cost, leading to increased sales prices, in our Manufacturing segment. Increased transmission services and wholesale revenues, partially offset by decreased retail revenues, within our Electric segment also contributed to higher operating revenues in the third quarter of 2021 compared to the same period last year. See our segment disclosures below for additional discussion of items impacting operating revenues.
Operating Expenses increased $58.7 million primarily due to increased costs of products sold in our Manufacturing and Plastics segments due to increased raw material costs and higher sales volumes, as well as increased labor costs. Operating expenses in our Electric segment increased primarily due to higher depreciation and amortization expense arising from our recent rate base investments and higher operating and maintenance expenses. See our segment disclosures below for additional discussion of items impacting operating expenses.
Interest Charges increased $1.1 million due to interest expense from our $40.0 million long-term debt issuance in August 2020, a higher level of short-term borrowings outstanding in 2021 compared to 2020 and a decrease in capitalized interest in 2021 following the completion and placement in service of Astoria Station in the first quarter of 2021.
Other Income decreased $1.5 million primarily due to lower earned equity AFUDC due to the completion and placement in-service of Astoria Station in the first quarter of 2021. During the construction of Astoria Station we earned AFUDC in our Minnesota jurisdiction.
Income Tax Expense increased $2.7 million primarily due to increased income before income taxes. Our effective tax rate was 18.3% in the third quarter of 2021 and 20.2% in the third quarter of 2020. The decrease in our effective tax rate was driven by PTCs earned in the third quarter of 2021 from our Merricourt wind farm, which was placed in service in the fourth quarter of 2020, partially offset by other permanent differences. 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 2021 and 2020.
The following table summarizes Electric segment operating results for the three months ended September 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Retail Revenues
$
96,438
$
99,605
$
(3,167)
(3.2)
%
Transmission Services Revenues
13,300
12,288
1,012
8.2
Wholesale Revenues
6,944
1,500
5,444
362.9
Other Electric Revenues
2,093
1,830
263
14.4
Total Operating Revenues
118,775
115,223
3,552
3.1
Production Fuel
17,698
11,554
6,144
53.2
Purchased Power
9,878
13,428
(3,550)
(26.4)
Operating and Maintenance Expenses
36,465
32,845
3,620
11.0
Depreciation and Amortization
17,874
15,647
2,227
14.2
Property Taxes
4,474
4,333
141
3.3
Operating Income
$
32,386
$
37,416
$
(5,030)
(13.4)
%
2021
2020
change
% change
Electric kilowatt-hour (kwh) Sales(in thousands)
Retail kwh Sales
1,076,580
1,075,336
1,244
0.1
%
Wholesale kwh Sales – Company Generation
174,187
75,884
98,303
129.5
Heating Degree Days
3
61
(58)
(95.1)
Cooling Degree Days
463
363
100
27.5
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 three months ended September 30, 2021 and 2020.
2021
2020
Heating Degree Days
5.8
%
115.1
%
Cooling Degree Days
132.7
%
104.6
%
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 2021 and 2020, and between years.
2021 vs
Normal
2021 vs
2020
2020 vs
Normal
Effect on Diluted Earnings Per Share
$
0.03
$
0.02
$
0.01
Retail Revenues decreased $3.2 million primarily due to the following:
•The recognition of $2.6 million of Minnesota transmission rider revenue in the third quarter of 2020 resulting from a favorable judicial decision regarding the state jurisdictional treatment of federally approved transmission projects.
•A $1.2 million decrease in fuel recovery revenues largely due to lower purchased power costs and credits provided to retail customers from increased margins on wholesale sales, but partially offset by increased recovery of higher production fuel costs.
•A decrease in revenue from the combination of reduced demand from residential and commercial and industrial customers, exclusive of the impact of weather, net of the effect of a change in customer usage mix.
These decreases in revenue were partially offset by a $1.2 million increase in consumption from the favorable impact of weather in the third quarter of 2021 compared to the same period last year.
Transmission Services Revenues increased $1.0 million primarily due to increased generator interconnection revenues.
Wholesale Revenues increased $5.4 million as a result of a 129.5% increase in wholesale sales volumes and a 101.7% increase in wholesale prices driven by increased fuel costs and market demand for wholesale energy.
Production Fuel costsincreased $6.1 million mainly as a result of a 41.4% increase in kwhs generated from our fuel-burning plants due to higher demand and favorable prices for energy in wholesale markets. In addition, increased fuel cost per kwh also contributed to higher production fuel costs in the third quarter of 2021.
Purchased Power costs to serve retail customers decreased $3.6 million primarily due to a 48.9% decrease in the volume of purchased power as our recent capacity additions provide additional generation resources to serve customer demand and market conditions led to operating our
existing facilities at higher capacity factors in lieu of purchasing power at higher market prices, but partially offset by an increase in the cost of purchased power per kwh in the third quarter of 2021.
Operating and MaintenanceExpense increased $3.6 million mainly due to:
•$1.4 million of Merricourt and Astoria Station operating and maintenance expenses incurred in the third quarter of 2021 as these facilities are now commercially operational.
•$2.1 million of maintenance costs arising from our planned outage at Big Stone plant, which began in the third quarter of 2021 and we expect will be completed in the fourth quarter of the year.
•Other additional expenses include an increase in transmission tariff expense from higher transmission volumes and increased travel costs as business travel recovers from the impact of COVID-19.
These expense increases were partially offset by, among other items, lower operating costs following the closure of Hoot Lake Plant in May 2021 and lower bad debt expense due to improving customer collections as the economic impact of COVID-19 has eased.
Depreciation and Amortization expense increased $2.2 million primarily due to Merricourt and Astoria Station being placed in service in the fourth quarter of 2020 and the first quarter of 2021, respectively.
MANUFACTURING SEGMENT RESULTS
The following table summarizes Manufacturing segment operating results for the three months ended September 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Operating Revenues
$
89,977
$
59,849
$
30,128
50.3
%
Cost of Products Sold (excluding depreciation)
70,148
44,444
25,704
57.8
Other Operating Expenses
10,161
6,901
3,260
47.2
Depreciation and Amortization
3,794
3,759
35
0.9
Operating Income
$
5,874
$
4,745
$
1,129
23.8
%
Operating Revenues increased $30.1 million primarily due to a 41.3% increase in material costs at BTD, which is passed through to customers, as steel prices increased significantly from the previous year. Steel prices have increased as steel mill production has not matched customer demand as mill capacity recovers from shutdowns in 2020 resulting from the COVID-19 pandemic. A 4.0% increase in sales volumes and an increase in scrap revenues, primarily due to higher scrap metal prices, also contributed to the increase in operating revenues. We anticipate steel prices will remain elevated for the remainder of 2021 and into 2022. Increased horticultural product sales volumes at T.O. Plastics in 2021, driven by increasing customer demand, as well as increased sales prices also contributed to increased operating revenues in 2021 as compared to 2020.
Cost of Products Sold increased $25.7 million primarily due to increased volumes and higher material, labor and freight costs at BTD. The increase in material cost is largely driven by increased steel prices as mentioned above. The increases in labor and freight costs and lower productivity resulted in lower gross profit margins compared to the same period in 2020. Lower productivity during the period was primarily the result of recent increases in headcount and the time required for new employee to achieve peak productivity. Increased sales volumes and production activity at T.O. Plastics also contributed to the increase in cost of products sold in 2021.
Other Operating Expenses increased $3.3 million in the third quarter of 2021 compared to 2020. In the third quarter of 2021 other operating expenses were impacted by increased incentive based compensation and other costs necessary to support higher business volumes.
PLASTICS SEGMENT RESULTS
The following table summarizes Plastics segment operating results for the three months ended September 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Operating Revenues
$
107,542
$
60,693
$
46,849
77.2
%
Cost of Products Sold (excluding depreciation)
64,064
42,415
21,649
51.0
Other Operating Expenses
3,832
3,250
582
17.9
Depreciation and Amortization
1,099
905
194
21.4
Operating Income
$
38,547
$
14,123
$
24,424
172.9
%
Operating Revenues increased $46.8 million, primarily due to a 103.6% increase in the price per pound of PVC pipe sold. The increase in sale prices was largely due to the combination of PVC resin supply constraints, which has led to limited PVC pipe inventory, and strong demand for PVC pipe products. Resin supply in the third quarter of 2021 was negatively impacted by disruptions caused by Hurricane Ida in the Gulf Coast region, which compounded supply constraints that began in the first quarter of 2021 as a result of plant shutdowns caused by extreme winter weather. Pounds of pipe sold in the third quarter of 2021 decreased 13.0% from the same period last year. We anticipate sales prices will remain elevated throughout the remainder of 2021 and into 2022, as resin suppliers work to fulfill purchase allotments and pipe manufacturers continue to replenish depleted inventories while customer demand remains strong.
Cost of Products Sold increased $21.6 million primarily due to increased PVC resin and other input material costs per pound, which increased 91.7% compared to the same period in the previous year. Increases in labor and freight costs in 2021 also contributed to the increase in cost of products sold.
Other Operating Expenses increased $0.6 million as a result of an increase in variable costs associated with the increased financial results in 2021.
CORPORATE COSTS
The following table summarizes Corporate operating results for the three months ended September 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Other Operating Expenses
$
2,231
$
3,471
$
(1,240)
(35.7)
%
Depreciation and Amortization
48
84
(36)
(42.9)
Operating Loss
$
2,279
$
3,555
$
(1,276)
(35.9)
%
Other Operating Expenses decreased $1.2 million primarily due to decreased stock and incentive based compensation cost as a result of the timing of expense recognition, which can fluctuate due to changes in estimates of annual financial performance relative to targeted amounts.
RESULTS OF OPERATIONS – YEAR TO DATE
Intersegment transactions were not material in 2021 or 2020 and amounted to less than $0.1 million of operating revenues and operating expenses for each period.
CONSOLIDATED RESULTS
The following table summarizes consolidated operating results for the nine months ended September 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Operating Revenues
$
863,612
$
663,258
$
200,354
30.2
%
Operating Expenses
685,063
543,331
141,732
26.1
Operating Income
178,549
119,927
58,622
48.9
Interest Charges
28,601
25,353
3,248
12.8
Nonservice Cost Components of Postretirement Benefits
1,511
2,581
(1,070)
(41.5)
Other Income
2,095
3,733
(1,638)
(43.9)
Income Before Income Taxes
150,532
95,726
54,806
57.3
Income Tax Expense
25,380
18,543
6,837
36.9
Net Income
$
125,152
$
77,183
$
47,969
62.1
%
Operating Revenues increased $200.4 million primarily due to higher PVC pipe prices within our Plastics segment and increased volumes and material costs, leading to higher sales prices, in our Manufacturing segment. Increased transmission services and wholesale revenues within our Electric segment also contributed to the higher operating revenues in 2021. See our segment disclosures below for additional discussion of items impacting operating revenues.
Operating Expenses increased $141.7 million in 2021 primarily due to increased costs of products sold in our Plastics and Manufacturing segments due to higher raw material costs and sales volumes. Operating expenses in our Electric segment increased primarily from higher operating and maintenance and depreciation and amortization expenses, in each case largely the result of our recent rate base investments and the associated operating costs of such investments. See our segment disclosures below for additional discussion of items impacting operating expenses.
Interest Charges increased $3.2 million in 2021 due to a debt issuance in our Electric segment in the third quarter of 2020, increased outstanding borrowings under our short-term debt arrangements, both of which were largely used to finance rate base investments in our Electric segment, and a decrease in capitalized interest in 2021 due to the completion and placement in service of Astoria Station in the first quarter of 2021.
Nonservice Cost Components of Postretirement Benefits decreased $1.1 million in 2021 due to a change in how prescription drug coverage is provided to retirees and the impact of nonservice costs from a decrease in the discount rate from 2020 to 2021.
Other Income decreased $1.6 million in 2021 due to a $2.7 million decrease in earned equity AFUDC due primarily to the completion and placement in service of Astoria Station in the first quarter of 2021, but partially offset by increases in the values of corporate-owned life insurance policies and other investments in 2021 compared to 2020.
Income Tax Expense increased $6.8 million in 2021 primarily due to increased income before income taxes. Our effective tax rate was 16.9% in 2021 and 19.4% in 2020 with the decrease primarily driven by PTCs earned in 2021 from our Merricourt wind farm, which was placed in service in the fourth quarter of 2020. 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.
The following table summarizes Electric segment operating results for the nine months ended September 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Retail Revenues
$
291,130
$
291,761
$
(631)
(0.2)
%
Transmission Services Revenues
37,085
32,802
4,283
13.1
Wholesale Revenues
14,711
3,141
11,570
368.4
Other Electric Revenues
5,703
5,548
155
2.8
Total Operating Revenues
348,629
333,252
15,377
4.6
Production Fuel
44,576
34,077
10,499
30.8
Purchased Power
40,273
45,940
(5,667)
(12.3)
Operating and Maintenance Expenses
114,615
106,639
7,976
7.5
Depreciation and Amortization
53,335
47,063
6,272
13.3
Property Taxes
13,136
12,601
535
4.2
Operating Income
$
82,694
$
86,932
$
(4,238)
(4.9)
%
Electric kilowatt-hour (kwh) Sales(in thousands)
Retail kwh Sales
3,511,730
3,538,299
(26,569)
(0.8)
%
Wholesale kwh Sales – Company Generation
358,761
156,948
201,813
128.6
Heating Degree Days
3,614
3,968
(354)
(8.9)
Cooling Degree Days
700
533
167
31.3
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 nine months ended September 30, 2021 and 2020.
2021
2020
Heating Degree Days
89.9
%
99.3
%
Cooling Degree Days
150.9
%
116.9
%
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 2021 and 2020, and between years.
2021 vs
Normal
2021 vs
2020
2020 vs
Normal
Effect on Diluted Earnings Per Share
$
0.02
$
0.01
$
0.01
Retail Revenues decreased $0.6 million primarily due to the following:
•A $4.7 million decrease in fuel recovery revenues largely due to lower purchased power costs and credits provided to retail customers from increased margins on wholesale sales, but partially offset by increased recovery of higher production fuel costs.
•The recognition of $2.6 million of Minnesota transmission rider revenue in the third quarter of 2020 resulting from a favorable judicial decision regarding the state jurisdictional treatment of federally approved transmission projects.
•A $1.6 million decrease in revenue from the combination of reduced demand from residential and commercial and industrial customers, exclusive of the impact of weather, net of the effect of a change in customer usage mix.
These decreases in revenue were partially offset by the following:
•A $3.6 million increase in rider revenues primarily related to the recovery of Merricourt and Astoria Station project costs and operating expenses.
•A $3.0 million increase in new revenue from an interim rate increase in Minnesota, net of estimated refunds, effective January 1, 2021 in connection with our rate case filed in November 2020.
•A $2.1 million increase in revenue from transmission rider recovery, due to increased transmission investments, and increased conservation improvement program spending.
Transmission Services Revenues increased $4.3 million primarily due to increased recovery of higher transmission costs and increased transmission investment as well as increased generator interconnection revenues.
Wholesale Revenues increased $11.6 million as a result of a 128.6% increase in wholesale sales volumes and a 104.9% increase in wholesale electric prices, primarily driven by increased fuel costs and high market demand for wholesale energy, which serves to drive up spot market prices for electricity.
Production Fuel costsincreased $10.5 million primarily as a result of a 30.8% increase in kwhs generated from our fuel-burning plants due to higher demand and favorable prices for energy in wholesale markets.
Purchased Power costs to serve retail customers decreased $5.7 million mainly due to a 26.7% decrease in the volume of purchased power as our recent capacity additions provide additional generation resources to serve customer demand and market conditions led to operating our existing facilities at higher capacity factors in lieu of purchasing power at higher market prices.
Operating and Maintenance Expense increased $8.0 million, which was primarily the result of:
•$4.0 million of Merricourt and Astoria Station operating and maintenance expenses incurred in 2021 as these facilities are now commercially operational.
•$2.1 million of maintenance costs arising from our planned outage at Big Stone plant, which began in the third quarter of 2021 and we expect will be completed in the fourth quarter of the year.
•Other additional costs including a $1.6 million increase in transmission tariff expenses, a $1.0 million increase in vegetative maintenance cost, and an increase in conservation program expenditures.
These expense increases were partially offset by, among other items, $1.7 million of lower bad debt expense due to improving customer collections as the economic impact of COVID-19 has eased and lower operating costs following the closure of Hoot Lake Plant in May 2021.
Depreciation and Amortization expense increased $6.3 million primarily due to Merricourt and Astoria Station being placed in service in the fourth quarter of 2020 and in February 2021, respectively.
MANUFACTURING SEGMENT RESULTS
The following table summarizes Manufacturing segment operating results for the nine months ended September 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Operating Revenues
$
250,085
$
174,276
$
75,809
43.5
%
Cost of Products Sold (excluding depreciation)
189,183
131,145
58,038
44.3
Other Operating Expenses
28,109
19,678
8,431
42.8
Depreciation and Amortization
11,395
11,244
151
1.3
Operating Income
$
21,398
$
12,209
$
9,189
75.3
%
Operating Revenues increased $75.8 million primarily due to higher revenues at BTD, which was largely driven by a 15.6% increase in sales volumes and a 25.5% increase in material costs, which are passed through to customers through increased sales prices. The increase in material costs is largely the result of historically high steel prices due to supply shortages as steel mill capacity rebounds from capacity reductions in 2020. Sales volumes in 2020 were negatively impacted by COVID-19 as customers implemented temporary plant shutdowns due to the pandemic. Sales volumes in 2021 have rebounded as customer demand across most end markets has been robust. An increase in horticultural product sales volumes at T.O. Plastics in 2021, driven by increasing customer demand, as well as increased sales prices, also contributed to increased operating revenues in 2021.
Cost of Products Sold increased $58.0 million primarily due to increased volumes and higher material, labor and freight costs at BTD. The increase in material cost is largely the result of high steel prices as mentioned above. Year to date gross profit margins are consistent with the prior year as increases in labor and freight costs and lower productivity in the third quarter of 2021 have been offset by higher sales volumes, as higher volumes have resulted in greater leveraging of fixed production costs. Increased sales volumes and production activity at T.O. Plastics has also contributed to the increase in cost of products sold in 2021. Year to date gross profit margins at T.O. Plastics increased compared to the same period in 2020, as higher production activities have resulted in greater leveraging of fixed production costs and sales prices have increased, resulting from input material cost inflation.
Other Operating Expenses increased $8.4 million in 2021 compared to 2020. Other operating expenses in 2020 were reduced by initiatives taken to reduce costs in an effort to mitigate the impact of declining sales volumes from the effects of COVID-19. Other operating expenses in 2021 were impacted by an increase in incentive based compensation arising from the improvement in financial results, and an increase in costs necessary to support the increase in business volumes.
The following table summarizes Plastics segment operating results for the nine months ended September 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Operating Revenues
$
264,898
$
155,769
$
109,129
70.1
%
Cost of Products Sold (excluding depreciation)
169,584
115,432
54,152
46.9
Other Operating Expenses
10,450
8,990
1,460
16.2
Depreciation and Amortization
3,200
2,667
533
20.0
Operating Income
$
81,664
$
28,680
$
52,984
184.7
%
Operating Revenues increased $109.1 million, primarily due to a 71.1% increase in the price per pound of PVC pipe sold. As discussed above, sale prices have rapidly increased in 2021 due to the combination of PVC resin supply constraints, which has led to limited PVC pipe inventory, and strong demand for PVC pipe products. Resin supply constraints has impacted our production and sales volumes were down slightly compared to the previous year.
Cost of Products Sold increased $54.2 million primarily due to increased PVC resin and other input costs, which increased 60.3% compared to the same period in the previous year. Increases in labor and freight costs in 2021 also contributed to the increase in cost of products sold.
Other Operating Expenses increased $1.5 million as a result of an increase in variable costs associated with increased financial results in 2021.
CORPORATE COSTS
The following table summarizes Corporate operating results for the nine months ended September 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Other Operating Expenses
$
7,028
$
7,638
$
(610)
(8.0)
%
Depreciation and Amortization
179
256
(77)
(30.1)
Operating Loss
$
7,207
$
7,894
$
(687)
(8.7)
%
Other Operating Expenses decreased $0.6 million due to net decreases in corporate overhead and operating costs.
REGULATORY RATE MATTERS
The following provides a summary of general rate case filings, rate rider filings and other regulatory filings that have or are expected to have a material impact on our operating results, financial position or cash flows.
GENERAL RATES
Minnesota Rate Case: On November 2, 2020, OTP filed a request with the MPUC for an increase in revenue recoverable through base rates in Minnesota. In its filing, OTP requested a net increase in annual revenue of approximately $14.5 million, or 6.77%, based on an allowed rate of return on rate base of 7.59% and an allowed rate of return on equity of 10.20% on an equity ratio of 52.5% of total capital. Through this proceeding, OTP has proposed changes to the mechanism of cost recovery, with some costs moving from riders into base rates and fuel, purchased power, and conservation program costs moving out of base rates and into riders. The filing also included a revenue decoupling mechanism proposal. Such mechanisms are designed to separate a utility's revenue from changes in energy sales. The decoupling mechanism uses a tracker balance through which authorized customer margins are subject to a true-up mechanism to maintain or cap a given level of revenues.
On December 3, 2020, the MPUC approved an interim annual rate increase of $6.9 million, or 3.2%, effective January 1, 2021. This approval was provided after an alternative recovery proposal was submitted by OTP, which, among other changes, requested the extension of depreciable lives of certain wind-related assets and deferred certain cost recovery decisions to the final rate determination. In the aggregate, this alternative recovery proposal reduced operating costs and delayed recovery of certain other costs by approximately $7.0 million to lessen the interim rate impact on customers.
In a filing submitted to the MPUC on April 30, 2021, OTP lowered its requested net annual revenue increase from its initial request of $14.5 million to $8.2 million, primarily due to a reduction in operating costs from amounts included in its November 2020 filing. The cost reductions include, among other items, lower depreciation expense on our wind generation assets due to the extension of depreciable lives from 25 to 35 years and a reduction in postretirement benefit costs.
On September 20, 2021, the Administrative Law Judge assigned to our rate case issued his recommendations to the MPUC, and the MPUC is expected to hold deliberations in early November with a written order expected to be issued by the end of January 2022. We anticipate final rates will be implemented by mid-2022.
The following table includes a summary of pending and recently concluded rate rider proceedings:
Recovery
Filing
Amount
Effective
Mechanism
Jurisdiction
Status
Date
(in millions)
Date
Notes
RRR
2019
MN
Approved
06/21/19
$
12.5
01/01/20
Includes return on Merricourt construction costs.
TCR
2018
MN
Approved
05/07/20
10.3
01/21/20
See below for additional details.
EUIC
2021
MN
Requested
06/07/21
1.3
01/01/22
Includes recovery of new infrastructure costs, including advanced metering, outage management and demand response systems.
RRR
2021
ND
Approved
03/07/21
11.8
04/01/21
Includes return on Merricourt construction costs.
GCR
2020
ND
Approved
06/10/20
6.2
07/01/20
Includes return on Astoria Station construction costs.
TCR
2022
ND
Requested
09/15/21
6.1
01/01/22
Includes recovery of three new transmission projects/programs.
RRR
2020
ND
Approved
03/18/20
5.8
04/01/20
Includes return on Merricourt construction costs.
TCR
2020
ND
Approved
08/31/20
5.6
01/21/20
Includes recovery of new transmission assets.
TCR
2021
ND
Approved
11/18/20
5.6
01/01/21
Includes recovery of eight new transmission projects.
GCR
2021
ND
Approved
03/01/21
5.2
07/01/21
Includes recovery of Astoria Station, net of anticipated savings associated with the retirement of Hoot Lake Plant.
TCR
2020
SD
Approved
01/29/20
2.3
03/02/20
Annual update to transmission cost recovery rider.
TCR
2021
SD
Approved
02/19/21
2.2
03/01/21
Includes recovery of two new transmission projects.
PIR
2020
SD
Approved
05/31/20
1.6
09/01/20
Includes return on Merricourt and Astoria Station construction costs.
Minnesota TCR. On May 1, 2017, the MPUC ordered OTP to include in the TCR rider retail rate base the Minnesota jurisdictional share of OTP's investments in certain transmission assets and all revenues received from other utilities under MISO's tariffed rates as a credit in its TCR revenue requirement calculations. The order had the effect of diverting interstate wholesale revenues that have been approved by the FERC to offset the FERC-approved expenses, effectively reducing OTP's recovery of FERC-approved expense levels.
On August 18, 2017, OTP filed an appeal of the MPUC order with the Minnesota Court of Appeals to contest the portion of the order requiring OTP to jurisdictionally allocate costs of the FERC transmission projects in the TCR rider. On June 11, 2018, the Minnesota Court of Appeals reversed the MPUC's order. On July 11, 2018, the MPUC filed a petition for review of the decision to the Minnesota Supreme Court, which granted review of the appellate court decision. The Minnesota Supreme Court issued its opinion on April 22, 2020, concluding the MPUC lacked authority to amend an existing TCR rider approved under Minnesota state law to include the costs and revenues associated with these transmission projects and affirming the decision of the Minnesota Court of Appeals.
On October 22, 2020, the MPUC approved OTP's request for a Minnesota TCR rider update with the exclusion of these transmission projects. In addition, the MPUC approved the inclusion of three new projects previously requested in the Minnesota TCR rider eligibility petition. Updated rates went into effect in January 2021. With this decision, one-half of the projected TCR rider tracker balance at December 2020 of $13.4 million will be included in the 2021 TCR rider annual revenue requirement, with the remainder included in the next annual update. The annual updates provide for recovery of approximately $2.6 million in MISO revenues credits to Minnesota customers through the TCR rider prior to September 30, 2020. As a result, OTP recognized additional rider revenue of $2.6 million during the third quarter of 2020.
INTEGRATED RESOURCE PLAN
Minnesota law requires utilities to submit to the MPUC for approval a 15-year advance IRP. A resource plan is a set of resource options a utility could use to meet the service needs of its customers over a forecast period, including an explanation of the utility’s supply and demand circumstances, and the extent to which each resource option would be used to meet those service needs. Typically, the filings are submitted every two years.
On September 1, 2021, OTP filed its 2022 IRP concurrently with regulators in the three states where OTP operates, Minnesota, North Dakota and South Dakota. The 2022 IRP includes OTP’s preferred plan for meeting customers’ anticipated capacity and energy needs while maintaining system reliability and low electric service rates.
The components of OTP's preferred plan include:
–the addition of dual fuel capability at our Astoria Station natural gas plant, allowing for the plant to burn fuel oil in addition to natural gas;
–the addition of 150 megawatts of solar generation in 2025;
–the addition of 100 megawatts of wind generation in 2027;
–the commencement of the process of withdrawing from our 35 percent ownership interest in Coyote Station, a jointly owned, coal-fired generation plant, by December 31, 2028; and
–the addition of 50 megawatts of solar generation in 2033.
The 2022 IRP requests approval for certain activities planned to commence within the next five years, which include the addition of dual fuel capacity at our Astoria Station natural gas plant, the addition of 150 megawatts of solar generation, and the withdrawal from our ownership interest in Coyote Station.
The preferred plan proposes to, subject to regulatory approval, create a regulatory asset as a vehicle to recover costs related to the future withdrawal from Coyote Station, including the net book value of the plant on the withdrawal date, anticipated decommissioning costs, and any costs incurred if a termination of the existing lignite sales agreement under which Coyote Station acquires all of its lignite coal fuel from a nearby mine is necessary. For its economic analysis, OTP developed an estimate of the reasonably foreseeable costs of withdrawing from Coyote Station at the end of 2028 of $68.5 million. These costs may differ from actual results due to the uncertainty and timing of future events associated with the terms and conditions of a withdrawal.
LIQUIDITY
LIQUIDITY OVERVIEW
We believe our financial condition is strong and our cash, other liquid assets, operating cash flows, existing lines of credit, access to capital markets, and borrowing ability because of investment-grade credit ratings, when taken together, provide us ample liquidity to conduct our business operations and fund our capital expenditure plans. Our liquidity, including our operating cash flows and access to capital markets, can be impacted by macroeconomic factors outside of our control, such as those which may be caused by COVID-19. In addition, our liquidity could be impacted by non-compliance with covenants under our various debt instruments. As of September 30, 2021, we were in compliance with all debt covenants (see the Financial Covenants section under Capital Resources below).
The following table presents the status of our lines of credit as of September 30, 2021 and December 31, 2020:
2021
2020
(in thousands)
Line Limit
Amount Outstanding
Letters of Credit
Amount Available
Amount Available
OTC Credit Agreement
$
170,000
$
36,624
$
—
$
133,376
$
104,834
OTP Credit Agreement
170,000
61,233
13,159
95,608
140,068
Total
$
340,000
$
97,857
$
13,159
$
228,984
$
244,902
We have an internal risk tolerance metric to maintain a minimum of $50 million of liquidity under the OTC Credit Agreement. Should additional liquidity be needed, this agreement includes an accordion feature allowing us to increase the amount available to $290 million, subject to certain terms and conditions. The OTP Credit Agreement also includes an accordion feature allowing OTP to increase that facility to $250 million, subject to certain terms and conditions.
CASH FLOWS
The following is a discussion of our cash flows for the nine months ended September 30, 2021 and 2020:
(in thousands)
2021
2020
Net Cash Provided by Operating Activities
$
154,752
$
141,276
Net Cash Provided by Operating Activities increased $13.5 million for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020. The increase in cash provided by operating activities was the result of increased earnings during the year, which was partially offset by increased working capital needs. Our level of working capital increased year over year, and was impacted by increased accounts receivables within our Manufacturing and Plastics segments, due to strong sales volumes and significantly increased sales prices in 2021, and higher inventory levels within our Manufacturing segment due to higher production volumes and increased material costs in 2021, but partially offset by increased accounts payable due to higher production volumes and increased costs in our Manufacturing and Plastics segments in 2021. We made a discretionary contribution to our pension plan of $10.0 million in the nine months ended September 30, 2021 compared to a contribution of $11.2 million in 2020.
(in thousands)
2021
2020
Net Cash Used in Investing Activities
$
117,084
$
222,385
Net Cash Used in Investing Activities decreased $105.3 million for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020. The decrease is primarily the result of lower capital investment within our Electric segment as capital spending on our large generation assets, Merricourt and Astoria Station, occurred throughout 2020 and was largely completed by the fourth quarter of 2020.
Net Cash (Used in) Provided by Financing Activities
$
(37,559)
$
104,814
Net Cash (Used in) Provided by Financing Activities decreased $142.4 million for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020, primarily as a result of a decrease in financing needs given the lower level of capital spending in our Electric segment in 2021 compared to 2020. Financing activities in the nine months ended September 30, 2021 included a net borrowing increase of $16.9 million under our line of credit facilities and dividend payments of $48.6 million ($1.17 per share).
Financing activities in the nine months ended September 30, 2020 included proceeds of $75.0 million from the issuance of long-term debt, a net borrowing increase of $42.6 million under our line of credit facilities and $34.8 million in proceeds raised from the issuance of common stock, net of issuance costs. We paid dividends of $45.1 million ($1.11 per share) in the nine months ended September 30, 2020.
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, regulatory changes, business expansion opportunities, the costs of labor, materials and equipment and our financial condition.
Our 2022 IRP, filed with the MPUC on September 1, 2021, outlined our preferred plan for meeting our electric customers’ anticipated energy needs while maintaining system reliability, which included significant planned additions and enhancements to our electric fleet of assets. The following provides a summary of the actual capital expenditures for the year ended December 31, 2020, and the anticipated capital expenditures for the period 2021 through 2026, for our Electric segment, inclusive of the additions outlined in our 2022 IRP, and our non-electric businesses:
(in millions)
2020
2021(1)
2022
2023
2024
2025
2026
Total 2022 - 2026
Electric Segment:
Renewables and Natural Gas Generation
23
30
80
92
92
160
454
Technology and Infrastructure
2
26
30
18
—
—
74
Distribution Plant Replacements
31
37
35
35
35
33
175
Transmission (includes replacements)
27
26
28
24
20
27
125
Other
34
30
29
32
36
23
150
Total Electric Segment
$
357
$
117
$
149
$
202
$
201
$
183
$
243
$
978
Manufacturing and Plastics Segments
15
36
33
46
31
21
22
153
Total Capital Expenditures
$
372
$
153
$
182
$
248
$
232
$
204
$
265
$
1,131
Total Electric Utility Average Rate Base
$
1,385
$
1,570
$
1,630
$
1,750
$
1,860
$
1,980
$
2,100
Annual Rate Base Growth
13.4
%
3.8
%
7.4
%
6.3
%
6.5
%
6.1
%
(1)Includes actual results for the nine months ended September 30, 2021, and anticipated capital expenditures for the fourth quarter of 2021.
CONTRACTUAL OBLIGATIONS
Our contractual obligations primarily include principal and interest payments due under our outstanding debt obligations, commitments to acquire coal, energy and capacity commitments, payments to meet our postretirement benefit obligations, and payment obligations under land easement and leasing arrangements. Our contractual obligations as of December 31, 2020 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, 2020. There were no material changes in our contractual obligations outside of the ordinary course of our business during the nine months ended September 30, 2021.
COMMON STOCK DIVIDENDS
We paid dividends to our common stockholders totaling $48.6 million, or $1.17 per share, in the first nine months of 2021. The determination of the amount of future cash dividends to be paid will depend on, among other things, our financial condition, improvement in earnings per share, cash flows from operations, the level of our capital expenditures and our future business prospects. As a result of certain statutory limitations or regulatory or financing agreements, restrictions could occur on the amount of distributions allowed to be made by our subsidiaries. See Note 10 to our consolidated financial statements included in this Quarterly Report on Form 10-Q for additional information. The decision to declare a dividend is reviewed quarterly by our Board of Directors.
Financial flexibility is provided by operating cash flows, unused lines of credit, and access to capital markets, which is aided by strong financial coverages and investment grade credit ratings. Equity or debt financing will be required in the period 2021 through 2025 to support our capital investments, primarily within our Electric segment to fund construction of new rate base and transmission investments. In addition, we may issue equity or debt financing to opportunistically reduce borrowings under our lines of credit, to satisfy or early retire our outstanding long-term debt, or to finance potential acquisition opportunities or for other corporate purposes.
REGISTRATION STATEMENTS
On May 3, 2021, we filed two registration statements with the SEC. The first statement, a shelf registration, allows us to offer for sale, from time to time, either separately or together in any combination, equity, debt or other securities described in the registration statement. The second registration statement allows for the issuance of up to 1,500,000 common shares under our Automatic Dividend Reinvestment and Share Purchase Plan, which provides our common shareholders, retail customers of OTP and other interested investors a method of purchasing our common shares by reinvesting their dividends and/or making optional cash investments. Shares purchased under the plan may be new issue common shares or common shares purchased on the open market. Both registration statements expire in May 2024.
SHORT-TERM DEBT
Otter Tail Corporation and Otter Tail Power Company are each party to a credit agreement (the OTC Credit Agreement and OTP Credit Agreement, respectively) which each provide for unsecured revolving lines of credit. On September 30, 2021, Otter Tail Corporation entered into a Fourth Amended and Restated Credit Agreement and Otter Tail Power Company entered into a Third Amended and Restated Credit Agreement, amending and restating the previously existing credit agreements to extend the maturity date of each agreement to September 30, 2026. The borrowing capacity and other significant terms of the agreements remained unchanged from the previous credit agreements. The following is a summary of key provisions and borrowing information as of, and for the nine months ended, September 30, 2021:
(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 September 30, 2021
—
13,159
Amount Outstanding as of September 30, 2021
36,624
61,233
Average Amount Outstanding During the Nine Months Ended September 30, 2021
58,703
51,911
Maximum Amount Outstanding During the Nine Months Ended September 30, 2021
79,718
72,471
Interest Rate as of September 30, 2021
1.59
%
1.33
%
Maturity Date
September 30, 2026
September 30, 2026
1Each facility includes an accordion featuring allowing the borrower to increase the borrowing limit if certain terms and conditions are met.
LONG-TERM DEBT
At September 30, 2021, we had $767.0 million of principal outstanding under long-term debt arrangements. These instruments generally provide for unsecured borrowings at fixed rates of interest with maturities ranging from 2021 to 2050.
On June 10, 2021, OTP entered into a Note Purchase Agreement pursuant to which OTP agreed to issue, in a private placement transaction, $230 million aggregate principal amount of senior unsecured notes. The funding of the notes will occur in two issuances, $140 million in November 2021 and $90 million in May 2022. The issuance of the notes is subject to the satisfaction of certain customary conditions to closing. We intend to use the proceeds of the notes to refinance existing long-term indebtedness, including long-term debt instruments with outstanding principal balances of $140 million and $30 million, which mature in December 2021 and August 2022, respectively, and for general corporate purposes.
Note 6 to our consolidated financial statements included in this Quarterly Report on Form 10-Q includes additional information regarding these short-term and long-term debt instruments.
Financial Covenants
Certain of our short- and long-debt agreements require Otter Tail Corporation and OTP to maintain certain financial covenants. As of September 30, 2021, we were in compliance with these financial covenants as further described below:
Otter Tail Corporation under its financial covenants, may not permit its ratio of interest-bearing debt to total capitalization to exceed 0.60 to 1.00, may not permit its interest and dividend coverage ratio to be less than 1.50 to 1.00, and may not permit its priority indebtedness to exceed 10% of our total capitalization. As of September 30, 2021, our interest-bearing debt to total capitalization was 0.47 to 1.00, our interest and dividend coverage ratio was 5.73 to 1.00, and we had no priority indebtedness outstanding.
OTP under its financial covenants, may not permit its ratio of debt to total capitalization to exceed 0.60 to 1.00, may not permit its interest and dividend coverage ratio to be less than 1.50 to 1.00, and may not permit its priority debt to exceed 20% of its total capitalization. As of September 30, 2021, OTP's interest-bearing debt to total capitalization was 0.47 to 1.00, its interest and dividend coverage ratio was 3.16 to 1.00, and OTP had no priority indebtedness outstanding.
As of September 30, 2021 we have outstanding letters of credit totaling $16.9 million, a portion of which reduces our borrowing capacity under our lines of credit. No outstanding letters of credit are reflected in outstanding short-term debt on our consolidated balance sheets. We do not have any other off-balance-sheet arrangements or any relationships with unconsolidated entities or financial partnerships. These entities are often referred to as structured finance special purpose entities or variable interest entities, which are established for the purpose of facilitating off-balance-sheet arrangements or for other contractually narrow or limited purposes. We are not exposed to any financing, liquidity, market or credit risk that could arise if we had such relationships.
The discussion and analysis of our results of operations are based on financial statements prepared in accordance with accounting principles generally accepted in the United States of America. Certain of our accounting policies require management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities in the preparation of our consolidated financial statements. We have disclosed in our Annual Report on Form 10-K for the year ended December 31, 2020 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, 2020.
ITEM 4.
CONTROLS AND PROCEDURES
Evaluation of Disclosures 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 September 30, 2021, 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 September 30, 2021.
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 September 30, 2021 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 Rate Matters.
ITEM 1A.
RISK FACTORS
There have been no material changes from the risk factors disclosed in Item 1A, Risk Factors, of our Annual Report on Form 10-K for the year ended December 31, 2020.
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)
