☒Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 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:
41,539,334CommonShares ($5 par value) asof July 30, 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
kW
kiloWatt
SEC
Securities and Exchange Commission
kwh
kilowatt-hour
T.O. Plastics
T.O. Plastics, Inc.
Merricourt
Merricourt Wind Energy Center
TCR
Transmission Cost Recovery Rider
MISO
Midcontinent Independent System Operator, Inc.
Vinyltech
Vinyltech Corporation
FORWARD-LOOKING INFORMATION
This 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, 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, 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 six months ended June 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 six months ended June 30, 2021 and 2020 are as follows:
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2021
2020
2021
2020
Operating Revenue1
Electric
$
106,155
$
98,130
$
229,855
$
218,000
Manufacturing
84,284
45,947
160,107
114,427
Plastics
95,169
48,679
157,356
95,076
Total
$
285,608
$
192,756
$
547,318
$
427,503
Net Income (Loss)
Electric
$
15,433
$
13,306
$
33,019
$
29,488
Manufacturing
5,705
238
11,089
5,165
Plastics
22,544
5,130
31,692
10,579
Corporate
(1,613)
(1,693)
(3,402)
(3,983)
Total
$
42,069
$
16,981
$
72,398
$
41,249
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 June 30, 2021 and December 31, 2020:
(in thousands)
June 30, 2021
December 31, 2020
Identifiable Assets
Electric
$
2,259,896
$
2,233,399
Manufacturing
220,896
191,005
Plastics
136,604
99,767
Corporate
54,191
54,183
Total
$
2,671,587
$
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 six months ended June 30, 2021 and 2020:
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2021
2020
2021
2020
Operating Revenues
Electric Segment
Retail: Residential
$
28,709
$
27,862
$
66,176
$
63,705
Retail: Commercial and Industrial
58,390
55,914
124,811
124,853
Retail: Other
1,888
1,777
3,706
3,598
Total Retail
88,987
85,553
194,693
192,156
Transmission
11,840
9,673
23,785
20,514
Wholesale
3,260
765
7,767
1,641
Other
2,068
2,139
3,610
3,689
Total Electric Segment
106,155
98,130
229,855
218,000
Manufacturing Segment
Metal Parts and Tooling
71,013
37,266
133,686
94,478
Plastic Products and Tooling
10,131
7,840
20,426
17,723
Scrap Metal Sales
3,140
841
5,995
2,226
Total Manufacturing Segment
84,284
45,947
160,107
114,427
Plastics Segment
PVC Pipe
95,169
48,679
157,356
95,076
Total Operating Revenue
285,608
192,756
547,318
427,503
Less: Noncontract Revenues Included Above
Electric Segment - ARP Revenues
(1,782)
209
(2,757)
122
Total Operating Revenues from Contracts with Customers
$
287,390
$
192,547
$
550,075
$
427,381
4. Select Balance Sheet Information
Receivables and Allowance for Credit Losses
Receivables as of June 30, 2021 and December 31, 2020 are as follows:
The following is a summary of activity in the allowance for credit losses for the six months ended June 30, 2021 and 2020:
(in thousands)
2021
2020
Beginning Balance, January 1
$
3,215
$
1,339
Additions Charged to Expense
284
1,371
Reductions for Amounts Written-Off, Net of Recoveries
(773)
(655)
Ending Balance, June 30
$
2,726
$
2,055
Inventories
Inventories consist of the following as of June 30, 2021 and December 31, 2020:
(in thousands)
June 30, 2021
December 31, 2020
Finished Goods
$
21,272
$
22,046
Work in Process
24,140
16,210
Raw Material, Fuel and Supplies
57,612
53,909
Total Inventories
$
103,024
$
92,165
Investments
The following is a summary of our investments as of June 30, 2021 and December 31, 2020:
(in thousands)
June 30, 2021
December 31, 2020
Corporate-Owned Life Insurance Policies
$
39,492
$
36,825
Debt Securities
9,227
9,260
Money Market Funds
1,861
4,075
Mutual Funds
5,201
1,662
Other Investments
28
34
Total Investments
$
55,809
$
51,856
The amount of unrealized gains and losses on debt securities as of June 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 June 30, 2021 and December 31, 2020 are not material.
Property, Plant and Equipment
Major classes of property, plant and equipment as of June 30, 2021 and December 31, 2020 include:
(in thousands)
June 30, 2021
December 31, 2020
Electric Plant in Service
Electric Plant in Service
$
2,699,352
$
2,531,352
Construction Work in Progress
87,676
203,078
Total Gross Electric Plant
2,787,028
2,734,430
Less Accumulated Depreciation and Amortization
811,134
778,988
Net Electric Plant
1,975,894
1,955,442
Nonelectric Property, Plant and Equipment
Nonelectric Property, Plant and Equipment in Service
261,065
258,730
Construction Work in Progress
12,936
9,290
Total Gross Nonelectric Property, Plant and Equipment
The following presents our current and long-term regulatory assets and liabilities as of June 30, 2021 and December 31, 2020 and the period we expect to recover or refund such amounts:
Period of
June 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
$
141,668
$
11,037
$
146,071
Alternative Revenue Program Riders2
Up to 3 years
6,505
8,982
8,871
9,373
Asset Retirement Obligations1
Asset lives
—
6,696
—
8,462
ISO Cost Recovery Trackers1
Up to 2 years
539
724
1,079
867
Unrecovered Project Costs1
Up to 3 years
4,114
1,492
361
2,989
Deferred Rate Case Expenses1
Various
888
110
360
230
Debt Reacquisition Premiums1
Up to 12 years
167
263
192
341
Other1
Various
—
83
—
62
Total Regulatory Assets
$
23,250
$
160,018
$
21,900
$
168,395
Regulatory Liabilities
Deferred Income Taxes
Asset lives
$
—
$
131,893
$
—
$
134,719
Plant Removal Obligations
Asset lives
5,556
96,164
—
98,707
Fuel Clause Adjustments
Up to 1 year
6,531
—
10,947
—
Alternative Revenue Program Riders
Various
3,094
1,761
3,581
470
Pension and Other Postretirement Benefit Plans
Up to 1 year
1,959
—
1,959
—
Other
Various
161
1,948
176
77
Total Regulatory Liabilities
$
17,301
$
231,766
$
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 June 30, 2021 and December 31, 2020:
Short-Term Debt
The following is a summary of our lines of credit as of June 30, 2021 and December 31, 2020:
June 30, 2021
December 31, 2020
(in thousands)
Line Limit
Amount Outstanding
Letters of Credit
Amount Available
Amount Available
OTC Credit Agreement
$
170,000
$
59,245
$
—
$
110,755
$
104,834
OTP Credit Agreement
170,000
68,712
12,671
88,617
140,068
Total
$
340,000
$
127,957
$
12,671
$
199,372
$
244,902
Both credit agreements are in place until October 31, 2024.
The following is a summary of outstanding long-term debt by borrower as of June 30, 2021 and December 31, 2020:
(in thousands)
Entity
Debt Instrument
Rate
Maturity
June 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
139,963
140,087
Unamortized Long-Term Debt Issuance Costs
2,497
2,650
Total Long-Term Debt Net of Unamortized Debt Issuance Costs
$
624,540
$
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 in aggregate principal amount of its 2.74% Series 2021A Senior Unsecured Notes due November 29, 2031, (b) $100 million in aggregate principal amount of its 3.69% Series 2021B Senior Unsecured Notes due November 29, 2051 and (c) $90 million in aggregate principal amount of its 3.77% Series 2022A Senior Unsecured Notes due May 20, 2052. As of June 30, 2021, there were no amounts outstanding. The funding of the notes will occur in two issuances, $140.0 million in November 2021 and $90.0 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 of 0.60 to 1.00, a minimum interest and dividend coverage ratio of 1.50 to 1.00, and a maximum level of priority indebtedness. As of June 30, 2021, OTC and OTP were in compliance with these financial covenants.
7. Pension Plan and Other Postretirement Benefits
Pension Plan
Components of net periodic pension benefit cost for the three and six months ended June 30, 2021 and 2020 are as follows:
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2021
2020
2021
2020
Service Cost–Benefit Earned During the Period
$
1,865
$
1,656
$
3,731
$
3,311
Interest Cost on Projected Benefit Obligation
2,915
3,263
5,830
6,526
Expected Return on Assets
(5,589)
(5,505)
(11,179)
(11,010)
Amortization of Net Actuarial Loss:
From Regulatory Asset
2,661
2,231
5,321
4,462
From Other Comprehensive Income
68
55
136
110
Net Periodic Pension Cost
$
1,920
$
1,700
$
3,839
$
3,399
Wehad no minimum funding requirement as of December 31, 2020 but made a discretionary plan contribution of $10.0 million in January 2021.
Executive Survivor and Supplemental Retirement Plan (ESSRP)
Components of net periodic pension benefit cost for the three and six months ended June 30, 2021 and 2020 are as follows:
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2021
2020
2021
2020
Service Cost–Benefit Earned During the Period
$
46
$
44
$
93
$
89
Interest Cost on Projected Benefit Obligation
307
362
614
724
Amortization of Net Actuarial Loss:
From Regulatory Asset
31
24
62
47
From Other Comprehensive Income
125
85
249
171
Net Periodic Pension Cost
$
509
$
515
$
1,018
$
1,031
Other Postretirement Benefits
Components of net periodic postretirement benefit cost for the three and six months ended June 30, 2021 and 2020 are as follows:
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2021
2020
2021
2020
Service Cost–Benefit Earned During the Period
$
431
$
462
$
861
$
924
Interest Cost on Projected Benefit Obligation
473
599
946
1,197
Amortization of Prior Service Cost
From Regulatory Asset
(1,398)
(1,170)
(2,795)
(2,339)
From Other Comprehensive Income
(36)
(29)
(72)
(58)
Amortization of Net Actuarial Loss
From Regulatory Asset
920
1,052
1,840
2,103
From Other Comprehensive Income
24
26
47
52
Net Periodic Postretirement Benefit Cost
$
414
$
940
$
827
$
1,879
8. Income Taxes
The reconciliation of the statutory federal income tax rate to our effective tax rate for each of the three and six months ended June 30, 2021 and 2020 is as follows:
Three Months Ended June 30,
Six Months Ended June 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)
(6.3)
—
(6.8)
—
Amortization of Excess Deferred Income Taxes
(2.0)
(3.4)
(2.4)
(3.8)
North Dakota Wind Tax Credit Amortization, Net of Federal Tax
(0.3)
(1.2)
(0.3)
(1.0)
Excess Tax Deduction on Stock Awards
—
(0.6)
—
(1.0)
Allowance for Equity Funds Used During Construction
(0.1)
(0.8)
(0.1)
(1.0)
Other, Net
(0.8)
(1.7)
(0.6)
(0.6)
Effective Tax Rate
16.5
%
18.3
%
15.8
%
18.6
%
We began generating PTCs from our Merricourt wind farm placed in service in the fourth quarter of 2020. No PTCs were generated during the six months ended June 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. T.O. Plastics is party to a resin supply agreement under which it must purchase all of a specified class of regrind resin delivered by the supplier at a periodically negotiated price per pound. The agreement expires in 2026.
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 $3.5 million as of June 30, 2021. This refund liability reflects our best estimate of required refunds to customers once all regulatory and judicial proceedings are finalized.
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, with state implementation plans targeted for submission to the EPA by July 31, 2021. States are required 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. We cannot predict with certainty the impact the state implementation plan may have on our business until the plan is finalized and adopted. 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 a required early retirement of, or the sale of our interest in, Coyote Station. 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. The arbitration was delayed through an effort to seek dispensation of the matter through the courts and through dispositive motions. The arbitration hearing is anticipated to be held in late 2021.
Other Contingencies. We are party to litigation and regulatory matters arising in the normal course of business. We regularly analyze relevant information and, as necessary, estimate and record accrued liabilities for legal, regulatory enforcement and other matters in which a loss is probable of occurring and can be reasonably estimated. We believe the effect on our consolidated operating results, financial position and cash flows, if any, for the disposition of all matters pending as of June 30, 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 June 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 June 30, 2021, OTP’s equity-to-total-capitalization ratio including short-term debt was 52.1% and its net assets restricted from distribution totaled approximately $682.0 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 $1.3 million and $1.2 million for the three months ended June 30, 2021 and 2020, respectively, and $5.5 million and $4.0 million for the six months ended June 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 six months ended June 30, 2021:
Shares
Weighted Average Grant-Date Fair Value
Nonvested, January 1, 2021
128,664
$
44.30
Granted
57,650
43.10
Vested
(46,371)
43.04
Forfeited
(1,577)
40.77
Nonvested, June 30, 2021
138,366
$
44.26
The fair value of vested awards was $2.1 million and $2.8 million during the six months ended June 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 six months ended June 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 six months ended June 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, June 30, 2021
189,600
$
42.54
The fair value of vested awards was $2.5 million and $3.4 million during the six months ended June 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 six months ended June 30, 2021 and 2020:
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2021
2020
2021
2020
Weighted Average Common Shares Outstanding – Basic
41,500
40,513
41,478
40,365
Effect of Dilutive Securities:
Stock Performance Awards
223
97
183
112
Stock Awards
75
47
80
56
Employee Stock Purchase Plan Shares and Other
20
20
18
28
Dilutive Effect of Potential Common Shares
318
164
281
196
Weighted Average Common Shares Outstanding – Diluted
41,818
40,677
41,759
40,561
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 six months ended June 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 June 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 June 30, 2021, the fair value of these contracts was $1.9 million, which is included in other current assets on the consolidated balance sheets.
The following tables present our assets measured at fair value on a recurring basis as of June 30, 2021 and December 31, 2020 classified by the input method used to measure fair value:
Level 1
Level 2
Level 3
June 30, 2021
Investments:
Money Market Funds
$
1,861
$
—
$
—
Mutual Funds
5,201
—
—
Corporate Debt Securities
—
2,393
—
Government-Backed and Government-Sponsored Enterprises’ Debt Securities
—
6,835
—
Derivative Instruments
—
1,879
—
Total Assets
$
7,062
$
11,107
$
—
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 June 30, 2021 and December 31, 2020:
June 30, 2021
December 31, 2020
(in thousands)
Carrying Amount
Fair Value
Carrying Amount
Fair Value
Cash and Cash Equivalents
$
1,480
$
1,480
$
1,163
$
1,163
Short-Term Debt
(127,957)
(127,957)
(80,997)
(80,997)
Long-Term Debt
(764,503)
(875,405)
(764,519)
(858,455)
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 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. Our Electric segment business provides a critical service to our customers and our manufacturing businesses provide products and support to critical infrastructure industries. We continue to operate our businesses in a manner that is safe for our employees and our customers.
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 concerns of 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 second 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 could impact our business and our financial results in future periods. We continue to monitor developments involving our workforce, customers, construction contractors, suppliers and vendors and the financial effects on our business. However, due to the unprecedented and evolving nature of this pandemic, we cannot predict the full extent of the impact COVID-19 will have on our operating results, financial condition and liquidity.
RESOURCE MATERIAL AVAILABILITY AND PRICING
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 have arisen primarily due to steel mill capacity reductions in 2020 in response to lower steel demand due to COVID-19. Resin shortages 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. Production and availability of steel and resin have begun to improve as steel mill and resin production facilities increase their capacities, but we anticipate supply constraints to persist through 2021. These supply shortages have led to significantly increased prices for steel and resin and limited our production capabilities.
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 increased costs. We anticipate increased steel prices will continue throughout the remainder of 2021 but begin to subside in 2022.
The increase in resin prices, along with low pipe inventories and robust domestic and global demand, have led to rapidly increased sales prices for PVC pipe within our Plastics segment. The increase in sale prices for PVC pipe has outpaced the increase in resin cost increases, leading to expanding gross profit margins and a significant increase in net earnings in our Plastics segment. We anticipate these market dynamics will continue throughout the remainder of 2021 but begin to subside in 2022. Accordingly, we do not anticipate Plastics segment earnings in 2022 to remain at current levels given the unique market dynamics present this year.
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 June 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Operating Revenues
$
285,608
$
192,756
$
92,852
48.2
%
Operating Expenses
225,786
164,847
60,939
37.0
Operating Income
59,822
27,909
31,913
114.3
Interest Charges
9,555
8,662
893
10.3
Nonservice Cost Components of Postretirement Benefits
624
868
(244)
(28.1)
Other Income
734
2,410
(1,676)
(69.5)
Income Before Income Taxes
50,377
20,789
29,588
142.3
Income Tax Expense
8,308
3,808
4,500
118.2
Net Income
$
42,069
$
16,981
$
25,088
147.7
%
Operating Revenues increased $92.9 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. Retail, transmission services and wholesale revenues within our Electric segment also contributed to higher operating revenues in the second 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 $60.9 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. 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 $0.9 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 $1.7 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. Also contributing to the decrease in other income was lower market-based gains on our corporate-owned life insurance policies and other investments in the second quarter of 2021 compared to the same period of 2020.
Income Tax Expense increased $4.5 million primarily due to increased income before income taxes. Our effective tax rate was 16.5% in the second quarter of 2021 and 18.3% in the second quarter of 2020. The decrease in our effective tax rate was driven by PTCs earned in the second 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 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 June 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Retail Revenues
$
88,987
$
85,553
$
3,434
4.0
%
Transmission Services Revenues
11,840
9,673
2,167
22.4
Wholesale Revenues
3,260
765
2,495
326.1
Other Electric Revenues
2,068
2,162
(94)
(4.3)
Total Operating Revenue
106,155
98,153
8,002
8.2
Production Fuel
12,164
8,788
3,376
38.4
Purchased Power
11,135
13,682
(2,547)
(18.6)
Operating and Maintenance Expenses
36,729
33,179
3,550
10.7
Depreciation and Amortization
18,153
15,740
2,413
15.3
Property Taxes
4,342
4,168
174
4.2
Operating Income
$
23,632
$
22,596
$
1,036
4.6
%
2021
2020
change
% change
Electric kilowatt-hour (kwh) Sales(in thousands)
Retail kwh Sales
1,086,631
1,033,053
53,578
5.2
%
Wholesale kwh Sales – Company Generation
104,151
42,140
62,011
147.2
Heating Degree Days
533
635
(102)
(16.1)
Cooling Degree Days
237
170
67
39.4
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 June 30, 2021 and 2020.
2021
2020
Heating Degree Days
101.1
%
122.1
%
Cooling Degree Days
206.1
%
156.0
%
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.
Retail Revenues increased $3.4 million primarily due to the following:
•A $1.5 million increase in new retail revenues 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 $1.5 million increase in retail revenue from commercial and industrial customers primarily due to increased demand as volumes improve from 2020, which was negatively impacted by COVID-19.
•A $1.4 million increase in revenues primarily related to the recovery of Merricourt and Astoria Station project costs and operating expenses.
•Recovery of increased conservation improvement program expenditures as well as increased transmission rider revenues.
These increases in revenue were partially offset by a $2.1 million decrease in fuel recovery revenues largely due to credits provided to customers from increased margins on wholesale sales.
Transmission Services Revenues increased $2.2 million primarily due to higher transmission volume from increased electrical demand as well as increased generator interconnection revenues.
Wholesale Revenues increased $2.5 million as a result of a 147.2% increase in wholesale sales volumes and a 72.4% increase in wholesale prices driven by high market demand for wholesale energy.
Production Fuel costsincreased $3.4 million mainly as a result of a 42.0% 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 $2.5 million primarily due to a 15.7% decrease in the volume of purchased power as our recent capacity additions provide additional generation resources to serve customer demand.
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 second quarter of 2021 as these facilities are now commercially operational.
•A $0.8 million increase in transmission tariff expenses.
•Other additional expenses including an increase in conservation improvement program expenditures, which are recovered through retail rates, increased vegetative maintenance expenses and plant maintenance expenses.
These expense increases were partially offset by, among other items, lower bad debt expense due to improving customer collections as the economic impact of COVID-19 has eased.
Depreciation and Amortization expense increased $2.4 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 June 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Operating Revenues
$
84,284
$
45,948
$
38,336
83.4
%
Cost of Products Sold
62,725
36,087
26,638
73.8
Other Operating Expenses
9,735
5,499
4,236
77.0
Depreciation and Amortization
3,844
3,739
105
2.8
Operating Income
$
7,980
$
623
$
7,357
n/m
Operating Revenues increased $38.3 million primarily from increased sales volumes at BTD. BTD experienced a 52.4% increase in sales volumes and $12.0 million increase in material costs, which are passed through to customers through increased sales prices. Sales volumes in the second quarter of 2020 were negatively impacted by COVID-19 as customers implemented temporary plant shutdowns due to the pandemic. Sales volumes in the second quarter of 2021 have rebounded as customer demand across all end markets has been robust. The increase in material costs are largely the result of historically high steel prices due to supply shortages as steel mill capacity rebounds from COVID-19 related capacity reductions in 2020. We anticipate steel prices will remain elevated for the remainder of 2021. Also contributing to the improved financial performance was an increase in scrap revenues primarily due to increased scrap metal prices but also higher volumes, and improved gross profit margins resulting from an increase in production volumes. Increased horticultural product sales at T.O. Plastics in 2021, driven by increasing customer demand, also contributed to increased operating revenues in 2021 as compared to 2020.
Cost of Products Sold increased $26.6 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 increase in sales volumes and production activity in 2021 has led to improved gross profit margins despite the higher labor and freight costs due to increased leveraging of fixed production costs. 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 $4.2 million in the second quarter of 2021 compared to 2020. Other operating expenses in the second quarter of 2020 were reduced by approximately $2.3 million as a result of initiatives taken to reduce operating costs to mitigate the impact of declining sales volumes from the effects of COVID-19. Other operating expenses in 2021 were impacted by increased incentive based compensation resulting from the improvement in segment financial results, and an increase in costs necessary to meet the increase in business volumes.
The following table summarizes Plastics segment operating results for the three months ended June 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Operating Revenues
$
95,169
$
48,679
$
46,490
95.5
%
Cost of Products Sold
59,853
37,747
22,106
58.6
Other Operating Expenses
3,674
2,970
704
23.7
Depreciation and Amortization
1,112
872
240
27.5
Operating Income
$
30,530
$
7,090
$
23,440
330.6
%
Operating Revenues increased $46.5 million due to a 73.9% increase in the price per pound of PVC pipe sold and a 12.4% increase in sales volumes. Sales prices of PVC pipe have rapidly escalated primarily due to continued PVC resin supply constraints as resin production facilities recover from plant shutdowns in the first quarter of 2021. The undersupply of resin has led to limited pipe inventories across the country. In addition, significant global demand for PVC resin has also impacted domestic selling prices. We anticipate sales prices will remain elevated through the end of 2021 as resin suppliers work to fulfill purchase allotments and pipe manufacturers replenish depleted inventories while customer demand remains strong. Sales volumes in the second quarter of 2020 were negatively impacted by COVID-19 as distributors reduced inventory levels due to the uncertainty over the impact of the pandemic.
Cost of Products Sold increased $22.1 million primarily due to increased PVC resin costs as described above. The 12.4% increase in sales volumes in 2021 also contributed to the increase in cost of products sold.
Other Operating Expenses increased $0.7 million primarily as a result of increased incentive based compensation cost directly related to increased segment profitability.
CORPORATE COSTS
The following table summarizes Corporate operating results for the three months ended June 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Other Operating Expenses
$
2,260
$
2,315
$
(55)
(2.4)
%
Depreciation and Amortization
60
85
(25)
(29.4)
Operating Loss
$
2,320
$
2,400
$
(80)
(3.3)
%
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 six months ended June 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Operating Revenues
$
547,318
$
427,503
$
119,815
28.0
%
Operating Expenses
443,297
360,305
82,992
23.0
Operating Income
104,021
67,198
36,823
54.8
Interest Charges
18,953
16,785
2,168
12.9
Nonservice Cost Components of Postretirement Benefits
1,006
1,739
(733)
(42.2)
Other Income
1,892
2,021
(129)
(6.4)
Income Before Income Taxes
85,954
50,695
35,259
69.6
Income Tax Expense
13,556
9,446
4,110
43.5
Net Income
$
72,398
$
41,249
$
31,149
75.5
%
Operating Revenues increased $119.8 million primarily due to higher PVC pipe prices and sales volumes within our Plastics segment and increased volumes and material costs, leading to higher sales prices, in our Manufacturing segment. Retail, transmission services and wholesale revenue with 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 $83.0 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 $2.2 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 $0.7 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 $0.1 million in 2021 due to a $1.6 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 largely offset by increases in the values of corporate-owned life insurance policies and other investments in 2021 compared to 2020.
Income Tax Expense increased $4.1 million in 2021 primarily due to increased income before income taxes. Our effective tax rate was 15.8% in 2021 and 18.6% 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.
ELECTRIC SEGMENT RESULTS
The following table summarizes Electric segment operating results for the six months ended June 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Retail Revenues
$
194,693
$
192,156
$
2,537
1.3
%
Transmission Services Revenues
23,785
20,514
3,271
15.9
Wholesale Revenues
7,767
1,641
6,126
373.3
Other Electric Revenues
3,610
3,718
(108)
(2.9)
Total Operating Revenue
229,855
218,029
11,826
5.4
Production Fuel
26,878
22,523
4,355
19.3
Purchased Power
30,395
32,512
(2,117)
(6.5)
Operating and Maintenance Expenses
78,150
73,794
4,356
5.9
Depreciation and Amortization
35,461
31,416
4,045
12.9
Property Taxes
8,662
8,268
394
4.8
Operating Income
$
50,309
$
49,516
$
793
1.6
%
Electric kilowatt-hour (kwh) Sales(in thousands)
Retail kwh Sales
2,435,150
2,462,963
(27,813)
(1.1)
%
Wholesale kwh Sales – Company Generation
184,574
81,064
103,510
127.7
Heating Degree Days
3,611
3,907
(296)
(7.6)
Cooling Degree Days
237
170
67
39.4
The operating results of our Electric segment are impacted by fluctuations in weather conditions and the resulting demand for electricity for heating and cooling. The following table shows heating and cooling degree days as a percent of normal for the six months ended June 30, 2021 and 2020.
2021
2020
Heating Degree Days
91.0
%
99.1
%
Cooling Degree Days
206.1
%
156.0
%
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
$
—
$
(0.01)
$
0.01
Retail Revenues increased $2.5 million primarily due to the following:
•A $3.7 million increase in new retail revenues 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 $3.0 million increase in rider revenues primarily related to the recovery of Merricourt operating expenses and Astoria Station project costs.
•A $1.5 million increase in rider revenue for the recovery of increased conservation improvement program spending.
These increases in revenue were partially offset by the following:
•A $3.5 million decrease in fuel recovery revenues largely due to credits provided to customers from increased margins on wholesale sales.
•A $2.2 million decrease in retail revenues from lower demand, including a $0.7 million impact from milder weather in 2021 compared with 2020. Retail sales volumes were lower in the first quarter of 2021 as compared to the first quarter of 2020 due to the ongoing impacts of COVID-19.
Transmission Services Revenues increased $3.3 million primarily due to increased transmission volume from increasing electrical demand as well as increased generator interconnection revenues.
Wholesale Revenues increased $6.1 million as a result of a 127.7% increase in wholesale sales volumes and a 107.9% increase in wholesale electric prices, primarily driven by high market demand and availability constraints during February of 2021, which drove up spot market prices for electricity.
Production Fuel costsincreased $4.4 million primarily as a result of a 25.4% 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 $2.1 million mainly due to a 17.5% decrease in the volume of purchased power as our recent capacity additions provide additional generation resources to serve customer demand.
Operating and Maintenance Expense increased $4.4 million, which was primarily the result of:
•$2.6 million of Merricourt and Astoria Station operating and maintenance expenses incurred in 2021 as these facilities are now commercially operational.
•A $1.5 million increase in conservation improvement program expenditures, which are recovered through retail rates.
•Other additional costs including a $1.0 million increase in transmission tariff expenses and increased compensation and insurance costs.
These expense increases were partially offset by, among other items, lower bad debt expense due to improving customer collections as the economic impact of COVID-19 has eased.
Depreciation and Amortization expense increased $4.0 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 six months ended June 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Operating Revenues
$
160,107
$
114,427
$
45,680
39.9
%
Cost of Products Sold
119,036
86,701
32,335
37.3
Other Operating Expenses
17,946
12,777
5,169
40.5
Depreciation and Amortization
7,601
7,485
116
1.5
Operating Income
$
15,524
$
7,464
$
8,060
108.0
%
Operating Revenues increased $45.7 million primarily due to higher revenues at BTD, which was largely driven by a 21.7% increase in sales volumes and a $16.4 million increase in material costs, which are passed through to customers through increased sales prices. Sales volumes in the second quarter of 2021 were impacted by strong end market demand in most markets served after recovering from significantly lower volumes in the second quarter of 2020 due to the effects of the COVID-19 pandemic. 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. An increase in horticultural product sales at T.O. Plastics in 2021, driven by increasing customer demand, has also contributed to increased operating revenues in 2021.
Cost of Products Sold increased $32.3 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. Gross profit margins have improved in 2021, despite the higher labor and freight costs, as higher production activities 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.
Other Operating Expenses increased $5.2 million in 2021 compared to 2020. Other operating expenses in 2020 were reduced by $2.5 million as a result of 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 increased 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 six months ended June 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Operating Revenues
$
157,356
$
95,076
$
62,280
65.5
%
Cost of Products Sold
105,519
73,017
32,502
44.5
Other Operating Expenses
6,619
5,740
879
15.3
Depreciation and Amortization
2,102
1,762
340
19.3
Operating Income
$
43,116
$
14,557
$
28,559
196.2
%
Operating Revenues increased $62.3 million due to a 54.8% increase in the price per pound of PVC pipe sold and a 6.9% increase in sales volumes. As discussed above, sale prices have rapidly increased in 2021 principally due to PVC resin supply constraints following production plant shutdowns and feedstock shortages arising from abnormally low temperatures and ice storms in the Gulf Coast region of the United States in February 2021. Resin supply shortages have led to limited pipe inventories across the country. Increased global demand for PVC resin has also contributed to rising domestic prices. Sales volumes in the second quarter of 2020 were negatively impacted by COVID-19 as distributors reduced inventory levels due to the uncertainty over the impact of the pandemic.
Cost of Products Sold increased $32.5 million primarily due to increased PVC resin costs as described above. The 6.9% increase in sales volumes in 2021 also contributed to the increase in cost of products sold.
Other Operating Expenses increased $0.9 million largely due to increased incentive based compensation costs resulting from increased segment operating results.
CORPORATE COSTS
The following table summarizes Corporate operating results for the six months ended June 30, 2021 and 2020:
(in thousands)
2021
2020
$ change
% change
Other Operating Expenses
$
4,797
$
4,167
$
630
15.1
%
Depreciation and Amortization
131
172
(41)
(23.8)
Operating Loss
$
4,928
$
4,339
$
589
13.6
%
Other Operating Expenses increased $0.6 million primarily due to increased incentive based compensation cost as a result of increased consolidated earnings.
REGULATORY RATE MATTERS
The following provides a summary of general rate case filings and rate rider 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 under general 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 in 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.
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.
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.
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 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 June 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 June 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
$
59,245
$
—
$
110,755
$
104,834
OTP Credit Agreement
170,000
68,712
12,671
88,617
140,068
Total
$
340,000
$
127,957
$
12,671
$
199,372
$
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 six months ended June 30, 2021 and 2020:
(in thousands)
2021
2020
Net Cash Provided by Operating Activities
$
68,574
$
73,901
Net Cash Provided by Operating Activities decreased $5.3 million for the six months ended June 30, 2021 compared to the six months ended June 30, 2020. An increase in net income in 2021 was more than offset by an increase in working capital requirements. Our level of working capital 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 six months ended June 30, 2021 compared to a contribution of $11.2 million in 2020.
(in thousands)
2021
2020
Net Cash Used in Investing Activities
$
76,403
$
121,005
Net Cash Used in Investing Activities decreased $44.6 million for the six months ended June 30, 2021 compared to the six months ended June 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, were largely completed in the fourth quarter of 2020.
(in thousands)
2021
2020
Net Cash Provided by Financing Activities
$
8,146
$
65,417
Net Cash Provided by Financing Activities decreased $57.3 million for the six months ended June 30, 2021 compared to the six months ended June 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 six months ended June 30, 2021 included a net borrowing increase of $47.0 million under our line of credit facilities and dividend payments of $32.4 million ($0.78 per share).
Financing activities in the six months ended June 30, 2020 included proceeds of $35.0 million from the issuance of long-term debt, a net borrowing increase of $35.2 million under our line of credit facilities and $26.9 million in proceeds raised from the issuance of common stock, net of issuance costs. We paid dividends of $29.9 million ($0.74 per share) in the six months ended June 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 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. Refer to Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, of our Form 10-K for the year ended December 31, 2020 for our capital expenditure plan for the five year period from 2021 through 2025.
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 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 six months ended June 30, 2021.
COMMON STOCK DIVIDENDS
We paid dividends to our common stockholders totaling $32.4 million, or $0.78 per share, in the first six 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 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 provide for unsecured revolving lines of credit. The following is a summary of key provisions and borrowing information as of and for the six months ended June 30, 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 June 30, 2021
—
12,671
Amount Outstanding as of June 30, 2021
59,245
68,712
Average Amount Outstanding During the Six Months Ended June 30, 2021
67,335
49,017
Maximum Amount Outstanding During the Six Months Ended June 30, 2021
79,718
72,471
Interest Rate as of June 30, 2021
1.6
%
1.3
%
Maturity Date
October 31, 2024
October 31, 2024
1Each facility includes an accordion featuring allowing the borrower to increase the borrowing limit if certain terms and conditions are met.
Note 6 to our consolidated financial statements included in this report on Form 10-Q includes additional information regarding these instruments.
LONG-TERM DEBT
At June 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 OTP’s senior unsecured notes. The funding of the notes will occur in two issuances, $140.0 million in November 2021 and $90.0 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 $30.0 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 report on Form 10-Q includes additional information regarding these instruments.
Financial Covenants
Certain of our short- and long-debt agreements require Otter Tail Corporation and OTP to maintain certain financial covenants. As of June 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 June 30, 2021, our Interest-Bearing Debt to Total Capitalization was 0.49 to 1.00, our Interest and Dividend Coverage Ratio was 5.35 to 1.00 and we had no Priority Indebtedness outstanding.
OTP under its financial covenants, may not permit its ratio of Debt to Total Capitalization to exceed 0.60 to 1.00, may not permit its Interest and Dividend Coverage Ratio to be less than 1.50 to 1.00, and may not permit its Priority Debt to exceed 20% of its Total Capitalization. As of June 30, 2021, OTP's Interest-Bearing Debt to Total Capitalization was 0.48 to 1.00, its Interest and Dividend Coverage Ratio was 3.44 to 1.00 and it had no Priority Indebtedness outstanding.
As of June 30, 2021 we have outstanding letters of credit totaling $16.4 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 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 June 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 June 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 June 30, 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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.
ITEM 6.
EXHIBITS
The following Exhibits are filed as part of, or incorporated by reference into, this report.
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)