☒Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2022 or
☐Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number 0-53713
OTTER TAIL CORPORATION
(Exact name of registrant as specified in its charter)
Minnesota
(State or other jurisdiction of incorporation or organization)
27-0383995
(I.R.S. Employer Identification No.)
215 South Cascade Street, Box 496, Fergus Falls,Minnesota
(Address of principal executive offices)
56538-0496
(Zip Code)
Registrant's telephone number, including area code: 866-410-8780
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Shares, par value $5.00 per share
OTTR
The Nasdaq Stock Market LLC
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes☑No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes☑No☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer☑
Accelerated Filer☐
Non-Accelerated Filer☐
Smaller Reporting Company☐
Emerging Growth Company☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes☐No☑
Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date:
41,630,952CommonShares ($5 par value) asof October 25, 2022.
The following abbreviations or acronyms are used in the text.
AGI
Advanced Grid Infrastructure Rider
OTC
Otter Tail Corporation
ARP
Alternative Revenue Program
OTP
Otter Tail Power Company
BTD
BTD Manufacturing, Inc.
NDDEQ
North Dakota Department of Environmental Quality
CIP
Conservation Improvement Program
PIR
Phase-In Rider
EAR
Energy Adjustment Rider
PSLRA
Private Securities Litigation Reform Act of 1995
EPA
Environmental Protection Agency
PTC
Production Tax Credits
ESSRP
Executive Survivor and Supplemental Retirement Plan
PVC
Polyvinyl chloride
FERC
Federal Energy Regulatory Commission
RHR
Regional Haze Rule
GCR
Generation Cost Recovery Rider
ROE
Return on equity
ISO
Independent System Operator
RRR
Renewable Resource Rider
IRP
Integrated Resource Plan
SEC
Securities and Exchange Commission
kwh
kilowatt-hour
SOFR
Secured Overnight Funds Rate
Merricourt
Merricourt Wind Energy Center
T.O. Plastics
T.O. Plastics, Inc.
MISO
Midcontinent Independent System Operator, Inc.
TCR
Transmission Cost Recovery Rider
MPUC
Minnesota Public Utilities Commission
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 "PSLRA"). When used in this Form 10-Q and in future filings by Otter Tail Corporation (the "Company") with the Securities and Exchange Commission (SEC), in the Company’s press releases and in oral statements, words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” "future," "goal," “intend,” "likely," “may,” “outlook,” “plan,” “possible,” “potential,” "probable," "projected," “should,” "target," “will,” “would” or similar expressions are intended to identify forward-looking statements within the meaning of the PSLRA. 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, inflation rates, 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 SEC, 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 (OTC) and its subsidiaries (collectively, the "Company", "us", "our" or "we") form a diverse, multi-platform business consisting of a vertically integrated, regulated utility with generation, transmission and distribution facilities complemented by manufacturing businesses providing metal fabrication for custom machine parts and metal components, manufacturing of extruded and thermoformed plastic products, and manufacturing of polyvinyl chloride (PVC) pipe products. We classify our business into three segments: Electric, Manufacturing and Plastics.
Basis of Presentation
The unaudited consolidated financial statements included herein have been prepared pursuant to the rules and regulations of the SEC for interim reporting. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles. In the opinion of management, we have included all adjustments, including normal recurring accruals, necessary for a fair presentation of the consolidated financial statements for the periods presented. The consolidated financial statements and condensed notes thereto should be read in conjunction with the consolidated financial statements and notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021.
Because of the seasonality of our businesses and other factors, the earnings for the three and nine months ended September 30, 2022 should not be taken as an indication of earnings for all or any part of the balance of the current year or as an indication of earnings for future years.
Use of Estimates
We use estimates based on the best information available in recording transactions and balances resulting from business operations. As better information becomes available or actual amounts are known, the recorded estimates are revised. Consequently, operating results can be affected by revisions to prior accounting estimates.
Reclassifications
Certain reclassifications of amounts previously reported have been made to the accompanying consolidated statements of shareholders' equity and consolidated statements of cash flows to maintain consistency and comparability between periods presented. The reclassifications had no impact on previously reported shareholders' equity, net cash provided by operating activities, net cash used in investing activities, net cash used in financing activities, or cash and cash equivalents.
2. Segment Information
We classify our business into three segments, Electric, Manufacturing and Plastics, consistent with our business strategy, organizational structure and our internal reporting and review processes used by our chief operating decision maker to make decisions regarding allocation of resources, to assess operating performance and to make strategic decisions.
Certain assets and costs are not allocated to our operating segments. Corporate operating costs include items such as corporate staff and overhead costs, the results of our captive insurance company and other items excluded from the measurement of operating segment performance. Corporate assets consist primarily of cash and cash equivalents, prepaid expenses, investments and fixed assets. Corporate is not an operating segment, rather it is added to operating segment totals to reconcile to consolidated amounts.
Information for each segment and our unallocated corporate costs for the three and nine months ended September 30, 2022 and 2021 are as follows:
The following provides the identifiable assets by segment and corporate assets as of September 30, 2022 and December 31, 2021:
(in thousands)
September 30, 2022
December 31, 2021
Identifiable Assets
Electric
$
2,347,461
$
2,283,776
Manufacturing
253,819
251,044
Plastics
179,925
162,565
Corporate
116,699
57,445
Total
$
2,897,904
$
2,754,830
3. Revenue
Presented below are our operating revenues to external customers, in total and by amounts arising from contracts with customers and alternative revenue program (ARP) arrangements, disaggregated by revenue source and segment for the three and nine months ended September 30, 2022 and 2021:
Three Months Ended September 30,
Nine Months Ended September 30,
(in thousands)
2022
2021
2022
2021
Operating Revenues
Electric Segment
Retail: Residential
$
35,122
$
33,902
$
108,883
$
100,067
Retail: Commercial and Industrial
83,022
60,557
232,532
185,376
Retail: Other
2,033
1,979
6,004
5,687
Total Retail
120,177
96,438
347,419
291,130
Transmission
13,156
13,300
37,409
37,085
Wholesale
7,196
6,944
13,196
14,711
Other
2,218
2,093
6,088
5,703
Total Electric Segment
142,747
118,775
404,112
348,629
Manufacturing Segment
Metal Parts and Tooling
84,054
76,455
261,923
210,141
Plastic Products and Tooling
12,723
10,198
36,584
30,624
Scrap Metal Sales
1,990
3,324
8,414
9,320
Total Manufacturing Segment
98,767
89,977
306,921
250,085
Plastics Segment
PVC Pipe
142,342
107,542
447,767
264,898
Total Operating Revenue
383,856
316,294
1,158,800
863,612
Less: Non-contract Revenues Included Above
Electric Segment - ARP Revenues
(548)
(33)
(7,937)
(2,790)
Total Operating Revenues from Contracts with Customers
$
384,404
$
316,327
$
1,166,737
$
866,402
4. Select Balance Sheet Information
Receivables and Allowance for Credit Losses
Receivables as of September 30, 2022 and December 31, 2021 are as follows:
The following is a summary of activity in the allowance for credit losses for the nine months ended September 30, 2022 and 2021:
(in thousands)
2022
2021
Beginning Balance, January 1
$
1,836
$
3,215
Additions Charged to Expense
518
177
Reductions for Amounts Written Off, Net of Recoveries
(806)
(1,060)
Ending Balance, September 30
$
1,548
$
2,332
Inventories
Inventories consist of the following as of September 30, 2022 and December 31, 2021:
(in thousands)
September 30, 2022
December 31, 2021
Raw Material, Fuel and Supplies
$
74,249
$
72,882
Work in Process
33,765
35,705
Finished Goods
38,362
39,903
Total Inventories
$
146,376
$
148,490
Investments
The following is a summary of our investments as of September 30, 2022 and December 31, 2021:
(in thousands)
September 30, 2022
December 31, 2021
Corporate-Owned Life Insurance Policies
$
37,288
$
41,078
Debt Securities
8,710
9,202
Money Market Funds
1,854
949
Mutual Funds
5,084
5,432
Other Investments
30
29
Total Investments
$
52,966
$
56,690
The amount of unrealized gains and losses on debt securities as of September 30, 2022 and December 31, 2021 was not material and no unrealized losses were deemed to be other-than-temporary. In addition, the amount of unrealized gains and losses on marketable equity securities still held as of September 30, 2022 and December 31, 2021 was not material.
Property, Plant and Equipment
Major classes of property, plant and equipment as of September 30, 2022 and December 31, 2021 include:
(in thousands)
September 30, 2022
December 31, 2021
Electric Plant
Electric Plant in Service
$
2,795,649
$
2,758,445
Construction Work in Progress
130,486
74,926
Total Gross Electric Plant
2,926,135
2,833,371
Less Accumulated Depreciation and Amortization
850,741
817,302
Net Electric Plant
2,075,394
2,016,069
Nonelectric Property, Plant and Equipment
Nonelectric Property, Plant and Equipment in Service
281,584
273,950
Construction Work in Progress
20,746
16,611
Total Gross Nonelectric Property, Plant and Equipment
The following presents our current and long-term regulatory assets and liabilities as of September 30, 2022 and December 31, 2021 and the period we expect to recover or refund such amounts:
Period of
September 30, 2022
December 31, 2021
(in thousands)
Recovery/Refund
Current
Long-Term
Current
Long Term
Regulatory Assets
Pension and Other Postretirement Benefit Plans1
Various
$
7,791
$
110,183
$
7,791
$
114,961
Alternative Revenue Program Riders2
Up to 2 years
7,528
1,988
11,889
5,564
Asset Retirement Obligations1
Asset lives
—
1,323
—
742
ISO Cost Recovery Trackers1
Up to 2 years
660
740
—
1,342
Unrecovered Project Costs1
Up to 5 years
320
1,063
2,136
1,455
Deferred Rate Case Expenses1
Various
412
848
607
1,131
Debt Reacquisition Premiums1
10 years
25
222
100
240
Fuel Clause Adjustments1
Up to 1 year
13,185
—
4,819
—
Other1
Various
—
226
—
73
Total Regulatory Assets
$
29,921
$
116,593
$
27,342
$
125,508
Regulatory Liabilities
Deferred Income Taxes
Asset lives
$
—
$
128,397
$
—
$
129,437
Plant Removal Obligations
Asset lives
8,526
106,008
8,306
101,595
Fuel Clause Adjustments
Up to 1 year
—
—
1,554
—
Alternative Revenue Program Riders
Various
4,178
6,048
5,772
3,336
Pension and Other Postretirement Benefit Plans
Up to 1 year
2,603
—
2,603
—
Derivative Instruments
Various
5,532
—
6,214
—
Other
Various
275
92
395
62
Total Regulatory Liabilities
$
21,114
$
240,545
$
24,844
$
234,430
1Costs subject to recovery without a rate of return.
2Amount eligible for recovery includes an incentive or rate of return.
Minnesota Rate Case
On November 2, 2020, Otter Tail Power Company (OTP) filed an initial request with the Minnesota Public Utilities Commission (MPUC) for an increase in revenue recoverable through base rates in Minnesota, and on December 3, 2020, the MPUC approved an interim annual rate increase of $6.9 million, or 3.2%, effective January 1, 2021.
On February 1, 2022, the MPUC issued its written order on final rates. The key provisions of the order included a revenue requirement of $209.0 million, based on a return on rate base of 7.18% and an allowed return on equity of 9.48% on an equity ratio of 52.5%. The order also authorized recovery of our remaining Hoot Lake Plant net asset over a five-year period and approved the requested decoupling mechanism for most residential and commercial customer rate groups with a cap of 4% of annual base revenues.
On May 12, 2022, OTP's final rate case compliance filing was approved by the MPUC. The filing included final revenue calculations, rate design and resulting tariff revisions, along with a determination of the interim rate refund, which resulted in an increase in revenues during the second quarter of 2022 of $4.1 million. Final rates took effect on July 1, 2022, and interim rate refunds of $15.3 million were applied to customer accounts in the third quarter of 2022.
6. Short-Term and Long-Term Borrowings
The following is a summary of our outstanding short- and long-term borrowings by borrower, OTC or OTP, as of September 30, 2022 and December 31, 2021:
The following is a summary of our lines of credit as of September 30, 2022 and December 31, 2021:
September 30, 2022
December 31, 2021
(in thousands)
Borrowing Limit
Amount Outstanding
Letters of Credit
Amount Available
Amount Available
OTC Credit Agreement
$
170,000
$
—
$
—
$
170,000
$
147,363
OTP Credit Agreement
170,000
—
9,919
160,081
88,315
Total
$
340,000
$
—
$
9,919
$
330,081
$
235,678
On October 31, 2022, OTC entered into a Fifth Amended and Restated Credit Agreement and OTP entered into a Fourth Amended and Restated Credit Agreement, in each case amending and restating the previously existing credit agreements to extend the maturity date of each credit facility from September 30, 2026 to October 29, 2027, and to replace LIBOR as a benchmark interest rate with the Secured Overnight Finance Rate (SOFR). The adoption of SOFR as a benchmark interest rate is in advance of the scheduled elimination of LIBOR as a benchmark interest rate on June 30, 2023. No other significant terms or conditions, including borrowing capacity, credit spreads or financial covenants, were modified under these amendments and restatements.
Long-Term Debt
The following is a summary of outstanding long-term debt by borrower as of September 30, 2022 and December 31, 2021:
(in thousands)
Borrower
Debt Instrument
Rate
Maturity
September 30, 2022
December 31, 2021
OTC
Guaranteed Senior Notes
3.55%
12/15/26
$
80,000
$
80,000
OTP
Series 2007B Senior Unsecured Notes
6.15%
08/20/22
—
30,000
OTP
Series 2007C Senior Unsecured Notes
6.37%
08/02/27
42,000
42,000
OTP
Series 2013A Senior Unsecured Notes
4.68%
02/27/29
60,000
60,000
OTP
Series 2019A Senior Unsecured Notes
3.07%
10/10/29
10,000
10,000
OTP
Series 2020A Senior Unsecured Notes
3.22%
02/25/30
10,000
10,000
OTP
Series 2020B Senior Unsecured Notes
3.22%
08/20/30
40,000
40,000
OTP
Series 2021A Senior Unsecured Notes
2.74%
11/29/31
40,000
40,000
OTP
Series 2007D Senior Unsecured Notes
6.47%
08/20/37
50,000
50,000
OTP
Series 2019B Senior Unsecured Notes
3.52%
10/10/39
26,000
26,000
OTP
Series 2020C Senior Unsecured Notes
3.62%
02/25/40
10,000
10,000
OTP
Series 2013B Senior Unsecured Notes
5.47%
02/27/44
90,000
90,000
OTP
Series 2018A Senior Unsecured Notes
4.07%
02/07/48
100,000
100,000
OTP
Series 2019C Senior Unsecured Notes
3.82%
10/10/49
64,000
64,000
OTP
Series 2020D Senior Unsecured Notes
3.92%
02/25/50
15,000
15,000
OTP
Series 2021B Senior Unsecured Notes
3.69%
11/29/51
100,000
100,000
OTP
Series 2022A Senior Unsecured Notes
3.77%
05/20/52
90,000
—
Total
$
827,000
$
767,000
Less:
Current Maturities, Net of Unamortized Debt Issuance Costs
—
29,983
Unamortized Long-Term Debt Issuance Costs
3,240
3,003
Total Long-Term Debt, Net of Unamortized Debt Issuance Costs
$
823,760
$
734,014
On June 10, 2021, OTP entered into a Note Purchase Agreement pursuant to which OTP agreed to issue, in a private placement transaction, $230.0 million of senior unsecured notes consisting of (a) $40.0 million of 2.74% Series 2021A Senior Unsecured Notes due November 29, 2031, (b) $100.0 million of 3.69% Series 2021B Senior Unsecured Notes due November 29, 2051 and (c) $90.0 million of 3.77% Series 2022A Senior Unsecured Notes due May 20, 2052. In November 2021, OTP issued its Series 2021A and Series 2021B Notes for aggregate proceeds of $140.0 million, which were used to repay the Series 2011A Notes in full. In May 2022, OTP issued its Series 2022A Notes for proceeds of $90.0 million, which were used to repay the Series 2007B Senior Unsecured Notes at their maturity in August 2022, to repay short-term borrowings, to fund capital expenditures, and for other general corporate purposes.
Financial Covenants
Certain of OTC's and OTP's short- and long-term debt agreements require the borrower, whether OTC or OTP, to maintain certain financial covenants, including a maximum debt to total capitalization ratio of 0.60 to 1.00, a minimum interest and dividend coverage ratio of 1.50 to 1.00, and a maximum level of priority indebtedness. As of September 30, 2022, OTC and OTP were in compliance with these financial covenants.
The Company sponsors a noncontributory funded pension plan (the "Pension Plan"), an unfunded, nonqualified Executive Survivor and Supplemental Retirement Plan (the "ESSRP"), both accounted for as defined benefit pension plans, and a postretirement healthcare plan accounted for as an other postretirement benefit plan.
The following tables include the components of net periodic benefit cost of our defined benefit pension plans and other postretirement benefits for the three and nine months ended September 30, 2022 and 2021:
Three Months Ended September 30,
Pension Benefits (Pension Plan)
Pension Benefits (ESSRP)
Postretirement Benefits
(in thousands)
2022
2021
2022
2021
2022
2021
Service Cost
$
1,644
$
1,866
$
48
$
47
$
335
$
430
Interest Cost
3,086
2,915
335
307
510
472
Expected Return on Assets
(5,921)
(5,590)
—
—
—
—
Amortization of Prior Service Cost
—
—
—
—
(1,433)
(1,432)
Amortization of Net Actuarial Loss
1,966
2,728
141
154
765
943
Net Periodic Benefit Cost
$
775
$
1,919
$
524
$
508
$
177
$
413
Nine Months Ended September 30,
Pension Benefits (Pension Plan)
Pension Benefits (ESSRP)
Postretirement Benefits
(in thousands)
2022
2021
2022
2021
2022
2021
Service Cost
$
4,932
$
5,597
$
146
$
140
$
1,004
$
1,291
Interest Cost
9,258
8,745
1,006
921
1,531
1,418
Expected Return on Assets
(17,763)
(16,769)
—
—
—
—
Amortization of Prior Service Cost
—
—
—
—
(4,300)
(4,299)
Amortization of Net Actuarial Loss
5,899
8,185
425
465
2,297
2,830
Net Periodic Benefit Cost
$
2,326
$
5,758
$
1,577
$
1,526
$
532
$
1,240
The following table includes the impact of regulation on the recognition of periodic benefit cost arising from pension and other postretirement benefits for the three and nine months ended September 30, 2022 and 2021:
Three Months Ended September 30,
Nine Months Ended September 30,
(in thousands)
2022
2021
2022
2021
Net Periodic Benefit Cost
$
1,476
$
2,840
$
4,435
$
8,524
Net Amount Amortized (Deferred) Due to the Effect of Regulation
499
8
823
15
Net Periodic Benefit Cost Recognized
$
1,975
$
2,848
$
5,258
$
8,539
Wehad no minimum funding requirements for our Pension Plan or any other postretirement benefit plans as of December 31, 2021, but made a discretionary contribution of $20.0 million to our Pension Plan in February 2022.
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, 2022 and 2021 is as follows:
Three Months Ended September 30,
Nine Months Ended September 30,
2022
2021
2022
2021
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)
(3.6)
(5.0)
(4.1)
(6.0)
Amortization of Excess Deferred Income Taxes
(0.9)
(1.6)
(0.7)
(2.0)
North Dakota Wind Tax Credit Amortization, Net of Federal Tax
(0.1)
(0.2)
(0.2)
(0.3)
Corporate-Owned Life Insurance
0.2
(0.3)
0.4
(0.6)
Other, Net
(0.5)
(0.6)
0.1
(0.2)
Effective Tax Rate
21.1
%
18.3
%
21.5
%
16.9
%
9. Commitments and Contingencies
Commitments
Ashtabula III Purchase. On June 23, 2022, OTP exercised its option to acquire the Ashtabula III wind farm, a 62.4 megawatt wind farm located in eastern North Dakota, for $49.7 million, subject to certain closing adjustments. Since 2013, OTP has purchased the wind-generated electricity from the Ashtabula III wind farm pursuant to a purchase power agreement, and that agreement granted OTP the option to purchase the wind farm. The purchase has received regulatory approval. We anticipate the transaction will close, subject to certain customary closing conditions, in January 2023.
Contingencies
FERC ROE. In November 2013 and February 2015, customers filed complaints with the Federal Energy Regulatory Commission (FERC) seeking to reduce the return on equity (ROE) component of the transmission rates that Midcontinent Independent System Operator, Inc. (MISO) transmission owners, including OTP, may collect under the MISO tariff rate. FERC's most recent order, issued on November 19, 2020, adopted a revised ROE methodology and set the base ROE at 10.02% (10.52% with an adder) effective for the fifteen-month period from November 2013 to February 2015 and on a prospective basis beginning in September 2016. The order also dismissed any complaints covering the period from February 2015 to May 2016. On August 9, 2022, the U.S. Court of Appeals for the District of Columbia Circuit vacated the FERC order citing a lack of reasoned explanation by FERC in its adoption of its revised ROE methodology as outlined in its November 2020 order. The U.S. Court of Appeals remanded the matter to FERC to reopen the proceedings.
Significant uncertainty exists as to how FERC will proceed upon remand and there is no prescribed timeline under which FERC must act. We have deferred recognition and recorded a refund liability of $2.5 million as of September 30, 2022. This refund liability reflects our best estimate of amounts previously collected from customers under the MISO tariff rate that may be required to be refunded to customers once all regulatory and judicial proceedings are complete and a final ROE is established for the periods outlined above.
Regional Haze Rule (RHR). The RHR was adopted in an effort to improve visibility in national parks and wilderness areas. The RHR requires states, in coordination with the Environmental Protection Agency (EPA) and other governmental agencies, to develop and implement plans to achieve natural visibility conditions. The second RHR implementation period covers the years 2018-2028. States are required to submit a state implementation plan to assess reasonable progress with the RHR and determine what additional emission reductions are appropriate, if any.
Coyote Station, OTP's jointly owned coal-fired power plant in North Dakota, is subject to assessment in the second implementation period under the North Dakota state implementation plan. The North Dakota Department of Environmental Quality (NDDEQ) submitted its state implementation plan to the EPA for approval in August 2022. In its plan, the NDDEQ concluded it is not reasonable to require additional emission controls during this planning period. The EPA has previously expressed disagreement with the NDDEQ's recommendation to forgo additional emission controls and has indicated that such a plan is not likely to be accepted.
We cannot predict with certainty the impact the state implementation plan may have on our business until the state implementation plan has been approved or otherwise acted on by the EPA. However, significant emission control investments could be required and the recovery of such costs from customers would require regulatory approval. Alternatively, investments in emission control equipment may prove to be uneconomic and result in the early retirement of or the sale of our interest in Coyote Station, subject to regulatory approval. We cannot estimate the ultimate financial effects such a retirement or sale may have on our consolidated operating results, financial position or cash flows, but such amounts could be material and the recovery of such costs in rates would be subject to regulatory approval.
Other Contingencies. We are party to litigation and regulatory matters arising in the normal course of business. We regularly analyze relevant information and, as necessary, estimate and record accrued liabilities for legal, regulatory enforcement and other matters in which a loss is probable of occurring and can be reasonably estimated. We believe the effect on our consolidated operating results, financial position and cash flows, if any, for the disposition of all matters pending as of September 30, 2022, other than those discussed above, will not be material.
On May 3, 2021, we filed a shelf registration statement with the SEC under which we may offer for sale, from time to time, either separately or together in any combination, equity, debt or other securities described in the shelf registration statement. No new debt or equity has been issued pursuant to the registration statement. The registration statement expires in May 2024.
On May 3, 2021, we filed a second registration statement with the SEC for the issuance of up to 1,500,000 common shares under an Automatic Dividend Reinvestment and a Share Purchase Plan, which provides shareholders, retail customers of OTP and other interested investors methods of purchasing our common shares, by reinvesting their dividends or making optional cash investments. Shares purchased under the plan may be newly issued common shares or common shares purchased on the open market. During the nine months ended September 30, 2022, we issued 97,046 shares under this plan. We repurchased a sufficient number of shares on the open market to satisfy issuance under the plan; accordingly no proceeds from the issuance were received. As of September 30, 2022, there were 1,287,774 shares available for purchase or issuance under the plan. The registration statement expires in May 2024.
Dividend Restrictions
OTC is a holding company with no significant operations of its own. The primary source of funds for payments of dividends to OTC's shareholders is from dividends paid or distributions made by OTC's subsidiaries. As a result of certain statutory limitations or regulatory or financing agreements, the amount of distributions allowed to be made by OTC's subsidiaries or the amount of dividends paid by OTC could be restricted. Both the OTC Credit Agreement and OTP Credit Agreement contain restrictions on the payment of cash dividends upon a default or event of default, including failure to maintain certain financial covenants. As of September 30, 2022, we were in compliance with these financial covenants.
Under the Federal Power Act, a public utility may not pay dividends from any funds properly included in a capital account. What constitutes “funds properly included in a capital account” is undefined in the Federal Power Act or the related regulations; however, the FERC has consistently interpreted the provision to allow dividends to be paid as long as i) the source of the dividends is clearly disclosed, ii) the dividend is not excessive and iii) there is no self-dealing on the part of corporate officials.
The MPUC indirectly limits the amount of dividends OTP can pay to OTC by requiring an equity-to-total-capitalization ratio between 48.0% and 58.7% based on OTP’s capital structure petition effective by order of the MPUC on January 26, 2022. As of September 30, 2022, OTP’s equity-to-total-capitalization ratio, including short-term debt, was 54.9% and its net assets restricted from distribution totaled approximately $686.6 million. Under the MPUC order, total capitalization for OTP cannot exceed $1.7 billion.
The following shows the changes in accumulated other comprehensive loss for the three and nine months ended September 30, 2022 and 2021:
Three Months Ended September 30,
2022
2021
(in thousands)
Pension and Other Postretirement Benefits
Net Unrealized Gains (Losses) on Available-for-Sale Securities
Total
Pension and Other Postretirement Benefits
Net Unrealized Gains (Losses) on Available-for-Sale Securities
Total
Balance, Beginning of Period
$
(6,621)
$
(292)
$
(6,913)
$
(8,425)
$
134
$
(8,291)
Other Comprehensive Loss Before Reclassifications, net of tax
—
(172)
(172)
—
(26)
(26)
Amounts Reclassified from Accumulated Other Comprehensive Income (Loss)
106
(1)
1
(2)
107
146
(1)
—
(2)
146
Total Other Comprehensive Income (Loss)
106
(171)
(65)
146
(26)
120
Balance, End of Period
$
(6,515)
$
(463)
$
(6,978)
$
(8,279)
$
108
$
(8,171)
Nine Months Ended September 30,
2022
2021
(in thousands)
Pension and Other Postretirement Benefits
Net Unrealized Gains (Losses) on Available-for-Sale Securities
Total
Pension and Other Postretirement Benefits
Net Unrealized Gains (Losses) on Available-for-Sale Securities
Total
Balance, Beginning of Period
$
(6,537)
$
13
$
(6,524)
$
(8,716)
$
209
$
(8,507)
Other Comprehensive Loss Before Reclassifications, net of tax
—
(477)
(477)
—
(58)
(58)
Amounts Reclassified from Accumulated Other Comprehensive Income (Loss)
22
(1)
1
(2)
23
437
(1)
(43)
(2)
394
Total Other Comprehensive Income (Loss)
22
(476)
(454)
437
(101)
336
Balance, End of Period
$
(6,515)
$
(463)
$
(6,978)
$
(8,279)
$
108
$
(8,171)
(1) Included in the computation of net periodic pension and other postretirement benefit costs. See Note 7.
(2) Included in other income (expense), net on the accompanying consolidated statements of income.
12. Share-Based Payments
Stock Compensation Expense
Stock-based compensation expense arising from our employee stock purchase plan and share-based compensation plans, recognized within operating expenses in the consolidated statements of income, amounted to $0.6 million and $0.8 million for the three months ended September 30, 2022 and 2021, respectively, and $6.1 million and $6.4 million for the nine months ended September 30, 2022 and 2021, respectively.
Restricted Stock Awards. We grant restricted stock awards to members of our Board of Directors and restricted stock units to certain key employees. The awards vest, depending on award type and recipient, either ratably over periods of three or four years or cliff vest after four years. Vesting is accelerated in certain circumstances, including on retirement.
The following is a summary of stock award activity for the nine months ended September 30, 2022:
Shares
Weighted Average Grant-Date Fair Value
Nonvested, January 1, 2022
138,093
$
44.48
Granted
51,439
59.96
Vested
(47,981)
45.30
Forfeited
—
—
Nonvested, September 30, 2022
141,551
$
49.83
The fair value of vested awards was $3.0 million and $2.1 million during the nine months ended September 30, 2022 and 2021, respectively.
Stock Performance Awards. Stock performance awards are granted to executive officers and certain other key employees. The awards vest at the end of a three-year performance period. The number of common shares awarded, if any, at the end of the performance period ranges from zero to 150% of the target amount based on two performance measures: i) total shareholder return relative to a peer group and ii) return on equity. Vesting of the awards is accelerated in certain circumstances, including on retirement. The amount of common shares awarded on an accelerated vesting is based either on actual performance at the end of the performance period or the amount of common shares earned at target.
The grant date fair value of stock performance awards granted during the nine months ended September 30, 2022 and 2021 was determined using a Monte Carlo fair value simulation model incorporating the following assumptions:
2022
2021
Risk-free interest rate
1.52
%
0.18
%
Expected term (in years)
3.00
3.00
Expected volatility
32.00
%
32.00
%
Dividend yield
2.90
%
3.60
%
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, 2022 (share amounts reflect awards at target):
Shares
Weighted Average Grant-Date Fair Value
Nonvested, January 1, 2022
189,600
$
42.54
Granted
55,800
54.91
Vested
(55,600)
43.30
Forfeited
—
—
Nonvested, September 30, 2022
189,800
$
45.95
The fair value of vested awards was $5.1 million and $2.5 million during the nine months ended September 30, 2022 and 2021, respectively.
13. Earnings Per Share
The numerator used in the calculation of both basic and diluted earnings per common share is net income. The denominator used in the calculation of basic earnings per common share is the weighted average number of common shares outstanding during the period. The denominator used in the calculation of diluted earnings per common share is derived by adjusting basic shares outstanding for the dilutive effect of potential common shares outstanding, which consist of time and performance based stock awards and employee stock purchase plan shares.
The following includes the computation of the denominator for basic and diluted weighted-average shares outstanding for the three and nine months ended September 30, 2022 and 2021:
Three Months Ended September 30,
Nine Months Ended September 30,
(in thousands)
2022
2021
2022
2021
Weighted Average Common Shares Outstanding – Basic
41,600
41,504
41,582
41,487
Effect of Dilutive Securities:
Stock Performance Awards
276
262
251
209
Restricted Stock Awards
97
88
96
82
Employee Stock Purchase Plan Shares and Other
1
15
1
17
Dilutive Effect of Potential Common Shares
374
365
348
308
Weighted Average Common Shares Outstanding – Diluted
41,974
41,869
41,930
41,795
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, 2022 and 2021.
OTP enters into derivative instruments to manage its exposure to future price variability and reduce volatility in prices for our retail customers. These derivative instruments are not designated as qualifying hedging transactions but provide for an economic hedge against future price variability. The instruments are recorded at fair value on the consolidated balance sheets. In accordance with rate-making and cost recovery processes, we recognize a regulatory asset or liability to defer losses or gains from derivative activity until settlement of the associated derivative instrument.
As of September 30, 2022, OTP had outstanding pay-fixed, receive-variable swap agreements with an aggregate notional amount of 156,800 megawatt-hours of electricity, which will be settled periodically throughout 2022 and 2023. As of September 30, 2022, the fair value of these derivative instruments was $5.4 million, of which $5.5 million is included in other current assets and $0.1 million, which is included in other noncurrent liabilities, on the consolidated balance sheets. As of December 31, 2021, the fair value of these types of derivative contracts was $6.2 million, which is included in other current assets. No contracts settled during the three months ended September 30, 2022. During the nine months ended September 30, 2022, contracts matured and were settled in an aggregate amount of $2.8 million. There were no contracts settled during the three or nine months ended September 30, 2021.
15. Fair Value Measurements
The following tables present our assets and liabilities measured at fair value on a recurring basis as of September 30, 2022 and December 31, 2021 classified by the input method used to measure fair value:
(in thousands)
Level 1
Level 2
Level 3
September 30, 2022
Assets:
Investments:
Money Market Funds
$
1,854
$
—
$
—
Mutual Funds
5,084
—
—
Corporate Debt Securities
—
1,424
—
Government-Backed and Government-Sponsored Enterprises’ Debt Securities
—
7,286
—
Derivative Instruments
—
5,532
—
Total Assets
$
6,938
$
14,242
$
—
Liabilities:
Derivative Instruments
$
—
$
169
$
—
Total Liabilities
$
—
$
169
$
—
December 31, 2021
Assets:
Investments:
Money Market Funds
$
949
$
—
$
—
Mutual Funds
5,432
—
—
Corporate Debt Securities
—
1,333
—
Government-Backed and Government-Sponsored Enterprises’ Debt Securities
—
7,869
—
Derivative Instruments
—
6,214
—
Total Assets
$
6,381
$
15,416
$
—
Level 1 fair value measurements are based on quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access at the measurement date.
The level 2 fair value measurements for government-backed and government-sponsored enterprises and corporate debt securities are determined on the basis of valuations provided by a third-party pricing service which utilizes industry accepted valuation models and observable market inputs to determine valuation. Some valuations or model inputs used by the pricing service may be based on broker quotes.
The level 2 fair value measurements for derivative instruments are determined by using inputs such as forward electric commodity prices, adjusted for location differences. These inputs are observable in the marketplace throughout the full term of the instrument, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace.
In addition to assets recorded at fair value on a recurring basis, we also hold financial instruments that are not recorded at fair value in the consolidated balance sheets but for which disclosure of the fair value of these financial instruments is provided.
The following reflects the carrying value and estimated fair value of these assets and liabilities as of September 30, 2022 and December 31, 2021:
September 30, 2022
December 31, 2021
(in thousands)
Carrying Amount
Fair Value
Carrying Amount
Fair Value
Assets:
Cash and Cash Equivalents
$
72,987
$
72,987
$
1,537
$
1,537
Total
72,987
72,987
1,537
1,537
Liabilities:
Short-Term Debt
—
—
91,163
91,163
Long-Term Debt
823,760
679,360
763,997
878,272
Total
$
823,760
$
679,360
$
855,160
$
969,435
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, 2021.
Otter Tail Corporation and its subsidiaries form a diverse group of businesses with operations classified into three segments: Electric, Manufacturing and Plastics. Our Electric segment business is a vertically integrated, regulated utility with generation, transmission and distribution facilities to serve our customers in western Minnesota, eastern North Dakota and northeastern South Dakota. Our Manufacturing segment provides metal fabrication for custom machine parts and metal components and manufactures extruded and thermoformed plastic products. Our Plastics segment manufactures PVC pipe for use in, among other applications, municipal and rural water, wastewater, and water reclamation projects.
STEEL AVAILABILITY AND PRICING
Steel is a key material input to BTD Manufacturing, Inc. (BTD), our metal fabrication business within our Manufacturing segment. Steel prices increased rapidly throughout 2021, peaking in the fourth quarter at historically high levels. Steel prices have been highly volatile in 2022, but began to steadily decline at the end of the second quarter and continued to decline throughout the third quarter. The increase in steel prices in the first half of 2022 led to increased sale prices for our products at BTD as we passed along material cost increases to our customers. Consistent with steel prices, scrap metal prices also increased throughout 2021 and remained elevated in the first half of 2022, positively impacting our financial results during this period, but began to decline at the end of the second quarter and declined sharply in the third quarter of 2022. We expect steel and scrap metal prices to decline modestly in the fourth quarter of 2022 and be near historical levels by the end of the year.
PVC PIPE SUPPLY AND DEMAND CONDITIONS
PVC resin is the primary material input of the PVC pipe manufactured by our Plastics segment businesses. Resin supply disruptions throughout 2021, along with robust domestic and global demand for PVC resin, led to significantly increased resin prices. Supply disruptions for resin and other additives and ingredients used in the manufacturing process also resulted in reduced manufacturing of PVC pipe and low pipe inventories across the industry. This combination of disrupted raw material supply and the resulting low PVC pipe inventories along with robust demand for PVC pipe led to rapidly increasing sale prices for PVC pipe throughout 2021 and the first half of 2022. The increase in sale prices has outpaced the increase in PVC resin costs, leading to expanding gross profit margins. Beginning in the third quarter of 2022, demand for PVC pipe began to decline as multiple, larger than anticipated, resin price reductions caused PVC pipe distributors and contractors to reduce purchase volumes in an effort to reduce inventory levels.
The unique market dynamics experienced by our Plastics segment businesses in 2021 and thus far in 2022 have resulted in a significant increase in earnings compared to prior periods. We currently expect earnings of our Plastics segment to remain elevated relative to historical levels through the end of 2022 and into 2023, but as the industry supply and demand conditions normalize we expect segment earnings to normalize beginning in 2024.
The marketplace dynamics impacting both our Manufacturing and Plastics segments are fluid and subject to change which may impact our operating results prospectively.
RESULTS OF OPERATIONS – QUARTER TO DATE
Provided below is a summary and discussion of our operating results on a consolidated basis followed by a discussion of the operating results of each of our segments: Electric, Manufacturing and Plastics. In addition to the segment results, we provide an overview of our Corporate costs. Our Corporate costs do not constitute a reportable segment but rather consist of unallocated general corporate expenses, such as corporate staff and overhead costs, the results of our captive insurance company and other items excluded from the measurement of segment performance. Corporate costs are added to operating segment totals to reconcile to totals on our consolidated statements of income.
The following table summarizes consolidated operating results for the three months ended September 30, 2022 and 2021:
(in thousands)
2022
2021
$ change
% change
Operating Revenues
$
383,856
$
316,294
$
67,562
21.4
%
Operating Expenses
267,723
241,766
25,957
10.7
Operating Income
116,133
74,528
41,605
55.8
Interest Charges
9,259
9,648
(389)
(4.0)
Nonservice Cost Components of Postretirement Benefits
(52)
505
(557)
(110.3)
Other Income (Expense)
(174)
203
(377)
(185.7)
Income Before Income Taxes
106,752
64,578
42,174
65.3
Income Tax Expense
22,513
11,824
10,689
90.4
Net Income
$
84,239
$
52,754
$
31,485
59.7
%
Operating Revenues increased $67.6 million primarily due to increases in PVC pipe sale prices within our Plastics segment and increased retail revenues within our Electric segment. PVC pipe sale prices increased due to the unique industry supply and demand dynamics described above. In our Electric segment, increased fuel recovery revenues, driven by higher fuel and purchased power costs, and increased commercial and industrial sales volumes contributed to higher operating revenues. In addition, increased sales volumes resulted in increased operating revenues in our Manufacturing segment. See our segment disclosures below for additional discussion of items impacting operating revenues.
Operating Expenses increased $26.0 million primarily due to increased purchased power and fuel costs in our Electric segment. Operating expenses in our Manufacturing segment increased primarily due to increased sales volumes. These increases were partially offset by a decrease in operating expenses in our Plastics segment, due to lower sales volumes. See our segment disclosures below for additional discussion of items impacting operating expenses.
Interest Charges decreased $0.4 million due to a decrease in the interest rate on our $140.0 million of fixed-rate long-term debt that was refinanced in December 2021, and a lower level of average short-term borrowings outstanding in 2022 compared to 2021.
Nonservice Cost Components of Postretirement Benefits decreased $0.6 million primarily due to the amortization of actuarial gains resulting from the increase in the discount rates used to measure our pension benefit and postretirement benefit liabilities as of December 31, 2021.
Other Income decreased $0.4 million primarily due to investment losses on our corporate-owned life insurance policies and other investments during the third quarter of 2022 compared to investment gains in the same period of the previous year.
Income Tax Expense increased $10.7 million primarily due to increased income before income taxes. Our effective tax rate was 21.1% in the third quarter of 2022 and 18.3% in the third quarter of 2021. The increase in our effective tax rate was driven by an increase in our income before income taxes without a corresponding increase in tax credits and other permanent differences that impact our effective tax rate. See Note 8 to our consolidated financial statements included in this Quarterly Report on Form 10-Q for additional information regarding factors impacting our effective tax rate in 2022 and 2021.
The following table summarizes Electric segment operating results for the three months ended September 30, 2022 and 2021:
(in thousands)
2022
2021
$ change
% change
Retail Revenues
$
120,177
$
96,438
$
23,739
24.6
%
Transmission Services Revenues
13,156
13,300
(144)
(1.1)
Wholesale Revenues
7,196
6,944
252
3.6
Other Electric Revenues
2,218
2,093
125
6.0
Total Operating Revenues
142,747
118,775
23,972
20.2
Production Fuel
24,972
17,698
7,274
41.1
Purchased Power
19,913
9,878
10,035
101.6
Operating and Maintenance Expenses
39,799
36,465
3,334
9.1
Depreciation and Amortization
17,669
17,874
(205)
(1.1)
Property Taxes
4,438
4,474
(36)
(0.8)
Operating Income
$
35,956
$
32,386
$
3,570
11.0
%
2022
2021
change
% change
Electric kilowatt-hour (kwh) Sales(in thousands)
Retail kwh Sales
1,275,051
1,076,580
198,471
18.4
%
Wholesale kwh Sales – Company Generation
99,890
174,187
(74,297)
(42.7)
Heating Degree Days
22
3
19
633.3
Cooling Degree Days
376
463
(87)
(18.8)
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, 2022 and 2021.
2022
2021
Heating Degree Days
43.1
%
5.8
%
Cooling Degree Days
108.4
%
132.7
%
The following table summarizes the estimated effect on diluted earnings per share of the difference in retail kwh sales under actual weather conditions and expected retail kwh sales under normal weather conditions in 2022 and 2021, and between years.
2022 vs
Normal
2022 vs
2021
2021 vs
Normal
Effect on Diluted Earnings Per Share
$
0.01
$
(0.02)
$
0.03
Retail Revenues increased $23.7 million primarily due to the following:
•A $16.0 million increase in fuel recovery revenues due to increased production fuel and purchased power costs as described below.
•A $4.3 million increase in retail revenues from increased sales volumes from commercial and industrial customers, including the impact of a new commercial customer load in North Dakota.
•A $1.2 million decrease in consumption from the impact of unfavorable weather in the third quarter of 2022 compared to the same period last year.
Retail revenues in the third quarter of 2021 were negatively impacted by adjustments to our estimated interim rate refund.
Production Fuel costsincreased $7.3 million primarily as a result of a 28% increase in fuel cost per kwh. Increased generation from our fuel-burning plants in the third quarter of 2022, as compared to the same period last year, also contributed to the increase in production fuel costs.
Purchased Power costs to serve retail customers increased $10.0 million due to a 45% increase in the price of purchased power per kwh, resulting from increased natural gas and market energy prices, and a 39% increase in the volume of purchased power due to increased customer demand.
Operating and MaintenanceExpense increased $3.3 million primarily due to an increase in maintenance activities, including our planned outage at Coyote Station, maintenance at our wind farm facilities, and vegetation management, as well as increased transmission tariff expenses.
The following table summarizes Manufacturing segment operating results for the three months ended September 30, 2022 and 2021:
(in thousands)
2022
2021
$ change
% change
Operating Revenues
$
98,767
$
89,977
$
8,790
9.8
%
Cost of Products Sold (excluding depreciation)
77,764
70,148
7,616
10.9
Other Operating Expenses
8,627
10,161
(1,534)
(15.1)
Depreciation and Amortization
3,996
3,794
202
5.3
Operating Income
$
8,380
$
5,874
$
2,506
42.7
%
Operating Revenues increased $8.8 million primarily due to a 17% increase in sales volumes at BTD, partially offset by lower steel prices, which resulted in a $5.4 million decrease in material costs that are passed through to customers. Declines in scrap metal prices resulted in a $1.3 million decrease in scrap revenue. End market demand remains strong, however, supply chain disruptions experienced by our customers have continued to cause unpredictable shipments of our products to our customers. Increases in sales prices and volumes at T.O. Plastics, due to continued strong customer demand, also contributed to the segment increase in operating revenues.
Cost of Products Sold increased $7.6 million primarily due to higher sales volumes, as described above, as well as increased labor costs, partially offset by favorable cost absorption and decreased material costs related to lower steel prices.
Other Operating Expenses decreased $1.5 million primarily due to decreased incentive compensation costs based on current year financial performance relative to established targets.
PLASTICS SEGMENT RESULTS
The following table summarizes Plastics segment operating results for the three months ended September 30, 2022 and 2021:
(in thousands)
2022
2021
$ change
% change
Operating Revenues
$
142,342
$
107,542
$
34,800
32.4
%
Cost of Products Sold (excluding depreciation)
61,597
64,064
(2,467)
(3.9)
Other Operating Expenses
3,921
3,832
89
2.3
Depreciation and Amortization
1,023
1,099
(76)
(6.9)
Operating Income
$
75,801
$
38,547
$
37,254
96.6
%
Operating Revenues increased $34.8 million due to a 57% increase in the price per pound of PVC pipe sold, as sales prices remain high due to extraordinary market conditions. Demand for PVC pipe began to soften during the third quarter as customers started to consume high priced inventory instead of buying additional PVC pipe. Sales volumes for the quarter decreased 15% due to softening customer demand.
Cost of Products Sold decreased $2.5 million primarily due to decreased sales volumes, as described above, partially offset by increased PVC resin and other input material costs, which increased 14.5% due to the market conditions described above. Resin prices in the third quarter of 2022 increased compared to the same period in the previous year, but decreased compared to the second quarter of 2022.
CORPORATE COSTS
The following table summarizes Corporate operating results for the three months ended September 30, 2022 and 2021:
(in thousands)
2022
2021
$ change
% change
Other Operating Expenses
$
3,976
$
2,231
$
1,745
78.2
%
Depreciation and Amortization
28
48
(20)
(41.7)
Operating Loss
$
4,004
$
2,279
$
1,725
75.7
%
Other Operating Expenses increased $1.7 million primarily due to increased employee health care costs and increased professional service costs.
The following table summarizes consolidated operating results for the nine months ended September 30, 2022 and 2021:
(in thousands)
2022
2021
$ change
% change
Operating Revenues
$
1,158,800
$
863,612
$
295,188
34.2
%
Operating Expenses
823,302
685,063
138,239
20.2
Operating Income
335,498
178,549
156,949
87.9
Interest Charges
27,198
28,601
(1,403)
(4.9)
Nonservice Cost Components of Postretirement Benefits
(824)
1,511
(2,335)
(154.5)
Other Income
(802)
2,095
(2,897)
(138.3)
Income Before Income Taxes
308,322
150,532
157,790
104.8
Income Tax Expense
66,143
25,380
40,763
160.6
Net Income
$
242,179
$
125,152
$
117,027
93.5
%
Operating Revenues increased $295.2 million primarily due to higher PVC pipe prices within our Plastics segment and increased sales volumes and material costs, which resulted in higher sales prices, in our Manufacturing segment. Increased retail revenues within our Electric segment due to increased fuel recovery revenues, increased sales volumes from commercial and industrial customers, and favorable weather impacts also contributed to the higher operating revenues in 2022. See our segment disclosures below for additional discussion of items impacting operating revenues.
Operating Expenses increased $138.2 million due to increased expenses across all three of our operating segments. Operating expenses in our Electric segment increased primarily from higher purchased power costs due to an increase in the volume and cost of purchased power, increased production fuel costs, and higher operating and maintenance expenses, due to increased planned outage maintenance costs, increased labor costs related to various maintenance activities, and increased transmission tariff expenses. Operating expenses in our Manufacturing segment increased primarily due to higher material costs, largely driven by higher steel prices and higher sales volumes at BTD. Operating expenses in our Plastics segment increased primarily due to increased PVC resin and other input costs, partially offset by decreased sales volumes. See our segment disclosures below for additional discussion of items impacting operating expenses.
Interest Charges decreased $1.4 million due to a lowering of our average interest rate on our long-term debt as a result of refinancing activity in 2021 and 2022, and a decrease in our average short-term borrowings compared to the previous year.
Nonservice Cost Components of Postretirement Benefits decreased $2.3 million primarily due to the amortization of actuarial gains resulting from the increase in the discount rates used to measure our pension benefit and postretirement benefit liabilities as of December 31, 2021.
Other Income decreased $2.9 million primarily due to investment losses on our corporate-owned life insurance policies and other investments during the nine months ended September 30, 2022 compared to investment gains in the same period last year.
Income Tax Expense increased $40.8 million primarily due to increased income before income taxes. Our effective tax rate was 21.5% for the nine months ended September 30, 2022 and 16.9% for the same period in the previous year. The increase in our effective tax rate was driven by an increase in our income before income taxes without a corresponding increase in tax credits and other permanent differences that impact our effective tax rate. See Note 8 to our consolidated financial statements included in 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, 2022 and 2021:
(in thousands)
2022
2021
$ change
% change
Retail Revenues
$
347,419
$
291,130
$
56,289
19.3
%
Transmission Services Revenues
37,409
37,085
324
0.9
Wholesale Revenues
13,196
14,711
(1,515)
(10.3)
Other Electric Revenues
6,088
5,703
385
6.8
Total Operating Revenues
404,112
348,629
55,483
15.9
Production Fuel
54,538
44,576
9,962
22.3
Purchased Power
64,604
40,273
24,331
60.4
Operating and Maintenance Expenses
126,460
114,615
11,845
10.3
Depreciation and Amortization
54,441
53,335
1,106
2.1
Property Taxes
13,304
13,136
168
1.3
Operating Income
$
90,765
$
82,694
$
8,071
9.8
%
2022
2021
change
% change
Electric kilowatt-hour (kwh) Sales(in thousands)
Retail kwh Sales
4,076,769
3,511,730
565,039
16.1
%
Wholesale kwh Sales – Company Generation
222,591
358,761
(136,170)
(38.0)
Heating Degree Days
4,559
3,614
945
26.1
Cooling Degree Days
530
700
(170)
(24.3)
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, 2022 and 2021.
2022
2021
Heating Degree Days
114.0
%
89.9
%
Cooling Degree Days
113.7
%
150.9
%
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 2022 and 2021, and between years.
2022 vs
Normal
2022 vs
2021
2021 vs
Normal
Effect on Diluted Earnings Per Share
$
0.08
$
0.06
$
0.02
Retail Revenues increased $56.3 million primarily due to the following:
•A $35.0 million increase in fuel recovery revenues primarily due to increased purchased power and production fuel costs, as described below, and a decrease in credits provided to retail customers from decreased margins recognized on wholesale sales.
•A $11.5 million increase in retail revenues from increased sales volumes from commercial and industrial customers, including the impact of a new commercial customer load in North Dakota.
•A $4.1 million increase in interim rate revenue due to the finalization of the interim rate refund, as approved by the MPUC in the second quarter of 2022.
•A $3.0 million increase in revenues from the favorable impact of weather in the first nine months of 2022 compared to the same period last year.
Retail revenues also benefited from increased transmission, renewable and phase-in rider revenue in the first nine months of 2022. These increases were partially offset by a decrease in conservation improvement program (CIP) revenue as a result of decreased CIP spending and related cost recovery. Retail revenues in 2021 were negatively impacted by adjustments to our estimated interim rate refund.
Production Fuel costsincreased $10.0 million due to a 32% increase in fuel cost per kwh, which was partially offset by a decrease in kwhs generated from our fuel-burning plants due to our planned outage at Coyote Station in 2022 and the retirement of Hoot Lake Plant in May 2021.
Purchased Power costs to serve retail customers increased $24.3 million due to a 44% increase in the volume of purchased power, resulting from the planned outage at Coyote Station, the retirement of Hoot Lake Plant and increased customer demand, and an 11% increase in the price of purchased power per kwh, resulting from increased natural gas and market energy prices.
Operating and Maintenance Expense increased $11.8 million, primarily due the following:
•Higher maintenance costs primarily arising from our planned outage at Coyote Station and increased maintenance costs at our wind generation assets.
•Increased transmission tariff expenses.
•Higher labor costs associated with increased maintenance activities, including vegetative management and other activities.
•Increased travel costs driven by higher fuel costs for our vehicle fleet and increased travel activities.
Partially offsetting these increases were lower CIP expenses compared to the previous year and a decrease in expenses from our Minnesota rate case compared to 2021.
MANUFACTURING SEGMENT RESULTS
The following table summarizes Manufacturing segment operating results for the nine months ended September 30, 2022 and 2021:
(in thousands)
2022
2021
$ change
% change
Operating Revenues
$
306,921
$
250,085
$
56,836
22.7
%
Cost of Products Sold (excluding depreciation)
242,440
189,183
53,257
28.2
Other Operating Expenses
27,363
28,109
(746)
(2.7)
Depreciation and Amortization
12,101
11,395
706
6.2
Operating Income
$
25,017
$
21,398
$
3,619
16.9
%
Operating Revenues increased $56.8 million primarily due to a $35.6 million increase in material costs at BTD, which are passed through to customers, as a result of higher steel prices. Steel prices have been highly volatile in 2022 and were higher on average compared to the previous year, which resulted in increased revenues as we sold through high-priced inventory. Operating revenues also increased due to a 7.6% increase in sales volumes and price increases related to inflationary costs being experienced across the business. Increases in sales prices and volumes at T.O. Plastics, primarily due to strong customer demand in the horticulture sector, also contributed to the increase in operating revenues.
Cost of Products Sold increased $53.3 million primarily due to higher material costs and sales volumes at BTD. The increase in material cost was largely driven by increased steel prices as mentioned above. Cost of products sold at BTD was positively impacted by favorable cost absorption in the first nine months of 2022 compared to the prior year. Increased sales volumes and material costs at T.O. Plastics also contributed to the increase in cost of products sold.
PLASTICS SEGMENT RESULTS
The following table summarizes Plastics segment operating results for the nine months ended September 30, 2022 and 2021:
(in thousands)
2022
2021
$ change
% change
Operating Revenues
$
447,767
$
264,898
$
182,869
69.0
%
Cost of Products Sold (excluding depreciation)
201,146
169,584
31,562
18.6
Other Operating Expenses
12,225
10,450
1,775
17.0
Depreciation and Amortization
3,173
3,200
(27)
(0.8)
Operating Income
$
231,223
$
81,664
$
149,559
183.1
%
Operating Revenues increased $182.9 million, primarily due to a 83% increase in the price per pound of PVC pipe sold. As discussed above, PVC pipe sale prices increased due to strong demand for PVC pipe products, limited PVC pipe inventories, and increases in the cost of resin. Resin and other material input supply constraints negatively impacted our production volumes, which coupled with low inventory levels, impacted sales volumes, which were down 7.5% compared to the previous year.
Cost of Products Sold increased $31.6 million primarily due to increased PVC resin and other input costs, which increased 29% due to the market conditions described above, partially offset by decreased sales volumes. Labor and overhead costs also increased from the previous year.
Other Operating Expenses increased $1.8 million primarily due to increased incentive compensation costs and sales commissions, which increased as a result of increased operating revenues and earnings compared to the previous year.
CORPORATE COSTS
The following table summarizes Corporate operating results for the nine months ended September 30, 2022 and 2021:
(in thousands)
2022
2021
$ change
% change
Other Operating Expenses
$
11,393
$
7,028
$
4,365
62.1
%
Depreciation and Amortization
114
179
(65)
(36.3)
Operating Loss
$
11,507
$
7,207
$
4,300
59.7
%
Other Operating Expenses increased $4.4 million primarily due to increased employee health care costs, increased professional service costs, increased incentive compensation costs based on the current year financial and operating performance, and increased travel costs.
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 an initial request with the MPUC for an increase in revenue recoverable through base rates in Minnesota, and on December 3, 2020, the MPUC approved an interim annual rate increase of $6.9 million, or 3.2%, effective January 1, 2021.
On February 1, 2022, the MPUC issued its written order on final rates. The key provisions of the order included a revenue requirement of $209.0 million, based on a return on rate base of 7.18% and an allowed return on equity of 9.48% on an equity ratio of 52.5%. The order also authorized recovery of our remaining Hoot Lake Plant net asset over a five-year period and approved the requested decoupling mechanism for most residential and commercial customer rate groups with a cap of 4% of annual base revenues.
On May 12, 2022, OTP's final rate case compliance filing was approved by the MPUC. The filing included final revenue calculations, rate design and resulting tariff revisions, along with a determination of the interim rate refund, which resulted in an increase in revenues during the second quarter of 2022 of $4.1 million. Final rates took effect on July 1, 2022, and interim rate refunds of $15.3 million were completed in the third quarter of 2022.
RATE RIDERS
The following table includes a summary of pending and recently concluded rate rider proceedings:
Recovery
Filing
Amount
Effective
Mechanism
Jurisdiction
Status
Date
(in millions)
Date
Notes
CIP - 2022
MN
Approved
04/01/22
$
10.8
10/01/22
Includes recovery of energy conservation improvement costs as well as a demand side management financial incentive.
CIP - 2021
MN
Approved
04/01/21
9.4
12/01/21
Includes recovery of energy conservation improvement costs as well as a demand side management financial incentive.
TCR - 2021
MN
Approved
11/23/21
7.2
08/01/22
Includes recovery of two new transmission projects.
RRR - 2021
MN
Approved
12/06/21
7.0
08/01/22
Includes return on Hoot Lake Solar construction costs and costs associated with the acquisition of the Ashtabula III wind farm.
RRR - 2021
ND
Approved
03/07/21
11.8
04/01/21
Includes recovery of Merricourt investment and operating costs.
RRR - 2022
ND
Approved
01/05/22
7.8
04/01/22
Includes Merricourt recovery, the proposed purchase of Ashtabula III and credits related to deferred taxes and production tax credits.
TCR - 2022
ND
Requested
09/15/22
7.5
01/01/23
Includes recovery of three new transmission projects, one transmission rebuild project and six transmission projects related to extending the useful life of transmission assets.
TCR - 2021
ND
Approved
09/15/21
6.1
01/01/22
Includes recovery of three new transmission projects/programs.
TCR - 2020
ND
Approved
11/18/20
5.6
01/01/21
Includes recovery of eight new transmission projects.
GCR - 2021
ND
Approved
03/01/21
5.2
07/01/21
Includes recovery of Astoria Station, net of anticipated savings associated with the retirement of Hoot Lake Plant.
GCR - 2022
ND
Approved
03/01/22
3.3
07/01/22
Annual update to generation cost recovery rider.
AGI - 2022
ND
Requested
07/08/22
3.1
01/01/23
Includes recovery of the advanced metering infrastructure, outage management system and demand response projects.
PIR - 2022
SD
Approved
06/01/22
3.0
09/01/22
Includes recovery of the Ashtabula III wind farm purchase, Merricourt, Astoria Station, and the Advanced Grid Infrastructure project, as well as load growth credits.
TCR - 2020
SD
Approved
01/29/20
2.3
03/02/20
Annual update to transmission cost recovery rider.
TCR - 2022
SD
Approved
10/29/21
2.2
03/01/22
Annual update to transmission cost recovery rider.
TCR - 2021
SD
Approved
02/19/21
2.2
03/01/21
Includes recovery of two new transmission projects.
Energy Adjustment Rider: On October 20, 2022, OTP filed supplemental comments in the Minnesota 2023 Energy Adjustment Rider (EAR) docket. As part of this filing, OTP proposed to refund the Minnesota portion of capacity auction revenues (see below for further details) through this rider and proposed a mechanism to address load reallocation due to the impact of a recent load addition in North Dakota. The filing proposed an assessment in 2022 and 2023 to determine whether actual, weather normalized earnings, as measured based on ROE, including the crediting of capacity auction revenues, are above or below our authorized ROE in Minnesota (9.48%). Under our proposal, should OTP under or over earn its authorized ROE, an adjustment to recover amounts from, or refund amounts to, Minnesota customers would be effectuated through the EAR. OTP proposed three ROE ranges above or below the allowed ROE for which a surcharge or refund would be calculated, including a 20 basis point range in which no surcharge or refund would be assessed, a 21 to 100 basis point range in which 50% of the over or under earning in this range would be collected from or refunded to customers, and a range above 100 basis points in which 100% of the over or under earning in this range would be collected from or refunded to customers. Our proposal is still pending before the MPUC. Should our proposal be accepted without modification, as of September 30, 2022, we estimated no refund or surcharge would be assessed under the requested mechanism.
MISO CAPACITY AUCTION
OTP offered 88 megawatts of excess capacity into the annual MISO planning resource auction for the period June 2022 through May 2023. As a result of a capacity shortage in the MISO region, capacity prices cleared the auction at maximum pricing. As a result, the 88 megawatts of auctioned capacity will generate approximately $9.3 million of net capacity auction revenues over the twelve month period beginning in June 2022. Through September 30, 2022, OTP has received approximately $2.9 million of excess capacity auction revenues. We anticipate a portion of the capacity auction revenues will be used to mitigate customer rate increases or returned to customers through various mechanisms in each jurisdiction.
INTEGRATED RESOURCE PLAN
On September 1, 2021, OTP filed its 2022 Integrated Resource Plan (2022 IRP) concurrently with regulators in the three states where OTP operates, Minnesota, North Dakota and South Dakota. The 2022 IRP included OTP’s preferred plan for meeting customers’ anticipated capacity and energy needs while maintaining system reliability and low electric service rates.
The components of OTP's preferred plan include:
–the addition of dual fuel capability at our Astoria Station natural gas plant;
–the addition of 150 megawatts of solar generation in 2025;
–the addition of 100 megawatts of wind generation in 2027;
–the commencement of the process of withdrawing from our 35 percent ownership interest in Coyote Station, a jointly owned, coal-fired generation plant, by December 31, 2028; and
–the addition of 50 megawatts of solar generation in 2033.
Although the 2022 IRP includes planned actions beyond 2026, regulators will not act on or approve planned actions in periods beyond 2026 as part of our 2022 IRP filing.
Subject to regulatory approval, the preferred plan proposes to create a regulatory asset as a vehicle to recover costs related to a future withdrawal from Coyote Station, including the net book value of the plant on the withdrawal date, anticipated decommissioning costs and any required costs incurred as a result of an early termination of the existing lignite sales agreement, under which Coyote Station acquires all of its lignite coal from a nearby mine. As part of the filing, OTP developed an estimate of the reasonably foreseeable costs of withdrawing from Coyote Station at the end of 2028 of $68.5 million. These costs may differ from actual results due to the uncertainty and timing of future events associated with the terms and conditions of a withdrawal.
On October 14, 2022, OTP submitted a supplemental filing to update its 2022 IRP, requesting the procedural schedule in Minnesota be amended to allow for additional time to update our resource modeling given significant changes in the energy industry since the original 2022 IRP filing, while maintaining the original procedural schedule as it relates to adding dual fuel capability at Astoria Station. Our original filing proposed fuel oil as the secondary on-site fuel at Astoria Station and our supplemental filing reflects revised cost estimates and liquified natural gas as the most cost-effective secondary fuel source. The recent changes which led to our request include FERC’s approval of MISO’s new seasonal resource adequacy construct, MISO’s proposal to significantly increase winter and spring planning reserve margins, and enactment of the Inflation Reduction Act. On November 1, 2022, the MPUC approved OTP's requested changes to the procedural schedule for the 2022 IRP. OTP plans to file an updated resource plan in March 2023, as approved under the amended schedule. In conjunction with the updated resource plan, OTP's preferred plan could change based on the results of the updated resource modeling incorporating the factors listed above, as well as other changes. A change to the preferred plan could ultimately impact the nature, timing and amount of future capital investments, as well as the potential for OTP's withdrawal from Coyote Station. A notice of the request submitted to the MPUC was also provided to the North Dakota Public Service Commission and South Dakota Public Utilities Commission.
LIQUIDITY
LIQUIDITY OVERVIEW
We believe our financial condition is strong and our cash and cash equivalents, other liquid assets, operating cash flows, existing lines of credit, access to capital markets and borrowing ability, because of investment-grade credit ratings, when taken together provide us ample liquidity to conduct our business operations, fund our short-term and long-term capital expenditure plans and satisfy our obligations as they become due. Our liquidity, including our operating cash flows and access to capital markets, can be impacted by macroeconomic factors outside of our control, including higher interest rates and debt capital costs and diminished credit availability. In addition, our liquidity could be impacted by non-
compliance with certain financial covenants under our various debt instruments. As of September 30, 2022, we were in compliance with all financial covenants (see the Financial Covenants section under Capital Resources below).
The following table presents the status of our lines of credit as of September 30, 2022 and December 31, 2021:
2022
2021
(in thousands)
Borrowing Limit
Amount Outstanding
Letters of Credit
Amount Available
Amount Available
OTC Credit Agreement
$
170,000
$
—
$
—
$
170,000
$
147,363
OTP Credit Agreement
170,000
—
9,919
160,081
88,315
Total
$
340,000
$
—
$
9,919
$
330,081
$
235,678
We have an internal risk tolerance metric to maintain a minimum of $50 million of liquidity under the OTC Credit Agreement. Should additional liquidity be needed, this agreement includes an accordion feature allowing us to increase the amount available to $290 million, subject to certain terms and conditions. The OTP Credit Agreement also includes an accordion feature allowing OTP to increase that facility to $250 million, subject to certain terms and conditions.
CASH FLOWS
The following is a discussion of our cash flows for the nine months ended September 30, 2022 and 2021:
(in thousands)
2022
2021
Net Cash Provided by Operating Activities
$
287,973
$
154,752
Net Cash Provided by Operating Activities increased $133.2 million for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021, due primarily to the $117.0 million increase in net income, largely due to increased earnings from our Plastics segment, and a lower level of working capital needs in the first nine months of 2022 compared to the prior year.
(in thousands)
2022
2021
Net Cash Used in Investing Activities
$
127,556
$
117,084
Net Cash Used in Investing Activities increased $10.5 million for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021. The increase in cash used in investing activities was primarily due to a higher amount of Electric segment capital investment compared to last year.
(in thousands)
2022
2021
Net Cash Used in Financing Activities
$
88,967
$
37,559
Net Cash Used in Financing Activities increased $51.4 million for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021. Financing activities for the nine months ended September 30, 2022 included the issuance of $90.0 million of long-term debt at OTP, which was used to repay $30.0 million of long-term debt that matured in August 2022, to repay short-term borrowings, fund capital expenditures, and for other general corporate purposes. Financing activities for the nine months ended September 30, 2022, also included net repayments of short-term borrowings of $91.2 million and dividend payments of $51.6 million. Financing activities for the nine months ended September 30, 2021 included net proceeds from short-term borrowings of $16.9 million and dividend payments of $48.6 million.
CAPITAL REQUIREMENTS
CAPITAL EXPENDITURES
We have a capital expenditure program for expanding, upgrading and improving our plants and operating equipment. Typical uses of cash for capital expenditures are investments in electric generation facilities and environmental upgrades, transmission and distribution lines, manufacturing facilities and upgrades, equipment used in the manufacturing process, and computer hardware and information systems. Our capital expenditure program is subject to review and regulatory approval and is revised in light of changes in demands for energy, technology, environmental laws, regulatory changes, business expansion opportunities, the costs of labor, materials and equipment and our financial condition.
We have updated our capital expenditure plans in our Electric segment in light of recent changes in the energy industry and recent regulatory actions, including FERC’s approval of MISO’s new seasonal resource adequacy construct, MISO’s proposal to significantly increase winter and spring planning reserve margins, MISO's approval of certain projects as part of its long-range transmission plan, and the enactment of the Inflation Reduction Act. The significant changes to our anticipated capital investments over the next five years include additional investment in multiple transmission projects, the modification of investments in wind generation, including the incorporation of wind repowering into our current capital investment plan, and a reduction in planned solar generation. The table below reflects these changes, as well as all other currently anticipated capital investments over the next five years in our Electric, Manufacturing, and Plastics segments.
The following provides a summary of actual capital expenditures for the year ended December 31, 2021, anticipated annual capital expenditures for the current year ending December 31, 2022, and anticipated capital expenditures for the next five years, along with electric utility average rate base and annual rate base growth:
(in millions)
2021
2022(1)
2023
2024
2025
2026
2027
Total 2023 - 2027
Electric Segment:
Renewables and Natural Gas Generation
$
33
$
88
$
119
$
88
$
79
$
10
$
384
Technology and Infrastructure
9
33
30
6
5
1
75
Distribution Plant Replacements
40
33
37
38
38
43
189
Transmission (includes replacements)
38
34
36
46
87
78
281
Other
30
26
25
30
25
22
128
Total Electric Segment
$
140
$
150
$
214
$
247
$
208
$
234
$
154
$
1,057
Manufacturing and Plastics Segments
32
34
48
53
29
25
24
179
Total Capital Expenditures
$
172
$
184
$
262
$
300
$
237
$
259
$
178
$
1,236
Total Electric Utility Average Rate Base
$
1,575
$
1,620
$
1,750
$
1,850
$
1,990
$
2,110
$
2,210
Annual Rate Base Growth
2.9
%
8.0
%
5.7
%
7.6
%
6.0
%
4.7
%
(1) Includes actual results for the nine months ended September 30, 2022, and anticipated capital expenditures for the fourth quarter of 2022.
CONTRACTUAL OBLIGATIONS
Our contractual obligations primarily include principal and interest payments due under our outstanding debt obligations, commitments to acquire coal, energy and capacity commitments, payments to meet our postretirement benefit obligations, and payment obligations under land easements and leasing arrangements.
On June 23, 2022, OTP exercised its option to acquire the Ashtabula III wind farm, a 62.4 megawatt wind farm located in eastern North Dakota, for $49.7 million, subject to certain closing adjustments. The purchase has received regulatory approval. We anticipate the transaction will close, subject to certain customary closing conditions, in January 2023.
Our contractual obligations as of December 31, 2021 are included in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the year ended December 31, 2021. Except for the Ashtabula III wind farm purchase described above, there were no material changes in our contractual obligations outside of the ordinary course of our business during the nine months ended September 30, 2022.
Off-Balance Sheet Arrangements
As of September 30, 2022, we have outstanding letters of credit totaling $13.0 million, a portion of which reduces our borrowing capacity under our lines of credit. No outstanding letters of credit are reflected in outstanding short-term debt on our consolidated balance sheets. We do not have any other off-balance sheet arrangements or any relationships with unconsolidated entities or financial partnerships that have, or are reasonably likely to have, a material current or future effect on our financial condition. These entities are often referred to as structured finance special purpose entities or variable interest entities, which are established for the purpose of facilitating off-balance sheet arrangements or for other contractually narrow or limited purposes. We are not exposed to any financing, liquidity, market or credit risk that could arise if we had such relationships.
COMMON STOCK DIVIDENDS
We paid dividends to our common stockholders totaling $51.6 million, or $1.2375 per share, in the first nine months of 2022. The determination of the amount of future cash dividends to be paid will depend on, among other things, our financial condition, our actual or expected level of earnings and cash flows from operations, the level of our capital expenditures and our future business prospects. As a result of certain statutory limitations or regulatory or financing agreements, the amount of dividends we are allowed to pay could be restricted. See Note 10 to our consolidated financial statements included in this Quarterly Report on Form 10-Q for additional information. The decision to declare a dividend is reviewed quarterly by our Board of Directors.
CAPITAL RESOURCES
Financial flexibility is provided by operating cash flows, unused lines of credit and access to capital markets, which is aided by strong financial coverages and investment grade credit ratings. Debt financing will be required in the five-year period from 2022 through 2026 to refinance maturing debt and to finance our capital investments. Our financing plans are subject to change and are impacted by our planned level of capital investments, and decisions to reduce borrowings under our lines of credit, to refund or retire early any of our outstanding debt, to complete acquisitions, or to use capital for other corporate purposes.
On May 3, 2021, we filed a shelf registration statement with the SEC under which we may offer for sale, from time to time, either separately or together in any combination, equity, debt or other securities described in the shelf registration statement. No new debt or equity has been issued pursuant to the registration statement. The registration statement expires in May 2024.
On May 3, 2021, we filed a second registration statement with the SEC for the issuance of up to 1,500,000 common shares under an Automatic Dividend Reinvestment and Share Purchase Plan, which provides shareholders, retail customers of OTP and other interested investors methods of purchasing our common shares by reinvesting their dividends or making optional cash investments. Shares purchased under the plan may be newly issued common shares or common shares purchased on the open market. As of September 30, 2022, there were 1,287,774 shares available for purchase or issuance under the plan. The registration statement expires in May 2024.
SHORT-TERM DEBT
OTC and OTP are each party to a credit agreement (the OTC Credit Agreement and OTP Credit Agreement, respectively) which each provide for unsecured revolving lines of credit. The following is a summary of key provisions and borrowing information as of, and for the nine months ended, September 30, 2022:
(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, 2022
—
9,919
Amount Outstanding as of September 30, 2022
—
—
Average Amount Outstanding During the Nine Months Ended September 30, 2022
15,625
30,235
Maximum Amount Outstanding During the Nine Months Ended September 30, 2022
58,715
74,519
Interest Rate as of September 30, 2022
4.64
%
4.39
%
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.
On October 31, 2022, OTC entered into a Fifth Amended and Restated Credit Agreement and OTP entered into a Fourth Amended and Restated Credit Agreement, in each case amending and restating the previously existing credit agreements to extend the maturity date of each agreement from September 30, 2026 to October 29, 2027 and to replace LIBOR as a benchmark interest rate with the Secured Overnight Finance Rate (SOFR). The adoption of SOFR as a benchmark interest rate is in advance of the scheduled elimination of LIBOR as a benchmark interest rate on June 30, 2023. We do not expect this change in benchmark interest rates will have a material impact on our operating results or cash flows. No other significant terms or conditions, including borrowing capacity, credit spreads or financial covenants, were modified under these amendments and restatements.
LONG-TERM DEBT
As of September 30, 2022, we had $827.0 million of principal outstanding under long-term debt arrangements. These instruments generally provide for unsecured borrowings at fixed rates of interest with maturities ranging from 2026 to 2052. Pursuant to a Note Purchase Agreement executed in June 2021, OTP issued its Series 2022A Notes due May 20, 2052, in May 2022 for aggregate proceeds of $90.0 million, a portion of which was used to repay the $30.0 million Series 2007B Notes at their maturity in August 2022.
Note 6 to our consolidated financial statements included in this Quarterly Report on Form 10-Q includes additional information regarding these short-term and long-term debt instruments.
Financial Covenants
Certain of our short- and long-term debt agreements require OTC and OTP to maintain certain financial covenants. As of September 30, 2022, we were in compliance with these financial covenants as further described below:
OTC, under its financial covenants, may not permit its ratio of interest-bearing debt to total capitalization to exceed 0.60 to 1.00, may not permit its interest and dividend coverage ratio to be less than 1.50 to 1.00, and may not permit its priority indebtedness to exceed 10 percent of its total capitalization. As of September 30, 2022, OTC's interest-bearing debt to total capitalization was 0.41 to 1.00, OTC's interest and dividend coverage ratio was 11.37 to 1.00, and OTC 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 percent of its total capitalization. As of September 30, 2022, OTP's interest-bearing debt to total capitalization was 0.45 to 1.00, OTP's interest and dividend coverage ratio was 3.65 to 1.00, and OTP had no priority indebtedness outstanding.
The discussion and analysis of our results of operations are based on financial statements prepared in accordance with generally accepted accounting principles in the United States of America. Certain of our accounting policies require management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities in the
preparation of our consolidated financial statements. We have disclosed in our Annual Report on Form 10-K for the year ended December 31, 2021 the critical accounting policies that affect our most significant estimates and assumptions used in preparing our consolidated financial statements. There have been no material changes to our critical accounting policies and estimates from those disclosed in the most recent Annual Report on Form 10-K.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in our market risk from those disclosed in Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in our Annual Report on Form 10-K for the year ended December 31, 2021.
ITEM 4.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures. Under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)) as of September 30, 2022, the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2022.
Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) under the Exchange Act) during the quarter ended September 30, 2022 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, 2021.
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)
