Otter Tail Corp: Form 10-Q for the period ended Mar 31, 2024

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, 2023.

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.

RESULTS OF OPERATIONS – QUARTER TO DATE

Provided below is a summary and discussion of our operating results on a consolidated basis followed by a discussion of the operating results of each of our segments: Electric, Manufacturing and Plastics. In addition to the segment results, we provide an overview of our Corporate costs. Our Corporate costs do not constitute a reportable segment, but rather consist of unallocated general corporate expenses, such as corporate staff and overhead costs, the results of our captive insurance company and other items excluded from the measurement of segment performance. Corporate costs are added to operating segment totals to reconcile to totals on our consolidated statements of income.

CONSOLIDATED RESULTS

The following table summarizes consolidated operating results for the three months ended March 31, 2024 and 2023:

(in thousands)

Operating Revenues increased $8.0 million primarily due to increased sales volumes in our Plastics segment driven by strong distributor and end market demand, partially offset by decreased sales volumes in our Manufacturing segment, and decreased retail revenues in our Electric segment driven by decreased fuel recovery revenues and the impact of unfavorable weather. See our segment disclosures below for additional discussion of items impacting operating revenues.

Operating Expenses decreased $6.3 million primarily due to decreased sales volumes in our Manufacturing segment, lower purchased power costs in our Electric segment and lower material costs in our Plastics segment. See our segment disclosures below for additional discussion of items impacting operating expenses.

Other Income (Expense) increased $2.5 million, primarily due to increased investment income earned on our short-term cash equivalent investments due to an increase in the cash available for investment and an increase in interest rates.

Income Tax Expense increased $4.5 million compared to the same period last year. Our effective tax rate was 19.3% in the first quarter of 2024 and 17.6% in the first quarter of 2023. The increase in our effective tax rate was primarily due to an increase in our income before taxes.

ELECTRIC SEGMENT RESULTS

The following table summarizes Electric segment operating results for the three months ended March 31, 2024 and 2023:

(in thousands)

The operating results of our Electric segment are impacted by fluctuations in weather conditions and the resulting demand for electricity for heating and cooling. The following table shows heating degree days as a percent of normal for the three months ended March 31, 2024 and 2023. There were no cooling degree days in our service territory during the three months ended March 31, 2024 and 2023.

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 2024 and 2023, and between years.

Retail Revenues decreased $12.0 million primarily due to the following:

• A $14.3 million decrease in fuel recovery revenues, primarily due to lower purchased power volumes driven by increased company generation and the unseasonably warm weather in much of our service territory.
• A $5.5 million decrease in revenues from the unfavorable impact of weather compared to last year.

The decreases in retail revenues described above were partially offset by the following:

• A $3.3 million increase in rider revenue, which included the recovery of costs of our wind repowering projects and other rate base investments.
• A $2.2 million increase in new retail revenues, net of an estimated refund, from an interim rate increase in North Dakota effective January 1, 2024, in connection with OTP's North Dakota rate case filed in November 2023.
• A $1.4 million increase in retail revenues due to increased sales volumes from commercial and industrial customers driven by additional demand.

Wholesale Revenues increased $1.6 million primarily due to a 44% increase in wholesale electric prices and a 31% increase in wholesale kwh sales.

Production Fuel costs increased $6.2 million primarily due to an increase in the generation from our coal-fired and natural gas facilities compared to the same period last year, partially due to an outage at Big Stone Plant in the first quarter of 2023.

Purchased Power costs to serve retail customers decreased $19.3 million primarily due to a 42% decrease in the amount of kwh purchased driven by lower customer demand resulting from unfavorable weather as well as an increase in purchased power in the first quarter of 2023 due to the outage at Big Stone Plant.

Operating and Maintenance Expenses increased $2.4 million primarily due to higher labor costs, driven by the hiring of additional employees, wage inflation, and increased employee retirement benefits, as well as an increase in health insurance-related costs.

MANUFACTURING SEGMENT RESULTS

The following table summarizes Manufacturing segment operating results for the three months ended March 31, 2024 and 2023:

(in thousands)

Operating Revenues decreased $7.4 million primarily due to decreased sales volumes at both of our manufacturing businesses. T.O. Plastics, our plastics thermoforming manufacturer, experienced a 35% decrease in sales volumes compared to the same period last year, primarily attributable to decreased sales of horticulture products as customers continue to reduce inventory levels and aim to return to more normal seasonal inventory stocking levels. BTD Manufacturing, our contract metal fabricator, experienced a 5% decrease in sales volumes compared to the same period last year. Sales volumes declined primarily in the lawn and garden and energy end markets, while demand remained relatively strong in other segments, including the recreational vehicle, agriculture, and industrial end markets.

Cost of Products Sold decreased $5.3 million primarily due to decreased sales volumes, as described above. The impacts of lower sales volumes were partially offset by reduced leverage of fixed manufacturing costs resulting from decreased production and sales volumes at T.O. Plastics.

PLASTICS SEGMENT RESULTS

The following table summarizes Plastics segment operating results for the three months ended March 31, 2024 and 2023:

(in thousands)

Operating Revenues increased $25.8 million primarily due to a 56% increase in sales volumes driven by customer sales volume growth and strong distributor and end market demand. Sales volumes in the first quarter of 2023 were significantly impacted by distributor destocking efforts as distributors managed inventory levels amid uncertain market conditions. Increased sales volumes in the first quarter of 2024 were partially offset by a 15% decrease in sales prices compared to the same period last year. As market dynamics have begun to normalize, sales prices have declined at a modest pace after peaking in mid-2022.

Cost of Products Sold increased $7.7 million primarily due to increased sales volumes, as discussed above. The impact of increased sales volumes was partially offset by decreased PVC resin costs. PVC resin and other input material costs decreased 27% compared to the same period in the previous year as the unique supply and demand conditions, which caused significant volatility and increases in resin costs, have subsided and resin costs have stabilized.

CORPORATE COSTS

The following table summarizes Corporate operating results for the three months ended March 31, 2024 and 2023:

(in thousands)

23

REGULATORY MATTERS

The following provides a summary of rate rider filings and other regulatory filings that have or are expected to have a material impact on our operating results, financial position or cash flows.

GENERAL RATES

North Dakota Rate Case

On November 2, 2023, OTP filed a request with the North Dakota Public Service Commission (NDPSC) for an increase in revenue recoverable under general rates in North Dakota. In its filing, OTP requested a net increase in annual revenue of $17.4 million, or 8.4%, based on an allowed rate of return on rate base of 7.85% and an allowed rate of return on equity of 10.6% on an equity ratio of 53.5% of total capital. Through this proceeding, OTP has proposed changes to the mechanism of cost and investment recovery, with recovery moving from riders into base rates. The filing also includes a proposal to implement a sales adjustment mechanism to address potential significant load additions or losses. The filing included an interim rate request of a net increase in annual revenue of $12.4 million, or 6.0%, which was approved by the NDPSC on December 13, 2023. Interim rates went into effect on January 1, 2024, and are subject to potential refund until the finalization of the rate case. An evidentiary hearing before the NDPSC has been scheduled for July 29, 2024, and we anticipate the final outcome of the case will occur in the third quarter of 2024.

RATE RIDERS

The following table includes a summary of pending and recently concluded rate rider proceedings with a significant revenue impact:

(in millions)

RESOURCE PLANNING

In 2021, OTP filed its 2022 Integrated Resource Plan (IRP) with regulators in the three states where OTP operates, Minnesota, North Dakota, and South Dakota. The IRP included OTP’s preferred plan for meeting customers’ anticipated capacity and energy needs while maintaining system reliability and low electric service rates. Through two supplemental filings in 2023, the IRP was modified and updated in response to regulatory developments, changing market conditions, and comments received from intervenors. In the latest supplemental filing, made only in Minnesota, OTP proposed to prospectively plan to serve its Minnesota customers with current legacy resources allocated to all jurisdictions consistent with past practice and certain new resources dedicated to and recovered solely from Minnesota customers and, as the need arises, to serve its other jurisdictions with new resources dedicated to and recovered from those jurisdictions. With the proposal of separated resource planning by jurisdiction, the most recent supplemental filing outlined OTP’s preferred plan for Minnesota only.

On April 2, 2024, OTP, the Minnesota Department of Commerce - Division of Energy Resources, the International Union of Operating Engineers Local 49, the North Central States Regional Council of Carpenters, and the Laborers’ International Union of North America entered into a settlement agreement to resolve all issues among the parties and recommend a decision to the MPUC to resolve the contested matters in the IRP. The terms of the settlement agreement outline the parties’ recommendation that the MPUC resolve the IRP and approve, among other items, the following:

• Approve the following renewable resource additions directly assigned to Minnesota customers, giving reasonable preference to projects located in Minnesota:
• 200 to 300 megawatts of solar generation by November 1, 2027, or as soon as practicable thereafter;
• 150 to 200 megawatts of wind generation by December 31, 2029, or as soon as practicable thereafter;
• Approve the proposal to add on-site liquefied natural gas storage at the Astoria Station natural gas plant;
• Approve the proposal to operate the Minnesota allocated share of the jointly owned Coyote Station coal-fired plant as an Available Maximum Emergency (AME) resource as soon as March 1, 2026, with the costs and benefits of designating and operating Coyote Station as an AME resource borne by customers in Minnesota;
• Authorize OTP to begin the process of withdrawing from the Minnesota allocated share of Coyote Station if a material, non-routine capital investment in the plant is required; and
• Require OTP to file its next Minnesota resource plan no later than May 15, 2026, in which OTP must develop a plan assuming the withdrawal from the Minnesota allocated share of Coyote Station as of December 31, 2031; provided that additional plans for consideration may be presented as well.

Other parties to the Minnesota IRP proceeding have not joined the settlement. The regulatory process is ongoing and the MPUC is not bound by this settlement and may accept, modify or deny the recommendations included in the settlement. Neither the settlement agreement nor OTP’s Minnesota preferred plan had been approved by the MPUC as of the date of this filing. A hearing before the MPUC has been scheduled for May 28, 2024.

ENVIRONMENTAL REGULATION

In April 2024, the EPA finalized new regulations under Section 111 of the Clean Air Act to regulate GHG emissions from existing and new fossil fuel-based power plants. The final rule establishes subcategories for new combustion turbines and existing coal-fired power plants to achieve certain CO2 emission reduction levels based on the respective subcategory. For existing coal-fired power plants the applicable subcategory is based upon the date at which the plant will cease operations.

We continue to review and evaluate the final regulations and their impact on our power plants and the potential impact to our operating results, financial condition and liquidity. Coyote Station and Big Stone Plant, our two co-owned coal-fired power plants, are within the scope of the regulations but we do not believe our combustion turbines would be within the scope of the final regulation.

In April 2024, the EPA also finalized regulations to strengthen and update Mercury and Air Toxics Standards (MATS) for coal-fired power plants, tightening the emission standard for toxic metals and finalizing a reduction standard for mercury from existing lignite-fired sources. The EPA also published a final rule under the Clean Water Act to reduce pollutants discharged through wastewater from coal-fired power plants and a final rule requiring the safe management of coal ash at inactive facilities, including requirements for ongoing monitoring and closure and post-closure care.

We continue to review and evaluate these final regulations, and their impact our operations, which could have a material impact on our operating results, financial condition and liquidity.

LIQUIDITY

LIQUIDITY OVERVIEW

We believe our financial condition is strong and our cash and cash equivalents, other liquid assets, operating cash flows, existing lines of credit, access to capital markets and borrowing ability, because of investment-grade credit ratings, when taken together, provide us ample liquidity to conduct our business operations, fund our short-term and long-term capital expenditure plans and satisfy our obligations as they become due. Our liquidity, including our operating cash flows and access to capital markets, could be impacted by macroeconomic factors outside of our control, including higher interest rates and debt capital costs and diminished credit availability. In addition, our liquidity could be impacted by non-compliance with certain financial covenants under our various debt instruments. As of March 31, 2024, we were in compliance with all financial covenants (see the Financial Covenants section under Capital Resources below).

The following table presents the status of our lines of credit as of March 31, 2024 and December 31, 2023:

(in thousands)

OTC and OTP are each party to separate credit agreements (the OTC Credit Agreement and OTP Credit Agreement, respectively) which provide for unsecured revolving lines of credit. Should additional liquidity be needed, the OTC Credit 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.

As of March 31, 2024, we had $330.9 million of available liquidity under our credit facilities and $238.2 million of available cash and cash equivalents, resulting in total available liquidity of $569.1 million, compared to total available liquidity of $373.7 million as of March 31, 2023.

CASH FLOWS

The following is a discussion of our cash flows for the three months ended March 31, 2024 and 2023:

(in thousands)

Net Cash Provided by Operating Activities increased $16.4 million for the three months ended March 31, 2024 compared to the three months ended March 31, 2023, primarily due to an increase in net income driven by increased earnings from our Plastics segment.

(in thousands)

Net Cash Used in Investing Activities decreased $24.5 million for the three months ended March 31, 2024 compared to the three months ended March 31, 2023. The decrease in cash used in investing activities was primarily due to a lower amount of Electric segment capital investment compared to last year, due to the purchase of the Ashtabula III wind farm for $50.6 million in January 2023.

(in thousands)

Net Cash Provided by Financing Activities decreased $18.2 million for the three months ended March 31, 2024 compared to the three months ended March 31, 2023. Financing activities for the three months ended March 31, 2024 included the issuance of $120.0 million of long-term debt at OTP, the proceeds of which were used to repay short-term borrowings of $81.4 million under the OTP credit agreement, fund Electric segment construction expenditures, and support operating activities. Financing activities for the three months ended March 31, 2024 also included dividend payments of $19.6 million. Financing activities for the three months ended March 31, 2023 included net short-term borrowings of $52.7 million and dividend payments of $18.3 million.

CAPITAL REQUIREMENTS

CAPITAL EXPENDITURES

Our capital expenditure plan includes investments in electric generation facilities, transmission and distribution lines, manufacturing facilities and upgrades, equipment used in the manufacturing process, and computer hardware and information systems. Our capital expenditure plan is subject to review and is revised in light of changes in demands for energy, technology, environmental laws, regulatory changes, business expansion opportunities, the costs of labor, materials and equipment and our financial condition. Refer to Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, of our Form 10-K for the year ended December 31, 2023 for our capital expenditure plans for the five year period from 2024 through 2028.

CONTRACTUAL OBLIGATIONS

Our contractual obligations primarily include principal and interest payments due under our outstanding debt obligations, commitments to acquire coal, energy and capacity commitments, payments to meet our postretirement benefit obligations, and payment obligations under land easements and leasing arrangements.

Our contractual obligations as of December 31, 2023 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, 2023. There were no material changes in our contractual obligations outside of the ordinary course of business during the three months ended March 31, 2024.

COMMON STOCK DIVIDENDS

We paid dividends to our common stockholders totaling $19.6 million, or $0.4675 per share, in the first three months of 2024. The determination of the amount of future cash dividends to be paid will depend on, among other things, our financial condition, our actual or expected level of earnings and cash flows from operations, the level of our capital expenditures and our future business prospects. As a result of certain statutory limitations or regulatory or financing agreements, the amount of dividends we are allowed to pay could be restricted. See Note 10 to our consolidated financial statements included in this Quarterly Report on Form 10-Q for additional information. The decision to declare dividends is reviewed quarterly by our Board of Directors.

CAPITAL RESOURCES

Financial flexibility is provided by operating cash flows, unused lines of credit and access to capital markets, and is aided by strong financial coverages and investment grade credit ratings. Debt financing will be required in the next five-years to refinance maturing debt and to finance our capital investments. Our financing plans are subject to change and are impacted by our planned level of capital investments, and decisions to reduce borrowings under our lines of credit, to refund or retire early any of our outstanding debt, to complete acquisitions, or to use capital for other corporate purposes.

REGISTRATION STATEMENTS

On May 3, 2024 we filed two registration statements with the SEC, replacing two previously filed registration statements upon their expiration. The first statement, a shelf registration, allows us to offer for sale, from time to time, either separately or together in any combination, equity, debt or other securities described in the registration statement. No new debt or equity has been issued pursuant to the registration statement. The second registration statement allows for the issuance of up to 1,500,000 common shares under our Automatic Dividend Reinvestment and Share Purchase Plan, which provides our common shareholders, retail customers of OTP and other interested investors a method of purchasing our common shares by reinvesting their dividends and/or making optional cash investments. Shares purchased under the plan may be newly issued common shares or common shares purchased on the open market. Both registration statements expire in May 2027.

SHORT-TERM DEBT

OTC and OTP are each party to a credit agreement (the OTC Credit Agreement and the OTP Credit Agreement, respectively) which each provides for unsecured revolving lines of credit. The following is a summary of key provisions and borrowing information as of, and for the three months ended, March 31, 2024:

(in thousands, except interest rates)

27

LONG-TERM DEBT

In March 2024, OTP entered into a Note Purchase Agreement pursuant to which OTP issued, in a private placement transaction, $120.0 million of senior unsecured notes consisting of (a) $60.0 million of 5.48% Series 2024A Senior Unsecured Notes due April 1, 2034, and (b) $60.0 million of 5.77% Series 2024B Senior Unsecured Notes due April 1, 2054. The proceeds of the notes were used to repay existing short-term borrowings, fund capital expenditures, and for general corporate purposes.

As of March 31, 2024, we had $947.0 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 2054. Note 6 to our consolidated financial statements included in this Quarterly Report on Form 10-Q includes additional information regarding these short-term and long-term debt instruments.

Financial Covenants

Certain of our short- and long-term debt agreements require OTC and OTP to maintain certain financial covenants. As of March 31, 2024, 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 March 31, 2024, OTC's interest-bearing debt to total capitalization was 0.39 to 1.00, OTC's interest and dividend coverage ratio was 11.18 to 1.00, and OTC had no priority indebtedness outstanding.

OTP, under its financial covenants, may not permit its ratio of interest-bearing debt to total capitalization to exceed 0.60 to 1.00, may not permit its interest and dividend coverage ratio to be less than 1.50 to 1.00, and may not permit its priority indebtedness to exceed 20 percent of its total capitalization. As of March 31, 2024, OTP's interest-bearing debt to total capitalization was 0.47 to 1.00, OTP's interest and dividend coverage ratio was 3.48 to 1.00, and OTP had no priority indebtedness outstanding.

CRITICAL ACCOUNTING POLICIES INVOLVING SIGNIFICANT ESTIMATES

The discussion and analysis of our results of operations are based on financial statements prepared in accordance with generally accepted accounting principles in the United States of America. Certain of our accounting policies require management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the preparation of our consolidated financial statements. We have disclosed in our Annual Report on Form 10-K for the year ended December 31, 2023 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.

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, 2023.

Evaluation of Disclosure Controls and Procedures. Under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)) as of March 31, 2024, the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2024.

Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) under the Exchange Act) during the quarter ended March 31, 2024 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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, 2023, except for the risk factor below.

Legislation, regulation, litigation or other actions related to climate change and greenhouse gas emissions could materially impact us.

Current and future federal, state, regional and international regulations to address global climate change and reduce GHG emissions, including measures such as mandated levels of renewable generation, mandatory reductions in CO2 emission levels, taxes on CO2 emissions, or cap-and-trade regimes, could require us to incur significant costs which could negatively impact our financial condition, operating results and liquidity if such costs cannot be recovered through rates granted by rate-making authorities or through increased market prices for electricity.

In April 2024, the EPA finalized new regulations under Section 111 of the Clean Air Act to regulate GHG emissions from existing and new fossil fuel-based power plants. The new regulations require existing coal-fired power plants to achieve certain CO2 emissions reduction levels, with the amount of reduction dependent upon the remaining operating life of the facility. The new regulation has the potential to materially impact the operations of our coal-fired power plants, which could have a material impact on our operating results, financial condition and liquidity.

In addition to complying with legislation and regulation, we could be subject to litigation related to climate change. If we were subjected to such litigation, the costs of such litigation could be significant and an adverse outcome could require substantial capital expenditures, changes in operations and possible payment of penalties or damages which could affect our financial condition, operating results and liquidity if the costs are not recoverable in rates or covered by insurance.