SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
☒ Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2020 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)
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
215 South Cascade Street, Box 496, Fergus Falls, Minnesota
(Address of principal executive offices)
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|
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☑ No ☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☑
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 has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued
its audit report. ☑
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑
The aggregate market value of common stock held by non-affiliates, computed by reference to the last sales price on June 30, 2020 was $1,546,518,975.
Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date:
41,510,455 Common Shares ($5 par value) as of February 16, 2021.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant's definitive Proxy Statement for its 2021 Annual Meeting of Shareholders is incorporated by reference into Part III of this Form 10-K.
The following abbreviations or acronyms are used in the text.
|ACE||Affordable Clean Energy||MNDOC||Minnesota Department of Commerce|
|AFUDC||Allowance for Funds Used During Construction||MPCA||Minnesota Pollution Control Agency|
|ARO||Asset Retirement Obligation||MPUC||Minnesota Public Utilities Commission|
|BTD||BTD Manufacturing, Inc.||MVP||Multi-Value Project|
|CCMC||Coyote Creek Mining Company, L.L.C.||MW||megawatts|
|carbon dioxide||NDDEQ||North Dakota Department of Environmental Quality|
|ECR||Environmental Cost Recovery||NDPSC||North Dakota Public Service Commission|
|EEI||Edison Electric Institute||NERC||North American Electric Reliability Corporation|
|EEP||Energy Efficiency Plan||Northern Pipe||Northern Pipe Products, Inc.|
|EPA||Environmental Protection Agency||OTP||Otter Tail Power Company|
|ESSRP||Executive Survivor and Supplemental Retirement Plan||PACE||Partnership in Assisting Community Expansion|
|FERC||Federal Energy Regulatory Commission||PTCs||Production tax credits|
|GCR||Generation Cost Recovery||PVC||Polyvinyl chloride|
|GHG||Greenhouse Gas||RHR||Regional Haze Rule|
|IRP||Integrated Resource Plan||ROE||Return on equity|
|kV||kiloVolt||SDPUC||South Dakota Public Utilities Commission|
|kW||kiloWatt||SRECs||Solar renewable energy credits|
|kwh||kilowatt-hour||T.O. Plastics||T.O. Plastics, Inc.|
|LSA||Lignite Sales Agreement||TCR||Transmission Cost Recovery|
|Merricourt||Merricourt Wind Energy Center||Varistar||Varistar Corporation|
|MISO||Midcontinent Independent System Operator, Inc.||Vinyltech||Vinyltech Corporation|
|MNCIP||Minnesota Conservation Improvement Program|
We make available free of charge at our website (www.ottertail.com) our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy and information statements, Forms 3, 4 and 5 filed on behalf of directors and executive officers and any amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission (SEC). These reports are also available on the SEC's website (www.sec.gov). Information on our and the SEC's websites is not deemed to be incorporated by reference into this report on Form 10-K.
|WHERE TO FIND MORE INFORMATION|
This report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the Act). When used in this Form 10-K and in future filings by the Company with the SEC, in the Company’s press releases and in oral statements, words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “outlook,” “plan,” “possible,” “potential,” “should,” “will,” “would” or similar expressions are intended to identify forward-looking statements within the meaning of the Act. Such statements are based on current expectations and assumptions and entail various risks and uncertainties that could cause actual results to differ materially from those expressed in such forward-looking statements. Such risks and uncertainties include the various factors set forth in Item 1A. Risk Factors of this report on Form 10-K and in our other SEC filings.
Otter Tail Corporation has interests in diversified operations that include an electric utility and manufacturing and plastic pipe businesses with corporate offices located in Fergus Falls, Minnesota and Fargo, North Dakota.
We classify our five operating companies into three segments consistent with our business strategy and management. The following depicts our three segments and the subsidiary entities included within each segment:
|ELECTRIC SEGMENT||MANUFACTURING SEGMENT||PLASTICS SEGMENT|
|Otter Tail Power Company (OTP)||BTD Manufacturing, Inc. (BTD)||Northern Pipe Products, Inc. (Northern Pipe)|
|T.O. Plastics, Inc. (T.O. Plastics)||Vinyltech Corporation (Vinyltech)|
Electric includes the generation, purchase, transmission, distribution and sale of electric energy in western Minnesota, eastern North Dakota and northeastern South Dakota. OTP, our largest operating subsidiary and primary business since 1907, serves more than 133,000 customers in 422 communities across a predominantly rural and agricultural service territory.
Manufacturing consists of businesses in the following manufacturing activities: contract machining; metal parts stamping, fabrication and painting; and production of plastic thermoformed horticultural containers, life science and industrial packaging, material handling components, and extruded raw material stock. These businesses have manufacturing facilities in Georgia, Illinois and Minnesota and sell products primarily in the United States.
Plastics consists of businesses producing polyvinyl chloride (PVC) pipe at plants in North Dakota and Arizona. The PVC pipe is sold primarily in the western half of the United States and Canada.
Throughout the remainder of this report, we use the terms "Company", "us", "our", or "we" to refer to Otter Tail Corporation and its subsidiaries collectively. We will also refer to our Electric, Manufacturing and Plastics segments and our individual subsidiaries as indicated above.
INVESTMENT AND GROWTH STRATEGY
We maintain a moderate risk profile by investing in rate base growth opportunities in our Electric segment and organic growth opportunities in our Manufacturing and Plastics segments. This strategy and risk profile are designed to provide a more predictable earnings stream, maintain our credit quality and preserve our ability to fund our dividend. Our goal is to deliver annual growth in earnings per share between five and seven percent over the next several years, using 2020 diluted earnings per share as the base for measurement. We expect our earnings growth to come from rate base investments in our Electric segment and from planned earnings growth arising from existing capacities within our Manufacturing and Plastics segments.
We will continue to review our business portfolio to identify additional opportunities to improve our risk profile, enhance our credit metrics and generate additional sources of cash to support the growth opportunities in our electric utility. We will also evaluate opportunities to allocate capital to potential acquisitions within our Manufacturing and Plastics segments.
We maintain a set of criteria used in evaluating the strategic fit of our operating businesses. The operating company should:
•Maintain a minimum level of net earnings and a return on invested capital in excess of the Company’s weighted average cost of capital,
•Have a strategic differentiation from competitors and a sustainable cost advantage,
•Operate within a stable and growing industry and be able to quickly adapt to changing economic cycles, and
•Have a strong management team committed to operational and commercial excellence.
Over time, we expect our Electric segment will provide approximately 75% of our overall earnings and our Manufacturing and Plastics segments will collectively provide approximately 25% of our overall earnings and continue to be a fundamental part of our strategy.
Our actual mix of earnings in 2020, 2019, 2018and the average for the five-year period ended December 31, 2020 is as follows:
Our employees are a critical resource and an integral part of our success. We strive to provide an environment of opportunity and accountability where people are valued and empowered to do their best work. We are focused on the health and safety of our employees and creating a culture of inclusion, excellence and learning. Our human capital management efforts include monitoring various metrics and objectives associated with i) employee safety, ii) workforce stability, iii) management and workforce demographics, including gender, racial and ethnic diversity, iv) leadership development and succession planning, and v) productivity. We have established the following programs in furtherance of these efforts:
•Safety is one of our core values. We engage a third party to conduct conformity assessments annually. We continually monitor the Occupational Safety and Health Administration Total Recordable Incident Rate and Lost Time Incident Rate. New cases are reported and evaluated for corrective action during monthly safety calls attended by safety professionals at all locations.
•We extend leadership development into the organization to build enterprise-wide understanding of our culture, strategy and processes. Annual succession planning, individual development planning, mentoring, and supervisory and leadership development programs all play a role in ensuring a capable leadership team now and in the future. Our skill progression and technical training programs help ensure we have a skilled and stable workforce.
•To enhance productivity and employee engagement, and to help our companies continue to be places where our employees choose to work and thrive, we have undertaken a multi-year series of employee engagement surveys. We use the feedback to help shape the future of our organization.
•We communicate annually to all employees on our Code of Conduct to help ensure understanding of the common principles that guide who we are and how we do business.
Across our operating companies and including our corporate team as of December 31, 2020, we employed 2,074 full-time employees:
|T.O. Plastics||163 |
|Segment Total||1,210 |
|Northern Pipe||100 |
|Segment Total||179 |
At December 31, 2020, 372 employees of OTP are represented by local unions of the International Brotherhood of Electrical Workers under two separate collective bargaining agreements expiring on August 31, 2023 and October 31, 2023. OTP has not experienced any strike, work stoppage or strike vote, and considers its present relations with employees to be good.
Contribution to Operating Revenues: 50% (2020), 50% (2019), 49% (2018)
OTP, headquartered in Fergus Falls, Minnesota, is a vertically integrated, regulated utility with generation, transmission and distribution facilities to serve its more than 133,000 residential, industrial and commercial customers in a service area encompassing approximately 70,000 square miles of western Minnesota, eastern North Dakota and northeastern South Dakota.
Our service territory is predominantly rural and agricultural and includes over 400 communities, most of which have populations of less than 10,000. While our customer base includes relatively few large customers, sales to commercial and industrial customers are significant, with one industrial customer accounting for 11% of segment operating revenues for the year ended December 31, 2020.
The following summarizes our retail electric revenues by state and by customer segment for the years ended December 31, 2020 and 2019:
In addition to retail revenue, our Electric segment also earns operating revenues from the transmission of electricity for others over the transmission assets we wholly or jointly own with other transmission service providers, and from the sale of electricity we generate and sell into the wholesale electricity market.
Retail electric sales are made to customers in assigned service territories. As a result, most retail customers do not have the ability to choose their electric supplier. Competition is present in some areas from municipally owned systems, rural electric cooperatives and, in certain respects, from on-site generators and co-generators. Electricity also competes with other forms of energy.
The degree of competition may vary from time to time depending on relative costs and supplies of other forms of energy and advances in technology; however, we believe OTP is well positioned to be successful in a competitive environment. A comparison of OTP's electric retail rates to the rates of other investor-owned utilities, cooperatives and municipals in the states OTP serves indicates OTP's rates are competitive.
Competition also arises from distributed generation, which is the generation of electricity on-site or close to where it is needed in small facilities designed to meet local needs. Distributed energy resources are utility- or customer-owned resources on the distribution grid that can include combined heat and power, solar photovoltaic, wind, battery storage, thermal storage, and demand-response technologies.
Wholesale electricity markets are competitive under the FERC's open access transmission tariffs, which require utilities to provide nondiscriminatory access to all wholesale users. In addition, the FERC has established a competitive process for the construction and operation of certain new electric transmission facilities whereby electric transmission providers, including the Midcontinent Independent System Operator, Inc. (MISO), of which OTP is a member, are required to remove from their tariffs a federal right of first refusal to construct transmission facilities selected in a regional transmission plan for purposes of cost allocation.
OTP has franchises to operate as an electric utility in substantially all of the incorporated municipalities it serves. Franchise rights generally require periodic renewal. No franchises are required to serve unincorporated communities in any of the three states that OTP serves.
GENERATION AND PURCHASED POWER
OTP primarily relies on company-owned generation, supplemented by purchase power agreements, to supply the energy to meet our customer needs. Wholesale market purchases and sales of electricity are used as necessary to balance supply and demand as seasonal or other variations occur.
As of December 31, 2020, OTP’s wholly or jointly owned plants and facilities and their dependable kilowatt (kW) capacity was:
| Capacity in kW|
|Baseload Plants|| |
Big Stone Plant(1)
|Hoot Lake Plant||143,100 |
|Total Baseload Net Plant||548,100 |
|Combustion Turbine and Small Diesel Units||107,900 |
|Hydroelectric Facilities||2,500 |
|Owned Wind Facilities (rated at nameplate)|| |
|Merricourt Wind Energy Center (75 turbines)||150,000 |
|Luverne Wind Farm (33 turbines)||49,500 |
|Ashtabula Wind Center (32 turbines)||48,000 |
|Langdon Wind Center (27 turbines)||40,500 |
|Total Owned Wind Facilities||288,000 |
(1) Reflects OTP's 53.9% ownership percentage of jointly-owned facility
(2) Reflects OTP's 35.0% ownership percentage of jointly-owned facility
In addition to the owned facilities described above, OTP had the following purchased power agreements in place on December 31, 2020:
|Purchased Wind Power (rated at nameplate and greater than 2,000 kW)|
|Ashtabula Wind III||62,400 |
|Total Purchased Wind||102,900 |
|Purchase of Capacity (in excess of 1 year and 500 kW)|| |
Great River Energy (through May 2021)
The following summarizes the percentage of our generating capacity by source, including owned and jointly-owned facilities and through power and capacity purchase arrangements, as of December 31, 2020, and the percentage of retail kilowatt-hours (kwh) sold by source during the year ended December 31, 2020:
Under MISO requirements, OTP is required to have sufficient capacity through wholly or jointly-owned generating capacity or purchased power agreements to meet its monthly weather-normalized forecast demand, plus a reserve obligation. OTP met its obligation for the 2019-2020 planning year and anticipates meeting this obligation prospectively.
Capacity Retirements and Additions
Hoot Lake Plant, our 142-meagwatt coal-fired power plant in Fergus Falls, Minnesota is approved for retirement in mid-2021.
As part of our investment plan to meet our future energy needs, we have the following projects at various stages of planning and construction or have been recently completed:
Merricourt Wind Energy Center (Merricourt) is a 150-megawatt wind farm located in southeastern North Dakota. Construction of the wind farm commenced in 2019 and the facility was in commercial operation in December 2020 at a cost of approximately $260.0 million.
Astoria Station Natural Gas Plant (Astoria) is a 245-megawatt simple cycle natural gas combustion turbine generation facility near Astoria, South Dakota. Construction began in 2019 and we anticipate the facility will be substantially complete in the first quarter of 2021. We anticipate total project costs will be $152.5 million.
Hoot Lake Plant Solar (HLP Solar) is a 49-megawatt solar farm under development on land on and around our Hoot Lake Plant in Fergus Falls, Minnesota. The project will include up to 150,000 solar panels at an anticipated cost of $60.0 million. We anticipate, subject to permitting and regulatory approval, the facility will be in commercial operation no later than the end of 2023.
Coal is the principal fuel burned at our Big Stone, Coyote and Hoot Lake generating plants. Coyote Station, a mine-mouth facility, burns North Dakota lignite coal. Hoot Lake Plant and Big Stone Plant burn western subbituminous coal transported by rail. We source coal for our coal-fired power plants through requirements contracts which do not include minimum purchase requirements but do require all coal necessary for the operation of the respective plant to be purchased from the counterparty. Our coal supply contracts for our Hoot Lake Plant, Big Stone Plant and Coyote Station have expiration dates in 2023, 2022 and 2040, respectively.
The supply agreement between the Coyote Station owners, including OTP, and the coal supplier includes provisions requiring the Coyote Station owners to purchase the membership interests of the coal supplier in the event of certain early termination events and at the expiration of the coal supply agreement in 2040. See Note 1 to our consolidated financial statements included in this report on Form 10-K for additional information.
Coal is transported to our non-mine-mouth facilities, Big Stone Plant and Hoot Lake Plant, by rail and is provided under a common carrier rate which includes a mileage-based fuel surcharge.
TRANSMISSION AND DISTRIBUTION
Our transmission and distribution assets deliver energy from energy generation sources to our customers. In addition, we earn revenue from the transmission of electricity over our wholly or jointly owned transmission assets for others under approved rate tariffs. As of December 31, 2020, we were the whole or partial owner of over 8,900 miles of transmission and distribution lines.
Midcontinent Independent System Operator, Inc. (MISO)
MISO is an independent, non-profit organization that operates the transmission facilities owned by other entities, including OTP, within its regional jurisdiction and administers energy and generation capacity markets. MISO has operational control of our transmission facilities above 100 kV. MISO seeks to optimize the efficiency of the interconnected system, provide solutions to regional planning needs and minimize risk to reliability through its security coordination, long-term regional planning, market monitoring, scheduling and tariff administration functions.
Electricity demand is affected by seasonal weather differences, with peak demand occurring in the summer and winter months. As a result, our Electric segment operating results may fluctuate on a seasonal basis. In addition, fluctuations in electricity demand within the same season but between years can impact our operating results. We monitor the level of heating and cooling degree days in a period to assess the impact of weather-related effects on our operating results between periods.
PUBLIC UTILITY REGULATION
OTP is subject to regulation of rates and other matters in each of the three states in which it operates and by the federal government for certain interstate operations. OTP operates under approved retail electric tariff rates in all three states it serves. Tariff rates are designed to recover plant investments, a return on those investments, and operating costs. In addition to determining rate tariffs, state regulatory commissions also authorize ROE, capital structure and depreciation rates of our plant investments. Decisions by our regulators can significantly impact our operating results, financial position and cash flows.
Below is a summary of the regulatory agencies with jurisdiction of electric rates over OTP along with the percentage of electric revenue for the year ended December 31, 2020 covered by each regulatory agency:
|Agency||Revenue||Areas of Regulation|
|Minnesota Public Utilities Commission |
Retail rates, issuance of securities, depreciation rates, capital structure, public utility services, construction of major facilities, establishment of exclusive assigned service areas, contracts with subsidiaries and other affiliated interests and other matters.
Selection or designation of sites for new generating plants (50,000 kW or more) and routes for transmission lines (100 kV or more).
Review and approval of fifteen-year Integrated Resource Plan.
|North Dakota Public Service Commission |
Retail rates, certain issuances of securities, construction of major utility facilities and other matters.
Approval of site and routes for new electric generating facilities (500 kW or more for wind generating facilities; 50,000 kW for non-wind generating facilities) and high voltage transmission lines (115 kV or more).
Review and approval of ten-year facility plan.
|South Dakota Public Utilities Commission |
Retail rates, public utility services, construction of major facilities, establishment of assigned service areas and other matters.
Approval of sites and routes for new electric generating facilities (100,000 kW or more) and most transmission lines (115 kV or more).
|Federal Energy Regulatory Commission |
Wholesale electricity sales, transmission and sale of electric energy in interstate commerce, interconnection of facilities, hyrdoelectric licensing and accounting policies and practices.
Compliance with NERC reliability standards, including standards on cybersecurity and protection of critical infrastructure.
In addition to base rates, there are other mechanisms for recovery of plant investments, including a return on investment, and operating expenses. The following is a summary of these recovery mechanisms:
|Recovery Mechanism||Jurisdiction(s)||Additional Information|
|Fuel Clause Adjustment (FCA)||MN, ND, SD||Provides for periodic billing adjustments for changes in prudently incurred costs of fuel and purchased power. In North and South Dakota, fuel and purchased power costs are generally adjusted on a monthly basis with over or under collections from the previous month applied to the next monthly billing. In Minnesota, fuel and purchased power costs are estimated on an annual basis and the accumulated difference between actual and estimated cost per kwh are refunded or recovered, subject to regulatory approval, in subsequent periods.|
|Transmission Cost Recovery Rider (TCR)||MN, ND, SD||Provides for recovery of costs outside of a general rate case for investments in new or modified electric transmission or distribution assets.|
|Environmental Cost Recovery Rider (ECR)||MN, ND, SD||Provides for recovery of costs outside of a general rate case for investments in certain environmental improvement projects.|
|Renewable Resource Rider (RRR)||MN, ND||Provides for recovery of costs outside of a general rate case for investments in certain new renewable energy projects.|
|Generation Cost Recovery Rider (GCR)||ND||Provides for the recovery of costs outside of a general rate case for investments in new generation facilities.|
|Phase-In Rider (PIR)||SD||Provides for the recovery of costs outside of a general rate case for investments in new generation facilities.|
|Conservation Improvement Program (CIP)||MN||Under Minnesota law, OTP is required to invest at least 1.5% of its gross operating revenues on energy conservation improvements. Recovery of these costs outside of a general rate case occurs through the CIP.|
|Energy Efficiency Plan (EEP)||SD||Provides for the recovery of costs from energy efficiency investments.|
Renewable Energy Standard
Minnesota has a renewable energy standard requiring utilities to generate or procure sufficient renewable generation such that the following percentages of total retail electric sales to Minnesota customers come from qualifying renewable sources: 17% by 2016; 20% by 2020 and 25% by 2025. We met the current renewable sources requirements with a combination of owned renewable generation and purchases from renewable generation sources. Minnesota law also requires 1.5% of total Minnesota electric sales by public utilities to be supplied by solar energy by 2020. For a public utility with between 50,000 and 200,000 retail electric customers, such as OTP, at least 10% of the 1.5% requirement must be met by solar energy generated by or procured from solar photovoltaic devices with a nameplate capacity of 40 kWs or less. OTP has purchased sufficient solar renewable energy credits (SRECs) to meet 100% of its 2020 obligation and approximately 70% of its 2021 obligation.
Under certain circumstances and after consideration of costs and reliability issues, the MPUC may modify or delay implementation of the standards. We are evaluating potential options for maintaining compliance and meeting the solar energy standard beyond 2021.
Integrated Resource Plan (IRP)
Under Minnesota law, utilities are required to submit for approval by the MPUC a 15-year advance IRP. An IRP is a set of resource options a utility could use to meet the service needs of its customers over the forecast period, including an explanation of the utility’s supply and demand circumstances, and the extent to which each resource option would be used to meet those service needs. The MPUC’s findings of fact and conclusions regarding IRPs are considered to be evidence, subject to rebuttal, in future rate reviews and other proceedings. Typically, IRPs are submitted every two years.
On April 26, 2017 the MPUC approved OTP’s 2017-2031 IRP filing with modifications and setting requirements for the next IRP. The approved IRP with modifications included the following items:
•The addition of 200 MW of wind resources in the 2018 to 2020 timeframe.
•The addition of 30 MW of solar resources by 2020 to comply with Minnesota's Solar Energy Standard.
•The addition of up to 250 MW of peaking capacity in 2021.
•Average annual energy savings of 46.8 gigawatt-hours (1.6% of retail sales).
•The addition of 100 MW to 200 MW of wind resources in the 2022 to 2023 timeframe.
The MPUC has granted us an extension for filing our next IRP to September 1, 2021. The extension provides additional time to assess the potential impact of two key Environmental Protection Agency (EPA) regulations: the federal Regional Haze Rule (RHR) and the Affordable Clean Energy (ACE) Rule. In connection with the extension, OTP made a supplemental filing on December 31, 2020 summarizing the results of scenario modeling evaluating RHR compliance cost options and a Coyote Station 2028 retirement scenario. The filing indicated, when modeled with externalities, that capital investments in additional environmental controls at Coyote Station does not result in the lowest-cost mix of resources for our customers. This IRP supplemental filing includes only a subset of our resource planning analysis and it is not conclusive. In addition, we cannot conclude how RHR will impact Coyote Station as key milestones remain in developing the state implementation plan in North Dakota. Finally, OTP is one of four partners in Coyote Station and cannot make a unilateral decision on its future. We expect to have more definitive information about the most cost-effective resource mix to meet customer needs when the next IRP is filed on September 1, 2021.
Capital Structure Petition
Minnesota law requires an annual filing of a capital structure petition with the MPUC. In this filing the MPUC reviews and approves OTP's capital structure. Once approved, OTP may issue securities without further petition or approval, provided the issuance is consistent with the purposes and amounts set forth in the approved petition. The MPUC approved OTP’s most recent capital structure petition on July 15, 2020, allowing for an equity-to-total-capitalization ratio between 47.5% and 58.1%, with total capitalization not to exceed $1.70 billion until the MPUC issues a new capital structure order for 2021.
OTP is subject to stringent federal and state environmental standards and regulations regarding, among other things, air, water and solid waste pollution. OTP's facilities have been designed, constructed, and as necessary, updated, to operate in compliance with applicable environmental regulations. However, new or amended laws and regulations, or changes in interpretations of current laws and regulations may require additional pollution control equipment or emission reduction measures, and there can be no assurance that our facilities will remain economic to operate. Prudent expenditures incurred to comply with environmental regulations are eligible to be recovered in rates granted by regulators in jurisdictions in which we operate; however, there can be no assurance that future costs will be granted recovery. Alternatively, additional pollution control equipment or other emission reduction measures may prove to be uneconomic with the potential to lead to an early closure of a facility.
For the five-year period ended December 31, 2020, OTP invested approximately $13.5 million, including $0.4 million in 2020, in environmental control facilities. Our 2021 and 2022 construction budgets include approximately $1.4 million and $1.2 million for such expenditures. The timing and amount of our expenditures may change as the regulatory environment changes.
Among current regulatory requirements, the Regional Haze Rule (RHR) could have the most significant impact on our operating results, financial condition and cash flows.
The EPA adopted the RHR in 1999 as an effort to improve visibility in national parks and wilderness areas. The RHR requires states, in coordination with the EPA and other governmental agencies, to develop and implement plans to work towards achieving natural visibility conditions by the year 2064. The second RHR implementation period covers the years 2018-2028, with state implementation plans to be submitted to the EPA by July 31, 2021. States are required to assess reasonable progress with the RHR and determine what additional emission reductions are appropriate, if any. Coyote Station, OTP's co-owned coal-fired power plant in North Dakota is subject to assessment in the second implementation period under the North Dakota state implementation plan. See Note 13 to our consolidated financial statements included in the report on Form 10-K for additional information.
Climate Change and Greenhouse Gas Regulation
Present and future federal, state, regional and international environmental regulations to address global climate change and reduce greenhouse gas (GHG) emissions may have a significant impact on our utility business. Combustion of fossil fuels for the generation of electricity is a considerable source of CO2 emissions, which is the primary GHG emitted by our utility operations.
Regulatory measures to address climate change continue to evolve. In January 2021, the EPA's Affordable Clean Energy Rule (ACE Rule) was vacated by the U.S. Court of Appeals for the District of Columbia Circuit and remanded to the EPA for further consideration. Future federal regulatory measures, including in response to the vacated rule ACE Rule, will be impacted by the Biden administration's priorities and objectives. While the eventual outcome of GHG regulation is unknown, we are taking steps to reduce our carbon footprint and mitigate CO2 emission levels in the process of generating electricity for our customers. Our initiatives include increasing the efficiency of our plants, adding renewable energy to our resource mix, and sponsoring energy conservation programs.
While the future financial impact of any current, proposed or pending litigation or regulation of GHG or other emissions is unknown at this time, any capital or operating costs incurred for additional pollution control equipment or emission reduction measures could materially adversely impact our future operating results, financial position and cash flows unless such costs could be recovered through related rates and/or future market prices for energy.
Contribution to Operating Revenues: 27% (2020), 30% (2019), 29% (2018)
Manufacturing consists of businesses engaged in the following activities: contract machining, metal parts stamping, fabrication and painting, and production of plastic thermoformed horticultural containers, life science and industrial packaging, and material handling components and extruded raw material stock. The following is a brief description of each of these businesses:
BTD Manufacturing, Inc. (BTD), with headquarters located in Detroit Lakes, Minnesota, provides metal fabrication services for custom machine parts and metal components through metal stamping, tool and die, machining, tube bending, welding and assembly in its facilities in Detroit Lakes and Lakeville, Minnesota, Washington, Illinois and Dawsonville, Georgia.
T.O. Plastics, Inc. (T.O. Plastics), with facilities in Otsego and Clearwater, Minnesota, manufactures extruded and thermoformed plastic products, including custom parts for customers in several industries and its own line of horticulture containers. Examples of products produced include clamshell packing, blister packs, returnable pallets and handling trays for shipping and storing odd-shaped or difficult-to-handle parts.
Our metal fabrication business primarily serves Midwestern and Southeastern U.S. manufacturers in the recreational vehicle, agricultural, oil and gas, lawn and garden, industrial and energy equipment end markets. Our plastic products business serves primarily U.S. customers in the medical and life sciences, industrial, recreational and electronics industries. The principal method of production distribution is by direct shipment to our customers through common carrier ground transportation.
No single customer or product of our manufacturing businesses accounted for 10% or more of our consolidated operating revenue in 2020. However, the top three customers combined to account for 46% of our 2020 Manufacturing segment operating revenue.
The various markets in which we compete are characterized by intense competition from both foreign and domestic manufacturers. These markets have many established manufacturers with broader product lines, greater distribution capabilities, greater capital resources, excess capacity, labor advantages and larger marketing, research and development staffs and facilities than our own.
We believe the principal competitive factors in our Manufacturing segment are product performance, quality, price, technical innovation, cost effectiveness, customer service and breadth of product line. We intend to continue to compete based on high-performance products, innovative production technologies, cost-effective manufacturing techniques, close customer relations and support, and increasing product offerings.
We use raw materials in the products we manufacture, including steel, aluminum, and polystyrene and other plastics resins. Managing price volatility and ensuring raw material availability are important aspects of our business. We attempt to pass increases in the costs of these raw materials on to our customers. Increases in the costs of raw materials that cannot be passed on to customers could have a negative effect on profit margins. Additionally, a certain amount of residual material (scrap) is a by-product of the manufacturing and production processes. Declines in commodity prices for these scrap materials due to weakened demand or excess supply can negatively impact the profitability of our Manufacturing segment as it reduces their ability to mitigate the cost associated with excess material.
Our manufacturing businesses are subject to environmental, health and safety laws and regulations, including those governing discharges to air and water, the management and disposal of hazardous substances, the cleanup of contaminated sites and health and safety matters.
Contribution to Operating Revenues: 23% (2020), 20% (2019), 22% (2018)
Plastics consists of businesses producing PVC pipe at plants in North Dakota and Arizona. The following is a brief description of these businesses:
Northern Pipe Products, Inc. (Northern Pipe), located in Fargo, North Dakota, manufactures and sells PVC pipe for municipal water, rural water, wastewater, storm drainage systems and other uses in the northern, midwestern, south-central and western regions of the United States as well as central and western Canada.
Vinyltech Corporation (Vinyltech), located in Phoenix, Arizona, manufactures and sells PVC pipe for municipal water, wastewater, water reclamation systems and other uses in the western, northwest and south-central regions of the United States.
PVC pipe is manufactured through a process known as extrusion. During this process, PVC compound (a dry powder-like substance) is introduced into an extrusion machine, where it is heated to a molten state and then forced through a sizing apparatus to produce the pipe. The newly extruded pipe is pulled through a series of water-cooling tanks, marked to identify the type of pipe and cut to finished lengths. Together our Plastic segment businesses have the current capacity to produce approximately 300 million pounds of PVC pipe annually.
PVC pipe products are marketed through a combination of independent sales representatives, company salespersons and customer service representatives. Customers for our PVC pipe products consist primarily of wholesalers and distributors and the principal method for distribution of our products is by common carrier ground transportation. No single customer of the PVC pipe companies accounted for 10% or more of our consolidated operating revenues in 2020. However, two customers combined to account for 45% of our 2020 Plastics segment operating revenue.
The plastic pipe industry is fragmented and competitive due to the number of producers, the small number of raw material suppliers and the fungible nature of the product. Due to shipping costs, competition is usually regional, instead of national, in scope. The principal factors of competition are price, customer service, and product performance. We compete not only against other plastic pipe manufacturers, but also ductile iron, steel and concrete pipe producers. Pricing pressure will continue to affect our operating margins in the future.
We will continue to compete based on our high-quality products, cost-effective production techniques and close customer relations and support.
PVC resins are acquired in bulk and shipped to our facilities by rail. There are four vendors from which we can source our PVC resin requirements. Two vendors provided over 99% of total resin purchases in 2020. The supply of PVC resin may also be limited primarily due to manufacturing capacity and the limited availability of raw material components. Most U.S. resin production plants are located in the Gulf Coast region. These plants are subject to the risk of damage and production shutdowns because of exposure to hurricanes that occur in this part of the United States. The loss of a key vendor, or any interruption or delay in the supply of PVC resin, could disrupt the ability of the Plastics segment to manufacture products, cause customers to cancel orders or result in increased expenses for obtaining PVC resin from alternative sources, if such sources were available. We believe we have good relationships with our key raw material vendors.
Due to the commodity nature of PVC resin and PVC pipe and the dynamic supply and demand factors worldwide, historically the markets for both PVC resin and PVC pipe have been very cyclical with significant fluctuations in prices and gross margins.
RISK FACTORS AND CAUTIONARY STATEMENTS
Our businesses are subject to various risks and uncertainties. Any of the risks described below or elsewhere in this report on Form 10-K or in our other SEC filings could materially adversely affect our business, financial condition, operating results and cash flows. Additional risks and uncertainties we are not presently aware of or that we currently consider immaterial may also affect our business, financial condition, operating results and cash flows.
Oversight of Risk and Related Processes
A key accountability of the Board of Directors is the oversight of material risk. Management and the Board of Directors have responsibility for overseeing the identification and mitigation of top risks. Management identifies and analyzes risks to determine the impact and other attributes such as timing, likelihood and management control. Identification and analysis occur formally through a top risk assessment conducted by senior management, the financial disclosure process, and internal auditing and compliance with financial and operational controls. Management also identifies and analyzes risk through development of goals and key performance indicators, which include risk identification to determine barriers to implementing our strategy. We promote a culture of compliance, including tone at the top. The process for risk mitigation includes adherence to our code of conduct and compliance policies, operation of formal risk management structures and overall business management to mitigate the risks inherent in the implementation of strategy. We manage and further mitigate risks through formal risk management structures, including a management executive risk committee and services such as internal audit/business risk management and legal. Management communicates regularly with our Board of Directors and key stakeholders regarding risk. Senior management presents and communicates a periodic risk assessment to our Board of Directors which provides information on the risks management believes are material, including the earnings impact, timing, likelihood and management control. The Board of Directors approaches oversight, management and mitigation of risk as an integral and continuous part of its governance of Otter Tail Corporation. The Board of Directors regularly reviews management’s top risk assessment and analyzes areas of existing and future risks and opportunities. Finally, the Board of Directors conducts an annual strategy session where our future plans and initiatives are reviewed.
The economic effects of the COVID-19 pandemic and measures taken to arrest its spread, as well as any emergency measures we take in response, could adversely impact our business, including our operating results, financial condition and liquidity.
The outbreak and global spread of COVID-19, which has been declared a pandemic by the World Health Organization, has adversely impacted economic activity and conditions worldwide and is currently impacting our business operations. The extent to which COVID-19 will continue to impact our business is highly uncertain and will depend on future developments, including the efficacy and availability of vaccines, the spread of COVID-19 variants and the extent of federal, state and local government responses affecting the economy. In particular, the COVID-19 pandemic could, among other things:
•reduce customer demand in our Manufacturing segment, where we experienced a significant but temporary decline in orders in 2020 as many of our customers temporarily closed their plants, which led to actions to reduce our operations, including furloughing of employees and eliminating positions;
•reduce customer demand in our Electric segment, including demand from commercial and industrial customers;
•reduce customer demand in our Plastics segment;
•result in lower PVC pipe sales due to potential delays or cancellation of public water and wastewater infrastructure projects caused by funding shortfalls;
•lead to disruptions of our workforce;
•force us to temporarily close certain plants or construction sites if precautions to prevent the spread of the virus at those locations are not effective;
•increase our bad debt expenses, particularly in our Electric segment;
•increase our future pension benefit cost and funding requirements;
•increase health insurance premiums;
•disrupt the supply chains, delivery systems or construction workforce related to our Electric segment maintenance requirements and capital expenditure plans, resulting in further delays and increased costs;
•disrupt global financial markets, reducing our ability to access capital necessary to finance such expenditures, and which could in the future negatively affect our liquidity; and
•result in a recession or market correction that could materially affect our business and the value of our common stock.
We continue to monitor developments involving our workforce, customers, construction contractors, suppliers and vendors and take steps to mitigate against additional impacts, but given the unprecedented and evolving nature of these circumstances, we cannot predict the full extent of the impact that COVID-19 will have on our operating results, financial condition and liquidity.
Our strategy includes large capital investments, which are subject to risks.
Our business strategy includes major capital investments at our existing companies. Our capital investment program planned for the next five years includes investments in renewable generation, transmission asset additions and upgrades, and technology and infrastructure projects. These capital projects are planned years in advance of their in-service dates and are subject to various risks including: obtaining necessary permits, licenses and approvals in a timely manner; adverse changes in regulatory treatment or public policy; changes in commodity pricing, equipment and construction costs; technology changes; delivery delays of critical materials and components; delays caused by construction accidents, injuries or public health crises; adverse weather conditions; unforeseen product defects; limited access to capital; and other adverse conditions. Capital investments in our Electric segment are subject to regulatory approval and are at risk of not being granted timely or full recovery of our investments. The inability to complete capital projects on budget and in a timely manner could adversely impact our financial condition and operating results.
Our acquisition or disposition strategies are subject to risk and may adversely impact our financial position and operating results.
As part of our business strategy, we continually assess our mix of businesses and potential strategic acquisitions or dispositions. This investment strategy is subject to various risks including the ability to identify appropriate acquisition candidates or successfully negotiate and finance any acquisitions. In addition, difficulties in integrating the operations, services, products and personnel of the acquired business, and the potential loss of key employees, customers and suppliers of the acquired business could adversely impact our financial condition and operating results.
The sale of any of our businesses may result in the recognition of a loss, if the business is sold for less than its book value and may expose us to risk arising from indemnification obligations that arose out of the conduct of the business prior to the sale. These obligations may include such things as warranty and environmental obligations or the recoverability of certain assets sold as part of the transaction. Unforeseen costs related to these obligations could impact our operating results.
Weather impacts, including normal seasonal fluctuation and extreme weather events could adversely affect our operating results.
Our Electric segment business is seasonal and weather patterns can have a material impact on our financial performance. Demand for electricity is normally greater in the winter and summer months. Unusually mild summers and winters could have an adverse effect on our financial condition and results of operations. In addition, our Plastics segment businesses are affected by weather’s impact on contractors whose work can be delayed and therefore reduce the need for PVC pipe during winter weather and extreme wet conditions.
Our businesses are located in areas that could be subject to natural disasters such as severe snow and ice storms, tornadoes, flooding and fires. These factors could result in interruption of our business and damage to our facilities. An extreme weather event within our utility service areas could directly affect our capital assets, causing disruption in service to customers and result in repair or replacement costs, due to downed wires and poles or damage to other operating equipment.
In addition to variations in seasonal weather patterns, more widespread climate change may also create physical and financial risk to our businesses. Physical risks of climate change, such as more frequent or more extreme weather events, changes in temperature and precipitation patterns, changes to ground and surface water availability, and other phenomena, could affect some or all of our operations. Severe weather or other natural disasters related to climate change could be destructive and result in increased costs and disruptions in our operations. Extreme weather conditions, such as uncommonly long periods of high or low ambient temperature, in general require more utility system backup, adding to costs and contributing to increased system stress on our utility infrastructure, which could cause service interruptions.
The loss of, or significant reduction in revenue from, any of our key customers could have an adverse effect on our operating results.
While no single customer provides more than 10% of our consolidated operating revenue, each of our segments have customers which account for over 10% of the segment’s operating revenues. In 2020, one customer accounted for 11% of Electric segment revenue, three customers combined to account for 46% of Manufacturing segment operating revenue and two customers combined to account for 45% of Plastics segment operating revenue. The loss of any one of these customers, or a significant decline in sales to these customers, would have a significant negative impact on the segment's financial position and operating results, and could have a significant negative impact on the Company’s consolidated financial position and operating results.
We are subject to counterparty credit risk.
We extend credit to our customers in the ordinary course of business in each of our operating segments. Our customers' ability to pay depends on a variety of factors including macroeconomic conditions, local economic conditions, including unemployment rates, and industry conditions in which our commercial and industrial customers operate. Increased customer delinquencies and bad debts could adversely impact our operating results and liquidity.
A cyber incident, security breach or system failure could adversely affect our business and operating results.
The operation of our business is dependent on the secure function of our computer hardware and software systems. Furthermore, all our businesses require us to collect and maintain sensitive customer data, as well as confidential employee and shareholder information, which is subject to electronic theft or loss. We also use third-party vendors to electronically process certain of our business transactions. Information systems, both ours and those of third parties, are vulnerable to security breaches by computer hackers and cyber terrorists, and the negligent or intentional breach of established controls and procedures or mismanagement of confidential information by employees. We may also be impacted by attacks and data security breaches of financial institutions, merchants or third-party processors. While we regularly conduct cybersecurity assessments, we cannot be certain our information security systems and protocols and those of our vendors and other third parties are sufficient to withstand a cyber-attack or other security breach.
A major cyber incident could result in significant expenses to investigate and repair security breaches or system damage and could lead to litigation, fines, other remedial action, heightened regulatory scrutiny and damage to our reputation. For example, we may be subject to liability under various federal, state and international data protection laws. These laws are subject to change and expansion and may require additional operational changes to comply.
The misappropriation, corruption or loss of personally identifiable information and other confidential data could lead to significant monetary damages, regulatory enforcement actions and breach notification and mitigation expenses such as credit monitoring and result in reputational damage affecting relations with shareholders, customers and regulators. In addition to property and casualty insurance which may cover restoration of data, certain physical damage or third-party injuries, we have cybersecurity insurance related to a breach event. However, damage and claims arising from such incidents may not be covered or may exceed the amount of any available insurance.
The inability to attract and retain a qualified workforce could have an adverse effect on our operations.
The success of our business heavily depends on the leadership of our executive officers and key employees to implement our strategy. In addition, all of our businesses rely on technical employees who possess certain specialized knowledge. The inability to attract and maintain a skilled and stable workforce may negatively affect our ability to service our customers, manufacture products, or successfully manage our business and achieve our objectives. Competition for skilled workers is high and can lead to increased labor expenses, decreased productivity and potentially lost business opportunities. Our ability to maintain productivity, relationships with customers, competitive costs, and quality services is limited by the ability to employ the necessary skilled personnel and could negatively affect our operating results, financial position and cash flows.
We are subject to capital market and interest rate risks.
We rely on access to debt and equity capital markets as a source of liquidity to fund our investment initiatives, including rate base growth investments in our Electric segment and opportunities for investment, including acquisitions, in our Manufacturing and Plastics segments. Capital markets are impacted by global and domestic economic conditions, monetary policy, commodity prices, geopolitical events and other factors. If we are unable to access capital on acceptable terms and at reasonable costs, our ability to implement our business plans may be adversely affected. In addition, higher market interest rates on outstanding variable-rate short-term indebtedness could also impact our operating results.
A decrease in our credit rating could increase our borrowing costs and result in additional contractual costs.
We rely on our investment grade credit ratings to provide acceptable costs for accessing the capital markets. A downgrade of our credit ratings could result in higher borrowing costs thereby negatively impacting our operating results and limiting our ability to access capital markets, which may negatively impact our ability to implement our business plans. In addition, OTP is a party to contracts that require the posting of collateral or settlement of applicable contracts if credit ratings fall below certain levels.
Our pension and other postretirement benefit plans are subject to investment and interest rate risks.
The financial obligations and related costs of our pension and other postretirement benefit plans are affected by numerous factors. Assumptions related to future costs, investment returns, actuarial estimates and interest rates have a significant effect on our funding obligations and the cost recognized for these plans. If our pension plan assets do not achieve our estimated long-term rate of return or if our other estimates prove to be inaccurate, our financial position, operating results and cash flows may be adversely impacted. In addition, our funding requirements could be impacted by changes to the Pension Protection Act.
We rely on our subsidiaries to provide sufficient earnings and cash flows to allow us to meet our financial obligations and pay dividends to our shareholders.
Otter Tail Corporation is a holding company with no significant operations of its own. The primary source of funds for payment of our financial obligations and dividends to our shareholders is from cash provided by our subsidiary companies. Our ability to meet our financial obligations and pay dividends on our common stock principally depends on the earnings, cash flows, capital requirements and general financial position of our subsidiary companies. In addition, OTP is subject to federal and state regulations which may restrict its ability to pay dividends. Finally, we are also reliant on our subsidiary companies to maintain compliance with financial covenants under our various short and long-term debt agreements. Our debt agreements include restrictions on the payment of cash dividends upon an event of default.
Changes in tax laws could materially affect our financial condition and operating results.
Our provision for income taxes and tax obligations are impacted by various tax laws and regulations, including the availability of various tax credits, IRS tax policies such as tax normalization, and at times, the ability to carryforward net operating losses. Changes in tax laws, regulations and interpretations could have an adverse effect on our financial condition and operating results. Tax law changes that reduce or eliminate production or investment tax credits may impact the economics of constructing certain electric generation resources, which may adversely impact our planned investments.
A significant impairment of our goodwill would negatively impact our financial position and operating results.
As of December 31, 2020, we had $37.6 million of goodwill recorded on our consolidated balance sheet. We have recorded goodwill for businesses in our Manufacturing and Plastics segments. Goodwill is tested for impairment annually or whenever events or changes in circumstances indicate impairment may have occurred. The goodwill impairment test requires us to estimate the fair value of the businesses being tested. Estimating the fair value of a business unit requires significant judgments and estimates, including estimates of future operating results and cash flows, among others. These estimates can be affected by numerous factors, including changes in economic, industry or market conditions, changes in business operations, changes in competition or changes in technologies. Any changes in key assumptions or material differences between actual and forecasted financial performance could affect our fair value estimates and lead to a goodwill impairment charge that could adversely affect our financial position and operating results, as well as impact compliance with financing agreement covenants.
ELECTRIC SEGMENT RISKS
General economic and industry conditions impact our business.
Several factors, many of which are beyond our control, may contribute to reduced demand for energy from our customers or increase the cost of providing energy to our customers. These risks include economic growth or decline in our service areas, demographic changes in our customer base and changes in customer demand or load growth, due to, among other items, proliferation of distributed generation, energy efficiency initiatives, and technological advancements. In addition, customer demand could be impacted by increased competition in our service territories or the loss of a service territory or franchise. Other risks include increased transmission or interconnection costs, generation curtailment, and changes in the manner in which wholesale power is purchased and sold. A decrease in revenues or an increase in expenses related to our electric operations could negatively impact our financial condition, operating results and liquidity.
Our utility business is significantly impacted by government legislation and regulation.
We are subject to federal and state legislation, government regulations and regulatory actions that may have a negative impact on our business and results of operations. The electric rates OTP is allowed to charge for its electric services are one of the most important items influencing our financial position, operating results and liquidity. The rates OTP charges its electric customers are subject to review and determination by state and federal regulators. Our ability to obtain rate adjustments to maintain reasonable rates of return depends on regulatory action under applicable statutes and regulations and we cannot provide assurance that rate adjustments will be obtained or reasonable rates of return on capital will be authorized. There is no assurance the applicable regulatory authority will judge all our costs to have been prudently incurred or that rates will produce full recovery of such costs. In addition, there could be changes in the regulatory environment that would impair the ability of OTP to recover costs historically collected from their customers. OTP will file rate cases with, or seek cost recovery authorization from, federal and state regulatory authorities. An adverse decision by one or more regulatory authorities concerning the level or method of determining electric utility rates, the authorized returns on equity, recoverability of fuel, purchase power and other costs, approval of depreciation rates, implementation of enforceable federal reliability standards or other regulatory matters, permitted business activities (such as ownership or operation of nonelectric businesses) or any prolonged delay in rendering a decision in a rate or other proceeding (including with respect to the recovery of capital expenditures in rates) could adversely impact our operating results.
Federal and state environmental regulation could require us to incur substantial capital expenditures and increased operating costs or make it no longer economically viable to operate some of our facilities.
We are subject to federal, state and local environmental laws and regulations relating to air quality, water quality, waste management, natural resources and health safety. These laws and regulations regulate the modification and operation of existing facilities, the construction and operation of new facilities and the proper storage, handling, cleanup and disposal of hazardous waste and toxic substances. Compliance with these legal requirements requires us to commit significant resources and funds toward environmental monitoring, installation and operation of pollution control equipment, payment of emission fees and securing environmental permits. Obtaining environmental permits can entail significant expense and cause substantial construction delays. Failure to comply with environmental laws and regulations, even if caused by factors beyond our control, may result in civil or criminal liabilities, penalties and fines.
Existing environmental laws or regulations may be revised, and new laws or regulations may be adopted or become applicable to us. Revised or additional regulations, which result in increased compliance costs or additional operating restrictions, particularly if those costs are not fully recoverable from customers, could have a material effect on our operating results and make it no longer economically viable to operate some of our facilities.
Legislation, regulation or other actions related to climate change, greenhouse gas emissions, and other air pollutants could materially impact us.
Current and future federal, state, regional and international regulations to address global climate change and reduce greenhouse gas GHG emissions and other air pollutants, 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 new costs, which could negatively impact our financial position, operating results and cash flows if such costs cannot be recovered through rates granted by ratemaking authorities or through increased market prices for electricity. Future federal regulatory rulemaking will be impacted by the Biden administration's priorities and objectives, which may include more stringent requirements for reducing GHG emissions and other air pollutants from existing fossil fuel-fired power plants, and other objectives that may impact our operating results, financial position or cash flows.
State implementation plans for compliance with the second implementation period of the RHR are due in mid-2021. Coyote Station, OTP's jointly-owned coal-fired power plant, is subject to assessment under the RHR as part of the state of North Dakota's state implementation plan. We cannot predict the impact the state implementation plan have on us until the plan is finalized and adopted. However, significant emission control investments could be required, or in light of the costs for such emission control equipment, there are scenarios where it may not be economically feasible to invest in such equipment and an early retirement of, or the sale of our interest in, Coyote Station would be necessary. The costs of such a retirement or sale would be material, a significant asset impairment charge could be required and OTP would be subject to state commission approval to recover such costs from customers. In addition, it may be necessary to pursue replacement electric generation facilities as an alternative, which may require incurring significant investment in new facilities that would be subject to regulatory permits and approvals.
In addition to complying with legislation and regulation, we could be subject to litigation related to climate change. 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 operating results and cash flows if the costs are not recoverable in rates or covered by insurance.
To the extent investors view climate change, fossil fuel combustion, and GHG emissions as a financial risk, our stock price or our ability to access capital markets on favorable terms and conditions could be adversely impacted.
Violations of extensive legal and regulatory compliance requirements may have a negative impact on our business and results of operations.
We are subject to an extensive legal and regulatory framework imposed under federal and state laws and regulatory agencies, including the FERC and the NERC. We could be subject to potential financial penalties for compliance violations. Our transmission systems and electric generation facilities are subject to the NERC mandatory reliability standards, including cybersecurity standards. If a serious reliability incident did occur, it could have a material effect on our operations or financial results. Some states have the authority to impose substantial penalties in the event of non-compliance. We attempt to mitigate the risk of regulatory penalties through formal training. However, there is no guarantee our compliance program will be sufficient to ensure against violations.
In addition, energy policy initiatives at the state or federal level could increase incentives for distributed generation or authorize municipal utility formation or acquisition of service territory, or local initiatives could introduce generation or distribution requirements that could change the current integrated utility model.
These laws and regulations significantly influence our operations and may affect our ability to recover costs from our customers. We are required to have numerous permits, licenses, approvals and certificates from the agencies and other organizations that regulate our business. We believe we have obtained the necessary approvals for our existing operations and that our business is conducted in accordance with applicable laws and regulatory requirements; however, we are unable to predict the impact on our operating results from the future regulatory activities of any of these agencies and other organizations. Changes in regulations or the imposition of additional regulations could have a material adverse impact on our results of operations.
Our transmission and generation facilities could be vulnerable to cyber and physical attack.
OTP owns electric transmission and generation facilities subject to mandatory and enforceable standards advanced by the NERC. These bulk electric system facilities provide the framework for the electrical infrastructure of OTP’s service territory and interconnected systems, the operation of which is dependent on information technology systems. Further, the information systems that operate OTP’s electric system are interconnected to external networks. Parties that wish to disrupt the U.S. bulk power system or OTP’s operations could view OTP’s computer systems, software or networks as attractive targets for cyber-attack.
In addition, OTP’s generation and transmission facilities are spread throughout a large service territory. These facilities could be subject to physical attack or vandalism that could disrupt OTP’s operations or conceivably the regional or U.S. bulk power system.
OTP is subject to mandatory cybersecurity and physical security regulatory requirements. OTP implements the NERC standards for operating its transmission and generation assets and stays abreast of best practices within business and the utility industry to protect its computers and computer-controlled systems from outside attack. We rely on industry accepted security measures and technology to securely maintain confidential and proprietary information necessary for the operation of our systems. In an effort to reduce the likelihood and severity of cyber intrusions, we have cybersecurity processes and controls and disaster recovery plans designed to protect and preserve the confidentiality, integrity and availability of data and systems. We also take prudent and reasonable steps to protect the physical security of our generation and transmission facilities. However, all these measures and technology may not adequately prevent security breaches or cyber-attacks or enable us to recover effectively from such a breach or attack. Any significant interruption or failure of our information systems or any significant breach of security due to cyber-attacks, hacking or internal security breaches or physical attack of our generation or transmission facilities could adversely affect our business and results of operations.
Our generating facilities are subject to operational risks that could result in unscheduled plant outages and increased costs.
The operation of electric generating facilities involves many risks, including facility shutdowns due to equipment or process failures; labor disputes; operator error; catastrophic events such as fires, explosions, and floods; the dependence on a specific fuel source; and the risk of performance below expected levels of output or efficiency. We could be subject to costs associated with any unexpected failure to produce or deliver power, including failures caused by a breakdown or forced outage, as well as repairing damages to facilities.
We rely on a limited number of suppliers to provide coal and coal transportation to our facilities. A failure to perform by any of these counterparties may arise due to liquidity challenges or insolvency, operational deficiencies, or other circumstances such as severe weather or natural disasters, which could impact our ability to provide service to our customers or require us to seek alternative sources for these products and services, if available, which could lead to increased costs adversely impacting our operating results.
Our generating facilities are subject to operational risks that could result in early closure or a sale of our interest.
Early closure of, or the sale of our interest in, a generating facility due to operational or economic factors, environmental regulation or risks of litigation could have a material adverse impact on our operating results. In the event of an early closure, a significant asset impairment charge could be required and we would be obligated to pay for costs of closure of our share of the generating facility. We may not be able to recover our remaining investment and the costs associated with the early closure, include costs associated with decommissioning, remediation, reclamation and restoration of the property, and any costs of terminating contracts associated with the generating facility, such as coal supply arrangements. In the event of a sale of our interest in a generating facility, we may not be able to negotiate the sale on favorable terms, which could result in the recognition of a loss on the sale and other potential liabilities.
The loss of a major generating facility would require OTP to identify and receive approval for other sources of generation for its customers, if available, and expose it to higher purchased power costs. In addition, OTP may not be able to obtain timely regulatory approval for new generation resources to replace closed facilities.
We are subject to risks associated with energy markets.
Our electric business is subject to the risks associated with energy markets, including market supply and changing energy prices. If we are faced with shortages in market supply, we may be unable to fulfill our contractual obligations to our retail, wholesale and other customers at previously anticipated costs. This could force us to obtain alternative energy or fuel supplies at higher costs or suffer increased liability for unfulfilled contractual obligations. Any significantly higher than expected energy or fuel costs would negatively affect our financial performance.
MANUFACTURING SEGMENT RISKS
Competition from foreign and domestic manufacturers, the price and availability of raw materials, trade policy and tariffs affecting prices and markets for raw material and manufactured products, prices and supply of scrap or recyclable material and general economic conditions could affect the revenues and earnings of our manufacturing businesses.
Our manufacturing businesses are subject to intense risks associated with competition from foreign and domestic manufacturers, many of whom have broader product lines, greater distribution capabilities, greater capital resources, larger marketing, research and development personnel and facilities and other capabilities that may place downward pressure on margins and profitability. The companies in our Manufacturing segment use a variety of raw materials in the products they manufacture, including steel, aluminum and polystyrene and other plastics resins. Costs for these items can fluctuate significantly. Federal trade policies, including imposed and proposed tariffs could significantly increase the prices and delivery of raw materials such as steel and aluminum that are critical to our manufacturing businesses. If our manufacturing businesses are not able to pass on cost increases to their customers, it could have a negative effect on profit margins in our Manufacturing segment. Additionally, a certain amount of residual material (scrap) is a by-product of the manufacturing and production processes used by our manufacturing companies. Declines in commodity prices for these scrap materials due to weakened demand or excess supply, can negatively impact the profitability of our manufacturing companies as it reduces their ability to mitigate the cost associated with excess material. Changes in macroeconomic conditions can negatively impact demand in the end-use markets for products and parts that we manufacture, resulting in reduced sales and profits. There is no assurance the initiatives underway to increase revenues and improve margins at our manufacturing businesses will be successful.
Economic conditions in the end markets in which our customers operate can have an adverse impact on our results of operations and cash flows.
Our manufacturing businesses derive a large amount of their revenues from customers in the following industry sectors: recreational vehicle/powersports, lawn and garden, construction, agriculture, energy, horticultural and life science. Factors affecting any of these industries in general, or any of our customers in particular, could adversely affect us because our net sales growth largely depends on the continued growth of our customers’ businesses in their respective industries. These factors include:
•seasonality of demand for our customers’ products which may cause our manufacturing capacity to be underutilized for periods of time;
•our customers’ failure to successfully market their products, to gain or retain widespread commercial acceptance of their products or to compete effectively in their industries;
•loss of market share for our customers’ products, which may lead our customers to reduce or discontinue purchasing our products and components and to reduce prices, thereby exerting pricing pressure on us;
•economic conditions in the markets in which our customers operate; in particular, the United States, including recessionary periods such as a global economic downturn;
•our customers’ decision to insource the production of components that has traditionally been outsourced to us; and
•product design changes or manufacturing process changes that may reduce or eliminate demand for the components we supply.
We expect future sales will continue to depend on the success of our customers. If economic conditions or demand for our customers’ products deteriorate, we may experience a material adverse effect on our business, operating results and financial condition.
Our business and operating results may be adversely affected if we are not able to maintain our manufacturing, engineering and technological expertise.
The markets for our manufacturing businesses are characterized by changing technology and evolving process development. The continued success of our businesses will depend on our ability to:
•hire, retain and expand our pool of qualified engineering and trade-skilled personnel;
•maintain technological leadership in our industry;
•implement new and expand on current robotics, automation and tooling technologies; and
•anticipate or respond to changes in manufacturing processes in a cost-effective and timely manner.
We may not be able to develop the capabilities required by our customers in the future. The emergence of new technologies, industry standards or customer requirements may render our equipment, inventory or processes obsolete or uncompetitive. We may have to acquire new technologies and equipment to remain competitive. The acquisition and implementation of new technologies and equipment may require us to incur significant expense and capital investment, which could reduce our margins and affect our operating results. When we establish or acquire new facilities, we may not be able to maintain or develop our manufacturing, engineering and technological expertise due to a lack of trained personnel, effective training of new staff or technical difficulties with machinery. Failure to anticipate and adapt to customers’ changing technological needs and requirements, to hire and retain a sufficient number of engineers, and to maintain manufacturing, engineering and technological expertise may have a material adverse effect on our businesses and operating results.
Our manufacturing operations are subject to environmental, health and safety laws and regulations that could result in liabilities to us.
Our manufacturing operations, which include painting and coating processes, are subject to environmental, health and safety laws and regulations, including those governing discharges to air and water, the management and disposal of hazardous substances, the cleanup of contaminated sites and health and safety matters. We could incur material costs, including cleanup costs, civil and criminal fines, penalties and third-party claims for cost recovery, property damage or personal injury as a result of violations of or liabilities under such laws and regulations. The ultimate cost of remediating contaminated sites, if any, is difficult to accurately predict and could exceed estimates. In addition, as environmental, health and safety laws and regulations have tended to become stricter, we could incur additional costs complying with requirements that are promulgated in the future.
PLASTICS SEGMENT RISKS
Our plastics operations are highly dependent on a limited number of vendors for PVC resin and a limited supply of PVC resin.
We rely on a limited number of vendors to supply the PVC resin used in our plastics business. Two vendors provided over 99% of our total purchases of PVC resin in 2020. In addition, the supply of PVC resin may be limited primarily due to manufacturing capacity and the limited availability of raw material components. Most U.S. resin production plants are located in the Gulf Coast region, which may increase the risk of a shortage of resin in the event of a hurricane or other natural disaster in that region. The loss of a key vendor or any interruption or delay in the availability or supply of PVC resin could disrupt our ability to deliver our plastic products, cause customers to cancel orders or require us to incur additional expenses to obtain PVC resin from alternative sources, if such sources are available.
We compete against many other manufacturers of PVC pipe and manufacturers of alternative products. Customers may not distinguish our products from those of our competitors.
The plastic pipe industry is fragmented and competitive due to the number of producers and the fungible nature of the product. We compete not only against other plastic pipe manufacturers, but also against ductile iron, steel and concrete pipe manufacturers. Due to shipping costs, competition is usually regional instead of national in scope, and the principal areas of competition are a combination of price, service, warranty, and product performance. Our inability to compete effectively in each of these areas and to distinguish our plastic pipe products from competing products may adversely affect the financial performance of our plastics business.
Changes in PVC resin prices can negatively affect our plastics business.
The PVC pipe industry is highly sensitive to commodity raw material pricing volatility. Historically, when resin prices are rising or stable, margins and sales volume have been higher and when resin prices are falling, sales volumes and margins have been lower. Changes in PVC resin prices can negatively affect PVC pipe prices, profit margins on PVC pipe sales and the value of our finished goods inventory.
External factors beyond our control can cause fluctuations in demand for our PVC pipe products and changes in our prices and margins, which could adversely impact our operating results.
Our PVC pipe products, sold through distributors and wholesalers, are primarily used in municipal and rural water projects, wastewater projects, storm drainage systems and reclamation systems. External factors beyond our control can cause volatility in raw material prices, demand for our products, prices of our product and volumes and deterioration in operating margins. These factors can magnify the impact of economic cycles on our business and results of operations. Examples of external factors include:
•general economic conditions including housing and construction markets which can be cyclical;
•increases in interest rates;
•severe weather and natural disasters;
•governmental regulation in the United States;
•funding shortages for municipal water and wastewater projects can also adversely impact demand for our products.
•pandemics and other public health threats.
GENERAL RISK FACTORS
Economic conditions could negatively impact our businesses.
Our businesses are affected by local, national and worldwide economic conditions. Tightening of credit in financial markets could adversely affect the ability of customers to finance purchases of our goods and services, resulting in decreased orders, cancelled or deferred orders, slower payment cycles, and increased bad debt and customer bankruptcies. Our businesses may also be adversely affected by decreases in the general level of economic activity, such as decreases in business and consumer spending. A decline in the level of economic activity and uncertainty regarding energy and commodity prices could adversely affect our results of operations and our future growth.
If we are unable to achieve the organic growth we expect, our financial performance may be adversely affected.
We expect much of our growth in the next few years will come from major capital investment at existing companies. To achieve the organic growth we expect, we must have access to the capital markets, be successful with capital expansion programs related to organic growth, develop new products and services, expand our markets and increase efficiencies in our businesses. Competitive and economic factors could adversely affect our ability to do this. If we are unable to achieve and sustain consistent organic growth, we will be less likely to meet our earnings growth targets, which may adversely affect the market price of our common shares.
|ITEM 1B.||UNRESOLVED STAFF COMMENTS|
The Coyote Station, which commenced operation in 1981, is a 414,000 kW (nameplate rating) mine-mouth plant located in the lignite coal fields near Beulah, North Dakota and is jointly owned by OTP, Northern Municipal Power Agency, Montana-Dakota Utilities Co. and Northwestern Public Service Company. OTP is the operating agent of the Coyote Station and owns 35% of the plant.
OTP, jointly with Northwestern Public Service Company and Montana-Dakota Utilities Co., owns the 414,000 kW (nameplate rating) Big Stone Plant in northeastern South Dakota which commenced operation in 1975. OTP is the operating agent of Big Stone Plant and owns 53.9% of the plant.
Located near Fergus Falls, Minnesota, the Hoot Lake Plant is comprised of two separate generating units: a unit built in 1959 (53,500 kW nameplate rating) and a unit added in 1964 (75,000 kW nameplate rating) and modified in 1988 to provide cycling capability, allowing this unit to be more efficiently brought online from a standby mode. These two generating units have a combined nameplate rating of 128,500 kW. Current plans are for both units to be retired from service in 2021.
OTP owns the 245,000 kW (nameplate rating) Astoria Station simple-cycle natural gas-fired combustion turbine generation facility near Astoria, South Dakota, scheduled to begin commercial operation in March 2021.
OTP owns 27 wind turbines at the Langdon, North Dakota Wind Energy Center with a nameplate rating of 40,500 kW, 32 wind turbines at the Ashtabula Wind Energy Center located in Barnes County, North Dakota with a nameplate rating of 48,000 kW, 33 wind turbines at the Luverne Wind Farm located in Griggs and Steele Counties, North Dakota with a nameplate rating of 49,500 kW and 75 wind turbines at the Merricourt Wind Energy Center located in McIntosh and Dickey Counties, North Dakota with a name plate rating of 150,000 kW.
As of December 31, 2020, OTP’s transmission facilities, which are interconnected with lines of other public utilities, consisted of 780 miles of 345 kV lines, of which 731 miles are jointly owned; 495 miles of 230 kV lines, of which 70 miles are jointly owned; 917 miles of 115 kV lines; and 4,011 miles of lower voltage lines, principally 41.6 kV. OTP owns the uprated portion of 48 miles of the 345 kV lines, with Minnkota Power Cooperative retaining title to the original 230 kV construction, and OTP owns an undivided interest in the remaining 345 kV line miles. OTP is a joint owner, with other regional utilities, in transmission lines with the following ownership interests: 14.8% in the 70 mile Bemidji-Grand Rapids 230 kV line, approximately 14.2% of 242 miles of energized line in the Fargo–Monticello 345 kV project, approximately 4.8% of 255 miles of energized line in the Brookings to Southeast Twin Cities 345 kV project, 50.0% of 72 miles of energized line in the Big Stone South–Brookings 345 kV project, and 50.0% of 162 miles of energized line in the Big Stone South–Ellendale 345 kV project.
In addition to the properties described above, all of which are utilized by the Electric segment, the Company owns and has investments in offices and service buildings utilized by each of its manufacturing and plastic pipe companies. The Company’s subsidiaries own facilities and equipment used in the manufacture of PVC pipe, thermoformed products, heavy metal fabricated products, metal parts stamping, fabricating, painting and contract machining.
Management of the Company believes the facilities and equipment described above are adequate for the Company’s present business.
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 13, "Commitments and Contingencies" to the consolidated financial statements.
|ITEM 3A.||INFORMATION ABOUT OUR EXECUTIVE OFFICERS|
Set forth below is a summary of the principal occupations and business experience during the past five years of the executive officers as defined by rules of the SEC. Each of the executive officers has been employed by the Company for more than five years in an executive or management position either with the Company or its wholly owned subsidiary, Otter Tail Power Company.
|Name and Age||Date Elected to Office||Current Position|
|Charles S. MacFarlane (56)||04/13/15||President and Chief Executive Officer|
|Kevin G. Moug (61)||04/09/01||Chief Financial Officer and Senior Vice President|
|Timothy J. Rogelstad (54)||04/14/14||Senior Vice President, Electric Platform|
|John Abbott (62)||02/11/15||Senior Vice President, Manufacturing Platform|
|Jennifer O. Smestad (50)||01/01/18||Vice President, General Counsel and Corporate Secretary|
Chuck MacFarlane has served as the Company’s President and Chief Executive Officer and as a member of the Company’s board of directors since April 13, 2015.
Kevin Moug has served as Chief Financial Officer and Senior Vice President of the Company since April 9, 2001.
Timothy Rogelstad has served as President of OTP and Senior Vice President, Electric Platform of the Company since April 14, 2014.
John Abbott has served as Senior Vice President, Manufacturing Platform, since February 5, 2015.
Jennifer Smestad was appointed to the position of Vice President, General Counsel and Corporate Secretary of the Company, effective January 1, 2018. Ms. Smestad joined the Company on May 14, 2001 as an Associate General Counsel and has served in various legal capacities of increasing responsibility at the Company and at OTP. She most recently served as General Counsel for OTP from March 1, 2013 to the present.
The term of office for each of the executive officers is one year and any executive officer elected may be removed by the vote of the board of directors at any time during the term. There are no family relationships between any of the executive officers or directors.
|ITEM 4.||MINE SAFETY DISCLOSURES|
|ITEM 5.||MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES|
Our common stock is traded on the Nasdaq Global Select Market under the Nasdaq symbol “OTTR”. As of December 31, 2020, there were approximately 12,344 holders of record of our common stock.
We do not have a publicly announced stock repurchase program and we did not repurchase any equity securities during the year ended December 31, 2020.
PERFORMANCE GRAPH COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN
This graph compares the cumulative total shareholder return on our common shares for the last five years with the cumulative return of The Nasdaq Stock Market Index and the Edison Electric Institute (EEI) Index over the same period (assuming the investment of $100 in each vehicle on December 31, 2015, and reinvestment of all dividends).
|OTTR||$||100.00 ||$||159.07 ||$||178.72 ||$||205.42 ||$||218.12 ||$||187.64 |
|EEI||$||100.00 ||$||117.44 ||$||131.19 ||$||136.02 ||$||171.09 ||$||169.10 |
|Nasdaq||$||100.00 ||$||113.01 ||$||137.17 ||$||129.71 ||$||170.14 ||$||206.32 |
|ITEM 7.||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 financial statements and the related notes appearing under Item 8 of this Form 10-K.
Otter Tail Corporation and its subsidiaries form a diverse group of businesses with operations classified into three segments: Electric, Manufacturing and Plastics. Our Electric business is a vertically integrated, regulated utility with generation, transmission and distribution facilities to serve our customers in western Minnesota, eastern North Dakota and northeastern South Dakota. Our Manufacturing segment provides metal fabrication for custom machine parts and metal components and manufactures extruded and thermoformed plastic products. Our Plastics segment manufactures PVC pipe for use in, among other applications, municipal and rural water, wastewater, and water reclamation projects.
Our strategy includes investing in rate base growth opportunities in our Electric segment and organic growth opportunities in our Manufacturing and Plastics segments. Investments in our Electric segment will lower our overall risk, create a more predictable earnings stream, improve our credit quality and preserve our ability to fund our dividend. Organic growth in our Manufacturing and Plastics segments comes from market expansion, new products and services, increased efficiencies and targeted capital investments.
All of our businesses in 2020 were confronted with operational or financial challenges resulting from the coronavirus (COVID-19) pandemic. Throughout the pandemic, we focused on maintaining the health and safety of our employees, customers and communities and ensuring continued electrical reliability and continuous delivery of products to our customers.
We expect reliable utility performance along with rate base investment opportunities over the next five years will provide us with a strong and growing base of revenues, earnings and cash flows. We also look to our manufacturing and plastic pipe companies to provide organic growth as well. Organic, internal growth comes from new products and services, market and plant expansion and increased efficiencies. We expect much of our growth in these businesses in the next few years will come from utilizing expanded plant capacity from capital investments made in previous years. We will also evaluate opportunities to allocate capital to potential acquisitions across our reporting segments. We are a committed long-term owner and do not acquire companies in pursuit of short-term gains. However, we will divest operating companies that no longer fit into our strategy and risk profile over the long term.
Our Electric segment continued the construction of rate base investments, including our Merricourt wind farm and Astoria Station natural gas combustion turbine in 2020. Merricourt is a 150-megawatt wind farm in southeastern North Dakota. Construction commenced in 2019 and the project was substantially completed in December 2020. Astoria Station is a 245-megawatt simple cycle natural gas combustion turbine generation facility near Astoria, South Dakota. Construction began in 2019 and we anticipate the facility will be in commercial operation in the first quarter of 2021. These rate base investments contributed to our Electric segment earnings growth in 2020.
The operating results of our Manufacturing segment were most significantly impacted by the effects of COVID-19 with product demand significantly decreasing in the second quarter as our customers slowed or temporarily shutdown their plant operations. Demand rebounded in certain end markets in the third and fourth quarters of 2020. Our Manufacturing businesses effectively managed their operations to meet the level of demand in the marketplace.
Our Plastic segment businesses were able to capitalize on opportunities in the marketplace arising due to supply disruptions and increasing global demand for PVC resin. Our ability to meet this demand created opportunities for increased product sales volumes and gross profit margins and resulted in a 33% increase in operating income in 2020.
In 2020 we accessed the capital markets to finance our capital investments. We issued $75.0 million of debt during 2020 and issued 1.3 million shares of common stock for net proceeds of $49.7 million under our various equity programs. Finally, we paid an annual dividend of $1.48 per share, or $60.3 million, completing our 82nd consecutive year of dividend payments to our shareholders.
Our net income in 2020 was $95.9 million, or $2.34 per diluted share, an increase of 10.4% from 2019 of $86.8 million, or $2.17 per diluted share. Our financial results were primarily driven by earnings in our Electric segment from returns on our rate base investments and management of our operating and maintenance expenses, and earnings in our Plastics segments due to increased sales volumes and gross profit margins.
Our earnings mix in 2020 was 70% from our Electric segment and 30% from the combination of our Manufacturing and Plastics segments and unallocated corporate costs. Electric segment earnings as a percentage of our total earnings were less than our long-term estimate of 75% due to very strong Plastics segment earnings in 2020.
We continue to monitor the progression of the novel coronavirus (COVID-19) and its impact on our businesses, employees, customers, construction contractors and vendors. As this pandemic continues, we are following the directives and advice of government leaders and medical professionals and have adopted practices to help curtail the spread of the virus and mitigate its impact on our communities, employees, construction contractors, customers and business operations. Our Electric segment business provides a critical service to our customers and our manufacturing businesses provide products and support to critical infrastructure industries. We continue to operate our businesses in a manner that is safe for our employees and our customers.
COVID-19 and the resulting economic conditions have had a material negative impact on the results of operations in our Manufacturing segment, and, to a lesser extent, also impacted the results of operations of our Electric and Plastics segments, but have not had a material impact on our consolidated financial position or liquidity.
Customer demand in our Manufacturing segment declined significantly in the second quarter of 2020. Sales volumes strengthened in the third and fourth quarters of the year due to strong recreational vehicle and lawn and garden end-market demand. Within our Electric segment, we experienced reduced demand from commercial and industrial customers, increased costs for bad debts, and had to manage through COVID-19-related disruptions at our construction sites, including Merricourt and Astoria Station, which posed a risk of construction delays and increased project costs. In our Plastics segment, we experienced lower sales volumes in the second quarter of 2020 as distributors reduced inventory levels given the uncertainty over the impact of COVID-19. Sales volumes recovered and gross profit margins increased in the third and fourth quarters due to increasing demand and concerns of supply disruptions.
Beginning in April 2020, in response to the actual and anticipated impact of COVID-19 on our business operations, we implemented a variety of policies, including furloughs, shift and pay reductions, wage and hiring freezes, suspension of certain employee benefits, a workforce reduction and other cost reduction efforts to mitigate the negative impact to our financial results. We continued to monitor the impacts of the pandemic on our businesses throughout the remainder of 2020 and adjusted our response as circumstances evolved.
We expect COVID-19 and the resulting economic conditions will continue to impact demand from commercial and industrial customers within our Electric segment and could disrupt customer demand within our Manufacturing and Plastics segments as the pandemic evolves. We also expect bad debt costs within our Electric segment will remain elevated due to the economic disruption created by the pandemic. COVID-19 also could cause disruptions in our capital expenditure plans, including project delays and increased project costs.
We continue to monitor developments involving our workforce, customers, construction contractors, suppliers and vendors and the financial effects on our business. However, due to the unprecedented and evolving nature of this pandemic, we cannot predict the full extent COVID-19 will have on our results of operations, financial condition and liquidity.
|FINANCIAL AND OTHER METRICS|
Heating Degree Days (HDDs) is a measure of how much (in degrees), and for how long (in days), the outside air temperature was below a certain normalized level. This measure is commonly used in calculations relating to the energy consumption required to heat buildings.
Cooling Degree Days (CDDs) is a measure of how much (in degrees), and for how long (in days), the outside air temperature was above a certain normalized level. This measure is commonly used in calculations relating to the energy consumption required to cool buildings.
Otter Tail Power Company (OTP) generally bases its forecasted kilowatt-hour (kwh) sales and rates on expected consumption under a normal level of HDDs and CDDs over a given period of time in its service territory. Increased or decreased levels of consumption for certain customer classifications are attributed to deviation from the norms and are a significant factor influencing consumption of electricity across our service territory. We present HDDs and CDDs to provide an indication of the impact of weather on kwh sales, revenues and earnings relative to forecast and on period-to-period results.
Utility Rate Base is the value of property on which a public utility is permitted to earn a specified rate of return in accordance with rules set by a regulatory agency. In general, the rate base consists of the value of property used by the utility in providing service. Rate base can also include: cash, working capital, materials and supplies, deductions for accumulated provisions for depreciation, contributions in aid of construction, customer advances for construction, accumulated deferred income taxes, and accumulated deferred investment tax credits, dependent on the method that is used in the calculation, which can vary from jurisdiction to jurisdiction. We present actual and forecasted levels of utility rate base in our outlook to provide an indication of expected investments on which we expect to earn future returns.
For a comparison of fiscal year 2019 to 2018, see Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our report on Form 10-K for the fiscal year ended December 31, 2019, filed with the SEC on February 20, 2020 and incorporated by reference into this report on Form 10-K.
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. Intersegment transactions were not material in 2020 or 2019 and amounted to less than $0.1 million of operating revenues and operating expenses for each year. In addition to the segment results, we provide an overview of our Corporate costs. Our Corporate costs do not constitute a reportable segment but rather consist of unallocated general corporate expenses, such as corporate staff and overhead costs, the results of our captive insurance company and other items excluded from the measurement of segment performance. Corporate costs are added to operating segment totals to reconcile to totals on our consolidated statements of income.
The following table summarizes our consolidated results of operations for the years ended December 31, 2020 and 2019:
|(in thousands)||2020||2019||$ change||% change|
|Operating Revenues||$||890,107 ||$||919,503 ||$||(29,396)||(3.2)||%|
|Operating Expenses||742,221 ||784,623 ||(42,402)||(5.4)|
|Operating Income||147,886 ||134,880 ||13,006 ||9.6 |
|Interest Charges||34,447 ||31,411 ||3,036 ||9.7 |
|Nonservice Cost Components of Postretirement Benefits||3,437 ||4,293 ||(856)||(19.9)|
|Other Income||6,055 ||5,112 ||943 ||18.4 |
|Income Before Income Taxes||116,057 ||104,288 ||11,769 ||11.3 |
|Income Tax Expense||20,206 ||17,441 ||2,765 ||15.9 |
|Net Income||$||95,851 ||$||86,847 ||$||9,004 ||10.4 ||%|
Operating Revenues decreased $29.4 million primarily due to reduced demand in our Manufacturing segment as our customers were impacted by the economic effects of COVID-19. In addition, Electric segment operating revenues were impacted by lower recoveries of decreased fuel and purchased power costs and the impact of unfavorable weather, but partially offset by operating revenues earned on our rate base investments. Plastics segment revenue increased in 2020 due to favorable market conditions benefiting sales volumes and prices. See our segment disclosures below for additional discussion of items impacting operating revenues.
Operating Expenses decreased $42.4 million in 2020 primarily due to lower costs of products sold in our Manufacturing segment as a result of the reduced sales volumes and lower fuel and purchased power costs in our Electric segment. Partially offsetting these decreases were higher costs of products sold in our Plastics segment due to increased sales volumes in 2020 and an increase in committed contributions to our charitable foundations. See our segment disclosures below for additional discussion of items impacting operating expenses.
Interest Charges increased $3.0 million in 2020 due to debt issuances in our Electric segment in the fourth quarter of 2019 and the first and third quarters of 2020, and increased outstanding borrowings under our short-term debt arrangements. The increase in our short and long-term debt borrowings were largely used to finance the rate base investments in our Electric segment.
Nonservice Cost Components of Postretirement Benefits decreased $0.9 million in 2020 mostly due to a decrease in pension plan nonservice costs, mainly actuarial loss amortization expenses, partially offset by interest cost increases on postretirement benefit plans.
Other Income increased $0.9 million in 2020 due to a $1.5 million increase in allowance for equity funds used during construction (AFUDC) on Electric segment construction work in progress, mainly for the Minnesota share of the Astoria Station project, partially offset by $0.6 million of decreases in the cash values of corporate-owned life insurance policies, interest income and other miscellaneous income.
Income Tax Expense increased $2.8 million in 2020 primarily due to increased income before income taxes along with reductions in certain permanent differences. These increases were partially offset by production tax credits generated in 2020 from our Merricourt wind farm placed in service in the fourth quarter of 2020. Our effective tax rate was 17.4% in 2020 and 16.7% in 2019. See Note 12 to our consolidated financial statements included in the report on Form 10-K for additional information regarding factors impacting our effective tax rate in 2020 and 2019.
ELECTRIC SEGMENT RESULTS
The following table summarizes the results of operations for our Electric segment for the years ended December 31, 2020 and 2019:
|(in thousands)||2020||2019||$ change||% change|
|Retail Sales Revenue||$||389,522 ||$||406,478 ||$||(16,956)||(4.2)||%|
|Transmission Services Revenues||44,001 ||40,542 ||3,459 ||8.5 |
|Wholesale Revenues||4,857 ||5,007 ||(150)||(3.0)|
|Other Electric Revenues||7,750 ||7,070 ||680 ||9.6 |
|Total Operating Revenue||446,130 ||459,097 ||(12,967)||(2.8)|
|Production Fuel||46,296 ||59,256 ||(12,960)||(21.9)|
|Purchased Power||61,698 ||72,066 ||(10,368)||(14.4)|
|Operation and Maintenance Expenses||150,848 ||153,529 ||(2,681)||(1.7)|
|Depreciation and Amortization||63,171 ||60,044 ||3,127 ||5.2 |
|Property Taxes||17,034 ||15,785 ||1,249 ||7.9 |
|Operating Income||$||107,083 ||$||98,417 ||$||8,666 ||8.8 ||%|
Electric kilowatt-hour (kwh) Sales (in thousands)
| || |
|Retail kwh Sales||4,776,687 ||4,969,089 ||(192,402)||(3.9)||%|
|Wholesale kwh Sales – Company Generation||236,528 ||198,569 ||37,959 ||19.1 |
|Heating Degree Days||6,174 ||7,240 ||(1,066)||(14.7)|
|Cooling Degree Days||534 ||392 ||142 ||36.2 |
Results of operations for the 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.
|Heating Degree Days||97.2 ||%||115.6 ||%|
|Cooling Degree Days||116.3 ||%||85.0 ||%|
The following table summarizes the estimated effect on diluted earnings per share of the difference in retail kwh sales under actual weather conditions and expected retail kwh sales under normal weather conditions in 2020 and 2019, and between years.
|Effect on Diluted Earnings Per Share||$||— ||$||(0.08)||$||0.08 |
Retail Sales Revenue decreased $17.0 million driven by:
•A $25.6 million decrease in revenue related to the recovery of decreased fuel and purchased power costs to serve retail customers. Decreased demand caused by the milder winter weather and COVID-19-related impacts on our commercial and industrial customers contributed to a 19.0% decrease in kwhs generated for system use. Purchased power costs decreased, despite a 6.9% increase in kwhs purchased, due to a 19.9% decrease in purchased power prices resulting from a decrease in market demand between periods.
•A $4.4 million decrease in revenue related to decreased kwh consumption due to milder winter weather in 2020 compared with 2019, reflected in the 14.7% decrease in HDDs in 2020 compared with 2019. The decrease in consumption due to the decrease in HDDs was only partially offset by an increase in consumption related to a 36.2% increase in CDDs in the summer of 2020 compared with the summer of 2019.
•A $2.9 million decrease due to decreased kwh sales to commercial and industrial customers mainly due to COVID-19-related impacts in 2020.
These decreases in revenue were partially offset by:
•An $11.0 million increase in Minnesota and North Dakota Renewable Rider Adjustment revenues related to earning a return on funds invested in Merricourt while the project was under construction.
•A $3.1 million increase in revenues from the North Dakota Generation Rider which went into effect in July 2019 to provide a return on funds invested in Astoria Station while the generation project is under construction.
•A $1.0 million increase due to a positive price variance arising from variances in sales under different tariffs.
•An $0.8 million increase in Conservation Improvement Program (CIP) and transmission cost recovery revenues.
Transmission Services Revenues increased $3.5 million due to increases of $1.9 million in transmission tariff revenues and $1.6 million in revenues from the recovery of infrastructure investment costs from interconnected generators.
Other Electric Revenue increased $0.7 million, which includes $1.9 million from the recovery of infrastructure investment costs from a large commercial customer in 2020, partially offset by a $1.2 million decrease in revenue from steam sales to an ethanol producer driven by lower natural gas prices resulting in the producer switching to an alternative generation source to meet its steam requirements.
Production Fuel costs decreased $13.0 million mainly as a result of a 22.0% decrease in kwhs generated from our fuel-burning plants due to lower customer demand and a 6.9% increase in kwh purchases for system use. Decreased system demand and lower prices for alternative fuels and generation sources, which drove market prices for electricity down in 2020, contributed to decreases in generation of 37.7% at Big Stone Plant and 36.7% at Hoot Lake Plant. These decreases were partially offset by a 13.7% increase in generation at Coyote Station, which was offline for maintenance during the entire second quarter of 2019.
Purchased Power costs to serve retail customers decreased $10.4 million as a result of a 19.9% decrease in purchased power prices, partially offset by a 6.9% increase in kwhs purchased. The increase in kwhs purchased was mainly due to a decrease in market prices for electricity in 2020 driven by low prices for natural gas-fired generation in combination with lower demand in 2020 due to COVID-19-related declines in electricity use by commercial and industrial consumers.
Operating and Maintenance Expense decreased $2.7 million mainly due to:
•A $2.8 million decrease in contracted services and materials and supplies expenses, mainly related to the Coyote Station's extended maintenance outage and Hoot Lake Plant turbine repairs in the second quarter of 2019 with no comparable expenses in 2020.
•A $2.7 million decrease in transmission tariff expenses related to decreased rates.
•A $1.3 million decrease in travel, meals and employee education expenses due to COVID-19-related travel restrictions.
•A $0.8 million decrease in pollution control reagent costs due to a 22.4% decrease in kwhs generated at Otter Tail Power Company's coal- burning plants.
These decreases in expense were partially offset by:
•A $2.0 million increase in customer bad debt expense provisions, mainly due to adoption of COVID-19-related service suspension and debt collection policies and financial constraints on some customers due to COVID-19.
•A $1.0 million increase in contribution commitments to Otter Tail Power Company's charitable foundation.
•A $0.6 million increase in land easement payments related to Merricourt.
•A $0.6 million increase in CIP expenditures.
•A $0.5 million increase in labor and benefit costs.
Depreciation and Amortization expense increased $3.1 million mainly due to 2019 capital additions for generation and transmission plant, a new customer information system, and the inception of depreciation of Merricourt assets in the fourth quarter of 2020.
Property Taxes increased $1.2 million due to property additions and increased valuations on existing property.
MANUFACTURING SEGMENT RESULTS
The following table summarizes the results of operations for our Manufacturing segment for the years ended December 31, 2020 and 2019:
|(in thousands)||2020||2019||$ change||% change|
|Operating Revenues||$||238,769 ||$||277,204 ||$||(38,435)||(13.9)||%|
|Cost of Products Sold||180,432 ||215,179 ||(34,747)||(16.1)|
|Other Operating Expenses||27,301 ||29,895 ||(2,594)||(8.7)|
|Depreciation and Amortization||14,933 ||14,261 ||672 ||4.7 |
|Operating Income||$||16,103 ||$||17,869 ||$||(1,766)||(9.9)||%|
Operating Revenues decreased $38.4 million primarily due to the following:
•At BTD, revenues decreased $37.3 million. Parts revenue was down $37.5 million, mainly due to decreased sales volumes across all end markets served by BTD, in order of magnitude: construction, industrial and energy equipment, lawn and garden, recreational vehicle and agricultural end markets. The decreased sales mainly resulted from customers implementing temporary plant shutdowns due to the COVID-19 pandemic. Lower prices related to the pass through of lower material costs accounted for an $18.5 million decrease in parts revenue, partially offset by $1.7 million in revenue increases due to product mix exclusive of the pass through of material cost reductions.
•At T.O. Plastics, revenues decreased $1.1 million. A $1.3 million increase in horticultural product sales was more than offset by decreases of $1.7 million in life science product sales, $0.5 million in industrial sales and $0.2 million in extrusion sales. However, COVID-19 had a negative impact on life science product sales as elective and non-critical surgeries and medical procedures were cancelled or delayed. Industrial product sales decreased due to COVID-19-related impacts on customer’s sales and service activities.
Cost of Products Sold decreased $34.7 million due to the following:
•Cost of products sold at BTD decreased $34.2 million as a result of both the decreased sales volume and the $18.5 million in lower material costs passed through to customers, but also due to labor cost decreases due to second quarter 2020 workforce reductions.
•Cost of products sold at T.O. Plastics decreased $0.6 million due to a $2.1 million decrease in material costs related to the decrease in sales volume, mostly offset by increases in other indirect costs and an increase in rental costs for more warehouse space.
Other Operating Expenses decreased $2.6 million primarily due to a $2.1 million decrease in operating expenses at BTD, mainly due to reductions in travel and outside services expenditures related to initiatives taken at BTD to mitigate the negative impacts on sales related to COVID-19. Operating expenses at T.O. Plastics decreased $0.5 million, including a $0.3 million write off of the value of destroyed property in 2019 related to the March 2019 partial roof collapse. T.O. Plastics travel and other selling expenses decreased by $0.2 million due to restrictions on activity in response to COVID-19-related safety initiatives.
BTD incurred $1.0 million in termination costs in the second quarter of 2020, with $0.9 million charged to cost of products sold and $0.1 million charged to operating expense, related to headcount reductions across all its sites in response to the ongoing reduction in sales volume.
Depreciation and Amortization increased $0.7 million due to an increase of $0.4 million at BTD related to recent investments in equipment and tooling, and a $0.3 million increase at T.O. Plastics including several large tooling and equipment projects and the addition of a pelletizer room.
PLASTICS SEGMENT RESULTS
The following table summarizes the results of operations for our Plastics segment for the years ended December 31, 2020 and 2019:
|(in thousands)||2020||2019||$ change||% change|
|Operating Revenues||$||205,249 ||$||183,257 ||$||21,992 ||12.0 ||%|
|Cost of Products Sold||148,835 ||139,974 ||8,861 ||6.3 |
|Other Operating Expenses||14,987 ||11,393 ||3,594 ||31.5 |
|Depreciation and Amortization||3,604 ||3,451 ||153 ||4.4 |
|Operating Income||$||37,823 ||$||28,439 ||$||9,384 ||33.0 ||%|
Operating Revenues increased $22.0 million due to an 8.0% increase in pounds of PVC pipe sold in combination with a 3.7% increase in the price per pound sold. The sales volume increase resulted from improved market conditions during the third and fourth quarters of 2020 driven by strong construction markets and concerns over raw material supply and product availability due to two resin suppliers invoking force majeure, anticipated impacts from hurricanes, significant global demand for PVC resin and limited pipe inventory across the country.
Cost of Products Sold increased $8.9 million due to the increase in sales volume, partially offset by a 1.5% decrease in the cost per pound of PVC pipe sold primarily due to lower material input costs.
Other Operating Expenses increased $3.6 million including a $2.0 million contribution commitment to Otter Tail Corporation’s charitable foundation in 2020 and additional increases in other expenses, primarily performance-based compensation.
The following table summarizes Corporate results of operations for the years ended December 31, 2020 and 2019:
|(in thousands)||2020||2019||$ change||% change|
|Other Operating Expenses||$||12,794 ||$||9,515 ||$||3,279 ||34.5 ||%|
|Depreciation and Amortization||329 ||330 ||(1)||(0.3)|
|Operating Loss||$||13,123 ||$||9,845 ||$||3,278 ||33.3 ||%|
Other Operating Expenses increased $3.3 million mainly as a result of a $2.5 million contribution commitment to Otter Tail Corporation’s charitable foundation in 2020 and a $1.5 million increase in labor and benefit expenses, partially offset by a $0.6 million decrease in corporate costs charged to subsidiaries.
The following provides a summary of our current general rates and a summary of recent rate case filings and rate rider filings that have or are expected to have a material impact on our operating results, financial position or cash flows.
The following includes a summary of electric base rates as determined in OTP's most recent general rate case in each state:
|Jurisdiction||Date||(in millions)||Rate Base||on Equity||Ratio|
|Minnesota||06/01/19||$||198.6 ||7.51 ||%||9.41 ||%||52.50 ||%|
|North Dakota||02/01/19||153.1 ||7.64 ||9.77 ||52.50 |
|08/01/19||35.5 ||7.09 ||8.75 ||52.92 |
|(1) Includes an earnings sharing mechanism to share with South Dakota customers any weather-normalized earnings above the authorized ROE of 8.75%. The mechanism requires annual customer refunds of 50% of any weather-normalized revenue creating earnings in excess of the authorized ROE up to a maximum of 9.50% and 100% refunds revenue creating earnings above 9.50%.|
Minnesota Rate Case: On November 2, 2020, OTP filed a request with the MPUC for an increase in revenue recoverable under general rates in Minnesota. In its filing, OTP requested a net increase in annual revenue of approximately $14.5 million, or 6.77%, based on an allowed rate of return on rate base of 7.59% and an allowed rate of return on equity of 10.20% on an equity ratio of 52.5% of total capital. Through this proceeding, OTP has proposed changes to the mechanism of cost recovery, with some costs moving from riders into base rates and fuel, and purchased power and conservation program costs moving out of base rates and into riders. The filing also included a revenue decoupling mechanism proposal. Such mechanisms are designed to separate a utility's revenue from changes in energy sales. The decoupling mechanism uses a tracker balance in which authorized customer margins are subject to a true-up mechanism to maintain or cap a given level of revenues.
On December 3, 2020, the MPUC approved an interim annual rate increase of $6.9 million, or 3.2%, effective January 1, 2021. This approval was provided after an alternative recovery proposal was submitted by OTP, which, among other changes, requested the extension of depreciable lives of certain wind-related assets and deferred certain cost recovery decisions to the final rate determination. In the aggregate, this alternative recovery proposal reduced operating costs and delayed recovery of certain other costs by approximately $7.0 million to lessen the interim rate impact on customers.
The following table includes a summary of pending and recently concluded rate rider proceedings:
|RRR - 2019||MN||Approved||06/21/19||$||12.5 ||01/01/20||Includes return on Merricourt construction costs.|
|TCR - 2018||MN||Approved||05/07/20||10.3 ||01/21/20||See below for additional details.|
|RRR - 2020||ND||Approved||03/18/20||5.8 ||04/01/20||Includes return on Merricourt construction costs.|
|GCR - 2020||ND||Approved||06/10/20||6.2 ||07/01/20||Includes return on Astoria Station construction costs.|
|TCR - 2020||ND||Approved||08/31/20||5.6 ||01/21/20||Includes recovery of new transmission assets.|
|TCR - 2020||SD||Approved||01/29/20||2.3||03/02/20||Annual update to transmission cost recovery rider.|
|PIR - 2020||SD||Approved||05/31/20||1.6||09/01/20||Includes return on Merricourt and Astoria Station construction costs.|
|TCR - 2021||ND||Approved||11/18/20||5.6||01/01/21||Includes recovery of eight new transmission projects.|
|RRR - 2021||ND||Requested||12/31/20||11.8||— ||Includes return on Merricourt construction costs.|
|TCR - 2021||SD||Requested||10/30/20||2.2||— ||Includes recovery of two new transmission projects.|
Minnesota TCR: On May 1, 2017, the MPUC ordered OTP to include in the TCR rider retail rate base the Minnesota jurisdictional share of OTP's investments in certain transmission assets and all revenues received from other utilities under MISO's tariffed rates as a credit in its TCR revenue requirement calculations. The order had the effect of diverting interstate wholesale revenues that have been approved by the FERC to offset the FERC-approved expenses, effectively reducing OTP's recovery of FERC-approved expense levels.
On August 18, 2017, OTP filed an appeal of the MPUC order with the Minnesota Court of Appeals to contest the portion of the order requiring OTP to jurisdictionally allocate costs of the FERC transmission projects in the TCR rider. On June 11, 2018, the Minnesota Court of Appeals reversed the MPUC's order. On July 11, 2018 the MPUC filed a petition for review of the decision to the Minnesota Supreme Court, which granted review of the appellate court decision. The Minnesota Supreme Court issued its opinion on April 22, 2020, concluding the MPUC lacked authority to amend an existing TCR rider approved under Minnesota state law to include the costs and revenues associated with these transmission projects and affirming the decision of the Minnesota Court of Appeals.
On October 22, 2020, the MPUC approved OTP's request for a Minnesota TCR rider update with the exclusion of these transmission projects. In addition, the MPUC approved the inclusion of three new projects previously requested in the Minnesota TCR rider eligibility petition. Updated rates went into effect in January 2021. With this decision, one-half of the projected TCR rider tracker balance at December 2020 of $13.4 million will be included in the 2021 TCR rider annual revenue requirement, with the remainder included in the next annual update. The annual updates provide for recovery of approximately $2.6 million in MISO revenues credits to Minnesota customers through the TCR rider prior to September 30, 2020. As a result, OTP recognized additional rider revenue of $2.6 million during the year ended December 31, 2020.
We believe our financial condition is strong and our cash, other liquid assets, operating cash flows, existing lines of credit, access to capital markets, and borrowing ability because of investment-grade credit ratings, when taken together, provide us ample liquidity to conduct business operations and fund capital expenditures related to expansion of existing businesses and development of new projects. Our liquidity, including our operating cash flows and access to capital markets, can be impacted by macroeconomic factors outside of our control, such as those which may be caused by COVID-19. In addition, our liquidity could be impacted by non-compliance with covenants under our various debt instruments. As of December 31, 2020, we were in compliance with all debt covenants (see the Financial Covenant section under Capital Resources below).
We continue to have sufficient liquidity under our credit facilities to support our business based on the current economic environment. We are closely monitoring our liquidity and capital market conditions given the uncertainty surrounding the impact of COVID-19, which could have an adverse effect on the availability and terms of future debt and equity financing.
The following table presents the status of our lines of credit as of December 31, 2020 and 2019:
|(in thousands)||Line Limit||Amount Outstanding||Letters |
|Amount Available||Amount Available|
|Otter Tail Corporation Credit Agreement||$||170,000 ||$||65,166 ||$||— ||$||104,834 ||$||164,000 |
|OTP Credit Agreement||170,000 ||15,831 ||14,101 ||140,068 ||154,524 |
|Total||$||340,000 ||$||80,997 ||$||14,101 ||$||244,902 ||$||318,524 |
We have an internal risk tolerance metric to maintain a minimum of $50 million of liquidity under the Otter Tail Corporation 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 $250 million, subject to certain terms and conditions.
The following is a discussion of our cash flows for the years ended December 31, 2020 and 2019:
|Net Cash Provided by Operating Activities||$||211,921 ||$||185,037 |
Net Cash Provided by Operating Activities increased $26.9 million primarily due to a $9.0 million increase in net income, a $11.3 million decrease in discretionary contributions to our funded pension plan and a $10.3 million reduction in working capital. Our working capital decrease was primarily the result of increased accounts payable due to increased construction program costs in our Electric segment. Our working capital level was also impacted by a decrease in inventories in our Manufacturing segment due to strong sales volumes in the fourth quarter of 2020 and increased outstanding receivables of $6.3 million primarily from our Manufacturing and Plastics segments due to strong sales volumes in the fourth quarter of 2020. Our average collection period on outstanding receivables on a consolidated basis increased from approximately 31 days in 2019 to approximately 34 days in 2020.
|Net Cash Used in Investing Activities||$||375,652 ||$||209,472 |
Net Cash Used in Investment Activities increased $166.2 million driven by our Electric segment capital investment plan, including construction of our Merricourt and Astoria Station projects.
|Net Cash Provided by Financing Activities||$||143,695 ||$||44,773 |
Net Cash Provided by Financing Activities increased $98.9 million as we issued debt and equity in 2020 and increased borrowings under our short-term debt agreements primarily to finance our Electric segment capital investments. We issued $75.0 million of long-term debt in 2020 and increased borrowings under our short-term debt arrangements by $75.0 million. In addition, we raised net proceeds of $49.7 million from issuances of common shares under our various equity programs, including our At-the-Market offering program and our Automatic Dividend Reinvestment and Share Purchase Plan. We also paid $60.3 million in common dividends in 2020. Financing activities in 2019 included the issuance of $100 million of long-term debt and the issuance of common shares generating net proceeds of $17.0 million. Proceeds from these debt and equity issuances were used to fund Electric segment construction costs and repay $12.6 million in short-term debt. We paid $55.7 million in common dividends in 2019.
We have a capital expenditure program for expanding, upgrading and improving our plants and operating equipment. Typical uses of cash for capital expenditures are investments in electric generation facilities and environmental upgrades, transmission and distribution lines, manufacturing facilities and upgrades, equipment used in the manufacturing process, and computer hardware and information systems. The capital expenditure program is subject to review and is revised in light of changes in demands for energy, technology, environmental laws, regulatory changes, business expansion opportunities, the costs of labor, materials and equipment and our financial condition.
The following provides a summary of capital expenditures for the years ended December 31, 2020 and 2019 for our Electric segment and non-electric businesses and anticipated capital expenditures for the five year period 2021 through 2025:
|Electric Segment:|| || || || || || || |
|Renewables and Natural Gas Generation||$||31 ||$||104 ||$||3 ||$||1 ||$||1 ||$||140 |
|Technology and Infrastructure||6 ||25 ||32 ||28 ||18 ||109 |
|Distribution Plant Replacements||24 ||27 ||30 ||30 ||27 ||138 |
|Transmission (includes replacements)||23 ||25 ||31 ||30 ||29 ||138 |
|Other||29 ||30 ||25 ||23 ||21 ||128 |
|Total Electric Segment||$||187 ||$||357 ||$||113 ||$||211 ||$||121 ||$||112 ||$||96 ||$||653 |
|Manufacturing and Plastics Segments||20 ||15 ||20 ||20 ||36 ||15 ||18 ||109 |
|Total Capital Expenditures||$||207 ||$||372 ||$||133 ||$||231 ||$||157 ||$||127 ||$||114 ||$||762 |
|Total Electric Utility Average Rate Base||$||1,170 ||$||1,385 ||$||1,585 ||$||1,630 ||$||1,720 ||$||1,754 ||$||1,769 |
|Rate Base Growth||14.4 ||%||2.8 ||%||5.5 ||%||2.0 ||%||0.9 ||%|
The following table summarizes our contractual obligations at December 31, 2020 and the effect these obligations are expected to have on our liquidity and cash flow in future periods.
|(in millions)||Total||Less than|
|Debt Obligations||$||848 ||$||221 ||$||30 ||$||— ||$||597 |
|Coal Contracts||573 ||23 ||47 ||49 ||454 |
|Interest on Debt Obligations||484 ||35 ||55 ||54 ||340 |
|Other Purchase Obligations (including land easements)||77 ||33 ||4 ||4 ||36 |
|Capacity and Energy Requirements||184 ||16 ||24 ||24 ||120 |
|Postretirement Benefit Obligations||118 ||4 ||11 ||12 ||91 |
|Operating Lease Obligations||22 ||5 ||8 ||6 ||3 |
|Total Contractual Cash Obligations||$||2,306 ||$||337 ||$||179 ||$||149 ||$||1,641 |
Coal contract obligations are based on estimated coal consumption and costs for the delivery of coal to Coyote Station from Coyote Creek Mining Company under the lignite sales agreement that ends in 2040. Postretirement benefit obligations include estimated cash expenditures for the payment of retiree medical and life insurance benefits and supplemental pension benefits under our unfunded Executive Survivor and Supplemental Retirement Plan, but do not include amounts to fund our noncontributory funded pension plan, as we are not currently required to make a contribution to that plan.
COMMON STOCK DIVIDENDS
We paid dividends to our common stockholders totaling $60.3 million, or $1.48 per share, in 2020. The determination of the amount of future cash dividends to be paid will depend on, among other things, our financial condition, improvement in earnings per share, cash flows from operations, the level of our capital expenditures and our future business prospects. As a result of certain statutory limitations or regulatory or financing agreements, restrictions could occur on the amount of distributions allowed to be made by our subsidiaries. See note 14 to our consolidated financial statements included in this report on Form 10-K for additional information. The decision to declare a dividend is reviewed quarterly by our Board of Directors. On February 1, 2021 our Board of Directors increased the quarterly dividend from $0.37 to $0.39 per common share.
Financial flexibility is provided by operating cash flows, unused lines of credit, strong financial coverages, investment grade credit ratings, and alternative financing arrangements such as leasing. Equity or debt financing will be required in the period 2021 through 2025 given the expansion plans related to our Electric segment to fund construction of new rate base and transmission investments, in the event we decide to reduce borrowings under our lines of credit, to refund or retire early any of our presently outstanding debt, to complete acquisitions or for other corporate purposes.
On May 3, 2018 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 through the expiration date of May 3, 2021.
On November 8, 2019 we entered into a Distribution Agreement with KeyBank under which we may offer and sell our common shares from time to time through KeyBank, as our distribution agent, up to an aggregate sales price of $75.0 million through an At-the-Market offering program. In 2020, we received proceeds of $37.0 million1, net of commissions paid to KeyBank of $0.5 million1 from the issuance of 868,4841 shares under this program. In total from the inception of the program through December 31, 2020, we have received proceeds under this program of $54.4 million.
On May 3, 2018 we also filed a shelf registration statement with the SEC for the issuance of up to 1,500,000 common shares under our Automatic Dividend Reinvestment and Share Purchase Plan (the Plan), which permits shares purchased by participants in the Plan to be either new issue common shares or common shares purchased in the open market. The shelf registration for the Plan expires on May 3, 2021. In 2020, we issued 320,173 shares for proceeds of $13.4 million under the Plan. As of December 31, 2020, 899,859 shares remain available for purchase or issuance under the Plan.
We intend to file new shelf registration statements in 2021 following the expiration of our current registration statements on May 3, 2021.
Otter Tail Corporation and Otter Tail Power Company are each party to a credit agreement (the OTC Credit Agreement and OTP Credit Agreement, respectively) which provide for unsecured revolving lines of credit. The agreements generally bear interest at LIBOR plus an applicable credit spread, which is subject to adjustment based on the credit ratings of the issuer. The LIBOR credit spread for the OTC Credit Agreement and OTP Credit Agreement was 1.50% and 1.25%, respectively, at December 31, 2020.
The following is a summary of key provisions and borrowing information as of and for the year ended December 31, 2020:
|(in thousands, except interest rates)||OTC Credit Agreement||OTP Credit Agreement|
|Borrowing Limit||$||170,000 ||$||170,000 |
Borrowing Limit if Accordion Exercised1
|290,000 ||250,000 |
|Amount Restricted Due to Outstanding Letters of Credit at Year-End||— ||14,101 |
|Amount Outstanding at Year-End||65,166 ||15,831 |
|Average Amount Outstanding During Year||32,355 ||734 |
|Maximum Amount Outstanding During the Year||65,166 ||15,831 |
|Interest Rate at Year-End||1.6 ||%||1.4 ||%|
|Maturity Date||October 31, 2024||October 31, 2024|
1Each facility includes an accordion featuring allowing the borrower to increase the borrowing limit if certain terms and conditions are met.
At December 31, 2020, we had $767.2 million of principal outstanding under long-term debt arrangements. Note 9 to our consolidated financial statements included in this report on Form 10-K includes information regarding these instruments. The agreements generally provide for unsecured borrowings at fixed rates of interest with maturities ranging from 2021 to 2050. One OTP debt instrument with a principal balance of $140.0 million matures in December 2021. We anticipate issuing long-term debt in 2021 with the proceeds used to satisfy this maturing instrument.
1In the fourth quarter of 2020, we received proceeds of $11.5 million, net of commission of $0.1 million, from the issuance of 280,400 shares.
Certain of our short- and long-debt agreements require Otter Tail Corporation and OTP to maintain certain financial covenants. As of December 31, 2020, we were in compliance with these financial covenants as further described below:
Otter Tail Corporation under its financial covenants, may not permit its ratio of Interest-Bearing Debt to Total Capitalization to exceed 0.60 to 1.00, may not permit its Interest and Dividend Coverage Ratio to be less than 1.50 to 1.00, and may not permit its Priority Indebtedness to exceed 10% of our Total Capitalization. As of December 31, 2020, our Interest-Bearing Debt to Total Capitalization was 0.49 to 1.00, our Interest and Dividend Coverage Ratio was 4.55 to 1.00 and we had no Priority Indebtedness outstanding.
OTP under its financial covenants, may not permit its ratio of Debt to Total Capitalization to exceed 0.60 to 1.00, may not permit its Interest and Dividend Coverage Ratio to be less than 1.50 to 1.00, and may not permit its Priority Debt to exceed 20% of its Total Capitalization. As of December 31, 2020, OTP's Interest-Bearing Debt to Total Capitalization was 0.46 to 1.00, its Interest and Dividend Coverage Ratio was 3.66 to 1.00 and it had no Priority Indebtedness outstanding.
None of our debt agreements include any provisions that would trigger an acceleration of the related debt as a result of changes in the credit rating levels assigned to the related obligor by rating agencies.
The credit ratings of Otter Tail Corporation and OTP as of December 31, 2020 are summarized below:
|Otter Tail Corporation||OTP|
|Corporate Credit/Long-Term Issuer Default Rating||Baa2||BBB-||BBB||A3||BBB||BBB+|
|Senior Unsecured Debt||n/a||BBB-||n/a||n/a||BBB+||BBB+|
As of December 31, 2020 we have outstanding letters of credit totaling $17.4 million, a portion of which reduces our borrowing capacity under our lines of credit. No outstanding letters of credit are reflected in outstanding short-term debt on our consolidated balance sheets. We do not have any other off-balance-sheet arrangements or any relationships with unconsolidated entities or financial partnerships. These entities are often referred to as structured finance special purpose entities or variable interest entities, which are established for the purpose of facilitating off-balance-sheet arrangements or for other contractually narrow or limited purposes. We are not exposed to any financing, liquidity, market or credit risk that could arise if we had such relationships.
|CRITICAL ACCOUNTING POLICIES INVOLVING SIGNIFICANT ESTIMATES|
Financial statements prepared in accordance with accounting principles generally accepted in the United States of America requires 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. While we believe the estimates and judgments we use in preparing our consolidated financial statements are appropriate and are based on the best available information, they are subject to future events and uncertainties regarding their outcome and therefore actual results may materially differ from these estimates. Management has discussed the application of these critical accounting policies and the development of these estimates with the Audit Committee of our Board of Directors. The following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements.
Our utility business is subject to regulation of rates and other matters by state utility commissions in Minnesota, North Dakota and South Dakota and by the FERC for certain interstate operations. Accordingly, our utility business must adhere to the accounting requirements of regulated operations, which requires the recognition of regulatory assets and regulatory liabilities for amounts that otherwise would impact the statement of income or comprehensive income when it is probable that such amounts will be collected from customers or credited to customers through the rate-making process. This guidance also provides recognition criteria for adjustments to rates outside of a general rate case proceeding which are provided for to encourage or incentivize investments in certain areas such as conservation, renewable energy, pollution reduction or control, improved infrastructure of the transmission grid or other programs that provide benefits to the general public under public policy, laws or regulations. Regulatory assets generally represent costs that have been incurred but have been deferred because future recovery from customers, as established through the rate-making process, is probable. Regulatory liabilities generally represent amounts to be refunded to customers or amounts currently collected from customers for future costs.
We assess the probability of recovery of regulatory assets and the obligations arising from regulatory liabilities on a quarterly basis. Our probability estimates incorporate numerous factors, including recent rate making decisions, historical precedents for similar matters, the regulatory environments in which we operate, and the impact these incurred costs may have on our customers. Changes in our assessments regarding the likelihood of recovery or settlement of our regulatory assets and liabilities may have a material impact on our operating results and financial position. Further, if we determine that all or a portion of our utility business no longer meets the criteria for continued application of regulatory accounting, or our regulators disallow recovery of a previously incurred cost or eliminate a regulatory liability, we would be required to remove the associated regulatory assets and liabilities from our consolidated balance sheet and recognize in the consolidated statement of income as an expense or income item in the period in which this accounting treatment is no longer applicable.
PENSION AND OTHER POSTRETIREMENT BENEFITS OBLIGATIONS AND COSTS
Pension and postretirement benefit liabilities and expenses are determined by actuaries using assumptions about the discount rate, expected return on plan assets, rate of compensation increase and healthcare cost-trend rates. See note 10 to our consolidated financial statements included in this report on Form 10-K for additional information on our pension and postretirement benefit plans and related assumptions.
These benefits, for any individual employee, can be earned and related expenses can be recognized and a liability accrued over periods of up to 30 or more years. These benefits can be paid out for up to 40 or more years after an employee retires. Estimates of liabilities and expenses related to these benefits are among our most critical accounting estimates. Although deferral and amortization of fluctuations in actuarially determined benefit obligations and expenses are provided for when actual results on a year-to-year basis deviate from long-range assumptions, compensation increases and healthcare cost increases or a reduction in the discount rate applied from one year to the next can significantly increase our benefit expenses in the year of the change. Also, a reduction in the expected rate of return on pension plan assets in our funded pension plan or realized rates of return on plan assets that are well below assumed rates of return or an increase in the anticipated life expectancy of plan participants could result in significant increases in recognized pension benefit expenses in the year of the change or for many years thereafter because actuarial losses can be amortized over the average remaining service lives of active employees.
The pension benefit cost for 2021 for our noncontributory funded pension plan is expected to be $8.4 million compared to $6.8 million in 2020, reflecting a decrease in the estimated discount rate used to determine annual benefit cost accruals from 3.47% in 2020 to 2.78% in 2021. The assumed rate of return on pension plan assets is 6.51% for 2021 compared with 6.88% for 2020. In selecting the discount rate, we consider the yields of fixed income debt securities, which have ratings of “Aa” published by recognized rating agencies, along with bond matching models specific to our plan’s cash flows as a basis to determine the rate.
Subsequent increases or decreases in actual rates of return on plan assets over assumed rates, increases or decreases in the discount rate, increases in future compensation levels, and increases in retiree healthcare cost inflation rates could significantly change projected costs.
The following table summarizes the impact on 2020 pension and postretirement costs for a 0.25 increase or decrease, holding all other variables constant, on certain key assumptions:
|Discount Rate||$||(1,158)||$||1,160 |
|Rate of Increase in Future Compensation||625 ||(610)|
|Long-Term Return on Plan Assets||(800)||800 |
|Other Postretirement Benefits:|
|Discount Rate||(366)||302 |
We believe the estimates made for our pension and other postretirement benefits are reasonable based on the information that is known at the point in time the estimates are made. These estimates and assumptions are subject to a number of variables and are subject to change.
Goodwill is required to be evaluated annually for impairment and more frequently as events or circumstances require. Goodwill is tested for impairment at the reporting unit level. We have identified two reporting units which carry a material amount of goodwill.
The goodwill impairment test is a single-step quantitative assessment which compares the estimated fair value of the reporting unit to its carrying value. An impairment charge is recognized if the carrying amount exceeds the estimated fair value in an amount that is equal to the excess but limited to the amount of recorded goodwill of the reporting unit. An optional qualitative impairment assessment may be performed prior to and may eliminate the need to perform the quantitative assessment.
Estimating the fair value of a reporting unit under the quantitative impairment method requires significant judgments and estimates. We estimate the fair value of our reporting units primarily using an income approach, which includes a discounted cash flow methodology to arrive at a fair value estimate by determining the present value of projected future cash flows over a specified period plus a terminal value to reflect cash flows beyond the projection period. The discount rate applied to the estimated future cash flows reflects our estimate of the weighted-average cost of capital of comparable entities. To supplement our income approach, we reference various market indications of fair value, where available, and includes fair value estimates using multiples derived from comparable enterprise values to EBITDA and revenue multiples, comparable price earnings ratios and, if available, comparable sales transactions for comparative peer companies.
Our discounted cash flow methodology incorporates significant estimates, which include assumptions of future operating results and cash flows, which are impacted by economic and industry conditions, the amount and timing of estimated capital expenditures, an estimated terminal growth rate, and the selection of an appropriate weighted-average cost of capital, among others.
Our goodwill impairment testing performed in the fourth quarter of 2020 indicated no impairment was present for either reporting unit and the estimated fair value of each reporting unit substantially exceeded the respective carrying value. We believe the estimates and assumptions used in our impairment assessments are reasonable and based on the best information available. However, these estimates and assumptions inherently include a degree of uncertainty. Significant adverse changes in our expectations for any of these estimates could result in an impairment charge in a future period which may materially impact our operating results and financial position.
|ITEM 7A.||QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK|
Market risk is the potential loss arising from adverse changes in market rates and prices. We are primarily exposed to interest rate and commodity price risk.
Interest Rate Risk
Our exposure to interest rate risk as of December 31, 2020 arises from outstanding short-term debt which is subject to variable rates of interest based on benchmark interest rates, primarily LIBOR. As of December 31, 2020 we had $81.0 million of short-term debt outstanding. Holding other variables constant, a one percentage point change in interest rates would have had an approximate $0.3 million impact to interest charges in 2020 based upon our average outstanding short-term debt during the year.
All of our outstanding long-term debt obligations on December 31, 2020 have fixed interest rates and thus are not subject to interest rate risk. We manage our interest rate risk through the issuance of fixed-rate debt with varying maturities, by limiting the amount of variable interest rate debt, and the utilization of short-term borrowings to allow flexibility in the timing and placement of long-term debt.
We have not used hedging instruments to manage interest risk arising from our portfolio of borrowings. We maintain a ratio of fixed-rate debt to total debt within a certain range. It is our policy to enter into interest rate transactions and other financial instruments only to the extent considered necessary to meet our stated objectives. We do not enter into interest rate transactions for speculative or trading purposes.
Commodity Price Risk
The companies in our Manufacturing segment are exposed to market risk related to changes in commodity prices for steel, aluminum, and polystyrene and other plastics resins. The price and availability of these raw materials could affect the revenues and earnings of our Manufacturing segment.
The companies in our Plastics segment are exposed to market risk related to changes in commodity prices for PVC resins, the raw material used to manufacture PVC pipe. The PVC pipe industry is highly sensitive to commodity raw material pricing volatility. Historically, when resin prices are rising or stable, sales volume has been higher and when resin prices are falling, sales volume has been lower. Operating income may decline when the supply of PVC pipe increases faster than demand. Due to the commodity nature of PVC resin and the dynamic supply and demand factors worldwide, it is very difficult to predict gross margin percentages or to assume that historical trends will continue.
We do not engage in any hedging activities to manage our commodity price risk.
|ITEM 8.||FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA|
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors of Otter Tail Corporation
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Otter Tail Corporation and subsidiaries (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and the schedules listed in the Index at Item 15 (collectively referred to as the “financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the criteria established in Internal Control—Integrated Framework (2013) issued by COSO.
Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report Regarding Internal Controls Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the