OTTER TAIL CORPORATION 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. OVERVIEWOtter 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 westernMinnesota , easternNorth Dakota and northeasternSouth 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 ourMerricourt wind farm andAstoria Station natural gas combustion turbine in 2020.Merricourt is a 150-megawatt wind farm in southeasternNorth Dakota . Construction commenced in 2019 and the project was substantially completed inDecember 2020 .Astoria Station is a 245-megawatt simple cycle natural gas combustion turbine generation facility nearAstoria, 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. COVID-19 We continue to monitor the progression of the novel coronavirus (COVID-19) and its impact on our businesses, employees, customers, construction contractors and vendors. As this pandemic continues, we are following the directives and advice of government leaders and medical professionals and have adopted practices to help curtail the spread of the virus and mitigate its impact on our communities, employees, construction contractors, customers and business operations. Our Electric segment business provides a critical service to our customers and our manufacturing businesses provide products and support to critical infrastructure industries. We continue to operate our businesses in a manner that is safe for our employees and our customers. 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.
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Table of Content s 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 andAstoria 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 inApril 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.
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Table of Content s RESULTS OF OPERATIONS 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 theSEC onFebruary 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. CONSOLIDATED RESULTS The following table summarizes our consolidated results of operations for the years endedDecember 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 theMinnesota share of theAstoria 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 ourMerricourt 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.
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Table of Content s ELECTRIC SEGMENT RESULTS The following table summarizes the results of operations for our Electric segment for the years endedDecember 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. 2020 2019 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. 2020 vs 2020 vs 2019 vs Normal 2019 Normal
Effect on Diluted Earnings Per Share $ -
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 inMinnesota and North Dakota Renewable Rider Adjustment revenues related to earning a return on funds invested inMerricourt while the project was under construction. •A$3.1 million increase in revenues from the North Dakota Generation Rider which went into effect inJuly 2019 to provide a return on funds invested inAstoria 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.
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Table of Content s 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 HootLake Plant . These decreases were partially offset by a 13.7% increase in generation atCoyote 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 theCoyote Station's extended maintenance outage and HootLake 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 atOtter 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 toOtter Tail Power Company's charitable foundation. •A$0.6 million increase in land easement payments related toMerricourt . •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 ofMerricourt 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 endedDecember 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.
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Table of Content s 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 theMarch 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 endedDecember 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 toOtter Tail Corporation's charitable foundation in 2020 and additional increases in other expenses, primarily performance-based compensation. CORPORATE COSTS The following table summarizes Corporate results of operations for the years endedDecember 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 toOtter Tail Corporation's charitable foundation in 2020 and a$1.5 million increase in labor and benefit expenses, partially offset by a$0.6 million decrease in corporate costs charged to subsidiaries. REGULATORY RATE MATTERS The following provides a summary of our current general rates and a summary of recent rate case filings and rate rider filings that have or are expected to have a material impact on our operating results, financial position or cash flows. GENERAL RATES The following includes a summary of electric base rates as determined in OTP's most recent general rate case in each state: Revenue Allowed Implementation Requirement Return on Return Equity Jurisdiction Date (in millions) Rate Base on Equity Ratio Minnesota 06/01/19$ 198.6 7.51 % 9.41 % 52.50 % North Dakota 02/01/19 153.1 7.64 9.77 52.50 South Dakota(1) 08/01/19 35.5 7.09 8.75 52.92 (1) Includes an earnings sharing mechanism to share withSouth 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%. 27
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Table of Content s Minnesota Rate Case: OnNovember 2, 2020 , OTP filed a request with the MPUC for an increase in revenue recoverable under general rates inMinnesota . 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. OnDecember 3, 2020 , the MPUC approved an interim annual rate increase of$6.9 million , or 3.2%, effectiveJanuary 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. RATE RIDERS The following table includes a summary of pending and recently concluded rate rider proceedings: Recovery Filing Amount Effective Mechanism Jurisdiction Status Date (in millions) Date Notes 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: OnMay 1, 2017 , the MPUC ordered OTP to include in the TCR rider retail rate base theMinnesota 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 theFERC to offset theFERC -approved expenses, effectively reducing OTP's recovery ofFERC -approved expense levels. OnAugust 18, 2017 , OTP filed an appeal of the MPUC order with theMinnesota Court of Appeals to contest the portion of the order requiring OTP to jurisdictionally allocate costs of theFERC transmission projects in the TCR rider. OnJune 11, 2018 , theMinnesota Court of Appeals reversed the MPUC's order. OnJuly 11, 2018 the MPUC filed a petition for review of the decision to theMinnesota Supreme Court , which granted review of the appellate court decision.The Minnesota Supreme Court issued its opinion onApril 22, 2020 , concluding the MPUC lacked authority to amend an existing TCR rider approved underMinnesota state law to include the costs and revenues associated with these transmission projects and affirming the decision of theMinnesota Court of Appeals . OnOctober 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 inJanuary 2021 . With this decision, one-half of the projected TCR rider tracker balance atDecember 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 toMinnesota customers through the TCR rider prior toSeptember 30, 2020 . As a result, OTP recognized additional rider revenue of$2.6 million during the year endedDecember 31, 2020 . LIQUIDITY LIQUIDITY OVERVIEW We believe our financial condition is strong and our cash, other liquid assets, operating cash flows, existing lines of credit, access to capital markets, and borrowing ability because of investment-grade credit ratings, when taken together, provide us ample liquidity to conduct business operations and fund 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 ofDecember 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.
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Table of Content s
The following table presents the status of our lines of credit as of
2020 2019
Amount Letters Amount Amount
(in thousands) Line Limit Outstanding of Credit Available Available
Otter Tail Corporation Credit
Agreement $ 170,000 $ 65,166 $ -
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.
CASH FLOWS
The following is a discussion of our cash flows for the years ended December 31,
2020 and 2019:
(in thousands) 2020 2019
Net Cash Provided by Operating Activities
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. (in thousands) 2020 2019
Net Cash Used in Investment Activities increased$166.2 million driven by our Electric segment capital investment plan, including construction of our Merricourt andAstoria Station projects. (in thousands) 2020 2019
Net Cash Provided by Financing Activities
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$55.7 million in common dividends in 2019.
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Table of Content s CAPITAL REQUIREMENTS CAPITAL EXPENDITURES We have a capital expenditure program for expanding, upgrading and improving our plants and operating equipment. Typical uses of cash for capital expenditures are investments in electric generation facilities and environmental upgrades, transmission and distribution lines, manufacturing facilities and upgrades, equipment used in the manufacturing process, and computer hardware and information systems. The capital expenditure program is subject to review and is revised in light of changes in demands for energy, technology, environmental laws, regulatory changes, business expansion opportunities, the costs of labor, materials and equipment and our financial condition. The following provides a summary of capital expenditures for the years endedDecember 31, 2020 and 2019 for our Electric segment and non-electric businesses and anticipated capital expenditures for the five year period 2021 through 2025: (in millions) 2019 2020 2021 2022 2023 2024 2025 Total Electric Segment:Renewables and Natural Gas Generation$ 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
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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 % CONTRACTUAL OBLIGATIONS The following table summarizes our contractual obligations atDecember 31, 2020 and the effect these obligations are expected to have on our liquidity and cash flow in future periods. Less than 1-3 3-5 More than (in millions) Total 1 Year Years Years 5 Years 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
Coal contract obligations are based on estimated coal consumption and costs for the delivery of coal toCoyote Station fromCoyote 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. OnFebruary 1, 2021 our Board of Directors increased the quarterly dividend from$0.37 to$0.39 per common share.
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Table of Content s CAPITAL RESOURCES 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. REGISTRATION STATEMENTS OnMay 3, 2018 we filed a shelf registration statement with theSEC 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 ofMay 3, 2021 . OnNovember 8, 2019 we entered into a Distribution Agreement withKeyBank under which we may offer and sell our common shares from time to time throughKeyBank , 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 toKeyBank of$0.5 million1 from the issuance of 868,4841 shares under this program. In total from the inception of the program throughDecember 31, 2020 , we have received proceeds under this program of$54.4 million . OnMay 3, 2018 we also filed a shelf registration statement with theSEC 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 onMay 3, 2021 . In 2020, we issued 320,173 shares for proceeds of$13.4 million under the Plan. As ofDecember 31, 2020 , 899,859 shares remain available for purchase or issuance under the Plan. We intend to file new shelf registration statements in 2021 following the expiration of our current registration statements onMay 3, 2021 . SHORT-TERM DEBTOtter Tail Corporation andOtter Tail Power Company are each party to a credit agreement (the OTC Credit Agreement and OTP Credit Agreement, respectively) which provide for unsecured revolving lines of credit. The agreements generally bear interest at LIBOR plus an applicable credit spread, which is subject to adjustment based on the credit ratings of the issuer. The LIBOR credit spread for the OTC Credit Agreement and OTP Credit Agreement was 1.50% and 1.25%, respectively, atDecember 31, 2020 . The following is a summary of key provisions and borrowing information as of and for the year endedDecember 31, 2020 : OTC Credit OTP Credit (in thousands, except interest rates) Agreement Agreement Borrowing Limit$ 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 %
October 31, October 31,
Maturity Date 2024 2024
1Each facility includes an accordion featuring allowing the borrower to increase the borrowing limit if certain terms and conditions are met.
LONG-TERM DEBT AtDecember 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 inDecember 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
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Table of Content s Financial Covenants Certain of our short- and long-debt agreements requireOtter Tail Corporation and OTP to maintain certain financial covenants. As ofDecember 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 ofDecember 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 ofDecember 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. Credit Ratings The credit ratings ofOtter Tail Corporation and OTP as ofDecember 31, 2020 are summarized below: Otter Tail Corporation OTP Moody's Fitch S&P Moody's Fitch S&P
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+
Outlook Stable Stable Negative Stable Stable Stable
OFF-BALANCE-SHEET ARRANGEMENTS
As ofDecember 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 inthe 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. REGULATORY ACCOUNTING Our utility business is subject to regulation of rates and other matters by state utility commissions inMinnesota ,North Dakota andSouth Dakota and by theFERC 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.
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Table of Content s 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$6.8 million in 2020, reflecting a decrease in the estimated discount rate used to determine annual benefit cost accruals from 3.47% in 2020 to 2.78% in 2021. The assumed rate of return on pension plan assets is 6.51% for 2021 compared with 6.88% for 2020. In selecting the discount rate, we consider the yields of fixed income debt securities, which have ratings of "Aa" published by recognized rating agencies, along with bond matching models specific to our plan's cash flows as a basis to determine the rate. Subsequent increases or decreases in actual rates of return on plan assets over assumed rates, increases or decreases in the discount rate, increases in future compensation levels, and increases in retiree healthcare cost inflation rates could significantly change projected costs. The following table summarizes the impact on 2020 pension and postretirement costs for a 0.25 increase or decrease, holding all other variables constant, on certain key assumptions: (in thousands) +0.25 -0.25 Pension Plan: Discount Rate$ (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 IMPAIRMENT
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.
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Table of Content s 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.
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