Item 7. Management’s Discussion and Analysis
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.
OVERVIEW
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 capitalizing on organic growth opportunities in our Manufacturing and Plastics segments. Investments in our Electric segment are expected to produce increased earnings and cash flows, lower our overall risk, create a more predictable earnings stream, improve our credit quality and preserve our ability to fund our dividend. Our Electric segment is complemented by our Manufacturing and Plastics segment businesses, which we expect to contribute to earnings growth by capitalizing
27
T able of Contents
on market expansion opportunities and increasing utilization of existing capacities, along with planned investments to create additional capacity and increased efficiencies. Collectively, our mix of businesses is expected to contribute to the achievement of our long-term targeted annual growth in earnings per share of 5 - 7%.
2023 FINANCIAL RESULTS
In 2023, our diversified business model generated record financial results, producing net income of $294.2 million, or $7.00 per diluted share, an increase of 4% from $284.2 million, or $6.78 per diluted share, in 2022. Our financial results for the year were driven by earnings growth in our Electric and Manufacturing segments, as well as lower corporate costs, as we benefited from returns on our short-term investments funded by the significant cash flows our businesses have generated over the last three years. Our Plastics segment again produced extraordinary financial results as we continued to capitalize on favorable industry dynamics; however, earnings in this segment did decline modestly from the record level achieved in 2022. In 2023, we paid an annual dividend of $1.75 per share, or $73.1 million, completing our 85th consecutive year of dividend payments to our shareholders.
Our Electric segment produced earnings growth of 6% in 2023, from $80.0 million in 2022 to $84.4 million in 2023, primarily due to increased rider revenue, increased commercial and industrial sales, and lower pension and other postretirement benefit costs, partially offset by increased operating and maintenance expenses and the impact of unfavorable weather.
Our Manufacturing segment produced earnings growth of 2% in 2023, from $21.0 million in 2022 to $21.5 million in 2023, primarily due to increased sales volumes at our metal fabrication business driven by strong end market demand across several markets we serve, and incremental volumes from additional work with existing customers. Increased sales volumes at our metal fabrication business were partially offset by increased labor and overhead costs, as well as decreased horticulture product sales volumes at our plastic thermoforming business.
Our Plastics segment earnings declined 4%, from $195.4 million in 2022 to $187.7 million in 2023. We experienced an unprecedented level of earnings in 2022, resulting from extraordinary industry supply and demand dynamics. Industry dynamics have begun to moderate, but at a modest pace, as further described below. Our Plastics segment businesses continued to capitalize on these industry conditions in 2023, producing earnings significantly in excess of pre-2021 levels.
Our earnings mix in 2023 was 29% from our Electric segment and 71% from the combination of our Manufacturing and Plastics segments excluding unallocated corporate costs. Electric segment earnings as a percentage of our total earnings were less than our long-term target of 65% due to the unique market conditions occurring in the plastics industry.
PVC PIPE SUPPLY AND DEMAND CONDITIONS
Extraordinary supply and demand conditions in the PVC industry beginning in 2021 have led to a significant expansion in operating margins and elevated earnings in our Plastics segment over the past three years. Periodic disruptions in the supply of resin, the primary material input used in the manufacturing of PVC pipe, coupled with robust demand for resin, led to a significant increase in the cost of resin beginning in 2021. Low industry volumes of PVC pipe and robust end market demand for the product led to a rapid and significant increase in sales prices for PVC pipe, significantly outpacing the increase in resin input costs, leading to increased operating margins within our Plastics segment.
Demand for PVC pipe began to soften in the second half of 2022, as distributors and contractors reduced purchase volumes in response to uncertain and competitive market conditions. Softening demand continued through the first half of 2023, but sales volumes in the second half of the year exceeded those in the previous year. Resin prices have declined from the previous year and although sales prices for PVC pipe have also declined, they have declined at a slower pace than resin prices, continuing to produce expanded operating margins from those experienced in 2022.
The unique market dynamics impacting our Plastics segment resulted in a significant increase in earnings in the last three years compared to historical levels. We expect these market conditions to gradually normalize over the course of 2024 and into 2025. The marketplace dynamics impacting our Plastics segments are fluid and subject to change and may impact our operating results prospectively.
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. Normal weather conditions are defined as the 20-year average of actual historical weather conditions. 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.
OTP generally bases its forecasted 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, 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, construction work in progress, deductions for accumulated provisions for depreciation, contributions in aid of construction, customer advances for construction, accumulated deferred income taxes, and, in some cases, accumulated deferred ITCs. We present actual and forecasted levels of utility rate base to provide an indication of expected investments on which we expect to earn future returns.
28
T able of Contents
RESULTS OF OPERATIONS
For a comparison of fiscal year 2022 to 2021, 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, 2022, filed with the SEC on February 15, 2023.
Provided below is a summary and discussion of our operating results on a consolidated basis followed by a discussion of the operating results of each of our segments, Electric, Manufacturing and Plastics. In addition to the segment results, we provide an overview of our Corporate costs. Our Corporate costs do not constitute a reportable segment, but rather consist of unallocated general corporate expenses, such as corporate staff and overhead costs, the results of our captive insurance company and other items excluded from the measurement of segment performance. Corporate costs are added to operating segment totals to reconcile to totals on our consolidated statements of income.
CONSOLIDATED RESULTS
The following table summarizes our consolidated results of operations for the years ended December 31, 2023 and 2022:
(in thousands) 2023 2022 $ change % change
Operating Revenues $ 1,349,166 $ 1,460,209 $ (111,043) (7.6) %
Operating Expenses 971,247 1,069,770 (98,523) (9.2)
Operating Income 377,919 390,439 (12,520) (3.2)
Interest Expense
(37,677) (36,016) (1,661) 4.6
Nonservice Components of Postretirement Benefits
10,597 1,075 9,522 n/m
Other Income 12,650 2,037 10,613 n/m
Income Before Income Taxes 363,489 357,535 5,954 1.7
Income Tax Expense 69,298 73,351 (4,053) (5.5)
Net Income $ 294,191 $ 284,184 $ 10,007 3.5 %
Operating Revenues decreased $111.0 million on a consolidated basis in 2023. Electric segment operating revenues decreased 4% primarily due to decreased fuel recovery and wholesale revenues and the impact of unfavorable weather, partially offset by increased rider revenues and increased commercial and industrial sales. Manufacturing segment operating revenues increased 1% primarily due to higher sales volumes in our metal fabrication business. Plastics segment operating revenues decreased 18% due to a combination of decreased sales volumes and sales prices. See our segment disclosures below for additional discussion of items impacting operating revenues.
Operating Expenses decreased $98.5 million in 2023. Electric segment operating expenses decreased primarily due to decreased purchased power costs resulting from lower market energy prices and lower fuel costs due to decreased natural gas prices. Operating expenses in our Manufacturing segment increased primarily due to increased sales volumes in our metal fabrication business and an increase in certain variable compensation costs. Operating expenses in our Plastics segment decreased primarily due to lower sales volumes and decreased PVC resin costs. See our segment disclosures below for additional discussion of items impacting operating expenses.
Interest Expense increased $1.7 million in 2023 due to an increase in our average short-term borrowings, primarily used to fund capital investments in our Electric segment, and increased interest rates on our short-term borrowings.
Nonservice Components of Postretirement Benefits improved by $9.5 million in 2023, having a positive impact on net income, primarily due to a change in actuarial assumptions used to measure our pension benefit and postretirement benefit obligations, including an increase in the discount rate applied and an increase in the expected return on assets assumption.
Other Income increased $10.6 million in 2023 primarily due to an increase in investment income earned on our short-term cash equivalent investments and investment gains from our corporate-owned life insurance policies compared to investment losses in the previous year.
Income Tax Expense decreased $4.1 million in 2023 primarily due to an increase in PTCs produced by our wind and solar generation assets. Our effective tax rate was 19.1% in 2023 and 20.5% in 2022. See Note 12 to our consolidated financial statements included in this report on Form 10-K for additional information regarding factors impacting our effective tax rate.
29
T able of Contents
ELECTRIC SEGMENT RESULTS
The following table summarizes the operating results of our Electric segment for the years ended December 31, 2023 and 2022:
(in thousands) 2023 2022 $ change % change
Retail Sales Revenue $ 455,840 $ 470,300 $ (14,460) (3.1) %
Transmission Services Revenues 52,555 52,213 342 0.7
Wholesale Revenues 12,459 18,539 (6,080) (32.8)
Other Electric Revenues 7,505 8,647 (1,142) (13.2)
Total Operating Revenue 528,359 549,699 (21,340) (3.9)
Production Fuel 60,339 65,110 (4,771) (7.3)
Purchased Power 78,292 100,281 (21,989) (21.9)
Operating and Maintenance Expenses 191,263 181,378 9,885 5.4
Depreciation and Amortization 75,330 72,050 3,280 4.6
Property Taxes 16,614 17,742 (1,128) (6.4)
Operating Income $ 106,521 $ 113,138 $ (6,617) (5.8) %
Electric kwh Sales (in thousands)
Retail kwh Sales 5,772,215 5,592,368 179,847 3.2 %
Wholesale kwh Sales 351,729 267,184 84,545 31.6
Heating Degree Days 6,259 7,122 (863) (12.1)
Cooling Degree Days 590 531 59 11.1
Our Electric segment operating results are impacted by fluctuations in weather conditions and the resulting demand for electricity for heating and cooling. The following table presents heating and cooling degree days as a percent of normal for the years ended December 31, 2023 and 2022:
2023 2022
Heating Degree Days 98.4 % 112.5 %
Cooling Degree Days 127.2 % 113.5 %
The following table summarizes the estimated effect on diluted earnings per share of the difference in retail sales under actual weather conditions and expected retail sales under normal weather conditions for the years ended December 31, 2023 and 2022, and between years:
2023 vs Normal 2023 vs 2022 2022 vs Normal
Effect on Diluted Earnings Per Share $ 0.02 $ (0.09) $ 0.11
Retail Revenues decreased $14.5 million primarily due to the following:
• A $26.2 million decrease in fuel recovery revenues, primarily due to lower purchased power and fuel costs arising from decreased market energy costs and natural gas prices, as described below.
• A $5.2 million decrease in revenues from the unfavorable impact of weather compared to last year.
• Our Minnesota rate case, which was finalized in 2022, included a determination of the final interim rate refund and resulted in an additional $4.1 million of retail revenue last year.
The decreases in retail revenues described above were partially offset by the following:
• A $10.5 million increase in retail revenues from increased sales volumes from commercial and industrial customers, including the impact of a new commercial customer load in North Dakota added during 2022.
• A $9.6 million increase in rider revenues, including recovery of our investment in the Ashtabula III wind farm, which we acquired in January 2023, and the recovery of our investment in Hoot Lake Solar, which was completed during the year, as well as operating costs associated with these facilities.
Wholesale Revenues decreased $6.1 million primarily due to a 49% decrease in wholesale electric prices driven by decreased fuel costs.
Production Fuel costs decreased $4.8 million due to a 17% decrease in fuel cost per kwh resulting from decreases in natural gas prices, partially offset by an increase in kwhs generated from our natural gas-burning plants.
Purchased Power costs to serve retail customers decreased $22.0 million due to a 14% decrease in the price of purchased power per kwh, primarily due to decreased market energy costs, as well as decreased purchase volumes due to the acquisition of the Ashtabula III wind farm and completion of our Hoot Lake Solar project in the current year. Prior to the acquisition of Ashtabula III, OTP purchased the wind generated electricity from the facility under the terms of a power purchase agreement.
30
T able of Contents
Operating and Maintenance Expense increased $9.9 million primarily due to:
• A $3.9 million increase in labor and benefit costs partially due to increased health insurance costs, wage increases, and increased headcount.
• A $2.2 million increase in vegetative maintenance costs.
• A $1.9 million increase in insurance expense due in part to the addition of Ashtabula III and Hoot Lake Solar to our generation fleet during the year.
• A $1.3 million increase in maintenance related to the addition and operation of Ashtabula III.
These expense increases were partially offset by, among other items, decreased outage-related costs and travel costs compared to the previous year.
Depreciation and Amortization expense increased $3.3 million primarily due to the acquisition of Ashtabula III and continued investment in distribution facilities during the year.
MANUFACTURING SEGMENT RESULTS
The following table summarizes the operating results of our Manufacturing segment for the years ended December 31, 2023 and 2022:
(in thousands) 2023 2022 $ change % change
Operating Revenues $ 402,781 $ 397,983 $ 4,798 1.2 %
Cost of Products Sold (excluding depreciation)
310,601 315,375 (4,774) (1.5)
Selling, General, and Administrative Expenses
44,545 37,341 7,204 19.3
Depreciation and Amortization 18,495 16,202 2,293 14.2
Operating Income $ 29,140 $ 29,065 $ 75 0.3 %
Operating Revenues increased $4.8 million primarily due to the combination of the following:
• At BTD, operating revenues increased $12.5 million primarily due to a combination of higher sales volumes and increased pricing. Sales volumes increased 12% compared to the previous year due to strong end market demand in several segments, including the construction, industrial, and agricultural segments, and incremental volumes from additional work with existing customers. Sales price increases were implemented during the year in response to labor and non-steel material cost inflation. Sales price increases and sales volume growth were partially offset by decreased steel prices, resulting in an 11% decrease in material costs, which are passed through to customers.
• At T.O. Plastics, operating revenues decreased $7.7 million primarily due to lower sales volumes. Sales volumes decreased 19% primarily due to decreased sales of horticulture products, as order and delivery lead times for these products have normalized after volatility experienced in the previous year, and customers reduced their inventory levels and are beginning to return to normal seasonal buying patterns.
Cost of Products Sold decreased $4.8 million primarily due to the combination of the following:
• Cost of products sold at BTD increased $0.8 million primarily due to higher sales volumes, as discussed above. Cost of products sold also increased due to lower productivity and inflationary cost pressures which resulted in higher non-steel material, labor and overhead costs. The increase in labor costs and lower level of productivity was partially attributable to increased shift incentives and overtime wages combined with increased staffing levels to meet higher production volumes and the time required for new employees to achieve peak productivity. The impacts of higher sales volumes and increased labor and overhead costs were largely offset by decreased material costs, as discussed above.
• Cost of products sold at T.O. Plastics decreased $5.6 million primarily due to lower sales volumes of horticulture products, as discussed above.
Selling, General, and Administrative Expenses increased $7.2 million primarily due to increased employee compensation from an increase in headcount, inflationary cost pressure and variable compensation driven by current year financial performance.
Depreciation and Amortization increased $2.3 million due to capital expenditures during the year, which included investments in facility improvements and purchases of equipment.
PLASTICS SEGMENT RESULTS
The following table summarizes the operating results for our Plastics segment for the years ended December 31, 2023 and 2022:
(in thousands) 2023 2022 $ change % change
Operating Revenues $ 418,026 $ 512,527 $ (94,501) (18.4) %
Cost of Products Sold (excluding depreciation)
143,521 227,569 (84,048) (36.9)
Selling, General, and Administrative Expenses
16,076 16,175 (99) (0.6)
Depreciation and Amortization 4,027 4,205 (178) (4.2)
Operating Income $ 254,402 $ 264,578 $ (10,176) (3.8) %
31
T able of Contents
Operating Revenues decreased $94.5 million primarily due to a 14% decrease in sales volumes. Sales volume decreases were attributable to softer end market demand coupled with distributor inventory management, as these customers reduced their inventory levels during the first half of the year after previously building higher inventory levels in response to market uncertainty and supply chain challenges. Operating revenue decreases were also the result of a 5% decrease in sales prices, as prices in 2023 decreased from record highs in 2022.
Cost of Products Sold decreased $84.0 million due to a 26% decrease in the cost per pound of PVC pipe sold, primarily due to lower resin costs, as well as the 14% decrease in sales volumes discussed above.
CORPORATE
The following table summarizes Corporate results of operations for the years ended December 31, 2023 and 2022:
(in thousands) 2023 2022 $ change % change
Selling, General, and Administrative Expenses
$ 12,042 $ 16,202 $ (4,160) (25.7) %
Depreciation and Amortization 102 140 (38) (27.1)
Operating Loss $ 12,144 $ 16,342 $ (4,198) (25.7) %
Selling, General, and Administrative Expenses decreased $4.2 million primarily due to lower health care costs related to our self-funded health insurance program in 2023 compared to higher claim costs in 2022.
REGULATORY MATTERS
The following provides a summary of OTP's current and recent rate case filings, rate rider filings, and other regulatory filings that have or are expected to have a material impact on our operating results, financial position, or cash flows.
RATE CASES
The following includes a summary of electric rate cases 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 07/01/22 $ 209.0 7.18 % 9.48 % 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 with South Dakota customers any weather-normalized earnings above the authorized ROE of 8.75%. The mechanism requires 50% of any weather-normalized revenue creating annual earnings in excess of the authorized ROE up to a maximum of 9.50% be returned to customers and 100% returns of revenue creating annual earnings above 9.50%.
North Dakota Rate Case: On November 2, 2023, OTP filed a request with the NDPSC for an increase in revenue recoverable under general rates in North Dakota. In its filing, OTP requested a net increase in annual revenue of $17.4 million, or 8.4%, based on an allowed rate of return on rate base of 7.85% and an allowed rate of return on equity of 10.6% on an equity ratio of 53.5% of total capital. Through this proceeding, OTP has proposed changes to the mechanism of cost and investment recovery, with recovery moving from riders into base rates. The filing also includes a proposal to implement a sales adjustment mechanism to address potential significant load additions or losses. The filing included an interim rate request of a net increase in annual revenue of $12.4 million, or 6.0%, which was approved by the NDPSC on December 13, 2023, and interim rates went into effect on January 1, 2024. These interim rate revenues, when collected, are subject to potential refund until the finalization of the rate case.
32
T able of Contents
RATE RIDERS
The following table includes a summary of substantial pending and recently concluded rate rider proceedings:
Recovery Filing Amount Effective
Mechanism Jurisdiction Status Date (in millions) Date Notes
RRR - 2023
MN Approved
11/01/22 $17.5 07/01/23 Recovery of Hoot Lake Solar costs, Ashtabula III costs, and true up for PTCs from Merricourt.
ECO - 2023
MN Approved 04/03/23 9.7 10/01/23 Recovery of energy conservation improvement costs as well as a demand side management financial incentive.
RRR - 2024
MN
Requested
12/04/23 8.0 07/01/24 Recovery of Hoot Lake Solar costs, Ashtabula III costs, wind upgrade project costs at our four owned wind facilities, and true up of PTCs for Merricourt.
RRR - 2023 ND Approved 12/30/22 12.2 05/01/23 Recovery of Merricourt, Ashtabula III and other costs.
RRR - 2022 ND Approved 01/05/22 7.8 04/01/22 Recovery of Merricourt costs, Ashtabula III costs, and deferred taxes and PTCs.
TCR - 2023
ND Approved 09/15/22 7.5 01/01/23 Recovery of transmission project costs.
TCR - 2024 ND Approved
11/02/23 4.5 01/01/24 Recovery of transmission project costs.
GCR - 2022 ND Approved 03/01/22 3.3 07/01/22 Annual update to generation cost recovery rider.
MDT - 2023
ND Approved 07/08/22 3.1 01/01/23 Recovery of advanced metering infrastructure, outage management system and demand response projects.
PIR - 2022 SD Approved 06/01/22 3.0 09/01/22 Recovery of Ashtabula III, Merricourt, Astoria Station, Advanced Grid Infrastructure project costs, and impact of load growth credits.
TCR - 2023
SD Approved
11/01/22 3.0 03/01/23 Recovery of transmission project costs.
RESOURCE PLANNING
On March 31, 2023, OTP submitted a supplemental resource plan filing to the MPUC, the NDPSC, and the South Dakota Public Utilities Commission (SDPUC). The supplemental filing updated OTP’s original 2022 Integrated Resource Plan (2022 IRP), which was filed on September 1, 2021. In the supplemental filing, OTP outlined its updated plan for meeting all customers’ anticipated capacity and energy needs while maintaining system reliability and low electric service rates in light of several changes that had occurred since the original filing, including significant winter and spring reserve planning margins adopted by MISO, tax credits made available for renewable energy projects under the Inflation Reduction Act, the enactment of the Clean Energy Bill in Minnesota, and volatility experienced in energy and capacity markets.
On December 15, 2023, OTP submitted a second supplemental resource plan filing to the MPUC outlining an updated plan specifically for meeting Minnesota customers’ anticipated capacity and energy needs while maintaining system reliability and low electric service rates. Based on feedback received on the preferred plan outlined in the March 31, 2023 supplemental filing and the inability to reach a consensus on certain aspects of the plan, the second supplemental filing includes a proposal to bifurcate OTP's resource planning by jurisdiction.
Under bifurcated resource planning, it is anticipated that OTP would develop two separate resource plans, one plan developed for Minnesota and a second developed for North Dakota and South Dakota. Each plan would be developed incorporating the assumption that all existing generation resources, except Hoot Lake Solar, would continue to be allocated to all jurisdictions using established jurisdictional allocators. Hoot Lake Solar is currently directly allocated to only Minnesota. As new generation resources are needed for each plan, those generation resources would be allocated to the jurisdiction that is needing the resource. To the extent a common generation resource is needed for both plans, that resource would be allocated using established jurisdictional allocators. This method of resource planning would diverge from OTP’s historical practice of planning on an integrated basis for all jurisdictions served.
With the proposal of bifurcated resource planning, the supplemental filing outlines OTP’s preferred plan for Minnesota only. The preferred plan in this supplemental filing includes:
• repowering four of our existing wind facilities in 2025;
• the addition of approximately 200 megawatts of solar generation in 2025;
• the addition of approximately 100 megawatts of wind generation in 2026;
• the addition of on-site liquefied natural gas fuel storage at our Astoria Station natural gas plant in 2027;
• the designation of Coyote Station, a jointly owned coal-fired generation plant, as an Available Maximum Emergency (AME) Resource beginning in 2029 and annually thereafter;
• a withdrawal from our 35 percent ownership interest in Coyote Station in the event we are required to make a major, non-routine capital investment in the plant; and
• the addition of approximately 50 megawatts of wind generation in 2032.
The preferred plan requests the MPUC issue an order requiring the Minnesota’s jurisdictionally allocated share of the generation from Coyote Station be designated as an AME Resource beginning March 1, 2029, subject to additional analysis to be performed by OTP. AME Resources are
33
T able of Contents
resources called on only in the event of a maximum generation event, such as in the cases of extreme heat, cold, or other extreme events. Designating Coyote Station as an AME Resource would allow us to retain Coyote Station’s capacity, thereby providing an important reliability benefit. This also helps ensure we remain compliant with market monitoring regulations and our contractual obligations to the co-owners of Coyote Station while advancing our compliance with Minnesota's carbon-free standard. The supplemental filing requests Minnesota customer rates continue to include the recovery of an allocated share of OTP’s costs associated with owning the plant, and a return on those costs, as well as the fixed costs of operating the plant. The variable cost of operating the plant, which consists primarily of variable fuel costs, would not be attributed to Minnesota customers, except when the plant is called upon to serve Minnesota customers in emergency situations.
The supplemental IRP filing made December 15, 2023 outlines our proposed resource plan for Minnesota. We anticipate filing future resource plans on a bifurcated basis in North Dakota and South Dakota.
LIQUIDITY
LIQUIDITY OVERVIEW
We believe our financial condition is strong and our cash, other liquid assets, operating cash flows, existing lines of credit, access to capital markets, and borrowing ability, because of investment-grade credit ratings, when taken together, provide us ample liquidity to conduct business operations and fund our capital expenditure program. Our liquidity, including our operating cash flows and access to capital markets, could be impacted by macroeconomic factors outside of our control. In addition, our liquidity could be impacted by non-compliance with covenants under our various debt instruments. As of December 31, 2023, we were in compliance with all debt covenants (see the Financial Covenant section under Capital Resources below).
The following table presents the status of our lines of credit as of December 31, 2023 and 2022:
2023 2022
(in thousands) Line Limit Amount Outstanding Letters
of Credit Amount Available Amount Available
OTC Credit Agreement
$ 170,000 $ — $ — $ 170,000 $ 170,000
OTP Credit Agreement 170,000 81,422 9,132 79,446 152,223
Total $ 340,000 $ 81,422 $ 9,132 $ 249,446 $ 322,223
OTC and OTP are each party to separate credit agreements (the OTC Credit Agreement and OTP Credit Agreement, respectively) which provide for unsecured revolving lines of credit. Should additional liquidity be needed, the OTC Credit Agreement includes an accordion feature allowing us to increase the amount available to $290 million, subject to certain terms and conditions. The OTP Credit Agreement also includes an accordion feature allowing OTP to increase that facility to $250 million, subject to certain terms and conditions.
As of December 31, 2023, we had $249.4 million of available liquidity under our credit facilities and $230.4 million of available cash and cash equivalents, resulting in total available liquidity of $479.8 million, compared to total available liquidity of $441.2 million as of December 31, 2022.
CASH FLOWS
The following is a discussion of our cash flows for the years ended December 31, 2023 and 2022:
(in thousands) 2023 2022
Net Cash Provided by Operating Activities $ 404,499 $ 389,309
Net Cash Provided by Operating Activities increased $15.2 million primarily due to an increase in net income, the absence of any pension contribution in 2023 due to the plan's funded status, and the timing of customer collections of forecasted fuel costs, partially offset by increased working capital. Working capital increased primarily due to an increase in receivables in our Plastics segment, due to increased sales volumes in the fourth quarter of the current year, and a decrease in payables due to the timing of capital investment spending in our Electric segment and inventory purchases in our Plastics segment compared to last year.
Unique market dynamics experienced by our Plastics segment businesses in 2023 and 2022 resulted in a significant increase in our overall cash from operations compared to prior periods, and we do not expect cash from operations at these levels to continue in future years.
(in thousands) 2023 2022
Net Cash Used in Investing Activities $ 289,287 $ 175,071
Net Cash Used in Investment Activities increased $114.2 million primarily due to a higher amount of Electric segment capital investment compared to last year, including the purchase of the Ashtabula III wind farm, investments in our Hoot Lake Solar facility and several wind repowering projects, transmission and distribution asset investments, and investments in new technology. Capital expenditures in our Manufacturing and Plastics segments increased $23.1 million as a result of investments in additional equipment and facility expansion projects at our Plastics segment facility in Arizona and our Manufacturing segment facility in Georgia.
34
T able of Contents
(in thousands) 2023 2022
Net Cash Used in Financing Activities $ 3,835 $ 96,779
Net Cash Used in Financing Activities decreased $92.9 million primarily due to increased short-term borrowings on our OTP credit facility, which were primarily used to fund capital expenditures in our Electric segment, including the acquisition of the Ashtabula III wind farm. Our financing activities in 2023 included net short-term borrowings of $73.2 million compared to net short-term repayments of $83.0 million in 2022. There was no change in our long-term debt in 2023. In 2022, OTP issued $60.0 million of long-term debt, net of retirements, which was primarily used to fund the repayment of short-term credit facility borrowings and fund capital expenditures. In 2023, we made dividend payments of $73.1 million compared to $68.8 million in 2022.
CAPITAL REQUIREMENTS
CAPITAL EXPENDITURES
Our capital expenditure plan includes investments in electric generation facilities, transmission and distribution lines, manufacturing facilities and upgrades, equipment used in the manufacturing process, and computer hardware and information systems. Our capital expenditure plan is subject to review and is revised in light of changes in demands for energy, technology, environmental laws, regulatory changes, business expansion opportunities, the costs of labor, materials and equipment and our financial condition.
The following provides a summary of capital expenditures for the years ended December 31, 2023 and 2022 for our Electric segment and non-electric businesses and anticipated capital expenditures for the five year period 2024 through 2028:
(in millions) 2022 2023 2024 2025 2026 2027 2028 Total
Electric Segment:
Renewables
$ 118 $ 93 $ 33 $ 113 $ 129 $ 486
Transmission
51 85 111 98 100 445
Distribution
38 39 36 38 39 190
Other 67 37 30 27 25 186
Total Electric Segment 148 241 274 254 210 276 293 1,307
Manufacturing and Plastics Segments 23 46 79 35 27 25 26 192
Total Capital Expenditures $ 171 $ 287 $ 353 $ 289 $ 237 $ 301 $ 319 $ 1,499
CONTRACTUAL OBLIGATIONS
The following table summarizes our contractual obligations at December 31, 2023 and the effect these obligations are expected to have on our liquidity and cash flow in future periods.
(in millions) Total Less than
1 Year 1-3
Years 3-5
Years More than
5 Years
Debt Obligations $ 908 $ 81 $ 80 $ 42 $ 705
Interest on Debt Obligations 602 35 70 62 435
Coal Contracts 485 24 49 52 360
Capacity and Energy Requirements 4 — — — 4
Postretirement Benefit Obligations 66 5 11 11 39
Other Purchase Obligations (including land easements) 79 6 9 5 59
Operating Lease Obligations 17 6 8 3 —
Total Contractual Cash Obligations $ 2,161 $ 157 $ 227 $ 175 $ 1,602
Coal contract obligations are based on estimated coal consumption and costs for the delivery of coal to Coyote Station from Coyote Creek Mining Company (CCMC) under the Lignite Sales Agreement (LSA) 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 (ESSRP), but do not include amounts to fund our noncontributory funded pension plan, as we are not currently required to make any contributions to that plan.
COMMON STOCK DIVIDENDS
We paid dividends to our shareholders totaling $73.1 million, or $1.75 per share, in 2023. The determination of the amount of future cash dividends to be paid will depend on, among other things, our financial condition, level of earnings and cash flows from operations, our capital expenditure plan 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 OTC subsidiaries to OTC. These intercompany distributions serve as the primary source of funding for dividends paid to our shareholders. 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 5, 2024, our Board of Directors increased the quarterly dividend from $0.4375 to $0.4675 per common share.
35
T able of Contents
CAPITAL RESOURCES
Financial flexibility is provided by operating cash flows, borrowing capacity under our lines of credit, strong financial coverages, investment grade credit ratings and alternative financing arrangements such as leasing. Debt financing will be required in the five-year period from 2024 through 2028 to refinance maturing debt and to finance our capital investments within our Electric segment. Our financing plans are subject to change and are impacted by our planned level of capital investments, a decision 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
On May 3, 2021, we filed a shelf registration statement with the SEC under which we may offer for sale, from time to time, either separately or together in any combination, equity, debt or other securities described in the shelf registration statement. The registration statement expires in May 2024, at which time we anticipate filing a new shelf registration statement. No shares were issued pursuant to the registration statement in 2023.
On May 3, 2021, we filed a second registration statement with the SEC for the issuance of up to 1,500,000 common shares under an Automatic Dividend Reinvestment and Share Purchase Plan, which provides shareholders, retail customers of OTP and other interested investors a method of purchasing our common shares by reinvesting their dividends or making optional cash investments. Shares purchased under the plan may be new issue common shares or common shares purchased on the open market. The registration statement expires in May 2024, at which time we plan to file a new registration statement. In 2023, we issued 105,663 shares under the plan. All shares issued under the plan to date have been open market purchases and there have been no new issue shares, resulting in no proceeds received by the Company. As of December 31, 2023, 1,145,330 shares remained available for purchase or issuance under the plan.
SHORT-TERM DEBT
The OTC Credit Agreement and OTP Credit Agreement provide for unsecured revolving lines of credit. The agreements generally bear interest at the Secured Overnight Financing Rate (SOFR) plus an applicable credit spread, which is subject to adjustment based on the credit ratings of the issuer. The weighted-average interest rate on all outstanding borrowings as of December 31, 2023 and 2022 was 6.70% and 5.61%.
The following is a summary of key provisions and borrowing information as of and for the year ended December 31, 2023:
(in thousands, except interest rates) OTC Credit Agreement OTP Credit Agreement
Borrowing Limit $ 170,000 $ 170,000
Borrowing Limit if Accordion Exercised 1
290,000 250,000
Amount Restricted Due to Outstanding Letters of Credit at Year-End — 9,132
Amount Outstanding at Year-End — 81,422
Average Amount Outstanding During Year — 50,883
Maximum Amount Outstanding During the Year — 87,788
Interest Rate at Year-End 6.85 % 6.70 %
Expiration Date October 29, 2027 October 29, 2027
1 Each facility includes an accordion feature allowing the borrower to increase the borrowing limit if certain terms and conditions are met.
LONG-TERM DEBT
At December 31, 2023, we had $827.0 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 2026 to 2052.
Financial Covenants
Certain of our short- and long-term debt agreements require OTC and OTP to maintain certain financial covenants. As of December 31, 2023, we were in compliance with these financial covenants as further described below:
OTC, under its financial covenants, may not permit its ratio of Interest-Bearing Debt to Total Capitalization to exceed 0.60 to 1.00, may not permit its Interest and Dividend Coverage Ratio to be less than 1.50 to 1.00, and may not permit its Priority Indebtedness to exceed 10% of our Total Capitalization. As of December 31, 2023, our Interest-Bearing Debt to Total Capitalization was 0.39 to 1.00, our Interest and Dividend Coverage Ratio was 10.85 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, 2023, OTP's Interest-Bearing Debt to Total Capitalization was 0.46 to 1.00, its Interest and Dividend Coverage Ratio was 3.54 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.
36
T able of Contents
Credit Ratings
The credit ratings of OTC and OTP as of December 31, 2023 are summarized below:
Otter Tail Corporation Otter Tail Power Company
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 A-
n/a
Outlook Stable Stable Stable Stable Stable Stable
CRITICAL ACCOUNTING ESTIMATES
Preparation of financial statements in accordance with accounting principles generally accepted in the United States of America and the Company’s discussion and analysis of its financial condition and operating results requires management to make assumptions, estimates and judgments that affect the reported amounts. While we believe the estimates, assumptions, 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 most 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 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 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 sheets and recognize those amounts in the consolidated statement of income as an expense or income item, or in the consolidated statement of comprehensive income as a loss or gain item, in the period in which this accounting treatment is no longer applicable.
As of December 31, 2023 and 2022, we had regulatory assets of $111.8 million and $119.7 million and regulatory liabilities of $302.0 million and $261.8 million. If future recovery of amounts recorded as regulatory assets was no longer probable we would be required to recognize an expense or loss in the period in which recovery was deemed to no longer be probable.
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. Likewise, compensation decreases and healthcare cost decreases or an increase in the discount rate applied from one year to the next can significantly decrease our benefit expenses in the year of the change. Also, a change 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 above or below assumed rates of return or a change in the anticipated life expectancy of plan participants could result in significant increases or decreases 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.
37
T able of Contents
We estimate the discount rate through the use of a hypothetical bond portfolio method, which incorporates yields on a collection of high credit quality bonds that produce cash flows similar to our anticipated future benefit payments.
We estimate the assumed long-term rate of return on plan assets based on asset category studies using historical market returns achieved by our asset portfolio allocation over long-term periods, as well as long-term projected return levels.
Pension plan assets are invested in a portfolio according to our return, liquidity and diversification objectives to provide a source of funding for plan obligations and manage contributions to the plan. The principal process for achieving these objectives is the asset allocation given the long-term risk, return, correlation and liquidity characteristics of each particular asset class.
At December 31, 2023, we set the discount rate used to measure our pension plan obligations at 5.57% and at 5.53% to measure postretirement healthcare obligations, a six and one basis point increase, respectively, from the estimates used at December 31, 2022. Our estimates used to determine benefit cost for 2023 included a discount rate of 5.51% for pension benefits and 5.52% for postretirement healthcare costs, a 248 and 251 basis point increase, respectively, from 2022 estimates. The 5.52% discount rate for postretirement healthcare costs was adjusted to 6.06% effective September 30, 2023, in connection with a remeasurement of our plan liability due to an amendment to the plan. The adjustment to 6.06% was a 305 basis point increase from the 2022 estimate. In addition, we estimated our assumed rate of return on pension assets to be 7.00% for 2023, a 70 basis point increase from our 2022 estimate.
The following table summarizes the impact on 2023 pension and postretirement costs for a 25 basis point increase or decrease, holding all other variables constant, on certain key assumptions:
(in thousands) +0.25 -0.25
Pension Plan:
Discount Rate $ 65 $ (72)
Rate of Increase in Future Compensation 259 245
Long-Term Return on Plan Assets (926) 926
Other Postretirement Benefits:
Discount Rate 13 3
For 2024, we expect pension and other postretirement benefit income to be $8.5 million compared to $9.5 million of income in 2023, due to the impacts of updated actuarial assumptions. See additional information at footnote 10 of the consolidated financial statements.
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.
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 include fair value estimates using multiples derived from comparable enterprise values to earnings before interest, taxes, depreciation, and amortization (EBITDA), 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 2023 indicated no impairment was present for either reporting unit and the estimated fair value of each reporting unit substantially exceeded the respective carrying value. As part of our testing, we perform various sensitivity analyses to understand if our conclusions are sensitive to changes in certain assumptions. A 1% decrease in projected operating revenues, a one hundred basis point decrease in projected gross profit margins and a twenty five basis point increase in the discount rate would not lead to a goodwill impairment charge for either reporting unit.
38
T able of Contents
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 include an inherent 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.