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Section 1: 10-Q (FORM 10-Q)

ottr20190930_10q.htm
0001466593Otter Tail Corpfalse--12-31Q320190000201101.501.252016 2017 20182015 2016 2017 2018Corporate cost included in nonservice cost components of postretirement benefits.Costs subject to recovery without a rate of return.Allocation of Costs: Costs included in OTP capital expenditures $ 333 $ 455 $ 1,059 $ 1,162 Service costs included in electric operation and maintenance expenses 1,007 1,119 2,961 3,561 Service costs included in other nonelectric expenses 33 41 99 121 Nonservice costs capitalized as regulatory assets (128 ) (29 ) (408 ) (74 ) Nonservice costs included in nonservice cost components of postretirement benefits (401 ) (74 ) (1,179 ) (235 )Allocation of Costs: Costs included in OTP capital expenditures $ 78 $ 108 $ 248 $ 275 Service costs included in electric operation and maintenance expenses 235 264 693 841 Service costs included in other nonelectric expenses 8 10 23 29 Nonservice costs capitalized as regulatory assets 284 301 905 769 Nonservice costs included in nonservice cost components of postretirement benefits 889 768 2,614 2,436 Amortization of prior service costs and net actuarial losses from other comprehensive income are included in nonservice cost components of postretirement benefits.Allocation of Costs: Service costs included in electric operation and maintenance expenses $ 26 $ 24 $ 78 $ 74 Service costs included in other nonelectric expenses 78 76 235 226 Nonservice costs included in nonservice cost components of postretirement benefits 557 645 1,672 1,934 Amount eligible for recovery under an alternative revenue program which includes an incentive or rate of return.1,500,0001,500,00000001,000,0001,000,00000005550,000,00050,000,00039,755,27739,664,8840.350.3351.051.00525100333.55 Dec. 15, 2026 4.63Dec. 01, 20216.15Aug. 20, 20226.37Aug. 20, 20274.68 Feb. 27, 2029 6.47Aug. 20, 20375.47 Feb. 27, 2044 4.07February 7, 20482.54March 18, 20213.55 Dec. 15, 2026 4.63Dec. 01, 20216.15Aug. 20, 20226.37Aug. 20, 20274.68 Feb. 27, 2029 6.47Aug. 20, 20375.47 Feb. 27, 2044 4.07February 7, 20482.54March 18, 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Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the quarterly period ended

September 30, 2019

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the transition period from

 

to

 

 

Commission file number

           0-53713

 

OTTER TAIL CORPORATION

(Exact name of registrant as specified in its charter)

 

              Minnesota

27-0383995

(State or other jurisdiction of

(I.R.S. Employer

incorporation or organization)

Identification No.)

 

215 South Cascade Street, Box 496, Fergus Falls, Minnesota    

56538-0496

(Address of principal executive offices)

(Zip Code)

 

866-410-8780

(Registrant's telephone number, including area code)

 

(Former name, former address and former fiscal year, if changed since last report)

 

Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:

 

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Shares, par value $5.00 per share

OTTR

The Nasdaq Stock Market LLC

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.      Yes  ☑     No  ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑       No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.:

 

Large accelerated filer ☑   Accelerated filer ☐  
     
Non-accelerated filer ☐  Smaller reporting company Emerging growth company

  

If an emerging growth company, indicate by checkmark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act  ☐

 

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).

Yes     No ☑

 

Indicate the number of shares outstanding of each of the issuer's classes of Common Stock, as of the latest practicable date:

 

October 31, 2019 39,759,054 Common Shares ($5 par value)

 

 

Table of Contents

 

 

OTTER TAIL CORPORATION

 

INDEX

 

Part I. Financial Information

Page No.

   

Item 1.

Financial Statements (not audited)

 
     
 

Consolidated Balance Sheets – September 30, 2019 and December 31, 2018 

2 & 3

     
 

Consolidated Statements of Income – Three and Nine Months Ended September 30, 2019 and 2018

4

     
 

Consolidated Statements of Comprehensive Income – Three and Nine Months Ended September 30, 2019 and 2018

5

     
 

Consolidated Statements of Common Shareholders’ Equity – Three and Nine Months Ended September 30, 2019 and 2018

6

     
 

Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2019 and 2018

7

     
 

Condensed Notes to Consolidated Financial Statements

8-38

     

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

39-57

     

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

57

     

Item 4.

Controls and Procedures

57

     

Part II. Other Information

 
     

Item 1.

Legal Proceedings

58

     

Item 1A.

Risk Factors 

58

     

Item 6.

Exhibits

58

     

Signatures

59

 

1

Table of Contents

 

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Otter Tail Corporation

Consolidated Balance Sheets

(not audited)

 

(in thousands)

 

September 30,

2019

   

December 31,

2018

 
                 

Assets

               
                 

Current Assets

               

Cash and Cash Equivalents

  $ 921     $ 861  

Accounts Receivable:

               

Trade—Net

    92,189       75,144  

Other

    8,884       9,741  

Inventories

    97,052       106,270  

Unbilled Receivables

    19,020       23,626  

Income Taxes Receivable

    -       2,439  

Regulatory Assets

    12,667       17,225  

Other

    6,926       6,114  

Total Current Assets

    237,659       241,420  
                 

Investments

    9,743       8,961  

Other Assets

    38,996       35,759  

Goodwill

    37,572       37,572  

Other IntangiblesNet

    11,562       12,450  

Regulatory Assets

    130,551       135,257  
                 

Right of Use Assets - Operating Leases

    21,953       -  
                 

Plant

               

Electric Plant in Service

    2,189,732       2,019,721  

Nonelectric Operations

    238,542       228,120  

Construction Work in Progress

    141,839       181,626  

Total Gross Plant

    2,570,113       2,429,467  

Less Accumulated Depreciation and Amortization

    877,958       848,369  

Net Plant

    1,692,155       1,581,098  
                 

Total Assets

  $ 2,180,191     $ 2,052,517  

 

See accompanying condensed notes to consolidated financial statements.

 

2

Table of Contents

 

Otter Tail Corporation

Consolidated Balance Sheets

(not audited)

 

(in thousands, except share data)

 

September 30,

2019

   

December 31,

2018

 
                 

Liabilities and Equity

               
                 

Current Liabilities

               

Short-Term Debt

  $ 108,997     $ 18,599  

Current Maturities of Long-Term Debt

    180       172  

Accounts Payable

    89,360       96,291  

Accrued Salaries and Wages

    19,151       24,857  

Accrued Federal and State Income Taxes

    3,945       -  

Other Accrued Taxes

    13,828       17,287  

Regulatory Liabilities

    6,311       738  

Current Operating Lease Liabilities

    4,006       -  

Other Accrued Liabilities

    7,409       12,149  

Total Current Liabilities

    253,187       170,093  
                 

Pensions Benefit Liability

    75,363       98,358  

Other Postretirement Benefits Liability

    73,668       71,561  

Long-Term Operating Lease Liabilities

    18,384       -  

Other Noncurrent Liabilities

    28,130       24,326  
                 

Commitments and Contingencies (note 9)

           
                 

Deferred Credits

               

Deferred Income Taxes

    124,602       120,976  

Deferred Tax Credits

    18,963       19,974  

Regulatory Liabilities

    238,781       226,469  

Other

    2,593       1,895  

Total Deferred Credits

    384,939       369,314  
                 

Capitalization

               

Long-Term Debt—Net

    590,015       590,002  
                 

Cumulative Preferred Shares – Authorized 1,500,000 Shares Without Par Value; Outstanding – None

    -       -  
                 

Cumulative Preference Shares – Authorized 1,000,000 Shares Without Par Value; Outstanding – None

    -       -  
                 

Common Shares, Par Value $5 Per Share—Authorized, 50,000,000 Shares; Outstanding, 2019—39,755,277 Shares; 2018—39,664,884 Shares

    198,776       198,324  

Premium on Common Shares

    346,294       344,250  

Retained Earnings

    215,931       190,433  

Accumulated Other Comprehensive Loss

    (4,496 )     (4,144 )

Total Common Equity

    756,505       728,863  

Total Capitalization

    1,346,520       1,318,865  

Total Liabilities and Equity

  $ 2,180,191     $ 2,052,517  

 

See accompanying condensed notes to consolidated financial statements.

 

3

Table of Contents

 

 

Otter Tail Corporation

Consolidated Statements of Income

(not audited)

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 

(in thousands, except share and per-share amounts)

 

2019

   

2018

   

2019

   

2018

 

Operating Revenues

                               

Electric:

                               

Revenues from Contracts with Customers

  $ 115,285     $ 105,749     $ 346,291     $ 334,858  

Changes in Accrued Revenues under Alternative Revenue Programs

    (921 )     (317 )     (1,601 )     (2,757 )

Total Electric Revenues

    114,364       105,432       344,690       332,101  

Product Sales under Contracts with Customers

    114,288       122,230       359,137       363,175  

Total Operating Revenues

    228,652       227,662       703,827       695,276  

Operating Expenses

                               

Production Fuel – Electric

    18,331       17,129       45,547       51,723  

Purchased Power – Electric System Use

    13,163       9,664       54,748       45,659  

Electric Operation and Maintenance Expenses

    35,869       33,897       114,107       111,113  

Cost of Products Sold (depreciation included below)

    88,747       93,361       277,325       275,691  

Other Nonelectric Expenses

    11,665       12,547       38,404       37,690  

Depreciation and Amortization

    19,657       18,708       58,229       56,216  

Property Taxes – Electric

    3,965       4,094       11,824       11,202  

Total Operating Expenses

    191,397       189,400       600,184       589,294  

Operating Income

    37,255       38,262       103,643       105,982  

Interest Charges

    7,539       7,549       23,190       22,597  

Nonservice Cost Components of Postretirement Benefits

    1,055       1,326       3,165       4,129  

Other Income

    1,020       1,245       3,114       3,135  

Income Before Income Taxes

    29,681       30,632       80,402       82,391  

Income Tax Expense

    4,936       7,359       13,907       14,207  

Net Income

  $ 24,745     $ 23,273     $ 66,495     $ 68,184  

Average Number of Common Shares OutstandingBasic

    39,714,672       39,621,524       39,694,677       39,592,705  

Average Number of Common Shares OutstandingDiluted

    39,946,739       39,903,565       39,922,580       39,882,105  

Basic Earnings Per Common Share

  $ 0.62     $ 0.59     $ 1.68     $ 1.72  

Diluted Earnings Per Common Share

  $ 0.62     $ 0.58     $ 1.67     $ 1.71  

 

See accompanying condensed notes to consolidated financial statements.

 

4

Table of Contents

 

 

Otter Tail Corporation

Consolidated Statements of Comprehensive Income

(not audited)

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 

(in thousands)

 

2019

   

2018

   

2019

   

2018

 

Net Income

  $ 24,745     $ 23,273     $ 66,495     $ 68,184  

Other Comprehensive Income (Loss):

                               

Unrealized Gain (Loss) on Available-for-Sale Securities:

                               

Reversal of Previously Recognized Gains Realized on Sale of Investments and Included in Other Income During Period

    (1 )     4       (5 )     (106 )

Unrealized Gains (Losses) Arising During Period

    30       (14 )     187       (93 )

Income Tax (Expense) Benefit

    (6 )     2       (38 )     42  

Change in Unrealized Gains on Available-for-Sale Securities – net-of-tax

    23       (8 )     144       (157 )

Pension and Postretirement Benefit Plans:

                               

Amortization of Unrecognized Postretirement Benefit Losses and Costs (note 11)

    130       232       389       692  

Income Tax Expense

    (34 )     (60 )     (101 )     (180 )

Adjustment to Income Tax Expense Related to 2017 Tax Cuts and Jobs Act

    -       -       -       (531 )

Pension and Postretirement Benefit Plans – net-of-tax

    96       172       288       (19 )

Total Other Comprehensive Income (Loss)

    119       164       432       (176 )

Total Comprehensive Income

  $ 24,864     $ 23,437     $ 66,927     $ 68,008  

 

See accompanying condensed notes to consolidated financial statements.

 

5

Table of Contents

 

 

Otter Tail Corporation

Consolidated Statements of Common Shareholders’ Equity

For the Three- and Nine-Month Periods Ended September 30, 2019 and 2018

(not audited)

 

(in thousands, except common shares outstanding)

 

Common

Shares

Outstanding

   

Par Value,

Common

Shares

   

Premium

on

Common

Shares

   

Retained

Earnings

   

Accumulated

Other

Comprehensive

Income/(Loss)

   

Total

Common

Equity

 

Balance, June 30, 2019

    39,754,902     $ 198,775     $ 345,030     $ 205,115     $ (4,615 )   $ 744,305  

Common Stock Issuances, Net of Expenses

    375       1       (37 )                     (36 )

Net Income

                            24,745               24,745  

Other Comprehensive Income

                                    119       119  

Employee Stock Incentive Plan Expense

                    1,301                       1,301  

Common Dividends ($0.35 per share)

                            (13,929 )             (13,929 )

Balance, September 30, 2019

    39,755,277     $ 198,776     $ 346,294     $ 215,931     $ (4,496 )   $ 756,505  
                                                 

Balance, June 30, 2018

    39,651,436     $ 198,257     $ 342,690     $ 179,605     $ (5,971 )   $ 714,581  

Common Stock Issuances, Net of Expenses

    25,225       126       (126 )                     -  

Common Stock Retirements

    (11,777 )     (59 )     (503 )                     (562 )

Net Income

                            23,273               23,273  

Other Comprehensive Loss

                                    164       164  

Employee Stock Incentive Plan Expense

                    1,149                       1,149  

Common Dividends ($0.335 per share)

                            (13,303 )             (13,303 )

Balance, September 30, 2018

    39,664,884     $ 198,324     $ 343,210     $ 189,575     $ (5,807 )   $ 725,302  
                                                 

Balance, December 31, 2018

    39,664,884     $ 198,324     $ 344,250     $ 190,433     $ (4,144 )   $ 728,863  

Common Stock Issuances, Net of Expenses

    145,617       728       (747 )                     (19 )

Common Stock Retirements

    (55,224 )     (276 )     (2,454 )                     (2,730 )

Net Income

                            66,495               66,495  

Other Comprehensive Income

                                    432       432  

ASU 2018-02 2017 TCJA Stranded Tax Transfer

                            784       (784 )     -  

Employee Stock Incentive Plan Expense

                    5,245                       5,245  

Common Dividends ($1.05 per share)

                            (41,781 )             (41,781 )

Balance, September 30, 2019

    39,755,277     $ 198,776     $ 346,294     $ 215,931     $ (4,496 )   $ 756,505  
                                                 

Balance, December 31, 2017

    39,557,491     $ 197,787     $ 343,450     $ 161,286     $ (5,631 )   $ 696,892  

Common Stock Issuances, Net of Expenses

    178,601       893       (986 )                     (93 )

Common Stock Retirements

    (71,208 )     (356 )     (2,656 )                     (3,012 )

Net Income

                            68,184               68,184  

Other Comprehensive Loss

                                    (176 )     (176 )

Employee Stock Incentive Plan Expense

                    3,402                       3,402  

Common Dividends ($1.005 per share)

                            (39,895 )             (39,895 )

Balance, September 30, 2018

    39,664,884     $ 198,324     $ 343,210     $ 189,575     $ (5,807 )   $ 725,302  

 

6

Table of Contents

 

 

Otter Tail Corporation

Consolidated Statements of Cash Flows

(not audited)

 

   

Nine Months Ended

September 30,

 

(in thousands)

 

2019

   

2018

 

Cash Flows from Operating Activities

               

Net Income

  $ 66,495     $ 68,184  

Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:

               

Depreciation and Amortization

    58,229       56,216  

Deferred Tax Credits

    (1,011 )     (1,054 )

Deferred Income Taxes

    3,487       7,529  

Change in Deferred Debits and Other Assets

    7,142       10,641  

Discretionary Contribution to Pension Plan

    (22,500 )     (20,000 )

Change in Noncurrent Liabilities and Deferred Credits

    10,344       (191 )

Allowance for Equity/Other Funds Used During Construction

    (1,602 )     (1,586 )

Stock Compensation Expense—Equity Awards

    5,245       3,402  

Other—Net

    312       (201 )

Cash (Used for) Provided by Current Assets and Current Liabilities:

               

Change in Receivables

    (16,213 )     (27,804 )

Change in Inventories

    9,218       (6,581 )

Change in Other Current Assets

    2,974       3,827  

Change in Payables and Other Current Liabilities

    (20,744 )     5,546  

Change in Interest and Income Taxes Receivable/Payable

    3,773       2,932  

Net Cash Provided by Operating Activities

    105,149       100,860  

Cash Flows from Investing Activities

               

Capital Expenditures

    (149,695 )     (74,489 )

Net Proceeds from Disposal of Noncurrent Assets

    4,111       1,879  

Cash Used for Investments and Other Assets

    (5,546 )     (3,324 )

Net Cash Used in Investing Activities

    (151,130 )     (75,934 )

Cash Flows from Financing Activities

               

Change in Checks Written in Excess of Cash

    383       (7 )

Net Short-Term Borrowings (Repayments)

    90,398       (96,882 )

Payments for Retirement of Capital Stock and Common Stock Issuance Expenses

    (2,765 )     (3,120 )

Proceeds from Issuance of Long-Term Debt

    -       100,000  

Short-Term and Long-Term Debt Issuance Expenses

    (66 )     (441 )

Payments for Retirement of Long-Term Debt

    (128 )     (148 )

Dividends Paid

    (41,781 )     (39,895 )

Net Cash Provided by (Used in) Financing Activities

    46,041       (40,493 )

Net Change in Cash and Cash Equivalents

    60       (15,567 )

Cash and Cash Equivalents at Beginning of Period

    861       16,216  

Cash and Cash Equivalents at End of Period

  $ 921     $ 649  

 

See accompanying condensed notes to consolidated financial statements.

 

7

Table of Contents

 

OTTER TAIL CORPORATION

 

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(not audited)

 

In the opinion of management, Otter Tail Corporation (the Company) has included all adjustments (including normal recurring accruals) necessary for a fair presentation of the consolidated financial statements for the periods presented. The consolidated financial statements and condensed notes thereto should be read in conjunction with the consolidated financial statements and notes included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2018. Because of seasonal and other factors, the earnings for the three- and nine-months ended September 30, 2019 should not be taken as an indication of earnings for all or any part of the balance of the year.

 

 

1. Summary of Significant Accounting Policies

 

Revenue Recognition

Due to the diverse business operations of the Company, recognition of revenue from contracts with customers depends on the product produced and sold or service performed. The Company recognizes revenue from contracts with customers at prices that are fixed or determinable as evidenced by an agreement with the customer, when the Company has met its performance obligation under the contract and it is probable that the Company will collect the amount to which it is entitled in exchange for the goods or services transferred or to be transferred to the customer. Depending on the product produced and sold or service performed and the terms of the agreement with the customer, the Company recognizes revenue either over time, in the case of delivery or transmission of electricity or related services or the production and storage of certain custom-made products, or at a point in time for the delivery of standardized products and other products made to the customer’s specifications where the terms of the contract require transfer of the completed product. Provisions for sales returns, early payment terms discounts, volume-based variable pricing incentives and warranty costs are recorded as reductions to revenue at the time revenue is recognized based on customer history, historical information and current trends.

 

In addition to recognizing revenue from contracts with customers under Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606) (ASC 606), the Company also records adjustments to Electric segment revenues for amounts subject to future collection under alternative revenue programs (ARPs) as defined in ASC Topic 980, Regulated Operations (ASC 980). The ARP revenue adjustments are recorded on the basis of recoverable costs incurred and returns earned under rate riders on a separate line on the face of the Company’s consolidated statements of income as they do not meet the criteria to be classified as revenue from contracts with customers.

 

Electric Segment Revenues—In the Electric segment, the Company recognizes revenue in two categories: (1) revenues from contracts with customers and (2) adjustments to revenues for amounts collectible under ARPs.

 

Most Electric segment revenues are earned from the generation, transmission and sale of electricity to retail customers at rates approved by regulatory commissions in the states where Otter Tail Power Company (OTP) provides service. OTP also earns revenue from the transmission of electricity for others over the transmission assets it owns separately, or jointly with other transmission service providers, under rate tariffs established by the independent transmission system operator and approved by the Federal Energy Regulatory Commission (FERC). A third source of revenue for OTP comes from the generation and sale of electricity to wholesale customers at contract or market rates. Revenues from all these sources meet the criteria to be classified as revenue from contracts with customers and are recognized over time as energy is delivered or transmitted. Revenue is recognized based on the metered quantity of electricity delivered or transmitted at the applicable rates. For electricity delivered and consumed after a meter is read but prior to the end of the reporting period, OTP records revenue and an unbilled receivable based on estimates of the kilowatt-hours (kwh) of energy delivered to the customer.

 

ARPs provide for adjustments to rates outside of a general rate case proceeding, usually as a surcharge applied to future billings typically through the use of rate riders subject to periodic adjustments, 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. ARP riders generally provide for the recovery of specified costs and investments and include an incentive component to provide the regulated utility with a return on amounts invested.

 

8

Table of Contents

 

OTP has recovered costs and earned incentives or returns on investments subject to recovery under several ARP rate riders, including:

 

 

In Minnesota: Transmission Cost Recovery (TCR), Environmental Cost Recovery (ECR), Renewable Resource Adjustment (RRA), Energy Intensive Trade Exposed and Conservation Improvement Program riders.

 

In North Dakota: TCR, ECR, RRA and Generation Cost Recovery (GCR) riders.

 

In South Dakota: TCR, ECR, Phase-in Rate Plan and Energy Efficiency Plan (conservation) riders.

 

OTP accrues ARP revenue on the basis of costs incurred, investments made and returns on those investments that qualify for recovery through established riders. Amounts billed under riders in effect at the time of the billing are included in revenues from contracts with customers net of amounts billed that are subject to refund through future rider adjustments. Amounts accrued and subject to recovery through future rider rate updates and adjustments are reported as changes in accrued revenues under ARPs on a separate line in the revenue section of the Company’s consolidated statement of income. See table in note 3 for total revenues billed and accrued under ARP riders for the three- and nine-month periods ended September 30, 2019 and 2018.

 

Manufacturing Segment Revenues—Companies in the Manufacturing segment, BTD Manufacturing, Inc. (BTD) and T.O. Plastics, Inc. (T.O. Plastics), earn revenue predominantly from the production and delivery of custom-made or standardized parts to customers across several industries. BTD also earns revenue from the production and sale of tools and dies to other manufacturers. For the production and delivery of standardized products and other products made to customer specifications where the terms of the contract require transfer of the completed product, the operating company has met its performance obligation and recognizes revenue at the point in time when the product is shipped. For revenue recognized on products when shipped, the operating companies have no further obligation to provide services related to such products. The shipping terms used in these instances are FOB shipping point.

 

Plastics Segment Revenues—Companies in our Plastics segment earn revenue predominantly from the sale and delivery of standardized polyvinyl chloride (PVC) pipe products produced at their manufacturing facilities. Revenue from the sale of these products is recognized at the point in time when the product is shipped based on prices agreed to in a purchase order. For revenue recognized on shipped products, there is no further obligation to provide services related to such product. The shipping terms used in these instances are FOB shipping point. The Plastics segment has one customer for which it produces and stores a product made to the customer’s specifications and design under a build and hold agreement. For sales to this customer, the operating company recognizes revenue as the custom-made product is produced, adjusting the amount of revenue for volume rebate variable pricing considerations the operating company expects the customer will earn and applicable early payment discounts the company expects the customer will take. Ownership of the pipe transfers to the customer prior to delivery and the operating company is paid a negotiated fee for storage of the pipe. Revenue for storage of the pipe is also recognized over time as the pipe is stored.

 

See operating revenue table in note 2 for a disaggregation of the Company’s revenues by business segment for the three- and nine-month periods ended September 30, 2019 and 2018.

 

Agreements Subject to Legally Enforceable Netting Arrangements

OTP has certain derivative contracts that are designated as normal purchases. Individual counterparty exposures for these contracts can be offset according to legally enforceable netting arrangements. The Company does not offset assets and liabilities under legally enforceable netting arrangements on the face of its consolidated balance sheet.

 

 

Fair Value Measurements

The Company follows ASC Topic 820, Fair Value Measurements and Disclosures (ASC 820), for recurring fair value measurements. ASC 820 provides a single definition of fair value, requires enhanced disclosures about assets and liabilities measured at fair value and establishes a hierarchical framework for disclosing the observability of the inputs utilized in measuring assets and liabilities at fair value. The three levels defined by the hierarchy and examples of each level are as follows:

 

Level 1 – Quoted prices are available in active markets for identical assets or liabilities as of the reported date. The types of assets and liabilities included in Level 1 are highly liquid and actively traded instruments with quoted prices, such as equities listed by the New York Stock Exchange and commodity derivative contracts listed on the New York Mercantile Exchange.

 

Level 2 – Pricing inputs are other than quoted prices in active markets but are either directly or indirectly observable as of the reported date. The types of assets and liabilities included in Level 2 are typically either comparable to actively traded securities or contracts, such as treasury securities with pricing interpolated from recent trades of similar securities, or priced with models using highly observable inputs, such as commodity options priced using observable forward prices and volatilities.

 

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Level 3 – Significant inputs to pricing have little or no observability as of the reporting date. The types of assets and liabilities included in Level 3 are those with inputs requiring significant management judgment or estimation and may include complex and subjective models and forecasts.

 

The following tables present, for each of the hierarchy levels, the Company’s assets and liabilities that are measured at fair value on a recurring basis as of September 30, 2019 and December 31, 2018:

 

September 30, 2019 (in thousands)

 

Level 1

   

Level 2

 

Level 3

Assets:

                 

Investments:

                 

Equity Funds – Held by Captive Insurance Company

  $ 1,462            

Corporate Debt Securities – Held by Captive Insurance Company

          $ 3,378    

Government-Backed and Government-Sponsored Enterprises’ Debt Securities – Held by Captive Insurance Company

            4,772    

Other Assets:

                 

Money Market and Mutual Funds – Retirement Plans

    2,661            

Total Assets

  $ 4,123     $ 8,150    

 

December 31, 2018 (in thousands)

 

Level 1

   

Level 2

 

Level 3

Assets:

                 

Investments:

                 

Equity Funds – Held by Captive Insurance Company

  $ 1,294            

Corporate Debt Securities – Held by Captive Insurance Company

          $ 5,898    

Government-Backed and Government-Sponsored Enterprises’ Debt Securities – Held by Captive Insurance Company

            1,586    

Other Assets:

                 

Money Market and Mutual Funds – Nonqualified Retirement Savings Plan

    838            

Total Assets

  $ 2,132     $ 7,484    

 

The level 2 fair values for Government-Backed and Government-Sponsored Enterprises’ and Corporate Debt Securities Held by the Company’s Captive Insurance Company are determined on the basis of valuations provided by a third-party pricing service which utilizes industry accepted valuation models and observable market inputs to determine valuation. Some valuations or model inputs used by the pricing service may be based on broker quotes.

 

Coyote Station Lignite Supply Agreement – Variable Interest Entity

In October 2012 the Coyote Station owners, including OTP, entered into a lignite sales agreement (LSA) with Coyote Creek Mining Company, L.L.C. (CCMC), a subsidiary of The North American Coal Corporation, for the purchase of lignite coal to meet the coal supply requirements of Coyote Station for the period beginning in May 2016 and ending in December 2040. The price per ton paid by the Coyote Station owners under the LSA reflects the cost of production, along with an agreed profit and capital charge. CCMC was formed for the purpose of mining coal to meet the coal fuel supply requirements of Coyote Station from May 2016 through December 2040 and, based on the terms of the LSA, is considered a variable interest entity (VIE) due to the transfer of all operating and economic risk to the Coyote Station owners, as the agreement is structured so that the price of the coal would cover all costs of operations as well as future reclamation costs. The Coyote Station owners are also providing a guarantee of the value of the assets of CCMC as they would be required to buy certain assets at book value should they terminate the contract prior to the end of the contract term and are providing a guarantee of the value of the equity of CCMC in that they are required to buy the entity at the end of the contract term at equity value. Under current accounting standards, the primary beneficiary of a VIE is required to include the assets, liabilities, results of operations and cash flows of the VIE in its consolidated financial statements. No single owner of Coyote Station owns a majority interest in Coyote Station and none, individually, has the power to direct the activities that most significantly impact CCMC. Therefore, none of the owners individually, including OTP, is considered a primary beneficiary of the VIE and the Company is not required to include CCMC in its consolidated financial statements.

 

If the LSA terminates prior to the expiration of its term or the production period terminates prior to December 31, 2040 and the Coyote Station owners purchase all of the outstanding membership interests of CCMC as required by the LSA, the owners will satisfy, or (if permitted by CCMC’s applicable lender) assume, all of CCMC’s obligations owed to CCMC’s lenders under its loans and leases. The Coyote Station owners have limited rights to assign their rights and obligations under the LSA without the consent of CCMC’s lenders during any period in which CCMC’s obligations to its lenders remain outstanding. In the event the contract is terminated because regulations or legislation render the burning of coal cost prohibitive and the assets worthless, OTP’s maximum exposure to loss as a result of its involvement with CCMC as of September 30, 2019 could be as high as $51.3 million, OTP’s 35% share of unrecovered costs.

 

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Inventories

Inventories, valued at the lower of cost or net realizable value, consist of the following:

 

   

September 30,

   

December 31,

 

(in thousands)

 

2019

   

2018

 

Finished Goods

  $ 29,601     $ 37,130  

Work in Process

    18,884       20,393  

Raw Material, Fuel and Supplies

    48,567