Otter Tail Corp

10. Commitments and Contingencies

Contingencies

FERC Return on Equity (ROE). In November 2013 and February 2015, customers filed complaints with the Federal Energy Regulatory Commission (FERC) seeking to reduce the ROE component of the transmission rates that MISO transmission owners, including OTP, may collect under the MISO tariff rate. FERC's most recent order, issued on November 19, 2020, adopted a revised ROE methodology and set the base ROE at 10.02% (10.52% with an adder) effective for the fifteen-month period from November 2013 to February 2015 and on a prospective basis beginning in September 2016. The order also dismissed any complaints covering the period from February 2015 to May 2016. On August 9, 2022, the U.S. Court of Appeals for the District of Columbia Circuit vacated the FERC order citing a lack of reasoned explanation by FERC in its adoption of its revised ROE methodology as outlined in its November 2020 order and remanded the matter to FERC to reopen the proceedings. In July 2024, FERC counsel indicated that the FERC plans to act within 120 days on the U.S. Court of Appeals remand and that the expectation is there will be no further briefings on the matter; rather, FERC intends to issue an order based on the record developed to date to resolve the ROE matter and remand proceedings.

Although FERC has indicated they will act on the remand before the end of the year, uncertainty remains as to what specific actions FERC will take in their final order. As a result, we have continued to defer recognition of certain revenues and recognize a refund liability related to this matter. The balance of the recorded refund liability was $2.9 million as of June 30, 2024, which is included in other current liabilities on the consolidated balance sheets. This refund liability reflects our best estimate of amounts previously collected from customers under the MISO tariff rate that may be required to be refunded to customers once all regulatory and judicial proceedings are complete and a final ROE is established for the periods outlined above.

Regional Haze Rule (RHR). The RHR was adopted in an effort to improve visibility in national parks and wilderness areas. The RHR requires states, in coordination with the Environmental Protection Agency (EPA) and other governmental agencies, to develop and implement plans to achieve natural visibility conditions. The second RHR implementation period covers the years 2018-2028. States are required to submit a state implementation plan to assess reasonable progress with the RHR and determine what additional emission reductions are appropriate, if any.

Coyote Station, OTP's jointly owned coal-fired power plant in North Dakota, is subject to assessment in the second implementation period under the North Dakota state implementation plan. The North Dakota Department of Environmental Quality (NDDEQ) submitted its state implementation plan to the EPA for approval in August 2022. In its plan, the NDDEQ concluded it is not reasonable to require additional emission controls during this planning period.

In June 2023, a coalition of environmental organizations filed a lawsuit against the EPA for failing to enforce the RHR. In response, the EPA proposed, through a consent decree filed in the U.S. District Court for the District of Columbia in March 2024, a timeline for it to act on 34 outstanding state implementation plans. Under the consent decree, which was issued on July 12, 2024, the EPA would approve, deny, partially approve or issue a federal implementation plan at assigned dates between 2024 and 2026, including a final decision on the North Dakota state implementation plan by November 2024.

In July 2024, the EPA published its proposed rule for North Dakota’s state implementation plan, in which the EPA proposed to approve certain aspects of the state implementation plan and disapprove of other aspects of the plan. The EPA proposes to find that North Dakota failed to submit a long-term strategy that includes enforceable emissions limitations, compliance schedules, and other measures necessary to make reasonable progress on national visibility goals. Specific to Coyote Station, the EPA contends North Dakota relied on non-statutory visibility modeling to reject the installation of emission controls. The EPA also proposes to find the North Dakota plan does not adequately demonstrate that existing limits for NOx and SO 2 at Coyote Station are sufficient to ensure progress towards the national visibility goals. The proposed rule remains subject to a 30-day comment period. We continue to anticipate final EPA action by November 2024.

We cannot predict with certainty the final resolution of regional haze compliance in North Dakota and specifically the impact, if any, on the operations of Coyote Station. However, significant emission control investments could be required and the recovery of such costs from customers would require regulatory approval. Alternatively, investments in emission control equipment may prove to be uneconomic and result in the early retirement, or sale, of our interest in Coyote Station, which would be subject to regulatory approval. We cannot estimate the ultimate financial effects such a retirement or sale may have on our consolidated operating results, financial position or cash flows, but such amounts could be material and the recovery of such costs in rates would be subject to regulatory approval.

Self-Funding of Transmission Upgrades for Generator Interconnections. The FERC has granted transmission owners within MISO the unilateral authority to determine the funding mechanism for interconnection transmission upgrades that are necessary to accommodate new generation facilities connecting to the electrical grid. Under existing FERC orders, transmission owners can unilaterally determine whether the generator pays the transmission owner in advance for the transmission upgrade or, alternatively, the transmission owner can elect to fund the upgrade and recover over time from the generator the cost of and a return on the upgrade investment (a self-funding). FERC’s orders granting transmission owners this unilateral funding authority have been judicially contested on the basis that transmission owners may be motivated to discriminate among generators in making funding determinations. In the most recent judicial proceedings, the petitioners argued to the U.S. Court of Appeals for the District of Columbia that FERC did not comply with a previous judicial order to fully develop a record regarding the risk of discrimination and the financial risk absorbed by transmission owners for generator-funded upgrades. In December 2022, the Court of Appeals ruled in favor of the petitioners remanding the matter to FERC, instructing the agency to adequately explain the basis of its orders. The Court of Appeals decision did not vacate transmission owners’ unilateral funding authority.

On June 13, 2024, FERC issued an Order to Show Cause proceeding against four Regional Transmission Organizations (RTOs), including MISO. Within its order, FERC indicates that the transmission tariffs of the RTOs appear to be unjust, unreasonable, and unduly discriminatory or preferential because they allow transmission owners to unilaterally elect transmission owner self-funding, which may increase costs, impose barriers to transmission interconnection and result in undue discrimination among interconnection customers.

The order requires each RTO to submit filings to either 1) show cause as to why the transmission tariff remains just and reasonable and not duly discriminatory or preferential, or 2) to explain what changes to the tariff it believes would remedy the identified concerns. The RTO filings are due 90 days after the order was issued and interested entities may file within 30 days thereafter to address the RTOs filings. The order also stipulates that if no final decision is reached by the conclusion of a 180-day period from the issuance of the order, FERC shall state the reasons why it did not act and provide its best estimate when it expects to issue a decision. FERC contemporaneously issued an order suspending the pending remand on the related case.

On July 15, 2024, a group of utilities, not including OTP, submitted to FERC a request for rehearing of the order on the basis of the legal and statutory authority of the order. In the alternative, the utilities also requested FERC rescind or withdraw the order.

OTP, as a transmission owner in MISO, has exercised its authority and elected to self-fund previous transmission upgrades necessary to accommodate new system generation. Under such an election, OTP is recovering the cost of the transmission upgrade and a return on that investment from the generator over a contractual period of time. Should the resolution of this matter eliminate transmission owners’ unilateral funding authority on either a prospective or retrospective basis, our financial results would be impacted. We cannot at this time reasonably predict the outcome of this matter given the uncertainty as to how FERC may ultimately decide on the matter after RTO's filings in response to the Order to Show Cause.

Other Contingencies. We are party to litigation and regulatory matters arising in the normal course of business. We regularly analyze relevant information and, as necessary, estimate and record accrued liabilities for legal, regulatory enforcement and other matters in which a loss is probable of occurring and can be reasonably estimated. We believe the effect on our consolidated operating results, financial position and cash flows, if any, for the disposition of all matters pending as of June 30, 2024, other than those discussed above, will not be material.

11. Stockholders' Equity

Registration Statements

On May 3, 2024, 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. No new debt or equity has been issued pursuant to the registration statement. The registration statement expires in May 2027.

On May 3, 2024, 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 methods of purchasing our common shares by reinvesting their dividends or making optional cash investments. Shares purchased under the plan may be newly issued common shares or common shares purchased on the open market. During the six months ended June 30, 2024, we issued 46,003 shares under this plan. We repurchased a sufficient number of shares on the open market to satisfy issuance under the plan; accordingly, no proceeds from the issuance were received. As of June 30, 2024, there were 1,099,327 shares available for purchase or issuance under the plan. The registration statement expires in May 2027.

Dividend Restrictions

OTC is a holding company with no significant operations of its own. The primary source of funds for payments of dividends to OTC's shareholders is from dividends paid or distributions made by OTC's subsidiaries. As a result of certain statutory limitations or regulatory or financing agreements, the amount of distributions allowed to be made by OTC's subsidiaries or the amount of dividends paid by OTC could be restricted. Both the OTC Credit Agreement and the OTP Credit Agreement contain restrictions on the payment of cash dividends upon a default or event of default, including failure to maintain certain financial covenants. As of June 30, 2024, we were in compliance with these financial covenants.

Under the Federal Power Act, a public utility may not pay dividends from any funds properly included in a capital account. What constitutes “funds properly included in a capital account” is undefined in the Federal Power Act or the related regulations; however, the FERC has consistently interpreted the provision to allow dividends to be paid as long as i) the source of the dividends is clearly disclosed, ii) the dividend is not excessive and iii) there is no self-dealing on the part of corporate officials.

The Minnesota Public Utilities Commission indirectly limits the amount of dividends OTP can pay to OTC by requiring an equity-to-total-capitalization ratio between 48.3% and 59.1% based on OTP’s current capital structure requirements. As of June 30, 2024, OTP’s equity-to-total-capitalization ratio, including short-term debt, was 52.9% and its net assets restricted from distribution totaled approximately $819 million. Under the MPUC order, total capitalization for OTP cannot exceed $2.0 billion.

12. Accumulated Other Comprehensive Income (Loss)

The following presents the changes in accumulated other comprehensive income (loss) for the three and six months ended June 30, 2024 and 2023:

13. Share-Based Payments

Stock Compensation Expense

Stock-based compensation expense arising from our employee stock purchase plan and share-based compensation plans recognized within operating expenses in the consolidated statements of income amounted to $1.3 million and $1.2 million for the three months ended June 30, 2024 and 2023 and $6.8 million and $6.5 million for the six months ended June 30, 2024 and 2023.

Restricted Stock Awards. Restricted stock awards are granted to executive officers and other key employees and members of the Company's Board of Directors. The awards vest, depending on award recipient, either ratably over a period ofthree orfour years or cliff vest after four years. Vesting is accelerated in certain circumstances, including upon retirement.

The following is a summary of stock award activity for the six months ended June 30, 2024:

The fair value of vested awards was $4.4 million and $3.1 million during the six months ended June 30, 2024 and 2023.

Stock Performance Awards. Stock performance awards are granted to executive officers and certain other key employees. The awards vest at the end of athree-year performance period. The number of common shares awarded, if any, at the end of the performance period ranges from zero to 150% of the target amount based ontwo performance measures: i) total shareholder return relative to a peer group and ii) ROE. Vesting of the awards is accelerated in certain circumstances, including on retirement. The number of common shares awarded on an accelerated vesting is based on actual performance at the end of the performance period.

The grant date fair value of stock performance awards granted during the six months ended June 30, 2024 and 2023 was determined using a Monte Carlo fair value simulation model incorporating the following assumptions:

The risk-free interest rate was derived from yields on U.S. government bonds of a similar term. The expected term of the award is equal to thethree-year performance period. Expected volatility was estimated based on actual historical volatility of our common stock. Dividend yield was estimated based on historical and future yield estimates.

The following is a summary of stock performance award activity for the six months ended June 30, 2024 (share amounts reflect awards at target):

The fair value of vested awards was $11.1 million and $5.3 million during the six months ended June 30, 2024 and 2023, respectively.

14. Earnings Per Share

The numerator used in the calculation of both basic and diluted earnings per share is net income. The denominator used in the calculation of basic earnings per share is the weighted-average number of shares outstanding during the period. The denominator used in the calculation of diluted earnings per share is derived by adjusting basic shares outstanding for the dilutive effect of potential shares outstanding, which consist of time- and performance-based stock awards and employee stock purchase plan shares.

The following includes the computation of the denominator for basic and diluted weighted-average shares outstanding for the three and six months ended June 30, 2024 and 2023:

For the three and six months ended June 30, 2024 and 2023, there wereno shares excluded from diluted weighted-average common shares outstanding because such shares were anti-dilutive.

15. Derivative Instruments

OTP enters into derivative instruments to manage its exposure to future market energy price variability and reduce volatility in prices for our retail customers. These derivative instruments are not designated as qualifying hedging transactions but provide for an economic hedge against future market energy price variability. The instruments are recorded at fair value on the consolidated balance sheets. In accordance with rate-making and cost recovery processes, we recognize a regulatory asset or liability to defer losses or gains from derivative activity until settlement of the associated derivative instrument.

As of June 30, 2024, OTP had multiple outstanding pay-fixed, receive-variable swap agreements with an aggregate notional amount of 221,200 megawatt-hours of electricity, with settlement dates extending to December 31, 2025. As of June 30, 2024, the fair value of these derivative instruments was $2.0 million, of which $1.5 million is included in other current liabilities and $0.5 million is included in long term liabilities on the consolidated balance sheets. As of December 31, 2023, the fair value of these derivative instruments was $4.2 million, which is included in other current liabilities. During the six months ended June 30, 2024 and 2023, contracts matured and were settled in an aggregate amount of a $2.7 million loss and a $16.0 million loss, respectively. Gains and losses recognized on the settlement of derivative instruments are returned to, or recovered from, our electric customers through fuel recovery mechanisms in each state. When recognized in the consolidated statements of income, these gains or losses are included in electric purchased power.

16. Fair Value Measurements

The following tables present our assets and liabilities measured at fair value on a recurring basis as of June 30, 2024 and December 31, 2023 classified by the input method used to measure fair value:

Level 1 fair value measurements are based on quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access at the measurement date.

The level 2 fair value measurements for government and corporate debt securities are determined based on 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.

The level 2 fair value measurements for derivative instruments are determined by using inputs such as forward electric commodity prices, adjusted for location differences. These inputs are observable in the marketplace throughout the full term of the instrument, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace.

In addition to assets recorded at fair value on a recurring basis, we also hold financial instruments that are not recorded at fair value in the consolidated balance sheets but for which disclosure of the fair value of these financial instruments is provided.

The following reflects the carrying value and estimated fair value of these assets and liabilities as of June 30, 2024 and December 31, 2023:

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash Equivalents: The carrying amount approximates fair value because of the short-term maturity of those instruments.

Short-Term Debt: The carrying amount approximates fair value because the debt obligations are short-term and the balances outstanding are subject to variable rates of interest which reset frequently, a Level 2 fair value input.

Long-Term Debt: The fair value of long-term debt is estimated based on current market indications for borrowings of similar maturities with similar terms, a Level 2 fair value input.