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 customers 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,

Reg

ated 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: (

) revenues from contracts with customers and (

) 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). These revenues account for over

80%

of other electric revenues reported in the table of disaggregated revenues in note

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.

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) and Conservation Improvement Program riders.

●

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

●

In South Dakota: TCR, ECR 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 ARP revenue adjustments on a separate line in the revenue section of the Company’s consolidated statement of income. See table in note

for total revenues billed and accrued under ARP riders for the

three

-month periods ended

March 31, 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

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

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

for a disaggregation of the Company’s revenues by business segment for the

three

-month periods ended

March 31, 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

– 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

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

– 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

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.

Level

– Significant inputs to pricing have little or

observability as of the reporting date. The types of assets and liabilities included in Level

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

March 31, 2019

and

December 31, 2018:

March 31, 201 9 (in thousands)	Level 1		Level 2		Level 3
Assets:
Investments:
Equity Funds – Held by Captive Insurance Company	$	1,444
Corporate Debt Securities – Held by Captive Insurance Company			$	5,975
Government-Backed and Government-Sponsored Enterprises’ Debt Securities – Held by Captive Insurance Company				1,644
Other Assets:
Money Market and Mutual Funds – Nonqualified Retirement Savings Plan		1,396
Total Assets	$	2,840	$	7,619

December 31, 201 8 (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

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

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.

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

March 31, 2019

could be as high as

$53.1

million, OTP’s

35%

share of unrecovered costs.

Inventories

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

	March 31,		December 31,
(in thousands)	2019		2018
Finished Goods	$	35,771	$	37,130
Work in Process		20,503		20,393
Raw Material, Fuel and Supplies		50,458		48,747
Total Inventories	$	106,732	$	106,270

Goodwill and Other Intangible Assets

An assessment of the carrying amounts of goodwill of the Company’s operating units as of

December 31, 2018

indicated the fair values are substantially in excess of their respective book values and

not

impaired.

The following table indicates there were

changes to goodwill by business segment during the

first

three

months of

2019:

(in thousands)	Gross Balance December 31, 2018		Accumulated Impairments		Balance (net of impairments) December 31, 2018		Adjustments to Goodwill in 2019		Balance (net of impairments) March 31, 2019
Manufacturing	$	18,270	$	--	$	18,270	$	--	$	18,270
Plastics		19,302		--		19,302		--		19,302
Total	$	37,572	$	--	$	37,572	$	--	$	37,572

Intangible assets with finite lives are amortized over their estimated useful lives and reviewed for impairment in accordance with requirements under ASC Topic

360

35,

Property, Plant, and Equipment—Overall—Subsequent Measurement

The following table summarizes the components of the Company’s intangible assets at

March 31, 2019

and

December

31,

2018:

March 31, 201 9 (in thousands)	Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount		Remaining Amortization Periods (months)
Amortizable Intangible Assets:
Customer Relationships	$	22,491	$	10,410	$	12,081	9	-	197
Other		154		81		73		17
Total	$	22,645	$	10,491	$	12,154

December 31, 201 8 (in thousands)	Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount		Remaining Amortization Periods (months)
Amortizable Intangible Assets:
Customer Relationships	$	22,491	$	10,127	$	12,364	12	-	200
Other		154		68		86		20
Total	$	22,645	$	10,195	$	12,450

The amortization expense for these intangible assets was:

	Three Months Ended
	March 31,
(in thousands)	2019		2018
Amortization Expense – Intangible Assets	$	296	$	345

The estimated annual amortization expense for these intangible assets for the next

five

years is:

(in thousands)		2019				2020				2021				2022				2023
Estimated Amortization Expense – Intangible Assets		$	1,184			$	1,133			$	1,099			$	1,099			$	1,099

Supplemental Disclosures of Cash Flow Information

	As of March 31,
(in thousands)	2019		2018
Noncash Investing Activities:
Transactions Related to Capital Additions not Settled in Cash	$	4,338	$	10,451

New Accounting Standards Adopted

ASU

2016

—In

February 2016

the FASB issued ASU

No.

2016

02,

Leases (Topic

842

)

(ASU

2016

). ASU

2016

is a comprehensive amendment of the ASC, creating Topic

842,

which supersedes the requirements under ASC Topic

840

on leases and requires the recognition of lease assets and lease liabilities on the balance sheet and the disclosure of key information about leasing arrangements. The amendments in ASU

2016

are effective for fiscal years beginning after

December 15, 2018,

including interim periods within those fiscal years. The main difference between previous Generally Accepted Accounting Principles in the United States (GAAP) and Topic

842

is the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. The Company adopted the amendments in ASU

2016

to its consolidated financial statements effective

January 1, 2019.

See note

for further information on leases and the Company’s elections for applying the new standard.

ASU

2018

—In

February 2018

the FASB issued ASU

No.

2018

02,

Income Statement—Reporting Comprehensive Income

(Topic

220

Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income

(ASU

2018

). The amendments in ASU

2018

02,

which are narrow in scope, allow a reclassification from accumulated other comprehensive income/(loss) (AOCI/(L)) to retained earnings for the stranded tax effects resulting from the Tax Cuts and Jobs Act (TCJA). Consequently, the amendments eliminate the stranded tax effects resulting from the TCJA and will improve the usefulness of information reported to financial statement users. The amendments in ASU

2018

also require certain disclosures about stranded tax effects and are effective for fiscal years beginning after

December 15, 2018,

and interim periods within those fiscal years. The amendments in ASU

2018

can be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the TCJA is recognized.

The Company adopted the updates in ASU

2018

effective

January 1, 2019,

applying them in the period of adoption and

not

retrospectively. On adoption, the Company reclassified

$784,000

of income tax effects of the TCJA on the gross deferred tax amounts reflected in AOCI/(L) at the date of enactment of the TCJA from AOCI/(L) to retained earnings so the remaining gross deferred tax amounts related to items in AOCI/(L) will reflect current effective tax rates.

Support for the determination of the stranded tax effects resulting from the enactment of the TCJA in AOCI/(L) is provided in the table below.

(in thousands)	Unrealized Gains on Available-for- Sale Securities		Unamortized Actuarial Losses and Prior Service Costs on Pension and Other Postretirement Benefits			AOCI/(L)
Balance on December 22, 2017 – Pre-tax	$	71	$	(5,672	)	$	(5,601	)
Effect of TCJA 14% Federal Tax Rate Reduction on Gross Deferred Tax Amounts	$	10	$	(794	)	$	(784	)

ASU

2017

—In

January 2017

the FASB issued ASU

No.

2017

04,

Intangibles—Goodwill and Other (Topic

350

): Simplifying the Test for Goodwill Impairment

(ASU

2017

), which simplifies how an entity is required to test goodwill for impairment by eliminating Step

from the goodwill impairment test. Step

measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. In computing the implied fair value of goodwill under Step

an entity must perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Under the amendments in ASU

2017

04,

an entity will perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity will recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized will

not

exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity will consider income tax effects from any tax-deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable.

The amendments in ASU

2017

modify the concept of impairment from the condition that exists when the carrying amount of goodwill exceeds its implied fair value to the condition that exists when the carrying amount of a reporting unit exceeds its fair value. An entity

longer will determine goodwill impairment by calculating the implied fair value of goodwill by assigning the fair value of a reporting unit to all of its assets and liabilities as if that reporting unit had been acquired in a business combination. Because these amendments eliminate Step

from the goodwill impairment test, they should reduce the cost and complexity of evaluating goodwill for impairment. The amendments in ASU

2017

are effective for annual or any interim goodwill impairment tests in fiscal years beginning after

December 15, 2019.

Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after

January 1, 2017.

The Company early adopted the amendments in ASU

2017

in the

first

quarter of

2019.

The Company had

indication that any of its goodwill was impaired, therefore, the adoption of the updated standard had

impact on the Company’s consolidated financial statements.