##### 



Exhibit 13-A SELECTED CONSOLIDATED FINANCIAL DATA (in thousands, except number of
shareholders and per-share data)
    

2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000 (1)
    
    
    1999 (1) (2)
    
    
    1994RevenuesElectric (7)
    
    $
    266,385
    
    
    $
    267,494
    
    
    $
    244,005
    
    
    $
    232,720
    
    
    $
    219,718
    
    
    $
    203,393
    
    
    $
    186,495Plastics
    
    
    115,426
    
    
    
    86,009
    
    
    
    82,931
    
    
    
    63,216
    
    
    
    82,667
    
    
    
    31,504
    
    
    
    Manufacturing
    
    
    226,577
    
    
    
    177,805
    
    
    
    142,390
    
    
    
    123,436
    
    
    
    97,506
    
    
    
    87,086
    
    
    
    13,083Health services
    
    
    114,318
    
    
    
    100,912
    
    
    
    93,420
    
    
    
    79,129
    
    
    
    66,319
    
    
    
    68,805
    
    
    
    45,555Other business operations (6)
    
    
    162,351
    
    
    
    114,726
    
    
    
    75,947
    
    
    
    72,191
    
    
    
    70,145
    
    
    
    59,327
    
    
    
    25,615Intersegment eliminations
    
    
    (2,733
    )
    
    
    (2,254
    )
    
    
    (1,036
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total operating revenues
    
    $
    882,324
    
    
    $
    744,692
    
    
    $
    637,657
    
    
    $
    570,692
    
    
    $
    536,355
    
    
    $
    450,115
    
    
    $
    270,748Income from continuing operations (6)
    
    
    39,980
    
    
    
    37,614
    
    
    
    44,176
    
    
    
    41,794
    
    
    
    39,210
    
    
    
    42,808
    
    
    
    27,831Income from discontinued operations
    
    
    2,215
    
    
    
    2,042
    
    
    
    1,952
    
    
    
    1,809
    
    
    
    1,832
    
    
    
    2,487
    
    
    
    644Net income
    
    
    42,195
    
    
    
    39,656
    
    
    
    46,128
    
    
    
    43,603
    
    
    
    41,042
    
    
    
    45,295
    
    
    
    28,475Cash flow from continuing operations (6)
    
    
    56,127
    
    
    
    72,644
    
    
    
    72,360
    
    
    
    73,808
    
    
    
    58,007
    
    
    
    78,635
    
    
    
    50,245Capital expenditures  continuing operations (6)
    
    
    49,792
    
    
    
    49,094
    
    
    
    74,074
    
    
    
    51,994
    
    
    
    44,956
    
    
    
    33,733
    
    
    
    29,804Total assets (5)
    
    
    1,134,148
    
    
    
    986,423
    
    
    
    914,112
    
    
    
    817,778
    
    
    
    772,562
    
    
    
    729,118
    
    
    
    612,749Long-term debt (6)
    
    
    261,810
    
    
    
    262,363
    
    
    
    254,279
    
    
    
    222,291
    
    
    
    188,939
    
    
    
    172,850
    
    
    
    153,183Redeemable preferred
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,000
    
    
    
    18,000
    
    
    
    18,000Basic earnings per share from continuing operations (3) (6)
    
    
    1.51
    
    
    
    1.44
    
    
    
    1.72
    
    
    
    1.62
    
    
    
    1.52
    
    
    
    1.65
    
    
    
    1.14Diluted earnings per share from continuing operations (3) (6)
    
    
    1.50
    
    
    
    1.43
    
    
    
    1.71
    
    
    
    1.61
    
    
    
    1.52
    
    
    
    1.65
    
    
    
    1.14Return on average common equity
    
    
    12.0
    %
    
    
    12.2
    %
    
    
    15.3
    %
    
    
    15.5
    %
    
    
    15.4
    %
    
    
    18.4
    %
    
    
    15.1
    %Dividends per common share
    
    
    1.10
    
    
    
    1.08
    
    
    
    1.06
    
    
    
    1.04
    
    
    
    1.02
    
    
    
    0.99
    
    
    
    0.86Dividend payout ratio
    
    
    70
    %
    
    
    72
    %
    
    
    59

    %
    
    
    62
    %
    
    
    64
    %
    
    
    57
    %
    
    
    74
    %Common shares outstanding  year end
    
    
    28,977
    
    
    
    25,724
    
    
    
    25,592
    
    
    
    24,653
    
    
    
    24,574
    
    
    
    24,571
    
    
    
    22,360Number of common shareholders (4)
    
    
    14,889
    
    
    
    14,723
    
    
    
    14,503
    
    
    
    14,358
    
    
    
    14,103
    
    
    
    13,438
    
    
    
    14,115
   Notes: (1)
    Restated to reflect the effects of two 2001 acquisitions accounted
for under the pooling-of-interests method. The impact of the poolings on
years prior to 1999 is not material.(2)
    1999 results include the sale of radio station assets for a net gain
of $8.1 million or 34 cents per share.(3)
    Based on average number of shares outstanding.(4)
    Holders of record at year end.(5)
    2002 and prior years are restated to reflect reclassification of
estimated removal costs from accumulated depreciation to a
regulatory liability.(6)
    Prior years are restated to exclude the operations of Midwest
Information Systems, Inc., which is classified as discontinued
operations. See note 15 to consolidated financial statements.(7)
    2002 and prior years are restated to reflect implementation of
accounting standard, EITF Issue 03-11.




---



##### 



MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Otter Tail Corporation and our subsidiaries form a diverse group of businesses with operations
classified into five segments: electric, plastics, manufacturing, health services and other
business operations. Our primary financial goals are to maximize earnings and cash flows and to
allocate capital profitably toward growth opportunities that will increase shareholder value.
Meeting these objectives enables us to preserve and enhance our financial capability by maintaining
optimal capitalization ratios and a strong interest coverage position, and preserving solid credit
ratings on outstanding securities, which, in the form of lower interest rates, benefits both our
customers and shareholders. Our vision is to create value and growth through the acquisition, long-term ownership and
decentralized operation of diverse businesses. Our strategy is straightforward: It is designed to
produce steady and predictable growth. This includes growing our core electric utility business
which provides a strong base of revenues, earnings and cash flows. In addition, we look to our
nonelectric operating companies to provide growth both organically and through acquisitions.
Organic, internal growth comes from new products and services, market expansion and increased
efficiencies. We adhere to strict guidelines when reviewing acquisition candidates since our aim is
to add companies that will produce an immediate positive impact on earnings along with long-term
growth potential. Owning well-run, profitable companies across different industries brings more
growth opportunities and more balance to results. In doing this, we avoid concentrating business
risk within a single industry. All our operating companies operate under a decentralized business
model with disciplined corporate oversight. We assess the performance of our operating companies over time, using the following criteria:  
    ability to provide returns on invested capital that exceed our weighted average cost of
capital over the long term; and
    assessment of an operating companys business and potential for future earnings growth. We are a committed long-term owner and therefore we do not acquire companies in pursuit of
short-term gains. However, we will divest operating companies if they do not meet these criteria
over the long term. The following major events occurred in our company in 2004:  
    In August 2004 we acquired Idaho Pacific Holdings, Inc. (IPH) of Ririe, Idaho, a leading
processor of dehydrated potato products in North America, for approximately $69.0 million
plus an earn-out of up to an additional $6.0 million if IPH achieves certain financial
targets for the period from August 1, 2004 through July 31, 2005.
    We issued 2.9 million of our common shares in a public offering generating $70.8 million
in cash proceeds net of expenses, which was used to pay down the bridge loan that financed
the acquisition of IPH.
    In October 2004, we amended the terms of two of our credit agreements solely to remove
the ratings triggers that would require accelerated repayment of debt under these
agreements in the event our senior unsecured debt is rated below Baa3 (Moodys) or BBB-(Standard & Poors). The removal of the ratings triggers resulted in no changes to the
interest rate charged on line borrowings and no material changes to other terms of the agreements.




---



##### 




    We announced our intention to sell Midwest Information Systems, Inc. (MIS) and exit the
telecommunications business. Therefore, the results of operations of MIS are classified and
reported under discontinued operations on our consolidated financial statements. Major growth strategies and initiatives in our companys future include:  
    Planned capital budget expenditures of $211 million for the years 2005-2009.
    The continued investigation and evaluation of acquisition opportunities.
    Completion of a feasibility study on building and being a joint owner in a proposed
600-megawatt electric generating station at our Big Stone Plant site. Our intent is to be
the operator of the proposed facility with an ownership interest of approximately 18%, if
it is built. This project has not yet been included in our five-year capital budget pending
the outcome of the feasibility study. A decision on whether to move forward with the
project is expected in 2005. The following table summarizes our consolidated results of operations for the years ended December
31: (in thousands)
    

    
    2004
    
    
    
    2003Operating revenues:Electric
    
    
    $
    266,385
    
    
    
    $
    267,494Nonelectric
    
    
    
    615,939
    
    
    

    
    477,198Total operating revenues
    
    
    $
    882,324
    
    
    
    $
    744,692Net income from continuing operations:Electric
    
    
    $
    31,535
    
    
    
    $
    34,146Nonelectric
    
    
    
    8,445
    
    
    
    
    3,46839,980
    
    
    
    
    37,614Net income from discontinued operations
    
    
    
    2,215
    
    
    
    
    2,042Total net income
    
    
    $
    42,195
    
    
    
    $
    39,656
 The 18.5% increase in consolidated revenues in 2004 compared with 2003 was due to revenue growth in
our nonelectric businesses. Revenues grew $48.8 million in our manufacturing segment and $29.4
million in our plastics segment in 2004, mainly as a result of increased unit sales and price
increases related to increases in raw material costs. Revenues in our other business operations
segment grew $47.6 million in 2004, mainly due to the acquisitions of Foley Company in November
2003 and IPH in August 2004. Increased sales of medical equipment and increased imaging revenues
contributed to a $13.4 million increase in health services revenues in 2004. The increases in nonelectric revenues along with productivity improvements, better capacity
utilization and improved operations in our health services segment resulted in an increase in net
income from nonelectric operations of $5.0 million in 2004 compared with 2003. Net income from our
electric segment declined in 2004 compared with 2003 primarily due to lower wholesale revenues
related to the one-time recognition of $1.2 million in unrealized after-tax gains on forward energy
contracts as a result of the initial application of mark-to-market accounting in 2003 and a $1.0
million reduction in net income from contracted construction work in 2004 compared with 2003. Following is a more detailed analysis of our operating results by business segment for the three
years ended




---



##### 



December 31, 2004, 2003 and 2002, followed by a discussion of our financial position at
the end of 2004, our outlook for 2005 and risk factors that may affect our future operating results
and financial position. RESULTS OF OPERATIONS This discussion and analysis should be read in conjunction with our consolidated financial
statements and related notes found elsewhere in this report. See note 2 to our consolidated
financial statements for a complete description of our lines of business, locations of operations
and principal products and services. Amounts presented in the segment tables below for 2004, 2003 and 2002 operating revenues, electric
operation and maintenance expenses, cost of goods sold and nonelectric segment operating expenses
will not agree with amounts presented in the consolidated statements of income due to the
elimination of intersegment transactions. The amounts of intercompany eliminations by income
statement line item are listed below: (in thousands)
    
    2004
    
    
    2003
    
    
    2002Operating revenues
    
    $
    2,733
    
    
    $
    2,254
    
    
    $
    1,036Electric operating and maintenance expenses
    
    
    
    
    
    
    
    
    
    
    222Cost of goods sold
    
    
    210
    
    
    
    343
    
    
    
    446Operating expenses
    
    
    2,523
    
    
    
    1,911
    
    
    
    368
 ELECTRIC The following table summarizes the results of operations for our electric segment for the years
ended December 31: %
    
    
    
    
    
    
    %(in thousands)
    
    2004
    
    
    change
    
    
    2003
    
    
    change
    
    
    2002Retail sales revenues
    
    $
    224,502
    
    
    
    3
    
    
    $
    217,611
    
    
    
    5
    
    
    $
    207,039Wholesale revenues
    
    
    23,825
    
    
    
    (6
    )
    
    
    25,472
    
    
    
    39
    
    
    
    18,295Net marked-to-market gains
    
    
    3,228
    
    
    
    (20
    )
    
    
    4,058
    
    
    
    
    
    
    
    Other revenues
    
    
    14,830
    
    
    
    (27
    )
    
    
    20,353
    
    
    
    9
    
    
    
    18,671Total operating revenues
    
    $
    266,385
    
    
    
    
    
    
    $
    267,494
    
    
    
    10
    
    
    $
    244,005Production fuel
    
    
    52,056
    
    
    
    2
    
    
    
    51,163
    
    
    
    16
    
    
    
    44,122Purchased power  retail use
    
    
    40,098
    
    
    
    11
    
    
    
    36,002
    
    
    
    16
    
    
    
    30,915Other operation and maintenance expenses
    
    
    85,361
    
    
    
    (2
    )
    
    
    87,186
    
    
    
    8
    
    
    
    80,756Depreciation and amortization
    
    
    24,236
    
    
    
    (7
    )
    
    
    26,008
    
    
    
    4
    
    
    
    24,910Property taxes
    
    
    10,411
    
    
    
    8
    
    
    
    9,598
    
    
    
    2
    
    
    
    9,423Operating income
    
    $
    54,223
    
    
    
    (6
    )
    
    $
    57,537
    
    
    
    7
    
    
    $
    53,879
 The $6.9 million increase in retail revenues from 2003 to 2004 is mainly due to a $4.0 million
increase in cost-of-energy (COE) revenues. The remaining increase in retail revenues was due to a
1.5% increase in retail kilowatt-hour (kwh) sales. The increase in retail sales reflects a 3.2%
increase in kwh sales to commercial and industrial customers, partially offset by a 2.0% decrease
in kwh sales to residential customers. The increase in commercial and industrial kwh sales reflects
increased sales to pipeline customers related to increased oil prices and increased sales to large
commercial customers due to a rebounding economy in 2004. Residential kwh sales decreased mainly as
a result of a 77.8% decrease in cooling degree-days in the summer of 2004 compared with the summer
of 2003. The increase in COE revenues is due to a 16.3% increase in kwh purchases for retail use in
2004 compared with 2003. Fuel and purchased power costs for retail use increased as a result of the
increase in retail kwh sales.




---



##### 



Wholesale revenues from sales of company-owned generation decreased $0.6 million in 2004 compared
with 2003 due to a 1.9% decrease in kwh sales combined with a 1.5% decrease in revenue per kwh of
generation sold. Fuel costs per kwh of generation used for wholesale sales decreased 2.6% between
the years resulting in a decrease in the gross margin per kwh sold from company-owned generation of
only 0.2%. Net margins on purchased power resold decreased $1.0 million despite a 2.2% increase in
kwh sales as a result of a 16.3% decrease in the gross margin per kwh of purchased power resold.
The 2003 mid-year change in the revenue recognition methodology applied to resales of purchased
power from contract-based prices to market-based prices as a result of adopting SFAS No. 133 in
July 2003 is a contributing factor to the 16.3% decrease in the gross margin per kwh of purchased
power resold between 2003 and 2004. The $0.8 million decrease in net marked-to-market gains on
forward energy contracts reflects the recognition of $2.1 million in net gains related to the
initial adoption of mark-to-market accounting on forward energy contracts in July 2003, partially
offset by a $1.3 million increase in mark-to-market gains recognized in 2004 compared with 2003 as
a result of applying mark-to-market accounting to forward energy contracts for all of 2004 compared
with applying it for only six months of 2003. In 2003, other electric operating revenues included revenues from contracted construction work
completed on a large wind farm project in North Dakota. The electric utility did not have a
construction contract of similar magnitude in 2004, which is the main reason for the $5.5 million
reduction in other electric revenues between 2003 and 2004. The $1.8 million decrease in other operation and maintenance expenses in 2004 compared with 2003
includes a $3.2 million reduction in costs related to contracted construction work on the wind farm
project completed in 2003. This reduction was partially offset by increases in regulatory expenses
and increases in expenses related to transmission services, and a $0.6 million net increase in
labor and benefit expenses after taking into account a $0.7 million reduction in retiree medical
benefit costs related to the Medicare prescription drug benefit subsidy recorded in 2004. The $1.8 million decrease in depreciation and amortization expense for 2004 compared with 2003 is
related to the extension of the depreciable service lives of certain units of electric utility
property. The extension of these depreciable service lives was included in the electric utilitys
annual depreciation study and depreciation rates approved by the Minnesota Public Utilities
Commission. The $0.8 million increase in property taxes in 2004 compared with 2003 is mainly
related to a 9.0% increase in the value of electric utility property apportioned to Minnesota
related to the value the state of Minnesota assigned to the utilitys Solway combustion turbine
generator property. The $10.6 million increase in retail revenues in 2003 compared with 2002 is mainly due to a $9.4
million increase in COE revenues. The remaining increase in retail revenues was due to a 0.7%
increase in retail kwh sales. The increase in retail sales reflects minor increases (less than 1%)
in residential, commercial and industrial kwh sales. Heating-degree-days totaling 9,071 in 2003
compared with 9,033 in 2002 were not a discernable factor contributing to 2003 sales variances. The
increase in COE revenues reflects a 13.2% increase in fuel and purchased power costs per kwh for
retail use in 2003 compared with 2002. Wholesale revenues from sales of company-owned generation increased $6.5 million in 2003 compared
with 2002 due to a 19.6% increase in kwh sales combined with a 29.0% increase in revenue per kwh of
generation sold. Net margins on resales of purchased power increased 10.9% between 2003 and 2002 as
a result of a 25.1% increase in kwh sales combined with a 14.1% increase in the margin per kwh
resold. A 36.1% increase in overall wholesale electric prices reflects increased demand for
electricity in the Mid-Continent Area Power Pool (MAPP) region. Higher prices in the wholesale
power markets also reflect generally increasing generation costs, reduced generation
from regional hydro facilities due to lower spring runoff and the lack of summer rainfall and
high-cost generation




---



##### 



from natural gas-fired peaking units. The higher prices, combined with
increased availability of electric utility-owned generation and well-timed energy purchases in 2003
compared to 2002, put the electric utility in a favorable position to respond to the increased
demand for electricity resulting in the increase in wholesale electric sales. Net marked-to-market
gains include $2.1 million in net unrealized gains on forward energy contracts at December 31, 2003
and $2.0 million in net gains realized during 2003. Other electric operating revenues increased $1.7 million in 2003 compared with 2002. The increase
reflects $2.5 million in increased transmission-related revenues from control area services,
transmission tariffs and shared use deficiency payments, and a $1.3 million increase in revenue
from the sale of steam to an ethanol plant that began operations in the third quarter of 2002,
offset by a $2.1 million reduction in revenues from contract work. Revenues from major projects
included $7.6 million from regional wind generation projects in 2003 compared to $9.9 million from
work on a North Dakota transmission line for another area utility that was completed in the fourth
quarter of 2002. The $7.0 million increase in production fuel expense in 2003 compared with 2002 is due to an
increase in fuel costs and generation at the electric utilitys coal-fired generating stations, and
an increase in fuel costs from combustion turbine generation. A 12.0% increase in the fuel cost per
kwh generated reflects increases in fuel cost per kwh at all of the electric utilitys generating
units including fuel costs for the electric utilitys new combustion turbine brought online in June
2003. The $5.1 million increase in purchased power costs for retail use in 2003 compared with 2002
was the result of a 21.3% increase in the cost per kwh purchased offset by a 4.0% decrease in kwh
purchases for retail use. The $6.4 million increase in other operation and maintenance expenses in 2003 compared with 2002
includes increased labor related expenses of $2.7 million as a result of annual wage increases of
about 3.5% and increases in employee benefit costs. Pole maintenance and tree-trimming costs
increased $1.0 million and transportation and travel-related expenses increased $1.0 million
between the years. Insurance costs including provisions for damages were up $0.8 million. Fuel
procurement costs increased $0.5 million, mainly related to litigation before the Surface
Transportation Board. Uncollectible accounts expense increased $0.4 million. The $1.1 million increase in depreciation and amortization expense for 2003 compared to 2002 is due
to an increase in depreciable plant base as a result of 2002 and 2003 capital expenditures. PLASTICS The following table summarizes the results of operations for our plastics segment for the years
ended December 31: %
    
    
    
    
    
    
    %(in thousands)
    
    2004
    
    
    change
    
    
    2003
    
    
    change
    
    
    2002Operating revenues
    
    $
    115,426
    
    
    
    34
    
    
    $
    86,009
    
    
    
    4
    
    
    $
    82,931Cost of goods sold
    
    
    96,834
    
    
    
    28
    
    
    
    75,894
    
    
    
    16
    
    
    
    65,628Operating expenses
    
    
    6,010
    
    
    
    51
    
    
    
    3,976
    
    
    
    (15
    )
    
    
    4,702Depreciation and amortization
    
    
    2,297
    
    
    
    8
    
    
    
    2,126
    
    
    
    21
    
    
    
    1,760Operating income
    
    $
    10,285
    
    
    
    156
    
    
    $
    4,013
    
    
    
    (63
    )
    
    $
    10,841
 The $29.4 million increase in plastics operating revenues in 2004 compared with 2003 reflects a
10.8% increase in the pounds of polyvinyl chloride (PVC) pipe sold between the years combined with
an 18.2% increase in the average sales price per pound of pipe sold. The increase in revenues was
partially offset by a $20.9 million increase in cost of goods sold reflecting an 11.5% increase in the average cost per pound of pipe
sold. The




---



##### 



average cost per pound of resin, the raw material used to produce PVC pipe, increased
19.0% between the periods. The gross margin per pound of pipe sold increased 68.0% in 2004 compared
with 2003. The $2.0 million increase in operating expenses between the periods primarily is due to
increases in compensation, sales commissions, travel and advertising directly related to increased
sales along with increases in building rental expenses and property taxes related to our
polyethylene pipe plant in Hampton, Iowa, which began operations in summer 2003. The increase in
depreciation and amortization expense relates mostly to manufacturing equipment purchased in 2003
and 2004. The $3.1 million increase in plastics operating revenues in 2003 compared with 2002 was due to an
8.2% increase in the average sales price per pound of pipe sold. The increase was partially offset
by a 4.2% decrease in pounds sold between the years. The increased revenue was more than offset by
the $10.3 million increase in cost of goods sold resulting from a 20.9% increase in the average
cost per pound of pipe sold. The average cost per pound of resin, the raw material used to produce
PVC pipe, increased 26.3% between the periods. Operating expenses decreased $0.7 million between
the periods primarily due to decreased compensation directly related to the decrease in gross
margins. The $0.4 million increase in depreciation and amortization expense is related to a $4.4
million increase in depreciable plant in 2002 and a $3.5 million increase in depreciable plant in
2003. MANUFACTURING The following table summarizes the results of operations for our manufacturing segment for the
years ended December 31: %
    
    
    
    
    
    
    %(in thousands)
    
    2004
    
    
    change
    
    
    2003
    
    
    change
    
    
    2002Operating revenues
    
    $
    226,577
    
    
    
    27
    
    
    $
    177,805
    
    
    
    25
    
    
    $
    142,390Cost of goods sold
    
    
    178,822
    
    
    
    28
    
    
    
    139,720
    
    
    
    29
    
    
    
    107,977Operating expenses
    
    
    25,145
    
    
    
    13
    
    
    
    22,244
    
    
    
    21
    
    
    
    18,411Depreciation and amortization
    
    
    8,701
    
    
    
    13
    
    
    
    7,708
    
    
    
    18
    
    
    
    6,525Operating income
    
    $
    13,909
    
    
    
    71
    
    
    $
    8,133
    
    
    
    (14
    )
    
    $
    9,477
 The manufacturing segments improved performance in 2004 can be attributed to certain companies
within this segment being able to offset increases in commodity prices with product pricing
increases and increased productivity and capacity utilization. The increases in productivity at our
metal parts stamping and fabrication company and our wind tower manufacturer resulted in a combined
increase in manufacturing segment operating income from these two companies of $6.5 million in 2004
compared with 2003. Revenue increases at the other manufacturing companies were offset by increased
costs and operating expenses resulting in a combined net decrease in operating income from these
companies of $0.7 million in 2004 compared with 2003. The $48.8 million increase in manufacturing operating revenues in 2004 compared with 2003 includes
increases of $18.5 million from our metal parts stamping and fabrication company, $10.7 million
from our manufacturer of wind towers, $8.6 million from our waterfront equipment company, $5.8
million from our manufacturer of thermoformed plastic and horticultural products and $5.7 million
from our manufacturer of structural steel products. The revenue increase at our metal parts
stamping and fabrication company is not only related to an increase in raw material costs,
especially steel, but also reflects a 12.7% increase in the number of units produced and sold at
this companys expanded manufacturing facilities in 2004 compared with 2003. The revenue increase
at our manufacturer of wind towers reflects increased steel prices and increased productivity and
plant utilization in 2004. Unit sales at our manufacturer of thermoformed plastic and horticultural
products increased 14.2% in 2004 compared with 2003. The revenue increases at our waterfront
equipment company and our manufacturer of structural steel products reflect increases in sales of
residential waterfront equipment, and increases in jobs in progress and product price increases related to higher raw material costs.




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##### 



The $39.1 million increase in cost of goods sold in 2004 compared with 2003 includes increases of
$13.3 million from our metal parts stamping and fabrication company, $8.4 million from our
waterfront equipment company, $7.7 million from our manufacturer of wind towers, $5.2 million from
our manufacturer of thermoformed plastic and horticultural products and $4.8 million from our
manufacturer of structural steel products. The increases in costs of goods sold at these companies
reflect production increases and higher raw material costs. The $2.9 million increase in
manufacturing segment operating expenses includes $1.9 million in increased expenses at our metal
parts stamping and fabrication company and $1.0 million in increased sales commissions at our
waterfront equipment company. The increase in operating expenses at our metal parts stamping and
fabrication company reflects increases in compensation expenses and increased promotional expenses
related to increased sales and losses related to the disposal of equipment no longer used in
production. The $1.0 million increase in depreciation and amortization expense in 2004 compared
with 2003 is mainly due to 2004 and 2003 equipment purchases at three of our manufacturing
companies. The $35.4 million increase in manufacturing operating revenues for 2003 compared with 2002 includes
a $25.7 million increase in revenue from the waterfront equipment companies acquired in 2002.
Revenues from our manufacturer of thermoformed plastic and horticultural products increased $8.0
million on an increase in the volume of products sold. Revenue at our metal parts stamping and
fabrication company increased $3.0 million and our manufacturer of wind towers recorded $1.5
million in increased revenue. These increases were offset by decreases in revenue of $2.5 million
from the manufacturer of structural steel products and $0.3 million from our manufacturer of
automobile frame-straightening equipment. The $31.7 million increase in cost of goods sold in 2003 compared with 2002 primarily reflects a
$19.1 million increase in costs of goods sold at our waterfront equipment companies combined with
increased costs of $6.0 million at our manufacturer of wind towers mostly in material costs, $5.3
million from our manufacturer of thermoformed plastic and horticultural products related to
increased sales, and $2.5 million from our metal parts stamping and fabrication company primarily
related to material costs. These increases were offset by a reduction in cost of goods sold of $0.4
million at our manufacturer of structural steel products, mainly related to reduced labor expenses,
and $0.1 million from our manufacturer of automobile frame-straightening equipment. The $1.2
million increase in depreciation and amortization expense in 2003 compared with 2002 is due to 2002
and 2003 plant expansions and equipment purchases at all our manufacturing companies. HEALTH SERVICES The following table summarizes the results of operations for our health services segment for the
years ended December 31: %
    
    
    
    
    
    
    %(in thousands)
    
    2004
    
    
    change
    
    
    2003
    
    
    change
    
    
    2002Operating revenues
    
    $
    114,318
    
    
    
    13
    
    
    $
    100,912
    
    
    
    8
    
    
    $
    93,420Cost of goods sold
    
    
    85,662
    
    
    
    14
    
    
    
    75,085
    
    
    
    13
    
    
    
    66,680Operating expenses
    
    
    17,662
    
    
    
    14
    
    
    
    15,442
    
    
    
    13
    
    
    
    13,676Depreciation and amortization
    
    
    5,047
    
    
    
    (2
    )
    
    
    5,137
    
    
    
    16
    
    
    
    4,410Operating income
    
    $
    5,947
    
    
    
    13
    
    
    $
    5,248
    
    
    
    (39
    )
    
    $
    8,654
 The $13.4 million increase in health services operating revenues for 2004 compared with 2003
reflects $6.9 million in additional imaging revenues and $6.5 million from sales and servicing of
equipment. The number of scans performed on a fee-per-scan basis decreased 14.1% while the average
fee per scan increased 17.7%. The increase in revenue from equipment sales includes $1.8 million in increased revenue related to the
acquisitions of




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##### 



Topline Medical and North Star Medical Systems in May and July of 2003. The $10.6
million increase in costs of goods sold in 2004 compared with 2003 includes $4.5 million related to
equipment sales and $6.1 million related to imaging and other services. The $2.2 million increase
in operating expenses reflects increases in compensation and benefits expenses and increases in
travel expenses related to the 2003 medical equipment company acquisitions and an expansion of
imaging services. The $7.5 million increase in health services operating revenues for 2003 compared with 2002
reflects $6.7 million in additional scan and other services revenue, mostly from the acquisitions
that occurred in 2002. Revenues from the sale of diagnostic imaging equipment increased $0.8
million between the periods in part due to recent acquisitions in 2003. The number of scans
performed increased 12.6% mainly due to the 2002 acquisitions, while the average fee per scan
decreased 1.8%. Although revenues from imaging services increased by $6.7 million in 2003 compared with 2002, the
increase was more than offset by increases in equipment and infrastructure costs incurred to
support expected revenue growth. While operating income for 2003 was significantly less than
operating income in 2002, the segments 2003 results improved significantly from early 2003 in part
due to steps taken by management to address increases in operating expenses of the diagnostic
imaging operations. The company that sells and services medical diagnostic and monitoring equipment
had a good year financially in 2003, but the results from imaging services were disappointing,
primarily due to aggressive growth combined with subsequent integration challenges. OTHER BUSINESS OPERATIONS The following table summarizes the results of operations for our other business operations segment,
which no longer includes our telecommunications business now being reported in discontinued
operations, for the years ended December 31: %
    
    
    
    
    
    
    %(in thousands)
    
    2004
    
    
    change
    
    
    2003
    
    
    change
    
    
    2002Operating revenues
    
    $
    162,351
    
    
    
    42
    
    
    $
    114,726
    
    
    
    51
    
    
    $
    75,947Cost of goods sold
    
    
    124,433
    
    
    
    51
    
    
    
    82,378
    
    
    
    77
    
    
    
    46,414Operating expenses
    
    
    43,783
    
    
    
    19
    
    
    
    36,646
    
    
    
    19
    
    
    
    30,679Depreciation and amortization
    
    
    4,063
    
    
    
    43
    
    
    
    2,841
    
    
    
    (3
    )
    
    
    2,921Operating (loss)
    
    $
    (9,928
    )
    
    
    (39
    )
    
    $
    (7,139
    )
    
    
    (76
    )
    
    $
    (4,067
    )
 The $47.6 million increase in operating revenues in 2004 compared with 2003 includes $40.6 million
from Foley acquired in November 2003 and $14.0 million from IPH acquired in August 2004. Revenues
at the energy services company increased $8.6 million in 2004 compared with 2003 mainly due to
increases in natural gas prices. Transportation company revenues increased $1.9 million, reflecting
increased brokerage activity and the pass through of increased diesel prices to customers.
Transportation company brokered miles increased 5.5% between the years while the combined miles
driven by the company-owned fleet and contracted owner-operators decreased 7.4%. Revenues from our
electrical contracting company decreased $17.7 million in 2004 compared with 2003 due to a lower
volume of available work in combination with excess capacity in its construction market. The $42.1 million increase in cost of goods sold in 2004 compared with 2003 includes $36.7 million
from Foley and $11.4 million from IPH. Cost of goods sold at our energy services company increased
$8.5 million in 2004 compared with 2003 due to increases in natural gas prices. Cost of goods sold
from our electrical contracting company decreased $14.6 million as a result of a lower volume of available work in 2004 compared
with 2003.




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##### 



The $7.1 million increase in operating expenses in 2004 compared with 2003 includes $2.7 million
from Foley and $0.9 million from IPH. Transportation company operating expenses increased $1.9
million mainly related to increased fuel costs and increased brokerage activity. Operating expenses
also reflect $1.3 million in increased unallocated corporate overhead costs mainly due to increases
in employee benefit costs and increased expenses for professional services related to compliance
with Sarbanes-Oxley Section 404 requirements. The $1.2 million increase in depreciation and
amortization expense is attributable to the acquisitions of Foley and IPH. The $2.8 million increase in operating losses in 2004 compared with 2003 includes $3.5 million in
increased operating losses at the corporations electrical contracting company as a result of
losses incurred on certain jobs in 2004 and $1.3 million in increased costs related to the
increases in unallocated corporate overhead. These operating loss increases were partially offset
by operating income increases of $1.3 million related to the acquisitions of Foley and IPH, $0.4
million from our energy services company and $0.3 million from our transportation company. The $38.8 million increase in operating revenue in 2003 compared with 2002 was mostly due to a
$13.8 million increase in revenues from natural gas sales at our energy services company related to
an increase in natural gas prices. In addition, construction revenues increased by $21.4 million,
of which $7.9 million came from Foley. Transportation revenues increased by $2.3 million between
the periods as a result of an 85.6% increase in brokered miles. The $36.0 million increase in cost
of goods sold reflects a $14.4 million increase in the cost of natural gas sold by our energy
services company and a $21.6 million increase in construction costs at our construction companies,
of which $6.5 million is attributable to Foley. The $6.0 million increase in operating expenses between the periods reflects a $2.4 million
increase in transportation operating expenses mainly related to increased brokerage activity. The
construction companies reported $1.0 million in increased operating expenses with $0.5 million of
the increase related to Foley. Operating expenses also reflect a $3.3 million increase in
unallocated corporate overhead costs mainly due to increased employee benefit costs and increases
in self-insurance costs. Operating expense at the energy services company decreased $1.9 million
from 2002 to 2003 as a result of decreased activity. We had recorded $250,000 in goodwill related
to the acquisition of an energy management firm in 2002. Based on an offer to purchase this entity
in the fourth quarter of 2003, we determined that the goodwill related to this entity was impaired
and, accordingly, recorded a $250,000 charge to operating income in the fourth quarter of 2003. DISCONTINUED OPERATIONS As a result of our intention to sell MIS and exit the telecommunications business, MIS is reported
as discontinued operations in our consolidated financial statements. The following table presents
MIS operating revenues, expenses, including interest and other income and deductions, and income
taxes, included on a net basis in income from discontinued operations on our 2004, 2003 and 2002
consolidated statements of income. %
    
    
    
    
    
    
    %(in thousands)
    
    2004
    
    
    change
    
    
    2003
    
    
    change
    
    
    2002Operating revenues
    
    $
    8,739
    
    
    
    2
    
    
    $
    8,547
    
    
    
    (2
    )
    
    $
    8,680Expenses
    
    
    5,041
    
    
    
    (2
    )
    
    
    5,138
    
    
    
    (5
    )
    
    
    5,422Income taxes
    
    
    1,483
    
    
    
    8
    
    
    
    1,367
    
    
    
    5
    
    
    
    1,306Income from discontinued operations
    
    $
    2,215
    
    
    
    8
    
    
    $
    2,042
    
    
    
    5
    
    
    $
    1,952




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##### 



CONSOLIDATED INTEREST CHARGES Interest expense increased $0.5 million in 2004 compared to 2003 primarily as a result of interest
expense on the bridge loan used to finance the acquisition of IPH. Interest expense increased $0.3 million in 2003 compared to 2002 as a result of lower variable
interest rates. The average interest rate paid on short-term debt decreased from 2.2% in 2002 to
1.7% in 2003. CONSOLIDATED INCOME TAXES Our effective tax rate on income from continuing operations was 29.8% for 2004 compared with 26.5%
for 2003. The increase reflects the impact of R&D tax credits claimed in 2003. Without these
credits, the 2003 effective tax rate would have been 27.5%. The remaining 2.3% difference in the
effective tax rate for 2004 compared to 2003 is a function of the level of fixed deductions and
credits in proportion to higher net income before tax in 2004 compared to 2003. See note 14 to
consolidated financial statements. Our effective tax rate on income from continuing operations was 26.5% for 2003 compared with 29.8%
for 2002. The reduction reflects the impact of prior-year R&D tax credits claimed in 2003. Without
these credits, the 2003 effective tax rate would have been 27.5%. The remaining 2.3% difference in
the effective tax rate for 2003 compared to 2002 is a function of the level of fixed deductions and
credits in proportion to lower net income before tax in 2003 compared to 2002. IMPACT OF INFLATION The electric utility operates under regulatory provisions that allow price changes in the cost of
fuel and purchased power to be passed to most customers through automatic adjustments to its rate
schedules under the cost-of-energy adjustment clause. Other increases in the cost of electric
service must be recovered through timely filings for electric rate increases with the appropriate
regulatory agency. Our plastics, manufacturing, health services, and other business operations consist entirely of
unregulated businesses. Increased operating costs are reflected in product or services pricing with
any limitations on price increases determined by the marketplace. The impact of inflation on these
segments has not been significant during the past few years because of the relatively low rates of
inflation experienced in the United States. Raw material costs, labor costs and interest rates are
important components of costs for companies in these segments. Any or all of these components could
be impacted by inflation or other pricing pressures, with a possible adverse effect on our
profitability, especially where increases in these costs exceed price increases on finished
products. In recent years, our operating companies have faced strong inflationary and other pricing
pressures with respect to steel, fuel and health care costs, which have been partially mitigated by
pricing adjustments.




---



##### 



2005 EXPECTATIONS We anticipate diluted earnings per share from continuing operations to be in a range from $1.50 to
$1.70. Total diluted earnings per share are expected to be in a range from $1.70 to $1.90 which
includes earnings from discontinued operations. Contributing to the earnings expectations for 2005 are the following items:  
    We expect solid performance in the electric segment in 2005 although net income is
anticipated to be lower than 2004 levels. This is primarily because of uncertainty in the
wholesale electric markets due to the expected implementation of Midwest Independent
Transmission System Operator electric markets on April 1, 2005 and anticipated increases in
transmission service costs. Regulated returns in 2005 for the electric segment are expected
to be consistent with authorized levels.
    We expect the plastics segment to perform well in 2005 due to continuing strong demand
in the southwestern region of the country. Net income for this segment is expected to be in
a range between 2003 and 2004 net earnings levels.
    The improving economy, continued enhancements in productivity and capacity utilization
and the extension of the federal Production Tax Credit are expected to result in increased
net income in our manufacturing segment.
    Our health services segment is expected to grow net income in 2005 as we continue to
realize earnings improvement from our imaging business.
    We expect our food ingredient processing business, which we anticipate will be a new
reporting segment in 2005, to generate net income in the range of $4.2 million to $5
million for the year ending December 31, 2005.
    Our other business operations segment is expected to show improved results over 2004 due
to the improving economy. The extension of the Production Tax Credit is expected to have a
positive impact on our electrical contracting business.
    We anticipate investing approximately $50 million in capital expenditures during 2005 in
addition to funding possible future acquisitions.
    Our outlook for 2005 reflects the anticipated impact of Statement of Financial
Accounting Standards No. 123(R), Share-Based Payment, which could lower earnings per share
results by as much as $0.02 per share in 2005. This standard requires all share-based
compensation awards be measured at fair value at the date of grant and expensed over their
vesting or service periods. This standard is effective beginning in the third quarter 2005;
however, it can be adopted earlier.
    Contributing to our overall earnings expectation for 2005 is our telecommunications
business which is being held for sale and is accounted for as discontinued operations. We
expect to realize a gain on the sale of this business in 2005. We also are exploring the
divestiture of certain other businesses in 2005 as part of an ongoing evaluation of the
prospects and growth opportunities of our business operations.




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##### 



LIQUIDITY We believe our financial condition is strong and that our cash, other liquid assets, operating cash
flows, access to capital markets through our universal shelf registration and borrowing ability
because of solid credit ratings, when taken together, provide adequate resources to fund ongoing
operating requirements and future capital expenditures related to expansion of existing businesses
and development of new projects. However, our operating cash flow and access to capital markets can
be impacted by macroeconomic factors outside our control. In addition, our borrowing costs can be
impacted by short-term and long-term debt ratings assigned to us by independent rating agencies,
which in part are based on certain credit measures such as interest coverage and leverage ratios. We have achieved a high degree of long-term liquidity by maintaining desired capitalization ratios
and solid credit ratings, implementing cost-containment programs, and investing in projects that
provide returns in excess of our weighted average cost of capital. Cash provided by operating activities from continuing and discontinued operations was $59.9 million
in 2004 compared with $77.0 million in 2003. The $17.1 million decrease in cash from operations
reflects an $8.6 million increase in income tax payments between the years, $4.0 million in
discretionary pension plan contributions in 2004 and a net increase in other components of working
capital mainly influenced by a $15.8 million increase in Costs and estimated earnings in excess of
billingsresulting from an increase in the value of jobs in progress under percentage of completion
accounting. The reduction in income tax payments in 2003 and the subsequent increase in 2004 is
partially due to an increase in income before income taxes in 2004 compared to 2003, but also
reflects a change in the methodology used for determining estimated tax payment requirements that
resulted in a change in the timing of 2002, 2003 and 2004 estimated tax payments. This change in
methodology had the effect of reducing estimated tax payments made in 2003 and deferring the
payment of a portion of 2003 income taxes into 2004. The $58.7 million increase in net cash used in investing activities in 2004 compared with 2003
reflects a $56.2 million increase in cash used to complete acquisitions and a $6.8 million increase
in cash used for other investments, offset by a $4.3 million increase in cash proceeds from the
sale of assets. The increase in cash used for acquisitions and other investments is mostly related
to the 2004 acquisition of IPH, in which $69.0 million in cash was paid and $6.0 million was placed
in escrow to pay off earn-out contingencies if IPH achieves certain financial targets for the
period from August 1, 2004 through July 31, 2005. In 2004, proceeds from the sale of assets
included cash from the sale of used equipment, the sale of our investment in Fargo Baseball LLC and
the sale of a building. Net cash provided by financing activities was $52.7 million in 2004 compared with $19.1 million in
net cash used in financing activities in 2003. The $71.8 million increase between the years was
mainly due to the following items:  
    Net proceeds of $70.8 million from the public offering of 2.9 million common shares in
December 2004.
    Proceeds of $7.3 million from the issuance of common stock for our automatic dividend
reinvestment and share purchase plan and our employee stock purchase plan in 2004.
    Net short-term borrowings increased $10.0 million in 2004.
    Proceeds from the issuance of long-term debt decreased $14.5 million in 2004. Proceeds
in 2003 included $16.3 million borrowed under a loan agreement with Lombard US Equipment
Finance Corporation.




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##### 



On August 16, 2004 we borrowed $76.0 million of unsecured and unsubordinated debt from UBS Loan
Finance LLC to finance the acquisition of IPH. We repaid $71.1 million of the loan balance in
December 2004 with proceeds from the public offering of 2.9 million shares of common stock. The
remaining unpaid balance of $4.9 million outstanding on December 31, 2004, was repaid in January
2005 from proceeds received for 175,000 of our common shares upon the partial exercise of the
over-allotment option granted to the underwriters of the December 2004 public offering and by
borrowing from our line of credit. The common stock was issued under a universal shelf registration
statement filed with the Securities and Exchange Commission that gives us the ability to issue up
to an additional $256 million of common stock, preferred stock, debt and certain other securities
from time to time. (BAR CHART)
    

(BAR CHART)CASH
REALIZATION RATIOS
CONTINUING OPERATIONS
- Cash flows from operations
- Net income
The cash realization ratio represents cash flows from continuing operations expressed as a
percent of net incoem form continuing operations.

    INTEREST-BEARING DEBT AS A
PERCENT OF TOTAL CAPITAL(millions
- Total capital
- Interest-bearing debt (includes short-term debt)
Otter Tail has maintained a 40-50% interest-bearing debt to total capital ratio for the past three years. The decrease from 2003 to 2004 reflects the issuance of $71 million in common equity in 2004.
 CAPITAL REQUIREMENTS We have a capital expenditure program for the expansion, upgrade and improvement of our plants and
operating equipment. Typical uses of cash for capital improvements are investments in electric
generation facilities, transmission and distribution lines, equipment used in the manufacturing
process, acquisitions of diagnostic medical equipment, transportation equipment and computer
hardware and information systems. The capital expenditure program is subject to review and is
revised annually in light of changes in demands for energy, technology, environmental laws,
regulatory changes, the costs of labor, materials and equipment, and our consolidated financial
condition. Consolidated capital expenditures for the years 2004, 2003 and 2002 were $49.8 million, $49.1
million and $74.1 million, respectively. The estimated capital expenditures for 2005 are $50.3
million and the total capital expenditures for the five-year period 2005 through 2009 are estimated
to be approximately $211 million.




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##### 



The breakdown of 2002, 2003 and 2004 actual and 2005 through 2009 estimated capital expenditures by
segment is as follows: (in millions)
    
    2002
    
    
    2003
    
    
    2004
    
    
    2005
    
    
    2005-2009Electric
    
    $
    46
    
    
    $
    28
    
    
    $
    25
    
    
    $
    28
    
    
    $
    135Plastics
    
    
    6
    
    
    
    4
    
    
    
    3
    
    
    
    2
    
    
    
    10Manufacturing
    
    
    15
    
    
    
    10
    
    
    
    13
    
    
    
    9
    
    
    
    47Health services
    
    
    4
    
    
    
    6
    
    
    
    4
    
    
    
    2
    
    
    
    5Other business operations
    
    
    3
    
    
    
    1
    
    
    
    5
    
    
    
    9
    
    
    
    14Total
    
    $
    74
    
    
    $
    49
    
    
    $
    50
    
    
    $
    50
    
    
    $
    211
 The following table summarizes our contractual obligations at December 31, 2004 and the effect
these obligations are expected to have on its liquidity and cash flow in future periods. Less than
    
    
    1-3
    
    
    3-5
    
    
    More than(in millions)
    
    Total
    
    
    1 year
    
    
    years
    
    
    years
    
    
    5 yearsLong-term debt obligations
    
    $
    268
    
    
    $
    6
    
    
    $
    59
    
    
    $
    6
    
    
    $
    197Interest on long-term debt obligations
    
    
    152
    
    
    
    15
    
    
    
    30
    
    
    
    23
    
    
    
    84Capacity and energy requirements
    
    
    146
    
    
    
    20
    
    
    
    35
    
    
    
    39
    
    
    
    52Operating lease obligations
    
    
    111
    
    
    
    30
    
    
    
    47
    
    
    
    25
    
    
    
    9Coal contracts (required minimums)
    
    
    100
    
    
    
    16
    
    
    
    32
    
    
    
    12
    
    
    
    40Other purchase obligations
    
    
    6
    
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    Total contractual cash obligations
    
    $
    783
    
    
    $
    93
    
    
    $
    203
    
    
    $
    105
    
    
    $
    382
 Interest on $24.4 million of variable-rate debt outstanding on December 31, 2004 was projected
based on the interest rates applicable to those debt instruments on December 31, 2004. CAPITAL RESOURCES Financial flexibility is provided by operating cash flows, our universal shelf registration, unused
lines of credit, strong financial coverages, solid credit ratings, and alternative financing
arrangements such as leasing. We have the ability to issue up to $256 million of common stock,
preferred stock, debt and certain other securities from time to time under our universal shelf
registration statement filed with the Securities and Exchange
Commission.
Additional short-term or long-term financing may be required in the period 2005 through 2009 in the
event we decide to refund or retire early any of our presently outstanding debt or cumulative
preferred shares, to complete acquisitions, to fund the construction of a new generating station at
the Big Stone Plant site if we decide to move forward with the project or for other corporate
purposes. There can be no assurance that any additional required financing will be available
through bank borrowings, debt or equity financing or otherwise, or that if such financing is
available, it will be available on terms acceptable to us. If adequate funds are not available on
acceptable terms, our businesses, results of operations, and financial condition could be adversely
affected. On April 28, 2004 we renewed our $70 million line of credit. The renewed agreement expires on April
27, 2005. The terms of the renewed line of credit at the time of renewal were essentially the same
as those in place prior to the renewal. In October 2004, we amended the terms of our $70 million
line of credit agreement to remove the ratings trigger that would require accelerated repayment of
any outstanding balance on the line of credit in the event our senior unsecured debt is rated below
Baa3 (Moodys) or BBB- (Standard & Poors). The removal of the ratings trigger resulted in no
changes to the interest rate charged on line borrowings and no material changes to other terms of
the agreement. Borrowings under the line of credit bear interest at LIBOR plus 0.6%, subject to
adjustment based on the ratings of our senior unsecured debt up to LIBOR plus 0.8% if the ratings
on our senior




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##### 



unsecured debt fall to BBB+ or below (Standard & Poors) or Baa1 or below (Moodys). We do not
anticipate any difficulties in renewing this line of credit. Our bank line of credit is a key source of operating capital and can provide interim financing of
working capital and other capital requirements, if needed. This line is available to support
borrowings of our nonelectric operations. We anticipate that the electric utilitys cash
requirements will be provided for by cash flows from electric utility operations. As of December
31, 2004, $35.0 million of our $70 million line of credit was in use. Our obligations under this
line of credit are guaranteed by our 100%-owned subsidiary that owns substantially all of our
nonelectric companies. Our line of credit, $90 million 6.63% senior notes, and Lombard US Equipment Finance note contain
the following covenants: a debt-to-total capitalization ratio not in excess of 60% and an interest
and dividend coverage ratio of at least 1.5 to 1. The 6.63% senior notes also require that priority
debt not be in excess of 20% of total capitalization. We were in compliance with all of the
covenants under our financing agreements as of December 31, 2004. Our obligations under the 6.63% senior notes are guaranteed by our 100%-owned subsidiary that owns
substantially all of our nonelectric companies. In October 2004, we also amended the terms of our
$90 million 6.63% senior notes to remove a ratings trigger that would require repayment of the
notes with a make-whole premium if our senior unsecured debt is rated below Baa3 (Moodys) or BBB- (Standard & Poors). Our Grant County and Mercer County pollution control refunding revenue bonds
require that we grant to Ambac Assurance Corporation, under a financial guaranty insurance policy relating to the bonds, a security interest in the assets of the electric utility if the rating on
our senior unsecured debt is downgraded to Baa2 or below (Moodys) or BBB or below (Standard & Poors). In December 2004 Standard & Poors Rating Services lowered our corporate credit rating and senior
unsecured debt rating from A-/negative to BBB+/negative. Moodys rating remains at A2/negative Our securities ratings at December 31, 2004 are: MoodysInvestors
    
    StandardService
    
    & PoorsSenior unsecured debt
    
    A2
    
    BBB+Preferred stock
    
    Baa1
    
    BBB-Outlook
    
    Negative
    
    Negative
 Disclosure of these securities ratings is not a recommendation to buy, sell or hold our securities.
Downgrades in these securities ratings could adversely affect our company. Further downgrades could
increase borrowing costs resulting in possible reductions to net income in future periods and
increase the risk of default on our debt obligations. Our ratio of earnings to fixed charges from continuing operations, which includes imputed finance
costs on operating leases, was 3.3x for 2004 and 2003 and our long-term debt interest coverage
ratio before taxes was 4.8x for 2004 compared to 4.2x for 2003. During 2005, we expect these
coverage ratios to increase over 2004 levels assuming 2005 net income meets our expectations.




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(BAR CHART) 
 OFF-BALANCE-SHEET ARRANGEMENTS We do not have any off-balance-sheet arrangements or any relationships with unconsolidated entities
or financial partnerships. These entities are often referred to as structured finance special
purpose entities or variable interest entities, which are established for the purpose of
facilitating off-balance-sheet arrangements or for other contractually narrow or limited purposes.
We are not exposed to any financing, liquidity, market or credit risk that could arise if we had
such relationships. RISK FACTORS AND CAUTIONARY STATEMENTS
THAT MAY AFFECT FUTURE RESULTS We are including the following factors and cautionary statements in this Annual Report to make
applicable and to take advantage of the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995 for any forward-looking statements made by us or on our behalf. Forward-looking
statements include statements concerning plans, objectives, goals, strategies, future events or
performance, and underlying assumptions (many of which are based, in turn, upon further
assumptions) and other statements that are other than statements of historical facts. From time to
time, we may publish or otherwise make available forward-looking statements of this nature. All
these forward-looking statements, whether written or oral and whether made by us or on our behalf,
are also expressly qualified by these factors and cautionary statements. Forward-looking statements
involve risks and uncertainties, which could cause actual results or outcomes to differ materially
from those expressed. Our expectations, beliefs and projections are expressed in good faith and are
believed by us to have a reasonable basis. Nonetheless, our expectations, beliefs or projections
may not be accomplished. Any forward-looking statement contained in this document speaks only as of the date on which the
statement is made, and we undertake no obligation to update any forward-looking statement or
statements to reflect events or circumstances that occur after the date on which the statement is
made or to reflect the occurrence of unanticipated events. New factors emerge from time to time,
and it is not possible for us to predict all of the factors, nor can we assess the effect of each
factor on our business or the extent to which any factor, or combination of factors, may cause
actual results to differ materially from those contained in any forward-looking statement. The
following factors and the other matters discussed herein are important factors that could cause




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actual results or outcomes for our company to differ materially from those discussed in the
forward-looking statements included elsewhere in this document. GENERAL Our plans to grow and diversify through capital expenditures and acquisitions may not be
successful, which could result in poor financial performance. As part of our business strategy, we intend to acquire new businesses. We may not be able to
identify appropriate acquisition candidates or successfully negotiate, finance or integrate
acquisitions. If we are unable to make acquisitions, we may be unable to realize the growth we
anticipate. Future acquisitions could involve numerous risks including: difficulties in integrating
the operations, services, products and personnel of the acquired business; and the potential loss
of key employees, customers and suppliers of the acquired business. If we are unable to
successfully manage these risks of an acquisition, we could face reductions in net income in future
periods. Federal and state environmental regulation could require us to incur substantial capital
expenditures which could result in increased operating costs. We are subject to federal, state and local environmental laws and regulations relating to air
quality, water quality, waste management, natural resources and health safety. These laws and
regulations regulate the modification and operation of existing facilities, the construction and
operation of new facilities and the proper storage, handling, cleanup and disposal of hazardous
waste and toxic substances. Compliance with these legal requirements requires us to commit
significant resources and funds toward environmental monitoring, installation and operation of
pollution control equipment, payment of emission fees and securing environmental permits. Obtaining
environmental permits can entail significant expense and cause substantial construction delays.
Failure to comply with environmental laws and regulations, even if caused by factors beyond our
control, may result in civil or criminal liabilities, penalties and fines. Existing environmental laws or regulations may be revised and new laws or regulations seeking to
protect the environment may be adopted or become applicable to us. Revised or additional
regulations, which result in increased compliance costs or additional operating restrictions,
particularly if those costs are not fully recoverable from customers, could have a material effect
on our results of operations. Volatile financial markets could restrict our ability to access capital and increase our borrowing
costs and pension plan expenses. We rely on access to both short- and long-term capital markets as a source of liquidity for capital
requirements not satisfied by cash flows from operations. If we are not able to access capital at
competitive rates, the ability to implement our business plans may be adversely affected. Market
disruptions or a downgrade of our credit ratings may increase the cost of borrowing or adversely
affect our ability to access one or more financial markets.




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Changes in the U.S. capital markets could also have significant effects on our pension plan. Our
pension income or expense is affected by factors including the market performance of the assets in
the master pension trust maintained for the pension plans for some of our employees, the weighted
average asset allocation and long-term rate of return of our pension plan assets, the discount rate
used to determine the service and interest cost components of our net periodic pension cost
(returns) and assumed rates of increase in our employees future compensation. If our pension plan
assets do not achieve positive rates of return, or if our estimates and assumed rates are not
accurate, our companys earnings may decrease because we would be unable to recognize gains from
the pension plan assets as income and, instead, we may need to provide additional funds to cover
our obligations to employees under the pension plan. ELECTRIC We may experience fluctuations in revenues and expenses related to our electric operations, which
may cause our financial results to fluctuate and could impair our ability to make distributions to
shareholders or scheduled payments on our debt obligations. A number of factors, many of which are beyond our control, may contribute to fluctuations in our
revenues and expenses from electric operations, causing our net income to fluctuate from period to
period. These risks include fluctuations in the volume and price of sales of electricity to
customers or other utilities, which may be affected by factors such as mergers and acquisitions of
other utilities, geographic location of other utilities, transmission costs (including increased
costs related to the formation and operation of regional transmission organizations), changes in
the manner in which wholesale power is sold and purchased (such as standard market design when
adopted by the Midwest Independent Transmission System Operator), unplanned interruptions at our
generating plants, the effects of regulation and deregulation, demographic changes in our customer
base and changes in our customer demand or load growth. Other risks include weather conditions
(including severe weather that could result in damage to our assets), fuel and purchased power
costs and the rate of economic growth or decline in our service areas. A decrease in revenues or an
increase in expenses related to our electric operations may reduce the amount of funds available
for our existing and future businesses, which could result in increased financing requirements,
impair our ability to make expected distributions to shareholders or impair our ability to make
scheduled payments on our debt obligations. Actions by the regulators of our electric operations could result in rate reductions, lower
revenues and earnings or delays in recovering capital expenditures. The corporation is subject to government regulations and regulatory actions that may have a
negative impact on its business and results of operations. The electric rates that we are allowed
to charge for our electric services are one of the most important items influencing our financial
position, results of operations and liquidity. The rates that we charge our electric customers are
subject to review and determination by state public utility commissions in Minnesota, North Dakota
and South Dakota. We are also regulated by the Federal Energy Regulatory Commission. An adverse
decision by one or more regulatory commissions concerning the level or method of determining
electric utility rates, the authorized returns on equity or other regulatory matters, permitted
business activities (such as ownership or operation of nonelectric businesses) or any prolonged
delay in rendering a decision in a rate or other proceeding (including with respect to the recovery
of capital expenditures in rates) could result in lower revenues and net income.




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We may not be able to respond effectively to deregulation initiatives in the electric industry,
which could result in reduced revenues and earnings. We may not be able to respond in a timely or effective manner to the changes in the electric
industry that may occur as a result of regulatory initiatives to increase competition. These
regulatory initiatives may include deregulation of the electric utility industry in some markets.
Although we do not expect retail competition to come to the states of Minnesota, North Dakota and
South Dakota in the foreseeable future, we expect competitive forces in the electric supply segment
of the electric business to continue to increase, which could reduce our revenues and earnings. Our electric generating facilities are subject to operational risks that could result in
unscheduled plant outages, unanticipated operation and maintenance expenses and increased power
purchase costs. Operation of electric generating facilities involves risks which can adversely affect energy output
and efficiency levels. Most of our generating capacity is coal-fired. We rely on a limited number
of suppliers of coal, making us vulnerable to increased prices for fuel and fuel transportation as
existing contracts expire or in the event of unanticipated interruptions in fuel supply.
Operational risks also include facility shutdowns due to breakdown or failure of equipment or
processes, labor disputes, operator error and catastrophic events such as fires, explosions,
floods, intentional acts of destruction or other similar occurrences affecting the electric
generating facilities. The loss of a major generating facility would require us to find other
sources of supply, if available, and expose us to higher purchased power costs. PLASTICS Our plastics operations are highly dependent on a limited number of vendors for PVC resin and a
limited supply of PVC resin. The loss of a key vendor, or any interruption or delay in the supply
of PVC resin, could result in reduced sales or increased costs for our plastics business. We rely on a limited number of vendors to supply the PVC resin used in our plastics business. Two
vendors accounted for approximately 98% of our total purchases of PVC resin in 2004 and
approximately 96% of our total purchases of PVC resin in 2003. In addition, the supply of PVC resin
may be limited primarily due to manufacturing capacity and the limited availability of raw material
components. The loss of a key vendor or any interruption or delay in the availability or supply of
PVC resin could disrupt our ability to deliver our plastic products, cause customers to cancel
orders or require us to incur additional expenses to obtain PVC resin from alternative sources, if
such sources are available. We compete against a large number of other manufacturers of PVC pipe and manufacturers of
alternative products. Customers may not distinguish our products from those of our competitors. The plastic pipe industry is highly fragmented and competitive, due to the large number of
producers and the fungible nature of the product. We compete not only against other PVC pipe
manufacturers, but also against ductile iron steel, concrete and clay pipe manufacturers. Due to
shipping costs, competition is usually regional, instead of national, in scope, and the principal
areas of competition are a combination of price, service, warranty and product performance. Our
inability to compete effectively in each of these areas and to distinguish our plastic pipe
products from competing products may adversely affect the financial performance of our plastics
business.




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MANUFACTURING Competition from foreign and domestic manufacturers, the price and availability of raw materials,
the availability of production tax credits and general economic conditions could affect the
revenues and earnings of our manufacturing businesses. Our manufacturing businesses are subject to risks associated with competition from foreign and
domestic manufacturers that have excess capacity, labor advantages and other capabilities that may
place downward pressure on margins and profitability. Raw material costs for items such as steel,
lumber, concrete, aluminum and resin have recently increased significantly and may continue to
increase. Our manufacturers may not be able to pass on the cost of such increases to their
respective customers. Each of our manufacturing companies has significant customers and
concentrated sales to such customers. If our relationships with significant customers should change
materially, it would be difficult to immediately and profitably replace lost sales. We believe the
demand for wind towers that we manufacture will depend primarily on the existence of either
renewable portfolio standards or a federal production tax credit for wind energy. HEALTH SERVICES Changes in the rates or methods of third-party reimbursements for our diagnostic imaging services
could result in reduced demand for those services or create downward pricing pressure, which would
decrease our revenues and earnings. Our health services businesses derive significant revenue from direct billings to customers and
third-party payors such as Medicare, Medicaid, managed care and private health insurance companies
for our diagnostic imaging services. Moreover, customers who use our diagnostic imaging services
generally rely on reimbursement from third-party payors. Adverse changes in the rates or methods of
third-party reimbursements could reduce the number of procedures for which we or our customers can
obtain reimbursement or the amounts reimbursed to us or our customers. Our health services operations has a dealership and other agreements with Philips Medical from
which it derives significant revenues from the sale and service of Philips Medical diagnostic
imaging equipment. This agreement can be terminated on 180 days written notice by either party for any reason. It also
includes other compliance requirements. If this agreement were terminated within the notice
provisions or we were not able to renew such agreements or comply with the agreements, the
financial results of our health services operations would be adversely affected. Technological change in the diagnostic imaging industry could reduce the demand for diagnostic
imaging services and require our health services operations to incur significant costs to upgrade
its equipment. Although we believe substantially all of our diagnostic imaging systems can be upgraded to maintain
their state-of-the-art character, the development of new technologies or refinements of existing
technologies might make our existing systems technologically or economically obsolete, or cause a
reduction in the value of, or reduce the need for, our systems. Actions by regulators of our health services operations could result in monetary penalties or
restrictions in our health services operations. Our health services operations are subject to federal and state regulations relating to licensure,
conduct of operations, ownership of facilities, addition of facilities and services and payment of
services. Our failure to comply with these regulations, or our inability to obtain and maintain
necessary regulatory approvals, may result




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in adverse actions by regulators with respect to our health services operations, which may include
civil and criminal penalties, damages, fines, injunctions, operating restrictions or suspension of
operations. Any such action could adversely affect our financial results. Courts and regulatory
authorities have not fully interpreted a significant number of these laws and regulations, and this
uncertainty in interpretation increases the risk that we may be found to be in violation. Any
action brought against us for violation of these laws or regulations, even if successfully
defended, may result in significant legal expenses and divert managements attention from the
operation of our businesses. OTHER BUSINESS OPERATIONS Our transportation company may be unable to maintain profitable operations if economic conditions
restrict its ability to recover the increasing costs of fuel, insurance and labor supplies. Our construction companies may be unable to properly bid and perform on projects. The profitability and success of our construction companies require us to identify, estimate and
timely bid on profitable projects. The quantity and quality of projects up for bids at any time is
uncertain. Additionally, once a project is awarded, we must be able to perform within cost
estimates that were set when the bid was submitted and accepted. A significant failure or an
inability to properly bid or perform on projects could lead to adverse financial results for our
construction companies. Our company that processes dehydrated potato flakes, flour and granules competes in a highly
competitive market, and is dependent on adequate sources of potatoes for processing. The market for processed, dehydrated potato flakes, flour and granules is highly competitive. The
profitability and success of our potato processing company, acquired in August 2004, is dependent
on superior product quality, competitive product pricing, strong customer relationships, raw
material costs and availability and customer demand for finished goods. In most product categories,
our company competes with numerous manufacturers of varying sizes in the United States. The principal raw material used by our potato processing company is off-grade potatoes from
growers. These potatoes are unsuitable for use in other markets due to imperfections. They are not
subject to the United States Department of Agricultures general requirements and expectations for
size, shape or color. While our food ingredient processing company has processing capabilities in
three geographically distinct growing regions, there can be no assurance it will be able to obtain
raw materials due to poor growing conditions, a loss of key growers and other factors. A loss of
raw materials or the necessity of paying much higher prices for raw materials could adversely
affect the financial performance of this company. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK At December 31, 2004 we had limited exposure to market risk associated with interest rates and
commodity prices and limited exposure to market risk associated with changes in foreign currency
exchange rates because the Canadian operations of IPH transact all sales in U.S. dollars. The majority of our consolidated long-term debt has fixed interest rates. The interest rate on
variable rate long-term debt is reset on a periodic basis reflecting current market conditions. We
manage our interest rate risk through the issuance of fixed-rate debt with varying maturities,
through economic refunding of debt through optional refundings, limiting the amount of variable
interest rate debt, and the utilization of short-term borrowings to allow flexibility in the timing
and placement of long-term debt. As of December 31, 2004 we had $24.4 million of long-term debt
subject to variable interest rates excluding $2.8 million in long-term debt




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included in Liabilities of discontinued operationson our December 31, 2004 consolidated balance
sheet. Assuming no change in our financial structure, if variable interest rates were to average
one percentage point higher or lower than the average variable rate on December 31, 2004, interest
expense and pretax earnings would change by approximately $244,000. We have not used interest rate swaps to manage net exposure to interest rate changes related to our
portfolio of borrowings. We maintain a ratio of fixed-rate debt to total debt within a certain
range. It is our policy to enter into interest rate transactions and other financial instruments
only to the extent considered necessary to meet our stated objectives. We do not enter into
interest rate transactions for speculative or trading purposes. The plastics companies are exposed to market risk related to changes in commodity prices for PVC
resins, the raw material used to manufacture PVC pipe. The PVC pipe industry is highly sensitive to
commodity raw material pricing volatility. Historically, when resin prices are rising or stable,
margins and sales volume have been higher and when resin prices are falling, sales volumes and
margins have been lower. Gross margins also decline when the supply of PVC pipe increases faster
than demand. Due to the commodity nature of PVC resin and the dynamic supply and demand factors
worldwide, it is very difficult to predict gross margin percentages or to assume that historical
trends will continue. Our energy services subsidiary markets natural gas to approximately 160 retail customers. Some of
these customers are served under fixed-price contracts. There is price risk associated with a
limited number of these fixed-price contracts since the corresponding cost of natural gas is not
immediately locked in. However, any price risk associated with these contracts is within the
acceptable risk parameters established in our risk management policy. We do not consider this price
risk to be material. These contracts call for the physical delivery of natural gas and are
considered executory contracts for accounting purposes. Current accounting guidance requires losses
on firmly committed executory contracts to be recognized when realized. In 2004, our energy services subsidiary entered into over-the-counter natural gas forward swap
transactions that qualify as derivatives subject to mark-to-market accounting under SFAS No. 133.
Although our energy services subsidiary manages its risk by balancing its position in these
transactions relative to its market position in the contracts entered into for physical delivery,
these swap transactions do not qualify for the normal purchases and sales exception nor do they
qualify for hedge accounting treatment under SFAS No. 133. These contracts are held for trading
purposes with both realized and unrealized net gains and losses reflected in revenue on our
consolidated statement of income for the year ended December 31, 2004 in accordance with the
guidance provided in EITF 02-3, Issues Involved in Accounting for Derivative Contracts Held for
Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities. The following table shows the effect of marking-to-market our energy services subsidiarys forward
natural gas swap transactions on our consolidated balance sheet as of December 31, 2004: December 31,(in thousands)
    
    2004Current asset  marked-to-market gain
    
    $
    1,834Current liability  marked-to-market loss
    
    
    (1,700
    )Net fair value of marked-to-market gas contracts
    
    $
    134




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The $134,000 in recognized but unrealized net gain on these forward natural gas swap transactions
marked-to-market on December 31, 2004 is expected to be realized on settlement as scheduled over
the following quarters in the amounts listed: 1st Quarter
    
    
    2nd Quarter
    
    
    3rd Quarter
    
    
    4th Quarter(in thousands)
    
    2005
    

    2005
    
    2005
    
    2005
    
    TotalNet gain
    
    $
    8
    
    
    $
    54
    
    
    $
    54
    
    
    $
    18
    
    
    $
    134
 We have minimal credit risk associated with the nonperformance or nonpayment by counterparties to
these forward gas swap transactions as we have only one major counterparty to these transactions
and this counterparty has a high investment grade credit rating. The electric utility has market, price and credit risk associated with forward contracts for the
purchase and sale of electricity. As of December 31, 2004 the electric utility had recognized, on a
pretax basis, $301,000 in net unrealized gains on open forward contracts for the purchase and sale
of electricity. Due to the nature of electricity and the physical aspects of the electricity
transmission system, unanticipated events affecting the transmission grid can result in
transmission constraints and the cancellation of scheduled transactions by the independent
transmission system operator. In these situations, the counterparties to the cancelled transaction
are generally not made whole for the difference in the contract price and the market price of the
electricity at the time of cancellation. In some instances the electric utility may deliver on a
sale where its offsetting purchase has been cancelled or is undeliverable, or take delivery on a
purchase where its offsetting sale has been cancelled or is undeliverable. All forward energy
transactions are subject to a small, and likely unquantifiable, risk of cancellation by the
independent transmission system operator due to unanticipated physical constraints on the
transmission system. At the time of cancellation, the electric utility could be in a gain or loss
position depending on the market price of electricity relative to the contract price and the
electric utilitys position in the transaction. The market prices used to value the electric utilitys forward contracts for the purchases and
sales of electricity are determined by survey of counterparties by the electric utilitys power
services personnel responsible for contract pricing. Of the forward energy contracts that are
marked-to-market as of December 31, 2004, 45% of the forward purchases of electricity have
offsetting sales in terms of volumes and delivery periods. The amount of unrealized
marked-to-market gains recognized on forward purchases of electricity that are not offset by
forward sales of electricity is $144,000. We have in place an energy risk management policy with a goal to manage, through the use of defined
risk management practices, price risk and credit risk associated with wholesale power purchases and
sales. These policies require that most forward sales of electricity in wholesale markets be
covered by offsetting forward purchases of electricity with matching terms and delivery dates or by
the portion of company-owned generation projected to be in excess of retail load requirements.
Currently, a portion of marked-to-market gains or losses on a sales contract will be offset by a
marked-to-market loss or gain on the offsetting purchase contract. Our energy risk management policy allows for open long positions with limitations on the aggregate
marked-to-market value of open positions. These positions are closely monitored and covered with
offsetting sales when the risk of loss exceeds predefined limits. The exposure to price risk of
these open positions as of December 31, 2004 was not material.




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The following tables show the effect of marking-to-market forward contracts for the purchase and
sale of electricity on our consolidated balance sheet as of December 31, 2004 and the change in our
consolidated balance sheet position from December 31, 2003 to December 31, 2004: December 31,(in thousands)
    
    2004Current asset  marked-to-market gain
    
    $
    711Regulatory asset  deferred marked-to-market loss
    
    
    331Total assets
    
    
    1,042Current liability  marked-to-market loss
    
    
    (544
    )Regulatory liability  deferred marked-to-market gain
    
    
    (197
    )Total liabilities
    
    
    (741
    )Net fair value of marked-to-market energy contracts
    
    $
    301
 Year ended(in thousands)
    
    December 31, 2004Fair value at beginning of year
    
    $
    2,057Amount realized on contracts entered into in 2003 and settled in 2004
    
    
    (1,967
    )Changes in fair value of contracts entered into in 2003
    
    
    (90
    )Net fair value of contracts entered into in 2003 at year-end 2004
    
    
    Changes in fair value of contracts entered into in 2004
    
    
    301Net fair value end of year
    
    $
    301
 The $301,000 in recognized but unrealized net gains on the forward energy purchases and sales
marked-to-market on December 31, 2004 is expected to be realized on physical settlement as
scheduled over the following quarters in the amounts listed: 1st Quarter
    
    
    2nd Quarter(in thousands)
    
    2005
    
    
    2005
    
    
    TotalNet gain
    
    $
    276
    

    
    $
    25
    
    
    $
    301
 We have credit risk associated with the nonperformance or nonpayment by counterparties to our
forward energy purchases and sales agreements. We have established guidelines and limits to manage
credit risk associated with wholesale power purchases and sales. Specific limits are determined by
a counterpartys financial strength. Our credit risk with our largest counterparty on delivered and
marked-to-market forward contracts as of December 31, 2004 was $10.6 million. As of December 31,
2004 we had a net credit risk exposure of $3.2 million from thirty-nine counterparties with
investment grade credit ratings. The $3.2 million credit risk exposure includes net amounts due to the electric utility on
receivables/payables from completed transactions billed and unbilled plus marked-to-market
gains/losses on forward contracts for the purchase and sale of electricity scheduled for delivery
after December 31, 2004. Individual counterparty exposures are offset according to legally
enforceable netting arrangements. Counterparties with investment grade credit ratings have minimum credit ratings of BBB- (Standard &
Poors), Baa3 (Moodys) or BBB- (Fitch).




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CRITICAL ACCOUNTING POLICIES INVOLVING SIGNIFICANT ESTIMATES Our significant accounting policies are described in note 1 to consolidated financial statements.
The discussion and analysis of the financial statements and results of operations are based on our
consolidated financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States. The preparation of these consolidated financial
statements requires management to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent assets and
liabilities. We use estimates based on the best information available in recording transactions and balances
resulting from business operations. Estimates are used for such items as depreciable lives, asset
impairment evaluations, tax provisions, collectability of trade accounts receivable, self-insurance
programs, valuation of forward energy contracts, unbilled electric revenues, unscheduled power
exchanges, service contract maintenance costs, percentage-of-completion and actuarially determined
benefits costs. As better information becomes available or actual amounts are known, estimates are
revised. Operating results can be affected by revised estimates. Actual results may differ from
these estimates under different assumptions or conditions. Management has discussed the application
of these critical accounting policies and the development of these estimates with the audit
committee of the board of directors. The following critical accounting policies affect the more
significant judgments and estimates used in the preparation of the consolidated financial
statements. PENSION AND OTHER
POSTRETIREMENT BENEFITS OBLIGATIONS AND COSTS Pension and postretirement benefit liabilities and expenses for our electric utility and corporate
employees are determined by actuaries using assumptions about the discount rate, expected return on
plan assets, rate of compensation increase and healthcare cost-trend rates. Further discussion of
our pension and postretirement benefit plans and related assumptions is included in note 11 to
consolidated financial statements. These benefits, for any individual employee, can be earned and related expenses can be recognized
and a liability accrued over periods of up to 40 or more years. These benefits can be paid out for
up to 40 or more years after an employee retires. Estimates of liabilities and expenses related to
these benefits are among our most critical accounting estimates. Although deferral and amortization
of fluctuations in actuarially determined benefit obligations and expenses are provided for when
actual results on a year-to-year basis deviate from long-range assumptions, compensation increases
and healthcare cost increases or a reduction in the discount rate applied from one year to the next
can significantly increase our benefit expenses in the year of the change. Also, a reduction in the
expected rate of return on pension plan assets in our funded pension plan or realized rates of
return on plan assets that are well below assumed rates of return could result in significant
increases in recognized pension benefit expenses in the year of the change or for many years
thereafter because actuarial losses can be amortized over the average remaining service lives of
active employees. The pension benefit cost for 2005 for our noncontributory funded pension plan is expected to be
$2.9 million compared to $2.0 million in 2004. The estimated discount rate used to determine annual
benefit cost accruals will decrease to 6.00% in 2005 from 6.25% used in 2004. In selecting the
discount rate, we use the yield of a fixed income debt security, which has a rating of Aa
published by a recognized rating agency along with a bond matching model as a basis to determine
the rate. Subsequent increases or decreases in actual rates of return on plan assets over assumed rates or
increases or decreases in the discount rate or rate of increase in future compensation levels could
significantly change projected costs. For 2004, all other factors being held constant: a 0.25
increase (or decrease) in the discount rate would have decreased (or increased) the 2004 pension
benefit cost by $150,000; a 0.25 increase (or decrease) in the assumed rate of increase in future
compensation levels would have increased (or decreased) the 2004 pension




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benefit cost by $325,000; a 0.25 increase (or decrease) in the expected long-term rate of return on
plan assets would have decreased (or increased) the 2004 pension benefit cost by $365,000. Increases or decreases in the discount rate or in retiree healthcare cost inflation rates could
significantly change our projected postretirement healthcare benefit costs. A 0.25 increase (or
decrease) in the discount rate would have decreased (or increased) the 2004 postretirement medical
benefit costs by $140,000. See note 11 to consolidated financial statements for the cost impact of
a change in medical cost inflation rates. We believe the estimates made for the 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. We continue to use
current methodologies to determine plan costs. REVENUE
RECOGNITION Our construction companies and three of our manufacturing companies record operating revenues on a
percentage-of-completion basis for fixed-price construction contracts. The method used to determine
the progress of completion is based on the ratio of costs incurred to total estimated costs. The
duration of the majority of these contracts is less than a year. Revenues recognized on jobs in
progress as of December 31, 2004 were $106 million. Expected losses on jobs in progress at year-end
2004 have been recognized. We believe the accounting estimate related to the
percentage-of-completion accounting on uncompleted contracts is critical to the extent that any
underestimate of total expected costs on fixed-price construction contracts could result in reduced
profit margins being recognized on these contracts at the time of completion. FORWARD ENERGY CONTRACTS
CLASSIFIED AS DERIVATIVES Our electric utilitys forward contracts for the purchase and sale of electricity and our energy
services companys forward natural gas swap transactions are derivatives subject to mark-to-market
accounting under accounting principles generally accepted in the United States. The market prices
used to value the electric utilitys forward contracts for the purchases and sales of electricity
are determined by survey of counterparties by the electric utilitys power services personnel
responsible for contract pricing and, as such, are estimates. Of the forward electric energy
contracts that are marked-to-market as of December 31, 2004, 45% of the forward energy purchases
have offsetting sales in terms of volumes and delivery periods. The amount of unrealized
marked-to-market gains recognized on forward energy purchases that are not offset by forward energy
sales is $144,000. All of the forward energy contracts for the purchase and sale of electricity
marked-to-market as of December 31, 2004 are scheduled for settlement prior to June 1, 2005. ALLOWANCE FOR DOUBTFUL
ACCOUNTS Our operating companies encounter risks associated with sales and the collection of the associated
accounts receivable. As such, they record provisions for accounts receivable that are considered to
be uncollectible. In order to calculate the appropriate monthly provision, the operating companies
primarily utilize historical rates of accounts receivables written off as a percentage of total
revenue. This historical rate is applied to the current revenues on a monthly basis. The historical
rate is updated periodically based on events that may change the rate such as a significant
increase or decrease in collection performance and timing of payments as well as the calculated
total exposure in relation to the allowance. Periodically, operating companies compare identified
credit risks with allowances that have been established using historical experience and adjust
allowances accordingly. In circumstances where an operating company is aware of a specific
customers inability to meet financial obligations, the operating company records a specific
allowance for bad debts to reduce the net recognized receivable to the amount it reasonably
believes will be collected.




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We believe the accounting estimates related to the allowance for
doubtful accounts is critical because the underlying assumptions used for the allowance can change from period to period and could
potentially cause a material impact to the income statement and working capital. During 2004, $1.6 million of bad debt expense (0.18% of total 2004 revenue of $882 million) was
recorded and the allowance for doubtful accounts was $2.8 million (2.2% of trade accounts
receivable) as of December 31, 2004. General economic conditions and specific geographic concerns
are major factors that may affect the adequacy of the allowance and may result in a change in the
annual bad debt expense. An increase or decrease of one percentage point in our consolidated
allowance for doubtful accounts based on outstanding receivables at December 31, 2004 would result
in a $1.3 million increase or decrease in bad debt expense. Although an estimated allowance for doubtful accounts on our operating companies accounts
receivable is provided for, the allowance for doubtful accounts on the electric segments wholesale
electric sales is insignificant in proportion to annual revenues from these sales. The electric
segment has not experienced a bad debt related to wholesale electric sales due largely to stringent
risk management criteria related to these sales. However, nonpayment on a single wholesale electric
sale could result in a significant bad debt expense. DEPRECIATION EXPENSE AND
DEPRECIABLE LIVES The provisions for depreciation of electric utility property for financial reporting purposes are
made on the straight-line method based on the estimated service lives (5 to 65 years) of the
properties. Such provisions as a percent of the average balance of depreciable electric utility
property were 2.77% in 2004, 3.07% in 2003 and 3.08% in 2002. Depreciation rates on electric
utility property are subject to annual regulatory review and approval, and depreciation expense is
recovered through rates set by ratemaking authorities. Although the useful lives of electric
utility properties are estimated, the recovery of their cost is dependent on the ratemaking
process. Deregulation of the electric industry could result in changes to the estimated useful
lives of electric utility property that could impact depreciation expense. Property and equipment of our nonelectric operations are carried at historical cost or at the
current appraised value if acquired in a business combination accounted for under the purchase
method of accounting and are depreciated on a straight-line basis over useful lives (3 to 40 years)
of the related assets. We believe that the lives and methods of determining depreciation are
reasonable, however, changes in economic conditions affecting the industries in which our
nonelectric companies operate or innovations in technology could result in a reduction of the
estimated useful lives of our nonelectric operating companies property, plant and equipment or in
an impairment write-down of the carrying value of these properties. TAXATION We are required to make judgments regarding the potential tax effects of various financial
transactions and our ongoing operations to estimate our obligations to taxing authorities. These
tax obligations include income, real estate and use taxes. These judgments include reserves for
potential adverse outcomes regarding tax positions that we have taken. While we believe the
resulting tax reserve balances as of December 31, 2004 reflect the most likely probable expected
outcome of these tax matters in accordance with SFAS No. 5, Accounting for Contingencies,and SFAS
No. 109, Accounting for Income Taxes, the ultimate outcome of such matters could result in
additional adjustments to our consolidated financial statements. However, we do not believe such
adjustments would be material based on items currently reserved for. Deferred income taxes are provided for revenue and expenses which are recognized in different
periods for income tax and financial reporting purposes. We assess our deferred tax assets for
recoverability based on both historical and anticipated earnings levels. We have not recorded a
valuation allowance related to the probability of recovery of our deferred tax assets as we believe
reductions in tax payments related to these assets will be fully realized in the future.




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##### 



ASSET
IMPAIRMENT We are required to test for asset impairment relating to property and equipment whenever events or
changes in circumstances indicate that the carrying value of an asset might not be recoverable. We
apply SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, in order to
determine whether or not an asset is impaired. This standard requires an impairment analysis when
indicators of impairment are present. If such indicators are present, the standard requires that if
the sum of the future expected cash flows from a companys asset, undiscounted and without interest
charges, is less than the carrying value, an asset impairment must be recognized in the financial
statements. The amount of the impairment is the difference between the fair value of the asset and
the carrying value of the asset. We believe the accounting estimates related to an asset impairment are critical because they are
highly susceptible to change from period to period reflecting changing business cycles and require
management to make assumptions about future cash flows over future years and the impact of
recognizing an impairment could have a significant effect on operations. Managements assumptions
about future cash flows require significant judgment because actual operating levels have
fluctuated in the past and are expected to continue to do so in the future. As of December 31, 2004 an assessment of the carrying values of our long-lived assets and other
intangibles indicated that these assets were not impaired. GOODWILL
IMPAIRMENT Goodwill is required to be evaluated annually for impairment, according to SFAS No. 142, Goodwill
and Other Intangible Assets. The standard requires a two-step process be performed to analyze
whether or not goodwill has been impaired. Step one is to test for potential impairment, and
requires that the fair value of the reporting unit be compared to its book value including
goodwill. If the fair value is higher than the book value, no impairment is recognized. If the fair
value is lower than the book value, a second step must be performed. The second step is to measure
the amount of impairment loss, if any, and requires that a hypothetical purchase price allocation
be done to determine the implied fair value of goodwill. This fair value is then compared to the
carrying value of goodwill. If the implied fair value is lower than the carrying value, an
impairment must be recorded. We believe accounting estimates related to goodwill impairment are critical because the underlying
assumptions used for the discounted cash flow can change from period to period and could
potentially cause a material impact to the income statement. Managements assumptions about
inflation rates and other internal and external economic conditions, such as earnings growth rate,
require significant judgment based on fluctuating rates and expected revenues. Additionally, SFAS
No. 142 requires goodwill be analyzed for impairment on an annual basis using the assumptions that
apply at the time the analysis is updated. As of December 31, 2004 an assessment of the carrying values of our goodwill indicated no
impairment. We currently have $1.0 million of goodwill recorded on our balance sheet related to our energy
services subsidiary that markets natural gas to approximately 160 retail customers. An evaluation
of projected cash flows from this operation in December 2004 indicated that the related goodwill
was not impaired. However, actual and projected cash flows from this operation are subject to
fluctuations due to low profit margins on natural gas sales combined with high volatility of
natural gas prices. Reductions in profit margins or the volume of natural gas sales could result in
an impairment of all or a portion of its related goodwill. We will continue to evaluate this
reporting unit for impairment on an annual basis and as conditions warrant. We currently have $6.7 million of goodwill recorded on our balance sheet related to the acquisition
of E.W. Wylie Corporation (Wylie), our flatbed trucking company. Highly competitive pricing in the
trucking industry in




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##### 



recent years had resulted in decreased operating margins and lower returns on invested capital for
Wylie. Wylies performance improved in 2004 and current projections are for operating margins to
increase from current levels over the next three to five years as demand for shipping continues to
increase relative to available shipping capacity and additional revenues are generated from added
terminal locations and increased brokerage activity. If current trends reverse and operating
margins do not increase according to our projections, the reductions in anticipated cash flows from
transportation operations may indicate that the fair value of Wylie is less than its book value
resulting in an impairment of goodwill and a corresponding charge against earnings. At December 31,
2004, assessment of Wylie indicated that its goodwill was not impaired. We will continue to
evaluate this reporting unit for impairment on an annual basis and as conditions warrant. PURCHASE
ACCOUNTING We account for our acquisitions under the purchase method of accounting and, accordingly, the
acquired assets and liabilities assumed are recorded at their respective fair values. The excess of
purchase price over the fair value of the assets acquired and liabilities assumed is recorded as
goodwill. The recorded values of assets and liabilities are based on third party estimates and
valuations when available. The remaining values are based on managements judgments and estimates,
and, accordingly, our consolidated financial position or results of operations may be affected by
changes in estimates and judgements. Acquired assets and liabilities assumed that are subject to critical estimates include property,
plant and equipment and intangible assets. The fair value of property, plant and equipment is based on valuations performed by qualified
internal personnel and/or outside appraisers. Fair values assigned to plant and equipment are based
on several factors including the age and condition of the equipment, maintenance records of the
equipment and auction values for equipment with similar characteristics at the time of purchase. Intangible assets are identified and valued using the guidelines of SFAS No. 141. The fair value
of intangible assets is based on estimates including royalty rates, customer attrition rates and
estimated cash flows. While the allocation of purchase price is subject to a high degree of judgment and uncertainty, we
do not expect the estimates to vary significantly once an acquisition is complete. We believe our
estimates have been reasonable in the past as there have been no significant valuation adjustments
to the final allocation of purchase price. KEY ACCOUNTING PRONOUNCEMENTS FASB Interpretation (FIN) No. 46 (revised December 2003), Consolidation of Variable Interest
Entities, is an interpretation of Accounting Research Bulletin No. 51, that addresses consolidation
by business enterprises of variable interest entities which have certain characteristics related to
equity at risk and rights and obligations to profits and losses. The effective date for application
of certain provisions of FIN 46 was the first quarter of 2004 for interests in variable interest
entities created before February 1, 2003 and held by a public entity that has not previously
applied the provisions of FIN 46. We have determined that we do not have any arrangements with
unconsolidated entities under FIN 46 except for majority interests in eight limited partnerships
that invest in tax-credit-qualifying, affordable-housing projects. The net investment in these
entities, which are currently accounted for on an equity-method basis, totaled $2.7 million as of
December 31, 2004. Full consolidation of these entities would not have a material effect on our
consolidated financial statements and would have no effect on our consolidated net income. We
include these entities in our consolidated financial statements on an equity method basis due to
immateriality. Consolidating these entities would have represented less than 0.5% of total assets
of the Company.




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##### 



FASB Staff Position No. FAS 106-2 (FSP 106-2), Accounting and Disclosure Requirements Related
to the Medicare Prescription Drug, Improvement and Modernization Act of 2003(the Act)  FSP 106-2
provides guidance on accounting for the effect of the federal subsidy for prescription drug plans
when the plans sponsor determines that the prescription drug benefits it offers to its retirees
are actuarially equivalent to those offered under Medicare Part D and will qualify for the federal
subsidy offered under the Act. The provisions of the Act provide for a federal subsidy for plans
that provide prescription drug benefits and meet certain qualifications, and alternatively would
allow prescription drug plan sponsors to coordinate with the Medicare benefit. We elected the
one-time deferral of accounting for the effects of the Act in the quarter ended March 31, 2004, the
first period in which accounting for the effects of the Act normally would have been reflected in
our financial statements. Our postretirement medical plan provides prescription drug coverage for all electric utility
company retirees. We have determined that the prescription drug benefits we offer to our retirees
who retired prior to 2003 are actuarially equivalent to those offered under Medicare Part D and
will qualify for the federal subsidy offered under the Act. We expect that our share of the cost of
the underlying postretirement prescription drug coverage on which the subsidy is based will be
reduced by the expected subsidy. During the third quarter of 2004, we adopted FSP 106-2 retroactive to the beginning of the year.
With the assistance of our actuarial advisors, we determined that the expected federal subsidy
reduced our accumulated postretirement benefit obligation (APBO) at January 1, 2004 by
approximately $4.9 million and reduced our net periodic benefit cost for 2004 by $757,000 of which
approximately 13.1% was credited to capital additions as a reduction of capitalized labor. The APBO
reduction will be accounted for as an actuarial experience gain in accordance with the guidance in
FAS 106 and, accordingly, was not included as a reduction to our net periodic benefit cost in 2004.
The adoption of FSP 106-2 had the effect of reducing 2004 operating expenses by $658,000.
Retroactive application will result in the restatement of first and second quarter 2004 operating
expenses and net income when these periods are presented in subsequent financial reports, reducing
operating expenses and increasing net income by $164,000 in each quarter. In accordance with the
provisions of the Act, the expected subsidy will have no effect on income tax expense. SFAS No. 151, Inventory Costs an amendment of ARB No. 43, Chapter 4, was issued in November 2004 to
clarify that abnormal amounts of idle facility expense, freight, handling costs and wasted
materials (spoilage) should be recognized as current-period charges. This statement also requires
that allocation of fixed production overheads to the costs of converting materials into finished
products be based on the normal capacity of the production facilities. The provisions of this
statement shall be effective for inventory costs incurred during fiscal years beginning after June
15, 2005 with earlier application permitted. We do not expect the application of the requirements
of SFAS No. 151 to have an effect on our consolidated net income, financial position or cash flows. SFAS No. 123 (revised 2004), Share-Based Payment(SFAS No. 123(R)), issued in December 2004 is a
revision of SFAS No. 123, Accounting for Stock-based Compensation, and supersedes APB Opinion No.
25, Accounting for Stock Issued to Employees. We currently report our stock-based compensation
under the requirements of APB Opinion No. 25 and furnish related pro forma footnote information
required under SFAS No. 123. Under SFAS No. 123(R), we will be required to record our stock-based
compensation as an expense on our income statement over the period earned based on the fair value
of the stock or options awarded on their grant date. SFAS No.123(R) becomes effective in July 2005
with early adoption allowed and, when adopted, can be applied under a modified prospective basis or
on a modified retrospective basis back to January 1, 2005. We will adopt SFAS No. 123(R) in July
2005 but have not determined whether we will apply the requirements prospectively or
retrospectively. In either event, we have determined that the application of SFAS No. 123(R)
reporting requirements will have the effect of reducing our 2005 net income by $300,000 to
$600,000.




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##### 



MANAGEMENTS REPORT REGARDING INTERNAL CONTROLS OVER FINANCIAL REPORTING Management is responsible for the preparation and integrity of the consolidated financial
statements and representations in this annual report. The consolidated financial statements of
Otter Tail Corporation have been prepared in conformity with generally accepted accounting
principles applied on a consistent basis and include some amounts that are based on informed
judgments and best estimates and assumptions of management. In order to assure the consolidated financial statements are prepared in conformance with generally
accepted accounting principles, management is responsible for establishing and maintaining adequate
internal controls over financial reporting, as such term is defined in Exchange Act Rules
13a-15(f). These internal controls are designed only to provide reasonable assurance, on a
cost-effective basis, that transactions are carried out in accordance with managements
authorizations and assets are safeguarded against loss from unauthorized use or disposition. Management has completed its assessment of the effectiveness of the Companys internal controls
over financial reporting as of December 31, 2004. In making this assessment, management used the
criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)
in Internal Control - Integrated Frameworkto conduct the required assessment of the effectiveness
of the Companys internal controls over financial reporting. As a part of this assessment, management excluded its acquisition of Idaho Pacific Holdings, Inc.
from its report on internal control over financial reporting due to the fact this acquisition was
completed in August 2004. Companies are allowed to exclude acquisitions from its assessment of
internal control during the first year of an acquisition under guidelines established by the
Securities and Exchange Commission. Idaho Pacific Holdings, Inc. represents 8.1% of consolidated
assets and 1.6% of consolidated revenues as of and for the year ended December 31, 2004. Based on this assessment, we believe that, as of December 31, 2004 the Companys internal controls
over financial reporting are effective based on those criteria. The Companys independent registered public accounting firm, Deloitte & Touche LLP, has audited our
consolidated financial statements included in this annual report and has also issued an attestation
report on managements assessment of the Companys internal controls over financial reporting. /s/ John Erickson John Erickson
President and Chief Executive Officer /s/ Kevin Moug Kevin Moug
Chief Financial Officer and Treasurer February 18, 2005




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##### 



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM TO THE SHAREHOLDERS OF OTTER TAIL CORPORATION We have audited the accompanying consolidated balance sheets and statements of capitalization
of Otter Tail Corporation and its subsidiaries (the
Company) as of December 31, 2004 and 2003, and
the related consolidated statements of income, common shareholders equity, and cash flows for each
of the three years in the period ended December 31, 2004. We also have audited managements
assessment, included in the accompanying Managements Report Regarding Internal Controls Over
Financial Reporting, that the Company maintained effective internal control over financial
reporting as of December 31, 2004, based on the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Control  Integrated Framework. The
Companys management is responsible for these financial statements, for maintaining effective
internal control over financial reporting, and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on these financial
statements, an opinion on managements assessment, and an opinion on the effectiveness of the
Companys internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement and whether effective internal control over financial reporting was maintained in all
material respects. Our audit of financial statements included examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, and evaluating the overall financial
statement presentation. Our audit of internal control over financial reporting included obtaining
an understanding of internal control over financial reporting, evaluating managements assessment,
testing and evaluating the design and operating effectiveness of internal control, and performing
such other procedures as we considered necessary in the circumstances. We believe that our audits
provide a reasonable basis for our opinions. A companys internal control over financial reporting is a process designed by, or under the
supervision of, the companys principal executive and principal financial officers, or persons
performing similar functions, and effected by the companys board of directors, management, and
other personnel to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A companys internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the financial statements.




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##### 



Because of the inherent limitations of
internal control over financial reporting,
including the possibility of collusion or improper management override of
controls, material misstatements due to
error or
fraud may not be prevented or detected on a timely basis. Also, projections of
any
evaluation of the effectiveness of the internal control over financial reporting to future periods
are subject to the risk that
the controls may become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate. In our opinion, such consolidated financial statements referred to above present fairly, in all
material respects, the financial position of the Company at December 31, 2004 and 2003, and the
results of its operations and its cash flows for each of the three years in the period ended
December 31, 2004, in conformity with accounting principles generally accepted in the United States
of America. Also in our opinion, managements assessment that the Company maintained effective
internal control over financial reporting as of December 31, 2004, is fairly stated, in all
material respects, based on the criteria established in Internal ControlIntegrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission. Furthermore, in our
opinion, the Company maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2004 based on the criteria established in Internal
ControlIntegrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway
Commission. As discussed in notes 5 and 16 to the consolidated financial statements, effective in 2003 the
Company adopted Statement of Financial Accounting Standards
(SFAS) No. 143, Accounting for Asset
Retirement Obligationsand SFAS No. 149, Amendment of Financial Accounting Standards Board
Statement No. 133 on Derivative and Hedging Activities. DELOITTE & TOUCHE LLP /s/ Deloitte & Touche LLP Minneapolis, Minnesota
February 18, 2005




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##### 



OTTER TAIL CORPORATION CONSOLIDATED BALANCE SHEETS, DECEMBER 31(in thousands)
    
    2004
    
    
    2003ASSETSCurrent assetsCash and cash equivalents
    
    $
    
    
    
    $
    7,311Accounts receivable:Trade (less allowance for doubtful accounts of
$2,822 for 2004 and $2,424 for 2003)
    
    
    124,537
    
    
    
    107,463Other
    
    
    6,677
    
    
    
    7,830Inventories
    
    
    77,296
    
    
    
    56,915Deferred income taxes
    
    
    5,014
    
    
    
    3,498Accrued utility revenues
    
    
    15,344
    
    
    
    14,866Costs and estimated earnings in excess of billings
    
    
    20,398
    
    
    
    4,591Other
    
    
    7,828
    
    
    
    10,385Assets held for sale from discontinued operations
    
    
    16,430
    
    
    
    17,265Total current assets
    
    
    273,524
    
    
    
    230,124Investments and other assets
    
    
    42,655
    
    
    
    33,452Goodwillnet
    
    
    92,196
    
    
    
    66,631Other intangiblesnet
    
    
    19,692
    
    
    
    7,096Deferred debitsUnamortized debt expense and reacquisition premiums
    
    
    7,291
    
    
    
    8,081Regulatory assets
    
    
    14,971
    
    
    
    14,669Other
    
    
    1,721
    
    
    
    1,600Total deferred debits
    
    
    23,983
    
    
    
    24,350PlantElectric plant in service
    
    
    890,200
    
    
    
    875,364Nonelectric operations
    
    
    214,079
    
    
    
    169,005Total
    
    
    1,104,279
    
    
    
    1,044,369Less accumulated depreciation and amortization
    
    
    440,650
    
    
    
    437,493Plantnet of accumulated depreciation and amortization
    
    
    663,629
    
    
    
    606,876Construction work in progress
    
    
    18,469
    
    
    
    17,894Net plant
    
    
    682,098
    
    
    
    624,770Total
    
    $
    1,134,148
    
    
    $
    986,423
 See accompanying notes to consolidated financial statements.




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##### 



OTTER TAIL CORPORATION CONSOLIDATED BALANCE SHEETS, DECEMBER 31(in thousands, except share data)
    
    2004
    
    
    2003LIABILITIES AND EQUITYCurrent liabilitiesShort-term debt
    
    $
    39,950
    
    
    $
    30,000Current maturities of long-term debt
    
    
    6,055
    
    
    
    8,598Accounts payable
    
    
    86,631
    
    
    
    81,994Accrued salaries and wages
    
    
    17,817
    
    
    
    14,521Accrued federal and state income taxes
    
    
    3,947
    
    
    
    3,731Other accrued taxes
    
    
    11,485
    
    
    
    10,448Other accrued liabilities
    
    
    10,417
    
    
    
    9,888Liabilities from discontinued operations
    
    
    5,211
    
    
    
    6,622Total current liabilities
    
    
    181,513
    
    
    
    165,802Pension benefit liability
    
    
    16,703
    
    
    
    16,919Other postretirement benefits liability
    
    
    25,053
    
    
    
    23,230Other noncurrent liabilities
    
    
    11,874
    
    
    
    11,102Commitments (note 8)Deferred creditsDeferred income taxes
    
    
    121,605
    
    
    
    101,016Deferred investment tax credit
    
    
    10,477
    
    
    
    11,630Regulatory liabilities
    
    
    56,909
    
    
    
    42,926Other
    
    
    1,662
    
    
    
    2,048Total deferred credits
    
    
    190,653
    
    
    
    157,620Capitalization (page 39)Long-term debt, net of current maturities
    
    
    261,810
    
    
    
    262,363Class B stock options of subsidiary
    
    
    1,832
    
    
    
    Cumulative preferred shares
    
    
    15,500
    
    
    
    15,500Common shares, par value $5 per shareauthorized, 50,000,000 shares;
outstanding, 200428,976,919 shares; 200325,723,814 shares
    
    
    144,885
    
    
    
    128,619Premium on common shares
    
    
    87,865
    
    
    
    26,515Unearned compensation
    
    
    (2,577
    )
    
    
    (3,313
    )Retained earnings
    
    
    199,427
    
    
    
    186,495Accumulated other comprehensive loss
    
    
    (390
    )
    
    
    (4,429
    )Total common equity
    
    
    429,210
    
    
    
    333,887Total capitalization
    
    
    708,352
    
    
    
    611,750Total
    
    $
    1,134,148
    
    
    $
    986,423
 See accompanying notes to consolidated financial statements.




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##### 



OTTER TAIL CORPORATION CONSOLIDATED
STATEMENTS OF INCOME  FOR THE YEARS ENDED DECEMBER 31( in thousands, except per-share amounts)
    
    2004
    
    
    2003
    
    
    2002Operating revenues
    
    $
    882,324
    
    
    $
    744,692
    
    
    $
    637,657Operating expensesProduction fuel
    
    
    52,056
    
    
    
    51,163
    
    
    
    44,122Purchased power
    
    
    40,098
    
    
    
    36,002
    
    
    
    30,915Electric operation and maintenance expenses
    
    
    85,361
    
    
    
    87,186
    
    
    
    80,534Cost of goods sold
    
    
    485,541
    
    
    
    372,734
    
    
    
    286,253Other nonelectric expenses
    
    
    90,077
    
    
    
    76,397
    
    
    
    67,100Depreciation and amortization
    
    
    44,344
    
    
    
    43,820
    
    
    
    40,526Property taxes
    
    
    10,411
    
    
    
    9,598
    
    
    
    9,423Total operating expenses
    
    
    807,888
    
    
    
    676,900
    
    
    
    558,873Operating income
    
    
    74,436
    
    
    
    67,792
    
    
    
    78,784Other income  net
    
    
    820
    
    
    
    1,145
    
    
    
    1,654Interest charges
    
    
    18,272
    
    
    
    17,760
    
    
    
    17,507Income from continuing operations before income taxes
    
    
    56,984
    
    
    
    51,177
    
    
    
    62,931Income
taxes - continuing operations
    
    
    17,004
    
    
    
    13,563
    
    
    
    18,755Income from continuing operations
    
    
    39,980
    
    
    
    37,614
    
    
    
    44,176Income from discontinued operationsnet of income taxes of $1,483, $1,367 and $1,306, respectively
    
    
    2,215
    
    
    
    2,042
    
    
    
    1,952Net Income
    
    
    42,195
    
    
    
    39,656
    
    
    
    46,128Preferred dividend requirements
    
    
    736
    
    
    
    735
    
    
    
    736Earnings available for common shares
    
    $
    41,459
    
    
    $
    38,921
    
    
    $
    45,392Average number of common shares outstandingbasic
    
    
    26,089
    
    
    
    25,673
    
    
    
    25,176Average number of common shares outstandingdiluted
    
    
    26,207
    
    
    
    25,826
    
    
    
    25,397Basic earnings per share:Continuing operations (net of preferred dividend requirement)
    
    $
    1.51
    
    
    $
    1.44
    
    
    $
    1.72Discontinued operations
    
    
    0.08
    
    
    
    0.08
    
    
    
    0.08$
    1.59
    
    
    $
    1.52
    
    
    $
    1.80Diluted earnings per share:Continuing operations (net of preferred dividend requirement)
    
    $
    1.50
    
    
    $
    1.43
    
    
    $
    1.71Discontinued operations
    
    
    0.08
    
    
    
    0.08
    
    
    
    0.08$
    1.58
    
    
    $
    1.51
    
    
    $
    1.79Dividends per common share
    
    $
    1.10
    
    
    $
    1.08
    
    
    $
    1.06
 See accompanying notes to consolidated financial statements.




---



##### 



OTTER TAIL CORPORATION CONSOLIDATED
STATEMENTS OF COMMON SHAREHOLDERS EQUITYAccumulatedCommon
    
    
    Par value,
    
    
    Premium on
    
    
    
    
    
    
    
    
    
    
    othershares
    
    
    common
    
    
    common
    
    
    Unearned
    
    
    Retained
    
    
    comprehensive
    
    
    Total( in thousands, except common shares outstanding)
    
    outstanding
    
    
    shares
    
    
    shares
    
    
    compensation
    
    
    earnings
    
    
    income/(loss)
    
    
    equityBalance, December 31, 2001
    
    
    24,653,490
    
    
    $
    123,267
    
    
    $
    1,526
    
    
    $
    (151
    )
    
    $
    156,641
    
    
    $
    (1,975
    )
    
    $
    279,308Common stock issuances
    
    
    938,670
    
    
    
    4,694
    
    
    
    22,094
    
    
    
    (2,674
    )
    
    
    
    
    
    
    
    
    
    
    24,114Amortization of unearned compensationstock awards
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    879
    
    
    
    
    
    
    
    
    
    
    
    879Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    46,128
    
    
    
    
    
    
    
    46,128Minimum pension liability adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,014
    )
    
    
    (10,014
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    36,114Tax benefit for exercise of stock options
    
    
    
    
    
    
    
    
    
    
    720
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    720Purchase stock for employee purchase plan
    
    
    
    
    
    
    
    
    
    
    (205
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (205
    )Cumulative preferred dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (736
    )
    
    
    
    
    
    
    (736
    )Common dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (26,729
    )
    
    
    
    
    
    
    (26,729
    )Balance, December 31, 2002
    
    
    25,592,160
    
    
    
    127,961
    
    
    
    24,135
    
    
    
    (1,946
    )
    
    
    175,304
    
    
    
    (11,989
    )
    
    
    313,465Common stock issuances
    
    
    140,621
    
    
    
    703
    
    
    
    2,793
    
    
    
    (2,477
    )
    
    
    
    
    
    
    
    
    
    
    1,019Common stock retirements
    
    
    (8,967
    )
    
    
    (45
    )
    
    
    (225
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (270
    )Amortization of unearned compensationstock awards
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,110
    
    
    
    
    
    
    
    
    
    
    
    1,110Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    39,656
    
    
    
    
    
    
    
    39,656Minimum pension liability adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,560
    
    
    
    7,560Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    47,216Tax benefit for exercise of stock options
    
    
    
    
    
    
    
    
    
    
    111
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    111Purchase stock for employee purchase plan
    
    
    
    
    
    
    
    
    
    
    (299
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (299
    )Cumulative preferred dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (735
    )
    
    
    
    
    
    
    (735
    )Common dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (27,730
    )
    
    
    
    
    
    
    (27,730
    )Balance, December 31, 2003
    
    
    25,723,814
    
    
    $
    128,619
    
    
    
    26,515
    
    
    
    (3,313
    )
    
    
    186,495
    
    
    
    (4,429
    )
    
    
    333,887Common stock issuances, net of expenses
    
    
    3,266,266
    
    
    
    16,332
    
    
    
    63,373
    
    
    
    (566
    )
    
    
    
    
    
    
    
    
    
    
    79,139Common stock retirements
    
    
    (13,161
    )
    
    
    (66
    )
    
    
    (283
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (349
    )Amortization of unearned compensationstock awards
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,302
    
    
    
    
    
    
    
    
    
    
    
    1,302Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    42,195
    
    
    
    
    
    
    
    42,195Unrealized loss on marketable equity securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (14
    )
    
    
    (14
    )Foreign currency exchange translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,014
    
    
    
    1,014Minimum pension liability adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,039
    
    
    
    3,039Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    46,234Tax benefit for exercise of stock options
    
    
    
    
    
    
    
    
    
    
    92
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    92Valuation of stock options of subsidiary acquired in 2004
    
    
    
    
    
    
    
    
    
    
    (1,832
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,832
    )Cumulative preferred dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (735
    )
    
    
    
    
    
    
    (735
    )Common dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (28,528
    )
    
    
    
    
    
    
    (28,528
    )Balance, December 31, 2004
    
    
    28,976,919
    
    
    $
    144,885
    
    
    $
    87,865
    
    
    $
    (2,577
    )
    
    $
    199,427
    
    
    $
    (390
    ) (a)
    
    $
    429,210
   (in thousands)
    
    Before Tax
    
    
    Tax Effect
    
    
    Net-of-taxMinimum supplemental pension liability adjustment
    
    $
    (2,317
    )
    
    $
    927
    
    
    $
    (1,390
    )Foreign currency exchange translation
    
    
    1,690
    
    
    
    (676
    )
    
    
    1,014Unrealized loss on marketable equity securities
    
    
    (23
    )
    
    
    9
    
    
    
    (14
    )Net accumulated other comprehensive loss
    
    $
    (650
    )
    
    $
    260
    
    
    $
    (390
    )
 See accompanying notes to consolidated financial statements.




---



##### 



OTTER TAIL CORPORATION CONSOLIDATED
STATEMENTS OF CASH FLOWS  FOR THE YEARS ENDED DECEMBER 31(in thousands)
    
    2004
    
    
    2003
    
    
    2002Cash flows from operating activitiesNet income
    
    $
    42,195
    
    
    $
    39,656
    
    
    $
    46,128Adjustments to reconcile net income to net cash provided by operating activities:Income from discontinued operations
    
    
    (2,215
    )
    
    
    (2,042
    )
    
    
    (1,952
    )Depreciation and amortization
    
    
    44,344
    
    
    
    43,820
    
    
    
    40,526Deferred investment tax creditnet
    
    
    (1,152
    )
    
    
    (1,152
    )
    
    
    (1,153
    )Deferred income taxes
    
    
    3,854
    
    
    
    3,134
    
    
    
    2,823Change in deferred debits and other assets
    
    
    (1,640
    )
    
    
    (3,324
    )
    
    
    (5,178
    )Discretionary contribution to pension plan
    
    
    (4,000
    )
    
    
    
    
    
    
    Change in noncurrent liabilities and deferred credits
    
    
    2,110
    
    
    
    8,026
    
    
    
    1,049Allowance for equity (other) funds used during construction
    
    
    (716
    )
    
    
    (1,355
    )
    
    
    (1,742
    )Unrealized losses/(gains) on derivatives net of regulatory deferral
    
    
    1,621
    
    
    
    (2,057
    )
    
    
    Othernet
    
    
    1,457
    
    
    
    1,629
    
    
    
    1,399Cash provided by (used for) current assets and current liabilities:Change in receivables and inventories
    
    
    (18,707
    )
    
    
    (35,402
    )
    
    
    (4,292
    )Change in other current assets
    
    
    (16,453
    )
    
    
    (2,520
    )
    
    
    (2,498
    )Change in payables and other current liabilities
    
    
    6,395
    
    
    
    19,049
    
    
    
    1,822Change in interest and income taxes payable
    
    
    (966
    )
    
    
    5,182
    
    
    
    (4,572
    )Net cash provided by continuing operations
    
    
    56,127
    
    
    
    72,644
    
    
    
    72,360Net cash provided by discontinued operations
    
    
    3,797
    
    
    
    4,311
    
    
    
    4,437Net cash provided by operating activities
    
    
    59,924
    
    
    
    76,955
    
    
    
    76,797Cash flows from investing activitiesCapital expenditures
    
    
    (49,792
    )
    
    
    (49,094
    )
    
    
    (74,074
    )Proceeds from disposal of noncurrent assets
    
    
    5,875
    
    
    
    1,607
    
    
    
    2,482Acquisitionsnet of cash acquired
    
    
    (69,069
    )
    
    
    (12,896
    )
    
    
    (6,591
    )(Increases)/Decreases in other investments
    
    
    (5,099
    )
    
    
    1,671
    
    
    
    (84
    )Net cash used in investing activitiescontinuing operations
    
    
    (118,085
    )
    
    
    (58,712
    )
    
    
    (78,267
    )Net cash used in investing activitiesdiscontinued operations
    
    
    (1,033
    )
    
    
    (1,696
    )
    
    
    (1,390
    )Net cash used in investing activities
    
    
    (119,118
    )
    
    
    (60,408
    )
    
    
    (79,657
    )Cash flows from financing activitiesNet short-term borrowings
    
    
    9,950
    
    
    
    
    
    
    
    25,507Proceeds from issuance of common stock, net of issuance expenses
    
    
    78,780
    
    
    
    1,072
    
    
    
    3,091Payments for retirement of common stock
    
    
    (349
    )
    
    
    
    
    
    
    Proceeds from issuance of long-term debt, net of issuance expenses
    
    
    4,065
    
    
    
    18,592
    
    
    
    62,447Payments for retirement of long-term debt
    
    
    (9,380
    )
    
    
    (8,786
    )
    
    
    (61,041
    )Dividends paid and other distributions
    
    
    (29,263
    )
    
    
    (28,937
    )
    
    
    (27,465
    )Net cash provided by (used in) financing activitiescontinuing operations
    
    
    53,803
    
    
    
    (18,059
    )
    
    
    2,539Net cash provided by (used in) financing activitiesdiscontinued operations
    
    
    (1,126
    )
    
    
    (1,092
    )
    
    
    (1,120
    )Net cash provided by (used in) financing activities
    
    
    52,677
    
    
    
    (19,151
    )
    
    
    1,419Effect of foreign exchange rate fluctuations on cash
    
    
    (794
    )
    
    
    
    
    
    
    Net change in cash and cash equivalents
    
    
    (7,311
    )
    
    
    (2,604
    )
    
    
    (1,441
    )Cash and
cash equivalents at beginning of year - continuing operations
    
    
    7,311
    
    
    
    9,915
    
    
    
    11,356Cash and
cash equivalents at end of year - continuing operations
    
    $
    
    
    
    $
    7,311
    
    
    $
    9,915Supplemental disclosures of cash flow informationCash paid during the year from continuing operations for:Interest (net of amount capitalized)
    
    $
    16,447
    
    
    $
    16,583
    
    
    $
    16,432Income taxes
    
    $
    15,657
    
    
    $
    6,963
    
    
    $
    21,301Cash paid during the year from discontinued operations for:Interest (net of amount capitalized)
    
    $
    107
    
    
    $
    198
    
    
    $
    399Income taxes
    
    $
    1,387
    
    
    $
    1,474
    
    
    $
    1,534
 See accompanying notes to consolidated financial statements.




---



##### 



OTTER TAIL CORPORATION CONSOLIDATED STATEMENTS OF CAPITALIZATION, DECEMBER 31(in thousands, except share data)
    
    2004
    
    
    2003Long-term debtLombard US Equipment Finance note, variable, 3.44% at December 31, 2004, due October 2, 2006
    
    $
    13,971
    
    
    $
    16,300Senior debentures 6.375%, due December 1, 2007
    
    
    50,000
    
    
    
    50,000Senior notes 6.63%, due December 1, 2011
    
    
    90,000
    
    
    
    90,000Insured senior notes 5.625%, due October 1, 2017
    
    
    40,000
    
    
    
    40,000Senior notes 6.80%, due October 1, 2032
    
    
    25,000
    
    
    
    25,000Pollution control refunding revenue bonds, variable, 2.24% at December 31, 2004, due December 1, 2012
    
    
    10,400
    
    
    
    10,400Grant County, South Dakota pollution control refunding revenue bonds 4.65%, due September 1, 2017
    
    
    5,185
    
    
    
    5,185Mercer County, North Dakota pollution control refunding revenue bonds 4.85%, due September 1, 2022
    
    
    20,735
    
    
    
    20,765Obligations of Varistar Corporation:8.15% five-year term note, due October 31, 2005
    
    
    540
    
    
    
    1,9577.80% ten-year term note, due October 31, 2007
    
    
    1,483
    
    
    
    3,960Various up to 11.83% at December 31, 2004
    
    
    11,235
    
    
    
    7,678Total
    
    
    268,549
    
    
    
    271,245Less:Current maturities
    
    
    6,055
    
    
    
    8,598Unamortized debt discount
    
    
    684
    
    
    
    284Total long-term debt
    
    
    261,810
    
    
    
    262,363Class B stock options of subsidiary
    
    
    1,832
    
    
    
    Cumulative preferred shareswithout par value (stated and
liquidating value $100 a share)authorized 1,500,000 shares;
Series outstanding: (a)$3.60, 60,000 shares
    
    
    6,000
    
    
    
    6,000$4.40, 25,000 shares
    
    
    2,500
    
    
    
    2,500$4.65, 30,000 shares
    
    
    3,000
    
    
    
    3,000$6.75, 40,000 shares
    
    
    4,000
    
    
    
    4,000Total preferred
    
    
    15,500
    
    
    
    15,500Cumulative preference shareswithout par value, authorized 1,000,000 shares; outstanding: noneTotal common shareholders equity
    
    
    429,210
    
    
    
    333,887Total capitalization
    
    $
    708,352
    
    
    $
    611,750
    Series
    
    Call price$3.60
    
    $
    102.254.40
    
    
    102.004.65
    
    
    101.506.75
    
    
    103.0375
 See accompanying notes to consolidated financial statements.




---



##### 



OTTER TAIL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002  1.
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES
OF CONSOLIDATION
The consolidated financial statements of Otter Tail Corporation and its wholly owned
subsidiaries (the Company) include the accounts of the following segments: electric, plastics,
manufacturing, health services and other business operations. The electric segment is regulated
while the other segments are not. See note 2 to the consolidated financial statements for
further descriptions of the Companys business segments. All significant intercompany balances
and transactions have been eliminated in consolidation except profits on sales to the regulated
electric utility company from nonregulated affiliates, which is in accordance with the
requirements of Statement of Financial Accounting Standards (SFAS) No. 71, Accounting for the
Effects of Certain Types of Regulation. These amounts are not material. REGULATION
AND STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 71
As a regulated entity, the Company and the electric utility account for the financial effects of
regulation in accordance with SFAS No. 71. This statement allows for the recording of a
regulatory asset or liability for costs that will be collected or refunded through the
ratemaking process in the future. In accordance with regulatory treatment, the Company defers
utility debt redemption premiums and amortizes such costs over the original life of the
reacquired bonds. See note 4 for further discussion. The Companys regulated business is subject to various state and federal agency regulations. The
accounting policies followed by this business are subject to the Uniform System of Accounts of
the Federal Energy Regulatory Commission (FERC). These accounting policies differ in some
respects from those used by the Companys nonelectric businesses. PLANT,
RETIREMENTS AND DEPRECIATION

Utility plant is stated at original cost. The cost of additions includes contracted work, direct
labor and materials, allocable overheads and allowance for funds used during construction (AFC).
AFC, a noncash item, is included in utility construction work in progress. The amount of AFC
capitalized was $949,000 for 2004, $1,970,000 for 2003 and $2,636,000 for 2002. The cost of
depreciable units of property retired less salvage is charged to accumulated depreciation.
Removal costs, when incurred, are charged against the accumulated reserve for estimated removal
costs, a regulatory liability. Maintenance, repairs and replacement of minor items of property
are charged to operating expenses. The provisions for utility depreciation for financial
reporting purposes are made on the straight-line method based on the estimated service lives of
the properties. Such provisions as a percent of the average balance of depreciable electric
utility property were 2.77% in 2004, 3.07% in 2003 and 3.08% in 2002. Gains or losses on asset
dispositions are taken to the accumulated provision for depreciation reserve and impact current
and future depreciation rates. Property and equipment of nonelectric operations are carried at historical cost or at the
then-current appraised value if acquired in a business combination accounted for under the
purchase method of accounting, and are depreciated on a straight-line basis over the assets
estimated useful lives (3 to 40 years). Maintenance and repairs are expensed as incurred. Gains
or losses on asset dispositions are included in the determination of operating income.




---



##### 



JOINTLY
OWNED PLANTS

The consolidated financial statements include the Companys 53.9% (Big Stone Plant) and 35%
(Coyote Station) ownership interests in the assets, liabilities, revenue and expenses of Big
Stone Plant and Coyote Station. Amounts at December 31, 2004 and 2003 included in the
consolidated balance sheet are as follows: Big Stone
    
    
    Coyote(in thousands)
    
    Plant
    
    
    StationDecember 31, 2004Electric plant in service
    
    $
    116,405
    
    
    $
    146,343Accumulated depreciation
    
    
    (70,904
    )
    
    
    (75,431
    )Net plant
    
    $
    45,501
    
    
    $
    70,912December 31, 2003Electric plant in service
    
    $
    116,240
    
    
    $
    146,431Accumulated depreciation
    
    
    (68,387
    )
    
    
    (72,946
    )Net plant
    
    $
    47,853
    
    
    $
    73,485
 The Companys share of direct revenue and expenses of the jointly owned plants is included in
operating revenue and expenses in the consolidated statements of income. RECOVERABILITY
OF LONG-LIVED ASSETS

The Company reviews its long-lived assets whenever events or changes in circumstances indicate
the carrying amount of the assets may not be recoverable. The Company determines potential
impairment by comparing the carrying value of the assets with net cash flows expected to be
provided by operating activities of the business or related assets. Should the sum of the
expected future net cash flows be less than the carrying values, the Company would determine
whether an impairment loss should be recognized. An impairment loss would be quantified by
comparing the amount by which the carrying value exceeds the fair value of the asset where fair
value is based on the discounted cash flows expected to be generated by the asset. INCOME
TAXES

Comprehensive interperiod income tax allocation is used for substantially all book and tax
temporary differences. Deferred income taxes arise for all temporary differences between the
book and tax basis of assets and liabilities. Deferred taxes are recorded using the tax rates
scheduled by tax law to be in effect when the temporary differences reverse. The Company
amortizes the investment tax credit over the estimated lives of the related property. REVENUE
RECOGNITION

Due to the diverse business operations of the Company, revenue recognition depends on the
product produced and sold. The Company recognizes revenue when the earnings process is complete,
evidenced by an agreement with the customer, there has been delivery and acceptance, and the
price is fixed or determinable. In cases where significant obligations remain after delivery,
revenue is deferred until such obligations are fulfilled. Provisions for sales returns and
warranty costs are recorded at the time of the sale based on historical information and current
trends. In the case of derivative instruments, such as the electric utilitys forward energy
contracts and the natural gas marketing companys swap transactions, marked-to-market and
realized gains and losses are recognized on a net basis in revenue in accordance with SFAS No.
133 and Emerging Issues Task Force (EITF) Issues 02-3 and 03-11. Gains and losses on forward
energy contracts subject to regulatory treatment are deferred and recognized on a net basis in
revenue in the period realized. For those operating businesses recognizing revenue when shipped, the operating businesses have
no further obligation to provide services related to such
product. The shipping terms used in these instances are FOB shipping point. Electric customers meters are read and bills are rendered monthly. Revenue is accrued for
electricity consumed but not yet billed. Rate schedules applicable to substantially all
customers include a cost-of-energy adjustment clauseunder which the rates are adjusted to
reflect changes in average cost of fuels and




---



##### 



purchased powerand a surcharge for recovery of
conservation-related expenses. Revenue is accrued for fuel and purchased power costs incurred in
excess of amounts recovered in base rates but not yet billed through the cost-of-energy
adjustment clause. Revenues on wholesale electricity sales from Company-owned generating units are recognized when
energy is delivered. The Companys unrealized gains and losses on forward energy contracts that do not meet the
definition of capacity contracts are marked-to-market and reflected on a net basis in electric
revenue on the Companys consolidated statement of income. Under SFAS No. 149, the Companys
forward energy contracts that do not meet the definition of a capacity contract and are
subject to unplanned netting do not qualify for the normal purchase and sales exception from
mark-to-market accounting. The Company is required to mark-to-market these forward energy
contracts and recognize changes in the fair value of these contracts as components of income
over the life of the contracts. Plastics operating revenues are recorded when the product is shipped. Health services operating revenues on major equipment and installation contracts are recorded
when the equipment is delivered or when installation is completed and accepted. Amounts received
in advance under customer service contracts are deferred and recognized on a straight-line basis
over the contract period. Revenues generated in the imaging operations are recorded on a
fee-per-scan basis when the scan is performed. Manufacturing operating revenues are recorded when products are shipped and on a
percentage-of-completion basis for construction type contracts. Other business operations operating revenues are recorded when services are rendered or
products are shipped. In the case of construction contracts, the percentage-of-completion method is
used. Some of the operating businesses enter into fixed-price construction contracts. Revenues under
these contracts are recognized on a percentage-of-completion basis. The method used to determine
the progress of completion is based on the ratio of costs incurred to total estimated costs. If
a loss is indicated at a point in time during a contract, a projected loss for the entire
contract is estimated and recognized. The following table summarizes costs incurred and billings
and estimated earnings recognized on uncompleted contracts: December 31,
    
    
    December 31,(in thousands)
    
    2004
    
    
    2003Costs incurred on uncompleted contracts
    
    $
    109,906
    
    
    $
    124,839Less billings to date
    
    
    (105,974
    )
    
    
    (137,881
    )Plus estimated earnings recognized
    
    
    13,172
    
    
    
    13,611$
    17,104
    
    
    $
    569
 The following costs and estimated earnings in excess of billings are included in the Companys
consolidated balance sheet. Billings in excess of
costs and estimated earnings on uncompleted contracts are included in accounts payable. December 31,
    
    
    December 31,(in thousands)
    
    2004
    
    
    2003Costs and estimated earnings in excess of billings on uncompleted contracts
    
    $
    20,398
    
    
    $
    4,591Billings in excess of costs and estimated earnings on uncompleted contracts
    
    
    (3,294
    )
    
    
    (4,022
    )$
    17,104
    
    
    $
    569
 FOREIGN
CURRENCY TRANSLATION

The functional currency for the operations of the Canadian subsidiary of Idaho Pacific Holdings,
Inc. (IPH), acquired in August 2004, is the Canadian dollar. The translation of Canadian
currency into U.S. dollars is performed for balance sheet accounts using exchange rates in
effect at the balance sheet dates, except for the common equity accounts, and for revenue and
expense accounts using a weighted average exchange during the year. Gains or losses resulting
from the




---



##### 



translation are included in Accumulated other comprehensive lossin the equity section
of the Companys consolidated balance sheet. All sales of the Canadian operations are in U.S.
dollars so there are no foreign currency transaction gains or losses on receivables to be
reported in the Companys consolidated statements of income. PRE-PRODUCTION
COSTS

The Company incurs costs related to the design and development of molds, dies and tools as part
of the manufacturing process. The Company accounts for these costs under EITF Issue 99-5,
Accounting for Pre-production Costs Related to Long-Term Supply Arrangements. The Company
capitalizes the costs related to the design and development of molds, dies and tools used to
produce products under a long-term supply arrangement, some of which are owned by the Company.
The balance of pre-production costs deferred on the balance sheet was $1,632,000 as of December
31, 2004 and $1,489,000 as of December 31, 2003. These costs are amortized over a three-year
period and evaluated annually for impairment. SHIPPING
AND HANDLING COSTS

The Company includes revenues received for shipping and handling in operating revenues. Expenses
paid for shipping and handling are recorded as part of cost of goods sold. STOCK-BASED
COMPENSATION

As described in note 6, the Company has elected to follow the accounting provisions of
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, for
stock-based compensation and to furnish the pro forma disclosures required under SFAS No. 123,
Accounting for Stock-Based Compensation. Had compensation costs for the stock options issued been determined based on estimated fair
value at the award dates, as prescribed by SFAS No. 123, the Companys net income for 2002
through 2004 would have decreased as presented in the table below. This may not be
representative of the pro forma effects for future years if additional options are granted. (in thousands, except per share amounts)
    
    2004
    
    
    2003
    
    
    2002Net incomeAs reported
    
    $
    42,195
    
    
    $
    39,656
    
    
    $
    46,128Total stock-based employee compensation
expense determined under fair value-based
method for all awards net of related
tax effects
    
    
    (1,087
    )
    
    
    (984
    )
    
    
    (1,038
    )Pro forma
    
    $
    41,108
    
    
    $
    38,672
    
    
    $
    45,090Basic earnings per shareAs reported
    
    $
    1.59
    
    
    $
    1.52
    
    
    $
    1.80Pro forma
    
    $
    1.55
    
    
    $
    1.48
    
    
    $
    1.76Diluted earnings per shareAs reported
    
    $
    1.58
    
    
    $
    1.51
    
    
    $
    1.79Pro forma
    
    $
    1.54
    
    
    $
    1.47
    
    
    $
    1.75
 USE OF
ESTIMATES

The Company uses estimates based on the best information available in recording transactions and
balances resulting from business operations. Estimates are used for such items as depreciable
lives, asset impairment evaluations, tax provisions, collectability of trade accounts
receivable, self-insurance programs, unbilled electric revenues, valuations of forward energy
contracts, unscheduled power exchanges, service contract maintenance costs,
percentage-of-completion and actuarially determined benefit costs. As better information becomes
available (or actual amounts are known), the recorded estimates are revised. Consequently,
operating results can be affected by revisions to prior accounting estimates. RECLASSIFICATIONS

Certain prior year amounts have been reclassified to conform to 2004 presentation. Such
reclassifications had no impact on net income, shareholders equity or cash flows provided from
operations. CASH
EQUIVALENTS

The Company considers all highly liquid debt instruments purchased with maturity of 90 days or
less to be cash equivalents.




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##### 



INVESTMENTS

The following table provides a breakdown of the Companys investments at December 31, 2004 and
2003: December 31,
    
    
    December 31,(in thousands)
    
    2004
    
    
    2003Cost method:Acquisition escrow account
    
    $
    6,017
    
    
    $
    Economic development loan pools
    
    
    879
    
    
    
    811Other
    
    
    1,743
    
    
    
    1,518Equity method:Affordable housing partnerships
    
    
    3,802
    
    
    
    4,616Other
    
    
    
    
    
    
    1,662Marketable securities classified as available-for-sale
    
    
    2,009
    
    
    
    Total investments
    
    $
    14,450
    
    
    $
    8,607
 The Companys investments in limited partnerships that invest in tax-credit-qualifying
affordable-housing projects provided tax credits of $1,418,000 in 2004, $1,412,000 in 2003 and
$1,418,000 in 2002. The reduction in other equity investments relates to the sale of the
Companys investment in Fargo Baseball, LLC. The Companys marketable securities classified as
available-for-sale are held for insurance reserve purposes and are reflected at their market
values on December 31, 2004, with $14,000 in unrealized losses included in other comprehensive
losses in the equity section of the Companys December 31, 2004 consolidated balance sheet. See
further discussion under note 12. INVENTORIES

The electric segment inventories are reported at average cost. All other segments inventories
are stated at the lower of cost (first-in, first-out) or market. Inventories consist of the following: December 31,
    
    
    December 31,(in thousands)
    
    2004
    
    
    2003Finished goods
    
    $
    36,639
    
    
    $
    20,349Work in process
    
    
    4,531
    
    
    
    6,234Raw material, fuel and supplies
    
    

    36,126
    
    
    
    30,332Total inventories
    
    $
    77,296
    
    
    $
    56,915
 GOODWILL
AND INTANGIBLE ASSETS

The Company accounts for goodwill and other intangible assets in accordance with the requirements
of SFAS No. 142, Goodwill and Other Intangible Assets,which eliminates the requirement to
amortize goodwill and indefinite-lived intangible assets, requiring instead those assets be
measured for impairment at least annually and more often when events indicate an impairment
could exist. Intangible assets with finite lives are amortized over their estimated useful lives
and reviewed for impairment in accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets.




---



##### 



The changes in the carrying amount of goodwill by segment are as follows: Adjustment toBalance
    
    
    goodwill
    
    
    Goodwill
    
    
    BalanceDecember 31,
    
    
    acquired in
    
    
    acquired
    
    
    December 31,(in thousands)
    
    2003
    
    
    2003
    
    
    in 2004
    
    
    2004Plastics
    
    $
    19,302
    
    
    $
    
    
    
    $
    
    
    
    $
    19,302Manufacturing
    
    
    8,232
    
    
    
    1,448
    
    
    
    
    
    
    
    9,680Health services
    
    
    24,333
    
    
    
    249
    
    
    
    
    
    
    
    24,582Other business operations
    
    
    14,764
    
    
    
    617
    
    
    
    23,251
    
    
    
    38,632Total
    
    $
    66,631
    
    
    $
    2,314
    
    
    $
    23,251
    
    
    $
    92,196
 Intangible assets with finite lives are being amortized over average lives that vary from one
to 25 years. The amortization expense for these intangible assets was $905,000 for 2004, $630,000
for 2003 and $535,000 for 2002. The estimated annual amortization expense for these intangible
assets for the next five years is: $947,000 for 2005, $815,000 for 2006, $693,000 for 2007,
$642,000 for 2008 and $518,000 for 2009. Total other intangibles as of December 31 are as follows: Gross carrying
    
    
    Accumulated
    
    
    Net carrying2004 (in thousands)
    
    amount
    
    
    amortization
    
    
    amountAmortized intangible assets:Covenants not to compete
    
    $
    2,609
    
    
    $
    1,925
    
    
    $
    684Customer relationships
    
    
    10,045
    
    
    
    148
    
    
    
    9,897Other intangible assets including contracts
    
    
    2,599
    
    
    
    1,423
    
    
    
    1,176Total
    
    $
    15,253
    
    
    $
    3,496
    
    
    $
    11,757Nonamortized intangible assets:Brand/trade name
    
    $
    7,935
    
    
    $
    
    
    
    $
    7,9352003 (in thousands)Amortized intangible assets:Covenants not to compete
    
    $
    2,610
    
    
    $
    1,483
    
    
    $
    1,127Other intangible assets including contracts
    
    
    2,367
    
    
    
    1,118
    
    
    
    1,249Total
    
    $
    4,977
    
    
    $
    2,601
    
    
    $
    2,376Nonamortized intangible assets:Brand/trade name
    
    $
    4,720
    
    
    $
    
    
    
    $
    4,720
 The Company periodically evaluates the recovery of intangible assets based on an analysis of
undiscounted future cash flows. Evaluations of intangible assets including goodwill completed in
January 2005 indicated none of the intangible assets reported on the Companys consolidated balance
sheet as of December 31, 2004 is impaired. NEW
ACCOUNTING PRONOUNCEMENTSFASB Interpretation (FIN) No. 46 (revised December 2003), Consolidation of Variable Interest
Entitiesis an interpretation of Accounting Research Bulletin No. 51, that addresses consolidation
by business enterprises of variable interest entities which have certain characteristics related to
equity at risk and rights and obligations to profits and losses. The effective date for application
of certain provisions of FIN 46 was the first quarter of 2004 for interests in variable interest
entities created before February 1, 2003 and held by a public entity that has not previously
applied the provisions of FIN 46. The Company has determined that it does not have any arrangements
with unconsolidated entities under FIN 46 except for majority interests in eight limited
partnerships that invest in tax-credit-qualifying, affordable-housing projects. The net investment
in these entities, which are currently accounted for on an equity method basis, totaled $2.7
million as of December 31, 2004. Full consolidation of these entities would not have a material
effect on the Companys consolidated financial




---



##### 



statements and would have no effect on its
consolidated net income. The Company includes these entities in its consolidated financial
statements on an equity method basis due to immateriality. Consolidating these entities would have
represented less than 0.5% of total assets of the Company. FASB Staff Position No. FAS 106-2 (FSP 106-2),Accounting and Disclosure Requirements Related
to the Medicare Prescription Drug, Improvement and Modernization Act of 2003(the Act)  FSP 106-2
provides guidance on accounting for the effect of the federal subsidy for prescription drug plans
when the plans sponsor determines that the prescription drug benefits it offers to its retirees
are actuarially equivalent to those offered under Medicare Part D and will qualify for the federal
subsidy offered under the Act. The provisions of the Act provide for a federal subsidy for plans
that provide prescription drug benefits and meet certain qualifications, and alternatively would
allow prescription drug plan sponsors to coordinate with the Medicare benefit. The Company elected
the one-time deferral of accounting for the effects of the Act in the quarter ended March 31, 2004,
the first
period in which accounting for the effects of the Act normally would have been reflected in
the Companys consolidated financial statements. The Companys postretirement medical plan provides prescription drug coverage for all electric
utility company retirees. The Company has determined that the prescription drug benefits it offers
to its retirees who retired prior to 2003 are actuarially equivalent to those offered under
Medicare Part D and will qualify for the federal subsidy offered under the Act. The Company expects
that its share of the cost of the underlying postretirement prescription drug coverage on which the
subsidy is based will be reduced by the expected subsidy. During the third quarter of 2004, the Company adopted FSP 106-2 retroactive to the beginning
of the year. The Company and its actuarial advisors determined that the expected federal subsidy
reduced the Companys accumulated postretirement benefit obligation (APBO) at January 1, 2004 by
approximately $4.9 million and reduced its net periodic benefit cost for 2004 by $757,000 of which
approximately 13.1% was credited to capital additions as a reduction of capitalized labor. The APBO
reduction will be accounted for as an actuarial experience gain in accordance with the guidance in
FAS 106 and was not included as a reduction to the net periodic benefit cost in 2004. The adoption
of FSP 106-2 had the effect of reducing 2004 operating expenses by $658,000. Retroactive
application resulted in the restatement of first and second quarter 2004 operating expenses and net
income, reducing operating expenses and increasing net income by $164,000 in each quarter. In
accordance with the provisions of the Act, the expected subsidy will have no effect on income tax
expense. SFAS No. 151,Inventory Costs an amendment of ARB No. 43, Chapter 4,was issued in November
2004 to clarify that abnormal amounts of idle facility expense, freight, handling costs and wasted
materials (spoilage) should be recognized as current-period charges. This statement also requires
that allocation of fixed production overheads to the costs of converting materials into finished
products be based on the normal capacity of the production facilities. The
provisions of this statement are effective for inventory costs incurred during fiscal years
beginning after June 15, 2005 with earlier application permitted. The Company does not expect the
application of the requirements of SFAS No. 151 to have an effect on the Companys consolidated net
income, financial position or cash flows. SFAS No. 123(R) (revised 2004),Share-Based Payment,issued in December 2004 is a revision of
SFAS No. 123, Accounting for Stock-based Compensation, and supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees. The Company currently reports its stock-based
compensation under the requirements of APB Opinion No. 25 and furnishes related pro forma footnote
information required under SFAS No. 123. Under SFAS No. 123(R), the Company will be required to
record its stock-based compensation as an expense on its income statement over the period earned
based on the fair value of the stock or options awarded on their grant date. SFAS No.123(R) becomes
effective in July 2005 with early adoption allowed and, when adopted, can be applied under a
modified prospective basis or on a modified retrospective basis back to January 1, 2005. The
Company will adopt SFAS No. 123(R) in July 2005 but has not determined whether it will apply the
requirements prospectively or retrospectively. In either event, the Company has determined that the
application of SFAS No. 123(R) reporting requirements will have the effect of reducing its 2005 net
income by $300,000 to $600,000.




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##### 



2.
    BUSINESS COMBINATIONS, DISPOSITIONS AND SEGMENT INFORMATION On August 18, 2004 the Company acquired all of the outstanding common stock of Idaho Pacific
Holdings, Inc., (IPH) of Ririe, Idaho, a leading processor of dehydrated potato products in North
America, for approximately $69.0 million in cash. An additional $6.0 million in cash was placed in
escrow to pay off earn-out contingencies if IPH achieves certain financial targets for the period
from August 1, 2004 through July 31, 2005. See notes 6 and 9 for information related to the
financing of this acquisition. The results of operations of IPH have been
included in the Companys consolidated results of operations since the date of acquisition.
Pro forma results have not been presented for the acquisition since the effect of the acquisition
on 2004 and previous years revenues, net income or earnings per share was not significant. This
acquisition adds a new platform to the Companys diversified portfolio of businesses. IPH is
headquartered in Ririe, Idaho, where its largest processing facility is located. It also has potato
dehydration plants in Souris, Prince Edward Island, Canada, and Center, Colorado. IPH supplies
products for use in foods such as mashed potatoes, snacks and baked goods. Its customers include
many of the largest domestic and international food manufacturers in the snack food, foodservice
and baking industries. IPH exports potato products to Europe, the Middle East, the Pacific Rim and
Central America. IPH had revenues of $43.5 million for its fiscal year ended July, 31, 2004. For
2004 IPH was included in the other business operations segment. The Company expects that for 2005
IPH will be a separate segment. Below is a condensed balance sheet at the date of the business combination disclosing the
preliminary allocation of the purchase price assigned to each major asset and liability category
for IPH. (in thousands)AssetsCurrent assets
    
    $
    17,766Plant
    
    
    35,296Goodwill
    
    
    23,087Other intangible assets
    
    
    13,200Total assets
    
    $
    89,349Liabilities and equityCurrent liabilities
    
    $
    5,485Deferred income taxes
    
    
    12,408Long-term debt
    
    
    1,987Class B common stock options
    
    
    1,832Equity
    
    
    67,637Total liabilities and equity
    
    $
    89,349
 The above allocations are preliminary, subject to adjustment. Goodwill and other intangible
assets related to the IPH acquisition are not deductible for income tax purposes. Other intangible
assets related to the IPH
acquisition include $10.0 million for customer relationships being amortized over 25 years and
a $3.2 million nonamortizable trade name. On November 1, 2003 the Company acquired the assets and operations of Foley Company (Foley)
for $12.3 million in cash. Foley is a mechanical and prime contracting firm based in Kansas City,
Missouri, that provides a range of specialty contracting including design-and-build services for
new construction, retrofitting, process piping, equipment settings, and instrumentation and control
systems. Major clients include water and wastewater treatment plants, hospital and pharmaceutical
facilities, power generation plants, and other industrial and manufacturing projects across a
multi-state service area. Foley Company had gross revenues of $44.8 million in 2002. This
acquisition expanded the Companys construction services to a broader geographic region. Foley is
included in the other business operations segment. In 2003, the Company also acquired Topline Medical, Inc., and North Star Medical Systems, Inc.
The aggregate price paid for the companies in 2003 was $1.9 million in cash. These acquisitions
allowed the health services segment to increase sales opportunities with an expanded line of
products.




---



##### 



Below is a condensed balance sheet disclosing the allocation of the purchase price assigned to each
major asset and liability category for the companies acquired in 2003. (in thousands)
    
    Foley
    
    
    OthersAssetsCurrent assets
    
    $
    9,847
    
    
    $
    675Plant
    
    
    3,793
    
    
    
    45Goodwill
    
    
    7,319
    
    
    
    1,924Other intangible assets
    
    
    1,653
    
    
    
    102Total assets
    
    $
    22,612
    
    
    $
    2,746Liabilities
and equityCurrent liabilities
    
    $
    8,618
    
    
    $
    669Long-term debt
    
    
    
    
    
    
    136Other long-term liabilities
    
    
    1,712
    
    
    
    Equity
    
    
    12,282
    
    
    
    1,941Total liabilities and equity
    
    $
    22,612
    
    
    $
    2,746
 Goodwill related to the Foley acquisition is not deductible for income tax purposes. The
goodwill related to the other acquisitions is deductible for income tax purposes over 15 years.
Other intangible assets related to the Foley acquisition include a $1.1 million nonamortizable
trade name and $553,000 in intangible assets being amortized over five years. Other intangible
assets related to the other acquisitions are being amortized over four years. On May 1, 2002 the Company acquired 100% of the outstanding stock of Computed Imaging Service,
Inc. (CIS), of Houston, Texas, for 158,257 shares of Otter Tail Corporation common stock and
approximately $1.2 million in cash. CIS provides computed tomography and magnetic resonance imaging
mobile services, interim rental, and sales and service of new, used and refurbished diagnostic
imaging equipment. CIS serves hospitals and other healthcare facilities in the south-central United
States. The acquisition of CIS allowed the Company to expand its existing health services
operations into another region of the country. CIS annual revenues were approximately $5.9 million
in 2001. On May 28, 2002 the Company acquired 100% of the outstanding stock
of ShoreMaster, Inc. (ShoreMaster), of Fergus Falls, Minnesota, for 303,124 shares of Otter
Tail Corporation common stock and $2.3 million in cash. ShoreMaster is a leading manufacturer of
waterfront equipment ranging from residential-use boatlifts and docks to commercial marina systems.
The acquisition of ShoreMaster provides diversification and growth opportunities for the Companys
manufacturing segment. ShoreMasters annual revenues were approximately $20 million in 2001. On October 1, 2002 the Company acquired 100% of the outstanding stock of Galva Foam Marine
Industries, Inc. (Galva Foam), of Camdenton, Missouri, for 256,940 shares of Otter Tail Corporation
common stock and approximately $1.0 million in cash. Galva Foam is a leading manufacturer of
waterfront equipment ranging from residential boatlifts and docks to commercial marina systems. The
acquisition of Galva Foam in combination with the May 2002 acquisition of ShoreMaster expands the
market reach of the Companys waterfront manufacturing product line nationwide with both saltwater
and freshwater products. Galva Foam had annual revenues of approximately $13 million in 2001. In 2002, the
Company also acquired two other businesses - one in energy management services
and the other in health services. The total purchase price for these businesses was approximately
$2 million in cash.




---



##### 



Below is a condensed balance sheet disclosing the fair value assigned to each major asset and
liability category for the companies acquired in 2002. (in thousands)
    
    CIS
    
    
    ShoreMaster
    
    
    Galva Foam
    
    
    OthersAssetsCurrent assets
    
    $
    1,439
    
    
    $
    9,510
    
    
    $
    4,953
    
    
    $
    131Plant
    
    
    3,975
    
    
    
    4,599
    
    
    
    1,713
    
    
    
    298Goodwill
    
    
    5,847
    
    
    
    4,292
    
    
    
    2,650
    
    
    
    1,616Other intangible assets
    
    
    30
    
    
    
    4,461
    
    
    
    41
    
    
    
    60Total assets
    
    $
    11,291
    
    
    $
    22,862
    
    
    $
    9,357
    
    
    $
    2,105Liabilities
and equityCurrent liabilities
    
    $
    1,747
    
    
    $
    9,642
    
    
    $
    2,304
    
    
    $
    32Long-term debt
    
    
    2,584
    
    
    
    2,723
    
    
    
    
    
    
    
    Other long-term liabilities
    
    
    707
    
    
    
    797
    
    
    
    372
    
    
    
    Equity
    
    
    6,253
    
    
    
    9,700
    
    
    
    6,681
    
    
    

    2,073Total liabilities and equity
    
    $
    11,291
    
    
    $
    22,862
    
    
    $
    9,357
    
    
    $
    2,105
 All of the acquisitions were accounted for using the purchase method of accounting. The pro
forma effect of these acquisitions on 2003 and 2002 revenues, net income or earnings per share was
not significant. SEGMENT
INFORMATION
The accounting policies of the segments are described under note 1  Summary of Significant
Accounting Policies. The Companys businesses have been classified into five segments based on
products and services and reach customers in all 50 states and international markets. The five
segments are: Electric, Plastics, Manufacturing, Health Services and Other Business
Operations. Electric includes the production, transmission, distribution and sale of electric energy in
Minnesota, North Dakota and South Dakota under the name Otter Tail Power Company. Electric
utility operations have been the Companys primary business since incorporation. Plastics consists of businesses producing polyvinyl chloride and polyethylene pipe in the Upper
Midwest and Southwest regions of the United States. Manufacturing consists of businesses in the following manufacturing activities: production of
waterfront equipment, wind towers, frame-straightening equipment and accessories for the auto
body shop industry, material and handling trays and horticultural containers, fabrication of
steel products, contract machining, and metal parts stamping and fabrication. These businesses
are located primarily in the Upper Midwest, Missouri and Utah. Health Services consists of businesses involved in the sale of diagnostic medical equipment,
patient monitoring equipment and related supplies and accessories. These businesses also
provide service maintenance, diagnostic imaging, positron emission tomography and nuclear
medicine imaging, portable X-ray imaging and rental of diagnostic medical imaging equipment to
various medical institutions located throughout the United States. Other Business Operations consists of businesses involved in food ingredient processing;
residential, commercial and industrial electric contracting industries; fiber optic and
electric distribution systems; waste-water, water and HVAC systems construction;
transportation; energy services and natural gas marketing and the
portion of corporate general and administrative expenses that are not allocated to other segments.
These businesses operate primarily in the Central United States, except for the transportation
company which operates in 48 states and six Canadian provinces and the food ingredient processing
business that has sales to the United States, Canada, Europe, the Middle East, the Pacific Rim and
Central America. The Companys electric operations, including wholesale power sales, are operated as a division of
Otter Tail Corporation, and the Companys energy services and natural gas marketing operations
are operated as a subsidiary of Otter Tail Corporation. Substantially all of the other
businesses are owned by a wholly owned subsidiary of the Company.




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##### 



The Company evaluates the performance of its business segments and allocates resources
to them based on earnings contribution and return on total invested capital. Information on
continuing operations for the business segments for 2004, 2003 and 2002 is presented in the
following table. (in thousands)
    
    2004
    
    
    2003
    
    
    2002Operating revenueElectric
    
    $
    266,385
    
    
    $
    267,494
    
    
    $
    244,005Plastics
    
    
    115,426
    
    
    
    86,009
    
    
    
    82,931Manufacturing
    
    
    226,577
    
    
    
    177,805
    
    
    
    142,390Health services
    
    
    114,318
    
    
    
    100,912
    
    
    
    93,420Other business operations
    
    
    162,351
    
    
    
    114,726
    
    
    
    75,947Intersegment eliminations
    
    
    (2,733
    )
    
    
    (2,254
    )
    
    
    (1,036
    )Total
    
    $
    882,324
    
    
    $
    744,692
    
    
    $
    637,657Depreciation and amortizationElectric
    
    $
    24,236
    
    
    $
    26,008
    
    
    $
    24,910Plastics
    
    
    2,297
    
    
    
    2,126
    
    
    
    1,760Manufacturing
    
    
    8,701
    
    
    
    7,708
    
    
    
    6,525Health services
    
    
    5,047
    
    
    
    5,137
    
    
    
    4,410Other business operations
    
    
    4,063
    
    
    
    2,841
    
    
    
    2,921Total
    
    $
    44,344
    
    
    $
    43,820
    
    
    $
    40,526Income before income taxesElectric
    
    $
    45,234
    
    
    $
    48,689
    
    
    $
    45,643Plastics
    
    
    9,453
    
    
    
    3,341
    
    
    
    9,478Manufacturing
    
    
    11,448
    
    
    
    5,695
    
    
    
    7,510Health services
    
    
    5,075
    
    
    
    4,197
    
    
    
    7,691Other business operations
    
    
    (14,226
    )
    
    
    (10,745
    )
    
    
    (7,391
    )Total
    
    $
    56,984
    
    
    $
    51,177
    
    
    $
    62,931Earnings available for common sharesElectric
    
    $
    30,799
    
    
    $
    33,411
    
    
    $
    31,244Plastics
    
    
    5,657
    
    
    
    2,019
    
    
    
    5,668Manufacturing
    
    
    6,911
    
    
    
    3,885
    
    
    
    4,524Health services
    
    
    2,951
    
    
    
    2,464
    
    
    
    4,555Other business operations
    
    
    (7,074
    )
    
    
    (4,900
    )
    
    
    (2,551
    )Total
    
    $
    39,244
    
    
    $
    36,879
    
    
    $
    43,440Capital expendituresElectric
    
    $
    25,368
    
    
    $
    28,177
    
    
    $
    45,842Plastics
    
    
    2,544
    
    
    
    3,984
    
    
    
    5,592Manufacturing
    
    
    13,471
    
    
    
    9,903
    
    
    
    15,049Health services
    
    
    3,919
    
    
    
    5,427
    
    
    
    3,874Other business operations
    
    
    4,490
    
    
    
    1,603
    
    
    
    3,717Total
    
    $
    49,792
    
    
    $
    49,094
    
    
    $
    74,074Identifiable assetsElectric
    
    $
    634,433
    
    
    $
    609,190
    
    
    $
    586,231Plastics
    
    
    67,574
    
    
    
    58,538
    
    
    
    54,926Manufacturing
    
    
    165,307
    
    
    
    138,493
    
    
    
    114,120Health services
    
    
    66,506
    
    
    
    67,587
    
    
    
    64,785Other business operations
    
    
    183,898
    
    
    
    95,350
    
    
    
    76,334Discontinued operations
    
    
    16,430
    
    
    
    17,265
    
    
    
    17,716Total
    
    $
    1,134,148
    
    
    $
    986,423
    
    
    $
    914,112
 No single external customer accounts for 10% or more of the Companys revenues.
Substantially all of the Companys long-lived assets are within the United States except for a
food ingredient processing dehydration plant in Souris, Prince Edward Island, Canada. For the
year ended December 31, 2004, 97.1% of the Companys consolidated revenue came from sales within
the United States and 2.0% came from sales in Canada, with the remaining 0.9% coming from
various foreign countries in Europe, the Middle East, the Pacific Rim and Asia. For the year
ended December 31, 2003, substantially all of the Companys consolidated revenue came from sales
within the United States.




---



##### 



3.
    RATE MATTERS On December 29, 2000 the North Dakota Public Service Commission (NDPSC) approved a
performance-based ratemaking plan that links allowed earnings in North Dakota to seven defined
performance standards in the areas of price, electric service reliability, customer
satisfaction and employee safety. The plan is in place through 2005, unless suspended or
terminated by the NDPSC or the Company. This plan provides the opportunity for the electric
utility to raise its allowed rate of return and share income with customers when earnings
exceed the allowed return. Because the electric utilitys 2002 and 2003 rates of return were
within the allowable range defined in the plan, no sharing occurred in 2003 or 2004. The
electric utilitys 2004 rate of return is expected to be within the allowable range defined in
the plan.  4.
    REGULATORY ASSETS AND LIABILITIES The following table indicates the amount of regulatory assets and liabilities recorded on the
Companys consolidated balance sheets: December 31,
    
    
    December 31,(in thousands)
    
    2004
    
    
    2003Regulatory assets:Deferred income taxes
    
    $
    14,526
    
    
    $
    12,750Debt expenses and reacquisition premiums
    
    
    3,424
    
    
    
    3,863Deferred conservation program costs
    
    
    1,203
    
    
    
    882Plant acquisition costs
    
    
    240
    
    
    
    285Deferred marked-to-market losses
    
    
    331
    
    
    
    1,802Accrued cost-of-energy revenue
    
    
    3,348
    
    
    
    3,693Accumulated ARO accretion/depreciation adjustment
    
    
    114
    
    
    
    117Total regulatory assets
    
    $
    23,186
    
    
    $
    23,392Regulatory liabilities:Accumulated reserve for estimated removal costs
    
    $
    49,823
    
    
    $
    33,579Deferred income taxes
    
    
    6,727
    
    
    
    7,496Deferred marked-to-market gains
    
    
    197
    
    
    
    1,684Gain on sale of division office building
    
    
    162
    
    
    
    167Total regulatory liabilities
    
    $
    56,909
    
    
    $
    42,926Net regulatory liability position
    
    $
    33,723
    
    
    $
    19,534
 The regulatory assets and liabilities related to deferred income taxes are the result of the
adoption of SFAS No. 109, Accounting for Income Taxes. Debt expenses and reacquisition premiums
are being recovered from electric utility customers over the remaining original lives of the
reacquired debt issues, the longest of which is 17.6 years. Deferred conservation program costs
included in Deferred debits  Otherrepresent mandated conservation expenditures recoverable
through retail electric rates over the next 1.5 years. Plant acquisition costs included in
Deferred debits  Otherwill be amortized over the next 5.4 years. Accrued cost-of-energy
revenue included in Accrued utility revenueswill be recovered over the next nine months. All
deferred marked-to-market gains and losses are related to forward purchases and sales of energy
scheduled for delivery prior to June 2005. The Accumulated reserve for estimated removal costs
is reduced for actual removal costs incurred. The remaining regulatory assets and liabilities
are being recovered from, or will be paid to, electric customers over the next 30 years. If for any reason, the Companys regulated businesses cease to meet the criteria for application
of SFAS No. 71 for all or part of their operations, the regulatory assets and liabilities that
no longer meet such criteria would be removed from the consolidated balance sheet and included
in the consolidated statement of income as an extraordinary expense or income item in the period
in which the application of SFAS No. 71 ceases.




---



##### 



5.
    FORWARD ENERGY CONTRACTS CLASSIFIED AS DERIVATIVES ELECTRICITY CONTRACTS With the issuance of SFAS No. 149 in 2003, all of the electric utilitys wholesale purchases and sales of energy under forward contracts that do not meet the definition of capacity contracts are considered derivatives subject to mark-to-market accounting. The electric utilitys objective in entering into forward contracts for the purchase and sale of energy is to optimize the use of its generating and transmission facilities and leverage its knowledge of wholesale energy markets in the region to maximize financial returns for the benefit of both its customers and shareholders. The electric utilitys intent in entering into these contracts is to settle them through the physical delivery of energy when physically possible and economically feasible. Although these contracts are classified as derivatives, the electric utility does not use them for hedging and does not presently hold these contracts for trading purposes. Electric revenues include $27,053,000 in 2004 and $29,530,000 in 2003 related to wholesale electric sales and net unrealized derivative gains on forward energy contracts broken down as follows for the years ended December 31: (in thousands)
    
    2004
    
    
    2003Wholesale salescompany-owned generation
    
    $
    17,795
    
    
    $
    18,428Wholesale salespurchased power at market prices
    
    
    134,715
    
    
    
    121,303Market cost of purchased power resold
    
    
    (128,685
    )
    
    
    (114,259
    )Net margins on wholesale sales of purchased power
    
    
    6,030
    
    
    
    7,044Marked-to-market gains on settled contracts
    
    
    12,663
    
    
    
    2,978Marked-to-market losses on settled contracts
    
    
    (9,736
    )
    
    
    (977
    )Net marked-to-market gain on settled contracts
    
    
    2,927
    
    
    
    2,001Unrealized marked-to-market gains on open contracts
    
    
    514
    
    
    
    6,338Unrealized marked-to-market losses on open contracts
    
    
    (213
    )
    
    
    (4,281
    )Net unrealized marked-to-market gain on open contracts
    
    
    301
    
    
    
    2,057Wholesale electric revenue
    
    $
    27,053
    
    
    $
    29,530
 The following tables show the effect of marking-to-market forward contracts for the purchase and
sale of energy on the Companys consolidated balance sheets as of December 31, 2004 and 2003 and
the change in its consolidated balance sheet position from December 31, 2003 to December 31,
2004: December 31,
    
    
    December 31,(in thousands)
    
    2004
    
    
    2003Current assetmarked-to-market gain
    
    $
    711
    
    
    $
    5,443Regulatory assetdeferred marked-to-market loss
    
    
    331
    
    
    
    1,802Total assets
    
    
    1,042
    
    
    
    7,245Current liabilitymarked-to-market loss
    
    
    (544
    )
    
    
    (3,504
    )Regulatory liabilitydeferred marked-to-market gain
    
    
    (197
    )
    
    
    (1,684
    )Total liabilities
    
    
    (741
    )
    
    
    (5,188
    )Net fair value of marked-to-market energy contracts
    
    $
    301
    
    
    $
    2,057
 Year endedDecember 31,(in thousands)
    
    2004Fair value at beginning of year
    
    $
    2,057Amount realized on contracts entered into in 2003 and settled in 2004
    
    
    (1,967
    )Changes in fair value of contracts entered into in 2003
    
    
    (90
    )Net fair value of contracts entered into in 2003 at year end 2004
    
    
    Changes in fair value of contracts entered into in 2004
    
    
    301Net fair value at end of year
    
    $
    301
 The $301,000 in recognized but unrealized net gains on the forward energy purchases and sales
marked-to-market as of December 31, 2004 is expected to be realized on physical settlement or
settled by offsetting agreement with the counterparty to the original contract as scheduled over
the following quarters in the amounts listed: 1st
    
    
    2ndQuarter
    
    
    Quarter(in thousands)
    
    2005
    
    
    2005
    
    
    TotalNet gain
    
    $
    276
    
    
    $
    25
    
    
    $
    301




---



##### 



Of the forward energy contracts that are marked-to-market as of December 31 2004, 45% of the
forward energy purchases have offsetting sales in terms of volumes and delivery periods. The
amount of unrealized marked-to-market gains recognized on forward energy purchases that are not
offset by forward energy sales is $144,000. NATURAL GAS CONTRACTS The Companys energy services subsidiary markets natural gas to approximately 160 retail
customers. Some of these customers are served under fixed-price contracts. These contracts call
for the physical delivery of natural gas and are considered executory contracts for accounting
purposes. Current accounting guidance requires losses on firmly committed executory contracts to
be recognized when realized. In November and December 2004, the Companys energy services subsidiary entered into
over-the-counter natural gas forward swap transactions that qualify as derivatives subject to
mark-to-market accounting under SFAS No. 133. Although the energy services subsidiary manages
its risk by balancing its position in these transactions relative to its market position in the
contracts entered into for physical delivery, these swap transactions do not qualify for the
normal purchases and sales exception nor do they qualify for hedge accounting treatment under
SFAS No. 133. These contracts are held for trading purposes with both realized and unrealized
net gains and losses reflected in revenue on the Companys consolidated statement of income for
the year ended December 31, 2004 in accordance with the guidance provided in EITF 02-3, Issues
Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved
in Energy Trading and Risk Management Activities. The Companys intent in entering into these
forward natural gas swap transactions is to make a profit on the change in prices of natural gas
contracted for future delivery. The following table provides a breakdown of the energy services subsidiarys natural gas swap
transactions trading activity in 2004: (in thousands)
    
    2004Gains on settled contracts
    
    $
    780Losses on settled contracts
    
    
    (747
    )Net Gain on settled contracts
    
    $
    33Unrealized gains on open contracts (derivative asset)
    
    
    1,834Unrealized losses on open contracts (derivative liability)
    
    
    (1,700
    )Net unrealized gain on open contracts
    
    
    134Net revenue recognized
    
    $
    167
  6.
    COMMON SHARES AND EARNINGS PER SHARE NEW ISSUANCES During December 2004, the Company completed a public offering of 2,900,000 shares under its
universal shelf registration statement filed with the Securities and Exchange Commission in
June. The public offering price was $25.45 per share with proceeds after underwriting discounts
and commissions of $24.50 per share. In addition during 2004, the Company issued 223,165 shares
to meet the requirements of the Companys dividend reinvestment program and share purchase plan,
66,958 shares to meet the requirements of the Companys employee stock purchase plan, 51,542 shares as a result of stock options exercised, 8,179 shares of restricted stock for officers
and directors compensation, net of shares withheld for taxes and 3,261 shares as directors
compensation. In January 2005, 175,000 shares of common stock were issued as a result of the underwriters
exercising a portion of their over-allotment option in connection with the Companys public
offering. The proceeds to the Company were $24.50 per share.




---



##### 



STOCK INCENTIVE PLAN Presented below is a summary of the stock options activity: 2004
    
    
    2003
    
    
    2002Average
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    Averageexercise
    
    
    
    
    
    
    exercise
    
    
    
    
    
    
    exerciseStock Option Activity
    
    Options
    
    
    price
    
    
    Options
    
    
    price
    
    
    Options
    
    
    priceOutstanding,
beginning of year
    
    
    1,531,125
    
    
    $
    25.16
    
    
    
    1,360,721
    
    
    $
    24.68
    
    
    
    1,265,042
    
    
    $
    22.62Granted
    
    
    72,400
    
    
    
    26.50
    
    
    
    222,750
    
    
    
    27.24
    
    
    
    278,750
    
    
    
    31.34Exercised
    
    
    51,468
    
    
    
    19.83
    
    
    
    47,700
    
    
    
    20.21
    
    
    
    130,797
    
    
    
    19.71Forfeited
    
    
    43,780
    
    
    
    27.37
    
    
    
    4,646
    
    
    
    23.09
    
    
    
    52,274
    
    
    
    22.83Outstanding, year-end
    
    
    1,508,277
    
    
    $
    25.35
    
    
    
    1,531,125
    
    
    
    25.16
    
    
    
    1,360,721
    
    
    
    24.68Exercisable, year-end
    
    
    1,111,681
    
    
    $
    24.27
    
    
    
    791,661
    
    
    $
    22.97
    
    
    
    449,385
    
    
    $
    21.75Fair value of options
granted during year
    
    $
    5.27
    
    
    
    
    
    
    $
    5.42
    
    
    
    
    
    
    $
    7.07
 Under the 1999 Stock Incentive Plan (Incentive Plan) a total of 2,600,000 common shares were
authorized for granting stock awards. The Incentive Plan provides for the grant of options,
performance awards, restricted stock, stock appreciation rights and other types of stock grants
or stock-based awards. The exercise price of the stock options is equal to the fair market value
per share at the date of the grant. Options granted to outside directors are exercisable
immediately and all other options granted prior to 2004 vest over a four-year period. Stock
options granted during April 2004 vested six months from the grant date. Restricted stock
granted as of December 31, 2004 vests ratably over a four-year period. The options expire ten
years after the date of the grant. The Company accounts for the Incentive Plan under APB No. 25. The fair values of the options granted were estimated using the Black-Scholes option-pricing model
under the following assumptions: 2004

    
    2003

    
    2002Risk-free interest rate
    
    
    3.9
    %
    
    
    3.7
    %
    
    
    5.2
    %Expected lives
    
    7 years
    
    7 years
    
    7 yearsExpected volatility
    
    
    25.7
    %
    
    
    26.3
    %
    
    
    26.0
    %Dividend yield
    
    
    4.0
    %
    
    
    4.0
    %
    
    
    4.0
    %
 The following table summarizes information about options outstanding as of December 31, 2004: Options outstanding
    
    
    Options exercisableWeighted-average
    
    
    Weighted-
    
    
    
    
    
    
    Weighted-Outstanding
    
    
    remaining
    
    
    average
    
    
    Exercisable
    
    
    averageRange of
    
    as of
    
    
    contractual
    
    
    exercise
    
    
    as of
    
    
    exerciseexercise prices
    
    12/31/04
    
    
    life (yrs)
    
    
    price
    
    
    12/31/04
    
    
    price$18.80-$21.94
    
    
    440,377
    
    
    
    4.6
    
    
    $
    19.48
    
    
    
    440,377
    
    
    $
    19.48$21.95-$25.07
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $25.08-$26.77
    
    
    583,400
    
    
    
    6.6
    
    
    $
    26.28
    
    
    
    476,150
    
    
    $
    26.29$26.78-$31.34
    
    
    484,500
    
    
    
    7.7
    
    
    $
    29.55
    
    
    
    195,154
    
    
    $
    30.15
 In addition to the stock options granted, 21,340, 90,900 and 85,800 shares of restricted stock
were granted during 2004, 2003 and 2002, respectively. The total compensation cost recognized in
income for stock-based employee compensation awards was $1,302,000 in 2004, $1,110,000 in 2003
and $879,000 in 2002. See note 1 for pro forma stock option information. During 2004, the Companys Board of Directors granted performance-based stock incentive awards
to the Companys executive officers under the Incentive Plan. Under these awards, the officers
could earn up to an aggregate of 70,500 shares of common stock based on the Companys stock
performance relative to the stock performances of its peer group of companies in the Edison
Electric Institute Index over a three-year period ending on December 31, 2006. The number of shares earned, if any, would be awarded and issued at the end of the three-year performance
period. The officers have no voting or dividend rights related to the eligible shares until the shares are issued at the end of the performance period. Due to the performance of the stock
price during 2004, no compensation expense was recognized during 2004 for this award.




---



##### 



EMPLOYEE STOCK PURCHASE PLAN The 1999 Employee Stock Purchase Plan (Purchase Plan) allows eligible employees to purchase the
Companys common shares at 85% of the lower market price at either the beginning or the end of
each six-month purchase period. Of the 400,000 common shares authorized for purchase under the
Purchase Plan, 64,267 were still available for purchase as of December 31, 2004. To provide shares for the Purchase Plan, 66,958 common shares were issued in 2004 and prior to 2004, common shares were purchased in the open market totaling 66,724 shares in 2003 and 57,997 shares in
2002. Beginning in 2005, the Company will purchase shares on the open market for this plan. DIVIDEND REINVESTMENT AND SHARE PURCHASE PLAN On August 30, 1996 the Company filed a shelf registration statement with the Securities and
Exchange Commission (SEC) for the issuance of up to 2,000,000 common shares pursuant to the
Companys Automatic Dividend Reinvestment and Share Purchase Plan (the Plan), which permits shares purchased by shareholders or customers who participate in the Plan to be either new issue common shares or common shares purchased in the open market. From June 1999 through December
2003, common shares needed for the Plan were purchased in the open market. From January through
October 2004 new shares were issued for this Plan. Starting in November the Company began
purchasing common shares on the open market. Through December 31, 2004, 944,507 common shares
had been issued to meet the requirements of the Plan. SHAREHOLDER RIGHTS PLAN On January 27, 1997 the Companys Board of Directors declared a dividend of one preferred share
purchase right (Right) for each outstanding common share held of record as of February 10, 1997.
One Right was also issued with respect to each common share issued after February 10, 1997. Each
Right entitles the holder to purchase from the Company one one-hundredth of a share of newly
created Series A Junior Participating Preferred Stock at a price of $70, subject to certain
adjustment. The Rights are exercisable when, and are not transferable apart from the Companys
common shares until, a person or group has acquired 15% or more, or commenced a tender or
exchange offer for 15% or more, of the Companys common shares. If the specified percentage of
the Companys common shares is acquired, each Right will entitle the holder (other than the
acquiring person or group) to receive, on exercise, common shares of either the Company or the
acquiring company having value equal to two times the exercise price of the Right. The Rights
are redeemable by the Companys Board of Directors in certain circumstances and expire on
January 27, 2007. EARNINGS PER SHARE Basic earnings per common share are calculated by dividing earnings available for common shares
by the average number of common shares outstanding during the period. Diluted earnings per
common share are calculated by adjusting outstanding shares, assuming conversion of all
potentially dilutive stock options. Stock options with exercise prices greater than the market
price are excluded from the calculation of diluted earnings per common share.  7.
    RETAINED EARNINGS RESTRICTION The Companys Articles of Incorporation, as amended, contain provisions that limit the amount of
dividends that may be paid to common shareholders by the amount of any declared but unpaid
dividends to holders of the Companys cumulative preferred shares. Under these provisions none
of the Companys retained earnings were restricted at December 31, 2004.  8.
    COMMITMENTS AND CONTINGENCIES At December 31, 2004 the electric utility had commitments under contracts in connection with
construction programs aggregating approximately $6,431,000. For capacity and energy
requirements, the electric utility has agreements extending through 2009 at annual costs of
approximately $19,850,000 in 2005, $17,165,000 in 2006, $18,140,000 in 2007, $18,963,000 in 2008
and $20,089,000 in 2009. The electric utility has contracts providing for the purchase and delivery of a significant
portion of its current coal requirements. These contracts expire in 2007 and 2016. In total, the
electric utility is committed to the minimum purchase of approximately $99,812,000 or to make
payments in lieu thereof, under these contracts. The cost-of-energy adjustment mechanism lessens the risk of loss from market price
changes because
it provides for recovery of most fuel costs.




---



##### 



The amounts of future operating lease payments are as follows: (in thousands)
    
    Electric
    
    
    Nonelectric
    
    
    Total2005
    
    $
    1,818
    
    
    $
    28,294
    
    
    $
    30,1122006
    
    
    1,818
    
    
    
    24,821
    
    
    
    26,6392007
    
    
    1,590
    
    
    
    19,019
    
    
    
    20,6092008
    
    
    1,135
    
    
    
    12,601
    
    
    
    13,7362009
    
    
    1,135
    
    
    
    9,850
    
    
    
    10,985Later years
    
    
    1,035
    
    
    
    8,122
    
    
    
    9,157Total
    
    $
    8,531
    
    
    $
    102,707
    
    
    $
    111,238
 Rent expense from continuing operations was $28,343,000, $25,503,000 and $22,032,000, for 2004,
2003 and 2002, respectively. The Company occasionally is a party to litigation arising in the normal course of business.
The Company regularly analyzes current information and, as necessary, provides accruals for
probable liabilities on the eventual disposition of these matters. The Company believes the
effect on its consolidated results of operations, financial position and cash flows, if any,
for the disposition of all currently pending matters will not be material.  9.
    SHORT-TERM AND LONG-TERM BORROWINGS SHORT-TERM DEBT There was $39,950,000 in short-term debt outstanding as of December 31, 2004, of which
$35,000,000 was borrowed against the Companys line of credit and $4,950,000 was the remaining
unpaid balance on a bridge loan used to finance the 2004 acquisition of IPH. As of December 31,
2004 the composite interest rate on the line borrowings was 2.8% and the interest rate on the
bridge loan was 3.0%. As of December 31, 2003 the Company had $30 million in short-term debt
outstanding at a composite interest rate of 1.5%. The average interest rate paid on short-term
debt was 2.2% in 2004 and 1.7% in 2003. In August 2004 the Company borrowed $76.0 million of unsecured and unsubordinated debt from UBS
Loan Finance LLC as a bridge loan to finance its acquisition of IPH. The Company repaid
$71,050,000 of the $76.0 million loan in December 2004 with proceeds from the issuance of 2.9
million shares of common stock. The remaining unpaid balance of $4,950,000, outstanding on
December 31, 2004, was repaid in January 2005 from the proceeds of 175,000 shares of common
stock issued from the over-allotment related to the public offering and by borrowing from the
Companys line of credit. The interest rate paid on the outstanding balance on bridge loan was
LIBOR plus 0.6%. On April 28, 2004 the Company renewed its $70 million line of credit. The renewed agreement
expires on April 27, 2005. The terms of the renewed line of credit at the time of renewal were
essentially the same as those in place prior to the renewal. In October 2004, the Company
amended the terms of its $70 million line of credit agreement solely to remove the ratings
trigger that would require accelerated repayment of any outstanding balance on the line of
credit in the event the Companys senior unsecured debt is rated below Baa3 (Moodys) or BBB-
(Standard & Poors). The removal of the ratings trigger resulted in no changes to the interest
rate charged on line borrowings and no material changes to other terms of the agreement.
Borrowings under the line of credit bear interest at LIBOR plus 0.6%, subject to adjustment
based on the ratings of the Companys senior unsecured debt. The Company does not anticipate any
difficulties in renewing this line of credit. The interest rate under the line of credit is subject to adjustment in the event of a change in
ratings on the Companys senior unsecured debt, up to LIBOR plus 0.8% if the ratings on the
Companys senior unsecured debt fall to BBB+ or below (Standard & Poors) or Baa1 or below
(Moodys). In December 2004 Standard & Poors Rating Services lowered the Companys corporate
credit rating and senior unsecured debt rating from A-/negative to BBB+/negative. Moodys rating
remains at A2/negative. As a result of this split rating, the Companys interest rate on its
line of credit increased to LIBOR plus 0.6%. The Companys bank line of credit is a key source of operating capital and can provide interim financing of working capital and other capital requirements, if needed. The
Companys obligations under this line of credit are guaranteed by a
100%-owned subsidiary of the
Company that owns substantially all of the Companys nonelectric
companies.




---



##### 



LONG-TERM DEBT The Company has the ability to issue up to $256 million of common stock, preferred stock, debt
and certain other securities from time to time under its universal shelf registration statement
filed with the Securities and Exchange Commission on June 4, 2004 and declared effective on
August 30, 2004. The Company issued no long-term debt under its universal shelf registration in 2004. In 2004,
$30,000 of Mercer County, North Dakota pollution control refunding revenue bonds 4.85%, due
September 1, 2022 were redeemed for estate settlement purposes and retired. On September 24, 2003, the Company borrowed $16.3 million under a loan agreement with Lombard US
Equipment Finance Corporation in the form of an unsecured note. The terms of the note require
quarterly principal payments in the amount of $582,143 commencing in January 2004 with a final
installment due on October 2, 2006, the stated maturity date of the note. The term of the note
can be extended for additional one-year periods following the stated maturity date through
October 1, 2010. The note bears interest at a variable rate of three-month LIBOR plus 1.43% on
the unpaid principal balance with interest payments due quarterly commencing on October 1, 2003
until the principal balance is repaid in full. The Company used proceeds from the note to pay
down borrowings under the Companys line of credit that were used to finance acquisitions and
capital expenditures of its nonelectric subsidiaries. The covenants associated with the note are
consistent with existing credit facilities. There are no rating triggers associated with this
note. On November 3, 2004 a Second Amendment to the Note Purchase Agreement dated as of December 31,
2001 for the $90 million 6.63% senior notes due December 1, 2011 between Otter Tail Corporation
and the holders of the notes was signed and made effective as of October 1, 2004. This amendment
eliminated the provision that would require repayment of the $90 million senior notes with a
make-whole premium if the Companys senior unsecured debt is rated below Baa3 (Moodys) or BBB-
(Standard & Poors). The amendment resulted in no changes to interest rates and no material
changes to other terms of the agreement. The Companys obligations under the 6.63% senior notes
are guaranteed by a 100%-owned subsidiary of the Company that owns substantially all of the
Companys nonelectric companies. The Companys Grant County and Mercer County pollution control refunding revenue bonds require
the Company grant to Ambac Assurance Corporation, under a financial guaranty insurance policy
relating to the bonds, a security interest in the assets of the electric utility if the rating
on the Companys senior unsecured debt is downgraded to Baa2 or below (Moodys) or BBB or below
(Standard & Poors). The aggregate amounts of maturities on bonds outstanding and other long-term obligations at
December 31, 2004, excluding the long-term debt reported under Liabilities from discontinued
operations, for each of the next five years are $6,055,000 for 2005, $4,331,000 for 2006,
$54,628,000 for 2007, $2,888,000 for 2008 and $2,849,000 for 2009. COVENANTS The Companys line of credit, its $90 million 6.63% senior notes due 2011 and Lombard US
Equipment Finance note contain covenants that require the Company to maintain a debt-to-total
capitalization ratio not in excess of 60% and an interest and dividend coverage ratio of at
least 1.5 to 1. The 6.63% senior notes also require that priority debt not be in excess of 20%
of total capitalization. As of December 31, 2004 the Company was in compliance with all of the covenants under its line
of credit and its other debt obligations.  10.
    CLASS B STOCK OPTIONS OF SUBSIDIARY In connection with the acquisition of IPH in August 2004, IPH management and certain other
employees elected to retain stock options for the purchase of 1,112 IPH Class B common shares
valued at $1.8 million. The combined exercise price of all the outstanding options is $487,000. The options are exercisable at any time and the option
holder must deliver cash to convert the option into a Class B share. Once the options are
converted to Class B shares, the Class B shareholder




---



##### 



cannot put the shares back to the Company
for 181 days. At that time, the Class B common shares are redeemable at any time during the
employment of the individual holder, subject to certain limits on the total number of Class B
common shares redeemable on an annual basis. The Class B common shares are non-voting, except in
the event of a merger, and do not participate in dividends but have liquidation rights at par
with the Class A common shares owned by the Company. The value of the Class B common shares
issued on exercise of the options represents an interest in IPH that changes as defined in the
agreement.  11.
    PENSION PLAN AND OTHER POSTRETIREMENT BENEFITS PENSION PLAN The Companys noncontributory funded pension plan covers substantially all electric utility and
corporate employees. The plan provides 100% vesting after five vesting years of service and for
retirement compensation at age 65, with reduced compensation in cases of retirement prior to age
62. The Company reserves the right to discontinue the plan but no change or discontinuance may
affect the pensions theretofore vested. The Companys policy is to fund pension costs accrued.
All past service costs have been provided for. The pension plan has a trustee who is responsible for pension payments to retirees. Four
investment managers are responsible for managing the plans assets. An independent actuary
performs the necessary actuarial valuations for the plan. The plan assets consist of common stock and bonds of public companies, U.S. government
securities, cash and cash equivalents. None of the plan assets are invested in common stock,
preferred stock or debt securities of the Company. The following tables provide a reconciliation of the changes in the plans benefit obligations
and fair value of assets over the two-year period ended December 31, 2004 and a statement of the
funded status as of December 31 of both years: (in thousands)
    
    2004
    
    
    2003Reconciliation of benefit obligation:Obligation at January 1
    
    $
    154,159
    
    
    $
    145,262Service cost
    
    
    4,063
    
    
    
    3,779Interest cost
    
    
    9,458
    
    
    
    9,491Benefit payments
    
    
    (8,600
    )
    
    
    (8,190
    )Actuarial loss
    
    
    7,110
    
    
    
    3,817Obligation at December 31
    
    $
    166,190
    
    
    $
    154,159Reconciliation of fair value of plan assets:Fair value of plan assets at January 1
    
    $
    132,811
    
    
    $
    113,803Actual return on plan assets
    
    
    13,474
    
    
    
    27,198Discretionary company contributions
    
    
    4,000
    
    
    
    Benefit payments
    
    
    (8,600
    )
    
    
    (8,190
    )Fair value of plan assets at December 31
    
    $
    141,685
    
    
    $
    132,811Funded status
    
    $
    (24,505
    )
    
    $
    (21,348
    )Unrecognized net actuarial loss
    
    
    28,607
    
    
    
    22,533Unrecognized prior service cost
    
    
    6,127
    
    
    
    7,025Net amount recognized
    
    $
    10,229
    
    
    $
    8,210
 The following table provides the amounts recognized in the consolidated balance sheets as of
December 31: (in thousands)
    
    2004
    
    
    2003Prepaid pension cost
    
    $
    10,229
    
    
    $
    8,210
 Additional information on the status of the pension plan as of December 31: (in thousands)
    
    2004
    
    
    2003Projected benefit obligation
    
    $
    166,190
    
    
    $
    154,159Accumulated benefit obligation
    
    
    137,682
    
    
    
    130,072Fair value of plan assets
    
    
    141,685
    
    
    
    132,811




---



##### 



Components of net periodic pension benefit cost: (in thousands)
    
    2004
    
    
    2003
    
    
    2002Service costbenefit earned during the period
    
    $
    4,063
    
    
    $
    3,779
    
    
    $
    3,120Interest cost on projected benefit obligation
    
    
    9,458
    
    
    
    9,491
    
    
    
    9,269Expected return on assets
    
    
    (12,438
    )
    
    
    (12,933
    )
    
    
    (14,957
    )Amortization of transition asset
    
    
    
    
    
    
    
    
    
    
    (73
    )Amortization of prior-service cost
    
    
    897
    
    
    
    1,170
    
    
    
    1,285Amortization of net gain
    
    
    
    
    
    
    
    
    
    
    (1,284
    )Net periodic pension cost/(income)
    
    $
    1,980
    
    
    $
    1,507
    
    
    $
    (2,640
    )
 Weighted-average assumptions used to determine benefit obligations at December 31: 2004
    
    
    2003Discount rate
    
    
    6.00
    %
    
    
    6.25
    %Rate of increase in future compensation level
    
    
    3.75
    %
    
    
    3.75
    %
 Weighted-average assumptions used to determine net periodic pension cost for the year ended
December 31: 2004
    
    
    2003Discount rate
    
    
    6.25
    %
    
    
    6.75
    %Long-term rate of return on plan assets
    
    
    8.50
    %
    
    
    8.50
    %Rate of increase in future compensation level
    
    
    3.75
    %
    
    
    4.25
    %
 To develop the expected long-term rate of return on assets assumption, the Company considered the
historical returns and the future expectations for returns for each asset class, as well as the
target asset allocation of the pension portfolio. The assumed rate of return on pension fund assets for the determination of 2005 net periodic
pension cost is 8.5%. The Companys pension plan weighted-average asset allocations at December 31, 2004 and 2003, by
asset category are as follows: Asset Category
    
    2004
    
    
    2003Large capitalization equity securities
    
    
    48.4
    %
    
    
    52.9
    %Small capitalization equity securities
    
    
    11.2
    %
    
    
    10.4
    %International equity securities
    
    
    14.7
    %
    
    
    12.9
    %Total equity securities
    
    
    74.3
    %
    
    
    76.2
    %Cash and fixed-income securities
    
    
    25.7
    %
    
    
    23.8
    %100.0
    %
    
    
    100.0
    %
 The following objectives guide the decisions and investment strategy of the Companys pension
committee for the pension plan (the Plan).  
    The Plan is managed to operate in perpetuity.
    The Plan will meet the pension benefit obligation payments of Otter Tail Corporation.
    The Plans assets should be invested with the objective of meeting current and future
payment requirements while minimizing annual contributions and their volatility.
    The asset strategy reflects the desire to meet current and future benefit payments. The asset allocation strategy developed by the Companys pension committee is based on the
current needs of the Plan, the investment objectives listed above, the investment preferences
and risk tolerance of the committee and a desired degree of diversification. The asset allocation strategy contains guideline percentages, at market value, of the total Plan
invested in various asset classes. The strategic target allocation shown in the table below is a
guide that will at times not be reflected in actual asset allocations that may be dictated by
prevailing market conditions, independent actions of the pension committee and/or investment
managers, and required cash flows to and from the Plan. The tactical range shown below provides
flexibility for the investment managers portfolios to vary around the target allocation without
the need for immediate rebalancing. The Companys pension committee monitors actual asset allocations and




---



##### 



directs contributions and withdrawals toward maintaining the targeted allocation percentages listed in the table below. Security class
    
    Strategic Target
    
    
    Tactical RangeLarge capitalization equity securities
    
    
    48
    %
    
    
    40%-55
    %Small capitalization equity securities
    
    
    12
    %
    
    
    9%-15
    %International equity securities
    
    
    10
    %
    
    
    5%-15
    %Total equity securities
    
    
    70
    %
    
    
    60%-80
    %Fixed-income securities
    
    
    30
    %
    
    
    20%-40
    %Cash Flows
 The
Company is not required to make a contribution to the pension plan in
2005. The following benefit payments, which reflect expected future service, as appropriate, are
expected to be paid: (in thousands)
    

    Years2005
    
    2006

    
    2007

    
    2008

    
    2009

    
    2010-2014$
    8,422
    
    
    $
    8,453
    
    
    $
    8,594
    
    
    $
    8,743
    
    
    $
    8,919
    
    
    $
    50,136
 EXECUTIVE SURVIVOR AND SUPPLEMENTAL RETIREMENT PLAN (ES&SRP) The Company has an unfunded, nonqualified benefit plan for executive officers and certain key
management employees. This plan provides defined benefit payments to these employees on their
retirement for life or to their beneficiaries on their death for a 15-year postretirement
period. Life insurance carried on certain plan participants is payable to the Company on the
employees death. There are no plan assets in this nonqualified benefit plan due to the nature
of the plan. The following tables provide a reconciliation of the changes in the plans benefit obligations
over the two-year period ended December 31, 2004 and a statement of the funded status as of
December 31 of both years: (in thousands)
    
    2004
    
    
    2003Reconciliation of benefit obligation:Obligation at January 1
    
    $
    24,451
    
    
    $
    20,309Service cost
    
    
    820
    
    
    
    417Interest cost
    
    
    1,489
    
    
    
    1,426Plan amendments
    
    
    
    
    
    
    1,083Actuarial (gain) loss
    
    
    (2,543
    )
    
    
    2,242Benefit payments
    
    
    (1,094
    )
    
    
    (1,026
    )Obligation at December 31
    
    $
    23,123
    
    
    $
    24,451Funded status:Funded status at December 31
    
    $
    (23,123
    )
    
    $
    (24,451
    )Unrecognized prior-service cost
    
    
    1,626
    
    
    
    1,772Unrecognized net actuarial loss
    
    
    8,737
    
    
    
    11,961Net amount recognized
    
    $
    (12,760
    )
    
    $
    (10,718
    )
 The following table provides the amounts recognized in the consolidated balance sheets as of
December 31: (in thousands)
    
    2004
    
    
    2003Accrued benefit liability
    
    $
    (16,703
    )
    
    $
    (16,919
    )Intangible asset
    
    
    1,626
    
    
    
    1,772Accumulated other comprehensive loss
    
    
    2,317
    
    
    
    4,429Net amount recognized
    
    $
    (12,760
    )
    
    $
    (10,718
    )
 Additional information on the ES&SRP defined benefit pension plan as of December 31: (in thousands)
    
    2004
    
    
    2003Projected benefit obligation
    
    $
    23,123
    
    
    $
    24,451Accumulated benefit obligation
    
    
    16,703
    
    
    
    16,919Fair value of plan assets
    
    
    
    
    
    
    




---



##### 



Components of net periodic pension benefit cost: (in thousands)
    
    2004
    
    
    2003
    
    
    2002Service costbenefit earned during the period
    
    $
    820
    
    
    $
    417
    
    
    $
    (51
    )Interest cost on projected benefit obligation
    
    
    1,489
    
    
    
    1,426
    
    
    
    1,175Amortization of prior-service cost
    
    
    147
    
    
    
    147
    
    
    
    86Recognized net actuarial loss
    
    
    680
    
    
    
    573
    
    
    
    398Net periodic pension cost
    
    $
    3,136
    
    
    $
    2,563
    
    
    $
    1,608Early retirement benefit
    
    
    
    
    
    
    
    
    
    
    240Total
    
    $
    3,136
    
    
    $
    2,563
    
    
    $
    1,848
 The change in the additional minimum liability included in other comprehensive loss was
($2,112,000) in 2004 and ($606,000) in 2003. Weighted-average assumptions used to determine benefit obligations at December 31: 2004
    
    
    2003Discount rate
    
    
    6.00
    %
    
    
    6.25
    %Rate of increase in future compensation level
    
    
    4.74
    %
    
    
    5.88
    %
 Weighted-average assumptions used to determine net periodic pension cost for the year ended
December 31: 2004
    
    
    2003Discount rate
    
    
    6.25
    %
    
    
    6.75
    %Rate of increase in future compensation level
    
    
    5.88
    %
    
    
    5.63
    %
 Cash Flows The ES&SRP is unfunded and has no assets; contributions are equal to the benefits paid to plan
participants. The following benefit payments, which reflect future service, as appropriate, are
expected to be paid: (in thousands)
    
    Years2005
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010-2014$         1,152
    
    $
    1,151
    
    
    $
    1,147
    
    
    $
    1,132
    
    
    $
    1,131
    
    
    $
    6,016
 On January 1, 2005, the Company amended this plan to reduce future benefits to plan participants
and reduce costs to the Company. POSTRETIREMENT BENEFITS The Company provides a portion of health insurance and life insurance benefits for retired
electric utility and corporate employees. Substantially all of the Companys electric utility
and corporate employees may become eligible for health insurance benefits if they reach age 55
and have 10 years of service. On adoption of SFAS No. 106, Employers Accounting for
Postretirement Benefits Other Than Pensions, in January 1993, the Company elected to recognize
its transition obligation related to postretirement benefits earned of approximately $14,964,000
over a period of 20 years. There are no plan assets. The following tables provide a reconciliation of the changes in the plans benefit obligations
over the two-year period ended December 31, 2004 and a statement of the funded status as of
December 31 of both years: (in thousands)
    
    2004
    
    
    2003Reconciliation of benefit obligation:Obligation at January 1
    
    $
    42,008
    
    
    $
    39,318Service cost
    
    
    1,133
    
    
    
    1,009Interest cost
    
    
    2,271
    
    
    
    2,619Benefit payments
    
    
    (3,449
    )
    
    
    (2,981
    )Participant premium payments
    
    
    1,134
    
    
    
    1,051Decrease due to Medicare Part D subsidy
    
    
    (4,935
    )
    
    
    Actuarial loss
    
    
    1,477
    
    
    
    992Obligation at December 31
    
    $
    39,639
    
    
    $
    42,008Funded status:Funded status at December 31
    
    $
    (39,639
    )
    
    $
    (42,008
    )Unrecognized transition obligation
    
    
    5,985
    
    
    
    6,734Unrecognized prior-service cost
    
    
    1,005
    
    
    
    700Unrecognized loss
    
    
    7,596
    
    
    
    11,344Net amount recognized
    
    $
    (25,053
    )
    
    $
    (23,230
    )




---



##### 



The net amounts recognized are shown on the consolidated balance sheets as of December 31, 2004 and
2003 under the title of Other postretirement benefits liability. Components of net periodic postretirement benefit cost: (in thousands)
    
    2004
    
    
    2003
    
    
    2002Service cost
    
    $
    1,170
    
    
    $
    1,009
    
    
    $
    615Interest cost
    
    
    2,580
    
    
    
    2,619
    
    
    
    2,166Amortization of transition obligation
    
    
    748
    
    
    
    748
    
    
    
    748Amortization of prior-service cost
    
    
    (305
    )
    
    
    (305
    )
    
    
    (305
    )Amortization of net loss
    
    
    702
    
    
    
    708
    
    
    
    Expense decrease due to Medicare part D subsidy
    
    
    (757
    )
    
    
    
    
    
    
    Net periodic postretirement benefit cost
    
    $
    4,138
    
    
    $
    4,779
    
    
    $
    3,224
 Weighted-average assumptions used to determine benefit obligations at December 31: 2004
    
    
    2003Discount rate
    
    
    6.00
    %
    
    
    6.25
    %
 Weighted-average assumptions used to determine net periodic postretirement benefit cost for the
year ended December 31: 2004
    
    
    2003Discount rate
    
    
    6.25
    %
    
    
    6.75
    %
 Assumed healthcare cost-trend rates as of December 31: 2004
    
    
    2003Healthcare cost-trend rate assumed for next year
    
    
    10.0
    %
    
    
    11.0
    %Rate at which the cost-trend rate is assumed to decline
    
    
    5.0
    %
    
    
    5.0
    %Year the rate reaches the ultimate trend rate
    
    
    2010
    
    
    
    2010
 Assumed healthcare cost-trend rates have a significant effect on the amounts reported for
healthcare plans. A one-percentage-point change in assumed healthcare cost-trend rates for 2004
would have the following effects: 1 point
    
    
    1 point(in thousands)
    
    increase
    
    
    decreaseEffect on total of service and interest cost
    
    $
    547
    
    
    $
    (440
    )Effect on the postretirement benefit obligation
    
    $
    4,909
    
    
    $
    (4,086
    )
 Cash Flows The Company expects to contribute $2.6 million net of expected employee contributions for the payment of retiree medical benefits
in 2005. The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid: (in thousands)
    
    Years2005
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010-2014$           2,581
    
    $
    2,267
    
    
    $
    2,395
    
    
    $
    2,457
    
    
    $
    2,519
    
    
    $
    13,026
 LEVERAGED EMPLOYEE STOCK OWNERSHIP PLAN The Company has a leveraged employee stock ownership plan for the benefit of all its electric
utility employees. Contributions made by the Company were $930,000 for 2004, $1,030,000 for 2003
and $1,100,000 for 2002.




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##### 



12.
    FAIR VALUE OF FINANCIAL INSTRUMENTS 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 AND SHORT-TERM INVESTMENTS The carrying amount approximates fair value because of the short-term maturity of those
instruments. OTHER INVESTMENTS The carrying amount approximates fair value. A portion of other investments is in financial
instruments that have variable interest rates that reflect fair value. The remainder of other
investments is accounted for by the equity method which, in the case of operating losses,
results in a reduction of the carrying amount. LONG-TERM DEBT The fair value of the Companys long-term debt is estimated based on the current rates available
to the Company for the issuance of debt. About $24.4 million of the Companys long-term debt,
which is subject to variable interest rates, approximates fair value. December 31, 2004
    
    
    December 31, 2003Carrying
    
    
    Fair
    
    
    Carrying
    
    
    Fair(in thousands)
    
    amount
    
    
    value
    
    
    amount
    
    
    valueCash and short-term investments
    
    $
    
    
    
    $
    
    
    
    $
    7,311
    
    
    $
    7,311Other investments
    
    
    14,450
    
    
    
    14,450
    
    
    
    8,607
    
    
    
    8,607Long-term debt
    
    
    (261,810
    )
    
    
    (291,155
    )
    
    
    (262,363
    )
    
    
    (289,774
    )
  13.
    PROPERTY, PLANT AND EQUIPMENT (December 31, in thousands)
    
    2004
    
    
    2003Electric plant:Production
    
    $
    347,800
    
    
    $
    346,890Transmission
    
    
    180,150
    
    
    
    175,953Distribution
    
    
    285,253
    
    
    
    272,909General
    
    
    76,997
    
    
    
    79,612Electric plant
    
    
    890,200
    
    
    
    875,364Less accumulated depreciation and amortization
    
    
    363,696
    
    
    
    368,899Electric plant net of accumulated depreciation
    
    
    526,504
    
    
    
    506,465Construction work in progress
    
    
    12,212
    
    
    
    13,938Net electric plant
    
    $
    538,716
    
    
    $
    520,403Nonelectric operations plant
    
    $
    214,079
    
    
    $
    169,005Less accumulated depreciation and amortization
    
    
    76,954
    
    
    
    68,594Nonelectric plant net of accumulated depreciation
    
    
    137,125
    
    
    
    100,411Construction work in progress
    
    
    6,257
    
    
    
    3,956Net nonelectric operations plant
    
    $
    143,382
    
    
    $
    104,367Net plant
    
    $
    682,098
    
    
    $
    624,770
 The estimated service lives for rate-regulated properties is 5 to 65 years. For nonelectric
property the estimated useful lives are from 3 to 40 years. Service Life Range(years)
    
    Low
    
    
    HighElectric fixed assets:Production plant
    
    
    34
    
    
    
    62Transmission plant
    
    
    40
    
    
    
    55Distribution plant
    
    
    15
    
    
    
    55General plant
    
    
    5
    
    
    
    65Nonelectric fixed assets
    
    
    3
    
    
    
    40




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##### 



14. INCOME TAXES The total income tax expense differs from the amount computed by applying the federal income tax
rate (35% in 2004, 2003 and 2002) to net income before total income tax expense for the
following reasons: (in thousands)
    
    2004
    
    
    2003
    
    
    2002Tax computed at federal statutory rate
    
    $
    19,944
    
    
    $
    17,912
    
    
    $
    22,026Increases (decreases) in tax from:State income taxes net of federal income tax
benefit
    
    
    1,774
    
    
    
    1,792
    
    
    
    2,227Investment tax credit amortization
    
    
    (1,152
    )
    
    
    (1,152
    )
    
    
    (1,152
    )Differences reversing in excess of federal rates
    
    
    (136
    )
    
    
    (1,283
    )
    
    
    (1,055
    )Dividend received/paid deduction
    
    
    (703
    )
    
    
    (707
    )
    
    
    (699
    )Affordable housing tax credits
    
    
    (1,418
    )
    
    
    (1,412
    )
    
    
    (1,418
    )Permanent and other differences
    
    
    (1,305
    )
    
    
    (1,587
    )
    
    
    (1,174
    )Total income tax expense
    
    $
    17,004
    
    
    $
    13,563
    
    
    $
    18,755Income tax
expense - discontinued operations
    
    $
    1,483
    
    
    $
    1,367
    
    
    $
    1,306Overall effective federal and state income tax rate
    
    
    30.5
    %
    
    
    27.4
    %
    
    
    30.3
    %Income tax expense includes the following:Current federal income taxes
    
    $
    15,006
    
    
    $
    10,666
    
    
    $
    17,863Current state income taxes
    
    
    2,894
    
    
    
    2,813
    
    
    
    3,492Deferred federal income taxes
    
    
    1,672
    
    
    
    2,675
    
    
    
    (162
    )Deferred state income taxes
    
    
    177
    
    
    
    (27
    )
    
    
    132Affordable housing tax credits
    
    
    (1,418
    )
    
    
    (1,412
    )
    
    
    (1,418
    )Investment tax credit amortization
    
    
    (1,152
    )
    
    
    (1,152
    )
    
    
    (1,152
    )Foreign income taxes
    
    
    (175
    )
    
    
    
    
    
    
    Total
    
    $
    17,004
    
    
    $
    13,563
    
    
    $
    18,755
 The Companys deferred tax assets and liabilities were composed of the following on December 31,
2004 and 2003: (in thousands)
    
    2004
    
    
    2003Deferred tax assetsAmortization of tax credits
    
    $
    6,698
    
    
    $
    7,437Vacation accrual
    
    
    2,219
    
    
    
    1,926Unearned revenue
    
    
    2,095
    
    
    
    1,592Benefit liabilities
    
    
    20,100
    
    
    
    18,051Cost of removal
    
    
    19,431
    
    
    
    13,096Differences related to property
    
    
    6,565
    
    
    
    6,079Transfer to regulatory liability
    
    
    31
    
    
    
    63Other
    
    
    2,853
    
    
    
    2,068Total deferred tax assets
    
    $
    59,992
    
    
    $
    50,312Deferred tax liabilitiesDifferences related to property
    
    $
    (155,491
    )
    
    $
    (128,568
    )Excess tax over book pension
    
    
    (4,041
    )
    
    
    (3,260
    )Transfer to regulatory asset
    
    
    (14,528
    )
    
    
    (12,751
    )Other
    
    
    (2,523
    )
    
    
    (3,251
    )Total deferred tax liabilities
    
    $
    (176,583
    )
    
    $
    (147,830
    )Deferred income taxes
    
    $
    (116,591
    )
    
    $
    (97,518
    )




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##### 



15.
    DISCONTINUED OPERATIONS Midwest Information Systems, Inc. (MIS):As part of an ongoing evaluation of the prospects and
growth opportunities of the Companys business operations, the Company has decided to exit the
telecommunications business. As of December 31, 2004 MIS met the requirements to be reported as
discontinued operations in accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets.The Company expects to complete the sale of this business prior
to the end of 2005. For segment reporting purposes, the discontinued operations had been
included in the other business operations segment. The results of discontinued operations for the years ended December 31, 2004, 2003 and 2002 are
summarized as follows: (in thousands)
    
    2004
    
    
    2003
    
    
    2002Operating revenues
    
    $
    8,739
    
    
    $
    8,547
    
    
    $
    8,680Income before income taxes
    
    
    3,698
    
    
    
    3,409
    
    
    
    3,258Income tax expense
    
    
    1,483
    
    
    
    1,367
    
    
    
    1,306
 At December 31, 2004 and 2003 the major components of assets and liabilities of the discontinued
operations were as follows: (in thousands)
    
    2004
    
    
    2003Current assets
    
    $
    275
    
    
    $
    250Investments and other assets
    
    
    2,270
    
    
    
    2,535Goodwillnet
    
    
    5,925
    
    
    
    5,925Net plant
    
    
    7,960
    
    
    
    8,555Assets of discontinued operations
    
    $
    16,430
    
    
    $
    17,265Current liabilities
    
    $
    2,920
    
    
    $
    3,199Deferred credits
    
    
    581
    
    
    
    593Long-term debt
    
    
    1,710
    
    
    
    2,830Liabilities of discontinued operations
    
    $
    5,211
    
    
    $
    6,622
  16.
    ASSET RETIREMENT OBLIGATIONS (AROS) The Companys asset retirement obligations include site restoration, the closure of ash pits and
the removal of storage tanks and asbestos at certain electric utility generating plants. The
Company has legal obligations associated with retirement of other long-lived assets used in its
electric operations that cannot be reasonably estimated because the useful lives of those assets
are not determinable. There are no assets legally restricted for the settlement of any of the
Companys asset retirement obligations. The present value of the legal asset retirement obligations as of December 31, 2004 of
$1,437,000 is included in Other noncurrent liabilitieson the Companys December 31, 2004
consolidated balance sheet. The ARO liability includes the original obligation of $377,000 less
a 2004 subsequent measurement adjustment of $28,000 plus accumulated accretion expense of
$1,088,000. Accumulated accretion on the AROs as of December 31, 2003 was $1,218,000. The change
in accumulated accretion in 2004 included accretion expense of $90,000 and an adjustment to
accumulated accretion of ($220,000) as a result of approved extensions of the depreciable lives
of Coyote Station and Big Stone Plant which pushed back the expected retirement date for these
plants.  17.
    SUBSEQUENT EVENTS On January 3, 2005 the Company acquired the assets of Performance Tool & Die, Inc., a
manufacturer of mid to large dies, of Lakeville, Minnesota, for $4.0 million. This company is a
division of BTD Manufacturing, Inc. Also on January 3, 2005 the Company acquired the stock of
Shoreline Industries, Inc., a manufacturer of boat lift motors located in Pine River, Minnesota,
for $2.2 million. This company is a subsidiary of ShoreMaster, Inc. On February 2, 2005, the Company entered into a nonbinding letter of intent to sell the stock of
St. George Steel Fabrication, Inc., which had 2004 revenues of $17.2 million. The sale is not
expected to have a material impact on the 2005 results of operations.




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##### 



18.
    QUARTERLY INFORMATION (UNAUDITED) Because of changes in the number of common shares outstanding and the impact of diluted shares,
the sum of the quarterly earnings per common share may not equal total earnings per common share. Three Months Ended
    
    March 31
    
    
    June 30
    
    
    September 30
    
    
    December 31(in thousands, except per share data)
    
    2004 (b)
    
    
    2003
    
    
    2004 (b)
    
    
    2003
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003Operating revenues (a)
    
    $
    204,608
    
    
    $
    170,187
    
    
    $
    209,115
    
    
    $
    178,029
    
    
    $
    220,106
    
    
    $
    198,860
    
    
    $
    248,495
    
    
    $
    197,616Operating income (a)
    
    
    15,486
    
    
    
    17,520
    
    
    
    14,628
    
    
    
    14,137
    
    
    
    19,815
    
    
    
    21,566
    
    
    
    24,507
    
    
    
    14,569Net Income:Continuing operations
    
    
    7,817
    
    
    
    9,415
    
    
    
    7,532
    
    
    
    7,960
    
    
    
    10,497
    
    
    
    11,527
    
    
    
    14,134
    
    
    
    8,712Discontinued operations
    
    
    442
    
    
    
    447
    
    
    
    500
    
    
    
    474
    
    
    
    529
    
    
    
    434
    
    
    
    744
    
    
    
    6878,259
    
    
    
    9,862
    
    
    
    8,032
    
    
    
    8,434
    
    
    
    11,026
    
    
    
    11,961
    
    
    
    14,878
    
    
    
    9,399Earnings available for common shares:Continuing operations
    
    
    7,633
    
    
    
    9,231
    
    
    
    7,348
    
    
    
    7,776
    
    
    
    10,313
    
    
    
    11,343
    
    
    
    13,950
    
    
    
    8,529Discontinued operations
    
    
    442
    
    
    
    447
    
    
    
    500
    
    
    
    474
    
    
    
    529
    
    
    
    434
    
    
    
    744
    
    
    
    6878,075
    
    
    
    9,678
    
    
    
    7,848
    
    
    
    8,250
    
    
    
    10,842
    
    
    
    11,777
    
    
    
    14,694
    
    
    
    9,216Basic earnings per share:Continuing operations
    
    $
    .29
    
    
    $
    .36
    
    
    $
    .28
    
    
    $
    .30
    
    
    $
    .40
    
    
    $
    .44
    
    
    $
    .52
    
    
    $
    .33Discontinued operations
    
    
    .02
    
    
    
    .02
    
    
    
    .02
    
    
    
    .02
    
    
    
    .02
    
    
    
    .02
    
    
    
    .03
    
    
    
    .03.31
    
    
    
    .38
    
    
    
    .30
    
    
    
    .32
    
    
    
    .42
    
    
    
    .46
    
    
    
    .55
    
    
    
    .36Diluted earnings per share:Continuing operations
    
    $
    .29
    
    
    $
    .36
    
    
    $
    .28
    
    
    $
    .30
    
    
    $
    .40
    
    
    $
    .44
    
    
    $
    .52
    
    
    $
    .33Discontinued operations
    
    
    .02
    
    
    
    .02
    
    
    
    .02
    
    
    
    .02
    
    
    
    .02
    
    
    
    .02
    
    
    
    .03
    
    
    
    .03.31
    
    
    
    .38
    
    
    
    .30
    
    
    
    .32
    
    
    
    .42
    
    
    
    .46
    
    
    
    .55
    
    
    
    .36Dividends paid per common share
    
    
    .275
    
    
    
    .27
    
    
    
    .275
    
    
    
    .27
    
    
    
    .275
    
    
    
    .27
    
    
    
    .275
    
    
    
    .27Price range:High
    
    $
    27.50
    
    
    $
    28.59
    
    
    $
    27.19
    
    
    $
    28.90
    
    
    $
    26.96
    
    
    $
    28.41
    
    
    $
    27.36
    
    
    $
    28.50Low
    
    
    26.00
    
    
    
    23.76
    
    
    
    24.07
    
    
    
    25.27
    
    
    
    23.77
    
    
    
    25.60
    
    
    
    24.99
    
    
    
    25.92Average number of common sharesoutstandingbasic
    
    
    25,793
    
    
    
    25,592
    
    
    
    25,891
    
    
    
    25,673
    
    
    
    26,010
    
    
    
    25,708
    
    
    
    26,663
    
    
    
    25,719Average number of common sharesoutstandingdiluted
    
    
    25,936
    
    
    
    25,730
    
    
    
    26,014
    
    
    
    25,855
    
    
    
    26,122
    
    
    
    25,869
    
    
    
    26,780
    
    
    
    25,876
   (a)
    
    From continuing operations.(b)
    
    Includes adjustment for Medicare Part D benefit of $164,000 per quarter under FSP 106-2
adopted in July 2004 but applied retroactively to January 1, 2004.




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##### 



Stock
Listing  Otter Tail Corporation common stock trades on The Nasdaq Stock Market.