##### 



SECURITIES AND EXCHANGE COMMISSION  FORM 10-Q (Mark
One)x
    
    QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
 Commission file number 0-368 OTTER TAIL CORPORATION 
  Minnesota
    
    
    
    41-0462685(State or other jurisdiction of
    
    
    
    (I.R.S. Employerincorporation or organization)
    
    
    
    Identification No.)
 215 South Cascade Street, Box 496, Fergus Falls, Minnesota
    
    56538-0496(Address of principal executive offices)
    
    (Zip Code)
 866-410-8780      Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES x NO o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2
of the Exchange Act). YES x NO o Indicate the number of shares outstanding of each of the issuers classes of
Common Stock, as of the latest practicable date: October 31, 2004  26,066,173 Common Shares ($5 par value)




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##### 



OTTER TAIL CORPORATION INDEX Page No.Part I. Financial InformationItem 1. Financial StatementsConsolidated Balance Sheets  September 30, 2004
and December 31, 2003 (Unaudited)
    
    
    2 & 3Consolidated Statements of Income  Three and Nine
Months
Ended September 30, 2004 and 2003 (Unaudited)
    
    
    4Consolidated Statements of Cash Flows  Nine Months
Ended September 30, 2004 and 2003 (Unaudited)
    
    
    5Notes to Consolidated Financial Statements (Unaudited)
    
    
    6-15Item 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    15-31Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    32-34Item 4. Controls and Procedures
    
    
    34Part II. Other InformationItem 6. Exhibits
    
    
    35Signatures
    
    
    35




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##### 



PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements 
 Otter Tail Corporation
Consolidated Balance Sheets
(Unaudited)-Assets- September 30,
    
    December 31,2004
    
    2003(Thousands of dollars)Current assetsCash and cash equivalents
    
    $
    
    
    
    $
    7,305Accounts receivable:Tradenet
    
    
    115,028
    
    
    
    107,634Other
    
    
    4,356
    
    
    
    7,830Inventories
    
    
    78,187
    
    
    
    56,966Deferred income taxes
    
    
    2,928
    
    
    
    3,532Accrued utility revenues
    
    
    10,586
    
    
    
    14,866Costs and estimated earnings in
excess of billings
    
    
    19,680
    
    
    
    4,591Other
    
    
    10,229
    
    
    
    10,385Total current assets
    
    
    240,994
    
    
    
    213,109Investments and other assets
    
    
    45,452
    
    
    
    35,987Goodwillnet
    
    
    95,952
    
    
    
    72,556Other intangiblesnet
    
    
    21,211
    
    
    
    7,096Deferred debitsUnamortized debt expense and reacquisition premiums
    
    
    7,516
    
    
    
    8,081Regulatory assets
    
    
    14,228
    
    
    
    14,669Other
    
    
    1,671
    
    
    
    1,600Total deferred debits
    
    
    23,415
    
    
    
    24,350PlantElectric plant in service
    
    
    883,682
    
    
    
    875,364Nonelectric operations
    
    
    233,679
    
    
    
    193,858Total plant
    
    
    1,117,361
    
    
    
    1,069,222Less accumulated depreciation and amortization
    
    
    454,413
    
    
    
    453,791Plantnet of accumulated depreciation and amortization
    
    
    662,948
    
    
    
    615,431Construction work in progress
    
    
    25,049
    
    
    
    17,894Net plant
    
    
    687,997
    
    
    
    633,325Total
    
    $
    1,115,021
    
    
    $
    986,423
 See accompanying notes to consolidated financial statements - 2 -




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##### 



Otter Tail Corporation
Consolidated Balance Sheets
(Unaudited)-Liabilities- September 30,
    
    December 31,2004
    
    2003(Thousands of dollars)Current liabilitiesShort-term debt
    
    $
    115,757
    
    
    $
    30,000Current maturities of long-term debt
    
    
    8,723
    
    
    
    9,718Accounts payable
    
    
    76,389
    
    
    
    83,338Accrued salaries and wages
    
    
    16,374
    
    
    
    14,677Accrued federal and state income taxes
    
    
    7,415
    
    
    
    4,152Other accrued taxes
    
    
    9,241
    
    
    
    10,491Other accrued liabilities
    
    
    10,365
    
    
    
    10,003Total current liabilities
    
    
    244,264
    
    
    
    162,379Pensions benefit liability
    
    
    18,451
    
    
    
    16,919Other postretirement benefits liability
    
    
    25,001
    
    
    
    23,230Other noncurrent liabilities
    
    
    11,931
    
    
    
    11,102Deferred creditsDeferred income taxes
    
    
    120,625
    
    
    
    101,596Deferred investment tax credit
    
    
    10,766
    
    
    
    11,630Regulatory liabilities
    
    
    57,482
    
    
    
    42,926Other
    
    
    1,781
    
    
    
    2,061Total deferred credits
    
    
    190,654
    
    
    
    158,213CapitalizationLong-term debt, net of current maturities
    
    
    261,271
    
    
    
    265,193Class B stock options of subsidiary
    
    
    1,832
    
    
    
    Cumulative
preferred shares
authorized 1,500,000 shares without par value;
outstanding 2004 and 2003  155,000 shares
    
    
    15,500
    
    
    
    15,500Cumulative
preference shares  authorized 1,000,000
shares without par value; outstanding  none
    
    
    
    
    
    
    Common
shares, par value $5 per share
authorized 50,000,000 shares;
outstanding 2004  26,055,638 and 2003  25,723,814
    
    
    130,278
    
    
    
    128,619Premium on common shares
    
    
    31,226
    
    
    
    26,515Unearned compensation
    
    
    (2,902
    )
    
    
    (3,313
    )Retained earnings
    
    
    191,902
    
    
    
    186,495Accumulated other comprehensive loss
    
    
    (4,387
    )
    
    
    (4,429
    )Total common equity
    
    
    346,117
    
    
    
    333,887Total capitalization
    
    
    624,720
    
    
    
    614,580Total
    
    $
    1,115,021
    
    
    $
    986,423
 See accompanying notes to consolidated financial statements - 3 -




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##### 



Otter Tail Corporation
Consolidated Statements of Income
(Unaudited) Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(In thousands, except share and per share amounts)Operating revenues
    
    $
    222,263
    
    
    $
    200,895
    
    
    $
    640,056
    
    
    $
    553,101Operating expensesProduction fuel
    
    
    12,477
    
    
    
    14,307
    
    
    
    38,267
    
    
    
    37,980Purchased power  system use
    
    
    10,050
    
    
    
    5,671
    
    
    
    30,875
    
    
    
    24,985Other electric operation and maintenance expenses
    
    
    19,158
    
    
    
    24,054
    
    
    
    62,637
    
    
    
    65,522Cost of goods sold
    
    
    123,297
    
    
    
    101,320
    
    
    
    346,849
    
    
    
    269,698Other nonelectric expenses
    
    
    22,263
    
    
    
    18,964
    
    
    
    67,469
    
    
    
    57,596Depreciation and amortization
    
    
    11,585
    
    
    
    11,718
    
    
    
    33,990
    
    
    
    34,208Property taxes
    
    
    2,722
    
    
    
    2,553
    
    
    
    7,570
    
    
    
    7,591Total operating expenses
    
    
    201,552
    
    
    
    178,587
    
    
    
    587,657
    
    
    
    497,580Operating income
    
    
    20,711
    
    
    
    22,308
    
    
    
    52,399
    
    
    
    55,521Other income
    
    
    125
    
    
    
    9
    
    
    
    944
    
    
    
    1,277Interest charges
    
    
    4,640
    
    
    
    4,526
    
    
    
    13,439
    
    
    
    13,338Income before income taxes
    
    
    16,196
    
    
    
    17,791
    
    
    
    39,904
    
    
    
    43,460Income taxes
    
    
    5,170
    
    
    
    5,830
    
    
    
    12,587
    
    
    
    13,203Net income
    
    
    11,026
    
    
    
    11,961
    
    
    
    27,317
    
    
    
    30,257Preferred dividend requirements
    
    
    184
    
    
    
    184
    
    
    
    552
    
    
    
    552Earnings available for common shares
    
    $
    10,842
    
    
    $
    11,777
    
    
    $
    26,765
    
    
    $
    29,705Basic earnings per common share
    
    $
    0.42
    
    
    $
    0.46
    
    
    $
    1.03
    
    
    $
    1.16Diluted earnings per common share
    
    $
    0.42
    
    
    $
    0.46
    
    
    $
    1.03
    
    
    $
    1.15Average number of common shares outstanding  basic
    
    
    26,010,252
    
    
    
    25,708,199
    
    
    
    25,898,244
    
    
    
    25,657,717Average number of common shares outstanding  diluted
    
    
    26,121,911
    
    
    
    25,868,975
    
    
    
    26,019,550
    
    
    
    25,810,697Dividends per common share
    
    $
    0.275
    
    
    $
    0.270
    
    
    $
    0.825
    
    
    $
    0.810
 See accompanying notes to consolidated financial statements - 4 -




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##### 



Otter Tail Corporation
Consolidated Statements of Cash Flows
(Unaudited) Nine months endedSeptember 30,2004
    
    2003(Thousands of dollars)Cash flows from operating activitiesNet income
    
    $
    27,317
    
    
    $
    30,257Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    33,990
    
    
    
    34,208Deferred investment tax credit
    
    
    (864
    )
    
    
    (864
    )Deferred income taxes
    
    
    2,562
    
    
    
    4,628Change in deferred debits and other assets
    
    
    460
    
    
    
    (1,587
    )Discretionary contribution to pension plan
    
    
    (4,000
    )
    
    
    Change in noncurrent liabilities and deferred credits
    
    
    3,767
    
    
    
    5,397Allowance for equity (other) funds used during construction
    
    
    (573
    )
    
    
    (1,214
    )Unrealized losses (gains) on derivatives
    
    
    1,756
    
    
    
    (3,901
    )Other  net
    
    
    1,407
    
    
    
    1,330Cash provided by (used for) current assets & current liabilities:Change in receivables and inventories
    
    
    (8,276
    )
    
    
    (45,985
    )Change in other current assets
    
    
    (14,323
    )
    
    
    (12,164
    )Change in payables and other current liabilities
    
    
    (10,162
    )
    
    
    8,463Change in interest and income taxes payable
    
    
    4,169
    
    
    
    9,230Net cash provided by operating activities
    
    
    37,230
    
    
    
    27,798Cash flows from investing activitiesCapital expenditures
    
    
    (35,003
    )
    
    
    (35,827
    )Proceeds from disposal of noncurrent assets
    
    
    3,418
    
    
    
    931Acquisitions, net of cash acquired
    
    
    (69,069
    )
    
    
    (1,815
    )(Increases) decreases in other investments
    
    
    (8,267
    )
    
    
    1,129Net cash used in investing activities
    
    
    (108,921
    )
    
    
    (35,582
    )Cash flows from financing activitiesNet borrowings of short-term debt
    
    
    85,757
    
    
    
    7,181Proceeds from issuance of common stock, net of issuance expenses
    
    
    7,796
    
    
    
    829Proceeds from issuance of long-term debt
    
    
    540
    
    
    
    18,540Payments for retirement of common stock
    
    
    (349
    )
    
    
    Payments for retirement of long-term debt
    
    
    (7,527
    )
    
    
    (6,963
    )Dividends paid and other distributions
    
    
    (21,910
    )
    
    
    (21,740
    )Net cash provided by (used in) financing activities
    
    
    64,307
    
    
    
    (2,153
    )Effect of exchange rate fluctuations on cash
    
    
    79
    
    
    
    Net change in cash and cash equivalents
    
    
    (7,305
    )
    
    
    (9,937
    )Cash and cash equivalents at beginning of period
    
    
    7,305
    
    
    
    9,937Cash and cash equivalents at end of period
    
    $
    
    
    
    $
    Supplemental cash flow informationCash paid for interest and income taxesInterest  net of amount capitalized
    
    $
    9,929
    
    
    $
    10,347Income taxes
    
    $
    9,024
    
    
    $
    2,308
 See accompanying notes to consolidated financial statements - 5 -




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OTTER TAIL CORPORATION 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  In the opinion of management, Otter Tail Corporation (the Company) has included
all adjustments (including normal recurring accruals) necessary for a fair
presentation of the consolidated results of operations for the periods
presented. The consolidated financial statements and notes thereto should be
read in conjunction with the consolidated financial statements and notes as of
and for the years ended December 31, 2003, 2002 and 2001 included in the
Companys Annual Report on Form 10-K for the fiscal year ended December 31,
2003. Because of seasonal and other factors, the earnings for the three-month
and nine-month periods ended September 30, 2004, should not be taken as an
indication of earnings for all or any part of the balance of the year. Acquisition 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.
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 was not material to the
Company.
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, baked goods and frozen side dishes. 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 employs 380 across its
three production facilities and had revenues of $43.5 million for its fiscal
year ended July, 31, 2004. The acquisition was financed with proceeds from a
$76.0 million bridge loan from UBS Loan Finance LLC.

The Company plans to utilize its universal shelf registration filed
with the Securities and Exchange Commission to repay the bridge loan. IPH is
included in the other business operations segment. In connection with the acquisition, 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. 6




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##### 



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
    
    $
    17,150Plant
    
    
    37,376Goodwill
    
    
    23,019Other intangible assets
    
    
    14,545Total assets
    
    $
    92,090Liabilities and equityCurrent liabilities
    
    $
    5,673Deferred income taxes
    
    
    14,961Long-term debt
    
    
    1,987Class B common stock options
    
    
    1,832Equity
    
    
    67,637Total liabilities and equity
    
    $
    92,090
 Revenue Recognition Due to the diverse business operations of the Company, revenue recognition
depends on the product produced or 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 and determinable.
In cases where significant obligations remain after delivery, revenue is
deferred until such obligations are fulfilled. Provisions for sale returns and
warranty costs are recorded at the time of sale based on historical information
and current trends. Amounts received in advance under customer service
contracts are deferred and recognized on a straight-line basis over the
contract period. In the case of derivative instruments, such as the electric
utilitys forward energy contracts, the Company recognizes gains and losses
based on changes in the fair market value of derivative instruments over the
period held, and also when realized on settlement, on a net basis in revenue in
a manner prescribed by Emerging Issues Task Force (EITF) Issue 03-11. Gains and
losses subject to regulatory treatment on forward energy contracts are deferred
and recognized on a net basis in revenue in the period in which the contract
settles. For those operating businesses recognizing revenue when products are 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. 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 percentage of completion is based on
the ratio of costs incurred to total estimated costs. The following summarizes
costs incurred, billings and estimated earnings recognized on uncompleted
contracts: September 30,
    
    December 31,(in thousands)
    
    2004
    
    2003Costs incurred on uncompleted contracts
    
    $
    148,687
    
    
    $
    124,839Less billings to date
    
    
    (150,750
    )
    
    
    (137,881
    )Plus estimated earnings recognized
    
    
    18,046
    
    
    
    13,611Net costs and estimated earnings on uncompleted contracts
    
    $
    15,983
    
    
    $
    569
 7




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##### 



The following amounts are included in the Companys consolidated balance
sheets. Billings in excess of costs and estimated earnings on uncompleted
contracts are included in Accounts payable: September 30,
    
    December 31,(in thousands)
    
    2004
    
    2003Costs and estimated earnings in excess of billings on uncompleted contracts
    
    $
    19,680
    
    
    $
    4,591Billings in excess of costs and estimated earnings on uncompleted contracts
    
    
    (3,697
    )
    
    
    (4,022
    )Net costs and estimated earnings on uncompleted contracts
    
    $
    15,983
    
    
    $
    569
 The percent of revenue recognized under the percentage-of-completion method
compared to total consolidated revenues was 22.3% for the nine months ended
September 30, 2004 compared with 18.1% for the nine months ended September 30,
2003. The increase reflects the addition of $38.1 million in revenue in the
first nine months of 2004 related to the acquisition of Foley Company in
November 2003. Stock-based compensation The Company has elected to follow the accounting provisions of Accounting
Principle Board Opinion No. 25, Accounting for Stock Issued to Employees, for
stock-based compensation and to furnish the pro forma disclosures required
under Statement of Financial Accounting Standards (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 three and nine month periods ended September 30, 2004
and September 30, 2003 would have decreased as presented in the table below.
This may not be representative of the pro forma effects for future periods if
additional options are granted. Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,(in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Net incomeAs reported
    
    $
    11,026
    
    
    $
    11,961
    
    
    $
    27,317
    
    
    $
    30,257Total stock-based employee compensation
expense determined under fair value
based method for all awards net of
related tax effects
    
    
    (330
    )
    
    
    (260
    )
    
    
    (874
    )
    
    
    (725
    )Pro forma
    
    $
    10,696
    
    
    $
    11,701
    
    
    $
    26,443
    
    
    $
    29,532Basic earnings per shareAs reported
    
    $
    0.42
    
    
    $
    0.46
    
    
    $
    1.03
    
    
    $
    1.16Pro forma
    
    $
    0.40
    
    
    $
    0.45
    
    
    $
    1.00
    
    
    $
    1.13Diluted earnings per shareAs reported
    
    $
    0.42
    
    
    $
    0.46
    
    
    $
    1.03
    
    
    $
    1.15Pro forma
    
    $
    0.40
    
    
    $
    0.45
    
    
    $
    1.00
    
    
    $
    1.12
 Reclassifications Certain prior year amounts reported on the Companys consolidated statement of
income have been reclassified to conform to 2004 presentation. Such
reclassifications had no impact on net income, shareholders equity or cash
provided by operating activities. 8




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##### 



Inventories Inventories consist of the following: September 30,
    
    December 31,(in thousands)
    
    2004
    
    2003Finished goods
    
    $
    26,240
    
    
    $
    20,349Work in process
    
    
    4,430
    
    
    
    6,234Raw material, fuel and supplies
    
    
    47,517
    
    
    
    30,383$
    78,187
    
    
    $
    56,966
 Goodwill and Other Intangible Assets Goodwill increased $23,396,000 in the first nine months of 2004 primarily as a
result of $23,019,000 in goodwill related to the acquisition of IPH, in August
2004. The following table summarizes the components of the Companys other intangible
assets at September 30, 2004 and December 31, 2003. September 30, 2004
    
    December 31, 2003Gross
    
    
    
    
    
    Net
    
    Gross
    
    
    
    
    
    Netcarrying
    
    Accumulated
    
    carrying
    
    carrying
    
    Accumulated
    
    carrying(in thousands)
    
    amount
    
    amortization
    
    amount
    
    amount
    
    amortization
    
    amountAmortized intangible assets:Covenants not to compete
    
    $
    2,610
    
    
    $
    1,817
    
    
    $
    793
    
    
    $
    2,610
    
    
    $
    1,483
    
    
    $
    1,127Customer relationships
    
    
    9,700
    
    
    
    46
    
    
    
    9,654
    
    
    
    
    
    
    
    
    
    
    
    Other intangible assets including contracts
    
    
    4,328
    
    
    
    1,384
    
    
    
    2,944
    
    
    
    2,367
    
    
    
    1,118
    
    
    
    1,249Total
    
    $
    16,638
    
    
    $
    3,247
    
    
    $
    13,391
    
    
    $
    4,977
    
    
    $
    2,601
    
    
    $
    2,376Non-amortized intangible assets:Brand/trade names
    
    $
    7,820
    
    
    $
    
    
    
    $
    7,820
    
    
    $
    4,720
    
    
    $
    
    
    
    $
    4,720
 Intangible assets with finite lives are being amortized over average lives
ranging from one to five years, except Customer relationships which are being
amortized over twenty-five years. The amortization expense for these intangible
assets was $646,000 for the nine months ended September 30, 2004 compared to
$448,000 for the nine months ended September 30, 2003. The estimated annual
amortization expense for these intangible assets for the next five years is:
$1,020,000 for 2004, $1,281,000 for 2005, $1,144,000 for 2006, $1,021,000 for
2007 and $969,000 for 2008. New Accounting Standards 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. 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 $2.8 million as of September 30, 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. 9




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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. 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 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 will reduce its net periodic benefit cost for 2004 by
approximately $757,000 of which approximately 13.1% will be credited to capital
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 the net periodic benefit cost
in 2004. The adoption of FSP 106-2 had the effect of reducing 2004 year-to-date
operating expenses by $493,000 and third quarter 2004 operating expenses by
$164,000 as of September 30, 2004. 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. Segment Information The Companys business operations consist of five segments based on products
and services. 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 (PVC) and polyethylene (PE) 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, mobile diagnostic imaging, mobile 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 in residential, commercial and
industrial electric contracting industries; fiber optic and electric
distribution systems; waste-water, water and HVAC systems construction;
transportation; telecommunications; energy services and natural gas marketing;
potato dehydration and processing; and the portion of corporate general and
administrative expenses 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 6 Canadian provinces. The Companys
processor of dehydrated potato products operates dehydration plants in
Colorado, Idaho and Prince Edward Island, Canada, and sells its products in
domestic and foreign markets. 10




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##### 



Operating Revenue Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,(in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Electric
    
    $
    62,640
    
    
    $
    74,128
    
    
    $
    195,944
    
    
    $
    201,298Plastics
    
    
    27,574
    
    
    
    23,414
    
    
    
    86,646
    
    
    
    65,996Manufacturing
    
    
    57,760
    
    
    
    49,793
    
    
    
    160,656
    
    
    
    133,350Health services
    
    
    27,741
    
    
    
    25,908
    
    
    
    80,014
    
    
    
    73,138Other business operations
    
    
    47,215
    
    
    
    27,883
    
    
    
    118,706
    
    
    
    79,869Intersegment eliminations
    
    
    (667
    )
    
    
    (231
    )
    
    
    (1,910
    )
    
    
    (550
    )Total
    
    $
    222,263
    
    
    $
    200,895
    
    
    $
    640,056
    
    
    $
    553,101
 Operating Income (Loss) Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,(in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Electric
    
    $
    12,219
    
    
    $
    20,944
    
    
    $
    38,630
    
    
    $
    45,760Plastics
    
    
    2,138
    
    
    
    (205
    )
    
    
    7,459
    
    
    
    4,356Manufacturing
    
    
    4,478
    
    
    
    (56
    )
    
    
    8,574
    
    
    
    6,188Health services
    
    
    1,813
    
    
    
    1,874
    
    
    
    2,769
    
    
    
    3,451Other business operations
    
    
    63
    
    
    
    (249
    )
    
    
    (5,033
    )
    
    
    (4,234
    )Total
    
    $
    20,711
    
    
    $
    22,308
    
    
    $
    52,399
    
    
    $
    55,521
 Identifiable Assets September 30,
    
    December 31,(in thousands)
    
    2004
    
    2003Electric
    
    $
    618,437
    
    
    $
    609,190Plastics
    
    
    64,980
    
    
    
    58,538Manufacturing
    
    
    166,391
    
    
    
    138,493Health services
    
    
    66,369
    
    
    
    67,587Other business operations
    
    
    198,844
    
    
    
    112,615Total
    
    $
    1,115,021
    
    
    $
    986,423
 Substantially all of the Companys long-lived assets are within the United
States except for a potato processing dehydration plant in Souris, Prince
Edward Island, Canada. For the three months ended September 30, 2004,
substantially all of the Companys consolidated revenue came from sales within
the United States. For the nine months ended September 30, 2004,
96.8% of the
Companys consolidated revenue came from sales within the United States and
2.6% came from sales in Canada. Common Shares and Earnings per Share On April 12, 2004 the Companys Board of Directors granted 72,400 stock options
to key employees and 17,050 shares of restricted stock to the directors and
certain key employees under the 1999 Stock Incentive Plan (the Plan). The
exercise price of the stock options is equal to the fair market value per share
at the date of the grant. The options vest six months from the grant date and
expire ten years after the date of the grant. As of 11




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##### 



September 30, 2004 a total
of 1,552,999 options were outstanding and a total of 214,434 shares of
restricted stock had been issued under the Plan. The Company accounts for the
Plan under Accounting Principles Board Opinion No. 25. On April 12, 2004 the Companys Board of Directors granted performance-based
stock incentive awards to the Companys executive officers under the Plan.
Under these awards, the officers could earn up to an aggregate of 70,500 shares
of the Companys 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. 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. Comprehensive Income Comprehensive income for the three months ended September 30, 2004 includes
$49,000 in foreign currency translation gains, net-of-tax, related to the
Canadian operations of IPH, $13,000 in unrealized gains, net-of-tax, on
investments in available-for-sale securities and net income of $11.0 million as
compared to $12.0 million of net income for the three months ended September
30, 2003. Comprehensive income for the nine months ended September 30, 2004 includes
$49,000 in foreign currency translation gains, net-of-tax, related to the
Canadian operations of IPH, $7,000 in unrealized losses, net-of-tax, on
investments in available-for-sale securities and net income of $27.3 million as
compared to $30.3 million of net income for the nine months ended September 30,
2003. 12




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##### 



Regulatory Assets and Liabilities As a regulated entity the Company and the electric utility account for the
financial effects of regulation in accordance with SFAS No. 71, Accounting for
the Effect of Certain Types of Regulation. This accounting standard allows for
the recording of a regulatory asset or liability for costs that will be
collected or refunded in the future as required under regulation. The following table indicates the amount of regulatory assets and liabilities
recorded on the Companys consolidated balance sheet: September 30,
    
    December 31,(in thousands)
    
    2004
    
    2003Regulatory assets:Deferred income taxes
    
    $
    13,678
    
    
    $
    12,750Debt expenses and reacquisition premiums
    
    
    3,534
    
    
    
    3,863Deferred conservation program costs
    
    
    1,045
    
    
    
    882Plant acquisition costs
    
    
    251
    
    
    
    285Deferred marked-to-market losses
    
    
    341
    
    
    
    1,802Accrued cost-of-energy revenue
    
    
    2,493
    
    
    
    3,693Accumulated ARO accretion/depreciation adjustment
    
    
    209
    
    
    
    117Total regulatory assets
    
    $
    21,551
    
    
    $
    23,392Regulatory liabilities:Accumulated reserve for estimated removal costs
    
    $
    49,682
    
    
    $
    33,579Deferred income taxes
    
    
    6,943
    
    
    
    7,496Deferred marked-to-market gains
    
    
    694
    
    
    
    1,684Gain on sale of division office building
    
    
    163
    
    
    
    167Total regulatory liabilities
    
    $
    57,482
    
    
    $
    42,926Net regulatory liability position
    
    $
    35,931
    
    
    $
    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 17.8 years. Deferred conservation program costs included in
Deferred debits  Other represent mandated conservation expenditures
recoverable through retail electric rates over the next 1.5 years. Plant
acquisition costs included in Deferred debits  Other will be amortized over
the next 5.7 years. Accrued cost-of-energy revenue included in Accrued utility
revenues will 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 from October 2004 through May 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 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. 13




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##### 



Pension Plan and Other Postretirement Benefits Pension PlanComponents of net periodic pension benefit cost of the Companys
noncontributory funded pension plan are as follows: Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,(in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Service costbenefit earned during the period
    
    $
    1,247
    
    
    $
    945
    
    
    $
    3,047
    
    
    $
    2,835Interest cost on projected benefit obligation
    
    
    2,393
    
    
    
    2,373
    
    
    
    7,093
    
    
    
    7,119Expected return on assets
    
    
    (3,314
    )
    
    
    (3,233
    )
    
    
    (9,314
    )
    
    
    (9,699
    )Amortization of prior-service cost
    
    
    223
    
    
    
    292
    
    
    
    673
    
    
    
    877Net periodic pension cost
    
    $
    549
    
    
    $
    377
    
    
    $
    1,499
    
    
    $
    1,132
 Cash Flows: The Company made $4.0 million in discretionary contributions to the
pension plan during the nine months ended September 30, 2004. The Company does
not intend to make any additional contributions in the fourth quarter of 2004. Executive Survivor and Supplemental Retirement PlanComponents of net periodic
pension benefit cost of the Companys unfunded, nonqualified benefit plan for
executive officers and certain key management employees are as follows: Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,(in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Service costbenefit earned during the period
    
    $
    205
    
    
    $
    104
    
    
    $
    615
    
    
    $
    312Interest cost on projected benefit obligation
    
    
    372
    
    
    
    356
    
    
    
    1,116
    
    
    
    1,069Amortization of prior-service cost
    
    
    37
    
    
    
    37
    
    
    
    111
    
    
    
    111Recognized net actuarial loss
    
    
    170
    
    
    
    144
    
    
    
    510
    
    
    
    430Net periodic pension cost
    
    $
    784
    
    
    $
    641
    
    
    $
    2,352
    
    
    $
    1,922
 Postretirement BenefitsComponents of net periodic postretirement benefit cost
for health insurance and life insurance benefits for retired electric utility
and corporate employees are as follows: Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,(in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Service costbenefit earned during the period
    
    $
    299
    
    
    $
    252
    
    
    $
    876
    
    
    $
    756Interest cost on projected benefit obligation
    
    
    645
    
    
    
    655
    
    
    
    1,935
    
    
    
    1,965Amortization of transition obligation
    
    
    184
    
    
    
    187
    
    
    
    561
    
    
    
    561Amortization of prior-service cost
    
    
    (74
    )
    
    
    (76
    )
    
    
    (228
    )
    
    
    (228
    )Amortization of net actuarial loss
    
    
    182
    
    
    
    177
    
    
    
    525
    
    
    
    531Effect of Medicare Part D expected subsidy
    
    
    (189
    )
    
    
    
    
    
    
    (567
    )
    
    
    Net periodic postretirement benefit cost
    
    $
    1,047
    
    
    $
    1,195
    
    
    $
    3,102
    
    
    $
    3,585
 Subsequent Events In October 2004, the Company amended the terms of its $70 million line of
credit agreement solely to remove a ratings trigger that would require
accelerated repayment of any outstanding balance on its $70 million line of
credit if the Companys senior unsecured debt is rated below Baa3 (Moodys) or
BBB- (Standard and Poors). The removal of the ratings trigger resulted in no
changes to interest rates and no material changes to other terms of the
agreement. 14




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##### 



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 following lenders: The Prudential
Life Insurance Company; Hartford Life Insurance Company; Medica Health Plan;
General Electric Capital Assurance Company; GE Capital Life Assurance Company
of New York; First Colony Life Insurance Company; Treasurer of The State of
South Carolina South Carolina Retirement System; AIG Edison Life Insurance
Company and Country Life Insurance Company 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
and Poors). The Company has no other relationships with these lenders. The
amendment resulted in no changes to interest rates and no material changes to
other terms of the agreement. As part of an ongoing evaluation of the prospects and growth opportunities of
its business operations, the Company has decided to exit its telecommunications
business (Midwest Information Systems, Inc.) and focus on growing other parts
of the Companys business operations. The Company has engaged Robert W. Baird &
Co. as its financial advisor to assist in the marketing process. This business
is expected to generate $5.1 million in earnings before interest, taxes and
depreciation for the year ending December 31, 2004 and has shareholders equity
of $13.6 million. On November 1, 2004, the Companys Board of Directors declared a quarterly
common stock dividend of 27.5 cents per share payable on December 10, 2004 to
shareholders of record on November 15, 2004. The Board also declared quarterly
dividends on the Companys four series of preferred shares. 
 Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations MATERIAL CHANGES IN FINANCIAL POSITION For the period 2004 through 2008, the Company estimates that funds internally
generated net of forecasted dividend payments will be sufficient to meet
scheduled debt retirements, provide for its estimated consolidated capital
expenditures and repay its currently outstanding short-term debt, except for
its $76 million bridge loan from UBS Loan Finance LLC. The Company has filed a
universal shelf registration with the Securities and Exchange Commission and
intends to utilize it to refinance the bridge loan. Reduced demand for
electricity, reductions in wholesale sales of electricity or margins on
wholesale sales, or declines in the number of products manufactured and sold by
the Company could have an effect on funds internally generated. Additional
equity or debt financing will be required in the period 2004 through 2008 in
the event the Company decides to refund or retire early any of its other
presently outstanding debt or cumulative preferred shares, to complete
acquisitions 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 the Company. If adequate funds are
not available on acceptable terms, the Companys business, results of
operations, and financial condition could be adversely affected. The Company began issuing new shares of common stock in January 2004 to meet
the requirements of its automatic dividend reinvestment and share purchase plan
and its employee stock purchase plan, rather than purchasing shares on the open
market. As a result, the Company issued 283,517 common shares and received $7.2
million in cash from the issuance of stock in the first nine months of 2004. On
November 1, 2004, the Company reverted to buying shares of its common stock on
the open market to meet the requirements of its automatic dividend reinvestment
and share purchase plan and its employee stock purchase plan. The Company also
received $0.7 million in cash from the issuance of 37,522 shares of common
stock for stock options exercised in the first nine months of 2004. On August 16, 2004 the Company borrowed $76.0 million of unsecured and
unsubordinated debt from UBS Loan Finance LLC to finance the acquisition of
IPH. The debt is due on August 12, 2005 and bears interest at LIBOR plus 0.5%. 15




---



##### 



The Company has filed a universal shelf registration statement with the
Securities and Exchange Commission that gives the Company the ability to issue
up to $335 million of common stock, preferred stock, debt and certain other
securities from time to time. The Company plans on utilizing the universal
shelf registration to refinance its $76 million bridge loan from UBS Loan
Finance LLC. 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 and 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 0.5%, subject to adjustment based on the
ratings of the Companys senior unsecured debt. This line is available to
support borrowings of the Companys nonelectric operations. The Company
anticipates that the electric utilitys cash requirements through April 2005
will be provided for by cash flows from electric utility operations. As of
September 30, 2004, $39.8 million of the Companys $70 million line of credit
was in use. 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. The Companys $76 million bridge loan from UBS Loan Finance LLC, its $70
million line of credit, its $90 million 6.63% senior notes and its $16.3
million note with Lombard US Equipment Finance 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. As
of September 30, 2004 the Company was in compliance with all of the covenants
under these financing agreements. In October 2004, the Company
also amended terms on its $90 million 6.63% senior notes to
remove a ratings trigger 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 and Poors). The Companys current securities ratings are: MoodysInvestors
    
    StandardService
    
    & PoorsSenior unsecured debt
    
    
    A2
    
    
    
    A-Preferred stock
    
    Baa1
    
    BBBOutlook
    
    Negative
    
    Negative
 The Companys disclosure of these securities ratings is not a recommendation to
buy, sell or hold its securities. Downgrades in these securities ratings could
adversely affect the Company. Further downgrades could increase borrowing costs
resulting in possible reductions to net income in future periods and increase
the risk of default on the Companys debt obligations. Net cash provided by operating activities increased $9.4 million for the nine
months ended September 30, 2004 compared to the nine months ended September 30,
2003 primarily as a result of a $35.5 million decrease in cash used for
receivables, inventories and other current assets, offset by a $23.7 million
increase in cash used to reduce payables and other current liabilities
including interest and income taxes payable. A reduction in net income of $2.9
million between the periods and $4.0 million in discretionary contributions to
the Companys pension plan in the first nine months of 2004 were partially
offset by an increase in noncash adjustments to net income of $5.7 million
related to mark-to-market accounting for forward energy contracts classified as
derivatives. An increase in other current assets of $14.3 million from December 31, 2003 to
September 30, 2004 is mainly due to an increase in costs and estimated earnings
in excess of billings at the Companys manufacturers of wind towers and
structural steel products, $13.8 million of which is at the wind tower
manufacturer located in West Fargo, North Dakota on contracts totaling $40
million that, in aggregate, are estimated to be 65% complete. 16




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##### 



Excluding $11.0 million in inventories acquired in the acquisition of IPH,
inventories increased by $10.2 million from December 31, 2003 to September 30,
2004. The increase in inventories in the first nine months of 2004 reflects
$7.8 million in increased inventories in the manufacturing segment related to
increases in steel prices and increased production activity and $2.0 million in
increased inventories in the plastics segment. Inventory at the metal parts
stamping and fabrication company increased $3.2 million related to a build-up
of work in process and finished goods inventory for customers forecasted
production needs. Inventory at St. George Steel, the structural steel products
and wind tower manufacturer located in Utah, increased $2.6 million in
connection with a large wind tower project scheduled for completion in
December. Inventory at the Companys manufacturer of waterfront equipment
increased $2.0 million. Inventories in the plastics segment increased $2.0
million despite a 9.7% decrease in the volume of finished goods in inventory as
a result of increases in raw material costs. Average resin prices increased
19.5% from December 2003 to September 2004. Excluding a $5.9 million increase in receivables from the acquisition of IPH,
consolidated receivables decreased by $1.9 million from December 31, 2003 to
September 30, 2004. A $4.3 million increase in receivables at the plastic pipe
companies reflects increased sales and increased prices in the plastics segment
from December 2003 to September 2004. The average price per pound of plastic
pipe sold was 31% higher in the third quarter of 2004 than in the fourth
quarter of 2003. A $3.8 million decrease in receivables in the electric utility
segment is mainly due to a reduction in contracted electrical construction work
from December 31, 2003 to September 30, 2004. Electric segment receivables at
year end 2003 included billings for a large wind tower project completed in the
fourth quarter of 2003. Receivables in the health services segment decreased
$1.4 million in the first nine months of 2004 and receivables at the energy
services company decreased by $0.6 million in the first nine months of 2004 as
a result of a reduction in natural gas consumption between winter and summer
seasons. Excluding a $4.4 million increase from the acquisition of IPH, consolidated
accounts payable and other current liabilities decreased by $10.2 million from
December 31, 2003 to September 30, 2004. Electric utility payables decreased
$12.3 million reflecting an $8.2 million reduction in purchased power payables
related to a seasonal decrease in demand between December and September, a $1.9
million reduction in property taxes payable related to the timing of property
tax payments and a $1.5 million reduction in accrued salaries and wages mainly
related to the payment of 2003 accrued bonuses and incentives in the first
quarter of 2004 and a decrease in year-to-date bonus accruals in 2004 compared
to 2003 as a result of decreased earnings between the periods. The plastic pipe
companies payables and other current liabilities decreased by $10.7 million
mainly related to payments made on raw materials purchased prior to December
31, 2003. Accounts payable and other current liabilities increased $5.8 million
at the manufacturing companies: $2.6 million at the manufacturers of wind
towers
and structural steel products, $1.8 million at the metal parts stamping and
fabrication company, $1.1 million at the manufacturer of waterfront equipment,
and $0.3 million at the other manufacturing companies. Health services accounts
payable and other current liabilities increased $2.2 million from December 31,
2003 to September 30, 2004. In the other business segment construction company
payables and other current liabilities increased by $1.0 million from December
31, 2003 to September 30, 2004. Net cash used in investing activities was $108.9 million for the nine months
ended September 30, 2004 compared to net cash used in investing activities of
$35.6 million for the nine months ended September 30, 2003. The variance
reflects a $67.3 million increase in cash paid for acquisitions and a $9.4
million increase in cash used for other investments mostly related to the
acquisition of IPH. Proceeds from the disposal of noncurrent assets increased
$2.5 million for the nine months ended September 30, 2004 compared with the
nine months ended September 30, 2003. The increase reflects the proceeds from
the sale of the Fargo-Moorhead RedHawks baseball team, the sale of used
diagnostic imaging equipment in the second and third quarters of 2004 and the
sale of Dakota Direct Controls, an energy management consulting firm located in
Sioux Falls, South Dakota, in the first quarter of 2004. Capital expenditures
decreased by $0.8 million between the periods. Capital expenditures at the
electric utility decreased by $1.9 million between the periods related to the
completion of the Solway gas-fired combustion turbine in June 2003. The plastic
segments capital expenditures decreased by $1.5 million between the periods
related to the completion of the new production facility in Hampton, Iowa in
2003. Capital expenditures at the manufacturing 17




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##### 



companies increased $4.0
million between the periods mainly related to new equipment purchases at the
waterfront equipment company and the metal parts stamping and fabrication
company. Capital expenditures at the health services companies decreased by
$1.6 million between the periods. Capital expenditures in the other business
segment increased by $0.2 million between the periods. Net cash provided by financing activities was $64.3 million for the nine months
ended September 30, 2004 compared with $2.2 million in net cash used in
financing activities for the nine months ended September 30, 2003. The increase
reflects the $76.0 million bridge loan used to finance the acquisition of IPH
in August 2004, a $2.6 million increase in borrowings under the Companys line
of credit and a $6.6 million increase in proceeds from the issuance of common
stock under the automatic dividend reinvestment and share purchase plan, the
employee stock purchase plan and from stock options exercised in the first nine
months of 2004 net of payments for the retirement of common stock. A decrease
of $18.0 million in proceeds from the issuance of long-term debt was related
primarily to the Lombard US Equipment Finance note issued in 2003. Contractual Obligations There have been no material changes in the Companys contractual obligations on
long-term debt, construction program commitments, capacity and energy
requirements or other purchase obligations from those reported in the Companys
Annual Report on Form 10-K for the year ended December 31, 2003. The electric
utilitys operating lease for rail cars used to ship coal to Hoot Lake Plant
expired on July 31, 2004. In August 2004, the electric utility entered into a
new agreement for the lease of 170 rail cars for the shipment of coal to Hoot
Lake Plant. The new lease term runs for 37 months through August 31, 2007 with
lease payments totaling $0.3 million in 2004, $0.7 million in 2005, $0.7
million in 2006 and $0.5 million in 2007. In September 2004, the Companys
health services company, DMS Imaging, Inc., signed agreements under an existing
master lease agreement for the lease of new imaging equipment. The terms of the
agreements range from 3.5 years to 6 years with lease payments totaling $2.4
million in 2004, $4.8 million in 2005, $4.8 million in 2006, $4.8 million in
2007, $3.8 million in 2008 and $3.5 million in the years after 2008. Also in the third quarter of 2004, the electric utility entered into an
agreement with Kennecott Coal Sales Company for the purchase of subbituminous
coal to be burned at its Hoot Lake Plant from July 1, 2004 through December 31,
2007. In July 2004, the electric utility signed separate agreements with both
Kennecott Coal Sales Company and Arch Coal Sales Company, Inc., for the
purchase of subbituminous coal to be burned at the Big Stone Plant from January
1, 2005 through December 31, 2007. The effect of these changes on the Companys
obligations disclosed under coal contracts in its 2003 Annual Report on Form
10-K as of December 31, 2003 over the period 2005 through 2007 will be to
increase those obligations by $15.7 million in 2005, $16.5 million in 2006 and
$15.7 million in 2007. For more information on contractual obligations and
commitments, see Item 7 in the Companys Annual Report on Form 10-K for the
year ended December 31, 2003. The electric utilitys transportation agreement with Burlington Northern Santa
Fe Railroad (BNSF) for the shipment of coal to Hoot Lake Plant expired on July
31, 2004. As of August 1, 2004, coal is being transported to Hoot Lake Plant
under general tariff rates for the shipment of subbituminous coal within the
United States. The electric utility is currently in the process of negotiating
a new agreement with BNSF for the shipment of coal to its Hoot Lake Plant. As disclosed in the Companys Annual Report on Form 10-K for the year ended
December 31, 2003, the Company does not have any material off-balance-sheet
arrangements or any material relationships with unconsolidated entities or
financial partnerships. 18




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##### 



MATERIAL CHANGES IN RESULTS OF OPERATIONS Comparison of the Three Months Ended September 30, 2004 and 2003 Consolidated Results of Operations Total operating revenues were $222.3 million for the three months ended
September 30, 2004 compared with
$200.9 million for the three months ended September 30, 2003. Operating income
was $20.7 million for the three months ended September 30, 2004 compared with
$22.3 million for the three months ended September 30, 2003. The Company
recorded diluted earnings per share of $0.42 for the three months ended
September 30, 2004 compared to $0.46 for the three months ended September 30,
2003. Following is a discussion of the results of operations by segment. Amounts presented in the following tables for the three month periods ended
September 30, 2004 and 2003 for operating revenues, cost of goods sold and
nonelectric segment operating expenses will not agree with amounts presented in
the consolidated statements of income for those periods due to the elimination
of intersegment transactions. The total intersegment eliminations include:
$667,000 in operating revenues, $49,000 in cost of goods sold and $618,000 in
other nonelectric expenses for the three months ended September 30, 2004; and
$231,000 in operating revenues, $132,000 in cost of goods sold and $99,000 in
other nonelectric expenses for the three months ended September 30, 2003. Electric Three months endedSeptember 30,(in thousands)
    
    2004
    
    2003
    
    ChangeRetail sales revenues
    
    $
    51,972
    
    
    $
    51,023
    
    
    $
    949Wholesale revenues:Sales from company-owned generation
    
    
    6,295
    
    
    
    7,749
    
    
    
    (1,454
    )Net margins on purchased power resold
    
    
    1,513
    
    
    
    2,895
    
    
    
    (1,382
    )Net marked-to-market (losses)/gains
    
    
    (931
    )
    
    
    3,901
    
    
    
    (4,832
    )Other revenues
    
    
    3,791
    
    
    
    8,560
    
    
    
    (4,769
    )Total operating revenues
    
    $
    62,640
    
    
    $
    74,128
    
    
    $
    (11,488
    )Production fuel
    
    
    12,477
    
    
    
    14,307
    
    
    
    (1,830
    )Purchased power  system use
    
    
    10,050
    
    
    
    5,671
    
    
    
    4,379Other electric operation and maintenance expenses
    
    
    19,158
    
    
    
    24,054
    
    
    
    (4,896
    )Depreciation and amortization
    
    
    6,014
    
    
    
    6,599
    
    
    
    (585
    )Property taxes
    
    
    2,722
    
    
    
    2,553
    
    
    
    169Operating income
    
    $
    12,219
    
    
    $
    20,944
    
    
    $
    (8,725
    )
 Retail revenue increased 1.9% on a 6.1% decrease in megawatt hour (mwh) sales
in the three months ended September 30, 2004 compared to the three months ended
September 30, 2003. The converse relationship is due to a $2.2 million increase
in cost-of-energy adjustment revenues between the quarters as average costs of
fuel and purchased power per mwh related to retail sales increased 25.8%
between the periods. A 77% reduction in cooling degree-days between the
quarters was a significant contributing factor to the decrease in mwh sales.
Residential mwh sales decreased 12.0% and commercial sales decreased 4.0%.
Industrial mwh sales decreased 2.5% while industrial revenues increased $0.9
million between the quarters as a function of the electric rates designed for
large industrial customers. 19




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##### 



The 18.8% decrease in revenue from wholesale electric sales from company-owned
generation reflects a 30.2% decrease in mwhs sold as a result of a combination
of lower demand for electricity due to milder weather in the region in the
third quarter of 2004 compared to the third quarter of 2003 and a reduction in
available generation in the summer of 2004 due to turbine blade failure at Hoot
Lake Unit 3 which caused the plant to be off-line for repairs for five weeks
in July and August. For the third quarter of 2004 compared with the third
quarter of 2003, mwh production at Hoot Lake Plant decreased 34.9%. The Company adopted mark-to-market accounting in the third quarter of 2003 with
the issuance of SFAS No. 149, which eliminated application of the normal
purchases and sales exception to the Companys forward energy contracts which
generally result in physical settlement but are subject to net settlement. On
adoption of SFAS No. 149, the Company recognized $3.9 million ($0.09 of
earnings per diluted share) in net mark-to-market gains on open forward
contracts for the purchase and sale of electricity as of September 30, 2003. Net margins at market prices on energy contracts settled in the third quarter
of 2004 totaled $1,513,000 at the time of settlement. Net margins at contract
prices on resales of purchased power in the third quarter of 2003 totaled
$2,895,000. As a result of the new mark-to-market accounting method, wholesale
margins from the resale of purchased power at market prices in the third
quarter of 2004 are not comparable to margins recorded at contract prices on
the resale of purchased power in the third quarter of 2003. The $931,000 in net
marked-to-market losses recognized on forward energy contracts in the third
quarter of 2004 was comprised of $444,000 in unrealized net losses and $487,000
in net marked-to-market losses realized during the quarter on contracts settled
in the quarter. The $4.8 million decrease in other electric operating revenues for the three
months ended September 30, 2004 compared to the three months ended September
30, 2003 is mainly due to a $5.2 million decrease in contracted construction
services revenue primarily related to the completion of a large wind-farm
project in North Dakota in 2003, offset by a $0.4 million increase in revenues
from electric transmission related services. Fuel costs decreased by 12.8% for the three months ended September 30, 2004
compared with the three months ended September 30, 2003 as a result of a 14.3%
decrease in generation partially offset by a 2.0% increase in the cost of fuel
per mwh generated. The decrease in generation corresponds to an 11.5% decrease
in mwhs generated for retail sales and a 30.2% decrease in mwhs generated for
resale between the periods. The 2.0% increase in the fuel cost per mwh
generated is reflective of a reduction in efficiencies related to lower levels
of generation especially at Hoot Lake Unit 3 which was off-line for five weeks
in July and August to repair a damaged turbine. Generation at Hoot Lake Plant
for the three months ended September 30, 2004 compared with the three months
ended September 30, 2003 decreased 34.9% while the cost per mwh generated at
Hoot Lake increased by 13.1%. Generation at the electric utilitys Big Stone
Plant decreased 9.6% while the fuel cost per mwh generated at the plant
increased 4.3% due to increased fuel and freight costs. Purchased power expense for energy purchased for system use (sale to retail
customers) increased 77.2% for the three months ended September 30, 2004
compared with the three months ended September 30, 2003 as a result of a 54.2%
increase in mwhs purchased combined with a 14.9% increase in the cost per mwh
purchased. The increase in mwhs purchased for system use is related to the
decrease in mwhs generated for system use while Hoot Lake Plants Unit 3 was
down for repairs. The 20.4% decrease in other electric operation and maintenance expenses for the
three months ended September 30, 2004 compared with the three months ended
September 30, 2003 reflects a $2.2 million decrease related to significantly
less contracted electrical construction work performed for others between the
periods and $2.4 million in lower employee benefit expenses in the third
quarter of 2004 compared to the third quarter of 2003. The 8.9% decrease in
depreciation expense is related to an annual depreciation study and
depreciation rates approved by the Minnesota Public Utilities Commission. 20




---



##### 



Plastics Three months endedSeptember 30,(in thousands)
    
    2004
    
    2003
    
    ChangeOperating revenues
    
    $
    27,574
    
    
    $
    23,414
    
    
    $
    4,160Cost of goods sold
    
    
    23,401
    
    
    
    22,043
    
    
    
    1,358Operating expenses
    
    
    1,466
    
    
    
    1,023
    
    
    
    443Depreciation and amortization
    
    
    569
    
    
    
    553
    
    
    
    16Operating income (loss)
    
    $
    2,138
    
    
    $
    (205
    )
    
    $
    2,343
 Plastics operating revenues for the three months ended September 30, 2004
compared with the three months ended September 30, 2003 increased 17.8% despite
a 10.7% reduction in pounds of polyvinyl chloride (PVC) pipe sold between the
periods as a result of a 31.9% increase in the price per pound of PVC pipe
sold. The price increase and its impact on revenue more than offset an 18.9%
increase in the cost per pound of PVC pipe sold and a $443,000 increase in
operating expenses, resulting in a $2.3 million increase in plastics operating
income. The cost per pound of resin, the raw material used to produce PVC pipe,
increased 23.2% between the periods. Gross margins on pipe sold increased $2.8
million and the gross margin per pound increased 238% between the periods. The
43.3% increase in plastics operating expenses is mainly due to increases in
salaries and sales commissions related to the increases in profitability,
increased employee benefit expenses, and increased building rent and property
tax expenses. Manufacturing Three months endedSeptember 30,(in thousands)
    
    2004
    
    2003
    
    ChangeOperating revenues
    
    $
    57,760
    
    
    $
    49,793
    
    
    $
    7,967Cost of goods sold
    
    
    45,375
    
    
    
    42,467
    
    
    
    2,908Operating expenses
    
    
    5,743
    
    
    
    5,332
    
    
    
    411Depreciation and amortization
    
    
    2,164
    
    
    
    2,050
    
    
    
    114Operating income (loss)
    
    $
    4,478
    
    
    $
    (56
    )
    
    $
    4,534
 The manufacturing segments improved performance for the three months ended
September 30, 2004 compared with the three months ended September 30, 2003 is
due 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 16.0% increase in operating revenues reflects revenue
increases of $5.4 million from the metal parts stamping and fabrication
company, $2.7 million from the manufacturer of thermoformed plastic and
horticultural products, $1.4 million from the waterfront equipment company and
$1.1 million from the manufacturer of structural steel products, offset by a
$2.6 million decrease in revenue from the manufacturer of wind towers. The
revenue increase at the metal parts stamping and fabrication company is mainly
attributable to an increase in stamping, fabrication and prototyping
activities. The revenue increase at the manufacturer of thermoformed plastic
and horticultural products reflects a 23.4% increase in the volume of all
products sold and a 22.6% increase in the average price per unit sold between
the periods. The increase in revenue from the waterfront equipment company
reflects increased sales of residential and commercial products as a result of
increased advertising, new products and dealership expansion that is partly
attributable to the acquisition of Missouri-based Galva Foam in October 2002.
The increase in revenue at the manufacturer of structural steel products is due
to an increase in the volume of work performed between the periods. The
decrease in revenues from the manufacturer of wind towers reflects a reduction
in product sales between the periods due to the delay in the renewal of the
expired federal production tax credit for wind energy signed into law in
October 2004. 21




---



##### 



Increased revenues in the manufacturing segment were only partially offset by a
6.8% increase in cost of goods sold for the three months ended September 30,
2004 compared with the three months ended September 30, 2003. The increase in
cost of goods sold primarily reflects increased costs of $4.0 million at the
metal parts stamping and fabrication company, $1.5 million at the manufacturer
of thermoformed plastic and horticultural products, $1.4 million at the
waterfront equipment company and $0.7 million at the manufacturer of structural
steel products, offset by a $4.6 million decrease in cost of goods sold at the
manufacturer of wind towers. Revenue increases at the metal parts stamping and
fabrication company and the thermoformed plastic and horticultural products
company exceeded the increases in cost of goods sold at these companies as they
were able to cover raw material cost increases through price increases in the
third quarter of 2004 resulting in greater profitability from work completed in
the third quarter of 2004 compared to third quarter of 2003. The increase in
costs at the manufacturer of structural steel products resulted from an
increase in the volume of work completed between the quarters and was
proportional to its increase in revenue, resulting in a $0.4 million increase
in gross profits between the periods. The decrease in cost of goods sold at the
wind tower manufacturer reflects third quarter 2003 costs of goods sold that
were in excess of third quarter 2003
revenues which contributed to $1.4 million in operating losses in the third
quarter of 2003 compared with $0.8 million in operating income in the third
quarter of 2004. The 7.7% increase in manufacturing operating expenses for the three months
ended September 30, 2004 compared with the three months ended September 30,
2003 is mainly due to an increase in incentive compensation accruals at the
metal parts stamping and fabrication company, increases in incentive
compensation accruals and equipment maintenance costs at the thermoformed
plastic and horticultural products company and increased sales commissions at
the waterfront equipment company. The 5.5% increase in depreciation and
amortization expenses between the periods is the result of plant additions and
expansion of manufacturing capacity. Health Services Three months endedSeptember 30,(in thousands)
    
    2004
    
    2003
    
    ChangeOperating revenues
    
    $
    27,741
    
    
    $
    25,908
    
    
    $
    1,833Cost of goods sold
    
    
    20,202
    
    
    
    19,326
    
    
    
    876Operating expenses
    
    
    4,487
    
    
    
    3,372
    
    
    
    1,115Depreciation and amortization
    
    
    1,239
    
    
    
    1,336
    
    
    
    (97
    )Operating income
    
    $
    1,813
    
    
    $
    1,874
    
    
    $
    (61
    )
 The 7.1% increase in health services operating revenues for the three months
ended September 30, 2004 compared with the three months ended September 30,
2003 reflects $1.3 million in additional revenue from the sale and servicing of
diagnostic imaging equipment and $0.5 million in additional revenue from
scanning services. The number of scans performed decreased 2.6% while the
average fee per scan increased 1.3% between the periods. The $1.8 million
increase in operating revenues between the quarters was offset by increases of
$0.9 million in cost of goods sold and $1.1 million in operating expenses. The 4.5% increase in cost of goods sold for the three months ended September
30, 2004 compared with the three months ended September 30, 2003 was
commensurate with the increases in equipment sales and service revenues between
the periods. The 33.1% increase in operating expenses between the periods is
mainly due to increases in sales and marketing related expenses including
salaries. The imaging business was also impacted by increased labor costs due
to a shortage of technologists.  22




---



##### 



Other Business Operations Three months endedSeptember 30,(in thousands)
    
    2004
    
    2003
    
    ChangeOperating revenues
    
    $
    47,215
    
    
    $
    27,883
    
    
    $
    19,332Cost of goods sold
    
    
    34,368
    
    
    
    17,616
    
    
    
    16,752Operating expenses
    
    
    11,185
    
    
    
    9,336
    
    
    
    1,849Depreciation and amortization
    
    
    1,599
    
    
    
    1,180
    
    
    
    419Operating income (loss)
    
    $
    63
    
    
    $
    (249
    )
    
    $
    312
 The 69.3% increase in operating revenues for the three months ended September
30, 2004 compared with the three months ended September 30, 2003 reflects $15.3
million in third quarter 2004 revenue from Foley Company (Foley) acquired in
the fourth quarter of 2003, $4.8 million in third quarter 2004 revenue from
IPH, acquired on August 18, 2004, $3.0 million in increased revenues at the
energy services company, $0.3 million in increased revenue at the flatbed
trucking company and $0.1 million in increased revenue at the
telecommunications company, offset by a $4.3 million reduction in revenues at
the Companys other construction company. The 95.1% increase in cost of goods between the quarters reflects $13.5 million
in third quarter 2004 cost of goods sold at Foley, $3.8 million in cost of
goods sold at IPH and a $3.2 million increase in cost of goods sold at the
energy services company, offset by a $3.8 million decrease in cost of goods
sold at the other construction company. The increases in revenues and cost of
goods sold at the energy services company reflects increases in natural gas
prices between the periods. The decrease in revenue and cost of goods sold at
the other construction company is due to a reduction in work in the third
quarter of 2004 compared to the third quarter of 2003. The other construction
company recorded $0.5 million in operating losses in the third quarter of 2004
compared with $0.1 million in operating income in the third quarter of 2003.
This decrease in operating income is due to lower volumes of work and lower
margins on the work due to excess capacity in the construction industry. The 19.8% increase in other business operations operating expenses is the
result of $0.8 million in operating expenses of Foley, $0.2 million in
operating expenses of IPH and $0.9 million in increased operating expenses at
the other operating companies reflecting increases in salaries and other
general and administrative expenses at the flatbed trucking company, increased
insurance costs and increased unallocated corporate overhead due to increased
defined benefit plan costs. The 35.5% increase in depreciation and amortization
expenses between the periods includes $0.1 million from the acquisition of
Foley and $0.3 million from the acquisition of IPH. Other Income and Income Taxes For the three months ended September 30, 2004 compared with the three months
ended September 30, 2003, other income increased $116,000 mainly related to a
decrease in expenditures related to studying the feasibility of building
another electric generating station at the Big Stone Plant site. The $0.7 million (11.3%) decrease in income tax expense between the quarters is
mainly due to a $1.6 million (9.0%) decrease in income before income taxes for
the three months ended September 30, 2004 compared with the three months ended
September 30, 2003. The effective tax rate for the three months ended September
30, 2004 was 31.9% compared to 32.8% for the three months ended September 30,
2003. 23




---



##### 



Comparison of the Nine Months Ended September 30, 2004 and 2003 Consolidated Results of Operations Total operating revenues were $640.1 million for the nine months ended
September 30, 2004 compared with
$553.1 million for the nine months ended September 30, 2003. Operating income
was $52.4 million for the nine months ended September 30, 2004 compared with
$55.5 million for the nine months ended September 30, 2003. The Company
recorded diluted earnings per share of $1.03 for the nine months ended
September 30, 2004 compared to $1.15 for the nine months ended September 30,
2003. Following is a discussion of the results of operations by segment. Amounts presented in the following tables for the nine month periods ended
September 30, 2004 and 2003 for operating revenues, cost of goods sold and
nonelectric segment operating expenses will not agree with amounts presented in
the consolidated statements of income for those periods due to the elimination
of intersegment transactions. The total intersegment eliminations include:
$1,910,000 in operating revenues, $171,000 in cost of goods sold and $1,739,000
in other nonelectric expenses for the nine months ended September 30, 2004; and
$550,000 in operating revenues, $243,000 in cost of goods sold and $307,000 in
other nonelectric expenses in for the nine months ended September 30, 2003. Electric Nine months endedSeptember 30,(in thousands)
    
    2004
    
    2003
    
    ChangeRetail sales revenues
    
    $
    164,437
    
    
    $
    160,062
    
    
    $
    4,375Wholesale revenues:Sales from company-owned generation
    
    
    14,172
    
    
    
    15,017
    
    
    
    (845
    )Net margins on purchased power resold
    
    
    3,448
    
    
    
    6,991
    
    
    
    (3,543
    )Net marked-to-market gains
    
    
    2,228
    
    
    
    3,901
    
    
    
    (1,673
    )Other revenues
    
    
    11,659
    
    
    
    15,327
    
    
    
    (3,668
    )Total operating revenues
    
    $
    195,944
    
    
    $
    201,298
    
    
    $
    (5,354
    )Production fuel
    
    
    38,267
    
    
    
    37,980
    
    
    
    287Purchased power  system use
    
    
    30,875
    
    
    
    24,985
    
    
    
    5,890Other electric operation and maintenance expenses
    
    
    62,637
    
    
    
    65,522
    
    
    
    (2,885
    )Depreciation and amortization
    
    
    17,965
    
    
    
    19,460
    
    
    
    (1,495
    )Property taxes
    
    
    7,570
    
    
    
    7,591
    
    
    
    (21
    )Operating income
    
    $
    38,630
    
    
    $
    45,760
    
    
    $
    (7,130
    )
 The 2.7% increase in retail electric revenue resulted from a 1.4% increase in
retail mwhs sold combined with a 1.4% increase in revenue per mwh sold in the
nine months ended September 30, 2004 compared with the nine months ended
September 30, 2003. The increase in revenue per mwh sold is mainly due to a
$2.9 million increase in cost-of-energy adjustment revenues. Increased sales
reflect increased consumption, mainly among commercial and industrial
customers. Revenue from sales to commercial customers increased $2.7 million on
a 1.1% increase in mwhs sold. Revenue from sales of lower priced electricity to
industrial customers increased $1.6 million on a 14.0% increase in mwhs sold
between the periods. Revenue from sales to residential customers was unchanged
between the periods on a 2.7% decrease in mwhs sold. Milder weather in the
summer of 2004 compared to the summer of 2003, reflected in a 78% reduction in
cooling degree-days between the periods, was a contributing factor to the
reduction in residential mwh sales. 24




---



##### 



The 5.6% decrease in revenue from wholesale electric sales from company-owned
generation reflects a 4.7% decrease in mwhs sold as a result of a combination
of milder weather in the region in the summer of 2004 and reduced generating
capacity available in July and August 2004 due to a five week shutdown of Hoot
Lake Unit 3 for repairs related to a turbine blade failure. The revenue per mwh
sold for the nine months ended September 30, 2004 compared with the nine months
ended September 30, 2003 decreased by 1.0%. The Company adopted mark-to-market accounting in the third quarter of 2003 with
the issuance of SFAS No. 149, which eliminated application of the normal
purchases and sales exception to the Companys forward energy contracts which
generally result in physical settlement but are subject to net settlement. Upon
adoption of SFAS No. 149, the Company recognized $3.9 million ($0.09 of
earnings per diluted share) in net mark-to-market gains on open forward
contracts for the purchase and sale of electricity as of September 30, 2003. Net margins at market prices on energy contracts settled in the first nine
months of 2004 totaled $3.4 million at the time of settlement. Net margins at
contract prices on energy contracts settled in the first nine months of 2003
totaled $7.0 million at the time of settlement. As a result of the new
mark-to-market accounting method, wholesale margins from the resale of
purchased power in the first nine months of 2004 are not comparable to the
margins recorded on the resale of purchased power in the first nine months of
2003. The $2.2 million in net marked-to-market gains recognized on forward
energy contracts in the first nine months of 2004 is comprised of $0.3 million
in unrealized net gains and $1.9 million in marked-to-market gains realized in
the first nine months of 2004. Net unrealized marked-to-market gains were
$2,057,000 on December 31, 2003. Of this amount, $1,947,000 was realized in the
first nine months of 2004, $20,000 remained unrealized as of September 30, 2004
and $90,000 was not realized due to subsequent marked-to-market net losses
recognized on contracts settled in the first nine months of 2004. The 23.9% decrease in other electric operating revenues for the nine months
ended September 30, 2004 compared to the nine months ended September 30, 2003
reflects a $5.7 million decrease in revenue from contracted construction
services mainly related to the completion of a large wind-farm project in North
Dakota in 2003, offset by $1.3 million in increased revenue related to electric
transmission services due to increased use of our transmission lines by others
and a $0.7 million increase in revenues from sales of steam to an ethanol plant
near the Big Stone Plant. Fuel costs increased by 0.8% for the nine months ended September 30, 2004
compared with the nine months ended September 30, 2003 as a result of a 0.9%
increase in generation. Generation at Coyote Station, the Companys generating
unit with the lowest fuel costs per mwh, increased 24.8% while its cost of fuel
per mwh generated increased 1.2%. Coyote Station was unavailable for generation
in April and May of 2003 due to a scheduled maintenance shutdown. Generation
increased 3.6% at the Big Stone Plant where the fuel cost per mwh generated
increased 3.8%. Generation at Hoot Lake Plant, the Companys steam powered
generating plant with higher fuel costs per mwh, decreased 27.8% while its cost
of fuel per mwh generated increased 5.8%. Hoot Lake Unit 3 was unavailable for
generation for six weeks during the second quarter of 2004 due to an extended
maintenance shutdown and for an additional five weeks in July and August 2004
for repairs related to a turbine blade failure. Purchased power expense for energy purchased for system use (sale to retail
customers) increased 23.6% for the nine months ended September 30, 2004
compared with the nine months ended September 30, 2003 as a result of a 16.4%
increase in mwhs purchased combined with a 6.2% increase in the cost per mwh
purchased. The increase in mwhs purchased for system use corresponds in part to
the increase in retail mwh sales. The 4.4% decrease in other electric operation and maintenance expenses for the
nine months ended September 30, 2004 compared with the nine months ended
September 30, 2003 reflects a $2.8 million reduction in costs related to
construction work performed for others between the periods mainly related to
the completion of a large wind-farm project in North Dakota in 2003. Increased
labor costs related to annual wage and salary increases averaging 3.5% have
been offset by decreases in accrued incentive pay related to lower net income
at the electric utility in 2004 compared with 2003 and less overtime paid in
the first nine months of 2004 compared to the first nine months of 2003. Other
electric operation and maintenance expenses also increased by $0.8 million for
outside 25




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##### 



services expenditures. These cost increases were offset by a $0.5
million expense reduction related to the expected federal subsidy of
prescription drug benefits and $0.4 million in reduced expenditures for
materials and supplies. The 7.7% decrease in depreciation expense is related to
an annual depreciation study and depreciation rates approved by the Minnesota
Public Utilities Commission. Plastics Nine months endedSeptember 30,(in thousands)
    
    2004
    
    2003
    
    ChangeOperating revenues
    
    $
    86,646
    
    
    $
    65,996
    
    
    $
    20,650Cost of goods sold
    
    
    73,204
    
    
    
    57,102
    
    
    
    16,102Operating expenses
    
    
    4,262
    
    
    
    2,992
    
    
    
    1,270Depreciation and amortization
    
    
    1,721
    
    
    
    1,546
    
    
    
    175Operating income
    
    $
    7,459
    
    
    $
    4,356
    
    
    $
    3,103
 The 31.3% increase in operating revenues for the nine months ended September
30, 2004 compared with the nine months ended September 30, 2003 is the result
of a 13.1% increase in pounds of polyvinyl chloride (PVC) pipe sold combined
with a 16.1% increase in the price per pound of PVC pipe sold. The increase in
revenue was partially offset by a 13.3% increase in the cost per pound of PVC
pipe sold. The cost per pound of resin, the raw material used to produce PVC
pipe, increased 15.5% between the periods. Increased sales combined with the
increased cost per pound of pipe sold resulted in the 28.2% increase in the
cost of goods sold. Gross margins on pipe sold increased $4.5 million while the
gross margin per pound sold increased 32.3% between the periods. The 42.4%
increase in operating expenses is mainly due to increases in salaries and sales
commissions related to the increase in pipe sales and increased travel,
insurance and property tax expenses. The 11.3% increase in depreciation and
amortization expense is due to 2003 plant additions, most of which related to
the completion of the polyethylene pipe factory in Hampton, Iowa. The companies in this segment are highly dependent on a limited number of
third-party vendors for PVC resin. In the first nine months of 2004, 100% of
resin purchased was from two vendors: 50% from one and 50% from the other. In
the first nine months of 2003, 97% of resin purchased was from the same two
vendors: 71% from one and 26% from the other. The Company believes its
relationships with its key raw material vendors are good. However, the loss of
a key supplier or any interruption or delay in the supply of PVC resin could
have a significant impact on the plastics segment. Manufacturing Nine months endedSeptember 30,(in thousands)
    
    2004
    
    2003
    
    ChangeOperating revenues
    
    $
    160,656
    
    
    $
    133,350
    
    
    $
    27,306Cost of goods sold
    
    
    127,541
    
    
    
    105,198
    
    
    
    22,343Operating expenses
    
    
    18,137
    
    
    
    16,094
    
    
    
    2,043Depreciation and amortization
    
    
    6,404
    
    
    
    5,870
    
    
    
    534Operating income
    
    $
    8,574
    
    
    $
    6,188
    
    
    $
    2,386
 The manufacturing segments improved performance for the nine months ended
September 30, 2004 compared with the nine months ended September 30, 2003 is
due 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 20.5% increase in operating revenues reflects revenue
increases of $9.0 million from the metal parts stamping and fabrication
company, $8.3 million from the waterfront equipment company, $4.9 million from 26




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##### 



the manufacturer of thermoformed plastic and horticultural products, $3.7
million from the manufacturer of wind towers, and $1.8 million from the
manufacturer of structural steel products, offset by a $0.4 million decrease in
revenue from the auto and truck frame-straightening equipment manufacturer. The
revenue increase at the metal parts stamping and fabrication company is mainly
attributable to an increase in stamping, fabrication and prototyping
activities. The increase in revenue from the waterfront equipment company
reflects increased sales of residential and commercial products as a result of
increased advertising, new products and dealership expansion that is partly
attributable to the acquisition of Missouri-based Galva Foam in October 2002.
The revenue increase at the manufacturer of thermoformed plastic and
horticultural products reflects an increase of 17.9% in the volume of units
sold and an 8.2% increase in the price per unit sold between the periods. The
increase in revenues from the manufacturer of wind towers reflects the sale of
towers to a Canadian customer in the first quarter of 2004. The increase in
revenue at the manufacturer of structural steel products is due to an increase
in the volume of work performed between the periods. Increased revenues in the manufacturing segment were partially offset by a
21.2% increase in cost of goods sold for the nine months ended September 30,
2004 compared with the nine months ended September 30, 2003. The increase in
cost of goods sold primarily reflects increased costs of $6.9 million at the
waterfront equipment company, $6.2 million at the metal parts stamping and
fabrication company, $4.3 million at the manufacturer of thermoformed plastic
and horticultural products, $3.3 million at the manufacturer of wind towers and
$1.8 million at the manufacturer of structural steel products, offset by a $0.2
million decrease in cost of goods sold at the auto and truck
frame-straightening equipment manufacturer. The increased costs were less than
the increases in manufacturing company revenues, resulting in an increase in
gross margins in the manufacturing segment of $5.0 million between the periods. The 12.7% increase in manufacturing operating expenses for the nine months
ended September 30, 2004 compared with the nine months ended September 30, 2003
reflects increases of $1.0 million at the metal parts stamping and fabrication
company, $0.9 million at the waterfront equipment company and $0.2 million at
the manufacturer of thermoformed plastic and horticultural products. The
increases in operating expenses mainly reflect increases in incentive
compensation accruals at the metal parts stamping and fabrication company,
increased sales commissions at the waterfront equipment company and
increased salaries, wages and equipment maintenance costs at the manufacturer
of thermoformed plastic and horticultural products. The 9.1% increase in
depreciation and amortization expenses between the periods is the result of
plant additions and expansion of manufacturing capacity. Health Services Nine months endedSeptember 30,(in thousands)
    
    2004
    
    2003
    
    ChangeOperating revenues
    
    $
    80,014
    
    
    $
    73,138
    
    
    $
    6,876Cost of goods sold
    
    
    59,824
    
    
    
    54,656
    
    
    
    5,168Operating expenses
    
    
    13,495
    
    
    
    11,232
    
    
    
    2,263Depreciation and amortization
    
    
    3,926
    
    
    
    3,799
    
    
    
    127Operating income
    
    $
    2,769
    
    
    $
    3,451
    
    
    $
    (682
    )
 The 9.4% increase in health services operating revenues for the nine months
ended September 30, 2004 compared with the nine months ended September 30, 2003
reflects $4.8 million in additional revenue from the sale and servicing of
diagnostic imaging equipment and $2.1 million in additional revenue from
scanning services. The number of scans performed decreased 2.2% while the
average fee per scan increased 2.0% between the periods. The increase in
equipment sales revenue is partially due to the acquisition of two medical
equipment supply companies in the second and third quarters of 2003 that added
to the products and geographic territory of the sales and service operations. 27




---



##### 



The 9.5% increase in cost of goods sold for the nine months ended September 30,
2004 compared with the nine months ended September 30, 2003 was directly
related to the increases in revenues. The 20.1% increase in operating expenses
between the periods is mainly related to increases in salaries, benefits and
sales commissions expenses, but also reflects increases in travel, advertising
and other sales related expenses. The imaging business has also been impacted
by increased labor costs due to a shortage of technologists in 2004. The 3.3%
increase in depreciation and amortization expense is related to an increase in
depreciable property as a result of equipment purchases in 2003. Other Business Operations Nine months endedSeptember 30,(in thousands)
    
    2004
    
    2003
    
    ChangeOperating revenues
    
    $
    118,706
    
    
    $
    79,869
    
    
    $
    38,837Cost of goods sold
    
    
    86,451
    
    
    
    52,985
    
    
    
    33,466Operating expenses
    
    
    33,314
    
    
    
    27,585
    
    
    
    5,729Depreciation and amortization
    
    
    3,974
    
    
    
    3,533
    
    
    
    441Operating (loss)
    
    $
    (5,033
    )
    
    $
    (4,234
    )
    
    $
    (799
    )
 The 48.6% increase in operating revenues for the nine months ended September
30, 2004 compared with the nine months ended September 30, 2003 reflects $38.1
million in 2004 revenue from Foley acquired in the fourth quarter of 2003, $4.8
million in third quarter 2004 revenue from IPH, acquired on August 18, 2004,
$3.2 million in increased revenues at the energy services company and $1.0
million in increased revenue at the flatbed trucking company, offset by a $9.5
million reduction in revenues at the Companys other construction company. The 63.2% increase in cost of goods between the periods reflects $34.3 million
in 2004 cost of goods sold at Foley, $3.8 million in cost of goods sold at IPH
and a $3.6 million increase in cost of goods sold at the energy services
company, offset by a $8.2 million decrease in cost of goods sold at the other
construction company. The increases in revenues and cost of goods sold at the
energy services company reflects increases in natural gas prices between the
periods. The decrease in revenue and cost of goods sold at the other
construction company is mainly due to a reduction in work in the second and
third quarters of 2004 compared to the second and third quarters of 2003.
Operating losses at the other construction company increased $1.7 million
between the periods to a $3.5 million loss for the nine months ended September
30, 2004. This increase is due to lower volumes of work and lower margins on
the work due to excess capacity in the construction industry and poor
performance on certain construction projects. The 20.8% increase in other business operations operating expenses is the
result of $2.2 million in operating expenses related to Foley, $0.2 million in
operating expenses related to IPH, a $1.2 million increase in operating
expenses at the flatbed trucking company related to increased brokerage
activity and increased salary and wage expenses related to an increase in
company-owned fleet miles driven and $2.1 million in increased expenses at the
other operating companies mainly reflecting increases in insurance costs and
increased unallocated corporate overhead due to increased defined benefit plan
costs. The 12.5% increase in depreciation and amortization expenses between the
periods is primarily due to the acquisitions of Foley and IPH. Other Income and Income Taxes For the nine months ended September 30, 2004 compared with the nine months
ended September 30, 2003, Other income decreased $333,000 mainly due to
decreases in miscellaneous income in the plastics and health services segments. 28




---



##### 



Income tax expense decreased $616,000 (4.7%) in the first nine months of 2004
compared to the first nine months of 2003 reflecting an 8.2% decrease in income
before income taxes. The effective tax rate for the nine months ended September
30, 2004 was 31.5% compared to 30.4% for the nine months ended September 30,
2003. The increase in the effective tax rate is due to an increase in deferred
income taxes related to normalization of deferred income taxes under regulatory
accounting at the electric utility and a $0.6 million reduction in nontaxable
income related to a reduction in allowance for equity funds used during
construction. 2004 Outlook by Segment Electric Assuming normal weather patterns, the Company expects the electric utility to
have a stronger fourth quarter in 2004 than the fourth quarter of 2003. In a
joint announcement on October 11, 2004, officials from Otter Tail Power
Company, Central Minnesota Municipal Power Agency, Great River Energy,
Heartland Consumers Power District, Hutchinson Utilities Commission, and
Missouri River Energy Services reported that the companies are investigating
the feasibility of another electric generating plant on the site of the
existing Big Stone Plant near Milbank, South Dakota. The group is exploring
the feasibility of building an approximately 600-megawatt coal-based
generating unit designed with the best available emissions technology as
prescribed by federal and state environmental regulations. The decision
whether to proceed with construction of the plant is expected in 2005. If
built, Big Stone II is projected to come online in 2011 and serve the
utilities native customer loads. The electric utility would expect to be the
plant operator of this facility and its plant ownership is not expected to
exceed 25%. Plastics Although sales volumes and margins typically decline in the fourth quarter due
to normal slowdown in construction activities as the winter season approaches,
the Company expects the plastics segment will have a good performance in the
fourth quarter due to continuing demand in the southwestern region of the
country. Manufacturing As anticipated, results for this segment improved in the third quarter and
there are objective signs of improved activity for the rest of the year.
Increasing commodity prices, such as steel, are being offset through product
pricing increases and increases in productivity and capacity utilization. The
manufacturing businesses continue, however, to be affected by the uncertainty
with regard to the pricing and availability of steel and other commodities. Health Services Revenues from the company that sells and services medical diagnostic and
monitoring equipment are expected to be strong for the fourth quarter based on
current backlog and produce financial results consistent with 2003.
Management continues to address the cost structure of the diagnostic imaging
operations with a continued emphasis on improving nonperforming assets. As the
changes are being implemented, it is expected that diagnostic imaging
operations will continue to show improved earnings in the fourth quarter. Other Business Operations The Company expects other business operations to have stronger results for the
fourth quarter of 2004 compared to the fourth quarter of 2003. The outlook for
other business operations includes the following considerations:  
    
    Foley will continue to generate net earnings through 2004 with strong
bidding activity and good backlog in place for the remainder of the
year.
    
    The acquisition of IPH is expected to generate additional net earnings for the remainder of 2004. 29




---



##### 




    
    The Companys other construction company continues to face lower volumes of work and tight margins.
    
    The Companys transportation and telecommunications businesses are
also expected to have improved performance over the fourth quarter of
2003. As part of an ongoing evaluation of the prospects and growth opportunities of
its business operations, the Company has decided to exit its telecommunications
business (Midwest Information Systems, Inc.) and focus on growing other parts
of the Companys business operations. The Company has engaged Robert W. Baird &
Co. as its financial advisor to assist in the marketing process. This business
is expected to generate $5.1 million in earnings before interest, taxes and
depreciation for the year ending December 31, 2004 and has shareholders equity
of $13.6 million. Critical Accounting Policies Involving Significant Estimates The discussion and analysis of the consolidated financial statements and
results of operations are based on the Companys 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. 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, environmental liabilities, 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. Goodwill Impairment The Company currently has $1.0 million of goodwill recorded on its balance
sheet related to its energy services subsidiary that markets natural gas to
approximately 150 retail customers. An evaluation of projected cash flows from
this operation in January 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. The Company will continue to evaluate this reporting
unit for impairment on an annual basis and as conditions warrant. The Company currently has $6.7 million of goodwill recorded on its balance
sheet related to the acquisition of E.W. Wylie Corporation (Wylie), its flatbed
trucking company. Highly competitive pricing in the trucking industry in recent
years has resulted in decreased operating margins and lower returns on invested
capital for Wylie. The company has improved performance 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 increases relative to available shipping capacity
and additional revenues are generated from added terminal locations and
increased brokerage activity. If current conditions persist and operating
margins do not increase according to Company 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, 2003,
assessment of Wylie indicated that its goodwill was not impaired. The Company
will continue to evaluate this reporting unit for impairment on an annual basis
and as conditions warrant. 30




---



##### 



A discussion of critical accounting policies is included in the Companys
Annual Report on Form 10-K for the fiscal year ended December 31, 2003. There
were no material changes in critical accounting policies or estimates during
the quarter ended September 30, 2004. Forward Looking Information  Safe Harbor Statement Under the Private
Securities Litigation Reform Act of 1995 In connection with the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995 (the Act), the Company has filed cautionary
statements identifying important factors that could cause the Companys actual
results to differ materially from those discussed in forward-looking statements
made by or on behalf of the Company. When used in this Form 10-Q and in future
filings by the Company with the Securities and Exchange Commission, in the
Companys press releases and in oral statements, words such as may, will,
expect, anticipate, continue, estimate, project, believes or
similar expressions are intended to identify some of the forward-looking
statements within the meaning of the Act and are included, along with this
statement, for purposes of complying with the safe harbor provision of the Act.
Factors that might cause such differences include, but are not limited to, the
Companys ongoing involvement in diversification efforts, the timing and scope
of deregulation and open competition, market valuations of forward energy
contracts, growth
of electric revenues, impact of the investment performance of the utilitys
pension plan, changes in the economy, governmental and regulatory
action, including investigations commenced by one or more agencies,
weather conditions, fuel and purchased power costs, environmental issues, resin
prices, the availability of off-grade potatoes due to poor growing conditions,
a loss of key potato growers and other factors discussed under Factors
affecting future earnings on pages 24-25 of the Companys 2003 Annual Report
to Shareholders, which is incorporated by reference in the Companys Annual
Report on Form 10-K for the fiscal year ended December 31, 2003. These factors
are in addition to any other cautionary statements, written or oral, which may
be made or referred to in connection with any such forward-looking statement or
contained in any subsequent filings by the Company with the Securities and
Exchange Commission. The Company undertakes no obligation to publicly update or
revise any forward-looking statements. 31




---



##### 



Item 3. Quantitative and Qualitative Disclosures About Market Risk At September 30, 2004 the Company had limited exposure to market risk
associated with interest rates. The majority of the Companys 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. The Company manages its 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 utilization of short-term borrowings to allow
flexibility in the timing and placement of long-term debt. As of September 30,
2004, the Company had
$28.1 million of long-term debt subject to variable interest rates. Assuming no
change in the Companys financial structure, if variable interest rates were to
average 1% higher or lower than the average variable rate on
September 30, 2004, interest expense and pre-tax earnings would change by
approximately $281,000 on an annual basis. The Company has short-term borrowing arrangements to provide financing for
working capital and other purposes for its nonelectric operations. The level of
borrowings under these arrangements varies from period to period, depending
upon, among other factors, operating needs, capital expenditures and
acquisition financing. On September 30, 2004 the Company had $115.8 million
outstanding short-term borrowings with variable interest rates under these
arrangements. The Company has not used interest rate swaps to manage net exposure to interest
rate changes related to the Companys portfolio of borrowings. The Company
maintains a ratio of fixed-rate debt to total debt within a certain range. It
is the Companys policy to enter into interest rate transactions and other
financial instruments only to the extent considered necessary to meet its
stated objectives. The Company does not enter into transactions for speculative
or trading purposes. The electric utilitys retail portion of fuel and purchased power costs are
subject to cost-of-energy adjustment clauses that mitigate the commodity price
risk by allowing a pass through of most of the increase or decrease in energy
costs to retail customers. In addition, the electric utility participates in an
active wholesale power market providing access to energy resources that may
serve to mitigate price risk. The electric utility has market, price and credit risk associated with forward
contracts for the purchase and sale of energy. Net unrealized marked-to-market
gains were $2,057,000 on December 31, 2003. Of this amount, $1,947,000 was
realized in the first nine months of 2004, $20,000 remained unrealized as of
September 30, 2004 and $90,000 was not realized due to subsequent
marked-to-market net losses recognized on contracts settled in the first nine
months of 2004. As of September 30, 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 energy in the last three months of 2004 and the
first five months of 2005. 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 September 30, 2004, 53% of the forward 32




---



##### 



energy purchases have offsetting
sales in terms of volumes and delivery periods. The Company has 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 forward sales of electricity in wholesale markets be covered by
offsetting forward purchases of electricity with matching terms and delivery
dates when projected market prices deviate from contract prices beyond limits
set forth in the Companys energy risk management policy 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. The Companys energy risk management policy allows for long open 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 September 30, 2004 was not material. 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 sheet as
of September 30, 2004 and the change in its consolidated balance sheet position
from December 31, 2003 to September 30, 2004: September 30,(in thousands)
    
    2004Current asset  marked-to-market gain
    
    $
    1,603Regulatory asset  deferred marked-to-market loss
    
    
    341Total assets
    
    
    1,944Current liability  marked-to-market loss
    
    
    (949
    )Regulatory liability  deferred marked-to-market gain
    
    
    (694
    )Total liabilities
    
    
    (1,643
    )Net fair value of marked-to-market energy contracts
    
    $
    301
 Year-to-date(in thousands)
    
    September 30, 2004Fair value at beginning of year
    
    $
    2,057Amount realized on contracts entered into in 2003 and settled in 2004
    
    
    (1,947
    )Changes in fair value of contracts entered into in 2003
    
    
    (15
    )Net fair value of contracts entered into in 2003 at end of period
    
    
    95Changes in fair value of contracts entered into in 2004
    
    
    206Net fair value end of period
    
    $
    301
 The $301,000 in recognized but unrealized net gains on the forward energy
purchases and sales marked-to-market as of September 30, 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: 4th Quarter
    
    1st Quarter
    
    2nd Quarter(in thousands)
    
    2004
    
    2005
    
    2005
    
    TotalNet gain
    
    $
    277
    
    
    $
    51
    
    
    $
    (27
    )
    
    $
    301
 33




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The electric utility has credit risk associated with the nonperformance or
nonpayment by counterparties to its forward energy purchases and sales
agreements. The Company has 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. The Companys credit risk
with its largest counterparty on delivered and marked-to-market forward
contracts as of September 30, 2004 was $4.6 million. As of September 30, 2004
the Company had a net credit risk exposure of $3.4 million from thirty-seven
counterparties with investment grade credit ratings. The $3.4 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 energy scheduled for delivery after September 30, 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). The Companys energy services subsidiary markets natural gas to approximately
150 retail customers. Some of these customers are served under fixed-price
contracts. There is price risk associated with these limited number of
fixed-price contracts since the corresponding cost of natural gas is not
immediately locked in. This price risk is not considered material to the
Company. 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. 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. The Company has limited exposure to market risk associated with changes in
foreign currency exchange rates because all sales by the Canadian operations of
the recently acquired IPH are in U.S. dollars, although the functional currency
of the Canadian operations is the Canadian dollar. 
 Item 4. Controls and Procedures Under the supervision and with the participation of the Companys management,
including the Chief Executive Officer and the Chief Financial Officer, the
Company evaluated the effectiveness of the design and operation of its
disclosure controls and procedures (as defined in Rule 13a-15(e) under the
Securities Exchange Act of 1934 (the Exchange Act)) as of September 30, 2004,
the end of the period covered by this report. Based on that evaluation, the
Chief Executive Officer and Chief Financial Officer concluded that the
Companys disclosure controls and procedures were effective as of September 30,
2004. During the fiscal quarter ended September 30, 2004, there were no changes in
the Companys internal controls over financial reporting (as defined in Rule
13a-15(f) under the Exchange Act) that has materially affected, or is
reasonably likely to materially affect, the Companys internal controls over
financial reporting. 34




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PART II. OTHER INFORMATION 
 Item 6. Exhibits  4.1
    
    Fifth Amendment dated as of October 28, 2004 to Credit Agreement dated as of April 30, 2002.4.2
    
    Second Amendment dated as of October 1, 2004 to Note Purchase Agreement dated as of December 1, 2001.4.3
    
    Credit Agreement dated as of August 13, 2004 among the
Company, the Banks party thereto, UBS Securities LLC, as
Arranger and UBS AG, Stamford Branch, as Agent. (Incorporated by
reference to Exhibit 4.12 to the Companys registration
statement on Form S-3, Registration No. 333-116206.)31.1
    
    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 
 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. OTTER TAIL CORPORATIONBy:
    
    /s/ Kevin G. MougKevin G. MougChief Financial Officer and Treasurer(Chief Financial Officer/Authorized Officer)
 Dated: November 9, 2004 35




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EXHIBIT INDEX Exhibit Number
    
    Description4.1
    
    Fifth Amendment dated as of October 28, 2004 to Credit Agreement dated as of April 30, 2002.4.2
    
    Second Amendment dated as of October 1, 2004 to Note Purchase Agreement dated as of December 1, 2001.4.3
    
    Credit Agreement dated as of August 13, 2004 among the
Company, the Banks party thereto, UBS Securities LLC, as
Arranger and UBS AG, Stamford Branch, as Agent. (Incorporated by
reference to Exhibit 4.12 to the Companys registration
statement on Form S-3, Registration No. 333-116206.)31.1
    
    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.