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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the transition period from                      to                     

OTTER TAIL CORPORATION

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 [   ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES [X] NO [   ]

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

April 30, 2003 — 25,683,168 Common Shares ($5 par value)

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OTTER TAIL CORPORATION

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Otter Tail Corporation
Consolidated Balance Sheets
(Unaudited)
-Assets-

See accompanying notes to consolidated financial statements

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Otter Tail Corporation
Consolidated Balance Sheets
(Unaudited)
-Liabilities-

See accompanying notes to consolidated financial statements

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Otter Tail Corporation
Consolidated Statements of Income
(Unaudited)

See accompanying notes to consolidated financial statements

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Otter Tail Corporation
Consolidated Statements of Cash Flows
(Unaudited)

See accompanying notes to consolidated financial statements

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OTTER TAIL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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 for the years ended December 31, 2002, 2001 and 2000 included in the Company’s 2002 Annual Report to the Securities and Exchange Commission on Form 10-K. Because of seasonal and other factors, the earnings for the three-month period ended March 31, 2003, should not be taken as an indication of earnings for all or any part of the balance of the year.

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.

For those operating businesses recognizing revenue when shipped, the operating businesses have no further obligation to provide services related to such product. The shipping terms used in these instances are FOB shipping point.

Some of the operating businesses enter into fixed-price construction contracts. Revenues under these contracts are recognized on a percentage-of-completion basis. The method used to determine the progress of completion is based on the ratio of costs incurred to total estimated costs. The following summarizes costs incurred and billings on uncompleted contracts:

The following costs incurred and billings are included in the Company’s consolidated balance sheet under Other Current Assets and Accounts Payable:

The percent of revenue recognized under the percentage-of-completion method compared to total consolidated revenues for the three months ended March 31, 2003 was 8.4% compared with 9.7% for the three months ended March 31, 2002.

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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 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 month periods ended March 31, 2003 and March 31, 2002 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.

Reclassifications

Certain prior year amounts have been reclassified to conform to 2003 presentation. Such reclassifications had no impact on net income, shareholders’ equity or cash provided by operating activities.

Inventories

Inventories consist of the following:

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Goodwill and Other Intangible Assets

There were no changes in the carrying amount of goodwill during the three months ended March 31, 2003.

The following table summarizes the components of the Company’s intangible assets at March 31, 2003 and December 31, 2002.

Intangible assets with finite lives are being amortized over average lives ranging from one to five years. The amortization expense for these intangible assets was $132,000 for the three months ended March 31, 2003 compared to $123,000 for the three months ended March 31, 2002. The estimated annual amortization expense for these intangible assets for the next five years is: $583,000 for 2003, $608,000 for 2004, $399,000 for 2005, $244,000 for 2006 and $132,000 for 2007.

New Accounting Standards

The FASB has issued SFAS No. 143, Accounting for Asset Retirement Obligations (ARO), which provides accounting requirements for retirement obligations associated with tangible long-lived assets. This statement is effective for fiscal years beginning after June 15, 2002. The Company adopted SFAS No. 143 on January 1, 2003. Retirement obligations associated with long-lived assets included within the scope of SFAS No. 143 are those for which there is a legal obligation to settle under existing or enacted law, statute, written or oral contract or by legal constructions under the doctrine of promissory estoppel. Adoption of SFAS No. 143 changed the accounting for ARO costs of the utility’s generating plants. Currently, estimated net salvage amounts are part of depreciation expense accruals collected in the utility’s rates and reported in accumulated depreciation. As of March 31, 2003 the Company estimates it has approximately $14.7 million related to net salvage costs recorded in accumulated depreciation on assets with ARO. SFAS No. 143 requires the present value of the future decommissioning cost to be recognized as a liability on the balance sheet with an offsetting amount being added to the capitalized cost of the related long-lived asset. The liability will be accreted to its present value each period and the capitalized cost will be depreciated over the useful life of the related asset.

The Company’s asset retirement obligations include site restoration, the closure of ash pits and the removal of storage tanks and asbestos at certain electric utility generating plants. The Company has legal obligations associated with retirement of other long-lived assets used in its electric operations that cannot be reasonably estimated because the useful lives of those assets are indeterminate. There are no assets legally restricted for the settlement of any of the Company’s asset retirement obligations.

The present value of the legal asset retirement obligations as of March 31, 2003 of $1,515,000 is included in Noncurrent liabilities on the Company’s March 31, 2003 balance sheet. The $1,515,000 liability includes the original obligation of $377,000 plus accumulated accretion expense of $1,113,000 from the date the obligation arose through January 1, 2003, plus $25,000 of additional accumulated accretion expense for the three months

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ended March 31, 2003. Since the recovery of these estimated removal costs, which includes accretion, has been provided for through the recovery of depreciation expense included as a component of current rates, there is no cumulative effect on income to be recorded related to the adoption of this accounting principle. All accumulated accretion expenses will be classified as regulatory assets until the actual cost to settle the asset retirement obligation has been incurred, at which time the associated accumulated accretion removal cost will be transferred to accumulated reserve for depreciation as dictated by regulatory accounting practices. The effects of the noncash transactions described above are not reflected in the Company’s consolidated statement of cash flows for the three months ended March 31, 2003.

The following table shows the amount of the asset retirement obligation liability that would have been included in Noncurrent liabilities in prior periods had the requirements of SFAS No. 143 been in effect in those periods.

Segment Information

The Company’s business operations consist of five segments based on products and services. Electric includes the electric utility operating in Minnesota, North Dakota and South Dakota. Plastics consists of businesses involved in the production of polyvinyl chloride (PVC) pipe in the Upper Midwest and Southwest regions of the United States. Manufacturing consists of businesses involved in the production of waterfront equipment, wind towers, frame-straightening equipment and accessories for the auto repair industry, custom plastic pallets, material and handling trays, horticultural containers, fabrication of steel products, contract machining, and metal parts stamping and fabrication located in the Upper Midwest, Missouri and Utah. Health services include businesses involved in the sale of diagnostic medical equipment, 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 in 40 states. Other business operations consists of businesses in electrical and telephone construction contracting, transportation, telecommunications, entertainment, energy services, and natural gas marketing, as well as the portion of corporate administrative and general expenses that are not allocated to other segments. The electrical and telephone construction contracting companies and energy services and natural gas marketing business operate primarily in the Upper Midwest. The telecommunications companies operate in central and northeast Minnesota and the transportation company operates in 48 states and 6 Canadian provinces. The Company evaluates the performance of its business segments and allocates resources to them based on earnings contribution and return on total invested capital.

Operating Income (Loss)

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Identifiable Assets

Substantially all sales and long-lived assets of the Company are within the United States.

Common Shares and Earnings per Share

Basic earnings per common share are calculated by dividing earnings available for common shares by the average number of common shares outstanding during the period. Diluted earnings per common share are calculated by adjusting outstanding shares, assuming conversion of all potentially dilutive stock options.

Comprehensive Income

The only elements of comprehensive income for the three months ended March 31, 2003 were net income of $9.9 million and an additional accumulated comprehensive loss of $81,000 related to the Company’s Executive Survivor & Supplemental Retirement Plan, as compared to $10.0 million of net income for the three months ended March 31, 2002.

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 statement allows for the recording of a regulatory asset or liability for costs that will be collected or refunded through the ratemaking process in the future.

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The following table indicates the amount of regulatory assets and liabilities recorded on the Company’s consolidated balance sheet:

The regulatory assets and liabilities related to deferred income taxes are the result of the adoption of SFAS No. 109, Accounting for Income Taxes. Deferred conservation program costs included in Deferred debits – Other represent mandated conservation expenditures recoverable through rates over the next 1.5 years. Plant acquisition costs included in Deferred debits – Other will be amortized over the next eight years. Accrued cost-of-energy revenue included in Accrued utility revenues will be recovered over the next six months. The remaining regulatory assets and liabilities are being recovered from electric customers over the next 32 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 item in the period in which the application of SFAS No. 71 ceases.

Subsequent Events

On April 14, 2003 the Company’s Board of Directors granted 222,750 stock options to key management employees and 90,900 shares of restricted stock to certain key executives and non-employee directors under the 1999 Stock Incentive 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 ratably over a four-year period and expire ten years after the date of the grant. As of April 30, 2003 a total of 1,555,894 options were outstanding and a total of 193,094 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 29, 2003 the Company renewed its $50 million line of credit. The terms of the renewed line of credit are essentially the same as those in place prior to the renewal. 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 2004 will be provided for by cash flows from electric utility operations.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

MATERIAL CHANGES IN FINANCIAL POSITION

For the period 2003 through 2007, the Company estimates that funds internally generated net of forecasted dividend payments, combined with funds on hand, will be sufficient to meet scheduled debt retirements, provide for its estimated consolidated capital expenditures and pay off most of its currently outstanding short-term debt. Reduced demand for electricity or products manufactured and sold by the Company could have an effect on funds internally generated. Additional short-term or long-term financing will be required in the period 2003 through 2007 in the event the Company decides to refund or retire early any of its 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, our business, results of operations, and financial condition could be adversely affected.

The Company has the ability to issue up to an additional $135 million of unsecured debt securities from time to time under its shelf registration statement on file with the SEC.

On April 29, 2003 the Company renewed its $50 million line of credit. The terms of the renewed line of credit are essentially the same as those in place prior to the renewal. 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 2004 will be provided for by cash flows from electric utility operations. As of March 31, 2003, $37 million of the $50 million line 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 line of credit contains a number of covenants that restrict the Company’s ability, with significant exceptions, to: engage in mergers or consolidations; dispose of assets; create liens on assets; engage in transactions with affiliates; take any action which would result in a decrease in the ownership interest in any subsidiary; redeem stock or any subsidiary’s stock and pay dividends on stock; make investments, loans or advances; guaranty the obligations of other persons or agree to maintain the net worth or working capital of, or provide funds to satisfy any other financial test applicable to, any other person; and enter into a contract that requires payment to be made by the Company whether or not delivery of the materials, supplies or services is ever made under the contract. In addition, the Company is required to comply with specified financial covenants, including maintaining 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. As of March 31, 2003, the Company was in compliance with all of the covenants under the line of credit. The interest rate under the line of credit is subject to adjustment in the event of a change in ratings on the Company’s senior unsecured debt, up to LIBOR plus 0.8% if the ratings on the Company’s senior unsecured debt fall to BBB+ or below (Standard & Poor’s) or Baa1 or below (Moody’s). The line of credit also provides for accelerated repayment in the event the Company’s long-term unsecured and unsubordinated debt is rated below BBB- (Standard & Poor’s) or Baa3 (Moody’s).

Cash provided by operating activities of $5.2 million for the three months ended March 31, 2003 combined with cash on hand of $9.9 million as of December 31, 2002 allowed the Company to pay dividends and fund 58% of its capital expenditures. Net cash provided by operating activities decreased $6.3 million for the three months ended March 31, 2003 compared to the three months ended March 31, 2002 primarily as a result of an increase in inventories in the first quarter of 2003 of $9.5 million compared to an increase in inventories of only $2.9 million in the first quarter of 2002. The increase in inventories is mainly due to the build-up of inventories at the companies that manufacture wind towers and waterfront equipment to meet projected demand for their products in 2003.

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Net cash used in investing activities was $14.3 million for the three months ended March 31, 2003 compared with net cash used in investing activities of $19.2 million for the three months ended March 31, 2002. A decrease in capital expenditures of $7.4 million between the periods was offset by a $0.6 million decrease in proceeds from the sale of noncurrent assets and a $1.8 million decrease in cash used in the purchase, or generated from the sale, of other investments. Capital expenditures at the electric utility decreased $3.8 million related to the completion of a major transmission line in the fourth quarter of 2002 and winding down of construction on the electric utility’s new gas-fired combustion turbine. Capital expenditures in other segments decreased by $3.6 between the quarters, reflecting a $2.5 million reduction in equipment purchases at the Company’s wind-tower manufacturing company, a $0.9 million reduction in equipment purchases at the Company’s metal parts stamping and fabrication company and a $2.0 million decrease in equipment expenditures at the Company’s transportation company, offset by a $2.0 million increase in capital expenditures at one of the Company’s pipe manufacturing companies related to the construction of a new production facility in Iowa.

Net cash provided by financing activities was slightly positive for the three months ended March 31, 2003 compared with net cash used in financing activities of $3.7 million for the three months ended March 31, 2002. The increase in cash from financing activities reflects a $1.6 million increase in net borrowings from the Company’s line of credit plus a $3.1 million increase in cash from net long-term debt financing and retirement activities, offset by a $0.5 million reduction in cash from the issuance of common stock and a $0.5 million increase in dividends paid and other distributions between the periods.

Proceeds from the $7.0 million increase in short-term debt outstanding in the first quarter of 2003 were mainly used to finance construction and operating activities at the Company’s nonelectric operating companies.

There are no material changes in the Company’s contractual obligations on long-term debt, coal contracts, construction program commitments, capacity and energy requirements, and operating leases from those reported in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002. 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, 2002.

The Company’s current securities ratings are:

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.

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MATERIAL CHANGES IN RESULTS OF OPERATIONS

Comparison of the Three Months Ended March 31, 2003 and 2002

Consolidated Results of Operations

Total operating revenues were $198.1 million for the three months ended March 31, 2003 compared with $157.7 million for the three months ended March 31, 2002. Operating income was $18.3 million for the three months ended March 31, 2003 compared with $18.9 million for the three months ended March 31, 2002. The Company recorded diluted earnings per share of $0.38 for the three months ended March 31, 2003 compared to $0.40 for the three months ended March 31, 2002.

Following is a discussion of the results of operations by segment.

Electric

The 26.3% increase in electric operating revenues for the three months ended March 31, 2003 compared with the three months ended March 31, 2002 reflects a $5.7 million (10.6%) increase in retail electric revenues, a $16.3 million (101.9%) increase in wholesale power revenues and a $2.4 million (50.6%) decrease in other electric operating revenues.

The increase in retail electric revenue resulted from a 5.0% increase in retail megawatt-hours sold between the periods combined with a 5.3% increase in revenue per megawatt-hour (mwh) sold. The increase in retail mwh sales is mainly the result of colder weather in the first quarter of 2003 compared with the first quarter of 2002. Heating degree-days increased from 4,090 in the first quarter of 2002 to 4,583 in the first quarter of 2003. This represents an increase of 12.1% in heating degree-days over 2002 and a 5.0% increase over a typical meteorological year in the region. The 5.3% increase in revenue per retail mwh sold reflects a $3.3 million increase in revenues related to increased fuel and purchased power costs passed on to most retail customers through the cost-of-energy adjustment factor included in retail rates.

The increase in wholesale power revenues resulted from a 52.5% increase in megawatt-hours sold combined with a 32.4% increase in wholesale electric prices during the three months ended March 31, 2003 compared with the three months ended March 31, 2002. The increase in mwh sales and higher wholesale prices reflect increased demand relative to available supply mainly due to colder weather in the region in the first quarter of 2003 compared with the first quarter of 2002.

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The decrease in other electric operating revenues reflects a $3.2 million decrease in billings related to the construction of a transmission line in North Dakota for another area utility that was completed in the fourth quarter of 2002, offset by $0.6 million in transmission related revenues from control area service tariffs first recorded in the second quarter of 2002 and $0.2 million in revenue from the sale of steam to an ethanol plant that began operations in the third quarter of 2002.

Fuel costs increased by 12.7% for the three months ended March 31, 2003 compared with the three months ended March 31, 2002 as a result of an 11.3% increase in the cost of fuel per mwh generated combined with a 1.3% increase in generation. The increase in the cost per mwh generated reflects increases in coal and coal transportation costs at Big Stone and Hoot Lake Plants along with increased generation from the Company’s internal combustion peaking generators in response to demand caused by the colder weather in the first quarter 2003.

Purchased power expense increased 87.9% for the three months ended March 31, 2003 compared with the three months ended March 31, 2002 as a result of a 40.3% increase in mwh purchases for retail customers and a 64.4% increase in mwh purchases for wholesale customers combined with a 6.0% increase in the cost per mwh purchased for retail customers and a 26.7% increase in the cost per mwh purchased for wholesale customers. Increased demand for electricity brought on by the colder weather in the first quarter 2003 was the main factor contributing to the increases in the volume and cost per mwh of purchased power.

The 2.8% decrease in other electric operation and maintenance expenses for the three months ended March 31, 2003 compared with the three months ended March 31, 2002 reflects a $2.2 million decrease in costs related to the 2002 construction of a transmission line for another area utility and a $0.8 million decrease in external services expenditures offset by increases of $1.1 million in labor costs, $0.5 million in material and operating supply expenses, $0.5 million in employee benefits related to postemployment medical costs and $0.3 million in transportation expenses. The decrease in external services expenses reflects the completion of a strategic sourcing project in 2002 and decreased use of outside tree-trimmers as a result of using internal resources that were assigned to transmission line construction projects in 2002. The increase in labor costs is due to an increase in employee benefit costs included in labor costs. The increases in material and transportation costs relates to a shifting of costs from outside construction contracts to internal use following completion of the transmission line construction project in 2002. The 4.9% increase in depreciation expense is due to a 3.1% increase in depreciable plant in 2002.

Plastics

The 44.5% increase in operating revenues for the three months ended March 31, 2003 compared with the three months ended March 31, 2002 is the result of a 9.3% increase in pounds of polyvinyl chloride (PVC) pipe sold combined with a 32.2% increase in the price per pound of PVC pipe sold. Cost of goods sold increased 47.6% mainly due to a 35.1% 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 53.4% between the periods. Operating expenses increased 21.3% primarily due to increased sales commissions directly related to the increase in sales. The 7.5% increase in depreciation and amortization expense is due to a $3.5 million increase in depreciable plant in 2002. The Company does not expect the strong market conditions to continue through the remainder of the year.

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Manufacturing