Summary of Significant Accounting Policies (Policies)

9 Months Ended

Sep. 30, 2016

Due to the diverse business operations of the Company, revenue recognition depends on the product produced and sold or service performed. The Company recognizes revenue when the earnings process is complete, evidenced by an agreement with the customer, there has been delivery and acceptance, the price is fixed or determinable and collectability is reasonably assured. In cases where significant obligations remain after delivery, revenue recognition is deferred until such obligations are fulfilled. Provisions for sales returns and warranty costs are recorded at the time of the sale based on historical information and current trends. In the case of derivative instruments, such as Otter Tail Power Company’s (OTP) 2015 forward energy contracts, marked-to-market and realized gains and losses are recognized on a net basis in revenue in accordance with the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 815, Derivatives and Hedging. Gains and losses on forward energy contracts subject to regulatory treatment, if any, are deferred and recognized on a net basis in revenue in the period realized.

For the Company’s operating companies recognizing revenue on certain products when shipped, those operating companies have no further obligation to provide services related to such product. The shipping terms used in these instances are FOB shipping point.

Agreements Subject to Legally Enforceable Netting Arrangements

The Company does not offset assets and liabilities under legally enforceable netting arrangements on the face of its consolidated balance sheet.

Fair Value Measurements

The Company follows ASC Topic 820, Fair Value Measurements and Disclosures (ASC 820), for recurring fair value measurements. ASC 820 provides a single definition of fair value, requires enhanced disclosures about assets and liabilities measured at fair value and establishes a hierarchal framework for disclosing the observability of the inputs utilized in measuring assets and liabilities at fair value. The three levels defined by the hierarchy and examples of each level are as follows:

Level 1 – Quoted prices are available in active markets for identical assets or liabilities as of the reported date. The types of assets and liabilities included in Level 1 are highly liquid and actively traded instruments with quoted prices, such as equities listed by the New York Stock Exchange and commodity derivative contracts listed on the New York Mercantile Exchange (NYMEX).

Level 2 – Pricing inputs are other than quoted prices in active markets, but are either directly or indirectly observable as of the reported date. The types of assets and liabilities included in Level 2 are typically either comparable to actively traded securities or contracts, such as treasury securities with pricing interpolated from recent trades of similar securities, or priced with models using highly observable inputs, such as commodity options priced using observable forward prices and volatilities.

Level 3 – Significant inputs to pricing have little or no observability as of the reporting date. The types of assets and liabilities included in Level 3 are those with inputs requiring significant management judgment or estimation and may include complex and subjective models and forecasts.

The following tables present, for each of the hierarchy levels, the Company’s assets and liabilities that are measured at fair value on a recurring basis as of September 30, 2016 and December 31, 2015:

September 30, 2016 (in thousands)	Level 1		Level 2		Level 3
Assets:
Investments:
Corporate Debt Securities – Held by Captive Insurance Company			$	4,408
Government-Backed and Government-Sponsored Enterprises’ Debt Securities – Held by Captive Insurance Company				3,506
Other Assets:
Money Market and Mutual Funds – Nonqualified Retirement Savings Plan	$	764
Total Assets	$	764	$	7,914
Liabilities:
Other Accrued Liabilities:
Derivative Liabilities – Forward Gasoline Purchase Contracts			$	49
Total Liabilities			$	49

December 31, 2015 (in thousands)	Level 1		Level 2		Level 3
Assets:
Current Assets – Other:
Money Market Escrow Accounts – AEV, Inc. and Foley Company Dispositions	$	2,000
Investments:
Government-Backed and Government-Sponsored Enterprises’ Debt Securities – Held by Captive Insurance Company			$	4,235
Corporate Debt Securities – Held by Captive Insurance Company				3,858
Other Assets:
Money Market and Mutual Funds – Nonqualified Retirement Savings Plan		196
Total Assets	$	2,196	$	8,093
Liabilities:
Other Accrued Liabilities:
Derivative Liabilities – Forward Gasoline Purchase Contracts			$	199
Total Liabilities			$	199

The valuation techniques and inputs used for the Level 2 fair value measurements in the table above are as follows:

Forward Gasoline Purchase Contracts – These contracts are priced based on NYMEX quoted prices for Reformulated Blendstock for Oxygenate Blending (RBOB) Gasoline contracts. Prices used for the fair valuation of these contracts are based on NYMEX daily reporting date quoted prices for RBOB contracts with the same settlement periods.

Government-Backed and Government-Sponsored Enterprises’ and Corporate Debt Securities Held by the Company’s Captive Insurance Company – Fair values are determined on the basis of valuations provided by a third-party pricing service which utilizes industry accepted valuation models and observable market inputs to determine valuation. Some valuations or model inputs used by the pricing service may be based on broker quotes.

Inventories

Inventories consist of the following:

	September 30,		December 31,
(in thousands)	2016		2015
Finished Goods	$	21,888	$	25,971
Work in Process		13,774		12,821
Raw Material, Fuel and Supplies		45,186		46,624
Total Inventories	$	80,848	$	85,416

Goodwill and Other Intangible Assets

On September 1, 2015 Miller Welding & Iron Works, Inc. (BTD-Illinois), a wholly owned subsidiary of BTD Manufacturing, Inc. (BTD), acquired the assets of Impulse Manufacturing, Inc. (Impulse) of Dawsonville, Georgia. The newly acquired business operates under the name BTD-Georgia. Based on the preliminary purchase price allocation, the difference in the fair value of assets acquired and the price paid for Impulse resulted in an initial estimate of acquired goodwill of $8.2 million. A final determination of the purchase price was agreed to in June 2016 resulting in a $2.2 million reduction in acquired goodwill in June 2016. See note 2 to the Company’s consolidated financial statements for more information.

An assessment of the carrying amounts of the remaining goodwill of the Company’s reporting units reported under continuing operations as of December 31, 2015 indicated the fair values are substantially in excess of their respective book values and not impaired.

The following table summarizes changes to goodwill by business segment during 2016:

(in thousands)	Gross Balance December 31, 2015		Accumulated Impairments		Balance (net of impairments) December 31, 2015		Adjustments to Goodwill in 2016			Balance (net of impairments) September 30, 2016
Manufacturing	$	20,430	$	—	$	20,430	$	(2,160	)	$	18,270
Plastics		19,302		—		19,302		—			19,302
Total	$	39,732	$	—	$	39,732	$	(2,160	)	$	37,572

Intangible assets with finite lives are amortized over their estimated useful lives and reviewed for impairment in accordance with requirements under ASC Topic 360-10-35, Property, Plant, and Equipment—Overall—Subsequent Measurement.

The following table summarizes the components of the Company’s intangible assets at September 30, 2016 and December 31, 2015:

September 30, 2016 (in thousands)	Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount		Remaining Amortization Periods
Amortizable Intangible Assets:
Customer Relationships	$	22,491	$	7,577	$	14,914	39-227 months
Covenant not to Compete		590		213		377	23 months
Total	$	23,081	$	7,790	$	15,291

December 31, 2015 (in thousands)
Amortizable Intangible Assets:
Customer Relationships	$	21,681	$	6,714	$	14,967	48-236 months
Covenant not to Compete		620		69		551	32 months
Other Intangible Assets		639		543		96	9 months
Emission Allowances		59		NA		59	Expensed as used
Total	$	22,999	$	7,326	$	15,673

The amortization expense for these intangible assets was:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(in thousands)	2016		2015		2016		2015
Amortization Expense – Intangible Assets	$	348	$	282	$	1,103	$	770

The estimated annual amortization expense for these intangible assets for the next five years is:

(in thousands)		2016				2017				2018				2019				2020
Estimated Amortization Expense – Intangible Assets		$	1,436			$	1,330			$	1,264			$	1,133			$	1,099

Supplemental Disclosures of Cash Flow Information

	As of September 30,
(in thousands)	2016		2015
Noncash Investing Activities:
Transactions Related to Capital Additions not Settled in Cash	$	11,552	$	21,760

Coyote Station Lignite Supply Agreement - Variable Interest Entity

Coyote Station Lignite Supply Agreement – Variable Interest Entity—In October 2012, the Coyote Station owners, including OTP, entered into a lignite sales agreement (LSA) with Coyote Creek Mining Company, L.L.C. (CCMC), a subsidiary of The North American Coal Corporation, for the purchase of lignite coal to meet the coal supply requirements of Coyote Station for the period beginning in May 2016 and ending in December 2040. The price per ton to be paid by the Coyote Station owners under the LSA will reflect the cost of production, along with an agreed profit and capital charge. CCMC was formed for the purpose of mining coal to meet the coal fuel supply requirements of Coyote Station from May 2016 through December 2040 and, based on the terms of the LSA, is considered a variable interest entity (VIE) due to the transfer of all operating and economic risk to the Coyote Station owners, as the agreement is structured so that the price of the coal would cover all costs of operations as well as future reclamation costs. The Coyote Station owners are also providing a guarantee of the value of the assets of CCMC as they would be required to buy certain assets at book value should they terminate the contract prior to the end of the contract term and are providing a guarantee of the value of the equity of CCMC in that they are required to buy the entity at the end of the contract term at equity value. Under current accounting standards, the primary beneficiary of a VIE is required to include the assets, liabilities, results of operations and cash flows of the VIE in its consolidated financial statements. No single owner of Coyote Station owns a majority interest in Coyote Station and none, individually, has the power to direct the activities that most significantly impact CCMC. Therefore, none of the owners individually, including OTP, is considered a primary beneficiary of the VIE and the Company is not required to include CCMC in its consolidated financial statements.

Under the LSA, all development period costs of the Coyote Creek coal mine incurred during the development period will be recovered from the Coyote Station owners over the full term of the production period, which commenced with the initial delivery of coal to Coyote Station in May 2016, by being included in the cost of production. The development fee and the capital charge incurred during the development period will be recovered from the Coyote Station owners over the first 52 months of the production period by being included in the cost of production during those months. If the LSA terminates prior to the expiration of its term or the production period terminates prior to December 31, 2040 and the Coyote Station owners purchase all of the outstanding membership interests of CCMC as required by the LSA, the owners will satisfy, or (if permitted by CCMC’s applicable lender) assume, all of CCMC’s obligations owed to CCMC’s lenders under its loans and leases. The Coyote Station owners have limited rights to assign their rights and obligations under the LSA without the consent of CCMC’s lenders during any period in which CCMC’s obligations to its lenders remain outstanding. Coyote Station started taking delivery of coal and paying for coal and the accumulated development fees and capital charges under the LSA in May 2016. OTP’s 35% share of the unrecovered development period costs, development fees and capital charges incurred by CCMC through September 30, 2016 is $61.7 million. In the event the contract is terminated because regulations or legislation render the burning of coal cost prohibitive and the assets worthless, OTP’s maximum exposure to loss as a result of its involvement with CCMC as of September 30, 2016 could be as high as $61.7 million.

New Accounting Standards

ASU 2014-09—In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (ASC 606). ASC 606 is a comprehensive, principles-based accounting standard which amends current revenue recognition guidance with the objective of improving revenue recognition requirements by providing a single comprehensive model to determine the measurement of revenue and the timing of revenue recognition. ASC 606 also requires expanded disclosures to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.

Amendments to the ASC in ASU 2014-09, as amended, are effective for fiscal years beginning after December 15, 2017. Early adoption is permitted, but not any earlier than January 1, 2017. Application methods permitted are: (1) full retrospective, (2) retrospective using one or more practical expedients and (3) retrospective with the cumulative effect of initial application recognized at the date of initial application. As of September 30, 2016 the Company has reviewed its revenue streams and contracts to determine areas where the amendments in ASU 2014-09 will be applicable and is evaluating transition options. The Company does not plan to adopt the updated guidance prior to January 1, 2018.

ASU 2015-03—In April 2015, the FASB issued ASU No. 2015-03, Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs (ASU 2015-03), which requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. ASU 2015-03 is effective for interim and annual reporting periods beginning after December 15, 2015 and must be applied retrospectively to balance sheets presented for periods prior to adoption. The Company adopted the updated standards in ASU 2015-03 in the first quarter of 2016. In conjunction with implementing this update, the Company is reclassifying the remaining balance of unamortized line of credit issuance costs from the deferred debit section of its consolidated balance sheet to other assets, eliminating the deferred debits section of its consolidated balance sheet and displaying long-term regulatory assets as a separate line item on its consolidated balance sheet. The effects of applying the guidance in ASU 2015-03 retrospectively to the Company’s December 31, 2015 consolidated balance sheet and of the associated reclassification of unamortized line of credit issuance costs are shown in the following table:

(in thousands)	Previously Stated		Adjustments			Restated
Other Assets	$	31,108	$	1,676		$	32,784
Unamortized Debt Expense		3,897		(3,897	)		—
Total Assets		1,820,904		(2,221	)		1,818,683

Current Liabilities
Current Maturities of Long-Term Debt		52,544		(122	)		52,422
Total Current Liabilities		271,238		(122	)		271,116
Capitalization
Long-Term Debt—Net		445,945		(2,099	)		443,846
Total Capitalization		1,050,968		(2,099	)		1,048,869
Total Liabilities and Equity		1,820,904		(2,221	)		1,818,683

ASU 2015-11—In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory, which requires that inventories be measured at the lower of cost or net realizable value instead of the lower of cost or market value. Net realizable value is defined as the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The standards update is effective prospectively for fiscal years and interim periods beginning after December 15, 2016, with early adoption permitted. The Company does not expect the adoption of the updated standard to have a material impact on its consolidated financial statements.

ASU 2016-02—In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (ASU 2016-02). ASU 2016-02 is a comprehensive amendment of the ASC, creating Topic 842, which will supersede the current requirements under ASC Topic 840 on leases and require the recognition of lease assets and lease liabilities on the balance sheet and the disclosure of key information about leasing arrangements. Topic 842 affects any entity that enters into a lease, with some specified scope exemptions. The main difference between previous GAAP and Topic 842 is the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. Topic 842 retains a distinction between finance leases and operating leases. The classification criteria for distinguishing between finance leases and operating leases are substantially similar to the classification criteria for distinguishing between capital leases and operating leases in the previous leases guidance. Topic 842 also requires qualitative and specific quantitative disclosures by lessees and lessors to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. The amendments in ASU 2016-02 are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application of the amendments in ASU 2016-02 is permitted. The Company is currently reviewing ASU 2016-02, identifying key impacts to its businesses to determine areas where the amendments in ASU 2016-02 will be applicable and evaluating transition options. The Company does not currently plan to apply the amendments in ASU 2016-02 to its consolidated financial statements prior to 2019.

ASU 2016-09—In March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (ASU 2016-09), which is intended to improve and simplify accounting and reporting requirements related to stock-based compensation programs. The amendments in ASU 2016-09 will change how companies account for certain aspects of share-based payments to employees. Under the updated standard, excess tax benefits related to vested awards recognized in stockholders' equity under prior guidance will be recognized in the income statement when the awards vest, and the level of shares that can be withheld to cover income taxes on awards to satisfy statutory income tax withholding obligations without triggering liability classification has been increased. The amendments in ASU 2016-09 are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for any interim or annual period. The Company is currently evaluating the impact this standard will have on its consolidated financial statements, but does not expect it to be material.