UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
/X/ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended MARCH 31,JUNE 30, 2007
or
/ / Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ______________ to ______________
Commission File Number 1-3548
ALLETE, INC.
(Exact name of registrant as specified in its charter)
MINNESOTA 41-0418150
(State or other jurisdiction of (IRS Employer
of incorporation or organization) Identification No.)
organization)
30 WEST SUPERIOR STREET
DULUTH, MINNESOTA 55802-2093
(Address of principal executive offices)
(Zip Code)
(218) 279-5000
(Registrant's telephone number, including area code)
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. /X/ Yes / / No
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
One):
Large Accelerated Filer /X/ Accelerated Filer/Filer / / Non-Accelerated Filer / /
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). / / Yes /X/ No
Common Stock, no par value,
30,526,83930,701,629 shares outstanding
as of AprilJune 30, 2007
INDEX
Page
Definitions 2
Safe Harbor Statement Under the Private Securities Litigation Reform Act
of 1995 3
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheet -
March 31,June 30, 2007 and December 31, 2006 4
Consolidated Statement of Income -
Quarter and Six Months Ended March 31,June 30, 2007 and 2006 5
Consolidated Statement of Cash Flows -
QuarterSix Months Ended March 31,June 30, 2007 and 2006 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 1617
Item 3. Quantitative and Qualitative Disclosures about Market
Risk 2428
Item 4. Controls and Procedures 2529
Part II. Other Information
Item 1. Legal Proceedings 2630
Item 1A. Risk Factors 2630
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds 2630
Item 3. Defaults Upon Senior Securities 2630
Item 4. Submission of Matters to a Vote of Security Holders 2630
Item 5. Other Information 2631
Item 6. Exhibits 2832
Signatures 2933
1 ALLETE FirstSecond Quarter 2007 Form 10-Q
DEFINITIONS
The following abbreviations or acronyms are used in the text. References in this
report to "we," "us" and "our" are to ALLETE, Inc. and its subsidiaries,
collectively.
ABBREVIATION OR ACRONYM TERM
- --------------------------------------------------------------------------------
2006 Form 10-K ALLETE's Annual Report on Form 10-K for
the Year Ended December 31, 2006
ALLETE ALLETE, Inc.
ALLETE Properties ALLETE Properties, LLC
AREA Arrowhead Regional Emission Abatement
Plan
ATC American Transmission Company LLC
BNI Coal BNI Coal, Ltd.
Boswell Boswell Energy Center
Company ALLETE, Inc. and its subsidiaries
DOC Minnesota Department of Commerce
EITF Emerging Issues Task Force Issue No.
EPA Environmental Protection Agency
ESOP Employee Stock Ownership Plan
FASB Financial Accounting Standards Board
FERC Federal Energy Regulatory Commission
FIN FASB Interpretations
FPL FPL Energy, LLC
GAAP Accounting Principles Generally Accepted
in the United States of America
Heating Degree Days Measure of the extent to which the
average daily temperature is below
65 degrees Fahrenheit, increasing
demand for heating
Laskin Laskin Energy Center
Minnesota Power An operating division of ALLETE, Inc.
Minnkota Power Minnkota Power Cooperative, Inc.
MISO Midwest Independent Transmission System
Operator, Inc.
Moody's Moody's Investors Service, Inc.
MPCA Minnesota Pollution Control Agency
MPUC Minnesota Public Utilities Commission
MW Megawatt(s)
Note ___ Note ___ to the consolidated financial
statements in this Form 10-Q
NOX Nitrogen Oxide
Palm Coast Park Palm Coast Park development project in
northeast Florida
Palm Coast Park District Palm Coast Park Community Development
District
PSCW Public Service Commission of Wisconsin
Rainy River Energy Rainy River Energy Corporation - Wisconsin
Resource Plan Integrated Resource Plan
SEC Securities and Exchange Commission
SFAS Statement of Financial Accounting
Standards No.
SO2 Sulfur Dioxide
Square Butte Square Butte Electric Cooperative
Standard & Poor's Standard & Poor's Ratings Group, a
division of McGraw-Hill Companies
SWL&P Superior Water, Light and Power Company
Taconite Harbor Taconite Harbor Energy Center
Town Center Town Center at Palm Coast development
project in northeast Florida
Town Center District Town Center at Palm Coast Community
Development District
WDNR Wisconsin Department of Natural
Resources
ALLETE FirstSecond Quarter 2007 Form 10-Q 2
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, we are hereby filing cautionary statements
identifying important factors that could cause our actual results to differ
materially from those projected in forward-looking statements (as such term is
defined in the Private Securities Litigation Reform Act of 1995) made by or on
behalf of ALLETE in this Quarterly Report on Form 10-Q, in presentations, in
response to questions or otherwise. Any statements that express, or involve
discussions as to expectations, beliefs, plans, objectives, assumptions, or
future events or performance (often, but not always, through the use of words or
phrases such as "anticipates," "believes," "estimates," "expects," "intends,"
"plans," "projects," "will likely result," "will continue," "could," "may,"
"potential," "target," "outlook" or similar expressions) are not statements of
historical facts and may be forward-looking.
Forward-looking statements involve estimates, assumptions, risks and
uncertainties, which are beyond our control and may cause actual results or
outcomes to differ materially from those that may be projected. These statements
are qualified in their entirety by reference to, and are accompanied by, the
following important factors, in addition to any assumptions and other factors
referred to specifically:
- our ability to successfully implement our strategic objectives;
- our ability to manage expansion and integrate acquisitions;
- prevailing governmental policies, regulatory actions, and legislation
including those of the United States Congress, state legislatures, the
FERC, the MPUC, the PSCW, and various local and county regulators, and
city administrators, about allowed rates of return, financings,
industry and rate structure, acquisition and disposal of assets and
facilities, real estate development, operation and construction of
plant facilities, recovery of purchased power and capitlcapital investments,
present or prospective wholesale and retail competition (including but
not limited to transmission costs), zoning and permitting of land held
for resale and environmental regulation;
- effects of restructuring initiatives in the electric industry;
- economic and geographic factors, including political and economic
risks;
- changes in and compliance with laws and policies;
- weather conditions;
- natural disasters and pandemic diseases;
- war and acts of terrorism;
- wholesale power market conditions;
- population growth rates and demographic patterns;
- effects of competition, including competition for retail and wholesale
customers;
- changes in the real estate market;
- pricing and transportation of commodities;
- changes in tax rates or policies or in rates of inflation;
- unanticipated project delays or changes in project costs;
- availability of construction materials and skilled construction labor
for capital projects;
- unanticipated changes in operating expenses and capital expenditures;
- global and domestic economic conditions;
- our ability to access capital markets and bank financing;
- changes in interest rates and the performance of the financial markets;
- our ability to replace a mature workforce and retain qualified, skilled
and experienced personnel; and
- the outcome of legal and administrative proceedings (whether civil or
criminal) and settlements that affect the business and profitability of
ALLETE.
Additional disclosures regarding factors that could cause our results and
performance to differ from results or performance anticipated by this report are
discussed in Item 1A under the heading "Risk Factors" in Part I of our 2006 Form
10-K. Any forward-looking statement speaks only as of the date on which such
statement is made, and we undertake no obligation to update any forward-looking
statement to reflect events or circumstances after the date on which that
statement is made or to reflect the occurrence of unanticipated events. New
factors emerge from time to time, and it is not possible for management to
predict all of these factors, nor can it assess the impact of each of these
factors on the businesses of ALLETE or the extent to which any factor, or
combination of factors, may cause actual results to differ materially from those
contained in any forward-looking statement. Readers are urged to carefully
review and consider the various disclosures made by us in this Form 10-Q and in
our other reports filed with the SEC that attempt to advise interested parties
of the factors that may affect our business.
3 ALLETE FirstSecond Quarter 2007 Form 10-Q
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLETE
CONSOLIDATED BALANCE SHEET
MILLIONS - UNAUDITED
MARCH 31,JUNE 30, DECEMBER 31,
2007 2006
- ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and Cash Equivalents $ 46.437.1 $ 44.8
Short-Term Investments 82.1121.8 104.5
Accounts Receivable (Less Allowance of $1.1 at March 31,June 30, 2007 and 73.467.7 70.9
December 31, 2006)
Inventories 44.346.9 43.4
Prepayments and Other 35.633.5 23.8
Deferred Income Taxes - 0.3
- ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Current Assets 281.8307.0 287.7
Property, Plant and Equipment - Net 933.0977.2 921.6
Investments 206.7207.8 189.1
Other Assets 138.6137.7 135.0
- ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $1,560.1$1,629.7 $1,533.4
- ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Current Liabilities
Accounts Payable $ 39.447.7 $ 53.5
Accrued Taxes 39.219.9 23.3
Accrued Interest 6.47.9 8.6
Long-Term Debt Due Within One Year 32.329.5 29.7
Deferred Profit on Sales of Real Estate 3.25.0 4.1
Other 24.920.5 24.3
- ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Current Liabilities 145.4130.5 143.5
Long-Term Debt 359.3409.2 359.8
Deferred Income Taxes 131.0130.5 130.8
Other Liabilities 229.2237.4 226.1
Minority Interest 7.58.8 7.4
- ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities 872.4916.4 867.6
- ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES
- ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Common Stock Without Par Value, 43.3 Shares Authorized,
30.530.7 and 30.4 Shares Outstanding 442.9455.0 438.7
Unearned ESOP Shares (69.7)(68.2) (71.9)
Accumulated Other Comprehensive Loss (8.6)(7.3) (8.8)
Retained Earnings 323.1333.8 307.8
- ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Shareholders' Equity 687.7713.3 665.8
- ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,560.1$1,629.7 $1,533.4
- ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
ALLETE FirstSecond Quarter 2007 Form 10-Q 4
ALLETE
CONSOLIDATED STATEMENT OF INCOME
MILLIONS EXCEPT PER SHARE AMOUNTS - UNAUDITED
QUARTER ENDED MARCH 31,SIX MONTHS ENDED
JUNE 30, JUNE 30,
2007 2006 2007 2006
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
OPERATING REVENUE $205.3 $192.5$ 223.3 $ 178.3 $ 428.6 $ 370.8
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Fuel and Purchased Power 77.7 69.492.9 63.0 170.6 132.4
Operating and Maintenance 74.6 74.584.6 76.8 159.2 151.3
Depreciation 11.711.9 12.2 23.6 24.4
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Operating Expenses 164.0 156.1189.4 152.0 353.4 308.1
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME FROM CONTINUING OPERATIONS 41.3 36.433.9 26.3 75.2 62.7
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
OTHER INCOME (EXPENSE)
Interest Expense (6.3)(6.1) (6.4) (12.4) (12.8)
Other 7.5 1.77.3 3.4 14.8 5.1
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Other Income (Expense) 1.2 (4.7)(3.0) 2.4 (7.7)
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS
BEFORE MINORITY INTEREST AND INCOME TAXES 42.5 31.735.1 23.3 77.6 55.0
MINORITY INTEREST 0.1 1.3 0.8 1.4 2.1
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES 42.4 30.433.8 22.5 76.2 52.9
INCOME TAX EXPENSE 16.1 11.611.2 8.9 27.3 20.5
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS 26.3 18.822.6 13.6 48.9 32.4
LOSS FROM DISCONTINUED OPERATIONS - (0.4) - (0.4)
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 26.322.6 $ 18.813.2 $ 48.9 $ 32.0
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
AVERAGE SHARES OF COMMON STOCK
Basic 28.2 27.7 28.1 27.6
Diluted 28.1 27.728.3 27.9 28.2 27.8
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
BASIC ANDEARNINGS PER SHARE OF COMMON STOCK
Continuing Operations $0.80 $0.50 $1.74 $1.18
Discontinued Operations - (0.02) - (0.02)
- -----------------------------------------------------------------------------------------------------------------------------
$0.80 $0.48 $1.74 $1.16
- -----------------------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER SHARE OF COMMON STOCK
Continuing Operations $0.93 $0.68$0.80 $0.49 $1.73 $1.17
Discontinued Operations - (0.02) - (0.02)
- -----------------------------------------------------------------------------------------------------------------------
$0.93 $0.68-----------------------------------------------------------------------------------------------------------------------------
$0.80 $0.47 $1.73 $1.15
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
DIVIDENDS PER SHARE OF COMMON STOCK $0.4100 $0.3625 $0.8200 $0.7250
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
5 ALLETE FirstSecond Quarter 2007 Form 10-Q
ALLETE
CONSOLIDATED STATEMENT OF CASH FLOWS
MILLIONS - UNAUDITED
QUARTERSIX MONTHS ENDED
MARCH 31,JUNE 30,
2007 2006
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net Income $26.3 $18.8$ 48.9 $ 32.0
Loss from Discontinued Operations - 0.4
Income from Equity Investments (0.8)(1.6) -
Gain on Sale of Assets (1.9)(2.1) -
Depreciation 11.7 12.223.6 24.4
Deferred Income Taxes 0.3 (1.7)(1.1) (4.7)
Minority Interest 0.1 1.31.4 2.1
Stock Compensation Expense 0.5 0.41.0 0.9
Bad Debt Expense 0.1 0.20.5 0.4
Changes in Operating Assets and Liabilities
Accounts Receivable 0.4 12.95.6 17.7
Inventories (0.9) 1.2(3.5) (9.0)
Prepayments and Other (11.8) 6.8(9.7) 2.2
Accounts Payable (10.5) (11.2)(6.9) (10.9)
Other Current Liabilities 10.7 14.6(9.7) (10.1)
Other Assets (0.1) (1.3)1.0 (1.1)
Other Liabilities 2.1 2.64.9 5.1
Net Operating Activities for Discontinued Operations - (12.6)(13.0)
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Cash from Operating Activities 26.2 44.252.3 36.4
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Proceeds from Sale of Available-For-Sale Securities 32.9 126.3187.2 410.6
Payments for Purchase of Available-For-Sale Securities (10.5) (170.9)(204.5) (414.1)
Changes to Investments (15.9) 2.4(17.8) (11.2)
Additions to Property, Plant and Equipment (25.5) (13.6)(70.1) (35.3)
Proceeds from Sale of Assets 1.31.4 -
Other (2.5) 4.41.5 2.5
Net Investing Activities from Discontinued Operations - 2.2
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Cash for Investing Activities (20.2) (49.2)(102.3) (45.3)
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Issuance of Common Stock 3.8 5.115.4 8.8
Issuance of Debt 110.2 50.0
Payments of Long-Term Debt 62.7 50.0
Payments of Debt (60.6) (51.4)(61.0) (52.0)
Dividends on Common Stock and Distributions to Minority Shareholders (10.3) (9.9)(22.3) (21.3)
Net Decrease in Book Overdrafts - (3.4)
Net- -----------------------------------------------------------------------------------------------------------------
Cash from (for) Financing Activities for Discontinued Operations42.3 (17.9)
- -
- -----------------------------------------------------------------------------------------------------------------------
Cash for Financing Activities (4.4) (9.6)
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
CHANGE IN CASH AND CASH EQUIVALENTS 1.6 (14.6)(7.7) (26.8)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 44.8 89.6
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $46.4 $75.0$ 37.1 $ 62.8
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
ALLETE FirstSecond Quarter 2007 Form 10-Q 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The accompanying unaudited consolidated financial statements and notes should be
read in conjunction with our 2006 Form 10-K. In our opinion, all adjustments
necessary for a fair statement of the results for the interim periods have been
made and have occurred in the normal course of business. The results of
operations for an interim period are not necessarily indicative of the results
to be expected for the full year.
NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
INVENTORIES. Inventories are stated at the lower of cost or market. Cost is
determined by the average cost method.
MARCH 31,JUNE 30, DECEMBER 31,
INVENTORIES 2007 2006
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
MILLIONS
Fuel $20.2$22.1 $18.9
Materials and Supplies 24.124.8 24.5
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Inventories $44.3$46.9 $43.4
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
ASSET RETIREMENT OBLIGATION (ARO). At June 30, 2007, our ARO balance was $35.9
million, ($27.2 million at December 31, 2006). This increase is primarily due to
the establishment of an ARO for our Taconite Harbor facility resulting from the
MPUC's approval of our decommissioning estimate.
SUPPLEMENTAL STATEMENT OF CASH FLOWS INFORMATION. AmountsAmount presented for June 30,
2006, havewhich was $19.4 million has been revised to eliminate intercompany
interest payments of $7.0 million from cash paid during the period for Interest
- - Net of Amounts Capitalized.
CONSOLIDATED STATEMENT OF CASH FLOWS
SUPPLEMENTAL DISCLOSURE
FOR THE QUARTERSIX MONTHS ENDED MARCH 31JUNE 30, 2007 2006
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
MILLIONS
Cash Paid During the Period for
Interest - Net of Amounts Capitalized $9.2 $8.8$14.3 $12.4
Income Taxes $1.9 $3.7$20.3 $31.1
Noncash Investing Activities
Accounts Payable for Capital Additions to
Property Plant and Equipment $3.6$1.2 -
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
NEW ACCOUNTING STANDARDS. SFAS 157. In September 2006, the FASB issued SFAS 157,
"Fair Value Measurements," to increase consistency and comparability in fair
value measurements by defining fair value, establishing a framework for
measuring fair value in generally accepted accounting principles, and expanding
disclosures about fair value measurements. SFAS 157 emphasizes that fair value
is a market-based measurement, not an entity-specific measurement. It clarifies
the extent to which fair value is used to measure recognized assets and
liabilities, the inputs used to develop the measurements, and the effect of
certain measurements on earnings for the period. SFAS 157 is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and is applied on a prospective basis. We are currently evaluating the impact
that the adoption of SFAS 157 would have on our consolidated financial position,
results of operations and cash flows.
SFAS 159. In February 2007, the FASB issued SFAS 159, "The Fair Value Option for
Financial Assets and Financial Liabilities," which is an elective, irrevocable
election to measure eligible financial instruments and certain other assets and
liabilities at fair value on an instrument-by-instrument basis. The election may
only be applied at specified election dates and to instruments in their entirety
rather than to portions of instruments. Upon initial election, the entity
reports the difference between the instruments' carrying value and their fair
value as a cumulative-effect adjustment to the opening balance of retained
earnings. At each subsequent reporting date, an entity shall report in earnings,
unrealized gains and losses on items for which the fair value option has been
elected. SFAS 159 is effective for financial statements issued for fiscal years
beginning after November 15, 2007, and is applied on a prospective basis. Early
adoption of SFAS 159 is permitted provided the entity also elects to adopt the
provisions of SFAS 157 as of the early adoption date selected for SFAS 159. We
are currently evaluating the impact that the adoption of SFAS 159 would have on
our consolidated financial position, results of operations and cash flows.
7 ALLETE FirstSecond Quarter 2007 Form 10-Q
NOTE 2. BUSINESS SEGMENTS
ENERGY
------------------------------------------------------------------------------
NONREGULATED
REGULATED ENERGY INVESTMENT REAL
CONSOLIDATED UTILITY OPERATIONS IN ATC ESTATE OTHER
- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
MILLIONS
FOR THE QUARTER ENDED MARCH 31,JUNE 30, 2007
Operating Revenue $205.3 $180.2 $16.8$223.3 $179.0 $16.2 - $8.2$ 28.0 $ 0.1
Fuel and Purchased Power 77.7 77.792.9 92.9 - - - -
Operating and Maintenance 74.6 56.9 14.484.6 61.2 14.9 - 2.9 0.47.8 0.7
Depreciation Expense 11.7 10.611.9 10.7 1.1 - - 0.1
- - --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from
Continuing Operations 41.3 35.0 1.333.9 14.2 0.2 - 5.3 (0.3)20.2 (0.7)
Interest Expense (6.3)(6.1) (5.2) (0.6)(0.2) - -(0.2) (0.5)
Other Income 7.5 0.5 2.3 $2.97.3 0.9 0.4 $3.2 - 1.82.8
- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations
Before Minority Interest
and Income Taxes 42.5 30.3 3.0 2.9 5.3 1.035.1 9.9 0.4 3.2 20.0 1.6
Minority Interest 0.11.3 - - - 0.11.3 -
- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations
Before Income Taxes 42.4 30.3 3.0 2.9 5.2 1.033.8 9.9 0.4 3.2 18.7 1.6
Income Tax Expense 16.1 11.5 0.8 1.1 2.1 0.6(Benefit) 11.2 3.8 (0.2) 1.3 7.2 (0.9)
- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations 26.322.6 $ 18.86.1 $ 2.2 $1.8 $3.10.6 $1.9 $ 0.4
-------------------------------------------------------------------11.5 $ 2.5
-------------------------------------------------------------
Loss from
Discontinued Operations -
Net of Tax -
- -----------------------------------------------------------------------------------------------------
Net Income $ 26.322.6
- ----------------------------------------------------
AT MARCH 31, 2007
Total Assets $1,560.1 $1,182.8 $79.5 $63.7 $90.6 $143.5
Property, Plant and Equipment - Net $933.0 $880.5 $49.0 - - $3.5
Accumulated Depreciation $817.5 $775.7 $40.1 - - $1.7
Capital Expenditures $21.9 $21.9 - - - --------------------------------------------------
FOR THE QUARTER ENDED MARCH 31,JUNE 30, 2006
Operating Revenue $192.5 $162.4$178.3 $146.5 $ 16.316.5 - $13.7$ 15.2 $ 0.1
Fuel and Purchased Power 69.4 69.463.0 63.0 - - - -
Operating and Maintenance 74.5 55.876.8 57.2 14.1 - 3.4 1.24.9 0.6
Depreciation Expense 12.2 11.1 1.11.0 - - 0.1
- - --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from
Continuing Operations 36.4 26.1 1.126.3 15.2 1.4 - 10.3 (1.1)(0.6)
Interest Expense (6.4) (5.1)(4.9) (0.5) - - (0.8)(1.0)
Other Income 1.7 - 0.33.4 0.5 - - 1.4
- ------------------------------------------------------------------------------------------------------------------------2.9
- --------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Minority Interest
and Income Taxes 31.7 21.023.3 10.8 0.9 - 10.3 (0.5)1.3
Minority Interest 1.30.8 - - - 1.30.8 -
- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Income Taxes 30.4 21.022.5 10.8 0.9 - 9.0 (0.5)9.5 1.3
Income Tax Expense (Benefit) 11.6 8.08.9 4.0 - - 4.03.9 1.0
- --------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations 13.6 $ 6.8 $ 0.9 - $ 5.6 $ 0.3
-------------------------------------------------------------
Loss from
Discontinued Operations -
Net of Tax (0.4)
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Net Income $ 13.2
- -------------------------------------------------
ALLETE Second Quarter 2007 Form 10-Q 8
NOTE 2. BUSINESS SEGMENTS (CONTINUED)
ENERGY
--------------------------------------
NONREGULATED
REGULATED ENERGY INVESTMENT REAL
CONSOLIDATED UTILITY OPERATIONS IN ATC ESTATE OTHER
- ----------------------------------------------------------------------------------------------------------------------
MILLIONS
FOR THE SIX MONTHS ENDED JUNE 30, 2007
Operating Revenue $428.6 $359.2 $33.0 - $ 36.2 $ 0.2
Fuel and Purchased Power 170.6 170.6 - - - -
Operating and Maintenance 159.2 118.1 29.3 - 10.7 1.1
Depreciation 23.6 21.3 2.2 - - 0.1
- ----------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from
Continuing Operations 18.875.2 49.2 1.5 - 25.5 (1.0)
Interest Expense (12.4) (10.4) (0.8) - (0.2) (1.0)
Other Income 14.8 1.4 2.7 $6.1 - 4.6
- ----------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations
Before Minority Interest
and Income Taxes 77.6 40.2 3.4 6.1 25.3 2.6
Minority Interest 1.4 - - - 1.4 -
- ----------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations
Before Income Taxes 76.2 40.2 3.4 6.1 23.9 2.6
Income Tax Expense (Benefit) 27.3 15.3 0.6 2.4 9.3 (0.3)
- ----------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations 48.9 $ 13.024.9 $ 0.9 -2.8 $3.7 $ 5.0 $(0.1)
-------------------------------------------------------------------14.6 $ 2.9
-------------------------------------------------------------
Loss from
Discontinued Operations -
Net of Tax -
- ------------------------------------------------------------------------------------------------------
Net Income $ 18.848.9
- ------------------------------------------------------------------------------------------------------
AT MARCH 31, 2006JUNE 30, 2007
Total Assets $1,404.0 $974.3 $105.2 - $70.4 $254.1$1,629.7 $1,218.9 $79.7 $64.4 $88.1 $178.6
Property, Plant and Equipment - Net $862.3 $803.2 $54.3$977.2 $925.2 $48.6 - - $3.4
Accumulated Depreciation $833.6 $790.7 $41.1 - - $1.8
Capital Expenditures $71.3 $70.4 $0.9 - - -
FOR THE SIX MONTHS ENDED JUNE 30, 2006
Operating Revenue $370.8 $308.9 $ 32.8 - $ 28.9 $ 0.2
Fuel and Purchased Power 132.4 132.4 - - - -
Operating and Maintenance 151.3 113.0 28.2 - 8.3 1.8
Depreciation 24.4 22.2 2.1 - - 0.1
- ----------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from
Continuing Operations 62.7 41.3 2.5 - 20.6 (1.7)
Interest Expense (12.8) (10.0) (1.0) - - (1.8)
Other Income 5.1 0.5 0.3 - - 4.3
- ----------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations
Before Minority Interest
and Income Taxes 55.0 31.8 1.8 - 20.6 0.8
Minority Interest 2.1 - - - 2.1 -
- ----------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations
Before Income Taxes 52.9 31.8 1.8 - 18.5 0.8
Income Tax Expense (Benefit) 20.5 12.0 - - 7.9 0.6
- ----------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations 32.4 $ 19.8 $ 1.8 - $ 10.6 $ 0.2
-------------------------------------------------------------
Loss from
Discontinued Operations -
Net of Tax (0.4)
- --------------------------------------------------
Net Income $ 32.0
- --------------------------------------------------
AT JUNE 30, 2006
Total Assets $1,386.1 $995.0 $104.6 - $72.4 $214.1
Property, Plant and Equipment - Net $871.6 $813.6 $53.2 - - $4.8
Accumulated Depreciation $797.5 $760.8 $35.1$807.4 $769.4 $36.4 - - $1.6
Capital Expenditures $13.6 $13.3 $0.3$35.3 $34.5 $0.8 - - -
9 ALLETE FirstSecond Quarter 2007 Form 10-Q 8
NOTE 3. INVESTMENTS
SHORT-TERM INVESTMENTS. At March 31,June 30, 2007 and December 31, 2006, we held $82.1$121.8
million and $104.5 million, respectively, of Short-Term investments,Investments, consisting
of auction rate bonds and variable rate demand notes classified as
available-for-sale securities. Our investments in these securities are recorded
at cost; however, their cost approximates fair value because the variable
interest rates for these securities typically reset every 7 to 35 days. Despite
the long-term nature of their stated contractual maturities, we have the ability
to quickly liquidate these securities. As a result, we had no cumulative gross
unrealized holding gains (losses) or gross realized gains (losses) from our
short-term investments. All income generated from these short-term investments
was recorded as interest income.
LONG-TERM INVESTMENTS. At March 31,June 30, 2007, Investments included the real estate
assets of ALLETE Properties, our investment in ATC, debt and equity securities
consisting primarily of securities held to fund employee benefits and our
emerging technology investments.
We account for our investment in ATC under the equity method of accounting,
pursuant to EITF 03-16, "Accounting for Investments in Limited Liability
Companies," which requires the use of the equity method of accounting for
investments in limited liability companies.
MARCH 31,JUNE 30, DECEMBER 31,
INVESTMENTS 2007 2006
- ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
MILLIONS
Real Estate Assets $ 90.688.1 $ 89.8
Debt and Equity Securities 43.446.3 36.4
Investment in ATC 63.764.4 53.7
Emerging Technology Investments 9.0 9.2
- ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Investments $206.7$207.8 $189.1
- ---------------------------------------------------------------------------------------------------------------------
MARCH 31,------------------------------------------------------------------------------------------------------------------
JUNE 30, DECEMBER 31,
REAL ESTATE ASSETS 2007 2006
- ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
MILLIONS
Land Held for Sale Beginning Balance $58.0 $48.0
Additions during period:Capitalized Improvements 2.85.6 18.8
Purchases - 1.4
Deductions during period: Cost of Real Estate Sold (0.9)(5.0) (10.2)
- ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Land Held for Sale Ending Balance 59.958.6 58.0
Long-Term Finance Receivables 17.116.0 18.3
Other 13.613.5 13.5
- ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Real Estate Assets $90.6$88.1 $89.8
- ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Consisted primarily of a shopping center.
Finance receivables have maturities ranging up to 7 years, accrue interest at
market-based rates and are net of an allowance for doubtful accounts of $0.2
million at March 31,June 30, 2007 ($0.2 million at December 31, 2006).
INVESTMENT IN ATC. In December 2005, we entered into an agreement with Wisconsin
Public Service Corporation and WPS Investments, LLC that provides for our
Wisconsin subsidiary, Rainy River Energy Corporation - Wisconsin, to invest $60
million in ATC. In May 2006, the PSCW reviewed and approved the request that
allowed Rainy River Energy to invest in ATC. Infirst six months of 2007, we invested an additional $8.7
million ($51.4 million invested through December 31, 2006) in ATC, reaching our
approximate $60 million investment commitment. As of March 31,June 30, 2007, our equity
investment balance in ATC was $63.7$64.4 million ($53.7 million at December 31,
2006), representing an 8.58.3 percent ownership interest.
9 ALLETE FirstSecond Quarter 2007 Form 10-Q 10
NOTE 4. SHORT-TERM AND LONG-TERM DEBT
On February 1, 2007, we issued $60 million in principal amount of First Mortgage
Bonds, 5.99% Series due February 1, 2027, in the private placement market.
Proceeds were used to retire $60 million in principal amount of First Mortgage
Bonds, 7% Series due on February 15, 2007.
On June 8, 2007, we issued $50 million of senior unsecured notes (Notes) in the
private placement market. The Notes bear an interest rate of 5.99 percent and
will mature on June 1, 2017. The Company has the option to prepay all or a
portion of the Notes at its discretion, subject to a make-whole provision. The
Company intends to use the proceeds from the sale of the Notes to fund utility
capital projects and for general corporate purposes.
NOTE 5. OTHER INCOME (EXPENSE)
QUARTER ENDED MARCH 31,SIX MONTHS ENDED
JUNE 30, JUNE 30,
2007 2006 2007 2006
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
MILLIONS
Loss
Gain (Loss) on Emerging Technology Investments $(0.9)$ 0.1 - $ (0.8) $(1.2)
Income from Investment in ATC (See Note 3) 2.93.2 - 6.1 -
Investment and Other Income 5.5 2.94.0 $3.4 9.5 6.3
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Other Income $ 7.57.3 $3.4 $ 1.714.8 $ 5.1
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
NOTE 6. INCOME TAX EXPENSE
QUARTER ENDED MARCH 31,SIX MONTHS ENDED
JUNE 30, JUNE 30,
2007 2006 2007 2006
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
MILLIONS
Current Tax Expense
Federal $11.9 $10.8$ 10.1 $ 9.6 $ 22.0 $ 20.4
State 3.9 2.5 2.3 6.4 4.8
- ------------------------------------------------------------------------------------------------------------------
15.8 13.3----------------------------------------------------------------------------------------------------------------------
12.6 11.9 28.4 25.2
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Deferred Tax Expense (Benefit)
Federal 0.2 (1.6)(1.5) (1.9) (1.3) (3.5)
State 0.4 0.20.3 (0.7) 0.7 (0.5)
- ------------------------------------------------------------------------------------------------------------------
0.6 (1.4)----------------------------------------------------------------------------------------------------------------------
(1.2) (2.6) (0.6) (4.0)
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Deferred Tax Credits (0.3) (0.3)(0.2) (0.4) (0.5) (0.7)
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Income Tax Expense from Continuing Operations 16.1 11.611.2 8.9 27.3 20.5
Income Tax Benefit from Discontinued Operations - (0.3) - (0.3)
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Income Tax Expense $16.1 $11.6$ 11.2 $ 8.6 $ 27.3 $ 20.2
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
For the quartersix months ended March 31,June 30, 2007, the effective tax rate on income from
continuing operations before minority interest was 37.935.1 percent (36.6(37.3 percent
for six months ended June 30, 2006). The effective rate of 35.1 percent for the
quartersix months ended March 31, 2006). The effective tax rate of 37.9 percent
for the quarter ended March 31,June 30, 2007, deviated from the statutory rate (approximately
40 percent) primarily due to a state income tax audit settlement ($1.5 million),
deductions for Medicare health subsidies, domestic manufacturing deduction,
allowance for funds used during construction (AFUDC) and depletion.
11 ALLETE Second Quarter 2007 Form 10-Q
NOTE 6. INCOME TAX EXPENSE (CONTINUED)
UNCERTAIN TAX POSITIONS. Effective January 1, 2007, we adopted the provisions of
FIN 48, "Accounting for Uncertainty in Income Taxes - an Interpretation of FASB
Statement No. 109." As a result of the implementation of FIN 48, we recognized a
$1.0 million increase in the liability for unrecognized tax benefits. The
adoption of FIN 48 also resulted in a reduction in retained earnings of $0.7
million, a reduction of deferred tax liabilities of $0.8 million and an increase
in accrued interest of $0.5 million. Subsequent to the implementation of FIN 48,
ALLETE's gross unrecognized tax benefits were $10.4 million. Of this total, $6.8
million (net of federal tax benefit on state issues) represents the amount of
unrecognized tax benefits that, if recognized, would favorably affect the
effective income tax rate.
ALLETE First Quarter 2007 Form 10-Q 10
NOTE 6. INCOME TAX EXPENSE (CONTINUED)
Included in the liability for unrecognized tax benefits balance as of January 1,
2007, are $0.8 million (net of federal tax benefit on state issues) of tax
positions for which the ultimate deductibility is highly certain, but for which
there is uncertainty about the timing of deductibility. Due to the impact of
deferred tax accounting, other than the accounting for interest and penalties,
the disallowance of the shorter deductibility period would not affect the annual
effective tax rate. The disallowance would, however, accelerate the payment of
cash to the taxing authority to an earlier period.
We recognize interest related to unrecognized tax benefits in interest expense
and penalties in operating expenses in the Consolidated Statement of Income. As
of January 1, 2007, the Company had $1.3 million of accrued interest and $0 ofno
accrued penalties related to unrecognized tax benefits included in the
Consolidated Balance Sheet. The liability for the payment of interest and
penalties did not materially changeis $0.8
million as of March 31,June 30, 2007.
In May 2007, we settled a state audit resulting in the recognition of a tax
benefit of $1.5 million. After the reversal of unrecognized tax benefits upon
the audit settlement, ALLETE's gross unrecognized tax benefits were $4.7 million
at June 30, 2007. Of this total, $3.1 million (net of federal benefit on state
issues) represented the amount of unrecognized tax benefits that, if recognized,
would favorably affect the effective tax rate.
We, along with our subsidiaries, file income tax returns in the U.S. federal and
various state jurisdictions. With few exceptions, ALLETE is no longer subject to
federal examination for years before 2003 or state examinations for years before
2001.
We expect that the amount of unrecognized tax benefits as of January 1,June 30, 2007, will
change in the next 12 months; however, we do not expect the change to have a
significant impact on our financial position, results of operations or cash
flows.
NOTE 7. DISCONTINUED OPERATIONS
In early 2005, we completed the exit from our Water Services businesses with the
sale of our wastewater assets in Georgia, which resulted in an immaterial gain.
In 2005, the Florida Public Service Commission approved the transfer of 63 water
and wastewater systems from Florida Water Services Corporation to Aqua Utilities
Florida, Inc. (Aqua Utilities) and ordered a $1.7 million reduction to plant
investment. The Company reserved for the reduction in 2005. On March 15, 2006,
the Company paid Aqua Utilities the adjustment refund amount of $1.7 million.
For the quarter and six months ended June 30, 2007, there were no financial
results to report as discontinued operations.
QUARTER ENDED SIX MONTHS ENDED
DISCONTINUED OPERATIONS JUNE 30, JUNE 30,
SUMMARY INCOME STATEMENT 2006 2006
- ----------------------------------------------------------------------------------------------------------------
MILLIONS
Loss on Disposal
Water Services $(0.7) $(0.7)
- ----------------------------------------------------------------------------------------------------------------
Income Tax Benefit
Water Services 0.3 0.3
- ----------------------------------------------------------------------------------------------------------------
Net Loss on Disposal (0.4) (0.4)
- ----------------------------------------------------------------------------------------------------------------
Loss from Discontinued Operations $(0.4) $(0.4)
- ----------------------------------------------------------------------------------------------------------------
ALLETE Second Quarter 2007 Form 10-Q 12
NOTE 8. COMPREHENSIVE INCOME (LOSS)
For the quarter ended March 31,June 30, 2007, total comprehensive income (loss), net of
tax, was $26.5$23.9 million ($19.113.2 million for the quarter ended March 31,June 30, 2006). For
the six months ended June 30, 2007, total comprehensive income (loss), net of
tax, was $50.4 million of comprehensive income ($32.3 million of comprehensive
loss, net of tax, for the six months ended June 30, 2006). Total comprehensive
income (loss) includes net income (loss), unrealized gains and losses on
securities classified as available-for-sale, and our unfunded pension
liabilities.
ACCUMULATED OTHER COMPREHENSIVE MARCH 31,JUNE 30,
INCOME (LOSS) - NET OF TAX 2007 2006
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
MILLIONS
Unrealized Gain on Securities $ 4.25.0 $ 2.4
Defined Benefit Pension and Other Postretirement Plans (12.8)(12.3) -
Additional Pension Liability - (14.9)
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Accumulated Other Comprehensive Loss $ (8.6)(7.3) $(12.5)
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
11 ALLETE First Quarter 2007 Form 10-Q
NOTE 8.9. EARNINGS PER SHARE
The difference between basic and diluted earnings per share arises from
outstanding stock options and performance share awards granted under our
Executive and Director Long-Term Incentive Compensation Plans. In accordance
with SFAS 128, "Earnings Per Share," for the quarter and six months ended March 31,June
30, 2007, 0.1 million options to purchase shares of common stock were excluded
from the computation of diluted earnings per share because the option exercise
prices were greater than the average market prices, and therefore, their effect
would be anti-dilutive. For the quarter and six months ended March 31,June 30, 2006, no
options to purchase shares of common stock were excluded from the computation of
diluted earnings per share.
2007 2006
----------------------------------------------------------------------------------------------------------------------------------------
RECONCILIATION OF BASIC AND DILUTED DILUTIVE DILUTIVE
EARNINGS PER SHARE BASIC SECURITIES DILUTED BASIC SECURITIES DILUTED
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
MILLIONS EXCEPT PER SHARE AMOUNTS
FOR THE QUARTER ENDED MARCH 31,JUNE 30,
Income from Continuing Operations $26.3$22.6 - $26.3 $18.8$22.6 $13.6 - $18.8$13.6
Common Shares 28.1 - 28.1 27.628.2 0.1 28.3 27.7 0.2 27.9
Per Share from Continuing Operations $0.93$0.80 - $0.93 $0.68$0.80 $0.50 - $0.68$0.49
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
FOR THE SIX MONTHS ENDED JUNE 30,
Income from Continuing Operations $48.9 - $48.9 $32.4 - $32.4
Common Shares 28.1 0.1 28.2 27.6 0.2 27.8
Per Share from Continuing Operations $1.74 - $1.73 $1.18 - $1.17
- -------------------------------------------------------------------------------------------------------------------
13 ALLETE Second Quarter 2007 Form 10-Q
NOTE 9.10. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
POSTRETIREMENT
PENSION HEALTH AND LIFE
-------------------------------------------------------------
COMPONENTS OF NET PERIODIC BENEFIT EXPENSE 2007 2006 2007 2006
- -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
MILLIONS
FOR THE QUARTER ENDED MARCH 31,JUNE 30,
Service Cost $ 1.3 $ 2.3 $ 1.00.9 $ 1.1
Interest Cost 5.7 5.5 1.9 1.95.6 1.8 1.8
Expected Return on Plan Assets (7.7) (7.1)(7.6) (7.2) (1.6) (1.4)
Amortization of Prior Service Costs 0.20.1 0.2 - -
Amortization of Net Loss 0.8 1.2 0.2 0.40.1 0.5
Amortization of Transition Obligation - -(0.1) 0.6 0.6
- -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Net Periodic Benefit Expense $ 0.3 $ 2.12.0 $ 2.11.8 $ 2.6
- -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
FOR THE SIX MONTHS ENDED JUNE 30,
Service Cost $ 2.6 $ 4.6 $ 1.9 $ 2.2
Interest Cost 11.4 11.1 3.7 3.7
Expected Return on Plan Assets (15.3) (14.3) (3.2) (2.8)
Amortization of Prior Service Costs 0.3 0.4 - -
Amortization of Net Loss 1.6 2.4 0.3 0.9
Amortization of Transition Obligation - (0.1) 1.2 1.2
- --------------------------------------------------------------------------------------------------------------------
Net Periodic Benefit Expense $ 0.6 $ 4.1 $ 3.9 $ 5.2
- --------------------------------------------------------------------------------------------------------------------
In 2005, we determined that our postretirement health care plans meet the
requirements of the Centers for Medicare and Medicaid Services' (CMS)
regulations and enrolled with the CMS to begin recovering the subsidy. We
expect
to receive thereceived our first subsidy payment of $0.3 million in 2007 for 2006 credits.
EMPLOYER CONTRIBUTIONS. For the quarter ended March 31,June 30, 2007, no contributions
were made to our pension or postretirement health and life plans. For the six
months ended june 30, 2007, no contributions were made to our pension plans and
$2.8 million of contributions were made to our postretirement health and life
plans. We do not expect to make any additional contributions to fund our pension
or postretirement health and life plans in 2007.
We do not expect to make any contributions to our
defined benefit pension plans in 2007.
ALLETE First Quarter 2007 Form 10-Q 12
NOTE 10.11. COMMITMENTS, GUARANTEES AND CONTINGENCIES
OFF-BALANCE SHEET ARRANGEMENTS. SQUARE BUTTE POWER PURCHASE AGREEMENT.Square Butte Power Purchase Agreement. Minnesota
Power has a power purchase agreement with Square Butte that extends through 2026
(Agreement). It provides a long-term supply of low-cost energy to customers in
our electric service territory and enables Minnesota Power to meet power pool
reserve requirements. Square Butte, a North Dakota cooperative corporation, owns
a 455-MW coal-fired generating unit (Unit) near Center, North Dakota. The Unit
is adjacent to a generating unit owned by Minnkota Power, a North Dakota
cooperative corporation whose Class A members are also members of Square Butte.
Minnkota Power serves as the operator of the Unit and also purchases power from
Square Butte.
Minnesota Power was entitled to approximately 71 percent of the Unit's output
under the Agreement prior to 2006. Beginning in 2006, Minnkota Power exercised
its option to reduce Minnesota Power's entitlement by approximately 5 percent
annually. We received notices from Minnkota Power reducing our output
entitlement by approximately 5 percent annually to 60 percent as of January 1,
2007, 55 percent on January 1, 2008, and 50 percent on January 1, 2009, and
thereafter. Minnkota Power has no further option to reduce Minnesota Power's
entitlement below 50 percent. Minnesota Power is obligated to pay its pro-rata
share of Square Butte's costs based on Minnesota Power's entitlement to Unit
output. Minnesota Power's payment obligation will be suspended if Square Butte
fails to deliver any power, whether produced or purchased, for a period of one
year. Square Butte's fixed costs consist primarily of debt service. At March 31,June 30,
2007, Square Butte had total debt outstanding of $297.6$324.2 million. Total annual
debt service for Square Butte is expected to be approximately $26 million in
each of the years 2007 through 2011. Variable operating costs include the price
of coal purchased from BNI Coal, our subsidiary, under a long-term contract.
ALLETE Second Quarter 2007 Form 10-Q 14
NOTE 11. COMMITMENTS, GUARANTEES AND CONTINGENCIES (CONTINUED)
LEASING AGREEMENTS. BNI Coal is obligated to make lease payments for a dragline
totaling $2.8 million annually for the lease term which expires in 2027. BNI
Coal has the option at the end of the lease term to renew the lease at a fair
market rental, to purchase the dragline at fair market value, or to surrender
the dragline and pay a $3.0 million termination fee. We lease other properties
and equipment under operating lease agreements with terms expiring through 2013.
The aggregate amount of minimum lease payments for all operating leases is $8.2
million in 2007, $7.6 million in 2008, $7.0 million in 2009, $6.5 million in
2010, $6.0 million in 2011 and $51.2 million thereafter.
COAL, RAIL AND SHIPPING CONTRACTS. We have three coal supply agreements with
various expiration dates ranging from December 2008 to December 2009. We also
have rail and shipping agreements for the transportation of all of our coal,
with various expiration dates ranging from December 2007 to December 2011. Our
minimum annual payment obligations under these coal, rail and shipping
agreements are currently $42.0 million in 2007, $16.4$16.0 million in 2008, $11.1$10.7
million in 2009 and no specific commitments beyond 2009. Our minimum annual
payment obligations will increase when annual nominations are made for coal
deliveries in future years.
EMERGING TECHNOLOGY PORTFOLIO. We have investments in emerging technologies
through minority investments in venture capital funds structured as limited
liability companies, and direct investments in privately-held, start-up
companies. We have committed to make additional investments in certain emerging
technology venture capital funds. The total future commitment was $2.0$1.8 million
at March 31,June 30, 2007 ($2.5 million at December 31, 2006), and will be invested in
2007. We do not have plans to make any additional investments beyond this
commitment.
13 ALLETE First Quarter 2007 Form 10-Q
NOTE 10. COMMITMENTS, GUARANTEES AND CONTINGENCIES (CONTINUED)
ENVIRONMENTAL MATTERS. Our businesses are subject to regulation of environmental
matters by various federal, state and local authorities. Due to stricter
environmental requirements through legislation and/or rulemaking in the future,
we anticipate that potential expenditures for environmental matters will be
material and will require significant capital investments. We review
environmental matters on a quarterly basis. Accruals for environmental matters
are recorded when it is probable that a liability has been incurred and the
amount of the liability can be reasonably estimated, based on current law and
existing technologies. These accruals are adjusted periodically as assessment
and remediation efforts progress or as additional technical or legal information
becomes available. Accruals for environmental liabilities are included in the
balance sheet at undiscounted amounts and exclude claims for recoveries from
insurance or other third parties. Costs related to environmental contamination
treatment and cleanup are charged to expense unless recoverable in rates from
customers.
SWL&P MANUFACTURED GAS PLANT. In May 2001, SWL&P received notice from the WDNR
that the City of Superior had found soil contamination on property adjoining a
former Manufactured Gas Plant (MGP) site owned and operated by SWL&P from 1889
to 1904. A report submitted in 2003 identified some MGP-like chemicals that were
found in the soil near the former plant site. The on-site investigation continued
through the fall of 2006. The final Phase II report is expected in Maywas issued on June 7, 2007,
confirming our understanding of the issues involved. The final Phase II Report
and Risk Assessment were sent to the WDNR for review on June 18, 2007. Although
it is not possible to quantify the potential clean-up cost until the
investigation is completed, a $0.5 million liability was recorded in December
2003 to address the known areas of contamination. The Company has recorded a
corresponding dollar amount as a regulatory asset to offset this liability. In
May 2005, the PSCW approved the collection through rates of $150,000 of site
investigation costs that had been incurred at the time SWL&P filed theirits 2005 rate
request. InOn December 11, 2006, the PSCW approved the recovery of an additional
$186,000 of site investigation costs that were incurred through 2005. ALLETE
maintains pollution liability insurance coverage that includes coverage for
SWL&P. A claim has been filed with respect to this matter. The insurance carrier
has issued a reservation of rights letter and the Company continues to work with
the insurer to determine the availability of insurance coverage.
15 ALLETE Second Quarter 2007 Form 10-Q
NOTE 11. COMMITMENTS, GUARANTEES AND CONTINGENCIES (CONTINUED)
EPA CLEAN AIR INTERSTATE RULE AND CLEAN AIR MERCURY RULE. In March 2005, the EPA
announced the final Clean Air Interstate Rule (CAIR) that reduces and
permanently caps emissions of SO2 and NOX in the eastern United States. The CAIR
includes Minnesota as one of the 28 states it considers as "significantly
contributing" to air quality standards non-attainment in other states. The EPA
also announced the final Clean Air Mercury Rule (CAMR) that reduces and
permanently caps electric utility mercury emissions nationwide. The CAIR and the
CAMR regulations have been challenged in the federal court system, which may
delay implementation or modify provisions. Minnesota Power is participating in a
legal challenge to the CAIR, but is not participating in a challenge to the
CAMR. However, if the CAMR and the CAIR do go into effect, Minnesota Power
expects to be required to: (1) make emissions reductions; (2) purchase mercury,
SO2 and NOX allowances through the EPA's cap-and-trade system; or (3) use a
combination of both.
Minnesota Power petitioned the EPA to review theirits CAIR determinations affecting
Minnesota. In July 2005, Minnesota Power also filed a Petition for Review with
the U.S. Court of Appeals for the District of Columbia Circuit (Court of
Appeals). In November 2005, the EPA agreed to reconsider certain aspects of the
CAIR, including the Minnesota Power petition addressing emissions applied to air
quality modeling used to determine Minnesota's inclusion in the CAIR region and
our claims about inequities in the SO2 allowance methodology. In March 2006, the
EPA announced that it would not make any changes to the CAIR as a result of the
petitions for reconsideration. Petitions for Review, including Minnesota
Power's, remain pending at the Court of Appeals. If the Petitions for Review
filed with the Court of Appeals are successful, we expect to incur significantly
lower compliance costs, consistent with the rules applicable to those states
determined to not be "significant contributors" to air quality non-attainment as
addressed under the CAIR. Resolution of the CAIR Petition for Review with the
Court of Appeals is anticipated in 2008.
ALLETE First Quarter 2007 Form 10-Q 14
NOTE 10. COMMITMENTS, GUARANTEES AND CONTINGENCIES (CONTINUED)
COMMUNITY DEVELOPMENT DISTRICT OBLIGATIONS. TOWN CENTER. In March 2005, the Town
Center District issued $26.4 million of tax-exempt, 6% Capital Improvement
Revenue Bonds, Series 2005, which are payable over 31 years (by May 1, 2036).
The bond proceeds (less capitalized interest, a debt service reserve fund and
cost of issuance) were used to pay for the construction of a portion of the
major infrastructure improvements at Town Center. The bonds are payable from and
secured by the revenue derived from assessments imposed, levied and collected by
the Town Center District. The assessments represent an allocation of the costs
of the improvements, including bond financing costs, to the lands within the
Town Center District benefiting from the improvements. The assessments were
billed to Town Center landowners beginning in November 2006. To the extent that
we still own land at the time of the assessment, in accordance with EITF 91-10,
we recognize the cost of our portion of these assessments, based upon our
ownership of benefited property. At March 31,June 30, 2007, we owned 7369 percent of the
assessable land in the Town Center District.District (73 percent at December 31, 2006).
PALM COAST PARK. In May 2006, the Palm Coast Park District issued $31.8 million
of tax-exempt, 5.7% Special Assessment Bonds, Series 2006, which are payable
over 31 years (by May 1, 2037). The bond proceeds (less capitalized interest, a
debt service reserve fund and cost of issuance) are being used to pay for the
construction of the major infrastructure improvements at Palm Coast Park and to
mitigate traffic and environmental impacts. The bonds are payable from and
secured by the revenue derived from assessments imposed, levied and collected by
the Palm Coast Park District. The assessments represent an allocation of the
costs of the improvements, including bond financing costs, to the lands within
the Palm Coast Park District benefiting from the improvements. The assessments
will be billed to Palm Coast Park landowners beginning in November 2007. To the
extent that we still own land at the time of the assessment, in accordance with
EITF 91-10, we will recognize the cost of our portion of these assessments,
based upon our ownership of benefited property. At March 31,June 30, 2007, we owned 9789
percent of the assessable land in the Palm Coast Park District.District (97 percent at
December 31, 2006).
OTHER. We are involved in litigation arising in the normal course of business.
Also in the normal course of business, we are involved in tax, regulatory and
other governmental audits, inspections, investigations and other proceedings
that involve state and federal taxes, safety, compliance with regulations, rate
base and cost of service issues, among other things. While the resolution of
such matters could have a material effect on earnings and cash flows in the year
of resolution, none of these matters are expected to materially change our
present liquidity position or have a material adverse effect on our financial
condition.
15 ALLETE FirstSecond Quarter 2007 Form 10-Q 16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our consolidated
financial statements, notes to those statements, management, discussion and
analysis from the 2006 Form 10-K and the other financial information appearing
elsewhere in this report. In addition to historical information, the following
discussion and other parts of this Form 10-Q contain forward-looking information
that involves risks and uncertainties. Readers are cautioned that
forward-looking statements should be read in conjunction with our disclosures in
this Form 10-Q under the headings: "Safe Harbor Statement Under the Private
Securities Litigation Reform Act of 1995" located on page 3 and "Risk Factors"
located in Part I, Item 1A, page 24 of our 2006 Form 10-K. The risks and
uncertainties described in this Form 10-Q and our 2006 Form 10-K are not the
only risks facing our Company. Additional risks and uncertainties that we are
not presently aware of, or that we currently consider immaterial, may also
affect our business operations. Our business, financial condition or results of
operations could suffer if the concerns set forth are realized.
EXECUTIVE SUMMARY
ALLETE is a diversified company providing fundamental products and services
since 1906. This includes our two core businesses--ENERGY and REAL ESTATE, as
well as our former operations in the water, paper, telecommunications and
automotive industries.
ENERGY is comprised of Regulated Utility, Nonregulated Energy Operations and
Investment in ATC.
- REGULATED UTILITY includes retail and wholesale rate regulated electric,
natural gas and water services in northeastern Minnesota and northwestern
Wisconsin under the jurisdiction of state and federal regulatory
authorities.
- NONREGULATED ENERGY OPERATIONS includes our coal mining activities in
North Dakota, approximately 50 MW of nonregulated generation and Minnesota
land sales.
- INVESTMENT IN ATC includes our equity ownership interest in ATC.
REAL ESTATE includes our Florida real estate operations.
OTHER includes our investments in emerging technologies, and earnings on cash
and short-term investments.
17 ALLETE FirstSecond Quarter 2007 Form 10-Q 16
EXECUTIVE SUMMARY (CONTINUED)
QUARTER ENDED MARCH 31,SIX MONTHS ENDED
JUNE 30, JUNE 30,
KILOWATTHOURS SOLD 2007 2006 2007 2006
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MILLIONS
Regulated Utility
Retail and Municipals
Residential 341.6 308.0231.7 229.1 573.3 537.1
Commercial 352.2 328.7320.9 315.5 673.1 644.2
Municipals 266.4 219.3229.2 216.1 495.6 435.4
Industrial 1,705.4 1,822.31,734.0 1,769.9 3,439.4 3,592.2
Other 22.2 20.019.0 18.6 41.3 38.6
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Total Retail and Municipals 2,687.8 2,698.32,534.8 2,549.2 5,222.7 5,247.5
Other Power Suppliers 524.0 505.1513.0 515.5 1,036.9 1,020.6
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Total Regulated Utility 3,211.8 3,203.43,047.8 3,064.7 6,259.6 6,268.1
Nonregulated Energy Operations 63.7 65.659.8 55.3 123.5 120.9
- --------------------------------------------------------------------------------
3,275.5 3,269.0------------------------------------------------------------------------------------------------------------------
3,107.6 3,120.0 6,383.1 6,389.0
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QUARTER ENDED MARCH 31,SIX MONTHS ENDED
JUNE 30, JUNE 30,
REAL ESTATE 2007 2006 2007 2006
REVENUE AND SALES ACTIVITY QUANTITYQTY AMOUNT QUANTITYQTY AMOUNT QTY AMOUNT QTY AMOUNT
- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
DOLLARS IN MILLIONS
Town Center Sales
Commercial Sq. Ft. 435,000 $ 12.6 170,695 $ 4.7 435,000 $ 12.6 250,695 $ 6.2
Residential Units 130 1.6 186 5.6 130 1.6 186 5.6
Palm Coast Park
Commercial Sq. Ft. 40,000 2.0 - - 80,000 $ 1.540,000 2.0 - -
Residential Units 406 11.1 - - 406 11.1 - -
Other Land Sales
Acres - - 10 5.2 367 $ 6.0 456 10.3466 15.5
Lots - --------------------------------------------------------------------------------- - - - - - -
- ------------------------------------------------------------------------------------------------------------------
Contract Sales Price 6.0 11.827.3 15.5 33.3 27.3
Revenue Recognized from
Previously Deferred Sales 1.3 1.51.0 2.7 2.3 4.3
Deferred Revenue - (0.7)(3.1) (3.2) (3.1) (4.0)
Adjustments - (0.1)(1.4) - --------------------------------------------------------------------------------(1.5)
- ------------------------------------------------------------------------------------------------------------------
Revenue from Land Sales 7.3 12.525.2 13.6 32.5 26.1
Other Revenue 0.9 1.22.8 1.6 3.7 2.8
- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
$ 8.228.0 $ 13.715.2 $ 36.2 $28.9
- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Acreage amounts are shown on a gross basis, including wetlands and minority interest.
Reflected total contract sales price on closed land transactions.
Contributed development dollars, which are credited to cost of real estate sold.
17 ALLETE FirstSecond Quarter 2007 Form 10-Q 18
NET INCOME
The following income discussion summarizes, by segment, a comparison of the quartersix
months ended March 31,June 30, 2007, to the quartersix months ended March 31,June 30, 2006.
REGULATED UTILITY contributed income of $18.8$24.9 million in 2007 ($13.019.8 million in
2006). The increase in earnings for 2007 reflect:reflects:
- increased electric sales to Residential, Commercialresidential, commercial and Municipalmunicipal
customers, as well as increased gas sales at SWL&P due to colder weather
in the first quarter of 2007;
- rate increases effective January 1, 2007, at SWL&P;
and
- increased sales to other power suppliers under long-term contract.contracts; and
- increased operations and maintenance expense relating to the Boswell Unit
4 outage.
NONREGULATED ENERGY OPERATIONS reported income of $2.2$2.8 million in 2007 ($0.91.8
million income in 2006), reflecting a $1.2 million after tax gain on land sold that was
part of the land received when we purchasedour purchase of Taconite Harbor.
INVESTMENT IN ATC contributed income of $1.8$3.7 million in 2007. Our initial
investment in ATC was in May 2006.
REAL ESTATE contributed income of $3.1$14.6 million in 2007 ($5.010.6 million in 2006).
Income was higher in 20062007 due to the timing and mix of land sale transaction
closings. Two large sales closed during the second quarter of 2007. The timing
of the closing of real estate sales varies from period to period and impacts
comparisons between years.
OTHER reflected net income of $0.4$2.9 million in 2007 ($0.10.2 million loss in 2006), primarily due
to additional investment income.a state tax audit settlement for $1.5 million and the release from a loan
guarantee for Northwest Airlines Corporation of $0.6 million after tax.
COMPARISON OF THE QUARTERS ENDED MARCH 31,JUNE 30, 2007 AND 2006
(SEE NOTE(See Note 2. BUSINESS SEGMENTS FOR FINANCIAL RESULTS BY SEGMENT.Business Segments for financial results by segment.)
REGULATED UTILITY
OPERATING REVENUE increased $17.8$32.5 million, or 1122 percent, from 2006
primarily due to increased fuel clause recoveries, increased kilowatthour
sales to Retail, Commercial and Municipal customers, increased power
marketing sales,prices, and increased gas revenuerate increases at SWL&P.
Fuel clause recoveries increased $7.3$30.4 million in 2007 primarily as a
result of increased purchased power expenses (See(see Fuel and Purchased Power
Expense discussion on the next page)below).
Residential, Commercial and Municipal kilowatthour sales increased 104.2
million, or 12 percent, from 2006 reflecting a 10 percent increase in
heating degree days in our service territory and two existing municipal
customers converting to full-energy requirements. The converting customers
contributed an additional 34.4 million in kilowatthour sales.
Revenue from other power suppliers increased $2.1$2.3 million, or 911 percent,
from 2006 primarily due to an 11 percent increase in kilowatthour sales to an existing
customer under a long-term contract expiring in 2010. (See Part 1, Item 3.
- Quantitative and Qualitative Disclosures about Market Risk - Power
Marketing.)
Natural gas revenue increased $0.9 million from 2006 primarily due to
higher sales as a result of colder weather and rate increasesthe price per
kilowatthour.
New rates at SWL&P. New
rates&P, which became effective January 1, 2007, at SWL&P and reflect a 2.8
percent increase in electric rates, a 1.4 percent increase in gas rates and
an 8.6 percent increase in water rates. These rate increases resulted in a
$0.3 million increase in operating revenue.
Revenue from electric sales to taconite customers accounted for 24 percent
of consolidated operating revenue in each of 2007 and 2006. Revenue from
electric sales to paper and pulp mills accounted for 9 percent of
consolidated operating revenue in each of 2007 and 2006. Revenue from
electric sales to pipelines accounted for 7 percent of consolidated
operating revenue in 2007 (6 percent in 2006).
Overall kilowatthour sales were similar to 2006. Residential, commercial
and municipal kilowatthour sales increased 21.1 million, or 3 percent, from
2006, while industrial kilowatthour sales decreased by 35.9 million, or 2
percent. The increase in residential, commercial and municipal kilowatthour
sales was primarily due to two existing municipal customers converting to
full-energy requirements. The reduction in industrial kilowatthour sales
was primarily due to production scheduling at one of our taconite
customers. Minor fluctuations in industrial kilowatthour sales generally do
not have a large impact on revenue due to a fixed demand component of
revenue that is less sensitive to changes in kilowatthours sales.
19 ALLETE Second Quarter 2007 Form 10-Q
REGULATED UTILITY (CONTINUED)
OPERATING EXPENSES increased $33.5 million, or 26 percent, from 2006.
FUEL AND PURCHASED POWER EXPENSE increased $29.9 million from 2006
primarily due to a $30.1 million increase in purchased power reflecting a
48 percent increase in kilowatthours purchased. Scheduled outages at
Boswell Unit 3 and Taconite Harbor Unit 2, low hydro generation and lower
Square Butte entitlement contributed to higher purchased power expenses.
The replacement power costs are recovered through the regulated utility
fuel adjustment clause in Minnesota.
Boswell Unit 4 completed generator repairs and returned to service May 13,
2007 as scheduled. The cost of the replacement coils was covered under the
original manufacturer's warranty.
OPERATING AND MAINTENANCE EXPENSE increased $4.0 million, or 7 percent,
from 2006 due to planned outages at Boswell Unit 3 and Taconite Harbor Unit
2, which resulted in higher plant maintenance.
DEPRECIATION decreased $0.4 million from 2006 primarily due to the life
extension of Boswell Unit 3.
OTHER INCOME increased $0.4 million from 2006 primarily due to higher
earnings from the capitalization of AFUDC due to increased construction
activity.
NONREGULATED ENERGY OPERATIONS
OPERATING REVENUE decreased $0.3 million, or 2 percent, from 2006
reflecting a decrease in sales prices due to BNI Coal's cost plus contract.
OPERATING EXPENSES increased $0.9 million, or 6 percent, from 2006
primarily due to increased property taxes.
INVESTMENT IN ATC
OTHER INCOME reflected $3.2 million of income in 2007 resulting from our
pro-rata share of ATC's earnings as discussed in Note 3. Our investment in
ATC began in May 2006.
REAL ESTATE
OPERATING REVENUE increased $12.8 million, or 84 percent, from 2006 due to
the timing and mix of land sale transaction closings. Two large sales
closed during the second quarter of 2007. Revenue from land sales in 2007
was $25.2 million, which included $1.0 million in previously deferred
revenue. In 2006, revenue from land sales was $13.6 million, which included
$2.7 million in previously deferred revenue.
For the quarter ended June 30, 2007, 435,000 commercial square feet sold at
Town Center (170,695 in 2006), and 40,000 commercial square feet sold at
Palm Coast Park (none in 2006). Town Center sold 130 residential units (186
in 2006) and Palm Coast Park sold 406 residential units (none in 2006).
There were no acres of other land sold during the second quarter of 2007
(10 acres in 2006).
OPERATING EXPENSES increased $2.9 million, or 59 percent, from 2006
reflecting an increase in selling expenses and the cost of real estate
sold.
INCOME TAXES
For the quarter ended June 30, 2007, the effective tax rate on income from
continuing operations before minority interest was 31.9 percent (38.2 percent
for the quarter ended June 30, 2006). The effective rate of 31.9 percent for the
quarter ended June 30, 2007, deviated from the statutory rate (approximately 40
percent) primarily due to a state income tax audit settlement ($1.5 million).
Excluding this $1.5 million item, the effective rate would have been 36.1
percent for the quarter ended June 30, 2007. Other items affecting the deviation
from the statutory rate include deductions for Medicare health subsidies,
domestic manufacturing deduction, AFUDC and depletion.
ALLETE Second Quarter 2007 Form 10-Q 20
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2007 AND 2006
REGULATED UTILITY
OPERATING REVENUE increased $50.3 million, or 16 percent, from 2006
primarily due to increased fuel clause recoveries, increased kilowatthour
sales to residential, commercial and municipal customers, increased power
marketing prices, and rate increases at SWL&P.
Fuel clause recoveries increased $37.7 million in 2007 as a result of
increased purchased power expenses (see Fuel and Purchased Power Expense
discussion below).
Revenue from other power suppliers increased $4.4 million, or 10 percent,
from 2006 primarily due to an 8.3 percent increase in the price per
kilowatthour.
New rates at SWL&P, which became effective January 1, 2007, reflect a 2.8
percent increase in electric rates, a 1.4 percent increase in gas rates and
an 8.6 percent increase in water rates. These rate increases resulted in a
$0.8 million increase in operating revenue.
Revenue from electric sales to taconite customers accounted for 23 percent
of consolidated operating revenue in 2007 (24 percent in 2006). Revenue
from electric sales to paper and pulp mills accounted for 9 percent of
consolidated operating revenue in each of 2007 and 2006. Revenue from
electric sales to pipelines accounted for 67 percent of consolidated
operating revenue in 2007 (6 percent in 2006).
ALLETE First Quarter 2007 Form 10-Q 18
COMPARISON OF THE QUARTERS ENDED MARCH 31, 2007 ANDOverall kilowatthour sales were similar to 2006. Residential, commercial
and municipal kilowatthour sales increased 125.3 million, or 8 percent,
from 2006 (CONTINUED)
REGULATED UTILITY (CONTINUED)while industrial kilowatthour sales decreased by 152.8 million,
or 4 percent. The increase in residential, commercial and municipal
kilowatthour sales was primarily due to a 12 percent increase in Heating
Degree Days (primarily in February) and two existing municipal customers
converting to full-energy requirements. The reduction in industrial
kilowatthour sales was primarily weather related. Minor fluctuations in
industrial kilowatthour sales generally do not have a large impact on
revenue due to a fixed demand component of revenue that is less sensitive
to changes in kilowatthours sales.
OPERATING EXPENSES increased $8.9$42.4 million, or 716 percent, from 2006.
FUEL AND PURCHASED POWER EXPENSE increased $8.3$38.2 million from 2006
primarily due to a $26.3$38.0 million increase in purchased power which was partially
offset by lower fuel expense.reflecting a
60 percent increase in kilowatthours purchased. The increase in purchased
power was primarily due to a
79 percent increase in kilowatthours purchasedthe following outages at our generation units:
- scheduled outage at Boswell Unit 3 relating to environmental
upgrades;
- scheduled outages at Laskin Unit 1 and higher energy prices.
Low hydro generation,Taconite Harbor Unit 2
relating to AREA plan environmental upgrades; and
- unplanned outages at Boswell Units 3 & 4, Laskin Unit 1
(relating to the AREA Plan environmental retrofits),4.
Additionally, low hydro generation and lower Square Butte entitlement
contributed to lower fuel and higher purchased power expenses.expense. The replacement power costs
are recovered through the regulated utility fuel adjustment clause in
Minnesota.
From mid-March to mid-April, output from Boswell Unit 4 was reduced
approximately 20 percent, duecompleted generator repairs and returned to a malfunction of one or more generator
stator coils. Boswell Unit 4 was removed from service in mid-April, and is
expected to be back in service at full capacity in mid-May after the
affected coils are replaced.May 13,
2007 as scheduled. The cost of the replacement coils arewere covered under the
original manufacturer's warranty.
OPERATING AND MAINTENANCE EXPENSE increased $1.1$5.1 million, or 25 percent,
from 2006 due to a $0.7$4.7 million increase in expenses associated with
outages at Boswell Units 3 & 4 and a $0.5 million increase at SWL&Pplant maintenance primarily due
to planned outages at our generating facilities.
DEPRECIATION decreased $0.9 million from 2006 primarily due to the life
extension of Boswell Unit 3.
OTHER INCOME increased natural gas purchases.
INTEREST EXPENSE$0.9 million from 2006 primarily due to higher
earnings from the capitalization of AFUDC due to increased $0.1 million, or 2 percent, from 2006.construction
activity.
21 ALLETE Second Quarter 2007 Form 10-Q
NONREGULATED ENERGY OPERATIONS
OPERATING REVENUE increased $0.5$0.2 million, or 31 percent, from 2006 primarily
due to increased coal sales at BNI.BNI Coal.
OPERATING EXPENSES increased $0.3$1.2 million, or 24 percent, from 2006 due to
a
$0.7 million increase in fuel and tire expense at BNI, partially offset by
lower natural gas prices at Rapids Energy Center.primarily due to increased property taxes.
OTHER INCOME increased $2.0$2.4 million from 2006 reflecting a $1.9 million
gain on land sold which was part of the land received when we purchased
Taconite Harbor.Harbor purchase.
INVESTMENT IN ATC
OTHER INCOME reflected $2.9$6.1 million of income in 2007 resulting from our
pro-rata share of ATC's earnings as discussed in Note 3. Our investment in
ATC began in May 2006.
REAL ESTATE
OPERATING REVENUE decreased $5.5increased $7.3 million, or 4025 percent, from 2006 due to
the timing and mix of land sale transaction closings. Two large sales
closed during the second quarter of 2007. Revenue from land sales in 2007
was $7.3$32.5 million, which included $1.3$2.3 million in previously deferred
revenue. In 2006, revenue from land sales was $12.5$26.1 million which included
$1.5$4.3 million in previously deferred revenue.
InThrough June 30, 2007, 435,000 commercial square feet were sold at Town
Center (250,695 in 2006), and 40,000 commercial square feet were sold at
Palm Coast Park (none in 2006). Town Center has sold 130 residential units
(186 in 2006) and Palm Coast Park has sold 406 residential units (none in
2006). During the first six months of 2007, 367 acres of other land waswere
sold (456(466 acres in 2006). For the quarter ended March 31,
2007, there were no commercial square feet sold. (80,000 commercial square
feet sold at Town Center in 2006).
OPERATING EXPENSES decreased $0.5increased $2.4 million, or 1529 percent, from 2006
reflecting a decreasean increase in selling expenses and the cost of real estate
sold ($0.9 million in
2007; $1.9 million in 2006).
19 ALLETE First Quarter 2007 Form 10-Q
COMPARISON OF THE QUARTERS ENDED MARCH 31, 2007 AND 2006 (CONTINUED)sold.
OTHER
OPERATING EXPENSES decreased $0.8$0.7 million from 2006 reflecting lower
general and administrative expenses.
INTEREST EXPENSE decreased $0.3 million from 2006.
OTHER INCOME increased $0.4$0.3 million from 2006 primarily due to additionalthe release
from a loan guarantee for Northwest Airlines Corporation of $1.0 million,
partially offset by less investment income.
INCOME TAXES
For the quartersix months ended March 31,June 30, 2007, the effective tax rate on income from
continuing operations before minority interest was 37.935.1 percent (36.6(37.3 percent
for the quartersix months ended March 31,June 30, 2006). The effective rate of 37.935.1 percent for the
quartersix months ended March 31,June 30, 2007, deviated from the statutory rate (approximately
40 percent) primarily due to a state income tax audit settlement ($1.5 million).
Excluding this $1.5 million item, the effective rate would have been 37.1
percent for the six months ended June 30, 2007. Other items affecting the
deviation from the statutory rate include deductions for Medicare health
subsidies, domestic manufacturing deduction, allowance for funds used during
constructionAFUDC and depletion.
CRITICAL ACCOUNTING ESTIMATES
Certain accounting measurements under applicable GAAP involve management's
judgment about subjective factors and estimates, the effects of which are
inherently uncertain. Accounting measurements that we believe are most critical
to our reported results of operations and financial condition include:
impairment of long-lived assets, pension and postretirement health and life
actuarial assumptions, regulatory accounting, valuation of investments and
provisions for environmental remediation. These policies are reviewed with the
Audit Committee of our Board of Directors on a regular basis and summarized in
Part II, Item 7 of our 2006 Form 10-K.
ALLETE Second Quarter 2007 Form 10-Q 22
OUTLOOK
EARNINGS GUIDANCE. We expect ALLETE's dilutedALLETE expects that its full-year 2007 earnings performance
will be between $3.00 and $3.05 per share in 2007. This guidance assumes lower
real estate sales during the second half of 2007 compared to the same period in
2006, normal weather patterns in Minnesota Power's service territory compared to
a warmer than normal third quarter in 2006, and higher income from continuing
operationsthe
investment in ATC due to bea larger investment balance in the range previously indicated2007. Due to difficult
market conditions in the 2006 10-K. The
guidance stated that the Company's earningsFlorida, some sales originally anticipated to close in 2007
are now being deferred. As a result of these sales deferrals, total year net
income from Real Estate is expected to be between $2.95 to
$3.05.less than 2006; net income in 2006 was
the largest ever for our real estate business. This earnings projectionguidance does not
include an impact from any investment we may make in new growth opportunities.
ENERGY.
LARGE POWER CUSTOMERS. Electric power is a key component in the mining, taconitepaper
production and paper productionpipeline industries. Sales to our Large Power Customers within
these industries represent more than half of Minnesota Power's regulated utility
electric sales. On April 25, 2007, the MPUC approved our electric service
agreement with PolyMet Mining, Inc. (PolyMet). In 2006, a contract for
approximately 70 MW was successfully negotiated with PolyMet, a new industrial
customer planning to start a copper, nickel and precious metals (non-ferrous)
mining operation in late 2008. If PolyMet's environmental permits are received
and start-up is achieved, the contract with PolyMet will run through at least
2018.
AREA AND BOSWELL 3 EMISSION REDUCTION PLAN. To date,As of June 30, 2007 we have spent
$17.7$28.6 million of the expected $60 million on the AREA project. On April 15,
2007, Laskin Unit 1 was placed back in service and cost-recovery will beginbegan May 1,
2007. A
cost-recovery filing was made forOn June 24, 2007 Taconite Harbor Unit 2 on March 27, 2007, with
expectedwas placed back in service and
cost-recovery beginningbegan July 1, 2007, pending MPUC approval. On April
26, 2007, the DOC filed comments recommending approval2007. As of the cost-recovery
filing for Taconite Harbor Unit 2. To date,June 30, 2007 we have spent $18.3$33.4
million of the expected $200 million on the Boswell Unit 3 emission reduction
plan. In late March 2007, the Boswell Unit 3 project received the necessary
construction permits. On April 25, 2007, the MPCA issued its assessment of the
Boswell Unit 3 Emission Reduction Planemission reduction plan under the Mercury Emissions Reduction Act
of 2006. The MPCA found that Minnesota Power's plan meets the statutory
requirements, and
found it appropriate. We expect to begin construction incost effective and groundbreaking for the Boswell Unit 3
project occurred on May 9, 2007. ALLETE First QuarterOn June 8, 2007 Form 10-Q 20
OUTLOOK (CONTINUED)the DOC filed comments
recommending approval of the cost recovery filing for the Boswell Unit 3
emission reduction plan. An MPUC hearing on the Boswell Unit 3 plan is scheduled
for October 2007.
MINNESOTA FUEL CLAUSE INVESTIGATION.CLAUSE. In June 2003, the MPUC initiated an investigation into
the continuing usefulness of the fuel clause as a regulatory tool for electric
utilities. Minnesota Power's initial comments on the proposed scope and
procedure of the investigation were filed in July 2003. In November 2003, the
MPUC approved the initial scope and procedure of the investigation. The
investigation's purpose was to focus on whether the fuel clause continues to be
an appropriate regulatory tool. Subsequent comments were filed during 2004. The
Docketfuel clause docket then became dormant while the MISO Day 2 Docket,docket, which held
many fuel clause considerations, became very active. In March 2007, the MPUC
solicited comments on whether the original fuel clause investigation should
continue and, if so, what issues should be pursued. Minnesota Power filed
comments in April 2007, suggesting that if the investigation continued, it
should focus on remaining key elements of the fuel clause, beyond the purchased
power transactions examined in the MISO Day 2 proceeding, such as fuel purchases
and outages. Additionally, Minnesota Power's comments suggested that more
specialized fuel clause issues be addressed in separate dockets on an as needed
basis. The fuel clause investigation docket is awaiting further action by the
MPUC.
23 ALLETE Second Quarter 2007 Form 10-Q
OUTLOOK (CONTINUED)
ENERGY. (Continued)
RENEWABLE ENERGY. In February 2007, the Minnesota Legislature enacted a law
requiring most electric utilities to generate 25 percent of their energy through
renewable energy sources by 2025. Minnesota Power worked with other stakeholders
to ensure the legislation included provisions for allowing regulatory assessment
of the ratepayer cost for and technical feasibility onof individual utilities of
meeting the 25 percent standard on individual utilities.standard. Minnesota Power was developing and making
renewable supply additions as part of its generation planning strategy prior to
this legislation and this activity will continue.continues.
In December 2006, we began purchasing the output from a 50-MW wind facility,
Oliver Wind I, located in North Dakota, Oliver Wind I, under a 25-year power purchase agreement
with an affiliate of FPL Energy.
In JanuaryEnergy, LLC.
On May 11, 2007, we filed with the MPUC approved a second 25-year wind power purchase
agreement and related renewable resource rider to purchase an additional 48-MW of wind energy from Oliver Wind II, an
expansion of Oliver Wind I located in North Dakota. The MPUC also allowed
immediate recovery of the costs for associated transmission upgrades. The
project is expected to be operational by the end of 2007,
pending MPUC approval. The MPUC hearing on the Oliver Wind II project was
scheduled for2007.
On May 3, 2007.
In April29, 2007, we filed with the MPUC for approval ofapproved two 20-year Community-
BasedCommunity-Based Energy
Development (C-BED) Project power purchase agreements. The 2.5-MW Wing River Wind
C-BED Project,project, with Wing River Wind, LLC, is expected to bebecame operational by the end of June 2007, pending MPUC approval.on July 6, 2007. The
30-MW Bear Creek Wind Partners project, with Bear Creek Wind Partners, LLC, is
expected to be operational by the end of 2008, pending MPUC approval. Per Minnesota Statute,
the power purchase agreements will be deemed approved unless objection is
received within 30 days of the filing, which would be on May 29, 2007.2008.
In the fall of 2007, pending MPUC approval of a wind facility site permit, we intend to begin construction of the $50 million, 25-MW
Taconite Ridge Wind Facility, to be located in Northeasternnortheastern Minnesota. On June
14, 2007, the MPUC issued a draft site permit, beginning the regulatory review
process. A public meeting was held July 11, 2007. The Taconite Ridge Wind
Facility is expected to become operational in mid-2008.
Minnesota Power continues to investigate additional renewable energy resources
including biomass, hydroelectric and wind generation that will help it meet the
Minnesota 25 percent renewable energy standard. In particular, Minnesota Power
is conducting a feasibility study for construction of a 40 to 50-MW biomass
generating unit at its Laskin Energy Center, as well as looking at opportunities
to expand biomass energy production at existing facilities. Additionally,
Minnesota Power is pursuing a potential 10-MW expansion of its Fond du Lac
hydroelectric station. The Company will submit plans regarding the additional
renewable energy options currently under study as a part of its Resource Plan
filing with the State of Minnesota by November 1, 2007. We will also make
specific renewable project filings for regulatory approval as needed.
INVESTMENT IN ATC. In February 2007, we completed our $60 million investment in
ATC. As of March 31,June 30, 2007, our equity investment was $63.7$64.4 million, representing
an 8.58.3 percent ownership interest. As opportunities arise, we plan to make
additional investments in ATC through general capital calls based upon our
pro-rata ownership interest in ATC. (See Note 3.)
REAL ESTATE. In June 2005, we began selling property from our Town Center
development project. In August 2006, we began selling property from our Palm
Coast Park development project. Since land is being sold before completion of
the project infrastructure, revenue and cost of real estate sold are recorded
using a percentage-of-completion method. As of March 31,June 30, 2007, we had $3.2$5.0
million ($4.36.5 million revenue; $0.9$1.2 million cost of real estate sold; $0.2$0.3
million selling expense) of deferred profit on sales of real estate, before
taxes and minority interest, on our consolidated balance sheet. The majority of
deferred profit relates to sales at Town Center.
21 ALLETE FirstSecond Quarter 2007 Form 10-Q 24
OUTLOOK (CONTINUED)
REAL ESTATE
PENDING CONTRACTS CONTRACT
AT MARCH 31,JUNE 30, 2007 QUANTITY SALES PRICE
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
DOLLARS IN MILLIONS
Town Center
Commercial Sq. Ft. 827,200442,200 $ 26.115.1
Residential Units 1,040 16.2910 14.6
Palm Coast Park
Commercial Sq. Ft. 50,000 2.5- -
Residential Units 2,387 60.11,981 39.1
Other Land
Acres 207 6.2220 11.0
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
$ 111.179.8
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Acreage amounts are approximate and shown on a gross basis, including wetlands and minority interest.
Acreage amounts may vary due to platting or surveying activity. Wetland amounts vary by property and are
often not formally determined prior to sale. Commercial square feet and residential units are estimated
and include minority interest. The actual property allocation at full build-out may be different than
these estimates.
At March 31,June 30, 2007, total pending land sales under contract were $111.1$79.8 million
($113.8 million at December 31, 2006) and are anticipated to close at various
times through 2012. Pending land sales under contract for properties at Town
Center and Palm Coast Park totaled $42.3$29.7 million ($40.1 million at December 31,
2006) and $62.6$39.1 million ($62.8 million at December 31, 2006), respectively. The
decrease in pending land sales under contract is mainly due to two large sales
that closed during the second quarter of 2007. In April 2007, Palm Coast Center,
LLC and Target Corporation closed for $12.6 million at Town Center and in June
2007, LRCF Palm Coast, LLC (Lowe Enterprises) closed on the first parcel of the
Sawmill Creek project at Palm Coast Park for $13.1 million pursuant to revised
contract terms. Under the amended contract, the total purchase price under
contract was reduced from $52.5 million to $42.0 million. In addition to the
base price, the amended contract allows us to receive participation revenue from
land sales to third parties if various formula based criteria are achieved.
Current contract terms with Lowe Enterprises allow for extensions on the
remaining three closings. The final closings will occur through 2011.
Prices on these contracts range from $20 to $60 per commercial square foot,
$8,000 to $34,000$30,000 per residential unit and $11,000 to $127,000$830,000 per acre for all
other properties. Prices per acre are stated on a gross acreage basis and are
dependent on the type and location of the properties sold. The majority of the
other properties under contract are zoned commercial or mixed use. In addition
to minimum-base price contracts, certain contracts, including the amended Lowe
Enterprises contract, allow us to receive participation revenue from land sales
to third parties if various formula-based criteria are achieved.
If a purchaser defaults under terms of a contract, our remedies generally
include retention of the purchaser's deposit and the ability to remarket the
property to other prospective buyers. In many cases, the purchaser has also
incurred significant costs in planning, designing and marketing of the property
under contract before the contract closes.
Conditions in the Florida real estate market may fluctuate over time. The real
estate market has been difficult across the United States, including Florida.
The difficult market conditions for Florida real estate have not improved as
quickly as we had originally expected, cauing some sales originally planned for
2007 to be deferred. We expect that Florida will continue to experience above
average long-term population growth and that current market conditions will
improve over time. We believe our entitled inventory of land, most of which is
located in one of the fastest growing areas of Florida, will continue to be
attractive to buyers.
25 ALLETE Second Quarter 2007 Form 10-Q
OUTLOOK (CONTINUED)
SUMMARY OF DEVELOPMENT PROJECTS
FOR THE QUARTERSIX MONTHS ENDED TOTAL RESIDENTIAL COMMERCIAL
MARCH 31,JUNE 30, 2007 OWNERSHIP ACRES UNITS SQ. FT.
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Town Center 80%
At December 31, 2006 1,356 2,222 2,705,310
Property Sold (81) (130) (435,000)
Change in Estimate 17 97 23,537177 72,736
- ---------------------------------------------------------------------------------------------------------------------
1,373 2,319 2,728,847-------------------------------------------------------------------------------------------------------------------------
1,292 2,269 2,343,046
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Palm Coast Park 100%
At December 31, 2006 4,337 3,760 3,156,800
Property Sold (863) (406) (40,000)
Change in Estimate 112 - -
- ---------------------------------------------------------------------------------------------------------------------
4,449 3,760 3,156,800-------------------------------------------------------------------------------------------------------------------------
3,586 3,354 3,116,800
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Ormond Crossings 100%
At December 31, 2006 5,960
Change in Estimate 8
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
5,968
- ---------------------------------------------------------------------------------------------------------------------
11,790 6,079 5,885,647-------------------------------------------------------------------------------------------------------------------------
10,846 5,623 5,459,846
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Acreage amounts are approximate and shown on a gross basis, including wetlands and minority interest. Acreage
amounts may vary due to platting or surveying activity. Wetland amounts vary by property and are often not
formally determined prior to sale.
Estimated and includes minority interest. The actual property breakdown at full build-out may be different than
these estimates.
Includes industrial, office and retail square footage.
A development order approval from the city of Ormond Crossings was received in December 2006, for up to 3,700
residential units and 5 million commercial square feet. A development order from Flagler County is currently under
review, and if approved, Ormond Crossings will receive entitlements for up to 700 additional residential units.
Actual build-out, however, will consider market demand as well as infrastructure and mitigation costs.
ALLETE First Quarter 2007 Form 10-Q 22
OUTLOOK (CONTINUED)
SUMMARY OF OTHER LAND INVENTORIES
FOR THE QUARTERSIX MONTHS ENDED
MARCH 31,JUNE 30, 2007 OWNERSHIP TOTAL MIXED USE RESIDENTIAL COMMERCIAL AGRICULTURAL
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
ACRES
ACRES
Palm Coast Holdings 80%
At December 31, 2006 2,136 1,404 346 247 139
Change in Estimate (666) (474) (244) 101 (49)
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
1,470 930 102 348 90
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Lehigh 80%
At December 31, 2006 223 - 140 74 9
Change in Estimate - - - - -
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
223 - 140 74 9
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Cape Coral 100%
At December 31, 2006 30 - 1 29 -
Property Sold (3) - - (3) -
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
27 - 1 26 -
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Other 100%
At December 31, 2006 934 - - - 934
Property Sold (364) - - - (364)
Change in Estimate (113) - - - (113)
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
457 - - - 457
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
2,177 930 243 448 556
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Acreage amounts are approximate and shown on a gross basis, including wetlands and minority interest. Acreage
amounts may vary due to platting or surveying activity. Wetland amounts vary by property and are often not
formally determined prior to sale. The actual property allocation at full build-out may be different than
these estimates.
Includes land located in Ormond Beach, Florida and other land located in Palm Coast, Florida not included in development projects.
ALLETE Second Quarter 2007 Form 10-Q 26
OUTLOOK (CONTINUED)
INCOME TAXES. ALLETE's aggregate federal and multi-state statutory tax rate is
expected to be approximately 40% for 2007. On an ongoing basis ALLETE, has
certain tax credits and other tax adjustments that will reduce the expected
effective tax rate to approximately 37% for 2007. These tax credits and
adjustments historically have included items such as investment tax credits,
depletion allowances, Medicare health subsidies as well as other items. The
effective rate will also be impacted by such items as changes in income from
operations before minority interest and income taxes, state and federal tax law
changes that become effective during the year, business combinations and
configuration changes, tax planning initiatives and resolution of prior years'
tax matters. Based upon our earnings per share guidance for 2007, we now expect
our effective tax rate for 2007 to be approximately 37%.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW ACTIVITIES
We believe our financial condition is strong, as evidenced by cash and cash
equivalents and short-term investments of $128.5$158.9 million, and a debt to total
capital ratio of 3638 percent at March 31,June 30, 2007.
OPERATING ACTIVITIES. Cash flows from operating activities were $26.2$52.3 million
for the quartersix months ended March 31,June 30, 2007 ($44.236.4 million for the quartersix months ended
March
31,June 30, 2006). Cash from operating activities was lowerhigher in 2007, primarily due
to an
$18.3 million changeincreased earnings from continuing operations compared to 2006 and no cash
used for discontinued operations in cash flow from deferred fuel costs (included2007. Cash used for discontinued operations
was higher in Prepayments and Other) yet to be recovered through future billings. Deferred
fuel costs increased2006 due to generation outages, lower hydro generation and
cooler weather in the first quarterpayment of 2007 resulting in increased purchased
power.$13.0 million of accrued liabilities
from 2005. Cash flow from accounts receivable collections in 2006 was higher due
to the collection of deferred fuel cost billings related to outages in late
2005. Cash used for discontinued operations wasprepayments and other is higher in 20062007 due to paymentan $11.2
million change in deferred fuel costs yet to be recovered through future
billings. The increases in deferred fuel costs are a result of $12.6
million of accrued liabilities from 2005.higher purchased
power expenses due to generation outages relating to the AREA Plan environmental
retrofits, lower hydro generation and lower Square Butte entitlement.
INVESTING ACTIVITIES. Cash flow used in investing activities was $20.2$102.3 million
for the quartersix months ended March 31,June 30, 2007 ($49.245.3 million for the quartersix months ended
March
31,June 30, 2006). Cash used forin investing activities was lowerhigher in 2007 than 2006,
primarily due to
decreasedadditions to property, plant and equipment and activity within our short-term
investment portfolio. In 2007, net proceeds of $22.4 million were received from the sale of short-term
investments, while 2006 included $44.6 million of net purchases. Cash used for
investing activities in 2007 reflected $8.7 million invested in ATC and an $11.9
million increase in additionsAdditions to property, plant and equipment were higher in
2007 than 2006 by $34.8 million primarily due to major environmental
construction projects. 23 ALLETE First QuarterActivity within our short-term investment portfolio
reflected increased net purchases of short-term investments of $17.3 million in
2007, Form 10-Q
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)while 2006 included $3.5 million of net purchases.
FINANCING ACTIVITIES. Cash flow used infrom financing activities was $4.4$42.3 million for
the quartersix months ended March 31,June 30, 2007 ($9.6(used for financing activities was $17.9
million for the quartersix months ended March
31,June 30, 2006). The decreaseincrease in cash used forflows from
financing activities reflected a $2.7is due to $50 million increaseof unsecured notes issued in borrowings under the
line of credit at ALLETE Propertiesprivate placement market in 2007June 2007. (See Securities below and dividends paid of $0.4 million.Note 4.)
WORKING CAPITAL. Additional working capital, if and when needed, generally is
provided by the sale of commercial paper. We have 0.50.3 million original issue
shares of our common stock available for issuance through INVEST DIRECT,Invest Direct, our
direct stock purchase and dividend reinvestment plan. We have bank lines of
credit aggregating $170.0 million, the majority of which expire in January 2012.
The amount and timing of future sales of our securities will depend upon market
conditions and our specific needs. We may sell securities to meet capital
requirements, to provide for the retirement or early redemption of issues of
long-term debt, to reduce short-term debt and for other corporate purposes.
SECURITIES
There have been no material changesOn June 8, 2007, we issued $50 million of senior unsecured notes (Notes) in the
private placement market. The Notes bear an interest rate of 5.99 percent and
will mature on June 1, 2017. The Company has the option to prepay all or a
portion of the Notes at its discretion, subject to a make-whole provision. The
Company intends to use the proceeds from the securities disclosed undersale of the heading "Securities" in Part II, Item 7 of our 2006Notes to fund utility
capital projects and for general corporate purposes.
27 ALLETE Second Quarter 2007 Form 10-K.10-Q
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
OFF-BALANCE SHEET ARRANGEMENTS
Off-balance sheet arrangements are summarized in our 2006 Form 10-K, with
additional disclosure discussed in Note 1011 of this Form 10-Q.
CAPITAL REQUIREMENTS
For the quartersix months ended March 31,June 30, 2007, capital expenditures for continuing
operations totaled $21.9$71.3 million ($13.635.3 million in 2006), which were spent in
the Regulated Utility segment. Internallysegment using a combination of internally generated funds
were the source of
funding for these expenditures.and debt issuances.
Real estate development expenditures are and will be funded with a revolving
development loan, and tax-exempt bonds issued by community development districts.districts and
internally generated funds. Additional disclosure regarding the Town Center and
Palm Coast Park district tax-exempt bonds is included in Note 1011 of this Form
10-Q.
ENVIRONMENTAL MATTERS AND OTHER
As previously discussed in our Critical Accounting Policies section, our
businesses are subject to regulation of environmental matters by various
federal, state and local authorities. Due to restrictive environmental
requirements through legislation and/or rulemaking in the future, we anticipate
that potential expenditures for environmental matters will be material and will
require significant capital investments. We are unable to predict the outcome of
the matters discussed in Note 1011 of this Form 10-Q.
NEW ACCOUNTING STANDARDS
New accounting standards are discussed in Note 1.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
SECURITIES INVESTMENTS
AVAILABLE-FOR-SALE SECURITIES. As of March 31,June 30, 2007, our available-for-sale
securities portfolio consisted of securities in a grantor trust established to
fund certain employee benefits included in Investments, and various auction rate
bonds and variable rate demand notes included in Short-Term Investments. Our
available-for-sale securities portfolio had a fair value of $109.9$151.7 million at
March 31,June 30, 2007 ($130.1 million at December 31, 2006) and a total unrealized
after-tax gain of $4.2$5.0 million at March 31,June 30, 2007 ($4.0 million at December 31,
2006).
We use the specific identification method as the basis for determining the cost
of securities sold. Our policy is to review, on a quarterly basis,
available-for-sale securities for other than temporary impairment by assessing
such factors as share price trends and the impact of overall market conditions.
As a result of our periodic assessments, we did not record any impairments on
our available-for-sale securities for the quarter ended March 31,June 30, 2007.
ALLETE First Quarter 2007 Form 10-Q 24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED)
EMERGING TECHNOLOGY PORTFOLIO. As part of our emerging technology portfolio, we
have several minority investments in venture capital funds and direct
investments in privately-held, start-up companies. We account for our
investments in venture capital funds under the equity method and account for our
direct investments in privately-held companies under the cost method based
primarily on our ownership percentages. The total carrying value of our emerging
technology portfolio was $9.0 million at March 31,June 30, 2007 ($9.2 million at December
31, 2006). Our policy is to review these investments quarterly for impairment by
assessing such factors as continued commercial viability of products, cash flow
and earnings. Any impairment would reduce the carrying value of the investment.
As a result of our periodic assessments, we did not record any impairments on
our emerging technology portfolio for the quarter ended June 30, 2007. Our basis
in direct investments in privately-held companies included in the emerging
technology portfolio was zero at March 31,both June 30, 2007 and December 31, 2006.
ALLETE Second Quarter 2007 Form 10-Q 28
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED)
COMMODITY PRICE RISK
Our regulated utility operations in Minnesota and Wisconsin incur costs for fuel
(primarily coal), power and natural gas purchased for resale in our regulated
service territories, and related transportation. Our regulated utilities'
exposure to price risk for these commodities is significantly mitigated by the
current ratemaking process and regulatory environment, which generally allows a
fuel clause surcharge if costs are in excess of those in our last rate filing.
Conversely, costs below those in our last rate filing resulted in a rate credit.
We seek to prudently manage our customers' exposure to price risk by entering
into contracts of various durations and terms for the purchase of coal and power
(in Minnesota), power and natural gas (in Wisconsin), and related transportation
costs.
POWER MARKETING
Our power marketing activities consist of (1) purchasing energy in the wholesale
market for resale in our regulated service territories when retail energy
requirements exceed generation output and (2) selling excess available
generation and purchased power.
From time to time, our utility operations may have excess generation that is
temporarily not required by retail and municipal customers in our regulated
service territory. We actively sell this generation to the wholesale market to
optimize the value of our generating facilities. This generation is typically
sold in the MISO market at market prices.
Approximately 200 MW of generation from our Taconite Harbor facility in northern
Minnesota has been sold through various long-term capacity and energy contracts.
Long-term, we have entered into two capacity and energy sales contracts totaling
175 MW (201 MW including a 15 percent reserve), which were effective May 1,
2005, and expire on April 30, 2010. Both contracts contain fixed monthly
capacity charges and fixed minimum energy charges. One contract provides for an
annual escalator to the energy charge based on increases in our cost of coal,
subject to a small minimum annual escalation. The other contract provides that
the energy charge will be the greater of a fixed minimum charge or an amount
based on the variable production cost of a combined-cycle, natural gas unit. Our
exposure in the event of a full or partial outage at our Taconite Harbor
facility is significantly limited under both contracts. When the buyer is
notified at least two months prior to an outage, there is no exposure. Outages
with less than two months notice are subject to an annual duration limitation
typical of this type of contract. We also have a 50-MW capacity and energy sales
contract that extends through April 2008, with formula pricing based on variable
production cost of a combustion-turbine, natural gas unit.
ITEM 4. CONTROLS AND PROCEDURES
We maintain a system of controls and procedures designed to provide reasonable
assurance as to the reliability of the financial statements and other
disclosures included in this report, as well as to safeguard assets from
unauthorized use or disposition. We evaluated the effectiveness of the design
and operation of our disclosure controls and procedures under the supervision
and with the participation of management, including our chief executive officer
and chief financial officer, as of the end of the period covered by this Form
10-Q. Based upon that evaluation, our chief executive officer and chief
financial officer concluded that our disclosure controls and procedures are
effective. While we continue to enhance our internal control over financial
reporting, there has been no change in our internal control over financial
reporting that occurred during our most recent fiscal quarter that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
2529 ALLETE FirstSecond Quarter 2007 Form 10-Q
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Material legal and regulatory proceedings are included in the discussion of
Other Information in Part II, Item 5 and/or Note 1011 of this Form 10-Q, and are
incorporated by reference herein.
ITEM 1A. RISK FACTORS
There have been no material changes from the risk factors disclosed under the
heading "Risk Factors" in Part I, Item 1A of our 2006 Form 10-K.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.(a) We held our Annual Meeting of Shareholders on May 8, 2007.
(b) Included in (c) below.
(c) The election of directors and the ratification of the appointment of
PricewaterhouseCoopers LLP, as the Company's independent registered public
accounting firm for 2007, were voted on at the 2007 Annual Meeting of
Shareholders.
The results were as follows:
VOTES
VOTES FOR WITHHELD
- ------------------------------------------------------------------------------------------------------------------
DIRECTORS
Kathleen A. Brekken 25,871,813 418,468
Heidi J. Eddins 23,456,099 2,834,183
Sidney W. Emery, Jr. 25,848,429 441,853
James J. Hoolihan 23,331,033 2,959,249
Madeleine W. Ludlow 23,456,062 2,834,220
George L. Mayer 23,319,274 2,971,008
Roger D. Peirce 23,298,748 2,991,533
Jack I. Rajala 22,694,844 3,595,438
Donald J. Shippar 23,247,493 3,042,789
Bruce W. Stender 23,319,884 2,970,398
- ------------------------------------------------------------------------------------------------------------------
VOTES BROKER
VOTES FOR AGAINST ABSTENTIONS NONVOTES
- ------------------------------------------------------------------------------------------------------------------
INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
PricewaterhouseCoopers LLP 25,633,128 516,411 140,740 -
- ------------------------------------------------------------------------------------------------------------------
(d) Not applicable.
ALLETE Second Quarter 2007 Form 10-Q 30
ITEM 5. OTHER INFORMATION
Reference is made to our 2006 Form 10-K for background information on the
following updates. Unless otherwise indicated, cited references are to our 2006
Form 10-K.
Ref. Page 817 - Energy - Regulated Utility, Large Power Customer Contracts,Real Estate, First Full Paragraph
On December 12, 2006, Minnesota Power announced it reached an agreementIn June 2007, LRCF Palm Coast, LLC (Lowe Enterprises) closed on the first parcel
of the Sawmill Creek project at Palm Coast Park for $13.1 million pursuant to
revised contract terms. Under the amended contract, the total purchase price
under contract was reduced from $52.5 million to $42.0 million. In addition to
the base price, the amended contract allows us to receive participation revenue
from land sales to third parties if various formula based criteria are achieved.
Current contract terms with PolyMet to provide all of its electric service needsLowe Enterprises allow for extensions on the
remaining three closings. The final closings will occur through 2018 at its
proposed copper, nickel and precious metals mining operation located in
northeastern Minnesota. PolyMet plans to begin commercial operations at its mine
and process plant complex near Hoyt Lakes, Minnesota, by late 2008, pending
completion of financing arrangements and receipt of regulatory approvals. Once
fully operational, it is anticipated that PolyMet will require approximately 70
MW of electric power, becoming one of Minnesota Power's large industrial
customers. The PolyMet electric service agreement was approved by the MPUC on
April 25, 2007.2011.
Ref. Page 849 - Energy - Regulated Utility, Large Power Customer Contracts - FifthContractual Obligations, First Full Paragraph and First Table
Unconditional purchase obligations represent our Square Butte power purchase
agreements, minimum purchase commitments under coal and rail contracts, and have
been updated to reflect additional purchase obligations for capital expenditures
related to the Taconite Ridge Wind Facility, AREA and Boswell Unit 3
environmental upgrade projects. The amounts included in the less than 1 year
column include amounts already paid in 2007.
MINIMUM REVENUE AND DEMAND UNDER CONTRACT MINIMUM MONTHLYPAYMENTS DUE BY PERIOD
-------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS LESS THAN 1 TO 3 4 TO 5 AFTER
AS OF MARCHDECEMBER 31, 2007 ANNUAL REVENUE MEGAWATTS2006 TOTAL 1 YEAR YEARS YEARS 5 YEARS
- ---------------------------------------------------------------------------------------------------------------------
MILLIONS
2007 $96.9 625
2008 $31.4 180
2009 $25.9 148
2010 $25.8 148
2011 $19.0 106
Long-Term Debt $ 639.7 $ 46.7 $ 65.1 $31.2 $496.7
Operating Lease Obligations 86.5 8.2 21.1 11.4 45.8
Unconditional Purchase Obligations 487.5 177.9 100.1 26.2 183.3
Investment in ATC 8.6 8.6 - - -
- ---------------------------------------------------------------------------------------------------------------------
$1,222.3 $241.4 $186.3 $68.8 $725.8
- ---------------------------------------------------------------------------------------------------------------------
Based on past experience, we believe revenue from our large power customers will be substantiallyIncludes interest and assumes variable interest rate in excess of
the minimum contract amounts.
Although several contracts have a feature that allows demand to go to zero after a two-year advance notice of a
permanent closure, this minimum revenue summary does not reflect this occurrence happening in the forecasted
period because we believe it is unlikely.effect at December 31, 2006, remains constant through
remaining term.
ALLETE First Quarter 2007 Form 10-Q 26
ITEM 5. OTHER INFORMATION (CONTINUED)
Ref. Page 16 - Real Estate, Fifth Full Paragraph
In April 2007, Palm Coast Center, LLC, (a joint venture between Developers
Realty Corporation "DRC" and Weingarten Realty Investors) and Target Corporation
closed on the entire 50-acre power center site. The aggregate sales price was
$12.6 million plus a $1.0 million contribution to pay a portion of the site
preparation costs.
Ref. Page 49 - Credit Ratings, Fifth Full Paragraph
CREDIT RATINGS
As of April 20, 2007 our securities have been rated by Standard & Poor's and by
Moody's. Rating agencies use both quantitative and qualitative measures in
determining a company's credit rating. According to the rating agencies, some of
these factors include business risk, liquidity risk, competitive position,
capital mix, financial condition, predictability of cash flows, management
strength and future direction. Some of the quantitative measures can be analyzed
through a few key financial ratios, while the qualitative ones are more
subjective. The disclosure of these credit ratings is not a recommendation to
buy, sell or hold our securities. Ratings are subject to revision or withdrawal
at any time by the assigning rating organization. Each rating should be
evaluated independently of any other rating.
CREDIT RATINGS STANDARD & POOR'S MOODY'S
- ---------------------------------------------------------------------------------------------------------------------
Issuer Credit Rating BBB+ Baa2
Commercial Paper A-2 P-2
Senior Secured
First Mortgage Bonds A- Baa1
Pollution Control Bonds A Baa1
Unsecured Debt
Collier County Industrial Development Revenue Bonds - Fixed Rate BBB -
- ---------------------------------------------------------------------------------------------------------------------
Ref. Page 7576 - Fuel Clause Recovery of MISO Day 2 Costs, SeventhFirst Full Paragraph
On January 8, 2007, the Minnesota Office of Attorney General petitioned for
reconsideration of the MPUC's December 20, 2006, order. Accordingly, Minnesota
Power delayed implementation of the order and continued to recover MISO Day 2
costs consistent with previously issued interim orders. On February 15, 2007,
the MPUC declined to address the Minnesota Office of Attorney General's request
for reconsideration. On April 10, 2007, the Minnesota Office of Attorney General
filed an appeal with the Minnesota Court of Appeals. The appeal does not alter
current cost recovery of MISO charges in accordance with the MPUC's order.
Minnesota Power timely responded to the Minnesota Office of Attorney General's
notice of filing, and awaitsfiling. On June 25, 2007, the court's scheduling order setting forth a
briefing schedule.
27Minnesota Office of Attorney General
filed its initial brief. Minnesota Power filed reply briefs on July 30, 2007.
31 ALLETE FirstSecond Quarter 2007 Form 10-Q
ITEM 6. EXHIBITS
EXHIBIT
NUMBER
10(a) Note Purchase Agreement, dated as of June 8, 2007, between ALLETE
and Thrivent Financial for Lutherans and The Northwestern Mutual Life
Insurance Company.
31(a) Rule 13a-14(a)/15d-14(a) Certification by the Chief Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31(b) Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial
Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32 Section 1350 Certification of Periodic Report by the Chief Executive
Officer and Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99 ALLETE News Release dated May 4,July 27, 2007, announcing 2007 firstsecond
quarter earnings. (THIS EXHIBIT HAS BEEN FURNISHED AND SHALL NOT BE
DEEMED "FILED" FOR PURPOSES OF SECTION 18 OF THE SECURITIES EXCHANGE
ACT OF 1934, NOR SHALL IT BE DEEMED INCORPORATED BY REFERENCE IN ANY
FILING UNDER THE SECURITIES ACT OF 1933, EXCEPT AS SHALL BE EXPRESSLY
SET FORTH BY SPECIFIC REFERENCE IN SUCH FILING.)
ALLETE FirstSecond Quarter 2007 Form 10-Q 2832
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.
ALLETE, INC.
May 4,July 26, 2007 Mark A. Schober
-------------------------------------------------
Mark A. Schober
Senior Vice President and Chief Financial Officer
May 4,July 26, 2007 Steven Q. DeVinck
-------------------------------------------------
Steven Q. DeVinck
Controller
29 ALLETE First Quarter 2007 Form 10-Q