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 JUNE 30, 2003
or
/ / Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File No. 1-3548
ALLETE, INC.
A Minnesota Corporation
IRS Employer Identification No. 41-0418150
30 West Superior Street
Duluth, Minnesota 55802-2093
Telephone - (218) 279-5000
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 and (2) has been subject to such filing requirements for
the past 90 days.
Yes X No
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
----- -----
Common Stock, no par value,
86,439,101 shares outstanding
as of July 31, 2003
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 -
June 30, 2003 and December 31, 2002 4
Consolidated Statement of Income -
Quarter and Six Months Ended June 30, 2003 and 2002 5
Consolidated Statement of Cash Flows -
Six Months Ended June 30, 2003 and 2002 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 25
Item 4. Controls and Procedures 26
Part II. Other Information
Item 1. Legal Proceedings 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information 27
Item 6. Exhibits and Reports on Form 8-K 28
Signatures 29
1 ALLETE Second Quarter 2003 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
- --------------------------------------------------------------------------------
2002 Form 10-K ALLETE's Annual Report on Form 10-K for
the Year Ended December 31, 2002
ADESA ADESA Corporation
ADESA Impact Collectively, Automotive Recovery Services, Inc.
and Impact Auto Auctions Ltd.
AFC Automotive Finance Corporation
ALLETE ALLETE, Inc.
APB Accounting Principals Board
Company ALLETE, Inc. and its subsidiaries
EBITDA Earnings Before Interest, Taxes, Depreciation
and Amortization Expense
EPA Environmental Protection Agency
ESOP Employee Stock Ownership Plan
FASB Financial Accounting Standards Board
FERC Federal Energy Regulatory Commission
Florida Water Florida Water Services Corporation
FPSC Florida Public Service Commission
GAAP Generally Accepted Accounting Principles
LIBOR London Interbank Offered Rate
Minnesota Power An operating division of ALLETE, Inc.
Minnkota Minnkota Power Cooperative, Inc.
MPUC Minnesota Public Utilities Commission
MW Megawatt(s)
NCUC North Carolina Utilities Commission
NRG Energy NRG Energy, Inc.
PSCW Public Service Commission of Wisconsin
SEC Securities and Exchange Commission
SFAS Statement of Financial Accounting Standards No.
Split Rock Energy Split Rock Energy LLC
Square Butte Square Butte Electric Cooperative
SWL&P Superior Water, Light and Power Company
WDNR Wisconsin Department of Natural Resources
ALLETE Second Quarter 2003 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, ALLETE is hereby filing cautionary statements
identifying important factors that could cause ALLETE's 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" or similar
expressions) are not statements of historical facts and may be forward-looking.
Forward-looking statements involve estimates, assumptions, risks and
uncertainties and are qualified in their entirety by reference to, and are
accompanied by, the following important factors, which are difficult to predict,
contain uncertainties, are beyond the control of ALLETE and may cause actual
results or outcomes to differ materially from those contained in forward-looking
statements:
- war and acts of terrorism;
- prevailing governmental policies and regulatory actions, including those
of the United States Congress, state legislatures, the FERC, the MPUC, the
FPSC, the NCUC, the PSCW, and various county regulators and city
administrators, about allowed rates of return, financings, industry and
rate structure, acquisition and disposal of assets and facilities,
operation and construction of plant facilities, recovery of purchased
power and capital investments, and present or prospective wholesale and
retail competition (including but not limited to transmission costs) as
well as general vehicle-related laws, including vehicle brokerage and
auction laws;
- unanticipated impacts of restructuring initiatives in the electric
industry;
- economic and geographic factors, including political and economic risks;
- changes in and compliance with environmental and safety laws and policies;
- weather conditions;
- natural disasters;
- market factors affecting supply and demand for used vehicles;
- wholesale power market conditions;
- population growth rates and demographic patterns;
- the effects of competition, including the competition for retail and
wholesale customers, as well as suppliers and purchasers of vehicles;
- pricing and transportation of commodities;
- changes in tax rates or policies or in rates of inflation;
- unanticipated project delays or changes in project costs;
- unanticipated changes in operating expenses and capital expenditures;
- capital market conditions;
- competition for economic expansion or development opportunities;
- our ability to manage expansion and integrate acquisitions; and
- the outcome of legal and administrative proceedings (whether civil or
criminal) and settlements that affect the business and profitability of
ALLETE.
Any forward-looking statement speaks only as of the date on which that statement
is made, and ALLETE undertakes 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 those factors, nor can it assess the impact of each of those
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.
3 ALLETE Second Quarter 2003 Form 10-Q
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLETE
CONSOLIDATED BALANCE SHEET
Millions - Unaudited
JUNE 30, DECEMBER 31,
2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and Cash Equivalents $ 232.8 $ 193.3
Trading Securities 0.1 1.8
Accounts Receivable (Less Allowance of $31.6 and $30.5) 469.9 383.8
Inventories 33.4 36.6
Prepayments and Other 15.9 14.1
Discontinued Operations 48.7 28.8
- ------------------------------------------------------------------------------------------------------------------------------------
Total Current Assets 800.8 658.4
Property, Plant and Equipment - Net 1,480.6 1,364.7
Investments 166.8 170.9
Goodwill 508.2 499.8
Other Intangible Assets 37.4 39.8
Other Assets 74.0 67.5
Discontinued Operations 341.4 346.1
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $3,409.2 $3,147.2
- ------------------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Current Liabilities
Accounts Payable $ 331.8 $ 202.6
Accrued Taxes, Interest and Dividends 50.5 36.4
Notes Payable - 74.5
Long-Term Debt Due Within One Year 283.1 283.7
Other 91.5 111.3
Discontinued Operations 29.9 29.7
- ------------------------------------------------------------------------------------------------------------------------------------
Total Current Liabilities 786.8 738.2
Long-Term Debt 753.2 661.3
Accumulated Deferred Income Taxes 138.1 139.8
Other Liabilities 156.3 137.6
Discontinued Operations 170.4 162.9
Commitments and Contingencies
- ------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities 2,004.8 1,839.8
- ------------------------------------------------------------------------------------------------------------------------------------
Company Obligated Mandatorily Redeemable
Preferred Securities of Subsidiary ALLETE Capital I
Which Holds Solely Company Junior Subordinated Debentures 75.0 75.0
- ------------------------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Common Stock Without Par Value, 130.0 Shares Authorized
86.4 and 85.6 Shares Outstanding 832.7 814.9
Unearned ESOP Shares (47.1) (49.0)
Accumulated Other Comprehensive Gain (Loss) 12.0 (22.2)
Retained Earnings 531.8 488.7
- ------------------------------------------------------------------------------------------------------------------------------------
Total Shareholders' Equity 1,329.4 1,232.4
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $3,409.2 $3,147.2
- ------------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
ALLETE Second Quarter 2003 Form 10-Q 4
ALLETE
CONSOLIDATED STATEMENT OF INCOME
Millions Except Per Share Amounts - Unaudited
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------
OPERATING REVENUE
Energy Services
Utility $ 125.8 $ 121.9 $ 263.8 $ 242.7
Nonregulated/Nonutility 32.7 32.2 73.8 54.3
Automotive Services 240.7 216.8 473.6 425.6
Investments 10.7 5.0 21.6 21.6
- -------------------------------------------------------------------------------------------------------------------
Total Operating Revenue 409.9 375.9 832.8 744.2
- -------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Fuel and Purchased Power
Utility 52.5 52.2 105.3 100.7
Nonregulated/Nonutility 12.4 7.0 27.0 7.9
Operations
Utility 52.6 50.8 110.3 101.6
Nonregulated/Nonutility 24.4 22.7 52.8 45.1
Automotive and Investments 189.9 169.3 380.0 342.3
Interest 13.9 16.2 28.7 32.1
- -------------------------------------------------------------------------------------------------------------------
Total Operating Expenses 345.7 318.2 704.1 629.7
- -------------------------------------------------------------------------------------------------------------------
OPERATING INCOME FROM CONTINUING OPERATIONS 64.2 57.7 128.7 114.5
DISTRIBUTIONS ON REDEEMABLE
PREFERRED SECURITIES OF ALLETE CAPITAL I 1.5 1.5 3.0 3.0
INCOME TAX EXPENSE 25.3 22.2 49.9 43.9
- -------------------------------------------------------------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS 37.4 34.0 75.8 67.6
INCOME FROM DISCONTINUED OPERATIONS - NET OF TAX 7.0 4.8 12.9 6.4
- -------------------------------------------------------------------------------------------------------------------
NET INCOME $ 44.4 $ 38.8 $ 88.7 $ 74.0
- -------------------------------------------------------------------------------------------------------------------
AVERAGE SHARES OF COMMON STOCK
Basic 82.6 81.0 82.4 80.7
Diluted 82.9 81.7 82.6 81.3
- -------------------------------------------------------------------------------------------------------------------
EARNINGS PER SHARE OF COMMON STOCK
BASIC
Continuing Operations $0.45 $0.42 $0.92 $0.84
Discontinued Operations 0.09 0.06 0.16 0.08
- -------------------------------------------------------------------------------------------------------------------
$0.54 $0.48 $1.08 $0.92
- -------------------------------------------------------------------------------------------------------------------
DILUTED
Continuing Operations $0.45 $0.41 $0.92 $0.83
Discontinued Operations 0.08 0.06 0.15 0.08
- -------------------------------------------------------------------------------------------------------------------
$0.53 $0.47 $1.07 $0.91
- -------------------------------------------------------------------------------------------------------------------
DIVIDENDS PER SHARE OF COMMON STOCK $0.2825 $0.275 $0.565 $0.55
- -------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
5 ALLETE Second Quarter 2003 Form 10-Q
ALLETE
CONSOLIDATED STATEMENT OF CASH FLOWS
Millions - Unaudited
SIX MONTHS ENDED
JUNE 30,
2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net Income $ 88.7 $ 74.0
Depreciation and Amortization 42.9 39.9
Deferred Income Taxes 12.0 9.5
Gain on Sale of Plant (17.0) -
Changes in Operating Assets and Liabilities
Trading Securities 1.7 (1.6)
Accounts Receivable (84.8) (42.2)
Inventories 3.2 1.8
Prepayments and Other Current Assets (1.8) 4.5
Accounts Payable 125.4 130.6
Other Current Liabilities (3.2) (26.3)
Other - Net 9.2 5.0
- ------------------------------------------------------------------------------------------------------------------------------------
Cash from Operating Activities 176.3 195.2
- ------------------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Proceeds from Sale of Investments 6.4 1.9
Additions to Investments (2.4) (2.9)
Additions to Property, Plant and Equipment (118.6) (97.5)
Acquisitions - Net of Cash Acquired (1.8) (17.2)
Other - Net (13.2) (9.7)
- ------------------------------------------------------------------------------------------------------------------------------------
Cash for Investing Activities (129.6) (125.4)
- ------------------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Issuance of Common Stock 17.8 28.2
Issuance of Long-Term Debt 65.9 8.6
Changes in Notes Payable - Net (72.9) (57.1)
Reductions of Long-Term Debt (3.2) (5.7)
Dividends on Common Stock (45.6) (43.0)
- ------------------------------------------------------------------------------------------------------------------------------------
Cash for Financing Activities (38.0) (69.0)
- ------------------------------------------------------------------------------------------------------------------------------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 30.8 9.9
- ------------------------------------------------------------------------------------------------------------------------------------
CHANGE IN CASH AND CASH EQUIVALENTS 39.5 10.7
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD <F1> 203.0 234.2
- ------------------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD <F1> $ 242.5 $ 244.9
- ------------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL CASH FLOW INFORMATION
Cash Paid During the Period for
Interest - Net of Capitalized $33.2 $36.8
Income Taxes $22.6 $33.7
- ------------------------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Included cash from Discontinued Operations.
</FN>
The accompanying notes are an integral part of these statements.
ALLETE Second Quarter 2003 Form 10-Q 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The accompanying unaudited consolidated financial statements and notes should be
read in conjunction with our 2002 Form 10-K. The financial information for prior
periods has been reclassified to include our vehicle import business in
discontinued operations. In our opinion, all adjustments necessary for a fair
statement of the results for the interim periods have been included. The results
of operations for an interim period may not give a true indication of the
results for the year.
NOTE 1. BUSINESS SEGMENTS
Millions
INVESTMENTS
ENERGY AUTOMOTIVE AND CORPORATE
CONSOLIDATED SERVICES SERVICES CHARGES
- -------------------------------------------------------------------------------------------------------------------
FOR THE QUARTER ENDED JUNE 30, 2003
Operating Revenue $409.9 $158.5 $240.7 <F1> $10.7
Operation and Other Expense 309.9 129.0 171.3 9.6
Depreciation and Amortization Expense 21.9 12.9 8.9 0.1
Interest Expense 13.9 5.1 3.7 5.1
- -------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing
Operations 64.2 11.5 56.8 (4.1)
Distributions on Redeemable
Preferred Securities of Subsidiary 1.5 0.6 - 0.9
Income Tax Expense (Benefit) 25.3 4.1 22.7 (1.5)
- -------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations 37.4 $ 6.8 $ 34.1 $(3.5)
--------------------------------------------------
Income from Discontinued Operations - Net
of Tax 7.0
- -----------------------------------------------------------
Net Income $ 44.4
- -----------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
FOR THE QUARTER ENDED JUNE 30, 2002
Operating Revenue $375.9 $154.1 $216.8 <F1> $ 5.0
Operation and Other Expense 281.9 120.5 153.8 7.6
Depreciation and Amortization Expense 20.1 12.2 7.8 0.1
Interest Expense 16.2 4.7 5.7 5.8
- -------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing
Operations 57.7 16.7 49.5 (8.5)
Distributions on Redeemable
Preferred Securities of Subsidiary 1.5 0.6 - 0.9
Income Tax Expense (Benefit) 22.2 6.4 19.5 (3.7)
- -------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations 34.0 $ 9.7 $ 30.0 $(5.7)
--------------------------------------------------
Income from Discontinued Operations - Net
of Tax 4.8
- -----------------------------------------------------------
Net Income $ 38.8
- -----------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Included $47.6 million of Canadian operating revenue in 2003 ($39.4 million in 2002).
</FN>
7 ALLETE Second Quarter 2003 Form 10-Q
NOTE 1. BUSINESS SEGMENTS (CONTINUED)
Millions
INVESTMENTS
ENERGY AUTOMOTIVE AND CORPORATE
CONSOLIDATED SERVICES SERVICES CHARGES
- -------------------------------------------------------------------------------------------------------------------
FOR THE SIX MONTHS ENDED JUNE 30, 2003
Operating Revenue $832.8 $337.6 $473.6 <F2> $21.6
Operation and Other Expense 632.6 269.7 347.5 15.4
Depreciation and Amortization Expense 42.8 25.7 17.0 0.1
Interest Expense 28.7 10.1 8.1 10.5
- -------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing
Operations 128.7 32.1 101.0 (4.4)
Distributions on Redeemable
Preferred Securities of Subsidiary 3.0 1.2 - 1.8
Income Tax Expense (Benefit) 49.9 11.9 40.2 (2.2)
- -------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations 75.8 $ 19.0 $ 60.8 $(4.0)
--------------------------------------------------
Income from Discontinued Operations - Net
of Tax 12.9
- -----------------------------------------------------------
Net Income $ 88.7
- -----------------------------------------------------------
Total Assets $3,409.2 <F1> $1,137.3 $1,718.5 <F3> $163.3
Property, Plant and Equipment - Net $1,480.6 $904.8 $571.8 $4.0
Accumulated Depreciation and Amortization $887.4 $726.7 $158.5 $2.2
Capital Expenditures $73.6 <F1> $38.1 $18.9 -
- -------------------------------------------------------------------------------------------------------------------
FOR THE SIX MONTHS ENDED JUNE 30, 2002
Operating Revenue $744.2 $297.0 $425.6 <F2> $21.6
Operation and Other Expense 557.8 231.2 307.6 19.0
Depreciation and Amortization Expense 39.8 24.1 15.6 0.1
Interest Expense 32.1 9.4 11.4 11.3
- -------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing
Operations 114.5 32.3 91.0 (8.8)
Distributions on Redeemable
Preferred Securities of Subsidiary 3.0 1.2 - 1.8
Income Tax Expense (Benefit) 43.9 12.3 36.1 (4.5)
- -------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations 67.6 $ 18.8 $ 54.9 $(6.1)
--------------------------------------------------
Income from Discontinued Operations - Net
of Tax 6.4
- -----------------------------------------------------------
Net Income $ 74.0
- -----------------------------------------------------------
Total Assets $3,401.9 <F1> $971.2 $1,650.9 <F3> $411.5
Property, Plant and Equipment - Net $1,368.4 $892.1 $472.2 $4.1
Accumulated Depreciation and Amortization $854.1 $715.3 $136.6 $2.2
Capital Expenditures $97.5 <F1> $44.9 $26.3 -
- -------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Discontinued Operations represented $390.1 million of total assets in 2003 ($368.3 million in 2002); and
$16.6 million of capital expenditures in 2003 ($26.3 million in 2002).
<F2> Included $87.7 million of Canadian operating revenue in 2003 ($73.7 million in 2002).
<F3> Included $214.6 million of Canadian assets in 2003 ($228.1 million in 2002).
</FN>
ALLETE Second Quarter 2003 Form 10-Q 8
NOTE 2. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
ACCOUNTS RECEIVABLE. AFC, through a wholly owned, consolidated subsidiary, sells
certain finance receivables through a revolving private securitization
structure. The securitization agreement allows for the revolving sale by the
subsidiary to third parties of up to $500 million in undivided interests in
eligible finance receivables. The securitization agreement expires in 2005.
AFC managed total receivables of $524.9 million at June 30, 2003 ($495.1 million
at December 31, 2002); $211.1 million of this amount represent receivables which
were included in accounts receivable on our consolidated balance sheet ($191.3
million at December 31, 2002) and $313.8 million of this amount represent
receivables sold in undivided interests through the securitization agreement
($303.8 million at December 31, 2002) which are off-balance sheet. AFC's
proceeds from the sale of the receivables to third parties were used to repay
borrowings from ALLETE and fund new loans to AFC's customers. AFC and the
subsidiary must each maintain certain financial covenants such as minimum
tangible net worth to comply with the terms of the securitization agreement. AFC
has historically performed better than the covenant thresholds set forth in the
securitization agreement. We are not currently aware of any changing
circumstances that would put AFC in noncompliance with the covenants.
ACCOUNTING FOR STOCK-BASED COMPENSATION. We have elected to account for
stock-based compensation in accordance with APB Opinion No. 25, "Accounting for
Stock Issued to Employees." Accordingly, no expense is recognized for employee
stock options granted. If we had applied the fair value recognition provisions
of SFAS 123, "Accounting for Stock-Based Compensation," we estimate that
stock-based compensation expense would have increased $0.6 million after tax in
the first six months of 2003 ($0.7 million after tax in the first six months of
2002), and basic and diluted earnings per share would have decreased $0.01 (a
$0.01 per share decrease in the first six months of 2002). These amounts were
calculated using the Black-Scholes option pricing model. We estimate the full
year impact to be approximately $1.3 million, or $0.02 per share, for 2003.
Expense is recognized for performance share awards, and amounted to
approximately $1.2 million after tax in the first six months of 2003 ($1.8
million in the first six months of 2002).
NOTE 3. GOODWILL AND OTHER INTANGIBLES
We conduct our annual goodwill impairment testing in the second quarter of each
year and the 2003 test resulted in no impairment. No event or change has
occurred that would indicate the carrying amount has been impaired since our
annual test.
GOODWILL
- ------------------------------------------------------------------------------------------------------------------------------------
Millions
Carrying Value, December 31, 2002 $499.8
Acquired during Year 1.8
Change due to Foreign Currency Translation Adjustment 6.6
- ------------------------------------------------------------------------------------------------------------------------------------
Carrying Value, June 30, 2003 $508.2
- ------------------------------------------------------------------------------------------------------------------------------------
JUNE 30, DECEMBER 31,
OTHER INTANGIBLE ASSETS 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Millions
Customer Relationships $29.6 $29.6
- ------------------------------------------------------------------------------------------------------------------------------------
Computer Software 26.2 32.6
Other 5.8 6.8
Accumulated Amortization (24.2) (29.2)
- ------------------------------------------------------------------------------------------------------------------------------------
Total $37.4 $39.8
- ------------------------------------------------------------------------------------------------------------------------------------
Other Intangible Assets are amortized using the straight-line method over
periods of two to forty years. Amortization expense for Other Intangible Assets
is expected to be about $10 million per year until fully amortized.
9 ALLETE Second Quarter 2003 Form 10-Q
NOTE 4. NEW ACCOUNTING STANDARDS
In January 2003 the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities." In general, a variable interest entity is one with
equity investors that do not have voting rights or do not provide sufficient
financial resources for the entity to support its activities. Under the new
rules, variable interest entities will be consolidated by the party that is
subject to the majority of the risk of loss or entitled to the majority of the
residual returns. The new rules are effective immediately for variable interest
entities created after January 31, 2003 and in the third quarter of 2003 for
previously existing variable interest entities. In June 2003 ADESA restructured
its financial arrangements with respect to four of its wholesale auction
facilities previously accounted for as operating leases. The transactions
included the assumption of $28 million of long-term debt, the issuance of $45
million of long-term debt and the recognition of $73 million of property, plant
and equipment. Interpretation No. 46 would have required ADESA to consolidate
the lessor under the lease arrangements in place prior to the restructuring. We
are not a party to any variable interest entity required to be consolidated upon
the adoption of Interpretation 46.
In May 2003 the FASB issued SFAS 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." In general,
SFAS 150 establishes standards for classification and measurement of certain
financial instruments with the characteristics of both liabilities and equity.
Mandatorily redeemable financial instruments must be classified as a liability
and the related payments must be reported as interest expense. The new rules are
effective immediately for financial instruments entered into after May 31, 2003
and in the third quarter of 2003 for previously existing financial instruments.
Beginning with the third quarter of 2003, we will be required to reclassify our
Mandatorily Redeemable Preferred Securities of ALLETE Capital I as a long-term
liability and reclassify the quarterly distributions as interest expense. This
will be a reclassification only and will not impact our results of operations.
NOTE 5. DISCONTINUED OPERATIONS
In 2002 we began to execute plans developed in a strategic review of all of the
Company's businesses to unlock shareholder value not reflected in the price of
our common stock. Businesses identified as having more value if operated by
potential purchasers rather than by us include our Water Services businesses in
Florida, North Carolina and Georgia and our auto transport business. We sold our
auto transport business and exited our retail stores at the end of first quarter
2002, and exited our vehicle import business in the first quarter of 2003.
The December 2002 asset purchase agreement Florida Water signed with the Florida
Water Services Authority, a governmental authority formed under the laws of the
state of Florida, was terminated by Florida Water in March 2003 after a Florida
court ruling delayed the sale. As a result, earnings from discontinued
operations for the six months ended June 30, 2003 included a $12.5 million ($7.9
million after tax) expense associated with selling our Water Services
businesses. This is included in Other Expense in the table below.
In March 2003, through a condemnation proceeding, Florida Water sold its Amelia
Island water and wastewater assets to Nassau County in Florida for $17.5
million. The transaction resulted in an after-tax gain of $9.8 million which was
included in our first quarter and six months ended 2003 earnings from
discontinued operations.
In May 2003, through a condemnation proceeding, Florida Water sold its water and
wastewater assets in Bradford and Clay counties in Florida to the Clay County
Utility Authority for $4.3 million. The transaction resulted in an after-tax
gain of $0.6 million which was included in our second quarter and six months
ended June 30, 2003 earnings from discontinued operations.
In July 2003, through another condemnation proceeding, Florida Water sold its
Martin County water and wastewater assets to Martin County for $2.4 million. The
transaction resulted in an after-tax gain of $0.5 million which will be included
in our third quarter 2003 earnings from discontinued operations.
ALLETE Second Quarter 2003 Form 10-Q 10
NOTE 5. DISCONTINUED OPERATIONS (CONTINUED)
On July 24, 2003 Florida Water signed a purchase agreement to sell seven of its
Florida water and wastewater systems to governmental entities in Florida for
$296 million payable at closing. The transaction is expected to result in an
after-tax gain of approximately $55 million. The water and wastewater systems
included in this purchase agreement represent approximately two-thirds of
Florida Water's assets and constitute systems serving the counties of Osceola,
Hernando, Citrus, Lee and Charlotte, and the communities of Marco Island and
Palm Coast. These systems combined serve approximately 152,000 customers. The
cash proceeds after transaction costs, retirement of Florida Water debt and
payment of income taxes are estimated at $158 million, and will be used to
retire debt at ALLETE. The sale is expected to close by the end of 2003 pending
satisfaction of certain contingencies and regulatory approvals in Florida.
Florida Water will continue to seek buyers for its remaining water and
wastewater facilities. Systems for which governmental buyers are not found are
expected to be sold to a private buyer.
We are using an investment banking firm to facilitate the sale of our Water
Services businesses in North Carolina and Georgia. Discussions with prospective
buyers are in process. We expect to enter into agreements to sell these
businesses in 2003.
As a result of our actions towards selling our Water Services businesses, we
believe it is appropriate to continue to reflect our remaining water assets as
discontinued operations as of June 30, 2003.
SUMMARY OF DISCONTINUED OPERATIONS
- ------------------------------------------------------------------------------------------------------------------------------------
Millions
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
INCOME STATEMENT 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Operating Revenue $31.2 $36.1 $62.1 $75.0
- ------------------------------------------------------------------------------------------------------------------------------------
Pre-Tax Income from
Operations (excluding Other Expense) $11.0 $10.7 $18.3 $17.0
Other Expense 0.7 - 16.0 -
- ------------------------------------------------------------------------------------------------------------------------------------
Pre-Tax Income from Operations 10.3 10.7 2.3 17.0
Income Tax Expense 3.9 4.3 1.1 6.7
- ------------------------------------------------------------------------------------------------------------------------------------
6.4 6.4 1.2 10.3
- ------------------------------------------------------------------------------------------------------------------------------------
Gain (Loss) on Disposal 1.0 (2.2) 19.0 (5.8)
Income Tax Expense (Benefit) 0.4 (0.6) 7.3 (1.9)
- ------------------------------------------------------------------------------------------------------------------------------------
0.6 (1.6) 11.7 (3.9)
- ------------------------------------------------------------------------------------------------------------------------------------
Income from Discontinued Operations $ 7.0 $ 4.8 $12.9 $ 6.4
- ------------------------------------------------------------------------------------------------------------------------------------
JUNE 30, DECEMBER 31,
BALANCE SHEET INFORMATION 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Assets of Discontinued Operations
Cash and Cash Equivalents $ 9.7 $ 9.7
Other Current Assets 39.0 19.1
Property, Plant and Equipment 314.5 311.5
Other Assets 26.9 34.6
- ------------------------------------------------------------------------------------------------------------------------------------
$390.1 $374.9
- ------------------------------------------------------------------------------------------------------------------------------------
Liabilities of Discontinued Operations
Current Liabilities $ 29.9 $ 29.7
Long-Term Debt 123.5 125.8
Other Liabilities 46.9 37.1
- ------------------------------------------------------------------------------------------------------------------------------------
$200.3 $192.6
- ------------------------------------------------------------------------------------------------------------------------------------
11 ALLETE Second Quarter 2003 Form 10-Q
NOTE 6. LONG-TERM DEBT
In June 2003 ADESA restructured its financial arrangements with respect to its
wholesale auction facilities located in Tracy, California; Boston,
Massachusetts; Charlotte, North Carolina; and Knoxville, Tennessee. These
wholesale auction facilities were previously accounted for as operating leases.
The transactions included the assumption of $28 million of long-term debt, the
issuance of $45 million of long-term debt and the recognition of $73 million of
property, plant and equipment. The $28 million of assumed long-term debt matures
April 1, 2020 and has a variable interest rate equal to the seven-day AA
Financial Commercial Paper Rate plus approximately 1.2%, while the $45 million
of long-term debt issued to finance the wholesale auction facility in Tracy,
California, matures July 30, 2006 and has a variable interest rate of prime or
LIBOR plus 1%. (See Note 4.)
In July 2003 ALLETE used internally generated funds to retire $25 million in
principal amount of the Company's First Mortgage Bonds, Series 6 1/4% due July
1, 2003.
In July 2003 ALLETE entered into a credit agreement to borrow $250 million from
a consortium of financial institutions, the proceeds of which were used to
redeem $250 million of the Company's Floating Rate First Mortgage Bonds due
October 20, 2003. The July 2003 credit agreement expires in July 2004, is
subject to interest at LIBOR plus 0.875% and is secured by the lien of the
Company's Mortgage and Deed of Trust. The credit agreement also has certain
mandatory prepayment provisions, including a requirement to repay an amount
equal to 75 percent of the net proceeds from the sale of water assets.
NOTE 7. INCOME TAX EXPENSE
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Millions
Current Tax Expense
Federal $15.6 $12.8 $32.3 $27.7
Foreign 7.3 3.9 9.2 6.7
State 2.3 1.8 6.1 3.5
- ------------------------------------------------------------------------------------------------------------------------------------
25.2 18.5 47.6 37.9
- ------------------------------------------------------------------------------------------------------------------------------------
Deferred Tax Expense (Benefit)
Federal 0.2 4.3 2.4 6.2
Foreign - - - 0.2
State 0.1 (0.3) 0.5 0.2
- ------------------------------------------------------------------------------------------------------------------------------------
0.3 4.0 2.9 6.6
- ------------------------------------------------------------------------------------------------------------------------------------
Deferred Tax Credits (0.2) (0.3) (0.6) (0.6)
- ------------------------------------------------------------------------------------------------------------------------------------
Income Taxes on Continuing Operations 25.3 22.2 49.9 43.9
Income Taxes on Discontinued Operations 4.3 3.7 8.4 4.8
- ------------------------------------------------------------------------------------------------------------------------------------
Total Income Tax Expense $29.6 $25.9 $58.3 $48.7
- ------------------------------------------------------------------------------------------------------------------------------------
ALLETE Second Quarter 2003 Form 10-Q 12
NOTE 8. COMPREHENSIVE INCOME
For the quarter ended June 30, 2003 total comprehensive income was $66.3 million
($44.8 million for the quarter ended June 30, 2002). For the six months ended
June 30, 2003 total comprehensive income was $122.9 million ($78.0 million for
the six months ended June 30, 2002). Total comprehensive income includes net
income, unrealized gains and losses on securities classified as
available-for-sale, changes in the fair value of an interest rate swap,
additional pension liability and foreign currency translation adjustments.
JUNE 30, DECEMBER 31,
ACCUMULATED OTHER COMPREHENSIVE GAIN (LOSS) 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Millions
Unrealized Gain (Loss) on Securities $ 0.3 $ (2.8)
Interest Rate Swap - (0.2)
Foreign Currency Translation Gain (Loss) 15.2 (15.7)
Additional Pension Liability (3.5) (3.5)
- -------------------------------------------------------------------------------------------------------------------
$ 12.0 $ (22.2)
- -------------------------------------------------------------------------------------------------------------------
NOTE 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. There was no
difference between basic and diluted earnings per share from continuing
operations for the quarter and six months ended periods in 2003.
RECONCILIATION OF BASIC AND DILUTED
EARNINGS PER SHARE
- -------------------------------------------------------------------------------------------------------------------
Millions Except Per Share Amounts
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, 2002 JUNE 30, 2002
----------------------------- -----------------------------
BASIC DILUTIVE DILUTED BASIC DILUTIVE DILUTED
EPS SECURITIES EPS EPS SECURITIES EPS
----------------------------- -----------------------------
Net Income from Continuing Operations $34.0 - $34.0 $67.6 - $67.6
Common Shares 81.0 0.7 81.7 80.7 0.6 81.3
Per Share from Continuing Operations $0.42 - $0.41 $0.84 - $0.83
- -------------------------------------------------------------------------------------------------------------------
13 ALLETE Second Quarter 2003 Form 10-Q
NOTE 10. COMMITMENTS, GUARANTEES AND CONTINGENCIES
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, a North Dakota cooperative corporation whose
Class A members are also members of Square Butte. Minnkota serves as the
operator of the Unit and also purchases power from Square Butte.
Minnesota Power is entitled to approximately 71 percent of the Unit's output
under the Agreement. After 2005 and upon compliance with a two-year advance
notice requirement, Minnkota has the option to reduce Minnesota Power's
entitlement by 5 percent annually, to a minimum of 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 is 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 June 30, 2003 Square Butte had total debt
outstanding of $282.2 million. Total annual debt service for Square Butte is
expected to be approximately $23.6 million in each of the years 2003 through
2007. Variable operating costs include the price of coal purchased from BNI
Coal, Ltd., our subsidiary, under a long-term contract. Minnesota Power's
payments to Square Butte are approved as purchased power expense for ratemaking
purposes by both the MPUC and the FERC.
LEASING AGREEMENTS. In June 2003 ADESA restructured its financial arrangement
with respect to its wholesale auction facilities located in Tracy, California;
Boston, Massachusetts; Charlotte, North Carolina; and Knoxville, Tennessee.
These wholesale auction facilities were previously accounted for as operating
leases. The transactions included the assumption of $28 million of long-term
debt, the issuance of $45 million of long-term debt and the recognition of $73
million of property, plant and equipment. (See Note 4.)
We lease other properties and equipment under operating lease agreements with
terms expiring through 2010. The aggregate amount of future minimum lease
payments for all operating leases during 2003 is $7.8 million ($10.6 million in
2004; $7.3 million in 2005; $5.7 million in 2006; $5.2 million in 2007; and
$55.5 million thereafter).
SPLIT ROCK ENERGY. We provide up to $50.0 million of credit support, in the form
of letters of credit and financial guarantees, to facilitate the power marketing
activities of Split Rock Energy. At June 30, 2003 this credit support backed
$1.7 million of Split Rock Energy's liabilities ($7.3 million at December 31,
2002). The credit support generally expires within one year from the date of
issuance.
KENDALL COUNTY POWER PURCHASE AGREEMENT. We have 275 MW of nonregulated
generation (non rate-base generation sold at market-based rates to the wholesale
market) through an agreement with NRG Energy that extends through September
2017. Under the agreement we pay a fixed capacity charge for the right, but not
the obligation, to capacity and energy from a 275 MW generating unit at NRG
Energy's Kendall County facility near Chicago, Illinois. The annual fixed
capacity charge is $21.8 million. We are responsible for arranging the natural
gas fuel supply. Our strategy is to enter into long-term contracts to sell a
significant portion of the 275 MW from the Kendall County facility, with the
balance to be sold in the spot market through short-term agreements. We
currently have long-term forward capacity and energy sales contracts for 100 MW
of Kendall County generation, with 50 MW expiring in April 2012 and the balance
in September 2017. In the first quarter of 2003 we entered into an additional 30
MW long-term forward capacity and energy sale contract that begins January 1,
2004 and expires in September 2017. Neither the Kendall County agreement nor the
related sales contracts are derivatives under SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities."
EMERGING TECHNOLOGY INVESTMENTS. We have investments in emerging technologies
through minority investments in venture capital funds and privately-held
start-up companies. These investments are accounted for using the cost method
and included in Investments on our consolidated balance sheet. The total
carrying value of these investments was $39.7 million at June 30, 2003 ($38.7
million at December 31, 2002). We have committed to make additional investments
in certain emerging technology holdings. The total future commitment was $5.9
million at June 30, 2003 ($7.7 million at December 31, 2002) and is expected to
be invested at various times through 2007.
ALLETE Second Quarter 2003 Form 10-Q 14
NOTE 10. COMMITMENTS, GUARANTEES AND CONTINGENCIES (Continued)
ENVIRONMENTAL MATTERS. Our businesses are subject to regulation by various
federal, state and local authorities concerning environmental matters. We do not
currently anticipate that potential expenditures for environmental matters will
be material; however, we are unable to predict the outcome of the issues
discussed below.
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's predecessors from 1889 to 1904. The
WDNR requested an environmental investigation be initiated. The WDNR also issued
SWL&P a Responsible Party letter in February 2002 to initiate tracking of the
project in the WDNR database so that progress can be monitored. The
environmental investigation is underway. The Phase II environmental site
investigation report was submitted to the WDNR in February 2003. This report
identified some MGP-like chemicals that were found in the soil. Initial test
results from sediment samples taken from nearby Superior Bay were inconsistent
with MGP-like chemicals. Additional samples were obtained in March 2003 from
Superior Bay near the site of the former MGP. The report on this sampling is
expected to be completed by the end of August 2003. The Company is unable to
predict the outcome of this matter at this time.
In May 2002 Minnesota Power received and subsequently responded to a third
request from the EPA, under Section 114 of the federal Clean Air Act Amendments
of 1990 (Clean Air Act), seeking additional information regarding capital
expenditures at all of its coal-fired generating stations. This action is part
of an industry-wide investigation assessing compliance with the New Source
Review and the New Source Performance Standards (emissions standards that apply
to new and changed units) of the Clean Air Act at electric generating stations.
We are unable to predict whether the EPA will take any action on this matter or
whether Minnesota Power will be required to incur any costs as a result.
In June 2002 Minnkota Power, the operator of Square Butte, received a Notice of
Violation from the EPA regarding alleged New Source Review violations at the
M.R. Young Station which includes the Square Butte generating unit. The EPA
claims certain capital projects completed by Minnkota Power should have gone
through the New Source Review process potentially resulting in new air permit
operating conditions. The Company is unable to predict the outcome of this
matter or the magnitude of costs should additional pollution controls be
required. Minnesota Power is obligated to pay its pro rata share of Square
Butte's costs based on Minnesota Power's entitlement to the Square Butte
generating unit's output.
15 ALLETE Second Quarter 2003 Form 10-Q
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
ALLETE's core operations are focused on two business segments. ENERGY SERVICES
includes electric and gas services, coal mining and telecommunications.
AUTOMOTIVE SERVICES, with operations across the United States and Canada,
includes a network of wholesale and total loss vehicle auctions, a finance
company, a vehicle remarketing company, a company that provides vehicle
inspection services to the automotive industry and its lenders, and a company
that provides Internet-based automotive parts location and nationwide insurance
claim audit services. INVESTMENTS AND CORPORATE CHARGES includes our Florida
real estate operations, investments in emerging technologies related to the
electric utility industry and corporate charges. Corporate charges represent
general corporate expenses, including interest, not specifically related to any
one business segment. In 2002 Investments and Corporate Charges included our
trading securities portfolio which was substantially liquidated during the
second half of 2002. DISCONTINUED OPERATIONS includes our Water Services
businesses, our auto transport business, our vehicle import business and our
retail stores.
CONSOLIDATED OVERVIEW
Net income for the quarter and six months ended June 30, 2003 increased 14
percent and 20 percent, respectively, from the same periods in 2002 and diluted
earnings per share for the quarter and six months ended June 30, 2003 increased
13 percent and 18 percent, respectively, from the same periods in 2002.
Net income from continuing operations for the quarter and six months ended June
30, 2003 increased 10 percent and 12 percent, respectively, from the same
periods in 2002 and diluted earnings per share from continuing operations for
the quarter and six months ended June 30, 2003 increased 10 percent and 11
percent, respectively, from the same periods in 2002.
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Millions Except Per Share Amounts
Operating Revenue
Energy Services $158.5 $154.1 $337.6 $297.0
Automotive Services 240.7 216.8 473.6 425.6
Investments 10.7 5.0 21.6 21.6
- ------------------------------------------------------------------------------------------------------------------------------------
$409.9 $375.9 $832.8 $744.2
- ------------------------------------------------------------------------------------------------------------------------------------
Operating Expenses
Energy Services $147.0 $137.4 $305.5 $264.7
Automotive Services 183.9 167.3 372.6 334.6
Investments and Corporate Charges 14.8 13.5 26.0 30.4
- ------------------------------------------------------------------------------------------------------------------------------------
$345.7 $318.2 $704.1 $629.7
- ------------------------------------------------------------------------------------------------------------------------------------
Net Income
Energy Services $ 6.8 $ 9.7 $19.0 $18.8
Automotive Services 34.1 30.0 60.8 54.9
Investments and Corporate Charges (3.5) (5.7) (4.0) (6.1)
- ------------------------------------------------------------------------------------------------------------------------------------
Continuing Operations 37.4 34.0 75.8 67.6
Discontinued Operations 7.0 4.8 12.9 6.4
- ------------------------------------------------------------------------------------------------------------------------------------
Net Income $44.4 $38.8 $88.7 $74.0
- ------------------------------------------------------------------------------------------------------------------------------------
Diluted Average Shares of Common Stock - Millions 82.9 81.7 82.6 81.3
- ------------------------------------------------------------------------------------------------------------------------------------
Diluted Earnings Per Share of Common Stock
Continuing Operations $0.45 $0.41 $0.92 $0.83
Discontinued Operations 0.08 0.06 0.15 0.08
- ------------------------------------------------------------------------------------------------------------------------------------
$0.53 $0.47 $1.07 $0.91
- ------------------------------------------------------------------------------------------------------------------------------------
ALLETE Second Quarter 2003 Form 10-Q 16
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
STATISTICAL INFORMATION 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
ENERGY SERVICES
Millions of Kilowatthours Sold
Utility
Retail
Residential 223.9 232.8 536.8 518.6
Commercial 289.6 295.1 616.0 609.6
Industrial 1,655.0 1,755.2 3,373.6 3,405.0
Other 18.3 17.8 38.8 37.6
Resale 505.4 400.8 913.2 843.7
- ------------------------------------------------------------------------------------------------------------------------------------
2,692.2 2,701.7 5,478.4 5,414.5
Nonregulated 281.1 226.7 700.2 310.3
- ------------------------------------------------------------------------------------------------------------------------------------
2,973.3 2,928.4 6,178.6 5,724.8
- ------------------------------------------------------------------------------------------------------------------------------------
AUTOMOTIVE SERVICES
Vehicles Sold
Wholesale 471,000 454,000 933,000 915,000
Total Loss 49,000 44,000 98,000 89,000
- ------------------------------------------------------------------------------------------------------------------------------------
520,000 498,000 1,031,000 1,004,000
Conversion Rate <F1> - Wholesale Vehicles 61.1% 59.7% 61.8% 62.6%
Vehicles Financed 241,000 241,000 474,000 478,000
- ------------------------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Conversion rate is the percentage of vehicles sold from those that were offered at auction.
</FN>
NET INCOME
The following net income discussion summarizes a comparison of the six months
ended June 30, 2003 to the six months ended June 30, 2002.
ENERGY SERVICES' net income was slightly higher than last year reflecting
increased sales of nonregulated generation, improved wholesale power prices and
more sales activity at our telecommunications business. Increased sales of
nonregulated generation resulted from facilities being available for a full six
months in 2003. Nonregulated generation facilities first came online at various
times during the first half of 2002. In 2002 net income included a $2.8 million
after-tax mark-to-market accounting gain on the Kendall County power purchase
agreement as required by accounting rules. These mark-to-market accounting rules
were rescinded in late 2002, and this $2.8 million gain was reversed in the
fourth quarter.
AUTOMOTIVE SERVICES reported a $5.9 million, or 11 percent, increase in net
income in 2003 in spite of difficult market conditions. The increase in net
income was attributable to increased vehicle sales, lower interest expense,
modest fee increases and efficiency gains at our auction facilities, and reduced
bad debt expense at AFC, our floorplan financing business. Year-to-date vehicles
sold were up 2 percent at our wholesale auction facilities and 10 percent at our
total loss auction facilities. Interest expense was down due to lower debt
balances, and bad debt expense at AFC was down reflecting improved credit
quality of the receivable portfolio and strong receivable portfolio management.
For the six months ended June 30, 2003 AFC contributed 29 percent of the net
income for Automotive Services (30 percent in 2002).
NON-GAAP FINANCIAL MEASURES. We believe EBITDA provides meaningful additional
information that helps us monitor and evaluate our ongoing operating results and
trends, and facilitates an understanding of our comparative operating
performance. EBITDA should not be considered in isolation nor as a substitute
for measures of performance prepared in accordance with GAAP. EBITDA is not an
alternative to cash flows as a measure of liquidity and may not be comparable
with EBITDA as defined by other companies. EBITDA is a common measure of
operating performance considered by investors, financial analysts and rating
agencies.
17 ALLETE Second Quarter 2003 Form 10-Q
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
AUTOMOTIVE SERVICES EBITDA 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Millions
Net Income $34.1 $30.0 $ 60.8 $ 54.9
Add Back:
Income Tax Expense 22.7 19.5 40.2 36.1
Interest Expense 3.7 5.7 8.1 11.4
Depreciation and Amortization Expense 8.9 7.8 17.0 15.6
- ------------------------------------------------------------------------------------------------------------------------------------
EBITDA $69.4 $63.0 $126.1 $118.0
- ------------------------------------------------------------------------------------------------------------------------------------
INVESTMENTS AND CORPORATE CHARGES' financial results in 2003 reflected more real
estate sales partially offset by losses on the sale of shares we held directly
in publicly-traded emerging technology investments. Financial results for 2002
included gains on the sale of certain emerging technology investments and losses
related to our trading securities portfolio which was subsequently liquidated
during the third quarter of 2002.
DISCONTINUED OPERATIONS' net income was up $6.5 million in 2003. Net income from
our Water Services businesses in 2003 reflected $10.4 million in after-tax gains
on the condemnation of Florida Water's utility systems in Nassau (Amelia
Island), Clay and Bradford counties. These gains were offset by $7.9 million of
after-tax expense associated with the sale of our water assets and a $2.2
million accrual for employee retention and severance incentives. Despite a 2.9
percent increase in total customers, water consumption was down 11 percent
because in 2003 above normal precipitation decreased consumption and in 2002
drier weather conditions increased consumption. Net income from other
discontinued operations in 2003 included a $1.3 million recovery from the
settlement of a lawsuit associated with our auto transport business, while net
income in 2002 included $3.9 million of exit charges related to the auto
transport business and the retail stores.
COMPARISON OF THE QUARTERS ENDED JUNE 30, 2003 AND 2002
ENERGY SERVICES
UTILITY operations include retail and wholesale rate regulated activities under
the jurisdiction of state and federal regulatory authorities.
NONREGULATED/NONUTILITY operations consist of nonregulated generation (non-rate
base generation sold at market-based rates to the wholesale market), coal mining
and telecommunication activities. Nonregulated generation consists primarily of
the Taconite Harbor Energy Center in northern Minnesota and generation secured
through the Kendall County power purchase agreement, a 15-year agreement with
NRG Energy at a facility near Chicago, Illinois.
OPERATING REVENUE in total was up $4.4 million, or 3 percent, in 2003 reflecting
increases from both utility and nonregulated/nonutility operations. UTILITY
operating revenue was up $3.9 million, or 3 percent, mainly due to higher fuel
clause recoveries. Improved wholesale power prices and higher gas prices also
contributed to the increase in operating revenue. Utility kilowatthour sales
were similar to the second quarter of last year. NONREGULATED/NONUTILITY revenue
increased $0.5 million, or 2 percent, in 2003 as increased sales of nonregulated
generation, improved wholesale power prices and more sales activity at our
telecommunications business offset a mark-to-market accounting gain recorded in
2002. Increased sales of nonregulated generation resulted from facilities being
available for a full three months in 2003. Nonregulated generation facilities
first came online at various times during the first half of 2002. As required by
accounting rules, a $4.7 million pre-tax mark-to-market accounting gain on the
Kendall County power purchase agreement was recorded in June 2002 and
subsequently reversed in the fourth quarter of 2002.
Revenue from electric sales to taconite customers accounted for 10 percent of
consolidated operating revenue in both 2003 and 2002. Electric sales to paper
and pulp mills accounted for 4 percent of consolidated operating revenue in both
2003 and 2002.
OPERATING EXPENSES in total were up $9.6 million, or 7 percent, in 2003. UTILITY
operating expenses were up $2.5 million, or 2 percent, in 2003 reflecting higher
purchased power and gas expense and general cost increases.
NONREGULATED/NONUTILITY operating expenses increased $7.1 million, or 24
percent, over the prior year mainly due to fuel and purchased power expenses for
nonregulated generation that came online during the first half of 2002 and
direct costs related to increased sales activity at our telecommunications
business.
ALLETE Second Quarter 2003 Form 10-Q 18
AUTOMOTIVE SERVICES
OPERATING REVENUE was up $23.9 million, or 11 percent, in 2003. Revenue from our
wholesale auction facilities was higher in 2003 primarily due to increased
sales, a sales mix shift and modest fee increases implemented at some of our
auction facilities. The number of vehicles sold at our wholesale auction
facilities increased 4 percent. The increased volume in commercial accounts,
which resulted in additional reconditioning services, offset a decline in dealer
consignment sales. A commercial account is a non-dealer consignor such as a
manufacturer, leasing company, insurance company, bank or finance company,
business fleet or rental company.
Revenue from our total loss auction facilities was up in 2003 reflecting an 11
percent increase in vehicles sold and expansion into new markets, including
combination sites at some of our wholesale auction facilities.
While the number of vehicles financed by AFC was similar to last year due to the
softness of the economy, revenue from AFC was higher in 2003 because lower
interest rates in 2003 reduced interest borrowing expense and strong receivable
portfolio management lowered bad debt expense.
OPERATING EXPENSES were up $16.6 million, or 10 percent, in 2003 primarily due
to additional expenses incurred for reconditioning services provided as a result
of a sales mix shift that has added more commercial accounts. Operating expenses
were also impacted by lower conversion rates at our Canadian wholesale auction
facilities which increased direct costs associated with processing vehicles
multiple times.
INVESTMENTS AND CORPORATE CHARGES
OPERATING REVENUE was up $5.7 million in 2003 primarily due to four large real
estate sales which contributed $7.9 million to revenue. Revenue from our
emerging technology investments was down $6.8 million in 2003 because revenue in
2003 included $3.5 million of losses related to the sale of shares the Company
held directly in publicly-traded investments and revenue in 2002 included a $3.3
million gain on the sale of certain investments. Revenue in 2002 also included
losses related to our trading securities portfolio which was liquidated during
the second half of 2002.
OPERATING EXPENSES were up $1.3 million in 2003 primarily due to higher expenses
related to our real estate operations because the cost of property sold in 2003
was higher than in 2002.
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2003 AND 2002
ENERGY SERVICES
OPERATING REVENUE in total was up $40.6 million, or 14 percent, in 2003
reflecting increases from both utility and nonregulated/nonutility operations.
UTILITY operating revenue was up $21.1 million, or 9 percent, mainly due to
higher fuel clause recoveries, improved wholesale power prices and earnings from
Split Rock Energy. Fuel clause recoveries increased due to higher purchased
power. Results from Split Rock Energy were up in 2003 due to increased power
marketing opportunities and higher wholesale power prices. Revenue from gas
sales were also up in 2003 due to higher gas prices. Utility kilowatthour sales
were up 1 percent from last year. NONREGULATED/NONUTILITY revenue increased
$19.5 million in 2003 primarily due to increased sales of nonregulated
generation, improved wholesale power prices and more sales activity at our
telecommunications business. Increased sales of nonregulated generation resulted
from facilities being available for a full six months in 2003. Nonregulated
generation facilities first came online at various times during the first half
of 2002. As required by accounting rules, a $4.7 million pre-tax mark-to-market
accounting gain on the Kendall County power purchase agreement was recorded in
June 2002 and subsequently reversed in the fourth quarter.
Revenue from electric sales to taconite customers accounted for 10 percent of
consolidated operating revenue in both 2003 and 2002. Electric sales to paper
and pulp mills accounted for 4 percent of consolidated operating revenue in both
2003 and 2002.
19 ALLETE Second Quarter 2003 Form 10-Q
OPERATING EXPENSES in total were up $40.8 million, or 15 percent, in 2003. The
increase was primarily attributable to increased fuel and purchased power
expenses. UTILITY operating expenses were up $14.0 million, or 7 percent, in
2003 primarily due to increased purchased power and gas expense, generating
station maintenance expense and employment costs. Higher purchased power costs
resulted from both increased wholesale prices and quantities purchased. Gas
expense was higher in 2003 due to increased prices. Planned maintenance outages
at Company generating stations necessitated higher quantities of purchased power
this year. Higher gas prices in 2003 also contributed to the increase in
operating expenses. NONREGULATED/NONUTILITY operating expenses increased $26.8
million over the prior year mainly due to fuel and purchased power expenses for
nonregulated generation that came online during the first half of 2002.
Purchased power expense in 2003 included six months of demand charges related to
the Kendall County power purchase agreement while 2002 included only two months.
The Kendall County agreement began in May 2002. Operating expenses were also
higher in 2003 due to increased sales activity at our telecommunications
business.
AUTOMOTIVE SERVICES
OPERATING REVENUE was up $48.0 million, or 11 percent, in 2003. Revenue from our
wholesale auction facilities was higher in 2003 primarily due to increased
sales, a sales mix shift and modest fee increases implemented at some of our
auction facilities. At our wholesale auction facilities 2 percent more vehicles
were sold in 2003. The increased volume in commercial accounts, which resulted
in additional reconditioning services, offset a decline in dealer consignment
sales.
Revenue from our total loss auction facilities was up in 2003 reflecting a 10
percent increase in vehicles sold and expansion into new markets, including
combination sites at some of our wholesale auction facilities.
While the number of vehicles financed by AFC was down slightly from last year
due to the softness of the economy, revenue from AFC was higher in 2003
primarily because strong receivable portfolio management lowered bad debt
expense.
OPERATING EXPENSES were up $38.0 million, or 11 percent, in 2003 primarily due
to additional expenses incurred for reconditioning services provided as a result
of a sales mix shift that has added more commercial accounts, and additional
costs incurred because of inclement weather. Operating expenses were also
impacted by lower conversion rates at our Canadian wholesale vehicle auctions
which increased direct costs associated with processing vehicles multiple times.
INVESTMENTS AND CORPORATE CHARGES
OPERATING REVENUE remained constant in 2003 as more real estate sales were
offset by less revenue from our emerging technology investments. In 2003 eight
large real estate sales contributed $14.5 million to revenue compared to 2002
when two large real estate sales contributed $4.9 million to revenue. In 2003 we
recognized $3.5 million of losses related to the sale of shares the Company held
directly in publicly-traded emerging technology investments, while in 2002 we
recognized a $3.3 million gain on the sale of certain emerging technology
investments. Revenue in 2002 also included losses on our trading securities
portfolio which was liquidated during the second half of 2002.
OPERATING EXPENSES were down $4.4 million, or 14 percent, in 2003 in part due to
lower incentive compensation expense and interest expense.
CRITICAL ACCOUNTING POLICIES
Certain accounting measurements under applicable generally accepted accounting
principles 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: uncollectible receivables and allowance for doubtful
accounts, impairment of goodwill and long-lived assets, pension and
postretirement health and life actuarial assumptions, and valuation of
investments. These policies are summarized in our 2002 Form 10-K.
ALLETE Second Quarter 2003 Form 10-Q 20
OUTLOOK
We remain focused on continuously improving the performance of our two core
businesses, Energy and Automotive Services, and monetizing those businesses that
are non-strategic or non-core. Our two core businesses remain strong and are
poised for earnings growth in their respective markets as economic conditions
improve. With solid financial results for the first six months of 2003, our
total year expectations have not changed.
We are continuing to pursue the sale of our Water Services businesses in
Florida, North Carolina and Georgia. During the first six months of 2003,
through condemnation proceedings, Florida Water sold its Amelia Island water and
wastewater assets to Nassau County and its water and wastewater assets in
Bradford and Clay counties to the Clay County Utility Authority. The combined
transactions resulted in a total after-tax gain of $10.4 million which was
included in our 2003 earnings from discontinued operations. In July 2003,
through another condemnation proceeding, Florida Water sold its Martin County
water and wastewater assets to Martin County for $2.4 million. The transaction
resulted in an after-tax gain of $0.5 million which will be included in our
third quarter 2003 earnings from discontinued operations. Condemnation
proceedings have also been initiated in Marion County for Florida Water's assets
in that county which serve approximately 15,000 customers.
On July 24, 2003 Florida Water signed a purchase agreement to sell seven of its
Florida water and wastewater systems to governmental entities in Florida for
$296 million payable at closing. The transaction is expected to result in an
after-tax gain of approximately $55 million. The water and wastewater systems
included in this purchase agreement represent approximately two-thirds of
Florida Water's assets and constitute systems serving the counties of Osceola,
Hernando, Citrus, Lee and Charlotte, and the communities of Marco Island and
Palm Coast. These systems combined serve approximately 152,000 customers. The
cash proceeds after transaction costs, retirement of Florida Water debt and
payment of income taxes are estimated at $158 million, and will be used to
retire debt at ALLETE. The sale is expected to close by the end of 2003 pending
satisfaction of certain contingencies and regulatory approvals in Florida.
Florida Water will continue to seek buyers for its remaining water and
wastewater facilities. Systems for which governmental buyers are not found are
expected to be sold to a private buyer.
We are using an investment banking firm to facilitate the sale of Water Services
businesses in North Carolina and Georgia. Discussions with prospective buyers
are in process. We expect to enter into agreements to sell these businesses in
2003. The proceeds from selling our Water Services businesses will give us the
ability to reduce debt, which will further strengthen our balance sheet.
Our Board of Directors and management remain committed to unlocking the value of
ALLETE. We continue to review, both internally and with outside advisors, the
benefits and risks of separating our Energy and Automotive Services businesses
into independent companies. When we ultimately reach a decision as to whether we
will separate our businesses, we will inform the market at that time through a
filing with the SEC. We are unable to predict the timing of that decision.
ENERGY SERVICES. While our power marketing activities benefited from higher than
expected wholesale power prices during the first six months of 2003, it is
uncertain whether higher prices will continue for the remainder of the year. We
anticipate 2003 net income from Energy Services to be similar to 2002. Global
economic conditions continue to affect our largest industrial retail customers
and are likely to continue over the next few years, as consolidation in the
steel and taconite industries continues, and while paper and pulp companies
search for even more efficiency and cost-cutting measures to compete in the
marketplace.
AUTOMOTIVE SERVICES. We continue to anticipate earnings from Automotive Services
to increase by about 15 percent in 2003. In 2003 vehicles sold through our
wholesale and total loss auction facilities combined are expected to increase by
4 percent to 7 percent, and the number of vehicles financed through AFC is
expected to increase by 5 percent. However, it will be difficult to achieve
these growth targets if economic conditions do not improve. Automotive Services
is focusing on growth in the volume of vehicles sold and financed, increased
ancillary services, and operating and technological efficiencies. Selective fee
increases have been implemented and more will be considered. The opening of
total loss auction facilities in Fremont, California; Medford (Long Island), New
York; and Manville, New Jersey, during the first six months of 2003 will also
contribute to 2003 earnings as will the new wholesale auction facilities in
Yaphank (Long Island), New York; Atlanta, Georgia; and Edmonton, Alberta. The
wholesale auction facility in Yaphank, which opened in June 2003, is a
greenfield site (a newly constructed facility in a new market). The new
wholesale auction facilities in Atlanta and Edmonton are under construction and
will replace aging facilities. Both are slated to open later this year.
21 ALLETE Second Quarter 2003 Form 10-Q
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW ACTIVITIES
A primary goal of our strategic plan is to improve cash flow from operations.
Our strategy includes growing the businesses both internally by expanding
facilities, services and operations (see Capital Requirements), and externally
through acquisitions. During the first six months of 2003 cash flow from
operating activities reflected strong operating results and continued focus on
working capital management. Cash flow from operations was higher in 2002 due to
the timing of the collection of certain finance receivables outstanding at
December 31, 2001. Cash flow from operations was also affected by a number of
factors representative of normal operations.
WORKING CAPITAL. As of June 30, 2003 our working capital needs included $283.1
million of long-term debt due later in 2003. (See Securities.) Additional
working capital, if and when needed, generally is provided by the sale of
commercial paper. During the second half of 2002 we liquidated our trading
securities portfolio and used the proceeds to reduce our short-term debt.
Approximately 4.1 million original issue shares of our common stock are
available for issuance through INVEST DIRECT, our direct stock purchase and
dividend reinvestment plan.
A substantial amount of ADESA's working capital is generated internally from
payments for services provided. ADESA, however, has arrangements to use proceeds
from the sale of commercial paper issued by ALLETE to meet short-term working
capital requirements arising from the timing of payment obligations to vehicle
sellers and the availability of funds from vehicle purchasers. During the sales
process, ADESA does not typically take title to vehicles.
AFC offers short-term on-site financing for dealers to purchase vehicles mostly
at auctions and takes a security interest in each vehicle financed. The
financing is provided through the earlier of the date the dealer sells the
vehicle or a general borrowing term of 30 to 45 days. AFC has arrangements to
use proceeds from the sale of commercial paper issued by ALLETE to meet its
short-term working capital requirements.
Significant changes in accounts receivable and accounts payable balances at June
30, 2003 compared to December 31, 2002 were due to increased sales and financing
activity at Automotive Services. Typically auction volumes are down during
December because of the holidays. As a result, ADESA and AFC had higher
receivables and higher payables at June 30, 2003.
AFC RECEIVABLES. AFC, through a wholly owned, consolidated subsidiary, sells
certain finance receivables through a revolving private securitization
structure. The securitization agreement allows for the revolving sale by the
subsidiary to third parties of up to $500 million in undivided interests in
eligible finance receivables. The securitization agreement expires in 2005.
AFC managed total receivables of $524.9 million at June 30, 2003 ($495.1 million
at December 31, 2002); $211.1 million of this amount represent receivables which
were included in accounts receivable on our consolidated balance sheet ($191.3
million at December 31, 2002) and $313.8 million of this amount represent
receivables sold in undivided interests through the securitization agreement
($303.8 million at December 31, 2002) which are off-balance sheet. AFC's
proceeds from the sale of the receivables to third parties were used to repay
borrowings from ALLETE and fund new loans to AFC's customers. AFC and the
subsidiary must each maintain certain financial covenants such as minimum
tangible net worth to comply with the terms of the securitization agreement. AFC
has historically performed better than the covenant thresholds set forth in the
securitization agreement. We are not currently aware of any changing
circumstances that would put AFC in noncompliance with the covenants.
SPLIT ROCK ENERGY. We provide up to $50.0 million in credit support, in the form
of letters of credit and financial guarantees, to facilitate the power marketing
activities of Split Rock Energy. At June 30, 2003 this credit support backed
$1.7 million of Split Rock Energy's liabilities ($7.3 million at December 31,
2002). The credit support generally expires within one year from the date of
issuance.
ALLETE Second Quarter 2003 Form 10-Q 22
SALE OF WATER PLANT ASSETS. In March 2003, through a condemnation proceeding,
Florida Water sold its Amelia Island water and wastewater assets to Nassau
County in Florida for $17.5 million. The transaction resulted in an after-tax
gain of $9.8 million which was included in our 2003 earnings from discontinued
operations. The system serves 5,000 customers. For an additional fee, Florida
Water will continue to operate the system for Nassau County for a period of 120
days or for such additional period of time as may be agreed to by the parties.
In May 2003, through a condemnation proceeding, Florida Water sold its water and
wastewater assets in Bradford and Clay counties in Florida to the Clay County
Utility Authority for $4.3 million. The transaction resulted in an after-tax
gain of $0.6 million which was included in our 2003 earnings from discontinued
operations. The systems serve 1,500 customers. For an additional fee, Florida
Water will continue to operate the systems for Clay County for a period of 90
days.
In July 2003, through another condemnation proceeding, Florida Water sold its
Martin County water and wastewater assets to Martin County for $2.4 million. The
transaction resulted in an after-tax gain of $0.5 million which will be included
in our third quarter 2003 earnings from discontinued operations. The systems
serve 1,300 customers.
Proceeds from these condemnations will be used to reduce debt and for general
corporate purposes.
SECURITIES. In March 2001 ALLETE, ALLETE Capital II and ALLETE Capital III,
jointly filed a registration statement with the SEC pursuant to Rule 415 under
the Securities Act of 1933. The registration statement, which has been declared
effective by the SEC, relates to the possible issuance of a remaining aggregate
amount of $387 million of securities which may include ALLETE common stock,
first mortgage bonds and other debt securities, and ALLETE Capital II and ALLETE
Capital III preferred trust securities. ALLETE also previously filed a
registration statement, which has been declared effective by the SEC, relating
to the possible issuance of $25 million of first mortgage bonds and other debt
securities. We may sell all or a portion of the remaining registered securities
if warranted by market conditions and our capital requirements. Any offer and
sale of the above mentioned securities will be made only by means of a
prospectus meeting the requirements of the Securities Act of 1933 and the rules
and regulations thereunder.
In June 2003 ADESA restructured its financial arrangements with respect to its
wholesale auction facilities located in Tracy, California; Boston,
Massachusetts; Charlotte, North Carolina; and Knoxville, Tennessee. These
wholesale auction facilities were previously accounted for as operating leases.
The transactions included the assumption of $28 million of long-term debt, the
issuance of $45 million of long-term debt and the recognition of $73 million of
property, plant and equipment. The $28 million of assumed long-term debt matures
April 1, 2020 and has a variable interest rate equal to the seven-day AA
Financial Commercial Paper Rate plus approximately 1.2%, while the $45 million
of long-term debt issued to finance the wholesale auction facility in Tracy,
California, matures July 30, 2006 and has a variable interest rate of prime or
LIBOR plus 1%.
In July 2003 ALLETE used internally generated funds to retire $25 million in
principal amount of the Company's First Mortgage Bonds, Series 6 1/4% due July
1, 2003.
In July 2003 ALLETE entered into a credit agreement to borrow $250 million from
a consortium of financial institutions, the proceeds of which were used to
redeem $250 million of the Company's Floating Rate First Mortgage Bonds due
October 20, 2003. The July 2003 credit agreement expires in July 2004, is
subject to interest at LIBOR plus 0.875% and is secured by the lien of the
Company's Mortgage and Deed of Trust. The credit agreement also has certain
mandatory prepayment provisions, including a requirement to repay an amount
equal to 75 percent of the net proceeds from the sale of water assets.
23 ALLETE Second Quarter 2003 Form 10-Q
CAPITAL REQUIREMENTS
As a result of the delay in selling our Water Services business, consolidated
capital expenditures for 2003 are now expected to be $172 million. Consolidated
capital expenditures for the six months ended June 30, 2003 totaled $73.6
million ($97.5 million in 2002). Expenditures for 2003 included $38.1 million
for Energy Services and $18.9 million for Automotive Services. Expenditures for
2003 also included $16.6 million to maintain our Water Services businesses while
they are in the process of being sold. An existing long-term line of credit and
internally generated funds were the primary sources of funding for these
expenditures. The 2003 capital expenditure amounts do not include $73 million of
property, plant and equipment recognized upon the restructuring of financial
arrangements with respect to four of our wholesale auction facilities previously
accounted for as operating leases.
NEW ACCOUNTING STANDARDS
In January 2003 the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities." In general, a variable interest entity is one with
equity investors that do not have voting rights or do not provide sufficient
financial resources for the entity to support its activities. Under the new
rules, variable interest entities will be consolidated by the party that is
subject to the majority of the risk of loss or entitled to the majority of the
residual returns. The new rules are effective immediately for variable interest
entities created after January 31, 2003 and in the third quarter of 2003 for
previously existing variable interest entities. In June 2003 ADESA restructured
its financial arrangements with respect to four of its wholesale auction
facilities previously accounted for as operating leases. The transactions
included the assumption of $28 million of long-term debt, the issuance of $45
million of long-term debt and the recognition of $73 million in property, plant
and equipment. Interpretation No. 46 would have required ADESA to consolidate
the lessor under the lease arrangements in place prior to the restructuring. We
are not a party to any variable interest entity required to be consolidated upon
the adoption of Interpretation 46.
In May 2003 the FASB issued SFAS 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." In general,
SFAS 150 establishes standards for classification and measurement of certain
financial instruments with the characteristics of both liabilities and equity.
Mandatorily redeemable financial instruments must be classified as a liability
and the related payments must be reported as interest expense. The new rules are
effective immediately for financial instruments entered into after May 31, 2003
and in the third quarter of 2003 for previously existing financial instruments.
Beginning with the third quarter of 2003, we will be required to reclassify our
Mandatorily Redeemable Preferred Securities of ALLETE Capital I as a long-term
liability and reclassify the quarterly distributions as interest expense. This
will be a reclassification only and will not impact our results of operations.
-------------------------------
READERS ARE CAUTIONED THAT FORWARD-LOOKING STATEMENTS INCLUDING THOSE CONTAINED
ABOVE, SHOULD BE READ IN CONJUNCTION WITH OUR DISCLOSURES UNDER THE HEADING:
"SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995" LOCATED ON PAGE 3 OF THIS FORM 10-Q.
ALLETE Second Quarter 2003 Form 10-Q 24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
SECURITIES INVESTMENTS
Our securities investments include certain securities held for an indefinite
period of time which are accounted for as available-for-sale securities.
Available-for-sale securities are recorded at fair value with unrealized gains
and losses included in accumulated other comprehensive income, net of tax.
Unrealized losses that are other than temporary are recognized in earnings. At
June 30, 2003 our available-for-sale securities portfolio consisted of
securities in a grantor trust established to fund certain employee benefits. Our
available-for-sale securities portfolio had a fair value of $14.2 million at
June 30, 2003 ($20.9 million at December 31, 2002) and a total unrealized
after-tax gain of $0.3 million at June 30, 2003 ($2.8 million loss at December
31, 2002). During the second quarter of 2003 we sold the investments we held
directly in our publicly-traded Emerging Technology portfolio and recognized a
$2.3 million after-tax loss at June 30, 2003. These publicly-traded emerging
technology investments were accounted for as available-for-sale securities prior
to sale.
As part of our Emerging Technology portfolio, we also have several minority
investments in venture capital funds and privately-held start-up companies.
These investments are accounted for using the cost method and included in
Investments on our consolidated balance sheet. The total carrying value of these
investments was $39.7 million at June 30, 2003 ($38.7 million at December 31,
2002). Our policy is to periodically review these investments 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.
FOREIGN CURRENCY
Our foreign currency exposure is limited to the conversion of operating results
of our Canadian and Mexican subsidiaries. We have not entered into any foreign
exchange contracts to hedge the conversion of our Canadian or Mexican operating
results into United States dollars.
POWER MARKETING
Minnesota Power purchases power for retail sales in our electric utility service
territory and sells excess generation in the wholesale market. We have about 500
MW of nonregulated generation available for sale to the wholesale market. Our
nonregulated generation includes about 225 MW from Taconite Harbor in northern
Minnesota that was acquired in October 2001. It also includes 275 MW of
generation obtained through a 15-year agreement, which commenced in May 2002,
with NRG Energy at the Kendall County facility near Chicago, Illinois. Under the
Kendall County agreement, we pay a fixed capacity charge for the right, but not
the obligation, to capacity and energy from a 275 MW generating unit. We are
responsible for arranging the natural gas fuel supply and are entitled to the
electricity produced. Our strategy is to sell a significant portion of our
nonregulated generation through long-term contracts of various durations. The
balance will be sold in the spot market through short-term agreements. We
currently have long-term forward capacity and energy sales contracts for 100 MW
of Kendall County generation, with 50 MW expiring in April 2012 and the balance
in September 2017. In the first quarter of 2003 we entered into an additional 30
MW long-term forward capacity and energy sale contract that begins January 1,
2004 and expires in September 2017. Neither the Kendall County agreement nor the
related sales contracts are derivatives under SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities."
The services of Split Rock Energy are used to fulfill purchase requirements for
retail load and to market excess generation. We own 50 percent of Split Rock
Energy which is a joint venture between Minnesota Power and Great River Energy.
The joint venture was formed to provide us with least cost supply, to provide
generation outage protection, to maximize the value of our generation assets and
to maximize power marketing revenue within prescribed limits. Split Rock Energy
operates in the wholesale energy markets, and engages in marketing activities by
entering into forward and option contracts for the purchase and sale of
electricity. These contracts are primarily short-term in nature with maturities
of less than one year. Although Split Rock Energy generally attempts to balance
its purchase and sale positions, commodity price risk sometimes exists or is
created. This risk is actively managed through a risk management program that
includes policies, procedures and limits established by the Split Rock Energy
Board of Governors. Minnesota Power holds two seats on this four member Board.
25 ALLETE Second Quarter 2003 Form 10-Q
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 in timely alerting them to material information required to be
included in our periodic SEC filings. There has been no significant change in
our internal control over financial reporting that occurred during our most
recent fiscal quarter that has materially affected, or is reasonable likely to
materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Material legal and regulatory proceedings are included in the discussion of
Other Information in Item 5. and are incorporated by reference herein.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) We held our Annual Meeting of Shareholders on May 13, 2003.
(b) Included in (c) below.
(c) The election of directors, the ratification of the appointment of
independent accountants and the reservation of an additional 500,000 shares
of ALLETE common stock for issuance under the ALLETE and Affiliated
Companies Employee Stock Purchase Plan were voted on at the Annual Meeting
of Shareholders.
The results were as follows:
VOTES
WITHHELD OR BROKER
VOTES FOR AGAINST ABSTENTIONS NONVOTES
- ------------------------------------------------------------------------------------------------------------------
DIRECTORS
Wynn V. Bussmann 71,127,209 3,089,520 - -
Thomas L. Cunningham 72,718,971 1,497,758 - -
Dennis E. Evans 72,603,034 1,613,695 - -
David G. Gartzke 72,663,315 1,553,414 - -
Peter J. Johnson 71,197,039 3,019,690 - -
George L. Mayer 71,203,137 3,013,592 - -
Jack I. Rajala 72,822,460 1,394,269 - -
Nick Smith 72,646,224 1,570,505 - -
Bruce W. Stender 71,223,742 2,992,987 - -
Donald C. Wegmiller 72,587,728 1,629,001 - -
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP 70,374,655 3,386,545 455,529 -
ALLETE AND AFFILIATED
COMPANIES EMPLOYEE STOCK
PURCHASE PLAN
Reservation of additional
shares to be issued 69,410,099 3,772,319 1,034,311 -
- ------------------------------------------------------------------------------------------------------------------
Effective June 1, 2003 Dennis O. Green and Deborah L. Weinstein were
elected by ALLETE's Board of Directors to serve as directors of ALLETE.
(d) Not applicable.
ALLETE Second Quarter 2003 Form 10-Q 26
ITEM 5. OTHER INFORMATION
Reference is made to our 2002 Form 10-K for background information on the
following updates. Unless otherwise indicated, cited references are to our 2002
Form 10-K.
Ref. Page 19. - Last Paragraph
Ref. Page 40. - Third Full Paragraph
Ref. Page 68. - Second Paragraph
Ref. Form 8-K dated March 7, 2003 and filed March 10, 2003
Ref. Form 8-K dated and filed March 14, 2003
Ref. 10-Q for the quarter ended March 31, 2003, Page 21. - Second Paragraph
Ref. Form 8-K dated and filed July 24, 2003
In May 2003, through a condemnation proceeding, Florida Water sold its water and
wastewater assets in Bradford and Clay counties in Florida to the Clay County
Utility Authority for $4.3 million. The transaction resulted in an after-tax
gain of $0.6 million which was included in our 2003 earnings from discontinued
operations. The systems serve 1,500 customers. For an additional fee, Florida
Water will continue to operate the systems for Clay County for a period of 90
days. The proceeds will be used to reduce debt and for general corporate
purposes.
In July 2003, through another condemnation proceeding, Florida Water sold its
Martin County water and wastewater assets to Martin County for $2.4 million. The
transaction resulted in an after-tax gain of $0.5 million which will be included
in our third quarter 2003 earnings from discontinued operations. The systems
serve 1,300 customers. The proceeds will be used to reduce debt and for general
corporate purposes.
Condemnation proceedings have also been initiated in Marion County for Florida
Water's assets in that county which serve approximately 15,000 customers.
Ref. Page 23. - Table - Contract Status for Minnesota Power Large Power
Customers
Ref. 10-Q for the quarter ended March 31, 2003, Page 21. - Fifth through
Tenth Paragraphs
Due to insufficient taconite pellet orders, Eveleth Mines LLC ceased pellet
production in mid-May 2003 and placed the plant on standby status allowing
production to resume later in 2003 if orders are received.
In May 2003 International Steel Group, Inc. completed the acquisition of
Bethlehem Steel Corp.'s mills and other property, including Bethlehem Steel
Corp.'s 62.3 percent share of Hibbing Taconite Co.
On May 20, 2003 U.S. Steel Corp. (USS) completed the acquisition of
substantially all of National Steel Corporation's assets. The acquisition
included National Steel Pellet Company (National Steel) in Keewatin, Minnesota,
which was renamed USS Keewatin Taconite. USS has agreed in principal to assume
the terms of an amended electric service contract between Minnesota Power and
National Steel. A new large power contract is expected to be executed in August
2003.
With the start-up of Missota Paper at the former Potlatch Corporation-Brainerd
site, the 10 MW large power contract with Potlatch for Brainerd and Grand Rapids
has been re-negotiated. The new contract provides for Grand Rapids to take
service under the large light and power service schedule through December 2008.
In addition, Potlatch will guarantee the demand payments at Missota Paper should
Missota Paper be unable to make the demand payments guaranteed by the previous
contract. In total, Minnesota Power has the same take-or-pay protection through
December 2008 as under the previous contract.
27 ALLETE Second Quarter 2003 Form 10-Q
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
4 Twenty-second Supplemental Indenture, dated as of July 1, 2003,
between ALLETE and The Bank of New York and Douglas J. MacInnes,
as Trustees.
10(a) Credit Agreement, dated as of July 18, 2003, among ALLETE, as
Borrower, Wells Fargo Bank, National Association, as Sole Lead
Arranger and Administrative Agent, Bank One, N.A., as Syndication
Agent, and the Other Financial Institutions Party Thereto.
10(b) Term Loan Agreement (without Exhibits), dated as of June 30, 2003,
among ADESA California, Inc., as Borrower, the Lenders Party
Thereto, and SunTrust Bank, as Administrative Agent.
10(c) Guaranty Agreement, dated as of June 30, 2003, among ADESA and
ALLETE, as Guarantors of ADESA California, Inc., the Borrower, and
SunTrust Bank, the Administrative Agent.
10(d) Borrower Promissory Note, dated April 3, 2000, between Assets
Holdings III, L.P. as Borrower, and Cornerstone Funding
Corporation I, as Issuer.
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.
(b) Reports on Form 8-K.
Report on Form 8-K filed April 25, 2003 with respect to Item 7. Financial
Statements, Pro Forma Financial Information and Exhibits, and Item 9.
Regulation FD Disclosure (Item 12. Results of Operations and Financial
Condition).
Report on Form 8-K filed May 28, 2003 with respect to Item 5. Other Events
and Regulation FD Disclosure.
Report on Form 8-K filed July 24, 2003 with respect to Item 5. Other Events
and Regulation FD Disclosure (Item 12. Results of Operations and Financial
Condition), and Item 7. Financial Statements, Pro Forma Financial
Information and Exhibits.
ALLETE Second Quarter 2003 Form 10-Q 28
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.
August 8, 2003 James K. Vizanko
----------------------------------------
James K. Vizanko
Vice President,
Chief Financial Officer and Treasurer
August 8, 2003 Mark A. Schober
----------------------------------------
Mark A. Schober
Vice President and Controller
29 ALLETE Second Quarter 2003 Form 10-Q
EXHIBIT INDEX
Exhibit
Number
- --------------------------------------------------------------------------------
4 Twenty-second Supplemental Indenture, dated as of July 1, 2003,
between ALLETE and The Bank of New York and Douglas J. MacInnes, as
Trustees.
10(a) Credit Agreement, dated as of July 18, 2003, among ALLETE, as
Borrower, Wells Fargo Bank, National Association, as Sole Lead
Arranger and Administrative Agent, Bank One, N.A., as Syndication
Agent, and the Other Financial Institutions Party Thereto.
10(b) Term Loan Agreement (without Exhibits), dated as of June 30, 2003,
among ADESA California, Inc., as Borrower, the Lenders Party Thereto,
and SunTrust Bank, as Administrative Agent.
10(c) Guaranty Agreement, dated as of June 30, 2003, among ADESA and
ALLETE, as Guarantors of ADESA California, Inc., the Borrower, and
SunTrust Bank, the Administrative Agent.
10(d) Borrower Promissory Note, dated April 3, 2000, between Assets
Holdings III, L.P. as Borrower, and Cornerstone Funding Corporation
I, as Issuer.
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.
ALLETE Second Quarter 2003 Form 10-Q