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 SEPTEMBER 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,
86,930,138 shares outstanding
as of October 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 -
September 30, 2003 and December 31, 2002 4
Consolidated Statement of Income -
Quarter and Nine Months Ended September 30, 2003
and 2002 5
Consolidated Statement of Cash Flows -
Nine Months Ended September 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 18
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 29
Item 4. Controls and Procedures 31
Part II. Other Information
Item 1. Legal Proceedings 31
Item 5. Other Information 31
Item 6. Exhibits and Reports on Form 8-K 33
Signatures 34
1 ALLETE Third 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 Principles 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
in the United States
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 Third 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:
- our ability to successfully implement our strategic objectives, including
the completion and impact of the proposed spin-off of our Automotive
Services business and the sale of our Water Services businesses;
- 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 Third Quarter 2003 Form 10-Q
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLETE
CONSOLIDATED BALANCE SHEET
Millions - Unaudited
SEPTEMBER 30, DECEMBER 31,
2003 2002
- --------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and Cash Equivalents $ 262.9 $ 193.3
Trading Securities - 1.8
Accounts Receivable (Less Allowance of $31.0 and $31.3) 485.3 383.8
Inventories 35.9 36.6
Prepayments and Other 14.8 14.1
Discontinued Operations 85.4 28.8
- --------------------------------------------------------------------------------------------------------------------
Total Current Assets 884.3 658.4
Property, Plant and Equipment - Net 1,486.4 1,364.7
Investments 166.9 170.9
Goodwill 508.1 499.8
Other Intangible Assets 36.2 39.8
Other Assets 74.2 67.5
Discontinued Operations 322.6 346.1
- --------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $3,478.7 $3,147.2
- --------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Current Liabilities
Accounts Payable $ 367.4 $ 202.6
Accrued Taxes, Interest and Dividends 56.9 36.4
Notes Payable 243.2 74.5
Long-Term Debt Due Within One Year 13.3 283.7
Other 90.2 111.3
Discontinued Operations 44.5 29.7
- --------------------------------------------------------------------------------------------------------------------
Total Current Liabilities 815.5 738.2
Long-Term Debt 788.1 696.4
Mandatorily Redeemable Preferred Securities 75.0 75.0
Accumulated Deferred Income Taxes 138.9 139.8
Other Liabilities 161.3 137.6
Discontinued Operations 134.1 127.8
Commitments and Contingencies
- --------------------------------------------------------------------------------------------------------------------
Total Liabilities 2,112.9 1,914.8
- --------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Common Stock Without Par Value, 130.0 Shares Authorized
86.8 and 85.6 Shares Outstanding 844.2 814.9
Unearned ESOP Shares (46.2) (49.0)
Accumulated Other Comprehensive Gain (Loss) 11.8 (22.2)
Retained Earnings 556.0 488.7
- --------------------------------------------------------------------------------------------------------------------
Total Shareholders' Equity 1,365.8 1,232.4
- --------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $3,478.7 $3,147.2
- --------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
ALLETE Third Quarter 2003 Form 10-Q 4
ALLETE
CONSOLIDATED STATEMENT OF INCOME
Millions Except Per Share Amounts - Unaudited
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------------------------
OPERATING REVENUE
Energy Services
Utility $127.0 $129.8 $ 390.8 $ 372.5
Nonregulated/Nonutility 37.0 41.4 110.8 95.7
Automotive Services 226.4 210.1 700.0 635.7
Investments 6.7 7.6 28.3 29.2
- --------------------------------------------------------------------------------------------------------------------
Total Operating Revenue 397.1 388.9 1,229.9 1,133.1
- --------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Fuel and Purchased Power
Utility 52.8 51.6 165.6 152.4
Nonregulated/Nonutility 12.1 14.5 31.6 22.3
Operations
Utility 48.8 44.8 159.1 146.4
Nonregulated/Nonutility 19.8 26.1 72.6 71.2
Automotive and Investments 181.1 173.6 561.1 515.9
Interest 17.2 17.8 50.1 54.1
- --------------------------------------------------------------------------------------------------------------------
Total Operating Expenses 331.8 328.4 1,040.1 962.3
- --------------------------------------------------------------------------------------------------------------------
OPERATING INCOME FROM CONTINUING OPERATIONS 65.3 60.5 189.8 170.8
INCOME TAX EXPENSE 25.9 22.2 75.3 65.6
- --------------------------------------------------------------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS 39.4 38.3 114.5 105.2
INCOME FROM DISCONTINUED OPERATIONS - NET OF TAX 8.2 6.8 21.8 13.9
- --------------------------------------------------------------------------------------------------------------------
NET INCOME $ 47.6 $ 45.1 $ 136.3 $ 119.1
- --------------------------------------------------------------------------------------------------------------------
AVERAGE SHARES OF COMMON STOCK
Basic 83.0 81.5 82.6 80.9
Diluted 83.4 81.9 82.9 81.5
- --------------------------------------------------------------------------------------------------------------------
EARNINGS PER SHARE OF COMMON STOCK
BASIC
Continuing Operations $0.47 $0.47 $1.38 $1.30
Discontinued Operations 0.10 0.08 0.27 0.17
- --------------------------------------------------------------------------------------------------------------------
$0.57 $0.55 $1.65 $1.47
- --------------------------------------------------------------------------------------------------------------------
DILUTED
Continuing Operations $0.47 $0.47 $1.38 $1.29
Discontinued Operations 0.10 0.08 0.26 0.17
- --------------------------------------------------------------------------------------------------------------------
$0.57 $0.55 $1.64 $1.46
- --------------------------------------------------------------------------------------------------------------------
DIVIDENDS PER SHARE OF COMMON STOCK $0.2825 $0.275 $0.8475 $0.825
- --------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
5 ALLETE Third Quarter 2003 Form 10-Q
ALLETE
CONSOLIDATED STATEMENT OF CASH FLOWS
Millions - Unaudited
NINE MONTHS ENDED
SEPTEMBER 30,
2003 2002
- --------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net Income $136.3 $119.1
Depreciation and Amortization 64.2 59.9
Deferred Income Taxes 16.5 15.1
Gain on Sale of Plant (28.2) -
Changes in Operating Assets and Liabilities
Trading Securities 1.8 112.1
Accounts Receivable (99.1) (2.5)
Inventories 1.0 (1.9)
Prepayments and Other (0.7) 8.9
Accounts Payable 160.3 56.8
Other Current Liabilities 12.8 (10.4)
Other Assets 0.5 (13.3)
Other Liabilities 15.5 13.0
- --------------------------------------------------------------------------------------------------------------------
Cash from Operating Activities 280.9 356.8
- --------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Proceeds from Sale of Plant 38.7 -
Proceeds from Sale of Available-For-Sale Securities 6.4 1.9
Additions to Investments (1.9) (20.9)
Additions to Property, Plant and Equipment (154.8) (138.4)
Acquisitions - Net of Cash Acquired (1.8) (17.2)
Other (13.1) (2.6)
- --------------------------------------------------------------------------------------------------------------------
Cash for Investing Activities (126.5) (177.2)
- --------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Issuance of Common Stock 29.3 35.3
Issuance of Long-Term Debt 71.3 14.2
Changes in Notes Payable - Net 171.6 (185.7)
Reductions of Long-Term Debt (280.7) (12.3)
Dividends on Common Stock (69.0) (65.5)
- --------------------------------------------------------------------------------------------------------------------
Cash for Financing Activities (77.5) (214.0)
- --------------------------------------------------------------------------------------------------------------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 30.5 0.4
- --------------------------------------------------------------------------------------------------------------------
CHANGE IN CASH AND CASH EQUIVALENTS 107.4 (34.0)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD <F1> 203.0 234.2
- --------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD <F1> $310.4 $200.2
- --------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL CASH FLOW INFORMATION
Cash Paid During the Period for
Interest - Net of Capitalized $55.1 $57.8
Income Taxes $35.3 $40.2
- --------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Included cash from Discontinued Operations.
</FN>
The accompanying notes are an integral part of these statements.
ALLETE Third 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. In our opinion, all adjustments
necessary for a fair presentation 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 SEPTEMBER 30, 2003
Operating Revenue $397.1 $164.0 $226.4 <F1> $ 6.7
Operation and Other Expense 293.4 120.9 164.8 7.7
Depreciation and Amortization Expense 21.2 12.6 8.6 -
Interest Expense 17.2 5.6 4.0 7.6
- ------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing Operations 65.3 24.9 49.0 (8.6)
Income Tax Expense (Benefit) 25.9 9.6 19.8 (3.5)
- ------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations 39.4 $ 15.3 $ 29.2 $(5.1)
------------------------------------------------
Income from Discontinued Operations - Net of Tax 8.2
- ---------------------------------------------------------------
Net Income $ 47.6
- ---------------------------------------------------------------
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
Operating Revenue $388.9 $171.2 $210.1 <F1> $ 7.6
Operation and Other Expense 290.8 125.0 158.7 7.1
Depreciation and Amortization Expense 19.8 12.0 7.8 -
Interest Expense 17.8 5.3 5.0 7.5
- ------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing Operations 60.5 28.9 38.6 (7.0)
Income Tax Expense (Benefit) 22.2 11.4 14.2 (3.4)
- ------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations 38.3 $ 17.5 $ 24.4 $(3.6)
------------------------------------------------
Income from Discontinued Operations - Net of Tax 6.8
- ---------------------------------------------------------------
Net Income $ 45.1
- ---------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Included $44.1 million of Canadian operating revenue in 2003 ($34.6 million in 2002).
</FN>
7 ALLETE Third Quarter 2003 Form 10-Q
NOTE 1. BUSINESS SEGMENTS (CONTINUED)
Millions
INVESTMENTS
ENERGY AUTOMOTIVE AND CORPORATE
CONSOLIDATED SERVICES SERVICES CHARGES
- ------------------------------------------------------------------------------------------------------------------
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003
Operating Revenue $1,229.9 $501.6 $700.0 <F2> $28.3
Operation and Other Expense 926.0 390.6 512.3 23.1
Depreciation and Amortization Expense 64.0 38.3 25.6 0.1
Interest Expense 50.1 16.9 12.1 21.1
- ------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing
Operations 189.8 55.8 150.0 (16.0)
Income Tax Expense (Benefit) 75.3 21.5 60.0 (6.2)
- ------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations 114.5 $ 34.3 $ 90.0 $(9.8)
------------------------------------------------
Income from Discontinued Operations - Net
of Tax 21.8
- ---------------------------------------------------------------
Net Income $ 136.3
- ---------------------------------------------------------------
Total Assets $3,478.7 <F1> $1,194.0 $1,713.5 <F3> $163.2
Capital Expenditures $109.8 <F1> $53.6 $30.3 -
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002
Operating Revenue $1,133.1 $468.2 $635.7 <F2> $ 29.2
Operation and Other Expense 848.6 356.2 466.3 26.1
Depreciation and Amortization Expense 59.6 36.1 23.4 0.1
Interest Expense 54.1 15.9 16.4 21.8
- ------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing
Operations 170.8 60.0 129.6 (18.8)
Income Tax Expense (Benefit) 65.6 23.7 50.3 (8.4)
- ------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations 105.2 $ 36.3 $ 79.3 $(10.4)
------------------------------------------------
Income from Discontinued Operations - Net
of Tax 13.9
- ---------------------------------------------------------------
Net Income $ 119.1
- ---------------------------------------------------------------
Total Assets $3,238.2 <F1> $1,095.9 $1,579.1 <F3> $193.8
Capital Expenditures $138.4 <F1> $63.6 $39.6 -
- ------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Discontinued Operations represented $408.0 million of total assets in 2003 ($369.4 million in 2002); and
$25.9 million of capital expenditures in 2003 ($35.2 million in 2002).
<F2> Included $131.8 million of Canadian operating revenue in 2003 ($108.3 million in 2002).
<F3> Included $216.2 million of Canadian assets in 2003 ($209.1 million in 2002).
</FN>
ALLETE Third Quarter 2003 Form 10-Q 8
NOTE 2. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
ACCOUNTS RECEIVABLE. AFC sells the majority of U.S. dollar denominated finance
receivables on a revolving basis to a wholly owned, bankruptcy remote, special
purpose subsidiary that is consolidated for accounting purposes. The special
purpose subsidiary has entered into a securitization agreement, which expires in
2005, that allows for the revolving sale to a bank conduit facility of up to a
maximum of $500 million in undivided interests in eligible finance receivables.
At September 30, 2003 AFC managed total finance receivables of $521.9 million
($501.4 million at December 31, 2002), of which $448 million had been sold to
the special purpose subsidiary ($423 million at December 31, 2002). The special
purpose subsidiary then in turn sold, with recourse to the special purpose
subsidiary, $315.3 million to the bank conduit facility at September 30, 2003
($303.8 million at December 31, 2002) leaving $206.6 million of finance
receivables recorded on our consolidated balance sheet at September 30, 2003
($197.6 million at December 31, 2002).
AFC's proceeds from the revolving sale of receivables to the bank conduit
facility were used to repay borrowings from ALLETE and fund new loans to
customers. AFC and the special purpose subsidiary must 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, and we are not
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, we recognize expense for performance
share awards granted and do not recognize expense for employee stock options
granted. The after-tax expense recognized for performance share awards was
approximately $1.8 million for the first nine months of 2003 ($2.7 million for
the first nine months of 2002). The following table illustrates the effect on
net income and earnings per share if we had applied the fair value recognition
provisions of SFAS 123, "Accounting for Stock-Based Compensation."
QUARTER ENDED NINE MONTHS ENDED
EFFECT OF SFAS 123 SEPTEMBER 30, SEPTEMBER 30,
ACCOUNTING FOR STOCK-BASED COMPENSATION 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Millions Except Per Share Amounts
Net Income
As Reported $47.6 $45.1 $136.3 $119.1
Less: Employee Stock Compensation Expense
Determined Under SFAS 123 - Net of Tax 0.3 0.3 0.8 1.0
- -------------------------------------------------------------------------------------------------------------------
Pro Forma Net Income $47.3 $44.8 $135.5 $118.1
- -------------------------------------------------------------------------------------------------------------------
Basic Earnings Per Share
As Reported $0.57 $0.55 $1.65 $1.47
Pro Forma $0.57 $0.55 $1.64 $1.46
Diluted Earnings Per Share
As Reported $0.57 $0.55 $1.64 $1.46
Pro Forma $0.57 $0.55 $1.63 $1.45
- -------------------------------------------------------------------------------------------------------------------
In the table above, the expense for employee stock options granted determined
under SFAS 123 was calculated using the Black-Scholes option pricing model and
the following assumptions:
2003 2002
- --------------------------------------------------------------------------------
Risk-Free Interest Rate 3.1% 4.4%
Expected Life - Years 5 5
Expected Volatility 25.2% 24.2%
Dividend Growth Rate 2% 2%
- --------------------------------------------------------------------------------
9 ALLETE Third Quarter 2003 Form 10-Q
NOTE 2. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SEPTEMBER 30, DECEMBER 31,
PROPERTY, PLANT AND EQUIPMENT 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Millions
Energy Services Utility Plant $1,454.3 $1,433.1
Construction Work in Progress 29.1 13.3
Accumulated Depreciation (694.2) (679.5)
- ------------------------------------------------------------------------------------------------------------------
Energy Services Utility Plant - Net 789.2 766.9
- ------------------------------------------------------------------------------------------------------------------
Energy Services Nonregulated/Nonutility 157.8 153.4
Construction Work in Progress 2.2 4.1
Accumulated Depreciation (41.7) (48.0)
- ------------------------------------------------------------------------------------------------------------------
Energy Services Nonregulated/Nonutility Plant - Net 118.3 109.5
- ------------------------------------------------------------------------------------------------------------------
Automotive Services 642.1 525.2
Construction Work in Progress 32.0 38.5
Accumulated Depreciation (99.2) (79.5)
- ------------------------------------------------------------------------------------------------------------------
Automotive Services Plant - Net 574.9 484.2
- ------------------------------------------------------------------------------------------------------------------
Other Plant - Net 4.0 4.1
- ------------------------------------------------------------------------------------------------------------------
Property, Plant and Equipment - Net $1,486.4 $1,364.7
- ------------------------------------------------------------------------------------------------------------------
Depreciation is computed using the estimated useful lives of the various classes
of plant. The MPUC and the PSCW have approved depreciation rates for our Energy
Services Utility Plant.
ESTIMATED USEFUL LIVES OF PROPERTY, PLANT AND EQUIPMENT
- --------------------------------------------------------------------------------
Energy Services Utility
Generation 5 to 30 years
Transmission 40 to 60 years
Distribution 30 to 70 years
Energy Services Nonregulated/Nonutility 5 to 35 years
Automotive Services
Building and Improvements 10 to 40 years
Other 3 to 10 years
- --------------------------------------------------------------------------------
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 are 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 became effective immediately for variable
interest entities created after January 31, 2003 and will become effective on
December 15, 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 No. 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 established 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
became 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 reclassified our
Mandatorily Redeemable Preferred Securities of ALLETE Capital I as a long-term
liability and reclassified the quarterly distributions as interest expense. This
was a reclassification only and did not impact our results of operations.
ALLETE Third Quarter 2003 Form 10-Q 10
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 6.5
- ------------------------------------------------------------------------------------------------------------------
Carrying Value, September 30, 2003 $508.1
- ------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31,
OTHER INTANGIBLE ASSETS 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Millions
Customer Relationships $29.6 $29.6
Computer Software 27.1 32.6
Other 5.7 6.8
Accumulated Amortization (26.2) (29.2)
- ------------------------------------------------------------------------------------------------------------------
Total $36.2 $39.8
- ------------------------------------------------------------------------------------------------------------------
Other Intangible Assets are amortized using the straight-line method.
Amortization periods are three to forty years for Customer Relationships, three
to seven years for Computer Software and two to ten years for Other.
Amortization expense for Other Intangible Assets is expected to be about $10
million per year until fully amortized.
NOTE 4. 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, which were under threats of condemnation, 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. Selling costs associated with this terminated
transaction were expensed in the first quarter of 2003 and are included in Gain
(Loss) on Disposal in the Summary of Discontinued Operations table on the
following page.
During the first nine months of 2003, Florida Water, primarily through
condemnation proceedings, sold its water and wastewater systems serving the
counties of Nassau (Amelia Island), Bradford, Clay, Martin, Hillsborough and
Marion for an aggregate sales price of $61 million. The after-tax gain
recognized on the sale of these systems, net of related selling, transaction and
accrued employee termination benefit costs, was $3 million for the quarter ($3.4
million for nine months ended September 30, 2003) and was included in our
earnings from Discontinued Operations. (See Gain (Loss) on Disposal in the
Summary of Discontinued Operations table on the following page.)
Florida Water has also entered into a First Amended and Restated Utility System
Asset Acquisition Agreement to sell, under threat of condemnation, an additional
eight water and wastewater systems serving the counties of Osceola, Hernando,
Citrus, Lee and Charlotte, and the communities of Marco Island, Palm Coast and
Deltona to governmental entities in Florida for a total sales price of $356
million. The sales of the Palm Coast and the Hernando County systems closed in
October 2003, and the Marco Island and Deltona systems closed in early November
2003. The sales of the remaining four systems are expected to close by the end
of 2003 pending satisfaction of certain contingencies and regulatory approvals
in Florida.
11 ALLETE Third Quarter 2003 Form 10-Q
NOTE 4. DISCONTINUED OPERATIONS (CONTINUED)
In October 2003 Florida Water sold its water and wastewater system serving Duval
County, Florida, to JEA (formerly Jacksonville Electric Authority) for
approximately $25 million.
Approximately 90 percent of Florida Water's assets have been sold, or are under
contract to be sold, for $442 million, which represents an after-tax gain to
Florida Water, net of all selling and transaction costs, of about $85 million.
To date, the expected net cash proceeds after transaction costs, retirement of
most Florida Water debt, and payment of income taxes are approximately $260
million. Net proceeds from these sales have been and will be used to retire debt
at ALLETE. Florida Water continues to seek buyers for its remaining water and
wastewater facilities, and expects to enter into agreements to sell these
remaining assets in 2003 and to close on these sales in 2004.
On October 21, 2003 the FPSC voted to initiate a proceeding to examine whether
the sale of Florida Water's assets involves a gain that should be shared with
Florida Water's customers. The question raised is whether the entire gain from
the asset sales should go to Florida Water and its shareholders, or should it be
shared with customers. Florida Water intends to vigorously contest any decision
to seek sharing of the gain with customers. Florida Water is unable to predict
the outcome of this proceeding.
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 our North
Carolina business in 2003 and our Georgia business in 2004 and to close both
sales in 2004 due to required regulatory approvals. Our Water Services
businesses in North Carolina and Georgia represented approximately 16 percent of
our total Water Services assets at September 30, 2003 (17 percent at December
31, 2002).
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 September 30, 2003.
SUMMARY OF DISCONTINUED OPERATIONS
- -------------------------------------------------------------------------------------------------------------------
Millions
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
INCOME STATEMENT 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Operating Revenue $28.4 $30.2 $90.5 $105.2
- ------------------------------------------------------------------------------------------------------------------
Pre-Tax Income from Operations $8.6 $11.2 $28.0 $29.4
Income Tax Expense 3.4 4.4 10.9 11.6
- ------------------------------------------------------------------------------------------------------------------
5.2 6.8 17.1 17.8
- ------------------------------------------------------------------------------------------------------------------
Gain (Loss) on Disposal 4.5 <F1> - 7.6 <F1><F2> (5.8)
Income Tax Expense (Benefit) 1.5 - 2.9 (1.9)
- ------------------------------------------------------------------------------------------------------------------
3.0 - 4.7 (3.9)
- ------------------------------------------------------------------------------------------------------------------
Income from Discontinued Operations $8.2 $ 6.8 $21.8 $13.9
- ------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Included $6.7 million of selling, transaction and employee termination benefit costs associated with the sale
of our water businesses for the quarter ($22.6 million for the nine months ended).
<F2> Included a $2.0 million recovery from a settlement related to the 2002 sale of our transport business.
</FN>
SEPTEMBER 30, DECEMBER 31,
BALANCE SHEET INFORMATION 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Assets of Discontinued Operations
Cash and Cash Equivalents $ 47.5 $ 9.7
Other Current Assets 37.9 19.1
Property, Plant and Equipment 296.9 311.5
Other Assets 25.7 34.6
- ------------------------------------------------------------------------------------------------------------------
$408.0 $374.9
- ------------------------------------------------------------------------------------------------------------------
Liabilities of Discontinued Operations
Current Liabilities $ 44.5 $ 29.7
Long-Term Debt 86.4 90.7
Other Liabilities 47.7 37.1
- ------------------------------------------------------------------------------------------------------------------
$178.6 $157.5
- ------------------------------------------------------------------------------------------------------------------
ALLETE Third Quarter 2003 Form 10-Q 12
NOTE 5. 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 2.)
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 $250 million in principal amount of the Company's Floating Rate
First Mortgage Bonds due October 20, 2003 were redeemed with proceeds from a
$250 million credit agreement entered into in July 2003. (See Note 6.)
On November 6, 2003 ALLETE redeemed $50 million in principal amount of the
Company's First Mortgage Bonds, 7 3/4% Series due June 1, 2007. Internally
generated funds and proceeds from the sale of Florida Water assets were used to
repay the principal, premium and accrued interest, totaling approximately $52.1
million, to the bondholders.
ALLETE's long-term debt arrangements contain financial covenants. The most
restrictive covenant requires ALLETE not to exceed a maximum ratio of funded
debt to total capital of .65 to 1.0. Failure to meet this covenant could give
rise to an event of default, if not corrected after notice from the trustee or
security holder; in which event ALLETE may need to pursue alternative sources of
funding. As of September 30, 2003 ALLETE's ratio of funded debt to total capital
was .44 to 1.0 and ALLETE was in compliance with its financial covenants.
Some of ALLETE's long-term debt arrangements contain "cross-default" provisions
that would result in an event of default if there is a failure under other
financing arrangements to meet payment terms or to observe other covenants that
would result in an acceleration of payments due.
NOTE 6. SHORT-TERM BORROWINGS AND COMPENSATING BALANCES
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 credit agreement expires in July 2004, has an interest
rate of 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. In accordance with these
provisions, $6.8 million was repaid in September 2003 and $10.4 million was
repaid in October 2003.
Our lines of credit contain financial covenants applicable to ALLETE. These
covenants require ALLETE (1) not to exceed a maximum ratio of funded debt to
total capital of .60 to 1.0 and (2) to maintain an interest coverage ratio of
not less than 3.00 to 1.00. Failure to meet these covenants could give rise to
an event of default, if not corrected after notice from the lender; in which
event ALLETE may need to pursue alternative sources of funding. As of September
30, 2003 ALLETE's ratio of funded debt to total capital was .44 to 1.0, the
interest coverage ratio was 5.43 to 1.00 and ALLETE was in compliance with these
financial covenants.
ALLETE's $175.0 million lines of credit contain cross-default provisions, under
which an event of default would arise if other ALLETE obligations in excess of
$5.0 million were in default.
At September 30, 2003, $175 million was available for use under ALLETE's lines
of credit.
13 ALLETE Third Quarter 2003 Form 10-Q
NOTE 7. INCOME TAX EXPENSE
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Millions
Current Tax Expense
Federal $14.8 $ 14.1 $ 46.7 $ 41.4
Foreign 4.5 2.5 13.6 9.2
State 4.2 1.7 10.3 5.1
- ------------------------------------------------------------------------------------------------------------------
23.5 18.3 70.6 55.7
- ------------------------------------------------------------------------------------------------------------------
Deferred Tax Expense
Federal 2.9 3.6 5.3 9.8
Foreign - 0.3 - 0.5
State - 0.6 0.5 0.8
- ------------------------------------------------------------------------------------------------------------------
2.9 4.5 5.8 11.1
- ------------------------------------------------------------------------------------------------------------------
Deferred Tax Credits (0.5) (0.6) (1.1) (1.2)
- ------------------------------------------------------------------------------------------------------------------
Income Taxes on Continuing Operations 25.9 22.2 75.3 65.6
Income Taxes on Discontinued Operations 4.9 4.4 13.8 9.7
- ------------------------------------------------------------------------------------------------------------------
Total Income Tax Expense $30.8 $ 26.6 $ 89.1 $ 75.3
- ------------------------------------------------------------------------------------------------------------------
NOTE 8. COMPREHENSIVE INCOME
For the quarter ended September 30, 2003 total comprehensive income was $47.4
million ($32.9 million for the quarter ended September 30, 2002). For the nine
months ended September 30, 2003 total comprehensive income was $170.3 million
($110.9 million for the nine months ended September 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.
SEPTEMBER 30, DECEMBER 31,
ACCUMULATED OTHER COMPREHENSIVE GAIN (LOSS) 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Millions
Unrealized Gain (Loss) on Securities $ 0.5 $ (2.8)
Interest Rate Swap - (0.2)
Foreign Currency Translation Gain (Loss) 14.8 (15.7)
Additional Pension Liability (3.5) (3.5)
- ------------------------------------------------------------------------------------------------------------------
$11.8 $(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 third quarter of 2002 and the quarter and nine months ended
periods in 2003.
RECONCILIATION OF BASIC AND DILUTED
EARNINGS PER SHARE BASIC DILUTIVE DILUTED
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 EPS SECURITIES EPS
- -------------------------------------------------------------------------------------------------
Millions Except Per Share Amounts
Net Income from Continuing Operations $105.2 - $105.2
Common Shares 80.9 0.6 81.5
Per Share from Continuing Operations $1.30 - $1.29
- -------------------------------------------------------------------------------------------------
ALLETE Third Quarter 2003 Form 10-Q 14
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 September 30, 2003 Square Butte had total
debt outstanding of $286.9 million. Total annual debt service for Square Butte
is expected to be approximately $24 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 2.)
We lease other properties and equipment under operating lease agreements with
terms expiring through 2032. The aggregate amount of 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 September 30, 2003 this credit support
backed $3.7 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 $38.5 million at September 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 September 30, 2003 ($7.7 million at December 31, 2002) and
is expected to be invested at various times through 2007.
15 ALLETE Third Quarter 2003 Form 10-Q
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.
The Company reviews environmental matters on a quarterly basis. If it is
probable a liability exists and we are reasonably able to estimate the costs
associated with any environmental matter, an estimated loss would be accrued on
our balance sheet. In the event of an insurable loss, our policy is to record
probable claims for recovery separately on our balance sheet and not as a
reduction of our accrued liability for loss.
SWL&P MANUFACTURED GAS PLANT. In May 2001 SWL&P received notice from the WDNR
that the City of Superior had found soil contamination on property adjoining a
former Manufactured Gas Plant (MGP) site owned and operated by SWL&P'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. Sediment samples were taken from nearby Superior Bay and the City
of Superior storm sewer that discharges into the Superior Bay during March and
April. The report on this sampling is expected to be available in November 2003.
SWL&P continues to work with the WDNR. Further investigative studies will be
performed. We are unable to predict what, or if any, remediation activities will
be required or the extent of our obligation. As a result, the Company has not
accrued any liability for this environmental matter.
MINNESOTA POWER COAL-FIRED GENERATING FACILITIES. 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 have received no
feedback from the EPA based on the information we submitted. There are, however,
several ongoing court cases involving EPA and other electric utilities for
alleged violations of these rules. It is expected that the outcome of some of
the cases could provide the utility industry direction on this topic. We are
unable to predict what actions, if any, may be required as a result of the EPA's
request for information. As a result, the Company has not accrued any liability
for this environmental matter.
SQUARE BUTTE GENERATING FACILITY. In June 2002 Minnkota, 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
should have gone through the New Source Review process potentially resulting in
new air permit operating conditions. Minnkota has held several meetings with the
EPA to discuss the alleged violations. Based on an EPA request, Minnkota is
performing a study related to the technological feasibility of installing
various controls for the reduction of nitrogen oxides (NOx) and sulfur dioxide
(SO2) emissions. Discussions with the EPA are ongoing and we are still unable to
predict the outcome or cost impacts. If Square Butte is required to make
significant capital expenditures to comply with EPA requirements, we expect such
capital expenditures to be debt financed. As such, our future cost of purchased
power would include our pro rata share of this additional debt service.
OTHER. The Company is involved in litigation arising in the normal course of
business. Also in the normal course of business, the Company is involved in tax,
regulatory and other governmental audits, inspections, investigations and other
proceedings that involve state and federal taxes, safety, compliance with
regulations, rate base and cost of service issues, among other things. While the
resolution of such matters could have a material effect on earnings and cash
flows in the year of resolution, none of these matters are expected to change
materially the Company's present liquidity position, nor have a material adverse
effect on the financial condition of the Company.
ALLETE Third Quarter 2003 Form 10-Q 16
NOTE 11. SUBSEQUENT EVENTS
SPIN-OFF OF AUTOMOTIVE SERVICES. In October 2003 our Board of Directors approved
a plan to spin off our Automotive Services business which will become a publicly
traded company to be named ADESA Corporation. The spin-off is expected to take
the form of a tax-free stock dividend to ALLETE's shareholders, who would
receive one ADESA share for each share of ALLETE stock they own.
The Board's decision was made after a lengthy review of strategic alternatives
and reflects ALLETE's intention to create long-term shareholder value. To
prepare for the spin-off and its operation as a stand-alone entity, our
Automotive Services business will immediately begin refinancing its debt.
Our Energy Services and Automotive Services businesses are two very distinct
businesses and we believe that this spin-off will better facilitate the
strategic objectives of both businesses. With its strong cash flow, we believe
that our Automotive Services business will be better positioned to pursue growth
opportunities as a stand-alone company and will appeal to a broader group of
institutional investors. For ALLETE, we believe the spin-off will create a
simplified regulatory and risk profile and a more stable credit rating, which
will enhance its ability to pursue strategic growth initiatives.
Our Automotive Services business, which will become ADESA Corporation, has a
network of 53 wholesale vehicle auctions, 28 total loss vehicle auctions and 82
AFC loan production offices that span the United States and Canada. AFC is the
largest provider of floorplanning for independent auto dealers in North America.
ADESA Impact is our total loss auction business and is the third largest auction
company in North America specializing in the sale of total loss vehicles. Our
Automotive Services business is based in Indianapolis, Indiana, with plans to
move into a new headquarters building in Carmel, Indiana, in spring 2004.
After the spin-off, ALLETE will be comprised of our Energy Services business,
which includes Minnesota Power, SWL&P, BNI Coal, Ltd., Enventis Telecom, Inc.
and Rainy River Energy Corporation, and ALLETE Properties, Inc., our real estate
operations in Florida. ALLETE's headquarters will remain in Duluth, Minnesota.
The Board, in consultation with its financial and legal advisors, is working on
the details that need to be finalized to accomplish the refinancing of the debt
of our Automotive Services business and the spin-off. The spin-off is subject to
the approval of ALLETE's Board of Directors of the final plan, favorable market
conditions, receipt of tax opinions, satisfaction of SEC requirements and other
customary conditions, and is expected to occur in mid-2004. The amount and
timing of future dividends on ALLETE common stock and ADESA Corporation common
stock following the spin-off is subject to the sole discretion of each company's
Board of Directors in light of all relevant facts, including earnings, general
business conditions and working capital requirements.
SPLIT ROCK ENERGY. In response to the changing strategies of both partners, we
have reached a tentative agreement to withdraw from Split Rock Energy in early
2004. We will work closely with Split Rock Energy and Great River Energy on
several transition issues to facilitate our exit from the joint venture. We
expect to retain some of the benefits of this partnership, such as joint load
and capability reporting, as well as emergency power supply backup with Great
River Energy. Subsequent to withdrawal from Split Rock Energy, we will perform
the functions that provide least cost supply to our retail customers and sell
our excess generation. We expect to recognize expenses in 2003 of approximately
$1.5 million after tax related to our withdrawal from Split Rock Energy.
17 ALLETE Third 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 nine months ended September 30, 2003 increased 6
percent and 14 percent, respectively, from the same periods in 2002 and diluted
earnings per share for the quarter and nine months ended September 30, 2003
increased 4 percent and 12 percent, respectively, from the same periods in 2002.
Net income from continuing operations for the quarter and nine months ended
September 30, 2003 increased 3 percent and 9 percent, respectively, from the
same periods in 2002. Diluted earnings per share from continuing operations for
the quarter were the same compared to 2002, and increased 7 percent for the nine
months ended September 30, 2003 over the same period in 2002.
A strong performance by our Automotive Services businesses in 2003 increased
earnings from continuing operations, while gains recognized in 2003 on the sale
of our water and wastewater systems in Florida contributed to increased earnings
from Discontinued Operations.
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Millions Except Per Share Amounts
Operating Revenue
Energy Services $164.0 $171.2 $ 501.6 $ 468.2
Automotive Services 226.4 210.1 700.0 635.7
Investments 6.7 7.6 28.3 29.2
- ------------------------------------------------------------------------------------------------------------------
$397.1 $388.9 $1,229.9 $1,133.1
- ------------------------------------------------------------------------------------------------------------------
Operating Expenses
Energy Services $139.1 $142.3 $ 445.8 $408.2
Automotive Services 177.4 171.5 550.0 506.1
Investments and Corporate Charges 15.3 14.6 44.3 48.0
- ------------------------------------------------------------------------------------------------------------------
$331.8 $328.4 $1,040.1 $962.3
- ------------------------------------------------------------------------------------------------------------------
Net Income
Energy Services $ 15.3 $ 17.5 $ 34.3 $ 36.3
Automotive Services 29.2 24.4 90.0 79.3
Investments and Corporate Charges (5.1) (3.6) (9.8) (10.4)
- ------------------------------------------------------------------------------------------------------------------
Continuing Operations 39.4 38.3 114.5 105.2
Discontinued Operations 8.2 6.8 21.8 13.9
- ------------------------------------------------------------------------------------------------------------------
Net Income $ 47.6 $ 45.1 $ 136.3 $119.1
- ------------------------------------------------------------------------------------------------------------------
Diluted Average Shares of Common Stock - Millions 83.4 81.9 82.9 81.5
- ------------------------------------------------------------------------------------------------------------------
Diluted Earnings Per Share of Common Stock
Continuing Operations $0.47 $0.47 $1.38 $1.29
Discontinued Operations 0.10 0.08 0.26 0.17
- ------------------------------------------------------------------------------------------------------------------
$0.57 $0.55 $1.64 $1.46
- ------------------------------------------------------------------------------------------------------------------
ALLETE Third Quarter 2003 Form 10-Q 18
NON-GAAP MEASURE OF LIQUIDITY. We believe earnings before interest, taxes,
depreciation and amortization expense (EBITDA) provides meaningful additional
information that helps us monitor and evaluate our ongoing results and trends.
EBITDA should not be considered in isolation nor as a substitute for measures of
liquidity prepared in accordance with GAAP which include:
CONSOLIDATED CASH FLOW
NINE MONTHS ENDED SEPTEMBER 30, 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Millions
Cash from Operating Activities $280.9 $356.8
Cash for Investing Activities $(126.5) $(177.2)
Cash for Financing Activities $(77.5) $(214.0)
- ------------------------------------------------------------------------------------------------------------------
We believe EBITDA is a widely accepted measure of liquidity considered by
investors, financial analysts and rating agencies. 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.
INVESTMENTS
ENERGY AUTOMOTIVE AND CORPORATE
EBITDA CONSOLIDATED SERVICES SERVICES CHARGES
- -------------------------------------------------------------------------------------------------------------------
Millions
FOR THE QUARTER ENDED SEPTEMBER 30, 2003
Net Income $ 47.6
Less: Income from Discontinued Operations 8.2
- ------------------------------------------------------------
Income (Loss) from Continuing Operations 39.4 $15.3 $29.2 $(5.1)
Add Back: Income Tax Expense (Benefit) 25.9 9.6 19.8 (3.5)
Interest Expense 17.2 5.6 4.0 7.6
Depreciation and Amortization 21.2 12.6 8.6 -
- -------------------------------------------------------------------------------------------------------------------
EBITDA $103.7 $43.1 $61.6 $(1.0)
- -------------------------------------------------------------------------------------------------------------------
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
Net Income $45.1
Less: Income from Discontinued Operations 6.8
- ------------------------------------------------------------
Income (Loss) from Continuing Operations 38.3 $17.5 $24.4 $(3.6)
Add Back: Income Tax Expense (Benefit) 22.2 11.4 14.2 (3.4)
Interest Expense 17.8 5.3 5.0 7.5
Depreciation and Amortization 19.8 12.0 7.8 -
- -------------------------------------------------------------------------------------------------------------------
EBITDA $98.1 $46.2 $51.4 $ 0.5
- -------------------------------------------------------------------------------------------------------------------
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003
Net Income $136.3
Less: Income from Discontinued Operations 21.8
- ------------------------------------------------------------
Income (Loss) from Continuing Operations 114.5 $ 34.3 $ 90.0 $(9.8)
Add Back: Income Tax Expense (Benefit) 75.3 21.5 60.0 (6.2)
Interest Expense 50.1 16.9 12.1 21.1
Depreciation and Amortization 64.0 38.3 25.6 0.1
- -------------------------------------------------------------------------------------------------------------------
EBITDA $303.9 $111.0 $187.7 $ 5.2
- -------------------------------------------------------------------------------------------------------------------
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002
Net Income $119.1
Less: Income from Discontinued Operations 13.9
- ------------------------------------------------------------
Income (Loss) from Continuing Operations 105.2 $ 36.3 $ 79.3 $(10.4)
Add Back: Income Tax Expense (Benefit) 65.6 23.7 50.3 (8.4)
Interest Expense 54.1 15.9 16.4 21.8
Depreciation and Amortization 59.6 36.1 23.4 0.1
- -------------------------------------------------------------------------------------------------------------------
EBITDA $284.5 $112.0 $169.4 $ 3.1
- -------------------------------------------------------------------------------------------------------------------
19 ALLETE Third Quarter 2003 Form 10-Q
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
STATISTICAL INFORMATION 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------
ENERGY SERVICES
Millions of Kilowatthours Sold
Utility
Retail
Residential 250.2 240.1 787.0 758.7
Commercial 347.5 327.5 963.5 937.1
Industrial 1,535.6 1,745.8 4,909.2 5,150.8
Other 20.5 18.9 59.3 56.5
Resale 736.2 567.6 1,649.4 1,411.3
- -------------------------------------------------------------------------------------------------------------------
2,890.0 2,899.9 8,368.4 8,314.4
Nonregulated 400.4 517.6 1,100.6 827.9
- -------------------------------------------------------------------------------------------------------------------
3,290.4 3,417.5 9,469.0 9,142.3
- -------------------------------------------------------------------------------------------------------------------
AUTOMOTIVE SERVICES
Vehicles Sold
Wholesale 458,000 433,000 1,391,000 1,348,000
Total Loss 45,000 41,000 143,000 131,000
- -------------------------------------------------------------------------------------------------------------------
503,000 474,000 1,534,000 1,479,000
Conversion Rate <F1> - Wholesale Vehicles 61.1% 56.0% 61.5% 60.3%
Vehicles Financed 238,000 237,000 712,000 715,000
- -------------------------------------------------------------------------------------------------------------------
<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 nine months
ended September 30, 2003 to the nine months ended September 30, 2002.
ENERGY SERVICES' net income in 2003 decreased $2.0 million from last year
despite increased sales of nonregulated generation and improved wholesale power
prices. The decrease in net income was primarily because 2002 included a $2.8
million mark-to-market accounting gain on the Kendall County power purchase
agreement and a $2.3 million one-time deferral of costs recoverable through the
utility fuel clause. Net income in 2003 also included higher employee benefit
expenses and increased expenses related to nonregulated generation. Increased
sales of nonregulated generation and higher expenses related to that generation
resulted from facilities being available for a full nine months in 2003.
Nonregulated generation facilities first came online at various times during the
first half of 2002. Accounting rules requiring the mark-to-market gain on the
Kendall County power purchase agreement were rescinded in late 2002, and this
$2.8 million mark-to-market gain was reversed in the fourth quarter of 2002.
AUTOMOTIVE SERVICES reported a $10.7 million, or 13 percent, increase in net
income in 2003. Higher net income in 2003 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 3 percent at our wholesale auction
facilities and 9 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 nine months ended September 30, 2003
AFC contributed 30 percent of the net income for Automotive Services (33 percent
in 2002).
INVESTMENTS AND CORPORATE CHARGES' financial results in 2003 reflected more real
estate sales partially offset by net losses on the sale of shares we held
directly in publicly-traded emerging technology investments. Financial results
for 2002 included net gains on the sale of certain emerging technology
investments and losses related to our trading securities portfolio which was
liquidated during the second half of 2002.
ALLETE Third Quarter 2003 Form 10-Q 20
DISCONTINUED OPERATIONS' net income was up $7.9 million in 2003. Net income from
our Water Services businesses in 2003 reflected the sale of Florida Water's
water and wastewater systems serving the counties of Nassau (Amelia Island),
Bradford, Clay, Martin, Hillsborough and Marion. The after-tax gain recognized
on the sale of these systems, net of related selling, transaction and accrued
employee termination benefits, was $3.4 million. Water consumption was down 11
percent in 2003 due to a 2 percent decrease in customers as a result of system
sales in 2003 and because above normal precipitation decreased consumption in
2003. 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 SEPTEMBER 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 down $7.2 million, or 4 percent, in 2003
reflecting decreases from both utility and nonregulated/nonutility operations.
UTILITY operating revenue was down $2.8 million, or 2 percent, mainly due to
decreased power marketing opportunities at Split Rock Energy. Utility
kilowatthour sales were similar to last year. NONREGULATED/NONUTILITY revenue
decreased $4.4 million, or 11 percent, in 2003 primarily due to less sales
activity at our telecommunications business.
Revenue from electric sales to taconite customers accounted for 8 percent of
consolidated operating revenue in 2003 (10 percent in 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 down $3.2 million, or 2 percent, in 2003. The
decrease was primarily attributable to decreased NONREGULATED/NONUTILITY
operating expenses. UTILITY operating expenses were up $5.1 million, or 5
percent, in 2003 primarily due to higher employee benefit expenses and a $4
million one-time deferral in 2002 of costs recoverable through the utility fuel
clause. The increase in employee benefit expenses was mostly due to pension and
postretirement health benefits, which increased due to lower discount rates and
expected rates of return on plan assets. NONREGULATED/NONUTILITY operating
expenses were down $8.3 million, or 20 percent, from the prior year mainly due
to decreased sales activity at our telecommunications business in 2003 and the
write off of costs associated with a canceled power plant project in Grand
Rapids, Minnesota, in 2002.
AUTOMOTIVE SERVICES
OPERATING REVENUE was up $16.3 million, or 8 percent, in 2003. Revenue from our
wholesale auction facilities was higher in 2003 primarily due to an increase in
vehicle sales and modest fee increases implemented at some of our auction
facilities. At our wholesale auction facilities 6 percent more vehicles were
sold in 2003. Dealer consignment sales improved at our wholesale vehicle
auctions.
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. Same store total
loss vehicle sales were up 4 percent in 2003 reflecting improved industry
volumes and market share increases during the third quarter of 2003.
As a result of the softness of the economy, revenue from AFC was similar to last
year as was the number of vehicles financed.
OPERATING EXPENSES were up $5.9 million, or 3 percent, in 2003 primarily due to
increased vehicle sales. 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.
21 ALLETE Third Quarter 2003 Form 10-Q
INVESTMENTS AND CORPORATE CHARGES
OPERATING REVENUE was down $0.9 million, or 12 percent, in 2003 as fewer real
estate sales were offset by net losses recognized in 2002 as a result of the
liquidation of our trading securities portfolio. In 2003 one large real estate
sale contributed $1.4 million to revenue compared to 2002 when two large real
estate sales contributed $2.5 million to revenue.
OPERATING EXPENSES were up $0.7 million, or 5 percent, in 2003 reflecting
increased corporate charges partially offset by lower expenses related to our
real estate operations because the cost of property sold in 2003 was lower than
in 2002.
Corporate Charges included operating and other expense totaling $4.9 million in
2003 ($2.2 million in 2002) for general corporate expenses such as employee
salaries and benefits, and legal and other outside contract service fees, and
interest expense of $7.6 million in 2003 ($7.5 million in 2002).
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
ENERGY SERVICES
OPERATING REVENUE in total was up $33.4 million, or 7 percent, in 2003
reflecting increases from both utility and nonregulated/nonutility operations.
UTILITY operating revenue was up $18.3 million, or 5 percent, mainly due to
higher fuel clause recoveries and wholesale power prices. Fuel clause recoveries
increased due to higher purchased power costs. 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 $15.1 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 nine 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 9 percent of
consolidated operating revenue in 2003 (10 percent in 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 $37.6 million, or 9 percent, in 2003. The
increase was primarily attributable to increased fuel and purchased power
expenses. UTILITY operating expenses were up $25.8 million, or 8 percent, in
2003 primarily due to increased purchased power and gas expense, as well as
increased employee benefit expenses. Higher purchased power costs resulted from
both increased wholesale prices and quantities purchased. Planned maintenance
outages at Company generating stations necessitated higher quantities of
purchased power this year. Gas expense was higher in 2003 due to increased
prices. Increased employee benefit expenses were mostly due to pension and
post-retirement health benefits, which increased due to lower discount rates and
expected rates of return on plan assets. Operating expenses in 2002 included a
$4 million one-time deferral of costs recoverable through the utility fuel
clause. NONREGULATED/NONUTILITY operating expenses increased $11.8 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 nine months of demand charges related to the Kendall
County power purchase agreement while 2002 included only five 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.
Operating expenses in 2002 included the write off of costs associated with a
canceled power plant project in Grand Rapids, Minnesota.
ALLETE Third Quarter 2003 Form 10-Q 22
AUTOMOTIVE SERVICES
OPERATING REVENUE was up $64.3 million, or 10 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 3 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 9
percent increase in vehicles sold and expansion into new markets, including
combination sites at some of our wholesale auction facilities. Same store total
loss vehicle sales were down 1 percent due to lower industry volumes and market
share decreases.
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 $43.9 million, or 9 percent, in 2003 primarily due to
additional expenses incurred for reconditioning and transportation services
provided as a result of a sales mix shift that has added more commercial
vehicles, 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 was down $0.9 million, or 3 percent, in 2003 as more real
estate sales were offset by less revenue from our emerging technology
investments. In 2003 nine large real estate sales contributed $15.9 million to
revenue compared to 2002 when four large real estate sales contributed $7.4
million to revenue. In 2003 we recognized a $3.5 million net loss 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 $3.7 million, or 8 percent, in 2003 in part due to
lower expenses related to our real estate operations because the cost of
property sold in 2003 was lower than in 2002.
Corporate Charges included operating and other expense totaling $11.0 million in
2003 ($11.4 million in 2002) for general corporate expenses such as employee
salaries and benefits, and legal and other outside contract service fees, and
interest expense of $21.0 million in 2003 ($21.8 million in 2002).
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.
23 ALLETE Third Quarter 2003 Form 10-Q
OUTLOOK
SPIN-OFF OF AUTOMOTIVE SERVICES. In October 2003 our Board of Directors approved
a plan to spin off our Automotive Services business which will become a publicly
traded company to be named ADESA Corporation. The spin-off is expected to take
the form of a tax-free stock dividend to ALLETE's shareholders, who would
receive one ADESA share for each share of ALLETE stock they own.
The Board's decision was made after a lengthy review of strategic alternatives
and reflects ALLETE's intention to create long-term shareholder value. To
prepare for the spin-off and its operation as a stand-alone entity, our
Automotive Services business will immediately begin refinancing its debt.
Our Energy Services and Automotive Services businesses are two very distinct
businesses and we believe that this spin-off will better facilitate the
strategic objectives of both businesses. With its strong cash flow, we believe
that our Automotive Services business will be better positioned to pursue growth
opportunities as a stand-alone company and will appeal to a broader group of
institutional investors. For ALLETE, we believe the spin-off will create a
simplified regulatory and risk profile and a more stable credit rating, which
will enhance its ability to pursue strategic growth initiatives.
Our Automotive Services business, which will become ADESA Corporation, has a
network of 53 wholesale vehicle auctions, 28 total loss vehicle auctions and 82
AFC loan production offices that span the United States and Canada. AFC is the
largest provider of floorplanning for independent auto dealers in North America.
ADESA Impact is our total loss auction business and is the third largest auction
company in North America specializing in the sale of total loss vehicles. Our
Automotive Services business is based in Indianapolis, Indiana, with plans to
move into a new headquarters building in Carmel, Indiana, in spring 2004.
After the spin-off, ALLETE will be comprised of our Energy Services business,
which includes Minnesota Power, SWL&P, BNI Coal, Ltd., Enventis Telecom, Inc.
and Rainy River Energy Corporation, and ALLETE Properties, Inc., our real estate
operations in Florida. ALLETE's headquarters will remain in Duluth, Minnesota.
The Board, in consultation with its financial and legal advisors, is working on
the details that need to be finalized to accomplish the refinancing of the debt
of our Automotive Services business and the spin-off. The spin-off is subject to
the approval of ALLETE's Board of Directors of the final plan, favorable market
conditions, receipt of tax opinions, satisfaction of SEC requirements and other
customary conditions, and is expected to occur in mid-2004. The amount and
timing of future dividends on ALLETE common stock and ADESA Corporation common
stock following the spin-off is subject to the sole discretion of each company's
Board of Directors in light of all relevant facts, including earnings, general
business conditions and working capital requirements.
ENERGY SERVICES. We continue to anticipate 2003 net income from Energy Services
will be similar to 2002. While our power marketing activities benefited from
higher than expected wholesale power prices during the first nine months of
2003, it is uncertain whether higher prices will continue for the remainder of
the year. Global economic conditions also 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, while the number of vehicles financed through AFC is
expected to be similar to 2002. 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 2003 are also contributing to 2003 earnings as are
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). Construction of new wholesale auction facilities to
replace aging facilities in Edmonton and Atlanta is complete. The new facilities
in Edmonton and Atlanta opened in September 2003 and October 2003, respectively.
ALLETE Third Quarter 2003 Form 10-Q 24
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 nine months of 2003, our
total year expectations have not changed.
SALE OF WATER ASSETS. Florida Water has been in the process of selling its
assets as part of an ALLETE strategic initiative to exit its water businesses.
Approximately 90 percent of Florida Water's assets have been sold, or are under
contract to be sold, for $442 million, which represents an after-tax gain to
Florida Water, net of all selling and transaction costs, of about $85 million.
To date, the expected net cash proceeds after transaction costs, retirement of
most Florida Water debt, and payment of income taxes are approximately $260
million. Net proceeds from these sales have been and will be used to retire debt
at ALLETE. Sales currently under contract are expected to close by the end of
2003 pending satisfaction of certain contingencies and regulatory approvals in
Florida. Florida Water continues to seek buyers for its remaining water and
wastewater facilities, and expects to enter into agreements to sell these
remaining assets in 2003 and to close on these sales in 2004.
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 our North
Carolina business in 2003 and our Georgia business in 2004, and to close on both
sales in 2004 due to required regulatory approvals. The proceeds from selling
our Water Services businesses will give us the ability to reduce debt, which
will further strengthen our balance sheet.
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 nine 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 liquidation of the trading securities portfolio and 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 September 30, 2003 our working capital needs included
$243.2 million of notes payable due in 2004. (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 3.9 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
September 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 September 30, 2003.
25 ALLETE Third Quarter 2003 Form 10-Q
AFC RECEIVABLES. AFC sells the majority of U.S. dollar denominated finance
receivables on a revolving basis to a wholly owned, bankruptcy remote, special
purpose subsidiary that is consolidated for accounting purposes. The special
purpose subsidiary has entered into a securitization agreement, which expires in
2005, that allows for the revolving sale to a bank conduit facility of up to a
maximum of $500 million in undivided interests in eligible finance receivables.
At September 30, 2003 AFC managed total finance receivables of $521.9 million
($501.4 million at December 31, 2002), of which $448 million had been sold to
the special purpose subsidiary ($423 million at December 31, 2002). The special
purpose subsidiary then in turn sold, with recourse to the special purpose
subsidiary, $315.3 million to the bank conduit facility at September 30, 2003
($303.8 million at December 31, 2002) leaving $206.6 million of finance
receivables recorded on our consolidated balance sheet at September 30, 2003
($197.6 million at December 31, 2002).
AFC's proceeds from the revolving sale of receivables to the bank conduit
facility were used to repay borrowings from ALLETE and fund new loans to
customers. AFC and the special purpose subsidiary must 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, and we are not
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 September 30, 2003 this credit support
backed $3.7 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.
SALE OF WATER PLANT ASSETS. During the first nine months of 2003, Florida Water,
primarily through condemnation proceedings, sold its water and wastewater
systems serving 29,000 customers in the counties of Nassau (Amelia Island),
Bradford, Clay, Martin, Hillsborough and Marion for an aggregate sales price of
$61 million. The after-tax gain recognized on the sale of these systems, net of
related selling, transaction and accrued employee termination benefit costs, was
$3.4 million for nine months ended September 30, 2003 and was included in our
earnings from Discontinued Operations.
Florida Water has also entered into a First Amended and Restated Utility System
Asset Acquisition Agreement to sell, under threat of condemnation, an additional
eight water and wastewater systems serving 187,000 customers in the counties of
Osceola, Hernando, Citrus, Lee and Charlotte, and the communities of Marco
Island, Palm Coast and Deltona to governmental entities in Florida for a total
sales price of $356 million. The sales of the Palm Coast and the Hernando County
systems closed in October 2003, and the Marco Island and Deltona systems closed
in early November 2003. The sales of the remaining four systems are expected to
close by the end of 2003 pending satisfaction of certain contingencies and
regulatory approvals in Florida.
In October 2003 Florida Water sold its water and wastewater system serving
11,000 customers in Duval County, Florida, to JEA for approximately $25 million.
Approximately 90 percent of Florida Water's assets have been sold, or are under
contract to be sold, for $442 million, which represents an after-tax gain to
Florida Water, net of all selling and transaction costs, of about $85 million.
To date, the expected net cash proceeds after transaction costs, retirement of
most Florida Water debt, and payment of income taxes are approximately $260
million. Net proceeds from these sales have been and will be used to retire debt
at ALLETE. Florida Water continues to seek buyers for its remaining water and
wastewater facilities, and expects to enter into agreements to sell these
remaining assets in 2003 and to close on these sales in 2004.
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
ALLETE Third Quarter 2003 Form 10-Q 26
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 in principal amount of the Company's Floating Rate First
Mortgage Bonds due October 20, 2003. The credit agreement expires in July 2004,
has an interest rate of 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. In
accordance with these provisions, $6.8 million was repaid in September 2003 and
$10.4 million was repaid in October 2003.
On November 6, 2003 ALLETE redeemed $50 million in principal amount of the
Company's First Mortgage Bonds, 7 3/4% Series due June 1, 2007. Internally
generated funds and proceeds from the sale of Florida Water assets were used to
repay the principal, premium and accrued interest, totaling approximately $52.1
million, to the bondholders.
ALLETE's long-term debt arrangements contain financial covenants. The most
restrictive covenant requires ALLETE not to exceed a maximum ratio of funded
debt to total capital of .65 to 1.0. Failure to meet this covenant could give
rise to an event of default, if not corrected after notice from the trustee or
security holder; in which event ALLETE may need to pursue alternative sources of
funding. As of September 30, 2003 ALLETE's ratio of funded debt to total capital
was .44 to 1.0 and ALLETE was in compliance with its financial covenants.
Some of ALLETE's long-term debt arrangements contain "cross-default" provisions
that would result in an event of default if there is a failure under other
financing arrangements to meet payment terms or to observe other covenants that
would result in an acceleration of payments due.
Our lines of credit contain financial covenants applicable to ALLETE. These
covenants require ALLETE (1) not to exceed a maximum ratio of funded debt to
total capital of .60 to 1.0 and (2) to maintain an interest coverage ratio of
not less than 3.00 to 1.00. Failure to meet these covenants could give rise to
an event of default, if not corrected after notice from the lender; in which
event ALLETE may need to pursue alternative sources of funding. As of September
30, 2003 ALLETE's ratio of funded debt to total capital was .44 to 1.0, the
interest coverage ratio was 5.43 to 1.00 and ALLETE was in compliance with these
financial covenants.
ALLETE's $175.0 million lines of credit contain cross-default provisions, under
which an event of default would arise if other ALLETE obligations in excess of
$5.0 million were in default.
CAPITAL REQUIREMENTS
As a result of the delay in selling our Water Services businesses, consolidated
capital expenditures for 2003 are now expected to be $172 million, a $38 million
increase from our original $134 million estimate. Consolidated capital
expenditures for the nine months ended September 30, 2003 totaled $109.8 million
($138.4 million in 2002). Expenditures for the nine months ended September 30,
2003 included $53.6 million for Energy Services and $30.3 million for Automotive
Services. Expenditures for the nine months ended September 30, 2003 also
included $25.9 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
27 ALLETE Third Quarter 2003 Form 10-Q
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.
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.
The Company reviews environmental matters on a quarterly basis. If it is
probable a liability exists and we are reasonably able to estimate the costs
associated with any environmental matter, an estimated loss would be accrued on
our balance sheet. In the event of an insurable loss, our policy is to record
probable claims for recovery separately on our balance sheet and not as a
reduction of our accrued liability for loss.
SWL&P MANUFACTURED GAS PLANT. In May 2001 SWL&P received notice from the WDNR
that the City of Superior had found soil contamination on property adjoining a
former Manufactured Gas Plant (MGP) site owned and operated by SWL&P'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. Sediment samples were taken from nearby Superior Bay and the City
of Superior storm sewer that discharges into the Superior Bay during March and
April. The report on this sampling is expected to be available in November 2003.
SWL&P continues to work with the WDNR. Further investigative studies will be
performed. We are unable to predict what, or if any, remediation activities will
be required or the extent of our obligation. As a result, the Company has not
accrued any liability for this environmental matter.
MINNESOTA POWER COAL-FIRED GENERATING FACILITIES. In May 2002 Minnesota Power
received and subsequently responded to a third request from the EPA, under
Section 114 of the 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 have received no feedback from the EPA based on the information we
submitted. There are, however, several ongoing court cases involving EPA and
other electric utilities for alleged violations of these rules. It is expected
that the outcome of some of the cases could provide the utility industry
direction on this topic. We are unable to predict what actions, if any, may be
required as a result of the EPA's request for information. As a result, the
Company has not accrued any liability for this environmental matter.
SQUARE BUTTE GENERATING FACILITY. In June 2002 Minnkota, 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
should have gone through the New Source Review process potentially resulting in
new air permit operating conditions. Minnkota has held several meetings with the
EPA to discuss the alleged violations. Based on an EPA request, Minnkota is
performing a study related to the technological feasibility of installing
various controls for the reduction of nitrogen oxides (NOx) and sulfur dioxide
(SO2) emissions. Discussions with the EPA are ongoing and we are still unable to
predict the outcome or cost impacts. If Square Butte is required to make
significant capital expenditures to comply with EPA requirements, we expect such
capital expenditures to be debt financed. As such, our future cost of purchased
power would include our pro rata share of this additional debt service.
ALLETE Third Quarter 2003 Form 10-Q 28
OTHER
The Company is involved in litigation arising in the normal course of business.
Also in the normal course of business, the Company is involved in tax,
regulatory and other governmental audits, inspections, investigations and other
proceedings that involve state and federal taxes, safety, compliance with
regulations, rate base and cost of service issues, among other things. While the
resolution of such matters could have a material effect on earnings and cash
flows in the year of resolution, none of these matters are expected to change
materially the Company's present liquidity position, nor have a material adverse
effect on the financial condition of the Company.
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 are 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 became effective immediately for variable interest
entities created after January 31, 2003 and will become effective on December
15, 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 No. 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 established 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
became 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 reclassified our
Mandatorily Redeemable Preferred Securities of ALLETE Capital I as a long-term
liability and reclassified the quarterly distributions as interest expense. This
was a reclassification only and did 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.
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
September 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
September 30, 2003 ($20.9 million at December 31, 2002) and a total unrealized
after-tax gain of $0.5 million at September 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. These publicly-traded emerging
technology investments were accounted for as available-for-sale securities prior
to sale.
29 ALLETE Third Quarter 2003 Form 10-Q
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 $38.5 million at September 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.
We account for our 50 percent ownership in Split Rock Energy under the equity
method of accounting. For the nine months ended September 30, 2003 our share of
Split Rock Energy's net income after tax was $2.9 million ($2.2 million for the
nine months ended September 30, 2002).
In response to the changing strategies of both partners, we have reached a
tentative agreement to withdraw from Split Rock Energy in early 2004. We will
work closely with Split Rock Energy and Great River Energy on several transition
issues to facilitate our exit from the joint venture. We expect to retain some
of the benefits of this partnership, such as joint load and capability
reporting, as well as emergency power supply backup with Great River Energy.
Subsequent to withdrawal from Split Rock Energy, we will perform the functions
that provide least cost supply to our retail customers and sell our excess
generation. We expect to recognize expenses in 2003 of approximately $1.5
million after tax related to our withdrawal from Split Rock Energy.
ALLETE Third Quarter 2003 Form 10-Q 30
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 change in our internal
control over financial reporting that occurred during our most recent fiscal
quarter that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
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 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. Form 10-Q for the quarter ended March 31, 2003, Page 21. - Third Paragraph
Ref. Form 8-K dated and filed July 24, 2003
Ref. Form 8-K dated and filed August 20, 2003
Ref. Form 8-K dated and filed August 27, 2003
Ref. Form 8-K dated and filed September 4, 2003
Ref. Form 8-K dated and filed September 15, 2003
Ref. Form 8-K dated and filed October 15, 2003
Ref. Form 8-K dated and filed October 30, 2003
Ref. Form 8-K dated and filed October 31, 2003
Ref. Form 8-K dated and filed November 6, 2003
On October 6, 2003 the City of Groveland filed its Petition in Eminent Domain
and Notice of Lis Pendens to condemn two Florida Water facilities in Lake
County, Sunshine Parkway and Palisades. On November 5, 2003 the Fifth Circuit
Court in Lake County entered a Stipulated Order of Taking and Incorporated Final
Judgment in the amount of $3.1 million, including $50,000 for attorney's fees.
The City took over operation of the facilities on the same day.
On October 21, 2003 the FPSC voted to initiate a proceeding to examine whether
the sale of Florida Water's assets involves a gain that should be shared with
Florida Water's customers. The question raised is whether the entire gain from
the asset sales should go to Florida Water and its shareholders, or should it be
shared with customers. Florida Water intends to vigorously contest any decision
to seek sharing of the gain with customers. Florida Water is unable to predict
the outcome of this proceeding.
31 ALLETE Third Quarter 2003 Form 10-Q
Ref. Page 20. - Eighth Full Paragraph
Ref. Page 24. - Sixth Paragraph
In response to the changing strategies of both partners, we have reached a
tentative agreement to withdraw from Split Rock Energy in early 2004. We will
work closely with Split Rock Energy and Great River Energy on several transition
issues to facilitate our exit from the joint venture. We expect to retain some
of the benefits of this partnership, such as joint load and capability
reporting, as well as emergency power supply backup with Great River Energy.
Subsequent to withdrawal from Split Rock Energy, we will perform the functions
that provide least cost supply to our retail customers and sell our excess
generation. We expect to recognize expenses in 2003 of approximately $1.5
million after tax related to our withdrawal from Split Rock Energy.
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
Ref. 10-Q for the quarter ended June 30, 2003, Page 27. - Fifth
through Eighth 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. On October 8, 2003
Cleveland Cliffs Inc. and Laiwu Steel Group Inc. of China jointly announced an
intent to acquire the assets of Eveleth Mines LLC. The decision to proceed will
be made when due diligence procedures are completed and after agreements can be
reached with key stakeholders of Eveleth Mines LLC.
In August 2003 U. S. Steel Corp. (USS) signed an amended electric service
contract with Minnesota Power for the Keewatin Taconite facility. The new
contract termination date is now four years from the date of notice of
cancellation.
In August 2003 the MPUC approved new electric service contracts with Blandin
Paper Company and Potlatch Corporation.
Ref. Page 24. - Second Paragraph
In August 2003 Minnesota Power agreed to sell Great River Energy 175 MW of firm
power under a five-year power purchase agreement. The agreement begins May 1,
2005.
Ref. Page 24. - Ninth Paragraph
On October 17, 2003 Rainy River Energy Corporation - Wisconsin, a wholly owned
subsidiary of the Company, filed with the PSCW a petition to amend the final
order approving the construction of a natural gas-fired electric generating
facility in Superior, Wisconsin. The Company requested a one year extension to
the approval to allow building to begin by December 9, 2004. While the
construction schedule was suspended in December 2002, we continue to study the
feasibility of the project. We have requested additional time to commence
construction under the issued permits.
Ref. Page 28. - Fourth Paragraph
On October 27, 2003 ADESA Atlanta held its first vehicle auction at the newly
constructed facility located on 280 acres in Fairburn, Georgia. The facility has
eight auction lanes, a state-of-the-art technology center, body, paint and
reconditioning shop, and storage for over 6,500 vehicles.
In early September 2003 ADESA Edmonton moved to their new site in Nisku,
Alberta, and held their first auction on September 9, 2003. Impact Auto
Auctions, Ltd. also relocated to this site in September 2003.
ALLETE Third Quarter 2003 Form 10-Q 32
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
10 Minnesota Power (now ALLETE) Executive Annual Incentive Plan as
amended, effective January 1, 1999 with amendments through January
2003.
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 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.
Report on Form 8-K filed August 20, 2003 with respect to Item 5. Other
Events and Regulation FD Disclosure.
Report on Form 8-K filed August 27, 2003 with respect to Item 5. Other
Events and Regulation FD Disclosure and Item 7. Financial Statements and
Exhibits.
Report on Form 8-K filed September 4, 2003 with respect to Item 5. Other
Events and Regulation FD Disclosure.
Report on Form 8-K filed September 15, 2003 with respect to Item 5. Other
Events and Regulation FD Disclosure.
Report on Form 8-K filed October 15, 2003 with respect to Item 5. Other
Events and Regulation FD Disclosure.
Report on Form 8-K filed October 24, 2003 with respect to Item 5. Other
Events and Regulation FD Disclosure and Item 7. Financial Statements and
Exhibits.
Report on Form 8-K filed October 30, 2003 with respect to Item 5. Other
Events and Regulation FD Disclosure.
Report on Form 8-K filed October 31, 2003 with respect to Item 5. Other
Events and Regulation FD Disclosure.
Report on Form 8-K filed November 6, 2003 with respect to Item 5. Other
Events and Regulation FD Disclosure.
33 ALLETE Third Quarter 2003 Form 10-Q
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.
November 12, 2003 James K. Vizanko
----------------------------------------------
James K. Vizanko
Vice President,
Chief Financial Officer and Treasurer
November 12, 2003 Mark A. Schober
----------------------------------------------
Mark A. Schober
Vice President and Controller
ALLETE Third Quarter 2003 Form 10-Q 34
EXHIBIT INDEX
Exhibit
Number
- --------------------------------------------------------------------------------
10 Minnesota Power (now ALLETE) Executive Annual Incentive Plan as amended,
effective January 1, 1999 with amendments through January 2003.
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 Third Quarter 2003 Form 10-Q