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ALLETE FORM 10-K 2003
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FORM 10-K
United States
Securities and Exchange Commission
Washington, D.C. 20549
(Mark One)
/X/ Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the fiscal year ended DECEMBER 31, 2003
/ / Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
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Commission File No. 1-3548
ALLETE, INC.
(Exact name of registrant as specified in its charter)
MINNESOTA 41-0418150
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
30 WEST SUPERIOR STREET, DULUTH, MINNESOTA 55802-2093
(Address of principal executive offices including zip code)
(218) 279-5000
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of Each Stock Exchange
Title of Each Class on Which Registered
------------------- -------------------
Common Stock, without par value New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes /X/ No / /
The aggregate market value of voting stock held by nonaffiliates on June 30,
2003 was $2,281,896,734.
As of March 8, 2004 there were 87,880,279 shares of ALLETE Common Stock,
without par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2004 Annual Meeting of Shareholders
are incorporated by reference in Part III.
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PAGE 7
ALLETE FORM 10-K 2003
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TABLE OF CONTENTS
DEFINITIONS....................................................................9
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT
OF 1995.......................................................................10
PART I
Item 1. Business.............................................................11
Energy Services......................................................12
Regulated Utility Electric Sales....................................12
Regulated Utility Purchased Power...................................15
Fuel................................................................15
Nonregulated Generation and Power Marketing.........................16
Regulatory Issues...................................................16
Competition.........................................................18
Franchises..........................................................18
Employees...........................................................18
Environmental Matters...............................................18
Automotive Services..................................................20
Wholesale Vehicle Auctions..........................................20
Dealer Financing....................................................23
Competition.........................................................25
Employees...........................................................25
Vehicle Regulation..................................................25
Environmental Matters...............................................26
Investments and Corporate Charges....................................27
Real Estate Operations..............................................27
Emerging Technology Investments.....................................27
Environmental Matters...............................................27
Executive Officers of the Registrant.................................28
Item 2. Properties...........................................................29
Item 3. Legal Proceedings....................................................29
Item 4. Submission of Matters to a Vote of Security Holders..................29
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities....................29
Item 6. Selected Financial Data..............................................30
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................32
Consolidated Overview...............................................32
Net Income..........................................................33
2003 Compared to 2002...............................................35
2002 Compared to 2001...............................................36
Critical Accounting Policies........................................36
Outlook.............................................................37
Liquidity and Capital Resources.....................................41
Capital Requirements................................................43
Environmental and Other Matters.....................................44
Market Risk.........................................................45
New Accounting Standards............................................46
Factors that May Affect Future Results..............................46
Item 7A. Quantitative and Qualitative Disclosures about Market Risk...........53
Item 8. Financial Statements and Supplementary Data..........................53
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure..................................53
Item 9A. Controls and Procedures..............................................53
PART III
Item 10. Directors and Executive Officers of the Registrant...................54
Item 11. Executive Compensation...............................................54
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters...........................54
Item 13. Certain Relationships and Related Transactions.......................54
Item 14. Principal Accountant Fees and Services...............................54
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K......55
SIGNATURES....................................................................59
CONSOLIDATED FINANCIAL STATEMENTS.............................................60
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ALLETE FORM 10-K 2003
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DEFINITIONS
ABBREVIATION
OR ACRONYM TERM
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ACE ACE Limited
ADESA Impact Automotive Recovery Services, Inc. and
Impact Auto, collectively
AFC Automotive Finance Corporation
ALLETE ALLETE, Inc. and its subsidiaries
APB Accounting Principles Board
BNI Coal BNI Coal, Ltd.
Boswell Boswell Energy Center
Capital Re Capital Re Corporation
CIP Conservation Improvement Program(s)
Company ALLETE, Inc. and its subsidiaries
EBITDA Earnings Before Interest, Taxes,
Depreciation and Amortization Expense
EITF Emerging Issues Task Force
Enventis Telecom Enventis Telecom, Inc.
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
Form 8-K ALLETE Current Report on Form 8-K
Form 10-K ALLETE Annual Report on Form 10-K
Form 10-Q ALLETE Quarterly Report on Form 10-Q
FPSC Florida Public Service Commission
GAAP Generally Accepted Accounting Principles
in the United States
GeoInsight GeoInsight, Inc.
Hibbard M.L. Hibbard Station
Impact Auto Impact Auto Auctions Ltd. and
Suburban Auto Parts Inc., collectively
Invest Direct ALLETE's Direct Stock Purchase and
Dividend Reinvestment Plan
kWh Kilowatthour(s)
kV Kilovolt(s)
Laskin Laskin Energy Center
Lehigh Lehigh Acquisition Corporation
LIBOR London Interbank Offer Rate
LTV LTV Steel Mining Co.
MAPP Mid-Continent Area Power Pool
MBtu Million British thermal units
Minnesota Power An operating division of ALLETE, Inc.
Minnkota Power Minnkota Power Cooperative, Inc.
MISO Midwest Independent Transmission System
Operator, Inc.
MPCA Minnesota Pollution Control Agency
MPUC Minnesota Public Utilities Commission
MTBE Methyl Tertiary-Butyl Ether
MW Megawatt(s)
MWh Megawatthour(s)
NCUC North Carolina Utilities Commission
Note ___ Note ___ to the consolidated financial
statements indexed in Item 15(a) of this
Form 10-K
NPDES National Pollutant Discharge Elimination
System
NRG Energy NRG Energy, Inc.
PSCW Public Service Commission of Wisconsin
QUIPS Quarterly Income Preferred Securities
Rainy River Energy Rainy River Energy Corporation
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
Taconite Harbor Taconite Harbor Energy Center
WDNR Wisconsin Department of Natural Resources
WPPI Wisconsin Public Power, Inc.
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ALLETE FORM 10-K 2003
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SAFE HARBOR STATEMENT UNDER THE
PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995
In connection with the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, we are hereby filing cautionary statements
identifying important factors that could cause our actual results to differ
materially from those projected in forward-looking statements (as such term is
defined in the Private Securities Litigation Reform Act of 1995) made by or on
behalf of ALLETE in this Annual Report on Form 10-K, 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 our control 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, Canadian federal government, state and
provincial 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 vehicle-related laws, including
vehicle brokerage and auction laws;
- unanticipated effects of restructuring initiatives in the electric
and automotive industries;
- 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 competition for retail and wholesale
customers, as well as sellers and buyers 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.
Additional disclosures regarding factors that could cause our results and
performance to differ from results or performance anticipated by this report are
discussed in Item 7. under the heading "Factors that May Affect Future Results"
located on page 46 of this Form 10-K. Any forward-looking statement speaks only
as of the date on which such statement is made, and we undertake no obligation
to update any forward-looking statement to reflect events or circumstances after
the date on which that statement is made or to reflect the occurrence of
unanticipated events. New factors emerge from time to time and it is not
possible for management to predict all of these factors, nor can it assess the
impact of each of these factors on the businesses of ALLETE or the extent to
which any factor, or combination of factors, may cause actual results to differ
materially from those contained in any forward-looking statement. Readers are
urged to carefully review and consider the various disclosures made by us in
this Form 10-K and in our other reports filed with the SEC that attempt to
advise interested parties of the factors that may affect our business.
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PAGE 10
ALLETE FORM 10-K 2003
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PART I
ITEM 1. BUSINESS
ALLETE has been incorporated under the laws of Minnesota since 1906.
References in this report to "we," "us" and "our" are to ALLETE and its
subsidiaries, collectively.
ALLETE files annual, quarterly and other reports and information with the
SEC. You can read and copy any information filed by ALLETE with the SEC at the
SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549.
You can obtain additional information about the Public Reference Room by calling
the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site
(www.sec.gov) that contains reports, proxy and information statements, and other
information regarding issuers that file electronically with the SEC, including
ALLETE. ALLETE also maintains an Internet site (www.allete.com) that contains
documents as soon as reasonably practicable after such material is
electronically filed with or furnished to the SEC.
As of December 31, 2003 we had approximately 13,000 employees, 4,000 of which
were part time. Our core operations in 42 states, nine Canadian provinces and
Mexico focus on two segments: ENERGY SERVICES which includes electric and gas
services, coal mining and telecommunications; and AUTOMOTIVE SERVICES which
includes wholesale vehicle auctions and related vehicle redistribution services
and dealer financing.
INVESTMENTS AND CORPORATE CHARGES include our 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.
For a detailed discussion of results of operations and trends, see Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations. For business segment information, see Notes 1 and 2.
SPIN-OFF OF AUTOMOTIVE SERVICES. After a lengthy review of our strategic
alternatives, in October 2003 we announced plans to spin off to ALLETE
shareholders our Automotive Services business which would become a publicly
traded company doing business as ADESA. The decision reflects our intention to
maximize the long-term value of each business by creating two separate, more
focused companies, and create long-term shareholder value. 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.
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. We believe that our Automotive Services
business will be better able to pursue a business growth strategy as an
independent company. For ALLETE, we believe the spin-off will create a
simplified regulatory and risk profile and a more stable credit rating, which
will enhance our ability to pursue strategic growth initiatives.
YEAR ENDED DECEMBER 31 2003 2002 2001
==========================================================================
Consolidated Operating
Revenue - Millions $1,619 $1,494 $1,526
Percentage of Consolidated
Operating Revenue
Energy Services
Regulated Utility
Industrial
Taconite Producers 9% 10% 10%
Paper and Wood Products 4 4 4
Pipelines and Other Industries 2 3 3
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Total Industrial 15 17 17
Residential 5 5 4
Commercial 5 5 5
Wholesale 5 5 6
Other Revenue 2 2 3
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Total Regulated Utility 32 34 35
Nonregulated 9 8 5
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Total Energy Services 41 42 40
Automotive Services 57 56 55
Investments 2 2 5
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100% 100% 100%
==========================================================================
Our Automotive Services business, which will do business as ADESA after the
spin-off, operates two main businesses that are integral parts of the vehicle
redistribution industry in North America. Wholesale vehicle auctions include 53
used vehicle auctions, 27 salvage vehicle auctions and related services, while
dealer financing consists of AFC's 80 loan production offices. Our Automotive
Services business will remain based in Indiana.
After the spin-off, ALLETE will be comprised of our Energy Services business,
which includes Minnesota Power, SWL&P, BNI Coal, Enventis Telecom and Rainy
River Energy, ALLETE Properties, Inc., our real estate operations in Florida,
and our emerging technology investments. ALLETE's headquarters will remain in
Duluth, Minnesota.
Our Board of Directors has retained financial and legal advisors to work with
management on the refinancing of ALLETE's and Automotive Services' debt which
will precede the spin-off. The spin-off is subject to the approval of the final
plan by ALLETE's Board of Directors, favorable market conditions, receipt of tax
opinions, satisfaction of SEC requirements and other customary conditions, and
is expected to occur in the third quarter of 2004.
SALE OF WATER PLANT ASSETS. During 2003 we substantially completed the sale
of our Water Services businesses. Approximately 90% of our water assets in
Florida were sold, under condemnation or imminent threat of condemnation, during
2003 for a total sales price of approximately $445 million. Proceeds were used
to pay down debt which strengthened our balance sheet. In addition, we reached
an agreement to sell our North Carolina water assets for
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ALLETE FORM 10-K 2003
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PART I
$48 million and the assumption of approximately $28 million in debt by the
purchaser. The North Carolina sale is awaiting approval of the NCUC and is
expected to close in mid-2004. We expect to enter into agreements to sell our
remaining water assets in Florida and Georgia in 2004.
In October 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. In November 2003 the FPSC issued a final order regarding
a similar gain on sale issue for Utilities, Inc. of Florida. In that order the
FPSC made several findings that could be helpful to Florida Water's case, namely
that courts have found that rates paid by customers do not vest ratepayers with
ownership rights to the property used to render service, and shareholders bear
the risk of gain or loss associated with investments made to provide service.
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.
ENERGY SERVICES
We categorize our Energy Services businesses as regulated utility operations
or nonregulated operations. Regulated utility operations include rate regulated
activities associated with generation, transmission and distribution of
electricity under the jurisdiction of state and federal regulatory authorities.
Nonregulated operations consist of coal mining, nonregulated generation
(non-rate base generation sold at market-based rates to the wholesale market)
and telecommunications. The discussion below summarizes the major businesses we
include in Energy Services. Statistical information is presented as of December
31, 2003 unless otherwise indicated. All subsidiaries are wholly owned unless
otherwise specifically indicated.
MINNESOTA POWER, an operating division of ALLETE, Inc., provides regulated
utility electric service in a 26,000 square mile service territory in
northeastern Minnesota. Minnesota Power supplies regulated utility electric
service to 135,000 retail customers and wholesale electric service to 16
municipalities. In addition, Minnesota Power has nonregulated generation
operations at the Taconite Harbor facility in northern Minnesota. SWL&P provides
regulated utility electric, natural gas and water service in northwestern
Wisconsin. SWL&P has 14,000 electric customers, 12,000 natural gas customers and
10,000 water customers.
Minnesota Power had an annual net peak load of 1,463 MW on January 13, 2003.
Our power supply sources are listed on the following page.
We have electric transmission and distribution lines of 500 kV (8 miles), 230
kV (606 miles), 161 kV (43 miles), 138 kV (66 miles), 115 kV (1,259 miles) and
less than 115 kV (6,935 miles). We own and operate 179 substations with a total
capacity of 8,562 megavoltamperes. Some of our transmission and distribution
lines interconnect with other utilities.
We own offices and service buildings, an energy control center and repair
shops, and lease offices and storerooms in various localities. Substantially all
of our electric plant is subject to mortgages which collateralize the
outstanding first mortgage bonds of Minnesota Power and of SWL&P. Generally, we
hold fee interest in our real properties subject only to the lien of the
mortgages. Most of our electric lines are located on land not owned in fee, but
are covered by appropriate easement rights or by necessary permits from
governmental authorities. WPPI owns 20% of Boswell Unit 4. WPPI has the right to
use our transmission line facilities to transport its share of Boswell
generation. (See Note 14.)
As of February 2004 Minnesota Power withdrew from active participation in
Split Rock Energy, a joint venture with Great River Energy, and will terminate
its ownership interest upon receipt of FERC approval which is expected in the
first half of 2004. (See Nonregulated Generation and Power Marketing.)
BNI COAL owns and operates a lignite mine in North Dakota. BNI Coal is the
lowest-cost supplier of lignite in North Dakota producing about 4 million tons
annually. Two electric generating cooperatives, Minnkota Power and Square Butte,
presently consume virtually all of BNI Coal's production of lignite under
cost-plus fixed fee coal supply agreements expiring in 2027. (See Fuel and Note
15.)
ENVENTIS TELECOM is an integrated data services provider offering fiber
optic-based communication and advanced data services to businesses and
communities in the Upper Midwest. Enventis Telecom provides converged IP (or
Internet protocol) services that allow all communications (voice, video and
data) to use the same optic-based delivery technology. Enventis Telecom owns or
has rights to approximately 1,600 route miles of fiber optic cable. These route
miles contain multiple fibers that total approximately 47,000 fiber miles.
Enventis Telecom also owns optronic and data switching equipment that is used to
"light up" the fiber optic cable. Enventis Telecom services customers from
facilities that are primarily leased from third parties.
RAINY RIVER ENERGY is engaged in the acquisition and development of
nonregulated generation and wholesale power marketing. Rainy River Energy has
entered into a 15-year power purchase agreement with NRG Energy at a facility in
Kendall County, Illinois. (See Nonregulated Generation and Power Marketing -
Kendall County.)
REGULATED UTILITY ELECTRIC SALES
Our regulated utility operations include retail and wholesale activities
under the jurisdiction of state and federal regulatory authorities. (See
Regulatory Issues.)
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ALLETE FORM 10-K 2003
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PART I
POWER SUPPLY
=======================================================================================================================
FOR THE YEAR ENDED
UNIT YEAR NET WINTER DECEMBER 31, 2003
REGULATED UTILITY NO. INSTALLED CAPABILITY ELECTRIC REQUIREMENTS
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MW MWh %
Steam
Coal-Fired
Boswell Energy Center 1 1958 69
near Grand Rapids, MN 2 1960 69
3 1973 349
4 1980 427
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914 6,445,652 55.0%
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Laskin Energy Center 1 1953 55
in Hoyt Lakes, MN 2 1953 55
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110 643,340 5.5
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Purchased Steam
M.L. Hibbard Station in Duluth, MN 3 & 4 1949, 1951 48 - -
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Total Steam 1,072 7,088,992 60.5
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Hydro
Group consisting of ten stations in MN Various 115 409,521 3.5
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Purchased Power
Square Butte burns lignite coal near Center, ND 322 2,288,921 19.5
All Other - Net - 1,938,958 16.5
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Total Purchased Power 322 4,227,879 36.0
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Total 1,509 11,726,392 100.0%
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UNIT YEAR YEAR NET
NONREGULATED NO. INSTALLED ACQUIRED CAPABILITY
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MW
Steam
Coal-Fired
Taconite Harbor Energy Center 1, 2 & 3 1957, 1957, 1967 2001 200
in Taconite Harbor, MN
Cloquet Energy Center 5 2001 2001 23
in Cloquet, MN
Rapids Energy Center <F1> 6 & 7 1980 2000 29
in Grand Rapids, MN
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Hydro
Conventional Run-of-River
Rapids Energy Center <F1> 4 & 5 1917 2000 1
in Grand Rapids, MN
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Power Purchase Agreement
Kendall County (Rainy River Energy) 3 2002 2002 275
located southwest of Chicago, IL
=======================================================================================================================
<FN>
<F1> The net generation is primarily dedicated to the needs of one customer.
</FN>
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ALLETE FORM 10-K 2003
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PART I
REGULATED UTILITY ELECTRIC SALES
FOR THE YEAR ENDED DECEMBER 31 2003 2002 2001
===============================================================
MILLIONS OF KILLOWATTHOURS
Retail
Residential 1,066 1,044 998
Commercial 1,286 1,257 1,234
Industrial 6,558 6,946 6,549
Other 79 78 75
Wholesale
Municipals and Others 2,155 1,807 2,086
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11,144 11,132 10,942
===============================================================
Minnesota Power has wholesale contracts with 16 municipal customers. (See
Regulatory Issues - Federal Energy Regulatory Commission.)
Approximately 60% of the ore consumed by integrated steel facilities in the
United States originates from six taconite customers of Minnesota Power.
Taconite, an iron-bearing rock of relatively low iron content that is abundantly
available in Minnesota, is an important domestic source of raw material for the
steel industry. Taconite processing plants use large quantities of electric
power to grind the ore-bearing rock, and agglomerate and pelletize the iron
particles into taconite pellets. Annual taconite production in Minnesota was 34
million tons in 2003 (39 million tons in 2002; 33 million tons in 2001). The
decrease in 2003 taconite production was due to the May 2003 shutdown of the
Eveleth Mines LLC operations that then reopened in December 2003 as United
Taconite LLC under new ownership that includes Cleveland-Cliffs Inc. and Laiwu
Steel Group, a Chinese-based steel producer. A rise in Chinese steel demand and
production has created a new market for the producers of taconite in North
America. United Taconite has the ability to produce 5 million to 6 million tons
of taconite annually with a portion of that production replacing taconite
pellets that will be shipped to China from other Cleveland-Cliffs Inc. owned
taconite operations. The decrease in 2001 taconite production was due to the
closing of LTV and the reduced demand for iron ore from the operating mines as a
result of high steel import levels and a softer economy. LTV, which was not a
Large Power Customer (defined below), formerly produced 7 million to 8 million
tons of taconite annually. Based on our research of the taconite industry,
Minnesota taconite production for 2004 is anticipated to be about 39 million
tons. As a result of continuing consolidation in the integrated steel business
and its resulting impact on taconite producers, Minnesota Power is unable to
predict taconite production levels for the next two to five years. We expect any
excess energy not used by our retail customers will be marketed primarily to the
regional wholesale market.
LARGE POWER CUSTOMER CONTRACTS. Minnesota Power has large power customer
contracts with 12 customers (Large Power Customers), each of which requires 10
MW or more of generating capacity. Large Power Customer contracts require
Minnesota Power to have a certain amount of generating capacity available. (See
Minimum Revenue and Demand Under Contract Table.) In turn, each Large Power
Customer is required to pay a minimum monthly demand charge that covers the
fixed costs associated with having this capacity available to serve the
customer, including a return on common equity. Most contracts allow customers to
establish the level of megawatts subject to a demand charge on a biannual (power
pool season) basis and require that a portion of their megawatt needs be
committed on a take-or-pay basis for at least a portion of the agreement. In
addition to the demand charge, each Large Power Customer is billed an energy
charge for each kilowatthour used that recovers the variable costs incurred in
generating electricity. Six of the Large Power Customers have interruptible
service for a portion of their needs which provides a discounted demand rate and
energy priced at Minnesota Power's incremental cost after serving all firm power
obligations. Minnesota Power also provides incremental production service for
customer demand levels above the contract take-or-pay levels. There is no demand
charge for this service and energy is priced at an increment above Minnesota
Power's cost. Incremental production service is interruptible. Contracts with 8
of the 12 Large Power Customers provide for deferral without interest of
one-half of demand charge obligations incurred during the first three months of
a strike or illegal walkout at a customer's facilities, with repayment required
over the 12-month period following resolution of the work stoppage.
All contracts continue past the contract termination date unless the required
advance notice of cancellation has been given. The advance notice of
cancellation varies from one to four years. Such contracts minimize the impact
on earnings that otherwise would result from significant reductions in
kilowatthour sales to such customers. Large Power Customers are required to
purchase all electric service requirements from Minnesota Power for the duration
of their contracts. The rates and corresponding revenue associated with capacity
and energy provided under these contracts are subject to change through the same
regulatory process governing all retail electric rates. (See Regulatory Issues -
Electric Rates.)
MINIMUM REVENUE AND DEMAND UNDER CONTRACT
AS OF MARCH 1, 2004
MINIMUM MONTHLY
ANNUAL REVENUE <F1> MEGAWATTS
===========================================================
2004 $99.5 million 635
2005 $50.5 million 294
2006 $36.1 million 202
2007 $30.6 million 181
2008 $16.2 million 93
===========================================================
<FN>
<F1> Based on past experience, we believe revenue from Large
Power Customers will be substantially in excess of the
minimum contract amounts.
</FN>
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ALLETE FORM 10-K 2003
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PART I
CONTRACT STATUS FOR MINNESOTA POWER LARGE POWER CUSTOMERS
AS OF MARCH 1, 2004
EARLIEST
CUSTOMER INDUSTRY LOCATION OWNERSHIP TERMINATION DATE
====================================================================================================================================
Hibbing Taconite Co. Taconite Hibbing, MN 62.3% International Steel December 31, 2008
Group, Inc.
23% Cleveland-Cliffs Inc.
14.7% Stelco Inc.
Ispat Inland Mining Company <F1> Taconite Virginia, MN Ispat Inland Steel Company March 31, 2008
U.S. Steel Corp. (USS) Minntac <F1> Taconite Mt. Iron, MN U.S. Steel Corp. March 31, 2008
USS Keewatin Taconite <F1><F2> Taconite Keewatin, MN U.S. Steel Corp. March 31, 2008
United Taconite LLC <F3> Taconite Eveleth, MN 70% Cleveland-Cliffs Inc. October 31, 2008
30% Laiwu Steel Group
Blandin Paper Company Paper Grand Rapids, MN UPM-Kymmene Corporation April 30, 2007
Boise Paper Solutions Paper International Falls, MN Boise Cascade Corporation December 31, 2008
Sappi Cloquet LLC Paper Cloquet, MN Sappi Limited December 31, 2008
Stora Enso North America, Paper and Pulp Duluth, MN Stora Enso Oyj April 30, 2009
Duluth Paper Mill and
Duluth Recycled Pulp Mill
USG Interiors, Inc. Manufacturer Cloquet, MN USG Corporation December 31, 2005
Enbridge Energy Company, Pipeline Deer River, MN Enbridge Energy Company, March 31, 2005
Limited Partnership <F4> Floodwood, MN Limited Partnership
Minnesota Pipeline Company <F4> Pipeline Staples, MN 60% Koch Pipeline Co. L.P. March 31, 2005
Little Falls, MN 40% Marathon Ashland
Park Rapids, MN Petroleum LLC
====================================================================================================================================
<FN>
<F1> The contract will terminate four years from the date of written notice from either Minnesota Power or the customer. No notice
of contract cancellation has been given by either party. Thus, the earliest date of cancellation is March 31, 2008.
<F2> Formerly National Steel Pellet Co., now renamed USS Keewatin Taconite. USS assumed the National Steel Pellet Co. Large Power
Customer contract.
<F3> In late 2003 United Taconite LLC was the successful bidder in a bankruptcy auction sale of the assets of Eveleth Mines LLC,
previously a Large Power Customer of Minnesota Power. United Taconite assumed the Eveleth Mines Large Power Customer contract.
<F4> The contract will terminate one year from the date of written notice from either Minnesota Power or the customer. No notice of
contract cancellation has been given by either party. Thus, the earliest date of cancellation is March 31, 2005.
</FN>
REGULATED UTILITY PURCHASED POWER
Minnesota Power has contracts to purchase capacity and energy from various
entities. The largest contract is with Square Butte. Under an agreement with
Square Butte expiring at the end of 2026, Minnesota Power is currently entitled
to approximately 71% (66% beginning in 2006) of the output of a 455-MW
coal-fired generating unit located near Center, North Dakota. (See Note 15.)
FUEL
Minnesota Power purchases low-sulfur, sub-bituminous coal from the Powder
River Basin coal field located in Montana. Coal consumption in 2003 for electric
generation at Minnesota Power's Minnesota coal-fired generating stations was
about 5.6 million tons. As of December 31, 2003 Minnesota Power had a coal
inventory of about 632,000 tons. Minnesota Power has three coal supply
agreements with various expiration dates extending through 2009. Under these
agreements Minnesota Power has the tonnage flexibility to procure 70% to 100% of
its total coal requirements. In 2004 Minnesota Power will obtain coal under
these coal supply agreements and in the spot market. This diversity in coal
supply options allows Minnesota Power to manage market price and supply risk and
to take advantage of favorable spot market prices. Minnesota Power is exploring
future coal supply options. It believes that adequate supplies of low-sulfur,
sub-bituminous coal will continue to be available.
In 2001 Minnesota Power and Burlington Northern and Santa Fe Railway Company
(Burlington Northern) entered into a long-term agreement under which Burlington
Northern transports all of Minnesota Power's coal by unit train from the Powder
River Basin directly to Minnesota Power's generating facilities or to a
designated interconnection point. Minnesota Power also has agreements with
Duluth Missabe and Iron Range Railway and Midwest Energy Resources Company to
transport coal from the Burlington Northern interconnection point to certain
Minnesota Power facilities.
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COAL DELIVERED TO MINNESOTA POWER
YEAR ENDED DECEMBER 31 2003 2002 2001
============================================================
Average Price Per Ton $20.02 $21.48 $20.52
Average Price Per MBtu $1.12 $1.19 $1.18
============================================================
The Square Butte generating unit operated by Minnkota Power burns North
Dakota lignite coal supplied by BNI Coal, in accordance with the terms of a
contract expiring in 2027. Square Butte's cost of lignite burned in 2003 was
approximately 66 cents per MBtu. The lignite acreage that has been dedicated to
Square Butte by BNI Coal is located on lands essentially all of which are under
private control and presently leased by BNI Coal. This lignite supply is
sufficient to provide the fuel for the anticipated useful life of the generating
unit.
NONREGULATED GENERATION AND POWER MARKETING
Nonregulated generation is non-rate base generation sold at market-based
rates to the wholesale market.
TACONITE HARBOR. In 2002 we started the Taconite Harbor generating facilities
which we purchased in 2001. The generation output is primarily being sold in the
wholesale market and is allocated in limited circumstances to Minnesota Power's
utility customers.
KENDALL COUNTY. In September 1999 Rainy River Energy entered into an amended
15-year power purchase agreement (Kendall County) with a company that was
subsequently purchased by NRG Energy, an independent power producer. The Kendall
County agreement includes the purchase of the output of one entire unit
(approximately 275 MW) of a four unit (approximately 1,100 MW) natural gas-fired
combined cycle generation facility located near Chicago, Illinois. Construction
of the generation facility was completed in 2002. Rainy River Energy's
obligation to pay fixed capacity related charges began May 1, 2002 and will end
on September 16, 2017. We currently have 130 MW (100 MW in 2003) of long-term
capacity sales contracts for the Kendall County generation, with 50 MW expiring
in April 2012 and 80 MW in September 2017.
SPLIT ROCK ENERGY is a joint venture of Minnesota Power and Great River
Energy from which Minnesota Power is withdrawing. Great River Energy is a
consumer-owned generation and transmission cooperative and is Minnesota's second
largest utility in terms of generating capacity. The joint venture combined the
two companies' power supply capabilities and customer loads for power pool
operations and generation outage protection. As of February 2004 in response to
the changing strategies of both parties, Minnesota Power withdrew from active
participation in Split Rock Energy, and will terminate its ownership interest
upon receipt of FERC approval which is expected in the first half of 2004. Some
of the benefits of this partnership have been retained, such as joint load and
capability reporting with Great River Energy. Minnesota Power has resumed
functions that provide least cost supply to our retail customers and marketing
power in our region based on supplies available from our generating assets.
OTHER. Rainy River Energy Corporation - Wisconsin continues to study the
feasibility of the construction of a natural gas-fired electric generating
facility in Superior, Wisconsin. In accordance with the PSCW's final order
approving the project, Rainy River Energy undertook preliminary site preparation
work in November and December of 2003.
In 2003 we sold 1.5 million MWh of nonregulated generation (1.2 million in
2002 and 0.2 million in 2001).
REGULATORY ISSUES
We are exempt from regulation under the Public Utility Holding Company Act of
1935 (PUHCA), except as to Section 9(a)(2) which relates to acquisition of
securities of public utility companies. If passed in its current form, the
pending federal energy bill will repeal PUHCA. However, we cannot predict the
future of this legislative effort.
We are subject to the jurisdiction of various regulatory authorities. The
MPUC has regulatory authority over Minnesota Power's service area in Minnesota,
retail rates, retail services, issuance of securities and other matters. The
FERC has jurisdiction over the licensing of hydroelectric projects, the
establishment of rates and charges for the sale of electricity for resale and
transmission of electricity in interstate commerce, and certain accounting and
record keeping practices. The PSCW has regulatory authority over the retail
sales of electricity, water and gas by SWL&P. The MPUC, FERC and PSCW had
regulatory authority over 23%, 3% and 3%, respectively, of our 2003 consolidated
operating revenue.
ELECTRIC RATES. Minnesota Power has historically designed its electric
service rates based on cost of service studies under which allocations are made
to the various classes of customers. Nearly all retail sales include billing
adjustment clauses which adjust electric service rates for changes in the cost
of fuel and purchased energy, and recovery of current and deferred CIP
expenditures.
In addition to Large Power Customer contracts, Minnesota Power also has
contracts with large industrial and commercial customers with monthly demands of
more than 2 MW but less than 10 MW of capacity. The terms of these contracts
vary depending upon the customer's demand for power and the cost of extending
Minnesota Power's facilities to provide electric service.
Minnesota Power requires that all large industrial and commercial customers
under contract specify the date when power is first required. Thereafter, the
customer is generally billed monthly for at least the minimum power for which
they contracted. These conditions are part of all contracts covering power to be
supplied to new large industrial and commercial customers and to current
customers as their contracts expire or are amended. All rates and other contract
terms are subject to approval by appropriate regulatory authorities.
FEDERAL ENERGY REGULATORY COMMISSION. The FERC has jurisdiction over our
wholesale electric service and operations. Minnesota Power's hydroelectric
facilities, which are located in Minnesota, are licensed by the FERC. (See
Environmental Matters - Water.)
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Minnesota Power has contracts with 16 Minnesota municipalities receiving
wholesale electric service. Two contracts are for service through 2005, while
the other 14 are for service through at least 2007. In 2003 municipal customers
purchased 735,000 MWh from Minnesota Power.
Minnesota Power and SWL&P are members of the MISO. Minnesota Power and SWL&P
retain ownership of their respective transmission assets and control area
functions, but their transmission network is under the regional operational
control of the MISO. They take and provide transmission service under the MISO
open access transmission tariff. In December 2001 FERC approved the MISO as the
nation's first regional transmission organization (RTO) under FERC's Order No.
2000 criteria, noting that it believes the MISO will benefit the public interest
by enhancing the reliability of the Midwest electric grid and facilitating and
enhancing wholesale competition. The MISO plans to accomplish this primarily
through standardization of rates, terms and conditions of transmission service
over a broad region encompassing all or parts of 20 states and one Canadian
province, and over 120,000 MW of generating capacity. MISO operations were
phased in during the first half of 2002. In late 2003 the MISO and the PJM
Interconnection LLC, an RTO serving all or parts of Pennsylvania, New Jersey,
the District of Columbia, Maryland, Ohio, Virginia, West Virginia and Delaware,
executed a joint operating agreement. The joint operating agreement, filed with
the FERC, will provide detailed information about each others' operations and
establishes procedures to strengthen and coordinate reliability.
The FERC is currently developing rules for a standard market design intended
to further define the functions and transmission tariff of the MISO and other
regional transmission providers. The MISO is focusing on reliability procedures
and on implementation of the FERC's standard market design elements by
development of an energy market tariff or tariffs if MISO membership determines
to form subregional markets within MISO. The MISO expects that an energy market
tariff will be filed with the FERC in the first half of 2004. Minnesota Power
will review the effects of the proposed definitive energy tariff at that time.
Minnesota Power also participates in MAPP, a power pool operating in parts of
eight states in the Upper Midwest and in three provinces in Canada. MAPP
functions include a regional reliability council that maintains generation
reserve sharing requirements. Minnesota Power is a member of the Mid-Continent
Area Energy Marketers Association (MEMA), recently formed to provide a regional
tariff for wholesale power and energy marketing under which its members trade.
On December 2, 2003 MEMA's wholesale capacity and energy tariff was approved by
the FERC and became effective.
MINNESOTA PUBLIC UTILITIES COMMISSION. Minnesota Power's retail rates are
based on a 1994 MPUC retail rate order that allows for an 11.6% return on common
equity dedicated to utility plant and resulted in an average rate increase of
approximately 6%. Minnesota Power is in the early stages of preparing a request
to increase rates for its utility operations sometime in the first half of 2005.
The request may be necessary to cover changes in the increased cost of doing
business.
At the end of 2003 our equity ratio was 64.44%, which was greater than the
55.03% plus or minus 15% (46.78% to 63.29%) approved by the MPUC in its 2003
order authorizing our capital structure. Our equity ratio was higher than the
approved MPUC ratio due to the recognition of gains from the sale of our Water
Services businesses and the redemption of long-term debt. On January 23, 2004 we
filed an amendment with the MPUC requesting that effective no later than March
1, 2004 a new equity ratio of 61.53% plus or minus 15% (52.30% to 70.76%) be
established until such time as our 2004 capital structure is approved. On
February 18, 2004 the MPUC approved at Minnesota Power's request.
In June 2003 the MPUC initiated an investigation into the continuing
usefulness of the fuel clause as a regulatory tool for electric utilities.
Minnesota Power's initial comments on the proposed scope and procedure of the
investigation were filed in July 2003. In November 2003 the MPUC approved the
initial scope and procedure of the investigation. The investigation will focus
on whether the fuel clause continues to be an appropriate regulatory tool. The
initial steps will be to review the clause's original purpose, structure and
rationale of the fuel adjustment clause (including its current operation and
relevance in today's regulatory environment), and then address its ongoing
appropriateness and other issues if the need for continued use of the fuel
adjustment clause is shown. Because this investigation is in its early stages,
we are unable to predict the outcome or impact, if any, at this time.
Minnesota requires investor owned electric utilities to spend a minimum of
1.5% of gross annual retail electric revenue on CIP each year. These investments
are recovered from retail customers through a billing adjustment and amounts
included in retail base rates. The MPUC allows utilities to accumulate, in a
deferred account for future recovery, all CIP expenditures as well as a carrying
charge on the deferred account balance. Minnesota Power's CIP investment goal
was $2.9 million for 2003 ($2.9 million for 2002; $2.7 million for 2001) with
actual spending of $5.2 million in 2003 ($4.0 million in 2002; $2.6 million in
2001). These amounts satisfied current spending requirements and all prior
years' spending shortfalls.
PUBLIC SERVICE COMMISSION OF WISCONSIN. SWL&P's current electric retail rates
are based on a September 2001 PSCW retail rate order that allows for a 12.25%
return on common equity and resulted in an average rate decrease of 3.4%. SWL&P
is preparing to file with the PSCW in mid-2004 a request to increase retail
rates for its utility operations to be effective sometime in early 2005. The
request would cover changes in the cost of doing business.
The ownership, control and operation of any affiliated wholesale nonregulated
generating plants in Wisconsin is subject to PSCW approval.
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In December 2003 the PSCW unanimously approved the revised $420 million cost
estimate for the Wausau-to-Duluth electric transmission line that Minnesota
Power, the American Transmission Company (ATC) and Wisconsin Public Service
Corporation have proposed. The line had been projected to cost about $215
million. The increased costs for the 220-mile, 345-kV line are attributable to
higher prices for construction materials, increased payments to landowners, more
aggressive environmental safeguards and a different accounting calculation for
interest on funds used during construction for ATC. Despite the cost increase,
Minnesota Power and transmission planners throughout the region believe the
transmission line is necessary. Minnesota Power is actively involved in the
permitting and construction activities which began at the end of January 2004;
however, it does not intend to finance or own the proposed line. An application
to cross the Namekagon River in Wisconsin was filed with the National Park
Service (NPS) in November 2001, and a draft Environmental Impact Statement is
expected to be issued by the NPS in early 2004. Construction is currently
anticipated to be complete in 2008.
COMPETITION
INDUSTRY RESTRUCTURING. State efforts across the country to restructure the
electric utility industry have slowed. Legislation or regulation that would
allow retail customer choice of their electric service provider has not gained
momentum in either Minnesota or Wisconsin.
At the national level the FERC continues in its efforts to have companies
join RTOs. FERC's sweeping Standard Market Design rulemaking, renamed the
Wholesale Market Platform, appears to have stalled, although FERC remains
committed to implementing most of the rule in a more piecemeal fashion.
Minnesota Power supports the creation of a robust wholesale electric market.
The electricity title of the pending federal energy legislation seeks to
maintain reliability, increase investments in new transmission capacity and
energy supply, and address wholesale price volatility while encouraging
wholesale competition. This legislation remains the subject of significant
controversy. We cannot predict the timing or substance of any future legislation
or regulation.
FRANCHISES
Minnesota Power holds franchises to construct and maintain an electric
distribution and transmission system in 90 cities and towns located within its
electric service territory. SWL&P holds similar franchises for electric, natural
gas and/or water systems in 15 cities and towns within its service territory.
The remaining cities and towns served do not require a franchise to operate
within their boundaries. Our exclusive service territories are established by
state regulatory agencies.
EMPLOYEES
At December 31, 2003 Energy Services had 1,400 full-time employees.
Minnesota Power, SWL&P and Enventis Telecom have 596 employees who are
members of the International Brotherhood of Electrical Workers (IBEW), Local 31.
A labor agreement between Minnesota Power and Local 31, which includes Enventis
Telecom, was in effect through January 31, 2004. On February 25, 2004 IBEW Local
31 approved a new two-year labor agreement with Minnesota Power, SWL&P and
Enventis Telecom that will be in effect through January 31, 2006. The agreement
provides wage increases of 3.25% in each of the two contract years. The union
voted to discontinue their participation in the Results Sharing program as of
the end of 2003.
BNI Coal had 96 employees who were members of the IBEW Local 1593. BNI Coal
and Local 1593 have a labor agreement which expires on March 31, 2004. In
accordance with terms of that agreement, a 3% increase took effect July 1, 2003.
Negotiations are underway for a new contract that would begin after the March
31, 2004 expiration date.
ENVIRONMENTAL MATTERS
Certain businesses included in our Energy Services segment are subject to
regulation by various federal, state and local authorities of air quality, water
quality, solid wastes and other environmental matters. We consider these
businesses to be in substantial compliance with those environmental regulations
currently applicable to their operations and believe all necessary permits to
conduct such operations have been obtained. We review environmental matters on a
quarterly basis. Accruals for environmental matters are recorded when it is
probable that a liability has been incurred and the amount of the liability can
be reasonably estimated, based on current law and existing technologies. These
accruals are adjusted periodically as assessment and remediation efforts
progress, or as additional technical or legal information become available.
Accruals for environmental liabilities are included in the balance sheet at
undiscounted amounts and exclude claims for recoveries from insurance or other
third parties. Costs related to environmental contamination treatment and
cleanups are charged to expense.
AIR. Minnesota Power's regulated generating facilities in Minnesota mainly
burn low-sulfur western sub-bituminous coal and Square Butte, located in North
Dakota, burns lignite coal. All of these facilities are equipped with pollution
control equipment such as scrubbers, baghouses or electrostatic precipitators.
The federal Clean Air Act Amendments of 1990 (Clean Air Act) created emission
allowances for sulfur dioxide. Each allowance is an authorization to emit one
ton of sulfur dioxide, and each utility must have sufficient allowances to cover
its annual emissions. Sulfur dioxide emission requirements are currently being
met by all of Minnesota Power's generating facilities. Most Minnesota Power
facilities have surplus allowances. Taconite Harbor expects to meet its sulfur
dioxide requirements by annually purchasing allowances, since it receives no
allowance allocation. Square Butte anticipates meeting its sulfur dioxide
requirements
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through increased use of existing scrubbers and by annually purchasing
additional allowances as necessary.
In accordance with the Clean Air Act, the EPA has established nitrogen oxide
limitations for electric generating units. To meet nitrogen oxide limitations,
Minnesota Power installed advanced low-emission burner technology and associated
control equipment to operate the Boswell and Laskin facilities at or below the
compliance emission limits. Nitrogen oxide limitations at Square Butte are being
met by combustion tuning.
Minnesota Power has obtained all necessary Title V air operating permits from
the MPCA for its applicable facilities to conduct electric operations.
In December 2000 the EPA announced its decision to regulate mercury emissions
from coal and oil-fired power plants under Section 112 of the Clean Air Act.
Section 112 will require all such power plants in the United States to adhere to
the EPA maximum achievable control technology (MACT) standards for mercury. The
EPA issued a proposed rule in December 2003. Final regulations defining control
requirements are planned for December 2004. The proposed rule offers two
different types of regulation: imposition of an annual average mercury emission
limitation applied at each unit or facility average under Section 112 and
imposition of a cap and trade program under Section 111, where an allocation of
mercury credits would be assigned and utilities would need to provide for a
combination of emission reductions and credit purchases to demonstrate
compliance. The EPA is soliciting comments about these approaches. In either
approach, continuous monitoring of mercury stack emissions is required to be in
service around 2008. Minnesota Power's preliminary estimates suggest that all of
our affected facilities can be outfitted with continuous mercury emission
monitors for under $2 million. Our unit mercury emissions tests indicate all of
our units should comply with the proposed unit specific target emission rate
without significant additional cost. Cost estimates about mercury cap and trade
program impacts would be premature at this time. The EPA is still soliciting
comments about this proposed alternative program and associated final mercury
credit allocations to units have not yet been defined.
During 2002 Minnesota Power received and 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 is, however, ongoing litigation involving the
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,
we have not accrued any liability for this environmental matter.
In December 2002 the EPA issued changes to the existing New Source Review
rules. These rules changed the procedures for MPCA review of projects at our
electric generating facilities. In October 2003 the EPA announced changes
clarifying the application of certain sections of the New Source Review rules.
These changes are not expected to have a material impact on Minnesota Power. On
December 24, 2003 the U.S. Court of Appeals for the District of Columbia Circuit
stayed the implementation of the October 2003 rule pending their further review
which is expected sometime in 2004.
In June 2002 Minnkota Power, the operator of Square Butte, received a Notice
of Violation from the EPA regarding alleged New Source Review violations at the
M.R. Young Station which includes the Square Butte generating unit. The EPA
claims certain capital projects completed by Minnkota Power should have been
reviewed pursuant to the New Source Review regulations potentially resulting in
new air permit operating conditions. Minnkota Power has held several meetings
with the EPA to discuss the alleged violations. Based on an EPA request,
Minnkota Power performed a study related to the technological feasibility of
installing various controls for the reduction of nitrogen oxides and sulfur
dioxide 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. Our future cost of purchased power
would include our pro rata share of this additional debt service. (See Note 15.)
WATER. The Federal Water Pollution Control Act of 1972 (FWPCA), as amended by
the Clean Water Act of 1977 and the Water Quality Act of 1987, established the
National Pollutant Discharge Elimination System (NPDES) permit program. The
FWPCA requires NPDES permits to be obtained from the EPA (or, when delegated,
from individual state pollution control agencies) for any wastewater discharged
into navigable waters. Minnesota Power has obtained all necessary NPDES permits,
including NPDES storm water permits for applicable facilities, to conduct its
electric operations.
Minnesota Power holds FERC licenses authorizing the ownership and operation
of seven hydroelectric generating projects with a total generating capacity of
about 115 MW. In June 1996 Minnesota Power filed in the U.S. Court of Appeals
for the District of Columbia Circuit a petition for review of the license as
issued by the FERC for Minnesota Power's St. Louis River Hydro Project. Separate
petitions for review were also filed by the U.S. Department of the Interior and
the Fond du Lac Band of Lake Superior Chippewa (Fond du Lac Band), two
intervenors in the licensing proceedings. The court consolidated the three
petitions for
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review and suspended the briefing schedule while Minnesota Power and the Fond du
Lac Band negotiate a reasonable fee for the use of tribal lands as mandated by
the new license. Both parties informed the court that these negotiations may
resolve other disputed issues, and they are obligated to report periodically to
the court the status of these discussions. Beginning in 1996, and most recently
in February 2004, Minnesota Power filed requests with the FERC for extensions of
time to comply with certain plans and studies required by the license that might
conflict with the settlement discussions. The Fond du Lac Band, the U.S.
Department of the Interior and Minnesota Power have reached a settlement
agreement for the St. Louis River Hydro Project. This settlement must be
approved by the FERC who would then amend the project license to reflect the
conditions of the settlement agreement. Minnesota Power is in the process of
preparing the filing for submission to the FERC in mid 2004.
SOLID AND HAZARDOUS WASTE. The Resource Conservation and Recovery Act of 1976
regulates the management and disposal of solid wastes and hazardous wastes. As a
result of this legislation, the EPA has promulgated various hazardous waste
rules. Minnesota Power is required to notify the EPA of hazardous waste activity
and routinely submits the necessary annual reports to the EPA. The MPCA and the
Wisconsin Department of Natural Resources (WDNR) are responsible for
administering solid and hazardous waste rules on the state level with oversight
by the EPA.
In response to EPA Region V's request for utilities to participate in the
Great Lakes Initiative by voluntarily removing remaining polychlorinated
biphenyl (PCB) inventories, Minnesota Power has scheduled replacement of PCB
capacitor banks and PCB-contaminated oil by the end of 2004. The total cost is
expected to be about $2.0 million of which $1.5 million was spent through
December 31, 2003.
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 SWL&P to initiate an environmental investigation. The WDNR also
issued SWL&P a Responsible Party letter in February 2002. The environmental
investigation is underway. In February 2003 SWL&P submitted a Phase II
environmental site investigation report to the WDNR. This report identified some
MGP-like chemicals that were found in the soil. During March and April 2003
sediment samples were taken from nearby Superior Bay. The report on the results
of this sampling is expected to be completed and sent to the WDNR during the
first quarter of 2004. A work plan for additional investigation by SWL&P was
filed on December 17, 2003 with the WDNR. This part of the investigation will
determine any impact to soil or ground water between the former MGP site and the
Superior Bay. Although it is not possible to quantify the potential clean-up
cost until the investigation is completed and a work plan is developed, a $0.5
million liability was recorded as of December 31, 2003 to address the known
areas of contamination. We have recorded a corresponding dollar amount as a
regulatory asset to offset this liability. The PSCW has approved SWL&P's
deferral of these MGP environmental investigation and potential clean-up costs
for future recovery in rates, subject to regulatory prudency review.
AUTOMOTIVE SERVICES
Automotive Services, headquartered in Carmel, Indiana, operates two main
businesses that are integral parts of the vehicle redistribution industry in the
United States and Canada: auctions and related services, and dealer financing.
Automotive Services includes several wholly owned subsidiaries, including ADESA,
ADESA Impact and AFC. The proposed spin-off is expected to take the form of a
tax-free stock dividend to ALLETE's shareholders, who would receive one ADESA,
Inc. share for each share of ALLETE common stock. ADESA, Inc. will be the parent
company of the subsidiaries we include in Automotive Services. Automotive
Services plans to grow by growing auction sales volume, optimizing revenue per
vehicle sold, continuing to improve operating efficiency, expanding into new
markets, and growing on-line auctions and related services. The discussion below
summarizes the businesses we include in Automotive Services. Statistical
information is presented as of December 31, 2003 unless otherwise indicated.
WHOLESALE VEHICLE AUCTIONS
We are the leading, national provider of wholesale vehicle auctions and
related vehicle redistribution services for the automotive industry in North
America. Most of our locations are stand-alone facilities dedicated to either
used vehicle auctions or salvage auctions, but in several locations, we have
been able to capitalize on the synergies of utilizing our facilities for both
types of auctions. In addition to vehicle auction services, we also provide
auctions and related services for specialty vehicles and equipment unique to the
recreational vehicle, commercial trucking, construction and utility industries.
We provide Internet-based solutions to institutional sellers who wish to
redistribute their vehicles to either franchised and/or independent dealers,
including on-line and bulletin board on-line live auctions running
simultaneously with our physical auctions. We feel that the physical auctions we
operate offer a superior method of vehicle redistribution when compared to
on-line auctions. As the use of on-line auctions has become an accepted practice
in the vehicle redistribution industry, we have developed on-line auction
technologies to complement our physical auction business. We believe we are well
positioned to offer the appropriate mix of physical and on-line auctions and
services to our customers to ensure the most effective and efficient
redistribution of their vehicles.
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USED VEHICLE AUCTIONS AND RELATED SERVICES. We are the second largest
wholesale used vehicle auction network in the United States and the largest in
Canada. We operate 53 used vehicle auction facilities in close proximity to
large concentrations of used vehicle dealers throughout North America, which we
own or lease. Each auction is a multi-lane, drive-through facility, and may have
additional buildings for reconditioning, registration, maintenance, bodywork,
and other ancillary and administrative services. Each auction also has secure
parking areas to store vehicles for auction. (See Used Vehicle Auctions Table.)
Our customers sold 1,810,000 used vehicles at our auctions in 2003 (1,741,000 in
2002; 1,761,000 in 2001).
Auctions are the hub of a massive redistribution system for used vehicles.
Our auctions enable institutional customers and selling dealers to sell used
vehicles to licensed franchised, independent and wholesale used vehicle dealers.
Our mission is to maximize the auction sales price for the sellers of used
vehicles by effectively and efficiently transferring the vehicles, paperwork
(including certificates of title and other evidence of ownership), and funds as
quickly as possible from the sellers to a large population of dealers seeking to
fill their inventory for resale to retail consumers. Auctions are held at least
weekly at every location and provide real-time wholesale market prices for the
vehicle redistribution industry. During the sales process, we do not generally
take title to or ownership of the vehicles consigned for auction but instead
facilitate the transfer of vehicle ownership directly from seller to buyer.
A central measure to the results of the used vehicle auction process is the
conversion percentage, which represents the number of vehicles sold as a percent
of the vehicles offered for sale. The number of vehicles offered for sale is the
key driver of the costs incurred in, and the number of vehicles sold is the key
driver of the related fees generated by, the redistribution process. Generally,
as the conversion percentage increases, so do the profitability and efficiency
of our auctions.
We provide a full range of services to both buyers and sellers, including:
- Auction services, such as marketing and advertising the vehicles to be
auctioned, dealer registration, storage of consigned and purchased
inventory, clearing of funds, arbitration of disputes, auction vehicle
registration, condition report processing, security for consigned
inventory, sales results reports, pre-sale lineups, and actual auctioning
of vehicles by licensed auctioneers.
- Internet-based solutions, including on-line bulletin board auctions and
on-line live auctions running simultaneously with our physical auctions.
- Inbound and outbound logistics administration with services provided by
both third party carriers and our auctions.
- Reconditioning services, including detailing, washing, body work, light
mechanical work, glass repair, dent repair, tire and key replacement, and
upholstery repair.
- Inspection and certification services whereby the auction performs a
physical inspection and produces a condition report, in addition to
varying levels of diagnostic testing for purposes of certification.
- Title processing and other paperwork administration.
- Outsourcing of remarketing functions and end of lease term management.
Each of these services may also be purchased separately from the auction
process.
SALVAGE AUCTIONS AND RELATED SERVICES. We are currently the third largest
salvage auction operator in North America, where the top three operators
constitute an estimated 72% of the vehicles sold through auctions. We operate 27
salvage auction facilities in the United States and Canada. Salvage auctions are
generally smaller than used vehicle auctions in terms of acreage and building
size and some locations share facilities with our used vehicle auctions. Most
salvage vehicles cannot be driven through lanes, and salvage auction facilities
are therefore less complex than wholesale used vehicle auction facilities,
consisting primarily of large lots for depositing salvage vehicles. Salvage
auction facilities typically have a small office building and a garage for truck
and loader repairs. (See Salvage Vehicle Auctions Table.) Our customers,
primarily insurance companies, sold an estimated 191,000 salvage vehicles at our
auctions in 2003 (175,000 in 2002; 148,000 in 2001).
Salvage vehicles are damaged vehicles that are branded as total losses for
insurance or business purposes as well as recovered stolen vehicles for which an
insurance settlement with the vehicle owner has already been made. We offer a
comprehensive selection of salvage recovery services. In addition to the core
auction process including inbound and outbound logistics, remarketing vehicle
claims services such as vehicle inspection, evaluation, titling and settlement
administration, remarketing and theft-recovered vehicle services. Used together
or independently, these services provide efficiency and speed of service to our
customers, helping them to mitigate their losses and manage the costs related to
processing the claims and related vehicles. We also provide the insurance
industry with professional claims outsourcing and recycled parts locating
services via an extensive network of third party suppliers of
used vehicle parts.
We provide solutions for all aspects of the salvage auction process,
including:
- Auction services, such as registering vehicles, clearing of funds,
reporting sales results and pre-sale lineups to customers, paying third
party storage centers for the release of vehicles and the physical
auctioning of the vehicles by licensed auctioneers.
- Inbound and outbound logistics administration with actual services
provided by both third party carriers and our auctions.
- Other services including vehicle inspections, evaluations, titling,
settlement administration, drive through damage
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PART I
NUMBER OF
STATE/ AUCTION
USED VEHICLE AUCTIONS CITY PROVINCE LANES
=============================================================================================
UNITED STATES
ADESA Birmingham Moody Alabama 10
ADESA Phoenix Chandler Arizona 12
ADESA Little Rock <F1> North Little Rock Arkansas 10
ADESA Golden Gate Tracy California 12
ADESA Los Angeles <F2> Mira Loma California 6
ADESA Sacramento Sacramento California 5
ADESA San Diego <F1> San Diego California 6
ADESA Colorado Springs Colorado Springs Colorado 5
ADESA Jacksonville <F3> Jacksonville Florida 6
ADESA Ocala Ocala Florida 5
ADESA Orlando-Sanford Sanford Florida 8
ADESA Tampa Tampa Florida 8
ADESA Atlanta <F1> Fairburn Georgia 8
ADESA Indianapolis Plainfield Indiana 10
ADESA Southern Indiana Edinburgh Indiana 3
ADESA Des Moines Grimes Iowa 5
ADESA Lexington Lexington Kentucky 6
ADESA Shreveport Shreveport Louisiana 5
ADESA Boston Framingham Massachusetts 11
ADESA Concord <F3> Acton Massachusetts 5
ADESA Lansing Dimondale Michigan 5
ADESA Kansas City Lee's Summit Missouri 7
ADESA St. Louis Barnhart Missouri 3
ADESA New Jersey Manville New Jersey 8
ADESA Buffalo <F3> Akron New York 10
ADESA Long Island Yaphank New York 6
ADESA Charlotte Charlotte North Carolina 10
ADESA Cincinnati/Dayton Franklin Ohio 8
ADESA Cleveland Northfield Ohio 8
ADESA Tulsa Tulsa Oklahoma 6
ADESA Pittsburgh Mercer Pennsylvania 8
ADESA Knoxville Lenoir City Tennessee 6
ADESA Memphis Memphis Tennessee 6
ADESA Austin <F1> Austin Texas 6
ADESA Dallas Mesquite Texas 8
ADESA Houston Houston Texas 8
ADESA San Antonio San Antonio Texas 8
ADESA Seattle Auburn Washington 4
ADESA Wisconsin Portage Wisconsin 5
CANADA
ADESA Calgary Airdrie Alberta 4
ADESA Edmonton <F3> Nisku Alberta 5
ADESA Vancouver <F1><F3> Richmond British Columbia 7
CAG Vancouver <F1> Surrey British Columbia 2
ADESA Winnipeg Winnipeg Manitoba 4
ADESA Moncton Moncton New Brunswick 2
ADESA St. John's <F1> St. John's Newfoundland 1
ADESA Halifax <F3> Enfield Nova Scotia 5
ADESA Kitchener Ayr Ontario 4
ADESA Ottawa <F3> Vars Ontario 5
ADESA Toronto Brampton Ontario 8
ADESA Montreal St. Eustache Quebec 12
ADESA Saskatoon <F1> Saskatoon Saskatchewan 2
MEXICO
ADESA Mexico <F4> Mexico City
=============================================================================================
<FN>
<F1> Leased auction facilities. (See Note 15.)
<F2> We currently lease part of the property on which this auction is located.
<F3> Shares facilities with salvage auction at the same location.
<F4> Holds auctions at one of our customer's facilities in Mexico City, Mexico.
</FN>
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ALLETE FORM 10-K 2003
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PART I
STATE/ TOTAL
SALVAGE VEHICLE AUCTIONS CITY PROVINCE ACREAGE
============================================================================================================
UNITED STATES
ADESA Impact - Fremont Fremont California 63
ADESA Impact - Jacksonville <F1> Jacksonville Florida 6
ADESA Impact - Miami <F2> Opa-Locka Florida 29
ADESA Impact - Orlando <F2> Orlando Florida 8
ADESA Impact - Clinton Clinton Maine 7
ADESA Impact - Saco Saco Maine 9
ADESA Impact - Concord <F1> Acton Massachusetts 10
ADESA Impact - Taunton East Taunton Massachusetts 29
ADESA Impact - Salem <F3> Salem New Hampshire 13
ADESA Impact - Albany Colonie New York 25
ADESA Impact - Buffalo <F1> Akron New York 15
ADESA Impact - Long Island <F2> Medford New York 4
ADESA Impact - Montgomery <F1> Rock Tavern New York 64
ADESA Impact - Clayton Clayton North Carolina 21
ADESA Impact - Rhode Island East Providence Rhode Island 15
ADESA Impact - Vermont Essex Vermont 28
CANADA
Impact Calgary <F2> Calgary Alberta 10
Impact Edmonton <F1><F2> Nisku Alberta 10
Impact Vancouver <F1><F2> Richmond British Columbia 3
Impact Moncton <F2> Moncton New Brunswick 8
Impact Halifax <F1><F2> Enfield Nova Scotia 6
Impact Hamilton <F2> Hamilton Ontario 12
Impact London <F2> London Ontario 17
Impact Toronto <F2> Stouffville Ontario 28
Impact Sudbury <F4> Sudbury Ontario 10
Impact Ottawa <F1><F2> Vars Ontario 9
Impact Montreal <F2><F5> Les Cedres Quebec 50
============================================================================================================
<FN>
<F1> Shares facilities with ADESA used vehicle auction at the same location.
<F2> Leased auction facilities. (See Note 15.)
<F3> We currently lease part of the property on which this auction is located.
<F4> Impact Auto owns 50% of this auction facility.
<F5> Holds a monthly auction at an independent auction facility in Quebec City, Quebec.
</FN>
assessment centers, claims auditing, recycled parts locating, and a
national call center.
- Internet-based solutions, including on-line bulletin board auctions and
on-line live auctions running simultaneously with our physical auctions.
Each of these services may also be purchased separately from the auction
process.
DEALER FINANCING
AFC primarily provides short-term inventory-secured financing, known as
floorplan financing, for used vehicle dealers in North America who purchase
vehicles from our auctions, independent auctions, auctions affiliated with other
auction networks and outside sources. In 2003 approximately 85% of the vehicles
floorplanned by AFC were vehicles purchased by dealers at auction. AFC has 80
loan production offices at or near vehicle auctions across North America and
arranged 950,000 loan transactions in 2003 (946,000 in 2002; 904,000 in 2001).
Our ability to provide floorplan financing facilitates the growth of vehicle
sales at auction, and also allows us to have a larger role in the entire
vehicle redistribution industry.
AFC's procedures and proprietary computer-based system enable us to manage
our credit risk by following each loan from origination to payoff, while
expediting services through its branch network. Our approximately 8,200 active
accounts (those accounts with financing for at least one vehicle outstanding),
had an average line of credit of $112,000. An average of nine vehicles were
floorplanned per active dealer with an approximate average value of $6,500 per
vehicle. Up to 12,000 dealers utilize their lines of credit during any twelve
month period.
AFC offices are conveniently located at or within close proximity of our
auctions and other auctions, which allows dealers to reduce transaction time by
providing immediate payment for vehicles purchased at auction. On-site financing
also enables AFC to share its information with auction representatives regarding
the financing capacity of customers, thereby increasing the purchasing potential
at auctions. Of AFC's 80 offices in North America, 58 are physically located at
auction facilities. Each of the remaining 22 AFC offices is
- --------------------------------------------------------------------------------
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ALLETE FORM 10-K 2003
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PART I
strategically located in close proximity to at least one of the auctions that it
services. In addition, AFC has the ability to send finance representatives
on-site to most approved independent auctions during auction sale-days.
Geographic proximity to our customers also gives our employees the ability to
stay in close contact with our outstanding accounts, thereby better enabling
them to manage credit risk.
Every floorplan financed vehicle is treated as an individual loan. Typically,
AFC assesses a floorplan fee at the inception of a loan and collects the fee
along with interest (accrued daily) when the loan is paid in full. AFC generally
only allows one loan per vehicle and permits payoffs to occur with only one
check per vehicle. In addition, AFC holds title or other evidence of ownership
to all vehicles which are floorplanned, except for vehicles floorplanned in
Michigan. Typical loan terms are 30 or 45 days, each with a possible curtailment
extension. For an additional fee, the curtailment extension allows the dealer to
extend the duration of the loan beyond the original term for another 30 to 45
days if the dealer makes an upfront payment towards principal, interest and
fees.
The extension of a credit line to a dealer starts with the underwriting
process. Credit lines up to $150,000 are extended using a proprietary scoring
model developed internally by AFC with no requirement for financial statements.
Credit lines in excess of $150,000 may be extended using underwriting guidelines
which require dealership and personal financial statements and tax returns. The
underwriting of each line of credit requires an analysis, write-up and
recommendation by the credit department and final review by a credit committee.
AFC takes a security interest in each financed vehicle, and collateral
management is an integral part of day-to-day operations at each AFC branch and
its Corporate headquarters. AFC's proprietary computer-based system facilitates
collateral management by providing real time access to dealer information and
enables our branch personnel to manage potential collection issues as soon as
they arise. Restrictions are automatically placed on customer accounts in the
event of a delinquency, insufficient funds received or poor audit results.
Branch personnel are proactive in managing collateral by monitoring loans and
notifying dealers that payments are coming due. In addition, routine audits, or
lot checks, are performed by an affiliated company. Poor results from lot checks
typically require branch personnel to take actions to determine the status of
missing collateral, including visiting the dealer personally, verifying units
held off-site and collecting payments for units sold. In some instances an audit
may identify a troubled account which could cause our collections department to
become involved.
AFC operates four divisions which are organized into ten regions in North
America. Each division and region is monitored by managers who oversee daily
operations. At the corporate level, AFC employs full-time collection specialists
and collection attorneys who are assigned to specific regions and monitor
collection activity for these areas. Collection specialists work closely with
the branches to track trends before an account becomes a troubled account and to
determine, together with collection attorneys, the best strategy to secure the
collateral once a troubled account is identified.
Once a new customer is extended credit, we emphasize service, growth and
management. All AFC employees at the management level participate in a two-stage
interactive training program at Automotive Services' corporate headquarters
that allows us to provide consistent services to our customers and consistent
monitoring of our accounts at local, regional and central levels.
The Eligible Active Dealers table depicts a range of the lines of credit
available to eligible dealers.
As of December 31, 2003 no single line of credit accounted for more than 10%
of the total credit extended by AFC. AFC's top five active dealers represented a
total committed credit of $93 million with a total outstanding principal amount
of $31 million. The single largest committed line of credit granted by AFC is
for $45 million, for which the obligor had $3.5 million outstanding on December
31, 2003. This obligor operates outside of AFC's normal floorplanning
arrangements with specific covenants that must be maintained, and borrows on a
revolving based line of credit with advances based on eligible inventory.
AFC's five largest write-offs for the past five years amounted to $3.8
million in aggregate, of which $1.4 million was recovered through ongoing
collection activity as well as insurance claims.
ELIGIBLE ACTIVE DEALERS - 2003
============================================================================================================
NUMBER OF DEALERS AGGREGATE MANAGED PRINCIPAL
NUMBER OF ELIGIBLE WITH OUTSTANDING AMOUNT OUTSTANDING AS
AVAILABLE LINE OF CREDIT ACTIVE DEALERS BALANCES OF DECEMBER 31, 2003
- ------------------------------------------------------------------------------------------------------------
Less than $150,000 11,337 7,648 $320,787,232
$150,001 to $500,000 512 495 102,780,909
$500,001 to $2,500,000 93 92 61,455,681
$2,500,001 to $5,000,000 6 6 11,998,355
$5,000,001 to $10,000,000 1 1 5,104,360
$10,000,001 and Greater 2 2 16,036,280
- ------------------------------------------------------------------------------------------------------------
Total 11,951 8,244 $518,162,817
============================================================================================================
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ALLETE FORM 10-K 2003
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PART I
COMPETITION
We are the only company to offer both used vehicle and salvage auctions,
floorplan financing for used vehicle dealers and a wide array of related vehicle
redistribution services. In the used vehicle auction industry, we compete with
Manheim Auctions, Inc. (Manheim), a subsidiary of Cox Enterprises, Inc., as well
as several smaller chains of auctions, and independent auctions, some of which
are affiliated through their membership in an industry organization named
ServNet(registered). Due to our national presence, competition is strongest with
Manheim for the supply of used vehicles from national level accounts of
institutional customers. Although the supply of these vehicles is dispersed
among all of the auctions in the used vehicle market, we compete most heavily
with the independent auctions (as well as Manheim and all others in the market)
for the supply of vehicles from dealers.
Due to the increased visibility of the Internet as a marketing and
distribution channel, new competition has arisen recently from Internet-based
companies and our own customers who have historically redistributed vehicles
through various channels including auctions. Direct sales of vehicles by
institutional customers and large dealer groups through internally developed or
third party on-line auctions have largely replaced telephonic and other
non-auction methods, becoming an increasing portion of overall used vehicle
redistribution. The extent of use of direct, on-line systems varies by customer
and, based upon our estimates, currently comprises approximately 3% to 5% of
overall used vehicle auction sales. Typically, these on-line auctions serve to
redistribute vehicles that have come off lease. In addition, some of our
competitors have begun to offer on-line auctions as all or part of their auction
business and other on-line auction companies now include used vehicles among the
products offered at their auctions. On-line auctions or other methods of
redistribution may diminish both the quality and quantity and reduce the value
of vehicles sold through traditional auction facilities.
In the salvage auction services industry, we compete with Copart, Inc.,
Insurance Auto Auctions, Inc., independent auctions, some of which are
affiliated through their membership in an industry organization named
Sadisco(registered), and a limited number of used vehicle auctions that
regularly redistribute salvage vehicles. Additionally, some dismantlers of
salvage vehicles and Internet-based companies have entered the market, thus
providing alternate avenues for sellers to redistribute salvage vehicles. We
believe further consolidation of the salvage auction service industry will occur
and are evaluating various means by which we can continue our growth plan.
Through strategic acquisitions, shared facilities with our used vehicle auctions
and greenfield expansion, we believe our salvage auction service business can
become a prominent salvage services auction provider to the insurance industry
in the United States.
In Canada we are the largest provider of used and salvage vehicle auction
services. Our competitors include vehicle recyclers and dismantlers, independent
vehicle auctions, brokers, Manheim and on-line auction companies. We believe we
are strategically positioned in this market by providing a full array of
value-added services to our customers including auctions and related services,
on-line programs, data analyses, and consultation.
The used vehicle inventory floorplan financing sector is characterized by
diverse and fragmented competition. AFC primarily provides short-term dealer
floorplan financing of wholesale vehicles to independent vehicle dealers in
North America. AFC's competition includes Manheim Automotive Financial Services,
other specialty lenders, banks and other financial institutions. AFC competes
primarily on the basis of quality of services, convenience of payment, scope of
services offered, and historical and consistent commitment to the sector.
EMPLOYEES
At December 31, 2003 Automotive Services had approximately 11,200 employees,
with 9,000 located in the United States and Mexico and 2,200 located in Canada.
About 64% of Automotive Services' work force consists of full-time employees.
Currently none of Automotive Services' employees participate in collective
bargaining agreements. In addition to our work force of employees, Automotive
Services also utilizes temporary labor services to assist in handling the
vehicles consigned during periods of peak volume and staff shortages. Nearly all
of Automotive Services' auctioneers are contract laborers providing their
services for a daily or weekly rate. Many of the services Automotive Services
provides are outsourced to third party providers that perform the services
either on-site or off-site. The use of third party providers depends upon the
resources available at each auction facility as well as peaks in the volume of
vehicles offered at auction.
VEHICLE REGULATION
Automotive Services' operations are subject to regulation, supervision and
licensing under various U.S. or Canadian federal, state, provincial and local
statutes, ordinances and regulations. Each auction is subject to laws in the
state or province in which it operates which regulate auctioneers and/or vehicle
dealers. Some of the transport vehicles used at our auctions are regulated by
the U.S. Department of Transportation or the Canadian Transportation Agency. The
acquisition and sale of salvage and theft recovered vehicles is regulated by
governmental agencies in each of the locations in which we operate. In many
states and provinces, regulations require that a salvage vehicle be forever
"branded" with a salvage notice in order to notify prospective purchasers of the
vehicle's previous salvage status. Some state, provincial and local regulations
also limit who can purchase salvage vehicles, as well as determine whether a
salvage vehicle can be sold as rebuildable or must be sold for parts only. Such
regulations can reduce the number of potential buyers of vehicles at salvage
auctions. In addition to the regulation of the sales and acquisition of
vehicles, we are also subject to various local zoning requirements with regard
to the location and operation of our auction and storage facilities.
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PAGE 25
ALLETE FORM 10-K 2003
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PART I
ENVIRONMENTAL MATTERS
Certain businesses in our Automotive Services segment are subject to
regulation by various U.S. and Canadian federal, state, provincial and local
authorities concerning air quality, water quality, solid wastes and other
environmental matters. In the vehicle redistribution industry, large numbers of
vehicles, including damaged vehicles at salvage auctions, are stored at auction
facilities and, during that time, releases of fuel, motor oil and other fluids
may occur, resulting in soil, air, surface water or groundwater contamination.
In addition, our facilities generate and/or store petroleum products and other
hazardous materials, including wastewater waste solvents and used oil, and body
shops at our facilities may release harmful air emissions associated with
painting. We could incur substantial expenditures for preventative,
investigative or remedial action and could be exposed to liability arising from
our operations, contamination by previous users of our acquired facilities, or
the disposal of our waste at off-site locations. We consider these businesses to
be in substantial compliance with those environmental regulations currently
applicable to their operations and believe all necessary permits to conduct such
operations have been obtained. We review environmental matters on a quarterly
basis. Accruals for environmental matters are recorded when it is probable that
a liability has been incurred and the amount of the liability can be reasonably
estimated, based on current law and existing technologies. These accruals are
adjusted periodically as assessment and remediation efforts progress, or as
additional technical or legal information becomes available. Accruals for
environmental liabilities are included in the balance sheet at undiscounted
amounts and exclude claims for recoveries from insurance or other third parties.
Costs related to environmental contamination treatment and cleanup are charged
to expense.
ADESA IMPACT TAUNTON FACILITY. In December 2003 the Massachusetts Department
of Environmental Protection (MDEP) identified ADESA Impact as a potentially
responsible party regarding contamination of several private drinking water
wells in a residential development that abuts the Taunton, Massachusetts salvage
vehicle auction facility. The wells had elevated levels of methyl tertiary-butyl
ether (MTBE). MTBE is an oxygenating additive in gasoline to reduce harmful
emissions. The EPA has identified MTBE as a possible carcinogen. ADESA Impact
engaged GeoInsight, an environmental services firm, to conduct tests of its soil
and groundwater at the salvage vehicle auction site, and we are providing
bottled water to some affected residents.
GeoInsight prepared an immediate response action (IRA) plan, which is
required by the MDEP to determine the extent of the environmental impact and
define activities to prevent further environmental contamination. The IRA plan,
which was filed on January 24, 2004, describes the initial activities ADESA
Impact performed, and proposes additional measures that it will use to further
assess the existence of any imminent hazard to human health. In addition, as
required by the MDEP, ADESA Impact is conducting an analysis to identify
sensitive receptors that may have been affected, including area schools and
municipal wells. GeoInsight does not believe that an imminent hazard condition
exists at the Taunton site; however, the investigation and assessment of site
conditions are ongoing.
In December 2003 GeoInsight collected soil samples, conducted groundwater
tests and provided oversight for the installation of monitoring wells in various
locations on and adjacent to the property adjoining the residential community.
The results of the soil and water tests indicated levels of MTBE exceeding MDEP
standards. In January 2004 we collected air samples from two residences that we
identified as having elevated drinking water concentrations of MTBE. We have
determined that inhalation of, or contact exposure to, this air poses minimal
risk to human health. In response to our empirical findings, we have proposed to
the MDEP that we install granular activated carbon filtration systems in the
approximately 30 affected residences.
ADESA Impact is preparing an IRA status report that must be submitted to the
MDEP by March 30, 2004, and will continue to prepare additional reports as
necessary. As of December 31, 2003 ADESA Impact has accrued $0.7 million to
cover the costs associated with ongoing testing, remediation and cleanup of the
site. We have filed a claim under our pollution liability insurance plan with
respect to this matter. We and our insurer are currently discussing the
availability of insurance coverage for this claim.
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PAGE 26
ALLETE FORM 10-K 2003
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PART I
INVESTMENTS AND CORPORATE CHARGES
Our Investments and Corporate Charges segment consists of 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. The discussion below summarizes the major components of the Investments
and Corporate Charges segment. Statistical information is presented as of
December 31, 2003 unless otherwise noted. All subsidiaries are wholly owned
unless otherwise specifically indicated.
REAL ESTATE OPERATIONS
Our real estate operations include CAPE CORAL HOLDINGS, INC.; PALM COAST
LAND, LLC; PALM COAST FOREST, LLC; TOMOKA HOLDINGS, LLC; WINTER HAVEN CITI
CENTRE, LLC; and an 80% ownership in LEHIGH. Through subsidiaries, we own
Florida real estate operations in five different locations:
- Lehigh Acres with 890 acres of residential and commercial land, east
of Fort Myers, Florida;
- Cape Coral, located west of Fort Myers, Florida, with 160 acres of mostly
commercially zoned land;
- Palm Coast, a planned community between St. Augustine and Daytona Beach,
Florida, with 12,000 acres of residential, commercial and industrial land;
- Tomoka, located near Ormand Beach, Florida with 6,200 acres of property;
and
- Winter Haven, located in central Florida, with a retail shopping center.
Our real estate operations may, from time to time, acquire packages of
diversified properties at low cost, then add value through entitlements and
infrastructure enhancements, and sell the properties at current market prices.
EMERGING TECHNOLOGY INVESTMENTS
From 1985 through 2003 we have invested more than $50 million in start-up
companies which are developing technologies that may be utilized by the electric
utility industry. We are committed to invest an additional $4.8 million at
various times through 2007. The investments were first made through emerging
technology funds (Funds) initiated by other electric utilities and us. We have
also made investments directly in privately held companies.
The Funds have made investments in companies that develop advanced
technologies to be used by the utility industry, including electrotechnologies,
renewable energy technologies, and software and communications technologies
related to utility customer support systems.
Companies in the Funds' portfolios may complete initial public offerings
(IPOs), and the Funds, may in some instances, distribute publicly tradable
shares to us. Some restrictions on sales may apply, including, but not limited
to, underwriter lock-up periods that typically extend for 180 days following an
IPO. As companies included in our emerging technology investments are sold, we
will recognize a gain or loss.
Since going public, the market value of the publicly traded investments has
experienced significant volatility. During 2003 we sold at a net loss the
remainder of our direct investment in the companies that have gone public.
We also have several minority investments in the Funds and privately-held
start-up companies. These investments are accounted for under the cost method
and included with Investments on our consolidated balance sheet. The total
carrying value of these investments was $37.5 million at December 31, 2003
($38.7 million at December 31, 2002).
Our policy is to review these investments quarterly for impairment by
assessing such factors as continued commercial viability of products, cash flow
and earnings. Any impairment would reduce the carrying value of the investment.
ENVIRONMENTAL MATTERS
Certain businesses included in our Investments and Corporate Charges segment
are subject to regulation by various federal, state and local authorities
concerning air quality, water quality, solid wastes and other environmental
matters. We consider these businesses to be in substantial compliance with those
environmental regulations currently applicable to their operations and believe
all necessary permits to conduct such operations have been obtained. We review
environmental matters on a quarterly basis. Accruals for environmental matters
are recorded when it is probable that a liability has been incurred and the
amount of the liability can be reasonably estimated, based on current law and
existing technologies. These accruals are adjusted periodically as assessment
and remediation efforts progress, or as additional technical or legal
information becomes available. Accruals for environmental liabilities are
included in the balance sheet at undiscounted amounts and exclude claims for
recoveries from insurance or other third parties. Costs related to environmental
contamination treatment and cleanup are charged to expense.
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PAGE 27
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
EXECUTIVE OFFICERS OF THE REGISTRANT
EXECUTIVE OFFICERS INITIAL EFFECTIVE DATE
====================================================================================================================================
DAVID G. GARTZKE, Age 60
Chairman - ALLETE;
Chairman, President and Chief Executive Officer - ALLETE Automotive Services, Inc.;
Chairman, President and Chief Executive Officer - ADESA, Inc.; and
Chairman and Chief Executive Officer - ADESA Corporation January 23, 2004
Chairman - ALLETE;
Chairman, President and Chief Executive Officer - ALLETE Automotive Services, Inc.; and
Chairman and Chief Executive Officer - ADESA Corporation January 21, 2004
Chairman, President and Chief Executive Officer - ALLETE;
Chairman, President and Chief Executive Officer - ALLETE Automotive Services, Inc.; and
Chairman and Chief Executive Officer - ADESA Corporation July 7, 2003
Chairman, President and Chief Executive Officer - ALLETE January 23, 2002
President - ALLETE August 28, 2001
Senior Vice President - Finance and Chief Financial Officer - ALLETE December 1, 1994
DONALD J. SHIPPAR, Age 55
President and Chief Executive Officer - ALLETE January 21, 2004
Executive Vice President - ALLETE and
President - Minnesota Power May 13, 2003
President and Chief Operating Officer - Minnesota Power January 1, 2001
DEBORAH A. AMBERG, Age 38
Vice President, General Counsel and Secretary March 8, 2004
BRENDA J. FLAYTON, Age 48
Vice President - Human Resources - ALLETE and
Vice President - Human Resources - ALLETE Automotive Services, Inc. October 22, 2003
Vice President - Human Resources - ALLETE July 22, 1998
JAMES P. HALLETT, Age 50
Executive Vice President - ALLETE;
Vice President - ADESA, Inc.; and
President and Chief Operating Officer - ADESA Corporation, LLC March 4, 2004
Executive Vice President - ALLETE;
Vice President - ADESA, Inc.; and
President and Chief Operating Officer - ADESA Corporation March 1, 2004
Executive Vice President - ALLETE and
President and Chief Operating Officer - ADESA Corporation January 30, 2004
Executive Vice President - ALLETE and
President - ADESA Corporation July 7, 2003
Executive Vice President - ALLETE and
President and Chief Executive Officer - ALLETE Automotive Services, Inc. November 5, 2001
Executive Vice President - ALLETE and Chief Executive Officer - ADESA Corporation October 1, 2001
Executive Vice President - ALLETE and
President and Chief Executive Officer - ADESA Corporation April 23, 1997
PHILIP R. HALVERSON, Age 55
Retired March 5, 2004
Vice President, General Counsel and Secretary January 1, 1996
MARK A. SCHOBER, Age 48
Senior Vice President and Controller February 1, 2004
Vice President and Controller April 18, 2001
Controller March 1, 1993
TIMOTHY J. THORP, Age 49
Vice President - Investor Relations and Corporate Communications November 16, 2001
JAMES K. VIZANKO, Age 50
Senior Vice President, Chief Financial Officer and Treasurer January 21, 2004
Vice President, Chief Financial Officer and Treasurer August 28, 2001
Vice President and Treasurer April 18, 2001
Treasurer March 1, 1993
- --------------------------------------------------------------------------------
PAGE 28
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
PART I
All of the executive officers have been employed by us for more than five
years in executive or management positions. In the five years prior to election
to the positions shown on the previous page, Ms. Amberg was senior attorney, Ms.
Flayton was director of human resources, Mr. Shippar was Minnesota Power's chief
operating officer, senior vice president of customer service and delivery, and
vice president of transmission and distribution, and Mr. Thorp was director of
investor relations.
There are no family relationships between any of the executive officers. All
officers and directors are elected or appointed annually.
The present term of office of the executive officers listed on the previous
page extends to the first meeting of our Board of Directors after the next
annual meeting of shareholders. Both meetings are scheduled for May 11, 2004.
ITEM 2. PROPERTIES
Properties are included in the discussion of our business in Item 1. and are
incorporated by reference herein.
ITEM 3. LEGAL PROCEEDINGS
Material legal and regulatory proceedings are included in the discussion of
our business in Item 1. and are incorporated by reference herein.
We are involved in litigation arising in the normal course of business. Also
in the normal course of business, we are involved in tax, regulatory and other
governmental audits, inspections, investigations and other proceedings that
involve state and federal taxes, safety, compliance with regulations, rate base
and cost of service issues, among other things. While the resolution of such
matters could have a material effect on earnings and cash flows in the year of
resolution, none of these matters are expected to change materially our present
liquidity position, nor have a material adverse effect on our financial
condition.
The staff of the SEC is conducting an informal inquiry relating to our
internal audit function, internal financial reporting and the loan loss
methodology at AFC. We are fully and voluntarily cooperating with the informal
inquiry, and the SEC staff has not asserted that we have acted improperly or
illegally. Although we cannot predict the length, scope or results of the
informal inquiry, based upon extensive review by the Audit Committee of our
Board of Directors with the assistance of independent counsel and our
independent auditors, we believe that we have acted appropriately and that this
inquiry will not result in action that has a material adverse impact on us or
our reported results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 2003.
- --------------------------------------------------------------------------------
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
We have paid dividends without interruption on our common stock since 1948. A
quarterly dividend of $0.2825 per share on our common stock will be paid on
March 1, 2004 to the holders of record on February 16, 2004. Our common stock is
listed on the New York Stock Exchange under the symbol ALE and our CUSIP number
is 018522102. Dividends paid per share, and the high and low prices for our
common stock for the periods indicated as reported by the New York Stock
Exchange on its NYSEnet website, are in the accompanying chart.
The amount and timing of dividends payable on our common stock are within the
sole discretion of our Board of Directors. In 2003 we paid out 40% of our per
share earnings in dividends.
Our Articles of Incorporation, and Mortgage and Deed of Trust contain
provisions which under certain circumstances would restrict the payment of
common stock dividends. As of December 31, 2003 no retained earnings were
restricted as a result of these provisions. At March 1, 2004 there were
approximately 37,000 common stock shareholders of record.
PRICE RANGE
--------------------- DIVIDENDS
QUARTER HIGH LOW PAID
======================================================================
2003 - First $24.05 $18.75 $0.2825
Second 26.70 20.50 0.2825
Third 27.86 25.45 0.2825
Fourth 31.00 27.05 0.2825
- ----------------------------------------------------------------------
Annual Total $1.13
- ----------------------------------------------------------------------
2002 - First $29.43 $24.25 $0.275
Second 31.10 27.09 0.275
Third 27.62 18.50 0.275
Fourth 23.80 18.65 0.275
- ----------------------------------------------------------------------
Annual Total $1.10
======================================================================
- --------------------------------------------------------------------------------
PAGE 29
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
PART II
ITEM 6. SELECTED FINANCIAL DATA
Operating results of our Water Services businesses, our vehicle transport
and import businesses, and our retail stores are included in discontinued
operations and, accordingly, amounts have been adjusted for all periods
presented. Common share and per share amounts have also been adjusted for all
periods to reflect our March 2, 1999 two-for-one common stock split.
2003 2002 2001 2000 1999 1998
====================================================================================================================================
MILLIONS
BALANCE SHEET
Assets
Current Assets $ 680.5 $ 629.6 $ 853.3 $ 677.2 $ 506.0 $ 444.6
Discontinued Operations - Current 14.9 28.8 42.2 41.5 43.7 29.1
Property, Plant and Equipment 1,499.0 1,364.7 1,323.3 1,201.1 1,003.4 955.5
Investments 204.6 170.9 155.4 128.7 212.0 277.3
Goodwill 511.0 502.0 491.9 472.8 181.0 169.8
Other Assets 103.4 105.1 106.1 87.3 82.4 91.2
Discontinued Operations - Other 87.9 346.1 310.3 305.4 284.1 241.4
- ------------------------------------------------------------------------------------------------------------------------------------
$3,101.3 $3,147.2 $3,282.5 $2,914.0 $2,312.6 $2,208.9
- ------------------------------------------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Current Liabilities $ 476.7 $ 708.5 $ 658.6 $ 661.9 $ 366.1 $ 326.3
Discontinued Operations - Current 49.5 29.7 45.9 45.1 32.2 19.7
Long-Term Debt 747.7 696.4 968.9 852.3 613.0 575.7
Mandatorily Redeemable Preferred Securities - 75.0 75.0 75.0 75.0 75.0
Other Liabilities 322.2 277.4 270.5 257.5 265.3 286.1
Discontinued Operations - Other 45.0 127.8 119.8 121.4 123.7 109.0
Redeemable Preferred Stock - - - - 20.0 20.0
Shareholders' Equity 1,460.2 1,232.4 1,143.8 900.8 817.3 797.1
- ------------------------------------------------------------------------------------------------------------------------------------
$3,101.3 $3,147.2 $3,282.5 $2,914.0 $2,312.6 $2,208.9
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME STATEMENT
Operating Revenue
Energy Services $ 659.6 $ 626.0 $ 618.7 $ 586.4 $ 553.1 $ 558.9
Automotive Services 922.3 835.8 832.1 522.6 383.2 305.5
Investments 36.9 32.5 74.8 77.4 57.8 55.5
- ------------------------------------------------------------------------------------------------------------------------------------
1,618.8 1,494.3 1,525.6 1,186.4 994.1 919.9
- ------------------------------------------------------------------------------------------------------------------------------------
Expenses
Fuel and Purchased Power 252.5 234.8 233.1 229.0 200.2 205.7
Operations 1,064.7 997.9 1,007.3 725.3 595.8 538.7
Interest Expense 66.6 70.5 83.0 67.1 57.8 62.9
- ------------------------------------------------------------------------------------------------------------------------------------
1,383.8 1,303.2 1,323.4 1,021.4 853.8 807.3
- ------------------------------------------------------------------------------------------------------------------------------------
Operating Income Before Capital Re and ACE 235.0 191.1 202.2 165.0 140.3 112.6
Income (Loss) from Investment in Capital Re
and Related Disposition of ACE - - - 48.0 (34.5) 15.2
- ------------------------------------------------------------------------------------------------------------------------------------
Operating Income from Continuing Operations 235.0 191.1 202.2 213.0 105.8 127.8
Income Tax Expense 91.9 72.2 73.3 76.1 50.0 48.2
- ------------------------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations 143.1 118.9 128.9 136.9 55.8 79.6
Income from Discontinued Operations 93.3 18.3 9.8 11.7 12.2 8.9
- ------------------------------------------------------------------------------------------------------------------------------------
Net Income 236.4 137.2 138.7 148.6 68.0 88.5
Preferred Dividends - - - 0.9 2.0 2.0
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings Available for Common Stock 236.4 137.2 138.7 147.7 66.0 86.5
Common Stock Dividends 93.2 89.2 81.8 74.5 73.0 65.0
- ------------------------------------------------------------------------------------------------------------------------------------
Retained (Deficit) in the Business $ 143.2 $ 48.0 $ 56.9 $ 73.2 $ (7.0) $ 21.5
====================================================================================================================================
- --------------------------------------------------------------------------------
PAGE 30
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
PART II
2003 2002 2001 2000 1999 1998
====================================================================================================================================
Shares Outstanding - Millions
Year-End 87.3 85.6 83.9 74.7 73.5 72.3
Average <F1>
Basic 82.8 81.1 75.8 69.8 68.4 64.0
Diluted 83.3 81.7 76.5 70.1 68.6 64.2
Diluted Earnings Per Share
Continuing Operations $1.72 $1.46 <F3> $1.68 $1.95 <F6> $0.79 <F6> $1.21
Discontinued Operations 1.12 <F2> 0.22 <F4> 0.13 <F5> 0.16 0.18 0.14
- ------------------------------------------------------------------------------------------------------------------------------------
$2.84 $1.68 $1.81 $2.11 $0.97 $1.35
- ------------------------------------------------------------------------------------------------------------------------------------
Return on Common Equity 17.7% 11.4% 13.3% 17.1% 8.3% 12.4%
Common Equity Ratio 64.4% 51.7% 49.9% 46.3% 49.3% 49.9%
Dividends Paid Per Share $1.13 $1.10 $1.07 $1.07 $1.07 $1.02
Dividend Payout 40% 66% 59% 51% 110% 76%
Book Value Per Share at Year-End $16.73 $14.39 $13.63 $12.06 $10.97 $10.86
Market Price Per Share
High $31.00 $31.10 $26.89 $25.50 $22.09 $23.13
Low $18.75 $18.50 $20.19 $14.75 $16.00 $19.03
Close $30.60 $22.68 $25.20 $24.81 $16.94 $22.00
Market/Book at Year-End 1.83 1.58 1.85 2.06 1.54 2.03
Price Earnings Ratio at Year-End 10.8 13.5 13.9 11.8 17.5 16.3
Dividend Yield at Year-End 3.7% 4.9% 4.2% 4.3% 6.3% 4.6%
Employees 13,115 14,181 13,763 12,633 8,246 7,003
Net Income
Energy Services $ 42.4 $ 41.8 <F3> $ 51.7 $ 44.5 $46.0 $48.3
Automotive Services 114.8 94.2 74.8 49.9 40.3 24.6
Investments and Corporate Charges (14.1) (17.1) 2.4 42.5 <F6> (30.5) <F6> 6.7
- ------------------------------------------------------------------------------------------------------------------------------------
Continuing Operations 143.1 118.9 128.9 136.9 55.8 79.6
Discontinued Operations 93.3 <F2> 18.3 <F4> 9.8 <F5> 11.7 12.2 8.9
- ------------------------------------------------------------------------------------------------------------------------------------
$236.4 $137.2 $138.7 $148.6 $68.0 $88.5
- ------------------------------------------------------------------------------------------------------------------------------------
Electric Customers - Thousands 149.0 147.0 145.0 144.0 139.7 138.1
Electric Sales - Millions of MWh
Regulated Utility 11.1 11.1 10.9 11.7 11.3 12.0
Nonregulated 1.5 1.2 0.2 0.2 - -
Company Use and Losses (0.9) (0.5) 0.5 0.5 0.5 0.2
- ------------------------------------------------------------------------------------------------------------------------------------
11.7 11.8 11.6 12.4 11.8 12.2
- ------------------------------------------------------------------------------------------------------------------------------------
Regulated Utility Power Supply - Millions of MWh
Steam Generation 7.1 7.2 6.9 6.4 6.2 6.3
Hydro Generation 0.4 0.5 0.5 0.5 0.7 0.6
Long-Term Purchase - Square Butte 2.3 2.3 1.9 2.4 2.3 2.1
Purchased Power 1.9 1.8 2.3 3.1 2.6 3.2
- ------------------------------------------------------------------------------------------------------------------------------------
11.7 11.8 11.6 12.4 11.8 12.2
- ------------------------------------------------------------------------------------------------------------------------------------
Coal Sold - Millions of Tons 4.3 4.6 4.1 4.4 4.5 4.2
Vehicles Sold - Thousands
Used 1,810 1,741 1,761 1,286 1,037 897
Salvage 191 175 148 33 - -
Loan Transactions - Thousands 950 946 904 795 695 531
Capital Expenditures - Millions $136.3 $201.2 $149.2 $168.7 $99.7 $80.8
====================================================================================================================================
<FN>
<F1> Excludes unallocated ESOP shares.
<F2> Included a $71.6 million, or $0.86 per share, after-tax gain on the sale of substantially all our Water Services businesses.
<F3> Included a $5.5 million, or $0.07 per share, charge related to the indefinite delay of a generation project in Superior,
Wisconsin.
<F4> Included $3.9 million, or $0.05 per share, in charges to complete the exit from the vehicle transport business and the retail
stores.
<F5> Included a $4.4 million, or $0.06 per share, estimated charge to exit the vehicle transport business.
<F6> In 2000 we recorded a $30.4 million, or $0.44 per share, gain on the sale of 4.7 million shares of ACE that we received in 1999
when Capital Re merged with ACE. As a result of the merger, in 1999 we recorded a $36.2 million, or $0.52 per share, charge.
</FN>
- --------------------------------------------------------------------------------
PAGE 31
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
PART II
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CONSOLIDATED OVERVIEW
During 2003 our efforts focused on our two core businesses, Energy Services
and Automotive Services. After a lengthy review of our strategic alternatives,
in October 2003 we announced plans to spin off our Automotive Services business.
We expect the spin-off to occur in the third quarter of 2004. This decision
reflects our intention to maximize the long-term value of each business by
creating two separate, more focused companies, and create long-term shareholder
value. (See Outlook.) We also substantially completed the sale of our Water
Services businesses. Proceeds from the sale of our water assets were used to pay
down debt which strengthened our balance sheet.
Net income and diluted earnings per share for 2003 increased 72% and 69% from
2002, respectively. Gains recognized in 2003 on the sale of substantially all
our water and wastewater systems in Florida contributed to increased earnings.
Net income and diluted earnings per share from continuing operations for 2003
increased 20% and 18% from 2002, respectively. A strong performance by our
Automotive Services businesses in 2003 increased earnings from continuing
operations.
2003 2002 2001
================================================================================
MILLIONS EXCEPT
PER SHARE AMOUNTS
Operating Revenue
Energy Services $ 659.6 $ 626.0 $ 618.7
Automotive Services 922.3 835.8 832.1
Investments 36.9 32.5 74.8
- --------------------------------------------------------------------------------
$1,618.8 $1,494.3 $1,525.6
- --------------------------------------------------------------------------------
Operating Expenses
Energy Services $ 590.6 $ 560.5 $ 534.6
Automotive Services 732.7 681.7 713.1
Investments and
Corporate Charges 60.5 61.0 75.7
- --------------------------------------------------------------------------------
$1,383.8 $1,303.2 $1,323.4
- --------------------------------------------------------------------------------
Net Income
Energy Services $ 42.4 $ 41.8 $ 51.7
Automotive Services 114.8 94.2 74.8
Investments and
Corporate Charges (14.1) (17.1) 2.4
- --------------------------------------------------------------------------------
Continuing Operations 143.1 118.9 128.9
Discontinued Operations 93.3 18.3 9.8
- --------------------------------------------------------------------------------
$236.4 $137.2 $138.7
- --------------------------------------------------------------------------------
Diluted Average Shares
of Common Stock 83.3 81.7 76.5
- --------------------------------------------------------------------------------
Diluted Earnings Per Share
of Common Stock
Continuing Operations $1.72 $1.46 $1.68
Discontinued Operations 1.12 0.22 0.13
- --------------------------------------------------------------------------------
$2.84 $1.68 $1.81
- --------------------------------------------------------------------------------
Return on Common Equity 17.7% 11.4% 13.3%
================================================================================
We measure performance of our operations through careful budgeting and
monitoring of contributions to consolidated net income by each business segment.
Our financial results for the past three years include the following
significant factors which impact the comparisons between years:
- SALE OF WATER PLANT ASSETS. Earnings from Discontinued Operations for 2003
included a $71.6 million, or $0.86 per share, after-tax gain on the sale of
substantially all our Water Services businesses.
- CHARGES. Earnings from Energy Services for 2002 included a $5.5 million, or
$0.07 per share, after-tax charge related to the indefinite delay of a
generation project in Superior, Wisconsin. Earnings from Discontinued
Operations for 2002 included $3.9 million, or $0.05 per share, of after-tax
charges to exit the vehicle transport business and the retail stores ($4.4
million, or $0.06 per share in 2001).
- GOODWILL. Earnings from Automotive Services for 2001 included $9.9 million,
or $0.13 per share, of goodwill amortization expense after tax. As required
by SFAS 142, goodwill amortization was discontinued in 2002.
- REAL ESTATE TRANSACTION. Earnings from Investments for 2001 included an
$11.1 million, or $0.15 per share, after-tax gain associated with our
largest ever single real estate transaction.
STATISTICAL INFORMATION 2003 2002 2001
========================================================================
ENERGY SERVICES
Millions of Kilowatthours Sold
Regulated Utility
Retail
Residential 1,066 1,044 998
Commercial 1,286 1,257 1,234
Industrial 6,558 6,946 6,549
Other 79 78 75
Resale 2,155 1,807 2,086
- ------------------------------------------------------------------------
11,144 11,132 10,942
Nonregulated 1,462 1,149 140
- ------------------------------------------------------------------------
12,606 12,281 11,082
- ------------------------------------------------------------------------
AUTOMOTIVE SERVICES
Thousands
Vehicles Sold
Used 1,810 1,741 1,761
Salvage 191 175 148
- ------------------------------------------------------------------------
2,001 1,916 1,909
- ------------------------------------------------------------------------
Conversion Rate <F1> -
Used Vehicles 61.0% 59.0% 58.1%
Loan Transactions 950 946 904
========================================================================
<FN>
<F1> Conversion rate is the percentage of vehicles sold from those that
were offered at auction.
</FN>
- --------------------------------------------------------------------------------
PAGE 32
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
PART II
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
FOR THE YEAR ENDED DECEMBER 31 2003 2002 2001
======================================================================================
MILLIONS
Cash from Operating Activities $245.8 $453.0 $103.6
Cash from (for) Investing Activities $212.3 $(244.4) $(297.4)
Cash from (for) Financing Activities $(470.7) $(242.6) $220.0
======================================================================================
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 flow as a measure of liquidity and may not be comparable with EBITDA as
defined by other companies.
EBITDA
INVESTMENTS
ENERGY AUTOMOTIVE AND CORPORATE
FOR THE YEAR ENDED CONSOLIDATED SERVICES SERVICES CHARGES
==================================================================================================================
MILLIONS
2003
Net Income $236.4
Less: Income from Discontinued Operations 93.3
- ------------------------------------------------------------------
Income (Loss) from Continuing Operations 143.1 $ 42.4 $114.8 $(14.1)
Add Back: Income Tax Expense (Benefit) 91.9 26.6 74.8 (9.5)
Interest Expense 66.6 22.4 16.0 28.2
Depreciation and Amortization Expense 86.5 51.1 35.3 0.1
- ------------------------------------------------------------------------------------------------------------------
EBITDA $388.1 $142.5 $240.9 $ 4.7
- ------------------------------------------------------------------------------------------------------------------
2002
Net Income $137.2
Less: Income from Discontinued Operations 18.3
- ------------------------------------------------------------------
Income (Loss) from Continuing Operations 118.9 $ 41.8 $ 94.2 $(17.1)
Add Back: Income Tax Expense (Benefit) 72.2 23.7 59.9 (11.4)
Interest Expense 70.5 21.2 21.2 28.1
Depreciation and Amortization Expense 81.7 48.8 32.8 0.1
- ------------------------------------------------------------------------------------------------------------------
EBITDA $343.3 $135.5 $208.1 $ (0.3)
- ------------------------------------------------------------------------------------------------------------------
2001
Net Income $138.7
Less: Income from Discontinued Operations 9.8
- ------------------------------------------------------------------
Income from Continuing Operations 128.9 $ 51.7 $ 74.8 $ 2.4
Add Back: Income Tax Expense (Benefit) 73.3 32.4 44.2 (3.3)
Interest Expense 83.0 22.5 35.3 25.2
Depreciation and Amortization Expense 88.9 45.9 42.7 0.3
- ------------------------------------------------------------------------------------------------------------------
EBITDA $374.1 $152.5 $197.0 $24.6
==================================================================================================================
NET INCOME
ENERGY SERVICES. Income from continuing operations in 2003 was up $0.6
million, or 1%, from 2002 reflecting increased sales of nonregulated generation
at our Taconite Harbor facility and improved wholesale power prices.
Increased sales of nonregulated generation and higher expenses related to
that generation resulted from Taconite Harbor being available for a full 12
months in 2003. Taconite Harbor generation first came online at various times
during the first half of 2002. Generation secured through the Kendall County
power purchase agreement began in May 2002. In total, the Kendall County
facility operated at a loss in 2003 due to negative spark spreads (the
differential between electric and natural gas prices) in the wholesale power
market and our resulting inability to cover the fixed capacity charge on
approximately 175 MW. We expect the facility to continue to generate losses
until such time as spark spreads improve or we are able to enter into additional
long-term capacity sales contracts.
- --------------------------------------------------------------------------------
PAGE 33
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
PART II
Wholesale power prices were higher in 2003 compared to 2002 when weak
wholesale power prices more than offset the positive impact of increased
nonregulated megawatthour sales. In 2001 our wholesale power marketing
activities were more profitable compared to 2002 due to warmer summer weather
and overall market conditions.
In 2003 higher employee pension and benefit expenses, and a charge to exit
our Split Rock Energy joint venture reduced income, while in 2002 a $5.5 million
charge related to the indefinite delay of a generation project in Superior,
Wisconsin, reduced income. Income in 2002 also included a $2.3 million one-time
deferral of costs recoverable through the regulated utility fuel clause that
increased income. Income in 2001 included the recovery of $2.6 million for 1998
CIP lost margins.
AUTOMOTIVE SERVICES. Income from continuing operations in 2003 was up $20.6
million, or 22%, from 2002. Higher income in 2003 was attributable to an
increased number of vehicles sold, fee increases, the introduction and expansion
of our service offerings, lower interest expense due to lower debt balances,
gains on sale of property and strong receivable portfolio management at AFC, our
floorplan financing business.
At ADESA used vehicle auction facilities, vehicles sold increased 4% over
2002. Total vehicles sold at our auctions decreased in 2002 as the price spreads
between new and used vehicles were disrupted by the increased manufacturer
incentives on new vehicles that were first introduced following the events of
September 11, 2001. The aggressive incentives offered by vehicle manufacturers
lowered the cost of owning a new vehicle, which in turn depressed prices for
late-model used vehicles. Sellers at used vehicle auctions tended to hold their
vehicles rather than immediately accept lower prices. In addition to the
incentives, the supply of program vehicles from rental repurchase programs
maintained by our institutional customers were lower in 2002 due to the decrease
in the sizes of rental car fleets in response to the decrease in the travel
industry after September 11, 2001. The size of the rental car fleets remained at
a lower level throughout 2002 as compared to the levels prior to September 11
leading to fewer turns of the fleets. Costs of assimilating the 28 used vehicle
auction facilities acquired or opened in 2000 also impacted 2001 results.
At our salvage vehicle auction facilities, vehicle sales continued to
increase reflecting expansion into new markets, which included adding salvage
auctions at some of our used vehicle auction facilities. During 2003 ADESA
Impact opened two auction facilities (two in 2002; 13 in 2001). In 2003, 9% more
vehicles were sold at our salvage vehicle auction facilities than in 2002.
Despite unseasonably dry weather conditions in 2002, which usually means fewer
salvage vehicles, the number of vehicles sold at our salvage vehicle auction
facilities was 18% higher in 2002 compared to 2001.
AFC contributed 32% of the income from Automotive Services in 2003 (37% in
2002; 40% in 2001). Income from AFC was higher in 2003 because of lower interest
and bad debt expense. Interest expense decreased due to lower debt balances and
rates. Bad debt expense was down reflecting improved credit quality of the
receivable portfolio and strong receivable portfolio management. Loan
transactions increased slightly to 950,000 in 2003. AFC managed total
receivables of $539 million at December 31, 2003 ($501 million at December 31,
2002; $505 million at December 31, 2001).
As required by SFAS 142, goodwill amortization was discontinued in 2002. This
mandated accounting change is a significant factor when comparing 2002 and 2001
earnings from Automotive Services. Earnings for 2001 included $9.9 million of
goodwill amortization expense after tax.
INVESTMENTS AND CORPORATE CHARGES. Net loss in 2003 decreased $3.0 million,
or 18%, from 2002. In 2003 more real estate sales were 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. In 2001 our real estate operations reported strong sales including an
$11.1 million gain on its largest single sale ever, and our trading securities
portfolio earned a negative 1.5% after-tax annualized return prior to
liquidation in 2002 compared to a positive 5.6% in 2001.
Corporate charges in 2003 reflected less interest expense due to lower debt
balances and lower interest rates. In 2002 and 2001 interest expense was higher
as a result of debt issued to fund strategic initiatives in early 2001.
Corporate charges in 2003 also reflected costs incurred for professional
services related to the business separation study, as well as higher incentive
compensation expenses. Incentive compensation expenses were lower in 2002 in
part due to lower 2002 earnings. In 2001 additional compensation expenses were
incurred for severance packages.
DISCONTINUED OPERATIONS included the financial results of our Water Services
businesses, our vehicle transport and import businesses, and our retail stores.
Net income from Discontinued Operations in 2003 was up $75.0 million from
2002 primarily due to the sale of water and wastewater systems serving various
counties and communities in Florida. A $71.6 million after-tax gain was
recognized on the sale of these systems, net of all selling, transaction and
employee termination benefit expenses, as well as impairment losses on certain
remaining assets.
Our Water Services businesses in North Carolina reported a 14% decrease in
water consumption because above normal precipitation decreased consumption in
2003.
Net income from Discontinued Operations was also higher in 2003 and 2002 due
to the adoption of SFAS 144 which required suspension of depreciation on our
Water Services assets. Income from Discontinued Operations included $7.5 million
of depreciation expense after tax in 2001.
Net income from other discontinued operations in 2003 included a $1.3 million
recovery from the settlement of a
- --------------------------------------------------------------------------------
PAGE 34
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
PART II
lawsuit associated with our vehicle transport business, while net income in 2002
included $3.9 million of exit charges related to the vehicle transport business
and the retail stores, and 2001 included a $4.4 million charge to exit the
vehicle transport business.
2003 COMPARED TO 2002
ENERGY SERVICES
Regulated utility operations include retail and wholesale rate regulated
activities under the jurisdiction of state and federal regulatory authorities.
Nonregulated operations consist of nonregulated electric generation (non-rate
base generation sold at market-based rates to the wholesale market), coal mining
and telecommunications activities. Nonregulated generation operations consist
primarily of Taconite Harbor 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, ending in 2017.
OPERATING REVENUE in total was up $33.6 million, or 5%, in 2003 reflecting
increases from both regulated utility and nonregulated operations. Regulated
utility operating revenue was up $7.2 million, or 1%, mainly due to higher fuel
clause recoveries and natural gas prices. Regulated utility kilowatthour sales
were similar to last year. Fuel clause recoveries increased due to higher
purchased power costs. Our 2003 equity in net income from Split Rock Energy
reflected a $2.3 million charge accrued at the time we reached an agreement to
withdraw from this joint venture. Nonregulated revenue increased $26.4 million,
or 22%, in 2003 primarily due to increased sales of nonregulated generation at
our Taconite Harbor facility, improved wholesale power prices and more sales
activity at our telecommunications business. Increased sales of nonregulated
generation resulted from Taconite Harbor being available for a full 12 months in
2003. Taconite Harbor generation first came online at various times during the
first half of 2002.
OPERATING EXPENSES in total were up $30.1 million, or 5%, in 2003. Regulated
utility operating expenses were up $26.3 million, or 6%, in 2003 primarily due
to increased purchased power and gas expense, as well as increased employee
pension and benefit expenses. Higher purchased power costs resulted from both
increased wholesale prices and quantities purchased. Planned maintenance outages
at our generating stations and lower output from our hydro facilities as a
result of drier weather necessitated higher quantities of purchased power this
year. Gas expense was higher in 2003 due to increased prices. Expenses for
pension and post-retirement health benefits increased mainly 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 operating expenses increased $3.8 million, or
3%, 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 a full 12 months of demand charges
related to the Kendall County power purchase agreement, while 2002 included only
eight months. Operating expenses were also higher in 2003 due to increased sales
activity at our telecommunications business. Operating expenses in 2002 included
a $9.5 million charge related to the indefinite delay of the generation project
in Superior, Wisconsin.
AUTOMOTIVE SERVICES
OPERATING REVENUE was up $86.5 million, or 10%, in 2003. Revenue from our
auction and related services was higher in 2003 primarily due to an increased
number of vehicles sold through our auctions, a shift towards the sale of more
institutional vehicles, selective fee increases and the increased Canadian
dollar currency exchange rate. At our used vehicle auction facilities, 4% more
vehicles were sold in 2003. Most of the auction volume growth consisted of
internal same store growth. Volumes increased in 2003 due to the stabilization
of wholesale used vehicle prices in mid-2003, increased demand for used vehicles
as retail demand increased during the year and an increase in volume from our
institutional customers. At our salvage auction facilities, vehicles sold
increased 9% as we expanded into new markets, including sites where we combined
salvage auctions with our existing used vehicle auction facilities. Same store
vehicles sold at our salvage auctions increased slightly less than 1%.
While the number of loan transactions by AFC was up slightly from last year,
revenue from AFC was up in 2003 primarily because strong receivable portfolio
management lowered bad debt expense. As customary for a finance company, we
report revenue net of interest expense and bad debt expense.
OPERATING EXPENSES were up $51.0 million, or 7%, in 2003 primarily due to
additional expenses incurred for reconditioning and logistics services as a
result of a shift towards the sale of more institutional vehicles at our
auctions, increased Canadian dollar currency exchange rate, and costs incurred
due to inclement weather and general inflationary increases.
INVESTMENTS AND CORPORATE CHARGES
OPERATING REVENUE was up $4.4 million, or 14%, in 2003 as more real estate
sales offset less revenue from our emerging technology investments. In 2003, 11
large real estate sales contributed $18.5 million to revenue compared to 2002
when five large real estate sales contributed $8.5 million to revenue. In 2003
we recognized a $3.5 million 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 $0.5 million, or 1%, 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.
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Corporate Charges included operating and other expense totaling $17.6 million
in 2003 ($16.5 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 $28.0 million in 2003 ($28.1 million in 2002).
2002 COMPARED TO 2001
ENERGY SERVICES
OPERATING REVENUE in total was up $7.3 million, or 1%, in 2002 as increased
revenue from nonregulated operations was partially offset by a decrease in
regulated utility revenue. Despite a slight increase in regulated utility
megawatthour sales, regulated utility revenue decreased $33.1 million, or 6%,
due to lower wholesale prices and fuel clause recoveries. Fuel clause recoveries
in 2002 were lower due to lower purchased power costs in 2002. Total regulated
utility megawatthour sales were up 2% over the prior year reflecting increased
retail sales to taconite customers. In addition, regulated utility revenue in
2001 included the recovery of $4.5 million for 1998 CIP lost margins.
Nonregulated revenue increased $40.4 million, or 51%, in 2002 primarily as a
result of about 500 MW of nonregulated generation that came online in 2002.
There were 1.2 million megawatthours of nonregulated generation sold in 2002.
OPERATING EXPENSES in total increased $25.9 million, or 5%, in 2002. The
increase was attributable to additional expenses for nonregulated generation
that came online in 2002 which were partially offset by lower regulated utility
operating expenses. Regulated utility operating expenses were down $33.3
million, or 7%, in 2002 primarily due to lower purchased power costs. Lower
purchased power costs resulted from both lower wholesale prices and a reduction
in the quantity of power purchased. Extended planned maintenance outages in 2001
necessitated higher quantities of purchased power. Nonregulated operating
expenses increased $59.2 million, or 77%, over the prior year mainly due to
expenses for nonregulated generation that came online in 2002. The increase in
nonregulated operating expenses also included the $9.5 million charge related to
the indefinite delay of the generation project in Superior, Wisconsin.
AUTOMOTIVE SERVICES
OPERATING REVENUE was up $3.7 million, or less than 1%, in 2002. At ADESA
used vehicle auction facilities, the number of vehicles sold in 2002 was similar
to 2001 because the rental car market had yet to restore vehicle fleets to
levels prior to the events of September 11, 2001, and manufacturer incentives on
new vehicles temporarily disrupted the price spreads between new and used
vehicles.
Despite unseasonably dry weather conditions in 2002 which usually means fewer
salvage vehicles, vehicles sold at our salvage vehicle auction facilities were
up 18% reflecting expansion into new markets, which included adding salvage
auctions at some of our used vehicle auction facilities. Operating revenue from
AFC was up in 2002 due to a 5% increase in loan transactions arranged through
our loan production offices and lower bad debt expense as a result of strong
portfolio management.
OPERATING EXPENSES were down $31.4 million, or 4%, in 2002 due to reduced
interest expense ($14.1 million) as a result of lower interest rates and a lower
debt balance, the discontinuance of goodwill amortization ($12.5 million) and
improved operating efficiencies. These decreases were partially offset by an
increase in operating expenses incurred to standardize operations at all of our
salvage vehicle auction facilities and expenditures for information technology
initiatives.
INVESTMENTS AND CORPORATE CHARGES
OPERATING REVENUE was down $42.3 million, or 57%, in 2002 primarily due to a
large real estate transaction recorded in 2001. Five large real estate sales in
2002 contributed $8.5 million to revenue, while in 2001 six large real estate
sales contributed $37.5 million to revenue, one of which was our real estate
operations' largest single transaction ever. Operating revenue in 2002 also
reflected less income from our trading securities portfolio which was
substantially liquidated during the second half of the year and had
significantly lower returns during the year.
OPERATING EXPENSES were down $14.7 million, or 19%, in 2002 because of
expenses associated with larger real estate sales in 2001. Also, in 2001
additional compensation expenses were incurred for severance packages.
Corporate Charges included operating and other expense totaling $16.5 million
in 2002 ($22.8 million in 2001) for general corporate expenses such as employee
salaries and benefits, and legal and other outside contract service fees, and
interest expense of $28.1 million in 2002 ($25.2 million in 2001).
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. These policies are
reviewed with the audit committee of our Board of Directors on a regular basis.
The following summarizes those accounting measurements we believe are most
critical to our reported results of operations and financial condition.
UNCOLLECTIBLE RECEIVABLES AND ALLOWANCE FOR DOUBTFUL ACCOUNTS. The allowance
for doubtful accounts and related bad debt expense is primarily attributable to
the financing activities of AFC. In establishing a proper allowance for doubtful
accounts, our quarterly evaluation includes consideration of historical
charge-off experience, current economic conditions and specific collection
issues. Changes to historical charge-off experience or existing economic
conditions would necessitate a corresponding increase or decrease in the
allowance for doubtful accounts. The credit quality of AFC's finance
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receivable portfolio has remained strong and the total amount of the allowance
for doubtful accounts has not changed materially over the last three years. A
10% increase in AFC's current allowance for doubtful accounts would increase bad
debt expense by approximately $1 million after tax; likewise, a 10% decrease in
the current allowance for doubtful accounts would decrease bad debt expense by
approximately $1 million after tax.
IMPAIRMENT OF GOODWILL AND LONG-LIVED ASSETS. We annually review our assets
for impairment. SFAS 142, "Goodwill and Other Intangible Assets" and SFAS 144,
"Accounting for the Impairment and Disposal of Long-Lived Assets" are the basis
for these analyses. Judgments and uncertainties affecting the application of
accounting for asset impairment include: economic conditions affecting market
valuations; changes in our business strategy; and changes in our forecast of
future operating cash flows and earnings.
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. All goodwill relates to the Automotive Services segment and
represents the excess of cost over identifiable tangible and intangible net
assets of businesses acquired.
We account for our long-lived assets at depreciated historical cost. A
long-lived asset is tested for recoverability whenever events or changes in
circumstances indicate that its carrying amount may not be recoverable. We would
recognize an impairment loss only if the carrying amount of a long-lived asset
is not recoverable from its undiscounted cash flows. Management judgment is
involved in both deciding if testing for recoverability is necessary and in
estimating undiscounted cash flows. Excluding impairment losses recorded on
certain remaining water assets held for sale, as of December 31, 2003 no
write-downs were required.
PENSION AND POSTRETIREMENT HEALTH AND LIFE ACTUARIAL ASSUMPTIONS. We account
for our pension and postretirement benefit obligations in accordance with the
provisions of SFAS 87, "Employers' Accounting for Pensions" and SFAS 106
"Employers' Accounting for Postretirement Benefits Other Than Pensions." These
standards require the use of assumptions in determining the obligations and
annual cost. An important actuarial assumption for pension and other
postretirement benefit plans is the expected long-term rate of return on plan
assets. In establishing this assumption, we consider the diversification and
allocation of plan assets, the actual long-term historical performance for the
type of securities invested in, the actual long-term historical performance of
plan assets and the impact of current economic conditions, if any, on long-term
historical returns. Our pension asset allocation is approximately 70% equity and
30% fixed-rate securities. Equity securities consist of a mix of market
capitalization sizes and also include investments in real estate and venture
capital. In response to changing market conditions, we have lowered our
actuarial assumption for the expected long-term rate of return and used 9% in
the September 30, 2003 pension actuarial study (9.5% at September 30, 2002; 10%
at September 30, 2001). We annually review our expected long-term rate of return
assumption, and will continue to adjust it to respond to any changing market
conditions. A 1/2% decrease in the expected long-term rate of return would
increase the annual expense for pension and other postretirement benefits by
approximately $1 million after tax; likewise, a 1/2% increase in the expected
long-term rate of return would decrease the annual expense by approximately $1
million after tax.
VALUATION OF INVESTMENTS. As part of our emerging technology portfolio, we
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 with Investments on our consolidated balance sheet. Our policy is
to quarterly 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 and be recognized
as a loss. We did not record any impairment loss on these investments in 2003
($1.5 million pretax in 2002; $0.2 million pretax in 2001).
PROVISION FOR ENVIRONMENTAL REMEDIATION. Our businesses are subject to
regulation by various U.S. and Canadian federal, state and local authorities
concerning environmental matters. We review environmental matters on a quarterly
basis. Accruals for environmental matters are recorded when it is probable that
a liability has been incurred and the amount of the liability can be reasonably
estimated, based on current law and existing technologies. These accruals are
adjusted periodically as assessment and remediation efforts progress, or as
additional technical or legal information become available. Accruals for
environmental liabilities are included in the balance sheet at undiscounted
amounts and exclude claims for recoveries from insurance or other third parties.
Costs related to environmental contamination treatment and cleanup are charged
to expense. We do not currently anticipate that potential expenditures for
environmental matters will be material; however, if we become subject to more
stringent remediation at known sites, if we discover additional contamination,
or discover previously unknown sites, or become subject to related personal or
property damage, we could incur material costs in connection with our
environmental remediation.
OUTLOOK
Our operations in 42 states, nine Canadian provinces and Mexico employ
approximately 13,000 employees. Since 1980 our average annual total shareholder
return is 17%. Approximately 44% of this average was attributed to dividends. A
$100 investment in ALLETE stock at the end of 1980 would have been worth $3,800
at the end of 2003, assuming reinvestment of dividends on the ex-dividend date.
By comparison, the Standard & Poor's 500 Index averaged
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13% for the same period, of which approximately 24% of the average was
attributed to dividends. A $100 investment in the Standard & Poor's 500 Index at
the end of 1980 would have been worth $1,600 at the end of 2003, assuming
reinvestment of dividends on the ex-dividend date.
We remain focused on continuously improving the performance of our two core
businesses, Energy and Automotive Services.
As part of a strategic initiative to exit our Water Services businesses,
during 2003 we sold, under condemnation or imminent threat of condemnation,
substantially all of our water assets in Florida for a total sales price of
approximately $445 million. In addition, we reached an agreement to sell our
North Carolina water assets for $48 million and the assumption of approximately
$28 million in debt by the purchaser. The North Carolina sale is awaiting
approval of the NCUC and is expected to close in mid-2004. We expect to sell our
remaining water assets in 2004.
Our two core businesses remain strong and are poised for growth in their
respective markets.
SPIN-OFF OF AUTOMOTIVE SERVICES. In October 2003 our Board of Directors
approved a plan to spin off to ALLETE shareholders our Automotive Services
business which will become a publicly traded company doing business as ADESA.
The spin-off, anticipated to occur in the third quarter of 2004, 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 spin-off is
subject to the approval of the final plan by ALLETE's Board of Directors,
favorable market conditions, receipt of tax opinions, satisfaction of SEC
requirements and other customary conditions.
In March 2004 our Board of Directors approved an initial public offering
(IPO) of approximately $150 million in common shares of ADESA, representing less
than 20% of all ADESA common stock outstanding. A registration statement was
filed with the SEC in March 2004, with the sale of ADESA stock expected to take
place as soon as practical after the registration statement becomes effective.
Subsequent to the IPO, ALLETE will continue to own and consolidate the remaining
portion of ADESA until consummation of the spin-off.
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. We believe that our Automotive Services
business will be better able to pursue a business growth strategy as an
independent company. 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 operates two main businesses that are
integral parts of the vehicle redistribution industry in North America. Auctions
and related services include 53 used vehicle auctions, 27 salvage vehicle
auctions and other related services, while dealer financing consists of AFC's 80
loan production offices. Our Automotive Services business will remain based in
Indiana.
After the spin-off, ALLETE will be comprised of our Energy Services business,
which includes Minnesota Power, SWL&P, BNI Coal, Enventis Telecom and Rainy
River Energy, ALLETE Properties, Inc., our real estate operations in Florida,
and our emerging technology investments. ALLETE's headquarters will remain in
Duluth, Minnesota.
ALLETE has a history of growing our nonregulated asset and earnings base
through careful analysis by our experienced management team. Near term we will
focus on growth opportunities in our existing business segments and on improving
both operational and financial performance. Longer term our strategy is to
expand into businesses or investments that meet our free cash flow and return on
investment criteria. We will continue to capitalize on our experienced
management team in finding businesses that ultimately enable ALLETE to provide
superior total shareholder returns.
Prior to the spin-off, ALLETE and ADESA will enter into recapitalization and
debt reallocation transactions. As part of this recapitalization, ADESA will use
a portion of the proceeds from the IPO and additional debt issuances to pay a
$100 million dividend to ALLETE, as well as repay intercompany debt ($136
million at December 31, 2003). ALLETE expects to use the funds received from
ADESA to reduce debt by approximately $150 million to $200 million, provide
capital for strategic initiatives and for general corporate purposes. ADESA
expects to use the remaining proceeds from the IPO and additional debt issuances
to repay existing debt and repurchase ADESA common stock from certain ALLETE
employee benefit plans upon consummation of the spin-off. Immediately following
the spin-off, we expect ALLETE's debt to capital ratio to be approximately 40%.
The amount and timing of future dividends on ALLETE common stock and ADESA
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. ALLETE's Board of
Directors expects to continue quarterly dividend payments at the current rate
until the time of the spin-off. At that time, ALLETE's Board of Directors
anticipates it will adjust the dividend rate to equal a payout ratio similar to
that of comparable companies.
Subsequent to the spin-off of ADESA, our Retirement Savings and Stock
Ownership Plan, or RSOP, (see Note 19) will have a significant amount of cash
generated from the sale of ADESA stock received in the spin-off. The RSOP
intends to use this cash to purchase ALLETE common stock, and federal income tax
laws generally provide up to 90 days to complete this purchase. To facilitate
the RSOP's purchase of ALLETE stock, we have sought Internal Revenue Service
(IRS) approval to extend the purchase period to approximately 600 days. We
expect the IRS to rule on our request later this year.
In connection with the IPO of ADESA common stock and the subsequent spin-off
of ADESA to ALLETE shareholders, ALLETE and ADESA have entered into various
separation agreements and indemnifications customary to a transaction of this
nature.
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ENERGY SERVICES. In 2004 net income from Energy Services will be negatively
impacted by higher pension and postretirement health expenses, and additional
expenses associated with planned maintenance at Square Butte. Pension and
postretirement health expenses are expected to be approximately $7 million
pretax higher than 2003, primarily due to a lower discount rate and expected
long-term return on plan assets. (See Note 18.) In 2004 Square Butte will
perform a planned multi-week maintenance outage, and we expect our pro rata
share of the cost to be approximately $6 million pretax.
In February 2004 we experienced a generator failure at our 534-MW Boswell
Energy Center Unit 4. As a result of the failure we expect to have to replace
significant components of the generator at an estimated capital cost of $5
million. The majority of the replacement cost is covered by insurance, subject
to a deductible of $1 million. We have entered into power purchase agreements to
replace the power lost during the Unit 4 outage, which is expected to continue
through May 2004. The cost of this additional power will be recovered through
the regulated utility fuel clause. We do not expect this outage to have a
material impact on our results of operations.
Over the next five years, we believe electric utilities will face three major
issues: the ongoing changes in regional transmission structure, the probable
enactment of stricter environmental regulations and possible federal legislation
impacting the structure and organization of the electric utility industry. The
FERC plans to consolidate transmission regions, which may impact states'
transmission regulation rights and create a more standard market design to
oversee how transmission prices are determined. Specifics are being debated by
legislative and regulatory bodies. Stricter environmental requirements may
require significant capital investments in the 2008 to 2012 timeframe. The
expenditures will relate to new emission controls on existing generating units.
Proposed rules defining requirements are expected to be finalized over the next
one to four years. Though stalled in 2003, a revised federal energy bill could
pass in 2004. More electric industry consolidation could occur and new players
could enter the industry if the Public Utility Holding Company Act of 1935 is
repealed as part of this legislation. This act imposes geographic restrictions
on large electric and gas utility operations and limits diversification into
nonutility businesses.
We believe our Energy Services business is well positioned to successfully
deal with these issues and to successfully compete. Our access to and ownership
of low-cost power are Energy Services' greatest strengths. We have adequate
generation to serve our native load. Power over and above our customers'
requirements will be marketed. We also have adequate transmission capacity. We
believe electric industry deregulation is unlikely in Minnesota or Wisconsin in
the next five years. We anticipate any load losses will be manageable and that
we will have ready access to sufficient capital for general business purposes.
Approximately 50% of our regulated utility electric sales are made to
taconite mines, paper producers and oil pipeline operators. Global economic
conditions continue to affect our largest industrial retail customers and are
likely to continue over the next few years, as consolidation in the steel and
taconite industries continues, and while paper and pulp companies search for
even more efficiency and cost-cutting measures to compete in the marketplace. A
rise in Chinese steel demand and production has created a new market for the
producers of taconite in North America. Based on our research of the taconite
industry, Minnesota taconite production for 2004 is anticipated to be about 39
million tons. The annual taconite production in Minnesota was 34 million tons in
2003 (39 million tons in 2002; 33 million tons in 2001).
Though changes may occur with some of our large industrial customers, the
taconite industry is stable at this time. Our strong relationships with
industrial customers are unique in the electric industry and enable us to work
closely with them to help ensure their success. We continue strengthening these
relationships to retain a strong industrial base in our region. On average we
expect approximately 1% growth in retail electric kilowatthour sales annually
over the next five years. We continue to make investments to maintain and
improve the integrity of our generating, transmission and distribution assets,
and maintain environmental compliance. Minnesota Power is in the early stages of
preparing a request to the MPUC to increase rates for its Minnesota electric
utility operations sometime in the first half of 2005. The request may be
necessary to cover the increased cost of doing business. Minnesota Power's last
rate increase for its electric utility operations was in 1994. SWL&P is
preparing to file with the PSCW in mid-2004 a request to increase retail rates
for its Wisconsin electric utility operations to be effective sometime in early
2005. The request would cover increases in the cost of doing business. SWL&P's
last rate order for its electric utility operations was in 2001.
In June 2003 the MPUC initiated an investigation into the continuing
usefulness of the fuel clause as a regulatory tool for electric utilities. The
investigation will focus on whether the fuel clause continues to be an
appropriate regulatory tool. The initial steps will be to review the clause's
original purpose, structure and rationale (including its current operation and
relevance in today's regulatory environment), and then address its ongoing
appropriateness and other issues if the need for continued use of the fuel
adjustment clause is shown. Because this investigation is in its early stages,
we are unable to predict the outcome or impact, if any, at this time.
In response to the changing strategies of both parties, as of February 2004
we withdrew from active participation in Split Rock Energy and will terminate
our ownership interest upon receipt of FERC approval which is expected in the
first half of 2004. We have reestablished our least-cost supply and marketing
functions within the Company.
Alternatives are being explored to reduce the negative earnings impact of the
Kendall County power contract.
Our strategy is to solidify our existing customer base and seek regulated
utility growth opportunities by: (1) being an advocate
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in our region for additional industrial customers to build or expand thus adding
new customer load growth; (2) using our existing assets and enhancing them to
develop new opportunities to primarily serve retail customers; and (3)
evaluating and developing Large Power Customer projects. We will also seek to
increase our presence as a supplier to regional utilities by looking for
nonregulated generation opportunities, joint ownership of newly constructed
generation, and promoting our capabilities as a regional capacity and energy
supplier to meet increasing regional load requirements.
AUTOMOTIVE SERVICES is pursuing strategic initiatives that are designed to
capitalize on its underlying business strengths, grow its business and improve
its profitability.
We seek continuing growth through various channels, including alternate
auction venues, combination used and salvage vehicle auction sites, acquisitions
of independent auctions, and greenfield development of new auctions. In areas
where we have existing operations, we seek to leverage upon existing
infrastructure and capital investments in used vehicle operations by opening new
salvage auction sites. Our auction sites in Jacksonville, Concord, Buffalo,
Edmonton, Vancouver, Halifax and Ottawa are shared facilities that have
successfully executed this strategy. We will continue to examine our existing
sites for opportunities to combine used vehicle and salvage auction operations.
We have been a consolidator in used vehicle auctions, which has fueled much
of our historical growth. We continue to consider acquiring independent used
vehicle auctions in markets where we do not have a presence. We also expect that
consolidation opportunities will be available for salvage auctions. In regions
where we do not have a presence or where we are not able to identify acquisition
sites or we do have a presence but our auction sites are inadequate or at
capacity, we will consider greenfield development or relocation of auction
sites. We have successfully demonstrated this strategy in recent years in the
following markets: Los Angeles, Boston, Des Moines, Colorado Springs, San
Francisco, Vancouver, Long Island, Atlanta and Edmonton. We also opened new
salvage auction sites in Orlando and Long Island separate from our used vehicle
operations in those markets. We may not, however, adequately anticipate all of
the demands that our growth will impose on our systems, procedures and
structures, including our financial and reporting control systems, data
processing systems and management structure.
We strive to capitalize on the growing pool of redistributed vehicles and to
increase the volume of used and salvage vehicles redistributed through our
auctions. Our initiatives include expanding marketing of our services, such as
selling additional reconditioning services and offering post-sale inspections
and certifications. We intend to increase the volume of vehicles sold by our
existing institutional customers and add to new accounts by enabling customers
to maximize the value of their vehicles through the redistribution process. We
believe we can continue to expand our market share by realizing the highest
prices for our customers' vehicles and providing the best service.
We plan to increase revenue by selling more services per vehicle, such as
reconditioning, inspection, certification, titling and settlement administration
services. We believe we can significantly increase service penetration among
both sellers and buyers due to the economic benefits that our pre- and
post-auction services provide.
We are improving our operating efficiency by further centralizing certain
administrative functions, optimizing and standardizing our redistribution
processes, improving our use of technology and better utilizing our existing
infrastructure. Current initiatives aim at providing better information
throughout the auction process and moving vehicles faster, more accurately and
more efficiently through the auction process.
We plan to continue to expand our existing on-line service offerings in
addition to introducing new on-line services to our customers. Direct sales of
used vehicles by institutional customers and large dealer groups through
internally developed or third party on-line auctions have largely replaced
telephonic and other non-auction methods, becoming an increasing portion of
overall used vehicle redistribution over the past several years. In addition, a
portion of the vehicles that were sold through a physical auction are now being
sold on-line. Although we have embraced the Internet and offer on-line auctions
and services as part of our standard service offerings, we cannot predict what
portion of overall sales will be conducted through on-line auctions or other
redistribution methods in the future and what impact this may have on our
auction facilities.
We are committed to investing additional capital and resources for emerging
technologies and service offerings in the vehicle redistribution industry. We
will continue to tailor on-line services to each of our customers to include an
appropriate mix of physical auctions and on-line services.
INVESTMENTS AND CORPORATE CHARGES. In 2004, excluding the financial
implications of the spin-off of Automotive Services, we expect net income from
Investments and Corporate Charges to be approximately $5 million to $10 million
higher primarily as a result of debt paid off in 2003 with proceeds from the
sale of our Water Services businesses and internally generated cash. The
financial implications of the spin-off of Automotive Services include one-time
expenses of the transaction for advisor fees, debt retirement premiums and the
impact of cash received from ADESA after the IPO.
Revenue from property sales by real estate operations continues to be three
to four times more than the acquisition cost, creating strong cash generation
and profitability. Our real estate operations may, from time to time, acquire
packages of diversified properties at low cost, add value through entitlements
and infrastructure enhancements, and sell the properties at current market
prices.
We have the potential to recognize gains or losses on the sale of investments
in our emerging technology portfolio. We plan to sell investments in our
emerging technology portfolio as shares are distributed to us. Some restrictions
on sales may apply, including, but not limited to, underwriter lock-up
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periods that typically extend for 180 days following an initial public offering.
We have committed to make additional investments in certain emerging technology
holdings. The total future commitment was $4.8 million at December 31, 2003 and
is expected to be invested at various times through 2007.
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 2003 cash flow from operating activities reflected strong operating
results and continued focus on working capital management. Cash flow from
operating activities 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.
Using both the proceeds from the sale of Water Services and internally
generated cash, we repaid $360 million in debt and $75 million in manditorily
redeemable preferred securities during 2003. By year end, we significantly
strengthened our balance sheet and reduced our debt to total capital percentage
to 36% (46% at December 31, 2002), while at the same time improving our current
ratio to 1.3 (0.9 at December 31, 2002).
WORKING CAPITAL. Additional working capital, if and when needed, generally is
provided by the sale of commercial paper. During 2002 we liquidated our trading
securities portfolio and used the proceeds to reduce our short-term debt.
Approximately 3.8 million original issue shares of our common stock are
available for issuance through Invest Direct, our direct stock purchase and
dividend reinvestment plan. We have bank lines of credit aggregating $196.5
million, the majority of which expire in December 2004 and are negotiated on an
annual basis. These bank lines of credit provide credit support for our
commercial paper program. The amount and timing of future sales of our
securities will depend upon market conditions and our specific needs. We may
sell securities to meet capital requirements, to provide for the retirement or
early redemption of issues of long-term debt, to reduce short-term debt and for
other corporate purposes.
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 generally take title to or ownership of the vehicles
consigned for auction but instead facilitate the transfer of vehicle ownership
directly from sellers to buyers.
AFC offers floorplan financing for dealers to purchase vehicles mostly at
auctions and takes a security interest in each financed vehicle. 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 not funded through securitization.
SALE OF WATER PLANT ASSETS. During 2003 we sold, under condemnation or
imminent threat of condemnation, substantially all of our water assets in
Florida for a total sales price of approximately $445 million. In addition, we
reached an agreement to sell our North Carolina water assets for $48 million and
the assumption of approximately $28 million in debt by the purchaser. The North
Carolina sale is awaiting approval of the NCUC and is expected to close in
mid-2004. We expect to sell our remaining water assets in 2004.
Earnings from Discontinued Operations for 2003 included a $71.6 million
after-tax gain on the sale of substantially all our Water Services businesses.
The gain was net of all selling, transaction and employee termination benefit
expenses, as well as impairment losses on certain remaining assets.
The net cash proceeds from the sale of all water assets, after transaction
costs, retirement of most Florida Water debt and payment of income taxes, are
expected to be approximately $300 million. These net proceeds have been, and
will be, used to retire debt at ALLETE.
OFF-BALANCE SHEET ARRANGEMENTS
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. Receivables sold are not
reported on our consolidated financial statements.
At December 31, 2003 AFC managed total finance receivables of $539 million
($501 million at December 31, 2002), of which $464 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, $334 million to the bank conduit facility at December 31, 2003 ($304
million at December 31, 2002) leaving $205 million of finance receivables
recorded on our consolidated balance sheet at December 31, 2003 ($197 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
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ALLETE FORM 10-K 2003
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forth in the securitization agreement, and we are not aware of any changing
circumstances that would put AFC in noncompliance with the covenants.
SECURITIES
In March 2001 ALLETE, ALLETE Capital II and ALLETE Capital III, jointly filed
a registration statement with the SEC pursuant to Rule 415 under the Securities
Act of 1933. The registration statement, which has been declared effective by
the SEC, relates to the possible issuance of a remaining aggregate amount of
$387 million of securities which may include ALLETE common stock, first mortgage
bonds and other debt securities, and ALLETE Capital II and ALLETE Capital III
preferred trust securities. ALLETE also previously filed a registration
statement, which has been declared effective by the SEC, relating to the
possible issuance of $25 million of first mortgage bonds and other debt
securities. We may sell all or a portion of the remaining registered securities
if warranted by market conditions and our capital requirements. Any offer and
sale of the above mentioned securities will be made only by means of a
prospectus meeting the requirements of the Securities Act of 1933 and the rules
and regulations thereunder.
In June 2003 ADESA restructured its financial arrangements with respect to
its used vehicle auction facilities located in Tracy, California; Boston,
Massachusetts; Charlotte, North Carolina; and Knoxville, Tennessee. These used
vehicle 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 used vehicle 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% of the net proceeds from the sale of water assets. In accordance
with these provisions, $197.0 million was repaid in 2003 and $53.0 million was
outstanding at December 31, 2003.
In November 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.
In December 2003 ALLETE redeemed through ALLETE Capital I, a wholly owned
statutory trust of ALLETE, all $75 million aggregate liquidation amount of its
8.05% Cumulative Quarterly Income Preferred Securities (QUIPS). The redemption
price was $25 per QUIPS plus accumulated and unpaid distributions to the
redemption date. Proceeds from the sale of Florida Water assets were used to
fund this redemption.
In January 2004 we used internally generated funds to retire approximately
$3.5 million in principal amount of Industrial Development Revenue Bonds Series
1994-A, due January 1, 2004.
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 December 31, 2003 ALLETE's ratio of funded debt to total capital
was .36 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. 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 December 31, 2003 ALLETE's ratio of
funded debt to total capital was .36 to 1.0, the interest coverage ratio was
5.83 to 1.00 and ALLETE was in compliance with these financial covenants.
ALLETE's 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.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
Our long-term debt obligations, including long-term debt due within one year,
represent the principal amount of bonds, notes and loans which are recorded on
our consolidated balance sheet plus interest.
Unconditional purchase obligations represent our Square Butte and Kendall
County power purchase agreements, and minimum purchase commitments under coal
and rail contracts.
Under our power purchase agreement with Square Butte that extends through
2026, we are obligated to pay our pro rata share of Square Butte's costs based
on our entitlement to the output of Square Butte's 455 MW coal-fired generating
unit near Center, North Dakota. Our payment obligation is
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ALLETE FORM 10-K 2003
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PAYMENTS DUE BY PERIOD
-------------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS TOTAL LESS THAN 1 YEAR 1 TO 3 YEARS 4 TO 5 YEARS AFTER 5 YEARS
====================================================================================================================
MILLIONS
Long-Term Debt $1,142.3 $ 84.6 $414.2 $211.1 $432.4
Operating Lease Obligations 104.4 14.8 25.0 10.7 53.9
Unconditional Purchase Obligations 550.7 22.9 68.8 45.9 413.1
- --------------------------------------------------------------------------------------------------------------------
$1,797.4 $122.3 $508.0 $267.7 $899.4
====================================================================================================================
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. The table above reflects our share of future debt
service based on our current output entitlement of 71% through 2005 and 66%
thereafter. In December 2003 we received notice from Minnkota Power that they
will reduce our output entitlement, effective January 1, 2006, by 5% to
approximately 66%. Minnkota Power has the option to reduce our entitlement by 5%
annually, to a minimum of 50%. (See Note 15.)
Under the Kendall County agreement, we pay a fixed capacity charge for the
right, but not the obligation, to utilize one 275 MW generating unit near
Chicago, Illinois. We are responsible for arranging the natural gas fuel supply
and are entitled to the electricity produced. (See Note 15.)
EMERGING TECHNOLOGY INVESTMENTS. We have investments in emerging technologies
through the minority investments in venture capital funds and privately-held
start-up companies. We have committed to make additional investments in certain
emerging technology holdings. The total future commitment was $4.8 million at
December 31, 2003 ($7.7 million at December 31, 2002) and is expected to be
invested at various times through 2007.
CREDIT RATINGS
Our securities have been rated by Standard & Poor's Ratings Services, a
division of The McGraw-Hill Companies, Inc. (Standard & Poor's) and by Moody's
Investors Service, Inc. (Moody's). In October 2003, following our announcement
that we will implement a major corporate restructuring that will separate our
two core businesses, Standard & Poor's reaffirmed that our BBB+ corporate credit
rating remains on CreditWatch with developing implications. Our BBB+ corporate
credit rating has been on CREDITWATCH DEVELOPING since January 2003 when we
first announced that we were considering a major corporate restructuring. In an
October 2003 press release Standard & Poor's stated that the CREDITWATCH listing
will be resolved in the very near future and is likely to result in no change to
ALLETE's ratings.
Rating agencies use both quantitative and qualitative measures in determining
a company's credit rating. These measures include business risk, liquidity risk,
competitive position, capital mix, financial condition, predictability of cash
flows, management strength and future direction. Some of the quantitative
measures can be analyzed through a few key financial ratios, while the
qualitative ones are more subjective. The disclosure of these credit ratings is
not a recommendation to buy, sell or hold our securities. Ratings are subject to
revision or withdrawal at any time by the assigning rating organization. Each
rating should be evaluated independently of any other rating.
STANDARD &
CREDIT RATINGS POOR'S MOODY'S
===========================================================
Issuer Credit Rating BBB+ Baa2
Commercial Paper A-2 P-2
Senior Secured
First Mortgage Bonds A Baa1
Pollution Control Bonds A Baa1
Senior Unsecured
Senior Notes BBB Baa2
Unsecured Debt BBB Baa2
===========================================================
PAYOUT RATIO
In 2003 we paid out 40% (66% in 2002; 59% in 2001) of our per share earnings
in dividends.
CAPITAL REQUIREMENTS
Consolidated capital expenditures totaled $136.3 million in 2003 ($201.2
million in 2002; $149.2 million in 2001). Expenditures for 2003 included $73.6
million for Energy Services and $26.9 million for Automotive Services.
Expenditures for 2003 also included $35.8 million to maintain our Water Services
businesses while they are in the process of being sold. An existing long-term
line of credit and internally generated funds were the primary sources of
funding for these expenditures. The 2003 capital expenditure amounts do not
include $73 million of property, plant and equipment recognized upon the
restructuring of financial arrangements with respect to four of our used vehicle
auction facilities previously accounted for as operating leases.
Capital expenditures are expected to be $98 million in 2004 and total about
$500 million for 2005 through 2008. The 2004 amount includes $63 million for
Energy Services and $35 million for Automotive Services. Energy Services'
expenditures are for system component replacement and upgrades,
telecommunication fiber and coal handling equipment. Automotive Services'
expenditures are for expansions and on-going improvements at existing vehicle
auction facilities and associated computer systems. We expect to draw an
additional $8 million from an existing long-term
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ALLETE FORM 10-K 2003
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PART II
line of credit to complete an investment in new coal handling equipment and use
internally generated funds to fund all other capital expenditures.
ENVIRONMENTAL AND OTHER MATTERS
As previously mentioned in our Critical Accounting Policies section, our
businesses are subject to regulation by various U.S. and Canadian federal,
state, provincial 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.
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 SWL&P to initiate an
environmental investigation. The WDNR also issued SWL&P a Responsible Party
letter in February 2002. The environmental investigation is underway. In
February 2003 SWL&P submitted a Phase II environmental site investigation report
to the WDNR. This report identified some MGP-like chemicals that were found in
the soil. During March and April 2003 sediment samples were taken from nearby
Superior Bay. The report on the results of this sampling is expected to be
completed and sent to the WDNR during the first quarter of 2004. A work plan for
additional investigation by SWL&P was filed on December 17, 2003 with the WDNR.
This part of the investigation will determine any impact to soil or ground water
between the former MGP site and the Superior Bay. Although it is not possible to
quantify the potential clean-up cost until the investigation is completed and a
work plan is developed, a $0.5 million liability was recorded as of December 31,
2003 to address the known areas of contamination. We have recorded a
corresponding dollar amount as a regulatory asset to offset this liability. The
PSCW has approved SWL&P's deferral of these MGP environmental investigation and
potential clean-up costs for future recovery in rates, subject to regulatory
prudency review.
MINNESOTA POWER COAL-FIRED GENERATING FACILITIES. During 2002 Minnesota Power
received and 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
is, however, ongoing litigation involving the 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, we have not accrued any liability for this
environmental matter.
SQUARE BUTTE GENERATING FACILITY. In June 2002 Minnkota Power, the operator
of Square Butte, received a Notice of Violation from the EPA regarding alleged
New Source Review violations at the M.R. Young Station which includes the Square
Butte generating unit. The EPA claims certain capital projects completed by
Minnkota Power should have been reviewed pursuant to the New Source Review
regulations potentially resulting in new air permit operating conditions.
Minnkota Power has held several meetings with the EPA to discuss the alleged
violations. Based on an EPA request, Minnkota Power performed a study related to
the technological feasibility of installing various controls for the reduction
of nitrogen oxides and sulfur dioxide 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. Our
future cost of purchased power would include our pro rata share of this
additional debt service.
ADESA IMPACT TAUNTON FACILITY. In December 2003 the Massachusetts Department
of Environmental Protection (MDEP) identified ADESA Impact as a potentially
responsible party regarding contamination of several private drinking water
wells in a residential development that abuts the Taunton, Massachusetts salvage
vehicle auction facility. The wells had elevated levels of MTBE. MTBE is an
oxygenating additive in gasoline which reduces harmful emissions. The EPA has
identified MTBE as a possible carcinogen. ADESA Impact engaged GeoInsight, an
environmental services firm, to conduct tests of its soil and groundwater at the
salvage vehicle auction site and we are providing bottled water to some affected
residents.
GeoInsight prepared an immediate response action (IRA) plan, which is
required by the MDEP, to determine the extent of the environmental impact and
define activities to prevent further environmental contamination. The IRA plan,
which was filed on January 24, 2004, describes the initial activities ADESA
Impact performed, and proposes additional measures that it will use to further
assess the existence of any imminent hazard to human health. In addition, as
required by the MDEP, ADESA Impact is conducting an analysis to identify
sensitive receptors that may have been affected, including area schools and
municipal wells. GeoInsight does not believe that an imminent hazard condition
exists at the Taunton site; however, the investigation and assessment of site
conditions are ongoing.
In December 2003 GeoInsight collected soil samples, conducted groundwater
tests and provided oversight for the installation of monitoring wells in various
locations on and adjacent to the property adjoining the residential community.
The results of the soil and water tests indicated levels of MTBE exceeding MDEP
standards. In January 2004 we collected air samples from two residences that we
identified as
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ALLETE FORM 10-K 2003
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having elevated drinking water concentrations of MTBE. We have determined that
inhalation of, or contact exposure to, this air poses minimal risk to human
health. In response to our empirical findings, we have proposed to the MDEP that
we install granular activated carbon filtration systems in the approximately 30
affected residences.
ADESA Impact is preparing an IRA status report that must be submitted to the
MDEP by March 30, 2004, and will continue to prepare additional reports as
necessary. As of December 31, 2003 ADESA Impact has accrued $0.7 million to
cover the costs associated with ongoing testing, remediation and cleanup of the
site.
ALLETE maintains pollution liability insurance coverage and has filed a claim
with respect to this matter. We and our insurer are determining the availability
of insurance coverage at this time.
OTHER
We are involved in litigation arising in the normal course of business. Also
in the normal course of business, we are involved in tax, regulatory and other
governmental audits, inspections, investigations and other proceedings that
involve state and federal taxes, safety, compliance with regulations, rate base
and cost of service issues, among other things. While the resolution of such
matters could have a material effect on earnings and cash flows in the year of
resolution, none of these matters are expected to materially change our present
liquidity position, nor have a material adverse effect on our financial
condition.
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
December 31, 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 $20.2 million at
December 31, 2003 ($20.9 million at December 31, 2002) and a total unrealized
after-tax gain of $0.8 million at December 31, 2003 ($2.8 million loss at
December 31, 2002). During 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.
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 with
Investments on our consolidated balance sheet. The total carrying value of these
investments was $37.5 million at December 31, 2003 ($38.7 million at December
31, 2002). Our policy is to review these investments on a quarterly basis 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. We did not record any impairment loss on these investments in
2003 ($1.5 million pretax in 2002; $0.2 million pretax in 2001).
INTEREST RATE SENSITIVE PRINCIPAL CASH FLOW BY EXPECTED MATURITY DATE
FINANCIAL INSTRUMENTS ---------------------------------------------------------------------------------------
FAIR
DECEMBER 31, 2003 2004 2005 2006 2007 2008 THEREAFTER TOTAL VALUE
=================================================================================================================================
DOLLARS IN MILLIONS
Long-Term Debt
Fixed Rate $4.3 $0.8 $91.3 $115.7 $181.4 $224.7 $618.2 $666.4
Average Interest Rate - % 6.4 7.6 7.7 7.1 7.6 6.3 7.0
Variable Rate $33.2 $29.4 $45.8 $3.3 $0.9 $54.4 $167.0 $169.4
Average Interest Rate - % <F1> 3.2 2.6 2.1 1.7 3.0 1.6 2.2
=================================================================================================================================
<FN>
<F1> Assumes rate in effect at December 31, 2003 remains constant through remaining term.
</FN>
FOREIGN CURRENCY
Our foreign currency exposure is limited to the conversion of operating
results of our Canadian and, to a lesser extent, 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. Mexican
operations are not material.
POWER MARKETING
Minnesota Power purchases power for retail sales in our regulated 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 200 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
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ALLETE FORM 10-K 2003
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PART II
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 contracts and in the daily spot market. We currently have long-term
capacity sales contracts for 130 MW (100 MW in 2003) of Kendall County
generation, with 50 MW expiring in April 2012 and the balance in September 2017.
In total, the Kendall County facility operated at a loss in 2003 due to negative
spark spreads (the differential between electric and natural gas prices) in the
wholesale power market and our resulting inability to cover the fixed capacity
charge on approximately 175 MW. We expect the facility to continue to generate
losses until such time as spark spreads improve or we are able to enter into
additional long-term capacity sales contracts.
Split Rock Energy is a joint venture between Minnesota Power and Great River
Energy from which we are withdrawing. Split Rock Energy was formed to combine
power supply capabilities and customer loads for power pool operations and
generation outage protection. In response to the changing strategies of both
parties, as of February 2004 we withdrew from active participation in Split Rock
Energy and will terminate our ownership interest upon receipt of FERC approval
which is expected in the first half of 2004. We have retained some of the
benefits of this partnership, such as joint load and capability reporting. We
have resumed performing the functions that provide least cost supply to our
retail customers and sell our excess generation.
NEW ACCOUNTING STANDARDS
In January 2004 the FASB issued FASB Staff Position SFAS 106-1, "Accounting
and Disclosure Requirements Related to the Medicare Prescription Drug,
Improvement and Modernization Act of 2003" (Act). This Staff Position allows
employers who sponsor a postretirement health plan that provides prescription
drug benefits to defer recognizing the effects of the Act in accounting for its
plan under SFAS 106, "Employers' Accounting for Postretirement Benefits Other
Than Pensions" until authoritative accounting guidance is issued. We provide
postretirement health benefits that include prescription drug benefits, and in
accordance with this Staff Position, have elected not to reflect the impact of
the Act in our 2003 financial statements. We expect the Act will eventually
reduce our costs for postretirement health benefits and are reviewing the impact
on our accumulated plan benefit obligation and expense going forward.
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 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 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. The
Mandatorily Redeemable Preferred Securities were redeemed in December 2003.
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. In December 2003 the FASB issued Interpretation No. 46R to replace and
clarify some of the provisions of Interpretation No. 46. Under Interpretation
46R, the rules became effective on December 15, 2003 for interest in certain
structures, and March 15, 2004 for interest in all other structures. We are not
a party to any variable interest entity required to be consolidated under
Interpretation No. 46R.
--------------------------------------------
FACTORS THAT MAY AFFECT FUTURE RESULTS
READERS ARE CAUTIONED THAT FORWARD-LOOKING STATEMENTS, INCLUDING THOSE
CONTAINED IN THIS FORM 10-K, 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 10 OF THIS FORM 10-K AND THE
FACTORS DESCRIBED BELOW. THE RISKS AND UNCERTAINTIES DESCRIBED IN THIS FORM 10-K
ARE NOT THE ONLY ONES FACING OUR COMPANY. ADDITIONAL RISKS AND UNCERTAINTIES
THAT WE ARE NOT PRESENTLY AWARE OF, OR THAT WE CURRENTLY CONSIDER IMMATERIAL,
MAY ALSO AFFECT OUR BUSINESS OPERATIONS. OUR BUSINESS, FINANCIAL CONDITION OR
RESULTS OF OPERATIONS COULD SUFFER IF THE CONCERNS SET FORTH BELOW ARE REALIZED.
THERE ARE RISKS ASSOCIATED WITH OUR RESTRUCTURING OF THE COMPANY.
In October 2003 we announced plans to restructure ALLETE by spinning off to
ALLETE shareholders our Automotive Services business which will become a
publicly traded company doing business as ADESA. Although we expect to complete
the restructuring in the third quarter of 2004, there are risks associated with
proceeding that could have adverse consequences, including:
- Cost synergies may be eliminated as some fixed operating costs will no
longer be shared, thereby potentially adversely affecting the results of
operations of the separate entities. For example, costs may increase as a
result of having two boards of directors and management teams, as well as
separate computer systems, financial audits and SEC compliance
requirements.
- The spin-off requires a favorable tax opinion. If not obtained and the
spin-off is not consummated for that or any other reason, ALLETE could face
challenges in
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refocusing the company, suffer a credibility crisis from the standpoint of
the financial markets and our shareholders and, consequently, ALLETE's
share price could be negatively impacted. If the spin-off is delayed, the
cost of the separation could increase.
- Shareholders could experience significant stock price volatility when the
businesses begin trading as separate companies. The value of the separate
shares could differ significantly from the value of the shares of the
combined company as the marketplace determines the price of the separate
shares. We are unable to predict how or at what level the shares will trade
publicly.
- There is no assurance as to the extent that dividends, if any, will be paid
on the shares of ADESA and the amount of dividends to be paid on the shares
of ALLETE after the spin-off may vary significantly from the amount
currently paid on the shares of the combined company.
- The ability of the separate companies to raise capital may be adversely
impacted. The cost of borrowing may increase and new separate credit
ratings will be assigned.
- ALLETE as a combined company has benefited from the diversification of
business operations. The lack of diversification faced by separate
companies may result in more stock price volatility. For example, if there
is a downturn in the auto business the share price of ADESA may decline
more sharply than if it was part of a more diversified entity.
WE ARE DEPENDENT ON OUR ABILITY TO SUCCESSFULLY ACCESS CAPITAL MARKETS.
Inability to access capital may limit our ability to execute business plans,
pursue improvements or make acquisitions that we may otherwise rely on for
future growth. We rely on access to both short-term borrowings, including the
issuance of commercial paper, and long-term capital markets as a significant
source of liquidity for capital requirements not satisfied by the cash flow from
our operations. If we are not able to access capital at competitive rates, the
ability to implement our business plans may be adversely affected. Market
disruptions or a downgrade of our credit ratings may increase the cost of
borrowing or adversely affect our ability to access one or more financial
markets.
OUR CREDIT RATINGS COULD BE REVISED DOWNWARD.
The current credit ratings for ALLETE's long-term debt are investment grade.
A rating reflects only the view of a rating agency, and it is not a
recommendation to buy, sell or hold securities. Any rating can be revised upward
or downward at any time by a rating agency if such rating agency decides that
circumstances warrant such a change. If Standard & Poor's or Moody's were to
downgrade ALLETE's long-term ratings, particularly below investment grade,
borrowing costs would increase and the potential pool of investors and funding
sources would likely decrease.
WE ARE SUBJECT TO EXTENSIVE GOVERNMENTAL REGULATIONS THAT MAY HAVE A NEGATIVE
IMPACT ON OUR BUSINESS AND RESULTS OF OPERATIONS.
We are subject to prevailing governmental policies and regulatory actions,
including those of the United States Congress, Canadian federal government,
state and provincial 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.
These governmental regulations significantly influence our operating environment
and may affect our ability to recover costs from our customers. We are required
to have numerous permits, approvals and certificates from the agencies that
regulate our business. We believe the necessary permits, approvals and
certificates have been obtained for existing operations and that our business is
conducted in accordance with applicable laws; however, we are unable to predict
the impact on operating results from the future regulatory activities of any of
these agencies. Changes in regulations or the imposition of additional
regulations could have an adverse impact on our results of operations.
Recent events in the energy markets that are beyond our control have
increased the level of public and regulatory scrutiny in our industry and in the
capital markets and have resulted in increased regulation and new accounting
standards. The reaction to these events may have negative impacts on our
business, financial condition and access to capital.
OUR OPERATIONS POSE CERTAIN ENVIRONMENTAL RISKS WHICH COULD ADVERSELY AFFECT OUR
RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
We are subject to extensive environmental laws and regulations affecting many
aspects of our present and future operations including air quality, water
quality, waste management and other environmental considerations. These laws and
regulations can result in increased capital, operating, and other costs, as a
result of compliance, remediation, containment and monitoring obligations,
particularly with regard to laws relating to power plant emissions. These laws
and regulations generally require us to obtain and comply with a wide variety of
environmental licenses, permits, inspections and other approvals. Both public
officials and private individuals may seek to enforce applicable environmental
laws and regulations. We cannot predict the financial or operational outcome of
any related litigation that may arise.
There are no assurances that existing environmental regulations will not be
revised or that new regulations seeking to protect the environment will not be
adopted or become applicable to us. Revised or additional regulations, which
result in increased compliance costs or additional operating restrictions,
particularly if those costs are not fully recoverable
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from customers, could have a material effect on our results of operations.
We cannot predict with certainty the amount or timing of all future
expenditures related to environmental matters because of the difficulty of
estimating clean up costs. There is also uncertainty in quantifying liabilities
under environmental laws that impose joint and several liability on all
potentially responsible parties. (See Environmental and Other Matters.)
In the vehicle redistribution industry, large numbers of vehicles, including
damaged vehicles at salvage vehicle auctions, are stored at auction facilities
and, during that time, releases of fuel, motor oil and other fluids may occur,
resulting in soil, surface water, air or groundwater contamination. In addition,
we generate and/or store petroleum products and other hazardous materials,
including wastewater, waste solvents and used oil run-off from our vehicle
reconditioning and detailing facilities, and body shops at our facilities may
release harmful air emissions associated with painting. We could incur
substantial expenditures for preventative, investigative or remedial action and
could be exposed to liability arising from our operations, contamination by
previous users of our acquired facilities, or the disposal of our waste at
off-site locations. Any such expenditures or liabilities could have a material
adverse effect on our results of operations and financial condition.
THE OPERATION AND MAINTENANCE OF OUR GENERATING FACILITIES INVOLVES RISKS THAT
COULD SIGNIFICANTLY INCREASE THE COST OF DOING BUSINESS.
The operation of generating facilities involves many risks, including start
up risks, breakdown or failure of facilities, lack of sufficient capital to
maintain the facilities, the dependence on a specific fuel source or the impact
of unusual or adverse weather conditions or other natural events, as well as the
risk of performance below expected levels of output or efficiency, the
occurrence of any of which could result in lost revenue and/or increased
expenses. A significant portion of Minnesota Power's facilities was constructed
many years ago. In particular, older generating equipment, even if maintained in
accordance with good engineering practices, may require significant capital
expenditures to keep it operating at peak efficiency. This equipment is also
likely to require periodic upgrading and improvement. Minnesota Power could be
subject to costs associated with any unexpected failure to produce power,
including failure caused by breakdown or forced outage, as well as repairing
damage to facilities due to storms, natural disasters, wars, terrorist acts and
other catastrophic events. Further, our ability to successfully and timely
complete capital improvements to existing facilities or other capital projects
is contingent upon many variables and subject to substantial risks. Should any
such efforts be unsuccessful, we could be subject to additional costs and/or the
write-off of our investment in the project or improvement.
ENERGY SERVICES MUST HAVE ADEQUATE AND RELIABLE TRANSMISSION AND DISTRIBUTION
FACILITIES TO DELIVER OUR ELECTRICITY TO OUR CUSTOMERS.
Minnesota Power depends on transmission and distribution facilities owned and
operated by other utilities, as well as its own such facilities, to deliver the
electricity it produces and sells to its customers, as well as to other energy
suppliers. If transmission capacity is inadequate, our ability to sell and
deliver electricity may be hindered, we may have to forgo sales or we may have
to buy more expensive wholesale electricity that is available in the
capacity-constrained area. The cost to provide service to these customers may
exceed the cost to service other customers, resulting in lower gross margins. In
addition, any infrastructure failure that interrupts or impairs delivery of
electricity to our customers could negatively impact the satisfaction of our
customers with our service.
THE PRICE OF ONE OF OUR MAJOR PRODUCTS, ELECTRICITY, AND/OR ONE OF OUR MAJOR
EXPENSES, FUEL, MAY BE VOLATILE.
Volatility in market prices for fuel and electricity may result from:
- severe or unexpected weather conditions;
- seasonality;
- changes in electricity usage;
- the current diminished liquidity in the wholesale power markets as well as
any future illiquidity in these or other markets;
- transmission or transportation constraints, inoperability or
inefficiencies;
- availability of competitively priced alternative energy sources;
- changes in supply and demand for energy commodities;
- changes in power production capacity;
- outages at Minnesota Power's generating facilities or those of our
competitors;
- changes in production and storage levels of natural gas, lignite, coal and
crude oil and refined products;
- natural disasters, wars, sabotage, terrorist acts, embargoes and other
catastrophic events; and
- federal, state, local and foreign energy, environmental and other
regulation and legislation.
Since fluctuations in fuel expense related to our regulated utility
operations are passed on to customers through our fuel clause, risk of
volatility in market prices for fuel and electricity mainly impacts our
nonregulated operations at this time.
THE VOLATILE NATURE OF VEHICLE SALES MAY ADVERSELY AFFECT OUR PROFITABILITY.
The vehicle industry is cyclical and historically has experienced periodic
downturns characterized by oversupply and weak demand. Many factors affect the
industry, including general economic conditions and consumer confidence, fuel
prices, the level of discretionary personal income, unemployment rates, interest
rates, credit availability and insurance premiums.
New and used vehicle sales substantially slowed immediately following the
terrorist attacks of September 11, 2001. In response, manufacturers introduced
new incentives (including
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0% financing) and rental car companies began to downsize their inventories. This
led to decreases in the prices of both used and salvage vehicles and a temporary
decline in conversion percentages in the auction industry because the prices
that buyers were willing to pay for vehicles did not match the prices that
sellers were willing to accept. In 2002 the manufacturers extended and increased
the incentives leading to additional declines in both used vehicle prices and
conversion percentages. We are not able to determine the long-term consequences
the terrorist attacks and/or subsequent outbreaks of hostilities might have on
general economic conditions, our industry, or ADESA, nor are we able to predict
how used vehicle prices and conversion percentages may be affected by new and
additional incentives or other changes by the manufacturers aimed at the new car
market.
Used vehicle sales are driven by consumer demand. As consumer demand
fluctuates, the volume and prices of used vehicles may be affected and the
demand for used vehicles at auction by dealers may likewise be affected. The
demand for used vehicles at auction by dealers may therefore have an effect on
the wholesale price of used vehicles and the conversion percentage of vehicles
sold at auction.
The number of new and used vehicles that are leased by consumers affects the
supply of vehicles coming to auction. As manufacturers and other lenders have
decreased the number of leases in the last few years and extended the lease
terms of some of the leases that were written, the number of off-lease vehicles
available at auction declined in 2003 and that decline is expected to continue
in 2004 and 2005. We are not able to predict the manufacturers' and other
lenders' approaches to leasing, and thus future volumes of off-lease vehicles
may be affected based upon leasing trends.
Program vehicles are vehicles used by rental car companies and other
companies with individual corporate fleets of vehicles that are returned to
manufacturers through repurchasing programs. The volume of program vehicles and
the terms of the programs have an effect on the volume of used vehicles
available for sale at auction since the majority of these vehicles are
redistributed via the used vehicle auction process.
Repossessed vehicles are a source of volume for used vehicle auctions and are
dependent upon both economic conditions and the policies of lenders regarding
their credit practices. As these economic conditions and policies change, the
volume of vehicles available for sale at auction may also be affected.
Insurance companies are the main source of salvage vehicles available for
sale at auction. The number of vehicles branded as salvage is dependent upon
several factors including government regulations, the extent of damage to the
vehicle, the number of accidents, and the policies of the insurance companies
with respect to claims settlement and redistribution of the salvage vehicles.
If the volume of used or salvage vehicles sold at our auctions were to
decline due to any of the factors described above or for any other reason, the
revenue we earn from successful auction transactions and ancillary services
would decline. In addition, the fixed costs associated with our auction
facilities would remain relatively constant. As a result of these consequences,
our profitability could be adversely affected.
ALLETE'S ENERGY SERVICES BUSINESS IS SUBJECT TO INCREASED COMPETITION.
The independent power industry includes numerous strong and capable
competitors, many of which have extensive experience in the operation,
acquisition and development of power generation facilities. Energy Services'
competition is based primarily on price and reputation for quality, safety and
reliability. The electric utility and natural gas industries are also
experiencing increased competitive pressures as a result of consumer demands,
technological advances, deregulation, greater availability of natural gas-fired
generation and other factors.
THE VEHICLE REDISTRIBUTION INDUSTRY IS HIGHLY COMPETITIVE AND WE MAY NOT BE ABLE
TO COMPETE SUCCESSFULLY.
We face significant competition for the supply of used and salvage vehicles
and for the buyers of those vehicles. We believe our principal competitors
include other used and/or salvage vehicle auction companies, wholesalers,
dealers, manufacturers and dismantlers, a number of whom may have established
relationships with sellers and buyers of vehicles and may have greater financial
resources than we have. Due to the limited number of sellers of used and
salvage vehicles, the absence of long-term contractual commitments between us
and our customers and the increasingly competitive market environment, there can
be no assurance that our competitors will not gain market share at our expense.
We may encounter significant competition for local, regional and national
supply agreements with sellers of used and salvage vehicles. There can be no
assurance that the existence of other local, regional or national contracts
entered into by our competitors will not have a material adverse effect on our
business or our expansion plans. Furthermore, we are likely to face competition
from major competitors in the acquisition of auction facilities, which could
significantly increase the cost of such acquisitions and thereby materially
impede our expansion objectives or have a material adverse effect on our results
of operations. These potential competitors may include consolidators of used
vehicle auctions, vehicle dismantling businesses, organized salvage vehicle
buying groups, vehicle manufacturers and on-line auction companies. While most
of our institutional customers have abandoned or reduced efforts to sell
vehicles directly without the use of service providers such as us, there can be
no assurance that this trend will continue, which could adversely affect our
market share, results of operations and financial condition.
We may also encounter competition in our floorplan financing business. The
floorplan financing sector is
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characterized by diverse and fragmented competition. AFC's competition includes
the financing arms of other auction providers, other speciality lenders, banks
and other financial institutions. There can be no assurance that the existence
of other floorplan financing providers nor the entrance of new providers to the
sector will not have a material adverse effect on AFC, its ability to compete
successfully in the floorplan financing sector, or our overall ability to
compete in the vehicle redistribution industry.
Additionally, existing or new competitors may be significantly larger and
have greater financial and marketing resources than we have; therefore, there
can be no assurance that we will be able to compete successfully in the future.
INCREASED USE OF ON-LINE WHOLESALE AUCTIONS MAY DIMINISH OUR SUPPLY OF VEHICLES.
Direct sales of used vehicles by institutional customers and large dealer
groups through internally developed or third party on-line auctions have largely
replaced telephonic and other non-auction methods, becoming an increasing
portion of overall used vehicle redistribution over the past several years. In
addition, a portion of the vehicles that were sold through a physical auction
are now being sold on-line. Typically, on-line auctions serve to redistribute
vehicles that have come off lease. The extent of use of direct, on-line systems
varies among institutional customers and currently comprises approximately 3% to
5% of overall used vehicle auction sales. In addition, some of our competitors
have begun to offer on-line auctions as all or part of their auction business
and other on-line auctions now include used vehicles among the products offered
at their auctions. On-line auctions or other methods of redistribution may
diminish both the quality and quantity and reduce the value of vehicles sold
through traditional auction facilities. Although we have embraced the Internet
and offer on-line auctions and services as part of our standard service
offerings, we cannot predict what portion of overall sales will be conducted
through on-line auctions or other redistribution methods in the future and what
impact this may have on our auction facilities.
OUR OPERATIONS ARE WEATHER SENSITIVE.
Our results of operations can be affected by changes in the weather. Weather
conditions directly influence the demand for electricity and natural gas, affect
the price of energy commodities and affect the ability to perform energy and
automotive services. Auction volumes tend to decline during prolonged periods of
winter weather conditions. In addition, mild weather conditions and decreases in
traffic volume can lead to a decline in the available supply of salvage vehicles
because fewer traffic accidents occur, resulting in fewer damaged vehicles
overall. We cannot predict future weather conditions and as a result, adverse
weather conditions could negatively affect our operations and financial
condition.
SEASONALITY OF THE AUCTION BUSINESS AFFECTS OUR QUARTERLY REVENUE AND EARNINGS.
Generally, the volume of vehicles sold at auction is highest in the first and
second calendar quarters of each year and slightly lower in the third quarter.
Fourth quarter sales are generally lower than all other quarters. This
seasonality is affected by several factors including weather, the timing of used
vehicles available for sale from the institutional customers, holidays, and the
seasonality of the retail market for used vehicles which affects the demand side
of the auction industry. As a result, the revenue and operating expenses related
to volume will fluctuate accordingly on a quarterly basis.
IF OUR SIGNIFICANT ENERGY SERVICES CUSTOMERS ARE NEGATIVELY IMPACTED BY WORLD
ECONOMICS, OUR REVENUE MAY BE NEGATIVELY IMPACTED.
Our Large Power Customers are impacted by world economics that affect their
competitive position and profitability. Taconite producers and paper and wood
products customers served by Minnesota Power compete in this world marketplace.
Their inability to compete in their global markets could have a material adverse
effect on their operations and continuation as a business. Any such failure
could have a material adverse effect on Energy Services results of operations
and the surrounding communities we serve.
WE ARE DEPENDENT ON GOOD LABOR RELATIONS.
We believe our relations to be good with our approximately 13,000 employees.
Energy Services has approximately 1,400 full-time employees, of which
approximately 700 are either a member of the International Brotherhood of
Electrical Workers Local 31 or Local 1593. Failure to successfully renegotiate
labor agreements could adversely affect the services we provide and our results
of operations. The labor agreements with Local 31 expire on January 31, 2006.
Negotiations are underway for a new contract with Local 1593. The existing
agreement with Local 1593 ends on March 31, 2004.
In addition to its regular employees, Automotive Services utilizes temporary
labor services to assist in handling the vehicles consigned to it during periods
of peak volume and staff shortages. Many of Automotive Services' employees, both
full-time and part-time, are unskilled, and in periods of strong economic
growth, we may find it difficult to compete for sufficient unskilled labor. Many
of the services we provide are outsourced to third party providers that perform
the services either on-site or off-site. The use of third party providers
depends upon the resources available at each auction facility as well as peaks
in the volume of vehicles offered at auction. If we are unable to maintain our
full-time, part-time or contract workforce or the necessary relationships with
third party providers, our operations may be adversely affected.
In addition, auctioneers at our auctions are highly skilled individuals who
are essential to the successful operation of our auction business. Nearly all of
our auctioneers are independent contractors who provide their services for a
daily or weekly rate. If we are unable to retain a sufficient number of
experienced auctioneers, our operations may be adversely affected.
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OUR AUTOMOTIVE SERVICES OPERATIONS SUBJECT US TO THE RISK OF COLLUSION,
MISCONDUCT AND OTHER IMPROPER BUSINESS PRACTICES BY OUR AUTOMOTIVE SERVICES
EMPLOYEES AND THIRD PARTIES.
In the past, some of our Automotive Services employees have acted in
collusion with one another, with individual contractors or third party service
providers, and/or with customers, in order to manipulate our policies,
procedures and systems. Some of our auction employees also have engaged in
misconduct or wrongdoing, including isolated acts of dishonesty and malfeasance,
exercised poor judgment or otherwise conducted business in an improper manner.
In addition, customers acting in collusion have redistributed vehicles through
our auctions on terms that were not arms length. As a result of these
activities, our services have been sold at a discount or for no fee, credit has
been extended outside of the normal course of operations, unnecessary services
have been provided and operating costs have increased. We have enhanced our
internal control systems and conduct random on-site audits of auction facilities
to identify and minimize these activities. While collusion, misconduct and other
improper business practices have not had a material adverse effect on our
operating results in the past, we cannot assure you that activities similar to
those described above will not occur in the future or will be detected by us in
a timely manner or before a material loss is incurred. If our internal controls
fail to prevent future acts of collusion, misconduct and other improper business
practices, resulting losses could have a material adverse effect on our results
of operations and financial condition.
IF WE ARE NOT ABLE TO RETAIN OUR EXECUTIVE OFFICERS AND KEY EMPLOYEES, WE MAY
NOT BE ABLE TO IMPLEMENT OUR BUSINESS STRATEGY AND OUR BUSINESS COULD SUFFER.
If we fail to retain our executive officers or key employees, our business
could suffer. We may have difficulty in retaining and attracting customers,
developing new services, negotiating favorable agreements with customers and
providing acceptable levels of customer service. Although leadership changes
will occur in connection with the spin-off, we cannot predict whether
significant resignations will occur. The success of our business heavily depends
on the leadership of our executive officers, all of whom are employees-at-will
and none of whom are subject to any agreements not to compete. If we lose the
service of one or more of our executive officers or key employees, or if one or
more of them decides to join a competitor or otherwise compete directly or
indirectly with us, we may not be able to successfully manage our business or
achieve our business objectives.
WE ASSUME THE SETTLEMENT RISK FOR ALL VEHICLES SOLD THROUGH OUR AUCTIONS.
As part of the fees earned for the services we provide relative to the sale
of each vehicle at auction, we assume the risk associated with collecting the
gross sales proceeds from buyers and likewise assume responsibility for
distributing to sellers the net sales proceeds of vehicles. The fees for each
vehicle are collected by adding the buyer-related fees to the gross sales
proceeds due from the buyer and deducting the seller-related fees from the gross
sales proceeds prior to distributing the net sales proceeds to the seller. The
amount we report as revenue for each vehicle only represents the fees associated
with our services and does not include the gross sales price of the consigned
vehicle. As a result, the accounts receivable from buyers are much larger on a
per vehicle basis than the combined seller- and buyer-related fees associated
with each transaction. We do not have recourse against sellers for any buyer's
failure to satisfy its debt. Since our revenue for each vehicle does not include
the gross sales proceeds, failure to collect the receivables in full would
result in a net loss up to the gross sales proceeds on a per vehicle basis in
addition to any expenses incurred to collect the receivables and to provide the
services associated with the vehicle. Although we take steps to mitigate this
risk, if we are unable to collect payments on a large number of vehicles our
resulting payment obligations and decreased fee revenue may have a material
adverse effect on our results of operations and financial condition.
In addition, in the ordinary course of business, it is our responsibility to
fully disclose any defects or other information relevant to the value of a
vehicle sold through our auctions that we have discovered or of which we have
been informed by the seller. In cases where we fail to properly disclose
information about a particular vehicle, we typically refund the fees collected
and void the sale of the vehicle. If we are unable to reach a settlement
satisfactory to the seller, we generally purchase the vehicle, which subjects us
to the costs and risks of resale.
WE RELY HEAVILY ON TECHNOLOGY TO PROTECT OUR RIGHTS WITH RESPECT TO OUR
BUSINESSES AND MUST ADAPT TO EVOLVING APPLICATIONS. CHANGES IN TECHNOLOGY COULD
CAUSE OUR SERVICES TO BECOME OBSOLETE AND, AS A RESULT, WE MAY LOSE CUSTOMERS.
In both our Energy Services and Automotive Services businesses, technology is
an integral part of our operations and is subject to evolving industry
standards. The information systems and processes necessary to support risk
management, sales, customer service and procurement and supply are new, complex
and extensive. To be successful, we must adapt to this evolving market by
continually improving the responsiveness, functionality and features of our
services and systems to meet our customers' changing needs. We may not be
successful in developing or acquiring technology which is competitive and
responsive to the needs of our customers and might lack sufficient resources to
continue to make the necessary investments in technology to compete with our
competitors. Without the timely introduction of new services and enhancements
that take advantage of the latest technology, some of our services could become
obsolete over time and we could lose a number of our customers.
We develop software internally and through outsourcing relationships, and we
have also licensed and may license in the future, copyrighted computer systems
software and trade secrets from third parties. While we attempt to ensure that
our intellectual property and similar proprietary rights are protected and that
the third party rights we need are licensed
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to us when entering into business relationships, our business partners,
consultants or other third parties may take actions that could materially and
adversely affect our rights or the value of our intellectual property, similar
proprietary rights or reputation. In addition, if we are subject to any
infringement claims, such claims may have an adverse effect on our business
operations.
OUR OPERATIONS MAY BE RESTRICTED BY VEHICLE-RELATED OR LENDING LAWS AND OTHER
REGULATIONS, INCLUDING VEHICLE BROKERAGE AND AUCTION LAWS.
Our operations are subject to regulation, supervision and licensing under
various U.S. or Canadian federal, state, provincial and local statutes,
ordinances and regulations. Each auction is subject to laws in the state or
province in which it operates which regulate auctioneers and/or vehicle dealers.
Some of the transport vehicles used at our auctions are regulated by the U.S.
Department of Transportation or the Canadian Transportation Agency. The
acquisition and sale of salvage and theft recovered vehicles is regulated by
governmental agencies in each of the locations in which we operate. In many
states and provinces, regulations require that the title of a salvage vehicle be
forever "branded" with a salvage notice in order to notify prospective
purchasers of the vehicle's previous salvage status. Some state, provincial and
local regulations also limit who can purchase salvage vehicles, as well as
determine whether a salvage vehicle can be sold as rebuildable or must be sold
for parts only. Such regulations can reduce the number of potential buyers of
vehicles at salvage auctions. In addition to the regulation of the sales and
acquisition of vehicles, we are also subject to various local zoning
requirements with regard to the location and operation of our auction and
storage facilities.
If we fail to comply with applicable regulations and requirements, we could
be subject to civil or criminal liability and the imposition of liens or fines.
In addition, existing regulations may be revised or reinterpreted, new laws and
regulations may be adopted or become applicable to us or our facilities, and
future changes in laws and regulation may have a detrimental effect on our
businesses.
A PORTION OF OUR REVENUE MAY BE DERIVED FROM NON-UNITED STATES SOURCES, WHICH
EXPOSES US TO FOREIGN EXCHANGE AND OTHER RISKS.
Approximately 10% of our consolidated revenue is derived from our Canadian
facilities. We also conduct operations in Mexico. As a result, fluctuations
between United States and non-United States currency values may adversely affect
our results of operations and financial position. In addition, there are tax
inefficiencies in repatriating cash flow from non-United States subsidiaries. To
the extent such repatriation is necessary for us to meet our debt service or
other obligations, these tax inefficiencies may adversely affect us.
ADEQUATE INSURANCE PROTECTION MAY NOT BE COST EFFECTIVE OR AVAILABLE TO MINIMIZE
RISK.
Insurance, warranties or performance guarantees may not cover any or all of
the lost revenue or increased expenses, including the cost of replacement power
and cancellation of sale days at auction sites. Likewise, our ability to obtain
insurance, and the cost of and coverage provided by such insurance, could be
affected by events outside our control.
RISKS ASSOCIATED WITH ACQUISITIONS MAY HINDER OUR ABILITY TO INCREASE REVENUE
AND EARNINGS.
Both the energy and vehicle redistribution industries are considered mature
industries in which low single digit growth is expected in industry unit sales.
Accordingly, our future growth depends in large part on our ability to increase
our volumes relative to our competition, acquire additional businesses, manage
expansion, control costs in our operations, introduce new services, and
consolidate future acquisitions into existing operations. In pursuing a strategy
of acquiring other businesses, we face risks commonly encountered with growth
through acquisitions. These risks include, but are not limited to:
- incurring significantly higher capital expenditures and operating expenses;
- failing to assimilate the operations and personnel of the acquired
businesses;
- entering new markets with which we are unfamiliar;
- potential undiscovered liabilities at acquired businesses;
- disrupting our ongoing business;
- diverting our limited management resources;
- failing to maintain uniform standards, controls and policies;
- impairing relationships with employees and customers as a result of changes
in management; and
- increasing expenses for accounting and computer systems, as well as
integration difficulties.
We may not adequately anticipate all of the demands that our growth will
impose on our systems, procedures and structures, including our financial and
reporting control systems, data processing systems and management structure. If
we cannot adequately anticipate and respond to these demands, our business could
be materially harmed.
Although we conduct what we believe to be a prudent level of investigation
regarding the operating condition of the businesses we purchase, in light of the
circumstances of each transaction, an unavoidable level of risk remains
regarding the actual operating condition of these businesses. Until we actually
assume operating control of such business assets, we may not be able to
ascertain the actual value of the acquired entity.
WE CANNOT GUARANTEE THAT GREENFIELD DEVELOPMENT OR RELOCATION OF AUCTION SITES
WILL BE PROFITABLE.
The costs of greenfield development or relocation of our auction sites may be
substantial. In addition, we may encounter delays and scope changes while an
auction site is under development that cause our capital investment to increase
and our returns to be lower than expected. Although our strategy is to secure
support from institutional customers and insurance companies prior to developing
new or relocated facilities, there is no guarantee that new or relocated
facilities will be able to attract these customers or deliver sustained revenue
or profit.
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ALLETE FORM 10-K 2003
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PART II
WE CAN OFFER YOU NO ASSURANCES THAT WE WILL BE ABLE TO CONTINUE EXECUTING AN
ACQUISITION STRATEGY WITHOUT THE COSTS OF FUTURE ACQUISITIONS ESCALATING.
Although there are potential acquisition candidates that fit our acquisition
criteria, we are not certain that we will be able to consummate any such
transactions in the future or identify those candidates that would result in the
most successful combinations, or that future acquisitions will be able to be
consummated at acceptable prices and terms. In addition, increased competition
for acquisition candidates could result in fewer acquisition opportunities for
us and higher acquisition prices. The magnitude, timing, pricing and nature of
future acquisitions will depend upon various factors, including:
- the availability of suitable acquisition candidates;
- competition with other industry groups or new industry consolidators for
suitable acquisitions;
- the negotiation of acceptable terms;
- our financial capabilities;
- the availability of skilled employees to manage the acquired companies; and
- general economic and business conditions.
We may be required to file applications and obtain clearances under
applicable federal antitrust laws before completing an acquisition. These
regulatory requirements may restrict or delay our acquisitions, and may increase
the cost of completing acquisitions.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition - Market Risk for information related to quantitative and
qualitative disclosure about market risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See our consolidated financial statements as of December 31, 2003 and 2002
and for each of the three years in the period ended December 31, 2003, and
supplementary data, also included, which are indexed in Item 15(a).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. 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-K. 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.
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ALLETE FORM 10-K 2003
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Unless otherwise stated, the information required for this Item is
incorporated by reference herein from our Proxy Statement for the 2004 Annual
Meeting of Shareholders (2004 Proxy Statement). Our 2004 Proxy Statement will be
filed with the SEC within 120 days after the end of our 2003 fiscal year.
- DIRECTORS. The information regarding directors will be included in the
"Election of Directors" section;
- AUDIT COMMITTEE FINANCIAL EXPERT. The information regarding the audit
committee financial expert will be included in the "Report of the Audit
Committee" section;
- EXECUTIVE OFFICERS. The information regarding executive officers is
included in Part I of this Form 10-K;
- SECTION 16(a) COMPLIANCE. The information regarding Section 16(a)
compliance will be included in the "Section 16(a) Beneficial Ownership
Reporting Compliance" section; and
- CODE OF ETHICS. We have adopted a written Code of Ethics that applies to
all of our employees, including our chief executive officer, chief
financial officer and controller. A copy of our Code of Ethics is available
on our website at www.allete.com and print copies are available to any
shareholder that requests a copy. Any amendment to the Code of Ethics or
any waiver of the Code of Ethics will be disclosed on our website at
www.allete.com promptly following the date of such amendment or waiver.
ITEM 11. EXECUTIVE COMPENSATION
The information required for this Item is incorporated by reference herein
from the "Compensation of Executive Officers" section in our 2004 Proxy
Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required for this Item is incorporated by reference herein
from the "Security Ownership of Beneficial Owners and Management" and the
"Equity Compensation Plan Information" sections in our 2004 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item is incorporated by reference herein
from the "Report of the Audit Committee" section in our 2004 Proxy Statement.
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ALLETE FORM 10-K 2003
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PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Certain Documents Filed as Part of this Form 10-K.
(1) Financial Statements PAGE
ALLETE
Report of Independent Auditors .......................................60
Consolidated Balance Sheet at
December 31, 2003 and 2002 ..........................................61
For the Three Years Ended December 31, 2003
Consolidated Statement of Income ....................................62
Consolidated Statement of Cash Flows ................................63
Consolidated Statement of Shareholders' Equity ......................64
Notes to Consolidated Financial Statements ........................65-83
(2) Financial Statement Schedules
Report of Independent Auditors on
Financial Statement Schedule ........................................84
Schedule II - ALLETE Valuation and
Qualifying Accounts and Reserves ....................................84
All other schedules have been omitted either because the information is
not required to be reported by ALLETE or because the information is
included in the consolidated financial statements or the notes.
(3) Exhibits including those incorporated by reference.
EXHIBIT NUMBER
- --------------------------------------------------------------------------------
*2(a) - First Amended and Restated Utility System Asset Acquisition
Agreement (without Appendices), entered into on August 25, 2003,
by and among Hernando County, the City of Marco Island, the City
of Palm Coast, Osceola County, Florida Governmental Utility
Authority, the City of Deltona and Florida Water Services
Corporation (filed as Exhibit 2 to the August 27, 2003 Form 8-K,
File No. 1-3548).
2(b) - Stock Purchase Agreement (without Exhibits and Schedules), dated
November 20, 2003, by and between Philadelphia Suburban
Corporation (now Aqua America, Inc.), as Purchaser, and ALLETE
Water Services, Inc., as Shareholder.
*3(a)1 - Articles of Incorporation, amended and restated as of May 8, 2001
(filed as Exhibit 3(b) to the March 31, 2001 Form 10-Q, File No.
1-3548).
*3(a)2 - Amendment to Certificate of Assumed Name, filed with the Minnesota
Secretary of State on May 8, 2001 (filed as Exhibit 3(a) to the
March 31, 2001 Form 10-Q, File No. 1-3548).
*3(b) - Bylaws, as amended effective May 8, 2001 (filed as Exhibit 3(c) to
the March 31, 2001 Form 10-Q, File No. 1-3548).
*4(a)1 - Mortgage and Deed of Trust, dated as of September 1, 1945, between
Minnesota Power & Light Company (now ALLETE) and The Bank of New
York (formerly Irving Trust Company) and Douglas J. MacInnes
(successor to Richard H. West), Trustees (filed as Exhibit 7(c),
File No. 2-5865).
*4(a)2 - Supplemental Indentures to ALLETE's Mortgage and Deed of Trust:
NUMBER DATED AS OF REFERENCE FILE EXHIBIT
- --------------------------------------------------------------------------------
First March 1, 1949 2-7826 7(b)
Second July 1, 1951 2-9036 7(c)
Third March 1, 1957 2-13075 2(c)
Fourth January 1, 1968 2-27794 2(c)
Fifth April 1, 1971 2-39537 2(c)
Sixth August 1, 1975 2-54116 2(c)
Seventh September 1, 1976 2-57014 2(c)
Eighth September 1, 1977 2-59690 2(c)
Ninth April 1, 1978 2-60866 2(c)
Tenth August 1, 1978 2-62852 2(d)2
Eleventh December 1, 1982 2-56649 4(a)3
Twelfth April 1, 1987 33-30224 4(a)3
Thirteenth March 1, 1992 33-47438 4(b)
Fourteenth June 1, 1992 33-55240 4(b)
Fifteenth July 1, 1992 33-55240 4(c)
Sixteenth July 1, 1992 33-55240 4(d)
Seventeenth February 1, 1993 33-50143 4(b)
Eighteenth July 1, 1993 33-50143 4(c)
Nineteenth February 1, 1997 1-3548
(1996 Form 10-K) 4(a)3
Twentieth November 1, 1997 1-3548
(1997 Form 10-K) 4(a)3
Twenty-first October 1, 2000 333-54330 4(c)3
Twenty-second July 1, 2003 1-3548
(June 30, 2003 Form 10-Q) 4
*4(b)1 - Indenture (for Unsecured Debt Securities), dated as of February 1,
2001, between ALLETE and LaSalle Bank National Association, as
Trustee (filed as Exhibit 4(d)1, File Nos. 333-57104, 333-57104-01
and 333-57104-02).
*4(b)2 - Officer's Certificate, dated February 21, 2001, establishing the
terms of the 7.80% Senior Notes, due February 15, 2008, of ALLETE
(filed as Exhibit 4(d)2, File Nos. 333-57104, 333-57104-01 and
333-57104-02).
*4(c)1 - Mortgage and Deed of Trust, dated as of March 1, 1943, between
Superior Water, Light and Power Company and Chemical Bank & Trust
Company and Howard B. Smith, as Trustees, both succeeded by U.S.
Bank Trust N.A., as Trustee (filed as Exhibit 7(c), File No.
2-8668).
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ALLETE FORM 10-K 2003
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PART IV
EXHIBIT NUMBER
- --------------------------------------------------------------------------------
*4(c)2 - Supplemental Indentures to Superior Water, Light and Power
Company's Mortgage and Deed of Trust:
NUMBER DATED AS OF REFERENCE FILE EXHIBIT
- --------------------------------------------------------------------------------
First March 1, 1951 2-59690 2(d)(1)
Second March 1, 1962 2-27794 2(d)1
Third July 1, 1976 2-57478 2(e)1
Fourth March 1, 1985 2-78641 4(b)
Fifth December 1, 1992 1-3548
(1992 Form 10-K) 4(b)1
Sixth March 24, 1994 1-3548
(1996 Form 10-K) 4(b)1
Seventh November 1, 1994 1-3548
(1996 Form 10-K) 4(b)2
Eighth January 1, 1997 1-3548
(1996 Form 10-K) 4(b)3
*4(d) - Rights Agreement, dated as of July 24, 1996, between Minnesota
Power & Light Company (now ALLETE) and the Corporate Secretary of
the Company, as Rights Agent (filed as Exhibit 4 to the August 2,
1996 Form 8-K, File No. 1-3548).
*4(e) - Indenture (for Unsecured Debt Securities), dated as of May 15,
1996, between ADESA Corporation and The Bank of New York, as
Trustee, relating to the ADESA Corporation's 7.70% Senior Notes,
Series A, Due 2006, and its 8.10% Senior Notes, Series B, Due 2010
(filed as Exhibit 4(k) to the 1996 Form 10-K, File No. 1-3548).
*4(f) - Guarantee of the Company, dated as of May 30, 1996, relating to
the ADESA Corporation's 7.70% Senior Notes, Series A, Due 2006
(filed as Exhibit 4(l) to the 1996 Form 10-K, File No. 1-3548).
*4(g) - ADESA Corporation Officer's Certificate 1-D-1, dated May 30, 1996,
relating to the ADESA Corporation's 7.70% Senior Notes, Series A,
Due 2006 (filed as Exhibit 4(m) to the 1996 Form 10-K, File No.
1-3548).
*4(h) - Guarantee of Minnesota Power, Inc. (now ALLETE), dated as of March
30, 2000, relating to ADESA Corporation's 8.10% Senior Notes,
Series B, Due 2010 (filed as Exhibit 4(a) to the March 31, 2000
Form 10-Q, File No. 1-3548).
*4(i) - ADESA Corporation Officer's Certificate 2-D-2, dated as of March
30, 2000, relating to ADESA Corporation's 8.10% Senior Notes,
Series B, Due 2010 (filed as Exhibit 4(b) to the March 31, 2000
Form 10-Q, File No. 1-3548).
*10(a) - Participation Agreement, dated as of March 31, 2000, among Asset
Holdings III, L.P., as Lessor, ADESA Corporation, as Lessee,
SunTrust Bank, as Credit Bank, and Cornerstone Funding Corporation
I, as Issuer (filed as Exhibit 10(a) to the March 31, 2000 Form
10-Q, File No. 1-3548).
*10(b) - Lease Agreement, dated as of March 31, 2000, between Asset
Holdings III, L.P., as Lessor, and ADESA Corporation, as Lessee
(filed as Exhibit 10(b) to the March 31, 2000 Form 10-Q, File No.
1-3548).
*10(c) - Reimbursement Agreement, dated as of March 31, 2000, between
SunTrust Bank, as Credit Bank, and Asset Holdings III, L.P., as
Lessor (filed as Exhibit 10(c) to the March 31, 2000 Form 10-Q,
File No. 1-3548).
*10(d) - Appendix I to Participation Agreement, Lease Agreement and
Reimbursement Agreement, all which are dated as of March 31, 2000,
relating to the Lease Financing for ADESA Corporation Auto Auction
Facilities (filed as Exhibit 10(d) to the March 31, 2000 Form
10-Q, File No. 1-3548).
*10(e) - Assignment of Lease and Rents (without Exhibit A) entered into as
of March 31, 2000, by and between Asset Holdings III, L.P., as
Lessor, and SunTrust Bank, as Credit Bank (filed as Exhibit 10(e)
to the March 31, 2000 Form 10-Q, File No. 1-3548).
*10(f) - Limited Guaranty of Minnesota Power, Inc.(now ALLETE), dated as of
March 31, 2000, relating to the Lease Financing for ADESA
Corporation Auto Auction Facilities (filed as Exhibit 10(f) to the
March 31, 2000 Form 10-Q, File No. 1-3548).
*10(g) - Borrower Promissory Note, dated April 3, 2000, between Asset
Holdings III, L.P. as Borrower, and Cornerstone Funding
Corporation I, as Issuer (filed as Exhibit 10(d) to the June 30,
2003 Form 10-Q, File No. 1-3548).
*10(h) - Trust Indenture (without Exhibits) between Development Authority
of Fulton County and SunTrust Bank, as Trustee, dated as of
December 1, 2002 (filed as Exhibit 10(k) to the 2002 Form 10-K,
File No. 1-3548).
*10(i) - Bond Purchase Agreement (without Exhibits), dated December 1,
2002, for the Development Authority of Fulton County Taxable
Economic Development Revenue Bonds (ADESA Atlanta, LLC Project)
Series 2002 (filed as Exhibit 10(l) to the 2002 Form 10-K, File
No. 1-3548).
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ALLETE FORM 10-K 2003
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PART IV
EXHIBIT NUMBER
- --------------------------------------------------------------------------------
*10(j) - Lease Agreement (without Exhibits) between Development Authority
of Fulton County and ADESA Atlanta, LLC, dated as of December 1,
2002 (filed as Exhibit 10(m) to the 2002 Form 10-K, File No.
1-3548).
*10(k) - Term Loan Agreement (without Exhibits), dated as of June 30, 2003,
among ADESA California, Inc., as Borrower, the Lenders Party
Thereto, and SunTrust Bank, as Administrative Agent (filed as
Exhibit 10(b) to the June 30, 2003 Form 10-Q, File No. 1-3548).
*10(l) - Guaranty Agreement, dated as of June 30, 2003, among ADESA and
ALLETE, as Guarantors of ADESA California, Inc., the Borrower, and
SunTrust Bank, the Administrative Agent (filed as Exhibit 10(c) to
the June 30, 2003 Form 10-Q, File No. 1-3548).
*10(m) - Receivables Purchase Agreement dated as of May 31, 2002, among AFC
Funding Corporation, as Seller, Automotive Finance Corporation, as
Servicer, Fairway Finance Corporation, as initial Purchaser, BMO
Nesbitt Burns Corp., as initial Agent and as Purchaser Agent for
Fairway Finance Corporation and XL Capital Assurance Inc., as
Insurer (filed as Exhibit 10(a) to the June 30, 2002 Form 10-Q,
File No. 1-3548).
*10(n) - Amended and Restated Purchase and Sale Agreement dated as of May
31, 2002, between AFC Funding Corporation and Automotive Finance
Corporation (filed as Exhibit 10(b) to the June 30, 2002 Form
10-Q, File No. 1-3548).
*10(o)1 - Wholesale Power Coordination and Dispatch Operating Agreement,
dated April 14, 2000, between Minnesota Power, Inc. (now ALLETE)
and Split Rock Energy LLC (filed as Exhibit 10(a) to the June 30,
2000 Form 10-Q, File No. 1-3548).
*10(o)2 - Letter addressed to the Federal Energy Regulatory Commission,
dated April 21, 2000, amending the Wholesale Power Coordination
and Dispatch Operating Agreement, dated April 14, 2000, between
Minnesota Power, Inc. (now ALLETE) and Split Rock Energy LLC
(filed as Exhibit 10(b) to the June 30, 2000 Form 10-Q, File No.
1-3548).
10(o)3 - Amended Wholesale Power Coordination and Dispatch Operating
Agreement, dated January 30, 2004, between Minnesota Power, Inc.
(now ALLETE) and Split Rock Energy LLC.
10(p) - Amended and Restated Withdrawal Agreement (without Exhibits and
Schedules), dated January 30, 2004, by and between Great River
Energy and Minnesota Power (now ALLETE). [Portions of this exhibit
have been omitted pursuant to a request for confidential treatment
and filed separately with the SEC.]
*10(q) - Power Purchase and Sale Agreement, dated as of May 29, 1998,
between Minnesota Power, Inc. (now ALLETE) and Square Butte
Electric Cooperative (filed as Exhibit 10 to the June 30, 1998
Form 10-Q, File No. 1-3548).
*10(r) - Credit Agreement, dated as of July 18, 2003, among ALLETE, as
Borrower, Wells Fargo Bank, National Association, as Sole Lead
Arranger and Administrative Agent, Bank One, N.A., as Syndication
Agent, and the Other Financial Institutions Party Thereto (filed
as Exhibit 10(a) to the June 30, 2003 Form 10-Q, File No. 1-3548).
10(s) - Third Amended and Restated Committed Facility Letter (without
Exhibits), dated December 23, 2003, to ALLETE from LaSalle Bank
National Association, as Agent.
+*10(t)1 - Minnesota Power (now ALLETE) Executive Annual Incentive Plan, as
amended, effective January 1, 1999 with amendments through January
2003 (filed as Exhibit 10 to the September 30, 2003 Form 10-Q,
File No. 1-3548).
+10(t)2 - November 2003 Amendment to the Minnesota Power (now ALLETE)
Executive Annual Incentive Plan.
+10(u) - ALLETE and Affiliated Companies Supplemental Executive Retirement
Plan, as amended and restated, effective January 1, 2004.
+*10(v)1 - Executive Investment Plan-I, as amended and restated, effective
November 1, 1988 (filed as Exhibit 10(c) to the 1988 Form 10-K,
File No. 1-3548).
+10(v)2 - Amendments through December 2003 to the Minnesota Power and
Affiliated Companies Executive Investment Plan-I.
+*10(w)1 - Executive Investment Plan-II, as amended and restated, effective
November 1, 1988 (filed as Exhibit 10(d) to the 1988 Form 10-K,
File No. 1-3548).
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ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
PART IV
EXHIBIT NUMBER
- --------------------------------------------------------------------------------
+10(w)2 - Amendments through December 2003 to the Minnesota Power and
Affiliated Companies Executive Investment Plan-II.
+*10(x) - Deferred Compensation Trust Agreement, as amended and restated,
effective January 1, 1989 (filed as Exhibit 10(f) to the 1988 Form
10-K, File No. 1-3548).
+*10(y)1 - Minnesota Power (now ALLETE) Executive Long-Term Incentive
Compensation Plan, effective January 1, 1996 (filed as Exhibit
10(a) to the June 30, 1996 Form 10-Q, File No. 1-3548).
+*10(y)2 - Amendments through January 2003 to the Minnesota Power (now
ALLETE) Executive Long-Term Incentive Compensation Plan (filed as
Exhibit 10(z)2 to the 2002 Form 10-K, File No. 1-3548).
+*10(z)1 - Minnesota Power (now ALLETE) Director Stock Plan, effective
January 1, 1995 (filed as Exhibit 10 to the March 31, 1995 Form
10-Q, File No. 1-3548).
+10(z)2 - Amendments through December 2003 to the Minnesota Power (now
ALLETE) Director Stock Plan.
+*10(aa)1 - Minnesota Power (now ALLETE) Director Compensation Deferral Plan
Amended and Restated, effective January 1, 1990 (filed as Exhibit
10(ac) to the 2002 Form 10-K, File No. 1-3548).
+10(aa)2 - October 2003 Amendment to the Minnesota Power (now ALLETE)
Director Compensation Deferral Plan.
12 - Computation of Ratios of Earnings to Fixed Charges (Unaudited).
*21 - Subsidiaries of the Registrant (reference is made to ALLETE's Form
U-3A-2 for the year ended December 31, 2003, File No. 69-78).
23(a) - Consent of Independent Accountants.
23(b) - Consent of General Counsel.
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 Annual Report by the Chief Executive
Officer and Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
- ------------------------------------
* Incorporated herein by reference as indicated.
+ Management contract or compensatory plan or arrangement required to be filed
as an exhibit to this report pursuant to Item 15(c) of Form 10-K.
(b) Reports on Form 8-K.
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.
Report on Form 8-K filed November 13, 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 December 5, 2003 with respect to Item 5. Other
Events and Regulation FD Disclosure.
Report on Form 8-K filed January 26, 2004 with respect to Item 5. Other
Events and Regulation FD Disclosure.
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PAGE 58
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Dated: March 11, 2004 By David G. Gartzke
-------------------------------
David G. Gartzke
Chairman
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- -------------------------------------------------------------------------------------------------------------
David G. Gartzke Chairman and Director March 11, 2004
- ----------------------------------
David G. Gartzke
Donald J. Shippar President and Chief Executive Officer March 11, 2004
- ----------------------------------
Donald J. Shippar
James K. Vizanko Senior Vice President, March 11, 2004
- ----------------------------------
James K. Vizanko Chief Financial Officer and Treasurer
Mark A. Schober Senior Vice President and Controller March 11, 2004
- ----------------------------------
Mark A. Schober
Wynn V. Bussmann Director March 11, 2004
- ----------------------------------
Wynn V. Bussmann
Thomas L. Cunningham Director March 11, 2004
- ----------------------------------
Thomas L. Cunningham
Dennis O. Green Director March 11, 2004
- ----------------------------------
Dennis O. Green
Peter J. Johnson Director March 11, 2004
- ----------------------------------
Peter J. Johnson
George L. Mayer Director March 11, 2004
- ----------------------------------
George L. Mayer
Jack I. Rajala Director March 11, 2004
- ----------------------------------
Jack I. Rajala
Nick Smith Director March 11, 2004
- ----------------------------------
Nick Smith
Bruce W. Stender Director March 11, 2004
- ----------------------------------
Bruce W. Stender
Donald C. Wegmiller Director March 11, 2004
- ----------------------------------
Donald C. Wegmiller
Deborah L. Weinstein Director March 11, 2004
- ----------------------------------
Deborah L. Weinstein
- --------------------------------------------------------------------------------
PAGE 59
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
REPORTS
REPORT OF INDEPENDENT AUDITORS
[PRICEWATERHOUSECOOPERS LLP LOGO]
To the Shareholders and
Board of Directors of ALLETE, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, of cash flows and of shareholders' equity
present fairly, in all material respects, the financial position of ALLETE, Inc.
and its subsidiaries at December 31, 2003 and 2002, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2003, in conformity with accounting principles generally accepted
in the United States of America. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 6 to the consolidated financial statements, the
Company adopted Statement of Financial Accounting Standards, No. 143,
"Accounting for Asset Retirement Obligations" on January 1, 2003. As discussed
in Notes 2 and 9 to the consolidated financial statements, the Company adopted
Statement of Financial Accounting Standards, No. 142, "Goodwill and Other
Intangible Assets" on January 1, 2002.
PricewaterhouseCoopers LLP
Minneapolis, Minnesota
February 9, 2004, except as to Note 3 which is as of March 8, 2004
- --------------------------------------------------------------------------------
REPORT OF MANAGEMENT
The consolidated financial statements and other financial information were
prepared by management, who is responsible for their integrity and objectivity.
The financial statements have been prepared in conformity with generally
accepted accounting principles and necessarily include some amounts that are
based on informed judgments and best estimates and assumptions of management.
To meet management's responsibilities with respect to financial information,
we maintain and enforce a system of internal accounting controls designed to
provide assurance, on a cost effective basis, that transactions are carried out
in accordance with management's authorizations and that assets are safeguarded
against loss from unauthorized use or disposition. The system includes an
organizational structure that provides an appropriate segregation of
responsibilities, careful selection and training of personnel, written policies
and procedures, and periodic reviews by our internal audit department. In
addition, we have personnel policies that require all employees to maintain a
high standard of ethical conduct. Management believes the system is effective
and provides reasonable assurance that all transactions are properly recorded
and have been executed in accordance with management's authorization. Management
modifies and improves our system of internal accounting controls in response to
changes in business conditions. Our internal audit staff is charged with the
responsibility for determining compliance with our procedures.
Six of our directors, not members of management, serve as the Audit
Committee. Our Board of Directors, through the Audit Committee, oversees
management's responsibilities for financial reporting. The Audit Committee meets
regularly with management, the internal auditors and the independent auditors to
discuss auditing and financial matters and to assure that each is carrying out
their responsibilities. The internal auditors and the independent auditors have
full and free access to the Audit Committee without management present.
PricewaterhouseCoopers LLP, independent auditors, are engaged to express an
opinion on the financial statements. Their audit is conducted in accordance with
generally accepted auditing standards and includes a review of internal controls
and tests of transactions to the extent necessary to allow them to report on the
fairness of our operating results and financial condition.
David G. Gartzke
David G. Gartzke
Chairman
Donald Shippar
Donald J. Shippar
President and Chief Executive Officer
James Vizanko
James K. Vizanko
Chief Financial Officer
- --------------------------------------------------------------------------------
PAGE 60
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
CONSOLIDATED FINANCIAL STATEMENTS
ALLETE CONSOLIDATED BALANCE SHEET
DECEMBER 31 2003 2002
==================================================================================================
MILLIONS
Assets
Current Assets
Cash and Cash Equivalents $ 223.0 $ 193.3
Trading Securities - 1.8
Accounts Receivable - Net 403.8 383.8
Inventories 37.9 36.6
Prepayments and Other 15.8 14.1
Discontinued Operations 14.9 28.8
- --------------------------------------------------------------------------------------------------
Total Current Assets 695.4 658.4
Property, Plant and Equipment - Net 1,499.0 1,364.7
Investments 204.6 170.9
Goodwill 511.0 502.0
Other Intangible Assets 33.3 37.6
Other Assets 70.1 67.5
Discontinued Operations 87.9 346.1
- --------------------------------------------------------------------------------------------------
Total Assets $3,101.3 $3,147.2
- --------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Liabilities
Current Liabilities
Accounts Payable $ 243.9 $ 202.6
Accrued Taxes, Interest and Dividends 35.2 36.4
Notes Payable 53.0 74.5
Long-Term Debt Due Within One Year 37.5 283.7
Other 107.1 111.3
Discontinued Operations 49.5 29.7
- --------------------------------------------------------------------------------------------------
Total Current Liabilities 526.2 738.2
Long-Term Debt 747.7 696.4
Mandatorily Redeemable Preferred Securities - 75.0
Accumulated Deferred Income Taxes 160.7 139.8
Other Liabilities 161.5 137.6
Discontinued Operations 45.0 127.8
Commitments and Contingencies
- --------------------------------------------------------------------------------------------------
Total Liabilities 1,641.1 1,914.8
- --------------------------------------------------------------------------------------------------
Shareholders' Equity
Common Stock Without Par Value, 130.0 Shares Authorized
87.3 and 85.6 Shares Outstanding 859.2 814.9
Unearned ESOP Shares (45.4) (49.0)
Accumulated Other Comprehensive Gain (Loss) 14.5 (22.2)
Retained Earnings 631.9 488.7
- --------------------------------------------------------------------------------------------------
Total Shareholders' Equity 1,460.2 1,232.4
- --------------------------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity $3,101.3 $3,147.2
==================================================================================================
The accompanying notes are an integral part of these statements.
- --------------------------------------------------------------------------------
PAGE 61
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
CONSOLIDATED FINANCIAL STATEMENTS
ALLETE CONSOLIDATED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31 2003 2002 2001
==================================================================================================
MILLIONS EXCEPT PER SHARE AMOUNTS
Operating Revenue
Energy Services
Regulated Utility $ 512.8 $ 505.6 $ 538.7
Nonregulated 146.8 120.4 80.0
Automotive Services 922.3 835.8 832.1
Investments 36.9 32.5 74.8
- --------------------------------------------------------------------------------------------------
Total Operating Revenue 1,618.8 1,494.3 1,525.6
- --------------------------------------------------------------------------------------------------
Operating Expenses
Fuel and Purchased Power
Regulated Utility 212.5 206.7 233.1
Nonregulated 40.0 28.1 -
Operations
Regulated Utility 217.7 197.0 204.1
Nonregulated 98.0 107.5 74.9
Automotive and Investments 749.0 693.4 728.3
Interest 66.6 70.5 83.0
- --------------------------------------------------------------------------------------------------
Total Operating Expenses 1,383.8 1,303.2 1,323.4
- --------------------------------------------------------------------------------------------------
Operating Income from Continuing Operations 235.0 191.1 202.2
Income Tax Expense 91.9 72.2 73.3
- --------------------------------------------------------------------------------------------------
Income from Continuing Operations 143.1 118.9 128.9
Income from Discontinued Operations - Net of Tax 93.3 18.3 9.8
- --------------------------------------------------------------------------------------------------
Net Income $ 236.4 $ 137.2 $ 138.7
- --------------------------------------------------------------------------------------------------
Average Shares of Common Stock
Basic 82.8 81.1 75.8
Diluted 83.3 81.7 76.5
- --------------------------------------------------------------------------------------------------
Earnings Per Share of Common Stock
Basic
Continuing Operations $1.72 $1.47 $1.70
Discontinued Operations 1.13 0.22 0.13
- --------------------------------------------------------------------------------------------------
$2.85 $1.69 $1.83
- --------------------------------------------------------------------------------------------------
Diluted
Continuing Operations $1.72 $1.46 $1.68
Discontinued Operations 1.12 0.22 0.13
- --------------------------------------------------------------------------------------------------
$2.84 $1.68 $1.81
- --------------------------------------------------------------------------------------------------
Dividends Per Share of Common Stock $1.13 $1.10 $1.07
==================================================================================================
The accompanying notes are an integral part of these statements.
- --------------------------------------------------------------------------------
PAGE 62
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
CONSOLIDATED FINANCIAL STATEMENTS
ALLETE CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31 2003 2002 2001
=======================================================================================================
MILLIONS
Operating Activities
Net Income $ 236.4 $ 137.2 $ 138.7
Gain on Sale of Plant (141.5) - -
Depreciation and Amortization 86.7 82.1 101.6
Deferred Income Taxes 14.3 26.9 10.3
Changes in Operating Assets and Liabilities - Net of the
Effects of Acquisitions
Trading Securities 1.8 153.8 (64.8)
Accounts Receivable (8.8) 74.9 (82.4)
Inventories (1.0) (3.8) (3.0)
Prepayments and Other (2.5) 2.0 (9.2)
Accounts Payable 37.0 (38.0) (23.9)
Other Current Liabilities 7.3 (7.8) 16.4
Other Assets (2.0) (3.9) (8.9)
Other Liabilities 18.1 29.6 28.8
- -------------------------------------------------------------------------------------------------------
Cash from Operating Activities 245.8 453.0 103.6
- -------------------------------------------------------------------------------------------------------
Investing Activities
Proceeds from Sale of Plant 444.7 - -
Proceeds from Sale of Available-For-Sale Securities 7.4 1.9 2.6
Additions to Investments (49.1) (24.5) (11.2)
Additions to Property, Plant and Equipment (181.3) (201.2) (149.2)
Acquisitions - Net of Cash Acquired (1.8) (32.7) (157.1)
Other (7.6) 12.1 17.5
- -------------------------------------------------------------------------------------------------------
Cash from (for) Investing Activities 212.3 (244.4) (297.4)
- -------------------------------------------------------------------------------------------------------
Financing Activities
Issuance of Long-Term Debt 85.2 18.4 125.2
Issuance of Common Stock 44.3 43.2 189.2
Changes in Notes Payable - Net (18.6) (200.5) 5.5
Reductions of Long-Term Debt (413.4) (14.5) (18.1)
Reductions of Mandatorily Redeemable Preferred Securities (75.0) - -
Dividends on Common Stock (93.2) (89.2) (81.8)
- -------------------------------------------------------------------------------------------------------
Cash from (for) Financing Activities (470.7) (242.6) 220.0
- -------------------------------------------------------------------------------------------------------
Effect of Exchange Rate Changes on Cash 39.2 2.7 (11.3)
- -------------------------------------------------------------------------------------------------------
Change in Cash and Cash Equivalents 26.6 (31.3) 14.9
Cash and Cash Equivalents at Beginning of Period <F1> 202.9 234.2 219.3
- -------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period <F1> $ 229.5 $ 202.9 $ 234.2
- -------------------------------------------------------------------------------------------------------
Supplemental Cash Flow Information
Cash Paid During the Period for
Interest - Net of Capitalized $69.2 $71.9 $84.2
Income Taxes $87.4 $49.2 $60.5
=======================================================================================================
<FN>
<F1> Included $6.5 million of cash from Discontinued Operations at December 31, 2003 ($9.6 million at
December 31, 2002).
</FN>
The accompanying notes are an integral part of these statements.
- --------------------------------------------------------------------------------
PAGE 63
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
CONSOLIDATED FINANCIAL STATEMENTS
ALLETE CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
ACCUMULATED
TOTAL OTHER UNEARNED
SHAREHOLDERS' RETAINED COMPREHENSIVE ESOP COMMON
EQUITY EARNINGS INCOME (LOSS) SHARES STOCK
=============================================================================================================================
MILLIONS
Balance at December 31, 2000 $ 900.8 $383.8 $(4.2) $(55.7) $576.9
Comprehensive Income
Net Income 138.7 138.7
Other Comprehensive Income - Net of Tax
Unrealized Gains on Securities - Net 2.5 2.5
Interest Rate Swap (1.5) (1.5)
Foreign Currency Translation Adjustments (11.3) (11.3)
--------
Total Comprehensive Income 128.4
Common Stock Issued - Net 193.4 193.4
Dividends Declared (81.8) (81.8)
ESOP Shares Earned 3.0 3.0
- -----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 1,143.8 440.7 (14.5) (52.7) 770.3
Comprehensive Income
Net Income 137.2 137.2
Other Comprehensive Income - Net of Tax
Unrealized Gains on Securities - Net (8.1) (8.1)
Interest Rate Swap 1.3 1.3
Foreign Currency Translation Adjustments 2.6 2.6
Additional Pension Liability (3.5) (3.5)
--------
Total Comprehensive Income 129.5
Common Stock Issued - Net 44.6 44.6
Dividends Declared (89.2) (89.2)
ESOP Shares Earned 3.7 3.7
- -----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 1,232.4 488.7 (22.2) (49.0) 814.9
Comprehensive Income
Net Income 236.4 236.4
Other Comprehensive Income - Net of Tax
Unrealized Gains on Securities - Net 3.6 3.6
Interest Rate Swap 0.2 0.2
Foreign Currency Translation Adjustments 39.2 39.2
Additional Pension Liability (6.3) (6.3)
--------
Total Comprehensive Income 273.1
Common Stock Issued - Net 44.3 44.3
Dividends Declared (93.2) (93.2)
ESOP Shares Earned 3.6 3.6
- -----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2003 $1,460.2 $631.9 $14.5 $(45.4) $859.2
=============================================================================================================================
The accompanying notes are an integral part of these statements.
- --------------------------------------------------------------------------------
PAGE 64
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
1 BUSINESS SEGMENTS
BUSINESS SEGMENTS
INVESTMENTS
AND
ENERGY AUTOMOTIVE CORPORATE
FOR THE YEAR ENDED DECEMBER 31 CONSOLIDATED SERVICES SERVICES CHARGES
====================================================================================================================
MILLIONS
2003
Operating Revenue $1,618.8 $659.6 $922.3 <F3> $ 36.9
Operation and Other Expense 1,230.7 517.1 681.4 32.2
Depreciation and Amortization Expense 86.5 51.1 35.3 0.1
Interest Expense 66.6 22.4 16.0 28.2
- --------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing Operations 235.0 69.0 189.6 (23.6)
Income Tax Expense (Benefit) 91.9 26.6 74.8 (9.5)
- --------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations 143.1 42.4 114.8 (14.1)
Income from Discontinued Operations - Net of Tax 93.3 <F1> - 0.3 -
- --------------------------------------------------------------------------------------------------------------------
Net Income $ 236.4 <F1> $42.4 $115.1 $(14.1)
- --------------------------------------------------------------------------------------------------------------------
Total Assets $3,101.3 <F2> $1,213.3 $1,632.7 <F4> $152.5
Capital Expenditures $136.3 <F2> $73.6 $26.9 -
- --------------------------------------------------------------------------------------------------------------------
2002
Operating Revenue $1,494.3 $626.0 $835.8 <F3> $ 32.5
Operation and Other Expense 1,151.0 490.5 627.7 32.8
Depreciation and Amortization Expense 81.7 48.8 32.8 0.1
Interest Expense 70.5 21.2 21.2 28.1
- --------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing Operations 191.1 65.5 154.1 (28.5)
Income Tax Expense (Benefit) 72.2 23.7 59.9 (11.4)
- --------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations 118.9 41.8 94.2 (17.1)
Income (Loss) from Discontinued Operations - Net of Tax 18.3 <F1> (1.2) (5.9) -
- --------------------------------------------------------------------------------------------------------------------
Net Income $ 137.2 <F1> $40.6 $88.3 $(17.1)
- --------------------------------------------------------------------------------------------------------------------
Total Assets $3,147.2 <F2> $1,150.9 $1,471.1 <F4> $150.3
Capital Expenditures $201.2 <F2> $80.9 $66.5 $5.7
- --------------------------------------------------------------------------------------------------------------------
2001
Operating Revenue $1,525.6 $618.7 $832.1 <F3> $74.8
Operation and Other Expense 1,151.5 466.2 635.1 50.2
Depreciation and Amortization Expense 88.9 45.9 42.7 0.3
Interest Expense 83.0 22.5 35.3 25.2
- --------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing Operations 202.2 84.1 119.0 (0.9)
Income Tax Expense (Benefit) 73.3 32.4 44.2 (3.3)
- --------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations 128.9 51.7 74.8 2.4
Income (Loss) from Discontinued Operations - Net of Tax 9.8 <F1> (1.6) (7.0) -
- --------------------------------------------------------------------------------------------------------------------
Net Income $138.7 <F1> $50.1 $67.8 $2.4
- --------------------------------------------------------------------------------------------------------------------
Total Assets $3,282.5 <F2> $1,049.1 $1,515.4 <F4> $365.5
Capital Expenditures $149.2 <F2> $59.9 $57.2 -
====================================================================================================================
<FN>
<F1> Included $93.0 million of income from Water Services businesses ($25.4 million in 2002; $18.4 million in 2001).
<F2> Discontinued operations represented $102.8 million of total assets in 2003 ($374.9 million in 2002; $352.5
million in 2001) and $35.8 million of capital expenditures in 2003 ($48.1 million in 2002; $32.1 million in
2001).
<F3> Included $173.1 million of Canadian operating revenue in 2003 ($141.9 million in 2002; $139.4 million in 2001).
<F4> Included $220.1 million of Canadian assets in 2003 ($184.7 million in 2002; $187.6 million in 2001).
</FN>
- --------------------------------------------------------------------------------
PAGE 65
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
2 OPERATIONS AND SIGNIFICANT ACCOUNT POLICIES
FINANCIAL STATEMENT PREPARATION. References in this report to "we," "us" and
"our" are to ALLETE and its subsidiaries, collectively. We prepare our financial
statements in conformity with generally accepted accounting principles. These
principles require management to make informed judgments, best estimates and
assumptions that affect the reported amounts of assets, liabilities, revenue and
expenses. Actual results could differ from those estimates.
PRINCIPLES OF CONSOLIDATION. Our consolidated financial statements include
the accounts of ALLETE and all of our majority owned subsidiary companies. All
material intercompany balances and transactions have been eliminated in
consolidation. Information for prior periods has been reclassified to present
comparable information for all periods.
BUSINESS SEGMENTS. Energy Services and Automotive Services segments were
determined based on products and services provided. The Investment and Corporate
Charges segment was determined based on short-term corporate liquidity needs and
the need to provide financial flexibility to pursue strategic initiatives in the
other business segments. We measure performance of our operations through
careful budgeting and monitoring of contributions to consolidated net income by
each business segment. Discontinued Operations included financial results of our
Water Services businesses, our vehicle transport and import businesses, and
our retail stores.
ENERGY SERVICES. Energy Services is engaged in the generation, transmission,
distribution and marketing of electricity, as well as coal mining and
telecommunications.
Minnesota Power, an operating division of ALLETE, and SWL&P, a wholly owned
subsidiary, provide regulated utility electric service to 149,000 retail
customers in northeastern Minnesota and northwestern Wisconsin. Approximately
50% of regulated utility electric sales are to large power customers (which
consists of five taconite producers, four paper and pulp mills, two pipeline
companies and one manufacturer) under all-requirements contracts with expiration
dates extending from March 2005 through April 2009. Regulated utility electric
rates are under the jurisdiction of various state and federal regulatory
authorities. Billings are rendered on a cycle basis. Revenue is accrued for
service provided but not billed. Regulated utility electric rates include
adjustment clauses that bill or credit customers for fuel and purchased energy
costs above or below the base levels in rate schedules and that bill retail
customers for the recovery of CIP expenditures not collected in base rates.
Minnesota Power and wholly owned subsidiary Rainy River Energy, through its
Kendall County power purchase agreement, also engage in nonregulated electric
generation and power marketing. Nonregulated generation is non-rate base
generation sold at market-based rates to the wholesale market.
BNI Coal, a wholly owned subsidiary, mines and sells lignite coal to two
North Dakota mine-mouth generating units, one of which is Square Butte. Square
Butte supplies approximately 71% (323 MW) of its output to Minnesota Power under
a long-term contract. (See Note 15.)
Enventis Telecom, a wholly owned subsidiary, is our telecommunications
business which is an integrated data services provider offering fiber
optic-based communication and advanced data services to businesses and
communities in Minnesota, Wisconsin and Missouri.
Split Rock Energy is a joint venture between Minnesota Power and Great River
Energy from which we are withdrawing. Split Rock Energy was formed to combine
power supply capabilities and customer loads for power pool operations and
generation outage protection. In response to the changing strategies of both
parties, as of February 2004 we withdrew from active participation in Split Rock
Energy and will terminate our ownership interest upon receipt of FERC approval
which is expected in the first half of 2004. We have retained some of the
benefits of the partnership, such as joint load and capability reporting. As a
result of withdrawing from active participation, we received a $10.0 million
distribution in February 2004 representing the majority of our capital account
balance on the date of withdrawal. The remaining balance in our capital account
will be distributed upon FERC approval. Prior to withdrawing from active
participation, we accounted for our 50% ownership interest in Split Rock Energy
under the equity method of accounting. For the year ended December 31, 2003 our
pre-tax equity income from Split Rock Energy was $2.9 million ($7.3 million in
2002; $3.6 million in 2001). We did not receive any cash distributions from
Split Rock Energy in 2003 ($2.6 million in 2002; $2.1 million in 2001). We
purchased power from Split Rock Energy to serve native load requirements and
sold generation to Split Rock Energy. Purchases and sales were at market rates.
In 2003 we made power purchases from Split Rock Energy of $50.9 million ($34.3
million in 2002; $56.1 million in 2001) and power sales to Split Rock Energy of
$19.6 million ($14.5 million in 2002; $13.3 million in 2001).
AUTOMOTIVE SERVICES. Automotive Services operates (through several wholly
owned subsidiaries) two main businesses that are integral parts of the vehicle
redistribution industry: auctions and related services, and dealer financing.
We are a service provider and do not actually buy and sell vehicles. We
provide auction, reconditioning, logistics, and other administrative outsourcing
services to wholesale vehicle buyers and sellers for a fee. Buyers are licensed
franchised, independent and wholesale used vehicle dealers, while sellers
include vehicle manufacturers, dealers, automotive fleet/lease companies, credit
unions and other financial institutions, finance companies and rental car
companies. We also provide floorplan financing.
- --------------------------------------------------------------------------------
PAGE 66
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
Revenue is recognized when the services we provide are performed. Revenue
includes the Company's fees for such services and interest earned on floorplan
receivables. We do not report the gross sales price of the vehicles in revenue
nor the related purchase price in operating expense.
Wholesale vehicle auctions include 53 used vehicle auctions, 27 salvage
vehicle auctions and other related services. Used vehicles are sold to dealers
through our used vehicle auctions, and salvage vehicle services are provided
primarily to insurance companies through our salvage auctions. Other related
services include inbound and outbound logistics, reconditioning, vehicle
inspection and certification, and titling services.
Dealer financing consists of AFC which provides short-term inventory-secured
financing for used vehicle dealers who purchase vehicles at auctions. AFC has 80
loan production offices located across North America. These offices provide
qualified dealers credit to purchase vehicles at any of the 500 plus auctions
and other outside sources approved by AFC.
AFC's revenue is comprised of gains on sales of receivables, and interest and
fee income. Revenue from AFC was $104.0 million in 2003 ($98.6 million in 2002;
$91.7 million in 2001). As is customary for finance companies, AFC's revenue is
reported net of interest expense of $0.3 million in 2003 ($1.3 million in 2002;
$3.4 million in 2001) and is included in Operating Revenue - Automotive Services
on our consolidated statement of income. Interest on finance receivables is
recognized based on the number of days the vehicle remains financed. AFC
generally sells its United States dollar denominated finance receivables through
a private securitization structure. Gains and losses on such sales are generally
recognized at the time of settlement based on the difference between the sales
proceeds and the allocated basis of the finance receivables sold, adjusted for
transaction fees.
INVESTMENTS AND CORPORATE CHARGES. Investments and Corporate Charges include
real estate operations, investments in emerging technologies related to the
electric utility industry and general corporate expenses, including interest,
not specifically related to any one business segment. Our real estate operations
include several wholly owned subsidiaries and an 80% ownership in Lehigh which
are consolidated in ALLETE's financial statements. All are Florida real estate
companies principally engaged in real estate acquisition, sales and investment
activities. Full profit recognition is recorded on sales upon closing provided
cash collections are at least 20% of the contract price and the other
requirements of GAAP concerning profit recognition are met.
Investments and corporate charges included Operation and Other Expense
totaling $17.6 million in 2003 ($16.5 million in 2002; $22.8 million in 2001)
for general corporate expenses such as employee salaries and benefits, and legal
and other outside contract service fees, and Interest Expense of $28.0 million
in 2003 ($28.1 million in 2002; $25.2 million in 2001). Also included in
Investments and Corporate Charges was our trading securities portfolio which was
liquidated during the second half of 2002.
PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment are recorded at
original cost and are reported on the balance sheet net of accumulated
depreciation. Expenditures for additions and significant replacements and
improvements are capitalized; maintenance and repair costs are expensed as
incurred. Expenditures for major plant overhauls are also accounted for using
this same policy. Gains or losses on nonregulated property, plant and equipment
are recognized when they are retired or otherwise disposed of. When regulated
utility property, plant and equipment are retired or otherwise disposed of, no
gain or loss is recognized.
LONG-LIVED ASSET IMPAIRMENTS. We periodically review our long-lived assets
whenever events indicate the carrying amount of the assets may not be
recoverable. Excluding impairment losses recorded on certain remaining water
assets held for sale, as of December 31, 2003 no write-downs were required.
ACCOUNTS RECEIVABLE. Accounts receivable are reported on the balance sheet
net of an allowance for doubtful accounts. The allowance is based on our
evaluation of the receivable portfolio under current conditions, the size of the
portfolio, overall portfolio quality, review of specific problems and such other
factors that in our judgment deserve recognition in estimating losses.
ACCOUNTS RECEIVABLE
DECEMBER 31 2003 2002
================================================================================
MILLIONS
Trade Accounts Receivable $224.2 $214.9
Less:Allowance for Doubtful Accounts 8.4 8.8
- --------------------------------------------------------------------------------
215.8 206.1
- --------------------------------------------------------------------------------
Finance Receivables
AFC - Net 187.0 177.3
Real Estate - Net 1.0 0.4
- --------------------------------------------------------------------------------
188.0 177.7
- --------------------------------------------------------------------------------
Total Accounts Receivable - Net $403.8 $383.8
================================================================================
AFC sells the majority of United States 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.
The outstanding receivables sold and a cash reserve equal to 1% of total
receivables sold serve as security interest for the receivables that have been
sold to the bank conduit facility.
- --------------------------------------------------------------------------------
PAGE 67
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
FINANCE RECEIVABLES MANAGED BY AFC
AT DECEMBER 31 TOTAL DELINQUENT<F1>
================================================================================
MILLIONS
2003
Finance Receivables Managed $538.8 $7.8
Less: Amounts Sold to Bank Facility 333.8
- --------------------------------------------------------------------------------
Gross Finance Receivables Recognized 205.0
Less: Allowance for Doubtful Accounts 18.0
- --------------------------------------------------------------------------------
Net Finance Receivables Recognized $187.0
- --------------------------------------------------------------------------------
2002
Finance Receivables Managed $501.1 $8.0
Less: Amounts Sold to Bank Facility 303.8
- --------------------------------------------------------------------------------
Gross Finance Receivables Recognized 197.3
Less: Allowance for Doubtful Accounts 20.0
- --------------------------------------------------------------------------------
Net Finance Receivables Recognized $177.3
- --------------------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31 2003 2002
- --------------------------------------------------------------------------------
MILLIONS
Net Credit Losses from Total
Receivables Managed $14.2 $14.7
Total Proceeds from Sales of
Finance Receivables $4,134.3 $4,142.3
================================================================================
<FN>
<F1> Defined as 60 days or more past due.
</FN>
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.
INVENTORIES. Inventories, which include fuel, material and supplies, are
stated at the lower of cost or market. Cost is determined by the average cost
method.
GOODWILL. All goodwill relates to the Automotive Services segment and
represents the excess of cost over identifiable tangible and intangible net
assets of businesses acquired. As required by SFAS 142, "Goodwill and Other
Intangible Assets," goodwill is no longer amortized after 2001. Prior to 2002 we
amortized goodwill on a straight-line basis over 40 years.
UNAMORTIZED EXPENSE, DISCOUNT AND PREMIUM ON DEBT. Expense, discount and
premium on debt are deferred and amortized over the lives of the related issues.
CASH AND CASH EQUIVALENTS. We consider all investments purchased with
maturities of three months or less to be cash equivalents.
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 $3 million in 2003 ($4 million in 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."
FOR THE YEAR ENDED
DECEMBER 31 2003 2002 2001
================================================================================
MILLIONS EXCEPT PER SHARE AMOUNTS
Net Income
As Reported $236.4 $137.2 $138.7
Less: Employee Stock Compensation
Expense Determined Under
SFAS 123 - Net of Tax (0.5) (1.4) 0.8
- --------------------------------------------------------------------------------
Pro Forma Net Income $235.9 $135.8 $139.5
- --------------------------------------------------------------------------------
Basic Earnings Per Share
As Reported $2.85 $1.69 $1.83
Pro Forma $2.85 $1.67 $1.84
- --------------------------------------------------------------------------------
Diluted Earnings Per Share
As Reported $2.84 $1.68 $1.81
Pro Forma $2.83 $1.66 $1.82
================================================================================
In the previous table, 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 2001
================================================================================
Risk-Free Interest Rate 3.1% 4.4% 5.0%
Expected Life - Years 5 5 5
Expected Volatility 25.2% 24.2% 22.2%
Dividend Growth Rate 2% 2% 2%
================================================================================
FOREIGN CURRENCY TRANSLATION. Results of operations for our Canadian and
Mexican subsidiaries are translated into United States dollars using the average
exchange rates during the period. Assets and liabilities are translated into
United States dollars using the exchange rate on the balance sheet date.
Resulting translation adjustments are recorded in the Accumulated Other
Comprehensive Gain (Loss) section of Shareholders' Equity on our consolidated
balance sheet.
ENVIRONMENTAL LIABILITIES. We review environmental matters on a quarterly
basis. Accruals for environmental matters are recorded when it is probable that
a liability has been incurred and the amount of the liability can be reasonably
estimated, based on current law and existing technologies. These accruals are
adjusted periodically as assessment and remediation efforts progress or as
additional technical or legal information becomes available. Accruals for
environmental liabilities are included in the balance sheet at undiscounted
amounts and exclude claims for recoveries from insurance or other third parties.
Costs related to environmental contamination treatment and cleanup are charged
to expense.
- --------------------------------------------------------------------------------
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ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
INCOME TAXES. We file a consolidated federal income tax return. Income taxes
are allocated to each subsidiary based on their taxable income. We account for
income taxes using the liability method as prescribed by SFAS 109, "Accounting
for Income Taxes." Under the liability method, deferred income tax liabilities
are established for all temporary differences in the book and tax basis of
assets and liabilities based upon enacted tax laws and rates applicable to the
periods in which the taxes become payable. Due to the effects of regulation on
Minnesota Power, certain adjustments made to deferred income taxes are, in turn,
recorded as regulatory assets or liabilities. Investment tax credits have been
recorded as deferred credits and are being amortized to income tax expense over
the service lives of the related property.
EXCISE TAXES. We collect an immaterial amount of excise taxes from our
customers levied by government entities. These taxes are stated separately on
the billing to the customer and recorded as a liability to be remitted to the
government entity. We account for the collection and payment of these taxes on
the net basis and neither the amounts collected or paid are reflected on our
consolidated statement of income.
NEW ACCOUNTING STANDARDS. In January 2004 the FASB issued FASB Staff Position
SFAS 106-1, "Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003" (Act). This Staff
Position allows employers who sponsor a postretirement health plan that provides
prescription drug benefits to defer recognizing the effects of the Act in
accounting for its plan under SFAS 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions" until authoritative accounting
guidance is issued. We provide postretirement health benefits that include
prescription drug benefits, and in accordance with this Staff Position, have
elected not to reflect the impact of the Act in our 2003 financial statements.
We expect the Act will eventually reduce our costs for postretirement health
benefits and are reviewing the impact on our accumulated plan benefit obligation
and expense going forward.
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 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 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. The
Mandatorily Redeemable Preferred Securities were redeemed in December 2003.
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. In December 2003 the FASB issued Interpretation No. 46R to replace and
clarify some of the provisions of Interpretation No. 46. Under Interpretation
46R, the rules became effective on December 15, 2003 for interest in certain
structures, and March 15, 2004 for interest in all other structures. We are not
a party to any variable interest entity required to be consolidated under
Interpretation No. 46R.
3 SPIN-OFF AND IPO OF AUTOMOTIVE SERVICES
In October 2003 our Board of Directors approved a plan to spin off to ALLETE
shareholders our Automotive Services business which will become a publicly
traded company doing business as ADESA. 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 spin-off is subject
to the approval of the final plan by ALLETE's Board of Directors, favorable
market conditions, receipt of tax opinions, satisfaction of SEC requirements and
other customary conditions, and is expected to occur in the third quarter of
2004. In accordance with SFAS 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," we will report the Automotive Services business in
discontinued operations after the spin-off.
In March 2004 our Board of Directors approved an initial public offering
(IPO) of approximately $150 million in common shares of ADESA, representing less
than 20% of all ADESA Common stock outstanding. A registration statement was
filed with the SEC in March 2004, with the sale of ADESA stock expected to take
place as soon as practical after the registration statement becomes effective.
Subsequent to the IPO, ALLETE will continue to own and consolidate the remaining
portion of ADESA until consummation of the spin-off.
4 DISCONTINUED OPERATIONS
In 2002 we began to execute plans developed in a strategic review of all our
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 imminent threats of condemnation, North Carolina and Georgia,
and our vehicle transport business. We sold our vehicle 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 2003 and are included in Gain (Loss) on
Disposal in the following table.
- --------------------------------------------------------------------------------
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ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
During 2003, we sold, under condemnation or imminent threat of condemnation,
substantially all of our water assets in Florida for a total sales price of
approximately $445 million. In addition, we reached an agreement to sell our
North Carolina water assets for $48 million and the assumption of approximately
$28 million in debt by the purchaser. The North Carolina sale is awaiting
approval of the NCUC and is expected to close in mid-2004. We expect to sell our
remaining water assets in Florida and Georgia in 2004.
Earnings from Discontinued Operations for 2003 included a $71.6 million, or
$0.86 per share, after-tax gain on the sale of substantially all our Water
Services businesses. The gain was net of all selling, transaction and employee
termination benefit expenses, as well as impairment losses on certain remaining
assets. In accordance with SFAS 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets," we recorded an impairment loss on certain remaining water
assets where the fair value, less costs to sell, was less than our carrying
amount.
The net cash proceeds from the sale of all water assets, after transaction
costs, retirement of most Florida Water debt and payment of income taxes, are
expected to be approximately $300 million. These net proceeds have been, and
will be, used to retire debt at ALLETE.
SUMMARY OF DISCONTINUED OPERATIONS
================================================================================
MILLIONS
INCOME STATEMENT
YEAR ENDED DECEMBER 31 2003 2002 2001
- --------------------------------------------------------------------------------
Operating Revenue $109.2 $134.0 $149.3
Pre-Tax Income
from Operations $ 32.8 $36.9 $23.8
Income Tax Expense 12.4 14.7 9.6
- --------------------------------------------------------------------------------
20.4 22.2 14.2
- --------------------------------------------------------------------------------
Gain (Loss) on Disposal 112.1 <F1> (5.8) (6.8)
Income Tax Expense (Benefit) 39.2 (1.9) (2.4)
- --------------------------------------------------------------------------------
72.9 (3.9) (4.4)
- --------------------------------------------------------------------------------
Income from
Discontinued Operations $ 93.3 $18.3 $ 9.8
- --------------------------------------------------------------------------------
<FN>
<F1> Included a $2.0 million recovery from a settlement related to the 2002 sale
of our vehicle transport business.
</FN>
BALANCE SHEET INFORMATION
DECEMBER 31 2003 2002
- --------------------------------------------------------------------------------
Assets of Discontinued Operations
Cash and Cash Equivalents $ 6.5 $ 9.6
Other Current Assets 8.4 19.2
Property, Plant and Equipment 81.2 311.6
Other Assets 6.7 34.5
- --------------------------------------------------------------------------------
$102.8 $374.9
- --------------------------------------------------------------------------------
Liabilities of Discontinued Operations
Current Liabilities $49.5 $ 29.7
Long-Term Debt 19.9 90.7
Other Liabilities 25.1 37.1
- --------------------------------------------------------------------------------
$94.5 $157.5
================================================================================
In October 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. In November 2003 the FPSC issued a final order regarding
a similar gain on sale issue for Utilities, Inc. In that order the FPSC made
several findings that could be helpful to Florida Water's case including among
others; that courts have found that rates paid by customers do not vest
ratepayers with ownership rights to the property used to render service, and
shareholders bear the risk of gain or loss associated with investments made to
provide service. 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.
5 ACQUISITIONS
ADESA AUCTION FACILITIES. In January 2001 we acquired all of the outstanding
stock of ComSearch in exchange for ALLETE common stock and paid cash to purchase
all of the assets of Auto Placement Center (now ADESA Impact) in transactions
with an aggregate value of $62.4 million. In May 2001 ADESA purchased the assets
of the I-44 Auto Auction in Tulsa, Oklahoma. ADESA Impact and ADESA Tulsa were
accounted for using the purchase method and financial results have been included
in our consolidated financial statements since the date of purchase. Pro forma
financial results were not material. ComSearch was accounted for as a pooling of
interests. Financial results for prior periods have not been restated to reflect
this pooling due to immateriality.
ACQUISITION OF ENVENTIS, INC. In July 2001 we acquired Enventis, Inc., a data
network systems provider headquartered in the Minneapolis-St. Paul area. In
connection with this acquisition, we issued 310,878 shares of ALLETE common
stock. Enventis was accounted for as a pooling of interests. Financial results
for prior periods have not been restated to reflect this pooling due to
immateriality.
ACQUISITION OF GENERATING FACILITY. In October 2001 we acquired certain
non-mining properties from LTV and Cleveland-Cliffs Inc. for $75 million. The
non-mining properties included a 200 MW nonregulated electric generating
facility located at Taconite Harbor in northeastern Minnesota.
REAL ESTATE ACQUISITIONS. In December 2002 our real estate subsidiary
purchased additional land near Palm Coast, Florida. The transaction was
accounted for using the purchase method.
In September 2001 our real estate subsidiary purchased Winter Haven Citi
Centre, a retail shopping center. In December 2001 and January 2002 real estate
subsidiaries purchased additional land in Palm Coast, Florida. These
transactions had a combined purchase price of approximately $31 million and were
accounted for using the purchase method.
- --------------------------------------------------------------------------------
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ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
6 PROPERTY, PLANT AND EQUIPMENT
PROPERTY, PLANT AND EQUIPMENT
FOR THE YEAR ENDED DECEMBER 31 2003 2002
================================================================================
MILLIONS
Energy Services Regulated Utility $1,475.7 $1,433.1
Construction Work in Progress 11.9 13.3
Accumulated Depreciation (692.3) (679.5)
- --------------------------------------------------------------------------------
Energy Services Regulated
Utility Plant - Net 795.3 766.9
- --------------------------------------------------------------------------------
Energy Services Nonregulated 161.2 153.4
Construction Work in Progress 1.6 4.1
Accumulated Depreciation (42.8) (48.0)
- --------------------------------------------------------------------------------
Energy Services Nonregulated
Plant - Net 120.0 109.5
- --------------------------------------------------------------------------------
Automotive Services 680.5 525.2
Construction Work in Progress 2.8 38.5
Accumulated Depreciation (103.6) (79.5)
- --------------------------------------------------------------------------------
Automotive Services Plant - Net 579.7 484.2
- --------------------------------------------------------------------------------
Other Plant - Net 4.0 4.1
- --------------------------------------------------------------------------------
Property, Plant and Equipment - Net $1,499.0 $1,364.7
================================================================================
Depreciation is computed using the straight-line method over 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 Regulated Utility
Generation 5 to 30 years
Transmission 40 to 60 years
Distribution 30 to 70 years
Energy Services Nonregulated 5 to 35 years
Automotive Services
Building and Improvements 5 to 40 years
Other 2 to 10 years
================================================================================
ASSET RETIREMENT OBLIGATIONS. Effective January 1, 2003 we adopted SFAS 143,
"Accounting for Asset Retirement Obligations." Under the new accounting
standard, we recognize, at fair value, obligations associated with the
retirement of tangible long-lived assets that result from the acquisition,
construction or development and/or normal operation of the asset. The associated
retirement costs are capitalized as part of the related long-lived asset and
depreciated over the useful life of the asset. Asset retirement obligations
relate primarily to the decommissioning of our utility steam generating
facilities and reclamation at BNI Coal, and are included in Other Liabilities on
our consolidated balance sheet. Prior to the adoption of SFAS 143, utility
decommissioning obligations were accrued through depreciation expense at
depreciation rates approved by the MPUC. Upon implementation of SFAS 143, we
reclassified previously recorded liabilities of $12.5 million from Accumulated
Depreciation and capitalized a net asset retirement cost of $6.7 million.
ASSET RETIREMENT OBLIGATION
================================================================================
MILLIONS
Obligation at December 31, 2002 -
Initial Obligation Upon Adoption of SFAS 143 $19.0
Accretion Expense 0.7
Additional Liabilities Incurred in 2003 1.0
- --------------------------------------------------------------------------------
Obligation at December 31, 2003 $20.7
================================================================================
7 REGULATORY MATTERS
We file for periodic rate revisions with the MPUC, the FERC and other state
regulatory authorities. Interim rates in Minnesota are placed into effect,
subject to refund with interest, pending a final decision by the appropriate
commission. In 2003, 29% of our consolidated operating revenue (32% in 2002; 31%
in 2001) was under regulatory authority. The MPUC had regulatory authority over
approximately 23% in 2003 (25% in 2002 and 2001) of our consolidated operating
revenue.
ELECTRIC RATES. New federal legislation and FERC regulations have been
proposed that aim to maintain reliability, assure adequate energy supply, and
address wholesale price volatility while encouraging wholesale competition.
Legislation or regulation that initiates a process which may lead to retail
customer choice of their electric service provider currently lacks momentum in
both Minnesota and Wisconsin. Legislative and regulatory activity as well as the
actions of competitors affect the way Minnesota Power strategically plans for
its future. We cannot predict the timing or substance of any future legislation
or regulation.
DEFERRED REGULATORY CHARGES AND CREDITS. Our regulated utility operations are
subject to the provisions of SFAS 71, "Accounting for the Effects of Certain
Types of Regulation." We capitalize as deferred regulatory charges incurred
costs which are probable of recovery in future utility rates. Deferred
regulatory credits represent amounts expected to be credited to customers in
rates. Deferred regulatory charges and credits are included in other assets and
other liabilities on our consolidated balance sheet.
DEFERRED REGULATORY CHARGES AND CREDITS
DECEMBER 31 2003 2002
================================================================================
MILLIONS
Deferred Charges
Income Taxes $ 14.1 $ 11.8
Conservation Improvement Programs 1.5 0.1
Premium on Reacquired Debt 3.8 3.9
Other 6.8 4.2
- --------------------------------------------------------------------------------
26.2 20.0
Deferred Credits - Income Taxes 39.3 39.5
- --------------------------------------------------------------------------------
Net Deferred Regulatory Liabilities $(13.1) $(19.5)
================================================================================
- --------------------------------------------------------------------------------
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ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
8 FINANCIAL INSTRUMENTS
SECURITIES INVESTMENTS. At December 31, 2003 Investments included securities
accounted for as available-for-sale under SFAS 115, "Accounting for Certain
Investments in Debt and Equity Securities," and securities in our emerging
technology portfolio accounted for under the cost method. Investment gains and
losses were included in Operating Revenue - Investments on our consolidated
income statement.
At December 31, 2003 our available-for-sale securities portfolio consisted of
securities in a grantor trust established to fund certain employee benefits.
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. We
use the specific identification method as the basis for determining the cost of
securities sold. Our policy is to review on a quarterly basis available-for-sale
securities for other than temporary impairment by assessing such factors as the
continued viability of products offered, cash flow, share price trends and the
impact of overall market conditions. As a result of our periodic assessments, we
did not record any impairment write-down on available-for-sale securities in
2003 or 2002. During the second quarter of 2003 we sold the publicly-traded
investments held in our 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.
AVAILABLE-FOR-SALE SECURITIES
================================================================================
MILLIONS
GROSS
UNREALIZED FAIR
AT DECEMBER 31 COST GAIN (LOSS) VALUE
- --------------------------------------------------------------------------------
2003 $18.8 $1.4 - $20.2
2002 $25.4 $0.7 $(5.2) $20.9
2001 $18.1 $10.3 $(1.9) $26.5
- --------------------------------------------------------------------------------
NET
UNREALIZED
GAIN (LOSS)
GROSS IN OTHER
YEAR ENDED SALES REALIZED COMPREHENSIVE
DECEMBER 31 PROCEEDS GAIN (LOSS) INCOME
- --------------------------------------------------------------------------------
2003 $6.4 $1.2 $(4.7) $2.4
2002 $12.1 $1.0 - $(11.8)
2001 - - - $3.6
================================================================================
As part of our emerging technology portfolio, we have several minority
investments in venture capital funds and privately-held start-up companies. The
total carrying value of these investments was $37.5 million at December 31, 2003
($38.7 million at December 31, 2002). Our policy is to quarterly 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. We did not record any impairment loss on these
investments in 2003 ($1.5 million pretax in 2002; $0.2 million pretax in 2001).
During the second half of 2002 we substantially liquidated our trading
securities portfolio and incurred a $2.9 million after-tax loss. Prior to
liquidation, the trading securities portfolio consisted primarily of the common
stock of various publicly traded companies and was included in current assets at
fair value. Changes in fair value were recognized in earnings, and the net
unrealized gain included in 2001 income was $0.9 million.
FINANCIAL INSTRUMENTS AND OFF-BALANCE SHEET RISKS. In October 2001 we entered
into an interest rate swap agreement which expired in January 2003. We have not
entered into any new interest rate swap agreements.
FAIR VALUE OF FINANCIAL INSTRUMENTS. With the exception of the items listed
below, the estimated fair values of all financial instruments approximate the
carrying amount. The fair values for the items below were based on quoted market
prices for the same or similar instruments.
FINANCIAL INSTRUMENTS
CARRYING FAIR
DECEMBER 31 AMOUNT VALUE
================================================================================
MILLIONS
Long-Term Debt
2003 $785.2 $835.8
2002 $980.1 $1,027.7
Quarterly Income Preferred
Securities
2003 - -
2002 $75.0 $75.5
================================================================================
CONCENTRATION OF CREDIT RISK. Financial instruments that subject us to
concentrations of credit risk consist primarily of accounts receivable.
Minnesota Power sells electricity to about 13 customers in northern Minnesota's
taconite, pipeline, paper and wood products industries. Receivables from these
customers totaled approximately $8 million at December 31, 2003 ($10 million at
December 31, 2002). Minnesota Power does not obtain collateral to support
utility receivables, but monitors the credit standing of major customers.
Due to the nature of our Automotive Services' business, substantially all
trade and finance receivables are due from vehicle dealers and insurance
companies. We have possession of vehicles or vehicle titles collateralizing a
significant portion of the trade and finance receivables.
- --------------------------------------------------------------------------------
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ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
9 GOODWILL AND OTHER INTANGIBLES
The table below sets forth what reported net income and earnings per share
would have been exclusive of amortization expense recognized related to goodwill
or other intangible assets that are no longer being amortized. Goodwill is no
longer amortized after 2001. All goodwill amortization related to continuing
operations.
2001
================================================================================
MILLIONS EXCEPT PER SHARE AMOUNTS
Net Income
Reported $138.7
Goodwill Amortization 9.9
- --------------------------------------------------------------------------------
Adjusted $148.6
- --------------------------------------------------------------------------------
Earnings Per Share
Basic
Reported $1.83
Goodwill Amortization 0.13
- --------------------------------------------------------------------------------
Adjusted $1.96
- --------------------------------------------------------------------------------
Diluted
Reported $1.81
Goodwill Amortization 0.13
- --------------------------------------------------------------------------------
Adjusted $1.94
================================================================================
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, 2001 $491.9
Acquired During Year 10.1
- --------------------------------------------------------------------------------
Carrying Value, December 31, 2002 502.0
Acquired During Year 0.8
Change Due to Foreign Currency Adjustment 8.2
- --------------------------------------------------------------------------------
Carrying Value, December 31, 2003 $511.0
================================================================================
OTHER INTANGIBLE ASSETS
DECEMBER 31 2003 2002
================================================================================
MILLIONS
Customer Relationships $ 29.6 $ 29.6
Computer Software 28.1 32.6
Other 5.7 6.7
Accumulated Amortization (30.1) (31.3)
- --------------------------------------------------------------------------------
Total $ 33.3 $ 37.6
================================================================================
Other Intangible Assets are amortized using the straight-line method.
Amortization periods are three to fifty years for Customer Relationships, one to
seven years for Computer Software and three to ten years for Other. Total
amortization expense for Other Intangible Assets was $9.0 million in 2003 ($10.2
million in 2002; $9.5 million in 2001) and is expected to be about $4 million to
$8 million over the next five years.
Costs incurred related to computer software developed or purchased for
internal use are capitalized during the application development stage of
software development. Included in total amortization expense for Other
Intangible Assets was $5.2 million related to computer software ($6.0 million in
2002; $4.0 million in 2001).
10 SHORT-TERM BORROWINGS AND COMPENSATING BALANCES
We have bank lines of credit aggregating $196.5 million ($217.0 million at
December 31, 2002), the majority of which expire in December 2004 and are
negotiated on an annual basis. These bank lines of credit make financing
available through short-term bank loans and provide credit support for
commercial paper. At December 31, 2003, $196.5 million was available for use
($216.3 million at December 31, 2002). There was no commercial paper issued as
of December 31, 2003 ($73.8 million in 2002 with a weighted average interest
rate of 1.79%).
Certain lines of credit require a commitment fee of 0.0150%. Interest rates
on short-term borrowings were 2.06% at December 31, 2003 (1.75% to 1.85% at
December 31, 2002). The total amount of compensating balances at December 31,
2003 and 2002, was immaterial.
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% of the net
proceeds from the sale of water assets. In accordance with these provisions
$197.0 million was repaid in 2003 and $53.0 million was outstanding at December
31, 2003.
Our lines of credit contain financial covenants. 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 December 31, 2003, ALLETE's ratio
of funded debt to total capital was .36 to 1.0, the interest coverage ratio was
5.83 to 1.00 and ALLETE was in compliance with these financial covenants.
ALLETE's lines of credit contain a cross-default provision, under which an
event of default would arise if other ALLETE obligations in excess of $5.0
million were in default.
- --------------------------------------------------------------------------------
PAGE 73
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
11 LONG-TERM DEBT
LONG-TERM DEBT
DECEMBER 31 2003 2002
================================================================================
MILLIONS
First Mortgage Bonds
6.68% Series Due 2007 $ 20.0 $ 20.0
7% Series Due 2007 60.0 60.0
7 1/2% Series Due 2007 35.0 35.0
7% Series Due 2008 50.0 50.0
6% Pollution Control Series E Due 2022 111.0 111.0
Floating Rate - 250.0
6 1/4% Series - 25.0
7 3/4% Series - 50.0
Senior Notes
7.70% Series A Due 2006 90.0 90.0
7.80% Due 2008 125.0 125.0
8.10% Series B Due 2010 35.0 35.0
Variable Notes
Due 2006 45.0 -
Due 2020 28.4 -
Capital Lease Obligation Due 2013 34.5 -
Variable Demand Revenue Refunding
Bonds Series 1997 A, B, C and D
Due 2007 - 2020 39.0 39.0
Industrial Development Revenue Bonds,
6.50% Due 2025 35.1 35.1
Other Long-Term Debt, 2.0 - 8.8%
Due 2004 - 2026 77.2 55.0
- --------------------------------------------------------------------------------
Total Long-Term Debt 785.2 980.1
Less Due Within One Year (37.5) (283.7)
- --------------------------------------------------------------------------------
Net Long-Term Debt $747.7 $ 696.4
================================================================================
The aggregate amount of long-term debt maturing during 2004 is $37.5 million
($30.2 million in 2005; $137.1 million in 2006; $119.0 million in 2007; $182.3
million in 2008; and $279.1 million thereafter). Substantially all of our
electric plant is subject to the lien of the mortgages securing various first
mortgage bonds.
At December 31, 2003 we had long-term bank lines of credit aggregating $38.0
million ($39.7 million at December 31, 2002). Drawn portions on these lines of
credit were $28.8 million in 2003 ($5.5 million in 2002).
In June 2003 ADESA restructured its financial arrangements with respect to
four of its used vehicle auction facilities previously accounted for as
operating leases. The transactions included the assumption of $28 million of
long-term debt and the issuance of $45 million of long-term debt. 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 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 $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 10.)
In November 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.
In December 2003 ADESA recorded $34.5 million of long-term debt in connection
with the capital lease obligation of one of its used vehicle auction facilities.
The debt matures December 2013 and has a fixed rate of 5%.
In January 2004 we used internally generated funds to retire approximately
$3.5 million in principal amount of Industrial Development Revenue Bonds Series
1994-A, due January 1, 2004.
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 December 31, 2003 ALLETE's ratio of funded debt to total capital
was .36 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.
The interest rate on the 7.80% Senior Note due 2008 will increase 0.50% to
1.00% in the event of a downgrade in ALLETE's senior unsecured long-term debt
ratings below investment grade.
The 6.68% Series Due 2007 and the 7% Series Due 2007 cannot be redeemed prior
to maturity. The 7 1/2% Series Due 2007 are redeemable after August 1, 2005 and
the 7% Series Due 2008 are redeemable after March 1, 2006. The remaining debt
may be redeemed in whole or in part at our option according to the terms of the
obligations.
12 MANDATORILY REDEEMABLE PREFERRED SECURITIES
In December 2003 ALLETE redeemed through ALLETE Capital I, a wholly owned
statutory trust of ALLETE, all $75 million of its 8.05% QUIPS. The redemption
price was $25 per QUIPS plus accumulated and unpaid distributions to the
redemption date. The QUIPS were issued in March 1996 and represented preferred
ownership interests in the assets of ALLETE Capital I. The sole asset of ALLETE
Capital I was 8.05% Junior Subordinated Debentures, Series A, Due 2015 issued by
ALLETE.
- --------------------------------------------------------------------------------
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ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
13 COMMON STOCK AND EARNINGS PER SHARE
Our Articles of Incorporation and mortgages contain provisions that, under
certain circumstances, would restrict the payment of common stock dividends. As
of December 31, 2003 no retained earnings were restricted as a result of these
provisions.
SUMMARY OF COMMON STOCK SHARES EQUITY
================================================================================
MILLIONS
Balance at December 31, 2000 74.7 $576.9
2001 Public Offering 6.6 150.0
Employee Stock Purchase Plan 0.1 1.4
Invest Direct <F1> 0.8 18.9
Other 1.7 23.1
- --------------------------------------------------------------------------------
Balance at December 31, 2001 83.9 770.3
2002 Employee Stock Purchase Plan 0.1 1.4
Invest Direct <F1> 0.8 19.6
Other 0.8 23.6
- --------------------------------------------------------------------------------
Balance at December 31, 2002 85.6 814.9
2003 Employee Stock Purchase Plan 0.1 1.4
Invest Direct <F1> 0.8 19.9
Other 0.8 23.0
- --------------------------------------------------------------------------------
Balance at December 31, 2003 87.3 $859.2
================================================================================
<FN>
<F1> Invest Direct is ALLETE's direct stock purchase and dividend reinvestment
plan.
</FN>
COMMON STOCK ISSUANCE. In May and June 2001 we sold 6.6 million shares of our
common stock in a public offering at $23.68 per share. Total net proceeds of
approximately $150 million were used to repay a portion of our short-term
borrowings with the remainder invested in short-term instruments.
SHAREHOLDER RIGHTS PLAN. In 1996 we adopted a rights plan that provides for a
dividend distribution of one preferred share purchase right (Right) to be
attached to each share of common stock.
The Rights, which are currently not exercisable or transferable apart from
our common stock, entitle the holder to purchase one two-hundredth of a share of
ALLETE's Junior Serial Preferred Stock A, without par value, at an exercise
price of $45. These Rights would become exercisable if a person or group
acquires beneficial ownership of 15% or more of our common stock or announces a
tender offer which would increase the person's or group's beneficial ownership
interest to 15% or more of our common stock, subject to certain exceptions. If
the 15% threshold is met, each Right entitles the holder (other than the
acquiring person or group) to purchase common stock (or, in certain
circumstances, cash, property or other securities of ours) having a market price
equal to twice the exercise price of the Right. If we are acquired in a merger
or business combination, or 50% or more of our assets or earning power are sold,
each exercisable Right entitles the holder to purchase common stock of the
acquiring or surviving company having a value equal to twice the exercise price
of the Right. Certain stock acquisitions will also trigger a provision
permitting the Board of Directors to exchange each Right for one share of our
common stock.
The Rights which expire on July 23, 2006, are nonvoting and may be redeemed
by us at a price of $0.005 per Right at any time they are not exercisable. One
million shares of Junior Serial Preferred Stock A have been authorized and are
reserved for issuance under the plan.
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.
RECONCILIATION OF
BASIC AND DILUTED BASIC DILUTIVE DILUTED
EARNINGS PER SHARE EPS SECURITIES EPS
================================================================================
2003
Income from
Continuing Operations $143.1 - $143.1
Common Shares 82.8 0.5 83.3
Per Share from
Continuing Operations $1.72 - $1.72
- --------------------------------------------------------------------------------
2002
Income from
Continuing Operations $118.9 - $118.9
Common Shares 81.1 0.6 81.7
Per Share from
Continuing Operations $1.47 - $1.46
- --------------------------------------------------------------------------------
2001
Income from
Continuing Operations $128.9 - $128.9
Common Shares 75.8 0.7 76.5
Per Share from
Continuing Operations $1.70 - $1.68
================================================================================
14 JOINTLY OWNED ELECTRIC FACILITY
We own 80% of the 534-MW Boswell Energy Center Unit 4 (Boswell Unit 4). While
we operate the plant, certain decisions about the operations of Boswell Unit 4
are subject to the oversight of a committee on which we and Wisconsin Public
Power, Inc. (WPPI), the owner of the other 20% of Boswell Unit 4, have equal
representation and voting rights. Each of us must provide our own financing and
is obligated to pay our ownership share of operating costs. Our share of direct
operating expenses of Boswell Unit 4 is included in operating expense on our
consolidated statement of income. Our 80% share of the original cost included in
electric plant at December 31, 2003 was $308 million ($310 million at December
31, 2002). The corresponding accumulated depreciation balance was $176 million
at December 31, 2003 ($170 million at December 31, 2002).
- --------------------------------------------------------------------------------
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ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
15 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 Power, a North Dakota cooperative corporation
whose Class A members are also members of Square Butte. Minnkota Power serves as
the operator of the Unit and also purchases power from Square Butte.
Minnesota Power is entitled to approximately 71% of the Unit's output under
the Agreement. After 2005 and upon compliance with a two-year advance notice
requirement, Minnkota Power has the option to reduce Minnesota Power's
entitlement by 5% annually, to a minimum of 50%. In December 2003 we received
notice from Minnkota Power that they will reduce our output entitlement,
effective January 1, 2006, by 5% to approximately 66%.
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 December 31, 2003 Square Butte had
total debt outstanding of $284.2 million. Total annual debt service for Square
Butte is expected to be $22.9 million in each of the years 2004 through 2008.
Variable operating costs include the price of coal purchased from BNI Coal, our
subsidiary, under a long-term contract.
Minnesota Power's cost of power purchased from Square Butte during 2003 was
$52.3 million ($60.9 million in 2002 and $63.3 million in 2001). This reflects
Minnesota Power's pro rata share of total Square Butte costs based on the 71%
output entitlement in 2003, 2002 and 2001. Included in this amount was Minnesota
Power's pro rata share of interest expense of $12.8 million in 2003 ($13.7
million in 2002; $14.2 million in 2001). 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 used vehicle auction facilities located in Tracy,
California; Boston, Massachusetts; Charlotte, North Carolina; and Knoxville,
Tennessee. These used vehicle 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.
We lease other properties and equipment in addition to those listed above
under operating lease agreements with terms expiring through 2032. The aggregate
amount of minimum lease payments for all operating leases during 2004 is $14.8
million ($10.6 million in 2005; $8.2 million in 2006; $6.1 million in 2007; $5.7
million in 2008; and $59.0 million thereafter). Total rent expense was $27.4
million in 2003 ($26.7 million in 2002; $26.9 million in 2001).
SPLIT ROCK ENERGY. We provided 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. Minimal credit support was
outstanding at December 31, 2003 ($7.3 million at December 31, 2002). We
withdrew from active participation in Split Rock Energy in February 2004.
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 also 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; the
balance will be sold in the spot market through short-term agreements. We
currently have 130 MW (100 MW in 2003) of long-term capacity sales contracts for
the Kendall County generation, with 50 MW expiring in April 2012 and 80 MW 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." In total, the Kendall County facility operated at a
loss in 2003 due to negative spark spreads (the differential between electric
and natural gas prices) in the wholesale power market and our resulting
inability to cover the fixed capacity charge on approximately 175 MW. We expect
the facility to continue to generate losses until such time as spark spreads
improve or we are able to enter into additional long-term capacity sales
contracts.
EMERGING TECHNOLOGY INVESTMENTS. We have investments in emerging technologies
through minority investments in venture capital funds and privately-held
start-up companies. We have committed to make additional investments in certain
emerging technology holdings. The total future commitment was $4.8 million at
December 31, 2003 ($7.7 million at December 31, 2002) and is expected to be
invested at various times through 2007.
ENVIRONMENTAL MATTERS. Our businesses are subject to regulation by various
U.S. and Canadian federal, state, provincial 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.
- --------------------------------------------------------------------------------
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ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
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 SWL&P to initiate an
environmental investigation. The WDNR also issued SWL&P a Responsible Party
letter in February 2002. The environmental investigation is underway. In
February 2003 SWL&P submitted a Phase II environmental site investigation report
to the WDNR. This report identified some MGP-like chemicals that were found in
the soil. During March and April 2003 sediment samples were taken from nearby
Superior Bay. The report on the results of this sampling is expected to be
completed and sent to the WDNR during the first quarter of 2004. A work plan for
additional investigation by SWL&P was filed on December 17, 2003 with the WDNR.
This part of the investigation will determine any impact to soil or ground water
between the former MGP site and the Superior Bay. Although it is not possible to
quantify the potential clean-up cost until the investigation is completed and a
work plan is developed, a $0.5 million liability was recorded as of December 31,
2003 to address the known areas of contamination. We have recorded a
corresponding dollar amount as a regulatory asset to offset this liability. The
PSCW has approved SWL&P's deferral of these MGP environmental investigation and
potential clean-up costs for future recovery in rates, subject to regulatory
prudency review.
MINNESOTA POWER COAL-FIRED GENERATING FACILITIES. During 2002 Minnesota Power
received and 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 is, however, ongoing litigation involving
the 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,
we have not accrued any liability for this environmental matter.
SQUARE BUTTE GENERATING FACILITY. In June 2002 Minnkota Power, the operator
of Square Butte, received a Notice of Violation from the EPA regarding alleged
New Source Review violations at the M.R. Young Station which includes the Square
Butte generating unit. The EPA claims certain capital projects completed by
Minnkota Power should have been reviewed pursuant to the New Source Review
regulations potentially resulting in new air permit operating conditions.
Minnkota Power has held several meetings with the EPA to discuss the alleged
violations. Based on an EPA request, Minnkota Power performed a study related to
the technological feasibility of installing various controls for the reduction
of nitrogen oxides and sulfur dioxide 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. Our
future cost of purchased power would include our pro rata share of this
additional debt service.
ADESA IMPACT TAUNTON FACILITY. In December 2003 the Massachusetts Department
of Environmental Protection (MDEP) identified ADESA Impact as a potentially
responsible party regarding contamination of several private drinking water
wells in a residential development that abuts the Taunton, Massachusetts salvage
vehicle auction facility. The wells had elevated levels of MTBE. MTBE is an
oxygenating additive in gasoline to reduce harmful emissions. The EPA has
identified MTBE as a possible carcinogen. ADESA Impact engaged GeoInsight,an
environmental services firm, to conduct tests of its soil and groundwater at the
salvage vehicle auction site.
GeoInsight prepared an immediate response action (IRA) plan, which is
required by the MDEP, to determine the extent of the environmental impact and
define activities to prevent further environmental contamination. The IRA plan,
which was filed on January 24, 2004, describes the initial activities ADESA
Impact performed, and proposes additional measures that it will use to further
assess the existence of any imminent hazard to human health. In addition, as
required by the MDEP, ADESA Impact is conducting an analysis to identify
sensitive receptors that may have been affected, including area schools and
municipal wells. GeoInsight does not believe that an imminent hazard condition
exists at the Taunton site; however, the investigation and assessment of site
conditions are ongoing.
In December 2003 GeoInsight collected soil samples, conducted groundwater
tests and provided oversight for the installation of monitoring wells in various
locations on and adjacent to the property adjoining the residential community.
The results of the soil and water tests indicated levels of MTBE exceeding MDEP
standards. In January 2004 we collected air samples from two residences that we
identified as having elevated drinking water concentrations of MTBE. We have
determined that inhalation of, or contact exposure to, this air poses minimal
risk to human health. In response to our empirical findings, we have proposed to
the MDEP that we install granular activated carbon filtration systems in the
approximately 30 affected residences.
ADESA Impact is preparing an IRA status report that must be submitted to the
MDEP by March 30, 2004, and will continue to prepare additional reports as
necessary. As of December 31, 2003 ADESA Impact has accrued $0.7 million to
cover the costs associated with ongoing testing, remediation and cleanup of the
site.
- --------------------------------------------------------------------------------
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ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
ALLETE maintains pollution liability insurance coverage and has filed a claim
with respect to this matter. We and our insurer are determining the availability
of insurance coverage at this time.
OTHER. We are involved in litigation arising in the normal course of
business. Also in the normal course of business, we are involved in tax,
regulatory and other governmental audits, inspections, investigations and other
proceedings that involve state and federal taxes, safety, compliance with
regulations, rate base and cost of service issues, among other things. While the
resolution of such matters could have a material effect on earnings and cash
flows in the year of resolution, none of these matters are expected to change
materially our present liquidity position, nor have a material adverse effect on
our financial condition.
16 INCOME TAX EXPENSE
INCOME TAX EXPENSE
YEAR ENDED DECEMBER 31 2003 2002 2001
================================================================================
MILLIONS
Current Tax Expense
Federal $ 45.2 $36.4 $51.4
Foreign 14.0 12.6 7.6
State 10.1 7.1 7.7
- --------------------------------------------------------------------------------
69.3 56.1 66.7
Deferred Tax Expense (Benefit)
Federal 20.0 14.8 6.9
Foreign - 0.1 0.2
State 3.1 0.7 (0.1)
- --------------------------------------------------------------------------------
23.1 15.6 7.0
Change in Valuation Allowance 0.9 1.9 1.0
- --------------------------------------------------------------------------------
Deferred Tax Credits (1.4) (1.4) (1.4)
- --------------------------------------------------------------------------------
Income Taxes on
Continuing Operations 91.9 72.2 73.3
Income Taxes on
Discontinued Operations 51.6 12.8 7.2
- --------------------------------------------------------------------------------
Total Income Tax Expense $143.5 $85.0 $80.5
================================================================================
RECONCILIATION OF TAXES
FROM FEDERAL STATUTORY
RATE TO TOTAL INCOME
TAX EXPENSE
YEAR ENDED DECEMBER 31 2003 2002 2001
================================================================================
MILLIONS
Tax Computed at Federal
Statutory Rate $133.0 $77.8 $76.7
Increase (Decrease) in Tax
State Income Taxes - Net of
Federal Income Tax Benefit 17.3 9.8 8.6
Foreign Taxes 1.9 3.0 1.9
Other (8.7) (5.6) (6.7)
- --------------------------------------------------------------------------------
Total Income Tax Expense $143.5 $85.0 $80.5
================================================================================
INCOME BEFORE INCOME TAXES
YEAR ENDED DECEMBER 31 2003 2002 2001
================================================================================
MILLIONS
United States $341.9 $191.4 $197.3
Canadian 38.0 30.8 21.9
- --------------------------------------------------------------------------------
Total $379.9 $222.2 $219.2
================================================================================
DEFERRED TAX ASSETS AND LIABILITIES
DECEMBER 31 2003 2002
================================================================================
MILLIONS
Deferred Tax Assets
Employee Benefits and Compensation $ 49.7 $ 43.4
Property Related 30.2 27.3
Investment Tax Credits 14.8 15.8
Allowance for Bad Debts 9.8 11.5
State NOL Carryover 8.7 8.6
Other 30.6 26.7
- --------------------------------------------------------------------------------
Gross Deferred Tax Assets 143.8 133.3
Deferred Tax Asset Valuation Allowance (8.7) (7.8)
- --------------------------------------------------------------------------------
Total Deferred Tax Assets 135.1 125.5
- --------------------------------------------------------------------------------
Deferred Tax Liabilities
Property Related 229.6 215.7
Investment Tax Credits 21.0 22.4
Intangibles 19.7 13.4
Employee Benefits and Compensation 15.1 9.0
Other 10.4 4.8
- --------------------------------------------------------------------------------
Total Deferred Tax Liabilities 295.8 265.3
- --------------------------------------------------------------------------------
Accumulated Deferred Income Taxes $160.7 $139.8
================================================================================
State net operating loss carryforwards of $8.7 million have an $8.2 million
valuation allowance, as we believe more likely than not they will expire before
they are utilized. These state net operating losses expire between 2004 and
2022.
UNDISTRIBUTED EARNINGS. Undistributed earnings of our foreign subsidiaries
were approximately $24.5 million at December 31, 2003 ($28.8 million at December
31, 2002). Since this amount has been or will be reinvested in property, plant
and working capital, we have not recorded the deferred taxes associated with the
repatriation of these investments.
- --------------------------------------------------------------------------------
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ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
17 OTHER COMPREHENSIVE INCOME
OTHER COMPREHENSIVE INCOME
PRE-TAX TAX EXPENSE NET-OF-TAX
YEAR ENDED DECEMBER 31 AMOUNT (BENEFIT) AMOUNT
====================================================================================================================
MILLIONS
2003
Unrealized Gain (Loss) on Securities
Gain During the Year $ 2.4 $ 1.0 $ 1.4
Add: Loss Included in Net Income 3.5 1.3 2.2
- --------------------------------------------------------------------------------------------------------------------
Net Unrealized Gain on Securities 5.9 2.3 3.6
Interest Rate Swap 0.2 - 0.2
Foreign Currency Translation Adjustments 39.2 - 39.2
Additional Pension Liability (10.8) (4.5) (6.3)
- --------------------------------------------------------------------------------------------------------------------
Other Comprehensive Income $ 34.5 $(2.2) $36.7
- --------------------------------------------------------------------------------------------------------------------
2002
Unrealized Gain (Loss) on Securities
Loss During the Year $(11.8) $(4.3) $(7.5)
Less: Gain Included in Net Income 1.0 0.4 0.6
- --------------------------------------------------------------------------------------------------------------------
Net Unrealized Loss on Securities (12.8) (4.7) (8.1)
Interest Rate Swap 2.3 1.0 1.3
Foreign Currency Translation Adjustments 2.6 - 2.6
Additional Pension Liability (6.0) (2.5) (3.5)
- --------------------------------------------------------------------------------------------------------------------
Other Comprehensive Loss $(13.9) $(6.2) $(7.7)
- --------------------------------------------------------------------------------------------------------------------
2001
Unrealized Gain (Loss) on Securities
Gain During the Year $ 3.6 $ 1.1 $ 2.5
Less: Gain Included in Net Income - - -
- --------------------------------------------------------------------------------------------------------------------
Net Unrealized Gain on Securities 3.6 1.1 2.5
Interest Rate Swap (2.5) (1.0) (1.5)
Foreign Currency Translation Adjustments (11.3) - (11.3)
- --------------------------------------------------------------------------------------------------------------------
Other Comprehensive Loss $(10.2) $ 0.1 $(10.3)
====================================================================================================================
ACCUMULATED OTHER COMPREHENSIVE INCOME
DECEMBER 31 2003 2002
====================================================================================================================
MILLIONS
Unrealized Gain (Loss) on Securities $ 0.8 $ (2.8)
Interest Rate Swap Loss - (0.2)
Foreign Currency Translation Gain (Loss) 23.5 (15.7)
Additional Pension Liability (9.8) (3.5)
- --------------------------------------------------------------------------------------------------------------------
$14.5 $(22.2)
====================================================================================================================
18 PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
We have noncontributory defined benefit pension plans covering eligible
Corporate and Energy Services' employees. The plans provide defined benefits
based on years of service and final average pay. We also have defined
contribution pension plans covering substantially all employees, for which the
annual aggregate cost was $9.1 million in 2003 ($9.7 million in 2002; $7.1
million in 2001).
We have postretirement health care and life insurance plans covering eligible
Corporate and Energy Services' employees. The postretirement health plans are
contributory with participant contributions adjusted annually. Postretirement
health and life benefits are funded through a combination of Voluntary Employee
Benefit Association trusts (VEBAs) established under section 501(c)(9) of the
Internal Revenue Code and an irrevocable grantor trust. Contributions deductible
for income tax purposes are made directly to the VEBAs; nondeductible
contributions are made to the irrevocable grantor trust. Amounts are transferred
from the irrevocable grantor trust to the VEBAs when they become deductible for
income tax purposes.
We use a September 30 measurement date for the pension and postretirement
health and life plans.
- --------------------------------------------------------------------------------
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ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
PENSION OBLIGATION AND FUNDED STATUS
AT SEPTEMBER 30 2003 2002
================================================================================
MILLIONS
Change in Benefit Obligation
Obligation, Beginning of Year $297.9 $259.1
Service Cost 6.7 5.6
Interest Cost 19.5 19.5
Actuarial Loss 45.7 29.4
Benefits Paid (16.4) (15.7)
- --------------------------------------------------------------------------------
Obligation, End of Year 353.4 297.9
Change in Plan Assets
Fair Value, Beginning of Year 265.7 281.9
Actual Return on Assets 33.5 (3.3)
Benefits Paid (16.4) (15.7)
Other 2.5 2.8
- --------------------------------------------------------------------------------
Fair Value, End of Year 285.3 265.7
Funded Status (68.1) (32.2)
Unrecognized Amounts
Net Loss 82.3 43.3
Prior Service Cost 6.0 6.9
Transition Obligation 0.3 0.4
- --------------------------------------------------------------------------------
Net Asset Recognized $ 20.5 $ 18.4
- --------------------------------------------------------------------------------
Amounts Recognized in Consolidated
Balance Sheet Consist of:
Prepaid Pension Cost $ 31.9 $ 27.8
Accrued Benefit Liability (31.2) (18.8)
Intangible Asset 3.0 3.4
Accumulated Other
Comprehensive Income 16.8 6.0
- --------------------------------------------------------------------------------
Net Asset Recognized $ 20.5 $ 18.4
================================================================================
COMPONENTS OF NET PERIODIC PENSION EXPENSE (INCOME)
YEAR ENDED DECEMBER 31 2003 2002 2001
================================================================================
MILLIONS
Service Cost $ 6.7 $ 5.6 $ 4.4
Interest Cost 19.5 19.5 18.3
Expected Return on Assets (28.8) (30.4) (29.6)
Amortized Amounts
Unrecognized Gain - (1.4) (2.5)
Prior Service Cost 0.9 0.8 0.5
Transition Obligation 0.2 0.2 0.5
- --------------------------------------------------------------------------------
Net Pension Income $ (1.5) $ (5.7) $ (8.4)
================================================================================
INFORMATION FOR PENSION PLAN WITH AN ACCUMULATED
BENEFIT OBLIGATION IN EXCESS OF PLAN ASSETS
AT SEPTEMBER 30 2003 2002
================================================================================
MILLIONS
Projected Benefit Obligation $137.8 $114.1
Accumulated Benefit Obligation $118.1 $99.8
Fair Value of Plan Assets $95.1 $88.6
================================================================================
ADDITIONAL PENSION INFORMATION
YEAR ENDED DECEMBER 31 2003 2002 2001
================================================================================
MILLIONS
Increase in Minimum Liability
Included in Other
Comprehensive Income $10.8 $6.0 -
================================================================================
The accumulated benefit obligation for all defined benefit pension plans was
$303.5 million and $259.3 million at September 30, 2003 and 2002, respectively.
POSTRETIREMENT HEALTH AND LIFE
OBLIGATION AND FUNDED STATUS
AT SEPTEMBER 30 2003 2002
================================================================================
MILLIONS
Change in Benefit Obligation
Obligation, Beginning of Year $ 99.5 $ 78.5
Service Cost 3.7 2.9
Interest Cost 6.6 5.9
Actuarial Loss 10.8 15.0
Participant Contributions 0.9 1.1
Benefits Paid (4.3) (3.9)
- --------------------------------------------------------------------------------
Obligation, End of Year 117.2 99.5
Change in Plan Assets
Fair Value, Beginning of Year 39.5 38.7
Actual Return on Assets 6.6 (1.5)
Employer Contribution 8.2 5.1
Participant Contributions 0.9 1.1
Benefits Paid (4.3) (3.9)
- --------------------------------------------------------------------------------
Fair Value, End of Year 50.9 39.5
Funded Status (66.3) (60.0)
Unrecognized Amounts
Net Loss 23.9 15.1
Transition Obligation 22.4 25.0
- --------------------------------------------------------------------------------
Accrued Cost $(20.0) $(19.9)
================================================================================
Under SFAS 106, "Employers' Accounting for Postretirement Benefits Other Than
Pensions," only assets in the VEBAs are treated as plan assets in the table
above for the purpose of determining funded status. In addition to the
postretirement health and life assets reported above, we had $20.2 million in an
irrevocable grantor trust at December 31, 2003 ($15.1 million at December 31,
2002). We consolidate the irrevocable grantor trust and it is included in
Investments on our consolidated balance sheet.
COMPONENTS OF NET PERIODIC POSTRETIREMENT
HEALTH AND LIFE EXPENSE
YEAR ENDED DECEMBER 31 2003 2002 2001
================================================================================
MILLIONS
Service Cost $ 3.7 $ 2.9 $ 2.7
Interest Cost 6.6 5.9 5.3
Expected Return on Assets (4.0) (3.9) (3.5)
Amortized Amounts
Unrecognized Gain 0.1 (0.2) (0.9)
Transition Obligation 2.4 2.4 2.4
- --------------------------------------------------------------------------------
Net Expense $ 8.8 $ 7.1 $ 6.0
================================================================================
- --------------------------------------------------------------------------------
PAGE 80
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
WEIGHTED-AVERAGE ASSUMPTIONS USED TO
DETERMINE BENEFIT OBLIGATIONS
AT SEPTEMBER 30 2003 2002
================================================================================
Discount Rate 6.0% 6.75%
Rate of Compensation Increase 3.5 - 4.5% 3.5 - 4.5%
Health Care Trend Rates:
Trend Rate 10% 10%
Ultimate Trend Rate 5% 5%
Year Ultimate Trend Rate Effective 2008 2008
================================================================================
WEIGHTED-AVERAGE ASSUMPTIONS
USED TO DETERMINE NET PERIODIC
BENEFIT COSTS
YEAR ENDED DECEMBER 31 2003 2002 2001
================================================================================
Discount Rate 6.75% 7.75% 8.00%
Expected Long-Term
Return on Plan Assets:
Pension 9.5% 10.0% 10.25%
Postretirement
Health and Life 7.6 - 9.5% 8.0 - 10.0% 6.0 - 10.0%
Rate of Compensation
Increase 3.5 - 4.5% 3.5 - 4.5% 3.5 - 4.5%
================================================================================
In establishing the expected long-term return on plan assets, we consider the
diversification and allocation of plan assets, the actual long-term historical
performance for the type of securities invested in, the actual long-term
historical performance of plan assets and the impact of current economic
conditions, if any, on long-term historical returns. The expected long-term
return on plan assets used to determine 2004 pension expense is 9.0%.
SENSITIVITY OF A ONE-PERCENTAGE-POINT
CHANGE IN HEALTH CARE TREND RATES
ONE PERCENT ONE PERCENT
INCREASE DECREASE
================================================================================
MILLIONS
Effect on Total of Postretirement
Health and Life Service
and Interest Cost $1.9 $(1.4)
Effect on Postretirement Health
and Life Obligation $18.8 $(12.6)
================================================================================
PLAN ASSET ALLOCATIONS
AT SEPTEMBER 30 2003 2002
================================================================================
Pension Plan Asset Categories:
Equity Securities 61.6% 44.0%
Debt Securities 27.8 32.9
Real Estate 2.8 12.1
Venture Capital 5.6 9.0
Cash 2.2 2.0
- --------------------------------------------------------------------------------
100.0% 100.0%
- --------------------------------------------------------------------------------
Postretirement Health and Life
Asset Categories (includes VEBAs
and irrevocable grantor trust):
Equity Securities 62.2% 56.4%
Debt Securities 36.3 43.6
Cash 1.5 -
- --------------------------------------------------------------------------------
100.0% 100.0%
================================================================================
Pension plan equity securities include ALLETE common stock in the amounts of
$25.8 million (9.1% of total plan assets) and $20.3 million (7.7% of total plan
assets) at September 30, 2003 and 2002, respectively.
To achieve strong returns within managed risk we diversify our asset
portfolio to approximate the target allocations in the table below. Equity
securities are diversified among domestic companies with large, mid and small
market capitalizations, as well as investments in international companies. In
addition, all debt securities must have a Standard & Poor's credit rating of A
or higher.
PLAN ASSET TARGET ALLOCATIONS
================================================================================
Pension Plan Asset Categories:
Equity Securities 58%
Debt Securities 30
Real Estate 5
Venture Capital 6
Cash 1
- --------------------------------------------------------------------------------
100%
- --------------------------------------------------------------------------------
Postretirement Health and Life
Asset Categories (includes VEBAs
and irrevocable grantor trust):
Equity Securities 62%
Debt Securities 35
Cash 3
- --------------------------------------------------------------------------------
100%
================================================================================
We expect to contribute approximately $8 million to our defined benefit
pension plans and $7 million to our postretirement health and life plans in
2004.
- --------------------------------------------------------------------------------
PAGE 81
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
19 EMPLOYEE STOCK AND INCENTIVE PLANS
EMPLOYEE STOCK OWNERSHIP PLAN. We sponsor a leveraged employee stock
ownership plan (ESOP) within the Retirement Savings and Stock Ownership Plan
that covers eligible Corporate and Energy Services' employees. In 1989 the ESOP
used the proceeds from a $16.5 million third-party loan, guaranteed by us, to
purchase 1.2 million shares of our common stock on the open market. The
remaining principal balance on the loan was refinanced in 2002. The refinanced
loan has a variable interest rate based on LIBOR and matures on December 31,
2004. In 1990 the ESOP issued a $75 million note (term not to exceed 25 years at
10.25%) to us as consideration for 5.6 million shares of our newly issued common
stock. The Company makes annual contributions to the ESOP equal to the ESOP's
debt service less available dividends received by the ESOP. The majority of
dividends received by the ESOP are used to pay debt service, with the balance
distributed to certain participants. The ESOP shares were initially pledged as
collateral for its debt. As the debt is repaid, shares are released from
collateral and allocated to participants, based on the proportion of debt
service paid in the year. The third-party debt of the ESOP is recorded as
long-term debt and the shares pledged as collateral are reported as unearned
ESOP shares on our consolidated balance sheet. As shares are released from
collateral, the Company reports compensation expense equal to the current market
price of the shares, and the shares become outstanding for earnings-per-share
computations. Dividends on allocated ESOP shares are recorded as a reduction of
retained earnings; available dividends on unallocated ESOP shares are recorded
as a reduction of debt and accrued interest. ESOP compensation expense was $3.7
million in 2003 ($3.9 million in 2002; $2.6 million in 2001).
YEAR ENDED DECEMBER 31 2003 2002 2001
================================================================================
MILLIONS
ESOP Shares
Allocated 3.6 3.8 3.9
Unreleased 3.4 3.7 4.0
- --------------------------------------------------------------------------------
Total 7.0 7.5 7.9
- --------------------------------------------------------------------------------
Fair Value of Unreleased Shares $105.0 $84.0 $100.3
================================================================================
STOCK OPTION AND AWARD PLANS. We have an Executive Long-Term Incentive
Compensation Plan (Executive Plan) and a Director Long-Term Stock Incentive Plan
(Director Plan). The Executive Plan allows for the grant of up to 9.7 million
shares of our common stock to key employees. To date, these grants have taken
the form of stock options, performance share awards and restricted stock awards.
The Director Plan allows for the grant of up to 0.3 million shares of our common
stock to nonemployee directors. Each nonemployee director receives an annual
grant of 1,500 stock options and a biennial grant of performance shares equal to
$10,000 in value of common stock at the date of grant. Stock options are
exercisable at the market price of common shares on the date the options are
granted, and vest in equal annual installments over two years with expiration
ten years from the date of grant. Performance shares are earned over multi-year
time periods and are contingent upon the attainment of certain performance goals
of ALLETE. Restricted stock vests once certain periods of time have elapsed. At
December 31, 2003, 3.8 million and 0.1 million shares were held in reserve for
future issuance under the Executive Plan and Director Plan, respectively.
AVERAGE
EXERCISE
STOCK OPTION ACTIVITY OPTIONS PRICE
================================================================================
OPTIONS IN MILLIONS
2003
Outstanding, Beginning of Year 2.3 $22.48
Granted 0.7 $20.59
Exercised (0.6) $20.44
Cancelled (0.1) $22.71
- --------------------------------------------------------------------------------
Outstanding, End of Year 2.3 $21.49
- --------------------------------------------------------------------------------
Exercisable, End of Year 1.4 $22.42
Fair Value of Options Granted
During the Year $2.72
- --------------------------------------------------------------------------------
2002
Outstanding, Beginning of Year 2.3 $20.18
Granted 0.8 $25.92
Exercised (0.7) $18.70
Cancelled (0.1) $23.77
- --------------------------------------------------------------------------------
Outstanding, End of Year 2.3 $22.48
- --------------------------------------------------------------------------------
Exercisable, End of Year 1.3 $20.23
Fair Value of Options Granted
During the Year $4.55
- --------------------------------------------------------------------------------
2001
Outstanding, Beginning of Year 2.4 $18.52
Granted 0.8 $23.63
Exercised (0.8) $18.39
Cancelled (0.1) $21.05
- --------------------------------------------------------------------------------
Outstanding, End of Year 2.3 $20.18
- --------------------------------------------------------------------------------
Exercisable, End of Year 1.2 $19.55
Fair Value of Options Granted
During the Year $3.89
================================================================================
- --------------------------------------------------------------------------------
PAGE 82
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
At December 31, 2003 options outstanding consisted of 0.2 million with an
exercise price of $13.69 to $16.25, and 2.1 million with an exercise price of
$20.51 to $25.68. The options with an exercise price of $13.69 to $16.25 have an
average remaining contractual life of 5.4 years with 0.2 million exercisable on
December 31, 2003 at an average price of $15.82. The options with an exercise
price of $20.51 to $25.68 have an average remaining contractual life of 7.5
years with 1.2 million exercisable on December 31, 2003 at an average price of
$23.53.
A total of 0.1 million performance share grants were awarded in February 2004
for performance periods ending in 2005 and 2006. The ultimate issuance is
contingent upon the attainment of certain future performance goals of ALLETE
during the performance periods. The grant date fair value of the performance
share awards was $1.9 million.
A total of 0.3 million performance share grants were awarded in 2002 and 2003
for the performance period ended December 31, 2003. The grant date fair value of
the share awards was $8.3 million. In early 2004, 50% of the shares will be
issued with the balance to be issued in 2005.
In February 2004 we granted stock options to purchase approximately 0.1
million shares of common stock (exercise price of $32.55 per share).
EMPLOYEE STOCK PURCHASE PLAN. We have an Employee Stock Purchase Plan that
permits eligible employees to buy up to $23,750 per year of our common stock at
95% of the market price. At December 31, 2003, 1.3 million shares had been
issued under the plan and 0.5 million shares were held in reserve for future
issuance.
20 QUARTERLY FINANCIAL DATA (UNAUDITED)
Information for any one quarterly period is not necessarily indicative of the
results which may be expected for the year. Financial results for 2003 included
a $71.6 million, or $0.86 per share, after-tax gain on the sale of substantially
all our Water Services businesses ($0.2 million first quarter and second
quarter; $3.0 million, or $0.04 per share, third quarter; $68.2 million, or
$0.82 per share, fourth quarter). The gain was net of all selling, transaction
and employee termination benefit expenses, as well as impairment losses on
certain remaining assets. Financial results for the first quarter of 2002
included charges of $1.6 million, or $0.02 per share and the second quarter of
2002 included $2.3 million, or $0.03 per share, of charges related to exiting
our vehicle transport business and retail store. Financial results for the
fourth quarter of 2002 included a $5.5 million, or $0.07 per share, charge
related to the indefinite delay of a generation project in Superior, Wisconsin.
QUARTER ENDED MAR. 31 JUN. 30 SEPT. 30 DEC. 31
====================================================================================================
MILLIONS EXCEPT
EARNINGS PER SHARE
2003
Operating Revenue $422.9 $409.9 $397.1 $388.9
Operating Income from
Continuing Operations $62.4 $62.1 $65.3 $45.2
Net Income
Continuing Operations $38.0 $37.1 $39.4 $28.6
Discontinued Operations 6.3 7.3 8.2 71.5
- ----------------------------------------------------------------------------------------------------
$44.3 $44.4 $47.6 $100.1
Earnings Available for
Common Stock $44.3 $44.4 $47.6 $100.1
Earnings Per Share of
Common Stock
Basic
Continuing Operations $0.46 $0.45 $0.47 $0.34
Discontinued Operations 0.08 0.09 0.10 0.86
- ----------------------------------------------------------------------------------------------------
$0.54 $0.54 $0.57 $1.20
Diluted
Continuing Operations $0.46 $0.45 $0.47 $0.34
Discontinued Operations 0.08 0.08 0.10 0.86
- ----------------------------------------------------------------------------------------------------
$0.54 $0.53 $0.57 $1.20
2002
Operating Revenue $367.2 $374.9 $387.9 $364.3
Operating Income from
Continuing Operations $54.7 $55.6 $60.5 $20.3
Net Income
Continuing Operations $33.2 $33.7 $38.3 $13.7
Discontinued Operations 2.0 5.1 6.8 4.4
- ----------------------------------------------------------------------------------------------------
$35.2 $38.8 $45.1 $18.1
Earnings Available for
Common Stock $35.2 $38.8 $45.1 $18.1
Earnings Per Share of
Common Stock
Basic
Continuing Operations $0.42 $0.41 $0.47 $0.17
Discontinued Operations 0.02 0.07 0.08 0.05
- ----------------------------------------------------------------------------------------------------
$0.44 $0.48 $0.55 $0.22
Diluted
Continuing Operations $0.42 $0.40 $0.47 $0.17
Discontinued Operations 0.02 0.07 0.08 0.05
- ----------------------------------------------------------------------------------------------------
$0.44 $0.47 $0.55 $0.22
====================================================================================================
- --------------------------------------------------------------------------------
PAGE 83
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT AUDITORS
ON FINANCIAL STATEMENT SCHEDULE
[PRICEWATERHOUSECOOPERS LLP LOGO OMITTED]
To the Board of Directors
of ALLETE, Inc.
Our audits of the consolidated financial statements referred to in our report
dated February 9, 2004, except as to Note 3 which is as of March 8, 2004
appearing on page 60 of this Form 10-K of ALLETE, Inc. and its subsidiaries also
included an audit of the Financial Statement Schedule listed in Item 15(a) of
this Form 10-K. In our opinion, the Financial Statement Schedule presents
fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements.
PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Minneapolis, Minnesota
February 9, 2004
- --------------------------------------------------------------------------------
SCHEDULE II
ALLETE
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
ADDITIONS
BALANCE AT -------------------- DEDUCTIONS BALANCE AT
BEGINNING CHARGED OTHER FROM END OF
FOR THE YEAR ENDED DECEMBER 31 OF YEAR TO INCOME CHANGES RESERVES<F1> PERIOD
=====================================================================================================================
MILLIONS
Reserve Deducted from Related Assets
Reserve For Uncollectible Accounts
2003 Trade Accounts Receivable $ 8.8 $ 3.1 - $ 3.5 $ 8.4
Finance Receivables - Current 20.0 14.8 - 16.8 18.0
Finance Receivables - Long-Term 1.7 - - 0.5 1.2
2002 Trade Accounts Receivable 6.1 5.7 - 3.0 8.8
Finance Receivables - Current 20.5 17.2 - 17.7 20.0
Finance Receivables - Long-Term 2.7 0.4 - 1.4 1.7
2001 Trade Accounts Receivable 5.1 4.4 - 3.4 6.1
Finance Receivables - Current 19.8 19.3 - 18.6 20.5
Finance Receivables - Long-Term 2.6 0.2 - 0.1 2.7
Deferred Asset Valuation Allowance
2003 Deferred Tax Assets 7.8 0.9 - - 8.7
2002 Deferred Tax Assets 6.0 1.8 - - 7.8
2001 Deferred Tax Assets 5.0 1.0 - - 6.0
=====================================================================================================================
<FN>
<F1> Reserve for uncollectible accounts includes bad debts written off.
</FN>
- --------------------------------------------------------------------------------
PAGE 84
ALLETE FORM 10-K 2003
- --------------------------------------------------------------------------------
EXHIBIT INDEX
EXHIBIT
NUMBER
- --------------------------------------------------------------------------------
2(b) - Stock Purchase Agreement (without Exhibits and Schedules), dated
November 20, 2003, by and between Philadelphia Suburban Corporation,
(now Aqua America, Inc.) as Purchaser, and ALLETE Water Services,
Inc., as Shareholder.
10(o)3 - Amended Wholesale Power Coordination and Dispatch Operating
Agreement, dated January 30, 2004, between Minnesota Power, Inc. (now
ALLETE) and Split Rock Energy LLC.
10(p) - Amended and Restated Withdrawal Agreement (without Exhibits and
Schedules), dated January 30, 2004, by and between Great River Energy
and Minnesota Power (now ALLETE). [Portions of this exhibit have been
omitted pursuant to a request for confidential treatment and filed
separately with the SEC.]
10(s) - Third Amended and Restated Committed Facility Letter (without
Exhibits), dated December 23, 2003, to ALLETE from LaSalle Bank
National Association, as Agent.
+10(t)2 - November 2003 Amendment to the Minnesota Power (now ALLETE) Executive
Annual Incentive Plan.
+10(u) - ALLETE and Affiliated Companies Supplemental Executive Retirement
Plan, as amended and restated, effective January 1, 2004.
+10(v)2 - Amendments through December 2003 to the Minnesota Power and
Affiliated Companies Executive Investment Plan-I.
+10(w)2 - Amendments through December 2003 to the Minnesota Power and
Affiliated Companies Executive Investment Plan-II.
+10(z)2 - Amendments through December 2003 to the Minnesota Power (now ALLETE)
Director Stock Plan.
+10(aa)2 - October 2003 Amendment to the Minnesota Power (now ALLETE) Director
Compensation Deferral Plan.
12 - Computation of Ratios of Earnings to Fixed Charges (Unaudited).
23(a) - Consent of Independent Accountants.
23(b) - Consent of General Counsel.
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 Annual Report by the Chief Executive
Officer and Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.