SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
/X/ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended MARCH 31, 2004
or
/ / Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File No. 1-3548
ALLETE, INC.
A Minnesota Corporation
IRS Employer Identification No. 41-0418150
30 West Superior Street
Duluth, Minnesota 55802-2093
Telephone - (218) 279-5000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days.
Yes X No
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
----- -----
Common Stock, no par value,
88,243,607 shares outstanding
as of March 31, 2004
INDEX
Page
Definitions 2
Safe Harbor Statement Under the Private Securities Litigation
Reform Act of 1995 3
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheet -
March 31, 2004 and December 31, 2003 4
Consolidated Statement of Income -
Quarter Ended March 31, 2004 and 2003 5
Consolidated Statement of Cash Flows -
Quarter Ended March 31, 2004 and 2003 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 17
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 24
Item 4. Controls and Procedures 25
Part II. Other Information
Item 1. Legal Proceedings 25
Item 5. Other Information 26
Item 6. Exhibits and Reports on Form 8-K 27
Signatures 28
1 ALLETE First Quarter 2004 Form 10-Q
DEFINITIONS
The following abbreviations or acronyms are used in the text. References in
this report to "we," "us" and "our" are to ALLETE, Inc. and its subsidiaries,
collectively.
ABBREVIATION OR ACRONYM TERM
- --------------------------------------------------------------------------------
2003 Form 10-K ALLETE's Annual Report on Form 10-K for
the Year Ended December 31, 2003
ADESA Impact Collectively, Automotive Recovery
Services, Inc. and Impact Auto
Auctions Ltd.
AFC Automotive Finance Corporation
ALLETE ALLETE, Inc.
ALLETE Properties ALLETE Properties, Inc.
APB Accounting Principles Board
Company ALLETE, Inc. and its subsidiaries
EBITDA Earnings Before Interest, Taxes,
Depreciation and Amortization Expense
EPA Environmental Protection Agency
ESOP Employee Stock Ownership Plan
FASB Financial Accounting Standards Board
FERC Federal Energy Regulatory Commission
Florida Water Florida Water Services Corporation
FPSC Florida Public Service Commission
GAAP Generally Accepted Accounting Principles
in the United States
GeoInsight GeoInsight, Inc.
IPO Initial Public Offering
LIBOR London Interbank Offered Rate
Minnesota Power An operating division of ALLETE, Inc.
Minnkota Power Minnkota Power Cooperative, Inc.
MDEP Massachusetts Department of Environmental
Protection
MGP Manufactured Gas Plant
MPUC Minnesota Public Utilities Commission
MTBE Methyl Tertiary-Butyl Ether
MW Megawatt(s)
NCUC North Carolina Utilities Commission
NRG Energy NRG Energy, Inc.
PSCW Public Service Commission of Wisconsin
SEC Securities and Exchange Commission
SFAS Statement of Financial Accounting
Standards No.
Split Rock Energy Split Rock Energy LLC
Square Butte Square Butte Electric Cooperative
SWL&P Superior Water, Light and Power Company
Taconite Harbor Taconite Harbor Energy Center
WDNR Wisconsin Department of Natural Resources
ALLETE First Quarter 2004 Form 10-Q 2
SAFE HARBOR STATEMENT
UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
In connection with the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, we are hereby filing cautionary statements
identifying important factors that could cause our actual results to differ
materially from those projected in forward-looking statements (as such term is
defined in the Private Securities Litigation Reform Act of 1995) made by or on
behalf of ALLETE in this Quarterly Report on Form 10-Q, in presentations, in
response to questions or otherwise. Any statements that express, or involve
discussions as to, expectations, beliefs, plans, objectives, assumptions or
future events or performance (often, but not always, through the use of words or
phrases such as "anticipates," "believes," "estimates," "expects," "intends,"
"plans," "projects," "will likely result," "will continue" 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 IPO and 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"
beginning on page 46 of our 2003 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 our 2003 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.
3 ALLETE First Quarter 2004 Form 10-Q
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLETE
CONSOLIDATED BALANCE SHEET
Millions - Unaudited
MARCH 31, DECEMBER 31,
2004 2003
- ------------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and Cash Equivalents $ 297.5 $ 223.0
Accounts Receivable (Less Allowance of $26.7 and $26.4) 599.3 403.8
Inventories 35.7 37.9
Prepayments and Other 15.1 15.8
Discontinued Operations 13.5 14.9
- ------------------------------------------------------------------------------------------------------------------------
Total Current Assets 961.1 695.4
Property, Plant and Equipment - Net 1,493.4 1,499.0
Investments 189.4 204.6
Goodwill 510.5 511.0
Other Intangible Assets 31.1 33.3
Other Assets 78.2 70.1
Discontinued Operations 89.7 87.9
- ------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $3,353.4 $3,101.3
- ------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Current Liabilities
Accounts Payable $ 475.0 $ 243.9
Accrued Taxes and Interest 53.3 35.2
Notes Payable 53.0 53.0
Long-Term Debt Due Within One Year 36.0 37.5
Other 87.4 107.1
Discontinued Operations 17.3 49.5
- ------------------------------------------------------------------------------------------------------------------------
Total Current Liabilities 722.0 526.2
Long-Term Debt 747.9 747.7
Accumulated Deferred Income Taxes 165.9 160.7
Other Liabilities 163.9 161.5
Discontinued Operations 41.9 45.0
Commitments and Contingencies
- ------------------------------------------------------------------------------------------------------------------------
Total Liabilities 1,841.6 1,641.1
- ------------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Common Stock Without Par Value, 130.0 Shares Authorized
88.2 and 87.3 Shares Outstanding 882.4 859.2
Unearned ESOP Shares (44.6) (45.4)
Accumulated Other Comprehensive Gain 12.4 14.5
Retained Earnings 661.6 631.9
- ------------------------------------------------------------------------------------------------------------------------
Total Shareholders' Equity 1,511.8 1,460.2
- ------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $3,353.4 $3,101.3
- ------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
ALLETE First Quarter 2004 Form 10-Q 4
ALLETE
CONSOLIDATED STATEMENT OF INCOME
Millions Except Per Share Amounts - Unaudited
QUARTER ENDED
MARCH 31,
2004 2003
- ------------------------------------------------------------------------------------------------------------------------
OPERATING REVENUE
Energy Services
Regulated Utility $141.4 $138.0
Nonregulated 40.9 41.1
Automotive Services 247.7 232.9
Investments 28.5 10.9
- ------------------------------------------------------------------------------------------------------------------------
Total Operating Revenue 458.5 422.9
- ------------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Fuel and Purchased Power
Regulated Utility 57.1 56.0
Nonregulated 11.8 11.4
Operations
Regulated Utility 57.4 57.8
Nonregulated 28.5 28.3
Automotive and Investments 203.4 190.1
Interest 13.1 16.9
- ------------------------------------------------------------------------------------------------------------------------
Total Operating Expenses 371.3 360.5
- ------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME FROM CONTINUING OPERATIONS 87.2 62.4
INCOME TAX EXPENSE 34.1 24.4
- ------------------------------------------------------------------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS 53.1 38.0
INCOME (LOSS) FROM DISCONTINUED OPERATIONS - NET OF TAX (0.6) 6.3
- ------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 52.5 $ 44.3
- ------------------------------------------------------------------------------------------------------------------------
AVERAGE SHARES OF COMMON STOCK
Basic 84.3 82.2
Diluted 84.8 82.3
- ------------------------------------------------------------------------------------------------------------------------
BASIC AND DILUTED
EARNINGS (LOSS) PER SHARE OF COMMON STOCK
Continuing Operations $0.63 $0.46
Discontinued Operations (0.01) 0.08
- ------------------------------------------------------------------------------------------------------------------------
$0.62 $0.54
- ------------------------------------------------------------------------------------------------------------------------
DIVIDENDS PER SHARE OF COMMON STOCK $0.2825 $0.2825
- ------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
5 ALLETE First Quarter 2004 Form 10-Q
ALLETE
CONSOLIDATED STATEMENT OF CASH FLOWS
Millions - Unaudited
QUARTER ENDED
MARCH 31,
2004 2003
- ------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net Income $ 52.5 $ 44.3
Depreciation and Amortization 21.7 20.9
Deferred Income Taxes 3.6 10.6
Gain on Sale of Plant - (12.5)
Changes in Operating Assets and Liabilities
Accounts Receivable (194.5) (79.0)
Inventories 2.2 4.4
Prepayments and Other 1.3 (1.0)
Accounts Payable 228.9 123.5
Other Current Liabilities (32.5) (17.8)
Other Assets (8.6) (4.9)
Other Liabilities 2.4 (2.4)
- ------------------------------------------------------------------------------------------------------------------------
Cash from Operating Activities 77.0 86.1
- ------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Proceeds from Sale of Available-For-Sale Securities 1.4 -
Changes to Investments 11.1 (3.0)
Additions to Property, Plant and Equipment (16.6) (27.1)
Other 4.4 (9.6)
- ------------------------------------------------------------------------------------------------------------------------
Cash from (for) Investing Activities 0.3 (39.7)
- ------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Issuance of Common Stock 23.2 11.3
Issuance of Long-Term Debt 2.8 11.1
Changes in Notes Payable - Net 0.9 (58.1)
Reductions of Long-Term Debt (4.3) (2.9)
Dividends on Common Stock (22.8) (22.2)
- ------------------------------------------------------------------------------------------------------------------------
Cash for Financing Activities (0.2) (60.8)
- ------------------------------------------------------------------------------------------------------------------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (2.5) 13.0
- ------------------------------------------------------------------------------------------------------------------------
CHANGE IN CASH AND CASH EQUIVALENTS 74.6 (1.4)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 229.5 203.0
- ------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD <F1> $304.1 $201.6
- ------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL CASH FLOW INFORMATION
Cash Paid During the Period for
Interest - Net of Capitalized $18.4 $21.7
Income Taxes $29.6 $1.3
- ------------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Included $6.6 million of cash from Discontinued Operations at March 31, 2004 ($7.9 million at March 31, 2003).
</FN>
The accompanying notes are an integral part of these statements.
ALLETE First Quarter 2004 Form 10-Q 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The accompanying unaudited consolidated financial statements and notes should be
read in conjunction with our 2003 Form 10-K. In our opinion, all adjustments
necessary for a fair presentation of the results for the interim periods have
been included. The results of operations for an interim period may not give a
true indication of the results for the year.
NOTE 1. BUSINESS SEGMENTS
Millions
ENERGY SERVICES
--------------------- INVESTMENTS
REGULATED NON- AUTOMOTIVE AND CORPORATE
CONSOLIDATED UTILITY REGULATED SERVICES CHARGES
- --------------------------------------------------------------------------------------------------------------------------------
FOR THE QUARTER ENDED MARCH 31, 2004
Operating Revenue $458.5 $141.4 $40.9 $247.7<F3> $28.5
Operation and Other Expense 336.5 104.6 37.8 179.5 14.6
Depreciation and Amortization Expense 21.7 9.9 2.5 9.3 -
Interest Expense 13.1 4.7 0.3 4.0 4.1
- --------------------------------------------------------------------------------------------------------------------------------
Operating Income from Continuing Operations 87.2 22.2 0.3 54.9 9.8
Income Tax Expense (Benefit) 34.1 8.3 (0.1) 21.6 4.3
- --------------------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations 53.1 13.9 0.4 33.3 5.5
Loss from Discontinued Operations - Net of Tax (0.6)<F1> - - - -
- --------------------------------------------------------------------------------------------------------------------------------
Net Income $ 52.5<F1> $ 13.9 $ 0.4 $ 33.3 $ 5.5
- --------------------------------------------------------------------------------------------------------------------------------
Total Assets $3,353.4<F2> $970.7 $234.1 $1,900.8<F4> $144.6
Property, Plant and Equipment - Net $1,493.4 $728.3 $189.0 $572.1 $4.0
Accumulated Depreciation $854.9 $700.7 $45.2 $109.0 -
Capital Expenditures $16.6<F2> $10.9 $2.8 $1.3 $0.1
FOR THE QUARTER ENDED MARCH 31, 2003
Operating Revenue $422.9 $138.0 $41.1 $ 232.9<F3> $10.9
Operation and Other Expense 322.7 103.5 37.2 176.2 5.8
Depreciation and Amortization Expense 20.9 10.3 2.5 8.1 -
Interest Expense 16.9 5.2 0.4 4.4 6.9
- --------------------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing Operations 62.4 19.0 1.0 44.2 (1.8)
Income Tax Expense (Benefit) 24.4 7.6 0.2 17.5 (0.9)
- --------------------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations 38.0 11.4 0.8 26.7 (0.9)
Income from Discontinued Operations - Net of Tax 6.3<F1> - - 0.5 -
- --------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) $ 44.3<F1> $ 11.4 $ 0.8 $ 27.2 $(0.9)
- --------------------------------------------------------------------------------------------------------------------------------
Total Assets $3,273.7<F2> $915.2 $208.0 $1,603.5<F4> $161.8
Property, Plant and Equipment - Net $1,388.4 $728.4 $165.9 $490.1 $4.0
Accumulated Depreciation $801.7 $677.5 $38.6 $85.6 -
Capital Expenditures $27.1<F2> $10.2 $3.5 $7.2 -
- --------------------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Included a $0.6 million loss from the Water Services businesses in 2004 ($5.8 million of income in 2003).
<F2> Discontinued Operations represented $103.2 million of total assets in 2004 ($385.2 million in 2003) and $1.5 million
of capital expenditures in 2004 ($6.2 million in 2003).
<F3> Included $45.8 million of Canadian operating revenue in 2004 ($40.1 million in 2003).
<F4> Included $273.5 million of Canadian assets in 2004 ($198.0 million in 2003).
</FN>
7 ALLETE First Quarter 2004 Form 10-Q
NOTE 2. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
ACCOUNTS RECEIVABLE. AFC sells the majority of U.S. dollar denominated finance
receivables on a revolving basis to a wholly owned, bankruptcy remote, special
purpose subsidiary that is consolidated for accounting purposes. The special
purpose subsidiary has entered into a securitization agreement, which expires in
2005, that allows for the revolving sale to a bank conduit facility of up to a
maximum of $500 million in undivided interests in eligible finance receivables.
Receivables sold are not reported on our consolidated financial statements.
At March 31, 2004 AFC managed total finance receivables of $618 million ($539
million at December 31, 2003), of which $527 million had been sold to the
special purpose subsidiary ($464 million at December 31, 2003). The special
purpose subsidiary then in turn sold, with recourse to the special purpose
subsidiary, $350 million to the bank conduit facility at March 31, 2004 ($334
million at December 31, 2003) leaving $268 million of finance receivables
recorded on our consolidated balance sheet at March 31, 2004 ($205 million at
December 31, 2003).
AFC's proceeds from the revolving sale of receivables to the bank conduit
facility were used to repay borrowings from ALLETE and fund new loans to
customers. AFC and the special purpose subsidiary must maintain certain
financial covenants such as minimum tangible net worth to comply with the terms
of the securitization agreement. AFC has historically performed better than the
covenant thresholds set forth in the securitization agreement, and we are not
aware of any changing circumstances that would put AFC in noncompliance with the
covenants.
ACCOUNTING FOR STOCK-BASED COMPENSATION. We have elected to account for
stock-based compensation in accordance with APB Opinion No. 25, "Accounting for
Stock Issued to Employees." Accordingly, we recognize expense for performance
share awards granted and do not recognize expense for employee stock options
granted. The after-tax expense recognized for performance share awards was
approximately $0.4 million for the first three months of 2004 ($0.7 million for
the first three months of 2003). The following table illustrates the effect on
net income and earnings per share if we had applied the fair value recognition
provisions of SFAS 123, "Accounting for Stock-Based Compensation."
QUARTER ENDED
EFFECT OF SFAS 123 MARCH 31,
ACCOUNTING FOR STOCK-BASED COMPENSATION 2004 2003
- --------------------------------------------------------------------------------------------------------------------
Millions Except Per Share Amounts
Net Income
As Reported $52.5 $44.3
Less: Employee Stock Compensation Expense
Determined Under SFAS 123 - Net of Tax (0.1) (0.1)
- --------------------------------------------------------------------------------------------------------------------
Pro Forma Net Income $52.4 $44.2
- --------------------------------------------------------------------------------------------------------------------
Basic Earnings Per Share
As Reported $0.62 $0.54
Pro Forma $0.62 $0.54
Diluted Earnings Per Share
As Reported $0.62 $0.54
Pro Forma $0.62 $0.54
- --------------------------------------------------------------------------------------------------------------------
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:
2004 2003
- --------------------------------------------------------------------------------------------------------------------
Risk-Free Interest Rate 3.3% 3.1%
Expected Life - Years 5 5
Expected Volatility 28.1% 25.2%
Dividend Growth Rate 2% 2%
- --------------------------------------------------------------------------------------------------------------------
ALLETE First Quarter 2004 Form 10-Q 8
NOTE 2. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
NOTE 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, Inc. The spin-off is expected to take
the form of a tax-free stock dividend to ALLETE's shareholders, who would
receive a pro rata number of shares of ADESA common stock for each share of
ALLETE common 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 IPO of approximately $150
million in common shares of ADESA, representing less than 20 percent 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 the completion of the spin-off.
NOTE 4. DISCONTINUED OPERATIONS
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. In April 2004 we
reached an agreement to sell our remaining 72 water and wastewater systems in
Florida to Aqua America, Inc. for $18 million. The transaction is scheduled to
close by the end of June 2004 and is subject to regulatory approval by the FPSC.
This approval process may result in an adjustment of the final purchase price
based on the FPSC's determination of plant investment for the system. The
ultimate ownership of nine of the 72 water and wastewater systems is subject to
the outcome of an asserted right of first refusal with a local municipality. We
expect to sell our water assets in Georgia in 2004. We exited our vehicle import
business in the first quarter of 2003.
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 ($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. 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.
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 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
9 ALLETE First Quarter 2004 Form 10-Q
NOTE 4. DISCONTINUED OPERATIONS (CONTINUED)
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.
SUMMARY OF DISCONTINUED OPERATIONS
- ----------------------------------------------------------------------------------------------------------------------
Millions
QUARTER ENDED
MARCH 31,
INCOME STATEMENT 2004 2003
- ----------------------------------------------------------------------------------------------------------------------
Operating Revenue $7.6 $30.9
- ----------------------------------------------------------------------------------------------------------------------
Pre-Tax Income (Loss) from Operations $(0.4) $ 7.9
Income Tax Expense (Benefit) (0.2) 3.1
- ----------------------------------------------------------------------------------------------------------------------
(0.2) 4.8
- ----------------------------------------------------------------------------------------------------------------------
Gain (Loss) on Disposal (0.6) 2.7<F1>
Income Tax Expense (Benefit) (0.2) 1.2
- ----------------------------------------------------------------------------------------------------------------------
(0.4) 1.5
- ----------------------------------------------------------------------------------------------------------------------
Income (Loss) from Discontinued Operations $(0.6) $6.3
- ----------------------------------------------------------------------------------------------------------------------
MARCH 31, DECEMBER 31,
BALANCE SHEET INFORMATION 2004 2003
- ----------------------------------------------------------------------------------------------------------------------
Assets of Discontinued Operations
Cash and Cash Equivalents $ 6.6 $ 6.5
Other Current Assets 6.9 8.4
Property, Plant and Equipment 83.0 81.2
Other Assets 6.7 6.7
- ----------------------------------------------------------------------------------------------------------------------
$103.2 $102.8
- ----------------------------------------------------------------------------------------------------------------------
Liabilities of Discontinued Operations
Current Liabilities $17.3 $49.5
Long-Term Debt 19.7 19.9
Other Liabilities 22.2 25.1
- ----------------------------------------------------------------------------------------------------------------------
$59.2 $94.5
- ----------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Included a $2.0 million recovery from a settlement related to the 2002 sale of our vehicle transport business in
2003.
</FN>
NOTE 5. INVESTMENTS
Investments includes the real estate assets of ALLETE Properties, debt and
equity securities consisting primarily of $43.9 million of securities held for
employee benefits ($41.4 million at December 31, 2003) and $34.5 million of
economic development revenue bonds held by ADESA in conjunction with a capital
lease of a vehicle auction facility in Georgia ($34.5 million at December 31,
2003), and our emerging technology investments.
MARCH 31, DECEMBER 31,
INVESTMENTS 2004 2003
- ----------------------------------------------------------------------------------------------------------------------
Millions
Real Estate Assets $ 75.5 $ 78.5
Debt and Equity Securities 78.8 88.6
Emerging Technology Investments 35.1 37.5
- ----------------------------------------------------------------------------------------------------------------------
$189.4 $204.6
- ----------------------------------------------------------------------------------------------------------------------
ALLETE First Quarter 2004 Form 10-Q 10
NOTE 6. GOODWILL AND OTHER INTANGIBLES
We conduct our annual goodwill impairment testing in the second quarter of each
year and the 2003 test resulted in no impairment. No event or change has
occurred that would indicate the carrying amount has been impaired since our
annual test.
GOODWILL
- -----------------------------------------------------------------------------------------------------------------
Millions
Carrying Value, December 31, 2003 $511.0
Acquired during Year -
Change due to Foreign Currency Translation Adjustment (0.5)
- -----------------------------------------------------------------------------------------------------------------
Carrying Value, March 31, 2004 $510.5
- -----------------------------------------------------------------------------------------------------------------
MARCH 31, DECEMBER 31,
OTHER INTANGIBLE ASSETS 2004 2003
- -----------------------------------------------------------------------------------------------------------------
Millions
Customer Relationships $29.6 $29.6
Computer Software 27.7 28.1
Other 5.7 5.7
Accumulated Amortization (31.9) (30.1)
- -----------------------------------------------------------------------------------------------------------------
$31.1 $33.3
- -----------------------------------------------------------------------------------------------------------------
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.
NOTE 7. SHORT-TERM BORROWINGS AND COMPENSATING BALANCES
In July 2003 ALLETE entered into a credit agreement to borrow $250 million from
a consortium of financial institutions, the proceeds of which were used to
redeem $250 million of the Company's Floating Rate First Mortgage Bonds due
October 20, 2003. The credit agreement expires in July 2004, has an interest
rate of LIBOR plus 0.875% and is secured by the lien of the Company's Mortgage
and Deed of Trust. The credit agreement also has certain mandatory prepayment
provisions, including a requirement to repay an amount equal to 75 percent of
the net proceeds from the sale of water assets. In accordance with these
provisions, $197.0 million was repaid in 2003. The remaining $53.0 million
outstanding at March 31, 2004 was repaid in April 2004.
Our lines of credit contain financial covenants. The most restrictive of these
covenants requires 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 March 31,
2004 ALLETE's ratio of funded debt to total capital was .36 to 1.0, the interest
coverage ratio was 6.53 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.
11 ALLETE First Quarter 2004 Form 10-Q
NOTE 8. LONG-TERM DEBT
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 March 31, 2004 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.
NOTE 9. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
POSTRETIREMENT HEALTH
PENSION AND LIFE
COMPONENTS OF PERIODIC BENEFIT EXPENSE ----------------------- -------------------------
THREE MONTHS ENDED MARCH 31, 2004 2003 2004 2003
- -------------------------------------------------------------------------------------------------------------------
Millions
Service Cost $2.1 $ 1.7 $1.1 $ 0.9
Interest Cost 5.2 4.9 1.8 1.7
Expected Return on Plan Assets (6.9) (7.2) (1.1) (1.0)
Amortization of Prior Service Costs 0.2 0.2 - -
Amortization of Net Loss 0.4 - 0.2 -
Amortization of Transition Obligation 0.1 0.1 0.6 0.6
- -------------------------------------------------------------------------------------------------------------------
Periodic Benefit Expense (Benefit) $1.1 $(0.3) $2.6 $ 2.2
- -------------------------------------------------------------------------------------------------------------------
NOTE 10. INCOME TAX EXPENSE
QUARTER ENDED
MARCH 31,
2004 2003
- -------------------------------------------------------------------------------------------------------------------
Millions
Current Tax Expense
Federal $22.1 $16.6
Foreign 3.7 1.9
State 5.0 3.7
- -------------------------------------------------------------------------------------------------------------------
30.8 22.2
- -------------------------------------------------------------------------------------------------------------------
Deferred Tax Expense
Federal 3.6 2.2
State 0.3 0.4
- -------------------------------------------------------------------------------------------------------------------
3.9 2.6
- -------------------------------------------------------------------------------------------------------------------
Deferred Tax Credits (0.6) (0.4)
- -------------------------------------------------------------------------------------------------------------------
Income Tax Expense on Continuing Operations 34.1 24.4
Income Tax Expense (Benefit) on Discontinued Operations (0.4) 4.3
- -------------------------------------------------------------------------------------------------------------------
Total Income Tax Expense $33.7 $28.7
- -------------------------------------------------------------------------------------------------------------------
ALLETE First Quarter 2004 Form 10-Q 12
NOTE 11. 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. For the quarters
ended March 31, 2004 and 2003, there were no differences between basic and
diluted earnings per share.
RECONCILIATION OF QUARTER ENDED QUARTER ENDED
BASIC AND DILUTED SHARES MARCH 31, 2004 MARCH 31, 2003
- -------------------------------------------------------------------------------------------------------------------
Millions
Dilutive Dilutive
Basic Securities Diluted Basic Securities Diluted
----------------------------- -----------------------------
Common Shares 84.3 0.5 84.8 82.2 0.1 82.3
- -------------------------------------------------------------------------------------------------------------------
NOTE 12. COMPREHENSIVE INCOME
For the quarter ended March 31, 2004 total comprehensive income was $50.4
million ($56.6 million for the quarter ended March 31, 2003). Total
comprehensive income includes net income, unrealized gains and losses on
securities classified as available-for-sale, additional pension liability and
foreign currency translation adjustments.
MARCH 31, DECEMBER 31,
ACCUMULATED OTHER COMPREHENSIVE GAIN 2004 2003
- -------------------------------------------------------------------------------------------------------------------
Millions
Unrealized Gain on Securities $ 1.2 $ 0.8
Foreign Currency Translation Gain 21.0 23.5
Additional Pension Liability (9.8) (9.8)
- -------------------------------------------------------------------------------------------------------------------
$12.4 $14.5
- -------------------------------------------------------------------------------------------------------------------
NOTE 13. 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 percent 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 percent annually, to a minimum of 50 percent. In December 2003
we received notice from Minnkota Power that they will reduce our output
entitlement, effective January 1, 2006, by 5 percent to approximately 66
percent. Minnesota Power is obligated to pay its pro rata share of Square
Butte's costs based on Minnesota Power's entitlement to Unit output. Minnesota
Power's payment obligation is suspended if Square Butte fails to deliver any
power, whether produced or purchased, for a period of one year. Square Butte's
fixed costs consist primarily of debt service. At March 31, 2004 Square Butte
had total debt outstanding of $284.5 million. Total annual debt service for
Square Butte is expected to be approximately $23 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
payments to Square Butte are approved as purchased power expense for ratemaking
purposes by both the MPUC and the FERC.
13 ALLETE First Quarter 2004 Form 10-Q
NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (CONTINUED)
LEASING AGREEMENTS. We lease properties and equipment under operating lease
agreements with terms expiring through 2019. The aggregate amount of minimum
lease payments for all operating leases during 2004 is $19.9 million ($16.1
million in 2005; $13.6 million in 2006; $6.5 million in 2007; $5.9 million in
2008; and $49.5 million thereafter). Automotive Services' portion of these
minimum lease payments is $18.8 million in 2004 ($15.2 million in 2005; $12.7
million in 2006; $5.9 million in 2007; $5.6 million in 2008; and $48.8 million
thereafter).
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 approximately $21 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." To date, the Kendall County
facility has operated at a loss 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 unsold capacity
(currently 145 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. We are utilizing Tenaska Power Services
Company to provide operational and scheduling services for the Kendall County
generating unit.
COAL AND SHIPPING CONTRACTS. We have three coal supply agreements with various
expiration dates ranging from December 2006 to December 2009. We also have rail
and shipping agreements for transportation of all of our coal with various
expiration dates ranging from December 2005 to December 2011. Our minimum annual
obligation under these coal and shipping agreements range from approximately $28
million in 2004 to $10 million in 2008.
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 $4.7 million at
March 31, 2004 ($4.8 million at December 31, 2003) 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.
We review environmental matters on a quarterly basis. Accruals for environmental
matters are recorded when it is probable that a liability has been incurred and
the amount of the liability can be reasonably estimated, based on current law
and existing technologies. These accruals are adjusted periodically as
assessment and remediation efforts progress or as additional technical or legal
information becomes available. Accruals for environmental liabilities are
included in the balance sheet at undiscounted amounts and exclude claims for
recoveries from insurance or other third parties. Costs related to environmental
contamination treatment and cleanup are charged to expense unless recoverable in
rates from customers.
SWL&P Manufactured Gas Plant. In May 2001 SWL&P received notice from the WDNR
that the City of Superior had found soil contamination on property adjoining a
former Manufactured Gas Plant (MGP) site owned and operated by SWL&P'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 was completed and sent
to the WDNR
ALLETE First Quarter 2004 Form 10-Q 14
NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (CONTINUED)
during the first quarter of 2004. The next phase of the investigation will be to
determine any impact to soil or ground water between the former MGP site and
Superior Bay. A work plan for this additional investigation by SWL&P was filed
on December 17, 2003 with the WDNR. 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 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 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 the soil and
groundwater at the salvage vehicle auction site.
GeoInsight prepared an immediate response action (IRA) plan, which was 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 proposed to the
MDEP that we install water filtration units in the approximately 30 affected
residences.
15 ALLETE First Quarter 2004 Form 10-Q
NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (CONTINUED)
ADESA Impact submitted an IRA plan status report to the MDEP on March 30, 2004.
Additionally, ADESA Impact is submitting bi-weekly status updates to the MDEP.
We have installed the water filtration units and have lowered MTBE detection
limits at the instruction of the MDEP. As a result, another three homes have
been identified as having detectable levels of MTBE in the drinking water.
A comprehensive ground water sampling event and residential sampling event were
conducted in April 2004. ADESA Impact's representatives met with the Taunton
City Council on April 20, 2004 to propose that ADESA Impact extend municipal
water services to the Matthews Landing community at an approximate cost of $1
million. By late June 2004, ADESA Impact expects to provide the Taunton City
Council with a detailed proposal to provide water service including engineering
work, flow modeling, surveys, site work, road-opening detail and a safety plan.
As of March 31, 2004 ADESA has accrued $1 million to cover the estimated costs
associated with the solution proposed to the Taunton City Council.
ADESA Impact has filed a claim with our insurance carrier with respect to this
matter. On March 30, 2004 our insurance carrier responded with a request for
additional information regarding the claims.
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.
ALLETE First Quarter 2004 Form 10-Q 16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
ALLETE's core operations are focused on two business segments. ENERGY SERVICES
includes electric and gas services, coal mining and telecommunications.
AUTOMOTIVE SERVICES, with operations across the United States, Canada and
Mexico, includes wholesale vehicle auctions and related vehicle redistribution
services as well as dealer financing. Auctions and related services include
wholesale used vehicle and salvage vehicle auctions. INVESTMENTS AND CORPORATE
CHARGES includes our Florida real estate operations, investments in emerging
technologies, and general corporate charges and interest not specifically
related to any one business segment. General corporate charges include employee
salaries and benefits as well as legal and other outside service fees.
DISCONTINUED OPERATIONS includes our Water Services businesses, and our vehicle
transport and import businesses.
CONSOLIDATED OVERVIEW
Strong performance across all business segments for the quarter ended March 31,
2004 increased net income and diluted earnings per share 19 percent and 15
percent, respectively, from the same period in 2003. Net income and diluted
earnings per share from continuing operations for the quarter ended March 31,
2004 increased 40 percent and 37 percent, respectively, from the same period in
2003.
THREE MONTHS ENDED
MARCH 31,
2004 2003
- --------------------------------------------------------------------------------------------------------------------
Millions Except Per Share Amounts
Operating Revenue
Energy Services $182.3 $179.1
Automotive Services 247.7 232.9
Investments 28.5 10.9
- --------------------------------------------------------------------------------------------------------------------
$458.5 $422.9
- --------------------------------------------------------------------------------------------------------------------
Operating Expenses
Energy Services $159.8 $159.1
Automotive Services 192.8 188.7
Investments and Corporate Charges 18.7 12.7
- --------------------------------------------------------------------------------------------------------------------
$371.3 $360.5
- --------------------------------------------------------------------------------------------------------------------
Net Income (Loss)
Energy Services $14.3 $12.2
Automotive Services 33.3 26.7
Investments and Corporate Charges 5.5 (0.9)
- --------------------------------------------------------------------------------------------------------------------
Continuing Operations 53.1 38.0
Discontinued Operations (0.6) 6.3
- --------------------------------------------------------------------------------------------------------------------
$52.5 $44.3
- --------------------------------------------------------------------------------------------------------------------
Diluted Average Shares of Common Stock - Millions 84.8 82.3
- --------------------------------------------------------------------------------------------------------------------
Diluted Earnings (Loss) Per Share of Common Stock
Continuing Operations $0.63 $0.46
Discontinued Operations (0.01) 0.08
- --------------------------------------------------------------------------------------------------------------------
$0.62 $0.54
- --------------------------------------------------------------------------------------------------------------------
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
THREE MONTHS ENDED MARCH 31, 2004 2003
- -----------------------------------------------------------------------------------------------------------------
Millions
Cash from Operating Activities $77.0 $86.1
Cash from (for) Investing Activities $0.3 $(39.7)
Cash for Financing Activities $(0.2) $(60.8)
- -----------------------------------------------------------------------------------------------------------------
17 ALLETE First Quarter 2004 Form 10-Q
We believe EBITDA is a widely accepted measure of liquidity considered by
investors, financial analysts and rating agencies. EBITDA is not an alternative
to cash flows as a measure of liquidity and may not be comparable with EBITDA as
defined by other companies.
ENERGY SERVICES
----------------------- INVESTMENTS
REGULATED NON- AUTOMOTIVE AND CORPORATE
EBITDA CONSOLIDATED UTILITY REGULATED SERVICES CHARGES
- -------------------------------------------------------------------------------------------------------------------
FOR THE QUARTER ENDED MARCH 31, 2004
Net Income $ 52.5
Less: Loss from Discontinued Operations (0.6)
- ---------------------------------------------------------
Income from Continuing Operations 53.1 $13.9 $0.4 $33.3 $ 5.5
Add Back: Income Tax Expense (Benefit) 34.1 8.3 (0.1) 21.6 4.3
Interest Expense 13.1 4.7 0.3 4.0 4.1
Depreciation and Amortization
Expense 21.7 9.9 2.5 9.3 -
- -------------------------------------------------------------------------------------------------------------------
EBITDA $122.0 $36.8 $3.1 $68.2 $13.9
- -------------------------------------------------------------------------------------------------------------------
FOR THE QUARTER ENDED MARCH 31, 2003
Net Income $ 44.3
Less: Income from Discontinued Operations 6.3
- ---------------------------------------------------------
Income (Loss) from Continuing Operations 38.0 $11.4 $0.8 $26.7 $(0.9)
Add Back: Income Tax Expense (Benefit) 24.4 7.6 0.2 17.5 (0.9)
Interest Expense 16.9 5.2 0.4 4.4 6.9
Depreciation and Amortization
Expense 20.9 10.3 2.5 8.1 -
- -------------------------------------------------------------------------------------------------------------------
EBITDA $100.2 $34.5 $3.9 $56.7 $ 5.1
- -------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED
MARCH 31,
STATISTICAL INFORMATION 2004 2003
- -------------------------------------------------------------------------------------------------------------------
ENERGY SERVICES
Millions of Kilowatthours Sold
Regulated Utility
Retail
Residential 310.3 312.9
Commercial 331.9 326.4
Industrial 1,766.8 1,718.5
Other 20.2 20.5
Resale
Municipals 213.8 200.6
Other Power Suppliers 217.2 207.3
- -------------------------------------------------------------------------------------------------------------------
2,860.2 2,786.2
Nonregulated 434.0 419.1
- -------------------------------------------------------------------------------------------------------------------
3,294.2 3,205.3
- -------------------------------------------------------------------------------------------------------------------
AUTOMOTIVE SERVICES
Vehicles Sold
Used 481,000 462,000
Salvage 58,000 49,000
- -------------------------------------------------------------------------------------------------------------------
539,000 511,000
Conversion Rate<F1> - Used Vehicles 68.4% 62.4%
Loan Transactions 263,000 233,000
- -------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Conversion rate is the percentage of vehicles sold from those that were offered at auction.
</FN>
ALLETE First Quarter 2004 Form 10-Q 18
NET INCOME
The following net income discussion summarizes a comparison of the three months
ended March 31, 2004 to the three months ended March 31, 2003.
ENERGY SERVICES' net income in 2004 was up $2.1 million. At Minnesota Power,
higher demand for energy by industrial customers contributed to the increase.
Total regulated utility kilowatthour sales increased 3 percent from last year.
AUTOMOTIVE SERVICES reported a $6.6 million increase in net income primarily due
to higher conversion rates and increased vehicle sales at ADESA auctions.
Vehicle sales were higher in 2004 due to increased demand for wholesale used
vehicles as demand for retail used vehicles continued to improve. The increase
in demand resulted in an increase in the number of vehicles sold the first time
offered at auction which raised the conversion rate to 68.4 percent in 2004
(62.4 percent in 2003). AFC, which provides dealer financing, arranged 13
percent more loan transactions in 2004 and contributed 30 percent of the net
income for Automotive Services in 2004 (32 percent in 2003).
INVESTMENTS AND CORPORATE CHARGES' net income in 2004 was up $6.4 million
reflecting strong demand for our real estate in Florida and reduced interest
expense. These positive developments were partially offset by an increase in
general corporate charges primarily resulting from costs associated with the
planned spin-off of Automotive Services. Net income from ALLETE Properties, our
real estate operations, was up $6.8 million in 2004 ($11.0 million in 2004; $4.2
million in 2003) primarily due an increase in the number as well as the
profitability of real estate sales closing during the first quarter of 2004. The
timing of real estate sales is unpredictable.
DISCONTINUED OPERATIONS included the financial results of our Water Services
businesses, and the vehicle transport and import businesses. Net income from
Discontinued Operations was down $6.9 million in 2004 primarily due to the
absence of water and wastewater systems sold in 2003. In 2003 the net gain on
disposal included gains on system sales as well as selling, transaction and
employee termination benefit expenses associated with selling the Water Services
businesses. Net income in 2003 also included a $1.3 million recovery from the
settlement of a lawsuit associated with our vehicle transport business.
COMPARISON OF THE QUARTERS ENDED MARCH 31, 2004 AND 2003
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 generation (non-rate base
generation sold at market-based rates to the wholesale market), coal mining and
telecommunication activities. Nonregulated generation consists primarily of the
Taconite Harbor Energy Center in northern Minnesota and generation secured
through the Kendall County power purchase agreement, a 15-year agreement with
NRG Energy at a facility near Chicago, Illinois.
OPERATING REVENUE in total was up $3.2 million, or 2 percent, in 2004 primarily
due to increases at our regulated utility operations. Regulated utility revenue
was up $3.4 million, or 2 percent, in 2004 primarily due to increased electric
sales and higher fuel clause recoveries because of higher purchased power costs.
Regulated utility kilowatthour sales were up 3 percent from last year reflecting
increased usage by industrial customers due to higher production levels. Equity
in net income from Split Rock Energy was $4.3 million lower in 2004 as a result
of Minnesota Power withdrawing from Split Rock Energy.
Revenue from electric sales to taconite customers accounted for 10 percent of
consolidated operating revenue in both 2004 and 2003. Electric sales to paper
and pulp mills accounted for 3 percent of consolidated operating revenue in both
2004 and 2003.
OPERATING EXPENSES in total were up $0.7 million, or less than 1 percent in
2004. Regulated utility operating expenses were up $0.2 million, or less than 1
percent, reflecting increased purchased power expense, and higher pension and
benefit expenses mostly offset by the absence of a demand payment associated
with a purchased power agreement that expired in 2003.
19 ALLETE First Quarter 2004 Form 10-Q
AUTOMOTIVE SERVICES
OPERATING REVENUE was up $14.8 million, or 6 percent, in 2004. Revenue from
auctions and related services was up $11.7 million, or 6 percent, primarily due
to increased vehicle sales volume and a favorable Canadian exchange rate. The
number of vehicles sold at the Company's vehicle auction facilities increased 6
percent from last year (4 percent at our wholesale used vehicle auctions; 18
percent at our salvage vehicle auctions). The demand for wholesale used vehicles
has increased as retail used vehicle sales continue to show improvement. At our
salvage auctions, vehicles sold increased due in part to market share gains at
U.S. locations and improved overall market conditions. Dealer financing revenue
was up $3.1 million, or 12 percent, in 2004 reflecting a 13 percent increase in
the number of loan transactions. The increase in retail used vehicle sales has
increased the demand for wholesale used vehicles and the inventory turnover rate
of AFC's customers which has driven up the number of loan transactions. Total
receivables managed by AFC were $618 million at March 31, 2004 ($527 million at
March 31, 2003).
OPERATING EXPENSES were up $4.1 million, or 2 percent, in 2004 reflecting
additional corporate charges of $1.2 million and separation expenses of $1.6
million incurred as Automotive Services prepares to be a stand-alone publicly
traded company, independent of ALLETE. In addition, 2004 expenses were
negatively impacted by higher Canadian exchange rates in 2004.
INVESTMENTS AND CORPORATE CHARGES
OPERATING REVENUE was up $17.6 million in 2004 primarily due to a $16.7 million
increase in revenue from ALLETE Properties as a result of more land sales. In
2004 ten large real estate sales contributed $20.1 million to revenue, while in
2003 four large real estate sales contributed $6.6 million to revenue.
OPERATING EXPENSES were up $6.0 million, or 47 percent, in 2004 primarily due to
more real estate sales and increased general corporate charges. These increases
were partially offset by lower interest expense. Operating expenses at ALLETE
Properties were up $5.3 million in 2004 because of more land sales. Corporate
charges increased $3.5 million ($5.2 million in 2004; $1.7 million in 2003)
reflecting higher personnel costs and $1.7 million of costs associated with the
planned spin-off of Automotive Services. Interest expense not specifically
related to any one business segment decreased $2.9 million ($4.0 million in
2004; $6.9 million in 2003) due to the redemption of quarterly income preferred
securities and various long-term debt issues in 2003 with both the proceeds from
the sale of our Water Services businesses and internally generated cash.
CRITICAL ACCOUNTING POLICIES
Certain accounting measurements under applicable GAAP involve management's
judgment about subjective factors and estimates, the effects of which are
inherently uncertain. Accounting measurements that we believe are most critical
to our reported results of operations and financial condition include:
uncollectible receivables and allowance for doubtful accounts, impairment of
goodwill and long-lived assets, pension and postretirement health and life
actuarial assumptions, valuation of investments and provisions for environmental
remediation. These policies are reviewed with the audit committee of our Board
of Directors on a regular basis and summarized in our 2003 Form 10-K.
OUTLOOK
We remain focused on continuously improving the performance of our two core
businesses, Energy Services and Automotive Services, which remain strong and
poised for growth in their respective markets.
SPIN-OFF OF AUTOMOTIVE SERVICES. We continue to anticipate that the spin-off to
ALLETE shareholders of our Automotive Services business will occur in the third
quarter of 2004. The spin-off of Automotive Services, which will become a
publicly traded company doing business as ADESA, Inc., is expected to take the
form of a tax-free stock dividend to ALLETE's shareholders, who would receive a
pro rata number of shares of ADESA common stock for each share of ALLETE common
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.
ALLETE First Quarter 2004 Form 10-Q 20
In March 2004 our Board of Directors approved an IPO of approximately $150
million in common shares of ADESA, representing less than 20 percent 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 the completion of the spin-off.
2004 EARNINGS GUIDANCE. After the separation of Automotive Services is
completed, ALLETE will be comprised of what is now classified as (1) Energy
Services, and (2) Investments and Corporate Charges. In 2003 net income from
these operations totaled $28.3 million. ALLETE now estimates that 2004 net
income from these remaining businesses will increase by 10 percent to 15 percent
over 2003, due primarily to stronger than originally anticipated sales at both
Minnesota Power and ALLETE Properties.
ALLETE expects to reduce its debt by an additional $150 million to $200 million
after the ADESA IPO and recapitalization, which is expected to occur in the
second quarter of 2004. The 2004 net income estimate does not include the
financial implications of the spin-off of Automotive Services such as one-time
expenses of the transaction for advisor fees, debt retirement premiums and the
impact of cash received from ADESA after the IPO.
ENERGY SERVICES. In February 2004 we experienced a generator failure at our
534-MW Boswell Energy Center Unit 4 (Unit 4). As a result of the failure, we
expect 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 adjustment clause in Minnesota.
With Unit 4 down, some work originally planned for 2005 and 2006 is being done
now to minimize future outages. We do not expect this outage to have a material
impact on our results of operations. Wisconsin Public Power, Inc. owns 20
percent of Unit 4.
INVESTMENTS AND CORPORATE CHARGES. ALLETE Properties, our Florida real estate
operations, owns approximately 18,000 acres of land near Fort Myers, Palm Coast
and Ormond Beach, Florida, as well as Winter Haven Citi Centre, a retail
shopping center in Winter Haven, Florida. We add value to the land through
entitlements and infrastructure improvements, and then sell it at current market
prices. Historically, proceeds from land sales have been three to four times our
book basis. Rental income at the retail shopping center in Winter Haven provides
a recurring stream of revenue. At March 31, 2004 our basis in land held by
ALLETE Properties was $47.1 million. ALLETE Properties does occasionally provide
seller financing, and outstanding finance receivables were $10.3 million at
March 31, 2004 with maturities ranging up to ten years. Outstanding finance
receivables accrue interest at market-based rates. At March 31, 2004 ALLETE
Properties also had $18.1 million of other assets which consisted primarily of
Winter Haven Citi Centre. We may selectively acquire additional land if it meets
our strategy of adding value through entitlement and infrastructure
improvements.
SALE OF REMAINING WATER ASSETS. In 2003 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. In April 2004 we
reached an agreement to sell our remaining 72 water and wastewater systems in
Florida to Aqua America, Inc. for $18 million. The transaction is scheduled to
close by the end of June 2004 and is subject to regulatory approval by the FPSC.
This approval process may result in an adjustment of the final purchase price
based on the FPSC's determination of plant investment for the system. The
ultimate ownership of nine of the 72 water and wastewater systems is subject to
the outcome of an asserted right of first refusal with a local municipality. We
expect to sell our water assets in Georgia in 2004.
21 ALLETE First Quarter 2004 Form 10-Q
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW ACTIVITIES
A primary goal of our strategic plan is to improve cash flow from operations.
Our strategy includes growing the businesses both internally by expanding
facilities, services and operations (see Capital Requirements), and externally
through acquisitions.
During the first three months of 2004 and 2003, cash flow from operating
activities was affected by a number of factors representative of normal
operations.
Consolidated cash and cash equivalents was $297.5 million at March 31, 2004
($223.0 million at December 31, 2003) of which $203.4 million ($116.2 million at
December 31, 2003) was at Automotive Services. The remaining balance was held by
ALLETE and its other subsidiaries.
WORKING CAPITAL. Additional working capital, if and when needed, generally is
provided by the sale of commercial paper. Approximately 3.6 million original
issue shares of our common stock are available for issuance through INVEST
DIRECT, our direct stock purchase and dividend reinvestment plan.
A substantial amount of ADESA's working capital is generated internally from
payments for services provided. ADESA, however, currently 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
buyers. During the sales process, ADESA does not generally take title to or
ownership of the vehicles consigned for auction but instead facilitates 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. Currently, 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.
Significant changes in accounts receivable and accounts payable balances at
March 31, 2004 compared to December 31, 2003 were due to increased sales and
financing activity at Automotive Services. Typically auction volumes are down
during December because of the holidays. As a result, ADESA and AFC had higher
receivables and higher payables at March 31, 2004.
AFC RECEIVABLES. AFC sells the majority of U.S. dollar denominated finance
receivables on a revolving basis to a wholly owned, bankruptcy remote, special
purpose subsidiary that is consolidated for accounting purposes. The special
purpose subsidiary has entered into a securitization agreement, which expires in
2005, that allows for the revolving sale to a bank conduit facility of up to a
maximum of $500 million in undivided interests in eligible finance receivables.
Receivables sold are not reported on our consolidated financial statements.
At March 31, 2004 AFC managed total finance receivables of $618 million ($539
million at December 31, 2003), of which $527 million had been sold to the
special purpose subsidiary ($464 million at December 31, 2003). The special
purpose subsidiary then in turn sold, with recourse to the special purpose
subsidiary, $350 million to the bank conduit facility at March 31, 2004 ($334
million at December 31, 2003) leaving $268 million of finance receivables
recorded on our consolidated balance sheet at March 31, 2004 ($205 million at
December 31, 2003).
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.
ALLETE First Quarter 2004 Form 10-Q 22
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 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.
In April 2004 we used internally generated funds to repay the remaining $53.0
million outstanding on a $250 million credit agreement which would have expired
in July 2004.
Our lines of credit and long-term debt agreements contain various financial
covenants. The most restrictive of these covenants are discussed in Notes 7 and
8 to our consolidated financial statements in Item 1 in this Form 10-Q.
CAPITAL REQUIREMENTS
Consolidated capital expenditures for the quarter ended March 31, 2004 totaled
$16.6 million ($27.1 million in 2003). Expenditures for the quarter ended March
31, 2004 included $13.7 million for Energy Services, $1.3 million for Automotive
Services and $0.1 million for Investments and Corporate Charges. Expenditures
for the quarter ended March 31, 2004 also included $1.5 million to maintain our
remaining Water Services businesses while they are in the process of being sold.
Internally generated funds were the primary source of funding for these
expenditures.
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 in Note 13 to our consolidated financial statements in Item 1 in this
Form 10-Q.
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.
NEW ACCOUNTING STANDARDS
New accounting standards are discussed in Note 2 to our consolidated financial
statements in Item 1 in this Form 10-Q.
-------------------------
READERS ARE CAUTIONED THAT FORWARD-LOOKING STATEMENTS INCLUDING THOSE CONTAINED
ABOVE, SHOULD BE READ IN CONJUNCTION WITH OUR DISCLOSURES UNDER THE HEADING:
"SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995" LOCATED ON PAGE 3 OF THIS FORM 10-Q.
23 ALLETE First Quarter 2004 Form 10-Q
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
SECURITIES INVESTMENTS
Our securities investments include certain securities held for an indefinite
period of time which are accounted for as available-for-sale securities.
Available-for-sale securities are recorded at fair value with unrealized gains
and losses included in accumulated other comprehensive income, net of tax.
Unrealized losses that are other than temporary are recognized in earnings. At
March 31, 2004 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 $20.9 million at
March 31, 2004 ($20.2 million at December 31, 2003) and a total unrealized
after-tax gain of $1.2 million at March 31, 2004 ($0.8 million at December 31,
2003).
As part of our Emerging Technology portfolio, we also have several minority
investments in venture capital funds and privately-held start-up companies.
These investments are accounted for using the cost method and included in
Investments on our consolidated balance sheet. The total carrying value of these
investments was $35.1 million at March 31, 2004 ($37.5 million at December 31,
2003). Our policy is to periodically review these investments for impairment by
assessing such factors as continued commercial viability of products, cash flow
and earnings. Any impairment would reduce the carrying value of the investment.
FOREIGN CURRENCY
Our foreign currency exposure is limited to the conversion of the operating
results of our Canadian subsidiaries 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.
COMMODITY PRICE RISK
Our regulated utility operations in Minnesota and Wisconsin incur costs for fuel
(primarily coal), power and natural gas purchased for resale in our regulated
service territories, and related transportation. Our regulated utilities'
exposure to price risk for these commodities is significantly mitigated by the
current ratemaking process and regulatory environment which generally allows a
fuel clause surcharge if costs are in excess of those in our last rate filing.
Conversely, costs below those in our last rate filing result in a rate credit.
We prudently manage our customers' exposure to price risk by entering into
contracts of various durations and terms for the purchase of coal and power (in
Minnesota), power and natural gas (in Wisconsin), and related transportation
costs.
POWER MARKETING
Our power marketing activities consist of selling excess available regulated
utility generation and purchased power, as well as selling nonregulated
generation.
From time-to-time, our regulated utility operations may have excess generation
that is temporarily not required by retail and municipal customers in our
regulated service territory. We actively sell this generation to the wholesale
market to optimize the value of our generating facilities. This generation is
generally sold in the spot market or under short-term contracts at market
prices.
We have approximately 500 MW of nonregulated generation available for sale to
the wholesale markets. This primarily consists of about 200 MW at our Taconite
Harbor facility in northern Minnesota and 275 MW obtained through a 15-year
power purchase agreement with NRG Energy at the Kendall County facility near
Chicago, Illinois.
The majority of Taconite Harbor's capability of approximately 200 MW has been
sold through various short-term and long-term capacity and energy contracts.
Short term, we have approximately 180 MW of capacity and energy sales contracts
and a 15 MW of forward energy sales contract, all of which expire on April 30,
2005. Long term, we have entered into two capacity and energy sales contracts
totaling 175 MW
ALLETE First Quarter 2004 Form 10-Q 24
(201 MW including a 15 percent reserve) which are effective May 1, 2005 and
expire on April 30, 2010. Both contracts contain fixed monthly capacity charges
and fixed minimum energy charges. One contract provides for an annual escalator
to the energy charge based on increases in our cost of coal, subject to a small
minimum annual escalation. The other contract provides that the energy charge
will be the greater of a fixed minimum charge or an amount based on the variable
production cost of a combined cycle natural gas unit. Our exposure in the event
of a full or partial outage at our Taconite Harbor facility is significantly
limited under both contracts. When the buyer is notified at least two months
prior to an outage, there is no exposure. Outages with less than two months
notice are subject to an annual duration limitation typical of this type of
contract.
Under the Kendall County agreement, which expires in September 2017, 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. Our strategy is to sell a significant portion of this
generation through long-term contracts of various durations. The balance will be
sold in the daily spot market or through short-term contracts. We currently have
long-term capacity sales contracts for 130 MW, with 50 MW expiring in April 2012
and the balance in September 2017. To date, the Kendall County facility has
operated at a loss 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 the unsold capacity (currently
145 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.
ITEM 4. CONTROLS AND PROCEDURES
We maintain a system of controls and procedures designed to provide reasonable
assurance as to the reliability of the financial statements and other
disclosures included in this report, as well as to safeguard assets from
unauthorized use or disposition. We evaluated the effectiveness of the design
and operation of our disclosure controls and procedures under the supervision
and with the participation of management, including our chief executive officer
and chief financial officer, as of the end of the period covered by this Form
10-Q. Based upon that evaluation, our chief executive officer and chief
financial officer concluded that our disclosure controls and procedures are
effective in timely alerting them to material information required to be
included in our periodic SEC filings. There has been no change in our internal
control over financial reporting that occurred during our most recent fiscal
quarter that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Material legal and regulatory proceedings are included in the discussion of
Other Information in Item 5. and are incorporated by reference herein.
In late 2003 the staff of the SEC initiated an informal inquiry relating to our
internal audit function, internal financial reporting and the loan loss
methodology at AFC. We have fully and voluntarily cooperated 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.
25 ALLETE First Quarter 2004 Form 10-Q
ITEM 5. OTHER INFORMATION
Reference is made to our 2003 Form 10-K for background information on the
following updates. Unless otherwise indicated, cited references are to our 2003
Form 10-K.
Ref. Page 12 - First Partial Paragraph
In April 2004 we reached an agreement to sell our remaining 72 water and
wastewater systems in Florida to Aqua America, Inc. for $18 million. The
transaction is scheduled to close by the end of June 2004 and is subject to
regulatory approval by the FPSC. This approval process may result in an
adjustment of the final purchase price based on the FPSC's determination of
plant investment for the system. The ultimate ownership of nine of the 72 water
and wastewater systems is subject to the outcome of an asserted right of first
refusal with a local municipality.
Ref. Page 12 - Seventh Full Paragraph
Ref. Page 39 - Eighth Paragraph
Ref. Page 46 - First Full Paragraph
Effective March 15, 2004 the FERC approved the termination of our ownership
interest in Split Rock Energy, the joint venture between Minnesota Power and
Great River Energy.
Ref. Page 18 - First Paragraph
In April 2004 the National Park Service (NPS) issued a draft Environmental
Impact Statement (DEIS) for a 60-day public comment period. The DEIS describes
the NPS' preferred option to cross the Namekagon River. Construction activities
have begun in Minnesota and eminent domain court actions are underway.
Ref. Page 18 - Eighth Paragraph
On March 30, 2004 the International Brotherhood of Electrical Workers Local 1593
and BNI Coal, Ltd., a wholly owned subsidiary of ALLETE, signed a one year
extension of the existing labor agreement which expired on March 31, 2004. The
contract terms remain the same.
Ref. Page 26 - Second through Fifth Paragraphs
ADESA Impact submitted an IRA plan status report to the MDEP on March 30, 2004.
Additionally, ADESA Impact is submitting bi-weekly status updates to the MDEP.
We have installed the water filtration units and have lowered MTBE detection
limits at the instruction of the MDEP. As a result, another three homes have
been identified as having detectable levels of MTBE in the drinking water.
A comprehensive ground water sampling event and residential sampling event were
conducted in April 2004. ADESA Impact's representatives met with the Taunton
City Council on April 20, 2004 to propose that ADESA Impact extend municipal
water services to the Matthews Landing community at an approximate cost of $1
million. By late June 2004, ADESA Impact expects to provide the Taunton City
Council with a detailed proposal to provide water service including engineering
work, flow modeling, surveys, site work, road-opening detail and a safety plan.
As of March 31, 2004 ADESA has accrued $1 million to cover the estimated costs
associated with the solution proposed to the Taunton City Council.
ADESA Impact has filed a claim with our insurance carrier with respect to this
matter. On March 30, 2004 our insurance carrier responded with a request for
additional information regarding the claims.
ALLETE First Quarter 2004 Form 10-Q 26
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
3 Bylaws of ALLETE, Inc., as amended effective March 8, 2004.
31(a) Rule 13a-14(a)/15d-14(a) Certification by the Chief Executive
Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31(b) Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial
Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32 Section 1350 Certification of Periodic Report by the Chief
Executive Officer and Chief Financial Officer Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K.
Report on Form 8-K filed January 26, 2004 with respect to Item 5. Other
Events and Regulation FD Disclosure.
27 ALLETE First Quarter 2004 Form 10-Q
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ALLETE, INC.
April 30, 2004 James K. Vizanko
-------------------------------------------------
James K. Vizanko
Senior Vice President,
Chief Financial Officer and Treasurer
April 30, 2004 Mark A. Schober
-------------------------------------------------
Mark A. Schober
Senior Vice President and Controller
ALLETE First Quarter 2004 Form 10-Q 28
EXHIBIT INDEX
EXHIBIT
NUMBER
- --------------------------------------------------------------------------------
3 Bylaws of ALLETE, Inc., as amended effective March 8, 2004.
31(a) Rule 13a-14(a)/15d-14(a) Certification by the Chief Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31(b) Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32 Section 1350 Certification of Periodic Report by the Chief Executive
Officer and Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
ALLETE First Quarter 2004 Form 10-Q