SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
/X/ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended JUNE 30, 2005
or
/ / Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number 1-3548
ALLETE, INC.
(Exact name of registrant as specified in its charter)
MINNESOTA 41-0418150
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
30 WEST SUPERIOR STREET
DULUTH, MINNESOTA 55802-2093
(Address of principal executive offices)
(Zip Code)
(218) 279-5000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months 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,
29,992,521 shares outstanding
as of June 30, 2005
INDEX
Page
Definitions 2
Safe Harbor Statement Under the Private Securities Litigation
Reform Act of 1995 3
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheet -
June 30, 2005 and December 31, 2004 4
Consolidated Statement of Income -
Quarter and Six Months Ended June 30, 2005 and 2004 5
Consolidated Statement of Cash Flows -
Six Months Ended June 30, 2005 and 2004 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 21
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 33
Item 4. Controls and Procedures 34
Part II. Other Information
Item 1. Legal Proceedings 34
Item 2. Unregistered Sales of Equity Securities and Use
of Proceeds 34
Item 3. Defaults Upon Senior Securities 34
Item 4. Submission of Matters to a Vote of Security Holders 35
Item 5. Other Information 36
Item 6. Exhibits 37
Signatures 38
1 ALLETE Second Quarter 2005 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
- --------------------------------------------------------------------------------
2004 Form 10-K ALLETE's Annual Report on Form 10-K for
the Year Ended December 31, 2004
ADESA ADESA, Inc.
AICPA American Institute of Certified Public
Accountants
ALLETE ALLETE, Inc.
ALLETE Properties ALLETE Properties, Inc.
APB Accounting Principles Board
Aqua America Aqua America, Inc.
BNI Coal BNI Coal, Ltd.
Boswell Boswell Energy Center
Company ALLETE, Inc. and its subsidiaries
Constellation Energy Commodities Constellation Energy Commodities Group,
Inc.
Enventis Telecom Enventis Telecom, Inc.
EPA Environmental Protection Agency
ESOP Employee Stock Ownership Plan
FASB Financial Accounting Standards Board
FERC Federal Energy Regulatory Commission
Florida Landmark Florida Landmark Communities, Inc.
Florida Water Florida Water Services Corporation
FPSC Florida Public Service Commission
FSP Financial Accounting Standards Board
Staff Position
GAAP Accounting Principles Generally
Accepted in the United States
Hibbard Hibbard Energy Center
Laskin Laskin Energy Center
Minnesota Power An operating division of ALLETE, Inc.
Minnkota Power Minnkota Power Cooperative, Inc.
MISO Midwest Independent Transmission System
Operator, Inc.
MPUC Minnesota Public Utilities Commission
MW Megawatt(s)
Note ___ Note ___ to the consolidated financial
statements in this Form 10-Q
PSCW Public Service Commission of Wisconsin
Rainy River Energy Rainy River Energy Corporation
SEC Securities and Exchange Commission
SFAS Statement of Financial Accounting
Standards No.
Split Rock Energy Split Rock Energy LLC
Square Butte Square Butte Electric Cooperative
SWL&P Superior Water, Light and Power Company
Taconite Harbor Taconite Harbor Energy Center
WDNR Wisconsin Department of Natural
Resources
ALLETE Second Quarter 2005 Form 10-Q 2
SAFE HARBOR STATEMENT
UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
In connection with the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, we are hereby filing cautionary statements
identifying important factors that could cause our actual results to differ
materially from those projected in forward-looking statements (as such term is
defined in the Private Securities Litigation Reform Act of 1995) made by or on
behalf of ALLETE in this Quarterly Report on Form 10-Q, in presentations, in
response to questions or otherwise. Any statements that express, or involve
discussions as to expectations, beliefs, plans, objectives, assumptions or
future events or performance (often, but not always, through the use of words or
phrases such as "anticipates," "believes," "estimates," "expects," "intends,"
"plans," "projects," "will likely result," "will continue," "could," "may,"
"potential," "target," "outlook" or similar expressions) are not statements of
historical facts and may be forward-looking.
Forward-looking statements involve estimates, assumptions, risks and
uncertainties and are qualified in their entirety by reference to, and are
accompanied by, the following important factors, in addition to any assumptions
and other factors referred to specifically in connection with such
forward-looking statements, 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;
- prevailing governmental policies and regulatory actions, including those of
the United States Congress, state legislatures, the FERC, the MPUC, the FPSC,
the PSCW, and various local and county regulators, and city administrators,
about allowed rates of return, financings, industry and rate structure,
acquisition and disposal of assets and facilities, real estate development,
operation and construction of plant facilities, recovery of purchased power
and capital investments, present or prospective wholesale and retail
competition (including but not limited to transmission costs), and zoning and
permitting of land held for resale;
- effects of restructuring initiatives in the electric industry;
- economic and geographic factors, including political and economic risks;
- changes in and compliance with environmental and safety laws and policies;
- weather conditions;
- natural disasters;
- war and acts of terrorism;
- wholesale power market conditions;
- population growth rates and demographic patterns;
- the effects of competition, including competition for retail and wholesale
customers;
- 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;
- global and domestic economic conditions;
- our ability to access capital markets;
- changes in interest rates and the performance of the financial markets;
- 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 36 of our 2004 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 2004 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 Second Quarter 2005 Form 10-Q
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLETE
CONSOLIDATED BALANCE SHEET
Millions - Unaudited
JUNE 30, DECEMBER 31,
2005 2004
- --------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and Cash Equivalents $ 79.1 $ 44.9
Restricted Cash - 30.3
Short-Term Investments 63.0 149.2
Accounts Receivable (Less Allowance of $2.0 and $2.0) 72.4 86.1
Inventories 36.2 34.0
Prepayments and Other 18.5 21.6
Deferred Income Taxes 25.8 -
Discontinued Operations 1.8 2.0
- --------------------------------------------------------------------------------------------------------------------
Total Current Assets 296.8 368.1
Property, Plant and Equipment - Net 883.0 883.1
Investments 123.3 124.5
Other Assets 48.1 52.8
Discontinued Operations 2.2 2.9
- --------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $1,353.4 $1,431.4
- --------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Current Liabilities
Accounts Payable $ 29.4 $ 40.0
Accrued Taxes 22.3 23.3
Accrued Interest 7.7 6.9
Long-Term Debt Due Within One Year 1.7 1.8
Deferred Profit on Sales of Real Estate 7.7 1.1
Other 16.9 24.7
Discontinued Operations 6.5 12.0
- --------------------------------------------------------------------------------------------------------------------
Total Current Liabilities 92.2 109.8
Long-Term Debt 389.3 390.2
Deferred Income Taxes 136.1 143.9
Other Liabilities 153.4 151.4
Minority Interest 6.0 5.6
- --------------------------------------------------------------------------------------------------------------------
Total Liabilities 777.0 800.9
- --------------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES
- --------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Common Stock Without Par Value, 43.3 Shares Authorized
30.0 and 29.7 Shares Outstanding 412.9 400.1
Unearned ESOP Shares (79.3) (51.4)
Accumulated Other Comprehensive Loss (11.4) (11.4)
Retained Earnings 254.2 293.2
- --------------------------------------------------------------------------------------------------------------------
Total Shareholders' Equity 576.4 630.5
- --------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,353.4 $1,431.4
- --------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
ALLETE Second Quarter 2005 Form 10-Q 4
ALLETE
CONSOLIDATED STATEMENT OF INCOME
Millions Except Per Share Amounts - Unaudited
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------
OPERATING REVENUE $ 186.8 $186.2 $ 393.7 $395.2
- ---------------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Fuel and Purchased Power 70.3 77.2 139.4 146.1
Operating and Maintenance 81.6 77.2 164.7 160.8
Kendall County Charge 77.9 - 77.9 -
Depreciation 12.7 12.5 25.3 24.9
- ---------------------------------------------------------------------------------------------------------------------------
Total Operating Expenses 242.5 166.9 407.3 331.8
- ---------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME (LOSS) FROM CONTINUING OPERATIONS (55.7) 19.3 (13.6) 63.4
- ---------------------------------------------------------------------------------------------------------------------------
OTHER INCOME (EXPENSE)
Interest Expense (6.7) (9.1) (13.5) (18.2)
Other 1.5 (3.5) (2.7) (3.1)
- ---------------------------------------------------------------------------------------------------------------------------
Total Other Expense (5.2) (12.6) (16.2) (21.3)
- ---------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE MINORITY INTEREST AND INCOME TAXES (60.9) 6.7 (29.8) 42.1
MINORITY INTEREST 0.2 0.5 1.4 1.9
- ---------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES (61.1) 6.2 (31.2) 40.2
INCOME TAX EXPENSE (BENEFIT) (21.5) 3.8 (9.6) 16.4
- ---------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE CHANGE IN ACCOUNTING PRINCIPLE (39.6) 2.4 (21.6) 23.8
INCOME (LOSS) FROM DISCONTINUED OPERATIONS - NET OF TAX (0.7) 34.3 (1.3) 65.6
CHANGE IN ACCOUNTING PRINCIPLE - NET OF TAX - - - (7.8)
- ---------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ (40.3) $ 36.7 $ (22.9) $ 81.6
- ---------------------------------------------------------------------------------------------------------------------------
AVERAGE SHARES OF COMMON STOCK
Basic 27.2 28.4 27.2 28.2
Diluted 27.2 28.5 27.2 28.4
- ---------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS (LOSS) PER SHARE OF COMMON STOCK
Continuing Operations $(1.45) $0.08 $(0.79) $0.85
Discontinued Operations (0.03) 1.21 (0.05) 2.32
Change in Accounting Principle - - - (0.28)
- ---------------------------------------------------------------------------------------------------------------------------
$(1.48) $1.29 $(0.84) $2.89
- ---------------------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS (LOSS) PER SHARE OF COMMON STOCK
Continuing Operations $(1.45) $0.08 $(0.79) $0.84
Discontinued Operations (0.03) 1.21 (0.05) 2.31
Change in Accounting Principle - - - (0.27)
- ---------------------------------------------------------------------------------------------------------------------------
$(1.48) $1.29 $(0.84) $2.88
- ---------------------------------------------------------------------------------------------------------------------------
DIVIDENDS PER SHARE OF COMMON STOCK $0.3150 $0.8475 $0.6150 $1.6950
- ---------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
5 ALLETE Second Quarter 2005 Form 10-Q
ALLETE
CONSOLIDATED STATEMENT OF CASH FLOWS
Millions - Unaudited
SIX MONTHS ENDED
JUNE 30,
2005 2004
- ---------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Income (Loss) from Continuing Operations $(21.6) $ 16.0
Change in Accounting Principle - 7.8
Loss on Impairment of Investments 5.1 5.5
Depreciation 25.3 24.9
Deferred Income Taxes (34.0) 0.7
Minority Interest 0.4 (0.5)
Changes in Operating Assets and Liabilities
Short-Term Investments (1.4) -
Accounts Receivable 13.7 (8.0)
Inventories (2.2) (2.5)
Prepayments and Other 3.1 (5.4)
Accounts Payable (10.6) 6.5
Other Current Liabilities (1.4) (19.5)
Other Assets 4.7 8.4
Other Liabilities 4.8 (1.4)
Net Operating Activities from (for) Discontinued Operations (5.9) 54.5
- ---------------------------------------------------------------------------------------------------------------------------
Cash from (for) Operating Activities (20.0) 87.0
- ---------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Proceeds from Sale of Available-For-Sale Securities 271.1 1.6
Payments for Purchase of Available-for-Sale Securities (183.5) -
Changes to Investments (3.4) 9.5
Additions to Property, Plant and Equipment (24.2) (34.7)
Other (1.6) (1.6)
Net Investing Activities from Discontinued Operations - 64.9
- ---------------------------------------------------------------------------------------------------------------------------
Cash from Investing Activities 58.4 39.7
- ---------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Issuance of Common Stock 12.8 34.9
Issuance of Long-Term Debt - 5.6
Changes in Notes Payable - Net - (53.0)
Reductions of Long-Term Debt (1.0) (4.6)
Dividends on Common Stock (16.0) (46.8)
Net Financing Activities from (for) Discontinued Operations (0.1) 328.9
- ---------------------------------------------------------------------------------------------------------------------------
Cash from (for) Financing Activities (4.3) 265.0
- ---------------------------------------------------------------------------------------------------------------------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH - DISCONTINUED OPERATIONS - (6.4)
- ---------------------------------------------------------------------------------------------------------------------------
CHANGE IN CASH AND CASH EQUIVALENTS 34.1 385.3
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD <F1> 46.1 226.1
- ---------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD <F1> $ 80.2 $611.4
- ---------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL CASH FLOW INFORMATION
Cash Paid During the Period for
Interest - Net of Capitalized $22.4 $26.4
Income Taxes $13.6 $59.6
- ---------------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Included $1.1 million of cash from Discontinued Operations at June 30, 2005 ($286.9 million at June 30, 2004) and $1.2
million at December 31, 2004 ($116.1 million at December 31, 2003).
</FN>
The accompanying notes are an integral part of these statements.
ALLETE Second Quarter 2005 Form 10-Q 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The accompanying unaudited consolidated financial statements and notes should be
read in conjunction with our 2004 Form 10-K. In our opinion, all adjustments
necessary for a fair statement of the results for the interim periods have been
made. The results of operations for an interim period may not give a true
indication of the results for the year.
NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
REAL ESTATE REVENUE AND EXPENSE RECOGNITION. Full profit recognition is recorded
on sales upon closing, provided cash collections are at least 20 percent of the
contract price and the other requirements of SFAS 66, "Accounting for Sales of
Real Estate," are met. In certain cases, where there are obligations to perform
significant development activities after the date of sale, we recognize profit
on a percentage-of-completion basis in accordance with SFAS 66. Pursuant to this
method of accounting, gross profit is recognized based upon the relationship of
development costs incurred as of that date to the total estimated costs to
develop the parcels, including all related amenities or common costs of the
entire project. Revenue and cost of real estate sold in excess of the amount
recognized based on the percentage-of-completion method is deferred and
recognized as revenue and cost of real estate sold during the period in which
the related development costs are incurred. Revenue and cost of real estate sold
are recorded net as Deferred Profit on Sales of Real Estate on our consolidated
balance sheet.
Land held for sale is recorded at the lower of cost or fair value determined by
the evaluation of individual land parcels. Real estate costs include the cost of
land acquired, subsequent development costs and costs of improvements,
capitalized development period interest, real estate taxes, and payroll costs of
certain employees devoted directly to the development effort. These real estate
costs incurred are capitalized to the cost of real estate parcels based upon the
relative sales value of parcels within each development project in accordance
with SFAS 67, "Accounting for Costs and Initial Rental Operations of Real Estate
Projects." When real estate is sold, the cost of sales includes the actual costs
incurred and the estimate of future completion costs allocated to the real
estate sold based upon the relative sales value method.
Whenever events or circumstances indicate that the carrying value of the real
estate may not be recoverable, impairment losses would be recorded and the
related assets would be adjusted to their estimated fair value, less costs to
sell.
REVISION IN THE CLASSIFICATION OF CERTAIN SECURITIES. In connection with the
preparation of this report, we concluded that it was appropriate to reclassify
our auction rate municipal bonds and variable rate municipal demand notes as
short-term investments. Previously, such investments had been classified as cash
and cash equivalents. Accordingly, we now report these securities as short-term
investments in a separate line item on our Consolidated Balance Sheet as of
December 31, 2004. As of June 30, 2004 and December 31, 2003, we had no
investments in these types of securities. Accordingly, there was no impact to
our Consolidated Statement of Cash Flows for the period ended June 30, 2004.
This change in classification does not affect previously reported cash flows
from operations or from financing activities in our previously reported
Consolidated Statements of Cash Flows, or our previously reported Consolidated
Statements of Income for any period.
For the year ended December 31, 2004, net cash used in investing activities
related to these short-term investments of $149.2 million was included in cash
and cash equivalents in our Consolidated Statement of Cash Flows.
SHORT-TERM INVESTMENTS. At June 30, 2005 and December 31, 2004, we held $61.6
million and $149.2 million, respectively, of short-term investments, consisting
of auction rate municipal bonds and variable rate municipal demand notes
classified as available-for-sale securities. Our investments in these securities
are recorded at cost, which approximates fair market value due to their variable
interest rates, which typically reset every 7 to 35 days. Despite the long-term
nature of their stated contractual maturities, we have the ability to quickly
liquidate these securities. As a result, we had no cumulative gross unrealized
holding gains (losses) or gross realized gains (losses) from our short-term
investments. All income generated from these short-term investments was recorded
as interest income.
7 ALLETE Second Quarter 2005 Form 10-Q
INVENTORIES. Inventories are stated at the lower of cost or market. Cost is
determined by the average cost method.
JUNE 30, DECEMBER 31,
INVENTORIES 2005 2004
- --------------------------------------------------------------------------------
MILLIONS
Fuel $13.4 $11.4
Materials and Supplies 22.0 20.4
Other 0.8 2.2
- --------------------------------------------------------------------------------
$36.2 $34.0
- --------------------------------------------------------------------------------
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 in net income for performance share
awards was approximately $0.6 million for the six months ended June 30, 2005
($0.8 million for the six months ended June 30, 2004). 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 SIX MONTHS ENDED
EFFECT OF SFAS 123 JUNE 30, JUNE 30,
ACCOUNTING FOR STOCK-BASED COMPENSATION 2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------------------------
Millions Except Per Share Amounts
Net Income (Loss)
As Reported $(40.3) $36.7 $(22.9) $81.6
Plus: Employee Stock Compensation Expense
Included in Net Income (Loss) - Net of Tax 0.3 0.4 0.6 0.8
Less: Employee Stock Compensation Expense
Determined Under SFAS 123 - Net of Tax 0.3 0.5 0.7 1.0
- ------------------------------------------------------------------------------------------------------------------
Pro Forma $(40.3) $36.6 $(23.0) $81.4
- ------------------------------------------------------------------------------------------------------------------
Basic Earnings (Loss) Per Share
As Reported $(1.48) $1.29 $(0.84) $2.89
Pro Forma $(1.48) $1.29 $(0.85) $2.89
Diluted Earnings (Loss) Per Share
As Reported $(1.48) $1.29 $(0.84) $2.88
Pro Forma $(1.48) $1.28 $(0.85) $2.87
- ------------------------------------------------------------------------------------------------------------------
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:
2005 2004
- ------------------------------------------------------------------------------------------------------------------
Risk-Free Interest Rate 3.7% 3.3%
Expected Life - Years 5 5
Expected Volatility 20.0% 28.1%
Dividend Growth Rate 5% 2%
- ------------------------------------------------------------------------------------------------------------------
ALLETE Second Quarter 2005 Form 10-Q 8
NEW ACCOUNTING STANDARDS. SFAS 123(R). In December 2004, the FASB issued SFAS
123(R), "Share-Based Payment," which will be effective for enterprises as of the
first interim or annual reporting period that begins after June 15, 2005. While
the SEC has permitted delayed application of SFAS 123(R) until fiscal years
beginning after June 15, 2005, we intend to adopt SFAS 123(R) in the third
quarter of 2005. SFAS 123(R) replaces SFAS 123, "Accounting for Stock-Based
Compensation," and supersedes APB Opinion No. 25, "Accounting for Stock Issued
to Employees." The new standard requires that the compensation cost relating to
share-based payment be recognized in financial statements at fair value. As
such, reporting employee stock options under the intrinsic value-based method
prescribed by APB Opinion No. 25 will no longer be allowed. Historically, we
have elected to use the intrinsic value method and have not recognized expense
for employee stock options granted. We estimate that the impact of adoption of
SFAS 123(R) in 2005 will be an additional expense of approximately $0.2 million
after tax.
INTERPRETATION NO. 47. In March 2005, the FASB issued Interpretation No. 47,
"Accounting for Conditional Asset Retirement Obligations." Interpretation No. 47
clarifies that the term "conditional asset retirement obligation" as used in
SFAS 143, "Accounting for Asset Retirement Obligations," refers to a legal
obligation to perform an asset retirement activity in which the timing and/or
method of settlement are conditional on a future event that may or may not be
within the control of the entity. However, the obligation to perform the asset
retirement activity is unconditional even though uncertainty exists about the
timing and/or method of settlement. Interpretation No. 47 requires that the
uncertainty about the timing and/or method of settlement of a conditional asset
retirement obligation be factored into the measurement of the liability when
sufficient information exists. Interpretation No. 47 also clarifies when an
entity would have sufficient information to reasonably estimate the fair value
of an asset retirement obligation. Interpretation No. 47 is effective for fiscal
years ending after December 15, 2005 (December 31, 2005 for calendar-year
enterprises). Retroactive application of interim financial information is
permitted, but not required. We are evaluating the impact of this
Interpretation, but do not expect it to have a material impact on our financial
position, results of operations or cash flows.
SFAS 109. In July 2005, the FASB issued an exposure draft of an Interpretation
of SFAS 109, "Accounting for Income Taxes." This proposed Interpretation
clarifies the accounting for uncertain tax positions. An enterprise would be
required to recognize, in its financial statements, the best estimate of the
impact of a tax position only if that position is probable of being sustained,
if audited by the taxing authorities, based solely on the technical merits of
the position. In evaluating whether the probable recognition threshold has been
met, this proposed Interpretation would require the presumption that the tax
position will be evaluated during an audit by taxing authorities. The term
probable is used in this proposed Interpretation consistent with its use in SFAS
5, "Accounting for Contingencies," to mean "the future event or events are
likely to occur."
Individual tax positions that fail to meet the probable recognition threshold
will generally result in the inability to recognize the benefit of such position
in the financial statements. This proposed Interpretation also provides guidance
on disclosure, accrual of interest and penalties, accounting in interim periods,
and transition. If adopted as proposed, this Interpretation would impact
financial statements effective as of the end of the first fiscal year ending
after December 15, 2005. We do not anticipate this Interpretation, if adopted as
proposed, will have a material impact on the Company.
SFAS 154. In May 2005, the FASB issued SFAS 154, "Accounting Changes and Error
Corrections" (SFAS 154) which replaces APB Opinion No. 20 "Accounting Changes"
and SFAS 3, "Reporting Accounting Changes in Interim Financial Statements-An
Amendment of APB Opinion No. 28." SFAS 154 provides guidance on the accounting
for and reporting of accounting changes and error corrections. It establishes
retrospective application, or the latest practicable date, as the required
method for reporting a change in accounting principle and the reporting of a
correction of an error. SFAS 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005. We
are currently evaluating the effect that the adoption of SFAS 154 will have on
our consolidated results of operations and financial condition but do not expect
it to have a material impact.
9 ALLETE Second Quarter 2005 Form 10-Q
NOTE 2. BUSINESS SEGMENTS
In 2005, we began allocating corporate charges and interest expense to our
business segments. For comparative purposes, segment information for 2004 has
been restated to reflect the new allocation method used in 2005 for corporate
charges and interest expense. This restatement had no impact on consolidated net
income or earnings per share.
NONREGULATED
REGULATED ENERGY REAL
CONSOLIDATED UTILITY OPERATIONS ESTATE OTHER
- ----------------------------------------------------------------------------------------------------------------
Millions
FOR THE QUARTER ENDED JUNE 30, 2005
Operating Revenue $186.8 $137.8 $26.5 $10.0 $12.5
Fuel and Purchased Power 70.3 64.6 5.7 - -
Operating and Maintenance 81.6 46.5 17.6 5.0 12.5
Kendall County Charge 77.9 - 77.9 - -
Depreciation Expense 12.7 9.8 2.1 - 0.8
- ----------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing
Operations (55.7) 16.9 (76.8) 5.0 (0.8)
Interest Expense (6.7) (4.4) (1.6) (0.2) (0.5)
Other Income 1.5 0.4 - - 1.1
- ----------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Minority Interest and Income Taxes (60.9) 12.9 (78.4) 4.8 (0.2)
Minority Interest 0.2 - - 0.2 -
- ----------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Income Taxes (61.1) 12.9 (78.4) 4.6 (0.2)
Income Tax Expense (Benefit) (21.5) 5.1 (27.9) 1.8 (0.5)
- ----------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations (39.6) $ 7.8 $(50.5) $ 2.8 $ 0.3
---------------------------------------------------
Loss from Discontinued Operations - Net of Tax (0.7)
- --------------------------------------------------------
Net Income (Loss) $(40.3)
- --------------------------------------------------------
FOR THE QUARTER ENDED JUNE 30, 2004
Operating Revenue $186.2 $136.8 $26.6 $6.8 $16.0
Fuel and Purchased Power 77.2 65.9 11.3 - -
Operating and Maintenance 77.2 44.9 13.8 2.5 16.0
Depreciation Expense 12.5 9.9 1.9 - 0.7
- ----------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing
Operations 19.3 16.1 (0.4) 4.3 (0.7)
Interest Expense (9.1) (4.6) (1.2) - (3.3)
Other Income (Expense) (3.5) 0.1 1.4 - (5.0)
- ----------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Minority Interest and Income Taxes 6.7 11.6 (0.2) 4.3 (9.0)
Minority Interest 0.5 - - 0.5 -
- ----------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Income Taxes 6.2 11.6 (0.2) 3.8 (9.0)
Income Tax Expense (Benefit) 3.8 4.2 (0.3) 1.7 (1.8)
- ----------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations 2.4 $ 7.4 $0.1 $2.1 $(7.2)
---------------------------------------------------
Income from Discontinued Operations - Net
of Tax 34.3
- --------------------------------------------------------
Net Income $ 36.7
- --------------------------------------------------------
ALLETE Second Quarter 2005 Form 10-Q 10
NOTE 2. BUSINESS SEGMENTS (CONTINUED)
NONREGULATED
REGULATED ENERGY REAL
CONSOLIDATED UTILITY OPERATIONS ESTATE OTHER
- ----------------------------------------------------------------------------------------------------------------
Millions
FOR THE SIX MONTHS ENDED JUNE 30, 2005
Operating Revenue $393.7 $285.4 $54.4 $27.7 $26.2
Fuel and Purchased Power 139.4 126.1 13.3 - -
Operating and Maintenance 164.7 97.6 32.7 9.5 24.9
Kendall County Charge 77.9 - 77.9 - -
Depreciation Expense 25.3 19.6 4.1 - 1.6
- ----------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing
Operations (13.6) 42.1 (73.6) 18.2 (0.3)
Interest Expense (13.5) (8.7) (2.9) (0.2) (1.7)
Other Income (Expense) (2.7) 0.4 0.2 - (3.3)
- ----------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Minority Interest and Income Taxes (29.8) 33.8 (76.3) 18.0 (5.3)
Minority Interest 1.4 - - 1.4 -
- ----------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Income Taxes (31.2) 33.8 (76.3) 16.6 (5.3)
Income Tax Expense (Benefit) (9.6) 13.1 (27.4) 6.9 (2.2)
- ----------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations (21.6) $ 20.7 $(48.9) $ 9.7 $(3.1)
---------------------------------------------------
Loss from Discontinued Operations - Net
of Tax (1.3)
- --------------------------------------------------------
Net Income (Loss) $(22.9)
- --------------------------------------------------------
Total Assets $1,353.4 <F1> $899.4 $178.6 $75.7 $195.7
Property, Plant and Equipment - Net $883.0 $728.8 $115.5 - $38.7
Accumulated Depreciation $788.0 $733.6 $43.5 - $10.9
Capital Expenditures $24.2 <F1> $20.7 $1.9 - $1.6
FOR THE SIX MONTHS ENDED JUNE 30, 2004
Operating Revenue $395.2 $278.2 $55.6 $34.4 $27.0
Fuel and Purchased Power 146.1 123.0 23.1 - -
Operating and Maintenance 160.8 94.6 28.3 10.2 27.7
Depreciation Expense 24.9 19.8 3.7 - 1.4
- ----------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing
Operations 63.4 40.8 0.5 24.2 (2.1)
Interest Expense (18.2) (9.3) (2.4) (0.1) (6.4)
Other Income (Expense) (3.1) 0.1 0.9 - (4.1)
- ----------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Minority Interest and Income Taxes 42.1 31.6 (1.0) 24.1 (12.6)
Minority Interest 1.9 - - 1.9 -
- ----------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Income Taxes 40.2 31.6 (1.0) 22.2 (12.6)
Income Tax Expense (Benefit) 16.4 11.7 (0.9) 9.2 (3.6)
- ----------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations 23.8 $ 19.9 $(0.1) $13.0 $(9.0)
---------------------------------------------------
Income from Discontinued Operations - Net of Tax 65.6
Change in Accounting Principle (7.8)
- --------------------------------------------------------
Net Income $ 81.6
- --------------------------------------------------------
Total Assets $3,681.6 <F1> $930.2 $188.5 $76.1 $392.2
Property, Plant and Equipment - Net $928.9 $734.2 $154.1 - $40.6
Accumulated Depreciation $756.6 $709.2 $39.2 - $8.2
Capital Expenditures $43.4 <F1> $24.7 $6.8 - $3.2
- ----------------------------------------------------------------------------------------------------------------
<FN>
<F1> Discontinued Operations represented $4.0 million of total assets in 2005 ($2,094.6 million in 2004) and
$0 of capital expenditures in 2005 ($8.7 million in 2004).
</FN>
11 ALLETE Second Quarter 2005 Form 10-Q
NOTE 3. INVESTMENTS
At June 30, 2005, Investments included the real estate assets of ALLETE
Properties, debt and equity securities consisting primarily of securities held
to fund employee benefits, and our emerging technology investments.
JUNE 30, DECEMBER 31,
INVESTMENTS 2005 2004
- --------------------------------------------------------------------------------
Millions
Real Estate Assets $ 75.7 $ 75.1
Debt and Equity Securities 38.9 35.8
Emerging Technology Investments 8.7 13.6
- --------------------------------------------------------------------------------
$ 123.3 $ 124.5
- --------------------------------------------------------------------------------
REAL ESTATE. At June 30, 2005, real estate assets included land of $45.3 million
($47.2 million at December 31, 2004), long-term finance receivables of $12.5
million ($9.7 million at December 31, 2004) and $17.9 million ($18.2 million at
December 31, 2004) of other assets, which consisted primarily of a shopping
center. Finance receivables have maturities ranging up to ten years, accrue
interest at market-based rates and are net of an allowance for doubtful accounts
of $0.6 million at June 30, 2005 ($0.7 million at December 31, 2004).
EMERGING TECHNOLOGY INVESTMENTS. In March 2005, we recorded $5.1 million ($3.3
million after tax) of impairment losses related to certain investments in
privately-held, start-up companies whose future business prospects have
diminished significantly. Recent developments at these companies indicated that
future commercial viability is unlikely, as is new financing necessary to
continue development. The total carrying value of our direct investments in
privately-held, start-up companies at June 30, 2005, was zero. Our remaining
emerging technology investments consist of our interests in certain venture
capital funds. We account for these investments under the equity method.
NOTE 4. SHORT-TERM AND LONG-TERM DEBT
On March 16, 2005, Florida Landmark, a wholly-owned subsidiary of Lehigh
Acquisition Corporation, which is an 80 percent owned subsidiary of ALLETE,
entered into an $8.5 million revolving development loan with CypressCoquina
Bank. The revolving development loan has an interest rate equal to the prime
rate, with an initial term of 36 months. The term of the loan may be extended 24
months, if certain conditions are met. The loan is guaranteed by Lehigh
Acquisition Corporation. No funds were drawn under this loan agreement at June
30, 2005.
On March 31, 2005, ALLETE executed a bond purchase agreement with certain
institutional buyers in the private placement market to sell $35 million of
ALLETE's first mortgage bonds. When issued, on or about August 1, 2005, the
bonds will carry an interest rate of 5.28% and will have a term of 15 years. In
June 2005, ALLETE called for redemption on August 1, 2005, $35 million in
principal amount of First Mortgage Bonds, 7 1/2% Series due 2007.
NOTE 5. KENDALL COUNTY CHARGE
On April 1, 2005, Rainy River Energy, a wholly-owned subsidiary of ALLETE,
completed the assignment of its power purchase agreement with LSP-Kendall
Energy, LLC, the owner of an energy generation facility located in Kendall
County, Illinois, to Constellation Energy Commodities. Rainy River Energy paid
Constellation Energy Commodities $73 million in cash to assume the power
purchase agreement, which is in effect through mid-September 2017. The payment
resulted in a charge to our operating income in the second quarter of 2005. The
tax benefits of the payment will be realized through a capital loss carry-back
for federal income tax purposes and have been recorded as current deferred
income tax assets. The tax benefits are expected to be realized in the first
half of 2006. In addition, consent, advisory and closing costs of $4.9 million
were incurred to complete the transaction. As a result of this transaction,
ALLETE incurred a charge to operating expenses totaling $77.9 million ($50.4
million after tax, or $1.84 per diluted share) in the second quarter of 2005.
ALLETE Second Quarter 2005 Form 10-Q 12
NOTE 6. OTHER INCOME (EXPENSE)
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------------------------
Millions
Gain (Loss) on Emerging Technology Investments $ 0.1 $(5.4) $(5.8) $(5.9)
Investment and Other Income 1.4 1.9 3.1 2.8
- ------------------------------------------------------------------------------------------------------------------
$ 1.5 $(3.5) $(2.7) $(3.1)
- ------------------------------------------------------------------------------------------------------------------
NOTE 7. INCOME TAX EXPENSE
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------------------------
Millions
Current Tax Expense
Federal $ 7.5 <F1> $ 2.6 $ 19.9 <F1> $ 11.3
State 1.3 <F1> 1.3 4.5 <F1> 4.4
- ------------------------------------------------------------------------------------------------------------------
8.8 3.9 24.4 15.7
- ------------------------------------------------------------------------------------------------------------------
Deferred Tax Expense (Benefit)
Federal (29.5) <F1> 0.1 (32.6) <F1> 1.7
State (0.4) - (0.7) (0.2)
- ------------------------------------------------------------------------------------------------------------------
(29.9) 0.1 (33.3) 1.5
- ------------------------------------------------------------------------------------------------------------------
Deferred Tax Credits (0.4) (0.2) (0.7) (0.8)
- ------------------------------------------------------------------------------------------------------------------
Income Tax Expense (Benefit) on Continuing Operations (21.5) 3.8 (9.6) 16.4
Income Tax Expense (Benefit) on Discontinued Operations (0.1) 28.1 (0.5) 49.3
Income Tax Benefit on Change in Accounting Principle - - - (5.5)
- ------------------------------------------------------------------------------------------------------------------
Total Income Tax Expense (Benefit) $(21.6) $31.9 $(10.1) $ 60.2
- ------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Included a current federal tax benefit of $1.3 million; current state tax benefit of $0.4 million and
deferred federal tax benefit of $25.8 million related to the Kendall County Charge. (See Note 5.)
</FN>
For the quarter and six months ended June 30, 2005, the effective rate for
income taxes deviated from the statutory rate, primarily as a result of the
emerging technology investment impairment losses recorded in March 2005 and the
Kendall County capital loss recorded in April 2005. The current benefit for
these items was limited to a federal benefit for income tax purposes. The state
tax benefit from these items is not expected to be realized currently or in
future periods. These state net capital loss carry forwards are entirely
reserved. Current taxes also increased in 2005, due to the expiration of the
accelerated depreciation deduction allowed by the Jobs and Growth Tax Relief Act
of 2003, which expired December 31, 2004. The effective rate for income taxes
for the six months ended June 30, 2004, increased due to nondeductible spin-off
costs related to the ADESA transaction.
NOTE 8. DISCONTINUED OPERATIONS
AUTOMOTIVE SERVICES. On September 20, 2004, the spin-off of our Automotive
Services business was completed by distributing to ALLETE shareholders all of
ALLETE's shares of ADESA common stock. One share of ADESA common stock was
distributed for each outstanding share of ALLETE common stock held at the close
of business on the September 13, 2004, record date.
WATER SERVICES. In June 2004, we essentially concluded our strategy to exit our
Water Services businesses when we completed the sale of our North Carolina water
assets and the sale of the remaining 72 water and wastewater systems in Florida.
Aqua America purchased our North Carolina water assets for $48 million and
assumed approximately $28 million in debt, and also purchased 63 of our water
and wastewater systems in Florida for $14 million. Seminole County purchased the
remaining 9 Florida
13 ALLETE Second Quarter 2005 Form 10-Q
NOTE 8. DISCONTINUED OPERATIONS (CONTINUED)
systems for a total of $4 million. The FPSC approved the Seminole County
transaction in September 2004. The transaction relating to the sale of 63 water
and wastewater systems in Florida to Aqua America remains subject to regulatory
approval by the FPSC. The approval process may result in an adjustment to the
final purchase price, based on the FPSC's determination of plant investment for
the systems. We anticipate a decision in late 2005. Gains in 2004 from the sale
of our North Carolina assets and the remaining systems in Florida were offset by
an adjustment to gains reported in 2003, resulting in an aggregate net loss of
$0.5 million in 2004 ($0.4 million loss first quarter; $5.8 million gain second
quarter; $0.2 million loss third quarter; $5.7 million loss fourth quarter).
In February 2005, we sold our wastewater assets in Georgia for an immaterial
gain. Florida Water continues to incur administrative expenses to support
transfer proceedings with the FPSC.
SUMMARY OF DISCONTINUED OPERATIONS
- -----------------------------------------------------------------------------------------------------------------------
Millions
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
INCOME STATEMENT 2005 2004 2005 2004
- -----------------------------------------------------------------------------------------------------------------------
Operating Revenue
Automotive Services - $232.1 - $479.8
Water Services - 7.5 - 15.1
- -----------------------------------------------------------------------------------------------------------------------
- $239.6 - $494.9
- -----------------------------------------------------------------------------------------------------------------------
Pre-Tax Income (Loss) from Operations
Automotive Services - $53.5 - $107.0
Water Services - 0.2 - (0.2)
- -----------------------------------------------------------------------------------------------------------------------
- 53.7 - 106.8
- -----------------------------------------------------------------------------------------------------------------------
Income Tax Expense
Automotive Services - 21.0 - 42.6
Water Services - 0.2 - -
- -----------------------------------------------------------------------------------------------------------------------
- 21.2 - 42.6
- -----------------------------------------------------------------------------------------------------------------------
Total Net Income from Operations - 32.5 - 64.2
- -----------------------------------------------------------------------------------------------------------------------
Gain (Loss) on Disposal
Automotive Services - (6.6) - (6.6)
Water Services $(0.8) 15.3 $(1.8) 14.7
- -----------------------------------------------------------------------------------------------------------------------
(0.8) 8.7 (1.8) 8.1
- -----------------------------------------------------------------------------------------------------------------------
Income Tax Expense (Benefit)
Automotive Services - (2.6) - (2.6)
Water Services (0.1) 9.5 (0.5) 9.3
- -----------------------------------------------------------------------------------------------------------------------
(0.1) 6.9 (0.5) 6.7
- -----------------------------------------------------------------------------------------------------------------------
Net Gain (Loss) on Disposal (0.7) 1.8 (1.3) 1.4
- -----------------------------------------------------------------------------------------------------------------------
Income (Loss) from Discontinued Operations $(0.7) $34.3 $(1.3) $ 65.6
- -----------------------------------------------------------------------------------------------------------------------
JUNE 30, DECEMBER 31,
BALANCE SHEET INFORMATION 2005 2004
- -----------------------------------------------------------------------------------------------------------------------
Assets of Discontinued Operations
Cash and Cash Equivalents $1.1 $1.2
Other Current Assets $0.7 $0.8
Property, Plant and Equipment $2.2 $2.9
Liabilities of Discontinued Operations
Current Liabilities $6.5 $12.0
- -----------------------------------------------------------------------------------------------------------------------
ALLETE Second Quarter 2005 Form 10-Q 14
NOTE 9. COMPREHENSIVE INCOME (LOSS)
For the quarter ended June 30, 2005, total comprehensive income (loss), net of
tax, was a $40.4 million loss ($32.7 million of comprehensive income, net of
tax, for the quarter ended June 30, 2004). For the six months ended June 30,
2005, total comprehensive income (loss), net of tax, was a $22.9 million loss
($75.5 million of comprehensive income, net of tax, for the six months ended
June 30, 2004). Total comprehensive income (loss) includes net income (loss),
unrealized gains and losses on securities classified as available-for-sale and
interest rate swaps, additional pension liability and foreign currency
translation adjustments.
ACCUMULATED OTHER COMPREHENSIVE JUNE 30,
INCOME (LOSS) - NET OF TAX 2005 2004
- ----------------------------------------------------------------------------------------------------------------
Millions
Unrealized Gain on Securities $ 1.5 $ 1.1
Additional Pension Liability (12.9) (9.8)
Interest Rate Swap - (0.3)
Foreign Currency Translation - Discontinued Operations - 17.4
- ----------------------------------------------------------------------------------------------------------------
$(11.4) $ 8.4
- ----------------------------------------------------------------------------------------------------------------
NOTE 10. EARNINGS PER SHARE
The difference between basic and diluted earnings per share arises from
outstanding stock options and performance share awards granted under our
Executive and Director Long-Term Incentive Compensation Plans. In accordance
with SFAS 128, "Earnings Per Share," in 2005, 0.1 million dilutive securities
were excluded in the computation of diluted earnings per share because a loss
from continuing operations existed for the quarter ended June 30, 2005 (0.2
million for the six months ended June 30, 2005). At June 30, 2004, no options to
purchase shares of common stock were excluded from the computation of diluted
earnings per share because they were anti-dilutive due to the option exercise
prices being greater than the average market price of the common stock.
2005 2004
-------------------------------------------------------------------
RECONCILIATION OF BASIC AND DILUTED DILUTIVE DILUTIVE
EARNINGS PER SHARE BASIC SECURITIES DILUTED BASIC SECURITIES DILUTED
- -------------------------------------------------------------------------------------------------------------------
Millions Except Per Share Amounts
FOR THE QUARTER ENDED JUNE 30,
Income (Loss) from Continuing Operations
Before Change in Accounting Principle $(39.6) - $(39.6) $2.4 - $2.4
Common Shares 27.2 - 27.2 28.4 0.1 28.5
Per Share from Continuing Operations $(1.45) - $(1.45) $0.08 - $0.08
- -------------------------------------------------------------------------------------------------------------------
FOR THE SIX MONTHS ENDED JUNE 30,
Income (Loss) from Continuing Operations
Before Change in Accounting Principle $(21.6) - $(21.6) $23.8 - $23.8
Common Shares 27.2 - 27.2 28.2 0.2 28.4
Per Share from Continuing Operations $(0.79) - $(0.79) $0.85 - $0.84
- -------------------------------------------------------------------------------------------------------------------
15 ALLETE Second Quarter 2005 Form 10-Q
NOTE 11. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
POSTRETIREMENT
PENSION HEALTH AND LIFE
---------------------------------------------------------
COMPONENTS OF PERIODIC BENEFIT EXPENSE 2005 2004 2005 2004
- -------------------------------------------------------------------------------------------------------------------
Millions
FOR THE QUARTER ENDED JUNE 30,
Service Cost $2.2 $2.1 $1.0 $1.0
Interest Cost 5.3 5.2 1.6 1.6
Expected Return on Plan Assets (7.1) (6.9) (1.2) (1.1)
Amortization of Prior Service Costs 0.2 0.2 - -
Amortization of Net Loss 0.8 0.4 0.2 0.1
Amortization of Transition Obligation - - 0.7 0.6
- -------------------------------------------------------------------------------------------------------------------
Periodic Benefit Expense $1.4 $1.0 $2.3 $2.2
- -------------------------------------------------------------------------------------------------------------------
FOR THE SIX MONTHS ENDED JUNE 30,
Service Cost $ 4.4 $ 4.2 $2.0 $2.1
Interest Cost 10.6 10.4 3.3 3.4
Expected Return on Plan Assets (14.2) (13.8) (2.4) (2.2)
Amortization of Prior Service Costs 0.4 0.4 - -
Amortization of Net Loss 1.6 0.8 0.4 0.3
Amortization of Transition Obligation 0.1 0.1 1.3 1.2
- -------------------------------------------------------------------------------------------------------------------
Periodic Benefit Expense $ 2.9 $ 2.1 $4.6 $4.8
- -------------------------------------------------------------------------------------------------------------------
In May 2004, the FASB issued FSP 106-2, "Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and Modernization Act of
2003," (Act) which provides accounting and disclosure guidance for employers
that sponsor postretirement health care plans that provide prescription drug
benefits. FSP 106-2 requires that the accumulated postretirement benefit
obligation and postretirement benefit cost reflect the impact of the Act upon
adoption. We provide postretirement health benefits that include prescription
drug benefits and have concluded that our prescription drug benefits will
qualify us for the federal subsidy to be provided for under the Act. We adopted
FSP 106-2 in the third quarter of 2004. The adoption of FSP 106-2 reduced our
after-tax postretirement medical expense by $0.5 million for the quarter ended
June 30, 2005 and $1.0 million for the six months ended June 30, 2005.
ALLETE Second Quarter 2005 Form 10-Q 16
NOTE 12. EMPLOYEE STOCK AND INCENTIVE PLANS
We sponsor a leveraged ESOP as part of our Retirement Savings and Stock
Ownership Plan (RSOP). As a result of the September 2004 spin-off of ADESA, the
ESOP received 3.3 million shares of ADESA common stock related to unearned ESOP
shares that have not been allocated to participants. The ESOP was required to
sell the ADESA common stock and use the proceeds to purchase ALLETE common stock
on the open market. At December 31, 2004, the ESOP had sold all of these ADESA
shares. The 3.3 million ADESA shares sold by the ESOP in 2004 resulted in total
proceeds of $65.9 million and an after-tax gain of $11.5 million, which we
recognized in the fourth quarter of 2004. Under the direction of an independent
trustee, the ESOP began using the proceeds to purchase shares of ALLETE common
stock in October 2004. As of February 15, 2005, the remaining proceeds ($30.3
million classified as Restricted Cash at December 31, 2004) had been used to
purchase ALLETE common stock, which were recorded using the treasury method as
Unearned ESOP Shares within Shareholders' Equity as presented on our
consolidated balance sheet.
SUMMARY OF ALLETE COMMON STOCK PURCHASES SHARES AMOUNT
- --------------------------------------------------------------------------------
Millions Except Shares
2004 October 80,600 $ 2.7
November 669,578 23.5
December 262,600 9.4
2005 January 544,797 21.4
February 214,928 8.9
- --------------------------------------------------------------------------------
1,772,503 $ 65.9
- --------------------------------------------------------------------------------
UNALLOCATED SHARES. As of June 30, 2005, there were 2,649,973 unallocated shares
of ALLETE common stock in the ESOP (2,001,505 shares at December 31, 2004),
which reflects 759,725 shares purchased and 111,257 shares allocated or used for
plan expenses in 2005. Pursuant to AICPA Statement of Position 93-6, "Employers'
Accounting for Employee Stock Ownership Plans," unallocated ALLETE common stock
currently held by the ESOP is treated as unearned ESOP shares and not considered
outstanding for earnings per share computations. ESOP shares are included in
earnings per share computations only after they are allocated to participants.
ALLOCATED SHARES. As of June 30, 2005, participants in the RSOP had $38.7
million, or 1.8 million shares, invested in ADESA common stock through an ADESA
common stock fund in the RSOP. Participants may transfer out of the ADESA common
stock fund at any time. If a participant chooses to transfer out of the ADESA
common stock fund, ADESA common stock is sold and the proceeds are reinvested in
a fund available in the RSOP as selected by the participant. One of the funds
available is an ALLETE common stock fund. Beginning in September 2005, the RSOP
is expected to start selling the ADESA common stock remaining in the RSOP as of
that date. An independent trustee will be directing the sale of the ADESA common
stock and will use the proceeds to purchase ALLETE common stock as required by
terms of the RSOP. We are unable to predict the date on which this process will
be complete.
17 ALLETE Second Quarter 2005 Form 10-Q
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 approximately 5 percent annually, to a minimum of 50 percent. In
December 2004 and 2003, we received notices from Minnkota Power that they will
reduce our output entitlement by approximately 5 percent beginning January 1,
2006 and 2007, to 66 percent and 60 percent, respectively. Minnesota Power is
obligated to pay its pro rata share of Square Butte's costs based on Minnesota
Power's entitlement to Unit output. Minnesota Power's payment obligation will be
suspended if Square Butte fails to deliver any power, whether produced or
purchased, for a period of one year. Square Butte's fixed costs consist
primarily of debt service. At June 30, 2005, Square Butte had total debt
outstanding of $311.5 million. Total annual debt service for Square Butte is
expected to be approximately $25 million in each of the years 2005 through 2009.
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 a purchased power expense for ratemaking purposes by both
the MPUC and the FERC.
LEASING AGREEMENTS. In September 2004, BNI Coal entered into an operating lease
agreement for a new dragline that was placed in service at BNI Coal's mine on
September 30, 2004. BNI Coal is obligated to make lease payments totaling $2.8
million annually for the lease term which expires in 2027. BNI Coal has the
option at the end of the lease term to renew the lease at a fair market rental,
to purchase the dragline at fair market value, or to surrender the dragline and
pay a $3.0 million termination fee.
We lease other properties and equipment under operating lease agreements with
terms expiring through 2013. The aggregate amount of minimum lease payments for
all of these other operating leases is $3.5 million in 2005, $3.3 million in
2006, $2.8 million in 2007, $2.1 million in 2008, $1.7 million in 2009 and $2.4
million thereafter.
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
payment obligations under these coal and shipping agreements are $38.7 million
in 2005, $12.3 million in 2006, $9.7 million in 2007, $10.1 million in 2008 and
$6.1 million in 2009.
EMERGING TECHNOLOGY PORTFOLIO. We have investments in emerging technologies
through minority investments in venture capital funds structured as limited
liability companies, and direct investments in privately-held, start-up
companies. The carrying value of our direct investments in privately-held,
start-up companies was zero at June 30, 2005 ($4.5 million at December 31,
2004). We have committed to make additional investments in certain emerging
technology venture capital funds. The total future commitment was $3.8 million
at June 30, 2005, ($4.5 million at December 31, 2004) and is expected to be
invested at various times through 2007. We do not have plans to make any
additional investments beyond this commitment.
ALLETE Second Quarter 2005 Form 10-Q 18
NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (CONTINUED)
ENVIRONMENTAL MATTERS. Our businesses are subject to regulation by various
federal, state and local authorities concerning environmental matters. We
anticipate that potential expenditures for environmental matters will be
material in the future, due to stricter environmental requirements through
legislation and/or rulemakings that are expected to require significant capital
investments. We are unable to predict if and when any such stricter
environmental requirements will be imposed and the impact they will have on the
Company. 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 under way. 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 near the former plant site. 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 during the first quarter of
2004. The next phase of the investigation was to determine any impact to soil or
ground water between the former MGP site and Superior Bay. The site work for
this phase of the investigation was performed during October 2004, and the final
report was sent to the WDNR in March 2005. Additional site investigation will be
needed during 2005. A work plan for the additional investigation will be filed
with the WDNR during the third quarter of 2005. Although it is not possible to
quantify the potential cleanup cost until the investigation is completed, a $0.5
million liability was recorded in December 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 cleanup costs for future recovery
in rates, subject to a regulatory prudency review. In May 2005, the PSCW
approved the collection through rates of $150,000 of site investigation costs
that had been incurred by the time SWL&P filed their most recent rate request.
ALLETE maintains pollution liability insurance coverage that includes coverage
for SWL&P. A claim has been filed with respect to this matter. The insurance
carrier has issued a reservation of rights letter and we continue to work with
the insurer to determine the availability of insurance coverage.
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. Discussions between Minnkota Power and 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.
CLEAN WATER ACT - AQUATIC ORGANISMS. In July 2004, the EPA issued Section 316(b)
Phase II Rule of the Clean Water Act to ensure that the location, design,
construction and capacity of cooling water intake structures at electric
generating facilities reflect the best technology available to reduce fish
mortality due to impingement (being pinned against screens or other parts of a
cooling water intake structure) or entrainment (being drawn into cooling water
systems and subjected to thermal, physical or chemical stresses). The new rule
for fish impingement requirements apply to the Boswell, Laskin, Hibbard and
Square Butte generating facilities. The impingement and entrainment requirements
apply to Taconite Harbor because it is located on Lake Superior. The rule
requires biological studies and engineering analyses to be performed within the
2005 to 2008 time frame. The estimated total cost of these studies for our
facilities is expected to be in the range of $0.5 million to $1.0 million. We
cannot yet estimate the capital expenditures that may be required as a result of
the study.
19 ALLETE Second Quarter 2005 Form 10-Q
NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (CONTINUED)
EPA CLEAN AIR INTERSTATE RULE AND CLEAN AIR MERCURY RULE. In March 2005, the EPA
announced the final Clean Air Interstate Rule (CAIR) that reduces and
permanently caps emissions of sulfur dioxide (SO2), nitrogen oxides (NOX) and
particulates in the eastern United States. The CAIR includes Minnesota as one of
the 28 states it considers as "eastern" states. The EPA also announced the final
Clean Air Mercury Rule (CAMR) that reduces and permanently caps emissions of
electric utility mercury emissions in the continental United States. Together,
the two rules address at least some of the emission reductions that were
targeted by the Clear Skies Act legislation that was not enacted in 2004. The
CAIR and the CAMR have been challenged in the court system, which may delay
implementation or modify provisions in the rules. Minnesota Power is
participating in a legal challenge to the CAIR but is not challenging the CAMR.
However, if the CAMR and the CAIR do go into effect, Minnesota Power expects to
be required to (1) make emissions reductions, (2) purchase mercury, SO2 and NOX
allowances through the EPA's cap-and-trade system, and/or (3) use a combination
of both. The Clear Skies legislation is being revisited and, if enacted, will
likely displace implementation of these rules.
We believe that CAIR contains flaws in its methodology and application, which
will cause Minnesota Power to incur significantly higher compliance costs.
Consequently, on July 11, 2005, Minnesota Power filed a Petition for Review with
the U.S. Court of Appeals for the District of Columbia Circuit. We also expect
to file a Petition for Reconsideration with the EPA. If the litigation and/or
the Petition for Reconsideration are successful, we expect to incur lower
compliance costs, consistent with the rules applicable to those states
considered as "western" states under the CAIR.
GUARANTEE. Minnesota Power guarantees $1.0 million of Northwest Airlines, Inc.'s
(NAI) payments of principal and interest on $24.7 million of "Duluth Airport
Lease Revenue Bonds" (to be paid out of lease revenues from NAI to the Duluth
Economic Development Authority). If NAI is delinquent in their rent payments,
the bond trustee may draw on the collateral of Minnesota Power to make the
payment. Minnesota Power's collateral is a Letter of Credit in favor of the
State of Minnesota. Minnesota Power would be entitled to reimbursement for any
draws on the collateral and such reimbursement obligation is secured by NAI's
Detroit to Paris international air route. Minnesota Power shares this security
interest with the State of Minnesota, St. Louis County and the City of Duluth.
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 Second Quarter 2005 Form 10-Q 20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our consolidated
financial statements and notes to those statements and the other financial
information appearing elsewhere in this report. In addition to historical
information, the following discussion and other parts of this report contain
forward-looking information that involves risks and uncertainties.
EXECUTIVE SUMMARY
ALLETE'S operations are comprised of four business segments. REGULATED UTILITY
includes retail and wholesale rate-regulated electric, water and gas services in
northeastern Minnesota and northwestern Wisconsin under the jurisdiction of
state and federal regulatory authorities. NONREGULATED ENERGY OPERATIONS
includes nonregulated generation (non-rate base generation sold at market-based
rates to the wholesale market) from Taconite Harbor in northern Minnesota and
our coal mining activities in North Dakota. Nonregulated Energy Operations also
included generation secured through the Kendall County power purchase agreement,
which was transferred in April 2005 to Constellation Energy Commodities. (See
Note 5.) REAL ESTATE includes our Florida real estate operations. OTHER includes
our telecommunications activities, investments in emerging technologies and
earnings on cash, cash equivalents and short-term investments. DISCONTINUED
OPERATIONS includes our Automotive Services business, our Water Services
businesses, and spin-off costs incurred by ALLETE.
During the first six months of 2005, our core energy and real estate businesses
continued to perform strongly. We completed the assignment of our Kendall County
power purchase agreement to Constellation Energy Commodities, which was a key
strategic accomplishment for the Company. As a result of this assignment, we
incurred a charge to our operating expenses totaling $77.9 million ($50.4
million after tax, or $1.84 per diluted share) in the second quarter of 2005
(Kendall County Charge). The assignment of the Kendall County power purchase
agreement has eliminated anticipated annual losses of approximately $8 million
after tax.
Since the Kendall County Charge significantly impacted the financial results
from continuing operations for the quarter and six months ended June 30, 2005,
we maintain that for comparative purposes, it is useful to present earnings
excluding the impact of this charge. The table below reflects actual results
adjusted for the exclusion of the Kendall County Charge.
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------------------------
Millions Except Per Share Amounts
Income (Loss) from Continuing Operations Before
Change in Accounting Principle $(39.6) $ 2.4 $(21.6) $23.8
Add Back: Kendall County Charge 50.4 - 50.4 -
- ------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations Before
Change in Accounting Principle
Excluding the Kendall County Charge 10.8 2.4 28.8 23.8
Income (Loss) from Discontinued Operations (0.7) 34.3 (1.3) 65.6
Change in Accounting Principle - - - (7.8)
- ------------------------------------------------------------------------------------------------------------------
$ 10.1 $36.7 $27.5 $81.6
- ------------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS (LOSS) PER SHARE OF COMMON STOCK
Continuing Operations Before Change in Accounting Principle $(1.45) $0.08 $(0.79) $0.84
Add Back: Kendall County Charge 1.84 - 1.84 -
- ------------------------------------------------------------------------------------------------------------------
Continuing Operations Before Change in Accounting Principle
Excluding the Kendall County Charge 0.39 0.08 1.05 0.84
Discontinued Operations (0.03) 1.21 (0.05) 2.31
Change in Accounting Principle - - - (0.27)
- ------------------------------------------------------------------------------------------------------------------
$ 0.36 $1.29 $1.00 $2.88
- ------------------------------------------------------------------------------------------------------------------
21 ALLETE Second Quarter 2005 Form 10-Q
Since the Kendall County Charge and discontinued operations significantly
impacted cash flow from continuing operations for the six months ended June 30,
2005 and 2004, respectively, we maintain that for comparative purposes, it is
useful to present cash flow activity excluding the impact of these items. The
table below reflects actual results adjusted for the exclusion of the Kendall
County Charge and discontinued operations.
CONSOLIDATED CASH FLOW
SIX MONTHS ENDED JUNE 30, 2005 2004
- -------------------------------------------------------------------------------------------------------------
Millions
Cash from (for) Operating Activities $(20.0) $87.0
Add Back: Kendall County Charge 77.9 -
Less: Discontinued Operations (5.9) 54.5
- -------------------------------------------------------------------------------------------------------------
$ 63.8 $32.5
- -------------------------------------------------------------------------------------------------------------
Cash from (for) Investing Activities $58.4 $39.7
Less: Discontinued Operations - 64.9
- -------------------------------------------------------------------------------------------------------------
$58.4 $(25.2)
- -------------------------------------------------------------------------------------------------------------
Cash from (for) Financing Activities $(4.3) $265.0
Less: Discontinued Operations (0.1) 328.9
- -------------------------------------------------------------------------------------------------------------
$(4.2) $(63.9)
- -------------------------------------------------------------------------------------------------------------
Excluding the Kendall County Charge, income from continuing operations was $10.8
million, or $0.39 per diluted share, for the quarter ended June 30, 2005 ($2.4
million, or $0.08 per diluted share, for the quarter ended June 30, 2004).
Strong electric sales and continued strong demand for real estate contributed to
higher earnings during the second quarter of 2005, as did lower interest expense
due to reduced debt balances and expense reductions following the spin-off of
Automotive Services and exit from the Water Services businesses in 2004. In
addition, second quarter 2004 included $3.2 million of impairment charges
related to our emerging technology investments.
Excluding the Kendall County Charge, income from continuing operations was $28.8
million, or $1.05 per diluted share, for the six months ended June 30, 2005
($23.8 million, or $0.84 per diluted share, for the six months ended June 30,
2004). In 2005, continued strong electric sales and the benefits of lower
interest expense due to reduced debt balances and expense reductions following
the spin-off of Automotive Services and exit from the Water Services businesses
in 2004, were partially offset by the timing of closing real estate
transactions.
Earnings per share for 2005 were favorably impacted by ALLETE common stock
purchased pursuant to the Company's Retirement Savings and Stock Ownership Plan.
(See Note 12.)
Excluding the Kendall County Charge, income in total was $10.1 million, or $0.36
per diluted share, for the quarter ended June 30, 2005 ($36.7 million, or $1.29
per diluted share, for the quarter ended June 30, 2004) and $27.5 million, or
$1.00 per diluted share, for the six months ended June 30, 2005 ($81.6 million,
or $2.88 per diluted share, for the six months ended June 30, 2004). The
decrease in net income in total reflected reduced earnings from discontinued
operations following the spin-off of Automotive Services and the exit from the
Water Services businesses.
ALLETE Second Quarter 2005 Form 10-Q 22
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------------------------
Millions Except Per Share Amounts
Operating Revenue
Regulated Utility $137.8 $136.8 $285.4 $278.2
Nonregulated Energy Operations 26.5 26.6 54.4 55.6
Real Estate 10.0 6.8 27.7 34.4
Other 12.5 16.0 26.2 27.0
- ------------------------------------------------------------------------------------------------------------------
$186.8 $186.2 $393.7 $395.2
- ------------------------------------------------------------------------------------------------------------------
Operating Expenses
Regulated Utility $120.9 $120.7 $243.3 $237.4
Nonregulated Energy Operations 103.3 <F1> 27.0 128.0 <F1> 55.1
Real Estate 5.0 2.5 9.5 10.2
Other 13.3 16.7 26.5 29.1
- ------------------------------------------------------------------------------------------------------------------
$242.5 $166.9 $407.3 $331.8
- ------------------------------------------------------------------------------------------------------------------
Interest Expense
Regulated Utility $4.4 $4.6 $ 8.7 $ 9.3
Nonregulated Energy Operations 1.6 1.2 2.9 2.4
Real Estate 0.2 - 0.2 0.1
Other 0.5 3.3 1.7 6.4
- ------------------------------------------------------------------------------------------------------------------
$6.7 $9.1 $13.5 $18.2
- ------------------------------------------------------------------------------------------------------------------
Other Income (Expense)
Regulated Utility $0.4 $ 0.1 $ 0.4 $ 0.1
Nonregulated Energy Operations - 1.4 0.2 0.9
Other 1.1 (5.0) (3.3) (4.1)
- ------------------------------------------------------------------------------------------------------------------
$1.5 $(3.5) $(2.7) $(3.1)
- ------------------------------------------------------------------------------------------------------------------
Net Income (Loss)
Regulated Utility $ 7.8 $ 7.4 $ 20.7 $19.9
Nonregulated Energy Operations (50.5) <F1> 0.1 (48.9) <F1> (0.1)
Real Estate 2.8 2.1 9.7 13.0
Other 0.3 (7.2) (3.1) (9.0)
- ------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations (39.6) 2.4 (21.6) 23.8
Income (Loss) from Discontinued Operations (0.7) 34.3 (1.3) 65.6
Change in Accounting Principle - - - (7.8)
- ------------------------------------------------------------------------------------------------------------------
Net Income (Loss) $(40.3) $36.7 $(22.9) $81.6
- ------------------------------------------------------------------------------------------------------------------
Diluted Average Shares of Common Stock 27.2 28.5 27.2 28.4
- ------------------------------------------------------------------------------------------------------------------
Diluted Earnings (Loss) Per Share of Common Stock
Continuing Operations $(1.45) <F1> $0.08 $(0.79) <F1> $0.84
Discontinued Operations (0.03) 1.21 (0.05) 2.31
Change in Accounting Principle - - - (0.27)
- ------------------------------------------------------------------------------------------------------------------
$(1.48) $1.29 $(0.84) $2.88
- ------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Included operating expenses totaling $77.9 million ($50.4 million after tax, or $1.84 per diluted share)
related to the assignment of the Kendall County power purchase agreement. (See Note 5.)
</FN>
In 2005, we began allocating corporate charges and interest expense to our
business segments. For comparative purposes, segment information for 2004 has
been restated to reflect the new allocation method used in 2005 for corporate
charges and interest expense. This restatement had no impact on consolidated net
income or earnings per share.
23 ALLETE Second Quarter 2005 Form 10-Q
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------------------------
KILOWATTHOURS SOLD
Millions
Regulated Utility
Retail and Municipals
Residential 229.9 228.8 549.7 539.1
Commercial 300.5 294.3 640.3 626.2
Industrial 1,746.9 1,770.0 3,524.0 3,536.8
Municipals 199.3 189.0 421.3 402.8
Other 18.1 17.8 38.5 38.0
- ------------------------------------------------------------------------------------------------------------------
2,494.7 2,499.9 5,173.8 5,142.9
Other Power Suppliers 366.9 168.4 603.6 385.6
- ------------------------------------------------------------------------------------------------------------------
2,861.6 2,668.3 5,777.4 5,528.5
Nonregulated Energy Operations 399.9 414.6 753.8 848.6
- ------------------------------------------------------------------------------------------------------------------
3,261.5 3,082.9 6,531.2 6,377.1
- ------------------------------------------------------------------------------------------------------------------
REAL ESTATE
Acres Sold 96 159 579 1,427
Lots Sold 0 12 7 211
- ------------------------------------------------------------------------------------------------------------------
NET INCOME
The following net income discussion summarizes a comparison of the six months
ended June 30, 2005, to the six months ended June 30, 2004.
REGULATED UTILITY contributed net income of $20.7 million in 2005 ($19.9 million
in 2004). In 2005, a 57 percent increase in kilowatthour sales to other power
suppliers, higher off-peak prices and continued strong retail electric sales
offset $1.1 million of additional planned maintenance expense at Company
generating facilities.
NONREGULATED ENERGY OPERATIONS reported a net loss of $48.9 million in 2005
($0.1 million net loss in 2004). In April 2005, we completed the assignment of
our Kendall County power purchase agreement to Constellation Energy Commodities.
As a result of this transaction, we incurred a charge to operating expenses
totaling $50.4 million after tax in the second quarter of 2005. Excluding the
Kendall County Charge, net income from nonregulated operations was up $1.5
million from last year, primarily due to power sales contracts that began in May
2004 and May 2005 at Taconite Harbor.
REAL ESTATE contributed net income of $9.7 million in 2005 ($13.0 million in
2004). Lower net income in 2005 was primarily attributed to the timing of the
closing of real estate transactions, which varies from period to period and
impacts comparisons between years.
During the second quarter of 2005, ALLETE Properties recorded its first sales
from the Town Center at Palm Coast development project in northeast Florida.
Since the project is currently under construction, revenue and expenses are
recorded using a percentage-of-completion method. (See Note 1.) As of June 30,
2005, we have $7.7 million of deferred profit on sales of real estate, before
taxes and minority interest, on our balance sheet. We expect most of this
deferred profit will be reflected in income during the next 18 months.
At June 30, 2005, total land sales under contract were $90.7 million, of which
$53.5 million were for properties in the Town Center at Palm Coast development
project. Pricing on these contracts range from $45,000 to $685,000 per acre for
the Town Center at Palm Coast development project, and $2,000 to $524,000 per
acre for all other properties. Prices per acre are stated on a gross acreage
basis and are dependent on the type and location of the properties sold. The
majority of the properties under contract are zoned commercial and mixed use.
ALLETE Second Quarter 2005 Form 10-Q 24
NET INCOME (CONTINUED)
OTHER reflected a net loss of $3.1 million in 2005 ($9.0 million net loss in
2004). In 2005, the Company benefited from the positive impact of lower interest
expense due to reduced debt balances and expense reductions following the
spin-off of Automotive Services and exit from the Water Services businesses in
2004, and a $1.2 million increase in earnings on cash, cash equivalents and
short-term investments. Losses from our emerging technology investments were
similar to last year. In 2005, we recorded $3.3 million of impairment losses
related to our emerging technology investments ($3.2 million in 2004).
DISCONTINUED OPERATIONS reflected a net loss of $1.3 million in 2005 ($65.6
million of net income in 2004). The absence of operations from Automotive
Services, spun off in September 2004, accounted for $60.4 million of the
decrease in income from discontinued operations. Income from Water Services was
down $6.5 million, primarily due to gains recognized in June 2004 on the sale of
Heater and the remaining 72 Florida Water systems. Water Services in 2005
reflected $1.3 million of administrative expenses incurred by Florida Water in
connection with the FPSC's transfer proceedings.
COMPARISON OF THE QUARTERS ENDED JUNE 30, 2005 AND 2004
REGULATED UTILITY
OPERATING REVENUE was up $1.0 million, or less than 1 percent, from 2004.
Revenue from other power suppliers (power marketing) was up $8.1 million
from 2004, due to a 118 percent increase in kilowatthour sales.
Transmission revenue was up $1.4 million from 2004, reflecting increased
MISO-related revenue. The Company is currently recovering other MISO
expenses, subject to refund with interest, through the fuel clause. Revenue
from sales to retail and municipal customers was down $8.4 million,
primarily due to lower fuel clause recoveries in 2005. Kilowatthour sales
to retail and municipal customers were similar to last year. As in 2004,
the Company's industrial customers are operating at high production levels,
with taconite and paper production at or near capacity, resulting in
kilowatthour sales to industrial customers similar to last year. Overall,
regulated utility kilowatthour sales were up 7 percent from 2004.
Revenue from electric sales to taconite customers accounted for 23 percent
of consolidated operating revenue in 2005 (26 percent in 2004). Electric
sales to paper and pulp mills accounted for 9 percent of consolidated
operating revenue in both 2005 and 2004.
OPERATING EXPENSES were up $0.2 million, or less than 1 percent, from 2004.
Fuel and purchased power expense was down $1.3 million from 2004, due to
lower purchased power expense in 2005. In 2004, an outage at Boswell Unit 4
required the Company to purchase additional power. The decrease in
purchased power expense was mostly offset by increased fuel expense, due to
a 53 percent increase in Company generation, and a $0.9 million increase in
MISO transmission expense. Other operating expenses were also higher in
2005 and included a $0.5 million increase in conservation improvement
program expenses, which are recovered through a billing adjustment clause.
In 2004, operating expenses included $0.3 million of expenses related to
Split Rock Energy, a joint venture, which we exited in March 2004.
INTEREST EXPENSE was down $0.2 million from 2004, due to lower effective
interest rates.
OTHER INCOME (EXPENSE) reflected $0.3 million more income in 2005,
primarily due to higher EPA auction proceeds received for sulfur dioxide
emission allowances.
25 ALLETE Second Quarter 2005 Form 10-Q
COMPARISON OF THE QUARTERS ENDED JUNE 30, 2005 AND 2004 (CONTINUED)
NONREGULATED ENERGY OPERATIONS
OPERATING REVENUE was down $0.1 million, or less than 1 percent, from 2004.
Revenue from nonregulated generation was down $1.9 million from 2004,
reflecting the absence of Kendall County operations following the
assignment of the Kendall County power purchase agreement partially offset
by increased revenue from Taconite Harbor. Overall, nonregulated
kilowatthour sales were down 4 percent from 2004. Revenue from Taconite
Harbor was up $2.6 million due to a 76-MW one-year capacity contract that
began in May 2004 and two 5-year contracts (175 MW in total) that began in
May 2005. Coal revenue, realized under a cost-plus contract, was up $1.9
million from 2004 because of higher coal production expenses (see operating
expense below).
OPERATING EXPENSES were up $76.3 million, from 2004, primarily due to a
$77.9 million charge related to the assignment of the Kendall County power
purchase agreement to Constellation Energy Commodities on April 1, 2005.
Fuel and purchased power expense was down $5.6 million from 2004,
reflecting the absence of operations at Kendall County partially offset by
increased fuel and purchased power expense at Taconite Harbor due to a 15
percent increase in kilowatthour sales. Other operating expenses at
Taconite Harbor were higher in 2005--sulfur dioxide emission allowance
expenses were up $1.0 million and depreciation expense was up $0.2 million
as a result of capitalized projects being completed and placed into
operation. Expenses related to our coal operations were up $1.8 million, in
part due to higher expenses associated with equipment repairs and a $0.7
million increase in lease expense related to the new dragline. In 2004,
fewer equipment repairs reduced operating expenses.
OTHER INCOME (EXPENSE) reflected $1.4 million less income in 2005--$0.7
million primarily due to the timing of contract services related to the
Duluth-to-Wausau transmission and $0.7 million due to fewer Minnesota land
sales.
REAL ESTATE
OPERATING REVENUE was up $3.2 million, or 47 percent, from 2004, primarily
because of the type and location of real estate sold. In 2005, 96 acres and
0 lots were sold for $8.6 million, excluding deferred revenue of $7.5
million. Town Center accounted for 42 of the 96 acres sold in 2005 ($1.7
million of revenue, excluding $7.5 million of deferred revenue). In 2004,
159 acres and 12 lots were sold for $5.2 million in 2004, excluding
deferred revenue of $0.
OPERATING EXPENSES were up $2.5 million from 2004. Cost of sales was $3.2
million in 2005, excluding deferred cost of sales of $1.7 million ($0.7
million, in 2004, excluding no deferred cost of sales).
OTHER
OPERATING REVENUE was down $3.5 million, or 22 percent, from 2004, due to
less revenue from our telecommunications business because of fewer
equipment sales.
OPERATING EXPENSES were down $3.4 million, or 20 percent, from 2004,
reflecting a $3.1 million decrease in expenses at our telecommunication
business, primarily due to lower cost of goods sold associated with fewer
equipment sales.
INTEREST EXPENSE was down $2.8 million from 2004, primarily due to lower
debt balances. The Company repaid a $53 million balance on a credit
agreement in April 2004 and $125 million of 7.80% Senior Notes in July
2004. A combination of internally-generated funds, proceeds from the sale
of our Water Services assets and proceeds received from ADESA were used to
repay debt.
OTHER INCOME (EXPENSE) reflected $6.1 million less expense in 2005 because
in 2004 we recorded $5.5 million of impairment losses related to our
privately-held emerging technology investments. Other income also reflected
a $0.7 million increase in earnings on cash, cash equivalents and
short-term investments in 2005.
ALLETE Second Quarter 2005 Form 10-Q 26
COMPARISON OF THE QUARTERS ENDED JUNE 30, 2005 AND 2004 (CONTINUED)
INCOME TAXES
The effective rate for income taxes in 2005 deviated from the statutory rate,
primarily as a result of the Kendall County capital loss recorded in April 2005.
The current benefit for the loss was limited to a federal benefit for income tax
purposes. The state tax benefit for this item is not expected to be realized
currently or in future periods. This state capital loss carry forward was
entirely reserved. Current taxes were higher in 2005, due to the expiration of
the accelerated depreciation deduction allowed by the Jobs and Growth Tax Relief
Act of 2003, which expired December 31, 2004. The effective rate for income
taxes in 2004 increased, due to nondeductible spin-off costs related to the
ADESA transaction.
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004
REGULATED UTILITY
OPERATING REVENUE was up $7.2 million, or 3 percent, from 2004. Revenue
from other power suppliers (power marketing) was up $10.1 million from
2004, due to a 57 percent increase in kilowatthour sales and higher
off-peak market prices. Transmission revenue was up $2.9 million from 2004,
reflecting increased MISO-related revenue. The Company is currently
recovering other MISO expenses, subject to refund with interest, through
the fuel clause. Revenue from sales to retail and municipal customers was
down $6.4 million, primarily due to lower fuel clause recoveries in 2005.
Kilowatthour sales to retail and municipal customers remained strong--up 1
percent from 2004. Sales to industrial customers were similar to last year
because, as in 2004, the Company's industrial customers are operating at
high production levels, with taconite and paper production at or near
capacity. Overall, regulated utility kilowatthour sales were up 5 percent
from 2004.
Revenue from electric sales to taconite customers accounted for 22 percent
of consolidated operating revenue in 2005 (23 percent in 2004). Electric
sales to paper and pulp mills accounted for 8 percent of consolidated
operating revenue in both 2005 and 2004.
OPERATING EXPENSES were up $5.9 million, or 2 percent, from 2004. Fuel and
purchased power expense was up $3.1 million from 2004, reflecting increased
fuel expense, due to a 32 percent increase in Company generation, and a
$2.3 million increase in MISO transmission expenses. These increases were
partially offset by lower purchased power expense in 2005. In 2004, an
outage at Boswell Unit 4 required additional power to be purchased.
Maintenance expenses were up $1.9 million from 2004, primarily due to more
planned maintenance in 2005. Other operating expenses were also higher in
2005 and included a $1.1 million increase in conservation improvement
program expenses, which are recovered through a billing adjustment clause.
In 2004, operating expenses included $2.0 million of expenses related to
Split Rock Energy, a joint venture, which we exited in March 2004.
INTEREST EXPENSE was down $0.6 million from 2004, due to lower effective
interest rates.
OTHER INCOME (EXPENSE) reflected $0.3 million more income in 2005,
primarily due to higher EPA auction proceeds received for sulfur dioxide
emission allowances.
NONREGULATED ENERGY OPERATIONS
OPERATING REVENUE was down $1.2 million, or 2 percent, from 2004. Revenue
from nonregulated generation was down $4.3 million from 2004, reflecting
the absence of Kendall County operations partially offset by increased
revenue from Taconite Harbor. Overall, nonregulated kilowatthour sales were
down 11 percent from 2004. Revenue from Taconite Harbor was up $2.0 million
due to a 76-MW one-year capacity contract that began in May 2004 and two
5-year contracts (175 MW in total) that began in May 2005. Coal revenue,
realized under a cost-plus contract, was up $3.6 million from 2004 because
of higher coal production expenses (see operating expense below).
27 ALLETE Second Quarter 2005 Form 10-Q
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004 (CONTINUED)
NONREGULATED ENERGY OPERATIONS (CONTINUED)
OPERATING EXPENSES were up $72.9 million from 2004, primarily due to the
$77.9 million charge related to the assignment of the Kendall County power
purchase agreement to Constellation Energy Commodities on April 1, 2005.
Nonregulated generation fuel and purchased power expense was down $9.8
million from 2004, reflecting the absence of Kendall County operations.
Operating expenses at Taconite Harbor were higher in 2005--sulfur dioxide
emission allowance expenses were up $1.5 million and depreciation expense
was up $0.3 million as a result of capitalized projects being completed and
placed into operation. Expenses related to our coal operations were up $3.5
million, in part due to higher expenses associated with equipment repairs
and a $1.4 million increase in lease expense related to the new dragline.
In 2004, fewer equipment repairs reduced operating expenses.
OTHER INCOME (EXPENSE) reflected $0.7 million less income in 2005,
primarily due to fewer Minnesota land sales.
REAL ESTATE
OPERATING REVENUE was down $6.7 million, or 19 percent, from 2004,
primarily due to lower sales volume. In 2005, 579 acres and 7 lots were
sold for $25.6 million, excluding deferred revenue of $8.5 million. Town
Center accounted for 42 of the 96 acres sold in 2005 ($1.7 million of
revenue, excluding $7.5 million of deferred revenue). In 2004, 1,427 acres
and 211 lots were sold for $31.3 million in 2004, excluding deferred
revenue of $0. Revenue from land sales was lower in 2005, primarily due to
timing of transactions closing. Revenue from lot sales was also lower in
2005 because in January 2004 we sold the remaining 184 lots at Sugarmill
Woods for $3.9 million, essentially exiting the lot sales business.
OPERATING EXPENSES were down $0.7 million, or 7 percent, from 2004,
primarily due to a $0.6 million decrease in selling expenses as a result of
lower sales volume in 2005. Cost of sales, however, was higher in
2005--$5.8 million, excluding deferred cost of sales of $1.8 million ($5.5
million in 2004, excluding deferred cost of sales of $0).
OTHER
OPERATING REVENUE was down $0.8 million, or 3 percent, from 2004, due to
decreased revenue from our telecommunications business because of fewer
equipment sales.
OPERATING EXPENSES were down $2.6 million, or 9 percent, from 2004,
reflecting a $1.7 million decrease in expenses at our telecommunication
business, primarily due to lower cost of goods sold associated with fewer
equipment sales, and a reduction in other expenses following the spin-off
of Automotive Services and exit from the Water Services businesses in 2004.
INTEREST EXPENSE was down $4.7 million from 2004, primarily due to lower
debt balances. The Company repaid a $53 million balance on a credit
agreement in April 2004 and $125 million of 7.80% Senior Notes in July
2004. A combination of internally-generated funds, proceeds from the sale
of our Water Services assets and proceeds received from ADESA were used to
repay debt.
OTHER INCOME (EXPENSE) reflected $0.8 million more income in 2005,
primarily due to a $1.8 million increase in earnings on cash and short-term
investments. In 2005, we recorded $5.1 million of impairment losses related
to our emerging technology investments ($5.5 million in 2004). In 2004,
$1.3 million of income from a rabbi trust, established to secure certain
deferred executive compensation, was recorded.
INCOME TAXES
The effective rate for income taxes in 2005 deviated from the statutory rate,
primarily as a result of the emerging technology investment impairment losses
recorded in March 2005 and the Kendall County capital loss recorded in April
2005. The current benefit for these items was limited to a federal benefit for
income tax purposes. The state tax benefit from these items is not expected to
be realized currently or in future periods. These state net capital loss carry
forwards are entirely reserved. Current taxes also increased in 2005, due to the
expiration of the accelerated depreciation deduction allowed by the Jobs and
Growth Tax Relief Act of 2003, which expired December 31, 2004. The effective
rate for income taxes for 2004 increased, due to nondeductible spin-off costs
related to the ADESA transaction.
ALLETE Second Quarter 2005 Form 10-Q 28
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:
impairment of 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 2004 Form 10-K.
OUTLOOK
The April 2005 assignment of the Kendall County power purchase agreement to
Constellation Energy Commodities was a key strategic accomplishment for the
Company. As a result of this assignment, we recorded expenses totaling $50.4
million after tax, or $1.84 per diluted share, in the second quarter of 2005,
and eliminated anticipated annual losses of approximately $8 million after tax.
We continue to expect ALLETE's earnings per share from continuing operations to
grow by 45 percent to 50 percent in 2005. The growth is expected to come from
continued strong real estate sales, lower interest expense and the transfer of
the Kendall County purchased power agreement. Our earnings expectation excludes
the one-time charge related to the Kendall County assignment and any earnings
from investments we may make in growth initiatives.
In 2005, we have fewer shares outstanding for earnings per share calculation
purposes. The ESOP used proceeds from the sale of ADESA stock to purchase ALLETE
common stock on the open market. Pursuant to AICPA Statement of Position 93-6,
"Employers' Accounting for Employee Stock Ownership Plans," unallocated ALLETE
common stock currently held by the ESOP is treated as unearned ESOP shares and
not considered outstanding for earnings per share computations. ESOP shares are
included in earnings per share computations after they are allocated to
participants.
REGULATED UTILITY AND NONREGULATED ENERGY OPERATIONS
As a result of MISO Day 2 implementation on April 1, 2005, energy transactions
to serve retail customers are sourced by wholesale transactions with MISO as the
counterparty. Minnesota Power filed a petition with the MPUC in February 2005 to
amend the fuel clause to accommodate costs and revenue related to MISO Day 2
market implementation. On March 24, 2005, the MPUC approved interim accounting
treatment of MISO Day 2 costs to be recovered through the fuel clause. This
interim treatment will continue until the MPUC addresses the cost recovery
petitions from Xcel Energy Inc., Otter Tail Power Company, Alliant Energy
Corporation and Minnesota Power. The MPUC action regarding MISO Day 2 will
include an analysis of how the fuel clause is affected, and whether it should be
modified as a result of MISO Day 2.
On April 14, 2005, the PSCW approved an 11.7 percent return on common equity and
a 3.9 percent average increase in retail utility rates for SWL&P customers. New
rates became effective May 19, 2005.
In June 2005, we reached a long-term, all requirements agreement with United
States Steel Corporation (USS) to provide electric service through October 2013
to its Minntac and Keewatin Taconite production facilities. Extending our
electric supply contract is an important achievement for both USS and Minnesota
Power. Electric power is a key component in the production of taconite and the
taconite industry consumes a sizable portion of the electricity we produce. This
agreement helps to provide planning certainty for both companies. The contract
is subject to MPUC approval. Minntac and Keewatin Taconite, combined, use 275
megawatts of electricity. USS is our largest customer and represents
approximately 12 percent of our consolidated annual revenue. We expect to be
successful with additional industrial customer contract extensions going
forward.
Also in June 2005, we added a significant resource to our Regulated Utility
generation portfolio when we entered into a 25-year agreement to purchase
approximately 50 megawatts of wind power from a new wind generation project to
be built in North Dakota by an affiliate of FPL Energy, LLC. FPL Energy expects
the facility to be operational by the end of 2006. The wind farm will include 33
new wind turbines linked to the Square Butte substation in Center, North Dakota.
The project is subject to certain conditions, including regulatory approvals, as
well as the extension of the federal production tax credit. We are actively
pursuing proposals for a second new wind farm to be located in northeastern
Minnesota.
29 ALLETE Second Quarter 2005 Form 10-Q
OUTLOOK (CONTINUED)
The U.S. Congress has completed debate on comprehensive energy legislation and
is expected to pass and send the legislation to the President. The bill could be
signed into law in early August 2005. Key provisions in the bill include:
mandatory electric reliability standards; FERC backstop siting authority for
transmission corridors of national interest, as well as, giving the Department
of Energy (DOE) "lead agency" authority to coordinate federal agencies involved
in siting transmission lines; and the repeal of the Public Utility Holding
Company Act of 1935 (PUHCA) giving the FERC additional authority over merger
reviews and allowing the states expanded books and records authority. The law
also reforms the hydro licensing process and supports the DOE's clean
coal/FutureGen program. We believe the overall impact on the electric utility
industry will be positive, but we are currently evaluating the effects of this
pending legislation and are unable to predict the impact on the Company's
results of operations and our operations in general.
REAL ESTATE
In March 2005, Florida Landmark signed an agreement with Developers Realty
Corporation (DRC) to develop the first phase of the urban core area of Town
Center at Palm Coast. The agreement also includes the development of a 51-acre
commercial retail site. The agreement provides that DRC has an inspection period
through July 31, 2005, which allows DRC to terminate the agreement with no
penalty. Revenue associated with this agreement is anticipated to be $21.8
million over the life of the contract, which extends to September 2012. DRC is a
regional commercial developer with strong ties to national retailers and has
experience developing "lifestyle center" projects. ALLETE Properties recorded
its first sales from Town Center at Palm Coast in the second quarter of 2005.
ALLETE Properties occasionally provides seller financing, and outstanding
finance receivables were $12.5 million at June 30, 2005, with maturities ranging
up to seven years. Outstanding finance receivables accrue interest at
market-based rates. These finance receivables are collateralized by the financed
properties.
SUMMARY OF DEVELOPMENT PROJECTS TOTAL RESIDENTIAL COMMERCIAL OFFICE INDUSTRIAL
AT JUNE 30, 2005 OWNERSHIP ACRES<F1> UNITS <F2> SQ. FT. <F2> SQ. FT.<F2> SQ. FT.<F2>
- -----------------------------------------------------------------------------------------------------------------------
Town Center at Palm Coast 80% 1,508 2,950 2,010,000 1,118,000 -
Palm Coast Park 100% 4,705 3,600 1,600,000 800,000 800,000
Ormond Crossings <F3> 100% 5,773 - - - -
- -----------------------------------------------------------------------------------------------------------------------
11,986 6,550 3,610,000 1,918,000 800,000
- -----------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Acreage amounts are approximate and shown on a gross basis, including wetlands and minority interest. Acreage
amounts may vary due to platting or surveying activity. Wetland amounts vary by property and are often not
formally determined prior to sale.
<F2> Estimated and includes minority interest. The actual property breakdown at full build-out may be different than
these estimates.
<F3> Units and square footage have not been determined.
</FN>
SUMMARY OF OTHER LAND INVENTORIES
AT JUNE 30, 2005 OWNERSHIP TOTAL MIXED USE RESIDENTIAL COMMERCIAL AGRICULTURAL
- -----------------------------------------------------------------------------------------------------------------------
ACRES <F1>
Palm Coast Holdings 80% 2,888 1,848 513 281 246
Lehigh 80% 827 600 134 84 9
Cape Coral 100% 71 - 1 70 -
Other 100% 908 - - - 908
- -----------------------------------------------------------------------------------------------------------------------
4,694 2,448 648 435 1,163
- -----------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Acreage amounts are approximate and shown on a gross basis, including wetlands and minority interest. Acreage
amounts may vary due to platting or surveying activity. Wetland amounts vary by property and are often not
formally determined prior to sale. The actual property breakdown at full build-out may be different than these
estimates.
</FN>
ALLETE Second Quarter 2005 Form 10-Q 30
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 our businesses both internally by expanding
facilities, services and operations (see Capital Requirements), and externally
through acquisitions.
We believe our financial condition is strong, as evidenced by cash and cash
equivalents of $79.1 million, $63.0 million of short-term investments and a debt
to total capital ratio of 40 percent at June 30, 2005.
Excluding the Kendall County Charge and discontinued operations, we continued to
generate strong cash flow from operating activities, which amounted to $63.8
million for the first six months of 2005 ($32.5 million for the first six months
of 2004). Cash from operating activities, excluding the Kendall County Charge
and discontinued operations, was higher in 2005, due to increased income from
continuing operations, the collection of an outstanding receivable at December
31, 2004, from American Transmission Company LLC for work on the
Duluth-to-Wausau transmission line and other receivables, and additional
deferred profit on real estate activities.
Cash from investing activities, excluding discontinued operations, was higher in
2005, primarily due to $87.6 million in net proceeds received from the sale of
short-term investments ($271.1 million in gross proceeds; $183.5 million for
purchases) and lower additions to property, plant and equipment in 2005, which
vary from period to period depending on projects. These increases were partially
offset by $12 million received from Split Rock Energy in 2004 upon termination
of the joint venture.
Cash for financing activities, excluding discontinued operations, was lower in
2005, primarily due to the repayment of a $53.0 million note payable in 2004.
ALLETE Properties' Town Center at Palm Coast development project in Florida
(Town Center) is being financed with a revolving development loan and tax-exempt
bonds. In March 2005, Florida Landmark entered into an $8.5 million revolving
development loan with CypressCoquina Bank to fund approximately $26 million of
Town Center development costs. The loan has an interest rate equal to the prime
rate with an initial term of 36 months. The term of the loan may be extended 24
months, if certain conditions are met. Also in March 2005, the Town Center at
Palm Coast Community Development District (Town Center CDD) issued $26.4 million
of tax-exempt, 6% Capital Improvement Revenue Bonds, Series 2005, due May 1,
2036 (Bonds). Approximately $21 million of the Bond proceeds will be used for
construction of infrastructure improvements at Town Center, with the remaining
funds to be used for capitalized interest, a debt service reserve fund and costs
of issuance. The Bonds are payable from and secured by the revenue derived from
assessments to be imposed, levied and collected by the Town Center CDD. The
assessments represent an allocation of the costs of the improvements, including
bond financing costs, to the lands within the Town Center CDD benefiting from
the improvements. The assessments will be included in the annual property tax
bills of land owners in the development project beginning in November 2006. Town
Center CDD is an independent unit of local government, created and established
in accordance with Florida's Uniform Community Development District Act of 1980
(Act). The Act provides legal authority for a community development district to
finance the construction of major infrastructure for community development with
general obligation, revenue and special assessment revenue debt obligations.
WORKING CAPITAL. Additional working capital, if and when needed, generally is
provided by the sale of commercial paper. Approximately 1 million original issue
shares of our common stock are available for issuance through Invest Direct, our
direct stock purchase and dividend reinvestment plan.
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
31 ALLETE Second Quarter 2005 Form 10-Q
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
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 March 2005, ALLETE executed a bond purchase agreement with certain
institutional buyers in the private placement market to sell $35 million of
ALLETE's first mortgage bonds. When issued, on or about August 1, 2005, the
bonds will carry an interest rate of 5.28% and will have a term of 15 years. In
June 2005, ALLETE called for redemption on August 1, 2005, $35 million in
principal amount of First Mortgage Bonds, 7 1/2% Series due 2007.
OFF-BALANCE SHEET ARRANGEMENTS
Off-balance sheet arrangements are summarized in our 2004 Form 10-K, with
additional disclosure discussed in Note 13 of this Form 10-Q.
CAPITAL REQUIREMENTS
For the six months ended June 30, 2005, capital expenditures for continuing
operations totaled $24.2 million ($34.7 million in 2004). Expenditures for the
six months ended June 30, 2005, included $20.7 million for Regulated Utility,
$1.9 million for Nonregulated Energy Operations and $1.6 million for Other,
which related to our telecommunications business. Internally-generated funds
were the source of funding for these expenditures.
Capital expenditures are expected to be $61 million in total for 2005 ($48
million for system component replacement and upgrades within Regulated Utility;
$11 million for system component replacement and upgrades, and coal handling
equipment within Nonregulated Energy Operations; and $2 million for
telecommunication fiber within Other). We expect to use internally-generated
funds to fund all capital expenditures.
Due to the passage of two new EPA rules in 2005 that reduce and permanently cap
emissions of mercury, sulfur dioxide, nitrogen oxides and particulates from the
electric utility industry, capital expenditures are expected to total about $675
million for 2006 through 2009, an increase of $175 million from the previously
anticipated $500 million. This estimated increase reflects additional
technological investment in our existing facilities. We are considering,
however, a combination of solutions that include both technology and emission
allowance purchases. We have commenced litigation in the U.S. Court of Appeals
for the District of Columbia Circuit and intend to file a Petition for
Reconsideration to have the EPA revisit flaws in the application and methodology
of the CAIR rule. If successful, we expect our compliance costs to be
approximately $175 million lower than our current expected capital expenditures,
which reflect application of the current rules to Minnesota Power's facilities.
(See Note 13.)
ENVIRONMENTAL MATTERS AND OTHER
As previously mentioned in our Critical Accounting Policies section, our
businesses are subject to regulation by various federal, state and local
authorities concerning environmental matters. We anticipate that potential
expenditures for environmental matters will be material in the future, due to
stricter environmental requirements through legislation and/or rulemakings that
are expected to require significant capital investments. We are unable to
predict the outcome of the issues discussed in Note 13.
NEW ACCOUNTING STANDARDS
New accounting standards are discussed in Note 1.
-----------------------------
READERS ARE CAUTIONED THAT FORWARD-LOOKING STATEMENTS INCLUDING THOSE CONTAINED
ABOVE, SHOULD BE READ IN CONJUNCTION WITH OUR DISCLOSURES UNDER THE HEADING:
"SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995" LOCATED ON PAGE 3 OF THIS FORM 10-Q.
ALLETE Second Quarter 2005 Form 10-Q 32
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
SECURITIES INVESTMENTS
AVAILABLE-FOR-SALE SECURITIES. Our securities investments include certain
securities, 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 (loss), net of
tax. Unrealized losses that are other than temporary are recognized in earnings.
At June 30, 2005, our available-for-sale securities portfolio consisted of
securities in a grantor trust established to fund certain employee benefits
included in Investments and various auction rate municipal bonds and variable
rate municipal demand notes included as Short-Term Investments. Our
available-for-sale securities portfolio had a fair value of $92.4 million at
June 30, 2005 ($179.4 million at December 31, 2004) and a total unrealized
after-tax gain of $1.5 million at June 30, 2005 ($1.5 million at December 31,
2004). We use the specific identification method as the basis for determining
the cost of securities sold. Our policy is to review on a quarterly basis
available-for-sale securities for other than temporary impairment by assessing
such factors as the continued viability of products offered, cash flow, share
price trends and the impact of overall market conditions. As a result of our
periodic assessments, we did not record any impairment on available-for-sale
securities for the six months ended June 30, 2005.
EMERGING TECHNOLOGY PORTFOLIO. As part of our emerging technology portfolio, we
have several minority investments in venture capital funds and direct
investments in privately-held, start-up companies. We account for our investment
in venture capital funds under the equity method and account for our direct
investment in privately-held companies under the cost method. The total carrying
value of our emerging technology portfolio was $8.7 million at June 30, 2005,
down $4.9 million from December 31, 2004. In March 2005, we recorded $5.1
million ($3.3 million after tax) of impairment losses, which included a reserve
for future commitments, that related to direct investments in certain
privately-held, start-up companies whose future business prospects have
diminished significantly. Recent developments at these companies indicated that
future commercial viability is unlikely, as is new financing necessary to
continue development. Our basis in cost method investments included in the
emerging technology portfolio was zero at June 30, 2005 ($4.5 million at
December 31, 2004). Our policy is to review these investments quarterly for
impairment by assessing such factors as continued commercial viability of
products, cash flow and earnings. Any impairment would reduce the carrying value
of the investment.
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 seek to prudently manage our customers' exposure to price risk by entering
into contracts of various durations and terms for the purchase of coal and power
(in Minnesota), power and natural gas (in Wisconsin), and related transportation
costs.
POWER MARKETING
Our power marketing activities consist of (1) purchasing energy in the wholesale
market for resale in our regulated service territories when retail energy
requirements exceed generation output, and (2) selling excess available
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 MISO market or under short-term contracts at market
prices.
We have approximately 200 MW of nonregulated generation available for sale to
the wholesale markets at our Taconite Harbor facility in northern Minnesota,
which has been sold through various short-term and long-term capacity and energy
contracts. Approximately 116 MW of existing capacity and energy sales contracts
expired on April 30, 2005. Long-term, we have entered into two capacity and
energy sales
33 ALLETE Second Quarter 2005 Form 10-Q
POWER MARKETING (CONTINUED)
contracts totaling 175 MW (201 MW including a 15 percent reserve), which were
effective May 1, 2005, and expire on April 30, 2010. Both contracts contain
fixed monthly capacity charges and fixed minimum energy charges. One contract
provides for an annual escalator to the energy charge based on increases in our
cost of coal, subject to a small minimum annual escalation. The other contract
provides that the energy charge will be the greater of a fixed minimum charge or
an amount based on the variable production cost of a combined-cycle, natural gas
unit. Our exposure in the event of a full or partial outage at our Taconite
Harbor facility is significantly limited under both contracts. When the buyer is
notified at least two months prior to an outage, there is no exposure. Outages
with less than two months' notice are subject to an annual duration limitation
typical of this type of contract. We also have a 50 MW capacity and energy sales
contract that extends through April 2008 and a 15 MW energy sales contract that
extends through May 2007. The 50 MW capacity and energy sales contract has fixed
pricing through January 2006 and market-based pricing thereafter.
In addition to generation, Taconite Harbor will meet its sales contract
obligations with two contracts that began in May 2005. We have a 50 MW capacity
and energy purchase contract that extends through April 2006, with fixed
capacity payments and the right to purchase energy at market price. We also have
a 25 MW fixed-priced energy purchase contract that extends through January 2006.
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. While we continue to enhance our internal
control over financial reporting, there has been no change in our internal
control over financial reporting that occurred during our most recent fiscal
quarter that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Material legal and regulatory proceedings are included in the discussion of
Other Information in Part II, Item 5 and/or Note 13, and are incorporated by
reference herein.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ALLETE Second Quarter 2005 Form 10-Q 34
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) We held our Annual Meeting of Shareholders on May 10, 2005.
(b) Included in (c) below.
(c) The election of directors, the ratification of the appointment of
PricewaterhouseCoopers LLP, as the Company's independent registered public
accounting firm for 2005, and the continuation of the ALLETE Executive
Long-Term Incentive Compensation Plan were voted on at the Annual Meeting
of Shareholders.
The results were as follows:
VOTES
VOTES FOR WITHHELD
---------------------------------------------------------------------------
DIRECTORS
Heidi J. Eddins 25,575,868 587,372
Peter J. Johnson 25,438,790 724,450
Madeleine W. Ludlow 25,520,384 642,856
George L. Mayer 25,437,028 726,212
Roger D. Peirce 25,397,560 765,680
Jack I. Rajala 25,322,780 840,460
Donald J. Shippar 25,643,498 519,742
Nick Smith 25,422,674 740,566
Bruce W. Stender 25,605,356 557,884
---------------------------------------------------------------------------
VOTES BROKER
VOTES FOR AGAINST ABSTENTIONS NONVOTES
--------------------------------------------------------------------------------------------------------------
INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
PricewaterhouseCoopers LLP 25,296,573 707,633 159,034 -
CONTINUATION OF THE EXECUTIVE
LONG-TERM INCENTIVE
COMPENSATION PLAN 17,743,925 3,081,478 861,677 4,476,160
- -------------------------------------------------------------------------------------------------------------------
(d) Not applicable.
35 ALLETE Second Quarter 2005 Form 10-Q
ITEM 5. OTHER INFORMATION
Reference is made to our 2004 Form 10-K for background information on the
following updates. Unless otherwise indicated, cited references are to our 2004
Form 10-K.
Ref. Page 8 - New Footnote to Contract Status for Minnesota Power Large Power
Customers Table
In June 2005, Minnesota Power reached a long-term agreement with United States
Steel Corporation (USS) to provide electric service through October 2013 to its
Minntac and Keewatin Taconite production facilities. USS is Minnesota Power's
largest energy customer. The contract is subject to MPUC approval.
Ref. Page 11 - First Paragraph
On May 27, 2005, we entered into a 25-year agreement with an affiliate of FPL
Energy, LLC to purchase all of the renewable energy from an approximately
50-megawatt wind facility to be built in North Dakota. FPL Energy, LLC expects
the facility to be operational by the end of 2006. The wind farm will include 33
new wind turbines linked to the Square Butte substation in Center, North Dakota.
The project is subject to certain conditions, including regulatory approvals, as
well as the extension of the federal production tax credit (PTC). In addition,
we are actively pursuing proposals for the purchase of renewable energy from a
second new wind farm that would be located in northeastern Minnesota. This
project, expected to be operational in 2006 or 2007, would be similar in size to
the North Dakota project and would be subject to contract negotiation and
execution, as well as regulatory approvals and extension of the PTC.
Ref. Page 11 - Seventh Paragraph
The U.S. Congress has completed debate on comprehensive energy legislation and
is expected to pass and send the legislation to the President. The bill could be
signed into law in early August 2005. Key provisions in the bill include:
mandatory electric reliability standards; FERC backstop siting authority for
transmission corridors of national interest, as well as, giving the Department
of Energy (DOE) "lead agency" authority to coordinate federal agencies involved
in siting transmission lines; and the repeal of the Public Utility Holding
Company Act of 1935 (PUHCA) giving the FERC additional authority over merger
reviews and allowing the states expanded books and records authority. The law
also reforms the hydro licensing process and supports the DOE's clean
coal/FutureGen program. We believe the overall impact on the electric utility
industry will be positive, but we are currently evaluating the effects of this
pending legislation and are unable to predict the impact on the Company's
results of operations and our operations in general.
Ref. Page 13 - New Paragraph after Second Paragraph
On June 24, 2005, a growth management bill was signed into law by the Governor
of Florida that will significantly change Florida's land development
regulations. Generally, the bill requires that sufficient roads, schools and
water supply be in place before future development can be approved by local
governments. Our Town Center and Palm Coast Park development projects were
"grandfathered" under the former regulations and will not be impacted. Ormond
Crossings and future Company projects will be regulated by the new legislation.
However, due to the large scale of these projects, roads, schools and water
supply were already being addressed in our development approvals. Smaller
developments will see the greatest negative effect of the legislation, which
could lead to a competitive advantage for us under our long-term strategy, but
could negatively impact our short-term efforts to obtain development approvals
for smaller projects.
ALLETE Second Quarter 2005 Form 10-Q 36
ITEM 6. EXHIBITS
EXHIBIT
NUMBER
10 Director Compensation Summary.
31(a) Rule 13a-14(a)/15d-14(a) Certification by the Chief Executive
Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31(b) Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial
Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32 Section 1350 Certification of Periodic Report by the Chief
Executive Officer and Chief Financial Officer Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
99 ALLETE News Release dated July 29, 2005, announcing 2005 second
quarter earnings. [THIS EXHIBIT HAS BEEN FURNISHED AND SHALL NOT BE
DEEMED "FILED" FOR PURPOSES OF SECTION 18 OF THE SECURITIES ACT OF
1934, NOR SHALL IT BE DEEMED INCORPORATED BY REFERENCE IN ANY
FILING UNDER THE SECURITIES ACT OF 1933, EXCEPT AS SHALL BE
EXPRESSLY SET FORTH BY SPECIFIC REFERENCE IN SUCH FILING.]
37 ALLETE Second Quarter 2005 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.
July 29, 2005 James K. Vizanko
-------------------------------------------------
James K. Vizanko
Senior Vice President and Chief Financial Officer
July 29, 2005 Mark A. Schober
-------------------------------------------------
Mark A. Schober
Senior Vice President and Controller
ALLETE Second Quarter 2005 Form 10-Q 38
EXHIBIT INDEX
EXHIBIT
NUMBER
- --------------------------------------------------------------------------------
10 Director Compensation Summary.
31(a) Rule 13a-14(a)/15d-14(a) Certification by the Chief Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31(b) Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32 Section 1350 Certification of Periodic Report by the Chief Executive
Officer and Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99 ALLETE News Release dated July 29, 2005, announcing 2005 second
quarter earnings. [THIS EXHIBIT HAS BEEN FURNISHED AND SHALL NOT BE
DEEMED "FILED" FOR PURPOSES OF SECTION 18 OF THE SECURITIES ACT OF
1934, NOR SHALL IT BE DEEMED INCORPORATED BY REFERENCE IN ANY FILING
UNDER THE SECURITIES ACT OF 1933, EXCEPT AS SHALL BE EXPRESSLY SET
FORTH BY SPECIFIC REFERENCE IN SUCH FILING.]
ALLETE Second Quarter 2005 Form 10-Q