SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
/X/ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended SEPTEMBER 30, 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
----- -----
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes No X
----- -----
Common Stock, no par value,
30,080,481 shares outstanding
as of September 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 -
September 30, 2005 and December 31, 2004 4
Consolidated Statement of Income -
Quarter and Nine Months Ended September 30, 2005 and 2004 5
Consolidated Statement of Cash Flows -
Nine Months Ended September 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 36
Item 4. Controls and Procedures 37
Part II. Other Information
Item 1. Legal Proceedings 38
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds 38
Item 3. Defaults Upon Senior Securities 38
Item 4. Submission of Matters to a Vote of Security Holders 38
Item 5. Other Information 38
Item 6. Exhibits 40
Signatures 41
1 ALLETE Third 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.
AREA Arrowhead Regional Emission Abatement
ATC American Transmission Company
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)
Northwest Airlines Northwest Airlines, Inc.
Note ___ Note ___ to the consolidated financial
statements in this Form 10-Q
NOx Nitrogen oxide
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.
SO2 Sulfur Dioxide
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
Tomoka Holdings Tomoka Holdings, LLC
Town Center Town Center at Palm Coast development
project in Florida
WDNR Wisconsin Department of Natural
Resources
ALLETE Third 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 under the heading "Factors that May Affect Future Results" in Item 7
of our 2004 Form 10-K and Item 2 of this Form 10-Q. 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 Third Quarter 2005 Form 10-Q
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLETE
CONSOLIDATED BALANCE SHEET
Millions - Unaudited
SEPTEMBER 30, DECEMBER 31,
2005 2004
- ----------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and Cash Equivalents $ 91.4 $ 44.9
Restricted Cash - 30.3
Short-Term Investments 66.8 149.2
Accounts Receivable (Less Allowance of $2.0 and $2.0) 66.9 86.1
Inventories 37.3 34.0
Prepayments and Other 22.3 21.6
Deferred Income Taxes 25.8 -
Discontinued Operations 0.6 2.0
- ----------------------------------------------------------------------------------------------------------------------
Total Current Assets 311.1 368.1
Property, Plant and Equipment - Net 886.6 883.1
Investments 126.8 124.5
Other Assets 46.9 52.8
Discontinued Operations 2.2 2.9
- ----------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $1,373.6 $1,431.4
- ----------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Current Liabilities
Accounts Payable $ 33.4 $ 40.0
Accrued Taxes 24.7 23.3
Accrued Interest 4.7 6.9
Long-Term Debt Due Within One Year 1.6 1.8
Deferred Profit on Sales of Real Estate 9.4 1.1
Other 20.7 24.7
Discontinued Operations 3.9 12.0
- ----------------------------------------------------------------------------------------------------------------------
Total Current Liabilities 98.4 109.8
Long-Term Debt 389.0 390.2
Deferred Income Taxes 134.0 143.9
Other Liabilities 156.8 151.4
Minority Interest 6.8 5.6
- ----------------------------------------------------------------------------------------------------------------------
Total Liabilities 785.0 800.9
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COMMITMENTS AND CONTINGENCIES
- ----------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Common Stock Without Par Value, 43.3 Shares Authorized
30.1 and 29.7 Shares Outstanding 417.1 400.1
Unearned ESOP Shares (78.1) (51.4)
Accumulated Other Comprehensive Loss (11.0) (11.4)
Retained Earnings 260.6 293.2
- ----------------------------------------------------------------------------------------------------------------------
Total Shareholders' Equity 588.6 630.5
- ----------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,373.6 $1,431.4
- ----------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
ALLETE Third Quarter 2005 Form 10-Q 4
ALLETE
CONSOLIDATED STATEMENT OF INCOME
Millions Except Per Share Amounts - Unaudited
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
- ----------------------------------------------------------------------------------------------------------------------
OPERATING REVENUE $187.0 $177.6 $580.7 $572.8
- ----------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Fuel and Purchased Power 66.9 71.9 206.3 218.0
Operating and Maintenance 74.5 70.1 239.2 230.9
Kendall County Charge - - 77.9 -
Depreciation 12.7 12.3 38.0 37.2
- ----------------------------------------------------------------------------------------------------------------------
Total Operating Expenses 154.1 154.3 561.4 486.1
- ----------------------------------------------------------------------------------------------------------------------
OPERATING INCOME FROM CONTINUING OPERATIONS 32.9 23.3 19.3 86.7
- ----------------------------------------------------------------------------------------------------------------------
OTHER INCOME (EXPENSE)
Interest Expense (6.7) (7.5) (20.2) (25.7)
Other 0.4 (18.3) (2.3) (21.4)
- ----------------------------------------------------------------------------------------------------------------------
Total Other Expense (6.3) (25.8) (22.5) (47.1)
- ----------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE MINORITY INTEREST AND INCOME TAXES 26.6 (2.5) (3.2) 39.6
MINORITY INTEREST 1.0 0.1 2.4 2.0
- ----------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES 25.6 (2.6) (5.6) 37.6
INCOME TAX EXPENSE (BENEFIT) 9.8 (2.0) 0.2 14.4
- ----------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE CHANGE IN ACCOUNTING PRINCIPLE 15.8 (0.6) (5.8) 23.2
INCOME (LOSS) FROM DISCONTINUED OPERATIONS - NET OF TAX (0.6) 13.7 (1.9) 79.3
CHANGE IN ACCOUNTING PRINCIPLE - NET OF TAX - - - (7.8)
- ----------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ 15.2 $ 13.1 $(7.7) $ 94.7
- ----------------------------------------------------------------------------------------------------------------------
AVERAGE SHARES OF COMMON STOCK
Basic 27.4 28.5 27.3 28.3
Diluted 27.5 28.6 27.3 28.5
- ----------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS (LOSS) PER SHARE OF COMMON STOCK
Continuing Operations $0.58 $(0.03) $(0.21) $0.82
Discontinued Operations (0.02) 0.48 (0.07) 2.80
Change in Accounting Principle - - - (0.28)
- ----------------------------------------------------------------------------------------------------------------------
$0.56 $ 0.45 $(0.28) $3.34
- ----------------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS (LOSS) PER SHARE OF COMMON STOCK
Continuing Operations $0.58 $(0.02) $(0.21) $0.82
Discontinued Operations (0.02) 0.47 (0.07) 2.78
Change in Accounting Principle - - - (0.27)
- ----------------------------------------------------------------------------------------------------------------------
$0.56 $ 0.45 $(0.28) $3.33
- ----------------------------------------------------------------------------------------------------------------------
DIVIDENDS PER SHARE OF COMMON STOCK $0.3150 $0.8475 $0.9300 $2.5425
- ----------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
5 ALLETE Third Quarter 2005 Form 10-Q
ALLETE
CONSOLIDATED STATEMENT OF CASH FLOWS
Millions - Unaudited
NINE MONTHS ENDED
SEPTEMBER 30,
2005 2004
- ----------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Income (Loss) from Continuing Operations
Before Change in Accounting Principle $ (5.8) $ 15.4
Change in Accounting Principle - 7.8
Loss on Impairment of Investments 5.1 5.5
Depreciation 38.0 37.2
Deferred Income Taxes (37.3) (2.8)
Minority Interest 1.2 (1.6)
Changes in Operating Assets and Liabilities
Accounts Receivable 19.2 (8.7)
Inventories (3.3) (6.7)
Prepayments and Other (0.7) (2.9)
Accounts Payable (6.6) (1.1)
Other Current Liabilities 3.5 (23.0)
Other Assets 5.9 (0.2)
Other Liabilities 10.7 3.1
Net Operating Activities from (for) Discontinued Operations (9.2) 119.9
- ----------------------------------------------------------------------------------------------------------------------
Cash from Operating Activities 20.7 141.9
- ----------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Proceeds from Sale of Available-For-Sale Securities 323.5 1.6
Payments for Purchase of Available-For-Sale Securities (241.0) (76.2)
Changes to Investments (5.0) 10.2
Additions to Property, Plant and Equipment (40.4) (48.8)
Other (3.1) 5.1
Net Investing Activities from Discontinued Operations - 60.1
- ----------------------------------------------------------------------------------------------------------------------
Cash from (for) Investing Activities 34.0 (48.0)
- ----------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Issuance of Common Stock 17.0 38.5
Issuance of Long-Term Debt 35.0 119.6
Changes in Notes Payable - Net - (53.0)
Reductions of Long-Term Debt (36.4) (240.9)
Dividends on Common Stock (24.9) (71.3)
Net Financing Activities for Discontinued Operations (0.1) (18.6)
- ----------------------------------------------------------------------------------------------------------------------
Cash for Financing Activities (9.4) (225.7)
- ----------------------------------------------------------------------------------------------------------------------
CHANGE IN CASH AND CASH EQUIVALENTS 45.3 (131.8)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD <F1> 46.1 229.5
- ----------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD <F1> $ 91.4 $ 97.7
- ----------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL CASH FLOW INFORMATION
Cash Paid During the Period for
Interest - Net of Amounts Capitalized $28.5 $42.8
Income Taxes $23.9 $61.8
- ----------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Included $0 of cash from Discontinued Operations at September 30, 2005 ($1.2 million at September 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 Third 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 are not necessarily
indicative of the results to be expected for the full 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 and is included in Investments on our
consolidated balance sheet. 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, impairments 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 our Form 10-Q for the quarterly period ended June 30, 2005, 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. We have also made
corresponding adjustments to our Consolidated Statement of Cash Flows for the
period ended September 30, 2004, to reflect the gross purchases and sales of
these securities as investing activities rather than as a component of cash and
cash equivalents. This change in classification does not affect 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 September 30, 2005 and December 31, 2004, we held
$66.8 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 Third Quarter 2005 Form 10-Q
NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INVENTORIES. Inventories are stated at the lower of cost or market. Cost is
determined by the average cost method.
SEPTEMBER 30, DECEMBER 31,
INVENTORIES 2005 2004
- ----------------------------------------------------------------------------------------------------------------------
MILLIONS
Fuel $13.2 $11.4
Materials and Supplies 22.4 20.4
Other 1.7 2.2
- ----------------------------------------------------------------------------------------------------------------------
$37.3 $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 $1.1 million for the nine months ended September 30,
2005 ($0.8 million for the nine months ended September 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 NINE MONTHS ENDED
EFFECT OF SFAS 123 SEPTEMBER 30, SEPTEMBER 30,
ACCOUNTING FOR STOCK-BASED COMPENSATION 2005 2004 2005 2004
- ----------------------------------------------------------------------------------------------------------------------
Millions Except Per Share Amounts
Net Income (Loss)
As Reported $15.2 $13.1 $(7.7) $94.7
Plus: Employee Stock Compensation Expense
Included in Net Income (Loss) - Net of Tax 0.5 - 1.1 0.8
Less: Employee Stock Compensation Expense
Determined Under SFAS 123 - Net of Tax 0.5 - 1.2 1.0
- ----------------------------------------------------------------------------------------------------------------------
Pro Forma Net Income (Loss) $15.2 $13.1 $(7.8) $94.5
- ----------------------------------------------------------------------------------------------------------------------
Basic Earnings (Loss) Per Share
As Reported $0.56 $0.45 $(0.28) $3.34
Pro Forma $0.56 $0.45 $(0.29) $3.34
Diluted Earnings (Loss) Per Share
As Reported $0.56 $0.45 $(0.28) $3.33
Pro Forma $0.56 $0.45 $(0.29) $3.32
- ----------------------------------------------------------------------------------------------------------------------
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 Third Quarter 2005 Form 10-Q 8
NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NEW ACCOUNTING STANDARDS. SFAS 123(R). In December 2004, the FASB issued SFAS
123(R), "Share-Based Payment," which will be effective for enterprises beginning
with the first interim or annual reporting period of the registrants' first
fiscal year beginning on or after June 15, 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 expect to
implement SFAS 123(R) beginning January 1, 2006, and do not believe it will have
a material impact on our financial position, results of operations or cash
flows.
The FASB has clarified the adoption of SFAS 123(R) with FSP SFAS 123(R)-1
"Classification and Measurement of Freestanding Financial Instruments Originally
Issued in Exchange for Employee Services under FASB Statement No. 123(R)" and
FSP SFAS 123(R)-2 "Practical Accommodation to the Application of Grant Date as
Defined in FASB Statement No. 123(R)." These staff positions clarify the
implementation of SFAS 123(R). We do not believe they will have a material
impact on the Company.
The FASB has proposed FSP SFAS 123(R)-c "Transition Election Related to
Accounting for the Tax Effects of Share-Based Payment Awards." This proposed
staff position provides for an alternate method for the implementation of SFAS
123(R). We do not believe it will have a material impact on the Company.
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. 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 be 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.
9 ALLETE Third Quarter 2005 Form 10-Q
NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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
that adoption will have a material impact.
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 SEPTEMBER 30, 2005
Operating Revenue $187.0 $137.4 $28.7 $11.2 $ 9.7
Fuel and Purchased Power 66.9 60.4 6.5 - -
Operating and Maintenance 74.5 45.5 16.6 2.8 9.6
Depreciation Expense 12.7 9.9 1.9 0.1 0.8
- ----------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing
Operations 32.9 21.6 3.7 8.3 (0.7)
Interest Expense (6.7) (4.3) (1.8) (0.1) (0.5)
Other Income 0.4 - 0.1 - 0.3
- ----------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Minority Interest and Income
Taxes 26.6 17.3 2.0 8.2 (0.9)
Minority Interest 1.0 - - 1.0 -
- ----------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Income Taxes 25.6 17.3 2.0 7.2 (0.9)
Income Tax Expense (Benefit) 9.8 6.7 0.4 3.2 (0.5)
- ----------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations 15.8 $ 10.6 $ 1.6 $ 4.0 $(0.4)
--------------------------------------------------------
Loss from Discontinued Operations -
Net of Tax (0.6)
- ----------------------------------------------------------
Net Income $ 15.2
- ----------------------------------------------------------
FOR THE QUARTER ENDED SEPTEMBER 30, 2004
Operating Revenue $177.6 $136.1 $25.5 $5.2 $ 10.8
Fuel and Purchased Power 71.9 63.4 8.5 - -
Operating and Maintenance 70.1 44.1 13.1 2.5 10.4
Depreciation Expense 12.3 9.7 1.9 - 0.7
- ----------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing
Operations 23.3 18.9 2.0 2.7 (0.3)
Interest Expense (7.5) (5.0) (1.4) (0.1) (1.0)
Other Income (Expense) (18.3) - 0.3 - (18.6)
- ----------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Minority Interest and Income
Taxes (2.5) 13.9 0.9 2.6 (19.9)
Minority Interest 0.1 - - 0.1 -
- ----------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Income Taxes (2.6) 13.9 0.9 2.5 (19.9)
Income Tax Expense (Benefit) (2.0) 5.7 0.2 1.0 (8.9)
- ----------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations (0.6) $ 8.2 $ 0.7 $1.5 $(11.0)
--------------------------------------------------------
Income from Discontinued Operations -
Net of Tax 13.7
- ----------------------------------------------------------
Net Income $ 13.1
- ----------------------------------------------------------
ALLETE Third Quarter 2005 Form 10-Q 10
NOTE 2. BUSINESS SEGMENTS (CONTINUED)
NONREGULATED
REGULATED ENERGY REAL
CONSOLIDATED UTILITY OPERATIONS ESTATE OTHER
- ----------------------------------------------------------------------------------------------------------------------
Millions
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005
Operating Revenue $580.7 $422.8 $83.1 $38.9 $35.9
Fuel and Purchased Power 206.3 186.5 19.8 - -
Operating and Maintenance 239.2 143.1 49.3 12.3 34.5
Kendall County Charge 77.9 - 77.9 - -
Depreciation Expense 38.0 29.5 6.0 0.1 2.4
- ----------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing
Operations 19.3 63.7 (69.9) 26.5 (1.0)
Interest Expense (20.2) (13.0) (4.7) (0.3) (2.2)
Other Income (Expense) (2.3) 0.4 0.3 - (3.0)
- ----------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Minority Interest and Income
Taxes (3.2) 51.1 (74.3) 26.2 (6.2)
Minority Interest 2.4 - - 2.4 -
- ----------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Income Taxes (5.6) 51.1 (74.3) 23.8 (6.2)
Income Tax Expense (Benefit) 0.2 19.8 (27.0) 10.1 (2.7)
- ----------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations (5.8) $ 31.3 $(47.3) $13.7 $(3.5)
--------------------------------------------------------
Loss from Discontinued Operations -
Net of Tax (1.9)
- ----------------------------------------------------------
Net Loss $ (7.7)
- ----------------------------------------------------------
Total Assets $1,373.6 <F1> $899.6 $183.4 $77.1 $210.7
Property, Plant and Equipment - Net $886.6 $729.5 $117.6 - $39.5
Accumulated Depreciation $800.6 $742.7 $45.0 - $12.9
Capital Expenditures $40.4 <F1> $31.1 $6.0 - $3.3
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004
Operating Revenue $572.8 $414.3 $81.1 $39.6 $ 37.8
Fuel and Purchased Power 218.0 186.4 31.6 - -
Operating and Maintenance 230.9 138.7 41.4 12.7 38.1
Depreciation Expense 37.2 29.5 5.6 - 2.1
- ----------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing
Operations 86.7 59.7 2.5 26.9 (2.4)
Interest Expense (25.7) (14.3) (3.8) (0.2) (7.4)
Other Income (Expense) (21.4) 0.1 1.2 - (22.7)
- ----------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Minority Interest and Income
Taxes 39.6 45.5 (0.1) 26.7 (32.5)
Minority Interest 2.0 - - 2.0 -
- ----------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Income Taxes 37.6 45.5 (0.1) 24.7 (32.5)
Income Tax Expense (Benefit) 14.4 17.4 (0.7) 10.2 (12.5)
- ----------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations 23.2 $ 28.1 $ 0.6 $14.5 $(20.0)
--------------------------------------------------------
Income from Discontinued Operations -
Net of Tax 79.3
Change in Accounting Principle (7.8)
- ----------------------------------------------------------
Net Income $ 94.7
- ----------------------------------------------------------
Total Assets $1,449.3 <F1> $919.6 $161.3 $74.8 $285.6
Property, Plant and Equipment - Net $885.0 $729.6 $117.1 - $38.3
Accumulated Depreciation $766.6 $717.6 $40.1 - $8.9
Capital Expenditures $65.0 <F1> $32.8 $11.5 - $4.5
- ----------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Discontinued Operations represented $2.8 million of total assets in 2005 ($8.0 million in 2004) and $0 of capital
expenditures in 2005 ($16.2 million in 2004).
</FN>
11 ALLETE Third Quarter 2005 Form 10-Q
NOTE 3. INVESTMENTS
At September 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.
SEPTEMBER 30, DECEMBER 31,
INVESTMENTS 2005 2004
- ----------------------------------------------------------------------------------------------------------------------
Millions
Real Estate Assets $ 77.1 $ 75.1
Debt and Equity Securities 40.5 35.8
Emerging Technology Investments 9.2 13.6
- ----------------------------------------------------------------------------------------------------------------------
$ 126.8 $ 124.5
- ----------------------------------------------------------------------------------------------------------------------
REAL ESTATE. At September 30, 2005, real estate assets included land of $45.8
million ($47.2 million at December 31, 2004), long-term finance receivables of
$13.3 million ($9.7 million at December 31, 2004) and $18.0 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 September 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 impairments 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 September 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
September 30, 2005.
On August 1, 2005, ALLETE issued $35 million of its first mortgage bonds, which
carry an interest rate of 5.28% and have a term of 15 years. On August 2, 2005,
we used proceeds from these newly issued bonds to redeem $35 million in
principal amount of First Mortgage Bonds, 7 1/2% Series due 2007.
On October 6, 2005, ALLETE accepted an offer from certain institutional buyers
in the private placement market to purchase $50 million of ALLETE's first
mortgage bonds. When issued, on or about March 1, 2006, the bonds will carry an
interest rate of 5.69% and will have a term of 30 years. ALLETE intends to use
the proceeds from the bonds to redeem a portion of ALLETE's outstanding debt.
ALLETE Third Quarter 2005 Form 10-Q 12
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 carryback
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.
NOTE 6. OTHER INCOME (EXPENSE)
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
- ----------------------------------------------------------------------------------------------------------------------
Millions
Debt Prepayment Premium and Unamortized
Debt Issuance Costs - $(18.5) - $(18.5)
Loss on Emerging Technology Investments $(0.1) (1.0) $(5.9) (6.9)
Investment and Other Income 0.5 1.2 3.6 4.0
- ----------------------------------------------------------------------------------------------------------------------
$ 0.4 $(18.3) $(2.3) $(21.4)
- ----------------------------------------------------------------------------------------------------------------------
NOTE 7. INCOME TAX EXPENSE
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
- ----------------------------------------------------------------------------------------------------------------------
Millions
Current Tax Expense
Federal $ 10.7 $0.4 $30.6 <F1> $11.7
State 2.4 1.1 6.9 <F1> 5.5
- ----------------------------------------------------------------------------------------------------------------------
13.1 1.5 37.5 17.2
- ----------------------------------------------------------------------------------------------------------------------
Deferred Tax Benefit
Federal (2.5) (2.2) (35.1) <F1> (0.5)
State (0.5) (1.1) (1.2) (1.3)
- ----------------------------------------------------------------------------------------------------------------------
(3.0) (3.3) (36.3) (1.8)
- ----------------------------------------------------------------------------------------------------------------------
Deferred Tax Credits (0.3) (0.2) (1.0) (1.0)
- ----------------------------------------------------------------------------------------------------------------------
Income Tax Expense (Benefit) on Continuing Operations 9.8 (2.0) 0.2 14.4
Income Tax Expense (Benefit) on Discontinued Operations (0.3) 11.0 (0.8) 60.3
Income Tax Benefit on Change in Accounting Principle - - - (5.5)
- ----------------------------------------------------------------------------------------------------------------------
Total Income Tax Expense (Benefit) $ 9.5 $9.0 $(0.6) $69.2
- ----------------------------------------------------------------------------------------------------------------------
<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 nine months ended September 30, 2005, the effective rate for income
taxes deviated from the statutory rate, primarily as a result of the emerging
technology investment impairments 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 and,
accordingly, are fully offset by a valuation allowance. 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 nine months ended
September 30, 2004, deviated from the statutory rate due to nondeductible
transaction costs related to the spin-off of Automotive Services.
13 ALLETE Third Quarter 2005 Form 10-Q
NOTE 8. DISCONTINUED OPERATIONS
AUTOMOTIVE SERVICES. On September 20, 2004, the spin-off of our Automotive
Services business (ADESA), 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 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 mid to late
December 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 and other expenses to
support transfer proceedings with the FPSC.
QUARTER ENDED NINE MONTHS ENDED
DISCONTINUED OPERATIONS SEPTEMBER 30, SEPTEMBER 30,
SUMMARY INCOME STATEMENT 2005 2004 2005 2004
- ----------------------------------------------------------------------------------------------------------------------
Millions
Operating Revenue
Automotive Services - $201.9 - $681.7
Water Services - 1.2 - 16.3
- ----------------------------------------------------------------------------------------------------------------------
- $203.1 - $698.0
- ----------------------------------------------------------------------------------------------------------------------
Pre-Tax Income (Loss) from Operations
Automotive Services - $25.8 - $132.8
Water Services - (0.7) - (0.9)
- ----------------------------------------------------------------------------------------------------------------------
- 25.1 - 131.9
- ----------------------------------------------------------------------------------------------------------------------
Income Tax Expense (Benefit)
Automotive Services - 11.4 - 54.0
Water Services - (0.3) - (0.3)
- ----------------------------------------------------------------------------------------------------------------------
- 11.1 - 53.7
- ----------------------------------------------------------------------------------------------------------------------
Total Net Income from Operations - 14.0 - 78.2
- ----------------------------------------------------------------------------------------------------------------------
Gain (Loss) on Disposal
Automotive Services - (0.1) - (6.7)
Water Services $(0.9) (0.3) $(2.7) 14.4
- ----------------------------------------------------------------------------------------------------------------------
(0.9) (0.4) (2.7) 7.7
- ----------------------------------------------------------------------------------------------------------------------
Income Tax Expense (Benefit)
Automotive Services - - - (2.6)
Water Services (0.3) (0.1) (0.8) 9.2
- ----------------------------------------------------------------------------------------------------------------------
(0.3) (0.1) (0.8) 6.6
- ----------------------------------------------------------------------------------------------------------------------
Net Gain (Loss) on Disposal (0.6) (0.3) (1.9) 1.1
- ----------------------------------------------------------------------------------------------------------------------
Income (Loss) from Discontinued Operations $(0.6) $13.7 $(1.9) $ 79.3
- ----------------------------------------------------------------------------------------------------------------------
ALLETE Third Quarter 2005 Form 10-Q 14
NOTE 8. DISCONTINUED OPERATIONS (CONTINUED)
DISCONTINUED OPERATIONS SEPTEMBER 30, DECEMBER 31,
SUMMARY BALANCE SHEET INFORMATION 2005 2004
- ----------------------------------------------------------------------------------------------------------------------
Millions
Assets of Discontinued Operations
Cash and Cash Equivalents - $1.2
Other Current Assets $0.6 $0.8
Property, Plant and Equipment $2.2 $2.9
Liabilities of Discontinued Operations
Current Liabilities $3.9 $12.0
- ----------------------------------------------------------------------------------------------------------------------
NOTE 9. COMPREHENSIVE INCOME (LOSS)
For the quarter ended September 30, 2005, total comprehensive income (loss), net
of tax, was comprehensive income of $15.6 million (a $3.7 million comprehensive
loss, net of tax, for the quarter ended September 30, 2004). For the nine months
ended September 30, 2005, total comprehensive income (loss), net of tax, was a
$7.3 million loss ($71.8 million of comprehensive income, net of tax, for the
nine months ended September 30, 2004). Total comprehensive income (loss)
includes net income (loss), unrealized gains and losses on securities classified
as available-for-sale, and additional pension liability.
ACCUMULATED OTHER COMPREHENSIVE SEPTEMBER 30,
INCOME (LOSS) - NET OF TAX 2005 2004
- ----------------------------------------------------------------------------------------------------------------------
Millions
Unrealized Gain on Securities $ 1.9 $ 1.4
Additional Pension Liability (12.9) (9.8)
- ----------------------------------------------------------------------------------------------------------------------
$(11.0) $(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," for the nine months ended September 30,
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 nine months ended September 30, 2005. At September 30, 2004, 0.1 million
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 SEPTEMBER 30,
Income (Loss) from Continuing Operations
Before Change in Accounting Principle $15.8 - $15.8 $(0.6) - $(0.6)
Common Shares 27.4 0.1 27.5 28.5 0.1 28.6
Per Share from Continuing Operations $0.58 - $0.58 $(0.03) - $(0.02)
- ----------------------------------------------------------------------------------------------------------------------
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
Income (Loss) from Continuing Operations
Before Change in Accounting Principle $(5.8) - $(5.8) $23.2 - $23.2
Common Shares 27.3 - 27.3 28.3 0.2 28.5
Per Share from Continuing Operations $(0.21) - $(0.21) $0.82 - $0.82
- ----------------------------------------------------------------------------------------------------------------------
15 ALLETE Third 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 SEPTEMBER 30,
Service Cost $2.1 $2.1 $1.1 $0.9
Interest Cost 5.4 5.2 1.6 1.6
Expected Return on Plan Assets (7.0) (6.9) (1.2) (1.2)
Amortization of Prior Service Costs 0.2 0.2 - -
Amortization of Net Loss 0.7 0.4 0.2 0.1
Amortization of Transition Obligation - 0.1 0.6 0.6
- ----------------------------------------------------------------------------------------------------------------------
Periodic Benefit Expense $1.4 $1.1 $2.3 $2.0
- ----------------------------------------------------------------------------------------------------------------------
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
Service Cost $ 6.5 $ 6.3 $3.1 $3.0
Interest Cost 16.0 15.6 4.9 5.0
Expected Return on Plan Assets (21.2) (20.7) (3.6) (3.4)
Amortization of Prior Service Costs 0.6 0.6 - -
Amortization of Net Loss 2.3 1.2 0.6 0.4
Amortization of Transition Obligation 0.1 0.2 1.9 1.8
- ----------------------------------------------------------------------------------------------------------------------
Periodic Benefit Expense $ 4.3 $ 3.2 $6.9 $6.8
- ----------------------------------------------------------------------------------------------------------------------
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 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 each of the
quarters ended September 30, 2005 and 2004, and $1.5 million for the nine months
ended September 30, 2005 ($1.0 million for the nine months ended September 30,
2004).
In 2005, we determined that our postretirement health care plans meet the
requirements of the Centers for Medicare and Medicaid Services' (CMS)
regulations, and are in the process of enrolling with the CMS to begin
recovering the subsidy in 2006.
ALLETE Third 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 Automotive
Services, 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 September 30, 2005, there were 2,614,140 unallocated
shares of ALLETE common stock in the ESOP (2,001,505 shares at December 31,
2004), which reflected 759,725 shares purchased and 147,090 shares allocated or
used for plan expenses during the first nine months of 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. In September 2005, the RSOP's independent trustee directed the
sale of the approximately 1.4 million shares of ADESA common stock that remained
invested in the RSOP participants' ADESA common stock funds at September 1,
2005. Proceeds from the sale of the ADESA common stock were $30.4 million, of
which the majority was used to purchase ALLETE common stock as required by the
terms of the RSOP. The process was completed on October 26, 2005. Proceeds
totaling $28.5 million were used to purchase a total of 644,450 shares of ALLETE
common stock (289,900 shares in September 2005; 354,550 shares in October 2005).
17 ALLETE Third 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 September 30, 2005, Square Butte had total debt
outstanding of $310.9 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, RAIL 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, rail and shipping
agreements are currently $40.5 million in 2005, $13.0 million in 2006, $9.7
million in 2007, $10.1 million in 2008 and $10.2 million in 2009. Upon
finalization of our nominations for coal deliveries during 2006, our minimum
annual payment obligations will increase; and once annual nominations are made
for coal deliveries during 2007, 2008 and 2009, our minimum annual payment
obligations during each of those years are also expected to increase.
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 September 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 $3.2 million
at September 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 Third 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 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 investigation was performed in September
and October of 2005 to further delineate the extent of the contamination. It is
anticipated that the final report for this portion of the investigation will be
completed in mid-2006. 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 - FISH IMPINGEMENT/ENTRAINMENT REDUCTION STANDARDS. 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 by specific percentages 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 fish impingement reduction
requirements apply to the Boswell, Laskin, Hibbard and Square Butte generating
facilities. Both impingement and entrainment reduction standards 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 timeframe. 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 to comply with the rule.
19 ALLETE Third 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 SO2, 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
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 of 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, in July 2005, Minnesota Power filed a Petition for Review with the
U.S. Court of Appeals for the District of Columbia Circuit. We also have filed 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. ALLETE guarantees $1.0 million of Northwest Airlines, Inc.'s
(Northwest Airlines) payments of principal and interest on $24.7 million of
"Duluth Airport Lease Revenue Bonds" (to be paid out of lease revenue from
Northwest Airlines to the Duluth Economic Development Authority). If Northwest
Airlines is delinquent in their rent payments, the bond trustee may draw on the
collateral of ALLETE to make the payment. ALLETE's collateral, in lieu of cash,
is a letter of credit in favor of the State of Minnesota. Although ALLETE would
have a claim to reimbursement for any draws on its letter of credit, we are
uncertain about the sufficiency of the security supporting our right to
reimbursement. ALLETE shares its security interest with the State of Minnesota,
St. Louis County and the City of Duluth. In September 2005, following Northwest
Airlines' bankruptcy filing and its default on other obligations, we recorded a
$1.0 million ($0.6 million after tax) charge to recognize the probable payment
of this guarantee.
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 Third 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) primarily 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 assigned to Constellation Energy Commodities in
April 2005. (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,
spin-off costs incurred by ALLETE and our Water Services businesses.
We provide financial statements that are prepared in accordance with GAAP. Along
with this information, we disclose and discuss certain pro forma financial
information in our quarterly earnings releases, on investor conference calls and
during investor conferences and related events. Management believes that pro
forma financial data supplements our GAAP financial statements by providing
investors with additional information which enhances the investors' overall
understanding of our financial performance and the comparability of our
operating results from period to period. The presentation of this additional
information is not meant to be considered in isolation or as a substitute for
results prepared in accordance with GAAP.
Financial results for the periods discussed in this Form 10-Q were significantly
impacted by the following two transactions:
- KENDALL COUNTY CHARGE. In the second quarter of 2005, we completed the
assignment of our Kendall County power purchase agreement to Constellation
Energy Commodities, which was a key strategic accomplishment for the Company
because it eliminated recurring operating losses. 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) (Kendall County
Charge).
- DEBT PREPAYMENT COST. In the third quarter of 2004, we incurred an $18.5
million ($10.9 million after tax, or $0.38 per diluted share) debt prepayment
cost as part of ALLETE's financial restructuring in preparation for the
spin-off of Automotive Services.
Since the April 2005 Kendall County Charge and the July 2004 debt prepayment
cost significantly impacted the financial results from continuing operations for
the periods discussed in this Form 10-Q, we believe that for comparative
purposes, it is useful to present earnings for each applicable period excluding
the impact of these two transactions. The table below reflects actual results
adjusted for the exclusion of the 2005 Kendall County Charge and the 2004 debt
prepayment cost.
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
- ----------------------------------------------------------------------------------------------------------------------
Millions
Income (Loss) from Continuing Operations Before
Change in Accounting Principle $15.8 $(0.6) $(5.8) $ 23.2
Add Back: Kendall County Charge - - 50.4 -
Debt Prepayment Cost - 10.9 - 10.9
- ----------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations Before
Change in Accounting Principle Excluding
Kendall County Charge and Debt Prepayment Cost 15.8 10.3 44.6 34.1
Income (Loss) from Discontinued Operations (0.6) 13.7 (1.9) 79.3
Change in Accounting Principle - - - (7.8)
- ----------------------------------------------------------------------------------------------------------------------
$15.2 $24.0 $42.7 $105.6
- ----------------------------------------------------------------------------------------------------------------------
21 ALLETE Third Quarter 2005 Form 10-Q
EXECUTIVE SUMMARY (CONTINUED)
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
- ----------------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS (LOSS) PER SHARE OF COMMON STOCK
Continuing Operations Before Change in Accounting Principle $0.58 $(0.02) $(0.21) $0.82
Add Back: Kendall County Charge - - 1.84 -
Debt Prepayment Cost - 0.38 - 0.38
- ----------------------------------------------------------------------------------------------------------------------
Continuing Operations Before Change in Accounting Principle
Excluding Kendall County Charge and Debt Prepayment Cost 0.58 0.36 1.63 1.20
Discontinued Operations (0.02) 0.47 (0.07) 2.78
Change in Accounting Principle - - - (0.27)
- ----------------------------------------------------------------------------------------------------------------------
$0.56 $0.83 $1.56 $3.71
- ----------------------------------------------------------------------------------------------------------------------
Cash flow from continuing operations was significantly impacted by the Kendall
County Charge in 2005, and the debt prepayment cost and discontinued operations
in 2004. Therefore, we believe 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
in 2005, and the debt prepayment cost and discontinued operations in 2004.
CONSOLIDATED CASH FLOW
NINE MONTHS ENDED SEPTEMBER 30, 2005 2004
- ----------------------------------------------------------------------------------------------------------------------
Millions
Cash from Operating Activities $ 20.7 $ 141.9
Add Back: Kendall County Charge 77.9 -
Debt Prepayment Cost - 10.9
Less: Discontinued Operations (9.2) 119.9
- ----------------------------------------------------------------------------------------------------------------------
$107.8 $ 32.9
- ----------------------------------------------------------------------------------------------------------------------
Cash from (for) Investing Activities $34.0 $ (48.0)
Less: Discontinued Operations - 60.1
- ----------------------------------------------------------------------------------------------------------------------
$34.0 $(108.1)
- ----------------------------------------------------------------------------------------------------------------------
Cash for Financing Activities $(9.4) $(225.7)
Add Back: Long-Term Debt Prepaid - 125.0
Less: Discontinued Operations (0.1) (18.6)
- ----------------------------------------------------------------------------------------------------------------------
$(9.3) $ (82.1)
- ----------------------------------------------------------------------------------------------------------------------
Excluding the 2004 debt prepayment cost, income from continuing operations and
diluted earnings per share for the quarter ended September 30, 2005, increased
53 percent and 61 percent, respectively, from the same period 2004. Strong
electric sales and continued strong demand for real estate contributed to higher
earnings during the third quarter of 2005.
Excluding the 2005 Kendall County Charge and the 2004 debt prepayment cost,
income from continuing operations and diluted earnings per share for the nine
months ended September 30, 2005, increased 31 percent and 36 percent,
respectively, from the same period in 2004. The increase in 2005 reflected
continued strong electric sales, 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.
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 2005 Kendall County Charge and the 2004 debt prepayment cost, in
total, net income and diluted earnings per share for the quarter ended September
30, 2005, were down 37 percent and 33 percent, respectively, from the comparable
period in 2004, and for the nine months ended September 30, 2005, were down 60
percent and 58 percent, respectively, from the comparable period in 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 Third Quarter 2005 Form 10-Q 22
EXECUTIVE SUMMARY (CONTINUED)
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
- ----------------------------------------------------------------------------------------------------------------------
Millions Except Per Share Amounts
Operating Revenue
Regulated Utility $137.4 $136.1 $422.8 $414.3
Nonregulated Energy Operations 28.7 25.5 83.1 81.1
Real Estate 11.2 5.2 38.9 39.6
Other 9.7 10.8 35.9 37.8
- ----------------------------------------------------------------------------------------------------------------------
$187.0 $177.6 $580.7 $572.8
- ----------------------------------------------------------------------------------------------------------------------
Operating Expenses
Regulated Utility $115.8 $117.2 $359.1 $354.6
Nonregulated Energy Operations 25.0 23.5 153.0 <F1> 78.6
Real Estate 2.9 2.5 12.4 12.7
Other 10.4 11.1 36.9 40.2
- ----------------------------------------------------------------------------------------------------------------------
$154.1 $154.3 $561.4 $486.1
- ----------------------------------------------------------------------------------------------------------------------
Interest Expense
Regulated Utility $4.3 $5.0 $13.0 $14.3
Nonregulated Energy Operations 1.8 1.4 4.7 3.8
Real Estate 0.1 0.1 0.3 0.2
Other 0.5 1.0 2.2 7.4
- ----------------------------------------------------------------------------------------------------------------------
$6.7 $7.5 $20.2 $25.7
- ----------------------------------------------------------------------------------------------------------------------
Other Income (Expense)
Regulated Utility - - $ 0.4 $ 0.1
Nonregulated Energy Operations $0.1 $ 0.3 0.3 1.2
Other 0.3 (18.6) <F2> (3.0) (22.7) <F2>
- ----------------------------------------------------------------------------------------------------------------------
$0.4 $(18.3) $(2.3) $(21.4)
- ----------------------------------------------------------------------------------------------------------------------
Net Income (Loss)
Regulated Utility $10.6 $ 8.2 $31.3 $ 28.1
Nonregulated Energy Operations 1.6 0.7 (47.3) <F1> 0.6
Real Estate 4.0 1.5 13.7 14.5
Other (0.4) (11.0) <F2> (3.5) (20.0) <F2>
- ----------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations 15.8 (0.6) (5.8) 23.2
Income (Loss) from Discontinued Operations (0.6) 13.7 (1.9) 79.3
Change in Accounting Principle - - - (7.8)
- ----------------------------------------------------------------------------------------------------------------------
Net Income (Loss) $15.2 $ 13.1 $(7.7) $ 94.7
- ----------------------------------------------------------------------------------------------------------------------
Diluted Average Shares of Common Stock 27.5 28.6 27.3 28.5
- ----------------------------------------------------------------------------------------------------------------------
Diluted Earnings (Loss) Per Share of Common Stock
Continuing Operations $0.58 $(0.02) <F2> $(0.21) <F1> $ 0.82 <F2>
Discontinued Operations (0.02) 0.47 (0.07) 2.78
Change in Accounting Principle - - - (0.27)
- ----------------------------------------------------------------------------------------------------------------------
$0.56 $0.45 $(0.28) $ 3.33
- ----------------------------------------------------------------------------------------------------------------------
<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 in April 2005. (See Note 5.)
<F2> Included an $18.5 million ($10.9 million after tax, or $0.38 per share) debt prepayment cost incurred in
July 2004 as part of ALLETE's financial restructuring in preparation for the spin-off of Automotive Services.
</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 Third Quarter 2005 Form 10-Q
EXECUTIVE SUMMARY (CONTINUED)
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
- ----------------------------------------------------------------------------------------------------------------------
KILOWATTHOURS SOLD
Millions
Regulated Utility
Retail and Municipals
Residential 254.5 233.7 804.2 772.8
Commercial 346.6 334.7 986.9 960.9
Industrial 1,782.8 1,736.9 5,306.8 5,273.7
Municipals 236.0 211.1 657.3 613.9
Other 20.7 19.9 59.2 57.9
- ----------------------------------------------------------------------------------------------------------------------
2,640.6 2,536.3 7,814.4 7,679.2
Other Power Suppliers 261.3 260.2 864.9 645.8
- ----------------------------------------------------------------------------------------------------------------------
2,901.9 2,796.5 8,679.3 8,325.0
Nonregulated Energy Operations 405.8 349.4 1,159.6 1,198.0
- ----------------------------------------------------------------------------------------------------------------------
3,307.7 3,145.9 9,838.9 9,523.0
- ----------------------------------------------------------------------------------------------------------------------
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
------------------------------------------------------------------------------------
REAL ESTATE ACTIVITY
CLOSED LAND TRANSACTIONS QTY AMOUNT QTY AMOUNT QTY AMOUNT QTY AMOUNT
- ----------------------------------------------------------------------------------------------------------------------
Dollars in Millions
Town Center Sales <F1>
Commercial Sq. Ft. 246,000 $ 5.0 - - 643,000 $15.1 - -
Residential Units - - - - - - - -
Other Land Sales
Acres 521 7.6 18 $3.7 1,058 32.2 1,445 $30.4
Lots - - - - 7 0.4 211 4.6
- ----------------------------------------------------------------------------------------------------------------------
Contract Sales Price <F2> - 12.6 - 3.7 - 47.7 - 35.0
Deferred Revenue - (2.5) - - - (11.0) - -
Adjustments <F3> - (0.7) - - - (1.6) - -
- ----------------------------------------------------------------------------------------------------------------------
Revenue from Land Sales $ 9.4 $3.7 $35.1 $35.0
- ----------------------------------------------------------------------------------------------------------------------
<FN>
<F1> For the quarter ended September 30, 2005, 27 acres were sold (70 acres for the nine months ended September 30,
2005).
<F2> Reflected total contract sales price. Land sales are recorded using a percentage-of-completion method. (See
Note 1.)
<F3> Primarily contributed development dollars, which are credited to cost of sales.
</FN>
NET INCOME
The following net income discussion summarizes a comparison of the nine months
ended September 30, 2005, to the nine months ended September 30, 2004.
REGULATED UTILITY contributed net income of $31.3 million in 2005 ($28.1 million
in 2004). In 2005, a 34 percent increase in kilowatthour sales to other power
suppliers, higher off-peak prices and continued strong retail electric sales
offset $2.2 million of additional planned maintenance expense at Company
generating facilities.
NONREGULATED ENERGY OPERATIONS reported a net loss of $47.3 million in 2005
($0.6 million of income 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. Nonregulated
Energy Operations in 2005 also reflected the absence of operating losses from
Kendall County and increased net income from coal operations.
ALLETE Third Quarter 2005 Form 10-Q 24
NET INCOME (CONTINUED)
REAL ESTATE contributed net income of $13.7 million in 2005 ($14.5 million in
2004). Lower net income in 2005 was primarily attributed to the deferral of
profit on certain real estate sales. In addition, the timing of the closing of
real estate transactions varies from period to period and impacts comparisons
between periods.
In the second quarter of 2005, we began selling property from our Town Center
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 September 30, 2005, we have $9.4 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 15 months.
At September 30, 2005, total pending land sales under contract were $94.2
million, of which $64.6 million were for properties in Town Center. Pricing on
these contracts range from $20 to $50 per commercial square foot and $15,000 to
$40,000 per residential unit for Town Center, and $8,000 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 other properties under contract are zoned commercial or mixed use.
REAL ESTATE
PENDING CONTRACTS CONTRACT
AT SEPTEMBER 30, 2005 QUANTITY SALES PRICE
- ----------------------------------------------------------------------------------------------------------------------
Dollars in Millions
Town Center
Commercial Sq. Ft. 1,272,500 $37.8
Residential Units 1,294 26.8
Other Land
Acres 1,155 29.6
- ----------------------------------------------------------------------------------------------------------------------
$94.2
- ----------------------------------------------------------------------------------------------------------------------
OTHER reflected a net loss of $3.5 million in 2005 (a $20.0 million net loss in
2004). In 2004, a $10.9 million debt prepayment cost associated with the
retirement of long-term debt was incurred as a part of our financial
restructuring in preparation for the spin-off of Automotive Services. 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
$1.5 million increase in earnings on cash, cash equivalents and short-term
investments. Equity losses from our emerging technology investments were $0.3
million lower than 2004. In 2005, we recognized $3.3 million of impairments
related to our emerging technology investments ($3.2 million in 2004). In 2005,
we also recognized a $0.6 million charge due to the probable payment under our
guarantee of Northwest Airlines debt. (See Note 13.)
DISCONTINUED OPERATIONS reflected a net loss of $1.9 million in 2005 ($79.3
million of net income in 2004). The absence of operations from Automotive
Services, spun off in September 2004, accounted for $74.7 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 Utilities, Inc. and the remaining 72 Florida Water systems. Water
Services' loss in 2005 reflected $1.9 million of administrative and other
expenses incurred by Florida Water in connection with the FPSC's transfer
proceedings.
25 ALLETE Third Quarter 2005 Form 10-Q
COMPARISON OF THE QUARTERS ENDED SEPTEMBER 30, 2005 AND 2004
REGULATED UTILITY
OPERATING REVENUE was up $1.3 million, or 1 percent, from 2004. Revenue
from other power suppliers was up $1.9 million from 2004, due to increased
capacity sales. Transmission revenue was up $0.8 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. (See Outlook.) Revenue from sales to retail and municipal
customers was down $1.9 million, primarily due to lower fuel clause
recoveries in 2005. (See operating expenses below.) Kilowatthour sales to
retail and municipal customers were up 4 percent from last year reflecting
increased usage. Residential and municipal customer usage was higher due to
warmer weather in 2005 compared to unusually cool weather in 2004.
Commercial usage was higher due to stronger economic conditions in our
electric service territory in 2005. As in 2004, the Company's industrial
customers are operating at high production levels, with taconite and paper
production at or near capacity. Kilowatthour sales to industrial customers
were up 3 percent from last year. Overall, regulated utility kilowatthour
sales were up 4 percent from 2004.
Revenue from electric sales to taconite customers accounted for 22 percent
of consolidated operating revenue in 2005 (24 percent in 2004). Revenue
from electric sales to paper and pulp mills accounted for 9 percent of
consolidated operating revenue in 2005 (10 percent in 2004).
OPERATING EXPENSES were down $1.4 million, or 1 percent, from 2004. Fuel
and purchased power expense was down $3.0 million from 2004, reflecting
decreased purchased power expense partially offset by a $1.3 million
increase in MISO transmission expense. In 2004, an extended outage at
Boswell Unit 4 required us to purchase additional power. Other operating
expenses were higher in 2005, primarily due to a $1.4 million increase in
maintenance expense.
INTEREST EXPENSE was down $0.7 million from 2004, due to lower effective
interest rates (5.98 percent in 2005; 7.13 percent in 2004).
NONREGULATED ENERGY OPERATIONS
OPERATING REVENUE was up $3.2 million, or 13 percent, from 2004. Revenue
from nonregulated generation was up $2.0 million from 2004, reflecting a
$6.0 million increase in revenue from Taconite Harbor partially offset by a
$4.7 million decrease in revenue from Kendall County. Revenue from Taconite
Harbor was higher in 2005 due to two 5-year contracts (175 MW in total)
that began in May 2005, while revenue from Kendall County was down in 2005
due to the absence of operations following the assignment of the Kendall
County power purchase agreement. Overall, nonregulated kilowatthour sales
were up 16 percent from 2004. Coal revenue, realized under a cost-plus
contract, was up $1.0 million from 2004, reflecting a 19 percent increase
in tons of coal sold and higher coal production expenses (see operating
expenses below).
OPERATING EXPENSES were up $1.5 million, or 6 percent, from 2004. Fuel and
purchased power expense was down $2.0 million from 2004, reflecting the
absence of operations at Kendall County, partially offset by increased fuel
and purchased power expense at Taconite Harbor. Other operating expenses
were $3.5 million higher in 2005 and reflected increased corporate
allocations, a $0.5 million increase in SO2 emission allowance expense at
Taconite Harbor and a $0.4 million increase in expenses related to our coal
operations. In 2005, expenses related to our coal operations reflected
increased fuel costs and a $0.7 million increase in lease expense related
to the new dragline, partially offset by lower maintenance expense. Coal
operations maintenance expenses were higher in 2004 due to scheduled
maintenance performed during a planned outage at Square Butte.
INTEREST EXPENSE was up $0.4 million from 2004, reflecting higher corporate
allocations.
ALLETE Third Quarter 2005 Form 10-Q 26
COMPARISON OF THE QUARTERS ENDED SEPTEMBER 30, 2005 AND 2004 (CONTINUED)
REAL ESTATE
OPERATING REVENUE was up $6.0 million from 2004, or 115 percent, primarily
due to a $5.7 million increase in revenue from land sales because of the
type and location of real estate sold. Town Center land sales accounted for
$1.8 million of the increase in revenue from land sales. In 2005, revenue
of $2.5 million, related to Town Center land sales, was deferred until
completion of development obligations are performed ($0 in 2004). In 2005,
548 acres were sold, of which 27 acres are located in Town Center. Town
Center sales included assignments of rights to build up to 246,000 square
feet of commercial space. In 2004, 18 acres were sold.
OPERATING EXPENSES were up $0.4 million from 2004 due to increased cost of
sales ($1.4 million in 2005; $0.9 million in 2004). In 2005, cost of sales
totaling $0.6 million and selling expense of $0.1 million related to Town
Center land sales were deferred until completion of development obligations
are performed. In 2004, no expenses were deferred.
OTHER
OPERATING REVENUE was down $1.1 million, or 10 percent, from 2004, due to
less revenue from our telecommunications business because of fewer
equipment sales.
OPERATING EXPENSES were down $0.7 million, or 6 percent, from 2004,
reflecting a decrease in expenses at our telecommunication business,
primarily due to lower cost of goods sold associated with fewer equipment
sales.
INTEREST EXPENSE was down $0.5 million from 2004, primarily due to lower
debt balances. The Company repaid $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 this debt.
OTHER INCOME (EXPENSE) reflected $18.9 million less expense in 2005 because
in 2004 we incurred an $18.5 million debt prepayment cost related to the
early redemption of $125 million in senior notes. In 2005, other income
(expense) reflected a $0.6 million increase in earnings on cash, cash
equivalents and short-term investments, a $0.9 million decrease in equity
losses related to our emerging technology investments and a $1.0 million
charge to record the probable payment under our guarantee of Northwest
Airlines debt.
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. The benefit related to this state capital loss
carryforward is fully offset by a valuation allowance. 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, primarily due to
nondeductible transaction costs related to the spin-off of Automotive Services.
27 ALLETE Third Quarter 2005 Form 10-Q
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
REGULATED UTILITY
OPERATING REVENUE was up $8.5 million, or 2 percent, from 2004. Revenue
from other power suppliers was up $12.0 million from 2004, due to a 34
percent increase in kilowatthour sales and higher off-peak market prices.
Transmission revenue was up $3.7 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. (See
Outlook.) Revenue from sales to retail and municipal customers was down
$8.3 million, primarily due to lower fuel clause recoveries in 2005. (See
operating expenses below.) Kilowatthour sales to retail and municipal
customers remained strong--up 2 percent from 2004 reflecting increased
usage. Residential and municipal customer usage was higher in 2005 due to
cooler winter weather and warmer summer weather in 2005 than in 2004.
Commercial usage was higher due to stronger economic conditions in our
electric service territory in 2005. Sales to industrial customers were
similar to last year (up 1 percent) 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 4 percent from 2004.
Revenue from electric sales to taconite customers accounted for 22 percent
of consolidated operating revenue in 2005 (23 percent in 2004). Revenue
from electric sales to paper and pulp mills accounted for 8 percent of
consolidated operating revenue in 2005 (9 percent in 2004).
OPERATING EXPENSES were up $4.5 million, or 1 percent, from 2004. Fuel and
purchased power expense was up $0.1 million from 2004 reflecting increased
fuel expense due to a 20 percent increase in Company generation and a $3.7
million increase in MISO transmission expenses, mostly offset by lower
purchased power expense in 2005. In 2004, an outage at Boswell Unit 4
required us to purchase additional power. Maintenance expenses were up $3.8
million from 2004, primarily due to more planned maintenance in 2005. Other
operating expenses were $0.6 million higher in 2005 and reflected a $1.0
million increase for vegetation management, a $1.0 million increase in
conservation improvement program expenses which are recovered through a
billing adjustment clause, and a variety of minor items partially offset by
a $2.0 million decrease in expenses related to Split Rock Energy. Split
Rock Energy was a joint venture, which we exited in March 2004.
INTEREST EXPENSE was down $1.3 million from 2004, due to lower effective
interest rates (6.06 percent in 2005; 6.93 percent in 2004).
NONREGULATED ENERGY OPERATIONS
OPERATING REVENUE was up $2.0 million, or 2 percent, from 2004. Revenue
from nonregulated generation was down $2.3 million from 2004, reflecting an
$11.0 million decrease from Kendall County partially offset by an $8.0
million increase in revenue from Taconite Harbor. Revenue from Kendall
County decreased due to the absence of Kendall County operations, while
revenue from Taconite Harbor increased 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. Overall, nonregulated kilowatthour sales were down
3 percent from 2004. Coal revenue, realized under a cost-plus contract, was
up $4.6 million from 2004 reflecting a 16 percent increase in the delivery
price per ton due to higher coal production expenses (see operating
expenses below).
OPERATING EXPENSES were up $74.4 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 $11.8
million from 2004, reflecting the absence of Kendall County operations.
Operating expenses at Taconite Harbor were higher in 2005--SO2 emission
allowance expenses were up $2.0 million and depreciation expense was up
$0.5 million as a result of capitalized projects being completed and placed
into operation. Expenses related to our coal operations were up $3.8
million, in part due to higher expenses associated with equipment repairs,
increased fuel costs and a $2.1 million increase in lease expense related
to the new dragline. In 2004, fewer equipment repairs resulted in lower
operating expenses.
INTEREST EXPENSE was up $0.9 million from 2004, reflecting higher corporate
allocations.
OTHER INCOME (EXPENSE) reflected $0.9 million less income in 2005,
primarily due to fewer Minnesota land sales. Minnesota land is primarily
land acquired when we purchased Taconite Harbor in 2001.
ALLETE Third Quarter 2005 Form 10-Q 28
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 (CONTINUED)
REAL ESTATE
OPERATING REVENUE was down $0.7 million, or 2 percent, from 2004,
reflecting strong land sales offset by the deferral of revenue associated
with certain real estate sales. Revenue from land sales was $35.1 million
in 2005 ($35.0 million in 2004). Town Center land sales accounted for $3.5
million of land sale revenue in 2005. In 2005, revenue of $11.0 million,
related primarily to Town Center land sales, was deferred until completion
of development obligations are performed ($0 in 2004). 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. In 2005, 1,128 acres and 7 lots were sold, of which 70
acres are located in Town Center. Town Center sales included assignments of
rights to build up to 643,000 square feet of commercial space. In 2004,
1,445 acres and 211 lots were sold. Revenue from our brokerage business,
Cape Properties, Inc., was down $1.3 million reflecting extraordinarily
strong sales in 2004.
OPERATING EXPENSES were down $0.3 million, or 2 percent, from 2004.
Expenses for our brokerage business were down $0.4 million due to
extraordinarily strong sales in 2004. Selling expenses were down $0.6
million from 2004 due to lower transaction costs and fewer brokerage
commissions on 2005 sales. Cost of sales were $0.8 million higher in 2005
($7.2 million in 2005; $6.4 million in 2004) due to more sales. In 2005,
cost of sales totaling $2.4 million and selling expense of $0.3 million
related primarily to Town Center land sales were deferred until completion
of development obligations are performed. In 2004, no expenses were
deferred.
OTHER
OPERATING REVENUE was down $1.9 million, or 5 percent, from 2004, due to
decreased revenue from our telecommunications business because of fewer
equipment sales.
OPERATING EXPENSES were down $3.3 million, or 8 percent, from 2004,
reflecting a $2.3 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 $5.2 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 this debt.
OTHER INCOME (EXPENSE) reflected $19.7 million less expense in 2005,
because in 2004 we incurred an $18.5 million debt prepayment cost related
to the early redemption of $125 million in senior notes. In 2005, other
income also reflected a $2.4 million increase in earnings on cash and
short-term investments. In 2005, equity losses from our emerging technology
investments decreased $0.6 million from 2004. In 2005, we also recorded
$5.1 million of impairments related to certain direct emerging technology
investments ($5.5 million in 2004), and a $1.0 million charge to recognize
the probable payment under our guarantee of Northwest Airlines debt. In
2004, we recognized $1.4 million of income from a rabbi trust, established
to secure certain deferred executive compensation.
INCOME TAXES
The effective rate for income taxes in 2005 deviated from the statutory rate,
primarily as a result of the emerging technology investment impairments 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. The benefit related to these state net capital
loss carryforwards is fully offset by a valuation allowance. 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 transaction costs related to the spin-off of Automotive
Services.
29 ALLETE Third Quarter 2005 Form 10-Q
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
Our financial performance through the first nine months of 2005 has exceeded our
original expectations and, as a result, we now expect ALLETE's 2005 earnings per
share from continuing operations to be 60 percent over 2004, excluding the
Kendall County Charge. The growth is expected to come from continued strong
energy and real estate sales, lower interest expense and the transfer of the
Kendall County power purchase agreement. 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.
In 2005, we have fewer shares outstanding for earnings per share calculation
purposes than the comparable periods in 2004. The ESOP used proceeds from the
sale of ADESA stock to purchase ALLETE common stock on the open market. (See
Note 12.) 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.
REGULATED UTILITY AND NONREGULATED ENERGY OPERATIONS
MISO. 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. In March 2005, the MPUC approved interim
accounting treatment of MISO costs to be recovered through the fuel clause,
subject to refund with interest. This interim treatment of MISO costs 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 costs will include an analysis of how the fuel
clause is affected, and whether it should be modified as a result of MISO Day 2.
We are unable to predict the extent of MISO related charges that will be
approved for recovery through the fuel clause.
LARGE POWER CUSTOMERS. In recent months we reached new long-term, all
requirements agreements with our largest energy customer, United States Steel
Corporation (USS), and our fifth largest energy customer, Mittal Steel USA
(Mittal Steel), a subsidiary of Mittal Steel Company N.V. Our long-term, all
requirements agreement with USS was approved by the MPUC in September 2005 and
provides for electric service through October 2013 to USS's Minntac and Keewatin
Taconite production facilities located on the Mesabi Iron Range in northeastern
Minnesota. Our long-term, all requirements agreement with Mittal Steel, which is
subject to MPUC approval, provides for electric service through December 2012
for Mittal Steel's Minorca Mine production facility near Virginia, Minnesota.
The extension of our electric supply contracts is an important achievement for
both our large power customers and Minnesota Power. Electric power is a key
component in the production of taconite and paper, and these industries consume
a sizable portion of the electricity we produce. These agreements help to
provide planning certainty for both our customers and us. Negotiations are
ongoing with other large power customers to enter into amended and restated
contracts anticipating three- to seven-year extensions beyond the notice of
cancellation period. We expect to be successful with additional industrial
customer contract extensions going forward.
ALLETE Third Quarter 2005 Form 10-Q 30
OUTLOOK (CONTINUED)
REGULATED UTILITY AND NONREGULATED ENERGY OPERATIONS (CONTINUED)
RESOURCE PLAN. In 2004, we filed an integrated resource plan (Resource Plan)
with the MPUC, detailing our retail energy demand projections and our energy
sourcing options to meet the projected demand over the next 15 years. We project
a load growth of approximately 200 megawatts by the 2009-2010 timeframe with
another 200 megawatts of growth anticipated by 2015. We have been working with
regulators and other stakeholders to determine the best way to meet our
projected customer needs for more electricity reliably, cost-effectively and in
an environmentally responsible way. We anticipate that the MPUC will formally
consider the Resource Plan by the end of 2005 or early 2006.
On October 24, 2005, we proposed to the MPUC a comprehensive solution to meet
our generation needs through the 2009-2010 timeframe that includes the following
key components:
- Transitioning our Taconite Harbor generating facility from wholesale sales
to retail sales to help meet the utility's forecasted base load energy
requirements. While we propose that Taconite Harbor would become part of
Minnesota Power's rate-based assets as of January 2006, current wholesale
contracts sourced from Taconite Harbor will be honored through their terms.
Utilizing Taconite Harbor would meet the near-term increased demand for
electricity without requiring the construction of new assets.
- Taconite Harbor generation is proposed to be supplemented with a
50-megawatt long-term power purchase agreement to meet near-term energy
needs.
- Our various resource additions are proposed to help meet forecasted base
load, support the expansion of our renewable generating assets and help meet
Minnesota's Renewable Energy Objective that seeks a 10 percent supply of
renewable energy in the state by 2015. We have applied for approval of a
power purchase agreement for 50 megawatts of wind energy purchased from a
plant in North Dakota. We are also actively pursuing an agreement for an
additional 50 megawatts of wind energy from facilities located in
northeastern Minnesota, (see Wind Power below) and are proposing to obtain 10
megawatts of additional hydro generation through an expansion of one of our
hydro electric stations.
Our proposal is supported by the Minnesota Department of Commerce and a group of
our large power customers. We are also discussing the agreement with the Office
of Attorney General-Residential Utilities Division.
AREA PLAN. In October 2005, we announced a $60 million environmental initiative
which is expected to significantly reduce emissions from two of our electric
generating facilities in northeastern Minnesota. Our Arrowhead Regional Emission
Abatement (AREA) plan is designed to further reduce emissions while maintaining
a reliable and reasonably-priced energy supply to meet the needs of our
customers. We believe that control and abatement technologies applicable to
these plants have matured to the point where further significant air emission
reductions can be attained through AREA in a relatively cost-effective manner.
At Taconite Harbor, we plan to employ multi-emission reduction technology, while
at Laskin we plan to install a retrofit to lower NOx emissions. Upon projected
completion of the retrofits, we estimate an emission reduction of over 60
percent for NOx at both facilities and a 65 percent reduction in SO2 at Taconite
Harbor. Laskin already has relatively low emission levels of SO2 due to existing
emission reduction technology. Additionally, with the emerging technology being
proposed for Taconite Harbor, there is the potential for as much as a 90 percent
reduction in mercury emissions.
On October 13, 2005, we filed the AREA plan with the MPUC. A second filing
detailing current cost recovery outside of a rate case for the plan is expected
to be made to the MPUC before the end of December 2005. If approved by the MPUC,
the rate impact on residential and general service customers is expected to be
about 2 percent and for large power customers the impact is expected to be about
3.3 percent when the plan is fully implemented at the end of 2008. Approval is
sought before June 30, 2006, when the statutory authorization for current cost
recovery on utility emission reduction investments sunsets. The filing process
will provide for written comments, public hearings and regional meetings on the
proposal. The Minnesota Pollution Control Agency has stated its intention to
issue a letter of support to the MPUC encouraging Minnesota Power's anticipated
efforts to reduce emissions.
31 ALLETE Third Quarter 2005 Form 10-Q
OUTLOOK (CONTINUED)
REGULATED UTILITY AND NONREGULATED ENERGY OPERATIONS (CONTINUED)
WIND POWER. In May 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 approximately 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 discussed above. In addition, we
are actively pursuing an agreement for another new wind farm to be located in
northeastern Minnesota.
ENERGY POLICY ACT. In August 2005, the Energy Policy Act of 2005 was signed into
law. Key provisions in the law 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 and are
evaluating the effects on our business as this legislation is being implemented.
ATC. ATC is a for-profit transmission-only company created by the transfer of
transmission assets previously owned by several electric utilities serving the
upper Midwest. In April 2003, the PSCW approved a transfer of interests in the
Wausau-to-Duluth electric transmission line project to ATC. As a result, ATC has
assumed primary responsibility for the overall management of the project and
will own and operate the completed Wausau-to-Duluth line.
We have a contractual opportunity related to ATC that, if exercised, would
ultimately result in our having an equity investment in ATC. We intend, if
approved by other parties, to invest $60 million in ATC by the end of 2006.
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 our Town
Center. The agreement also includes the development of a 51-acre commercial
retail site. 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.
In August 2005, Tomoka Holdings, which is owned by ALLETE Properties, submitted
a Development of Regional Impact (DRI) Application for Development Approval to
the East Central Florida Regional Planning Council for its nearly 6,000-acre
Ormond Crossings project. Development uses and intensities proposed in the DRI
include 5 million square feet of commercial, office and industrial opportunities
along with up to 4,400 residential units. We anticipate that the DRI approval
process will be concluded within approximately 16 months at which time we would
receive a Development Order from the City of Ormond Beach. The Ormond Crossings
DRI application represents the launch of our third major real estate development
in Florida and the largest in terms of acreage.
Ground was broken on the Town Center development earlier in 2005 and
construction is slated to begin on the Palm Coast Park property in 2006. Florida
recently granted the Palm Coast Park Community Development District authority to
issue special assessment revenue bonds to finance its property development.
ALLETE Third Quarter 2005 Form 10-Q 32
OUTLOOK (CONTINUED)
REAL ESTATE (CONTINUED)
ALLETE Properties occasionally provides seller financing, and outstanding
finance receivables were $13.3 million at September 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
AT SEPTEMBER 30, 2005 OWNERSHIP ACRES <F1> UNITS <F2> SQ. FT. <F2><F3>
- ----------------------------------------------------------------------------------------------------------------------
Town Center at Palm Coast 80%
At December 31, 2004 1,550 2,950 3,525,000
Property Sold (70) - (643,000)
- ----------------------------------------------------------------------------------------------------------------------
1,480 2,950 2,882,000
- ----------------------------------------------------------------------------------------------------------------------
Palm Coast Park 100% 4,705 3,600 3,200,000
- ----------------------------------------------------------------------------------------------------------------------
Ormond Crossings 100%
At December 31, 2004 5,850 <F4> <F4>
Change in Estimate <F1> 110
- ----------------------------------------------------------------------------------------------------------------------
5,960
- ----------------------------------------------------------------------------------------------------------------------
12,145 6,550 6,082,000
- ----------------------------------------------------------------------------------------------------------------------
<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> Includes industrial, office and retail square footage.
<F4> The DRI filed in August 2005 proposed 4,400 residential units and 5 million square feet of commercial space, and
is subject to approval by regulating governmental entities.
</FN>
SUMMARY OF OTHER LAND INVENTORIES
AT SEPTEMBER 30, 2005 OWNERSHIP TOTAL MIXED USE RESIDENTIAL COMMERCIAL AGRICULTURAL
- ----------------------------------------------------------------------------------------------------------------------
ACRES <F1>
Palm Coast Holdings 80%
At December 31, 2004 3,099 2,040 513 291 255
Property Sold (518) (333) (167) (10) (8)
- ----------------------------------------------------------------------------------------------------------------------
2,581 1,707 346 281 247
- ----------------------------------------------------------------------------------------------------------------------
Lehigh 80%
At December 31, 2004 1,082 840 140 93 9
Property Sold (469) (450) - (19) -
- ----------------------------------------------------------------------------------------------------------------------
613 390 140 74 9
- ----------------------------------------------------------------------------------------------------------------------
Cape Coral 100%
At December 31, 2004 104 - 1 103 -
Property Sold (34) - - (34) -
- ----------------------------------------------------------------------------------------------------------------------
70 - 1 69 -
- ----------------------------------------------------------------------------------------------------------------------
Other 100%
At December 31, 2004 908 - - - 908
Property Sold (37) - - - (37)
Contributed Land (30) - - - (30)
Change in Estimate <F1> 103 - - - 103
- ----------------------------------------------------------------------------------------------------------------------
944 - - - 944
- ----------------------------------------------------------------------------------------------------------------------
4,208 2,097 487 424 1,200
- ----------------------------------------------------------------------------------------------------------------------
<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>
33 ALLETE Third Quarter 2005 Form 10-Q
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW ACTIVITIES
A primary goal of our strategic plan is to improve cash flow from operations.
Our strategy includes growing 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 $91.4 million, $66.8 million of short-term investments and a debt
to total capital ratio of 40 percent at September 30, 2005.
Cash from operating activities was lower in 2005 due to the spin-off of
Automotive Services and sale of our Water Service businesses in 2004, and the
Kendall County Charge in 2005. Cash flow from operating activities was $20.7
million for the first nine months of 2005 ($141.9 million for the first nine
months of 2004). Excluding the Kendall County Charge in 2005, and the debt
prepayment cost and discontinued operations in 2004, we continued to generate
strong cash flow from operating activities, which amounted to $107.8 million for
the first nine months of 2005 ($32.9 million for the first nine 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 ATC for work on the Duluth-to-Wausau transmission line and other
receivables, and additional deferred profit on real estate activities.
Cash from investing activities was higher in 2005, primarily due to a $157.1
million increase in net proceeds received from the sale of short-term
investments. Gross proceeds from the sale of available-for-sale securities were
$323.5 million in 2005 ($1.6 million in 2004) and purchases were $241.0 million
($76.2 million in 2004). The increase was offset by proceeds received in 2004
from the sale of our remaining Water Services businesses. Cash from investing
activities, excluding discontinued operations, was higher in 2005, primarily due
to the $157.1 million increase in net proceeds received from the sale of
short-term investments mentioned above. Cash from investing activities was also
higher due to 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 was lower in 2005, primarily due to the redemption
of $125 million in senior notes and the repayment of a $53.0 million note
payable in 2004. In addition, dividends paid on common stock were $46.4 million
lower in 2005, primarily due to the change in dividends following the spin-off
of Automotive Services.
Our Town Center development project in Florida 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.
ALLETE Third Quarter 2005 Form 10-Q 34
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
SECURITIES
In March 2001, ALLETE, ALLETE Capital II and ALLETE Capital III, jointly filed a
registration statement with the SEC, pursuant to Rule 415 under the Securities
Act of 1933. The registration statement, which has been declared effective by
the SEC, relates to the possible issuance of a remaining aggregate amount of
$387 million of securities, which may include ALLETE common stock, first
mortgage bonds and other debt securities, and ALLETE Capital II and ALLETE
Capital III preferred trust securities. ALLETE also previously filed a
registration statement, which has been declared effective by the SEC, relating
to the possible issuance of $25 million of first mortgage bonds and other debt
securities. We may sell all or a portion of the remaining registered securities
if warranted by market conditions and our capital requirements. Any offer and
sale of the above-mentioned securities will be made only by means of a
prospectus meeting the requirements of the Securities Act of 1933 and the rules
and regulations thereunder.
On August 1, 2005, ALLETE issued $35 million of its first mortgage bonds, which
carry an interest rate of 5.28% and have a term of 15 years. On August 2, 2005,
we used proceeds from these newly issued bonds to redeem $35 million in
principal amount of First Mortgage Bonds, 7 1/2% Series due 2007.
On October 6, 2005, ALLETE accepted an offer from certain institutional buyers
in the private placement market to purchase $50 million of ALLETE's first
mortgage bonds. When issued, on or about March 1, 2006, the bonds will carry an
interest rate of 5.69% and will have a term of 30 years. ALLETE intends to use
the proceeds from the bonds to redeem a portion of ALLETE's outstanding debt.
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 nine months ended September 30, 2005, capital expenditures for
continuing operations totaled $40.4 million ($48.8 million in 2004).
Expenditures for the nine months ended September 30, 2005, included $31.1
million for Regulated Utility, $6.0 million for Nonregulated Energy Operations
and $3.3 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 $63 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 $4 million for
telecommunication fiber within Other). We expect to use internally-generated
funds to fund all capital expenditures.
Due primarily to the passage of two new EPA rules in 2005 that reduce and
permanently cap emissions of mercury, SO2, NOx and particulates from the
electric utility industry, capital expenditures are expected to total about $560
million for 2006 through 2009, of which approximately $300 million is expected
to be for environmental compliance. The new estimate is down $115 million from
the previously anticipated $675 million and reflects a plan that incorporates a
combination of solutions that include both technology and emission allowance
purchases, and timing and scheduling of environmental retrofit during this
period.
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.
35 ALLETE Third Quarter 2005 Form 10-Q
NEW ACCOUNTING STANDARDS
New accounting standards are discussed in Note 1.
---------------------
FACTORS THAT MAY AFFECT FUTURE RESULTS
READERS ARE CAUTIONED THAT FORWARD-LOOKING STATEMENTS, INCLUDING THOSE CONTAINED
IN THIS FORM 10-Q, 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 2 OF THIS FORM 10-Q, AS WELL AS THE FACTORS
DESCRIBED IN OUR 2004 FORM 10-K AND ANY UPDATES MENTIONED BELOW. THE RISKS AND
UNCERTAINTIES DESCRIBED IN THIS FORM 10-Q ARE NOT THE ONLY ONES FACING OUR
COMPANY. ADDITIONAL RISKS AND UNCERTAINTIES THAT WE ARE NOT PRESENTLY AWARE OF,
OR THAT WE CURRENTLY CONSIDER IMMATERIAL, MAY ALSO AFFECT OUR BUSINESS
OPERATIONS. OUR BUSINESS, FINANCIAL CONDITION OR RESULTS OF OPERATIONS COULD
SUFFER IF THE CONCERNS SET FORTH BELOW ARE REALIZED.
THE OCCURRENCE OF NATURAL DISASTERS IN FLORIDA COULD ADVERSELY AFFECT OUR
BUSINESS.
The occurrence of natural disasters in Florida, such as hurricanes, floods,
fires, unusually heavy or prolonged rain or droughts, could have a material
adverse effect on our ability to develop and sell properties or realize income
from our projects. The occurrence of natural disasters could also cause
increases in property insurance rates and deductibles which could reduce demand
or selling price for our properties.
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 September 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 $97.1 million at
September 30, 2005 ($179.4 million at December 31, 2004) and a total unrealized
after-tax gain of $1.9 million at September 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 of
available-for-sale securities for the nine months ended September 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 $9.2 million at September 30,
2005, down $4.4 million from December 31, 2004. In March 2005, we recorded $5.1
million ($3.3 million after tax) of impairments, 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 September 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.
ALLETE Third Quarter 2005 Form 10-Q 36
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED)
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 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 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. 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.
37 ALLETE Third Quarter 2005 Form 10-Q
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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 7 - Minimum Revenue and Demand Under Contract Table
Ref. Page 28 - Form 10-Q for the Quarter Ended March 31, 2005 - Minimum Revenue
and Demand Under Contract Table
MINIMUM REVENUE AND DEMAND UNDER CONTRACT MINIMUM MONTHLY
AS OF OCTOBER 1, 2005 ANNUAL REVENUE <F1> MEGAWATTS
- ----------------------------------------------------------------------------------------------------------------------
2005 $109.0 697
2006 $63.3 377
2007 $35.9 192
2008 $26.0 148
2009 $21.5 124
- ----------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Based on past experience, we believe revenue from our large power customers will be substantially in excess of
the minimum contract amounts.
</FN>
Ref. Page 8 - Footnotes to Contract Status for Minnesota Power Large Power
Customers Table
Ref. Page 36 - Form 10-Q for the Quarter Ended June 30, 2005 - Second Paragraph
In August 2005, we reached a new long-term, all-requirements agreement with
Mittal Steel USA (Mittal) to provide all electric service needs through December
2012 for Mittal's Minorca Mine production facility. On September 21, 2005,
Minnesota Power filed with the MPUC a petition for approval of its new electric
service agreement with Mittal.
In September 2005, the MPUC approved our new long-term, all requirements
agreement with United States Steel Corporation (USS) to provide electric service
through October 2013 to USS's Minntac and Keewatin Taconite production
facilities.
ALLETE Third Quarter 2005 Form 10-Q 38
ITEM 5. OTHER INFORMATION (CONTINUED)
Ref. Page 10 - Eighth Paragraph and Page 16 - First and Second Full Paragraphs
In October 2005, Minnesota Power announced a $60 million environmental
initiative which is expected to significantly reduce emissions from two of its
electric generating facilities in northeastern Minnesota. Minnesota Power's
Arrowhead Regional Emission Abatement (AREA) plan is designed to further reduce
emissions while maintaining a reliable and reasonably-priced energy supply to
meet the needs of its customers. We believe that control and abatement
technologies applicable to these plants have matured to the point where further
significant air emission reductions can be attained through AREA in a relatively
cost-effective manner.
At Taconite Harbor, Minnesota Power plans to employ multi-emission reduction
technology, while at Laskin we plan to install a retrofit to lower NOx
emissions. Upon projected completion of the retrofits, Minnesota Power estimates
an emission reduction of over 60 percent for NOx at both facilities and a 65
percent reduction in SO2 at Taconite Harbor. Laskin already has relatively low
emission levels of SO2 due to existing emission reduction technology.
Additionally, with the emerging technology being proposed for Taconite Harbor,
there is the potential for as much as a 90 percent reduction in mercury
emissions.
On October 13, 2005, Minnesota Power filed the AREA plan with the MPUC. A second
filing detailing current cost recovery outside of a rate case for the plan is
expected to be made to the MPUC before the end of December 2005. If approved by
the MPUC, the rate impact on residential and general service customers is
expected to be about 2 percent and for large power customers the impact is
expected to be about 3.3 percent when the plan is fully implemented at the end
of 2008. Approval is sought before June 30, 2006, when the statutory
authorization for current cost recovery on utility emission reduction
investments sunsets. The filing process will provide for written comments,
public hearings and regional meetings on the proposal. The Minnesota Pollution
Control Agency has stated its intention to issue a letter of support to the MPUC
encouraging Minnesota Power's anticipated efforts to reduce emissions.
Ref. Page 10 - Last Paragraph
Ref. Page 11 - First Paragraph
On October 24, 2005, we proposed to the MPUC a comprehensive solution to meet
our generation needs through the 2009-2010 timeframe that includes the following
key components: (1) Transitioning our Taconite Harbor generating facility from
wholesale sales to retail sales to help meet the utility's forecasted base load
energy requirements. While we propose that Taconite Harbor would become part of
Minnesota Power's rate-based assets as of January 2006, current wholesale
contracts sourced from Taconite Harbor will be honored through their terms.
Utilizing Taconite Harbor would meet the near-term increased demand for
electricity without requiring the construction of new assets. (2) Taconite
Harbor generation is proposed to be supplemented with a 50-megawatt long-term
power purchase agreement to meet near-term energy needs. (3) Our various
resource additions are proposed to help meet forecasted base load, support the
expansion of our renewable generating assets and help meet Minnesota's Renewable
Energy Objective that seeks a 10 percent supply of renewable energy by 2015. We
have applied for approval of a power purchase agreement for 50 megawatts of wind
energy purchased from a plant in North Dakota. We are also actively pursuing an
agreement for an additional 50 megawatts of wind energy from facilities located
in northeastern Minnesota, and are proposing to obtain 10 megawatts of
additional hydro generation through an expansion of one of our hydro electric
stations.
Our proposal is supported by the Minnesota Department of Commerce and a group of
our large power customers. We are also discussing the agreement with the Office
of Attorney General-Residential Utilities Division.
39 ALLETE Third Quarter 2005 Form 10-Q
ITEM 5. OTHER INFORMATION (CONTINUED)
Ref. Page 11 - Fourth Paragraph
ATC is a for-profit transmission-only company created by the transfer of
transmission assets previously owned by several electric utilities serving the
upper Midwest. In April 2003, the PSCW approved a transfer of interests in the
Wausau-to-Duluth electric transmission line project to ATC. As a result, ATC has
assumed primary responsibility for the overall management of the project and
will own and operate the completed Wausau-to-Duluth line.
We have a contractual opportunity related to ATC that, if exercised, would
ultimately result in our having an equity investment in ATC. We intend, if
approved by other parties, to invest $60 million in ATC by the end of 2006.
ITEM 6. EXHIBITS
EXHIBIT
NUMBER
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 October 28, 2005, announcing 2005 third
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 Third Quarter 2005 Form 10-Q 40
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.
October 28, 2005 James K. Vizanko
---------------------------------------------------
James K. Vizanko
Senior Vice President and Chief Financial Officer
October 28, 2005 Mark A. Schober
---------------------------------------------------
Mark A. Schober
Senior Vice President and Controller
41 ALLETE Third Quarter 2005 Form 10-Q
EXHIBIT INDEX
EXHIBIT
NUMBER
- --------------------------------------------------------------------------------
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 October 28, 2005, announcing 2005 third
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 Third Quarter 2005 Form 10-Q