SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549



                                    FORM 10-Q


(Mark One)

/X/  Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
     Act of 1934

     For the quarterly period ended MARCH 31, 2006

                                       or

/ /  Transition  Report  Pursuant  to Section  13 or 15(d) of the  Securities
     Exchange Act of 1934

     For the transition period from ______________ to ______________


                          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. /X/ Yes / / No

Indicate by check mark whether the registrant is a large  accelerated  filer, an
accelerated  filer or a  non-accelerated  filer (as defined in Rule 12b-2 of the
Exchange Act).

Large Accelerated Filer /X/   Accelerated Filer / /   Non-Accelerated Filer / /

Indicate by check mark  whether the  registrant  is a shell  company (as defined
in Rule 12b-2 of the Exchange Act). / / Yes /X/ No


                           Common Stock, no par value,
                          30,261,553 shares outstanding
                              as of April 30, 2006



                                      INDEX

                                                                            Page

Definitions                                                                   2

Safe Harbor Statement Under the Private Securities Litigation
Reform Act of 1995                                                            3

Part I.  Financial Information

         Item 1.  Financial Statements

             Consolidated Balance Sheet -
                  March 31, 2006 and December 31, 2005                        4

             Consolidated Statement of Income -
                  Quarter Ended March 31, 2006 and 2005                       5

             Consolidated Statement of Cash Flows -
                  Quarter Ended March 31, 2006 and 2005                       6

             Notes to Consolidated Financial Statements                       7

         Item 2.  Management's Discussion and Analysis of Financial
                  Condition and Results of Operations                        19

         Item 3.  Quantitative and Qualitative Disclosures about
                  Market Risk                                                29

         Item 4.  Controls and Procedures                                    30

Part II. Other Information

         Item 1.  Legal Proceedings                                          31

         Item 1A. Risk Factors                                               31

         Item 2.  Unregistered Sales of Equity Securities and
                  Use of Proceeds                                            32

         Item 3.  Defaults Upon Senior Securities                            32

         Item 4.  Submission of Matters to a Vote of Security Holders        32

         Item 5.  Other Information                                          32

         Item 6.  Exhibits                                                   35

Signatures                                                                   36

1                      ALLETE First Quarter 2006 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
- --------------------------------------------------------------------------------

2005 Form 10-K                          ALLETE's Annual Report on Form 10-K for
                                            the Year Ended December 31, 2005
ALLETE                                  ALLETE, Inc.
ALLETE Properties                       ALLETE Properties, Inc.
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.
DOC                                     Minnesota Department of Commerce
Enventis Telecom                        Enventis Telecom, Inc.
EITF                                    Emerging Issues Task Force Issue No.
EPA                                     Environmental Protection Agency
ESOP                                    Employee Stock Ownership Plan
FASB                                    Financial Accounting Standards Board
FERC                                    Federal Energy Regulatory Commission
Florida Water                           Florida Water Services Corporation
FSP                                     Financial Accounting Standards Board
                                            Staff Position
GAAP                                    Accounting Principles Generally Accepted
                                            in the United States of America
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.
MPCA                                    Minnesota Pollution Control Agency
MPUC                                    Minnesota Public Utilities Commission
MW                                      Megawatt(s)
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
Square Butte                            Square Butte Electric Cooperative
SWL&P                                   Superior Water, Light and Power Company
Taconite Harbor                         Taconite Harbor Energy Center
Town Center                             Town Center at Palm Coast development
                                            project in Florida
WDNR                                    Wisconsin Department of Natural
                                            Resources

                       ALLETE First Quarter 2006 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;
  -   our ability to manage expansion and integrate acquisitions;
  -   prevailing governmental  policies and  regulatory actions, including those
      of the United States Congress, state legislatures, the FERC, the MPUC, 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;
  -   our ability to obtain viable real estate for development purposes;
  -   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 replace a mature workforce,  and retain qualified, skilled
      and experienced personnel; 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 "Risk  Factors" in Part I, Item 1A of our 2005 Form
10-K and Part II,  Item 1A 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 this Form 10-Q and in our other reports filed with the SEC that attempt
to advise interested parties of the factors that may affect our business.

3                      ALLETE First Quarter 2006 Form 10-Q



PART I.  FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS


                                                         ALLETE
                                               CONSOLIDATED BALANCE SHEET
                                                  MILLIONS - UNAUDITED

                                                                                    MARCH 31,        DECEMBER 31,
                                                                                      2006               2005
- -------------------------------------------------------------------------------------------------------------------
                                                                                               
ASSETS

Current Assets
    Cash and Cash Equivalents                                                       $   75.0           $   89.6
    Short-Term Investments                                                             161.5              116.9
    Accounts Receivable (Less Allowance of $1.0 for 2006 and 2005)                      66.0               79.1
    Inventories                                                                         31.9               33.1
    Prepayments and Other                                                               17.0               23.8
    Deferred Income Taxes                                                               32.1               31.0
    Discontinued Operations                                                                -                0.4
- -------------------------------------------------------------------------------------------------------------------

        Total Current Assets                                                           383.5              373.9

Property, Plant and Equipment - Net                                                    862.3              860.4

Investments                                                                            112.3              117.7

Other Assets                                                                            45.9               44.6

Discontinued Operations                                                                    -                2.2
- -------------------------------------------------------------------------------------------------------------------

TOTAL ASSETS                                                                        $1,404.0           $1,398.8
- -------------------------------------------------------------------------------------------------------------------

LIABILITIES AND SHAREHOLDERS' EQUITY

LIABILITIES

Current Liabilities
    Accounts Payable                                                                $   30.3           $   44.7
    Accrued Taxes                                                                       41.8               19.1
    Accrued Interest                                                                     4.7                7.4
    Long-Term Debt Due Within One Year                                                  61.8                2.7
    Deferred Profit on Sales of Real Estate                                              7.8                8.6
    Other                                                                               18.6               24.2
    Discontinued Operations                                                                -               13.0
- -------------------------------------------------------------------------------------------------------------------

        Total Current Liabilities                                                      165.0              119.7

Long-Term Debt                                                                         327.3              387.8

Deferred Income Taxes                                                                  137.7              138.4

Other Liabilities                                                                      148.0              144.1

Minority Interest                                                                        6.5                6.0
- -------------------------------------------------------------------------------------------------------------------

        Total Liabilities                                                              784.5              796.0
- -------------------------------------------------------------------------------------------------------------------

COMMITMENTS AND CONTINGENCIES
- -------------------------------------------------------------------------------------------------------------------

SHAREHOLDERS' EQUITY

Common Stock Without Par Value, 43.3 Shares Authorized
    30.2 and 30.1 Shares Outstanding                                                   426.6              421.1

Unearned ESOP Shares                                                                   (76.5)             (77.6)

Accumulated Other Comprehensive Loss                                                   (12.5)             (12.8)

Retained Earnings                                                                      281.9              272.1
- -------------------------------------------------------------------------------------------------------------------

        Total Shareholders' Equity                                                     619.5              602.8
- -------------------------------------------------------------------------------------------------------------------

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY                                          $1,404.0           $1,398.8
- -------------------------------------------------------------------------------------------------------------------

                            The accompanying notes are an integral part of these statements.


                      ALLETE First Quarter 2006 Form 10-Q                      4




                                                         ALLETE
                                            CONSOLIDATED STATEMENT OF INCOME
                                      MILLIONS EXCEPT PER SHARE AMOUNTS - UNAUDITED

                                                                                            QUARTER ENDED
                                                                                              MARCH 31,
                                                                                      2006                  2005
- -------------------------------------------------------------------------------------------------------------------
                                                                                                    

OPERATING REVENUE                                                                    $192.5                $193.3
- -------------------------------------------------------------------------------------------------------------------

OPERATING EXPENSES
    Fuel and Purchased Power                                                           69.4                  67.6
    Operating and Maintenance                                                          74.5                  72.7
    Depreciation                                                                       12.2                  11.9
- -------------------------------------------------------------------------------------------------------------------

        Total Operating Expenses                                                      156.1                 152.2
- -------------------------------------------------------------------------------------------------------------------

OPERATING INCOME FROM CONTINUING OPERATIONS                                            36.4                  41.1
- -------------------------------------------------------------------------------------------------------------------

OTHER INCOME (EXPENSE)
    Interest Expense                                                                   (6.4)                 (6.8)
    Other                                                                               1.7                  (4.2)
- -------------------------------------------------------------------------------------------------------------------

        Total Other Expense                                                            (4.7)                (11.0)
- -------------------------------------------------------------------------------------------------------------------

INCOME FROM CONTINUING OPERATIONS
    BEFORE MINORITY INTEREST AND INCOME TAXES                                          31.7                  30.1

MINORITY INTEREST                                                                       1.3                   1.2
- -------------------------------------------------------------------------------------------------------------------

INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES                                  30.4                  28.9

INCOME TAX EXPENSE                                                                     11.6                  11.5
- --------------------------------------------------------------------------------------------------------------------

INCOME FROM CONTINUING OPERATIONS                                                      18.8                  17.4

INCOME FROM DISCONTINUED OPERATIONS - NET OF TAX                                          -                     -
- -------------------------------------------------------------------------------------------------------------------

NET INCOME                                                                           $ 18.8                $ 17.4
- -------------------------------------------------------------------------------------------------------------------

AVERAGE SHARES OF COMMON STOCK
    Basic                                                                              27.6                  27.2
    Diluted                                                                            27.7                  27.4
- -------------------------------------------------------------------------------------------------------------------

BASIC AND DILUTED EARNINGS PER SHARE OF COMMON STOCK
    Continuing Operations                                                             $0.68                 $0.64
    Discontinued Operations                                                               -                     -
- -------------------------------------------------------------------------------------------------------------------

                                                                                      $0.68                 $0.64
- -------------------------------------------------------------------------------------------------------------------

DIVIDENDS PER SHARE OF COMMON STOCK                                                 $0.3625               $0.3000
- -------------------------------------------------------------------------------------------------------------------

                            The accompanying notes are an integral part of these statements.


5                      ALLETE First Quarter 2006 Form 10-Q




                                                         ALLETE
                                          CONSOLIDATED STATEMENT OF CASH FLOWS
                                                  MILLIONS - UNAUDITED


                                                                                             QUARTER ENDED
                                                                                               MARCH 31,
                                                                                      2006                  2005
- -------------------------------------------------------------------------------------------------------------------
                                                                                                     

OPERATING ACTIVITIES
     Net Income                                                                     $  18.8                $ 17.4
     Loss on Impairment of Investments                                                    -                   5.1
     Depreciation                                                                      12.2                  11.9
     Deferred Income Taxes                                                             (1.7)                 (3.6)
     Minority Interest                                                                  1.3                   1.2
     Stock Compensation Expense                                                         0.4                   0.3
     Bad Debt Expense                                                                   0.2                   0.2
     Changes in Operating Assets and Liabilities
        Accounts Receivable                                                            12.9                   8.7
        Inventories                                                                     1.2                  (0.3)
        Prepayments and Other                                                           6.8                  (5.6)
        Accounts Payable                                                              (11.2)                 (5.1)
        Other Current Liabilities                                                      14.6                   7.0
     Other Assets                                                                      (1.3)                  2.5
     Other Liabilities                                                                  2.6                  (1.3)
     Net Operating Activities for Discontinued Operations                             (12.6)                 (7.3)
- -------------------------------------------------------------------------------------------------------------------

              Cash from Operating Activities                                           44.2                  31.1
- -------------------------------------------------------------------------------------------------------------------

INVESTING ACTIVITIES
     Proceeds from Sale of Available-For-Sale Securities                              126.3                 210.5
     Payments for Purchase of Available-For-Sale Securities                          (170.9)                (93.3)
     Changes to Investments                                                             2.4                  (2.4)
     Additions to Property, Plant and Equipment                                       (13.6)                 (8.9)
     Other                                                                              4.4                   1.7
     Net Investing Activities for Discontinued Operations                               2.2                  (0.6)
- -------------------------------------------------------------------------------------------------------------------

              Cash from (for) Investing Activities                                    (49.2)                107.0
- -------------------------------------------------------------------------------------------------------------------

FINANCING ACTIVITIES
        Issuance of Common Stock                                                        5.1                   6.2
        Issuance of Long-Term Debt                                                     50.0                     -
        Reductions of Long-Term Debt                                                  (51.4)                 (0.6)
        Dividends on Common Stock and Distributions to Minority Shareholders           (9.9)                 (7.4)
        Net Decrease in Book Overdrafts                                                (3.4)                    -
- -------------------------------------------------------------------------------------------------------------------

              Cash for Financing Activities                                            (9.6)                 (1.8)
- -------------------------------------------------------------------------------------------------------------------

CHANGE IN CASH AND CASH EQUIVALENTS                                                   (14.6)                136.3

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD <F1>                                  89.6                  46.1
- -------------------------------------------------------------------------------------------------------------------

CASH AND CASH EQUIVALENTS AT END OF PERIOD <F1>                                     $  75.0                $182.4
- -------------------------------------------------------------------------------------------------------------------

SUPPLEMENTAL CASH FLOW INFORMATION
        Cash Paid During the Period for
          Interest - Net of Amounts Capitalized                                       $12.1                 $10.6
          Income Taxes                                                                 $3.7                  $1.4
- -------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Included $1.2 of cash from Discontinued Operations at March 31, 2005.
</FN>
                            The accompanying notes are an integral part of these statements.


                      ALLETE First Quarter 2006 Form 10-Q                      6



                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The accompanying unaudited consolidated financial statements and notes should be
read in  conjunction  with our 2005 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

Certain  reclassifications  have been made to prior years' amounts to conform to
current  year  classifications.  We revised our  Consolidated  Statement of Cash
Flows for the quarter ended March 31, 2005, to reconcile Net Income to Cash from
Operating   Activities.   Previously,   we  reconciled  Income  from  Continuing
Operations to Cash from Operating Activities.  In addition, we have reclassified
certain  amounts in our balance  sheet,  statement of income,  statement of cash
flows and segment information to reflect  discontinued  operations treatment for
our   telecommunications   business  which  we  sold  in  December  2005.  These
reclassifications  had no effect on previously reported consolidated net income,
shareholders' equity, comprehensive income or cash flows.

REVISION IN THE  CLASSIFICATION OF CERTAIN  SECURITIES.  In the quarterly period
ended June 30, 2005, we concluded  that it was  appropriate  to  reclassify  our
auction rate bonds and variable  rate 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 March 31, 2006 (and
for the  year  ended  December  31,  2005).  We  have  also  made  corresponding
adjustments  to our  Consolidated  Statement  of Cash Flows for the period ended
March 31, 2005, 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 quarter ended March 31, 2005, cash used in investing  activities related
to these short-term investments of $32.0 million was previously included in cash
and cash equivalents in our Consolidated Statement of Cash Flows.

SHORT-TERM INVESTMENTS.  At March 31, 2006 and December 31, 2005, we held $161.5
million and $116.9 million, respectively, of short-term investments,  consisting
of  auction  rate  bonds  and  variable   rate  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.

INVENTORIES.  Inventories  are  stated at the lower of cost or  market.  Cost is
determined by the average cost method.



                                             MARCH 31,            DECEMBER 31,
INVENTORIES                                    2006                   2005
- --------------------------------------------------------------------------------
MILLIONS

                                                            
Fuel                                          $ 9.8                   $11.0
Materials and Supplies                         22.1                    22.1
- --------------------------------------------------------------------------------

Total Inventories                             $31.9                   $33.1
- --------------------------------------------------------------------------------


7                      ALLETE First Quarter 2006 Form 10-Q



NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

STOCK-BASED COMPENSATION EXPENSE. Effective January 1, 2006, we adopted the fair
value  recognition  provisions of SFAS 123R,  "Share-Based  Payment,"  using the
modified  prospective   transition  method.  Under  this  method,  we  recognize
compensation expense for all share-based payments granted after January 1, 2006,
and those granted  prior to but not yet vested as of January 1, 2006.  Under the
fair  value  recognition  provisions  of SFAS  123R,  we  recognize  stock-based
compensation net of an estimated forfeiture rate and only recognize compensation
expense for those shares  expected to vest over the required  service  period of
the award.  Prior to our  adoption of SFAS 123R,  we accounted  for  share-based
payments under Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" and related interpretations.

STOCK INCENTIVE PLAN. Under our Executive Long-Term Incentive Compensation Plan,
share-based  awards may be issued to  employees  via a broad  range of  methods,
including  non-qualified  and  incentive  stock  options,   performance  shares,
performance units, restricted stock, stock appreciation rights and other awards.
There are 3.2 million  shares of common stock  reserved  for issuance  under the
plan,  with 1.6 million of these shares  available  for issuance as of March 31,
2006. We currently have the following types of share-based awards outstanding:

     NON-QUALIFIED  STOCK OPTIONS.  The options allow for the purchase of shares
     of common stock at a price equal to the stock's market value at the date of
     grant. Options become exercisable  beginning one year after the grant date,
     with one-third vesting each year over three years. Options may be exercised
     up to ten  years  following  the date of  grant.  In the case of  qualified
     retirement,  death or disability,  options vest  immediately and the period
     over which the options can be exercised is shortened.  Employees have up to
     three months to exercise  vested  options  upon  voluntary  termination  or
     involuntary  termination  without  cause.  All options are  cancelled  upon
     termination  for  cause.  All  options  vest  immediately  upon a change of
     control, as defined in the award agreement.  We determine the fair value of
     options using the  Black-Scholes  option pricing model.  The estimated fair
     value of  options,  including  the  effect  of  estimated  forfeitures,  is
     recognized as expense on the straight-line  basis over the options' vesting
     periods.

     The following  assumptions were used in determining the fair value of stock
     options granted during the first quarter of 2006,  under the  Black-Scholes
     model:



                                                                      2006
     ---------------------------------------------------------------------------
                                                                   
     Risk-Free Interest Rate                                          4.5%
     Expected Life - Years                                               5
     Expected Volatility                                               20%
     Dividend Growth Rate                                               5%
     ---------------------------------------------------------------------------


     The risk-free  interest rate for periods within the contractual life of the
     option  is based on the U.S.  Treasury  yield  curve in effect at the grant
     date.  Expected volatility is based on the historic volatility of our stock
     and the stock of peer  companies,  and the implied  volatility  of publicly
     traded  options.   We  utilize  historical  option  exercise  and  employee
     termination data to estimate the option life.

     PERFORMANCE  SHARES.  Under  these  awards,  the level of shares  earned is
     contingent upon attaining  specific  performance  targets over a three-year
     performance  period.  In  the  case  of  qualified  retirement,   death  or
     disability  during a performance  period,  a pro-rata  portion of the award
     will be earned at the  conclusion  of the  performance  period based on the
     performance  goals  achieved.  In the case of termination of employment for
     any reason other than qualified retirement,  death or disability,  no award
     will be earned. If there is a change in control,  a pro-rata portion of the
     award will be paid based on the  greater  of actual  performance  up to the
     date of the  change in  control  or target  performance.  The fair value of
     these awards is equal to the grant date fair value which is estimated based
     upon the assumed  share-based  payment  three years from the date of grant.
     Compensation  cost is recognized  over the  three-year  performance  period
     based on our  estimate of the number of shares  which will be earned by the
     award recipients.

                      ALLETE First Quarter 2006 Form 10-Q                      8



NOTE 1.  OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

EMPLOYEE  STOCK  PURCHASE PLAN (ESPP).  Under our ESPP,  eligible  employees may
purchase  ALLETE  common stock at a 5 percent  discount  from the market  price.
Because the discount is not greater than 5 percent,  we are not required by SFAS
123R to apply fair value accounting to these awards.

RETIREMENT SAVINGS AND STOCK OWNERSHIP PLAN (RSOP).  Shares held in our RSOP are
excluded from SFAS 123R and are  accounted  for in accordance  with the American
Institute  of  Certified  Public  Accountants'  Statement  of Position No. 93-6,
"Employers' Accounting for Employee Stock Ownership Plans."

The following  share-based  compensation  expense amounts were recognized in our
consolidated statement of income for the periods presented.



                                                                   QUARTER ENDED
                                                                     MARCH 31,
SHARE-BASED COMPENSATION EXPENSE                                       2006
- --------------------------------------------------------------------------------
MILLIONS
                                                                
Stock Options                                                          $0.2
Performance Shares                                                      0.2
- --------------------------------------------------------------------------------

Total Share-Based Compensation Expense                                 $0.4
- --------------------------------------------------------------------------------

Income Tax Benefit                                                     $0.2
- --------------------------------------------------------------------------------


There were no significant  capitalized  stock-based  compensation costs at March
31, 2006.

As of March 31, 2006, the total  compensation  cost for nonvested awards not yet
recognized in our statements of income was $2.6 million. This amount is expected
to be recognized over a weighted-average period of 1.33 years.

The following  table presents the pro forma effect of stock-based  compensation,
had we applied the provisions of SFAS 123 for the quarter ended March 31, 2005.



                                                                                        QUARTER ENDED
EFFECT OF SFAS 123                                                                        MARCH 31,
ACCOUNTING FOR STOCK-BASED COMPENSATION                                                     2005
- -----------------------------------------------------------------------------------------------------
MILLIONS EXCEPT PER SHARE AMOUNTS
                                                                                     
Net Income
   As Reported                                                                              $17.4
   Plus: Employee Stock Compensation Expense Included in Net Income - Net of Tax              0.3
   Less: Employee Stock Compensation Expense Determined Under SFAS 123 - Net of Tax           0.4
- -----------------------------------------------------------------------------------------------------

   Pro Forma Net Income                                                                     $17.3
- -----------------------------------------------------------------------------------------------------

Basic Earnings Per Share
   As Reported                                                                              $0.64
   Pro Forma                                                                                $0.64

Diluted Earnings Per Share
   As Reported                                                                              $0.64
   Pro Forma                                                                                $0.63
- -----------------------------------------------------------------------------------------------------


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
- -----------------------------------------------------------------------------------------------------
                                                                                         
Risk-Free Interest Rate                                                                     3.7%
Expected Life - Years                                                                          5
Expected Volatility                                                                          20%
Dividend Growth Rate                                                                          5%
- -----------------------------------------------------------------------------------------------------


9                     ALLETE First Quarter 2006 Form 10-Q



NOTE 1.  OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

The following table presents information regarding our outstanding stock options
for the quarter ended March 31, 2006.



                                                             WEIGHTED AVERAGE                   WEIGHTED AVERAGE
                                                                 EXERCISE/        AGGREGATE         REMAINING
                                               NUMBER OF        CONVERSION        INTRINSIC        CONTRACTUAL
                                                SHARES             VALUE            VALUE              TERM
- ----------------------------------------------------------------------------------------------------------------
                                                                                  MILLIONS
                                                                                    
Outstanding at December 31, 2005                357,827            $34.29            $3.5            7.4 years
Granted                                         115,653            $44.15
Exercised                                       (12,783)           $25.92
Forfeited or Expired                             (6,233)           $38.25
- ----------------------------------------------------------------------------------------------------------------

Outstanding at March 31, 2006                   454,464            $36.98            $4.4            7.9 years
- ----------------------------------------------------------------------------------------------------------------

Exercisable at March 31, 2006                   233,801            $31.93            $3.4            6.6 years
- ----------------------------------------------------------------------------------------------------------------


The weighted-average  grant-date fair value of options was $6.49 for the quarter
ended  March 31,  2006.  The  intrinsic  value of a stock award is the amount by
which the fair value of the  underlying  stock exceeds the exercise price of the
award.  The total intrinsic  value of options  exercised was $0.3 million during
the quarter ended March 31, 2006.

The following  table  presents  information  regarding our unvested  performance
shares for the quarter ended March 31, 2006.



                                                                WEIGHTED AVERAGE
                                               NUMBER OF           GRANT DATE
                                                SHARES             FAIR VALUE
- --------------------------------------------------------------------------------
                                                          
Nonvested at December 31, 2005                  97,884               $38.63
Granted                                         24,958               $44.07
Awarded                                        (49,076)              $37.76
Forfeited                                       (1,751)              $39.55
- --------------------------------------------------------------------------------

Nonvested at March 31, 2006                     72,015               $41.09
- --------------------------------------------------------------------------------

                      ALLETE First Quarter 2006 Form 10-Q                     10



NOTE 2.  BUSINESS SEGMENTS

Financial  results by segment for the  periods  presented  were  impacted by the
integration of our Taconite Harbor  facility into the Regulated  Utility segment
effective  January  1,  2006.  The  redirection  of  Taconite  Harbor  from  our
Nonregulated  Energy Operations  segment to our Regulated Utility segment was in
accordance  with the Company's  Integrated  Resource Plan  (Resource  Plan),  as
approved by the MPUC. Under the terms of our Resource Plan, we have operated the
Taconite  Harbor  facility as a  rate-based  asset within the  Minnesota  retail
jurisdiction  effective  January 1, 2006.  Prior to January 1, 2006, we operated
our  Taconite  Harbor  facility  as  nonregulated   generation   (non-rate  base
generation  sold at  market-based  rates to the  wholesale  market).  Historical
financial  results of Taconite  Harbor for periods prior to the  redirection are
included in our Nonregulated Energy Operations segment.



                                                                                                NONREGULATED
                                                                                  REGULATED        ENERGY         REAL
                                                                 CONSOLIDATED      UTILITY       OPERATIONS      ESTATE     OTHER
- ------------------------------------------------------------------------------------------------------------------------------------
MILLIONS
                                                                                                            
FOR THE QUARTER ENDED MARCH 31, 2006

Operating Revenue                                                   $192.5          $162.4          $16.3         $13.7     $ 0.1
Fuel and Purchased Power                                              69.4            69.4              -             -         -
Operating and Maintenance                                             74.5            55.8           14.1           3.4       1.2
Depreciation Expense                                                  12.2            11.1            1.1             -         -
- ------------------------------------------------------------------------------------------------------------------------------------

Operating Income (Loss) from Continuing Operations                    36.4            26.1            1.1          10.3      (1.1)
Interest Expense                                                      (6.4)           (5.1)          (0.5)            -      (0.8)
Other Income                                                           1.7               -            0.3             -       1.4
- ------------------------------------------------------------------------------------------------------------------------------------

Income (Loss) from Continuing Operations
    Before Minority Interest and Income Taxes                         31.7            21.0            0.9          10.3      (0.5)
Minority Interest                                                      1.3               -              -           1.3         -
- ------------------------------------------------------------------------------------------------------------------------------------

Income (Loss) from Continuing Operations
    Before Income Taxes                                               30.4            21.0            0.9           9.0      (0.5)
Income Tax Expense (Benefit)                                          11.6             8.0              -           4.0      (0.4)
- ------------------------------------------------------------------------------------------------------------------------------------

Income (Loss) from Continuing Operations                              18.8          $ 13.0           $0.9         $ 5.0     $(0.1)
                                                                                  --------------------------------------------------
Income from Discontinued Operations - Net of Tax                         -
- ----------------------------------------------------------------------------

Net Income                                                          $ 18.8
- ----------------------------------------------------------------------------

Total Assets                                                      $1,404.0          $974.3         $105.2         $70.4    $254.1
Property, Plant and Equipment - Net                                 $862.3          $803.2          $54.3             -      $4.8
Accumulated Depreciation                                            $797.5          $760.8          $35.1             -      $1.6
Capital Expenditures                                                 $13.6           $13.3           $0.3             -         -


FOR THE QUARTER ENDED MARCH 31, 2005

Operating Revenue                                                   $193.3          $147.6          $27.9         $17.7     $ 0.1
Fuel and Purchased Power                                              67.6            60.0            7.6             -         -
Operating and Maintenance                                             72.7            52.6           15.1           4.5       0.5
Depreciation Expense                                                  11.9             9.8            2.0             -       0.1
- ------------------------------------------------------------------------------------------------------------------------------------

Operating Income (Loss) from Continuing Operations                    41.1            25.2            3.2          13.2      (0.5)
Interest Expense                                                      (6.8)           (4.3)          (1.3)            -      (1.2)
Other Income (Expense)                                                (4.2)              -            0.2             -      (4.4)
- ------------------------------------------------------------------------------------------------------------------------------------

Income (Loss) from Continuing Operations
    Before Minority Interest and Income Taxes                         30.1            20.9            2.1          13.2      (6.1)
Minority Interest                                                      1.2               -              -           1.2         -
- ------------------------------------------------------------------------------------------------------------------------------------

Income (Loss) from Continuing Operations
    Before Income Taxes                                               28.9            20.9            2.1          12.0      (6.1)
Income Tax Expense (Benefit)                                          11.5             8.0            0.5           5.1      (2.1)
- ------------------------------------------------------------------------------------------------------------------------------------

Income (Loss) from Continuing Operations                              17.4          $ 12.9           $1.6         $ 6.9     $(4.0)
                                                                                  --------------------------------------------------
Income from Discontinued Operations - Net of Tax                         -
- ----------------------------------------------------------------------------

Net Income                                                          $ 17.4
- ----------------------------------------------------------------------------

Total Assets                                                      $1,408.1 <F1>     $915.4         $150.9         $72.1    $219.7
Property, Plant and Equipment - Net                                 $847.3          $726.2         $116.1             -      $5.0
Accumulated Depreciation                                            $767.9          $725.0          $41.5             -      $1.4
Capital Expenditures                                                  $9.5 <F1>       $8.2           $0.7             -         -
- ------------------------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Discontinued Operations represented $50.0 million of total assets and $0.6 million of capital expenditures in 2005.
</FN>


11                    ALLETE First Quarter 2006 Form 10-Q



NOTE 3.  INVESTMENTS

At March  31,  2006,  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.



                                                             MARCH 31,         DECEMBER 31,
INVESTMENTS                                                    2006                2005
- -------------------------------------------------------------------------------------------
MILLIONS
                                                                         
Real Estate Assets                                            $ 70.4              $ 73.7
Debt and Equity Securities                                      33.2                34.8
Emerging Technology Investments                                  8.7                 9.2
- -------------------------------------------------------------------------------------------

Total Investments                                             $112.3              $117.7
- -------------------------------------------------------------------------------------------




                                                           QUARTER ENDED       YEAR ENDED
                                                             MARCH 31,        DECEMBER 31,
REAL ESTATE ASSETS                                             2006                2005
- -------------------------------------------------------------------------------------------
MILLIONS
                                                                        
Land Held for Sale Beginning Balance                           $48.0               $47.2
    Additions during period: Capitalized Improvements            2.2                 9.4
    Deductions during period: Cost of Real Estate Sold          (1.9)               (8.6)
- -------------------------------------------------------------------------------------------

Land Held for Sale Ending Balance                               48.3                48.0
Long-Term Finance Receivables                                    6.6                 7.4
Other <F1>                                                      15.5                18.3
- -------------------------------------------------------------------------------------------

Total Real Estate Assets                                       $70.4               $73.7
- -------------------------------------------------------------------------------------------
<FN>
<F1> Consisted primarily of a shopping center.
</FN>


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 $0.5
million at March 31, 2006 ($0.6 million at December 31, 2005).


NOTE 4.  SHORT-TERM AND LONG-TERM DEBT

In January  2006, we renewed,  increased  and extended a committed,  syndicated,
unsecured   revolving   credit   facility  (Line)  with  LaSalle  Bank  National
Association  for $150  million  ($100  million at December 31,  2005).  The Line
matures on January 11, 2011, and requires an annual commitment fee of 0.125%. At
our request and subject to certain conditions, the Line may be increased to $200
million and extended for two additional  12-month periods.  The Line may be used
for general  corporate  purposes,  working  capital and to provide  liquidity in
support of our commercial paper program. We may prepay amounts outstanding under
the Line in whole or in part at our discretion. Additionally, we may irrevocably
terminate or reduce the size of the Line prior to maturity.

In March  2006,  we issued $50  million in  principal  amount of First  Mortgage
Bonds, 5.69% Series due March 1, 2036.  Proceeds were used to redeem $50 million
in principal amount of First Mortgage Bonds, 7% Series due March 1, 2008.

                      ALLETE First Quarter 2006 Form 10-Q                     12



NOTE 5.  OTHER INCOME (EXPENSE)



                                                             QUARTER ENDED
                                                               MARCH 31,
                                                         2006             2005
- --------------------------------------------------------------------------------
MILLIONS
                                                                   
Loss on Emerging Technology Investments                 $(1.2)           $(5.9)
Investment and Other Income                               2.9              1.7
- --------------------------------------------------------------------------------

Total Other Income (Expense)                            $ 1.7            $(4.2)
- --------------------------------------------------------------------------------



NOTE 6.  INCOME TAX EXPENSE



                                                             QUARTER ENDED
                                                               MARCH 31,
                                                         2006             2005
- --------------------------------------------------------------------------------
MILLIONS
                                                                   
Current Tax Expense
     Federal                                            $10.8            $12.1
     State                                                2.5              3.1
- --------------------------------------------------------------------------------

                                                         13.3             15.2
- --------------------------------------------------------------------------------

Deferred Tax Expense (Benefit)
     Federal                                             (1.6)            (3.1)
     State                                                0.2             (0.3)
- --------------------------------------------------------------------------------

                                                         (1.4)            (3.4)
- --------------------------------------------------------------------------------

Deferred Tax Credits                                     (0.3)            (0.3)
- --------------------------------------------------------------------------------

Income Tax Expense for Continuing Operations             11.6             11.5
Income Tax Expense for Discontinued Operations              -              0.1
- --------------------------------------------------------------------------------

Total Income Tax Expense                                $11.6            $11.6
- --------------------------------------------------------------------------------


For the quarter ended March 31, 2006,  the  effective  rate for income taxes was
36.6 percent (38.2  percent for the quarter ended March 31, 2005).  The decrease
in the effective rate was primarily due to state tax planning  initiatives.  The
effective  tax rate of 36.6  percent  for the  quarter  ended  March  31,  2006,
deviated  from  the  statutory  rate,   primarily  due  to  state  tax  planning
initiatives,   investment  tax  credits,  and  deductions  for  Medicare  health
subsidies and depletion.

13                    ALLETE First Quarter 2006 Form 10-Q



NOTE 7.  DISCONTINUED OPERATIONS

ENVENTIS  TELECOM.  On  December  30,  2005,  we  sold  all  the  stock  of  our
telecommunications subsidiary,  Enventis Telecom, to Hickory Tech Corporation of
Mankato,  Minnesota. In accordance with SFAS 144, "Accounting for the Impairment
or  Disposal of  Long-Lived  Assets," we have  reported  our  telecommunications
business in discontinued operations for the quarter ended March 31, 2005.

WATER  SERVICES.  In early 2005, we completed  the exit from our Water  Services
businesses  with the sale of our wastewater  assets in Georgia for an immaterial
gain. In 2005, the Florida Public Service Commission approved the transfer of 63
water and wastewater systems from Florida Water to Aqua Utilities Florida,  Inc.
(Aqua Utilities) and ordered a $1.7 million reduction to plant  investment.  The
Company  reserved for the reduction in 2005. On March 15, 2006, the Company paid
Aqua Utilities the adjustment refund amount of $1.7 million.

For the quarter ended March 31, 2006, there were no financial  results to report
as discontinued operations.




QUARTER ENDED
DISCONTINUED OPERATIONS                                              MARCH 31,
SUMMARY INCOME STATEMENT                                               2005
- --------------------------------------------------------------------------------
MILLIONS
                                                                  
Operating Revenue - Enventis Telecom                                  $13.7
- --------------------------------------------------------------------------------

Enventis Telecom
     Pre-Tax Income from Operations                                    $1.1
     Income Tax Expense                                                 0.5
- --------------------------------------------------------------------------------

         Total Income from Operations - Enventis Telecom                0.6
- --------------------------------------------------------------------------------

Water Services
     Loss on Disposal                                                  (1.0)
     Income Tax Benefit                                                (0.4)
- --------------------------------------------------------------------------------

         Net Loss on Disposal - Water Services                         (0.6)
- --------------------------------------------------------------------------------

Income from Discontinued Operations                                    $0.0
- --------------------------------------------------------------------------------





DISCONTINUED OPERATIONS                                            DECEMBER 31,
SUMMARY BALANCE SHEET INFORMATION                                      2005
- --------------------------------------------------------------------------------
MILLIONS
                                                                
Assets of Discontinued Operations
     Other Current Assets                                              $0.4
     Property, Plant and Equipment                                     $2.2

Liabilities of Discontinued Operations
     Current Liabilities                                              $13.0
- --------------------------------------------------------------------------------


                      ALLETE First Quarter 2006 Form 10-Q                     14



NOTE 8.  COMPREHENSIVE INCOME

For the quarter ended March 31, 2006, total  comprehensive  income,  net of tax,
was $19.1 million  ($17.5  million for the quarter ended March 31, 2005).  Total
comprehensive  income  includes  net  income,  unrealized  gains  and  losses on
securities classified as available-for-sale, and additional pension liability.




ACCUMULATED OTHER COMPREHENSIVE                                 MARCH 31,
INCOME (LOSS) - NET OF TAX                                 2006           2005
- --------------------------------------------------------------------------------
MILLIONS
                                                                   
Unrealized Gain on Securities                             $  2.4         $  1.6
Additional Pension Liability                               (14.9)         (12.9)
- --------------------------------------------------------------------------------
                                                          $(12.5)        $(11.3)
- --------------------------------------------------------------------------------



NOTE 9.  EARNINGS PER SHARE

The  difference  between  basic  and  diluted  earnings  per share  arises  from
outstanding  stock  options  and  performance  share  awards  granted  under our
Executive and Director  Long-Term  Incentive  Compensation  Plans. In accordance
with SFAS 128,  "Earnings Per Share," for the three months ended March 31, 2006,
no options to purchase  shares of common stock were excluded in the  computation
of diluted  earnings per share  because the average  market  prices were greater
than the option  exercise  prices  (119,077  shares were  excluded for the three
months ended March 31, 2005).



                                                                             2006                                2005
                                                                --------------------------------------------------------------------
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 MARCH 31,

Income from Continuing Operations                                 $18.8         -        $18.8        $17.4         -        $17.4
Common Shares                                                      27.6       0.1         27.7         27.2       0.2         27.4
Per Share from Continuing Operations                              $0.68         -        $0.68        $0.64         -        $0.64
- ------------------------------------------------------------------------------------------------------------------------------------



NOTE 10.  PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS



                                                                                                                    POSTRETIREMENT
                                                                                 PENSION                            HEALTH AND LIFE
                                                                           ---------------------------------------------------------
COMPONENTS OF NET PERIODIC BENEFIT EXPENSE                                   2006       2005                        2006       2005
- ------------------------------------------------------------------------------------------------------------------------------------
MILLIONS
                                                                                                                   
FOR THE QUARTER ENDED MARCH 31,

Service Cost                                                                 $2.3       $2.2                        $1.1       $1.0
Interest Cost                                                                 5.5        5.3                         1.9        1.7
Expected Return on Plan Assets                                               (7.1)      (7.1)                       (1.4)      (1.2)
Amortization of Prior Service Costs                                           0.2        0.2                           -          -
Amortization of Net Loss                                                      1.2        0.8                         0.4        0.2
Amortization of Transition Obligation                                           -        0.1                         0.6        0.6
- ------------------------------------------------------------------------------------------------------------------------------------
Net Periodic Benefit Expense                                                 $2.1       $1.5                        $2.6       $2.3
- ------------------------------------------------------------------------------------------------------------------------------------


In 2005,  we  determined  that our  postretirement  health  care  plans meet the
requirements   of  the  Centers  for  Medicare  and  Medicaid   Services'  (CMS)
regulations,  and enrolled  with the CMS to begin  recovering  the  subsidy.  We
expect to receive the first subsidy check in early 2007 for 2006 credits.

15                    ALLETE First Quarter 2006 Form 10-Q



NOTE 11.  COMMITMENTS, GUARANTEES AND CONTINGENCIES

OFF-BALANCE SHEET ARRANGEMENTS. 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 was entitled to  approximately  71 percent of the Unit's output
under the Agreement.  Beginning in 2006,  Minnkota Power exercised its option to
reduce Minnesota Power's entitlement by approximately 5 percent annually,  to 66
percent.  We received notices from Minnkota Power that they would further reduce
our output  entitlement by  approximately 5 percent on January 1, 2007 and 2008,
to 60 percent and 55  percent,  respectively.  Minnkota  Power has the option to
reduce Minnesota Power's entitlement to 50 percent. Minnesota Power is obligated
to pay its pro rata share of Square  Butte's  costs based on  Minnesota  Power's
entitlement  to  Unit  output.  Minnesota  Power's  payment  obligation  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 March 31,  2006,  Square  Butte had total  debt
outstanding  of $304.9  million.  Total  annual debt service for Square Butte is
expected to be approximately $26 million in each of the years 2006 through 2010.
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.  BNI Coal is obligated to make lease payments for a dragline
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 operating leases is $6.4
million in 2006,  $5.9 million in 2007,  $5.2  million in 2008,  $4.7 million in
2009, $4.2 million in 2010 and $46.9 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  2006 to December  2011.  Our
minimum  annual  payment   obligations  under  these  coal,  rail  and  shipping
agreements  are  currently  $45.2  million in 2006,  $9.5 million in 2007,  $9.7
million in 2008, $5.8 million in 2009 and no specific  commitments  beyond 2009.
Our minimum annual payment obligations will increase when annual nominations are
made for coal deliveries in future years.

FUEL CLAUSE RECOVERY OF MISO DAY 2 COSTS.  Minnesota Power filed a petition with
the MPUC in  February  2005 to amend its fuel  clause to  accommodate  costs and
revenue  related  to the MISO Day 2 energy  market,  the  market  through  which
Minnesota Power engages in wholesale energy transactions in MISO's day-ahead and
real-time  markets  (MISO Day 2). On April 7, 2005,  the MPUC  approved  interim
accounting  treatment of MISO Day 2 costs to be accounted for on a net basis and
recovered through the fuel clause, subject to refund with interest. This interim
treatment has continued while the MPUC has addressed the cost recovery petitions
from Xcel Energy Inc., Otter Tail Power Company,  Alliant Energy Corporation and
Minnesota Power.

On December 21, 2005, the MPUC issued an order which denied recovery through the
fuel  clause  of  uplift   charges,   congestion   revenue  and  expenses,   and
administrative  costs related to Minnesota Power's MISO Day 2 market activities.
Minnesota Power requested  rehearing of the order in a filing made with the MPUC
on January 10, 2006. The other three utilities  affected by the order also filed
for  rehearing,  as did the DOC and MISO. In a hearing on February 9, 2006,  the
MPUC  granted  rehearing  of the MISO  Day 2 docket  and  suspended  the  refund
obligation  for  charges  recovered  through  the fuel  clause and denied in the
December 21, 2005 order.  The MPUC will review the MISO Day 2 costs to determine
which costs should be recovered on a current  basis  through the fuel clause and
which costs are more appropriately

                      ALLETE First Quarter 2006 Form 10-Q                     16



NOTE 11.  COMMITMENTS, GUARANTEES AND CONTINGENCIES (CONTINUED)

deferred for potential recovery through base rates. The MPUC's order documenting
the February 9, 2006,  hearing was issued  February 24, 2006. The parties had 60
days to issue their recommendations to the MPUC. The Company is working with the
other utilities,  the DOC and other stakeholders to prepare the report. On April
11, 2006, the parties requested an extension to file their  recommendations with
the MPUC.  On April 24, 2006,  the MPUC  approved an extension to June 22, 2006.
The Company is unable to predict the outcome of this matter.

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 March 31, 2006,  and December 31, 2005. We have
committed to make additional  investments in certain emerging technology venture
capital  funds.  The total future  commitment was $3.0 million at March 31, 2006
($3.1  million at December  31,  2005),  and may be  invested  at various  times
through 2007.  We do not have plans to make any  additional  investments  beyond
this commitment.

INVESTMENT IN ATC. In December 2005, we entered into an agreement with Wisconsin
Public  Service  Corporation  and WPS  Investments,  LLC that  provides  for our
Wisconsin subsidiary,  Rainy River Energy Corporation - Wisconsin, to invest $60
million in ATC. Our  investment  is expected to represent an estimated 9 percent
ownership  interest in ATC. On May 4, 2006,  the PSCW  reviewed and approved the
request that allows us to invest in ATC. We anticipate  investing $60 million in
ATC by the end of 2006. Our first investment is expected to occur in May 2006.

ENVIRONMENTAL MATTERS. Our businesses are subject to regulation of environmental
matters by various federal, state and local authorities.  Due to future stricter
environmental  requirements through legislation and/or rulemaking, we anticipate
that potential  expenditures for environmental matters will be material and will
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 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.  In
February  2003,  SWL&P  submitted a Phase II  environmental  site  investigation
report to the WDNR.  This report  identified  some MGP-like  chemicals that were
found in the soil near the  former  plant  site.  During  March and April  2003,
sediment  samples were taken from nearby Superior Bay. The report on the results
of this  sampling was completed and sent to the WDNR during the first quarter of
2004. The next phase of the investigation was to determine any impact to soil or
ground water  between the former MGP site and Superior  Bay.  Site work for this
phase of the  investigation  was performed  during  October 2004,  and the final
report was sent to the WDNR in March 2005.  Additional  site  investigation  was
performed  during  September and October 2005. The  investigation  will continue
during  the summer of 2006.  It is  anticipated  that the final  report for this
portion of the investigation  will be completed by the end of 2006.  Although it
is not possible to quantify the potential  clean-up cost until the investigation
is completed,  a $0.5 million liability was recorded in December 2003 to address
the known  areas of  contamination.  The Company  has  recorded a  corresponding
dollar  amount as a  regulatory  asset to offset  this  liability.  The PSCW has
approved SWL&P's deferral of these MGP environmental investigation and potential
clean-up costs for future  recovery in rates,  subject to 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 at 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 the Company continues to work with the insurer to determine the availability
of insurance coverage.

17                    ALLETE First Quarter 2006 Form 10-Q



NOTE 11.  COMMITMENTS, GUARANTEES AND CONTINGENCIES (CONTINUED)

SQUARE BUTTE GENERATING FACILITY. On April 24, 2006, Minnkota Power announced it
has reached a  settlement  agreement  with the EPA and the State of North Dakota
regarding  emissions at the M.R. Young Station,  which includes the Square Butte
generating  unit. 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.  The EPA claimed 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
and possible  significant  capital  expenditures  to comply.  As a result of the
settlement agreement,  the current Square Butte flue gas desulfurization  system
(FGD) will be  upgraded  in 2010 to  increase  its  removal  efficiency  from 70
percent to 90 percent.  Capital  expenditures for the emission control additions
and modifications on Square Butte are estimated at $35 million.  These estimated
capital  expenditures  may be  significantly  offset by the sale of surplus  SO2
allowance  credits  created with the early  upgrade of the FGD system,  which is
being upgraded two years earlier than required by Federal rules.  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.  On April 24,
2006, a Complaint and a Consent Decree with respect to this settlement agreement
were filed in U.S. District Court for the District of North Dakota (Court).  The
Consent Decree is open to public comment for 30 days after which,  if entered as
an order by the Court,  will  constitute a final  settlement  of this issue.  If
finalized,  the Consent Decree settlement would also require Square Butte to pay
approximately  $0.6 million in  administrative  costs and penalties in 2006, and
$3.3 million  toward  additional  environmental  projects  including  wind power
installations or power purchase agreements.

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 and NOX in many states in the eastern United
States.  The CAIR  includes  Minnesota  as one of the 28 states it  considers an
"eastern"  state. The EPA also announced the final Clean Air Mercury Rule (CAMR)
that reduces and  permanently  caps electric  utility  mercury  emissions in the
continental  United  States.  The  CAIR  and  the  CAMR  regulations  have  been
challenged  in the  court  system,  which  may  delay  implementation  or modify
provisions.  Minnesota Power is  participating in a legal challenge to the CAIR,
but is not participating in the challenge of 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, or (3) use a combination of both.

We believe that the CAIR  contains  flaws in its  methodology  and  application,
which will cause Minnesota Power to incur higher compliance costs. Consequently,
on July 11,  2005,  Minnesota  Power  filed a Petition  for Review with the U.S.
Court of Appeals for the District of Columbia  Circuit  (Court of  Appeals).  On
November 22, 2005,  the EPA agreed to  reconsider  certain  aspects of the CAIR,
including the Minnesota  Power  petition  addressing  modeling used to determine
Minnesota's  inclusion in the CAIR region and claims about inequities in the SO2
allowance  methodology.  On March 16,  2006,  the EPA denied all  petitions  for
reconsideration with respect to the CAIR. However, if Minnesota Power's Petition
for Review  with the Court of Appeals is  successful,  we expect to incur  lower
compliance  costs,   consistent  with  the  rules  applicable  to  those  states
considered as "western"  states under the CAIR.  Resolution of the CAIR Petition
for Review with the Court of Appeals is anticipated by mid-2007.

COMMUNITY  DEVELOPMENT DISTRICT  OBLIGATIONS.  In March 2005, the Town Center at
Palm Coast Community  Development  District (Town Center  District) issued $26.4
million of tax-exempt,  6% Capital  Improvement  Revenue Bonds, Series 2005, due
May 1,  2036.  The  bonds  were  issued  to fund a  portion  of the Town  Center
development project. 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  imposed,  levied and  collected  by the Town  Center
District.   The  assessments  represent  an  allocation  of  the  costs  of  the
improvements,  including  bond  financing  costs,  to the lands  within the Town
Center  District  benefiting  from the  improvements.  The  assessments  will be
included in the annual  property tax bills of  landowners  beginning in November
2006.  To the extent  that we still own land at the time of the  assessment,  in
accordance  with EITF  91-10,  we will  recognize  an  expense  for our pro rata
portion of assessments, based upon our ownership of benefited property. At March
31, 2006, we owned  approximately  91 percent of the assessable land in the Town
Center District.

                      ALLETE First Quarter 2006 Form 10-Q                     18



NOTE 11. COMMITMENTS, GUARANTEES AND CONTINGENCIES (CONTINUED)

OTHER.  We are involved in litigation  arising in the normal course of business.
Also in the normal course of business,  we are involved in tax,  regulatory  and
other  governmental  audits,  inspections,  investigations and other proceedings
that involve state and federal taxes, safety, compliance with regulations,  rate
base and cost of service  issues,  among other things.  While the  resolution of
such matters could have a material effect on earnings and cash flows in the year
of  resolution,  none of these  matters are  expected to  materially  change our
present liquidity position,  nor have a material adverse effect on our financial
condition.


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.  Readers are
cautioned that forward-looking statements should be read in conjunction with our
disclosures in this Form 10-Q under the headings:  "Safe Harbor  Statement Under
the  Private  Securities  Litigation  Reform Act of 1995"  located on page 3 and
"Risk  Factors"  located  in Part I,  Item 1A of our 2005 Form 10-K and Part II,
Item 1A of this Form 10-Q.  The risks and  uncertainties  described in this Form
10-Q and our 2005 Form 10-K are not the only ones facing our Company. Additional
risks and uncertainties that we are not presently aware of, or that we currently
consider  immaterial,  may also affect our business  operations.  Our  business,
financial  condition or results of  operations  could suffer if the concerns set
forth are realized.

EXECUTIVE SUMMARY

ALLETE's  operations focus on two core  businesses--ENERGY  and REAL ESTATE.  In
addition, we have other operations that provide earnings to the Company.

ENERGY is comprised of Regulated  Utility,  Nonregulated  Energy Operations and,
beginning in the second quarter of 2006, Investment in ATC 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 our  coal mining activities in
        North Dakota, under 50 MW of nonregulated  generation and Minnesota land
        sales.

        In 2005,  Nonregulated  Energy  Operations  also  included  nonregulated
        generation  (non-rate base generation sold at market-based  rates to the
        wholesale   market)  from  our  Taconite  Harbor  facility  in  northern
        Minnesota,  and  generation  secured  through the Kendall  County  power
        purchase  agreement.  Effective  January  1, 2006,  Taconite  Harbor was
        integrated into our Regulated  Utility  business to help meet forecasted
        base load energy  requirements.  In April 2005, the Kendall County power
        purchase agreement was assigned to Constellation Energy Commodities.

     -  INVESTMENT  IN ATC  will include  our  ownership  interest  in  ATC.  In
        December  2005,  we entered  into an agreement  that  provides for us to
        invest  $60 million in ATC by the  end of 2006. Our first  investment is
        expected to occur in May 2006.

REAL ESTATE includes our Florida real estate operations.

OTHER includes our investments in emerging  technologies,  and earnings on cash,
cash equivalents and short-term investments.

Financial  results by segment for the periods  presented  and  discussed in this
Form 10-Q were impacted by the  integration of our Taconite Harbor facility into
the Regulated  Utility  segment  effective  January 1, 2006. The  redirection of
Taconite Harbor from our Nonregulated Energy Operations segment to our Regulated
Utility  segment was in accordance with the Company's  Integrated  Resource Plan
(Resource  Plan), as approved by the MPUC. Under the terms of our Resource Plan,
we have operated the Taconite

19                   ALLETE First Quarter 2006 Form 10-Q



EXECUTIVE SUMMARY (CONTINUED)

Harbor facility as a rate-based asset within the Minnesota  retail  jurisdiction
effective  January 1, 2006.  Prior to January 1, 2006,  we operated our Taconite
Harbor  facility as nonregulated  generation.  Historical  financial  results of
Taconite  Harbor  for  periods  prior to the  redirection  are  included  in our
Nonregulated Energy Operations segment.

Reported net income for the quarter ended March 31, 2006, was $18.8 million,  or
$0.68 per diluted  share ($17.4  million,  or $0.64 per diluted  share,  for the
quarter ended March 31, 2005). In 2006, net income was higher due to the absence
of  Kendall  County  operating  losses  ($1.9  million  in  2005)  and  emerging
technology  impairments ($3.3 million in 2005). These factors were mostly offset
by higher  operating  expense  and a $1.9  million  decrease in income from Real
Estate,  primarily due to the timing and mix of real estate sold.  Although warm
temperatures in early 2006 reduced energy sales to our  residential,  commercial
and municipal  customers,  sales to our large power customers  remained  strong.
Minnesota Power's taconite mining customers  continue to operate at historically
high output levels.  In total,  kilowatthour  sales in 2006 were similar to 2005
sales.



                                                            QUARTER ENDED
                                                              MARCH 31,
                                                       2006               2005
- --------------------------------------------------------------------------------
MILLIONS EXCEPT PER SHARE AMOUNTS
                                                                   
Operating Revenue
     Regulated Utility                                $162.4             $147.6
     Nonregulated Energy Operations                     16.3               27.9
     Real Estate                                        13.7               17.7
     Other                                               0.1                0.1
- --------------------------------------------------------------------------------
                                                      $192.5             $193.3
- --------------------------------------------------------------------------------
Operating Expenses
     Regulated Utility                                $136.3             $122.4
     Nonregulated Energy Operations                     15.2               24.7
     Real Estate                                         3.4                4.5
     Other                                               1.2                0.6
- --------------------------------------------------------------------------------
                                                      $156.1             $152.2
- --------------------------------------------------------------------------------
Interest Expense
     Regulated Utility                                  $5.1               $4.3
     Nonregulated Energy Operations                      0.5                1.3
     Other                                               0.8                1.2
- --------------------------------------------------------------------------------
                                                        $6.4               $6.8
- --------------------------------------------------------------------------------
Other Income (Expense)
     Nonregulated Energy Operations                     $0.3              $ 0.2
     Other                                               1.4               (4.4)
- --------------------------------------------------------------------------------
                                                        $1.7              $(4.2)
- --------------------------------------------------------------------------------
Income (Loss)
     Regulated Utility                                 $13.0              $12.9
     Nonregulated Energy Operations                      0.9                1.6
     Real Estate                                         5.0                6.9
     Other                                              (0.1)              (4.0)
- --------------------------------------------------------------------------------
     Income from Continuing Operations                  18.8               17.4
     Income from Discontinued Operations                   -                  -
- --------------------------------------------------------------------------------
     Net Income                                        $18.8              $17.4
- --------------------------------------------------------------------------------
Diluted Average Shares of Common Stock                  27.7               27.4
- --------------------------------------------------------------------------------
Diluted Earnings Per Share of Common Stock
     Continuing Operations                             $0.68              $0.64
     Discontinued Operations                               -                  -
- --------------------------------------------------------------------------------
                                                       $0.68              $0.64
- --------------------------------------------------------------------------------


                      ALLETE First Quarter 2006 Form 10-Q                     20



EXECUTIVE SUMMARY (CONTINUED)



                                                                                                                QUARTER ENDED
                                                                                                                   MARCH 31,
KILOWATTHOURS SOLD                                                                                        2006                2005
- ------------------------------------------------------------------------------------------------------------------------------------
MILLIONS
                                                                                                                      
     Regulated Utility
         Retail and Municipals
              Residential                                                                                 308.0               319.8
              Commercial                                                                                  328.7               339.8
              Industrial                                                                                1,822.3             1,777.1
              Municipals                                                                                  219.3               222.0
              Other                                                                                        20.0                20.4
- ------------------------------------------------------------------------------------------------------------------------------------
                                                                                                        2,698.3             2,679.1
         Other Power Suppliers                                                                            505.1               236.7
- ------------------------------------------------------------------------------------------------------------------------------------
                                                                                                        3,203.4             2,915.8
     Nonregulated Energy Operations                                                                        65.6               353.9
- ------------------------------------------------------------------------------------------------------------------------------------
                                                                                                        3,269.0             3,269.7
- ------------------------------------------------------------------------------------------------------------------------------------




                                                                                                 QUARTER ENDED
                                                                                                    MARCH 31,
REAL ESTATE                                                                          2006                               2005
REVENUE AND SALES ACTIVITY                                                  QUANTITY      AMOUNT               QUANTITY      AMOUNT
- ------------------------------------------------------------------------------------------------------------------------------------
DOLLARS IN MILLIONS
                                                                                                                 
Town Center Sales
   Commercial Sq. Ft.                                                        80,000       $ 1.5                      -           -

Other Land Sales
   Acres                                                                        456        10.3                    483       $17.6
   Lots                                                                           -           -                      7         0.4
- ------------------------------------------------------------------------------------------------------------------------------------

Contract Sales Price <F1>                                                                  11.8                               18.0

Revenue Recognized from Previously Deferred Sales                                           1.5                                  -

Deferred Revenue                                                                           (0.7)                              (1.0)

Adjustments <F2>                                                                           (0.1)                                 -
- ------------------------------------------------------------------------------------------------------------------------------------

Revenue from Land Sales                                                                    12.5                               17.0

Other Revenue                                                                               1.2                                0.7
- ------------------------------------------------------------------------------------------------------------------------------------
                                                                                          $13.7                              $17.7
- ------------------------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Reflected total contract sales price on closed land transactions.
<F2> Contributed development dollars, which are credited to cost of real estate sold.
</FN>


NET INCOME

The  following  income  discussion  summarizes a comparison  of the three months
ended March 31, 2006, to the three months ended March 31, 2005, by segment.

REGULATED UTILITY  contributed income of $13.0 million in 2006 ($12.9 million in
2005). Income was higher in 2006 due to the inclusion of kilowatthour sales from
our  Taconite  Harbor  generating  assets,  effective  January  1,  2006.  While
kilowatthour sales to other power suppliers increased 113 percent,  the increase
was  attributable to the inclusion of Taconite  Harbor.  Absent Taconite Harbor,
income from sales to other power suppliers  reflected  decreased sales and lower
prices  in 2006.  A 3  percent  increase  in  kilowatthour  sales to  industrial
customers due to continued  healthy  economic  conditions  in Minnesota  Power's
service territory and customers operating at historically high production levels
was offset by a 3 percent  decrease in  residential,  commercial  and  municipal
sales due to warm weather in 2006. Higher operating expenses in 2006, mostly due
to the inclusion of expenses related to Taconite Harbor, reduced income.

21                    ALLETE First Quarter 2006 Form 10-Q



NET INCOME (CONTINUED)

NONREGULATED  ENERGY  OPERATIONS  reported  income of $0.9 million in 2006 ($1.6
million in 2005),  reflecting  the absence of income from Taconite  Harbor ($2.3
million  in  2005)  which  is now  reported  as part of  Regulated  Utility  and
operating  losses from Kendall County ($1.9 million in 2005). The Kendall County
power purchase  agreement was assigned to  Constellation  Energy  Commodities in
April 2005.

REAL ESTATE  contributed  income of $5.0 million in 2006 ($6.9 million in 2005).
Income  was lower in 2006 due to the  timing  and mix of land  sale  transaction
closings.  The timing of the closing of real estate  sales varies from period to
period and impacts comparisons between years.

In 2005, we began selling property from our Town Center  development  project in
northeast  Florida.  Since land is being sold before  completion  of the project
infrastructure,  revenue  and cost of real estate  sold are  recorded  using the
percentage-of-completion  method.  As of March 31, 2006,  we had $7.8 million of
deferred profit on sales of real estate,  before taxes and minority interest, on
our balance sheet, the majority of which relates to Town Center.  We expect most
of this deferred profit will be reflected in income by the end of 2006.

At March 31, 2006,  total  pending land sales under  contract were $85.3 million
and are  anticipated  to close at various times  through 2012.  Pricing on these
contracts range from $20 to $50 per commercial  square foot,  $15,000 to $40,000
per residential  unit and $8,700 to $524,000 per acre for all other  properties.
The majority of the other  properties  under  contract are zoned  commercial  or
mixed use. Prices per acre are stated on a gross acreage basis and are dependent
on the type and  location of the  properties  sold.  In addition to minimum base
price contracts,  certain contracts allow us to receive participation revenue to
the extent that an agreed upon  percentage  of gross  revenue from land sales by
our purchaser exceeds the minimum base price.



REAL ESTATE
PENDING CONTRACTS                                                    CONTRACT
AT MARCH 31, 2006                                 QUANTITY          SALES PRICE
- --------------------------------------------------------------------------------
DOLLARS IN MILLIONS
                                                              
Town Center
     Commercial Sq. Ft.                          1,149,200             $35.2
     Residential Units                               1,292              26.8

Palm Coast Park
     Residential Units                                 500               7.5

Other Land
     Acres                                             604              15.8
- --------------------------------------------------------------------------------
                                                                       $85.3
- --------------------------------------------------------------------------------


OTHER reflected a loss of $0.1 million in 2006 (a $4.0 million loss in 2005). In
2006, a $0.6 million  increase in earnings on excess cash offset  equity  losses
related to emerging  technology  investments ($0.5 million in 2006; $0.1 million
in 2005). In 2005, the Company  recorded $3.3 million of impairments  related to
two privately-held emerging technology investments.

DISCONTINUED OPERATIONS included our Water Services businesses that we sold over
the three-year period 2003 to 2005, and our telecommunications  business that we
sold in December  2005. In 2005,  $0.6 million of income from  Enventis  Telecom
operations  was offset by $0.6  million  of  administrative  and other  expenses
incurred to support Florida Water transfer proceedings. (See Note 7.)

                      ALLETE First Quarter 2006 Form 10-Q                     22



COMPARISON OF THE QUARTERS ENDED MARCH 31, 2006 AND 2005

REGULATED UTILITY

     OPERATING REVENUE was up $14.8 million,  or 10 percent,  from 2005. Revenue
     and kilowatthour sales from other power suppliers were up $11.4 million and
     113  percent,  respectively,  from 2005,  primarily  due to the addition of
     Taconite Harbor sales to the Regulated Utility segment effective January 1,
     2006.  Absent Taconite Harbor,  revenue from sales to other power suppliers
     reflected  decreased sales and lower prices in 2006.  Revenue from sales to
     retail and municipal customers was up $3.5 million, primarily due to higher
     fuel  clause   recoveries  in  2006.   (See  operating   expenses   below.)
     Kilowatthour  sales  to  industrial  customers  were  up 3  percent  due to
     continued  strong economic  conditions,  offset by a 3 percent  decrease in
     residential,  commercial and municipal sales due to warm weather in January
     and a mild  March  in 2006.  Gas  revenue  was up $0.4  million  from  2005
     reflecting new gas rates  effective in May 2005,  offset by decreased usage
     due to warmer weather in 2006.

     Revenue from electric sales to taconite customers  accounted for 24 percent
     of  consolidated  operating  revenue in 2006 (23 percent in 2005).  Revenue
     from  electric  sales to paper and pulp  mills  accounted  for 9 percent of
     consolidated operating revenue in 2006 (8 percent in 2005).

     OPERATING EXPENSES were up $13.9 million, or 11 percent, from 2005.

     FUEL AND PURCHASED  POWER EXPENSE.  Fuel and purchased power expense was up
     $9.4  million  from 2005,  reflecting  the  inclusion  of  Taconite  Harbor
     operations  beginning in 2006 ($5.3 million) and increased expenses related
     to  other  Company  generating  facilities  ($2.8  million).  In  addition,
     expenses related to outages at Boswell Unit 4 and Square Butte in late 2005
     were  recognized in the first quarter of 2006 due to the timing of recovery
     through the fuel clause.  Additional purchased power expense incurred while
     Boswell Unit 3 was down for  maintenance  following a cooling tower failure
     in February and March 2005 was not recognized until second quarter 2005.

     OTHER OPERATING  EXPENSES.  In total, other operating expenses were up $4.5
     million from 2005. Employee  compensation was up $1.9 million primarily due
     to the  inclusion  of  Taconite  Harbor,  annual  wage  increases  and  the
     inclusion of union  employees in our results  sharing  compensation  awards
     program.  Depreciation  expense  increased  $1.3 million  primarily  due to
     capitalized projects completed in 2005.  Vegetation  management was up $0.9
     million  reflecting more performed in 2006.  Pension expense increased $0.6
     million due to a reduction in the discount  rate.  Purchased gas costs were
     up $0.3 million due to higher prices in 2006. In total,  plant  maintenance
     expense  decreased  $0.4 million from 2005.  The decrease  reflected a $2.8
     million  reduction  in expenses at Boswell  Unit 3 partially  offset by the
     inclusion  of  Taconite  Harbor  maintenance  in 2006  ($1.5  million)  and
     increased  maintenance expense at other Company generating  facilities.  In
     2005,  planned  maintenance  was performed at Boswell Unit 3 while the unit
     was down due to a cooling tower failure.

     INTEREST EXPENSE was up $0.8 million, or 19 percent,  from 2005, due to the
     inclusion of Taconite Harbor in 2006.

NONREGULATED ENERGY OPERATIONS

     OPERATING REVENUE was down $11.6 million,  or 42 percent,  from 2005 due to
     the absence of revenue from  Taconite  Harbor  ($11.4  million in 2005) and
     Kendall County ($3.1 million in 2005).  Effective January 1, 2006, Taconite
     Harbor is reported as part of Regulated Utility.  Kendall County operations
     ceased  April 1,  2005,  when  the  Company  assigned  the  power  purchase
     agreement  to  Constellation   Energy   Commodities.   Revenue  from  other
     nonregulated  generation  was up $0.8  million from 2005  primarily  due to
     recovery of higher  purchased  gas costs.  Coal revenue,  realized  under a
     cost-plus  contract,  was up $0.5 million from 2005 reflecting a 10 percent
     increase  in the  delivery  price  per ton due to  higher  coal  production
     expenses. (See operating expenses below.)

     OPERATING  EXPENSES were down $9.5 million,  or 38 percent,  from 2005. The
     decrease  was due to the  absence of expenses  related to  Taconite  Harbor
     ($5.8 million in 2005) and Kendall County ($6.3 million in 2005).  Expenses
     for other nonregulated generation were up $0.6 million due to higher prices
     for purchased gas in 2006. Expenses related to coal operations were up $0.3
     million, mainly due to increased lease expenses in 2006.

     INTEREST EXPENSE was down $0.8 million, or 62 percent, from 2005 due to the
     absence of Taconite Harbor in 2006.

23                    ALLETE First Quarter 2006 Form 10-Q



COMPARISON OF THE QUARTERS ENDED MARCH 31, 2006 AND 2005 (CONTINUED)

REAL ESTATE

     OPERATING REVENUE was down $4.0 million,  or 23 percent,  from 2005, due to
     the timing and mix of land sale  transaction  closings.  Revenue  from land
     sales was $12.5  million in 2006 which  included $1.5 million of previously
     deferred revenue.  In 2005,  revenue from land sales was $17.0 million.  In
     2006,  456 acres of other  land  were sold (483  acres and 7 lots in 2005).
     Sales at Town Center  represented  the rights to build up to 80,000  square
     feet of commercial space in 2006. The first land sales for Town Center were
     recorded  in June 2005.  At March 31,  2006,  revenue of $10.7  million was
     deferred,  of  which  $8.1  million  relates  to Town  Center,  and will be
     recognized on a  percentage-of-completion  basis as development obligations
     are completed.

     OPERATING  EXPENSES  were  down  $1.1  million,  or 24  percent,  from 2005
     reflecting  a $0.7  million  decrease in the cost of real estate sold ($1.9
     million in 2006;  $2.6  million in 2005),  and a $0.4  million  decrease in
     selling  expenses due to the mix of land sold.  At March 31, 2006,  cost of
     real estate sold totaling $2.6 million and selling expenses of $0.3 million
     were deferred and will be recognized on a percentage-of-completion basis as
     development  obligations  are  completed.  The  majority  of  the  deferred
     expenses relate to Town Center.

OTHER

     OPERATING  EXPENSES  were up  $0.6  million,  or 100  percent,  from  2005,
     reflecting higher general and administrative expenses in 2006.

     INTEREST  EXPENSE  was  down  $0.4  million,  or  33  percent,  from  2005,
     reflecting the positive impact of first mortgage bonds  refinanced at lower
     interest rates in August 2005 ($35 million) and March 2006 ($50 million).

     OTHER INCOME (EXPENSE)  reflected $5.8 million more income in 2006 due to a
     $1.1  million  increase  in  earnings  on excess  cash and the  absence  of
     emerging technology impairments. In 2005, the Company recorded $5.1 million
     of  impairments   related  to  two   privately-held   emerging   technology
     investments. Other income (expense) also reflected equity losses related to
     emerging  technology  investments  of $0.8 million in 2006 ($0.2 million in
     2005).

INCOME TAXES

For the quarter ended March 31, 2006,  the  effective  rate for income taxes was
36.6 percent (38.2  percent for the quarter ended March 31, 2005).  The decrease
in the effective rate was primarily due to state tax planning  initiatives.  The
effective  tax rate of 36.6  percent  for the  quarter  ended  March  31,  2006,
deviated  from  the  statutory  rate,   primarily  due  to  state  tax  planning
initiatives,   investment  tax  credits,  and  deductions  for  Medicare  health
subsidies and depletion.


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 2005 Form 10-K.

                      ALLETE First Quarter 2006 Form 10-Q                     24



OUTLOOK

EARNINGS  GUIDANCE.  We  continue  to expect  ALLETE's  earnings  per share from
continuing operations to grow by 15 percent to 20 percent in 2006. The growth is
expected to come from continued  strong  electric  sales,  increased real estate
sales, the elimination of projected  operating  losses from Kendall County,  the
elimination of impairments related to our emerging technology  investments,  and
our investment in ATC.

ENERGY.  Over the next several  years,  we believe  electric  utilities  will be
facing the  unfolding  impacts of three  major  developments  that  occurred  in
2005--changes in regional transmission operation,  the development of rulemaking
on the enactment of stricter  environmental  regulations and federal legislation
impacting the structure and  organization of the electric utility  industry.  We
believe our energy  businesses  are well  positioned to  successfully  deal with
these  issues  and to  compete  successfully.  Our  access to and  ownership  of
low-cost power are our greatest strengths. We anticipate that we will have ready
access to sufficient capital for general business purposes.

RESOURCE PLAN. In 2006, the MPUC approved our Integrated Resource Plan (Resource
Plan).  The Resource Plan detailed our retail energy demand  projections and our
energy sourcing options to meet projected  demand.  One of the key components of
the Resource Plan was the redirection of our Taconite Harbor generating facility
from nonregulated  energy operations to regulated utility  operations  effective
January 1, 2006. The Taconite  Harbor  generation  will be  supplemented  with a
50-MW long-term power purchase  agreement with Manitoba Hydro.  Expansion of our
renewable generating assets to meet Minnesota's  Renewable Energy Objective that
seeks a 10 percent supply of qualified  renewable  energy resources in the state
by  2015  for  each  Minnesota  utility  was  also  approved.   In  April  2006,
construction  began on a 50-MW wind  facility in North Dakota and is expected to
be  completed  in the fall of 2006.  We will  purchase the output from this wind
facility  under a 25-year  power  purchase  agreement  with an  affiliate of FPL
Energy, LLC. We predict that retail demand by customers in our service territory
will  increase at an average  annual  rate of 1.5 percent to 2019.  We project a
load  growth  of  approximately  150 MW by 2010  with  another  200 MW of growth
anticipated by 2015.

LARGE  POWER  CONTRACTS.  In  March  and  April  2006,  the  MPUC  approved  new
all-requirements  agreements  with Stora Enso Oyj's Duluth mills through  August
31,  2013,  and  UPM-Kymmene  Corporation's  Blandin  Paper mill in Grand Rapids
through April 30, 2010.  Three other  long-term  agreements were approved by the
MPUC in 2005,  extending  contracts for an additional  four to eight years.  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  represent more
than  half  of  Minnesota  Power's  regulated  utility  electric  sales.   These
agreements help to provide planning certainty for both our customers and us.

MISO AND FUEL  CLAUSE.  On  February  24,  2006,  the MPUC  issued an order that
granted rehearing of the MISO Day 2 docket and suspended the refund  obligation.
The  Company  is  working  with  other  Minnesota  utilities,  the DOC and other
stakeholders  to  prepare a joint  recommendation,  required  by the MPUC in its
February 24, 2006 order,  of which costs should be recovered on a current  basis
through  the fuel  clause and which costs are more  appropriately  deferred  for
potential  recovery through base rates. The parties have until June 22, 2006, to
report to the MPUC. (See Note 11.)

INVESTMENT  IN ATC. On May 4, 2006,  the PSCW  reviewed and approved the request
that allows us to invest $60 million in ATC.  We  anticipate  having $60 million
invested in ATC by the  end of 2006, with our first investment expected to occur
in May.

RATE  CASE.  On May 1,  2006,  SWL&P  filed  an  application  with  the PSCW for
authority  to  increase  retail  utility  rates an average of 5.2 percent and is
requesting an 11.7 percent  return on common  equity.  The Company  expects that
hearings  will be conducted in late 2006 and new rates will become  effective in
January 2007.

REAL ESTATE.  Progress continues on our three major planned development projects
in Florida--Town Center, which will be a new downtown for Palm Coast; Palm Coast
Park, which is located in northwest Palm Coast; and Ormond  Crossings,  which is
located in Ormond Beach along Interstate 95.

25                    ALLETE First Quarter 2006 Form 10-Q



OUTLOOK (CONTINUED)

TOWN CENTER. We began selling property from our Town Center development  project
in northeast  Florida in 2005.  Developers  who have purchased land from us have
started construction of buildings. Since land is being sold before completion of
the project  infrastructure,  revenue and cost of real estate sold are  recorded
using a  percentage-of-completion  method. Pending land sales under contract for
properties at Town Center totaled $62.0 million at March 31, 2006.

PALM COAST  PARK.  At March 31,  2006,  pending  land sales under  contract  for
properties at Palm Coast Park totaled $7.5  million.  On May 4, 2006, we entered
into a contract for a $52.5 million sale of land. Under this contract, land will
be purchased in four phases,  with  closings to occur in 2007 through  2009.  We
will have the  opportunity  to  receive  participation  revenue as part of these
sales  contracts.   Sales   negotiations   continue  on  one  other  residential
development tract.

As of March 31, 2006,  we had $7.8  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 by the end of 2006.

ALLETE  Properties  occasionally  provides  seller  financing,  and  outstanding
finance receivables were $6.6 million at March 31, 2006, 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 INVENTORY                                    RESIDENTIAL             COMMERCIAL
FOR THE QUARTER ENDED  MARCH 31, 2006                   OWNERSHIP              UNITS <F1>             SQ. FT. <F1><F2>
- ------------------------------------------------------------------------------------------------------------------------
                                                                                            
Town Center at Palm Coast                                   80%
     At December 31, 2005                                                       2,833                2,927,700
     Property Sold                                                                  -                  (80,000)
     Change in Estimate                                                            80                        -
- ------------------------------------------------------------------------------------------------------------------------

                                                                                2,913                2,847,700

Palm Coast Park                                            100%                 3,600                3,200,000

Ormond Crossings                                           100%                  <F3>                     <F3>
- ------------------------------------------------------------------------------------------------------------------------

                                                                                6,513                6,047,700
- ------------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Estimated and includes minority interest. The actual property breakdown at full  build-out  may  be  different than
     these estimates.
<F2> Includes industrial, office and retail square footage.
<F3> The Development of Regional Impact  Application for  Development Approval submitted  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
FOR THE QUARTER ENDED
MARCH 31, 2006                        OWNERSHIP      TOTAL     MIXED USE    RESIDENTIAL   COMMERCIAL   AGRICULTURAL
- --------------------------------------------------------------------------------------------------------------------
                                                                                     
ACRES <F1>

Palm Coast Holdings                      80%
     At December 31, 2005                            2,566       1,692          346           281          247
     Property Sold                                     (66)        (47)           -           (18)          (1)
- --------------------------------------------------------------------------------------------------------------------

                                                     2,500       1,645          346           263          246
- --------------------------------------------------------------------------------------------------------------------

Lehigh                                   80%
     At December 31, 2005                              613         390          140            74            9
     Property Sold                                    (390)       (390)           -             -            -
- --------------------------------------------------------------------------------------------------------------------

                                                       223           -          140            74            9
- --------------------------------------------------------------------------------------------------------------------

Cape Coral                              100%            41           -            1            40            -

Other                                   100%           944           -            -             -          944
- --------------------------------------------------------------------------------------------------------------------

                                                     3,708       1,645          487           377        1,199
- --------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Acreage amounts are approximate and shown  on  a gross  basis,  including   wetlands  and   minority  interest.
     Acreage amounts may vary due to platting or surveying activity. Wetland amounts vary by property  and are often
     not formally  determined prior  to  sale. The actual property breakdown at full build-out may be different than
     these estimates.
</FN>


                      ALLETE First Quarter 2006 Form 10-Q                     26


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 and short-term  investments of $236.5  million,  and a debt to total
capital ratio of 39 percent at March 31, 2006.

OPERATING ACTIVITIES.  Cash flow from operating activities was $44.2 million for
the quarter ended March 31, 2006 ($31.1  million for the quarter ended March 31,
2005).  Cash from operating  activities  was higher in 2006,  primarily due to a
$13.1 million change in deferred fuel costs  (included in Prepayments and Other)
caused by the timing of  outages at our  generating  facilities.  Deferred  fuel
costs  related  to outages in late 2005 were  collected  in our fuel  adjustment
clause  during 2006,  while  deferred fuel costs related to outages in the first
quarter of 2005 were not  collected  until the second  quarter of 2005. In 2005,
cash for operating  activities  reflected payment of a $9.1 million  arbitration
award related to our discontinued operations. Cash from operating activities was
lower in 2006, due to a $6.1 million  change in accounts  payable which was also
caused  primarily  by  the  timing  of  outages  at our  generating  facilities.
Purchased power accruals  related to outages in late 2005 were paid in the first
quarter of 2006 while purchased  power accruals  related to outages in the first
quarter of 2005 were not paid until the second quarter of 2005.

INVESTING  ACTIVITIES.  Cash flow for investing activities was $49.2 million for
the quarter ended March 31, 2006 (cash flow from investing  activities of $107.0
million for the quarter ended March 31, 2005). Cash for investing activities was
higher in 2006 than 2005,  primarily  due to  activities  within our  short-term
investments.  In 2006,  net purchases of $44.6 million were used for  short-term
investments,  while  2005  included  $117.2  million of net  proceeds  that were
received from the sale of short-term  investments.  Gross proceeds from the sale
of available-for-sale  securities were $126.3 million in 2006 ($210.5 million in
2005) and  purchases  were  $170.9  million  ($93.3  million in 2005).  Cash for
investing  activities  in 2006 was also $4.7 million  higher due to additions to
property, plant and equipment which vary from year to year.

FINANCING  ACTIVITIES.  Cash flow for financing  activities was $9.6 million for
the quarter  ended March 31, 2006 ($1.8  million for the quarter ended March 31,
2005). The increase in cash for financing activities was primarily attributed to
a $3.4 million decrease in book overdrafts.  Cash for financing  activities also
increased in 2006 due to an additional $2.5 million of dividends paid because of
more shares  outstanding  and an  increase in the  dividend  rate.  In 2006,  we
refinanced  $50 million of first  mortgage  bonds at a lower rate. The new bonds
will mature in 2036.

WORKING CAPITAL.  Additional working capital,  if and when needed,  generally is
provided by the sale of commercial  paper.  We have 0.7 million  original  issue
shares of our common stock  available for issuance  through INVEST  DIRECT,  our
direct  stock  purchase and dividend  reinvestment  plan.  We have bank lines of
credit aggregating $170.0 million, the majority of which expire in January 2011.
In January  2006, we renewed,  increased  and extended a committed,  syndicated,
unsecured revolving credit facility with LaSalle Bank National  Association,  as
Agent,  for $150 million  (Line).  The Line matures on January 11, 2011.  At our
request and subject to certain  conditions,  the Line may be  increased  to $200
million and extended for two additional  12-month periods. We may prepay amounts
outstanding under the Line in whole or in part at our discretion.  Additionally,
we may  irrevocably  terminate or reduce the size of the Line prior to maturity.
The Line may be used for  general  corporate  purposes,  working  capital and to
provide  liquidity in support of our commercial  paper  program.  The amount and
timing of future sales of our securities will depend upon market  conditions and
our specific  needs.  We may sell  securities to meet capital  requirements,  to
provide for the retirement or early  redemption of issues of long-term  debt, to
reduce short-term debt and for other corporate purposes.


27                    ALLETE First Quarter 2006 Form 10-Q



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.

In March  2006,  we issued $50  million in  principal  amount of First  Mortgage
Bonds, 5.69% Series due March 1, 2036.  Proceeds were used to redeem $50 million
in principal amount of First Mortgage Bonds, 7% Series due March 1, 2008.

Long-term  debt due within one year includes $60 million of first mortgage bonds
due  February  2007 that  cannot be  redeemed  prior to  maturity.  We intend to
refinance this debt on a long-term basis.

OFF-BALANCE SHEET ARRANGEMENTS

Off-balance  sheet  arrangements  are  summarized  in our 2005 Form  10-K,  with
additional disclosure discussed in Note 11 of this Form 10-Q.

CAPITAL REQUIREMENTS

For the quarter  ended  March 31,  2006,  capital  expenditures  for  continuing
operations  totaled $13.6 million ($8.9 million in 2005).  Expenditures  for the
quarter ended March 31, 2006,  included $13.3 million for Regulated  Utility and
$0.3 million for Nonregulated Energy Operations. Internally-generated funds were
the source of funding for these expenditures.

Real  estate  development  expenditures  are and will be funded with a revolving
development loan and tax-exempt bonds issued by community development districts.
The Town  Center at Palm  Coast  Community  Development  District  issued  $26.4
million  of  tax-exempt  bonds in 2005.  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.  We anticipate  that the Palm Coast
Park  Community  Development  District  will  issue  tax-exempt  bonds  to  fund
construction of  infrastructure  improvements for our Palm Coast Park project in
mid-2006.  Company  expenditures  related  to our real  estate  developments  in
Florida  increase  the  value  of our  land  assets,  which  are  classified  as
Investments on our consolidated balance sheet.


ENVIRONMENTAL MATTERS AND OTHER

As  previously  discussed  in our  Critical  Accounting  Policies  section,  our
businesses  are  subject  to  regulation  of  environmental  matters  by various
federal,  state and local  authorities.  Due to  future  stricter  environmental
requirements through legislation and/or rulemaking, we anticipate that potential
expenditures  for  environmental  matters  will be  material  and  will  require
significant  capital  investments.  We are unable to predict  the outcome of the
issues discussed in Note 11.


                      ALLETE First Quarter 2006 Form 10-Q                     28



ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

SECURITIES INVESTMENTS

AVAILABLE-FOR-SALE   SECURITIES.  Our  available-for-sale  securities  portfolio
consists of securities in a grantor trust  established to fund certain  employee
benefits  included in  Investments,  and various auction rate bonds and variable
rate  demand  notes  included  as  Short-Term  Investments.   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.  Our  short-term
investments classified as available-for-sale  securities,  however, are recorded
at cost,  which  approximates  fair market value due to their variable  interest
rates that 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. Our  available-for-sale  securities portfolio had a fair value of $184.5
million at March 31,  2006  ($139.5  million at December  31,  2005) and a total
unrealized  after-tax  gain of $2.4  million at March 31, 2006 ($2.1  million at
December 31, 2005).

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  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 quarter  ended March 31,
2006.

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  because of our
ownership  percentage.  The  total  carrying  value of our  emerging  technology
portfolio  was $8.7  million at March 31,  2006 ($9.2  million at  December  31,
2005).  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.
Our basis in direct  investments  in  privately-held  companies  included in the
emerging technology portfolio was zero at March 31, 2006, and December 31, 2005.


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.

29                    ALLETE First Quarter 2006 Form 10-Q



ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED)

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
generation and purchased power.

From time to time,  our 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.

Approximately 200 MW of generation from our Taconite Harbor facility in northern
Minnesota has been sold through various long-term capacity and energy contracts.
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.  The 50-MW  capacity and energy sales
contract had fixed pricing  through  January 2006, with formula pricing based on
variable production cost of a combustion-turbine, natural gas unit thereafter.


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.

                      ALLETE First Quarter 2006 Form 10-Q                     30



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 11, and are  incorporated  by
reference herein.


ITEM 1A. RISK FACTORS

Other than the risk factors below,  there have been no material changes from the
risk factors  disclosed  under the heading "Risk  Factors" in Part I, Item 1A of
our 2005 Form 10-K.

WE ARE DEPENDENT ON GOOD LABOR RELATIONS.

We believe our  relations  to be good with our  approximately  1,500  employees.
Approximately  700 of these  employees  are members of either the  International
Brotherhood  of  Electrical  Workers  (IBEW) Local 31 or Local 1593.  Failure to
successfully renegotiate labor agreements could adversely affect the services we
provide and our results of operations. On February 28, 2006, members of the IBEW
Local No. 31 ratified a new three-year  labor agreement with SWL&P and Minnesota
Power that is  retroactive  to February 1, 2006.  Wage increases are 3.1 percent
for 2006 and 2007,  and 3.0 percent for 2008.  The agreement also includes union
employees in the results sharing  compensation  awards program starting in 2006.
The labor agreement with Local 1593 at BNI Coal expires on March 31, 2008.

RISKS  ASSOCIATED WITH  ACQUISITIONS  MAY HINDER OUR ABILITY TO INCREASE REVENUE
AND EARNINGS.

In pursuing a strategy of acquiring  other  businesses,  we face risks  commonly
encountered with growth through  acquisitions.  These risks include, but are not
limited to:

  -  incurring significantly higher capital expenditures and operating expenses;
  -  regulatory review or approval;
  -  failing  to  assimilate  the  operations  and  personnel  of  the  acquired
     businesses;
  -  entering new, unfamiliar markets;
  -  potential undiscovered liabilities at acquired businesses;
  -  disrupting our ongoing business;
  -  diverting our limited management resources;
  -  failing to maintain uniform standards, controls and policies;
  -  impairing relationships with employees and customers as a result of changes
     in management; and
  -  increasing  expenses  for support services and computer systems, as well as
     integration difficulties.

We may not adequately  anticipate all of the demands that our growth will impose
on our systems, procedures and structures, including our financial and reporting
control systems, data processing systems and management structure.  If we cannot
adequately  anticipate  and  respond to these  demands,  our  business  could be
materially harmed.

Although  we  conduct  what we believe  to be a prudent  level of  investigation
regarding the operating condition of the businesses we purchase, in light of the
circumstances  of  each  transaction,  an  unavoidable  level  of  risk  remains
regarding the actual operating condition of these businesses.  Until we actually
assume  operating  control  of  such  business  assets,  we may  not be  able to
ascertain the actual value of the acquired entity.

31                    ALLETE First Quarter 2006 Form 10-Q



ITEM 1A. RISK FACTORS (CONTINUED)

WE ARE EXPOSED TO RISKS ASSOCIATED WITH REAL ESTATE DEVELOPMENT.

Our real estate  development  activities entail risks that include  construction
delays or cost  overruns,  which may  increase  project  development  costs.  In
addition,  the effects of the  rebuilding  efforts due to  destructive  weather,
including  hurricanes,  could cause increased prices for construction  materials
and create labor shortages which could increase our development costs.

Our real estate development activities require significant capital expenditures.
We obtain funds for our capital  expenditures  through cash flow from operations
and financings,  including the financings of the community development districts
in which our  development  projects are  located.  We cannot be certain that the
funds  available  from these  sources will be sufficient to fund our required or
desired  capital  expenditures  for  development.  If we are  unable  to  obtain
sufficient  funds,  we may have to  defer or  otherwise  limit  our  development
activities. If we are unsuccessful in our selling efforts, we may not be able to
recover these capital expenditures.

COMPETITION FOR LAND COULD ADVERSELY AFFECT OUR REAL ESTATE BUSINESS.

Over the past few years,  we have  experienced  an increase in  competition  for
suitable land in the Florida real estate market. The availability of undeveloped
land for  purchase  that  meets our  internal  criteria  depends  on a number of
factors outside our control, including land availability in general, competition
with other developers and land buyers for desirable property,  inflation in land
prices, zoning, allowable development density and other regulatory requirements.
Our  long-term  ability to acquire land suitable for  development  at reasonable
prices  in  locations  where we feel  there is a viable  market  is  crucial  in
maintaining our business success.


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 2005  Form  10-K  for  background  information  on the
following updates. Unless otherwise indicated,  cited references are to our 2005
Form 10-K.

Ref. Page 7 - Minimum Revenue and Demand Under Contract Table



MINIMUM REVENUE AND DEMAND UNDER CONTRACT                                MINIMUM                       MONTHLY
AS OF APRIL 1, 2006                                                   ANNUAL REVENUE <F1><F2>         MEGAWATTS
- -----------------------------------------------------------------------------------------------------------------
                                                                                                
     2006                                                              $95.4 million                     616
     2007                                                              $38.0 million                     206
     2008                                                              $27.7 million                     158
     2009                                                              $25.9 million                     151
     2010                                                              $17.8 million                      98
- -----------------------------------------------------------------------------------------------------------------
<FN>
<F1> Based on past experience, we  believe revenue from our large power customers will be substantially in excess
     of the minimum contract amounts.
<F2> Although several contracts have a feature  that allows demand  to go to zero after a two-year advance notice
     of a  permanent  closure, this  minimum revenue summary  does not reflect  this occurrence  happening in the
     forecasted period because we believe it is unlikely.
</FN>


                      ALLETE First Quarter 2006 Form 10-Q                     32



ITEM 5.  OTHER INFORMATION (CONTINUED)

Ref. Page 10 - Eighth Full Paragraph

On February 24, 2006, the MPUC issued an order documenting the February 9, 2006,
hearing that granted rehearing of the MISO Day 2 docket and suspended the refund
obligation.  The Company is working with the other Minnesota utilities,  the DOC
and other stakeholders to prepare a joint  recommendation,  required by the MPUC
in its February 24, 2006 order,  of which costs should be recovered on a current
basis  through the fuel clause and which costs are more  appropriately  deferred
for  potential  recovery  through base rates.  The parties had 60 days to report
their  recommendations  to the MPUC.  On April 24,  2006,  the MPUC  approved an
extension for the parties to file their  recommendations  by June 22, 2006.  The
Company is unable to predict the outcome of this matter.


Ref. Page 11 - First Paragraph

LARGE POWER CONTRACTS. On March 7, 2006, the MPUC approved Minnesota Power's new
electric service agreement with Stora Enso Oyj's Duluth mills through August 31,
2013. On April 7, 2006, the MPUC approved Minnesota Power's new electric service
agreement  with  UPM-Kymmene  Corporation's  Blandin  Paper mill in Grand Rapids
through April 30, 2010.


Ref. Page 11 - Second Paragraph

RESOURCE PLAN. In 2006, the MPUC approved our Integrated Resource Plan (Resource
Plan).  The Resource Plan detailed our retail energy demand  projections and our
energy sourcing options to meet projected demand. Key components of the Resource
Plan  included  redirection  of our Taconite  Harbor  generating  facility  from
nonregulated energy operations to regulated utility operations effective January
1, 2006.  The  Taconite  Harbor  generation  will be  supplemented  with a 50-MW
long-term  power  purchase  agreement  with  Manitoba  Hydro.  Expansion  of our
renewable generating assets to meet Minnesota's  Renewable Energy Objective that
seeks a 10 percent supply of qualified  renewable  energy resources in the state
by 2015 for each Minnesota utility was also approved.


Ref. Page 11 - Sixth Paragraph and Page 20 - Second Full Paragraph

SQUARE BUTTE GENERATING FACILITY. On April 24, 2006, Minnkota Power announced it
has reached a  settlement  agreement  with the EPA and the State of North Dakota
regarding  emissions at the M.R. Young Station,  which includes the Square Butte
generating  unit. 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.  The EPA claimed 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.  The current Square Butte flue gas desulfurization (FGD) system will
be  upgraded in 2010 to increase  its removal  efficiency  from 70 percent to 90
percent.   Capital   expenditures  for  the  emission   control   additions  and
modifications  on Square Butte are  estimated at $35  million.  These  estimated
capital  expenditures  may be  significantly  offset by the sale of surplus  SO2
allowance  credits  created with the early  upgrade of the FGD system,  which is
being upgraded two years earlier than required by Federal rules.  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.  On April 24,
2006, a Complaint and a Consent Decree with respect to this settlement agreement
were filed in U.S. District Court for the District of North Dakota (Court).  The
Consent Decree is open to public comment for 30 days after which,  if entered as
an order by the Court,  will  constitute a final  settlement  of this issue.  If
finalized,  the Consent Decree settlement would also require Square Butte to pay
approximately  $0.6 million in  administrative  costs and penalties in 2006, and
$3.3 million  toward  additional  environmental  projects  including  wind power
installations or power purchase agreements.

33                    ALLETE First Quarter 2006 Form 10-Q



ITEM 5.  OTHER INFORMATION (CONTINUED)

Ref. Page 12 - Fifth Full Paragraph

On May 1,  2006,  SWL&P  filed an  application  with the PSCW for  authority  to
increase retail utility rates an average of 5.2 percent.  This average  increase
is comprised of a 4.6 percent increase in electric rates, a 2.4 percent increase
in gas rates and a 19.8 percent increase in water rates. The proposed  increases
are due to increased operating costs and the need to construct  additional water
storage.  SWL&P is  requesting  an 11.7  percent  return on common  equity.  The
Company  expects that hearings will be conducted in late 2006 and new rates will
become effective in January 2007.


Ref. Page 14 - Fourth Paragraph

In December  2005, we entered into an agreement  with  Wisconsin  Public Service
Corporation and WPS Investments, LLC that provides for our Wisconsin subsidiary,
Rainy River Energy  Corporation  - Wisconsin,  to invest $60 million in ATC. Our
investment is expected to represent an estimated 9 percent ownership interest in
ATC. On May 4, 2006,  the PSCW  reviewed and approved the request that allows us
to invest in ATC. We anticipate having $60 million invested in ATC by the end of
2006. Our first investment is expected to occur in May 2006.


Ref. Page 16 - Third Full Paragraph

On May 4, 2006, ALLETE Properties  entered into a $52.5 million contract for the
sale of  residential  and  commercial  land at its Palm Coast  Park  development
project.  Under this  contract,  land will be  purchased  in four  phases,  with
closings to occur in 2007 through 2009, and includes the  opportunity to receive
participation  revenue.  The development will include 1,459 residential  housing
units, a championship  golf course,  and  neighborhood  retail and office space,
along with a community park and school site.


Ref. Page 20 - Insert before First Full Paragraph
Ref. Page 49 - Fifth Paragraph

On April 27, 2006, an agreement was announced by Minnesota Governor Tim Pawlenty
on language for a proposed utility mercury emission reduction bill in Minnesota.
Minnesota Power, along with Xcel Energy Inc., the MPCA, the Minnesota Chamber of
Commerce,  the DOC and an umbrella  organization of environmental  groups called
Mercury Free  Minnesota,  had been meeting for several  months in negotiation on
bill  language at the request of the  Governor.  The bill was  presented  to and
approved by the Minnesota House of Representatives on May 1, 2006. The Minnesota
Senate passed the bill on May 4, 2006.  The bill is now ready for the Governor's
signature  and he is expected to sign it in the near  future.  This  legislation
would require  Minnesota Power to file mercury emission  reduction plans for its
Boswell  Units 3 and 4, with one plan due December 31, 2007,  and the other plan
due July 1, 2011, with installation of mercury emission reduction technology and
equipment by December 31, 2010, and December 31, 2014,  respectively.  The plans
must include one in which the mercury  reduction  goal is 90 percent.  Alternate
plans,  with the  percentage  of  reduction  elected  by the  utility,  are also
required to be filed. Minnesota Power may apply mercury emissions achieved under
its Arrowhead  Regional  Emission  Abatement plan at Taconite  Harbor toward the
reduction  goal required  under  approved plans for Boswell Units 3 and 4. Filed
plans must be reviewed and approved by the MPCA and the MPUC under criteria that
include, among other things, technical feasibility,  environmental benefit, cost
effectiveness  and  rate  impact.  The  legislation  encourages   multi-emission
reduction plans and also extends a statutory provision for current cost recovery
outside of a rate case for approved emission reduction  expenditures,  including
mercury  and  other  types of  emissions,  from  2006  through  2013.  The draft
legislation  generally  comports  with  Minnesota  Power's plans for its Boswell
Units 3 and 4 mercury and other emission  retrofits.  Mercury emission reduction
expenditures  planned for Boswell  Unit 3 are  estimated at $200 million and are
included in the $280 million we expect to spend for environmental  upgrades from
2007 through 2010. Minnesota Power anticipates that costs for these expenditures
will be recovered from customers on a current basis,  subject to approval by the
MPUC. The Company plans to make a filing with the MPUC for current cost recovery
on these Boswell Unit 3 costs later this year.

                      ALLETE First Quarter 2006 Form 10-Q                     34



ITEM 5.  OTHER INFORMATION (CONTINUED)

Ref. Page 21 - Sixth Paragraph

On February 28, 2006,  members of the  International  Brotherhood  of Electrical
Workers (IBEW) Local No. 31 ratified a new three-year labor agreement with SWL&P
and Minnesota  Power that is retroactive to February 1, 2006. Wage increases are
3.1 percent for 2006 and 2007,  and 3.0 percent  for 2008.  The  agreement  also
includes  union  employees in the results  sharing  compensation  awards program
starting in 2006.


ITEM 6.  EXHIBITS

EXHIBIT
NUMBER

      4  Twenty-fifth  Supplemental  Indenture,  dated  as of  December 1, 2005,
         between ALLETE  and The  Bank of New York  and Douglas J. MacInnes,  as
         Trustees.

  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.

35                    ALLETE First Quarter 2006 Form 10-Q




                                   SIGNATURES


Pursuant  to the  requirements  of the  Securities  Exchange  Act of  1934,  the
registrant  has duly  caused  this  report  to be  signed  on its  behalf by the
undersigned thereunto duly authorized.




                                                 ALLETE, INC.





May 8, 2006                                    James K. Vizanko
                               -------------------------------------------------
                                               James K. Vizanko
                               Senior Vice President and Chief Financial Officer




May 8, 2006                                      Mark A. Schober
                               -------------------------------------------------
                                                 Mark A. Schober
                                      Senior Vice President and Controller


                      ALLETE First Quarter 2006 Form 10-Q                     36



                                  EXHIBIT INDEX

EXHIBIT
NUMBER
- --------------------------------------------------------------------------------

      4    Twenty-fifth  Supplemental  Indenture,  dated as of December 1, 2005,
           between ALLETE and The Bank  of New York  and Douglas J. MacInnes, as
           Trustees.

  31(a)    Rule 13a-14(a)/15d-14(a) Certification by the Chief Executive Officer
           Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

  31(b)    Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial Officer
           Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

     32    Section 1350 Certification of  Periodic Report by the Chief Executive
           Officer  and Chief Financial Officer Pursuant to  Section  906 of the
           Sarbanes-Oxley Act of 2002.


                       ALLETE First Quarter 2006 Form 10-Q