SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
/X/ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended JUNE 30, 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,
30,321,240 shares outstanding
as of June 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 -
June 30, 2006 and December 31, 2005 4
Consolidated Statement of Income -
Quarter and Six Months Ended June 30, 2006 and 2005 5
Consolidated Statement of Cash Flows -
Six Months Ended June 30, 2006 and 2005 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 23
Item 3. Quantitative and Qualitative Disclosures about Market
Risk 38
Item 4. Controls and Procedures 39
Part II. Other Information
Item 1. Legal Proceedings 40
Item 1A. Risk Factors 40
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds 40
Item 3. Defaults Upon Senior Securities 40
Item 4. Submission of Matters to a Vote of Security Holders 40
Item 5. Other Information 41
Item 6. Exhibits 42
Signatures 43
1 ALLETE Second 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.
AREA Arrowhead Regional Emission Abatement
Plan
ATC American Transmission Company LLC
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
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
Palm Coast District Palm Coast Park Community Development
District
Palm Coast Park Palm Coast Park development project in
Florida
PSCW Public Service Commission of Wisconsin
Rainy River Energy Rainy River Energy Corporation
Resource Plan Integrated Resource Plan
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
Town Center District Town Center at Palm Coast Community
Development District
WDNR Wisconsin Department of Natural
Resources
ALLETE Second 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 and pandemic diseases;
- 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 our Quarterly Reports on Form 10-Q for 2006. 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 Second Quarter 2006 Form 10-Q
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLETE
CONSOLIDATED BALANCE SHEET
MILLIONS - UNAUDITED
JUNE 30, DECEMBER 31,
2006 2005
- -----------------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and Cash Equivalents $ 62.8 $ 89.6
Short-Term Investments 120.4 116.9
Accounts Receivable (Less Allowance of $1.0 for 2006 and 2005) 61.0 79.1
Inventories 42.1 33.1
Prepayments and Other 21.6 23.8
Deferred Income Taxes 33.1 31.0
Discontinued Operations - 0.4
- -----------------------------------------------------------------------------------------------------------------------------
Total Current Assets 341.0 373.9
Property, Plant and Equipment - Net 871.6 860.4
Investments 127.8 117.7
Other Assets 45.7 44.6
Discontinued Operations - 2.2
- -----------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $1,386.1 $1,398.8
- -----------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Current Liabilities
Accounts Payable $ 30.4 $ 44.7
Accrued Taxes 15.8 19.1
Accrued Interest 7.2 7.4
Long-Term Debt Due Within One Year 61.6 2.7
Deferred Profit on Sales of Real Estate 8.1 8.6
Other 18.0 24.2
Discontinued Operations - 13.0
- -----------------------------------------------------------------------------------------------------------------------------
Total Current Liabilities 141.1 119.7
Long-Term Debt 326.9 387.8
Deferred Income Taxes 135.4 138.4
Other Liabilities 149.2 144.1
Minority Interest 5.7 6.0
- -----------------------------------------------------------------------------------------------------------------------------
Total Liabilities 758.3 796.0
- -----------------------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES
- -----------------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Common Stock Without Par Value, 43.3 Shares Authorized,
30.3 and 30.1 Shares Outstanding 430.8 421.1
Unearned ESOP Shares (75.6) (77.6)
Accumulated Other Comprehensive Loss (12.5) (12.8)
Retained Earnings 285.1 272.1
- -----------------------------------------------------------------------------------------------------------------------------
Total Shareholders' Equity 627.8 602.8
- -----------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,386.1 $1,398.8
- -----------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
ALLETE Second Quarter 2006 Form 10-Q 4
ALLETE
CONSOLIDATED STATEMENT OF INCOME
MILLIONS EXCEPT PER SHARE AMOUNTS - UNAUDITED
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2006 2005 2006 2005
- -----------------------------------------------------------------------------------------------------------------------------
OPERATING REVENUE $178.3 $174.4 $370.8 $367.7
- -----------------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Fuel and Purchased Power 63.0 68.9 132.4 136.5
Operating and Maintenance 76.8 71.7 151.3 144.4
Kendall County Charge - 77.9 - 77.9
Depreciation 12.2 11.9 24.4 23.8
- -----------------------------------------------------------------------------------------------------------------------------
Total Operating Expenses 152.0 230.4 308.1 382.6
- -----------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME (LOSS) FROM CONTINUING OPERATIONS 26.3 (56.0) 62.7 (14.9)
- -----------------------------------------------------------------------------------------------------------------------------
OTHER INCOME (EXPENSE)
Interest Expense (6.4) (6.7) (12.8) (13.5)
Other 3.4 1.5 5.1 (2.7)
- -----------------------------------------------------------------------------------------------------------------------------
Total Other Expense (3.0) (5.2) (7.7) (16.2)
- -----------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE MINORITY INTEREST AND INCOME TAXES 23.3 (61.2) 55.0 (31.1)
MINORITY INTEREST 0.8 0.2 2.1 1.4
- -----------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES 22.5 (61.4) 52.9 (32.5)
INCOME TAX EXPENSE (BENEFIT) 8.9 (21.6) 20.5 (10.1)
- -----------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS 13.6 (39.8) 32.4 (22.4)
LOSS FROM DISCONTINUED OPERATIONS - NET OF TAX (0.4) (0.5) (0.4) (0.5)
- -----------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ 13.2 $(40.3) $ 32.0 $(22.9)
- -----------------------------------------------------------------------------------------------------------------------------
AVERAGE SHARES OF COMMON STOCK
Basic 27.7 27.2 27.6 27.2
Diluted 27.9 27.2 27.8 27.2
- -----------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS (LOSS) PER SHARE OF COMMON STOCK
Continuing Operations $0.50 $(1.46) $1.18 $(0.82)
Discontinued Operations (0.02) (0.02) (0.02) (0.02)
- -----------------------------------------------------------------------------------------------------------------------------
$0.48 $(1.48) $1.16 $(0.84)
- -----------------------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS (LOSS) PER SHARE OF COMMON STOCK
Continuing Operations $0.49 $(1.46) $1.17 $(0.82)
Discontinued Operations (0.02) (0.02) (0.02) (0.02)
- -----------------------------------------------------------------------------------------------------------------------------
$0.47 $(1.48) $1.15 $(0.84)
- -----------------------------------------------------------------------------------------------------------------------------
DIVIDENDS PER SHARE OF COMMON STOCK $0.3625 $0.3150 $0.7250 $0.6150
- -----------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
5 ALLETE Second Quarter 2006 Form 10-Q
ALLETE
CONSOLIDATED STATEMENT OF CASH FLOWS
MILLIONS - UNAUDITED
SIX MONTHS ENDED
JUNE 30,
2006 2005
- -----------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net Income (Loss) $ 32.0 $(22.9)
Loss from Discontinued Operations 0.4 0.5
Loss on Impairment of Investments - 5.1
Depreciation 24.4 23.8
Deferred Income Taxes (4.7) (34.1)
Minority Interest 2.1 1.4
Stock Compensation Expense 0.9 0.6
Bad Debt Expense 0.4 0.4
Changes in Operating Assets and Liabilities
Accounts Receivable 17.7 15.7
Inventories (9.0) (3.6)
Prepayments and Other 2.2 1.8
Accounts Payable (10.9) (9.5)
Other Current Liabilities (10.1) (0.9)
Other Assets (1.1) 4.7
Other Liabilities 5.1 3.0
Net Operating Activities for Discontinued Operations (13.0) (6.0)
- -----------------------------------------------------------------------------------------------------------------------------
Cash from (for) Operating Activities 36.4 (20.0)
- -----------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Proceeds from Sale of Available-For-Sale Securities 410.6 271.1
Payments for Purchase of Available-For-Sale Securities (414.1) (183.5)
Changes to Investments (11.2) (3.4)
Additions to Property, Plant and Equipment (35.3) (22.6)
Other 2.5 (1.8)
Net Investing Activities from (for) Discontinued Operations 2.2 (1.4)
- -----------------------------------------------------------------------------------------------------------------------------
Cash from (for) Investing Activities (45.3) 58.4
- -----------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Issuance of Common Stock 8.8 12.8
Issuance of Long-Term Debt 50.0 -
Payments of Long-Term Debt (52.0) (1.0)
Dividends on Common Stock and Distributions to Minority Shareholders (21.3) (16.0)
Net Decrease in Book Overdrafts (3.4) -
Net Financing Activities for Discontinued Operations - (0.1)
- -----------------------------------------------------------------------------------------------------------------------------
Cash for Financing Activities (17.9) (4.3)
- -----------------------------------------------------------------------------------------------------------------------------
CHANGE IN CASH AND CASH EQUIVALENTS (26.8) 34.1
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD <F1> 89.6 46.1
- -----------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD <F1> $ 62.8 $ 80.2
- -----------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL CASH FLOW INFORMATION
Cash Paid During the Period for
Interest - Net of Amounts Capitalized $19.4 $16.4
Income Taxes $31.1 $13.6
- -----------------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Included $1.1 million of cash from Discontinued Operations at June 30, 2005 and $1.2 million at December 31, 2004.
The accompanying notes are an integral part of these statements.
</FN>
ALLETE Second 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 June 30, 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.
INVENTORIES. Inventories are stated at the lower of cost or market. Cost is
determined by the average cost method.
JUNE 30, DECEMBER 31,
INVENTORIES 2006 2005
- --------------------------------------------------------------------------------
MILLIONS
Fuel $20.0 $11.0
Materials and Supplies 22.1 22.1
- --------------------------------------------------------------------------------
Total Inventories $42.1 $33.1
- --------------------------------------------------------------------------------
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 June 30,
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 common 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.
7 ALLETE Second Quarter 2006 Form 10-Q
NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following assumptions were used in determining the fair value of stock
options granted during the first six months of 2006, under the
Black-Scholes option-pricing model:
2006
- --------------------------------------------------------------------------------
Risk-Free Interest Rate 4.5%
Expected Life 5 Years
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 our peer group companies. We utilize historical option
exercise and employee termination data to estimate the option life.
Dividend growth rate is based upon historic growth rates in our dividends
and the dividends of our peer group companies.
PERFORMANCE SHARES. Under these awards, the number 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.
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 since our adoption of
FAS 123R.
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
SHARE-BASED COMPENSATION EXPENSE 2006 2006
- --------------------------------------------------------------------------------
MILLIONS
Stock Options $0.2 $0.4
Performance Shares 0.3 0.5
- --------------------------------------------------------------------------------
Total Share-Based Compensation Expense $0.5 $0.9
- --------------------------------------------------------------------------------
Income Tax Benefit $0.2 $0.4
- --------------------------------------------------------------------------------
There were no significant capitalized stock-based compensation costs at June 30,
2006.
As of June 30, 2006, the total compensation cost for nonvested awards not yet
recognized in our statements of income was $2.2 million. This amount is expected
to be recognized over a weighted-average period of 1.3 years.
ALLETE Second Quarter 2006 Form 10-Q 8
NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following table presents the pro forma effect of stock-based compensation,
had we applied the provisions of SFAS 123 for the quarter and six months ended
June 30, 2005.
QUARTER ENDED SIX MONTHS ENDED
PRO FORMA EFFECT OF SFAS 123 JUNE 30, JUNE 30,
ACCOUNTING FOR STOCK-BASED COMPENSATION 2005 2005
- -----------------------------------------------------------------------------------------------------------------------------
MILLIONS EXCEPT PER SHARE AMOUNTS
Net Loss
As Reported $(40.3) $(22.9)
Plus: Employee Stock Compensation Expense
Included in Net Loss - Net of Tax 0.3 0.6
Less: Employee Stock Compensation Expense
Determined Under SFAS 123 - Net of Tax 0.3 0.7
- -----------------------------------------------------------------------------------------------------------------------------
Pro Forma Net Loss $(40.3) $(23.0)
- -----------------------------------------------------------------------------------------------------------------------------
Basic Loss Per Share
As Reported $(1.48) $(0.84)
Pro Forma $(1.48) $(0.85)
Diluted Loss Per Share
As Reported $(1.48) $(0.84)
Pro Forma $(1.48) $(0.85)
- -----------------------------------------------------------------------------------------------------------------------------
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 5 Years
Expected Volatility 20%
Dividend Growth Rate 5%
- ------------------------------------------------------------------------------------------------------------------------
The following table presents information regarding our outstanding stock options
for the six months ended June 30, 2006.
WEIGHTED-AVERAGE
WEIGHTED-AVERAGE AGGREGATE REMAINING
NUMBER OF EXERCISE INTRINSIC CONTRACTUAL
SHARES PRICE VALUE TERM
- ------------------------------------------------------------------------------------------------------------------------
MILLIONS
Outstanding at December 31, 2005 357,827 $34.29 $3.5 7.4 years
Granted 115,653 $44.15
Exercised (20,966) $25.81
Forfeited or Expired (6,233) $38.25
- ------------------------------------------------------------------------------------------------------------------------
Outstanding at June 30, 2006 446,281 $37.19 $4.5 7.7 years
- ------------------------------------------------------------------------------------------------------------------------
Exercisable at June 30, 2006 225,618 $32.16 $3.4 6.4 years
- ------------------------------------------------------------------------------------------------------------------------
The weighted-average grant-date fair value of options was $6.49 for the six
months ended June 30, 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 $0.4 million
during the six months ended June 30, 2006.
9 ALLETE Second Quarter 2006 Form 10-Q
NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following table presents information regarding our nonvested performance
shares for the six months ended June 30, 2006.
WEIGHTED-AVERAGE
NUMBER OF GRANT DATE
SHARES FAIR VALUE
- -----------------------------------------------------------------------------------------------------------------------------
Nonvested at December 31, 2005 97,884 $38.63
Granted 25,752 $44.00
Awarded (49,076) $37.76
Forfeited (1,785) $39.53
- -----------------------------------------------------------------------------------------------------------------------------
Nonvested at June 30, 2006 72,775 $41.10
- -----------------------------------------------------------------------------------------------------------------------------
NEW ACCOUNTING STANDARDS. FSP INTERPRETATION NO. 46(R)-6. In April 2006, the
FASB issued Staff Position Interpretation No. 46(R)-6, "Determining the
Variability to Be Considered in Applying FASB Interpretation No. 46(R)," which
addresses how an enterprise should determine the variability to be considered in
applying FASB Interpretation No. 46, "Consolidation of Variable Interest
Entities." The variability that is considered in applying Interpretation No.
46(R) affects the determination of: (a) whether the entity is a variable
interest entity (VIE); (b) which interests are variable interests in the entity;
and (c) which party, if any, is the primary beneficiary of the VIE. This FSP
provides a guide for the qualitative analysis of the design of the entity and
clarifying guidance to assist in determining the variability to consider in
applying Interpretation No. 46(R), determining which interests are variable
interests, and ultimately determining which variable interest holder, if any, is
the primary beneficiary.
FSP Interpretation No. 46(R)-6 is applied prospectively to all entities with
which the Company first becomes involved and to all entities previously required
to be analyzed under Interpretation No. 46(R) when a reconsideration event has
occurred, effective as of the first day of the first reporting period after June
15, 2006. We do not expect this FSP to have a material impact on existing
contracts. We will evaluate the impact of this new guidance on any new contracts
or any changes to existing contracts executed after the effective date to
determine applicability of this FSP.
INTERPRETATION NO. 48. In June 2006, the FASB issued Interpretation No. 48,
"Accounting for Uncertainty in Income Taxes - an interpretation of FASB
Statement No. 109." Interpretation No. 48 clarifies the accounting for uncertain
tax positions in accordance with SFAS 109, "Accounting for Income Taxes." The
Company will be required to recognize in its financial statements the largest
tax benefit of a tax position that is "more-likely-than-not" to be sustained on
audit based solely on the technical merits of the position as of the reporting
date. The term "more-likely-than-not" means a likelihood of more than 50
percent. Interpretation No. 48 also provides guidance on new disclosure
requirements, reporting and accrual of interest and penalties, accounting in
interim periods and transition. Interpretation No. 48 is effective as of the
beginning of the first fiscal year after December 15, 2006, which will be as of
January 1, 2007, for calendar-year companies. Only tax positions that meet the
"more-likely-than-not" threshold at that date may be recognized. The cumulative
effect of initially applying Interpretation No. 48 will be recognized as a
change in accounting principle as of the end of the period in which
Interpretation No. 48 is adopted. The Company has begun an evaluation of the
impact of applying this interpretation as of January 1, 2007, which will be the
effective date of the interpretation for the Company. We do not expect
Interpretation No. 48 to have a material impact on our financial position,
results of operation or cash flows.
ALLETE Second 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 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
primarily to the wholesale market). Historical financial results of Taconite
Harbor for periods prior to the redirection are included in our Nonregulated
Energy Operations segment.
ENERGY
----------------------------
NONREGULATED
REGULATED ENERGY REAL
CONSOLIDATED UTILITY OPERATIONS ESTATE OTHER
- --------------------------------------------------------------------------------------------------------------------------
MILLIONS
FOR THE QUARTER ENDED JUNE 30, 2006
Operating Revenue $178.3 $146.5 $16.5 $15.2 $ 0.1
Fuel and Purchased Power 63.0 63.0 - - -
Operating and Maintenance 76.8 57.2 14.1 4.9 0.6
Depreciation Expense 12.2 11.1 1.0 - 0.1
- --------------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from
Continuing Operations 26.3 15.2 1.4 10.3 (0.6)
Interest Expense (6.4) (4.9) (0.5) - (1.0)
Other Income 3.4 0.5 - - 2.9
- --------------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations
Before Minority Interest and Income Taxes 23.3 10.8 0.9 10.3 1.3
Minority Interest 0.8 - - 0.8 -
- --------------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations
Before Income Taxes 22.5 10.8 0.9 9.5 1.3
Income Tax Expense 8.9 4.0 - 3.9 1.0
- --------------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations 13.6 $ 6.8 $0.9 $ 5.6 $ 0.3
------------------------------------------------------
Loss from Discontinued Operations - Net of Tax (0.4)
- ----------------------------------------------------------------
Net Income $ 13.2
- ----------------------------------------------------------------
FOR THE QUARTER ENDED JUNE 30, 2005
Operating Revenue $174.4 $137.8 $26.5 $10.0 $ 0.1
Fuel and Purchased Power 68.9 63.2 5.7 - -
Operating and Maintenance 71.7 47.9 17.6 5.0 1.2
Kendall County Charge 77.9 - 77.9 - -
Depreciation Expense 11.9 9.8 2.1 - -
- --------------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing Operations (56.0) 16.9 (76.8) 5.0 (1.1)
Interest Expense (6.7) (4.4) (1.6) (0.2) (0.5)
Other Income 1.5 0.4 - - 1.1
- --------------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Minority Interest and Income Taxes (61.2) 12.9 (78.4) 4.8 (0.5)
Minority Interest 0.2 - - 0.2 -
- --------------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Income Taxes (61.4) 12.9 (78.4) 4.6 (0.5)
Income Tax Expense (Benefit) (21.6) 5.1 (27.9) 1.8 (0.6)
- --------------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations (39.8) $ 7.8 $(50.5) $ 2.8 $ 0.1
------------------------------------------------------
Loss from Discontinued Operations - Net of Tax (0.5)
- ----------------------------------------------------------------
Net Loss $(40.3)
- ----------------------------------------------------------------
11 ALLETE Second Quarter 2006 Form 10-Q
NOTE 2. BUSINESS SEGMENTS (CONTINUED)
ENERGY
----------------------------
NONREGULATED
REGULATED ENERGY REAL
CONSOLIDATED UTILITY OPERATIONS ESTATE OTHER
- --------------------------------------------------------------------------------------------------------------------------
MILLIONS
FOR THE SIX MONTHS ENDED JUNE 30, 2006
Operating Revenue $370.8 $308.9 $32.8 $28.9 $ 0.2
Fuel and Purchased Power 132.4 132.4 - - -
Operating and Maintenance 151.3 113.0 28.2 8.3 1.8
Depreciation Expense 24.4 22.2 2.1 - 0.1
- --------------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing Operations 62.7 41.3 2.5 20.6 (1.7)
Interest Expense (12.8) (10.0) (1.0) - (1.8)
Other Income 5.1 0.5 0.3 - 4.3
- --------------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations
Before Minority Interest and Income Taxes 55.0 31.8 1.8 20.6 0.8
Minority Interest 2.1 - - 2.1 -
- --------------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations
Before Income Taxes 52.9 31.8 1.8 18.5 0.8
Income Tax Expense 20.5 12.0 - 7.9 0.6
- --------------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations 32.4 $ 19.8 $ 1.8 $10.6 $ 0.2
------------------------------------------------------
Loss from Discontinued Operations - Net of Tax (0.4)
- --------------------------------------------------------------------
Net Income $ 32.0
- --------------------------------------------------------------------
AT JUNE 30, 2006
Total Assets $1,386.1 $995.0 $104.6 $72.4 $214.1
Property, Plant and Equipment - Net $871.6 $813.6 $53.2 - $4.8
Accumulated Depreciation $807.4 $769.4 $36.4 - $1.6
Capital Expenditures $35.3 $34.5 $0.8 - -
FOR THE SIX MONTHS ENDED JUNE 30, 2005
Operating Revenue $367.7 $285.4 $ 54.4 $27.7 $ 0.2
Fuel and Purchased Power 136.5 123.2 13.3 - -
Operating and Maintenance 144.4 100.5 32.7 9.5 1.7
Kendall County Charge 77.9 - 77.9 - -
Depreciation Expense 23.8 19.6 4.1 - 0.1
- --------------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) from Continuing Operations (14.9) 42.1 (73.6) 18.2 (1.6)
Interest Expense (13.5) (8.7) (2.9) (0.2) (1.7)
Other Income (Expense) (2.7) 0.4 0.2 - (3.3)
- --------------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Minority Interest and Income Taxes (31.1) 33.8 (76.3) 18.0 (6.6)
Minority Interest 1.4 - - 1.4 -
- --------------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Income Taxes (32.5) 33.8 (76.3) 16.6 (6.6)
Income Tax Expense (Benefit) (10.1) 13.1 (27.4) 6.9 (2.7)
- --------------------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations (22.4) $ 20.7 $(48.9) $ 9.7 $(3.9)
------------------------------------------------------
Loss from Discontinued Operations - Net of Tax (0.5)
- --------------------------------------------------------------------
Net Loss $(22.9)
- --------------------------------------------------------------------
AT JUNE 30, 2005
Total Assets $1,353.4 <F1> $899.4 $178.6 $75.7 $150.2
Property, Plant and Equipment - Net $849.3 $728.8 $115.5 - $5.0
Accumulated Depreciation $778.6 $733.6 $43.5 - $1.5
Capital Expenditures $24.2 <F1> $20.7 $1.9 - -
- --------------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Discontinued Operations represented $49.5 million of total assets and $1.6 million of capital expenditures in 2005.
</FN>
ALLETE Second Quarter 2006 Form 10-Q 12
NOTE 3. INVESTMENTS
SHORT-TERM INVESTMENTS. At June 30, 2006 and December 31, 2005, we held $120.4
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 fair market value which equates to cost because the variable interest rates
for these securities 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.
LONG-TERM INVESTMENTS. At June 30, 2006, Investments included the real estate
assets of ALLETE Properties, our investment in ATC, debt and equity securities
consisting primarily of securities held to fund employee benefits, and our
emerging technology investments.
JUNE 30, DECEMBER 31,
INVESTMENTS 2006 2005
- ------------------------------------------------------------------------------------------------------------------------
MILLIONS
Real Estate Assets $ 72.4 $ 73.7
Debt and Equity Securities 34.9 34.8
Investment in ATC 11.5 -
Emerging Technology Investments 9.0 9.2
- ------------------------------------------------------------------------------------------------------------------------
Total Investments $127.8 $117.7
- ------------------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
REAL ESTATE ASSETS 2006 2005
- ------------------------------------------------------------------------------------------------------------------------
MILLIONS
Land Held for Sale Beginning Balance $48.0 $47.2
Additions during period: Capitalized Improvements 6.1 9.4
Deductions during period: Cost of Real Estate Sold (4.6) (8.6)
- ------------------------------------------------------------------------------------------------------------------------
Land Held for Sale Ending Balance 49.5 48.0
Long-Term Finance Receivables 7.5 7.4
Other <F1> 15.4 18.3
- ------------------------------------------------------------------------------------------------------------------------
Total Real Estate Assets $72.4 $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 $0.4
million at June 30, 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, as Agent, 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 without premium
or penalty. Additionally, we may irrevocably terminate or reduce the size of the
Line prior to maturity without premium or penalty. No funds were drawn under
this Line at June 30, 2006.
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.
13 ALLETE Second Quarter 2006 Form 10-Q
NOTE 4. SHORT-TERM AND LONG-TERM DEBT (CONTINUED)
On July 5, 2006, the Collier County Industrial Development Authority issued
$27.8 million of Industrial Development Variable Rate Demand Refunding Revenue
Bonds Series 2006 due 2025 (Refunding Bonds) on behalf of ALLETE. Proceeds from
the Refunding Bonds and internally generated funds will be used to redeem $29.1
million of outstanding Collier County Industrial Development Refunding Revenue
Bonds 6.5% Series 1996 due 2025 which were called on July 5, 2006, for
redemption on August 9, 2006. As a result of an early redemption premium, we
will recognize a $0.6 million charge to other expense in the third quarter of
2006.
NOTE 5. COMMON STOCK
SHAREHOLDER RIGHTS PLAN. In 1996, we adopted a rights plan that provides for a
dividend distribution of one preferred share purchase right (Right) to be
attached to each share of common stock. In July 2006, we amended the rights plan
to extend the expiration of the Rights to July 11, 2009. The amendment also
provides that the Company may not consolidate, merge, or sell a majority of its
assets or earning power if doing so would be counter to the intended benefits of
the Rights or would result in the distribution of Rights to the shareholders of
the other parties to the transaction. Finally, the amendment provides for the
creation of a committee of independent directors to annually review the terms
and conditions of the amended rights plan (Rights Plan), as well as to consider
whether termination or modification of the Rights Plan would be in the best
interests of the shareholders and to make a recommendation based on such review
to the Board of Directors.
The Rights, which are currently not exercisable or transferable apart from our
common stock, entitle the holder to purchase one-and-a-half one-hundredths
(three two-hundredths) of a share of ALLETE's Junior Serial Preferred Stock A,
without par value. The purchase price, as defined in the Rights Plan, remains at
$90. These Rights would become exercisable if a person or group acquires
beneficial ownership of 15 percent or more of our common stock or announces a
tender offer which would increase the person's or group's beneficial ownership
interest to 15 percent or more of our common stock, subject to certain
exceptions. If the 15 percent threshold is met, each Right entitles the holder
(other than the acquiring person or group) to receive, upon payment of the
purchase price, the number of shares of common stock (or, in certain
circumstances, cash, property or other securities of ours) having a market value
equal to twice the exercise price of the Right. If we are acquired in a merger
or business combination, or 50 percent or more of our assets or earning power
are sold, each exercisable Right entitles the holder to receive, upon payment of
the purchase price, the number of shares of common stock of the acquiring or
surviving company having a value equal to twice the exercise price of the Right.
Certain stock acquisitions will also trigger a provision permitting the Board of
Directors to exchange each Right for one share of our common stock.
The Rights are nonvoting and may be redeemed by us at a price of $0.005 per
Right at any time they are not exercisable. One million shares of Junior Serial
Preferred Stock A have been authorized and are reserved for issuance under the
Rights Plan.
NOTE 6. KENDALL COUNTY CHARGE
On April 1, 2005, Rainy River Energy, a wholly-owned subsidiary of ALLETE,
completed the assignment of its power purchase agreement with LSP-Kendall
Energy, LLC, the owner of an energy generation facility located in Kendall
County, Illinois, to Constellation Energy Commodities. Rainy River Energy paid
Constellation Energy Commodities $73 million in cash to assume the power
purchase agreement that remains in effect through mid-September 2017. The
payment resulted in a charge to our operating income in the second quarter of
2005. The tax benefits of the payment will be realized through a capital loss
carryback for federal income tax purposes and have been recorded as current
deferred income tax assets. The tax benefits are expected to be realized in
2006. In addition, consent, advisory and closing costs of $4.9 million were
incurred to complete the transaction. As a result of this transaction, ALLETE
incurred a charge to operating expenses totaling $77.9 million ($50.4 million
after tax, or $1.84 per diluted share) in the second quarter of 2005.
ALLETE Second Quarter 2006 Form 10-Q 14
NOTE 7. OTHER INCOME (EXPENSE)
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2006 2005 2006 2005
- ------------------------------------------------------------------------------------------------------------------------
MILLIONS
Gain (Loss) on Emerging Technology Investments - $0.1 $(1.2) $(5.8)
Investment and Other Income $3.4 1.4 6.3 3.1
- ------------------------------------------------------------------------------------------------------------------------
Total Other Income (Expense) $3.4 $1.5 $ 5.1 $(2.7)
- ------------------------------------------------------------------------------------------------------------------------
NOTE 8. INCOME TAX EXPENSE
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2006 2005 2006 2005
- ------------------------------------------------------------------------------------------------------------------------
MILLIONS
Current Tax Expense
Federal $ 9.6 $ 7.4 <F1> $20.4 $19.5 <F1>
State 2.3 1.4 <F1> 4.8 4.5 <F1>
- ------------------------------------------------------------------------------------------------------------------------
11.9 8.8 25.2 24.0
- ------------------------------------------------------------------------------------------------------------------------
Deferred Tax Benefit
Federal (1.9) (29.5) <F1> (3.5) (32.6) <F1>
State (0.7) (0.5) (0.5) (0.8)
- ------------------------------------------------------------------------------------------------------------------------
(2.6) (30.0) (4.0) (33.4)
- ------------------------------------------------------------------------------------------------------------------------
Deferred Tax Credits (0.4) (0.4) (0.7) (0.7)
- ------------------------------------------------------------------------------------------------------------------------
Income Tax Expense (Benefit) from Continuing Operations 8.9 (21.6) 20.5 (10.1)
Income Tax Benefit from Discontinued Operations (0.3) (0.1) (0.3) -
- ------------------------------------------------------------------------------------------------------------------------
Total Income Tax Expense (Benefit) $ 8.6 $(21.7) $20.2 $(10.1)
- ------------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Included a current federal tax benefit of $1.3 million, current state tax benefit of $0.4 million and deferred
federal tax benefit of $25.8 million related to the Kendall County charge. (See Note 6.)
</FN>
For the six months ended June 30, 2006, the effective rate for income taxes was
37.3 percent (32.5 percent benefit for the six months ended June 30, 2005). The
increase in the effective rate over last year was primarily due to the emerging
technology impairment and the Kendall County capital loss recorded in April
2005. The current benefit for these items was limited to the federal benefit as
the state net capital loss carryforwards from 2005 are entirely reserved. The
effective rate of 37.3 percent for the six months ended June 30, 2006, was less
than the statutory rate primarily because of investment tax credits, and
deductions for Medicare health subsidies and depletion.
15 ALLETE Second Quarter 2006 Form 10-Q
NOTE 9. 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 reported our telecommunications business
in discontinued operations for the quarter and six months ended June 30, 2005.
WATER SERVICES. In early 2005, we completed the exit from our Water Services
businesses with the sale of our wastewater assets in Georgia, which resulted in
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 and six months ended June 30, 2006, financial results reflected
additional legal and administrative expenses to exit the Water Services
businesses.
QUARTER ENDED SIX MONTHS ENDED
DISCONTINUED OPERATIONS JUNE 30, JUNE 30,
SUMMARY INCOME STATEMENT 2006 2005 2006 2005
- ------------------------------------------------------------------------------------------------------------------------
MILLIONS
Operating Revenue - Enventis Telecom - $12.4 - $26.1
- ------------------------------------------------------------------------------------------------------------------------
Pre-Tax Income from Operations
Enventis Telecom - $ 0.4 - $ 1.5
Income Tax Expense
Enventis Telecom - 0.1 - 0.6
- ------------------------------------------------------------------------------------------------------------------------
Total Income from Operations - 0.3 - 0.9
- ------------------------------------------------------------------------------------------------------------------------
Loss on Disposal
Water Services $(0.7) (0.8) $(0.7) (1.8)
Enventis Telecom - (0.2) - (0.2)
- ------------------------------------------------------------------------------------------------------------------------
(0.7) (1.0) (0.7) (2.0)
- ------------------------------------------------------------------------------------------------------------------------
Income Tax Benefit
Water Services (0.3) (0.1) (0.3) (0.5)
Enventis Telecom - (0.1) - (0.1)
- ------------------------------------------------------------------------------------------------------------------------
(0.3) (0.2) (0.3) (0.6)
- ------------------------------------------------------------------------------------------------------------------------
Net Loss on Disposal (0.4) (0.8) (0.4) (1.4)
- ------------------------------------------------------------------------------------------------------------------------
Loss from Discontinued Operations $(0.4) $(0.5) $(0.4) $(0.5)
- ------------------------------------------------------------------------------------------------------------------------
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 Second Quarter 2006 Form 10-Q 16
NOTE 10. COMPREHENSIVE INCOME (LOSS)
For the quarter ended June 30, 2006, total comprehensive income (loss), net of
tax, was comprehensive income of $13.2 million (a $40.4 million comprehensive
loss, net of tax, for the quarter ended June 30, 2005). For the six months ended
June 30, 2006, total comprehensive income (loss), net of tax, was comprehensive
income of $32.3 million (a $22.9 million comprehensive loss, net of tax, for the
six months ended June 30, 2005). Total comprehensive income (loss) includes net
income (loss), unrealized gains and losses on securities classified as
available-for-sale, and additional pension liability.
ACCUMULATED OTHER COMPREHENSIVE JUNE 30,
INCOME (LOSS) - NET OF TAX 2006 2005
- ------------------------------------------------------------------------------------------------------------------------
MILLIONS
Unrealized Gain on Securities $ 2.4 $ 1.5
Additional Pension Liability (14.9) (12.9)
- ------------------------------------------------------------------------------------------------------------------------
$(12.5) $(11.4)
- ------------------------------------------------------------------------------------------------------------------------
NOTE 11. EARNINGS PER SHARE
The difference between basic and diluted earnings per share arises from
outstanding stock options and performance share awards granted under our
Executive and Director Long-Term Incentive Compensation Plans. In accordance
with SFAS 128, "Earnings Per Share," for the quarter and six months ended June
30, 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. In 2005, 0.1 million dilutive
securities were excluded in the computation of diluted earnings per share
because their effect would have been anti-dilutive due to our loss from
continuing operations for the quarter ended June 30, 2005 (0.2 million for the
six months ended June 30, 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 JUNE 30,
Income (Loss) from Continuing Operations $13.6 - $13.6 $(39.8) - $(39.8)
Common Shares 27.7 0.2 27.9 27.2 - 27.2
Per Share from Continuing Operations $0.50 - $0.49 $(1.46) - $(1.46)
- ------------------------------------------------------------------------------------------------------------------------
FOR THE SIX MONTHS ENDED JUNE 30,
Income (Loss) from Continuing Operations $32.4 - $32.4 $(22.4) - $(22.4)
Common Shares 27.6 0.2 27.8 27.2 - 27.2
Per Share from Continuing Operations $1.18 - $1.17 $(0.82) - $(0.82)
- ------------------------------------------------------------------------------------------------------------------------
17 ALLETE Second Quarter 2006 Form 10-Q
NOTE 12. 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 JUNE 30,
Service Cost $2.3 $2.2 $1.1 $1.0
Interest Cost 5.6 5.3 1.8 1.6
Expected Return on Plan Assets (7.2) (7.1) (1.4) (1.2)
Amortization of Prior Service Costs 0.2 0.2 - -
Amortization of Net Loss 1.2 0.8 0.5 0.2
Amortization of Transition Obligation (0.1) - 0.6 0.7
- ------------------------------------------------------------------------------------------------------------------------
Net Periodic Benefit Expense $2.0 $1.4 $2.6 $2.3
- ------------------------------------------------------------------------------------------------------------------------
FOR THE SIX MONTHS ENDED JUNE 30,
Service Cost $4.6 $4.4 $2.2 $2.0
Interest Cost 11.1 10.6 3.7 3.3
Expected Return on Plan Assets (14.3) (14.2) (2.8) (2.4)
Amortization of Prior Service Costs 0.4 0.4 - -
Amortization of Net Loss 2.4 1.6 0.9 0.4
Amortization of Transition Obligation (0.1) 0.1 1.2 1.3
- ------------------------------------------------------------------------------------------------------------------------
Net Periodic Benefit Expense $4.1 $2.9 $5.2 $4.6
- ------------------------------------------------------------------------------------------------------------------------
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.
In July 2006, we made an $8.3 million contribution to the Company's defined
benefit plan.
ALLETE Second Quarter 2006 Form 10-Q 18
NOTE 13. 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 will 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 June 30, 2006, Square Butte had total debt
outstanding of $304.6 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 denied in the December
21, 2005 order. The MPUC requested that the affected utilities and interested
parties provide a joint recommendation regarding 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 deferred for
19 ALLETE Second Quarter 2006 Form 10-Q
NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (CONTINUED)
potential recovery through base rates. The requested joint report and
recommendations were filed with the MPUC on June 23, 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 June 30, 2006, and December 31, 2005. We have
committed to make additional investments in certain emerging technology venture
capital funds. The total future commitment was $2.5 million at June 30, 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. As of June 30, 2006, we had invested
$11.5 million in ATC and anticipate investing an additional $48.5 million by the
end of 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 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 a report was
sent to the WDNR in March 2005. Additional site investigation was performed
during September and October 2005. The investigation will continue through 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 2005
rate request. In May 2006, SWL&P filed an application with the PSCW for
authority to increase retail utility rates by an average of 5.2 percent. This
filing includes a request to recover an additional $186,000 of site
investigation costs that had been incurred through 2005. 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.
ALLETE Second Quarter 2006 Form 10-Q 20
NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (CONTINUED)
SQUARE BUTTE GENERATING FACILITY. On April 24, 2006, Minnkota Power announced 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, and an over-fire air system will also be installed in
2007 to reduce NOx emissions. 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 by the early upgrade of the FGD system,
which is being upgraded two years earlier than required by Federal rules. We
expect Square Butte will utilize debt to finance such capital expenditures. Our
future cost of purchased power from the Square Butte generating unit 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 was open to public comment during which time one comment letter
was received from the Dakota Resource Council. We believe the items raised in
the letter will not compromise the agreement and Minnkota Power expects the
final order will be issued by the Court constituting a final settlement of this
issue. On July 25, 2006, the EPA filed a motion with the Court to approve the
Consent Decree. When 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. Minnesota Power
is obligated to pay its pro rata share of Square Butte's costs based on
Minnesota Power's entitlement to the output from the Square Butte generating
unit.
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 federal 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 our claims about inequities in the
SO2 allowance methodology. On March 15, 2006, the EPA announced that it would
not make any changes to the CAIR as a result of the petitions for
reconsideration. Petitions for Review (including Minnesota Power's) remain
pending at the Court of Appeals. If the Petitions for Review filed with the
Court of Appeals are 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.
21 ALLETE Second Quarter 2006 Form 10-Q
NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (CONTINUED)
COMMUNITY DEVELOPMENT DISTRICT OBLIGATIONS. TOWN CENTER. In March 2005, the 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 June
30, 2006, we owned approximately 85 percent of the assessable land in the Town
Center District.
PALM COAST PARK. In May 2006, the Palm Coast District issued $31.8 million of
tax-exempt, 5.7% Special Assessment Bonds, Series 2006, due May 1, 2037. The
bonds were issued to fund a portion of the Palm Coast Park development project.
Bond proceeds of $26.3 million will be used for the construction of
environmental, traffic mitigation and infrastructure improvements, including
utility extensions, roadways, parks, drainage, recreational facilities,
landscaping and a multi-purpose trail system. The remaining funds will be used
for capitalized interest, a debt service reserve fund and the costs of issuance.
The bonds are payable from and secured by the revenue derived from assessments
imposed, levied and collected by the Palm Coast District. The assessments
represent an allocation of the costs of the improvements, including bond
financing costs, to the lands within the Palm Coast District benefiting from the
improvements. The assessments will be included in the annual property tax bills
of landowners beginning in 2007. 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 June 30, 2006, we owned all assessable land in the Palm
Coast District.
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.
ALLETE Second Quarter 2006 Form 10-Q 22
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 our Quarterly Reports on Form 10-Q for 2006. The risks and
uncertainties described in this Form 10-Q and our 2005 Form 10-K are not the
only risks 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
will include Investment in ATC.
- 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, approximately 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 primarily
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 includes our ownership interest in ATC. In December 2005,
we entered into an agreement that provides for us to invest $60 million in
ATC. As of June 30, 2006, we had invested $11.5 million in ATC and
anticipate investing an additional $48.5 million by the end of 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 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. Historical financial results of
Taconite Harbor for periods prior to the redirection are included in our
Nonregulated Energy Operations segment.
Financial results for the periods presented and discussed in this Form 10-Q were
also impacted by the assignment of our Kendall County power purchase agreement
to Constellation Energy Commodities, which was a key strategic accomplishment
for the Company. As a result of this assignment, we incurred a charge to our
operating expenses totaling $77.9 million ($50.4 million after tax, or $1.84 per
diluted share) in the second quarter of 2005 (Kendall County Charge).
23 ALLETE Second Quarter 2006 Form 10-Q
EXECUTIVE SUMMARY (CONTINUED)
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2006 2005 2006 2005
- -------------------------------------------------------------------------------------------------------------
MILLIONS EXCEPT PER SHARE AMOUNTS
Operating Revenue
Regulated Utility $146.5 $137.8 $308.9 $285.4
Nonregulated Energy Operations 16.5 26.5 32.8 54.4
Real Estate 15.2 10.0 28.9 27.7
Other 0.1 0.1 0.2 0.2
- -------------------------------------------------------------------------------------------------------------
$178.3 $174.4 $370.8 $367.7
- -------------------------------------------------------------------------------------------------------------
Operating Expenses
Regulated Utility $131.3 $120.9 $267.6 $243.3
Nonregulated Energy Operations 15.1 103.3 <F1> 30.3 128.0 <F1>
Real Estate 4.9 5.0 8.3 9.5
Other 0.7 1.2 1.9 1.8
- -------------------------------------------------------------------------------------------------------------
$152.0 $230.4 $308.1 $382.6
- -------------------------------------------------------------------------------------------------------------
Interest Expense
Regulated Utility $4.9 $4.4 $10.0 $ 8.7
Nonregulated Energy Operations 0.5 1.6 1.0 2.9
Real Estate - 0.2 - 0.2
Other 1.0 0.5 1.8 1.7
- -------------------------------------------------------------------------------------------------------------
$6.4 $6.7 $12.8 $13.5
- --------------------------------------------------------------------------------------------------------------
Other Income (Expense)
Regulated Utility $0.5 $0.4 $0.5 $ 0.4
Nonregulated Energy Operations - - 0.3 0.2
Other 2.9 1.1 4.3 (3.3)
- -------------------------------------------------------------------------------------------------------------
$3.4 $1.5 $5.1 $(2.7)
- -------------------------------------------------------------------------------------------------------------
Income (Loss)
Regulated Utility $ 6.8 $ 7.8 $19.8 $ 20.7
Nonregulated Energy Operations 0.9 (50.5) <F1> 1.8 (48.9) <F1>
Real Estate 5.6 2.8 10.6 9.7
Other 0.3 0.1 0.2 (3.9)
- -------------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations 13.6 (39.8) 32.4 (22.4)
Loss from Discontinued Operations (0.4) (0.5) (0.4) (0.5)
- -------------------------------------------------------------------------------------------------------------
Net Income (Loss) $13.2 $(40.3) $32.0 $(22.9)
- -------------------------------------------------------------------------------------------------------------
Diluted Average Shares of Common Stock 27.9 27.2 27.8 27.2
- -------------------------------------------------------------------------------------------------------------
Diluted Earnings (Loss)
Per Share of Common Stock
Continuing Operations $0.49 $(1.46) $1.17 $(0.82)
Discontinued Operations (0.02) (0.02) (0.02) (0.02)
- -------------------------------------------------------------------------------------------------------------
$0.47 $(1.48) $1.15 $(0.84)
- -------------------------------------------------------------------------------------------------------------
<FN>
<F1> Included operating expenses totaling $77.9 million ($50.4 million after tax, or $1.84 per diluted share)
related to the assignment of the Kendall County power purchase agreement. (See Note 6.)
</FN>
ALLETE Second Quarter 2006 Form 10-Q 24
EXECUTIVE SUMMARY (CONTINUED)
Net income for the quarter ended June 30, 2006, was $13.2 million, or $0.47 per
diluted share (a $40.3 million, or $1.48 per diluted share, net loss for the
quarter ended June 30, 2005). Net income was higher in 2006 due to the absence
of the $50.4 million, or $1.84 per share, Kendall County Charge incurred in the
second quarter of 2005, a $2.8 million increase in income from Real Estate and a
$0.8 million increase in earnings on our excess cash.
Net income for the six months ended June 30, 2006, was $32.0 million, or $1.15
per diluted share (a $22.9 million, or $0.84 per diluted share, net loss for the
six months ended June 30, 2005). Net income was higher in 2006 due to the
absence of: (1) the $50.4 million, or $1.84 per share, Kendall County Charge
incurred in the second quarter of 2005; (2) Kendall County operating losses
($1.9 million in 2005); and (3) emerging technology impairments ($3.3 million in
2005). Net income in 2006 also reflected a $0.9 million increase in income from
Real Estate and a $1.3 million increase in earnings on our excess cash.
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
KILOWATTHOURS SOLD 2006 2005 2006 2005
- -------------------------------------------------------------------------------------------------------------
MILLIONS
Regulated Utility
Retail and Municipals
Residential 229.1 229.9 537.1 549.7
Commercial 315.5 300.5 644.2 640.3
Industrial 1,769.9 1,746.9 3,592.2 3,524.0
Municipals 216.1 199.3 435.4 421.3
Other 18.6 18.1 38.6 38.5
- -------------------------------------------------------------------------------------------------------------
2,549.2 2,494.7 5,247.5 5,173.8
Other Power Suppliers 515.5 366.9 1,020.6 603.6
- -------------------------------------------------------------------------------------------------------------
3,064.7 2,861.6 6,268.1 5,777.4
Nonregulated Energy Operations 55.3 399.9 120.9 753.8
- -------------------------------------------------------------------------------------------------------------
3,120.0 3,261.5 6,389.0 6,531.2
- -------------------------------------------------------------------------------------------------------------
25 ALLETE Second Quarter 2006 Form 10-Q
EXECUTIVE SUMMARY (CONTINUED)
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2006 2005 2006 2005
-------------------------------------------------------------------------------
REAL ESTATE
REVENUE AND SALES ACTIVITY QTY AMOUNT QTY AMOUNT QTY AMOUNT QTY AMOUNT
- ------------------------------------------------------------------------------------------------------------------
DOLLARS IN MILLIONS
Town Center Sales
Commercial Sq. Ft. 170,695 $ 4.7 397,000 $10.1 250,695 $ 6.2 397,000 $10.1
Residential Units 186 5.6 - - 186 5.6 - -
Other Land Sales
Acres 10 5.2 54 6.9 466 15.5 537 24.5
Lots - - - - - - 7 0.4
- ------------------------------------------------------------------------------------------------------------------
Contract Sales Price <F1> 15.5 17.0 27.3 35.0
Revenue Recognized from
Previously Deferred Sales 2.7 - 4.3 -
Deferred Revenue (3.2) (7.5) (4.0) (8.5)
Adjustments <F2> (1.4) (0.9) (1.5) (0.9)
- ------------------------------------------------------------------------------------------------------------------
Revenue from Land Sales 13.6 8.6 26.1 25.6
Other Revenue 1.6 1.4 2.8 2.1
- ------------------------------------------------------------------------------------------------------------------
$15.2 $10.0 $28.9 $27.7
- ------------------------------------------------------------------------------------------------------------------
<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 six months ended
June 30, 2006, to the six months ended June 30, 2005, by segment.
REGULATED UTILITY contributed income of $19.8 million in 2006 ($20.7 million in
2005). Lower earnings in 2006 reflected higher operating expenses partially
offset by an 8 percent increase in kilowatthour sales. Operating expenses were
higher in 2006 due to the inclusion of Taconite Harbor, effective January 1,
2006, and increased planned maintenance, employee compensation and pension
expenses. Electric sales increased 490.7 million kilowatthours, or 8 percent,
primarily due to the inclusion of Taconite Harbor and its pre-existing wholesale
energy sales obligation.
NONREGULATED ENERGY OPERATIONS reported income of $1.8 million in 2006 ($48.9
million loss in 2005). In April 2005, we completed the assignment of our Kendall
County power purchase agreement to Constellation Energy Commodities. As a result
of this transaction, we incurred a charge to operating expenses totaling $50.4
million after tax in the second quarter of 2005. In 2006, financial results
reflected the absence of income from Taconite Harbor ($2.5 million in 2005)
which is now reported as part of Regulated Utility and operating losses from
Kendall County ($1.9 million in 2005). Net income from our coal operations was
up $0.5 million from 2005 primarily due to a 2 percent increase in tons of coal
sold.
ALLETE Second Quarter 2006 Form 10-Q 26
NET INCOME (CONTINUED)
REAL ESTATE contributed income of $10.6 million in 2006 ($9.7 million in 2005).
Income was higher in 2006 due to the timing and mix of land sale transaction
closings, and increased earnings from prior and current year land sales at our
Town Center development project which are accounted for under the
percentage-of-completion method. 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, cost of real estate sold and selling expenses are
recorded using the percentage-of-completion method as development obligations
are completed. As of June 30, 2006, we had $8.1 million ($11.2 million revenue;
$2.7 million cost of real estate sold; $0.4 million selling expense) of deferred
profit on sales of real estate, before taxes and minority interest, on our
balance sheet. The majority of deferred profit relates to Town Center and we
expect most will be reflected in income by the end of 2006.
At June 30, 2006, total pending land sales under contract were $128.9 million
and are anticipated to close at various times through 2012. Pricing on these
contracts range from $20 to $50 per commercial square foot, $8,600 to $40,000
per residential unit and $8,700 to $126,000 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, certain contracts
allow us to receive participation revenue when gross revenue from land sales by
our purchaser exceeds contractually defined price levels. Deposits have been
made for all pending contracts; however, most pending contracts are subject to
due diligence that allows the purchaser to terminate the contract for a period
of time. One of the currently pending contracts is subject to an unexpired due
diligence period. If a purchaser defaults under a contract, our remedy is
limited to forfeiture of the deposit as liquidated and agreed upon damages.
REAL ESTATE
PENDING CONTRACTS CONTRACT
AT JUNE 30, 2006 QUANTITY <F1> SALES PRICE
- --------------------------------------------------------------------------------
DOLLARS IN MILLIONS
Town Center
Commercial Sq. Ft. 981,290 $ 30.5
Residential Units 1,214 22.7
Palm Coast Park
Commercial Sq. Ft. 50,000 2.5
Residential Units 2,469 61.8
Other Land
Acres 607 11.4
- --------------------------------------------------------------------------------
$128.9
- --------------------------------------------------------------------------------
<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. Commercial square feet and residential
units are estimated and include minority interest. The actual property
allocation at full build-out may be different than these estimates.
</FN>
OTHER reflected net income of $0.2 million in 2006 (a $3.9 million loss in
2005). In 2006, a $1.3 million increase in earnings on excess cash offset equity
losses related to emerging technology investments ($0.6 million in 2006; $0.2
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 from 2003 to 2005, and Enventis Telecom, our
telecommunications business that we sold in December 2005. In 2006, discontinued
operations reflected a $0.4 million loss for additional legal and administrative
expenses related to exiting the Water Services businesses. In 2005, $0.8 million
of income from Enventis Telecom was offset by $1.3 million of administrative and
other expenses incurred to support Florida Water transfer proceedings. (See Note
9.)
27 ALLETE Second Quarter 2006 Form 10-Q
COMPARISON OF THE QUARTERS ENDED JUNE 30, 2006 AND 2005
REGULATED UTILITY
OPERATING REVENUE was up $8.7 million, or 6 percent, from 2005, primarily
due to increased kilowatthour sales. Electric sales increased 203.1 million
kilowatthours, or 7 percent, due mostly to the addition of Taconite Harbor
wholesale power agreements to the Regulated Utility segment effective
January 1, 2006. The majority of Taconite Harbor sales are reflected in
sales to other power suppliers which were up 148.6 million kilowatthours,
or 41 percent, and $6.4 million. Absent the inclusion of pre-existing
Taconite Harbor wholesale obligations, sales to other power suppliers were
down reflecting less excess energy available for sale due to a planned
outage at our Boswell Unit 4 generating facility in 2006. Electric sales to
retail and municipal customers increased 54.5 million kilowatthours, or 2
percent, and $0.7 million, due to strong demand from commercial, industrial
and municipal customers.
Revenue from electric sales to taconite customers accounted for 24 percent
of consolidated operating revenue in 2006 (25 percent in 2005). Revenue
from electric sales to paper and pulp mills accounted for 9 percent of
consolidated operating revenue in both 2006 and 2005.
OPERATING EXPENSES were up $10.4 million, or 9 percent, from 2005.
FUEL AND PURCHASED POWER EXPENSE. Fuel and purchased power expense was down
$0.2 million from 2005 reflecting the inclusion of Taconite Harbor
beginning in 2006 ($5.5 million) offset by reduced fuel expense, primarily
at our Boswell Unit 4 generating facility due to a planned maintenance
outage in 2006.
OTHER OPERATING EXPENSES. In total, other operating expenses were up $10.6
million from 2005. In total, plant maintenance expense increased $3.5
million from 2005 reflecting the inclusion of Taconite Harbor maintenance
in 2006 ($0.7 million) and increased maintenance expense at other Company
generating facilities, primarily due to a planned outage at our Boswell
Unit 4 generating facility ($1.9 million). Employee compensation was up
$3.1 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 the inclusion of Taconite Harbor. MISO expenses were up
$0.8 million. Pension expense increased $0.6 million due to a reduction in
the discount rate.
INTEREST EXPENSE was up $0.5 million, or 11 percent, from 2005 due to the
inclusion of Taconite Harbor in 2006, partially offset by lower effective
interest rates (5.91 percent in 2006; 6.19 percent in 2005).
NONREGULATED ENERGY OPERATIONS
OPERATING REVENUE was down $10.0 million, or 38 percent, from 2005 due to
the absence of revenue from Taconite Harbor ($13.3 million in 2005).
Effective January 1, 2006, Taconite Harbor is reported as part of the
Regulated Utility segment. Coal revenue, realized under a cost-plus
contract, was up $1.7 million from 2005 reflecting a 6 percent increase in
the delivery price per ton due to higher coal production expenses (see
operating expenses below), and a 10 percent increase in tons of coal sold
in 2006. Tons of coal sold were lower in 2005 due to a plant outage at the
Square Butte generating facility.
OPERATING EXPENSES were down $88.2 million, or 85 percent, from 2005
reflecting the absence of a $77.9 million charge related to the assignment
of the Kendall County power purchase agreement to Constellation Energy
Commodities on April 1, 2005, and expenses related to Taconite Harbor
($12.3 million in 2005). Expenses related to coal operations were up $1.3
million, mainly due to increased equipment leases and fuel expenses in
2006.
INTEREST EXPENSE was down $1.1 million, or 69 percent, from 2005 primarily
due to the absence of Taconite Harbor in 2006.
ALLETE Second Quarter 2006 Form 10-Q 28
COMPARISON OF THE QUARTERS ENDED JUNE 30, 2006 AND 2005 (CONTINUED)
REAL ESTATE
OPERATING REVENUE was up $5.2 million, or 52 percent, from 2005, due to the
timing and mix of land sale transaction closings, and increased revenue
from prior and current year land sales at our Town Center development
project which are accounted for under the percentage-of-completion method.
Revenue from land sales was $13.6 million in 2006 which included $2.7
million of previously deferred revenue. In 2005, revenue from land sales
was $8.6 million. In 2006, 10 acres of other land were sold (54 acres in
2005). Sales at Town Center represented 186 residential units and the
rights to build up to 170,695 square feet of commercial space in 2006
(397,000 commercial square feet in 2005). In 2006, revenue of $3.2 million
($7.5 million in 2005) was deferred and will be recognized on a
percentage-of-completion basis as development obligations are completed.
OPERATING EXPENSES were down $0.1 million, or 2 percent, from 2005
reflecting a $0.5 million decrease in the cost of real estate sold ($2.7
million in 2006; $3.2 million in 2005) due to the mix of land sold,
partially offset by a $0.3 million increase in selling expenses due to
higher brokerage fees.
OTHER
OPERATING EXPENSES were down $0.5 million, or 42 percent, from 2005,
reflecting lower general and administrative expenses in 2006.
OTHER INCOME (EXPENSE) reflected $1.8 million more income in 2006 primarily
due to a $1.3 million increase in earnings on excess cash.
INCOME TAXES
For the quarter ended June 30, 2006, the effective rate for income taxes was
38.2 percent (35.3 percent benefit for the quarter ended June 30, 2005). The
increase in the effective rate over last year was primarily due to the emerging
technology impairment and the Kendall County capital loss recorded in April
2005. The current benefit for these items was limited to the federal benefit as
the state net capital loss carryforwards from 2005 are entirely reserved. The
effective rate of 38.2 percent for the quarter ended June 30, 2006, was less
than the statutory rate, primarily because of investment tax credits, and
deductions for Medicare health subsidies and depletion.
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2006 AND 2005
REGULATED UTILITY
OPERATING REVENUE was up $23.5 million, or 8 percent, from 2005, primarily
due to increased kilowatthour sales. Electric sales increased 490.7 million
kilowatthours, or 8 percent, due mostly to the addition of Taconite Harbor
wholesale power agreements to the Regulated Utility segment effective
January 1, 2006. The majority of Taconite Harbor sales are reflected in
sales to other power suppliers which were up 417.0 million kilowatthours or
69 percent, and $17.8 million. Absent the inclusion of pre-existing
Taconite Harbor wholesale obligations, sales to other power suppliers were
down reflecting less excess energy available for sale due to a planned
outage at our Boswell Unit 4 generating facility in 2006. Electric sales to
retail and municipal customers increased 73.7 million kilowatthours, or 1
percent, and $4.2 million, mainly due to strong demand from industrial
customers.
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 both 2006 and 2005.
29 ALLETE Second Quarter 2006 Form 10-Q
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2006 AND 2005 (CONTINUED)
REGULATED UTILITY (CONTINUED)
OPERATING EXPENSES were up $24.3 million, or 10 percent, from 2005.
FUEL AND PURCHASED POWER EXPENSE. Fuel and purchased power expense was up
$9.2 million from 2005, reflecting the inclusion of Taconite Harbor
operations beginning in 2006 ($10.8 million) and higher prices paid for
purchased power, partially offset by lower fuel expense at our generating
facilities due to planned outages.
OTHER OPERATING EXPENSES. In total, other operating expenses were up $15.1
million from 2005. Employee compensation was up $5.1 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. In total, plant maintenance expense increased $3.1 million from
2005 reflecting the inclusion of Taconite Harbor maintenance in 2006 ($2.2
million) and increased planned maintenance expense at Boswell Unit 4 ($2.1
million) partially offset by a decrease in maintenance expenses at Boswell
Unit 3 ($2.3 million). In 2005, planned maintenance was performed at
Boswell Unit 3 while the unit was down due to a cooling tower failure.
Depreciation expense increased $2.6 million primarily due to the inclusion
of Taconite Harbor. Pension expense increased $1.2 million due to a
reduction in the discount rate. Vegetation management expenses were up $1.0
million reflecting more work performed in 2006. MISO expenses were up $0.6
million.
INTEREST EXPENSE was up $1.3 million, or 15 percent, from 2005, due to the
inclusion of Taconite Harbor in 2006 partially offset by lower effective
interest rates (5.94 percent in 2006; 6.13 percent in 2005).
NONREGULATED ENERGY OPERATIONS
OPERATING REVENUE was down $21.6 million, or 40 percent, from 2005 due to
the absence of revenue from Taconite Harbor ($24.7 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 to be included with our operations effective April 1, 2005, when the
Company assigned the power purchase agreement to Constellation Energy
Commodities. Coal revenue, realized under a cost-plus contract, was up $2.2
million from 2005 reflecting a 10 percent increase in the delivery price
per ton due to higher coal production expenses (see operating expenses
below) and a 2 percent increase in tons of coal sold in 2006. Tons of coal
sold were lower in 2005 due to a plant outage at the Square Butte
generating facility.
OPERATING EXPENSES were down $97.7 million, or 76 percent, from 2005
reflecting the absence of a $77.9 million charge related to the assignment
of the Kendall County power purchase agreement to Constellation Energy
Commodities on April 1, 2005, expenses related to Taconite Harbor ($19.0
million in 2005) and other expenses related to Kendall County ($6.3 million
in 2005) that were incurred prior to April 1, 2005. Expenses related to
coal operations were up $1.6 million mainly due to increased equipment
leases and fuel expenses in 2006.
INTEREST EXPENSE was down $1.9 million, or 66 percent, from 2005 primarily
due to the absence of Taconite Harbor in 2006.
ALLETE Second Quarter 2006 Form 10-Q 30
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2006 AND 2005 (CONTINUED)
REAL ESTATE
OPERATING REVENUE was up $1.2 million, or 4 percent, from 2005, due to the
timing and mix of land sale transaction closings, and increased revenue
from prior and current year land sales at our Town Center development
project which are accounted for under the percentage-of-completion method.
Revenue from land sales was $26.1 million in 2006 which included $4.3
million of previously deferred revenue. In 2005, revenue from land sales
was $25.6 million. In 2006, 466 acres of other land were sold (537 acres
and 7 lots in 2005). Sales at Town Center represented 186 residential units
and the rights to build up to 250,695 square feet of commercial space in
2006 (397,000 commercial square feet in 2005). The first land sales for
Town Center were recorded in June 2005. In 2006, revenue of $4.0 million
($8.5 million in 2005) was deferred and will be recognized on a
percentage-of-completion basis as development obligations are completed.
OPERATING EXPENSES were down $1.2 million, or 13 percent, from 2005
reflecting a $1.2 million decrease in the cost of real estate sold ($4.6
million in 2006; $5.8 million in 2005), due to the mix of land sold.
OTHER
OTHER INCOME (EXPENSE) reflected $7.6 million more income in 2006 due to a
$2.5 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 ($0.3 million in
2005).
INCOME TAXES
For the six months ended June 30, 2006, the effective rate for income taxes was
37.3 percent (32.5 percent benefit for the six months ended June 30, 2005). The
increase in the effective rate over last year was primarily due to the emerging
technology impairment and the Kendall County capital loss recorded in April
2005. The current benefit for these items was limited to the federal benefit as
the state net capital loss carryforwards from 2005 are entirely reserved. The
effective rate of 37.3 percent for the six months ended June 30, 2006, was less
than the statutory rate primarily because of investment tax credits and
deductions for Medicare health subsidies and depletion.
NON-GAAP FINANCIAL MEASURES
We prepare financial statements in accordance with GAAP. Along with this
information, we disclose and discuss certain non-GAAP financial information in
our quarterly earnings releases, on investor conference calls and during
investor conferences and related events. Management believes that non-GAAP
financial data supplements our GAAP financial statements by providing investors
with additional information which enhances the investors' overall understanding
of our financial performance and the comparability of our operating results from
period to period. The presentation of this additional information is not meant
to be considered in isolation or as a substitute for our results of operations
prepared and presented in accordance with GAAP.
As earlier mentioned, our financial results for 2005 were significantly impacted
by a $50.4 million after tax, or $1.84 per share, charge due to the assignment
of the Kendall County power purchase agreement to Constellation Energy
Commodities. (See Note 6.)
Since the Kendall County transaction significantly impacted the financial
results from continuing operations in 2005, we believe that, for comparative
purposes and a more accurate reflection of our ongoing operations, it is useful
to present diluted earnings per share from continuing operations for each
applicable period excluding the impact of this transaction. The table below
reconciles actual reported diluted earnings per share from continuing operations
to the adjusted results that exclude the Kendall County transaction in the
respective periods.
31 ALLETE Second Quarter 2006 Form 10-Q
NON-GAAP FINANCIAL MEASURES (CONTINUED)
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2006 2005 2006 2005
- -----------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS (LOSS) PER SHARE OF COMMON STOCK
Continuing Operations - As Reported $0.49 $(1.46) $1.17 $(0.82)
Add: Kendall County Charge - 1.84 - 1.84
- -----------------------------------------------------------------------------------------------------------------
Continuing Operations - As Adjusted $0.49 $ 0.38 $1.17 $1.02
- -----------------------------------------------------------------------------------------------------------------
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.
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 as outlined in
our 2005 Form 10-K. The growth is expected to come from continued strong
electric sales, increased real estate sales and our investment in ATC. It also
reflects the absence of operating losses from Kendall County and impairments
related to our emerging technology investments which impacted the Company's
financial results in 2005.
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 Resource Plan, which 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 which extends from 2009 to 2015. This
agreement was executed in June 2006 and will be filed for approval with the
MPUC. Expansion of our renewable generating assets to meet Minnesota's Renewable
Energy Objective was also approved. The Renewable Energy Objective seeks a 10
percent supply of qualified renewable energy resources for each Minnesota
utility by 2015. In April 2006, construction began on a 50-MW wind facility in
North Dakota and is expected to be completed by the end 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 anticipate 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.
ALLETE Second Quarter 2006 Form 10-Q 32
OUTLOOK (CONTINUED)
AREA AND BOSWELL 3 EMISSION REDUCTION PLANS. In May 2006, the MPUC approved our
filing for cost recovery of planned expenditures to reduce emissions to meet
pending federal requirements at Taconite Harbor and Laskin under the AREA plan.
The approval allows Minnesota Power to recover costs for SO2, NOx and mercury
emission reductions made at these facilities without a rate proceeding.
Minnesota Power plans to complete installation of new equipment at the first of
two Laskin units this fall, with the first of three Taconite Harbor unit
installations anticipated to be completed by mid-2007. Work on all units is
anticipated to be completed by the end of 2008. Cost recovery filings will be
made 90 days prior to the anticipated in-service date for the equipment at each
unit, with rate recovery beginning the month following the in-service date.
In May 2006, we announced plans to make emission reduction investments at our
Boswell Unit 3 generating unit. Plans include reductions of particulate, SO2,
NOx and mercury emissions to meet pending federal and state requirements. The
estimated cost for these reductions is $200 million, which the Company expects
to spend from 2007 through 2010. Recovery of capital costs and incremental
operating and maintenance expenses, as well as a return on investment, will
commence when the project is in service. In addition, Minnesota legislation
allows for a cash return on investment for construction work in progress. We
plan to file for MPCA and MPUC approval of these plans and related expenditures
later this year. The MPUC filing would request approval for cost recovery and
returns on these investments without a rate proceeding.
LARGE POWER CONTRACTS. 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. 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 our large power customers and Minnesota Power because it
provides 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 worked 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 joint report and recommendations were
filed with the MPUC on June 23, 2006. The MPUC is requesting public comments on
the report and further action on the recommendation is anticipated later in
2006. (See Note 13.)
EXCELSIOR ENERGY INC. (Excelsior) has proposed to construct two 600 MW (net)
coal-gasification generation units in northern Minnesota. The project is in the
early development stages but may be an option for our long-term forecasted
energy and capacity needs. Excelsior says the facility could be operational in
2011, but needs to obtain the necessary permits and financing. In 2003, the
Minnesota legislature enacted several provisions that provide Excelsior with
special considerations, including requiring utilities within the state to
"consider" Excelsior before pursuing new resource additions within Minnesota. In
December 2005, Excelsior filed a petition with the MPUC seeking approval of an
unexecuted power purchase agreement with Xcel Energy Inc. In January 2006,
Minnesota Power filed comments with the MPUC in Excelsior's proposed power
purchase agreement proceeding, focusing on the importance to the state of
maintaining a range of base load energy options, including multiple fuel types
and generating technologies. In April 2006, the MPUC referred Excelsior's
petition to an administrative law proceeding to further develop the record in
the case for subsequent MPUC deliberations. Minnesota Power continues to be a
participant in these proceedings, focusing its comments on energy policy and
infrastructure impacts.
INVESTMENT IN ATC. On May 4, 2006, the PSCW reviewed and approved the request
that allows us to invest $60 million in ATC. As of June 30, 2006, we had
invested $11.5 million and anticipate investing an additional $48.5 million by
the end of 2006.
33 ALLETE Second Quarter 2006 Form 10-Q
OUTLOOK (CONTINUED)
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. Cost of service studies and
rate designs for all retail customer classes were filed on June 1, 2006. The
PSCW has set tentative dates of August 8, 2006, for the pre-hearing conference
and November 21, 2006, for the hearing. The Company anticipates that 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.
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 activities. 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 $53.2 million at June 30, 2006.
PALM COAST PARK. In May 2006, Palm Coast District issued $31.8 million of
tax-exempt, special assessment bonds, the majority of which will be used to fund
the construction of environmental, traffic mitigation and infrastructure
improvements at Palm Coast Park. At June 30, 2006, pending land sales under
contract for properties at Palm Coast Park totaled $64.3 million which included
a contract for a $52.5 million sale of land that will be purchased in four
phases, with closings to occur in 2007 through 2009. We have the opportunity to
receive participation revenue as part of these sales contracts.
ORMOND CROSSINGS. We anticipate that the Development of Regional Impact approval
process will be concluded in late 2006, at which time we would receive a
Development Order from the City of Ormond Beach. Engineering, design and
permitting will continue through 2007. It is not anticipated that any sales will
be made at Ormond Crossings until 2008.
As of June 30, 2006, we had $8.1 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 $7.5 million at June 30, 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 SIX MONTHS ENDED JUNE 30, 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 (186) (250,695)
Change in Estimate 87 6,375
- -------------------------------------------------------------------------------------------------
2,734 2,683,380
Palm Coast Park 100% 3,600 3,200,000
Ormond Crossings 100% <F3> <F3>
- -------------------------------------------------------------------------------------------------
6,334 5,883,380
- -------------------------------------------------------------------------------------------------
<FN>
<F1> Estimated and includes minority interest. The actual property allocation 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>
ALLETE Second Quarter 2006 Form 10-Q 34
OUTLOOK (CONTINUED)
SUMMARY OF OTHER LAND INVENTORIES
FOR THE SIX MONTHS ENDED
JUNE 30, 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)
Change in Estimate (97) - - - (97)
- ---------------------------------------------------------------------------------------------------------------------------
2,403 1,645 346 263 149
- ---------------------------------------------------------------------------------------------------------------------------
Lehigh 80%
At December 31, 2005 613 390 140 74 9
Property Sold (390) (390) - - -
- ---------------------------------------------------------------------------------------------------------------------------
223 - 140 74 9
- ---------------------------------------------------------------------------------------------------------------------------
Cape Coral 100%
At December 31, 2005 41 - 1 40 -
Property Sold (10) - - (10) -
- ---------------------------------------------------------------------------------------------------------------------------
31 - 1 30 -
- ---------------------------------------------------------------------------------------------------------------------------
Other <F2> 100% 944 - - - 944
- ---------------------------------------------------------------------------------------------------------------------------
3,601 1,645 487 367 1,102
- ---------------------------------------------------------------------------------------------------------------------------
<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 allocation at full build-out may be different than these estimates.
<F2> Includes land located in Ormond Beach, Florida, and other land located in Palm Coast, Florida not included in
development projects.
</FN>
35 ALLETE Second Quarter 2006 Form 10-Q
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW ACTIVITIES
A primary goal of our strategic plan is to improve cash flow from operations.
Our strategy includes growing our businesses both internally by expanding
facilities, services and operations (see Capital Requirements), and externally
through acquisitions.
We believe our financial condition is strong, as evidenced by cash and cash
equivalents and short-term investments of $183.2 million, and a debt to total
capital ratio of 38 percent at June 30, 2006.
OPERATING ACTIVITIES. Cash flow from operating activities was $36.4 million for
the six months ended June 30, 2006 (cash flow for operating activities of $20.0
million for the six months ended June 30, 2005). Cash from operating activities
was higher in 2006, primarily due to the $77.9 million Kendall County charge in
2005. Cash used for inventories was $5.4 million higher in 2006 reflecting more
coal purchases in anticipation of maintenance on some coal handling equipment in
the fall of 2006. Cash used for discontinued operations was higher in 2006 due
to the total payment of all 2005 accrued liabilities.
INVESTING ACTIVITIES. Cash flow for investing activities was $45.3 million for
the six months ended June 30, 2006 (cash flow from investing activities of $58.4
million for the six months ended June 30, 2005). Cash used for investing
activities was higher in 2006 than 2005, primarily due to activities within our
short-term investments. In 2006, net purchases of $3.5 million were used for
short-term investments, while 2005 included $87.6 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 $410.6 million in 2006 ($271.1
million in 2005) and purchases were $414.1 million ($183.5 million in 2005).
Cash used for investing activities in 2006 reflected $11.5 million invested in
ATC and a $12.7 million increase in additions to property, plant and equipment
which vary from year to year.
FINANCING ACTIVITIES. Cash flow for financing activities was $17.9 million for
the six months ended June 30, 2006 ($4.3 million for the six months ended June
30, 2005). Cash used for financing activities increased in 2006 due to an
additional $5.3 million of dividends paid because of more shares outstanding and
an increase in the dividend rate. Cash from financing activities was $4.0
million lower in 2006, primarily due to fewer shares issued under our long-term
incentive compensation plan. In 2006, we refinanced $50 million of first
mortgage bonds at a lower rate. The new bonds 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 without premium
or penalty. Additionally, we may irrevocably terminate or reduce the size of the
Line prior to maturity without premium or penalty. 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.
In May 2006, Palm Coast District issued $31.8 million of tax-exempt, 5.7%
Special Assessment Bonds, Series 2006, due May 1, 2037. The bonds were issued to
fund a portion of the Palm Coast Park development project in Florida. Bond
proceeds of $26.3 million will be used for the construction of environmental,
traffic mitigation and infrastructure improvements, including utility
extensions, roadways, parks, drainage, recreational facilities, landscaping and
a multi-purpose trail system. The remaining funds will be used for capitalized
interest, a debt service reserve fund and the costs of issuance. The bonds are
payable from and secured by the revenue derived from assessments imposed, levied
and collected by the Palm Coast District. The assessments represent an
allocation of the costs of the improvements, including bond financing costs, to
the lands within the Palm Coast District benefiting from the improvements. The
assessments will be included in the annual property tax bills of landowners
beginning in 2007.
ALLETE Second Quarter 2006 Form 10-Q 36
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.
On July 5, 2006, the Collier County Industrial Development Authority issued
$27.8 million of Industrial Development Variable Rate Demand Refunding Revenue
Bonds Series 2006 due 2025 (Refunding Bonds) on behalf of ALLETE. Proceeds from
the Refunding Bonds and internally generated funds will be used to redeem $29.1
million of outstanding Collier County Industrial Development Refunding Revenue
Bonds 6.5% Series 1996 due 2025 which were called on July 5, 2006, for
redemption on August 9, 2006. As a result of an early redemption premium, we
will recognize a $0.6 million charge to other expense in the third quarter of
2006.
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 13 of this Form 10-Q.
CAPITAL REQUIREMENTS
For the six months ended June 30, 2006, capital expenditures for continuing
operations totaled $35.3 million ($22.6 million in 2005). Expenditures for the
six months ended June 30, 2006, included $34.5 million for Regulated Utility and
$0.8 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 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. The
Palm Coast District issued $31.8 million of tax-exempt bonds in May 2006. Bond
proceeds of $26.3 million will be used for the construction of environmental,
traffic mitigation and infrastructure improvements at Palm Coast Park, with the
remaining funds to be used for capitalized interest, a debt service reserve fund
and costs of issuance. Company expenditures related to our real estate
developments in Florida increase the carrying value of our land assets, which
are classified as Investments on our consolidated balance sheet.
37 ALLETE Second Quarter 2006 Form 10-Q
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 13.
NEW ACCOUNTING STANDARDS
New accounting standards are discussed in Note 1.
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 in 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 are recorded at fair
market value which equates to cost because the variable interest rates for these
securities 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 $143.9
million at June 30, 2006 ($139.5 million at December 31, 2005) and a total
unrealized after-tax gain of $2.4 million at June 30, 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 six months ended June 30,
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 based primarily on
our ownership percentages. The total carrying value of our emerging technology
portfolio was $9.0 million at June 30, 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 June 30, 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.
ALLETE Second Quarter 2006 Form 10-Q 38
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, with formula pricing based on variable
production cost of a combustion-turbine, natural gas unit.
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.
39 ALLETE Second Quarter 2006 Form 10-Q
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Material legal and regulatory proceedings are included in the discussion of
Other Information in Part II, Item 5 and/or Note 13, and are incorporated by
reference herein.
ITEM 1A. RISK FACTORS
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 and Part II,
Item 1A of our Form 10-Q for the Quarter Ended March 31, 2006.
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
(a) We held our Annual Meeting of Shareholders on May 9, 2006.
(b) Included in (c) below.
(c) The election of directors and the ratification of the appointment of
PricewaterhouseCoopers LLP, as the Company's independent registered public
accounting firm for 2006 were voted on at the Annual Meeting of
Shareholders.
The results were as follows:
VOTES
VOTES FOR WITHHELD
- --------------------------------------------------------------------------------------------------------------------
DIRECTORS
Heidi J. Eddins 26,116,843 432,795
James J. Hoolihan 25,425,168 1,124,470
Peter J. Johnson 25,791,795 757,843
Madeleine W. Ludlow 26,067,724 481,914
George L. Mayer 26,091,618 458,020
Roger D. Peirce 26,002,438 547,200
Jack I. Rajala 25,734,994 814,644
Donald J. Shippar 25,765,280 784,358
Nick Smith 25,715,577 834,061
Bruce W. Stender 25,765,606 784,032
- --------------------------------------------------------------------------------------------------------------------
VOTES BROKER
VOTES FOR AGAINST ABSTENTIONS NONVOTES
- --------------------------------------------------------------------------------------------------------------------
INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
PricewaterhouseCoopers LLP 25,876,490 542,654 130,494 -
- --------------------------------------------------------------------------------------------------------------------
(d) Not applicable.
ALLETE Second Quarter 2006 Form 10-Q 40
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 12 - First, Second and Third Full Paragraphs
In May 2006, the MPUC approved our filing for cost recovery of planned
expenditures to reduce emissions to meet pending federal requirements at
Taconite Harbor and Laskin under the AREA plan. The approval allows Minnesota
Power to recover costs for SO2, NOx and mercury emission reductions made at
these facilities without a rate proceeding. Minnesota Power plans to complete
installation of new equipment at the first of two Laskin units this fall, with
the first of three Taconite Harbor unit installations anticipated to be
completed by mid-2007. Work on all units is anticipated to be completed by the
end of 2008. Cost recovery filings will be made 90 days prior to the anticipated
in-service date for the equipment at each unit, with rate recovery beginning in
the month following the in-service date.
Ref. Page 20 - Sixth Full Paragraph
On June 16, 2006, Minnesota Power filed an application with the MPCA for a
variance from a clarified ash pond discharge standard for mercury included in
its National Pollutant Discharge Elimination System (NPDES) permit for Laskin.
The variance requests an extension for Laskin to meet mercury discharge
requirements which become effective March 23, 2007, as set forth in Laskin's
NPDES permit issued by the MPCA in May 2005. Currently there is no feasible
technology available that would enable Laskin to meet the March 23, 2007
deadline to lower the mercury in its wastewater discharge. The Company is
actively researching and testing treatment technology options, but is unable to
predict the outcome of this matter.
Ref. Page 20 - Seventh Full Paragraph
Minnesota Power, the Fond du Lac Band of Lake Superior Chippewa and the U.S.
Department of Interior (DOI) reached a settlement agreement to resolve each
party's respective appeals of the St. Louis River Project hydroelectric license.
In December 2004, Minnesota Power filed an application for an amendment to the
St. Louis River Project license incorporating the settlement agreement. On June
22, 2006, the FERC issued an order modifying and approving Minnesota Power's
application to amend the license consistent with the settlement agreement. The
FERC declined a request by the DOI to vacate portions of the original license
order as part of the license amendment process. The order by the FERC, otherwise
adopts the material provisions of the settlement as part of the amended project
license. The order became final and non-appealable on July 22, 2006.
41 ALLETE Second Quarter 2006 Form 10-Q
ITEM 6. EXHIBITS
EXHIBIT
NUMBER
10(a) First Amendment to Fourth Amended and Restated Committed Facility
Letter dated June 19, 2006, by and among ALLETE and LaSalle Bank
National Association, as Agent.
10(b)1 Financing Agreement between Collier County Industrial Development
Authority and ALLETE dated as of July 1, 2006.
10(b)2 Letter of Credit Agreement, dated as of July 5, 2006, among ALLETE,
Participating Banks and Wells Fargo Bank, National Association, as
Administrative Agent and Issuing Bank.
31(a) Rule 13a-14(a)/15d-14(a) Certification by the Chief Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31(b) Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32 Section 1350 Certification of Periodic Report by the Chief Executive
Officer and Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99 ALLETE News Release dated July 28, 2006, announcing 2006 second
quarter earnings. (THIS EXHIBIT HAS BEEN FURNISHED AND SHALL NOT BE
DEEMED "FILED" FOR PURPOSES OF SECTION 18 OF THE SECURITIES EXCHANGE
ACT OF 1934, NOR SHALL IT BE DEEMED INCORPORATED BY REFERENCE IN ANY
FILING UNDER THE SECURITIES ACT OF 1933, EXCEPT AS SHALL BE EXPRESSLY
SET FORTH BY SPECIFIC REFERENCE IN SUCH FILING.)
ALLETE Second Quarter 2006 Form 10-Q 42
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ALLETE, INC.
July 28, 2006 Mark A. Schober
-------------------------------------------------
Mark A. Schober
Senior Vice President and Chief Financial Officer
July 28, 2006 Steven Q. DeVinck
-------------------------------------------------
Steven Q. DeVinck
Controller
43 ALLETE Second Quarter 2006 Form 10-Q
EXHIBIT INDEX
EXHIBIT
NUMBER
- --------------------------------------------------------------------------------
10(a) First Amendment to Fourth Amended and Restated Committed Facility
Letter dated June 19, 2006, by and among ALLETE and LaSalle Bank
National Association, as Agent.
10(b)1 Financing Agreement between Collier County Industrial Development
Authority and ALLETE dated as of July 1, 2006.
10(b)2 Letter of Credit Agreement, dated as of July 5, 2006, among ALLETE,
Participating Banks and Wells Fargo Bank, National Association, as
Administrative Agent and Issuing Bank.
31(a) Rule 13a-14(a)/15d-14(a) Certification by the Chief Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31(b) Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32 Section 1350 Certification of Periodic Report by the Chief Executive
Officer and Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99 ALLETE News Release dated July 28, 2006, announcing 2006 second
quarter earnings. (THIS EXHIBIT HAS BEEN FURNISHED AND SHALL NOT BE
DEEMED "FILED" FOR PURPOSES OF SECTION 18 OF THE SECURITIES EXCHANGE
ACT OF 1934, NOR SHALL IT BE DEEMED INCORPORATED BY REFERENCE IN ANY
FILING UNDER THE SECURITIES ACT OF 1933, EXCEPT AS SHALL BE EXPRESSLY
SET FORTH BY SPECIFIC REFERENCE IN SUCH FILING.)
ALLETE Second Quarter 2006 Form 10-Q