UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
DC 20549
FORM
10-Q
(Mark
One)
|
T
|
Quarterly
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934
|
For the
quarterly period ended
September 30,
2008
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 incorporation or organization)
|
|
(IRS
Employer 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 (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
T
Yes
£
No
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
|
Large
Accelerated Filer
T
|
Accelerated
Filer
£
|
|
Non-Accelerated
Filer
£
|
Smaller
Reporting Company
£
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
£
Yes
T
No
Common
Stock, no par value,
31,630,343
shares outstanding
as of
September 30, 2008
INDEX
|
|
|
|
Page
|
|
|
|
|
|
|
|
Definitions
|
|
|
3
|
|
|
|
|
|
|
|
|
Safe
Harbor Statement
Under the Private
Securities Litigation Reform Act of 1995
|
5
|
|
|
|
|
|
|
|
|
Part
I.
|
Financial
Information
|
|
|
|
|
|
|
|
|
|
|
Item
1.
|
Financial
Statements
|
|
|
|
|
|
|
|
|
|
|
Consolidated
Balance Sheet -
|
|
|
|
|
|
September
30, 2008 and December 31, 2007
|
6
|
|
|
|
|
|
|
|
|
|
Consolidated
Statement of Income -
|
|
|
|
|
|
Quarter
and Nine Months Ended September 30, 2008 and 2007
|
7
|
|
|
|
|
|
|
|
|
|
Consolidated
Statement of Cash Flows -
|
|
|
|
|
|
Nine
Months Ended September 30, 2008 and 2007
|
8
|
|
|
|
|
|
|
|
|
|
Notes
to Consolidated Financial Statements
|
9
|
|
|
|
|
|
|
|
|
|
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition
and
Results of Operations
|
23
|
|
|
|
|
|
|
|
|
|
Item
3.
|
Quantitative
and Qualitative Disclosures about Market Risk
|
37
|
|
|
|
|
|
|
|
|
|
Item
4.
|
Controls
and Procedures
|
38
|
|
|
|
|
|
|
|
|
Part
II.
|
Other
Information
|
|
|
|
|
|
|
|
|
|
|
Item
1.
|
Legal
Proceedings
|
39
|
|
|
|
|
|
|
|
|
|
Item
1A.
|
Risk
Factors
|
39
|
|
|
|
|
|
|
|
|
|
Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
39
|
|
|
|
|
|
|
|
|
|
Item
3.
|
Defaults
Upon Senior Securities
|
39
|
|
|
|
|
|
|
|
|
|
Item
4.
|
Submission
of Matters to a Vote of Security Holders
|
39
|
|
|
|
|
|
|
|
|
|
Item
5.
|
Other
Information
|
40
|
|
|
|
|
|
|
|
|
|
Item
6.
|
Exhibits
|
43
|
|
|
|
|
|
|
|
|
Signatures
|
|
|
44
|
|
ALLETE
Third Quarter 2008 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
|
|
AFUDC
|
Allowance
for Funds Used During Construction – consisting of the cost of both the
debt and equity funds used to finance utility plant additions during
construction periods
|
|
ALLETE
|
ALLETE,
Inc.
|
|
ALLETE
Properties
|
ALLETE
Properties, LLC and its subsidiaries
|
|
AREA
|
Arrowhead
Regional Emission Abatement
|
|
ATC
|
American
Transmission Company LLC
|
|
BNI
Coal
|
BNI
Coal, Ltd.
|
|
BNSF
|
BNSF
Railway Company
|
|
Boswell
|
Boswell
Energy Center
|
|
Company
|
ALLETE,
Inc. and its subsidiaries
|
|
DC
|
Direct
Current
|
|
DOC
|
Minnesota
Department of Commerce
|
|
EITF
|
Emerging
Issues Task Force
|
|
EPA
|
Environmental
Protection Agency
|
|
ESOP
|
Employee
Stock Ownership Plan
|
|
FASB
|
Financial
Accounting Standards Board
|
|
FERC
|
Federal
Energy Regulatory Commission
|
|
Form
10-K
|
ALLETE
Annual Report on Form 10-K
|
|
Form
10-Q
|
ALLETE
Quarterly Report on Form 10-Q
|
|
FPL
Energy
|
FPL
Energy, LLC
|
|
FSP
|
FASB
Staff Position
|
|
GAAP
|
United
States Generally Accepted Accounting Principles
|
|
GHG
|
Greenhouse
Gases
|
|
Heating
Degree Days
|
Measure
of the extent to which the average daily temperature is below 65 degrees
Fahrenheit, increasing demand for heating.
|
|
Invest
Direct
|
ALLETE’s
Direct Stock Purchase and Dividend Reinvestment Plan
|
|
kV
|
Kilovolt(s)
|
|
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
/ MWh
|
Megawatt(s)
/ Megawatt-hour(s)
|
|
Non-residential
|
Retail
commercial, non-retail commercial, office, industrial, warehouse, storage
and institutional
|
|
NO
X
|
Nitrogen
Oxide
|
|
Note
___
|
Note
___ to the consolidated financial statements in this Form
10-Q
|
|
OAG
|
Office
of the Attorney General
|
|
OES
|
Minnesota
Office of Energy Security
|
|
Oliver
Wind I
|
Oliver
Wind I Energy Center
|
|
Oliver
Wind II
|
Oliver
Wind II Energy Center
|
ALLETE
Third Quarter 2008 Form 10-Q
|
Definitions
(Continued)
|
|
Abbreviation
or Acronym
|
Term
|
|
Palm
Coast Park
|
Palm
Coast Park development project in Florida
|
|
Palm
Coast Park District
|
Palm
Coast Park Community Development District
|
|
PSCW
|
Public
Service Commission of Wisconsin
|
|
SEC
|
Securities
and Exchange Commission
|
|
SFAS
|
Statement
of Financial Accounting Standards No.
|
|
SO
2
|
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
Third Quarter 2008 Form 10-Q
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, which are
beyond our control and may cause actual results or outcomes to differ materially
from those that may be projected. These statements 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:
|
·
|
our
ability to successfully implement our strategic
objectives;
|
|
·
|
our
ability to manage expansion and integrate acquisitions;
|
|
·
|
prevailing
governmental policies, regulatory actions, and legislation 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, capital investments and other expenses, present or
prospective wholesale and retail competition (including but not limited to
transmission costs), zoning and permitting of land held for resale and
environmental matters;
|
|
·
|
the
potential impacts of climate change and future regulation to restrict the
emissions of GHG on our Regulated Utility operations
;
|
|
·
|
effects
of restructuring initiatives in the electric industry;
|
|
·
|
economic
and geographic factors, including political and economic
risks;
|
|
·
|
changes
in and compliance with laws and policies;
|
|
·
|
weather
conditions;
|
|
·
|
natural
disasters and pandemic diseases;
|
|
·
|
war
and acts of terrorism;
|
|
·
|
wholesale
power market conditions;
|
|
·
|
population
growth rates and demographic patterns;
|
|
·
|
effects
of competition, including competition for retail and wholesale
customers;
|
|
·
|
changes
in the real estate market;
|
|
·
|
pricing
and transportation of commodities;
|
|
·
|
changes
in tax rates or policies or in rates of inflation;
|
|
·
|
unanticipated
project delays or changes in project costs;
|
|
·
|
availability
and management
of construction
materials and skilled construction labor for capital
projects;
|
|
·
|
unanticipated
changes in operating expenses
,
capital and land
development expenditures;
|
|
·
|
global
and domestic economic conditions to us or our
customers;
|
|
·
|
our
ability to access capital markets and bank financing;
|
|
·
|
changes
in interest rates and the performance of the financial
markets;
|
|
·
|
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 in
Item 1A under the heading “Risk Factors” in Part I of our 2007 Form 10-K. Any
forward-looking statement speaks only as of the date on which such statement is
made, and we undertake no obligation to update any forward-looking statement to
reflect events or circumstances after the date on which that statement is made
or to reflect the occurrence of unanticipated events. New factors emerge from
time to time, and it is not possible for management to predict all of these
factors, nor can it assess the impact of each of these factors on the businesses
of ALLETE or the extent to which any factor, or combination of factors, may
cause actual results to differ materially from those contained in any
forward-looking statement. Readers are urged to carefully review and consider
the various disclosures made by us in 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.
ALLETE
Third Quarter 2008 Form 10-Q
PART
I. FINANCIAL INFORMATION
|
|
|
ITEM
1. FINANCIAL STATEMENTS
|
|
ALLETE
CONSOLIDATED
BALANCE SHEET
Millions
– Unaudited
|
|
|
|
September
30,
|
December
31,
|
|
|
|
|
2008
|
2007
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
Current
Assets
|
|
|
|
|
|
|
Cash
and Cash Equivalents
|
$
|
78.1
|
$
|
23.3
|
|
|
Short-Term
Investments
|
|
–
|
|
23.1
|
|
|
Accounts
Receivable (Less Allowance of $1.0 at September 30, 2008
|
|
|
|
|
|
|
|
and
$1.0 at December 31, 2007)
|
|
64.9
|
|
79.5
|
|
|
Inventories
|
|
59.9
|
|
49.5
|
|
|
Prepayments
and Other
|
|
16.9
|
|
39.1
|
|
|
|
Total
Current Assets
|
|
219.8
|
|
214.5
|
|
Property,
Plant and Equipment - Net
|
|
1,292.4
|
|
1,104.5
|
|
Investments
|
|
213.3
|
|
213.8
|
|
Other
Assets
|
|
122.1
|
|
111.4
|
|
Total
Assets
|
$
|
1,847.6
|
$
|
1,644.2
|
|
|
|
|
|
|
|
|
|
Liabilities
and Shareholders' Equity
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
Current
Liabilities
|
|
|
|
|
|
|
Accounts
Payable
|
$
|
58.5
|
$
|
72.7
|
|
|
Accrued
Taxes
|
|
16.4
|
|
14.8
|
|
|
Accrued
Interest
|
|
8.9
|
|
7.8
|
|
|
Notes
Payable
|
|
6.0
|
|
–
|
|
|
Long-Term
Debt Due Within One Year
|
|
17.2
|
|
11.8
|
|
|
Deferred
Profit on Sales of Real Estate
|
|
0.8
|
|
2.7
|
|
|
Other
|
|
28.0
|
|
27.3
|
|
|
|
Total
Current Liabilities
|
|
135.8
|
|
137.1
|
|
Long-Term
Debt
|
|
537.2
|
|
410.9
|
|
Deferred
Income Taxes
|
|
165.8
|
|
144.2
|
|
Other
Liabilities
|
|
199.5
|
|
200.1
|
|
Minority
Interest
|
|
9.6
|
|
9.3
|
|
|
Total
Liabilities
|
|
1,047.9
|
|
901.6
|
|
|
|
|
|
|
|
|
|
Commitments
and Contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders'
Equity
|
|
|
|
|
|
Common
Stock Without Par Value, 43.3 Shares Authorized, 31.6 and
30.8
|
|
|
|
|
|
|
Shares
Outstanding
|
|
497.6
|
|
461.2
|
|
Unearned
ESOP Shares
|
|
(58.5)
|
|
(64.5)
|
|
Accumulated
Other Comprehensive Loss
|
|
(8.8)
|
|
(4.5)
|
|
Retained
Earnings
|
|
369.4
|
|
350.4
|
|
|
Total
Shareholders' Equity
|
|
799.7
|
|
742.6
|
|
Total
Liabilities and Shareholders' Equity
|
$
|
1,847.6
|
$
|
1,644.2
|
ALLETE
Third Quarter 2008 Form 10-Q
ALLETE
CONSOLIDATED
STATEMENT OF INCOME
Millions
Except Per Share Amounts – Unaudited
|
|
|
|
Quarter
Ended
|
Nine
Months Ended
|
|
|
|
|
September
30,
|
September
30,
|
|
|
|
|
2008
|
2007
|
2008
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Revenue
|
$
|
201.7
|
$
|
200.8
|
$
|
604.9
|
$
|
629.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
Fuel
and Purchased Power
|
|
81.0
|
|
91.8
|
|
242.3
|
|
262.4
|
|
|
Operating
and Maintenance
|
|
73.4
|
|
72.1
|
|
239.6
|
|
231.3
|
|
|
Depreciation
|
|
13.5
|
|
12.2
|
|
39.1
|
|
35.8
|
|
|
|
Total
Operating Expenses
|
|
167.9
|
|
176.1
|
|
521.0
|
|
529.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Income
|
|
33.8
|
|
24.7
|
|
83.9
|
|
99.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Income (Expense)
|
|
|
|
|
|
|
|
|
|
|
Interest
Expense
|
|
(7.5)
|
|
(6.3)
|
|
(21.4)
|
|
(18.7)
|
|
|
Equity
Earnings in ATC
|
|
4.2
|
|
3.2
|
|
11.2
|
|
9.3
|
|
|
Other
|
|
2.8
|
|
3.2
|
|
13.9
|
|
11.9
|
|
|
|
Total
Other Income (Expense)
|
|
(0.5)
|
|
0.1
|
|
3.7
|
|
2.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
Before Minority Interest and Income Taxes
|
|
33.3
|
|
24.8
|
|
87.6
|
|
102.4
|
|
Income
Tax Expense
|
|
8.4
|
|
8.1
|
|
28.3
|
|
35.4
|
|
Minority
Interest
|
|
0.2
|
|
0.2
|
|
0.3
|
|
1.6
|
|
Net
Income
|
$
|
24.7
|
$
|
16.5
|
$
|
59.0
|
$
|
65.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
Shares of Common Stock
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
29.1
|
|
28.5
|
|
28.9
|
|
28.2
|
|
|
Diluted
|
|
29.3
|
|
28.5
|
|
29.0
|
|
28.3
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and Diluted Earnings Per Share of Common Stock
|
$
|
0.85
|
$
|
0.58
|
$
|
2.04
|
$
|
2.31
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends
Per Share of Common Stock
|
$
|
0.43
|
$
|
0.41
|
$
|
1.29
|
$
|
1.23
|
The
accompanying notes are an integral part of these statements.
ALLETE
Third Quarter 2008 Form 10-Q
ALLETE
CONSOLIDATED
STATEMENT OF CASH FLOWS
Millions
- Unaudited
|
|
Nine
Months Ended
|
|
|
September
30,
|
|
|
|
|
2008
|
2007
|
|
|
|
|
|
|
|
|
|
Operating
Activities
|
|
|
|
|
|
|
Net
Income
|
$
|
59.0
|
$
|
65.4
|
|
|
Allowance
for Funds Used During Construction
|
|
(2.6)
|
|
(2.2)
|
|
|
Income
from Equity Investments, net of dividends
|
|
(2.4)
|
|
(1.9)
|
|
|
Gain
on Sale of Assets
|
|
(4.7)
|
|
(2.1)
|
|
|
Gain
on Sale of Available for Sale Securities
|
|
(6.5)
|
|
–
|
|
|
Depreciation
Expense
|
|
39.1
|
|
35.8
|
|
|
Deferred
Income Tax Expense
|
|
18.4
|
|
3.8
|
|
|
Minority
Interest
|
|
0.3
|
|
1.6
|
|
|
Stock
Compensation Expense
|
|
1.3
|
|
1.5
|
|
|
Bad
Debt Expense
|
|
0.9
|
|
0.8
|
|
|
Changes
in Operating Assets and Liabilities
|
|
|
|
|
|
|
|
Accounts
Receivable
|
|
13.6
|
|
11.3
|
|
|
|
Inventories
|
|
(10.4)
|
|
(5.2)
|
|
|
|
Prepayments
and Other
|
|
20.2
|
|
(1.6)
|
|
|
|
Accounts
Payable
|
|
(13.0)
|
|
(6.1)
|
|
|
|
Other
Current Liabilities
|
|
1.5
|
|
(14.5)
|
|
|
Other
Assets
|
|
(10.7)
|
|
0.1
|
|
|
Other
Liabilities
|
|
(3.3)
|
|
9.5
|
|
|
|
Cash
from Operating Activities
|
|
100.7
|
|
96.2
|
|
|
|
|
|
|
|
|
|
Investing
Activities
|
|
|
|
|
|
|
Proceeds
from Sale of Available-For-Sale Securities
|
|
58.5
|
|
374.3
|
|
|
Payments
for Purchase of Available-For-Sale Securities
|
|
(45.1)
|
|
(340.2)
|
|
|
Investment
in ATC
|
|
(5.2)
|
|
(8.7)
|
|
|
Changes
to Investments
|
|
5.3
|
|
(9.3)
|
|
|
Additions
to Property, Plant and Equipment
|
|
(210.0)
|
|
(134.5)
|
|
|
Proceeds
from Sale of Assets
|
|
20.3
|
|
1.4
|
|
|
Other
|
|
(4.1)
|
|
3.0
|
|
|
|
Cash
for Investing Activities
|
|
(180.3)
|
|
(114.0)
|
|
|
|
|
|
|
|
|
|
Financing
Activities
|
|
|
|
|
|
|
Issuance
of Common Stock
|
|
35.2
|
|
19.9
|
|
|
Issuance
of Debt
|
|
140.1
|
|
110.3
|
|
|
Payments
of Long-Term Debt
|
|
(8.4)
|
|
(61.4)
|
|
|
Dividends
on Common Stock
|
|
(38.5)
|
|
(34.4)
|
|
|
Changes
in Notes Payable
|
|
6.0
|
|
–
|
|
|
|
Cash
from Financing Activities
|
|
134.4
|
|
34.4
|
|
|
|
|
|
|
|
|
|
Change
in Cash and Cash Equivalents
|
|
54.8
|
|
16.6
|
|
Cash
and Cash Equivalents at Beginning of Period
|
|
23.3
|
|
44.8
|
|
|
|
|
|
|
|
|
|
Cash
and Cash Equivalents at End of Period
|
$
|
78.1
|
$
|
61.4
|
The
accompanying notes are an integral part of these statements.
ALLETE
Third Quarter 2008 Form 10-Q
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
The
accompanying unaudited consolidated financial statements have been prepared in
accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X
and do not include all of the information and notes required by GAAP for
complete financial statements. Similarly, the December 2007 consolidated balance
sheet was derived from audited financial statements but does not include all
disclosures required by GAAP. In the opinion of management, the accompanying
unaudited consolidated financial statements contain all normal and recurring
adjustments necessary to make a fair statement of the consolidated financial
position, results of operations and cash flows of ALLETE for the interim periods
presented. Operating results for the periods ended September 30, 2008, are not
necessarily indicative of results that may be expected for any other interim
period or for the year ending December 31, 2008. For further information, refer
to the consolidated financial statements and notes included in our 2007 Form
10-K.
NOTE
1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Inventories.
Inventories are
stated at the lower of cost or market. Cost is determined by the average cost
method.
|
|
September
30,
|
December
31,
|
|
Inventories
|
2008
|
2007
|
|
Millions
|
|
|
|
|
|
|
|
Fuel
|
$25.5
|
$22.1
|
|
Materials
and Supplies
|
34.4
|
27.4
|
|
|
|
|
|
Total
Inventories
|
$59.9
|
$49.5
|
Supplemental
Statement of Cash Flows Information.
|
Consolidated
Statement of Cash Flows
Supplemental
Disclosure
For
the Nine Months Ended September 30,
|
2008
|
2007
|
|
Millions
|
|
|
|
|
|
|
|
Cash
Paid During the Period for
|
|
|
|
Interest
– Net of Amounts Capitalized
|
$20.1
|
$21.9
|
|
Income
Taxes
|
$4.9
|
$29.3
|
|
Noncash
Investing Activities
|
|
|
|
Change
in Accounts Payable for Capital Additions to Property Plant and
Equipment
|
$(1.1)
|
$4.6
|
New Accounting Standards.
SFAS 157
. In
September 2006, the FASB issued SFAS 157, “Fair Value Measurements,” to increase
consistency and comparability in fair value measurements by defining fair value,
establishing a framework for measuring fair value in GAAP, and expanding
disclosures about fair value measurements. SFAS 157 emphasizes that fair value
is a market-based measurement, not an entity-specific measurement. It clarifies
the extent to which fair value is used to measure recognized assets and
liabilities, the inputs used to develop the measurements, and the effect of
certain measurements on earnings for the period. SFAS 157 is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and is applied on a prospective basis. In February 2008, the FASB issued FSP FAS
157-1, "Application of FAS 157 to FAS 13 and Other Accounting Pronouncements
That Address Fair Value Measurements for Purposes of Lease Classification or
Measurement under FAS 13", which excludes FAS 13, "Accounting for Leases," and
its related interpretive accounting pronouncements that address leasing
transactions, from the scope of FAS 157.
Also in
February 2008, the FASB issued FSP FAS 157-2, "Effective Date of FASB Statement
157," which delayed the effective date of SFAS 157 for all nonrecurring fair
value measurements of nonfinancial assets and liabilities until fiscal years
beginning after November 15, 2008. The Company elected to defer the adoption of
the nonrecurring fair value measurement disclosures of nonfinancial assets and
liabilities. The adoption of FSP FAS 157-2 is not expected to have a material
impact on the Company's results of operations, cash flows or financial
position.
ALLETE
Third Quarter 2008 Form 10-Q
NOTE
1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES – New Accounting
Standards (Continued)
The
implementation of SFAS 157 for financial assets and financial liabilities and
FSP FAS 157-1, effective January 1, 2008, did not have a material impact on our
consolidated financial position and results of operations. See Note 12
–
Recurring Fair Value Measures for additional information. We are currently
assessing the impact of SFAS 157 for nonfinancial assets and nonfinancial
liabilities on our consolidated financial position, results of operations and
cash flows, but we do not believe it will have a material impact on the
Company.
In
October 2008, the FASB issued FSP FAS 157-3. This FSP amends SFAS 157, “Fair
Value Measurements,” to clarify various application issues with regard to the
measurement principles of SFAS 157 when the market for financial assets is not
active. This FSP became effective on October 10, 2008, and is applicable to
prior periods for which financial statements have not yet been issued. The
adoption of FSP FAS 157-3 is not expected to have a material impact on the
Company's results of operations, cash flows or financial position.
SFAS 141R.
In December 2007,
the FASB issued SFAS 141 (revised 2007), “Business Combinations,” to increase
the relevance, representational faithfulness, and comparability of the
information a reporting entity provides in its financial reports about a
business combination and its effects. SFAS 141R replaces SFAS 141, “Business
Combinations”, but retains the fundamental requirements of SFAS 141 that the
acquisition method of accounting be used and an acquirer be identified for all
business combinations. SFAS 141R expands the definition of a business and of a
business combination and establishes how the acquirer is to: (1) recognize and
measure in its financial statements the identifiable assets acquired, the
liabilities assumed, and any noncontrolling interest in the acquiree; (2)
recognize and measure the goodwill acquired in the business combination or a
gain from a bargain purchase; and (3) determine what information to disclose to
enable users of the financial statements to evaluate the nature and financial
effects of the business combination. SFAS 141R is applicable to business
combinations for which the acquisition date is on or after the beginning of the
first annual reporting period beginning on or after December 15, 2008, and is to
be applied prospectively. Early adoption is prohibited. SFAS 141R will impact
ALLETE if we elect to enter into a business combination subsequent to December
31, 2008.
SFAS 160.
In December 2007,
the FASB issued SFAS 160, “Noncontrolling Interests in Consolidated Financial
Statements – an amendment of Accounting Research Bulletin (ARB) 51,” to improve
the relevance, comparability, and transparency of the financial information a
reporting entity provides in its consolidated financial statements. SFAS 160
amends ARB 51 to establish accounting and reporting standards for noncontrolling
interests in subsidiaries and to make certain consolidation procedures
consistent with the requirements of SFAS 141R. It defines a noncontrolling
interest in a subsidiary as an ownership interest in the consolidated entity
that should be reported as equity in the consolidated financial statements. SFAS
160 changes the way the consolidated income statement is presented by requiring
consolidated net income to include amounts attributable to the parent and the
noncontrolling interest. SFAS 160 establishes a single method of accounting for
changes in a parent’s ownership interest in a subsidiary which do not result in
deconsolidation. SFAS 160 also requires expanded disclosures that clearly
identify and distinguish between the interests of the parent and the interests
of the noncontrolling owners of a subsidiary. SFAS 160 is effective for
financial statements issued for fiscal years beginning on or after December 15,
2008, and interim periods within those fiscal years. Early adoption is
prohibited. SFAS 160 shall be applied prospectively, with the exception of the
presentation and disclosure requirements which shall be applied retrospectively
for all periods presented. ALLETE Properties does have certain noncontrolling
interests in consolidated subsidiaries. If SFAS 160 had been applied as of
September 30, 2008, the $9.6 million reported as Minority Interest in the
Liabilities section on our consolidated balance sheet would have been reported
as $9.6 million of Noncontrolling Interest in Subsidiaries in the Equity section
of our consolidated balance sheet. Effective January 1, 2009, SFAS 160 will
impact the presentation of our consolidated balance sheet; however, we do not
believe it will have a material impact on the consolidated financial position,
results of operations, and cash flows of the Company.
ALLETE
Third Quarter 2008 Form 10-Q
NOTE
1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES – New Accounting
Standards (Continued)
SFAS 161.
In March 2008, the
FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging
Activities – an amendment of SFAS 133,” to enhance disclosures about an entity’s
derivative and hedging activities and improve the transparency of financial
reporting. Entities will be required to provide enhanced disclosures about (1)
how and why derivatives instruments are used, (2) how derivative instruments are
accounted for, and (3) how derivative instruments affect the entities financial
position, financial performance and cash flows. These disclosures better convey
the purpose of derivative use in terms of the risks that the entity is intending
to manage by requiring fair value disclosures in a tabular format, providing
more information about an entity’s liquidity and requiring cross-referencing
within the footnotes. SFAS 161 is effective for financial statements issued for
fiscal years and interim periods beginning after November 15, 2008, with early
adoption encouraged. We did not have any material derivative instruments at
September 30, 2008. In the event we elect to enter into a material derivative
instrument or hedging activity in the future, SFAS 161 will have an impact on
our disclosure requirements.
NOTE
2. BUSINESS SEGMENTS
|
|
|
Energy
|
|
|
|
|
|
|
Nonregulated
|
|
|
|
|
|
|
Regulated
|
Energy
|
Investment
|
Real
|
|
|
|
Consolidated
|
Utility
|
Operations
|
in
ATC
|
Estate
|
Other
|
|
Millions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For
the Quarter Ended September 30, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Revenue
|
$201.7
|
$179.1
|
$18.2
|
–
|
$4.3
|
$0.1
|
|
Fuel
and Purchased Power
|
81.0
|
81.0
|
–
|
–
|
–
|
–
|
|
Operating
and Maintenance
|
73.4
|
53.6
|
15.8
|
$
0.1
|
3.8
|
0.1
|
|
Depreciation
|
13.5
|
12.4
|
1.1
|
–
|
–
|
–
|
|
|
|
|
|
|
|
|
|
Operating
Income (Loss)
|
33.8
|
32.1
|
1.3
|
(0.1)
|
0.5
|
–
|
|
Interest
Expense
|
(7.5)
|
(6.1)
|
(0.2)
|
–
|
(0.1)
|
(1.1)
|
|
Equity
Earnings in ATC
|
4.2
|
–
|
–
|
4.2
|
–
|
–
|
|
Other
Income
|
2.8
|
0.6
|
–
|
–
|
0.2
|
2.0
|
|
|
|
|
|
|
|
|
|
Income
Before Minority Interest and Income Taxes
|
33.3
|
26.6
|
1.1
|
4.1
|
0.6
|
0.9
|
|
Income
Tax Expense (Benefit)
|
8.4
|
9.9
|
0.2
|
1.6
|
0.2
|
(3.5)
|
|
Minority
Interest
|
0.2
|
–
|
–
|
–
|
0.2
|
–
|
|
Net
Income
|
$24.7
|
$16.7
|
$0.9
|
$2.5
|
$0.2
|
$4.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For
the Quarter Ended September 30, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Revenue
|
$200.8
|
$179.0
|
$16.9
|
–
|
$4.8
|
$0.1
|
|
Fuel
and Purchased Power
|
91.8
|
91.8
|
–
|
–
|
–
|
–
|
|
Operating
and Maintenance
|
72.1
|
52.6
|
15.4
|
–
|
3.9
|
0.2
|
|
Depreciation
|
12.2
|
11.0
|
1.1
|
–
|
0.1
|
–
|
|
|
|
|
|
|
|
|
|
Operating
Income (Loss)
|
24.7
|
23.6
|
0.4
|
–
|
0.8
|
(0.1)
|
|
Interest
Expense
|
(6.3)
|
(5.3)
|
(0.6)
|
–
|
(0.1)
|
(0.3)
|
|
Equity
Earnings in ATC
|
3.2
|
–
|
–
|
$3.2
|
–
|
–
|
|
Other
Income
|
3.2
|
1.0
|
0.5
|
–
|
0.5
|
1.2
|
|
|
|
|
|
|
|
|
|
Income
Before Minority Interest and Income Taxes
|
24.8
|
19.3
|
0.3
|
3.2
|
1.2
|
0.8
|
|
Income
Tax Expense (Benefit)
|
8.1
|
6.3
|
(0.3)
|
1.3
|
0.4
|
0.4
|
|
Minority
Interest
|
0.2
|
–
|
–
|
–
|
0.2
|
–
|
|
Net
Income
|
$16.5
|
$13.0
|
$0.6
|
$1.9
|
$0.6
|
$0.4
|
ALLETE
Third Quarter 2008 Form 10-Q
NOTE
2. BUSINESS SEGMENTS (Continued)
|
|
|
Energy
|
|
|
|
|
|
|
Nonregulated
|
|
|
|
|
|
|
Regulated
|
Energy
|
Investment
|
Real
|
|
|
|
Consolidated
|
Utility
|
Operations
|
in
ATC
|
Estate
|
Other
|
|
Millions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For
the Nine Months Ended September 30, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Revenue
|
$604.9
|
$535.9
|
$53.8
|
–
|
$14.9
|
$0.3
|
|
Fuel
and Purchased Power
|
242.3
|
242.3
|
–
|
–
|
–
|
–
|
|
Operating
and Maintenance
|
239.6
|
179.4
|
47.6
|
$0.3
|
11.2
|
1.1
|
|
Depreciation
|
39.1
|
35.6
|
3.4
|
–
|
–
|
0.1
|
|
|
|
|
|
|
|
|
|
Operating
Income (Loss)
|
83.9
|
78.6
|
2.8
|
(0.3)
|
3.7
|
(0.9)
|
|
Interest
Expense
|
(21.4)
|
(17.5)
|
(0.9)
|
–
|
(0.4)
|
(2.6)
|
|
Equity
Earnings in ATC
|
11.2
|
–
|
–
|
11.2
|
–
|
–
|
|
Other
Income
|
13.9
|
2.8
|
0.7
|
–
|
0.7
|
9.7
|
|
|
|
|
|
|
|
|
|
Income
Before Minority Interest and Income Taxes
|
87.6
|
63.9
|
2.6
|
10.9
|
4.0
|
6.2
|
|
Income
Tax Expense (Benefit)
|
28.3
|
23.9
|
0.3
|
4.4
|
1.5
|
(1.8)
|
|
Minority
Interest
|
0.3
|
–
|
–
|
–
|
0.3
|
–
|
|
Net
Income
|
$59.0
|
$40.0
|
$2.3
|
$6.5
|
$2.2
|
$8.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At
September 30, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Assets
|
$1,847.6
|
$1,492.0
|
$87.1
|
$73.9
|
$81.8
|
$112.8
|
|
Property,
Plant and Equipment – Net
|
$1,292.4
|
$1,239.3
|
$49.8
|
–
|
–
|
$3.3
|
|
Accumulated
Depreciation
|
$854.2
|
$806.2
|
$46.2
|
–
|
–
|
$1.8
|
|
Capital
Expenditures
|
$211.1
|
$207.3
|
$3.8
|
–
|
–
|
–
|
|
|
|
|
|
|
|
|
|
For
the Nine Months Ended September 30, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Revenue
|
$629.4
|
$538.2
|
$49.9
|
–
|
$41.0
|
$0.3
|
|
Fuel
and Purchased Power
|
262.4
|
262.4
|
–
|
–
|
–
|
–
|
|
Operating
and Maintenance
|
231.3
|
170.7
|
44.7
|
–
|
15.1
|
0.8
|
|
Depreciation
|
35.8
|
32.3
|
3.3
|
–
|
0.1
|
0.1
|
|
|
|
|
|
|
|
|
|
Operating
Income (Loss)
|
99.9
|
72.8
|
1.9
|
–
|
25.8
|
(0.6)
|
|
Interest
Expense
|
(18.7)
|
(15.7)
|
(1.4)
|
–
|
(0.3)
|
(1.3)
|
|
Equity
Earnings in ATC
|
9.3
|
–
|
–
|
$9.3
|
–
|
–
|
|
Other
Income
|
11.9
|
2.4
|
3.2
|
–
|
1.0
|
5.3
|
|
|
|
|
|
|
|
|
|
Income
Before Minority Interest and Income Taxes
|
102.4
|
59.5
|
3.7
|
9.3
|
26.5
|
3.4
|
|
Income
Tax Expense
|
35.4
|
21.6
|
0.3
|
3.7
|
9.7
|
0.1
|
|
Minority
Interest
|
1.6
|
–
|
–
|
–
|
1.6
|
–
|
|
Net
Income
|
$65.4
|
$37.9
|
$3.4
|
$5.6
|
$15.2
|
$3.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At
September 30, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Assets
|
$1,646.5
|
$1,264.5
|
$78.9
|
$65.0
|
$86.7
|
$151.4
|
|
Property,
Plant and Equipment – Net
|
$1,033.8
|
$983.1
|
$47.3
|
–
|
–
|
$3.4
|
|
Accumulated
Depreciation
|
$843.2
|
$799.3
|
$42.1
|
–
|
–
|
$1.8
|
|
Capital
Expenditures
|
$141.3
|
$140.2
|
$1.1
|
–
|
–
|
–
|
ALLETE
Third Quarter 2008 Form 10-Q
NOTE
3. INVESTMENTS
Investments.
At September 30,
2008, our long-term investment portfolio included the real estate assets of
ALLETE Properties, debt and equity securities consisting primarily of securities
held to fund employee benefits, our investment in ATC, our emerging technology
portfolio and auction rate securities.
|
|
September
30,
|
December
31,
|
|
Investments
|
2008
|
2007
|
|
Millions
|
|
|
|
Real
Estate Assets
|
$81.8
|
$91.3
|
|
Debt
and Equity Securities
(a)
|
42.9
|
39.7
|
|
Investment
in ATC
|
73.9
|
65.7
|
|
Emerging
Technology Portfolio
|
7.5
|
7.9
|
|
Other
|
7.2
|
9.2
|
|
Total
Investments
|
$213.3
|
$213.8
|
(a)
See Note 12 – Recurring Fair Value Measures
for information on fair
values relating to investments in debt and equity securities.
|
|
September
30,
|
December
31,
|
|
Real
Estate Assets
|
2008
|
2007
|
|
Millions
|
|
|
|
|
|
|
|
Land
Held for Sale Beginning Balance
|
$62.6
|
$58.0
|
|
Additions
during period: Capitalized Improvements
|
6.8
|
12.8
|
|
Purchases
|
–
|
–
|
|
Deductions
during period: Cost of Real Estate Sold
|
(1.6)
|
(8.2)
|
|
|
|
|
|
Land
Held for Sale Ending Balance
|
67.8
|
62.6
|
|
Long-Term
Finance Receivables
|
13.9
|
15.3
|
|
Other
(a)
|
0.1
|
13.4
|
|
|
|
|
|
Total
Real Estate Assets
|
$81.8
|
$91.3
|
(a)
Consisted primarily of a shopping center that was sold on May 1, 2008. The
pre-tax gain of $4.5 million resulting from this sale is included in operating
revenue on the Consolidated Statement of Income.
Finance Receivables.
Finance
receivables, which are fully collateralized by property sold, accrue interest at
market-based rates and are net of an allowance for doubtful accounts of $0.1
million at September 30, 2008 ($0.2 million at December 31, 2007). The majority
are receivables having maturities up to five years.
Investment in ATC.
Our
Wisconsin subsidiary, Rainy River Energy Corporation - Wisconsin, has a 7.8
percent ownership interest in ATC, a Wisconsin-based public utility that owns
and maintains electric transmission assets in parts of Wisconsin, Michigan,
Minnesota and Illinois. ATC provides transmission service under rates regulated
by the FERC that are set in accordance with the FERC’s policy of encouraging the
independent operation and ownership of, and investment in, transmission
facilities. We account for our investment in ATC under the equity method of
accounting, pursuant to EITF 03-16, “Accounting for Investments in Limited
Liability Companies.” On October 31, 2008, we invested an additional $2.3
million in ATC.
|
ALLETE's
Interest in ATC
|
|
|
|
|
|
|
As
of September 30, 2008
|
|
|
|
|
|
|
Millions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity
Investment Balance at December 31, 2007
|
|
|
$65.7
|
|
2008
Cash Investments
|
|
|
|
|
|
5.2
|
|
Equity
in ATC Earnings
|
|
|
|
|
|
11.2
|
|
Distributed
ATC Earnings
|
|
|
|
|
|
(8.2)
|
|
Equity
Investment Balance at September 30, 2008
|
|
|
$73.9
|
ALLETE
Third Quarter 2008 Form 10-Q
NOTE
3. INVESTMENTS (Continued)
Auction Rate Securities.
As of
September 30, 2008, we held $19.4 million of investments ($23.1 million at
December 31, 2007) consisting of three auction rate municipal bonds (auction
rate securities) with stated maturity dates ranging between 16 and 28 years.
These auction rate securities (ARS) consist of guaranteed student loans insured
or reinsured by the federal government. These ARS were historically auctioned
every 35 days to set new rates and provide a liquidating event in which
investors could either buy or sell securities. The auctions have been unable to
sustain themselves during 2008 due to the overall lack of credit market
liquidity and we have been unable to liquidate our ARS. We have classified the
ARS as long-term and have the ability to hold these securities to maturity,
until called by the issuer, or until liquidity returns to this market. In the
meantime, these securities will pay a default rate which is typically above
market interest rates.
The
Company has used a discounted cash flow model to determine the estimated fair
value of its investment in ARS as of September 30, 2008. The assumptions used in
preparing the discounted cash flow model include the following: estimated
interest rates, estimated discount rates (using yields of comparable traded
instruments adjusted for illiquidity and other risk factors), amount of cash
flows, and expected holding periods of the ARS. These inputs reflect the
Company’s judgments about assumptions that market participants would use in
pricing ARS including assumptions about risk. As of September 30, 2008, the
Company determined there was no decline in the fair value of its ARS
investments.
Based
upon the results of the discounted cash flow model and the fact that these ARS
consist of guaranteed student loans insured or reinsured by the federal
government no other than temporary impairment loss has been
reported.
NOTE
4. SHORT-TERM AND LONG-TERM DEBT
Short-Term Debt.
On May 16,
2008, Florida Landmark Communities, Inc., a wholly owned subsidiary of Lehigh
Acquisition Corporation, renewed and extended a revolving development loan with
RBC Bank (successor by merger to CypressCoquina Bank) for $8.5 million. As of
September 30, 2008, $7.9 million was drawn on the line of credit leaving $0.6
million available for use. In October 2008, the revolving development loan was
amended and restated as a $10.0 million term loan and ALLETE Properties through
its subsidiaries entered into an additional $3.0 million revolving development
loan with Intracoastal Bank.
On May
21, 2008, BNI Coal, a wholly owned subsidiary of ALLETE, entered into a $6.0
million Promissory Note and Supplement (Line of Credit) with CoBANK, ACB. The
Line of Credit has a variable interest rate with the option to fix the rate
based on LIBOR plus a certain spread. The term of the Line of Credit is 12
months, with the option to renew annually. The Line of Credit is being used for
general corporate purposes. As of September 30, 2008, the full amount of $6.0
million was drawn on the Line of Credit.
Long-Term Debt.
On February 1,
2008, we issued $60 million in principal amount of First Mortgage Bonds, 4.86%
Series due April 1, 2013, in the private placement market. We have the option to
prepay all or a portion of the bonds at our discretion, subject to a make-whole
provision. The bonds are subject to additional terms and conditions which are
customary for this type of transaction. We intend to use the proceeds from the
sale of the bonds to fund utility capital expenditures and for general corporate
purposes.
On May
14, 2008, we issued $75 million in principal amount of First Mortgage Bonds,
6.02% Series due May 1, 2023, in the private placement market. We have
the option to prepay all or a portion of the bonds at our discretion, subject to
a make-whole provision. The bonds are subject to additional terms and conditions
which are customary for this type of transaction. We intend to use the proceeds
from the sale of the bonds to fund utility capital expenditures and for general
corporate purposes.
ALLETE
Third Quarter 2008 Form 10-Q
NOTE
5. REGULATORY MATTERS
Electric Rates.
Entities
within our Regulated Utility segment file for periodic rate revisions with the
MPUC, the FERC or the PSCW.
On
February 8, 2008, the FERC approved Minnesota Power’s wholesale rate increase
effective March 1, 2008. Our wholesale customers consist of 16 municipalities in
Minnesota and two private utilities in Wisconsin, including SWL&P. The FERC
authorized an average 10 percent increase for wholesale municipal customers, a
12.5 percent increase for SWL&P, and an overall return on equity of 11.25
percent. On an annualized basis, the rate increase is expected to result in
approximately $8 million in additional revenue. Incremental revenue in 2008 from
the FERC authorized wholesale rate increase is expected to be approximately $7
million.
On May 2,
2008, Minnesota Power filed a rate increase request with the MPUC seeking an
average increase of approximately 10 percent for retail customers. The rate
filing seeks an overall return on equity of 11.15 percent, and a capital
structure consisting of 54.8 percent equity and 45.2 percent debt. On an
annualized basis, the requested rate increase would generate approximately $45
million in additional revenue. Subsequent to the May filing, adjustments have
been made and Minnesota Power is now seeking an average rate increase of 8.75
percent, which would generate approximately $41 million in additional revenue on
an annualized basis. Interim rates were effective on August 1, 2008, and will
result in an average increase of approximately 7.5 percent or approximately $36
million for retail customers subject to refund pending the final rate order.
Incremental revenue in 2008 from the interim Minnesota retail rate increase is
expected to be approximately $13 million. The rate case schedule was approved at
an August 2008 prehearing conference, and all scheduled public hearings were
held in September and October 2008. Evidentiary hearings are scheduled for
November 2008. The final rate order is expected in the second quarter of 2009.
We cannot predict the amount of any rate increase the MPUC may
approve.
SWL&P’s
current retail rates are based on a 2006 PSCW retail rate order, effective
January 1, 2007. On May 14, 2008, SWL&P filed a rate increase request with
the PSCW seeking an average increase of approximately 5 percent for retail
customers. The rate filing seeks an overall return on equity of 11.5 percent,
and a capital structure consisting of 57.1 percent equity and 42.9 percent debt.
On an annualized basis, the requested rate increase would generate approximately
$4 million in additional revenue. Evidentiary and public hearings were held
October 7, 2008. The Company anticipates new rates will take effect in January
2009. We cannot predict the amount of any rate increase the PSCW may
approve.
NOTE
6. OTHER INCOME (EXPENSE) – OTHER
|
|
Quarter
Ended
|
Nine
Months Ended
|
|
|
September
30,
|
September
30,
|
|
|
2008
|
2007
|
2008
|
2007
|
|
Millions
|
|
|
|
|
|
|
|
|
|
|
|
Loss
on Emerging Technology Investments
|
$(0.1)
|
$(0.2)
|
$(0.6)
|
$(1.0)
|
|
AFUDC
–
Equity
|
0.5
|
1.0
|
2.6
|
2.2
|
|
Investment
and Other Income
|
2.4
|
2.4
|
11.9
|
10.7
|
|
|
|
|
|
|
|
Total
Other Income
|
$2.8
|
$3.2
|
$13.9
|
$11.9
|
ALLETE
Third Quarter 2008 Form 10-Q
NOTE
7. INCOME TAX EXPENSE
|
|
|
Quarter
Ended
|
Nine
Months Ended
|
|
|
|
September
30,
|
September
30,
|
|
|
|
2008
|
2007
|
2008
|
2007
|
|
Millions
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
Tax Expense
|
|
|
|
|
|
|
Federal
(a)
|
$2.2
|
$2.5
|
$10.2
|
$24.5
|
|
|
State
(b)
|
(3.1)
|
0.7
|
(0.3)
|
7.1
|
|
|
|
(0.9)
|
3.2
|
9.9
|
31.6
|
|
|
|
|
|
|
|
|
Deferred
Tax Expense (Benefit)
|
|
|
|
|
|
|
Federal
(a)
|
6.9
|
3.5
|
15.0
|
2.2
|
|
|
State
|
2.6
|
1.7
|
4.1
|
2.4
|
|
|
|
9.5
|
5.2
|
19.1
|
4.6
|
|
|
|
|
|
|
|
|
Deferred
Tax Credits
|
(0.2)
|
(0.3)
|
(0.7)
|
(0.8)
|
|
Total
Income Tax Expense
|
$8.4
|
$8.1
|
$28.3
|
$35.4
|
|
(a)
|
Federal
current tax expense is lower and federal deferred tax expense is higher
than previous year due to lower pre-tax income and bonus depreciation
provisions in the Economic Stimulus Act of
2008.
|
|
(b)
|
State
current tax expense includes a benefit for the recognition of the Kendall
County loss for state purposes. The Federal tax benefit had been
recognized previously.
|
For the
nine months ended September 30, 2008, the effective tax rate on income before
minority interest and income taxes was 32.3 percent (34.6 percent for the nine
months ended September 30, 2007). The 2008 effective rate was impacted by two
non-recurring items; the recognition of a benefit on a previously uncertain tax
position for $1.7 million due to the closing of a tax year, and the reversal of
a state valuation allowance for $2.4 million due to the completion of an
Internal Revenue Service (IRS) review. The effective tax rate of 32.3 percent
deviated from the statutory rate of approximately 40 percent due to the previous
two items stated and deductions for Medicare health subsidies, AFUDC-Equity,
investment tax credits and wind production tax credits.
Uncertain Tax Positions.
Effective January 1, 2007, we adopted the provisions of FIN 48,
“Accounting for Uncertainty in Income Taxes - an Interpretation of FASB
Statement 109.” Due to the closing of a tax year in the period ended September
30, 2008, $1.7 million of previously unrecognized tax benefits were recognized.
As of September 30, 2008 we had gross unrecognized tax benefits of $6.2 million
($5.3 million as of December 31, 2007). Of that total, $1.5 million (net of
federal benefit on state issues) represents the amount of unrecognized tax
benefits that, if recognized, would favorably affect the effective income tax
rate.
We do not
anticipate that the total unrecognized tax benefits will change significantly
within the next 12 months.
NOTE
8. COMPREHENSIVE INCOME (LOSS)
The
components of total comprehensive income were as follows:
|
Other
Comprehensive Income (Loss)
|
Quarter
Ended
|
Nine
Months Ended
|
|
Net
of Tax
|
September
30,
|
September
30,
|
|
|
2008
|
2007
|
2008
|
2007
|
|
Millions
|
|
|
|
|
|
Net
Income
|
$24.7
|
$16.5
|
$59.0
|
$65.4
|
|
Other
Comprehensive Income
|
|
|
|
|
|
|
Unrealized
Gain (Loss) on Securities
|
(1.3)
|
(0.6)
|
(2.0)
|
0.4
|
|
|
Reclassification
Adjustment for Gains Included in Income
|
–
|
–
|
(3.8)
|
–
|
|
|
Defined
Benefit Pension and Other Postretirement Plans
|
0.2
|
0.4
|
1.5
|
0.9
|
|
Total
Other Comprehensive Income (Loss)
|
(1.1)
|
(0.2)
|
(4.3)
|
1.3
|
|
Total
Comprehensive Income
|
$23.7
|
$16.3
|
$54.7
|
$66.7
|
ALLETE
Third Quarter 2008 Form 10-Q
NOTE
9. EARNINGS PER SHARE
The
difference between basic and diluted earnings per share arises from outstanding
stock options and performance share awards granted under our Executive and
Director Long-Term Incentive Compensation Plans. In accordance with SFAS 128,
“Earnings Per Share,” for the quarter and nine months ended September 30, 2008,
0.2 million options to purchase shares of common stock were excluded from the
computation of diluted earnings per share because the option exercise prices
were greater than the average market prices, and therefore, their effect would
have been anti-dilutive. For the quarter and nine months ended September 30,
2007, 0.1 million options to purchase shares of common stock were excluded from
the computation of diluted earnings per share.
|
|
|
2008
|
|
|
|
2007
|
|
|
Reconciliation
of Basic and Diluted
|
|
Dilutive
|
|
|
|
Dilutive
|
|
|
Earnings
Per Share
|
Basic
|
Securities
|
Diluted
|
|
Basic
|
Securities
|
Diluted
|
|
Millions
Except Per Share Amounts
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For
the Quarter Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Income
|
$24.7
|
–
|
$24.7
|
|
$16.5
|
–
|
$16.5
|
|
Common
Shares
|
29.1
|
0.2
|
29.3
|
|
28.5
|
–
|
28.5
|
|
Earnings
Per Share
|
$0.85
|
–
|
$0.85
|
|
$0.58
|
–
|
$0.58
|
|
|
|
|
|
|
|
|
|
|
For
the Nine Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Income
|
$59.0
|
–
|
$59.0
|
|
$65.4
|
–
|
$65.4
|
|
Common
Shares
|
28.9
|
0.1
|
29.0
|
|
28.2
|
0.1
|
28.3
|
|
Earnings
Per Share
|
$2.04
|
–
|
$2.04
|
|
$2.31
|
–
|
$2.31
|
NOTE
10. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
|
|
|
|
Postretirement
|
|
|
Pension
|
Health
and Life
|
|
Components
of Net Periodic Benefit Expense
|
2008
|
2007
|
2008
|
2007
|
|
Millions
|
|
|
|
|
|
|
|
|
|
|
|
For
the Quarter Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
|
Service
Cost
|
$1.5
|
$1.3
|
$1.0
|
$1.2
|
|
Interest
Cost
|
6.3
|
5.7
|
2.4
|
2.1
|
|
Expected
Return on Plan Assets
|
(8.1)
|
(7.7)
|
(1.8)
|
(1.6)
|
|
Amortization
of Prior Service Costs
|
0.2
|
0.2
|
–
|
–
|
|
Amortization
of Net Loss
|
0.4
|
0.8
|
0.4
|
0.4
|
|
Amortization
of Transition Obligation
|
–
|
–
|
0.6
|
0.6
|
|
|
|
|
|
|
|
Net
Periodic Benefit Expense
|
$0.3
|
$0.3
|
$2.6
|
$2.7
|
|
|
|
|
|
|
|
For
the Nine Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
|
Service
Cost
|
$4.4
|
$3.9
|
$3.0
|
$3.1
|
|
Interest
Cost
|
18.9
|
17.1
|
7.2
|
5.8
|
|
Expected
Return on Plan Assets
|
(24.3)
|
(23.0)
|
(5.4)
|
(4.8)
|
|
Amortization
of Prior Service Costs
|
0.5
|
0.5
|
–
|
–
|
|
Amortization
of Net Loss
|
1.2
|
2.4
|
1.2
|
0.7
|
|
Amortization
of Transition Obligation
|
–
|
–
|
1.8
|
1.8
|
|
|
|
|
|
|
|
Net
Periodic Benefit Expense
|
$0.7
|
$0.9
|
$7.8
|
$6.6
|
ALLETE
Third Quarter 2008 Form 10-Q
NOTE
10. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
(Continued)
Employer Contributions.
As of
September 30, 2008, we have contributed $10.9 million to our pension plan and
$13.4 million to our postretirement health and life plan. We do not anticipate
making additional contributions to either plan in 2008.
We have
historically used a September 30 measurement date for the pension and
postretirement health and life plans. Pursuant to SFAS 158, we are required
to change our measurement date to December 31 during the year ending December
31, 2008. On January 1, 2008, we recorded three months of pension expense as a
reduction to retained earnings in the amount of $1.6 million, net of tax, to
reflect the impact of this measurement date change. Also on January 1, 2008, we
recorded $0.8 million relating to three months of amortization for transition
obligations, prior service costs, and prior gains and losses within accumulated
other comprehensive income.
NOTE
11. COMMITMENTS, GUARANTEES AND CONTINGENCIES
Off-Balance Sheet Arrangements.
Square Butte Power
Purchase Agreement (Agreement).
Minnesota Power has a power purchase
agreement with Square Butte that extends through 2026. The Agreement provides a
long-term supply of low-cost energy to customers in our electric service
territory and helps Minnesota Power to meet power pool reserve requirements.
Square Butte, a North Dakota cooperative corporation, owns a 455-MW coal-fired
generating unit (Unit) near Center, North Dakota. The Unit is adjacent to a
generating unit owned by Minnkota Power, a North Dakota cooperative corporation
whose Class A members are also members of Square Butte. Minnkota Power serves as
the operator of the Unit and also purchases power from Square
Butte.
Minnesota
Power is entitled to 55 percent of the Unit’s output beginning January 1, 2008,
and 50 percent on January 1, 2009 and thereafter. Minnkota Power has no option
to reduce Minnesota Power’s entitlement below 50 percent.
Minnesota
Power is obligated to pay its pro rata share of Square Butte’s costs based on
Minnesota Power’s entitlement to the Unit’s output. Minnesota Power’s payment
obligation will be suspended if Square Butte fails to deliver any power, whether
produced or purchased, for a period of one year. Square Butte’s fixed costs
consist primarily of debt service. At September 30, 2008, Square Butte had total
debt outstanding of $315.6 million. Total annual debt service for Square Butte
is expected to be approximately $29 million in each of the years 2008 through
2012. Variable operating costs include the price of coal purchased from BNI
Coal, our subsidiary, under a long-term contract.
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 2016. The aggregate
amount of minimum lease payments for all operating leases is $8.1 million in
2008, $8.1 million in 2009, $7.7 million in 2010, $7.2 million in 2011, $6.6
million in 2012 and $48.7 million thereafter.
Wind Power Purchase Agreements.
We have two wind power purchase agreements with an affiliate of FPL
Energy to purchase the output from two wind facilities, Oliver Wind I and Oliver
Wind II located near Center, North Dakota. We began purchasing the output from
Oliver Wind I, a 50-MW facility, in December 2006 and the output from Oliver
Wind II, a 48-MW facility in November 2007. Each agreement is for 25 years and
provides for the purchase of all output from the facilities. There are no fixed
capacity charges, and we only pay for energy as it is delivered to
us.
ALLETE
Third Quarter 2008 Form 10-Q
NOTE
11. COMMITMENTS, GUARANTEES AND CONTINGENCIES
(Continued)
Coal, Rail and Shipping
Contracts.
We have three coal supply agreements with various expiration
dates ranging from December 2009 to December 2011. We also have rail and
shipping agreements for the transportation of all of our coal, with various
expiration dates ranging from December 2008 to December 2011. Our minimum annual
payment obligations under these coal, rail and shipping agreements are currently
$45.0 million in 2008, $14.9 million in 2009, $9.5 million in 2010, $5.4 million
in 2011 and no specific commitments beyond 2011. Our minimum annual payment
obligations will increase when annual nominations are made for coal deliveries
in future years.
On
January 24, 2008, we received a letter from BNSF alleging that the Company
defaulted on a material obligation under the Company’s Coal Transportation
Agreement (CTA). In the notice, BNSF claimed the Company underpaid approximately
$1.6 million for coal transportation services in 2006 and that failure to pay
such amount plus interest may result in BNSF’s termination of the CTA. We
believe we do not owe the amount claimed. On April 1, 2008, to ensure that BNSF
does not attempt to terminate the CTA, we paid under protest the full amount
claimed by BNSF and filed a demand for arbitration of the issue. We are
currently in discussions to resolve the dispute, but are unable to predict the
outcome at this time. The delivered costs of fuel for the Company’s generation
are recoverable from Minnesota Power’s utility customers through the fuel
adjustment clause.
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. We have committed to make
additional investments in certain emerging technology venture capital funds. The
total future commitment was $0.7 million at September 30, 2008, ($1.0
million at December 31, 2007). We do not have plans to make any additional
investments beyond this commitment.
Settlement.
Two of our
subsidiaries, which were involved in our discontinued water operations, were
named in a claim brought by Capital Resources and Properties, Inc. (CRP). CRP
sold certain wastewater treatment assets to Georgia Water in 2001. The purchase
agreement called for the payment of $2.0 million upon the satisfaction of
specific contingencies. CRP alleged that Georgia Water and ALLETE Water Services
were obligated to pay the contractual amount plus interest and attorney fees
pursuant to the purchase agreement, and that the contingencies were satisfied in
2005 or were waived, or were otherwise due and owing. In June 2008, we settled
the claim brought by CRP for $1.2 million which approximates our reserve
established in prior periods.
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.
ALLETE
Third Quarter 2008 Form 10-Q
NOTE
11. COMMITMENTS, GUARANTEES AND CONTINGENCIES
(Continued)
Environmental
Matters (Continued)
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. A report submitted in 2003 identified some MGP-like chemicals that were
found in the soil near the former plant site. The final Phase II report was
issued in June 2007 and sent to the WDNR along with the Risk Assessment for
review. A remediation plan was developed during the fourth quarter of 2007 and
sent to the WDNR in March 2008. Cost estimates and bids for the first phase of
the remediation are being prepared. The first phase will include the removal of
approximately 2,000 cubic yards of soil that will be shipped to a certified
landfill. 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 approved the collection through rates of $0.3 million 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.
EPA Clean Air Interstate
Rule.
In March 2005, the EPA announced the Clean Air Interstate Rule
(CAIR) that sought to reduce and permanently cap emissions of SO
2
, NO
X
and
particulates in the eastern United States. The CAIR included Minnesota as one of
the 28 states it considered as “significantly contributing” to air quality
standards non-attainment in other downwind states. On July 11, 2008, the United
States Court of Appeals for the District of Columbia Circuit (Court) vacated the
CAIR and remanded the rulemaking to the EPA for reconsideration while also
granting the Minnesota Power petition that the EPA reconsider including
Minnesota as a CAIR state. The EPA and several other parties have petitioned the
Court to reconsider its decision. It is uncertain how the Court will
respond.
If the
EPA revises the CAIR, the EPA would need to specifically justify including
Minnesota with those states subject to such revised rules. If the CAIR becomes
effective, we expect to be required to supplement planned emission control
retrofits to address regional haze concerns by making emission allowance
purchases, supplemental emission reductions or a combination of both. If the
CAIR does not go into effect, we expect that emission reduction measures taken
with AREA and Boswell Unit 3 emission control retrofits will be sufficient to
satisfy environmental requirements for the next several years.
EPA Clean Air Mercury Rule.
In March 2005, the EPA also announced the Clean Air Mercury Rule (CAMR) that
would have reduced and permanently capped emissions of electric utility mercury
emissions in the continental United States. In February 2008, the Court
overturned the CAMR and remanded the rulemaking to the EPA for reconsideration.
In October 2008, the Department of Justice (DOJ), on behalf of the EPA,
petitioned the Supreme Court to review the Court’s decision in the CAMR case. It
is uncertain how the Supreme Court will respond. Cost estimates for complying
with future mercury regulations under the Clean Air Act are therefore premature
at this time.
Real Estate.
As of September
30, 2008, ALLETE Properties, through its subsidiaries, had surety bonds
outstanding of $21.1 million ($35.9 million at December 31, 2007) primarily
related to performance and maintenance obligations to governmental entities to
construct improvements in ALLETE Properties’ various projects. The remaining
work to be completed on these improvements is estimated to be approximately
$12.9 million ($6.4 million at December 31, 2007) and ALLETE Properties does not
believe it is likely that any of these outstanding bonds will be drawn
upon.
ALLETE
Third Quarter 2008 Form 10-Q
NOTE
11. 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, which are
payable through property tax assessments on the landowners over 31 years (by May
1, 2036). The bond proceeds (less capitalized interest, a debt service reserve
fund and cost of issuance) were used to pay for the construction of a portion of
the major infrastructure improvements at Town Center. 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 were billed to Town Center landowners effective in November 2006. To
the extent that we still own land at the time of an assessment, in accordance
with EITF 91-10, “Accounting for Special Assessments and Tax Increment Financing
Entities,” we will incur the cost of our portion of these assessments, based
upon our ownership of benefited property. At September 30, 2008, we owned
approximately 69 percent of the assessable land in the Town Center District
(approximately 69 percent at December 31, 2007). As we sell property, the
obligation to pay special assessments will pass to the new landowners. Under
EITF 91-10, these bonds are not reflected as debt on our consolidated balance
sheet.
Palm Coast Park.
In May 2006,
the Palm Coast Park District issued $31.8 million of tax-exempt, 5.7% Special
Assessment Bonds, Series 2006, which are payable through property tax
assessments on the landowners over 31 years (by May 1, 2037). The bond proceeds
(less capitalized interest, a debt service reserve fund and cost of issuance)
were used to pay for the construction of the major infrastructure improvements
at Palm Coast Park and to mitigate traffic and environmental impacts. The bonds
are payable from and secured by the revenue derived from assessments imposed,
levied and collected by the Palm Coast Park District. The assessments represent
an allocation of the costs of the improvements, including bond financing costs,
to the lands within the Palm Coast Park District benefiting from the
improvements. The assessments were billed to Palm Coast Park landowners
effective in November 2007. To the extent that we still own land at the time of
an assessment, in accordance with EITF 91-10, “Accounting for Special
Assessments and Tax Increment Financing Entities,” we will incur the cost of our
portion of these assessments, based upon our ownership of benefited property. At
September 30, 2008, we owned approximately 86 percent of the assessable land in
the Palm Coast Park District (approximately 86 percent at December 31, 2007). As
we sell property, the obligation to pay special assessments will pass to the new
landowners. Under EITF 91-10, these bonds are not reflected as debt on our
consolidated balance sheet.
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,
or have a material adverse effect on our financial condition.
NOTE
12. RECURRING FAIR VALUE MEASURES
Effective
January 1, 2008, the Company adopted SFAS 157 as discussed in Note 1, which,
among other things, requires enhanced disclosures about assets and liabilities
carried at fair value.
As
defined in SFAS 157, fair value is the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date (exit price). The Company utilizes market
data or assumptions that market participants would use in pricing the asset or
liability, including assumptions about risk and the risks inherent in the inputs
to the valuation technique. These inputs can be readily observable, market
corroborated, or generally unobservable. The Company primarily applies the
market approach for recurring fair value measurements and endeavors to utilize
the best available information. Accordingly, the Company utilizes valuation
techniques that maximize the use of observable inputs and minimize the use of
unobservable inputs. The Company is able to classify fair value balances based
on the observability of those inputs. SFAS 157 establishes a fair value
hierarchy that prioritizes the inputs used to measure fair value. The hierarchy
gives the highest priority to unadjusted quoted prices in active markets for
identical assets or liabilities (Level 1 measurement) and the lowest priority to
unobservable inputs (Level 3 measurement). The three levels of the fair value
hierarchy defined by SFAS 157 are as follows:
ALLETE
Third Quarter 2008 Form 10-Q
NOTE
12. RECURRING FAIR VALUE MEASURES (Continued)
Level 1 –
Quoted prices are available in active markets for identical assets or
liabilities as of the reporting date. Active markets are those in which
transactions for the asset or liability occur in sufficient frequency and volume
to provide pricing information on an ongoing basis. Instruments in this category
include primarily mutual fund investments held to fund employee benefits and
deferred compensation.
Level 2 –
Pricing inputs are other than quoted prices in active markets included in Level
1, which are either directly or indirectly observable as of the reporting date.
Level 2 includes those financial instruments that are valued using models or
other valuation methodologies. These models are primarily industry-standard
models that consider various assumptions, including quoted forward prices for
commodities, time value, volatility factors, and current market and contractual
prices for the underlying instruments, as well as other relevant economic
measures. Substantially all of these assumptions are observable in the
marketplace throughout the full term of the instrument, can be derived from
observable data or are supported by observable levels at which transactions are
executed in the marketplace. Instruments in this category represent the
Company’s deferred compensation obligation.
Level 3 –
Pricing inputs include significant inputs that are generally less observable
from objective sources. These inputs may be used with internally developed
methodologies that result in management’s best estimate of fair value. At each
balance sheet date, management performs an analysis of all instruments subject
to SFAS 157 and includes in Level 3 all of those whose fair value is based on
significant unobservable inputs. Instruments in this category include auction
rate securities consisting of guaranteed student loans classified as Level 3
investments as of September 30, 2008. The Company also holds certain financial
transmission rights (FTRs) related to our participation in MISO. These FTRs are
accounted for as derivatives. While our valuation of these FTRs is based on
Level 3 inputs, the fair value of our FTRs at September 30, 2008, is immaterial,
and as a result we have not presented them in the tables below.
The
following table sets forth by level within the fair value hierarchy the
Company's financial assets and liabilities that were accounted for at fair value
on a recurring basis as of September 30, 2008. As required by SFAS 157,
financial assets and liabilities are classified in their entirety based on the
lowest level of input that is significant to the fair value measurement. The
Company's assessment of the significance of a particular input to the fair value
measurement requires judgment, and may affect the valuation of fair value assets
and liabilities and their placement within the fair value hierarchy levels.
|
|
At
Fair Value as of September 30, 2008
|
|
Recurring Fair Value
Measures
|
|
Level
1
|
|
Level
2
|
|
Level
3
|
|
Total
|
|
Millions
|
|
|
|
|
|
|
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
Mutual
Funds
|
|
$19.8
|
|
–
|
|
–
|
|
$19.8
|
|
Bonds
|
|
–
|
|
$3.7
|
|
–
|
|
3.7
|
|
Auction
Rate Securities
|
|
–
|
|
–
|
|
$19.4
|
(a)
|
19.4
|
|
Total
Assets
|
|
$19.8
|
|
$3.7
|
|
$19.4
|
|
$42.9
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
Deferred
compensation obligation
|
|
–
|
|
$7.6
|
|
–
|
|
$7.6
|
|
Total
Liabilities
|
|
–
|
|
$7.6
|
|
–
|
|
$7.6
|
|
Total
Net Assets (Liabilities)
|
|
$19.8
|
|
$(3.9)
|
|
$19.4
|
|
$35.3
|
|
|
(a)
|
See
Note 3 – Investments for additional
information.
|
|
Recurring
Fair Value Measures For The Nine Months Ended September 30,
2008
|
Auction
Rate
|
|
Activity
in Level 3
|
|
Securities
|
|
Millions
|
|
|
|
|
|
|
|
|
Balance
as of January 1, 2008
|
|
|
|
|
–
|
|
|
Purchases,
sales, issuances and settlements, net
(a)
|
|
|
$(5.8)
|
|
|
Level
3 transfers in
|
|
|
|
|
25.2
|
|
Balance
as of September 30, 2008
|
|
|
|
|
$19.4
|
|
|
(a)
|
Primarily
due to a $5.2 million transfer of auction rate securities to our Voluntary
Employee Benefit Association trust used to fund postretirement health and
life benefits.
|
ALLETE
Third Quarter 2008 Form 10-Q
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, notes to those statements, management’s discussion and
analysis from the 2007 Form 10-K and the other financial information appearing
elsewhere in this report. In addition to historical information, the following
discussion and other parts of this Form 10-Q 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 heading: “Safe Harbor Statement Under the Private
Securities Litigation Reform Act of 1995” located on page 5 and “Risk Factors”
located in Part I, Item 1A, page 22 of our 2007 Form 10-K. The risks and
uncertainties described in this Form 10-Q and our 2007 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.
OVERVIEW
ALLETE is
a diversified company that has provided fundamental products and services since
1906. These include our former operations in the water, paper,
telecommunications and automotive industries and the
Energy
and
Real Estate
businesses we
operate today.
Energy
is comprised of
Regulated Utility, Nonregulated Energy Operations and Investment in
ATC.
|
|
·
|
Regulated Utility
includes retail and wholesale rate regulated electric, natural gas and
water 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.
|
|
|
·
|
Investment in ATC
includes our equity ownership interest in
ATC.
|
Real Estate
includes our
Florida real estate operations.
Other
includes our investments
in emerging technologies, and earnings on cash and short-term
investments.
ALLETE is
incorporated under the laws of Minnesota. Our corporate headquarters are in
Duluth, Minnesota. Statistical information is presented as of September 30,
2008, unless otherwise indicated. All subsidiaries are wholly owned unless
otherwise specifically indicated. References in this report to “we,” “us” and
“our” are to ALLETE and its subsidiaries, collectively.
ALLETE
Third Quarter 2008 Form 10-Q
OVERVIEW
(Continued)
|
|
Quarter
Ended
|
Nine
Months Ended
|
|
|
September
30,
|
September
30,
|
|
Kilowatt-hours
Sold
|
2008
|
2007
|
2008
|
2007
|
|
Millions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Regulated
Utility
|
|
|
|
|
|
|
Retail
and Municipals
|
|
|
|
|
|
|
|
Residential
|
252.1
|
258.8
|
853.9
|
832.1
|
|
|
|
Commercial
|
360.5
|
360.5
|
1,027.7
|
1,033.6
|
|
|
|
Municipals
|
243.0
|
255.7
|
742.5
|
751.3
|
|
|
|
Industrial
|
1,854.1
|
1,775.8
|
5,466.2
|
5,215.2
|
|
|
|
Other
|
20.5
|
21.5
|
62.0
|
62.8
|
|
|
|
|
Total
Retail and Municipals
|
2,730.2
|
2,672.3
|
8,152.3
|
7,895.0
|
|
|
|
|
|
|
|
|
|
|
|
Other
Power Suppliers
|
464.8
|
571.9
|
1,244.0
|
1,608.8
|
|
|
|
|
Total
Regulated Utility
|
3,195.0
|
3,244.2
|
9,396.3
|
9,503.8
|
|
|
|
|
|
|
|
|
|
|
|
Nonregulated
Energy Operations
|
60.6
|
60.7
|
168.9
|
184.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Kilowatt-hours Sold
|
3,255.6
|
3,304.9
|
9,565.2
|
9,688.0
|
|
|
Quarter
Ended
|
Nine
Months Ended
|
|
|
September
30,
|
September
30,
|
|
Real
Estate
|
2008
|
2007
|
2008
|
2007
|
|
Revenue
and Sales Activity
(a)
|
Qty
|
Amount
|
Qty
|
Amount
|
Qty
|
Amount
|
Qty
|
Amount
|
|
Dollars
in Millions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Town
Center Sales
|
|
|
|
|
|
|
|
|
|
Non-residential
Sq. Ft.
|
–
|
–
|
50,000
|
$1.8
|
–
|
–
|
474,476
|
$14.5
|
|
Residential
Units
|
–
|
–
|
–
|
–
|
–
|
–
|
130
|
1.6
|
|
|
|
|
|
|
|
|
|
|
|
Palm
Coast Park
|
|
|
|
|
|
|
|
|
|
Non-residential
Sq. Ft.
|
–
|
–
|
–
|
–
|
–
|
–
|
40,000
|
2.0
|
|
Residential
Units
|
–
|
–
|
–
|
–
|
–
|
–
|
406
|
11.1
|
|
|
|
|
|
|
|
|
|
|
|
Other
Land Sales
|
|
|
|
|
|
|
|
|
|
Acres
(b)
|
1
|
$0.7
|
83
|
$3.0
|
52
|
$4.6
|
450
|
$8.9
|
|
|
|
|
|
|
|
|
|
|
|
Contract
Sales Price
(c)
|
|
0.7
|
|
4.8
|
|
4.6
|
|
38.1
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
Recognized from Previously Deferred Sales
|
|
2.6
|
|
0.1
|
|
2.6
|
|
2.4
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
Revenue
|
|
–
|
|
(1.1)
|
|
–
|
|
(4.2)
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
from Land Sales
|
|
3.3
|
|
3.8
|
|
7.2
|
|
36.3
|
|
|
|
|
|
|
|
|
|
|
|
Other
Revenue
(d)
|
|
1.0
|
|
1.0
|
|
7.7
|
|
4.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$4.3
|
|
$4.8
|
|
$14.9
|
|
$41.0
|
(a) Quantity
amounts are approximate until final build-out.
(b) Acreage
amounts are shown on a gross basis, including wetlands and minority
interest.
(c) Reflected
total contract sales price on closed land transactions.
(d) Other
Revenue includes traffic impact fees, forfeited deposits, investment income and
the sale of a shopping center.
ALLETE
Third Quarter 2008 Form 10-Q
OVERVIEW
(Continued)
Financial
Overview
(See Note
2 – Business Segments for financial results by segment.)
The
following net income discussion summarizes, by segment, a comparison of the nine
months ended September 30, 2008, to the nine months ended September
30, 2007.
Regulated Utility
contributed
income of $40.0 million in 2008 ($37.9 million in 2007). The increase in
earnings is primarily the result of higher rates. Higher rates resulted from a
March 1, 2008 increase in FERC approved wholesale rates, an August 1, 2008
interim rate increase for retail customers in Minnesota, and current cost
recovery on our environmental retrofit projects. Rate increases were partially
offset by the expiration of sales contracts to Other Power Suppliers, and higher
operations and maintenance expense, depreciation expense and interest
expense.
Nonregulated Energy Operations
contributed income of $2.3 million in 2008 ($3.4 million in 2007). The decrease
is primarily due to higher gains from land sales in Minnesota during
2007.
Investment in ATC
contributed
income of $6.5 million in 2008 ($5.6 million in 2007).
Real Estate
contributed income
of $2.2 million in 2008 ($15.2 million in 2007). Income was lower in 2008 due to
the continued weak real estate market.
Other
contributed income of
$8.0 million in 2008 ($3.3 million in 2007). The increase is primarily due to a
$3.8 million after-tax gain realized from the sale of certain available for
sale securities in the first quarter of 2008, tax benefits, and the related
interest recognized in the third quarter 2008. The gain on the sale of certain
available for sale securities was triggered when securities were sold to
reallocate investments to meet defined investment allocations based upon an
approved investment strategy.
COMPARISON
OF THE QUARTERS ENDED SEPTEMBER 30, 2008 AND 2007
(See Note
2 – Business Segments for financial results by segment.)
Regulated
Utility
Operating
revenue
increased slightly from 2007 primarily as a result of higher
rates and kilowatt-hour sales to retail and municipal customers. The increase
was mostly offset by decreased fuel clause recoveries and the expiration of
sales contracts to Other Power Suppliers.
Higher
rates resulted from the August 1, 2008 interim rate increase subject to refund
for retail customers in Minnesota of $7.1 million, current cost recovery on our
environmental retrofit projects of $2.7 million, and the March 1, 2008 increase
in FERC approved wholesale rates of $1.5 million.
Fuel
clause recoveries decreased $27.5 million in 2008 primarily as a result of
decreased purchased power expenses reflecting higher Company hydro and wind
generation, and additional generation from Square Butte (see Fuel and Purchased
Power Expense discussion below).
Revenue
from sales to Other Power Suppliers decreased $3.7 million from 2007 due to the
expiration of sales contracts.
Kilowatt-hour
sales to our retail and municipal customers increased 2 percent from 2007,
primarily due to a 4 percent increase in industrial load. The increase in
industrial sales in 2008 primarily reflects increased sales to one taconite
customer that was partially idled in 2007. Total regulated utility kilowatt-hour
sales were down 2 percent as the expiration of sales contracts to Other Power
Suppliers more than offset the increased retail and municipal
sales.
Revenue
from electric sales to taconite customers accounted for 28 percent of
consolidated operating revenue in 2008 (26 percent in 2007). Revenue from
electric sales to paper and pulp mills accounted for 10 percent of consolidated
operating revenue in 2008 and 2007. Revenue from electric sales to pipelines and
other industrials accounted for 7 percent of consolidated operating revenue in
2008 and 2007.
ALLETE
Third Quarter 2008 Form 10-Q
COMPARISON
OF THE QUARTERS ENDED SEPTEMBER 30, 2008 AND 2007 (Continued)
Operating
expenses
decreased $8.4 million from 2007.
Fuel and Purchased Power
Expense
decreased $10.8 million, or 12 percent, from 2007, primarily due
to a decrease in purchase power expense reflecting higher generation and fewer
scheduled outages.
Operating and Maintenance
Expense
increased $1.0 million, or 2 percent, from 2007 due to higher gas
prices and higher salaries and wages, reflecting inflationary
increases.
Depreciation Expense
increased $1.4 million from 2007 reflecting higher property, plant and
equipment balances as a result of increased property placed in service due to
the Company’s construction activity.
Interest Expense
increased $0.8 million, or 15 percent, from 2007 primarily due to higher
long term debt balances as a result of increased construction
activity.
Nonregulated
Energy Operations
Operating
revenue
increased $1.3 million, or 8 percent, from 2007 primarily due to
higher coal sales at BNI Coal.
Operating
expenses
increased $0.4 million, or 2 percent, from 2007 primarily due to
higher fuel expense and dragline repairs at BNI Coal.
Investment
in ATC
Equity
Earnings
increased $1.0 million, or 31 percent, from 2007 resulting from
our pro-rata share of ATC’s earnings on an increased investment balance as
discussed in Note 3.
Real
Estate
Operating
revenue
decreased $0.5 million from 2007. Revenue from land sales was
$3.3 million in 2008 and included $2.6 million in previously deferred revenue.
In 2007, revenue from land sales was $3.8 million, which included $0.1 million
in previously deferred revenue. There were no sales at Town Center or Palm Coast
Park for the quarter ended September 30, 2008. For the quarter ended September
30, 2007, 50,000 non-residential square feet were sold at Town
Center.
Operating
expenses
decreased $0.2 million, or 5 percent, from 2007 reflecting a
decrease in the cost of real estate sold and decreased selling
expenses.
Other
Other income
increased $0.8 million from 2007 primarily due to interest income related
to tax benefits recognized in the third quarter of 2008 partially offset by
lower earnings on cash and short-term investments.
Income
Taxes
For the
quarter ended September 30, 2008, the effective tax rate on income before
minority interest and income taxes was 25.2 percent (32.7 percent for the
quarter ended September 30, 2007). The effective rate was lower in 2008 due to
the recognition of a non-recurring benefit on a previously uncertain tax
position for $1.7 million due to the closing of a tax year and the reversal
of a state valuation allowance for $2.4 million due to the completion of an IRS
review. The effective tax rate of 25.2 percent for the quarter ended September
30, 2008, deviated from the statutory rate (approximately 40 percent) primarily
due to the two tax benefit items previously discussed as well as deductions for
Medicare health subsidies, AFUDC-Equity, investment tax credits and wind
production tax credits.
ALLETE
Third Quarter 2008 Form 10-Q
COMPARISON
OF THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
Regulated
Utility
Operating
revenue
decreased $2.3 million from 2007 primarily as a result of
decreased fuel clause recoveries and the expiration of sales contracts to Other
Power Suppliers. The decrease was offset by higher rates, increased gas sales,
and kilowatt-hour sales to retail and municipal customers.
Higher
rates resulted from current cost recovery on our environmental retrofit projects
of $12.8 million, the August 1, 2008 interim rate increase subject to refund for
retail customers in Minnesota of $7.1 million, and the March 1, 2008 increase in
FERC approved wholesale rates of $3.9 million.
Fuel
clause recoveries decreased $42.6 million in 2008 primarily as a result of
decreased purchased power expenses reflecting higher Company steam, hydro and
wind generation and additional generation from Square Butte (see Fuel and
Purchased Power Expense discussion below).
Revenue
from sales to Other Power Suppliers decreased $17.1 million from 2007 due to the
expiration of sales contracts.
Kilowatt-hour
sales to our retail and municipal customers increased 3 percent from 2007,
primarily due to a 5 percent increase in industrial sales. The increase in
industrial sales in 2008 primarily reflects increased sales to one taconite
customer that was partially idled in 2007 and another customer that was shutdown
due to weather related issues in 2007. Total regulated utility kilowatt-hour
sales are down 1 percent as the expiration of sales contracts to Other Power
Supplier more than offset the increased retail and municipal sales.
Revenue
from electric sales to taconite customers accounted for 27 percent of
consolidated operating revenue in 2008 (24 percent in 2007). Revenue from
electric sales to paper and pulp mills accounted for 9 percent of consolidated
operating revenue in 2008 and 2007. Revenue from electric sales to pipelines and
other industrials accounted for 7 percent of consolidated operating revenue in
2008 and 2007.
Operating
expenses
decreased $8.1 million from 2007.
Fuel and Purchased Power
Expense
decreased $20.1 million, or 8 percent, from 2007, primarily due
to a decrease in purchase power expense. In 2007, scheduled and unscheduled
outages drove the higher purchased power.
Operating and Maintenance
Expense
increased $8.7 million, or 5 percent, over 2007 primarily due to
increased gas purchases reflecting a colder 2008, transmission expense, and
higher salaries and wages relating to annual inflationary
increases.
Depreciation Expense
increased $3.3 million from 2007 reflecting higher property, plant, and
equipment balances as a result of increased property placed in service due to
the Company’s construction activity.
Interest Expense
increased $1.8 million, or 11 percent, from 2007 primarily due to higher
long term debt balances from increased construction activity.
Other income
increased $0.4 million from 2007 due to higher earnings from the
capitalization of AFUDC-Equity reflecting increased construction
activity.
Nonregulated
Energy Operations
Operating
revenue
increased $3.9 million, or 8 percent, from 2007, primarily due to
higher coal sales and prices at BNI Coal.
Operating
expenses
increased $3.0 million, or 6 percent, from 2007 primarily due to
higher fuel expense and dragline repairs at BNI Coal.
ALLETE
Third Quarter 2008 Form 10-Q
COMPARISON
OF THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007 (Continued)
Nonregulated
Energy Operations (Continued)
Other income
decreased $2.5 million from 2007 due to higher gains from land sales in
Minnesota during 2007.
Investment
in ATC
Equity
Earnings
increased $1.9 million, or 20 percent, from 2007 resulting from
our pro-rata share of ATC’s earnings on an increased investment balance as
discussed in Note 3.
Real
Estate
Operating
revenue
decreased $26.1 million from 2007. Revenue from land sales was
$7.2 million in 2008 and included $2.6 million in previously deferred revenue.
In 2007, revenue from land sales was $36.3 million, which included $2.4 million
in previously deferred revenue and reflected two large sales that closed during
the second quarter of 2007. Operating revenue in 2008 also included the pre-tax
gain of $4.5 million resulting from the sale of the retail shopping center in
Winter Haven, Florida on May 1, 2008.
There
were no sales at Town Center or Palm Coast Park for the nine months ended
September 30, 2008. Through September 30, 2007, 474,476 non-residential square
feet were sold at Town Center and 40,000 non-residential square feet were sold
at Palm Coast Park. Also in 2007, Town Center sold 130 residential units and
Palm Coast Park sold 406 residential units. For the nine months ended September
30, 2008, 52 acres of Other Land was sold (450 acres in 2007).
Operating
expenses
decreased $4.0 million, or 26 percent, from 2007 reflecting a
decrease in the cost of real estate sold and decreased selling
expenses.
Other
Operating
expenses
increased $0.3 million from 2007 as a result of additional
expense related to our Georgia Water dispute as discussed in Note
11.
Other income
increased $4.4 million from 2007 primarily due to a $3.8 million
after-tax gain realized from the sale of certain available for sale securities
in the first quarter of 2008 and interest income related to tax benefits
recognized in the third quarter of 2008. The gain was triggered when securities
were sold to reallocate investments to meet defined investment allocations based
upon an approved investment strategy.
The increase was
partially offset by lower earnings on cash and short-term investments reflecting
lower average cash balances, lower average interest rates, and the 2007 release
from a loan guarantee for Northwest Airlines Corporation of $1.0
million.
Income
Taxes
For the
nine months ended September 30, 2008, the effective tax rate on income before
minority interest and income taxes was 32.3 percent (34.6 percent for nine
months ended September 30, 2007). The effective rate was lower in 2008 due to
the recognition of a non-recurring benefit on a previously uncertain tax
position for $1.7 million due to the closing of a tax year and the reversal
of a state valuation allowance for $2.4 million due to the completion of an
IRS review. The effective tax rate of 32.3 percent for the nine months ended
September 30, 2008, deviated from the statutory rate (approximately 40 percent)
primarily due to the two tax benefit items previously discussed as well as
deductions for Medicare health subsidies, AFUDC-Equity, investment tax credits
and wind production tax credits. We expect that the effective tax rate on income
before minority interest and income taxes to be approximately 34 percent for
2008.
ALLETE
Third Quarter 2008 Form 10-Q
CRITICAL
ACCOUNTING ESTIMATES
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: real estate
revenue and expense recognition, pension and postretirement health and life
actuarial assumptions, regulatory accounting, the valuation of investments and
taxation. These policies are reviewed with the Audit Committee of our Board of
Directors on a regular basis and summarized in Part II, Item 7 of our 2007 Form
10-K.
OUTLOOK
Earnings Guidance.
ALLETE
reaffirms its previously stated earnings guidance of a range from $2.70 to $2.90
per share for 2008.
Energy.
As part of our
strategy, we will leverage the strengths of our Regulated Utility business to
improve our strategic and financial outlook and seek growth opportunities in
close proximity to existing operations in the Midwest. We believe electric
industry deregulation is unlikely in Minnesota and Wisconsin in the next five
years.
Minnesota
Power expects significant rate base growth over the next several years as it
makes capital expenditures to comply with renewable energy requirements and
environmental mandates. In addition, significant investment will be made in our
existing low-cost generation fleet to provide for continued future operations as
we continue to believe ownership of low-cost generation is a competitive
advantage. Minnesota Power will also look for transmission opportunities which
strengthen and enhance the regional transmission grid and take advantage of our
geographic location between sources of renewable energy and growing energy
markets. Our capital investments will be recovered through a combination of
current cost recovery riders and anticipated increased base electric rates. We
may experience kilowatt-hour growth due to the potential for up to 400 MW
of additional growth from several new industrial customers planning projects in
our service territory.
Our
energy strategy is to be a leader in the movement toward renewable energy and
cleaner power plants. We believe we can meet our customers’ electric energy
needs for the next decade while achieving real reductions in total carbon
emissions. We are aggressively pursuing our renewable energy resources and
expect to comply with Minnesota’s renewable energy requirements prior to the
2025 deadline.
Renewable Generation Sources.
The areas in which we operate have strong wind, water and biomass
resources, and provide us with opportunities to develop a number of renewable
forms of generation. Our electric service area in northeastern Minnesota is well
situated for delivery of renewable energy that is generated here and in
adjoining regions. We intend to secure the most cost competitive and
geographically advantageous renewable energy resources available. We believe
that the demand for these resources is likely to grow, and the costs of the
resources to generate renewable energy will continue to escalate. While we
intend to maintain our disciplined approach to developing generation assets, we
also believe that by acting sooner rather than later we can deliver lower cost
power to our customers and maintain or improve our cost competitiveness among
regional utilities. We will continue to work cooperatively with our customers,
our regulators and the communities we serve to develop generation options that
reflect the needs of our customers as well as the environment. We believe that
our location and our proactive leadership in developing renewable generation
provide us with a competitive advantage. For more than a century, we have been
Minnesota’s leading producer of renewable hydroelectric energy.
We have
already begun executing our renewable energy and cleaner power plant strategy.
Taconite Ridge Wind I, a $50 million, 25-MW wind facility located in
northeastern Minnesota became operational in July 2008. Costs related to the
construction of this facility have been included in our May 2, 2008 rate
filing.
On May
13, 2008, we announced plans to develop several hundred megawatts of wind energy
in North Dakota and purchase an existing 250 kV DC transmission line to
transport this wind energy to customers while gradually reducing the supply of
energy currently delivered to our system on this same transmission line from
Square Butte’s coal-fired Milton R. Young Unit 2. The North Dakota wind project
is expected to complete the mandated 2025 renewable energy supply requirements
for our retail load. In September 2008, we signed an agreement to purchase the
transmission line from Square Butte Electric Cooperative for approximately
$80 million. The transaction is subject to regulatory approvals and is
anticipated to close in 2009.
ALLETE
Third Quarter 2008 Form 10-Q
OUTLOOK
(Continued)
Energy
(Continued)
Integrated Resource Plan (IRP).
On October 31, 2007, we filed our IRP, a comprehensive estimate of future
capacity needs within the Minnesota Power service territory. On July 25, 2008,
we filed a request with the MPUC for approval to re-file our IRP by October 1,
2009, in order to incorporate the North Dakota wind project and otherwise update
our load forecasting and modeling in the IRP. In October 2008, the MPUC issued
an order approving the request to re-file the IRP by October 1,
2009.
Climate Change
. A key
component of our energy strategy is a goal to reduce overall GHG emissions.
While there continues to be debate about the causes and extent of global
warming, certain scientific evidence suggests that emissions from fossil fuel
generation facilities are a contributing factor. Minnesota Power has a long
history of environmental stewardship.
We
believe that future regulations may restrict the emissions of GHGs from our
generation facilities. Several proposals on the federal level to “cap” the
amount of GHG emissions have been made. Other proposals consider establishing
emissions allowances or taxes as economic incentives to address the GHG
emissions issue.
In 2007,
Minnesota passed legislation establishing non-binding targets for GHG
reductions. This legislation establishes a goal of reducing statewide GHG
emissions across all sectors producing those emissions to a level at least 15
percent below 2005 levels by 2015, at least 30 percent below 2005 levels by
2025, and at least 80 percent below 2005 levels by 2050. Minnesota is also
participating in the Midwestern Greenhouse Gas Accord, a regional effort to
develop a multi-state approach to GHG emission reductions. We are proactively
taking steps to strategically engage the GHG emission issue and the impact of
climate change regulation on our business.
Minnesota
Power is addressing this environmental challenge by taking the following steps
that also ensure reliable and competitive generation resources to continue to
meet our customer’s requirements:
|
|
·
|
We
will consider only carbon minimizing resources to supply power to our
customers. We will not consider a new coal resource without a reasonable
carbon emission solution.
|
|
|
·
|
We
will aggressively pursue Minnesota’s Renewable Energy Standard by adding
significant renewable resources to our portfolio of generation facilities
and power supply agreements.
|
|
|
·
|
We
will continue to improve the efficiency of coal-based generation
facilities.
|
|
|
·
|
We
plan to implement aggressive demand side conservation
efforts.
|
|
|
·
|
We
will continue to support research of technologies to reduce carbon
emissions from generation facilities and support carbon sequestration
efforts.
|
|
|
·
|
We
plan to achieve overall carbon emission reductions while maintaining
competitively priced electric service to our
customers.
|
The
Company has become a “founding reporter” of The Climate Registry, an
organization established to measure and publicly report GHG emissions
consistently and accurately across borders and industry sectors. This non-profit
organization includes 39 states, six Canadian provinces, three Native American
tribes, two Mexican states and the District of Columbia. In becoming one of the
founding reporters of The Climate Registry, we have voluntarily committed to
measure, independently verify and publicly report our GHG emissions annually,
using The Climate Registry General Reporting Protocol. This method of reporting
is based on the internationally recognized GHG measurements standards of the
World Resources Institute and World Business Council on Sustainable
Development.
ALLETE
Third Quarter 2008 Form 10-Q
OUTLOOK
(Continued)
Energy
(Continued)
Rate Cases
. Entities within
our Regulated Utility segment file for periodic rate revisions with the MPUC,
the FERC or the PSCW.
On
February 8, 2008, the FERC approved Minnesota Power’s wholesale rate increase
effective March 1, 2008. Our wholesale customers consist of 16 municipalities in
Minnesota and two private utilities in Wisconsin, including SWL&P. The FERC
authorized an average 10 percent increase for wholesale municipal customers, a
12.5 percent increase for SWL&P, and an overall return on equity of 11.25
percent. On an annualized basis, the rate increase is expected to result in
approximately $8 million in additional revenue. Incremental revenue in 2008 from
the FERC authorized wholesale rate increase is expected to be approximately $7
million.
As of
September 30, 2008, Minnesota Power has signed new contracts with 15 Minnesota
wholesale customers and has 1 contract in the cancellation period. The new
contracts transition each customer to formula-based rates, which means that
rates can be adjusted annually based on changes in costs. Two new agreements
with private utilities in Wisconsin, including SWL&P, were also signed in
September 2008. Both contracts are subject to PSCW approval. We anticipate
filing a request to implement formula-based rates with the FERC in the fourth
quarter of 2008, based on the terms of these new contracts, and are requesting
an effective date of January 1, 2009.
On May 2,
2008, Minnesota Power filed a rate increase request with the MPUC seeking an
average increase of approximately 10 percent for retail customers. The rate
filing seeks an overall return on equity of 11.15 percent, and a capital
structure consisting of 54.8 percent equity and 45.2 percent debt. On an
annualized basis, the requested rate increase would generate approximately $45
million in additional revenue. Subsequent to the May filing, adjustments have
been made and Minnesota Power is now seeking an average rate increase of 8.75
percent, which would generate approximately $41 million in additional revenue on
an annualized basis. Interim rates were effective on August 1, 2008, and will
result in an average increase of approximately 7.5 percent or approximately $36
million for retail customers subject to refund pending the final rate order.
Incremental revenue in 2008 from the interim Minnesota retail rate increase is
expected to be approximately $13 million. The rate case schedule was approved at
an August 2008 prehearing conference, and all scheduled public hearings were
held in September and October 2008. Evidentiary hearings are scheduled for
November 2008. The final rate order is expected in the second quarter of 2009.
We cannot predict the amount of any rate increase the MPUC may
approve.
SWL&P’s
current retail rates are based on a 2006 PSCW retail rate order, effective
January 1, 2007. On May 14, 2008, SWL&P filed a rate increase request with
the PSCW seeking an average increase of approximately 5 percent for retail
customers. The rate filing seeks an overall return on equity of 11.5 percent,
and a capital structure consisting of 57.1 percent equity and 42.9 percent debt.
On an annualized basis, the requested rate increase would generate approximately
$4 million in additional revenue. Evidentiary and public hearings were held
October 7, 2008. The Company anticipates rates will take effect in January 2009.
We cannot predict the amount of any rate increase the PSCW may
approve.
Large Power Customers
. In
March 2008, a contract was signed with Northshore Mining Company to serve up to
10 MW of new load beginning April 1, 2008. Northshore Mining needs additional
power for the restart of a taconite pellet furnace. The furnace will produce
about 800,000 tons of pellets annually. The contract requires Minnesota Power to
provide for Northshore Mining’s electric requirements that are in excess of
their ability to supply them through their wholly owned generation facilities.
The contract was approved by the MPUC on September 5, 2008.
In
September 2008, Cliffs Natural Resources Inc. (Cliffs) and Minnesota Power
signed new contracts for service to Hibbing Taconite Co. and United Taconite
LLC. These electric service agreements, which are subject to MPUC approval,
extend the existing contract terms out to at least December 31, 2015. On
October 28, 2008, Cliffs announced it will temporarily idle two small pellet
furnaces at Northshore Mining and one small pellet furnace at United Taconite.
Due to the smaller size of these facilities and their contractual obligations to
Minnesota Power, we believe the financial impact of these temporary shutdowns
will be immaterial to our earnings in 2008.
ALLETE
Third Quarter 2008 Form 10-Q
OUTLOOK
(Continued)
Energy
(Continued)
AREA and Boswell 3 Emission
Reduction Plan.
In May 2006, the MPUC approved our filing for current
cost recovery of expenditures to reduce emissions to meet pending federal
requirements at Taconite Harbor and Laskin under the AREA Plan. The AREA Plan
approval allows Minnesota Power to recover Minnesota jurisdictional costs for
SO
2
,
NO
x
and mercury emission reductions made at these facilities without a rate
proceeding. Cost recovery from retail customers includes a return on investment
and recovery of incremental expense. The AREA Plan is expected to significantly
reduce emissions from Taconite Harbor and Laskin, while maintaining a reliable
and reasonably-priced energy supply to meet the needs of our customers. We
believe that control and abatement technologies applicable to these plants have
matured to the point where further significant air emission reductions can be
attained in a relatively cost-effective manner. AREA Plan cost recovery remains
available for future use on Taconite Harbor Unit 3.
In May
2006, we announced plans to make emission reduction investments at our Boswell
Unit 3 generating unit. Plans include reductions of particulate, SO
2
, NO
x
and
mercury emissions to meet pending federal and state requirements. In March 2007,
the Boswell Unit 3 project received the necessary construction permits. In
October 2007, the MPUC issued a written order approving Minnesota Power’s
request for cost recovery for the Boswell Unit 3 emission reduction plan with
some minor modifications and additional reporting requirements. The MPUC
approval authorized a cash return on construction work in progress during the
construction phase in lieu of AFUDC-Equity and allows for a return on investment
and current cost recovery of incremental operations and maintenance expenses
once the new equipment is installed and the unit is placed back in service in
late 2009. In December 2007, the MPUC approved Boswell Unit 3’s rate adjustment
for 2008 and we began cost recovery on January 1, 2008. In September 2008, we
filed a petition with the MPUC to approve the Boswell Unit 3’s rate adjustment
for 2009. The filing would allow cost recovery relating to additional
investments planned for 2009.
Boswell NO
x
Reduction Plan.
In September
2008, we submitted to the MPCA and MPUC a $92 million environmental initiative
proposing cost recovery for NO
x
emission
reductions from Boswell Units 1, 2, and 4 pursuant to Minnesota statute. If
approved by the MPUC, the Boswell NO
x
Reduction
Plan is expected to significantly reduce NO
x
emissions
from Boswell Units 1, 2 and 4. In addition and simultaneously with the outage
for NO
x
reduction
equipment installation, we plan to install an efficiency upgrade to the existing
turbine/generator at Boswell Unit 4 adding approximately 60 MW of output with no
additional emissions. A second filing requesting cost recovery for the plan will
be submitted to the MPUC by early 2009.
Transmission.
In September
2008, we filed a petition with the MPUC seeking total 2009 rate recovery of
$2.2 million for ongoing expenses related to the Badoura and Tower
transmission projects and certain MISO related transmission facility charges. If
approved, the new rates would take affect on January 1, 2009. The Tower and
Badoura projects are being developed to address transmission inadequacies in
northeastern Minnesota. Both projects will provide regional transmission
benefits through increased voltage support and additional line
capacity.
Depreciation.
On October 23,
2008, the MPUC voted to increase depreciation rates for certain assets effective
January 1, 2008. Minnesota Power had been seeking to have the increased
depreciation rates become effective with the date of final rates in the current
retail rate filing (expected to be in the second quarter of 2009). A written
Order from the MPUC has not been issued on this matter, and Minnesota Power may
seek reconsideration of this decision after receipt of the Order. This decision,
if not reconsidered by the MPUC, would increase depreciation expense in 2008 by
approximately $3 million. We cannot predict the outcome of this
matter.
ALLETE
Third Quarter 2008 Form 10-Q
OUTLOOK
(Continued)
Energy
(Continued)
Fuel Clause Recovery of MISO Day 2
Costs.
We filed a petition with the MPUC in February 2005 to amend our
fuel clause to accommodate costs and revenue related to the day-ahead and
real-time markets through which we engage in wholesale energy transactions in
MISO (MISO Day 2). In December 2006, the MPUC issued an order (the MISO Day 2
Order) allowing us and the other utilities involved in the proceeding to
continue recovering MISO Day 2 charges through the Minnesota retail fuel clause
except for MISO Day 2 administrative charges.
The MISO
Day 2 Order granted deferred accounting treatment for three MISO Day 2 charge
types that were determined to be administrative charges. Under the order, we
refunded, through customer bills, approximately $2 million of administrative
charges previously collected through the fuel clause between April 1, 2005, and
December 31, 2006, and recorded these administrative charges as a regulatory
asset. We were also permitted to continue accumulating MISO Day 2 administrative
charges after December 31, 2006, and record them as a regulatory asset to be
recovered through our next rate filing. MISO Day 2 costs, along with the
amortization of the regulatory asset, are being recovered in interim rates that
became effective August 1, 2008. The balance of this regulatory asset was $4.3
million at September 30, 2008 ($3.7 million at December 31, 2007). See Note 5 –
Regulatory Matters for additional information.
Minnesota Fuel Clause
Investigation.
In June 2003, the MPUC initiated an investigation into the
continuing usefulness of the fuel clause as a regulatory tool for electric
utilities. Our initial comments on the proposed scope and procedure of the
investigation were filed in July 2003. In November 2003, the MPUC approved the
initial scope and procedure of the investigation. The fuel clause docket then
became dormant while the MISO Day 2 docket, which held many fuel clause
considerations, became active. In March 2007, the MPUC solicited comments on
whether the original fuel clause investigation should continue and, if so, what
issues should be pursued. We filed comments in April 2007, suggesting that if
the investigation continued, it should focus on remaining key elements of the
fuel clause, beyond the purchased power transactions examined in the MISO Day 2
proceeding, such as fuel purchases and outages. We filed additional comments in
September 2007, updating our previous filings in the fuel clause investigation
docket to account for changes occurring since the investigation began in July
2003. Since filing the additional comments, a number of stakeholder sessions
have been held at the OES offices, the primary outcome of which was the adoption
by the MPUC of a requirement for an annual fuel clause report to customers by
utilities. The fuel clause investigation docket is awaiting further action by
the MPUC pending these ongoing discussions regarding fuel clause report content
and format.
Investment in ATC.
As of
September 30, 2008, our equity investment was $73.9 million, representing a 7.8
percent ownership interest. As additional opportunities arise, we plan to make
additional investments in ATC through general capital calls based upon our
pro-rata ownership interest in ATC. On October 31, 2008, we invested an
additional $2.3 million in ATC. See Note 3 – Investments for additional
information.
Real Estate.
Florida real
estate market conditions continue to remain weak and we are unable to predict
when market conditions will improve. We expect our real estate operations to be
profitable in 2008, however total net income is expected to be significantly
less than 2007.
Substantially
all of our properties have key entitlements in place. With minimal debt, low
ongoing carrying costs and a low inventory book basis, we expect that our real
estate business will continue to be profitable over the long term. We believe
the northeastern Florida market area where a large portion of our real estate
inventory is located will continue to experience above average long-term
population growth, and our inventory of mixed-use land in those areas will
remain attractive to buyers.
ALLETE
Properties plans to maximize the value of the property it currently owns through
entitlement, infrastructure improvements and orderly sales of properties. In
addition to managing its current real estate inventory, ALLETE Properties is
focused on identifying, acquiring, entitling and developing infrastructure on
land in Florida and other parts of the southeast United States.
On May 1,
2008, ALLETE Properties sold a retail shopping center in Winter Haven, Florida
for $20.0 million. This sale resulted in an after-tax gain of approximately $3
million.
ALLETE
Third Quarter 2008 Form 10-Q
OUTLOOK
(Continued)
Real
Estate (Continued)
|
Summary
of Development Projects
|
|
For
the Nine Months Ended
|
|
Total
|
Residential
|
Non-residential
|
|
September
30, 2008
|
Ownership
|
Acres
(a)
|
Units
(b)
|
Sq.
Ft.
(b,
c)
|
|
Town
Center
|
80%
|
|
|
|
|
At
December 31, 2007
|
|
991
|
2,289
|
2,228,200
|
|
Property
Sold
|
|
–
|
–
|
–
|
|
Change
in Estimate
|
|
–
|
–
|
–
|
|
|
|
991
|
2,289
|
2,228,200
|
|
Palm
Coast Park
|
100%
|
|
|
|
|
At
December 31, 2007
|
|
3,436
|
3,154
|
3,116,800
|
|
Property
Sold
|
|
–
|
–
|
–
|
|
Change
in Estimate
|
|
–
|
85
|
–
|
|
|
|
3,436
|
3,239
|
3,116,800
|
|
Ormond
Crossings
|
100%
|
|
|
|
|
At
December 31, 2007
|
|
5,968
|
(d)
|
(d)
|
|
Change
in Estimate
|
|
–
|
|
|
|
|
|
5,968
|
|
|
|
|
|
10,395
|
5,528
|
5,345,000
|
|
(a)
|
Acreage
amounts are approximate and shown on a gross basis, including wetlands and
minority interest.
|
|
(b)
|
Estimated
and includes minority interest. Density at build out may differ from these
estimates.
|
|
(c)
|
Depending
on the project, non-residential includes retail commercial, non-retail
commercial, office, industrial, warehouse, storage and
institutional.
|
|
(d)
|
A development order approved
by the City of Ormond Beach includes up to 3,700 residential units and 5
million square feet of non-residential space. We estimate the first two
phases of Ormond Crossings will include 2,500-3,200 residential units and
2.5-3.5 million square feet of various types of non-residential
space.
Density of the residential and
non-residential components of the project will be determined based upon
market and traffic mitigation cost considerations. Approximately 2,000
acres will be devoted to a regionally significant wetlands mitigation
bank.
|
|
Other
Land
(a)
|
|
|
|
|
|
|
For
the Nine Months Ended
|
|
|
|
Non-
|
|
|
September
30, 2008
|
Total
|
Mixed
Use
|
Residential
|
residential
|
Agricultural
|
|
Acres
(b)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
|
|
|
|
|
|
|
|
At
December 31, 2007
|
1,573
|
362
|
248
|
424
|
539
|
|
|
Property
Sold
|
(52)
|
(2)
|
(47)
|
(3)
|
–
|
|
|
Change
in Estimate
|
–
|
–
|
–
|
–
|
–
|
|
|
|
1,521
|
360
|
201
|
421
|
539
|
|
(a)
|
Other
land includes land located in Palm Coast, Florida not included in
development projects, Lehigh and Cape
Coral.
|
|
(b)
|
Acreage
amounts are approximate and shown on a gross basis, including wetlands and
minority interest.
|
At
September 30, 2008, total pending land sales under contract were $12.4 million
($55.2 million at December 31, 2007) and are scheduled to close at various times
through 2009. Pending contracts at Town Center include 20,000 non-residential
square feet totaling $0.6 million and 390 residential units totaling $7.9
million. Pending contracts at Palm Coast Park include 200 residential units
totaling $3.0 million. Other Land pending contracts include 106 acres totaling
$1.0 million. Pending contract prices range from $20 to $30 per non-residential
square foot, $15,000 to $25,000 per residential unit, and $9,500 per acre for
all other properties. Prices per acre are stated on a gross acreage basis and
are
dependent
on the type and location of the properties
sold. The majority of the Other Land under contract is zoned non-residential or
mixed use. Certain contracts allow us to receive participation revenue from land
sales to third parties if various formula-based criteria are achieved. In July
2008, a $28.9 million contract with LDD Palm Coast North LLC, a subsidiary of
Lowe Enterprises was terminated, and a $0.6 million contract deposit was
forfeited. We are currently reviewing the best options to proceed with this
property. We believe this property, along with the remaining property at our
Palm Coast Park development project, continues to have long-term
value.
If a
purchaser defaults on a sales contract, the legal remedy is usually limited to
terminating the contract and retaining the purchaser’s deposit. The property is
then available for resale. In many cases, contract purchasers incur significant
costs
during due diligence, planning, designing and
marketing the property before the contract closes, therefore they have
substantially more at risk than the deposit.
ALLETE
Third Quarter 2008 Form 10-Q
OUTLOOK
(Continued)
Real
Estate (Continued)
From time
to time, we continue to have discussions with other buyers under pending
contracts. Our objective is to proactively assist our buyers through this
current period of weak market conditions, as we believe the long-term prospects
for our properties are favorable. Our discussions sometimes result in
adjustments to contract terms, and may include extending closing dates, revised
pricing or termination.
As of
September 30, 2008, we had approximately $0.8 million of deferred profit on
sales of real estate, before taxes and minority interest, on our balance sheet.
All of the deferred profit relates to Town Center and is expected to be
recognized in 2008 as the remaining development obligations are
completed.
LIQUIDITY
AND CAPITAL RESOURCES
Cash
Flow Activities
ALLETE is
well-positioned to meet the Company’s immediate cash flow needs. With our cash
balance of approximately $78 million, $176 million in Lines of Credit which
includes a syndicated committed line of credit of $150 million, and
continued access to debt and equity markets, we project sufficient capital
availability through the immediate term. In addition we have flexibility in the
portion of our capital investment program that deals with future years’
renewable initiatives.
Operating Activities.
Cash
from operating activities was up $4.5 million compared to the nine months ended
September 30, 2007 due to decreased working capital requirements and increased
deferred income tax expense, which was partially offset by lower net income and
higher contributions to defined benefit pension and postretirement health plans
(included in Other Liabilities on the Consolidated Statement of Cash Flows).
Working capital requirements decreased mainly due to lower uncollected purchased
power costs (included in Prepayments and Other on the Consolidated Statement of
Cash Flows). Deferred income tax expense increased due to the bonus depreciation
provisions of the Economic Stimulus Act of 2008, and contributions to defined
benefit pension and postretirement health plans increased $24.3 million over the
nine months ended September 30, 2007.
Investing Activities.
Cash
flow used for investing activities was $180.3 million for the nine months ended
September 30, 2008 ($114.0 million for the nine months ended September 30,
2007). Cash used for investing activities was higher than 2007 reflecting
increased capital additions to property, plant, and equipment which were
partially offset by the proceeds from the sale of assets (retail shopping
center) in Winter Haven, Florida.
Financing Activities.
Cash
flow from financing activities was $134.4 million for the nine months ended
September 30, 2008 ($34.4 million for the nine months ended September 30, 2007).
The increase in cash flow from financing activities resulted from the issuance
of two series of first mortgage bonds: $60 million in February 2008 and $75
million in May 2008. In addition, 759,008 shares of common stock were
issued for net proceeds of approximately $35 million.
Working Capital.
Additional
working capital, if and when needed, generally is provided by the sale of
commercial paper. We have 0.9 million original issue shares of our common stock
available for issuance through
Invest Direct
, our direct
stock purchase and dividend reinvestment plan. Additionally, we have 1.8 million
original issue shares of common stock available for issuance through a
Distribution Agreement with KCCI, Inc. We have consolidated bank lines of credit
aggregating to $176.0 million, the majority of which expire in January 2012. 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.
ALLETE
Third Quarter 2008 Form 10-Q
LIQUIDITY
AND CAPITAL RESOURCES (Continued)
Auction Rate Securities.
As of
September 30, 2008, we held $19.4 million of investments ($23.1 million at
December 31, 2007) consisting of three auction rate municipal bonds with stated
maturity dates ranging between 16 and 28 years. These auction rate securities
(ARS) consist of guaranteed student loans insured or reinsured by the federal
government. These ARS were historically auctioned every 35 days to set new rates
and provide a liquidating event in which investors could either buy or sell
securities. The auctions have been unable to sustain themselves during 2008 due
to the overall lack of credit market liquidity and we have been unable to
liquidate our ARS. Therefore, we have classified the ARS as long-term
investments and we have the ability to hold these securities to maturity, until
called by the issuer, or until liquidity returns to this market. As a result,
these securities will pay a default rate which is typically above market
interest rates.
The
Company has used a discounted cash flow model to determine the estimated fair
value of its investment in ARS as of September 30, 2008. The assumptions used in
preparing the discounted cash flow model include the following: estimated
interest rates, estimated discount rates (using yields of comparable traded
instruments adjusted for illiquidity and other risk factors), amount of cash
flows, and expected holding periods of the ARS. These inputs reflect the
Company’s judgments about assumptions that market participants would use in
pricing ARS including assumptions about risk. For the quarter ended September
30, 2008, the Company determined there was no decline in the fair value of its
ARS investments; therefore, no other than temporary impairment loss has been
reported.
Securities.
On February 1,
2008, we issued $60 million in principal amount of First Mortgage Bonds, 4.86%
Series due April 1, 2013, in the private placement market. We have the option to
prepay all or a portion of the bonds at our discretion, subject to a make-whole
provision. The bonds are subject to additional terms and conditions which are
customary for this type of transaction. We intend to use the proceeds from the
sale of the bonds to fund utility capital expenditures and for general corporate
purposes.
On May
14, 2008, we issued $75 million in principal amount of First Mortgage Bonds,
6.02% Series due May 1, 2023, in the private placement market. We have the
option to prepay all or a portion of the bonds at our discretion, subject to a
make-whole provision. The bonds are subject to additional terms and conditions
which are customary for this type of transaction. We intend to use the proceeds
from the sale of the bonds to fund utility capital expenditures and for general
corporate purposes.
On
February 19, 2008, we entered into a Distribution Agreement with KCCI, Inc. with
respect to the issuance and sale of up to 2.5 million shares of our common
stock, without par value. The shares may be offered for sale, from time to time,
in accordance with the terms of the Distribution Agreement, which terminates on
June 30, 2009. For the three months ended September 30,
2008, 528,400 shares of common stock were issued under this agreement
resulting in net proceeds of $23.2 million and compensation of $15,852 was paid
to KCCI, Inc. under agreement. For the nine months ended September 30, 2008,
653,400 shares of common stock have been issued under this agreement resulting
in net proceeds of $28.7 million and compensation of $19,602 was paid to KCCI,
Inc. under agreement.
Off-Balance
Sheet Arrangements
Off-balance
sheet arrangements are summarized in our 2007 Form 10-K, with additional
disclosure discussed in Note 11 of this Form 10-Q.
Capital
Requirements
For the
nine months ended September 30, 2008, capital expenditures totaled $211.1
million ($141.3 million for the nine months ended September 30, 2007).
The expenditures were primarily made in the Regulated Utility segment.
Internally generated funds and additional debt and equity issuances were the
primary sources of funding.
ALLETE
Third Quarter 2008 Form 10-Q
PENSION
AND OTHER POSTRETIREMENT BENEFIT PLANS
As of
September 30, 2008, our defined benefit pension and post retirement plan assets
have declined significantly since December 31, 2007. We will measure our plans’
asset values, pension and post retirement benefit obligations and calculate our
2009 pension and post retirement benefit expense and 2009 annual plan
contribution requirements at December 31, 2008.
At this
time we are unable to predict the plans’ assets values, and required valuation
parameters that will be used to calculate our related obligations, and the
resulting expenses and funding requirements for these plans at December 31,
2008.
Based
upon internal models as of September 30, 2008, considering current market
conditions, estimates of the plans’ current asset values and using estimates of
current market based obligation valuation parameters, we do not expect current
market conditions would have a material impact on the Company’s pension or post
employment benefit expense or plan funding requirements during the next 12
months.
ENVIRONMENTAL
MATTERS AND OTHER
Our
businesses are subject to regulation of environmental matters by various
federal, state and local authorities. Due to restrictive environmental
requirements through legislation and/or rulemaking in the future, 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 matters discussed in Note 11 of this
Form
10-Q.
NEW
ACCOUNTING STANDARDS
New
accounting standards are discussed in Note 1 of this Form 10-Q.
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
SECURITIES
INVESTMENTS
Available-For-Sale Securities.
As of September 30, 2008, our available-for-sale securities portfolio consisted
of securities in a grantor trust, established to fund certain employee benefits,
and auction rate securities. Our available-for-sale securities portfolio had a
fair value of $42.9 million at September 30, 2008 ($39.7 million at December 31,
2007), and a total unrealized after-tax loss of $0.7 million at September 30,
2008 ($5.1 million unrealized after tax gain at December 31, 2007). See Note 3 –
Investments for additional information.
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 share price trends and the impact of overall market conditions.
As a result of our periodic assessments, we did not record any impairments on
our available-for-sale securities for the quarter ended September 30,
2008.
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 investments in privately-held companies under the cost method
because of our ownership percentage. The total carrying value of our emerging
technology portfolio was $7.5 million at September 30, 2008 ($7.9 million at
December 31, 2007). 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. No impairments were recorded in the quarter ended September
30, 2008. In 2007, we recorded $0.5 million ($0.3 million after tax) of
impairments related to our venture capital funds whose future business prospects
had significantly diminished. Developments at these companies indicated that
future commercial viability was unlikely, as was new financing necessary to
continue development.
ALLETE
Third Quarter 2008 Form 10-Q
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(Continued)
COMMODITY
PRICE RISK
Our
regulated utility operations in Minnesota and Wisconsin incur costs for fuel
(primarily coal), power and natural gas purchased for resale in our regulated
service territories, and related transportation. Our regulated utilities’
exposure to price risk for these commodities is significantly mitigated by the
current ratemaking process and regulatory environment, which generally allows a
fuel clause surcharge if costs are in excess of those in our last rate filing.
Conversely, costs below those in our last rate filing resulted in a rate credit.
We seek to prudently manage our customers’ exposure to price risk by entering
into contracts of various durations and terms for the purchase of coal and power
(in Minnesota), power and natural gas (in Wisconsin), and related transportation
costs.
POWER
MARKETING
Our power
marketing activities consist of (1) purchasing energy in the wholesale market
for resale in our regulated service territories when retail energy requirements
exceed generation output and (2) selling excess available energy and purchased
power.
From time
to time, our utility operations may have excess energy that is temporarily not
required by retail and wholesale customers in our regulated service territory.
We actively sell this energy to the wholesale market to optimize the value of
our generating facilities. This energy is typically sold in the MISO market at
market prices.
Approximately
200 MW of capacity and energy from our Taconite Harbor facility in northern
Minnesota has been sold through various long-term capacity and energy contracts.
We have two 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. These
contracts qualify for the normal purchase normal sale exception under SFAS 133
“Accounting for Derivative Instruments and Hedging Activities” and are not
required to be recorded at fair value.
ITEM
4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and
Procedures.
As of September 30, 2008, evaluations were performed, under
the supervision and with the participation of management, including our
principal executive officer and principal financial officer, of the
effectiveness of the design and operation of ALLETE’s disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities
Exchange Act of 1934 (Exchange Act)). Based upon those evaluations, our
principal executive officer and principal financial officer have concluded that
such disclosure controls and procedures are effective to provide assurance that
information required to be disclosed in ALLETE’s reports filed or submitted
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the SEC’s rules and forms and such information is
accumulated and communicated to our management, including our principal
executive officer and principal financial officer, to allow timely decisions
regarding required disclosure.
Changes in Internal Controls.
While we continue to enhance our internal control over financial reporting,
there has been no change in our internal control over financial reporting that
occurred during our most recent fiscal quarter that has materially affected, or
is reasonably likely to materially affect, our internal control over financial
reporting.
ALLETE
Third Quarter 2008 Form 10-Q
PART
II. OTHER INFORMATION
ITEM
1. LEGAL PROCEEDINGS
Clean Air Act.
On August 8,
2008, Minnesota Power received a Notice of Violation (NOV) from the United
States EPA asserting violations of the New Source Review (NSR) requirements of
the Clean Air Act at Boswell Units 1-4 and Laskin Unit 2. The NOV also asserts
that the Boswell Unit 4 Title V permit was violated. The NOV asserts that seven
projects undertaken at these coal-fired plants between the years 1981 and 2000
should have been reviewed under the NSR requirement. Minnesota Power believes
the projects were in full compliance with the Clean Air Act, NSR requirements
and applicable permits.
The EPA
has been conducting a nationwide enforcement initiative since 1999 relating to
NSR requirements. In 2000, 2001, and 2002 Minnesota Power received requests from
the EPA pursuant to Section 114(a) of the Clean Air Act seeking information
regarding capital expenditures with respect to the Boswell and Laskin. Minnesota
Power responded to these requests; however, we had no further communications
from the EPA regarding the information provided until receipt of the
NOV.
We are
engaged in discussions with the EPA regarding resolution of these matters, but
we are unable to predict the outcome of these discussions. Since 2006, Minnesota
Power has significantly reduced and continues to reduce emissions at Boswell and
Laskin. The resolution could result in civil penalties and the installation of
control technology, some of which is already planned or completed for other
regulatory requirements. Any costs of installing pollution control technology
would likely be eligible for recovery in rates over time subject to MPUC and
FERC approval in a rate proceeding. We are unable to predict the ultimate
financial impact or the resolution of these matters at this time.
Any
additional material legal and regulatory proceedings are included in the
discussion of Other Information in Part II, Item 5 and/or Note 11 of this Form
10-Q, and are incorporated by reference herein.
ITEM
1A. RISK FACTORS
Other
than the following risk factor, there have been no material changes from the
risk factors disclosed under the heading “Risk Factors” in Part I, Item 1A of
our 2007 Form 10-K.
We
rely on access to financing sources and capital markets. If we do not have
access to sufficient capital in the amount and at the times needed, our ability
to execute our business plans, make capital expenditures or pursue acquisitions
that we may otherwise rely on for future growth could be impaired.
We rely
on access to capital markets as sources of liquidity for capital requirements
not satisfied by our cash flow from operations. If we are not able to access
capital on satisfactory terms, the ability to implement our business plans may
be adversely affected. Market disruptions or a downgrade of our credit ratings
may increase the cost of borrowing or adversely affect our ability to access one
or more financial markets. Such disruptions could include a severe prolonged
economic downturn, the bankruptcy of non-affiliated industry leaders in the same
line of business or financial services sector, deterioration in capital market
conditions, volatility in commodity prices or events such as those currently
being experienced in the United States and abroad.
ITEM
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS
None.
ITEM
3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ALLETE
Third Quarter 2008 Form 10-Q
ITEM
5. OTHER INFORMATION
Reference
is made to our 2007 Form 10-K for background information on the following
updates. Unless otherwise indicated, cited references are to our 2007 Form
10-K.
Ref. Page
8 – Energy – Regulated Utility, Large Power Customer Contracts – Fifth
Paragraph
|
|
Minimum
|
|
|
Minimum
Revenue and Demand Under Contract
|
Annual
Revenue
(a,
b)
|
Monthly
|
|
As
of October 1, 2008
|
(Millions)
|
Megawatts
|
|
|
|
|
|
2008
|
$107.8
|
734
|
|
2009
|
$40.0
|
242
|
|
2010
|
$25.5
|
148
|
|
2011
|
$25.3
|
148
|
|
2012
|
$23.3
|
136
|
|
|
|
|
|
(a)
|
Based
on past experience, we believe revenue from our Large Power Customers will
be substantially in excess of the minimum contract
amounts.
|
|
(b)
|
Although
several contracts have a feature that allows demand to go to zero after a
two-year advance notice of a permanent closure, this minimum revenue
summary does not reflect this occurrence happening in the forecasted
period because we believe it is
unlikely.
|
Ref. Page
13 – Energy-Regulated Utility, Federal Energy Regulatory Commission – First
Paragraph
Ancillary Services Market (ASM).
In February 2007, MISO filed revisions to its tariff aimed at
establishing a market for energy and operating reserves. In February 2008, FERC
issued its
Order on Ancillary
Services Filing.
The launch of the ASM market has been delayed until
January 2009. In May 2008, Minnesota Power and the other investor-owned
utilities in Minnesota prepared a joint filing seeking MPUC approval for the
authority to account for costs and revenues that have been instituted by the ASM
market. Comments on the joint filing were received in early July 2008, and
replies have been filed. The new ASM market is not expected to have a material
impact on the Company.
Ref. Page
13 – Energy - Regulated Utility, Minnesota Public Utilities Commission – First
Paragraph
On May 2,
2008, Minnesota Power filed a rate increase request with the MPUC seeking an
average increase of approximately 10 percent for retail customers. The rate
filing seeks an overall return on equity of 11.15 percent, and a capital
structure consisting of 54.8 percent equity and 45.2 percent debt. On an
annualized basis, the requested rate increase would generate approximately $45
million in additional revenue. Subsequent to the May filing, adjustments have
been made and Minnesota Power is now seeking an average rate increase of 8.75
percent, which would generate approximately $41 million in additional revenue on
an annualized basis. Interim rates were effective on August 1, 2008, and will
result in an average increase of approximately 7.5 percent or approximately $36
million for retail customers subject to refund pending the final rate order.
Incremental revenue in 2008 from the interim Minnesota retail rate increase is
expected to be approximately $13 million. The rate case schedule was approved at
an August 2008 prehearing conference, and all scheduled public hearings were
held in September and October 2008. Evidentiary hearings are scheduled for
November 2008. The final rate order is expected in the second quarter of 2009.
We cannot predict the amount of any rate increase the MPUC may
approve.
Ref. Page
13 – Energy-Regulated Utility, Minnesota Public Utilities Commission – Second
Paragraph
Integrated Resource Plan.
On
October 31, 2007, we filed our IRP, a comprehensive estimate of future capacity
needs within the Minnesota Power service territory. On July 25, 2008, we filed a
request with the MPUC for approval to re-file our IRP by October 1, 2009, in
order to incorporate the North Dakota wind project and otherwise update our load
forecasting and modeling in the IRP. In October 2008, the MPUC issued an order
approving the request to re-file the IRP by October 1, 2009.
ALLETE
Third Quarter 2008 Form 10-Q
ITEM
5. OTHER INFORMATION (Continued)
Ref. Page
14 – Energy-Regulated Utility, Public Service Commission of Wisconsin – First
Paragraph
SWL&P’s
current retail rates are based on a 2006 PSCW retail rate order, effective
January 1, 2007. On May 14, 2008, SWL&P filed a rate increase request with
the PSCW seeking an average increase of approximately 5 percent for retail
customers. The rate filing seeks an overall return on equity of 11.5 percent,
and a capital structure consisting of 57.1 percent equity and 42.9 percent debt.
On an annualized basis, the requested rate increase would generate approximately
$4 million in additional revenue. Evidentiary and public hearings were held
October 7, 2008. The Company anticipates new rates will take effect in January
2009. We cannot predict the amount of any rate increase the PSCW may
approve.
Ref. Page
19 – Environmental Matters, Air, Clean Air Act – First Paragraph
On August
8, 2008, Minnesota Power received a Notice of Violation (NOV) from the United
States EPA asserting violations of the New Source Review (NSR) requirements of
the Clean Air Act at Boswell Units 1-4 and Laskin Unit 2. The NOV also asserts
that the Boswell Unit 4 Title V permit was violated. The NOV asserts that seven
projects undertaken at these coal-fired plants between the years 1981 and 2000
should have been reviewed under the NSR requirement. Minnesota Power believes
the projects were in full compliance with the Clean Air Act, NSR requirements
and applicable permits.
The EPA
has been conducting a nation-wide enforcement initiative since 1999 relating to
NSR requirements. In 2000, 2001, and 2002 Minnesota Power received requests from
the EPA for information pursuant to Section 114(a) of the Clean Air Act seeking
information regarding capital expenditures with respect to the Boswell and
Laskin. Minnesota Power responded to these requests; however, we have had no
further communications from the EPA regarding the information provided until
receipt of the NOV.
We are
engaged in discussions with the EPA regarding resolution of these matters, but
we are unable to predict the outcome of these discussions. Since 2006, Minnesota
Power has significantly reduced and continues to reduce emissions at Boswell and
Laskin. The resolution could result in civil penalties and the installation of
control technology, some of which is already planned or completed for other
regulatory requirements. Any costs of installing pollution control technology
would likely be eligible for recovery in rates over time subject to MPUC and
FERC approval in a rate proceeding. We are unable to predict the ultimate
financial impact or the resolution of these matters at this time.
Ref. Page
19 – Environmental Matters - Air – Second Paragraph
EPA Clean Air Interstate
Rule.
In March 2005, the EPA announced the Clean Air Interstate Rule
(CAIR) that sought to reduce and permanently cap emissions of SO
2
, NO
X
and
particulates in the eastern United States. The CAIR included Minnesota as one of
the 28 states it considered as “significantly contributing” to air quality
standards non-attainment in other downwind states. On July 11, 2008, the United
States Court of Appeals for the District of Columbia Circuit (Court) vacated the
CAIR and remanded the rulemaking to the EPA for reconsideration while also
granting the Minnesota Power petition that the EPA reconsider including
Minnesota as a CAIR state. The EPA and several other parties have petitioned the
Court to reconsider its decision. It is uncertain how the court will
respond.
If the
EPA revises the CAIR, the EPA would need to specifically justify including
Minnesota with those states subject to such revised rules. If the CAIR becomes
effective, we expect we will be required to supplement planned emission control
retrofits to address regional haze concerns by making emission allowance
purchases, supplemental emission reductions or a combination of both. If CAIR
does not go into effect, we expect that emission reduction measures taken with
AREA and Boswell Unit 3 emission control retrofits will be sufficient to satisfy
environmental requirements for the next several years.
ALLETE
Third Quarter 2008 Form 10-Q
ITEM
5. OTHER INFORMATION (Continued)
Ref. Page
19 – Environmental Matters – Air – Fourth Paragraph
EPA Clean Air Mercury Rule.
In March 2005, the EPA announced the Clean Air Mercury Rule (CAMR) that would
have reduced and permanently capped emissions of electric utility mercury
emissions in the continental United States. In February 2008, the Court
overturned the CAMR and remanded the rulemaking to the EPA for reconsideration.
In October 2008, the Department of Justice (DOJ), on behalf of the EPA,
petitioned the Supreme Court to review the Court’s decision in the CAMR case. It
is uncertain how the Supreme Court will respond. Cost estimates for complying
with future mercury regulations under the Clean Air Act are therefore premature
at this time.
Ref. Page
20 – Employees – Third Paragraph
On May
14, 2008, the labor agreement between BNI Coal and the International Brotherhood
of Electrical Workers (IBEW) local 1593 was signed for a three year
period.
ALLETE
Third Quarter 2008 Form 10-Q
ITEM
6. EXHIBITS
Exhibit
Number
|
31(a)
|
Rule
13a-14(a)/15d-14(a) Certification by the Chief Executive Officer Pursuant
to Section 302 of the Sarbanes-Oxley Act of
2002.
|
|
31(b)
|
Rule
13a-14(a)/15d-14(a) Certification by the Chief Financial Officer Pursuant
to Section 302 of the Sarbanes-Oxley Act of
2002.
|
|
|
32
|
|
Section
1350 Certification of Periodic Report by the Chief Executive Officer and
Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
|
|
|
99
|
|
ALLETE
News Release dated October 31, 2008, announcing 2008 third 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
Third Quarter 2008 Form 10-Q
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
|
|
|
ALLETE,
INC.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
October
31, 2008
|
|
/s/
Mark A. Schober
|
|
|
|
Mark
A. Schober
|
|
|
|
Senior
Vice President and Chief Financial Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
October
31, 2008
|
|
/s/
Steven Q. DeVinck
|
|
|
|
Steven
Q. DeVinck
|
|
|
|
Controller
|
ALLETE
Third Quarter 2008 Form 10-Q