Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q
(Mark One)
x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended March 31, 2018
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.   x Yes   ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   x Yes   ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer x
Accelerated Filer ¨
 
Non-Accelerated Filer ¨
Smaller Reporting Company ¨
 
 
Emerging Growth Company ¨
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ¨

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

Common Stock, without par value,
51,271,007 shares outstanding
as of March 31, 2018



Index
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

ALLETE, Inc. First Quarter 2018 Form 10-Q
2


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 – the cost of both debt and equity funds used to finance regulated utility plant additions during construction periods
ALLETE
ALLETE, Inc.
ALLETE Clean Energy
ALLETE Clean Energy, Inc. and its subsidiaries
ALLETE Properties
ALLETE Properties, LLC and its subsidiaries
ALLETE Transmission Holdings
ALLETE Transmission Holdings, Inc.
ATC
American Transmission Company LLC
Bison
Bison Wind Energy Center
BNI Energy
BNI Energy, Inc. and its subsidiary
Boswell
Boswell Energy Center
Camp Ripley
Camp Ripley Solar Array
CO2
Carbon Dioxide
Company
ALLETE, Inc. and its subsidiaries
CIP
Conservation Improvement Program
Cliffs
Cleveland-Cliffs Inc.
CSAPR
Cross-State Air Pollution Rule
DC
Direct Current
EIS
Environmental Impact Statement
EITE
Energy-Intensive Trade-Exposed
EPA
United States Environmental Protection Agency
ERP Iron Ore
ERP Iron Ore, LLC
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
GAAP
Generally Accepted Accounting Principles in the United States of America
GHG
Greenhouse Gases
GNTL
Great Northern Transmission Line
Invest Direct
ALLETE’s Direct Stock Purchase and Dividend Reinvestment Plan
IRP
Integrated Resource Plan
Item ___
Item ___ of this Form 10-Q
kV
Kilovolt(s)
kW / kWh
Kilowatt(s) / Kilowatt-hour(s)
Laskin
Laskin Energy Center
Magnetation
Magnetation, LLC
Manitoba Hydro
Manitoba Hydro-Electric Board
MATS
Mercury and Air Toxics Standards
Mesabi Metallics
Mesabi Metallics Company, LLC (formerly Essar Steel Minnesota, LLC)
Minnesota Power
An operating division of ALLETE, Inc.
Minnkota Power
Minnkota Power Cooperative, Inc.
MISO
Midcontinent Independent System Operator, Inc.

ALLETE, Inc. First Quarter 2018 Form 10-Q
3


Abbreviation or Acronym
Term
Montana-Dakota Utilities
Montana-Dakota Utilities Co., a division of MDU Resources Group, Inc.
MPCA
Minnesota Pollution Control Agency
MPUC
Minnesota Public Utilities Commission
MW / MWh
Megawatt(s) / Megawatt-hour(s)
NAAQS
National Ambient Air Quality Standards
NDPSC
North Dakota Public Service Commission
NOL
Net Operating Loss
NO2
Nitrogen Dioxide
NOX
Nitrogen Oxides
Northern States Power
Northern States Power Company, a subsidiary of Xcel Energy Inc.
Northshore Mining
Northshore Mining Company, a wholly-owned subsidiary of Cleveland-Cliffs Inc.
Note ___
Note ___ to the Consolidated Financial Statements in this Form 10-Q
NPDES
National Pollutant Discharge Elimination System
Oliver Wind I
Oliver Wind I Energy Center
Oliver Wind II
Oliver Wind II Energy Center
Palm Coast Park District
Palm Coast Park Community Development District in Florida
PolyMet
PolyMet Mining Corp.
PPA / PSA
Power Purchase Agreement / Power Sales Agreement
PPACA
Patient Protection and Affordable Care Act of 2010
PSCW
Public Service Commission of Wisconsin
SEC
Securities and Exchange Commission
Silver Bay Power
Silver Bay Power Company, a wholly-owned subsidiary of Cleveland-Cliffs Inc.
SO2
Sulfur Dioxide
Square Butte
Square Butte Electric Cooperative, a North Dakota cooperative corporation
SWL&P
Superior Water, Light and Power Company
Taconite Harbor
Taconite Harbor Energy Center
TCJA
Tax Cuts and Job Act of 2017 (Public Law 115-97)
Tenaska
Tenaska Energy, Inc. and Tenaska Energy Holdings, LLC
Thomson
Thomson Energy Center
Tonka Water
Tonka Equipment Company
Town Center District
Town Center at Palm Coast Community Development District in Florida
UPM Blandin
UPM, Blandin Paper Mill owned by UPM-Kymmene Corporation

U.S.
United States of America
U.S. Water Services
U.S. Water Services Holding Company and its subsidiaries
USS Corporation
United States Steel Corporation
WTG
Wind Turbine Generator



ALLETE, Inc. First Quarter 2018 Form 10-Q
4


Forward-Looking Statements

Statements in this report that are not statements of historical facts are considered “forward-looking” and, accordingly, involve risks and uncertainties that could cause actual results to differ materially from those discussed. Although such forward-looking statements have been made in good faith and are based on reasonable assumptions, there can be no assurance that the expected results will be achieved. Any statements that express, or involve discussions as to, future expectations, risks, beliefs, plans, objectives, assumptions, events, uncertainties, financial performance, or growth strategies (often, but not always, through the use of words or phrases such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “projects,” “likely,” “will continue,” “could,” “may,” “potential,” “target,” “outlook” or words of similar meaning) are not statements of historical facts and may be forward-looking.

In connection with the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, we are providing this cautionary statement to identify important factors that could cause our actual results to differ materially from those indicated in forward-looking statements made by or on behalf of ALLETE in this Form 10-Q, in presentations, on our website, in response to questions or otherwise. 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 in connection with such forward-looking statements that could cause our actual results to differ materially from those indicated in the forward-looking statements:

our ability to successfully implement our strategic objectives;
global and domestic economic conditions affecting us or our customers;
changes in and compliance with laws and regulations;
changes in tax rates or policies or in rates of inflation;
the outcome of legal and administrative proceedings (whether civil or criminal) and settlements;
weather conditions, natural disasters and pandemic diseases;
our ability to access capital markets and bank financing;
changes in interest rates and the performance of the financial markets;
project delays or changes in project costs;
changes in operating expenses and capital expenditures and our ability to raise revenues from our customers in regulated rates or sales price increases at our Energy Infrastructure and Related Services businesses;
the impacts of commodity prices on ALLETE and our customers;
our ability to attract and retain qualified, skilled and experienced personnel;
effects of emerging technology;
war, acts of terrorism and cyberattacks;
our ability to manage expansion and integrate acquisitions;
population growth rates and demographic patterns;
wholesale power market conditions;
federal and state regulatory and legislative actions that impact regulated utility economics, including our allowed rates of return, capital structure, ability to secure financing, industry and rate structure, acquisition and disposal of assets and facilities, operation and construction of plant facilities and utility infrastructure, recovery of purchased power, capital investments and other expenses, including present or prospective environmental matters;
effects of competition, including competition for retail and wholesale customers;
effects of restructuring initiatives in the electric industry;
the impacts on our Regulated Operations segment of climate change and future regulation to restrict the emissions of GHG;
effects of increased deployment of distributed low-carbon electricity generation resources;
the impacts of laws and regulations related to renewable and distributed generation;
pricing, availability and transportation of fuel and other commodities and the ability to recover the costs of such commodities;
our current and potential industrial and municipal customers’ ability to execute announced expansion plans;
real estate market conditions where our legacy Florida real estate investment is located may not improve;
the success of efforts to realize value from, invest in, and develop new opportunities in, our Energy Infrastructure and Related Services businesses; and
factors affecting our Energy Infrastructure and Related Services businesses, including fluctuations in the volume of customer orders, unanticipated cost increases, changes in legislation and regulations impacting the industries in which the customers served operate, the effects of weather, creditworthiness of customers, ability to obtain materials required to perform services, and changing market conditions.



ALLETE, Inc. First Quarter 2018 Form 10-Q
5


Forward-Looking Statements (Continued)

Additional disclosures regarding factors that could cause our results or performance to differ from those anticipated by this report are discussed in Part 1, Item 1A under the heading “Risk Factors” of ALLETE’s 2017 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 ALLETE in this Form 10-Q and in other reports filed with the SEC that attempt to identify the risks and uncertainties that may affect ALLETE’s business.

ALLETE, Inc. First Quarter 2018 Form 10-Q
6


PART I.  FINANCIAL INFORMATION

ITEM 1.  CONSOLIDATED FINANCIAL STATEMENTS

ALLETE
CONSOLIDATED BALANCE SHEET
Unaudited
 
March 31,
2018

 
December 31,
2017

Millions
 
 
 
Assets
 
 
 
Current Assets
 
 
 
Cash and Cash Equivalents

$98.5

 

$98.9

Accounts Receivable (Less Allowance of $2.1 and $2.1)
128.2

 
135.1

Inventories – Net
143.1

 
95.9

Prepayments and Other
33.8

 
37.6

Total Current Assets
403.6

 
367.5

Property, Plant and Equipment – Net
3,786.1

 
3,822.4

Regulatory Assets
376.0

 
384.7

Investment in ATC
120.1

 
118.7

Other Investments
52.8

 
53.1

Goodwill and Intangible Assets – Net
224.5

 
225.9

Other Non-Current Assets
109.0

 
107.7

Total Assets

$5,072.1

 

$5,080.0

Liabilities and Shareholders’ Equity
 
 
 
Liabilities
 
 
 
Current Liabilities
 
 
 
Accounts Payable

$88.1

 

$136.3

Accrued Taxes
60.5

 
50.0

Accrued Interest
14.6

 
17.6

Long-Term Debt Due Within One Year
106.2

 
64.1

Other
130.2

 
83.2

Total Current Liabilities
399.6

 
351.2

Long-Term Debt
1,396.5

 
1,439.2

Deferred Income Taxes
229.7

 
230.5

Regulatory Liabilities
516.0

 
532.0

Defined Benefit Pension and Other Postretirement Benefit Plans
175.2

 
191.8

Other Non-Current Liabilities
257.8

 
267.1

Total Liabilities
2,974.8

 
3,011.8

Commitments, Guarantees and Contingencies (Note 13)

 

Shareholders’ Equity
 
 
 
Common Stock Without Par Value, 80.0 Shares Authorized, 51.3 and 51.1 Shares Issued and Outstanding
1,407.4

 
1,401.4

Accumulated Other Comprehensive Loss
(27.9
)
 
(22.6
)
Retained Earnings
717.8

 
689.4

Total Shareholders’ Equity
2,097.3

 
2,068.2

Total Liabilities and Shareholders’ Equity

$5,072.1

 

$5,080.0

The accompanying notes are an integral part of these statements.

ALLETE, Inc. First Quarter 2018 Form 10-Q
7


ALLETE
CONSOLIDATED STATEMENT OF INCOME
Unaudited
 
Three Months Ended
 
March 31,
 
2018
2017
Millions Except Per Share Amounts
 
 
Operating Revenue
 
 
Contracts with Customers – Utility

$270.2


$281.6

Contracts with Customers – Non-utility
82.0

78.1

Other – Non-utility
6.0

5.9

Total Operating Revenue
358.2

365.6

Operating Expenses
 
 
Fuel, Purchased Power and Gas – Utility
100.9

96.6

Transmission Services – Utility
18.4

16.6

Cost of Sales – Non-utility
32.9

31.5

Operating and Maintenance
86.5

84.4

Depreciation and Amortization
45.8

50.5

Taxes Other than Income Taxes
16.3

14.4

Total Operating Expenses
300.8

294.0

Operating Income
57.4

71.6

Other Income (Expense)
 
 
Interest Expense
(16.9
)
(17.2
)
Equity Earnings in ATC
4.7

6.1

Other
2.1

1.6

Total Other Expense
(10.1
)
(9.5
)
Income Before Income Taxes
47.3

62.1

Income Tax Expense (Benefit)
(3.7
)
13.1

Net Income

$51.0


$49.0

Average Shares of Common Stock
 
 
Basic
51.2

50.2

Diluted
51.4

50.4

Basic Earnings Per Share of Common Stock

$1.00


$0.97

Diluted Earnings Per Share of Common Stock

$0.99


$0.97

Dividends Per Share of Common Stock

$0.56


$0.535

The accompanying notes are an integral part of these statements.

ALLETE, Inc. First Quarter 2018 Form 10-Q
8


ALLETE
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
Unaudited
 
Three Months Ended
 
March 31,
 
2018
 
2017
Millions
 
 
 
Net Income

$51.0

 

$49.0

Other Comprehensive Income (Loss)
 
 
 
Unrealized Gain (Loss) on Securities
 
 
 
Net of Income Tax Expense of $– and $0.3
(0.1
)
 
0.3

Defined Benefit Pension and Other Postretirement Benefit Plans
 
 
 
Net of Income Tax Expense of $0.1 and $0.1
0.4

 
0.2

Total Other Comprehensive Income
0.3

 
0.5

Total Comprehensive Income

$51.3

 

$49.5

The accompanying notes are an integral part of these statements.


ALLETE, Inc. First Quarter 2018 Form 10-Q
9


ALLETE
CONSOLIDATED STATEMENT OF CASH FLOWS
Unaudited
 
Three Months Ended
 
March 31,
 
2018
 
2017
Millions
 
 
 
Operating Activities
 
 
 
Net Income

$51.0

 

$49.0

AFUDC – Equity
(0.3
)
 
(0.2
)
Income from Equity Investments – Net of Dividends
(0.5
)
 
(1.5
)
Change in Fair Value of Contingent Consideration

 
(0.4
)
Loss (Gain) on Sales of Investments and Property, Plant and Equipment
(0.1
)
 
0.1

Depreciation Expense
44.5

 
49.2

Amortization of PSAs
(6.0
)
 
(5.9
)
Amortization of Other Intangible Assets and Other Assets
2.8

 
2.9

Deferred Income Tax Expense
(4.4
)
 
13.0

Share-Based and ESOP Compensation Expense
1.7

 
1.8

Defined Benefit Pension and Postretirement Benefit Expense
2.2

 
2.5

Provision for Interim Rate Refund
4.4

 

Provision for Tax Reform Refund
7.5

 

Bad Debt Expense (Recoveries)
0.3

 
(0.4
)
Changes in Operating Assets and Liabilities
 
 
 
Accounts Receivable
6.3

 
0.1

Inventories
(0.3
)
 
(6.3
)
Prepayments and Other
(1.2
)
 
1.8

Accounts Payable
(0.1
)
 
(11.3
)
Other Current Liabilities
17.3

 
(1.0
)
Cash Contributions to Defined Benefit Pension Plans
(15.0
)
 
(1.7
)
Changes in Regulatory and Other Non-Current Assets
3.8

 
9.6

Changes in Regulatory and Other Non-Current Liabilities
7.4

 
(2.6
)
Cash from Operating Activities
121.3

 
98.7

Investing Activities
 
 
 
Proceeds from Sale of Available-for-sale Securities
3.3

 
0.3

Payments for Purchase of Available-for-sale Securities
(5.3
)
 
(0.5
)
Investment in ATC
(1.6
)
 
(3.1
)
Changes to Other Investments
2.5

 
(1.2
)
Additions to Property, Plant and Equipment
(88.1
)
 
(36.7
)
Other Investing Activities
0.2

 
0.1

Cash for Investing Activities
(89.0
)
 
(41.1
)
Financing Activities
 
 
 
Proceeds from Issuance of Common Stock
4.3

 
70.6

Changes in Notes Payable

 
1.3

Repayments of Long-Term Debt
(1.9
)
 
(26.3
)
Acquisition-Related Contingent Consideration Payments

 
(15.1
)
Dividends on Common Stock
(28.7
)
 
(26.9
)
Other Financing Activities
(0.2
)
 

Cash from (for) Financing Activities
(26.5
)
 
3.6

Change in Cash, Cash Equivalents and Restricted Cash
5.8

 
61.2

Cash, Cash Equivalents and Restricted Cash at Beginning of Period
110.1

 
38.3

Cash, Cash Equivalents and Restricted Cash at End of Period

$115.9

 

$99.5

The accompanying notes are an integral part of these statements.

ALLETE, Inc. First Quarter 2018 Form 10-Q
10


ALLETE
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
Unaudited
 
Total Shareholders’
Equity
Retained
Earnings
Accumulated
Other
Comprehensive
Loss
Common
Stock
Millions
 
 
 
 
Balance as of December 31, 2017

$2,068.2


$689.4

$(22.6)

$1,401.4

Adjustments to Opening Balance – Net of Income Taxes (a)
0.5

6.1

(5.6
)

Balance as of January 1, 2018
2,068.7

695.5

(28.2
)
1,401.4

Comprehensive Income
 
 
 
 
Net Income
51.0

51.0



Other Comprehensive Income – Net of Income Taxes
 
 
 
 
Unrealized Loss on Debt Securities
(0.1
)

(0.1
)

Defined Benefit Pension and Other Postretirement Plans
0.4


0.4


Total Comprehensive Income
51.3

 
 
 
Common Stock Issued
6.0



6.0

Dividends Declared
(28.7
)
(28.7
)


Balance as of March 31, 2018

$2,097.3


$717.8

$(27.9)

$1,407.4

(a)
Reflects the impacts associated with the recently adopted accounting standards concerning Financial Instruments, Revenue from Contracts with Customers and the Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. (See Note 1. Operations and Significant Accounting Policies.)

The accompanying notes are an integral part of these statements.

ALLETE, Inc. First Quarter 2018 Form 10-Q
11


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – UNAUDITED

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 31, 2017, Consolidated Balance Sheet was derived from audited financial statements, but does not include all disclosures required by GAAP. In management’s opinion, these unaudited financial statements include all adjustments necessary for a fair statement of financial results. All adjustments are of a normal, recurring nature, except as otherwise disclosed. Operating results for the three months ended March 31, 2018, are not necessarily indicative of results that may be expected for any other interim period or for the year ending December 31, 2018. For further information, refer to the Consolidated Financial Statements and notes included in our 2017 Form 10-K.

NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

Cash, Cash Equivalents and Restricted Cash. We consider all investments purchased with original maturities of three months or less to be cash equivalents. Restricted cash amounts included in Prepayments and Other on the Consolidated Balance Sheet include collateral deposits required under an ALLETE Clean Energy loan agreement and U.S. Water Service’s standby letters of credit. The restricted cash amounts included in Other Non-Current Assets represents collateral deposits required under an ALLETE Clean Energy loan agreement and PSAs, and deposits from a SWL&P customer in aid of future capital expenditures. The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the Consolidated Balance Sheet that aggregate to the amount presented in the Consolidated Statement of Cash Flows. During the first quarter of 2018, the Company updated the presentation of its Consolidated Statement of Cash Flows to include restricted cash with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the Consolidated Statement of Cash Flows. (See Recently Adopted Pronouncements - Statement of Cash Flows: Restricted Cash.)
Cash, Cash Equivalents and Restricted Cash
March 31,
2018

 
December 31,
2017

 
March 31,
2017

 
December 31,
2016

Millions
 
 
 
 
 
 
 
Cash and Cash Equivalents

$98.5

 

$98.9

 

$81.8

 

$27.5

Restricted Cash included in Prepayments and Other
8.8

 
2.6

 
9.1

 
2.2

Restricted Cash included in Other Non-Current Assets
8.6

 
8.6

 
8.6

 
8.6

Cash, Cash Equivalents and Restricted Cash in the Consolidated Statement of Cash Flows

$115.9

 

$110.1

 

$99.5

 

$38.3


Inventories – Net. Inventories are stated at the lower of cost or net realizable value. Inventories in our Regulated Operations segment are carried at an average cost or first-in, first-out basis. Inventories in our U.S. Water Services and ALLETE Clean Energy segments, and Corporate and Other operations are carried at an average cost, first-in, first-out or specific identification basis.
Inventories – Net
March 31,
2018

 
December 31,
2017

Millions
 
 
 
Fuel (a)

$33.8

 

$34.8

Materials and Supplies
46.9

 
46.5

Construction of Wind Energy Facility (b)
46.9

 

Raw Materials
2.8

 
2.8

Work in Progress
4.2

 
4.2

Finished Goods
9.3

 
8.3

Reserve for Obsolescence
(0.8
)
 
(0.7
)
Total Inventories – Net

$143.1

 

$95.9

(a)
Fuel consists primarily of coal inventory at Minnesota Power.
(b)
On February 28, 2018, Montana-Dakota Utilities exercised its option to purchase the Thunder Spirit II wind energy facility upon completion, resulting in a reclassification of the project value from Property, Plant and Equipment – Net to Inventory – Net as ALLETE Clean Energy will no longer own and operate the facility upon completion.



ALLETE, Inc. First Quarter 2018 Form 10-Q
12


NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Other Non-Current Assets
March 31,
2018

 
December 31,
2017

Millions
 
 
 
Contract Assets (a)

$31.0

 

$31.6

Finance Receivable
10.9

 
11.0

Other
67.1

 
65.1

Total Other Non-Current Assets

$109.0

 

$107.7

(a)
Contract Assets include payments made to customers as an incentive to execute or extend service agreements. The contract payments are being amortized over the term of the respective agreements.
Other Current Liabilities
March 31,
2018

 
December 31,
2017

Millions
 
 
 
Provision for Interim Rate Refund (a)

$28.1

 

PSAs
21.5

 

$24.5

Contract Liabilities (b)
20.0

 
8.7

Provision for Tax Reform Refund (c)
7.5

 

Contingent Consideration (d)
5.5

 

Other
47.6

 
50.0

Total Other Current Liabilities

$130.2

 

$83.2

(a)
Provision for Interim Rate Refund is expected to be refunded to Minnesota Power’s regulated retail customers in the first quarter of 2019. (See Note 6. Regulatory Matters.)
(b)
Contract Liabilities include deposits received as a result of entering into contracts with our customers prior to completing our performance obligations.
(c)
Provision for Tax Reform Refund is deferred as a regulatory liability pending the outcome of regulatory proceedings with the MPUC and PSCW. (See Note 6. Regulatory Matters.)
(d)
Contingent Consideration relates to the estimated fair value of the earnings-based payment resulting from the U.S. Water Services acquisition. (See Note 5. Fair Value.)
Other Non-Current Liabilities
March 31,
2018

 
December 31,
2017

Millions
 
 
 
Asset Retirement Obligation

$122.9

 

$122.7

PSAs
86.3

 
89.5

Contingent Consideration (a)

 
5.4

Other
48.6

 
49.5

Total Other Non-Current Liabilities

$257.8

 

$267.1

(a)
Contingent Consideration relates to the estimated fair value of the earnings-based payment resulting from the U.S. Water Services acquisition. (See Note 5. Fair Value.)

ALLETE, Inc. First Quarter 2018 Form 10-Q
13


NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Supplemental Statement of Cash Flows Information.
Three Months Ended March 31,
2018

 
2017

Millions
 
 
 
Cash Paid for Interest – Net of Amounts Capitalized

$19.3

 

$18.9

Noncash Investing and Financing Activities
 

 
 

Decrease in Accounts Payable for Capital Additions to Property, Plant and Equipment
$(48.1)
 
$(3.5)
Reclassification of Property, Plant and Equipment to Inventory (a)

$46.9

 

Capitalized Asset Retirement Costs

$0.8

 

$19.3

AFUDC–Equity

$0.3

 

$0.2

ALLETE Common Stock Contributed to the Pension Plans

 

$13.5

(a)
On February 28, 2018, Montana-Dakota Utilities exercised its option to purchase the Thunder Spirit II wind energy facility upon completion, resulting in a reclassification of the project value from Property, Plant and Equipment – Net to Inventory – Net as ALLETE Clean Energy will no longer own and operate the facility upon completion.

Subsequent Events. The Company performed an evaluation of subsequent events for potential recognition and disclosure through the date of the financial statements issuance.

Revenue.

Contracts with Customers Utility includes sales from our regulated operations for generation, transmission and distribution of electric service, and distribution of water and gas services to our customers. Also included is an immaterial amount of regulated steam generation that is used during production of paper and pulp.

Contracts with Customers Non-utility includes sales of goods and services to customers from ALLETE Clean Energy, U.S. Water Services and our Corporate and Other businesses.

Other Non-utility is the non-cash revenue recognized by ALLETE Clean Energy for the amortization of differences between contract prices and estimated market prices for PSAs that were assumed during the acquisition of various wind energy facilities.

Revenue Recognition

Revenue is recognized upon transfer of control of promised goods or services to our customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. Revenue is recognized net of allowance for returns and any taxes collected from customers, which are subsequently remitted to the appropriate governmental authorities. We account for shipping and handling activities that occur after the customer obtains control of goods as a cost rather than an additional performance obligation thereby recognizing revenue at time of shipment and accruing shipping and handling costs when control transfers to our customers. We have a right to consideration from our customers in an amount that corresponds directly with the value to the customer for our performance completed to date; therefore, we may recognize revenue in the amount to which we have a right to invoice.

Nature of Revenue Streams

Utility

Residential and Commercial includes sales for electric, gas or water service to customers, who have implied contracts with the utility, under rates governed by the MPUC, PSCW or FERC. Customers are billed on a monthly cycle basis and revenue is recognized for electric, gas or water service delivered during the billing period. Revenue is accrued for service provided but not yet billed at period end. Performance obligations with these customers are satisfied at time of delivery to customer meters and simultaneously consumed.

ALLETE, Inc. First Quarter 2018 Form 10-Q
14


NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Revenue (Continued)

Municipal includes sales to 16 non-affiliated municipal customers in Minnesota under long-term wholesale electric contracts. All wholesale electric contracts include a termination clause requiring a three-year notice to terminate. These contracts have termination dates ranging from 2019 through at least 2032, with a majority of contracts effective through at least 2024. Performance obligations with these customers are satisfied at the time energy is delivered to an agreed upon municipal substation or meter.

Industrial includes sales recognized from contracts with customers in the taconite mining, iron concentrate, paper, pulp and secondary wood products, pipeline and other industries. Industrial sales accounted for approximately 49 percent of total regulated utility kWh sales for the three months ended March 31, 2018. Within industrial revenue, Minnesota Power has 9 Large Power Customer contracts, each serving requirements of 10 MW or more of customer load. These contracts automatically renew past the contract term unless a four-year advanced written notice is given. Large Power Customer contracts have earliest termination dates ranging from 2022 through 2026. We satisfy our performance obligations for these customers at the time energy is delivered to an agreed upon customer substation. Revenue is accrued for energy provided but not yet billed at period end. Based on current contracts with industrial customers, we expect to recognize minimum revenue for the fixed contract components of approximately $70 million per annum through 2019, $50 million in 2020 and 2021, $30 million in 2022 and $30 million for aggregate years thereafter, which reflects the termination notice period in these contracts. When determining minimum revenue, we assume that customer contracts will continue under the contract renewal provision; however, if long-term contracts are renegotiated and subsequently approved by the MPUC or there are changes within our industrial customer class, these amounts may be impacted. Contracts with customers that contain variable pricing or quantity components are excluded from the expected minimum revenue amounts.
 
Other Power Suppliers includes the sale of energy under long-term PSAs with two customers as well as MISO market and liquidation sales. Expiration dates of these PSAs range from 2020 through 2026. Performance obligations with these customers are satisfied at the time energy is delivered to an agreed upon delivery point defined in the contract (generally the MISO pricing node). Based on current contracts with customers, we expect to recognize minimum revenue for fixed contract components of approximately $10 million per annum through 2019. Other power supplier contracts that extend beyond 2020 contain variable pricing components that prevent us from estimating future minimum revenue, and therefore are not included.

Other Revenue includes all remaining individually immaterial revenue streams for Minnesota Power and SWL&P, and is comprised of steam sales to paper and pulp mills, wheeling revenue and other sources. Revenue for steam sales to customers is recognized at the time steam is delivered and simultaneously consumed, and includes standard payment terms. Revenue is recognized at the time each performance obligation is satisfied.

Alternative Programs includes revenue that is driven by factors outside of our regulated entities’ control or as a result of the achievement of certain objectives, such as CIP financial incentives. This revenue is accounted for in accordance with the accounting standards for alternative revenue programs which allow for the recognition of revenue under an alternative revenue program if the program is established by an order from the utility’s regulatory commission, the order allows for automatic adjustment of future rates, the amount of revenue recognized is objectively determinable and probable of recovery, and the revenue will be collected within 24 months following the end of the annual period in which it is recognized. CIP financial incentives are recognized in the period in which the MPUC approves the filing, which is typically mid-year.

Non-utility

ALLETE Clean Energy

Long-term PSA revenue includes all sales recognized under long-term contracts for production, curtailment, capacity and associated renewable energy credits for ALLETE Clean Energy generation facilities. Expiration dates of these PSAs range from 2018 through 2032. Performance obligations for these contracts are satisfied at the time energy is delivered to an agreed upon point, or production is curtailed at the request of the customer, at specified prices. Revenue from the sale of renewable energy credits is recognized at the same time the related energy is delivered to the customer when sold to the same party.

Other is the non-cash revenue recognized by ALLETE Clean Energy for the amortization of differences between contract prices and estimated market prices on assumed PSAs. As part of wind energy facility acquisitions, ALLETE Clean Energy assumed various PSAs that were above or below estimated market prices at the time of acquisition; the resulting differences between contract prices and estimated market prices are amortized to revenue over the remaining PSA term.

ALLETE, Inc. First Quarter 2018 Form 10-Q
15


NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Revenue (Continued)

U.S. Water Services

Point-in-time revenue is recognized for purchases by customers for chemicals, consumable equipment (e.g. filters, pumps and valves) or related maintenance and repair services as the customer’s usage and needs change over time. These goods and services are purchased on an as-needed basis by the customers and therefore revenue can be variable. Products are shipped to the customer in accordance with the terms of the purchase order, and performance obligations are satisfied at the time of shipment of goods or when services have been rendered to the customer.

Contract includes monthly revenue from contracts with customers to provide chemicals, consumable equipment and services to meet customer needs during the contract period. As agreed with the customer, a fixed amount is invoiced based on the goods and services to be provided under the contract. The duration of these contracts generally range in length from three months to five years and automatically renew. A 30-day notice is required to terminate such contracts without penalty after contract execution. Performance obligations are satisfied during the period as goods and service are delivered in accordance with the terms of the contract.

Capital Project includes the sale of equipment and other components assembled to create a water treatment system for the customer. These projects are provided under contracts at an agreed upon price to meet a customer's specifications and typically take less than one year to complete. In general, progress payments are received throughout the project period and are recorded as contract liabilities until performance obligations are satisfied at the time the equipment and other components are delivered to the customer’s site.

Corporate and Other

Long-term Contract encompasses the sale and delivery of coal to customer generation facilities. Revenue is recognized on a monthly basis at the cost of production plus a specified profit per ton of coal delivered to the customer. Coal sales are secured under long-term coal supply agreements extending through 2037. Performance obligations are satisfied during the period as coal is delivered to customer generation facilities.

Other primarily includes revenue from BNI Energy which is unrelated to coal, the sale of real estate from ALLETE Properties, and non-rate base steam generation that is sold for use during production of paper and pulp. Performance obligations are satisfied when control transfers to the customer.

Payment Terms

Payment terms and conditions vary across our businesses. Aside from our taconite-producing Large Power Customers, payment terms generally require payment to be made within 15 to 30 days from the end of the period that the service has been rendered or goods provided. In the case of its taconite-producing Large Power Customers, as permitted by the MPUC, Minnesota Power requires weekly payments for electric usage based on monthly energy usage estimates. These customers receive estimated bills based on Minnesota Power’s estimate of the customers’ energy usage, forecasted energy prices and fuel adjustment clause estimates. Minnesota Power’s taconite-producing Large Power Customers have generally predictable energy usage on a weekly basis and any differences that occur are trued-up the following month. Due to the timing difference of revenue recognition from the timing of invoicing and payment, the customer receives credit for the time value of money; however, we have determined that our contracts do not include a significant financing component as the period in which we transfer the service to the customer and when they pay for such service is minimal.

Assets Recognized From the Costs to Obtain a Contract with a Customer

We recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We expense incremental costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. As of March 31, 2018, we have $31.0 million of assets recognized for costs incurred to obtain contracts with our customers ($31.6 million as of December 31, 2017). Management determined the amount of costs to be recognized as assets based on actual costs incurred and paid to obtain and fulfill these contracts to provide goods and services to our customers. Assets recognized to obtain contracts are amortized on a straight-line basis over the contract term as a non-cash reduction to revenue. For the three months ended March 31, 2018, and 2017, we recognized $0.6 million of non-cash amortization.

ALLETE, Inc. First Quarter 2018 Form 10-Q
16


NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

New Accounting Pronouncements.

Recently Adopted Pronouncements

Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. In February 2018, the FASB issued an update allowing for a one-time reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the enactment of the TCJA. With the enactment of the new federal tax rates in 2017, entities were required to adjust deferred tax assets and liabilities to reflect the lower federal rate with the effect of this reduction impacting income from continuing operations in the period of enactment, even in instances where the related income tax effects of items were originally recognized in other comprehensive income. As such, companies were left with stranded tax effects in accumulated other comprehensive income that did not reflect the appropriate tax rate. This guidance is effective in the first quarter of 2019 with early adoption permitted. The Company elected to early adopt this guidance in the first quarter of 2018 which resulted in a reduction of $5.7 million to Accumulated Other Comprehensive Loss and a corresponding increase to Retained Earnings for the reclassification of the stranded income tax effects.

Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. In March 2017, the FASB issued an accounting standard update to improve the presentation of net periodic pension and postretirement benefit costs. Under the guidance, an entity is required to present the service cost component of the net periodic benefit cost in the same income statement line as other employee compensation costs arising from services rendered during the period. The guidance also allows only the service cost component of the periodic cost to be eligible for capitalization on a prospective basis. The other components of net periodic expense must be presented separately from the line item that includes the service cost and must be excluded from the operating income subtotal. The Company adopted the guidance in the first quarter of 2018 and retrospectively adjusted the presentation of the service cost component and the other components of net periodic costs in the Consolidated Statement of Income. The retrospective adjustment for the three months ended March 31, 2017, from Operating and Maintenance and Cost of Sales – Non-utility was an increase of $1.1 million and a decrease of $0.1 million, respectively, resulting in an increase of $1.0 million to Other Income (Expense) – Other. There was no impact to net income as a result of adoption.

Financial Instruments. In 2016, the FASB issued an accounting standard update which requires entities to measure equity investments at fair value and recognize any changes in fair value in net income unless the investments qualify for the practicability exception. The practicability exception will be available for equity investments that do not have readily determinable fair values. The amendments of this update were adopted by the Company in the first quarter of 2018 which resulted in a cumulative-effect transition adjustment reducing Retained Earnings by $0.1 million, including the tax effect, for the previously unrealized loss on available-for-sale equity securities in Accumulated Other Comprehensive Loss as of December 31, 2017.

Classification of Certain Cash Receipts and Cash Payments. In 2016, the FASB issued an accounting standard update which addresses the following eight specific cash flow issues: debt prepayment or debt extinguishment costs; settlement of zero‑coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (including bank-owned life insurance policies); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. The amendments of this update were adopted by the Company in the first quarter of 2018. There was no impact to the Consolidated Statement of Cash Flows as a result of adoption.

Statement of Cash Flows: Restricted Cash. In 2016, the FASB issued an accounting standard update related to the presentation of restricted cash in the Company’s Consolidated Statement of Cash Flows. The update requires that the Consolidated Statement of Cash Flows explain the change during the period in cash, cash equivalents and restricted cash. Restricted cash should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the Consolidated Statement of Cash Flows. This guidance update was adopted by the Company in the first quarter of 2018 and was applied retrospectively to the periods presented in the Consolidated Statement of Cash Flows which resulted in a net increase in cash from financing activities of $6.9 million for the three months ended March 31, 2017. Additional disclosure, including a reconciliation of the beginning-of-period and end-of-period cash on hand to the statement of cash flows is included in this note. (See Cash, Cash Equivalents and Restricted Cash.)

ALLETE, Inc. First Quarter 2018 Form 10-Q
17


NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
New Accounting Pronouncements (Continued)

Revenue from Contracts with Customers. In 2014, the FASB issued amended revenue recognition guidance that clarifies the principles for recognizing revenue from contracts with customers by providing a single comprehensive model to determine the measurement of revenue and timing of recognition. The guidance requires an entity to recognize revenue in a manner that depicts the transfer of goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled to in exchange for those goods or services. The guidance requires expanded disclosures relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Additionally, qualitative and quantitative disclosures regarding customer contracts, significant judgments and changes in those judgments, and the assets recognized from the costs to obtain or fulfill a contract are required. The Company adopted this accounting guidance in the first quarter of 2018 and elected to apply the modified retrospective method of adoption to all contracts as of the date of initial application. The overall financial impact to the consolidated financial statements as a result of adoption of the new standard is immaterial. Based on the nature of the contracts with our customers and our related performance obligations which transfer control, a $0.5 million after-tax cumulative‑effect transition adjustment was made to increase opening Retained Earnings. We have included additional disclosures in the notes to the consolidated financial statements including additional information on the Company’s revenue streams and related performance obligations required to be satisfied in order to recognize revenue. (See Revenue Recognition.)

Practical Expedients

The following practical expedients were used by the Company as part of the adoption of the new revenue recognition guidance:
We have a right to consideration from our customers in an amount that corresponds directly with the value to such customer for performance completed to date; therefore, we may recognize revenue in the amount to which we have a right to invoice.
We do not adjust the promised amount of consideration for the effects of a significant financing component as at contract inception we expect that the period between when we transfer a promised good or service to a customer and when the customer pays for that good or service will be one year or less.
Where applicable, we adopted this guidance using the portfolio approach in which contracts that have similar characteristics were reviewed as a portfolio. The effects on the financial statements of applying this guidance to the portfolio would not differ materially from applying the guidance to each individual contract.
We recognize the incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset that would otherwise have been recognized is one year or less.

Recently Issued Pronouncements

Simplifying the Test for Goodwill Impairment. In January 2017, the FASB issued updated guidance which simplifies the measurement of goodwill impairment by removing step two of the goodwill impairment test that requires the determination of the fair value of individual assets and liabilities of a reporting unit. The updated guidance requires goodwill impairment to be measured as the amount by which a reporting unit’s carrying value exceeds its fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. This guidance is effective for the Company beginning in the first quarter of 2020, with early adoption permitted on a prospective basis.

Leases. In 2016, the FASB issued an accounting standard update which revises the existing guidance for leases. Under the revised guidance, lessees will be required to recognize a “right-of-use” asset and a lease liability for all leases with a term greater than 12 months. The new standard also requires additional quantitative and qualitative disclosures by lessees and lessors to enable users of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. The accounting for leases by lessors and the recognition, measurement, and presentation of expenses and cash flows from leases are not expected to significantly change as a result of the new guidance. We expect to make approximately $80 million in minimum lease payments due in future years (undiscounted). The revised guidance is effective for the Company beginning in the first quarter of 2019 with early adoption permitted. We are currently evaluating the impact of the revised lease guidance on our Consolidated Financial Statements.

ALLETE, Inc. First Quarter 2018 Form 10-Q
18


NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Income Taxes. Under SEC Staff Accounting Bulletin 118 (SAB 118), which was issued in December 2017, companies were allowed up to one year to complete the required analyses and accounting for the TCJA. SAB 118 requires companies to disclose which tax positions are considered complete, which tax positions are considered provisional and which tax provisions reflect prior law. At December 31, 2017, we were reasonably able to estimate the effects of the TCJA, and therefore recorded provisional amounts associated with the changes under the TCJA. The provisional amounts incorporate assumptions made based upon the Company’s current interpretation of the TCJA, and may change as the Company receives additional clarification and implementation guidance. We have not made any adjustments to our accounting to date, although the accounting is still considered provisional while we complete our analysis. Any adjustments recorded to the provisional amounts in 2018 will be included in income from operations as an adjustment to income tax expense.

Reclassification of Prior Income Statement. Beginning with the second quarter of 2017, the Company enhanced its presentation of Operating Revenue and certain Operating Expenses on the Consolidated Statement of Income by presenting the caption Operating Revenue separately as Operating Revenue – Utility and Operating Revenue – Non-utility. In conformity with the current presentation, we now present $281.6 million of Operating Revenue as Operating Revenue – Utility for the three months ended March 31, 2017, as it is generated from our regulated utility operations. Non-utility revenue of $84.0 million for the three months ended March 31, 2017, is now presented as Operating Revenue – Non-utility. In addition, the captions Fuel and Purchased Power and Cost of Sales have been updated to Fuel, Purchased Power and Gas – Utility and Cost of Sales – Non-utility. As a result, we have reclassified $3.6 million relating to the cost of gas sales at SWL&P from the historic caption Cost of Sales to Fuel, Purchased Power and Gas – Utility for the three months ended March 31, 2017.


NOTE 2. INVESTMENTS

Investments. As of March 31, 2018, the investment portfolio included the legacy real estate assets of ALLETE Properties, debt and equity securities consisting primarily of securities held in other postretirement plans to fund employee benefits, the cash equivalents within these plans and other assets consisting primarily of land in Minnesota.
Other Investments
March 31,
2018

 
December 31,
2017

Millions
 
 
 
ALLETE Properties

$26.0

 

$26.4

Available-for-sale Securities (a)
21.1

 
19.1

Cash Equivalents
2.0

 
3.8

Other
3.7

 
3.8

Total Other Investments

$52.8

 

$53.1

(a)
As of March 31, 2018, the aggregate amount of available-for-sale corporate and governmental debt securities maturing in one year or less was $0.9 million, in one year to less than three years was $3.4 million, in three years to less than five years was $3.3 million and in five or more years was $1.1 million.

Land Inventory. Land inventory is accounted for as held for use and is recorded at cost, unless the carrying value is determined not to be recoverable in accordance with the accounting standards for property, plant and equipment, in which case the land inventory is written down to estimated fair value. Land values are reviewed for indicators of impairment on a quarterly basis and no impairment was recorded for the three months ended March 31, 2018, and 2017.

Available-for-Sale Securities. We account for our available-for-sale securities portfolio in accordance with the guidance for certain investments in debt and equity securities. Our available-for-sale securities portfolio consisted primarily of securities held in other postretirement plans to fund employee benefits. Gross realized and unrealized gains and losses on our available-for-sale securities were immaterial for the three months ended March 31, 2018, and 2017.



ALLETE, Inc. First Quarter 2018 Form 10-Q
19


NOTE 3. ACQUISITIONS

The following acquisitions are consistent with ALLETE’s stated strategy of investing in energy infrastructure and related services businesses to complement its regulated businesses, balance exposure to business cycles and changing demand, and provide potential long-term earnings growth. The pro forma impact of the following acquisitions was not significant, either individually or in the aggregate, to the results of the Company for the three months ended March 31, 2018, and 2017.

2017 Activity.

Tonka Water. In September 2017, U.S. Water Services acquired 100 percent of Tonka Water. Total consideration for the transaction was $19.2 million, including a working capital adjustment. Consideration of $19.0 million was paid in cash on the acquisition date and a working capital adjustment of $0.2 million was paid in the fourth quarter of 2017. Tonka Water is a supplier of municipal and industrial water treatment systems and will expand U.S. Water Services’ geographic and customer markets.

The acquisition was accounted for as a business combination and the purchase price was allocated based on the estimated fair values of the assets acquired and the liabilities assumed at the date of acquisition. The purchase price accounting, which was finalized in 2018, is reflected in the following table. Fair value measurements were valued primarily using the discounted cash flow method and replacement cost basis.
Millions
 
Assets Acquired
 
Accounts Receivable

$5.1

Other Current Assets
5.1

Trade Names (a)
0.9

Goodwill (a)(b)
16.9

Other Non-Current Assets
0.2

Total Assets Acquired

$28.2

Liabilities Assumed
 
Current Liabilities

$9.0

Total Liabilities Assumed

$9.0

Net Identifiable Assets Acquired

$19.2

(a) Presented within Goodwill and Intangible Assets – Net on the Consolidated Balance Sheet. (See Note 4. Goodwill and Intangible Assets.)
(b)
Recognized goodwill is attributable to the assembled workforce and anticipated synergies. For tax purposes, the purchase price allocation resulted in $4.1 million of deductible goodwill.

Acquisition-related costs were immaterial, expensed as incurred during 2017 and recorded in Operating and Maintenance on the Consolidated Statement of Income.



ALLETE, Inc. First Quarter 2018 Form 10-Q
20


NOTE 4. GOODWILL AND INTANGIBLE ASSETS

The aggregate carrying amount of goodwill was $148.3 million as of March 31, 2018, and December 31, 2017. There have been no changes to goodwill by reportable segment for the three months ended March 31, 2018.

Balances of intangible assets, net, excluding goodwill as of March 31, 2018, are as follows:
 
December 31,
2017

 
 Amortization
 
March 31,
2018

Millions
 
 
 
 
 
Intangible Assets
 
 
 
 
 
Definite-Lived Intangible Assets
 
 
 
 
 
Customer Relationships

$54.7

 
$(1.1)
 

$53.6

Developed Technology and Other (a)
6.3

 
(0.3)
 
6.0

Total Definite-Lived Intangible Assets
61.0

 
(1.4)
 
59.6

Indefinite-Lived Intangible Assets
 
 
 
 
 
Trademarks and Trade Names
16.6

 
n/a
 
16.6

Total Intangible Assets

$77.6

 
$(1.4)
 

$76.2

(a)
Developed Technology and Other includes patents, non-compete agreements, land easements and trade names with finite lives.

Customer relationships have a remaining useful life of approximately 20 years, and developed technology and other have remaining useful lives ranging from approximately 1 year to approximately 11 years (weighted average of approximately 7 years). The weighted average remaining useful life of all definite-lived intangible assets as of March 31, 2018, is approximately 18 years.

Amortization expense for intangible assets was $1.4 million for the three months ended March 31, 2018, and 2017. Accumulated amortization was $16.2 million as of March 31, 2018 ($14.8 million as of December 31, 2017). The estimated amortization expense for definite-lived intangible assets for the remainder of 2018 is $4.0 million. Estimated annual amortization expense for definite‑lived intangible assets is $4.9 million in 2019, $4.7 million in 2020, $4.6 million in 2021, $4.3 million in 2022 and $37.1 million thereafter.


NOTE 5. FAIR VALUE

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). We utilize 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. We primarily apply the market approach for recurring fair value measurements and endeavor to utilize the best available information. Accordingly, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. These inputs, which are used to measure fair value, are prioritized through the fair value hierarchy. 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). Descriptions of the three levels of the fair value hierarchy are discussed in Note 9. Fair Value to the Consolidated Financial Statements in our 2017 Form 10-K.

The following tables set forth by level within the fair value hierarchy our assets and liabilities that were accounted for at fair value on a recurring basis as of March 31, 2018, and December 31, 2017. Each asset and liability is classified based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment, which may affect the valuation of these assets and liabilities and their placement within the fair value hierarchy levels. The estimated fair value of Cash and Cash Equivalents listed on the Consolidated Balance Sheet approximates the carrying amount and therefore is excluded from the recurring fair value measures in the following tables.

ALLETE, Inc. First Quarter 2018 Form 10-Q
21


NOTE 5. FAIR VALUE (Continued)
 
Fair Value as of March 31, 2018
Recurring Fair Value Measures
Level 1

 
Level 2

 
Level 3

 
Total

Millions
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Investments (a)
 
 
 
 
 
 
 
Available-for-sale – Equity Securities

$12.4

 

 

 

$12.4

Available-for-sale – Corporate and Governmental Debt Securities

 

$8.7

 

 
8.7

Cash Equivalents
2.0

 

 

 
2.0

Total Fair Value of Assets

$14.4

 

$8.7

 

 

$23.1

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Deferred Compensation (b)

 

$20.2

 

 

$20.2

U.S. Water Services Contingent Consideration (c)

 

 

$5.5

 
5.5

Total Fair Value of Liabilities

 

$20.2

 

$5.5

 

$25.7

Total Net Fair Value of Assets (Liabilities)

$14.4

 
$(11.5)
 
$(5.5)
 
$(2.6)
(a)
Included in Other Investments on the Consolidated Balance Sheet.
(b)
Included in Other Non-Current Liabilities on the Consolidated Balance Sheet.
(c)
Included in Other Current Liabilities on the Consolidated Balance Sheet.
 
Fair Value as of December 31, 2017
Recurring Fair Value Measures
Level 1

 
Level 2

 
Level 3

 
Total

Millions
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Investments (a)
 
 
 
 
 
 
 
Available-for-sale – Equity Securities

$10.2

 

 

 

$10.2

Available-for-sale – Corporate and Governmental Debt Securities

 

$8.9

 

 
8.9

Cash Equivalents
3.8

 

 

 
3.8

Total Fair Value of Assets

$14.0

 

$8.9

 

 

$22.9

 
 
 
 
 
 
 
 
Liabilities (b)
 
 
 
 
 
 
 
Deferred Compensation

 

$18.2

 

 

$18.2

U.S. Water Services Contingent Consideration

 

 

$5.4

 
5.4

Total Fair Value of Liabilities

 

$18.2

 

$5.4

 

$23.6

Total Net Fair Value of Assets (Liabilities)

$14.0

 
$(9.3)
 
$(5.4)
 
$(0.7)
(a)
Included in Other Investments on the Consolidated Balance Sheet.
(b)
Included in Other Non-Current Liabilities on the Consolidated Balance Sheet.

The Level 3 liability in the preceding tables is the result of the 2015 acquisition of U.S. Water Services. Changes in the U.S. Water Services Contingent Consideration can result from modifications to the shareholder agreement, changes in discount rates, timing of milestones that trigger payment, or the timing and amount of earnings estimates. The following table provides a reconciliation of the beginning and ending balances of the U.S. Water Services Contingent Consideration measured at fair value using Level 3 measurements as of March 31, 2018. Management analyzes the fair value of the contingent liability on a quarterly basis and makes adjustments as appropriate.
Recurring Fair Value Measures
 
Activity in Level 3
 
Millions
 
Balance as of December 31, 2017

$5.4

Accretion
0.1

Balance as of March 31, 2018

$5.5


ALLETE, Inc. First Quarter 2018 Form 10-Q
22


NOTE 5. FAIR VALUE (Continued)

For the three months ended March 31, 2018, and the year ended December 31, 2017, there were no transfers in or out of Levels 1, 2 or 3.

Fair Value of Financial Instruments. With the exception of the item listed in the following table, the estimated fair value of all financial instruments approximates the carrying amount. The fair value for the item listed in the following table was based on quoted market prices for the same or similar instruments (Level 2).
Financial Instruments
Carrying Amount
 
Fair Value
Millions
 
 
 
Long-Term Debt, Including Long-Term Debt Due Within One Year
 
 
 
March 31, 2018
$1,512.2
 
$1,583.1
December 31, 2017
$1,513.3
 
$1,627.6

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis. Non-financial assets such as equity method investments, goodwill, intangible assets, and property, plant and equipment are measured at fair value when there is an indicator of impairment and recorded at fair value only when an impairment is recognized. For the three months ended March 31, 2018, and the year ended December 31, 2017, there were no triggering events or indicators of impairment for these non-financial assets.


NOTE 6. REGULATORY MATTERS

Regulatory matters are summarized in Note 4. Regulatory Matters to our Consolidated Financial Statements in our 2017 Form 10‑K, with additional disclosure provided in the following paragraphs.

Electric Rates. Entities within our Regulated Operations segment file for periodic rate revisions with the MPUC, PSCW or FERC. As authorized by the MPUC, Minnesota Power also recognizes revenue under cost recovery riders for transmission, renewable, and environmental investments and expenditures. (See Transmission Cost Recovery Rider, Renewable Cost Recovery Rider and Environmental Improvement Rider.) Revenue from cost recovery riders was $24.1 million for the three months ended March 31, 2018 ($24.2 million for the three months ended March 31, 2017).

2016 Minnesota General Rate Case. In November 2016, Minnesota Power filed a retail rate increase request with the MPUC which sought an average increase of approximately 9 percent for retail customers. The rate filing sought a return on equity of 10.25 percent and a 53.81 percent equity ratio. On an annualized basis, the requested final rate increase would have generated approximately $55 million in additional revenue. In December 2016, Minnesota Power filed a request to modify its original interim rate proposal reducing its requested interim rate increase to $34.7 million from the original request of approximately $49 million due to a change in its electric sales forecast. In December 2016 orders, the MPUC accepted the November 2016 filing as complete and authorized an annual interim rate increase of $34.7 million beginning in January 2017.

In February 2017, Minnesota Power filed an additional request to further reduce its requested interim rate increase. In an April 2017 order, the MPUC approved Minnesota Power’s updated retail rate request resulting in a reduction in the annual interim rate increase to $32.2 million beginning in May 2017. As a result of working with intervenors and further developments as the rate review progressed, Minnesota Power’s final rate request was adjusted to approximately $49 million on an annualized basis. In an order dated March 12, 2018, the MPUC affirmed determinations made at a hearing on January 18, 2018, regarding Minnesota Power’s general rate case including allowing a return on common equity of 9.25 percent and a 53.81 percent equity ratio. Upon commencement of final rates, we expect additional revenue of approximately $13 million on an annualized basis. Final rates are expected to commence in the fourth quarter of 2018; interim rates will be collected through this period which will be partially offset by the recognition of a corresponding reserve. Minnesota Power has recorded a reserve for an interim rate refund of approximately $41 million as of March 31, 2018 ($32 million as of December 31, 2017). The MPUC also disallowed Minnesota Power’s regulatory asset for deferred fuel adjustment clause costs due to the anticipated adoption of a forward-looking fuel adjustment clause methodology resulting in a $19.5 million pre-tax charge to Fuel, Purchased Power and Gas – Utility in the fourth quarter of 2017.

As part of its decision in Minnesota Power’s 2016 general rate case, the MPUC extended the depreciable lives of Boswell Unit 3, Unit 4 and common facilities to 2050 primarily to mitigate rate increases for our customers, and shortened the depreciable lives of Boswell Unit 1 and Unit 2 to 2022, resulting in a net decrease to depreciation expense of approximately $25 million pre-tax on an annual basis.

ALLETE, Inc. First Quarter 2018 Form 10-Q
23


NOTE 6. REGULATORY MATTERS (Continued)
Electric Rates (Continued)

On April 2, 2018, Minnesota Power filed a petition for reconsideration with the MPUC requesting reconsideration of certain decisions in the MPUC’s order dated March 12, 2018, collectively representing approximately $20 million to $25 million in additional revenue on an annualized basis. Minnesota Power’s petition included requesting reconsideration of the allowed return on common equity, recovery of the prepaid pension asset in rate base, certain disallowed expenses, and certain transmission revenue adjustments. On April 12, 2018, Minnesota Power responded to a Minnesota Department of Commerce (DOC) request for reconsideration requesting that the MPUC generally accept, with modifications and conditions, the DOC’s proposal to reduce the depreciable lives of Boswell Unit 3, Unit 4 and common facilities to 2035 and use the benefits of the TCJA to offset the resulting increase in customer rates. We expect a decision on reconsideration by mid-year in 2018. We are unable to predict the outcome of this regulatory proceeding.

Energy-Intensive Trade-Exposed Customer Rates. An EITE customer ratemaking law was enacted in 2015 which established a Minnesota energy policy to have competitive rates for certain industries such as mining and forest products. In 2015, Minnesota Power filed a rate schedule petition with the MPUC for EITE customers and a corresponding rider for EITE cost recovery. In a March 2016 order, the MPUC dismissed the petition without prejudice. In June 2016, Minnesota Power filed a revised EITE petition with the MPUC which included additional information on the net benefits analysis, limits on eligible customers and term lengths for the EITE discount. The rate adjustments were intended to be revenue and cash flow neutral to Minnesota Power. The MPUC approved a reduction in rates for EITE customers in a December 2016 order and subsequently approved cost recovery in an April 2017 order; collection of the discount was subject to the MPUC’s review of Minnesota Power’s compliance filing implementing approval of a recovery mechanism, with the subsequent order issued in October 2017 that modified the April 2017 order. During 2017, Minnesota Power provided discounts of $8.6 million that were recorded as a receivable. In September 2017, Minnesota Power informed its EITE customers that it had suspended the EITE discount due to a concern that it was not revenue and cash flow neutral to Minnesota Power based on an MPUC decision at a hearing in September 2017, as well as the interim rate reduction and decisions in its 2016 general rate case. Based on the MPUC’s decisions at a hearing on January 18, 2018, as part of Minnesota Power’s 2016 general rate case, Minnesota Power reinstated the EITE discount effective January 1, 2018. Minnesota Power expects the discount to EITE customers to be approximately $15 million annually based on EITE customer current operating levels. While interim rates are in effect for Minnesota Power’s 2016 general rate case, discounts provided to EITE customers will offset interim rate refund reserves for non-EITE customers. Minnesota Power provided $4.3 million of discounts to EITE customers during the three months ended March 31, 2018 ($2.3 million for the three months ended March 31, 2017).

FERC-Approved Wholesale Rates. Minnesota Power has 16 non-affiliated municipal customers in Minnesota. SWL&P is a Wisconsin utility and a wholesale customer of Minnesota Power. All wholesale contracts include a termination clause requiring a three-year notice to terminate.

Minnesota Power’s wholesale electric contract with the Nashwauk Public Utilities Commission is effective through at least December 31, 2032. No termination notice may be given for this contract prior to July 1, 2029. The wholesale electric service contracts with SWL&P and another municipal customer are effective through at least May 31, 2021, and through June 30, 2019, respectively. Under the agreement with SWL&P, no termination notice has been given. The other municipal customer provided termination notice for its contract in 2016. Minnesota Power currently provides approximately 29 MW of average monthly demand to this customer. The rates included in these three contracts are set each July 1 based on a cost-based formula methodology, using estimated costs and a rate of return that is equal to Minnesota Power’s authorized rate of return for Minnesota retail customers. The formula-based rate methodology also provides for a yearly true-up calculation for actual costs incurred.

Minnesota Power’s wholesale electric contracts with 14 municipal customers are effective through varying dates ranging from 2024 through 2029 with a majority effective through at least December 31, 2024. No termination notices may be given prior to three years before maturity. These contracts include fixed capacity charges through 2018; beginning in 2019, the capacity charge will be determined using a cost-based formula methodology with limits on the annual change from the previous year’s capacity charge. The base energy charge for each year of the contract term will be set each January 1, subject to monthly adjustment, and will also be determined using a cost-based formula methodology.

Transmission Cost Recovery Rider. Minnesota Power has an approved cost recovery rider for certain transmission investments and expenditures. In a 2016 order, the MPUC approved Minnesota Power’s updated customer billing rates which allow Minnesota Power to charge retail customers on a current basis for the costs of constructing certain transmission facilities plus a return on the capital invested. As a result of the MPUC approval of the certificate of need for the GNTL in 2015, the project is eligible for cost recovery under the existing transmission cost recovery rider. Minnesota Power is funding the construction of the GNTL with a subsidiary of Manitoba Hydro (see Great Northern Transmission Line), and anticipates including its portion of the investments and expenditures for the GNTL in future transmission bill factor filings.

ALLETE, Inc. First Quarter 2018 Form 10-Q
24


NOTE 6. REGULATORY MATTERS (Continued)
Electric Rates (Continued)

Renewable Cost Recovery Rider. Minnesota Power has an approved cost recovery rider for investments and expenditures related to Bison and the restoration and repair of Thomson. The cost recovery rider allows Minnesota Power to charge retail customers on a current basis for the costs of certain renewable investments plus a return on the capital invested. Updated customer billing rates for the renewable cost recovery rider were approved by the MPUC in a November 2017 order.

Minnesota Power also has approval for current cost recovery of investments and expenditures related to compliance with the Minnesota Solar Energy Standard. (See Minnesota Solar Energy Standard.) Currently, there is no approved customer billing rate for solar costs.

Environmental Improvement Rider. Minnesota Power has an approved environmental improvement rider for investments and expenditures related to the implementation of the Boswell Unit 4 mercury emissions reduction plan completed in 2015. Updated customer billing rates for the environmental improvement rider were approved by the MPUC in a 2016 order; however, implementation of the updated rates was delayed pending resolution of Minnesota Power’s 2016 general rate case based on a March 2017 MPUC order. On April 9, 2018, Minnesota Power filed an updated environmental improvement factor filing and requested to implement the updated billing rates to coincide with the implementation of final rates from its 2016 general rate case. (See 2016 Minnesota General Rate Case.) Upon approval of the filing and implementation of final rates from its 2016 general rate case, Minnesota Power will be authorized to include updated billing rates on customer bills.

Fuel Adjustment Clause Reform Pilot. In a December 2017 order, the MPUC adopted a three-year pilot program to implement certain procedural reforms to the Minnesota utilities’ automatic fuel adjustment clause (FAC) for fuel and purchased power. The order will change the method of accounting for all Minnesota electric utilities to a monthly budgeted, forwarded-looking FAC with an annual prudence review and true-up to actual allowed costs. The MPUC is seeking input from Minnesota electric utilities and other stakeholders on the implementation and transition accounting needed to adopt the change. The three-year pilot program is expected to begin in 2019. In an order dated March 12, 2018, the MPUC affirmed determinations made at a hearing on January 18, 2018, at which the MPUC disallowed Minnesota Power’s regulatory asset for deferred fuel adjustment clause costs due to the anticipated adoption of the forward-looking fuel adjustment clause methodology in this proceeding resulting in a $19.5 million pre-tax charge to Fuel, Purchased Power and Gas – Utility in the fourth quarter of 2017.

Tax Cuts and Jobs Act of 2017. In December 2017, the MPUC opened a docket to review the effects of the TCJA on electric and natural gas rates and services in Minnesota, including the legislation’s impact on tax rates and utilities’ deferred income tax assets and liabilities. On March 2, 2018, Minnesota Power submitted an initial filing to the MPUC regarding the impacts of the TCJA on Minnesota Power. In this filing, Minnesota Power proposed to use the net tax benefits as an offset to other regulated costs, to the extent Minnesota Power is able to earn its allowed return on common equity, and flow the remainder of the benefits to customers through a new tax cost recovery rider. On April 20, 2018, Minnesota Power responded to intervenor comments requesting that the MPUC generally accept, with modifications and conditions, the DOC’s proposal to reduce the depreciable lives of Boswell Unit 3, Unit 4 and common facilities to 2035 and use the benefits of the TCJA to offset the resulting increase in customer rates.

On January 10, 2018, the PSCW also opened a docket to review the effects of the TCJA and directed Wisconsin utilities to defer its impacts until further direction is provided by the PSCW. On February 9, 2018, SWL&P filed comments with the PSCW regarding the impacts of the TCJA on SWL&P. In this filing, SWL&P proposed deferring the benefits of the TCJA and incorporating any deferred refunds or credits into its next general rate case.

We have recorded the impact of the remeasurement of deferred income tax assets and liabilities in 2017 and the federal income tax rate change in 2018 resulting from the TCJA for Minnesota Power and SWL&P as regulatory assets and liabilities as the benefits of the TCJA are deferred pending the outcome of these regulatory proceedings. We are unable to predict the outcome of these regulatory proceedings.

2016 Wisconsin General Rate Case. SWL&P’s current retail rates are based on a 2017 PSCW retail rate order effective in August 2017 that allows for a 10.5 percent return on common equity and a 55 percent equity ratio. SWL&P’s retail rates prior to August 2017 were based on a 2012 PSCW retail rate order that provided for a 10.9 percent return on equity. On an annualized basis, SWL&P expects to collect additional revenue of $2.5 million under the 2017 PSCW retail rate order.

ALLETE, Inc. First Quarter 2018 Form 10-Q
25


NOTE 6. REGULATORY MATTERS (Continued)

Integrated Resource Plan. In 2015, Minnesota Power filed its 2015 IRP with the MPUC which included an analysis of a variety of existing and future energy resource alternatives and a projection of customer cost impact by class. The 2015 IRP also contained steps in Minnesota Power’s EnergyForward strategic plan including the economic idling of Taconite Harbor Units 1 and 2 which occurred in 2016, the ceasing of coal-fired operations at Taconite Harbor in 2020, and the addition of between 200 MW and 300 MW of natural gas-fired generation in the next decade. In a 2016 order, the MPUC approved Minnesota Power’s 2015 IRP with modifications. The order accepted Minnesota Power’s plans for Taconite Harbor, directed Minnesota Power to retire Boswell Units 1 and 2 no later than 2022, required an analysis of generation and demand response alternatives to be filed with a natural gas resource proposal, and required Minnesota Power to conduct request for proposals for additional wind, solar and demand response resource additions subject to further MPUC approvals. In 2016, Minnesota Power announced Boswell Units 1 and 2 will be retired, which is expected to occur in the fourth quarter of 2018.

In July 2017, Minnesota Power submitted a resource package to the MPUC requesting approval of PPAs for the output of a 250 MW wind energy facility and a 10 MW solar energy facility as well as approval of a 250 MW natural gas energy PPA. These agreements are subject to MPUC approval of the construction of a 525 MW to 550 MW combined-cycle natural gas‑fired generating facility which will be jointly owned by Dairyland Power Cooperative and a subsidiary of ALLETE. Minnesota Power would purchase approximately 50 percent of the facility's output starting in 2025. In a September 2017 order, the MPUC approved Minnesota Power’s request to extend the next IRP filing deadline until October 1, 2019, and Minnesota Power’s request that approval for the natural gas energy PPA be decided through an administrative law judge process. A public hearing was held February 28, 2018, and public comments were due March 23, 2018. The administrative law judge is expected to provide a recommendation by July 2018, and the Company anticipates a MPUC decision in the second half of 2018. The MPUC did not take any action regarding the wind and solar energy PPAs which will be refiled separately from the natural gas energy PPA.

Great Northern Transmission Line. Minnesota Power is constructing the GNTL, an approximately 220-mile 500-kV transmission line between Manitoba and Minnesota’s Iron Range that was proposed by Minnesota Power and Manitoba Hydro. In 2015, a certificate of need was approved by the MPUC. Based on this approval, Minnesota Power’s portion of the investments and expenditures for the project are eligible for cost recovery under its existing transmission cost recovery rider and are anticipated to be included in future transmission cost recovery filings. (See Transmission Cost Recovery Rider.) Also in 2015, the FERC approved our request to recover on construction work in progress related to the GNTL from Minnesota Power’s wholesale customers. In a 2016 order, the MPUC approved the route permit for the GNTL which largely follows Minnesota Power’s preferred route, including the international border crossing, and in 2016, the U.S. Department of Energy issued a presidential permit to cross the U.S.-Canadian border, which was the final major regulatory approval needed before construction in the U.S. could begin. Site clearing and pre‑construction activities commenced in the first quarter of 2017 with construction expected to be completed in 2020. To date, most of the right-of-way has been cleared, foundation installation and transmission tower assembly have commenced and tower construction is expected to begin in 2018. Total project cost in the U.S., including substation work, is estimated to be between $560 million and $710 million, of which Minnesota Power’s portion is expected to be between $300 million and $350 million; the difference will be recovered from a subsidiary of Manitoba Hydro as contributions in aid of construction. Total project costs of $211.4 million have been incurred through March 31, 2018, of which $110.0 million has been recovered from a subsidiary of Manitoba Hydro.

Manitoba Hydro must obtain regulatory and governmental approvals related to a new transmission line in Canada known as the Manitoba-Minnesota Transmission Project (MMTP) that will connect with the GNTL. In 2015, Manitoba Hydro submitted the final preferred route and EIS for the MMTP to the Manitoba Conservation and Water Stewardship for siting and environmental approval, which remains pending. In 2016, Manitoba Hydro filed an application with the Canadian National Energy Board (NEB) requesting authorization to construct and operate the MMTP. The NEB determined that Manitoba Hydro’s application was complete in December 2017, and scheduled public hearings for this summer. The NEB is required to make a decision on the MMTP by March 2019 but is not precluded from making a decision prior to that date. Approval of the Canadian federal cabinet is also required. The MMTP is subject to legal and regulatory challenges which Minnesota Power is actively monitoring. Manitoba Hydro has informed Minnesota Power that it continues to work towards completing the MMTP on schedule. In order to meet the transmission in-service requirements in PPAs with Minnesota Power, Manitoba Hydro has indicated that it would need to start construction of the MMTP in December 2018. We are unable to predict the outcome of the Canadian regulatory review process, including the timing thereof or whether any onerous conditions may be imposed, or the timing of the completion of the MMTP, including the impact of any delays that may result in construction schedule adjustments. Any significant delays in the MMTP construction schedule may result in Minnesota Power adjusting the GNTL construction schedule and impact the timing of capital expenditures and associated cost recovery under our transmission cost recovery rider.

ALLETE, Inc. First Quarter 2018 Form 10-Q
26


NOTE 6. REGULATORY MATTERS (Continued)
Great Northern Transmission Line (Continued)
 
Construction of Manitoba Hydro’s Keeyask hydroelectric generation facility, which will provide the power to be sold under PPAs with Minnesota Power that is to be transmitted on the MMTP and the GNTL, commenced in 2014 and is anticipated to be in service by early 2021.

MISO Return on Equity Complaints. In 2013, several customer groups located within the MISO service area filed complaints with the FERC requesting, among other things, a reduction in the base return on equity used by MISO transmission owners, including ALLETE and ATC, to 9.15 percent. In 2015, a federal administrative law judge ruled on the complaint proposing a reduction in the base return on equity to 10.32 percent, or 10.82 percent including an incentive adder for participation in a regional transmission organization. In 2016, the FERC issued an order affirming the administrative law judge’s recommendation.

In 2015, an additional complaint was filed with the FERC seeking an order to further reduce the base return on equity to 8.67 percent. In 2016, a federal administrative law judge ruled on the additional complaint proposing a further reduction in the base return on equity to 9.70 percent, or 10.20 percent including an incentive adder for participation in a regional transmission organization, subject to approval or adjustment by the FERC. A final decision from the FERC on the administrative law judge’s recommendation is pending, which is not expected to have a material impact on our Consolidated Financial Statements.

Minnesota Solar Energy Standard. Minnesota law requires at least 1.5 percent of total retail electric sales, excluding sales to certain customers, to be generated by solar energy by the end of 2020. At least 10 percent of the 1.5 percent mandate must be met by solar energy generated by or procured from solar photovoltaic devices with a nameplate capacity of 40 kW or less and community solar garden subscriptions. In a 2016 order, the MPUC approved Camp Ripley, a 10 MW utility scale solar project at the Camp Ripley Minnesota Army National Guard base and training facility near Little Falls, Minnesota, as eligible to meet the solar energy standard and for current cost recovery. Camp Ripley was completed in the fourth quarter of 2016. In a 2016 order, the MPUC approved a community solar garden project in northeastern Minnesota, which is comprised of a 1 MW solar array owned and operated by a third party with the output purchased by Minnesota Power and a 40 kW solar array that is owned and operated by Minnesota Power. Minnesota Power believes Camp Ripley and the community solar garden arrays will meet approximately one‑third of the overall mandate. Additionally, in a February 2017 order, the MPUC approved Minnesota Power’s proposal to increase the amount of solar rebates available for customer-sited solar installations and recover costs of the program through Minnesota Power’s renewable cost recovery rider. The proposal to incentivize customer‑sited solar installations and community solar garden subscriptions is expected to meet a portion of the required small scale solar mandate.

Regulatory Assets and Liabilities. Our regulated utility operations are subject to accounting guidance for the effect of certain types of regulation. Regulatory assets represent incurred costs that have been deferred as they are probable for recovery in customer rates. Regulatory liabilities represent obligations to make refunds to customers and amounts collected in rates for which the related costs have not yet been incurred. The Company assesses quarterly whether regulatory assets and liabilities meet the criteria for probability of future recovery or deferral. No regulatory assets or liabilities are currently earning a return. The recovery, refund or credit to rates for these regulatory assets and liabilities will occur over the periods either specified by the applicable regulatory authority or over the corresponding period related to the asset or liability.

ALLETE, Inc. First Quarter 2018 Form 10-Q
27


NOTE 6. REGULATORY MATTERS (Continued)
Regulatory Assets and Liabilities (Continued)
Regulatory Assets and Liabilities
March 31,
2018

 
December 31,
2017

Millions
 
 
 
Non-Current Regulatory Assets
 
 
 
Defined Benefit Pension and Other Postretirement Benefit Plans

$217.7

 

$220.3

Income Taxes
110.4

 
112.8

Asset Retirement Obligations
30.4

 
29.6

Manufactured Gas Plant 
7.8

 
8.1

PPACA Income Tax Deferral
5.0

 
5.0

Conservation Improvement Program
0.2

 
3.3

Other
4.5

 
5.6

Total Non-Current Regulatory Assets

$376.0

 

$384.7

 
 
 
 
Current Regulatory Liabilities (a)
 
 
 
Provision for Interim Rate Refund (b)

$28.1

 

Provision for Tax Reform Refund (c)

7.5

 

Total Current Regulatory Liabilities
35.6

 

Non-Current Regulatory Liabilities
 
 
 
Income Taxes
406.2

 

$411.2

Wholesale and Retail Contra AFUDC
59.1

 
57.9

Plant Removal Obligations
21.8

 
20.3

North Dakota Investment Tax Credits
14.3

 
14.1

Cost Recovery Riders 
11.1

 
2.2

Provision for Interim Rate Refund (a)

 
23.7

Other
3.5

 
2.6

Total Non-Current Regulatory Liabilities
516.0

 
532.0

Total Regulatory Liabilities

$551.6

 

$532.0

(a)
Current regulatory liabilities are presented within Other Current Liabilities on the Consolidated Balance Sheet.
(b)
This amount is expected to be refunded to Minnesota Power’s regulated retail customers in the first quarter of 2019 and includes $12.9 million of discounts provided to EITE customers that will be offset against interim rate refunds as of March 31, 2018 ($8.6 million as of December 31, 2017). (See 2016 Minnesota General Rate Case and Energy-Intensive Trade‑Exposed Customer Rates.)
(c)
We have recorded the impact of the federal income tax rate change in 2018 due to the TCJA for Minnesota Power and SWL&P as regulatory liabilities and a reduction in revenue as the benefits of the TCJA are deferred pending the outcome of regulatory proceedings with the MPUC and PSCW. (See Tax Cuts and Jobs Act of 2017.)


NOTE 7. INVESTMENT IN ATC

Our wholly-owned subsidiary, ALLETE Transmission Holdings, owns approximately 8 percent of ATC, a Wisconsin-based utility that owns and maintains electric transmission assets in portions of Wisconsin, Michigan, Minnesota and Illinois. We account for our investment in ATC under the equity method of accounting. As of March 31, 2018, our equity investment in ATC was $120.1 million ($118.7 million at December 31, 2017). In the first three months of 2018, we invested $1.6 million in ATC, and on April 30, 2018, we invested an additional $2.3 million. We expect to make additional investments of $2.6 million in 2018.
ALLETE’s Investment in ATC
 
Millions
 
Equity Investment Balance as of December 31, 2017

$118.7

Cash Investments
1.6

Equity in ATC Earnings
4.7

Distributed ATC Earnings
(5.2
)
Amortization of the Remeasurement of Deferred Income Taxes (a)
0.3

Equity Investment Balance as of March 31, 2018

$120.1

(a) Amortization related to the impact of the remeasurement of deferred income tax assets and liabilities resulting from the TCJA.


ALLETE, Inc. First Quarter 2018 Form 10-Q
28


NOTE 7. INVESTMENT IN ATC (Continued)

In 2016, the FERC issued an order reducing ATC’s authorized return on equity to 10.32 percent, or 10.82 percent including an incentive adder for participation in a regional transmission organization.

In 2016, a federal administrative law judge ruled on an additional complaint proposing a further reduction in the base return on equity to 9.70 percent, or 10.20 percent including an incentive adder for participation in a regional transmission organization, subject to approval or adjustment by the FERC. A final decision from the FERC on the administrative law judge’s recommendation is pending. (See Note 6. Regulatory Matters.)


NOTE 8. SHORT-TERM AND LONG-TERM DEBT

The following tables present the Company’s short-term and long-term debt as of March 31, 2018, and December 31, 2017:
March 31, 2018
Principal

 
Unamortized Debt Issuance Costs
 
Total

Millions
 
 
 
 
 
Short-Term Debt

$106.6

 
$(0.4)
 

$106.2

Long-Term Debt
1,405.6

 
(9.1)
 
1,396.5

Total Debt

$1,512.2

 
$(9.5)
 

$1,502.7

December 31, 2017
Principal

 
Unamortized Debt Issuance Costs
 
Total

Millions
 
 
 
 
 
Short-Term Debt

$64.6

 
$(0.5)
 

$64.1

Long-Term Debt
1,448.7

 
(9.5)
 
1,439.2

Total Debt

$1,513.3

 
$(10.0)
 

$1,503.3


On April 16, 2018, ALLETE issued and sold $60.0 million of its First Mortgage Bonds (the Bonds) that bear interest at 4.07 percent. The Bonds will mature in April 2048 and pay interest semi-annually in April and October of each year, commencing on October 16, 2018. ALLETE has the option to prepay all or a portion of the Bonds at its discretion, subject to a make-whole provision. The Bonds are subject to additional terms and conditions which are customary for these types of transactions. ALLETE intends to use the proceeds from the sale of the Bonds to fund utility capital investment and for general corporate purposes. The Bonds were sold in reliance on an exemption from registration under Section 4(a)(2) of the Securities Act of 1933, as amended, to institutional accredited investors.

Financial Covenants. Our long-term debt arrangements contain customary covenants. In addition, our lines of credit and letters of credit supporting certain long-term debt arrangements contain financial covenants. Our compliance with financial covenants is not dependent on debt ratings. The most restrictive financial covenant requires ALLETE to maintain a ratio of indebtedness to total capitalization (as the amounts are calculated in accordance with the respective long-term debt arrangements) of less than or equal to 0.65 to 1.00, measured quarterly. As of March 31, 2018, our ratio was approximately 0.42 to 1.00. Failure to meet this covenant would give rise to an event of default if not cured after notice from the lender, in which event ALLETE may need to pursue alternative sources of funding. Some of ALLETE’s debt arrangements contain “cross-default” provisions that would result in an event of default if there is a failure under other financing arrangements to meet payment terms or to observe other covenants that would result in an acceleration of payments due. ALLETE has no significant restrictions on its ability to pay dividends from retained earnings or net income. As of March 31, 2018, ALLETE was in compliance with its financial covenants.



ALLETE, Inc. First Quarter 2018 Form 10-Q
29


NOTE 9. INCOME TAX EXPENSE
 
Three Months Ended
 
March 31,
 
2018
 
2017
Millions
 
 
 
Current Income Tax Expense (a)
 
 
 
Federal

 

State

$0.7

 
$0.1
Total Current Income Tax Expense

$0.7

 
$0.1
Deferred Income Tax Expense (Benefit)
 
 
 
Federal (b)
$(6.8)
 

$7.3

State
2.6

 
5.9

Investment Tax Credit Amortization
(0.2
)
 
(0.2
)
Total Deferred Income Tax Expense (Benefit)
$(4.4)
 

$13.0

Total Income Tax Expense (Benefit)
$(3.7)
 

$13.1

(a)
For the three months ended March 31, 2018, and 2017, the federal and state current tax expense was minimal due to NOLs which resulted from the bonus depreciation provisions of the Protecting Americans from Tax Hikes Act of 2015, the Tax Increase Prevention Act of 2014 and the American Taxpayer Relief Act of 2012.
(b)
For the three months ended March 31, 2018, the federal tax benefit is primarily due to the reduction of the federal statutory tax rate from 35 percent to 21 percent enacted as part of the TCJA, and production tax credits.

The Company's tax provision for interim periods is determined using an estimate of its annual effective tax rate, adjusted for discrete items arising in that quarter. In each quarter, the Company updates its estimate of the annual effective tax rate, and if the estimated annual effective tax rate changes, the Company would make a cumulative adjustment in that quarter.
 
Three Months Ended
Reconciliation of Taxes from Federal Statutory
March 31,
Rate to Total Income Tax Expense
2018
 
2017
Millions
 
 
 
Income Before Non-Controlling Interest and Income Taxes

$47.3

 

$62.1

Statutory Federal Income Tax Rate
21
%
 
35
%
Income Taxes Computed at Statutory Federal Rate

$9.9

 

$21.7

Increase (Decrease) in Income Tax Due to:
 
 
 
State Income Taxes – Net of Federal Income Tax Benefit
2.6

 
3.9

Production Tax Credits
(14.4
)
 
(13.0
)
Regulatory Differences for Utility Plant
(2.5
)
 
0.1

Other
0.7

 
0.4

Total Income Tax Expense (Benefit)
$(3.7)
 

$13.1


For the three months ended March 31, 2018, the effective tax rate was a benefit of 7.8 percent (expense of 21.1 percent for the three months ended March 31, 2017).

Uncertain Tax Positions. As of March 31, 2018, we had gross unrecognized tax benefits of $1.7 million ($1.7 million as of December 31, 2017). Of the total gross unrecognized tax benefits, $0.8 million represents the amount of unrecognized tax benefits included on the Consolidated Balance Sheet that, if recognized, would favorably impact the effective income tax rate. The unrecognized tax benefit amounts have been presented as reductions to the tax benefits associated with NOL and tax credit carryforwards on the Consolidated Balance Sheet.

ALLETE and its subsidiaries file a consolidated federal income tax return as well as combined and separate state income tax returns in various jurisdictions. ALLETE has no open federal or state audits, and is no longer subject to federal examination for years before 2014, or state examination for years before 2013.



ALLETE, Inc. First Quarter 2018 Form 10-Q
30


NOTE 10. RECLASSIFICATIONS OUT OF ACCUMULATED OTHER COMPREHENSIVE LOSS

Changes in Accumulated Other Comprehensive Loss. Comprehensive income (loss) is the change in shareholders’ equity during a period from transactions and events from non-owner sources, including net income. The amounts recorded to accumulated other comprehensive loss include unrealized gains and losses on available-for-sale securities and defined benefit pension and other postretirement items, consisting of deferred actuarial gains or losses and prior service costs or credits.

For the three months ended March 31, 2018, and 2017, reclassifications out of accumulated other comprehensive loss for the Company were not material. Changes in accumulated other comprehensive loss for the three months ended March 31, 2018, are presented on the Consolidated Statement of Shareholders’ Equity.


NOTE 11. EARNINGS PER SHARE AND COMMON STOCK

We compute basic earnings per share using the weighted average number of shares of common stock outstanding during each period. The difference between basic and diluted earnings per share, if any, arises from outstanding stock options, non-vested restricted stock units and performance share awards granted under our Executive Long-Term Incentive Compensation Plan. For the three months ended March 31, 2018, and 2017, no options to purchase shares of ALLETE common stock were excluded from the computation of diluted earnings per share.
 
 
 
2018
 
 
 
 
 
2017
 
 
Reconciliation of Basic and Diluted
 
 
Dilutive
 
 
 
 
 
Dilutive
 
 
Earnings Per Share
Basic
 
Securities
 
Diluted
 
Basic
 
Securities
 
Diluted
Millions Except Per Share Amounts
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31,
 

 
 
 
 

 
 
 
 
 
 
Net Income

$51.0

 
 
 

$51.0

 

$49.0

 
 
 

$49.0

Average Common Shares
51.2

 
0.2

 
51.4

 
50.2

 
0.2

 
50.4

Earnings Per Share

$1.00

 
 
 

$0.99

 

$0.97

 
 
 

$0.97



NOTE 12. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
 
Pension
 
Other
Postretirement
Components of Net Periodic Benefit Cost
2018
 
2017
 
2018
 
2017
Millions
 
 
 
 
 
 
 
Three Months Ended March 31,
 
 
 
 
 
 
 
Service Cost

$2.7

 

$2.5

 

$1.2

 

$1.1

Interest Cost (a)
7.4

 
8.1

 
1.8

 
1.9

Expected Return on Plan Assets (a)
(11.0
)
 
(10.6
)
 
(2.7
)
 
(2.6
)
Amortization of Prior Service Credits (a)

 

 
(0.4
)
 
(0.5
)
Amortization of Net Loss (a)
3.0

 
2.5

 
0.2

 
0.1

Net Periodic Benefit Cost

$2.1

 

$2.5

 

$0.1

 

(a)
These components of net periodic benefit cost are included in the line item “Other” under Other Income (Expense) on the Consolidated Statement of Income.

Employer Contributions. For the three months ended March 31, 2018, we contributed $15.0 million in cash to the defined benefit pension plans ($1.7 million in cash and $13.5 million in ALLETE common stock for the three months ended March 31, 2017); we do not expect to make additional contributions to our defined benefit pension plans in 2018. For the three months ended March 31, 2018, and 2017, we made no contributions to our other postretirement benefit plans; we do not expect to make any contributions to our other postretirement benefit plans in 2018.



ALLETE, Inc. First Quarter 2018 Form 10-Q
31


NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES

Power Purchase Agreements. Our long-term PPAs have been evaluated under the accounting guidance for variable interest entities. We have determined that either we have no variable interest in the PPAs or, where we do have variable interests, we are not the primary beneficiary; therefore, consolidation is not required. These conclusions are based on the fact that we do not have both control over activities that are most significant to the entity and an obligation to absorb losses or receive benefits from the entity’s performance. Our financial exposure relating to these PPAs is limited to our capacity and energy payments.

Our PPAs are summarized in Note 11. Commitments, Guarantees and Contingencies to our Consolidated Financial Statements in our 2017 Form 10-K, with additional disclosure provided in the following paragraphs.

Square Butte PPA. Minnesota Power has a PPA with Square Butte that extends through 2026 (Agreement). Minnesota Power is obligated to pay its pro rata share of Square Butte’s costs based on its entitlement to the output of Square Butte’s 455 MW coal‑fired generating unit. Minnesota Power’s output entitlement under the Agreement is 50 percent for the remainder of the Agreement, subject to the provisions of the Minnkota Power PSA. (See Minnkota Power PSA.) Square Butte’s costs consist primarily of debt service, operating and maintenance, depreciation and fuel expenses. As of March 31, 2018, Square Butte had total debt outstanding of $314.5 million. Fuel expenses are recoverable through Minnesota Power’s fuel adjustment clause and include the cost of coal purchased from BNI Energy under a long-term contract.

Minnesota Power’s cost of power purchased from Square Butte during the three months ended March 31, 2018, was $17.3 million ($20.3 million for the three months ended March 31, 2017). This reflects Minnesota Power’s pro rata share of total Square Butte costs based on the 50 percent output entitlement. Included in this amount was Minnesota Power’s pro rata share of interest expense of $2.3 million ($2.3 million for the same period in 2017). Minnesota Power’s payments to Square Butte are approved as a purchased power expense for ratemaking purposes by both the MPUC and the FERC.

Minnkota Power PSA. Minnesota Power has a PSA with Minnkota Power, which commenced in 2014. Under the PSA, Minnesota Power is selling a portion of its entitlement from Square Butte to Minnkota Power, resulting in Minnkota Power’s net entitlement increasing and Minnesota Power’s net entitlement decreasing until Minnesota Power’s share is eliminated at the end of 2025. Of Minnesota Power’s 50 percent output entitlement, it sold to Minnkota Power approximately 28 percent in 2018 and in 2017.

Oconto Electric Cooperative PSA. On March 6, 2018, Minnesota Power entered into a PSA with Oconto Electric Cooperative. The contract begins in January 2019 and is effective through May 2026. Under the PSA, Minnesota Power expects to provide approximately 25 MW of energy and capacity at fixed prices.

Coal, Rail and Shipping Contracts. Minnesota Power has coal supply agreements providing for the purchase of a significant portion of its coal requirements through December 2018 and a portion of its coal requirements through December 2021. Minnesota Power also has coal transportation agreements in place for the delivery of a significant portion of its coal requirements through December 2018. The estimated minimum payments under these supply and transportation agreements is $21.5 million for the remainder of 2018, $1.8 million in 2019, and none thereafter. The costs of fuel and related transportation costs for Minnesota Power’s generation are recoverable from Minnesota Power’s utility customers through the fuel adjustment clause.

Leasing Agreements. BNI Energy is obligated to make lease payments for a dragline totaling $2.8 million annually during the lease term, which expires in 2027. BNI Energy has the option at the end of the lease term to renew the lease at fair market value, to purchase the dragline at fair market value, or to surrender the dragline and pay a $3.0 million termination fee. We also lease other properties and equipment under operating lease agreements with a majority of terms expiring through 2024. The aggregate amount of minimum lease payments for all operating leases is $3.6 million for the remainder of 2018, $12.8 million in 2019, $9.5 million in 2020, $7.3 million in 2021, $6.1 million in 2022 and $30.0 million thereafter.

Transmission. We continue to make investments in transmission opportunities that strengthen or enhance the transmission grid or take advantage of our geographical location between sources of renewable energy and end users. These include the GNTL, investments to enhance our own transmission facilities, investments in other transmission assets (individually or in combination with others) and our investment in ATC.


ALLETE, Inc. First Quarter 2018 Form 10-Q
32


NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (Continued)
Transmission (Continued)

Great Northern Transmission Line. As a condition of the 250-MW long-term PPA entered into with Manitoba Hydro, construction of additional transmission capacity is required. As a result, Minnesota Power is constructing the GNTL, an approximately 220‑mile 500-kV transmission line between Manitoba and Minnesota’s Iron Range that was proposed by Minnesota Power and Manitoba Hydro in order to strengthen the electric grid, enhance regional reliability and promote a greater exchange of sustainable energy.

In 2015, a certificate of need was approved by the MPUC. Based on this approval, Minnesota Power’s portion of the investments and expenditures for the project are eligible for cost recovery under its existing transmission cost recovery rider and are anticipated to be included in future transmission cost recovery filings. (See Note 6. Regulatory Matters.) Also in 2015, the FERC approved our request to recover on construction work in progress related to the GNTL from Minnesota Power’s wholesale customers. In a 2016 order, the MPUC approved the route permit for the GNTL which largely follows Minnesota Power’s preferred route, including the international border crossing, and in 2016, the U.S. Department of Energy issued a presidential permit to cross the U.S.‑Canadian border, which was the final major regulatory approval needed before construction in the U.S. could begin. Site clearing and pre‑construction activities commenced in the first quarter of 2017 with construction expected to be completed in 2020. To date, most of the right-of-way has been cleared, foundation installation and transmission tower assembly have commenced and tower construction is expected to begin in 2018. Total project cost in the U.S., including substation work, is estimated to be between $560 million and $710 million, of which Minnesota Power’s portion is expected to be between $300 million and $350 million; the difference will be recovered from a subsidiary of Manitoba Hydro as contributions in aid of construction. Total project costs of $211.4 million have been incurred through March 31, 2018, of which $110.0 million has been recovered from a subsidiary of Manitoba Hydro.

Manitoba Hydro must obtain regulatory and governmental approvals related to a new transmission line in Canada known as the Manitoba-Minnesota Transmission Project (MMTP) that will connect with the GNTL. In 2015, Manitoba Hydro submitted the final preferred route and EIS for the MMTP to the Manitoba Conservation and Water Stewardship for siting and environmental approval, which remains pending. In 2016, Manitoba Hydro filed an application with the Canadian National Energy Board (NEB) requesting authorization to construct and operate the MMTP. The NEB determined that Manitoba Hydro’s application was complete in December 2017, and scheduled public hearings for this summer. The NEB is required to make a decision on the MMTP by March 2019 but is not precluded from making a decision prior to that date. Approval of the Canadian federal cabinet is also required. The MMTP is subject to legal and regulatory challenges which Minnesota Power is actively monitoring. Manitoba Hydro has informed Minnesota Power that it continues to work towards completing the MMTP on schedule. In order to meet the transmission in-service requirements in PPAs with Minnesota Power, Manitoba Hydro has indicated that it would need to start construction of the MMTP in December 2018. We are unable to predict the outcome of the Canadian regulatory review process, including the timing thereof or whether any onerous conditions may be imposed, or the timing of the completion of the MMTP, including the impact of any delays that may result in construction schedule adjustments. Any significant delays in the MMTP construction schedule may result in Minnesota Power adjusting the GNTL construction schedule and impact the timing of capital expenditures and associated cost recovery under our transmission cost recovery rider.

Construction of Manitoba Hydro’s Keeyask hydroelectric generation facility, which will provide the power to be sold under PPAs with Minnesota Power that is to be transmitted on the MMTP and the GNTL, commenced in 2014 and is anticipated to be in service by early 2021.

Environmental Matters.

Our businesses are subject to regulation of environmental matters by various federal, state and local authorities. A number of regulatory changes to the Clean Air Act, the Clean Water Act and various waste management requirements have been promulgated by both the EPA and state authorities over the past several years. Minnesota Power’s facilities are subject to additional requirements under many of these regulations. Minnesota Power is reshaping its generation portfolio, over time, to reduce its reliance on coal, has installed cost-effective emission control technology, and advocates for sound science and policy during rulemaking implementation.

We consider our businesses to be in substantial compliance with currently applicable environmental regulations and believe all necessary permits have been obtained. We anticipate that with many state and federal environmental regulations and requirements finalized, or to be finalized in the near future, potential expenditures for future environmental matters may be material and require significant capital investments. Minnesota Power has evaluated various environmental compliance scenarios using possible outcomes of environmental regulations to project power supply trends and impacts on customers.

ALLETE, Inc. First Quarter 2018 Form 10-Q
33


NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (Continued)
Environmental Matters (Continued)

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. Accruals are adjusted as assessment and remediation efforts progress, or as additional technical or legal information becomes available. Accruals for environmental liabilities are included in the Consolidated 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 expensed unless recoverable in rates from customers.

Air. The electric utility industry is regulated both at the federal and state level to address air emissions. Minnesota Power’s generating facilities mainly burn low-sulfur western sub-bituminous coal. All of Minnesota Power’s coal-fired generating facilities are equipped with pollution control equipment such as scrubbers, baghouses and low NOX technologies. Under currently applicable environmental regulations, these facilities are substantially compliant with emission requirements.

New Source Review (NSR). In 2008, Minnesota Power received a Notice of Violation (NOV) from the EPA asserting violations of the NSR requirements of the Clean Air Act at Boswell and Laskin Unit 2 between the years of 1981 and 2001. Minnesota Power received an additional NOV in 2011 alleging that two projects undertaken at Rapids Energy Center in 2004 and 2005 should have been reviewed under the NSR requirements and that the Rapids Energy Center’s Title V permit was violated. Minnesota Power reached a settlement with the EPA regarding these NOVs and entered into a Consent Decree, which was approved by the U.S. District Court for the District of Minnesota in 2014. The Consent Decree provided for, among other requirements, more stringent emissions limits at all affected units, the option of refueling, retrofitting or retiring certain small coal units, and the addition of 200 MW of wind energy. Provisions of the Consent Decree require that, by no later than December 31, 2018, Boswell Units 1 and 2 must be retired, refueled, repowered, or emissions rerouted through existing emission control technology at Boswell. In 2016, Minnesota Power announced that Boswell Units 1 and 2 will be retired in 2018 as part of its EnergyForward strategic plan. We believe that costs to retire Boswell Units 1 and 2 will be eligible for recovery in rates over time, subject to regulatory approval in a rate proceeding.

Cross-State Air Pollution Rule (CSAPR). The CSAPR requires certain states in the eastern half of the U.S., including Minnesota, to reduce power plant emissions that contribute to ozone or fine particulate pollution in other states. The CSAPR does not require installation of controls but does require facilities have sufficient allowances to cover their emissions on an annual basis. These allowances are allocated to facilities from each state’s annual budget, and can be bought and sold. Based on our review of the NOx and SO2 allowances issued and pending issuance, we currently expect generation levels and emission rates will result in continued compliance with the CSAPR.

Mercury and Air Toxics Standards (MATS) Rule. Under Section 112 of the Clean Air Act, the EPA is required to set emission standards for hazardous air pollutants (HAPs) for certain source categories. The final MATS rule addressed such emissions from coal-fired utility units greater than 25 MW and established categories of HAPs, including mercury, trace metals other than mercury, and acid gases. The EPA established emission limits for these categories of HAPs and work practice standards for the remaining categories. Construction on the project to implement the Boswell Unit 4 mercury emissions reduction plan to position the unit for MATS compliance was completed in 2015. Investments and compliance work previously completed at Boswell Unit 3, including emission reduction investments completed in 2009, meet the requirements of the MATS rule. The conversion of Laskin Units 1 and 2 to operate on natural gas in 2015 positioned those units for MATS compliance.

Minnesota Mercury Emissions Reduction Act/Rule. Minnesota Power was required to implement a mercury emissions reduction project for Boswell Unit 4 by December 31, 2018. The Boswell Unit 4 environmental upgrade discussed above (see Mercury and Air Toxics Standards (MATS) Rule) fulfills the requirements of the Minnesota Mercury Emissions Reduction Act.

National Ambient Air Quality Standards (NAAQS). The EPA is required to review the NAAQS every five years. If the EPA determines that a state’s air quality is not in compliance with the NAAQS, the state is required to adopt plans describing how it will reduce emissions to attain the NAAQS. Four NAAQS have either recently been revised or are currently proposed for revision, as described below.

Ozone NAAQS. All areas of Minnesota currently meet the new standard based on the most recent available ambient monitoring data; however, some areas in the metropolitan Twin Cities and southwest portion of the state are close to exceeding the standard. As a result, voluntary efforts to reduce ground-level ozone continue in the state. No additional costs for compliance are anticipated at this time.

ALLETE, Inc. First Quarter 2018 Form 10-Q
34


NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (Continued)
Environmental Matters (Continued)

Particulate Matter NAAQS. The EPA has designated the entire state of Minnesota as unclassifiable/attainment; however, Minnesota sources may ultimately be required to reduce their emissions to assist with attainment in neighboring states. In 2016, environmental groups filed a lawsuit against the EPA in the U.S. District Court for the Northern District of California alleging the EPA had failed to fully implement the PM2.5 standards in certain states, including Minnesota, by not enforcing states’ submittals of required infrastructure implementation plans for the 2012 PM2.5 NAAQS. The outcome of this litigation is uncertain, and as such, any costs for complying with the final Particulate Matter NAAQS cannot be estimated at this time.

NO2 NAAQS. Ambient monitoring data indicates that Minnesota is likely in compliance with the one-hour NAAQS standard for NO2. In July 2017, the EPA proposed retaining the current one-hour and annual NO2 NAAQS. Additional compliance costs for the one-hour NO2 NAAQS are not expected at this time.

SO2 NAAQS. In 2015, the EPA finalized the SO2 data requirements rule (DRR) for the 2010 one-hour NAAQS to assist the states in implementing the standard. The MPCA initially informed Minnesota Power that compliant SO2 modeling completed at Minnesota Power's Boswell and Taconite Harbor facilities would satisfy the DRR obligations and no further modeling would be required; however, the DRR also require facilities have federally-enforceable permit limits at which the one-hour SO2 NAAQS compliance was modeled by January 2017. Taconite Harbor was issued an amended air permit in 2016, containing the new modeling limits at that facility. The MPCA did not meet the January 2017, deadline to amend the Boswell permit. The MPCA is in discussions with the EPA on alternate compliance pathways to use existing completed modeling at current limits. In August 2017, the EPA proposed retaining the current primary SO2 one-hour NAAQS. Compliance costs for the one-hour SO2 NAAQS are not expected to be material.

Climate Change. The scientific community generally accepts that emissions of GHG are linked to global climate change which creates physical and financial risks. Physical risks could include, but are not limited to: increased or decreased precipitation and water levels in lakes and rivers; increased temperatures; and changes in the intensity and frequency of extreme weather events. These all have the potential to affect the Company’s business and operations. We are addressing climate change by taking the following steps that also ensure reliable and environmentally compliant generation resources to meet our customers’ requirements:

Expanding our renewable power supply;
Providing energy conservation initiatives for our customers and engaging in other demand side management efforts;
Improving efficiency of our generating facilities;
Supporting research of technologies to reduce carbon emissions from generating facilities and carbon sequestration efforts; and
Evaluating and developing less carbon intensive future generating assets such as efficient and flexible natural gas-fired generating facilities.

EPA Regulation of GHG Emissions. In 2010, the EPA issued the Prevention of Significant Deterioration (PSD) and Title V Greenhouse Gas Tailoring Rule (Tailoring Rule). The Tailoring Rule establishes permitting thresholds required to address GHG emissions for new facilities, existing facilities that undergo major modifications and other facilities characterized as major sources under the Clean Air Act’s Title V program. For our existing facilities, the rule does not require amending our existing Title V operating permits to include GHG requirements, however, GHG requirements may be added to our existing Title V operating permits by the MPCA as these permits are renewed or amended.

In 2014, the U.S. Supreme Court invalidated the aspect of the Tailoring Rule that established higher permitting thresholds for GHG than for other pollutants subject to PSD; however, the court also upheld the EPA’s ability to require best available control technology (BACT) for GHG from sources already subject to regulation under PSD. Minnesota Power’s coal-fired generating facilities are already subject to regulation under PSD, so we anticipate that ultimately PSD for GHG will apply to our facilities, but the timing of the promulgation of a replacement for the Tailoring Rule is uncertain. The PSD applies to existing facilities only when they undertake a major modification that increases emissions.

In 2016, the EPA published a proposed rule in the Federal Register to revise its PSD and Title V regulatory provisions concerning GHG emissions. In this proposed rule, the EPA proposes to amend its regulations to clarify that a source’s obligation to obtain a PSD or Title V permit is triggered only by non-GHG pollutants. If the PSD or Title V permitting requirements are triggered by non-GHG, NSR pollutants, then these programs will also apply to the source’s GHG emissions. The proposed rule, as currently written, is not expected to have a material impact on the Title V permitting for current operations.

ALLETE, Inc. First Quarter 2018 Form 10-Q
35


NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (Continued)
Environmental Matters (Continued)

In 2014, the EPA announced a proposed rule under Section 111(d) of the Clean Air Act for existing power plants entitled “Carbon Pollution Emission Guidelines for Existing Stationary Sources: Electric Generating Units”, also referred to as the Clean Power Plan (CPP). The EPA issued the final CPP in 2015, together with a proposed federal implementation plan and a model rule for emissions trading. In 2016, the U.S. Supreme Court issued an order staying the effectiveness of the rule until after the appellate court process is complete. In 2016, the U.S. Court of Appeals for the District of Columbia heard oral arguments and is currently deliberating. If the CPP is upheld at the completion of the appellate process, all of the CPP regulatory deadlines are expected to be reset based on the length of time that the appeals process takes. The EPA is precluded from enforcing the CPP while the U.S. Supreme Court stay is in force; however, the MPCA has been holding a series of meetings on the CPP for educational and planning purposes in the interim. Minnesota Power has been actively involved in these MPCA meetings, and is closely monitoring the appeals process.

If upheld, the CPP would establish uniform CO2 emission performance rates for existing fossil fuel-fired and natural gas-fired combined cycle generating units, setting state-specific goals for CO2 emissions from the power sector. State goals were determined based on CPP source-specific performance emission rates and each state’s mix of power plants. The EPA filed a motion with the U.S. Court of Appeals for the District of Columbia Circuit to hold CPP-related litigation in suspension while the EPA is reviewing the rule. In October 2017, the EPA issued a notice of proposed rulemaking, proposing to repeal the CPP. In December 2017, an Advanced Notice of Proposed Rulemaking (ANPRM) for a CPP replacement rule was published in the Federal Register.

Minnesota Power is currently evaluating the CPP rescission and recently proposed ANPRM for a CPP replacement rule as it relates to the State of Minnesota as well as its potential impact on the Company. Minnesota has already initiated several measures consistent with those called for under the CPP. Minnesota Power is implementing its EnergyForward strategic plan that provides for significant emission reductions and diversifying its electricity generation mix to include more renewable and natural gas energy. (See Note 6. Regulatory Matters.)

We are unable to predict the GHG emission compliance costs we might incur; however, the costs could be material. Minnesota Power would seek recovery of additional costs through a rate proceeding.

Water. The Clean Water Act requires National Pollutant Discharge Elimination System (NPDES) permits be obtained from the EPA (or, when delegated, from individual state pollution control agencies) for any wastewater discharged into navigable waters. We have obtained all necessary NPDES permits, including NPDES storm water permits for applicable facilities, to conduct our operations.

Clean Water Act - Aquatic Organisms. In 2014, EPA regulations under Section 316(b) of the Clean Water Act setting standards applicable to cooling water intake structures for the protection of aquatic organisms became effective. The regulations require existing large power plants and manufacturing facilities that withdraw greater than 25 percent of water from adjacent water bodies for cooling purposes and have a design intake flow of greater than 2 million gallons per day, to limit the number of aquatic organisms that are impacted by the facility’s intake structure or cooling system. The Section 316(b) rule will be implemented through NPDES permits issued to covered facilities. No NPDES permits for Minnesota Power facilities have been re-issued containing Section 316(b) requirements since the final rule became effective. Should the MPCA require significant modifications to Minnesota Power’s intake structures, a preliminary assessment indicates that Minnesota Power could incur costs of compliance up to $15 million over the next five years. Minnesota Power would seek recovery of additional costs through a rate proceeding.

Steam Electric Power Generating Effluent Guidelines. In 2015, the EPA issued revised federal effluent limit guidelines (ELG) for steam electric power generating stations under the Clean Water Act. It set effluent limits and prescribed BACT for several wastewater streams, including flue gas desulphurization (FGD) water, bottom ash transport water and coal combustion landfill leachate. In September 2017, the EPA announced a two-year postponement of the ELG compliance date of November 1, 2018, to November 1, 2020, while the agency reconsiders bottom ash transport water and FGD wastewater provisions.

The final ELG rule’s potential impact on Minnesota Power operations is primarily at Boswell. Boswell currently discharges bottom ash contact water through its NPDES permit, and also has a closed-loop FGD system that does not discharge, but may do so in the future. Under the existing ELG rule, bottom ash transport water discharge must cease no later than December 31, 2023. Bottom ash contact water will either need to be re-used in a closed-loop process, routed to a FGD scrubber, or the bottom ash handling system will need to be converted to a dry process. If FGD wastewater is discharged in the future, it will require additional wastewater treatment. The ELG rule provision regarding these two waste-streams are being reconsidered and may change prior to November 1, 2020. Efforts have been underway at Boswell for several years to reduce the amount of water discharged and evaluate potential re-use options in its plant processes.

ALLETE, Inc. First Quarter 2018 Form 10-Q
36


NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (Continued)
Environmental Matters (Continued)

At this time, we cannot estimate what compliance costs we might incur related to these or other potential future water discharge regulations; however, the costs could be material, including costs associated with retrofits for bottom ash handling, pond dewatering, pond closure, and wastewater treatment and reuse. Minnesota Power would seek recovery of additional costs through a rate proceeding.

Solid and Hazardous Waste. The Resource Conservation and Recovery Act of 1976 regulates the management and disposal of solid and hazardous wastes. We are required to notify the EPA of hazardous waste activity and, consequently, routinely submit reports to the EPA.

Coal Ash Management Facilities. Minnesota Power stores or disposes coal ash at four of its electric generating facilities by the following methods: storing ash in lined onsite impoundments (ash ponds), disposing of dry ash in a lined dry ash landfill which has been idled and has a temporary landfill cover in place, applying ash to land as an approved beneficial use and trucking ash to state permitted landfills.

Coal Combustion Residuals from Electric Utilities (CCR). In 2015, the EPA published the final rule regulating CCR as nonhazardous waste under Subtitle D of the Resource Conservation and Recovery Act (RCRA) in the Federal Register. The rule includes additional requirements for new landfill and impoundment construction as well as closure activities related to certain existing impoundments. Costs of compliance for Boswell and Laskin are expected to occur primarily over the next 10 years and be between approximately $65 million and $100 million. The EPA has indicated to Minnesota Power that the Taconite Harbor landfill is a CCR unit, based on the EPA’s interpretation of the CCR rule language. Minnesota Power has agreed to post the required CCR information for the Taconite Harbor landfill on Minnesota Power’s website while the CCR issue is resolved. Minnesota Power continues to work on minimizing costs through evaluation of beneficial re-use and recycling of CCR and CCR-related waters. In September 2017, the EPA announced its intention to formally reconsider the CCR rule under Subtitle D of the RCRA and on March 15, 2018, published the first phase of the proposed rule revisions in the federal register. Compliance costs, if any, for CCR at Taconite Harbor cannot be estimated at this time. Minnesota Power would seek recovery of additional costs through a rate proceeding.

Other Environmental Matters

Manufactured Gas Plant Site. We are reviewing and addressing environmental conditions at a former manufactured gas plant site located in Superior, Wisconsin, and formerly operated by SWL&P. SWL&P has been working with the Wisconsin Department of Natural Resources (WDNR) in determining the extent and location of contamination at the site and surrounding properties. In December 2017, the WDNR authorized SWL&P to transition from site investigation into the remedial design process. As of March 31, 2018, we have recorded a liability of approximately $7 million for remediation costs at this site (approximately $8 million as of December 31, 2017), and a corresponding regulatory asset as we expect recovery of these remediation costs to be allowed by the PSCW. We expect to incur these costs over the next four years.

Other Matters.

ALLETE Clean Energy. ALLETE Clean Energy’s wind energy facilities have PSAs in place for their entire output and expire in various years between 2018 and 2032. As of March 31, 2018, ALLETE Clean Energy has $16.2 million outstanding in standby letters of credit.

U.S. Water Services. As of March 31, 2018, U.S. Water Services has $0.8 million outstanding in standby letters of credit.

BNI Energy. As of March 31, 2018, BNI Energy had surety bonds outstanding of $49.9 million and a letter of credit for an additional $0.6 million related to the reclamation liability for closing costs associated with its mine and mine facilities. Although its coal supply agreements obligate the customers to provide for the closing costs, additional assurance is required by federal and state regulations. BNI Energy’s total reclamation liability is currently estimated at $47.5 million. BNI Energy does not believe it is likely that any of these outstanding surety bonds or the letter of credit will be drawn upon.

ALLETE Properties. As of March 31, 2018, ALLETE Properties had surety bonds outstanding and letters of credit to governmental entities totaling $8.6 million primarily related to development and maintenance obligations for various projects. The estimated cost of the remaining development work is $6.1 million. ALLETE Properties does not believe it is likely that any of these outstanding surety bonds or letters of credit will be drawn upon.

ALLETE, Inc. First Quarter 2018 Form 10-Q
37


NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (Continued)
Other Matters (Continued)

Community Development District Obligations. At March 31, 2018, we owned 70 percent of the assessable land in the Town Center District (70 percent at December 31, 2017) and 27 percent of the assessable land in the Palm Coast Park District (33 percent at December 31, 2017). At March 31, 2018, ownership levels, our annual assessments related to capital improvement and special assessment bonds for the ALLETE Properties projects within these districts are approximately $1.4 million for Town Center at Palm Coast and $0.6 million for Palm Coast Park. As we sell property at these projects, the obligation to pay special assessments will pass to the new landowners. In accordance with accounting guidance, these bonds are not reflected as debt on our Consolidated Balance Sheet.

Legal Proceedings.

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, and compliance with regulations, rate base and cost of service issues, among other things. We do not expect the outcome of these matters to have a material effect on our financial position, results of operations or cash flows.


NOTE 14. BUSINESS SEGMENTS

We present three reportable segments: Regulated Operations, ALLETE Clean Energy and U.S. Water Services. We measure performance of our operations through budgeting and monitoring of contributions to consolidated net income by each business segment.

Regulated Operations includes three operating segments which consist of our regulated utilities, Minnesota Power and SWL&P, as well as our investment in ATC. ALLETE Clean Energy is our business focused on developing, acquiring and operating clean and renewable energy projects. U.S. Water Services is our integrated water management company. The ALLETE Clean Energy and U.S. Water Services reportable segments comprise our Energy Infrastructure and Related Services businesses. We also present Corporate and Other which includes two operating segments, BNI Energy, our coal mining operations in North Dakota, and ALLETE Properties, our legacy Florida real estate investment, along with other business development and corporate expenditures, unallocated interest expense, a small amount of non-rate base generation, approximately 5,000 acres of land in Minnesota, and earnings on cash and investments.

ALLETE, Inc. First Quarter 2018 Form 10-Q
38


NOTE 14. BUSINESS SEGMENTS (Continued)
 
Three Months Ended
 
March 31,
 
2018
2017
Millions
 
 
Operating Revenue (a)
 
 
Regulated Operations
 
 
Residential

$40.7


$39.5

Commercial
36.6

38.2

Municipal
14.0

18.2

Industrial
114.9

121.7

Other Power Suppliers
43.7

41.2

Other
20.3

22.8

Total Regulated Operations
270.2

281.6

 
 
 
Energy Infrastructure and Related Services
 
 
 
 
 
ALLETE Clean Energy
 
 
Long-term PSA
18.6

17.8

Other
6.0

5.9

Total ALLETE Clean Energy
24.6

23.7

 
 
 
U.S. Water Services
 
 
Point-in-Time
22.3

21.8

Contract
9.5

8.9

Capital Project
6.4

1.4

Total U.S. Water Services
38.2

32.1

 
 
 
Corporate and Other
 
 
Long-term Contract
20.0

22.1

Other
5.2

6.1

Total Corporate and Other
25.2

28.2

Total Operating Revenue

$358.2


$365.6

Net Income (Loss)
 
 
Regulated Operations

$43.9


$43.5

 
 
 
Energy Infrastructure and Related Services
 
 
ALLETE Clean Energy
8.1

6.7

U.S. Water Services
(1.4
)
(0.3
)
 
 
 
Corporate and Other
0.4

(0.9
)
Total Net Income

$51.0


$49.0

(a)
With the adoption of new revenue recognition guidance, the Company has enhanced the presentation of business segment Operating Revenue. (See Note 1. Operations and Significant Accounting Policies.)
 
March 31,
2018

December 31,
2017

Millions
 
 
Assets
 
 
Regulated Operations

$3,877.0


$3,886.6

 
 
 
Energy Infrastructure and Related Services
 
 
ALLETE Clean Energy
620.4

600.5

U.S. Water Services
287.4

292.4

 
 
 
Corporate and Other
287.3

300.5

Total Assets

$5,072.1


$5,080.0


ALLETE, Inc. First Quarter 2018 Form 10-Q
39


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

The following discussion should be read in conjunction with our Consolidated Financial Statements and notes to those statements, Management’s Discussion and Analysis of Financial Condition and Results of Operations from the 2017 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 and our 2017 Form 10-K under the headings: “Forward-Looking Statements” located on page 6 and “Risk Factors” located in Part I, Item 1A, beginning on page 25 of our 2017 Form 10-K. The risks and uncertainties described in this Form 10-Q and our 2017 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 risks are realized.

Regulated Operations includes our regulated utilities, Minnesota Power and SWL&P, as well as our investment in ATC, a Wisconsin-based regulated utility that owns and maintains electric transmission assets in portions of Wisconsin, Michigan, Minnesota and Illinois. Minnesota Power provides regulated utility electric service in northeastern Minnesota to approximately 145,000 retail customers. Minnesota Power also has 16 non-affiliated municipal customers in Minnesota. SWL&P is a Wisconsin utility and a wholesale customer of Minnesota Power. SWL&P provides regulated utility electric, natural gas and water service in northwestern Wisconsin to approximately 15,000 electric customers, 13,000 natural gas customers and 10,000 water customers. Our regulated utility operations include retail and wholesale activities under the jurisdiction of state and federal regulatory authorities. (See Note 6. Regulatory Matters.)

ALLETE Clean Energy focuses on developing, acquiring, and operating clean and renewable energy projects. ALLETE Clean Energy currently owns and operates, in four states, approximately 535 MW of nameplate capacity wind energy generation that is contracted under PSAs of various durations. ALLETE Clean Energy also engages in the development of wind energy facilities to operate under long-term PSAs or for sale to others upon completion.

U.S. Water Services provides integrated water management for industry by combining chemical, equipment, engineering and service for customized solutions to reduce water and energy usage, and improve efficiency.

Corporate and Other is comprised of BNI Energy, our coal mining operations in North Dakota, ALLETE Properties, our legacy Florida real estate investment, other business development and corporate expenditures, unallocated interest expense, a small amount of non-rate base generation, approximately 5,000 acres of land in Minnesota, and earnings on cash and investments.

ALLETE is incorporated under the laws of Minnesota. Our corporate headquarters are in Duluth, Minnesota. Statistical information is presented as of March 31, 2018, 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.

Financial Overview

The following net income discussion summarizes a comparison of the three months ended March 31, 2018, to the three months ended March 31, 2017.

Net income for the three months ended March 31, 2018, was $51.0 million, or $0.99 per diluted share, compared to $49.0 million, or $0.97 per diluted share, for the same period in 2017. Earnings per share dilution was $0.02 due to additional shares of common stock outstanding as of March 31, 2018.

Regulated Operations net income was $43.9 million for the three months ended March 31, 2018, compared to $43.5 million for the same period in 2017. Net income at Minnesota Power was slightly lower than 2017 primarily due to reserves for an interim rate refund, discounts provided to EITE customers, lower transmission revenue, and higher property taxes. These decreases were mostly offset by lower depreciation expense due to the timing of the MPUC’s decision to modify the depreciable lives at Boswell, lower operating and maintenance expense, higher sales to industrial customers due to the start-up of Keetac in March 2017, and higher sales to residential customers due to colder weather. Net income at SWL&P was higher than 2017 due to the implementation of updated rates in August 2017 and colder weather in 2018. Our after-tax equity earnings in ATC for the three months ended March 31, 2018, were consistent with the same period in 2017.

ALLETE, Inc. First Quarter 2018 Form 10-Q
40


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (Continued)

ALLETE Clean Energy net income was $8.1 million for the three months ended March 31, 2018, compared to $6.7 million for the same period in 2017. Net income in 2018 included a lower federal income tax rate due to the TCJA and $0.6 million after‑tax of additional production tax credits generated as ALLETE Clean Energy continues to execute its refurbishment strategy. These increases were partially offset by higher operating and maintenance expenses.
 
U.S. Water Services net loss was $1.4 million for the three months ended March 31, 2018, compared to $0.3 million for the same period in 2017. The net loss in 2018 includes higher operating expenses, partially offset by increased revenue primarily resulting from the September 2017 acquisition of Tonka Water. The first quarter of 2018 was also negatively impacted by the timing of equipment sales and colder weather reducing chemical sales. The net loss in 2018 included $0.3 million of after-tax expense recognized as cost of sales related to purchase accounting for sales backlog.

Corporate and Other net income was $0.4 million for the three months ended March 31, 2018, compared to a net loss of $0.9 million for the same period in 2017. Results in 2018 increased primarily due to higher revenue at ALLETE Properties and lower interest expense.


COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2018 AND 2017

(See Note 14. Business Segments for financial results by segment.)

Regulated Operations
Three Months Ended March 31,
2018

2017

Millions
 
 
Operating Revenue – Utility

$270.2


$281.6

Fuel, Purchased Power and Gas – Utility
100.9

96.6

Transmission Services – Utility
18.4

16.6

Operating and Maintenance
55.5

56.1

Depreciation and Amortization
34.3

39.7

Taxes Other than Income Taxes
15.1

13.2

Operating Income
46.0

59.4

Interest Expense
(14.9
)
(14.0
)
Equity Earnings in ATC
4.7

6.1

Other Income
1.6

1.3

Income Before Income Taxes
37.4

52.8

Income Tax Expense (Benefit)
(6.5
)
9.3

Net Income

$43.9


$43.5


Operating Revenue Utility decreased $11.4 million, or 4 percent, from 2017 reflecting reserves related to the federal income tax rate change due to the TCJA, interim retail rate refund reserves, discounts provided to EITE customers, lower transmission revenue and lower FERC formula-based rates, partially offset by higher revenue from kWh sales and conservation improvement program recoveries.

Reserves related to the federal income tax rate change due to the TCJA of $7.5 million were recognized during 2018. We have recorded the impact of the federal income tax rate change due to the TCJA for Minnesota Power and SWL&P as regulatory liabilities pending the outcome of regulatory proceedings with the MPUC and PSCW. (See Note 6. Regulatory Matters.)

Interim rates, net of reserves, decreased $4.5 million from 2017 as interim rate refund reserves were recognized during 2018 due to the regulatory outcome of the MPUC’s decisions in Minnesota Power’s 2016 general rate case. (See Note 6. Regulatory Matters.)

Transmission revenue decreased $2.5 million primarily due to lower MISO-related revenue. (See Operating Expenses - Transmission Services – Utility.)

ALLETE, Inc. First Quarter 2018 Form 10-Q
41


COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2018 AND 2017 (Continued)
Regulated Operations (Continued)

Revenue from wholesale customers under FERC formula-based rates decreased $1.2 million from 2017 primarily due to lower rates.

Revenue from kWh sales increased $3.4 million from 2017 primarily due to higher sales to Industrial, Residential and Municipal customers, partially offset by discounts provided to EITE customers in 2018. Sales to Industrial customers increased 4.6 percent primarily due to increased taconite production. USS Corporation restarted production at its Keetac plant in March 2017. Sales to Residential and Municipal customers increased in 2018, primarily due to colder temperatures in 2018. Heating degree days in Duluth, Minnesota were approximately 13 percent higher in 2018 compared to 2017. Sales to Other Power Suppliers decreased 3.7 percent from 2017 as a result of increased sales to Industrial customers, which was more than offset by higher pricing on PSAs with these customers. Sales to Other Power Suppliers are sold at market-based prices into the MISO market on a daily basis or through bilateral agreements of various durations.
Kilowatt-hours Sold
 
 
 
 
Quantity
 
%
Three Months Ended March 31,
2018

 
2017

 
Variance
 
Variance
Millions
 
 
 
 
 
 
 
Regulated Utility
 
 
 
 
 
 
 
Retail and Municipal
 
 
 
 
 
 
 
Residential
342

 
323