ALLETE
ALLETE INC (Form: 10-Q, Received: 08/01/2013 08:04:10)
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 June 30, 2013

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, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

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

Common Stock, no par value,
40,127,405 shares outstanding
as of June 30, 2013




INDEX
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2013 and December 31, 2012
 
 
 
 
 
 
 
 
Quarter and Six Months Ended June 30, 2013 and 2012
 
 
 
 
 
 
 
 
Quarter and Six Months Ended June 30, 2013 and 2012
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2013 and 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

ALLETE Second Quarter 2013 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
AC
Alternating Current
AFUDC
Allowance for Funds Used During Construction – the cost of both debt and equity funds used to finance utility plant additions during construction periods
ALLETE
ALLETE, Inc.
ALLETE Clean Energy
ALLETE Clean Energy, Inc.
ALLETE Properties
ALLETE Properties, LLC, and its subsidiaries
ArcelorMittal
ArcelorMittal USA, Inc.
ATC
American Transmission Company LLC
Bison
Bison Wind Energy Center
BNI Coal
BNI Coal, Ltd.
Boswell
Boswell Energy Center
CAIR
Clean Air Interstate Rule
CO 2
Carbon Dioxide
Company
ALLETE, Inc., and its subsidiaries
CSAPR
Cross-State Air Pollution Rule
DC
Direct Current
EPA
Environmental Protection Agency
ESOP
Employee Stock Ownership Plan
FASB
Financial Accounting Standards Board
FERC
Federal Energy Regulatory Commission
Form 10-K
ALLETE Annual Report on Form 10-K
Form 10-Q
ALLETE Quarterly Report on Form 10-Q
GAAP
United States Generally Accepted Accounting Principles
GHG
Greenhouse Gases
Invest Direct
ALLETE’s Direct Stock Purchase and Dividend Reinvestment Plan
Item ___
Item ___ of this Form 10-Q
kV
Kilovolt(s)
Laskin
Laskin Energy Center
LIBOR
London Interbank Offered Rate
MACT
Maximum Achievable Control Technology
Manitoba Hydro
Manitoba Hydro-Electric Board
MATS
Mercury and Air Toxics Standards
Medicare Part D
Medicare Part D provision of The Patient Protection and Affordable Care Act of 2010
Minnesota Power
An operating division of ALLETE, Inc.
Minnkota Power
Minnkota Power Cooperative, Inc.

ALLETE Second Quarter 2013 Form 10-Q
3



Definitions (Continued)
 
Abbreviation or Acronym
Term
MISO
Midcontinent Independent System Operator, 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
Non-residential
Retail commercial, non-retail commercial, office, industrial, warehouse, storage and institutional
NO 2
Nitrogen Dioxide
NO X
Nitrogen Oxides
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
Palm Coast Park development project in Florida
Palm Coast Park District
Palm Coast Park Community Development District
PolyMet
PolyMet Mining Corporation
PPA
Power Purchase Agreement
PPACA
Patient Protection and Affordable Care Act of 2010
PSCW
Public Service Commission of Wisconsin
Rainy River Energy
Rainy River Energy Corporation - Wisconsin
SEC
Securities and Exchange Commission
SIP
State Implementation Plan
SO 2
Sulfur Dioxide
Square Butte
Square Butte Electric Cooperative
SWL&P
Superior Water, Light and Power Company
Taconite Harbor
Taconite Harbor Energy Center
Taconite Ridge
Taconite Ridge Energy Center
Town Center
Town Center at Palm Coast development project in Florida
Town Center District
Town Center at Palm Coast Community Development District
U.S.
United States of America
USS Corporation
United States Steel Corporation
WDNR
Wisconsin Department of Natural Resources


ALLETE Second Quarter 2013 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;
regulatory or legislative actions, including those of the United States Congress, state legislatures, the FERC, the MPUC, the PSCW, the NDPSC, the EPA and various state, local and county regulators, and city administrators, that impact 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, recovery of purchased power, capital investments and other expenses, including present or prospective wholesale and retail competition and environmental matters;
our ability to manage expansion and integrate acquisitions;
our current and potential industrial and municipal customers’ ability to execute announced expansion plans;
the impacts on our Regulated Operations of climate change and future regulation to restrict the emissions of GHG;
effects of restructuring initiatives in the electric industry;
economic and geographic factors, including political and economic risks;
changes in and compliance with laws and regulations;
weather conditions, natural disasters and pandemic diseases;
war, acts of terrorism and cyber attacks;
wholesale power market conditions;
population growth rates and demographic patterns;
effects of competition, including competition for retail and wholesale customers;
zoning and permitting of land held for resale, real estate development or changes in the real estate market;
pricing, availability and transportation of fuel and other commodities and the ability to recover the costs of such commodities;
changes in tax rates or policies or in rates of inflation;
project delays or changes in project costs;
availability and management   of construction materials and skilled construction labor for capital projects;
changes in operating expenses and capital expenditures;
global and domestic economic conditions affecting us or our customers;
our ability to access capital markets and bank financing;
changes in interest rates and the performance of the financial markets;
our ability to replace a mature workforce and retain qualified, skilled and experienced personnel; and
the outcome of legal and administrative proceedings (whether civil or criminal) and settlements.

Additional disclosures regarding factors that could cause our results or performance to differ from those anticipated by this report are discussed in Item 1A under the heading “Risk Factors” beginning on page 27 of our 2012 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 we assess the impact of each of these factors on our businesses or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statement. Readers are urged to carefully review and consider the various disclosures made by us in this Form 10-Q and in our other reports filed with the SEC that attempt to identify the risks and uncertainties that may affect our business.

ALLETE Second Quarter 2013 Form 10-Q
5



PART I.  FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS
ALLETE
CONSOLIDATED BALANCE SHEET
Millions – Unaudited
 
June 30,
2013
 
December 31,
2012
 
 
 
 
Assets
 
 
 
Current Assets
 
 
 
Cash and Cash Equivalents

$145.0

 

$80.8

Accounts Receivable (Less Allowance of $1.1 and $1.0)
78.7

 
89.0

Inventories
71.0

 
69.8

Prepayments and Other
26.2

 
33.6

Total Current Assets
320.9

 
273.2

Property, Plant and Equipment - Net
2,397.2

 
2,347.6

Regulatory Assets
337.5

 
340.3

Investment in ATC
111.2

 
107.3

Other Investments
140.2

 
143.5

Other Non-Current Assets
43.9

 
41.5

Total Assets

$3,350.9

 

$3,253.4

Liabilities and Equity
 
 
 
Liabilities
 
 
 
Current Liabilities
 
 
 
Accounts Payable

$52.1

 

$90.5

Accrued Taxes
26.4

 
30.2

Accrued Interest
15.9

 
15.6

Long-Term Debt Due Within One Year
37.9

 
84.5

Other
60.8

 
62.6

Total Current Liabilities
193.1

 
283.4

Long-Term Debt
1,064.7

 
933.6

Deferred Income Taxes
435.5

 
423.8

Regulatory Liabilities
63.1

 
60.1

Defined Benefit Pension and Other Postretirement Benefit Plans
216.2

 
228.2

Other Non-Current Liabilities
129.3

 
123.3

Total Liabilities
2,101.9

 
2,052.4

Commitments, Guarantees and Contingencies (Note 14)

 

Equity
 
 
 
Common Stock Without Par Value, 80.0 Shares Authorized, 40.1 and 39.4 Shares Outstanding
819.3

 
784.7

Unearned ESOP Shares
(17.2
)
 
(21.3
)
Accumulated Other Comprehensive Loss
(21.0
)
 
(22.0
)
Retained Earnings
467.9

 
459.6

Total Equity
1,249.0

 
1,201.0

Total Liabilities and Equity

$3,350.9

 

$3,253.4

The accompanying notes are an integral part of these statements.

ALLETE Second Quarter 2013 Form 10-Q
6



ALLETE
CONSOLIDATED STATEMENT OF INCOME
Millions Except Per Share Amounts – Unaudited
 
Quarter Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2013
2012
 
2013
2012
 
 
 
 
 
 
Operating Revenue

$235.6


$216.4

 

$499.4


$456.4

Operating Expenses
 
 
 
 
 
Fuel and Purchased Power
78.7

72.1

 
165.2

149.2

Operating and Maintenance
103.8

96.2

 
208.5

196.1

Depreciation
28.7

24.8

 
56.9

49.4

Total Operating Expenses
211.2

193.1

 
430.6

394.7

Operating Income
24.4

23.3

 
68.8

61.7

Other Income (Expense)
 
 
 
 
 
Interest Expense
(12.8
)
(10.1
)
 
(25.1
)
(21.1
)
Equity Earnings in ATC
5.0

4.8

 
10.2

9.4

Other
1.5

1.2

 
4.2

1.9

Total Other Expense
(6.3
)
(4.1
)
 
(10.7
)
(9.8
)
Income Before Income Taxes
18.1

19.2

 
58.1

51.9

Income Tax Expense
4.1

4.8

 
11.6

13.1

Net Income

$14.0


$14.4

 

$46.5


$38.8

Average Shares of Common Stock
 
 
 
 
 
Basic
39.4

37.3

 
39.2

37.0

Diluted
39.6

37.4

 
39.3

37.1

Basic Earnings Per Share of Common Stock

$0.36


$0.39

 

$1.19


$1.05

Diluted Earnings Per Share of Common Stock

$0.35


$0.39

 

$1.18


$1.05

Dividends Per Share of Common Stock

$0.475


$0.46

 

$0.95


$0.92

The accompanying notes are an integral part of these statements.

ALLETE Second Quarter 2013 Form 10-Q
7



ALLETE
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
Millions – Unaudited


 
Quarter Ended
 
Six Months Ended
 
June 30,
 
June 30,
Comprehensive Income (Loss)
2013
 
2012
 
2013
 
2012
Millions
 
 
 
 
 
 
 
Net Income

$14.0

 

$14.4

 

$46.5

 

$38.8

Other Comprehensive Income (Loss)
 
 
 
 
 
 
 
Unrealized Gain (Loss) on Securities
 
 
 
 
 
 
 
Net of Income Taxes of $0.1, $(0.5), $0.1 and $0.2
0.1

 
(0.5
)
 
0.1

 
0.5

Unrealized Gain (Loss) on Derivatives
 
 
 
 


 


Net of Income Taxes of $0.1, $–, $0.1 and $(0.1)

 
(0.1
)
 
0.1

 
(0.2
)
Defined Benefit Pension and Other Postretirement Benefit Plans
 
 
 
 
 
 
 
 Net of Income Taxes of $0.3, $0.4, $0.5 and $0.7
0.5

 
0.5

 
0.8

 
1.0

Total Other Comprehensive Income (Loss)
0.6

 
(0.1
)
 
1.0

 
1.3

Comprehensive Income

$14.6

 

$14.3

 

$47.5

 

$40.1

The accompanying notes are an integral part of these statements.


ALLETE Second Quarter 2013 Form 10-Q
8



ALLETE
CONSOLIDATED STATEMENT OF CASH FLOWS
Millions – Unaudited
 
Six Months Ended
 
June 30,
 
2013
 
2012
 
 
 
 
Operating Activities
 
 
 
Net Income

$46.5

 

$38.8

Allowance for Funds Used During Construction – Equity
(2.1
)
 
(1.9
)
Income from Equity Investments, Net of Dividends
(2.3
)
 
(1.7
)
Gain on Sale of Assets
(0.1
)
 

Gain on Sale of Investments
(0.8
)
 

Depreciation Expense
56.9

 
49.4

Amortization of Debt Issuance Costs
0.5

 
0.5

Deferred Income Tax Expense
11.6

 
13.1

Share-Based Compensation Expense
1.3

 
1.2

ESOP Compensation Expense
4.0

 
3.7

Defined Benefit Pension and Postretirement Benefit Expense
11.2

 
13.8

Bad Debt Expense
0.4

 
0.5

Changes in Operating Assets and Liabilities
 
 
 
Accounts Receivable
9.9

 
12.4

Inventories
(1.2
)
 
(0.2
)
Prepayments and Other
7.4

 
1.6

Accounts Payable
(10.1
)
 
(8.2
)
Other Current Liabilities
(5.8
)
 

Cash Contributions to Defined Benefit Pension and Other Postretirement Benefit Plans
(10.8
)
 

Changes in Regulatory and Other Non-Current Assets
(8.0
)
 
(1.8
)
Changes in Regulatory and Other Non-Current Liabilities
2.6

 
6.9

Cash from Operating Activities
111.1

 
128.1

Investing Activities
 
 
 
Proceeds from Sale of Available-for-sale Securities
8.1

 
1.0

Payments for Purchase of Available-for-sale Securities
(1.4
)
 
(1.0
)
Investment in ATC
(1.6
)
 
(2.0
)
Changes to Other Investments
(2.6
)
 
(3.2
)
Additions to Property, Plant and Equipment
(128.6
)
 
(221.8
)
Proceeds from Sale of Assets
0.9

 

Cash for Investing Activities
(125.2
)
 
(227.0
)
Financing Activities
 
 
 
Proceeds from Issuance of Common Stock
33.3

 
30.5

Proceeds from Issuance of Long-Term Debt
150.0

 
15.6

Payments for Notes Payable

 
(1.1
)
Payments for Long-Term Debt
(65.5
)
 
(3.1
)
Debt Issuance Costs
(1.3
)
 

Dividends on Common Stock
(38.2
)
 
(35.5
)
Cash from Financing Activities
78.3

 
6.4

Change in Cash and Cash Equivalents
64.2

 
(92.5
)
Cash and Cash Equivalents at Beginning of Period
80.8

 
101.1

Cash and Cash Equivalents at End of Period

$145.0

 

$8.6

The accompanying notes are an integral part of these statements.

ALLETE Second Quarter 2013 Form 10-Q
9



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X and do not include all of the information and notes required by GAAP for complete financial statements. Similarly, the December 31, 2012 , Consolidated Balance Sheet was derived from audited financial statements but does not include all disclosures required by GAAP. All adjustments are of a normal, recurring nature, except as otherwise disclosed. Operating results for the period ended June 30, 2013 , are not necessarily indicative of results that may be expected for any other interim period or for the year ending December 31, 2013 . For further information, refer to the consolidated financial statements and notes included in our 2012 Form 10-K.


NOTE 1.  OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

Inventories. Inventories are stated at the lower of cost or market. Amounts removed from inventory are recorded on an average cost basis.
Inventories
June 30,
2013

 
December 31,
2012

Millions
 
 
 
Fuel

$25.3

 

$28.0

Materials and Supplies
45.7

 
41.8

Total Inventories

$71.0

 

$69.8


Prepayments and Other Current Assets
June 30,
2013

 
December 31,
2012

Millions
 
 
 
Deferred Fuel Adjustment Clause

$18.3

 

$22.5

Other
7.9

 
11.1

Total Prepayments and Other Current Assets

$26.2

 

$33.6


Other Current Liabilities
June 30,
2013

 
December 31,
2012

Millions
 
 
 
Customer Deposits

$29.1

 

$28.8

Other
31.7

 
33.8

Total Other Current Liabilities

$60.8

 

$62.6


Other Non-Current Liabilities
June 30,
2013

 
December 31,
2012

Millions
 
 
 
Asset Retirement Obligation

$81.6

 

$77.9

Other
47.7

 
45.4

Total Other Non-Current Liabilities

$129.3

 

$123.3



ALLETE Second Quarter 2013 Form 10-Q
10


NOTE 1.  OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Supplemental Statement of Cash Flows Information.

For the Six Months Ended June 30,
2013

 
2012

Millions
 
 
 
Cash Paid During the Period for Interest – Net of Amounts Capitalized

$22.8

 

$21.7

Cash Paid During the Period for Income Taxes

$0.6

 

$0.2

Noncash Investing and Financing Activities
 

 
 

Decrease in Accounts Payable for Capital Additions to Property, Plant and Equipment

$28.2

 

$14.8

Capitalized Asset Retirement Costs

$1.9

 

$2.4

AFUDC – Equity

$2.1

 

$1.9


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

New Accounting Standards.

Amounts Reclassified Out of Accumulated Other Comprehensive Income. In February 2013, the FASB issued an accounting standard update on disclosure of amounts reclassified out of accumulated other comprehensive income. This update requires entities to provide information about amounts reclassified out of accumulated other comprehensive income by component. In addition, entities are required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under GAAP to be reclassified in their entirety to net income, entities are required to cross-reference to other disclosures required under GAAP that provide additional detail on these amounts. This guidance was adopted beginning with the quarter ended March 31, 2013, and required additional disclosures but did not have an impact on our consolidated financial position, results of operations, or cash flows. (See Note 11. Reclassifications Out of Accumulated Other Comprehensive Income (Loss).)

ALLETE Second Quarter 2013 Form 10-Q
11


NOTE 2.  BUSINESS SEGMENTS

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 parts of Wisconsin, Michigan, Minnesota and Illinois. Investments and Other is comprised primarily of BNI Coal, our coal mining operations in North Dakota, ALLETE Properties, our Florida real estate investment, and ALLETE Clean Energy, our business aimed at developing or acquiring capital projects that create energy solutions via wind, solar, biomass, midstream gas and oil infrastructure, among other energy-related projects. This segment also includes other business development and corporate expenditures, a small amount of non-rate base generation, approximately 6,000 acres of land in Minnesota, and earnings on cash and investments.

 
Consolidated
Regulated Operations
Investments and Other
Millions
 
 
 
For the Quarter Ended June 30, 2013
 
 
 
Operating Revenue

$235.6


$215.8


$19.8

Fuel and Purchased Power Expense
78.7

78.7


Operating and Maintenance Expense
103.8

82.8

21.0

Depreciation Expense
28.7

27.1

1.6

Operating Income (Loss)
24.4

27.2

(2.8
)
Interest Expense
(12.8
)
(10.4
)
(2.4
)
Equity Earnings in ATC
5.0

5.0


Other Income
1.5

1.1

0.4

Income (Loss) Before Income Taxes
18.1

22.9

(4.8
)
Income Tax Expense (Benefit)
4.1

6.6

(2.5
)
Net Income (Loss)

$14.0


$16.3

$(2.3)

 
Consolidated
Regulated Operations
Investments and Other
Millions
 
 
 
For the Quarter Ended June 30, 2012
 
 
 
Operating Revenue

$216.4


$197.0


$19.4

Fuel and Purchased Power Expense
72.1

72.1


Operating and Maintenance Expense
96.2

76.1

20.1

Depreciation Expense
24.8

23.4

1.4

Operating Income (Loss)
23.3

25.4

(2.1
)
Interest Expense
(10.1
)
(9.9
)
(0.2
)
Equity Earnings in ATC
4.8

4.8


Other Income
1.2

1.2


Income (Loss) Before Income Taxes
19.2

21.5

(2.3
)
Income Tax Expense (Benefit)
4.8

7.1

(2.3
)
Net Income

$14.4


$14.4




ALLETE Second Quarter 2013 Form 10-Q
12


NOTE 2.  BUSINESS SEGMENTS (Continued)

 
Consolidated
Regulated Operations
Investments and Other
Millions
 
 
 
For the Six Months Ended June 30, 2013
 
 
 
Operating Revenue

$499.4


$457.2


$42.2

Fuel and Purchased Power Expense
165.2

165.2


Operating and Maintenance Expense
208.5

165.0

43.5

Depreciation Expense
56.9

53.9

3.0

Operating Income (Loss)
68.8

73.1

(4.3
)
Interest Expense
(25.1
)
(21.1
)
(4.0
)
Equity Earnings in ATC
10.2

10.2


Other Income
4.2

2.2

2.0

Income (Loss) Before Income Taxes
58.1

64.4

(6.3
)
Income Tax Expense (Benefit)
11.6

16.0

(4.4
)
Net Income (Loss)

$46.5


$48.4

$(1.9)
 
 
 
 
As of June 30, 2013
 
 
 
Total Assets

$3,350.9


$2,997.0


$353.9

Property, Plant and Equipment – Net

$2,397.2


$2,329.6


$67.6

Accumulated Depreciation

$1,202.8


$1,143.2


$59.6

Capital Additions

$100.2


$97.2


$3.0


 
Consolidated
 
Regulated Operations
 
Investments and Other
Millions
 
 
 
 
 
For the Six Months Ended June 30, 2012
 
 
 
 
 
Operating Revenue

$456.4

 

$415.6

 

$40.8

Fuel and Purchased Power Expense
149.2

 
149.2

 

Operating and Maintenance Expense
196.1

 
154.2

 
41.9

Depreciation Expense
49.4

 
46.6

 
2.8

Operating Income (Loss)
61.7

 
65.6

 
(3.9
)
Interest Expense
(21.1
)
 
(19.5
)
 
(1.6
)
Equity Earnings in ATC
9.4

 
9.4

 

Other Income (Expense)
1.9

 
2.0

 
(0.1
)
Income (Loss) Before Income Taxes
51.9

 
57.5

 
(5.6
)
Income Tax Expense (Benefit)
13.1

 
18.7

 
(5.6
)
Net Income

$38.8

 

$38.8

 

 
 
 
 
 
 
As of June 30, 2012
 

 
 

 
 

Total Assets

$2,962.2

 

$2,755.4

 

$206.8

Property, Plant and Equipment – Net

$2,177.5

 

$2,119.9

 

$57.6

Accumulated Depreciation

$1,124.5

 

$1,070.1

 

$54.4

Capital Additions

$235.1

 

$232.3

 

$2.8




ALLETE Second Quarter 2013 Form 10-Q
13



NOTE 3.  INVESTMENTS

Investments. Our long-term investment portfolio includes the 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
June 30,
2013

 
December 31,
2012

Millions
 
 
 
ALLETE Properties

$91.1

 

$91.1

Available-for-sale Securities (a)
20.4

 
26.8

Cash Equivalents
24.4

 
20.7

Other
4.3

 
4.9

Total Other Investments

$140.2

 

$143.5

(a)
As of June 30, 2013 , the aggregate amount of available-for-sale corporate debt securities maturing in one year or less was $1.2 million , in one year to less than three years was $5.1 million , in three years to less than five years was $1.3 million , and in five or more years was $0.9 million .

ALLETE Properties
June 30,
2013

 
December 31,
2012

Millions
 
 
 
Land Inventory Beginning Balance

$86.5

 

$86.0

Deeds to Collateralized Property

 
0.5

Cost of Sales

 
(0.2
)
Capitalized Improvements and Other
0.1

 
0.2

Land Inventory Ending Balance
86.6

 
86.5

Long-Term Finance Receivables (net of allowances of $0.6 and $0.6)
1.4

 
1.4

Other
3.1

 
3.2

Total Real Estate Assets

$91.1

 

$91.1


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 fair value. Land values are reviewed for impairment on a quarterly basis and no impairments were recorded for the six months ended June 30, 2013 ( none for the year ended December 31, 2012 ).

Long-Term Finance Receivables. As of June 30, 2013 , long-term finance receivables were $1.4 million net of allowance ( $1.4 million net of allowance as of December 31, 2012 ). Long-term finance receivables are collateralized by property sold, accrue interest at market-based rates and are net of an allowance for doubtful accounts. As of June 30, 2013 , we had an allowance for doubtful accounts of $0.6 million ( $0.6 million as of December 31, 2012 ).



ALLETE Second Quarter 2013 Form 10-Q
14


NOTE 4. DERIVATIVES

During the third quarter of 2011, we entered into a variable-to-fixed interest rate swap (Swap), designated as a cash flow hedge, in order to manage the interest rate risk associated with a $75.0 million Term Loan. The Term Loan has a variable interest rate equal to the one-month LIBOR plus 1.00 percent , has a maturity of August 25, 2014, and represents approxi mately 7 percent of the Company’s outstanding long-term debt as of June 30, 2013 . (See Note 8. Short-Term and Long-Term Debt.) The Sw ap agreement has a notional amount equal to the underlying debt principal and matures on August 25, 2014. The Swap agreement involves the receipt of variable rate amounts in exchange for fixed rate interest payments over the life of the agreement without an exchange of the underlying notional amount. The variable rate of the Swap is equal to the one-month LIBOR and the fixed rate is equal to 0.825 percent . Cash flows from the interest rate swap are expected to be highly effective in offsetting the variable interest expense of the debt attributable to fluctuations in the one-month LIBOR interest rate over the life of the Swap. If it is determined that a derivative is not or has ceased to be effective as a hedge, the Company prospectively discontinues hedge accounting with respect to that derivative. The shortcut method is used to assess hedge effectiveness. At inception, all shortcut method requirements were satisfied; thus changes in the value of the Swap are deemed 100 percent effective. As a result, there was no ineffectiveness recorded for the quarter and six months ended June 30, 2013. The mark-to-market fluctuation on the cash flow hedge was recorded in accumulated other comprehensive income on the Consolidated Balance Sheet. As of June 30, 2013 , the fair value of the Swap was a $0.5 million liability (a $0.7 million liability as of December 31, 2012 ) and is included in other non-current liabilities on the Consolidated Balance Sheet. Cash flows from derivative activities are presented in the same category as the item being hedged on the Consolidated Statement of Cash Flows. Amounts recorded in other comprehensive income related to cash flow hedges will be recognized in earnings when the hedged transactions occur or when it is probable that the hedged transactions will not occur. Gains or losses on interest rate hedging transactions are reflected as a component of interest expense on the Consolidated Statement of Income.


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 2012 Form 10-K.


ALLETE Second Quarter 2013 Form 10-Q
15


NOTE 5. FAIR VALUE (Continued)

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 June 30, 2013 and December 31, 2012 . 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 and 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 are excluded from the recurring fair value measures in the tables below.

 
Fair Value as of June 30, 2013
Recurring Fair Value Measures
Level 1
 
Level 2
 
Level 3
 
Total
Millions
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
Investments
 
 
 
 
 
 
 
Available-for-sale – Equity Securities

$11.9

 

 

 

$11.9

Available-for-sale – Corporate Debt Securities

 

$8.5

 

 
8.5

Cash Equivalents
24.4

 

 

 
24.4

Total Fair Value of Assets

$36.3

 

$8.5

 

 

$44.8

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Deferred Compensation

 

$15.7

 

 

$15.7

Derivatives – Interest Rate Swap

 
0.5

 

 
0.5

Total Fair Value of Liabilities

 

$16.2

 

 

$16.2

 
 
 
 
 
 
 
 
Total Net Fair Value of Assets (Liabilities)

$36.3

 
$(7.7)
 

 

$28.6


 
Fair Value as of December 31, 2012
Recurring Fair Value Measures
Level 1
 
Level 2
 
Level 3
 
Total
Millions
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
Investments
 
 
 
 
 
 
 
Available-for-sale – Equity Securities

$18.0

 

 

 

$18.0

Available-for-sale – Corporate Debt Securities

 

$8.8

 

 
8.8

Cash Equivalents
20.7

 

 

 
20.7

Total Fair Value of Assets

$38.7

 

$8.8

 

 

$47.5

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Deferred Compensation

 

$14.0

 

 

$14.0

Derivatives – Interest Rate Swap

 
0.7

 

 
0.7

Total Fair Value of Liabilities

 

$14.7

 

 

$14.7

 
 
 
 
 
 
 
 
Total Net Fair Value of Assets (Liabilities)

$38.7

 
$(5.9)
 

 

$32.8


There was no activity in Level 3 during the six months ended June 30, 2013 and 2012 .

The Company’s policy is to recognize transfers in and transfers out of a given level as of the actual date of the event or of the change in circumstances that caused the transfer. For the six months ended June 30, 2013 and 2012 , there were no transfers in or out of Levels 1, 2 or 3.


ALLETE Second Quarter 2013 Form 10-Q
16


NOTE 5. FAIR VALUE (Continued)

Fair Value of Financial Instruments. With the exception of the item listed in the table below, the estimated fair value of all financial instruments approximates the carrying amount. The fair value for the item listed below 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 Current Portion
 
 
 
June 30, 2013
$1,102.6
 
$1,160.2
December 31, 2012
$1,018.1
 
$1,143.7


NOTE 6.  REGULATORY MATTERS

Electric Rates. Entities within our Regulated Operations segment file for periodic rate revisions with the MPUC, the FERC or the PSCW.

2010 Minnesota Rate Case. Minnesota Power’s current retail rates are based on a 2011 MPUC retail rate order, effective June 1, 2011, that allows for a 10.38 percent return on common equity and a 54.29 percent equity ratio.

In February 2011, Minnesota Power appealed the MPUC’s interim rate decision in the Company’s 2010 rate case to the Minnesota Court of Appeals. The Company appealed the MPUC’s finding of exigent circumstances in the interim rate decision with the primary arguments being that the MPUC exceeded its statutory authority, made its decision without the support of a body of record evidence and that the decision violated public policy. The Company desires to resolve whether the MPUC’s finding of exigent circumstances was lawful for application in future rate cases. In December 2011, the Minnesota Court of Appeals concluded that the MPUC did not err in finding exigent circumstances and properly exercised its discretion in setting interim rates. In January 2012, the Company filed a petition for review at the Minnesota Supreme Court (Court). In February 2012, the Court granted the petition for review and oral arguments were held before the Court in October 2012. A decision is expected in the third quarter of 2013. We cannot predict the outcome at this time.

FERC-Approved Wholesale Rates. Minnesota Power’s non-affiliated municipal customers consist of 16 municipalities in Minnesota and 1 private utility in Wisconsin. SWL&P, a wholly-owned subsidiary of ALLETE, is also a private utility in Wisconsin and a customer of Minnesota Power. Minnesota Power’s formula-based contract with the City of Nashwauk is effective April 1, 2013 through June 30, 2024, and the restated formula-based contracts with the remaining 15 Minnesota municipal customers and SWL&P are effective through June 30, 2019. The rates included in these 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 our authorized rate of return for Minnesota retail customers (currently 10.38 percent ). The cost-based formula methodology also provides for a yearly true-up calculation for actual costs incurred. The contract terms include a termination clause requiring a three -year notice to terminate. Under the City of Nashwauk contract, no termination notice may be given prior to July 1, 2021. Under the restated contracts, no termination notices may be given prior to June 30, 2016. A two -year cancellation notice is required for the one private non-affiliated utility in Wisconsin, and on December 31, 2011, this wholesale customer submitted a cancellation notice with termination effective on December 31, 2013. The 17 MW of average monthly demand currently provided to this wholesale customer is expected to be used, upon termination, to supply power for prospective additional retail and municipal load.

2012 Wisconsin Rate Case.   SWL&P’s 2013 retail rates are based on a 2012 PSCW retail rate order, effective January 1, 2013, that allows for a 10.9 percent return on common equity. The new rates reflect an average overall increase of 2.4 percent for retail customers (a 13.8 percent increase in water rates, a 1.2 percent increase in electric rates, and a 0.2 percent decrease in natural gas rates). On an annualized basis, the rate increase will generate approximately $1.7 million in additional revenue.

Transmission Cost Recovery Riders. Minnesota Power has an approved cost recovery rider in place for certain transmission investments and expenditures. The continued use of the 2009 billing factor was approved by the MPUC in May 2011, which allows 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. In June 2011, Minnesota Power filed an updated billing factor that includes additional transmission expenditures, which is expected to be approved in the second half of 2013.


ALLETE Second Quarter 2013 Form 10-Q
17


NOTE 6. REGULATORY MATTERS (Continued)

Renewable Cost Recovery Riders. The Bison Wind Energy Center in North Dakota consists of 292 MW of nameplate capacity and was completed in various phases through 2012. Customer billing rates for Bison were approved by the MPUC in a November 2011 order and are based on investments and expenditures through that period. Minnesota Power filed a cost recovery petition with the MPUC on May 31, 2013, to update customer billing rates for subsequent investments and expenditures since 2011, which is expected to be approved in the second half of 2013.

Rapids Energy Center. In December 2012, Minnesota Power filed with the MPUC for approval to transfer the assets of Rapids Energy Center from non-rate base generation to Minnesota Power’s Regulated Operations. Rapids Energy Center is a generation facility that is located at the UPM, Blandin Paper Mill (Blandin). Minnesota Power and Blandin entered into a new electric service agreement in September 2012 which is also subject to MPUC approval. We expect a decision from the MPUC on these filings in late 2013.

ALLETE Clean Energy. In August 2011, the Company filed with the MPUC for approval of certain affiliated interest agreements between ALLETE and ALLETE Clean Energy. These agreements relate to various relationships with ALLETE, including the accounting for certain shared services, as well as the transfer of transmission and wind development rights in North Dakota to ALLETE Clean Energy. These transmission and wind development rights are separate and distinct from those needed by Minnesota Power to meet Minnesota’s renewable energy standard requirements. In July 2012, the MPUC issued an order approving certain administrative items related to accounting for shared services and the transfer of meteorological towers, while deferring decisions related to transmission and wind development rights pending the MPUC’s further review of Minnesota Power’s future retail electric service needs.

Integrated Resource Plan . In May 2011, the MPUC issued its final order approving our 2010 Integrated Resource Plan. As a condition of the final order, a required baseload diversification study evaluating the impact of additional environmental regulations over the next two decades was filed in February 2012. Minnesota Power’s 2013 Integrated Resource Plan, filed on March 1, 2013, details our “EnergyForward” strategic plan and includes an analysis of a variety of existing and future energy resource alternatives and a projection of customer cost impact by class. A decision by the MPUC on this plan is expected in late 2013.

Boswell Mercury Emissions Reduction Plan. Minnesota Power is required to implement a mercury emissions reduction project for Boswell Unit 4 under the Minnesota Mercury Emissions Reduction Act and the Federal MATS rule. In August 2012, Minnesota Power filed its mercury emissions reduction plan for Boswell Unit 4 with the MPUC and the MPCA. The plan proposes that Minnesota Power install pollution controls by early 2016 to address both the Minnesota mercury emissions reduction requirements and the Federal MATS rule. Costs to implement the Boswell Unit 4 mercury emissions reduction plan are included in the estimated capital expenditures required for compliance with the MATS rule and are estimated to be between $350 million and $400 million . The MPCA issued its report on March 1, 2013, in support of the Boswell Unit 4 mercury emissions reduction plan stating that the plan is appropriate for accomplishing the objectives of reducing emissions of mercury and other pollutants under the Minnesota Statutes and recommended that the MPUC accept the report’s findings. We expect a decision by the MPUC on the plan in the third quarter of 2013. Upon approval by the MPUC, we anticipate filing a petition to include investments and expenditures in customer billing rates.

The Patient Protection and Affordable Care Act of 2010 (PPACA). In March 2010, the PPACA was signed into law. One of the provisions changed the tax treatment for retiree prescription drug expenses by eliminating the tax deduction for expenses that are reimbursed under Medicare Part D, beginning January 1, 2013. Based on this provision, we are subject to additional taxes in the future and were required to reverse previously recorded tax benefits which resulted in a non-recurring charge to net income of $4.0 million in 2010. In October 2010, we submitted a filing with the MPUC requesting deferral of the retail portion of the tax charge taken in 2010 resulting from the PPACA. In May 2011, the MPUC approved our request for deferral until the next rate case and as a result we recorded an income tax benefit of $2.9 million and a related regulatory asset of $5.0 million in the second quarter of 2011.

Regulatory Assets and Liabilities. Our regulated utility operations are subject to the accounting guidance for Regulated Operations. We capitalize incurred costs which are probable of recovery in future utility rates as regulatory assets. Regulatory liabilities   represent amounts expected to be refunded or credited to customers in rates. No regulatory assets or liabilities are currently earning a return.




ALLETE Second Quarter 2013 Form 10-Q
18


NOTE 6. REGULATORY MATTERS (Continued)

Regulatory Assets and Liabilities
June 30,
2013

 
December 31,
2012

Millions
 
 
 
Current Regulatory Assets (a)
 
 
 
Deferred Fuel

$18.3

 

$22.5

Total Current Regulatory Assets
18.3

 
22.5

Non-Current Regulatory Assets
 
 
 
Future Benefit Obligations Under
 
 
 
Defined Benefit Pension and Other Postretirement Benefit Plans
251.5

 
260.7

Income Taxes
34.3

 
36.0

Asset Retirement Obligation
13.9

 
12.1

Cost Recovery Riders (b)
29.2

 
18.5

PPACA Income Tax Deferral
5.0

 
5.0

Conservation Improvement Program

 
4.3

Other
3.6

 
3.7

Total Non-Current Regulatory Assets
337.5

 
340.3

 
 
 
 
Total Regulatory Assets

$355.8

 

$362.8

 
 
 
 
Non-Current Regulatory Liabilities
 
 
 
Income Taxes

$17.7

 

$19.5

Plant Removal Obligations
19.3

 
18.1

Wholesale and Retail Contra AFUDC
16.7

 
15.5

Conservation Improvement Program
2.7

 

Other
6.7

 
7.0

Total Non-Current Regulatory Liabilities

$63.1

 

$60.1

(a)
Current regulatory assets are included in prepayments and other on the Consolidated Balance Sheet.
(b)
The cost recovery rider regulatory asset is primarily due to capital expenditures related to Bison.


NOTE 7.  INVESTMENT IN ATC

Our wholly-owned subsidiary, Rainy River Energy, owns approximately 8 percent of ATC, a Wisconsin-based utility that owns and maintains electric transmission assets in parts of Wisconsin, Michigan, Minnesota and Illinois. ATC rates are FERC-approved and are based on a 12.2 percent return on common equity dedicated to utility plant. We account for our investment in ATC under the equity method of accounting. As of June 30, 2013 , our equity investment in ATC was $111.2 million ( $107.3 million at December 31, 2012 ). In the first six months of 2013 , we invested $1.6 million in ATC, and on July 30, 2013, we invested an additional $0.8 million . We expect to make additional investments of approximately $0.7 million in 2013 .

ALLETE’s Investment in ATC
 
Millions
 
Equity Investment Balance as of December 31, 2012

$107.3

Cash Investments
1.6

Equity in ATC Earnings
10.2

Distributed ATC Earnings
(7.9
)
Equity Investment Balance as of June 30, 2013

$111.2



ALLETE Second Quarter 2013 Form 10-Q
19


NOTE 7.  INVESTMENT IN ATC (Continued)

ATC’s summarized financial data for the quarters and six months ended June 30, 2013 and 2012 , is as follows:
 
Quarter Ended
 
Six Months Ended
ATC Summarized Financial Data
June 30,
 
June 30,
Income Statement Data
2013
 
2012
 
2013
 
2012
Millions
 
 
 
 
 
 
 
Revenue

$152.1

 
$152.2
 

$303.9

 

$299.8

Operating Expense
69.9

 
71.8
 
139.7

 
141.3

Other Expense
20.9

 
21.1
 
42.4

 
41.1

Net Income

$61.3

 
$59.3
 

$121.8

 

$117.4

ALLETE’s Equity in Net Income

$5.0

 
$4.8
 

$10.2

 

$9.4



NOTE 8.  SHORT-TERM AND LONG-TERM DEBT

Short-Term Debt. As of June 30, 2013 , total short-term debt outstanding was $37.9 million ( $84.5 million as of December 31, 2012 ) and consisted of long-term debt due within one year. Short-term debt as of December 31, 2012 included $60.0 million of long-term debt that matured in April 2013.

Long-Term Debt. As of June 30, 2013 , total long-term debt outstanding was $1,064.7 million ( $933.6 million as of December 31, 2012 ).

On April 2, 2013, we issued $150.0 million of the Company’s First Mortgage Bonds (Bonds) in the private placement market in three series as follows:
Maturity Date
Principal Amount
Interest Rate
April 15, 2018
$50 Million
1.83%
October 15, 2028
$40 Million
3.30%
October 15, 2043
$60 Million
4.21%

We have the option to prepay all or a portion of the 1.83 percent Bonds at our discretion at any time, subject to a make-whole provision. We have the option to prepay all or a portion of the 3.30 percent Bonds at our discretion at any time prior to April 15, 2028, subject to a make-whole provision, and at any time on or after April 15, 2028, at par, including, in each case, accrued and unpaid interest. We also have the option to prepay all or a portion of the 4.21 percent Bonds at our discretion at any time prior to April 15, 2043, subject to a make-whole provision, and at any time on or after April 15, 2043, at par, including, in each case, accrued and unpaid interest. The Bonds are subject to additional terms and conditions of our utility mortgage. Proceeds from the sale of the Bonds will be used to fund utility capital investments, repay debt, and/or 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 certain institutional accredited investors in a private placement.

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 June 30, 2013 , our ratio was approximately 0.47 to 1.00 . Failure to meet this covenant would give rise to an event of default if not cured after notice from a 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. As of June 30, 2013 , ALLETE was in compliance with its financial covenants.



ALLETE Second Quarter 2013 Form 10-Q
20


NOTE 9.  OTHER INCOME (EXPENSE)

 
 
Quarter Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2013
 
2012
 
2013
 
2012
Millions
 
 
 
 
 
 
 
 
AFUDC – Equity
 

$1.0

 

$1.2

 

$2.1

 

$1.9

Gain on Sale of Available-for-sale Securities
 

 

 
0.8

 

Investments and Other Income
 
0.5

 

 
1.3

 

Total Other Income
 

$1.5

 

$1.2

 

$4.2

 

$1.9



NOTE 10.  INCOME TAX EXPENSE
 
 
Quarter Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2013
 
2012
 
2013
 
2012
Millions
 
 
 
 
 
 
 
 
Current Tax Expense (Benefit)
 
 
 
 
 
 
 
 
Federal (a)
 
$(0.2)
 

 

 

State (a)
 

 

 

 

Total Current Tax Expense (Benefit)
 
(0.2
)
 

 

 

Deferred Tax Expense (Benefit)
 
 
 
 
 
 
 
 
Federal
 
3.6

 

$4.8

 

$8.2

 

$13.2

State (b)
 
0.9

 
0.2

 
3.8

 
0.3

Investment Tax Credit Amortization
 
(0.2
)
 
(0.2
)
 
(0.4
)
 
(0.4
)
Total Deferred Tax Expense
 
4.3

 
4.8

 
11.6

 
13.1

Total Income Tax Expense
 

$4.1

 

$4.8

 

$11.6

 

$13.1

(a)
We incurred net operating losses (NOLs) due to the bonus depreciation provisions of the American Taxpayer Relief Act of 2012 and the Tax Relief Unemployment Insurance Reauthorization and Job Creation Act of 2010 for the quarter and six months ended June 30, 2013 and 2012. The 2013 and 2012 federal and state NOLs will be carried forward to offset future taxable income.
(b)
The quarter and six months ended June 30, 2012 , reflected increased state tax benefit from state renewable tax credits compared to the quarter and six months ended June 30, 2013.

For the six months ended June 30, 2013 , the effective tax rate was 20.0 percent ( 25.2 percent for the six months ended June 30, 2012 ). The decrease from the effective tax rate for the six months ended June 30, 2012 , was primarily due to increased federal production tax credits. The effective tax rate deviated from the statutory rate of approximately 41 percent primarily due to deductions for AFUDC ‑ Equity, investment tax credits, federal production tax credits, state income tax credits and depletion.
 
Uncertain Tax Positions. As of June 30, 2013 , we had gross unrecognized tax benefits of $2.6 million ( $2.7 million as of December 31, 2012 ). Of the total gross unrecognized tax benefits, $0.7 million represents the amount of unrecognized tax benefits included in the Consolidated Balance Sheet that, if recognized, would favorably impact the effective income tax rate.

ALLETE’s IRS exam for tax years 2005 through 2009 is currently under review at the IRS appeals office. We expect the IRS appeals process to be completed during the next twelve months, resulting in the reversal of substantially all of the unrecognized tax benefits as of June 30, 2013 . The unrecognized tax benefits are primarily due to tax positions which are timing in nature and therefore would have an immaterial impact on our effective tax rate if recognized.

ALLETE Second Quarter 2013 Form 10-Q
21




NOTE 11. RECLASSIFICATIONS OUT OF ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

Changes in Accumulated Other Comprehensive Loss by Component

Unrealized Gains and Losses on Available-for-sale Securities (a)
Defined Benefit Pension, Other Postretirement Items (a)
Gains and Losses on Cash Flow Hedge (a)
Total (a)
Millions
 
 
 
 
For the Quarter Ended June 30, 2013
 
 
 
 
Beginning Balance
$(0.1)
$(21.2)
$(0.3)
$(21.6)
Other Comprehensive Income (Loss) Before Reclassifications
0.1

(2.6
)

(2.5
)
Amounts Reclassified From Accumulated Other Comprehensive Loss

3.1


3.1

Net Other Comprehensive Income
0.1

0.5


0.6

Ending Balance

$(20.7)
$(0.3)
$(21.0)
 
 
 
 
 
For the Six Months Ended June 30, 2013
 
 
 
 
Beginning Balance
$(0.1)
$(21.5)
$(0.4)
$(22.0)
Other Comprehensive Income (Loss) Before Reclassifications
0.6

(5.5
)
0.1

(4.8
)
Amounts Reclassified From Accumulated Other Comprehensive Loss
(0.5
)
6.3


5.8

Net Other Comprehensive Income
0.1

0.8

0.1

1.0

Ending Balance

$(20.7)
$(0.3)
$(21.0)
(a)
Amounts shown are net of tax.



ALLETE Second Quarter 2013 Form 10-Q
22




NOTE 11. RECLASSIFICATIONS OUT OF ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) (Continued)

Reclassifications Out of Accumulated Other Comprehensive Loss
Details About Accumulated Other Comprehensive Loss Components
Amount Reclassified from Accumulated Other Comprehensive Loss (a)
 
Affected Income Statement Line Item
Millions
 
 
 
For the Quarter Ended June 30, 2013
 
 
 
Amortization of Defined Benefit Pension and Other Postretirement Items
 
 
 
Prior Service Costs

$0.7

 
(b)
Actuarial Gains and Losses
(5.8
)
 
(b)
 
(5.1
)
 
 
 
2.0

 
Income Tax Expense
 
$(3.1)
 
 
Total Reclassifications
$(3.1)
 
 
 
 
 
 
For the Six Months Ended June 30, 2013
 
 
 
Unrealized Gains on Available-for-sale Securities

$0.8

 
Other Income (Expense) - Other
 
(0.3
)
 
Income Tax Expense
 

$0.5

 
 
 
 
 
 
Amortization of Defined Benefit Pension and Other Postretirement Items
 
 
 
Prior Service Costs

$1.2

 
(b)
Actuarial Gains and Losses
(11.5
)
 
(b)
 
(10.3
)
 
 
 
4.0

 
Income Tax Expense
 
$(6.3)
 
 
Total Reclassifications
$(5.8)
 
 
(a)
Amounts in parentheses indicate charges to net income.
(b)
These components of accumulated other comprehensive loss are included in the computation of net pension and other postretirement benefit expense. (See Note 13. Pension and Other Postretirement Benefit Plans.)



ALLETE Second Quarter 2013 Form 10-Q
23


NOTE 12.  EARNINGS PER SHARE AND COMMON STOCK

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 quarters and six months ended June 30, 2013 and 2012 , zero and 0.3 million options to purchase shares of common stock, respectively, were excluded from the computation of diluted earnings per share because the option exercise prices were greater than the average market prices; therefore, their effect would have been anti-dilutive.

 
 
 
2013
 
 
 
 
 
2012
 
 
Reconciliation of Basic and Diluted
 
 
Dilutive
 
 
 
 
 
Dilutive
 
 
Earnings Per Share
Basic
 
Securities
 
Diluted
 
Basic
 
Securities
 
Diluted
Millions Except Per Share Amounts
 
 
 
 
 
 
 
 
 
 
 
For the Quarter Ended June 30,
 
 
 
 
 
 
 
 
 
 
 
Net Income

$14.0

 
 
 

$14.0

 

$14.4

 
 
 

$14.4

Average Common Shares
39.4

 
0.2

 
39.6

 
37.3

 
0.1

 
37.4

Earnings Per Share

$0.36

 
 
 

$0.35

 

$0.39

 
 
 

$0.39

For the Six Months Ended June 30,
 

 
 
 
 

 
 
 
 
 
 
Net Income

$46.5

 
 
 

$46.5

 

$38.8

 
 
 

$38.8

Average Common Shares
39.2

 
0.1

 
39.3

 
37.0

 
0.1

 
37.1

Earnings Per Share

$1.19

 
 
 

$1.18

 

$1.05

 
 
 

$1.05



NOTE 13.  PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS

 
Pension
 
Other
Postretirement
Components of Net Periodic Benefit Expense
2013
 
2012
 
2013
 
2012
Millions
 
 
 
 
 
 
 
For the Quarter Ended June 30,
 
 
 
 
 
 
 
Service Cost

$2.5

 

$2.3

 

$1.0

 

$1.1

Interest Cost
6.5

 
6.6

 
1.7

 
2.3

Expected Return on Plan Assets
(8.8
)
 
(8.9
)
 
(2.4
)
 
(2.5
)
Amortization of Prior Service Costs

 
0.1

 
(0.7
)
 
(0.5
)
Amortization of Net Loss
5.4

 
4.4

 
0.4

 
1.9

Amortization of Transition Obligation

 

 

 
0.1

Net Periodic Benefit Expense

$5.6

 

$4.5

 

 

$2.4

 
 
 
 
 
 
 
 
For the Six Months Ended June 30,
 
 
 
 
 
 
 
Service Cost

$5.0

 

$4.6

 

$2.0

 

$2.1

Interest Cost
13.0

 
13.2

 
3.4

 
4.7

Expected Return on Plan Assets
(17.6
)
 
(17.7
)
 
(4.9
)
 
(5.0
)
Amortization of Prior Service Costs
0.1

 
0.2

 
(1.3
)
 
(0.9
)
Amortization of Net Loss
10.7

 
8.7

 
0.8

 
3.8

Amortization of Transition Obligation

 

 

 
0.1

Net Periodic Benefit Expense

$11.2

 

$9.0

 

 

$4.8


Employer Contributions. For the six months ended June 30, 2013 , no contributions were made to our defined benefit pension plan ( none for the six months ended June 30, 2012 ). For the six months ended June 30, 2013 , we contributed $10.8 million to our other postretirement benefit plan ( none for the six months ended June 30, 2012 ). We do not expect to contribute to our defined benefit pension plan in 2013 , and we do not expect to make any additional contributions to our other postretirement benefit plan in 2013 .



ALLETE Second Quarter 2013 Form 10-Q
24




NOTE 14.  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.

Square Butte PPA. Minnesota Power has a PPA with Square Butte that extends through 2026 (Agreement). It provides a long-term supply of energy to customers in our electric service territory and enables Minnesota Power to meet reserve requirements. Square Butte, a North Dakota cooperative corporation, owns a 455 MW coal-fired generating unit (Unit) near Center, North Dakota. The Unit is adjacent to a generating unit owned by Minnkota Power, a North Dakota cooperative corporation whose Class A members are also members of Square Butte. Minnkota Power serves as the operator of the Unit and also purchases power from Square Butte.

Minnesota Power is obligated to pay its pro rata share of Square Butte’s costs based on Minnesota Power’s entitlement to Unit output. Our output entitlement under the Agreement is 50 percent for the remainder of the contract, subject to the provisions of the Minnkota Power sales agreement described below. Minnesota Power’s payment obligation will be suspended if Square Butte fails to deliver any power, whether produced or purchased, for a period of one year. Square Butte’s costs consist primarily of debt service, operating and maintenance, depreciation and fuel expenses. As of June 30, 2013 , Square Butte had total debt outstanding of $404.9 million . Annual debt service for Square Butte is expected to be approximately $44 million in each of the years 2013 through 2017 , of which Minnesota Power’s obligation is 50 percent . Fuel expenses are recoverable through our fuel adjustment clause and include the cost of coal purchased from BNI Coal, under a long-term contract.

Minnesota Power’s cost of power purchased from Square Butte during the six months ended June 30, 2013 was $33.0 million ( $33.0 million for the six months ended June 30, 2012 ). 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 $5.3 million during the six months ended June 30, 2013 ( $5.6 million for the six months ended June 30, 2012 ). 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 Sales Agreement. In December 2009, Minnesota Power entered into a power sales agreement with Minnkota Power. Under the power sales agreement, Minnesota Power will sell a portion of its output 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.

No power will be sold under the 2009 agreement until Minnkota Power has placed in service a new AC transmission line, which is expected to occur by the end of the first quarter of 2014. This new AC transmission line will allow Minnkota Power to transmit its entitlement from Square Butte directly to its customers, which in turn will enable Minnesota Power to transmit additional wind generation on the existing DC transmission line.

Minnkota Power PPA. In December 2012, Minnesota Power entered into a long-term PPA with Minnkota Power. Under this agreement, Minnesota Power will purchase 50 MW of capacity and the energy associated with that capacity over the term June 1, 2016 through May 31, 2020. The agreement includes a fixed capacity charge and energy pricing that escalates at a fixed rate annually over the term.

Oliver Wind I and II PPAs. In 2006 and 2007, Minnesota Power entered into two long-term wind PPAs with an affiliate of NextEra Energy, Inc. to purchase the output from Oliver Wind I ( 50 MW) and Oliver Wind II ( 48 MW)—wind facilities located near Center, North Dakota. Each agreement is for 25 years and provides for the purchase of all output from the facilities at fixed energy prices. There are no fixed capacity charges and we only pay for energy as it is delivered to us.

Manitoba Hydro PPAs. Minnesota Power has a long-term PPA with Manitoba Hydro that expires in April 2015. Under this agreement Minnesota Power is purchasing 50 MW of capacity and the energy associated with that capacity. Both the capacity price and the energy price are adjusted annually by the change in a governmental inflationary index.
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