ALLETE
ALLETE INC (Form: 10-Q, Received: 11/03/2014 08:01:47)

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 September 30, 2014

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, without par value,
44,499,229 shares outstanding
as of September 30, 2014



Index
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2014 and December 31, 2013
 
 
 
 
 
 
 
 
For the Quarter and Nine Months Ended September 30, 2014 and 2013
 
 
 
 
 
 
 
 
For the Quarter and Nine Months Ended September 30, 2014 and 2013
 
 
 
 
 
 
 
 
For the Nine Months Ended September 30, 2014 and 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

ALLETE, Inc. Third Quarter 2014 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 utility plant additions during construction periods
ALLETE
ALLETE, Inc.
ALLETE Clean Energy
ALLETE Clean Energy, Inc.
ALLETE Properties
ALLETE Properties, LLC, and its subsidiaries
ATC
American Transmission Company LLC
Bison Wind Energy Center
Bison 1, 2 & 3 Wind Facilities
Bison 4
Bison 4 Wind Project
BNI Coal
BNI Coal, Ltd.
Boswell
Boswell Energy Center
CAIR
Clean Air Interstate Rule
CO 2
Carbon Dioxide
Company
ALLETE, Inc., and its subsidiaries
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
GNTL
Great Northern Transmission Line
IBEW
International Brotherhood of Electrical Workers
Invest Direct
ALLETE’s Direct Stock Purchase and Dividend Reinvestment Plan
Item ___
Item ___ of this Form 10-Q
kV
Kilovolt(s)
kWh
Kilowatt-hour
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
Minnesota Power
An operating division of ALLETE, Inc.
Minnkota Power
Minnkota Power Cooperative, Inc.
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
NOL
Net Operating Loss
Non-residential
Retail commercial, non-retail commercial, office, industrial, warehouse, storage and institutional

ALLETE, Inc. Third Quarter 2014 Form 10-Q
3


Abbreviation or Acronym
Term
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
Thomson
Thomson 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



ALLETE, Inc. Third Quarter 2014 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;
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;
changes in and compliance with laws and regulations;
effects of competition, including competition for retail and wholesale customers;
effects of restructuring initiatives in the electric industry;
changes in tax rates or policies or in rates of inflation;
the impacts on our Regulated Operations segment of climate change and future regulation to restrict the emissions of greenhouse gases;
the impacts of laws and regulations related to renewable and distributed generation;
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;
availability and management   of construction materials and skilled construction labor for capital projects;
changes in operating expenses and capital expenditures and our ability to recover these costs;
pricing, availability and transportation of fuel and other commodities and the ability to recover the costs of such commodities;
our ability to replace a mature workforce and retain qualified, skilled and experienced personnel;
effects of emerging technology;
war, acts of terrorism and cyber attacks;
our ability to manage expansion and integrate acquisitions;
our current and potential industrial and municipal customers’ ability to execute announced expansion plans;
population growth rates and demographic patterns; and
zoning and permitting of land held for resale, real estate development or changes in the real estate market.

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 28 of ALLETE’s Annual Report on Form 10-K for the year ended December 31, 2013 . 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, Inc. Third Quarter 2014 Form 10-Q
5


PART I.  FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS
ALLETE
CONSOLIDATED BALANCE SHEET
Millions – Unaudited
 
September 30,
2014
 
December 31,
2013
 
 
 
 
Assets
 
 
 
Current Assets
 
 
 
Cash and Cash Equivalents

$150.5

 

$97.3

Accounts Receivable (Less Allowance of $1.0 and $1.1)
82.4

 
96.3

Inventories
71.6

 
59.3

Prepayments and Other
29.3

 
35.1

Deferred Income Taxes
24.0

 
19.0

Total Current Assets
357.8

 
307.0

Property, Plant and Equipment - Net
3,121.5

 
2,576.5

Regulatory Assets
277.1

 
263.8

Investment in ATC
120.7

 
114.6

Other Investments
116.4

 
146.3

Other Non-Current Assets
74.4

 
68.6

Total Assets

$4,067.9

 

$3,476.8

Liabilities and Equity
 
 
 
Liabilities
 
 
 
Current Liabilities
 
 
 
Accounts Payable

$92.7

 

$99.9

Accrued Taxes
30.9

 
34.8

Accrued Interest
14.8

 
15.7

Long-Term Debt Due Within One Year
85.3

 
27.2

Notes Payable
2.7

 

Other
60.4

 
52.6

Total Current Liabilities
286.8

 
230.2

Long-Term Debt
1,289.2

 
1,083.0

Deferred Income Taxes
509.7

 
479.1

Regulatory Liabilities
103.1

 
81.0

Defined Benefit Pension and Other Postretirement Benefit Plans
116.8

 
133.4

Other Non-Current Liabilities
231.6

 
127.2

Total Liabilities
2,537.2

 
2,133.9

Commitments, Guarantees and Contingencies (Note 15)

 

Equity
 
 
 
ALLETE’s Equity
 
 
 
Common Stock Without Par Value, 80.0 Shares Authorized, 44.5 and 41.4 Shares Outstanding
1,035.3

 
885.2

Unearned ESOP Shares
(8.6
)
 
(14.3
)
Accumulated Other Comprehensive Loss
(16.1
)
 
(17.1
)
Retained Earnings
518.6

 
489.1

Total ALLETE Equity
1,529.2

 
1,342.9

Non-Controlling Interest in Subsidiaries
1.5

 

Total Equity
1,530.7

 
1,342.9

Total Liabilities and Equity

$4,067.9

 

$3,476.8

The accompanying notes are an integral part of these statements.

ALLETE, Inc. Third Quarter 2014 Form 10-Q
6


ALLETE
CONSOLIDATED STATEMENT OF INCOME
Millions Except Per Share Amounts – Unaudited
 
Quarter Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
2013
 
2014
2013
 
 
 
 
 
 
Operating Revenue

$288.9


$251.0

 

$846.1


$750.4

Operating Expenses
 
 
 
 
 
Fuel and Purchased Power
88.9

80.5

 
268.7

245.7

Operating and Maintenance
105.7

102.7

 
340.6

311.2

Depreciation
33.5

29.4

 
99.5

86.3

Total Operating Expenses
228.1

212.6

 
708.8

643.2

Operating Income
60.8

38.4

 
137.3

107.2

Other Income (Expense)
 
 
 
 
 
Interest Expense
(13.2
)
(12.7
)
 
(39.5
)
(37.8
)
Equity Earnings in ATC
5.3

4.9

 
15.6

15.1

Other
2.1

3.3

 
6.0

7.5

Total Other Expense
(5.8
)
(4.5
)
 
(17.9
)
(15.2
)
Income Before Non-Controlling Interest and Income Taxes
55.0

33.9

 
119.4

92.0

Income Tax Expense
13.4

8.7

 
27.1

20.3

Net Income
41.6

25.2

 
92.3

71.7

Less: Non-Controlling Interest in Subsidiaries


 
0.4


Net Income Attributable to ALLETE

$41.6


$25.2

 

$91.9


$71.7

Average Shares of Common Stock
 
 
 
 
 
Basic
42.9

39.8

 
42.1

39.4

Diluted
42.9

39.9

 
42.3

39.5

Basic Earnings Per Share of Common Stock

$0.97


$0.63

 

$2.18


$1.82

Diluted Earnings Per Share of Common Stock

$0.97


$0.63

 

$2.17


$1.81

Dividends Per Share of Common Stock

$0.49


$0.475

 

$1.47


$1.425

The accompanying notes are an integral part of these statements.

ALLETE, Inc. Third Quarter 2014 Form 10-Q
7


ALLETE
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
Millions – Unaudited


 
Quarter Ended
 
Nine Months Ended
 
September 30,
 
September 30,
Comprehensive Income
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Net Income

$41.6

 

$25.2

 

$92.3

 

$71.7

Other Comprehensive Income (Loss)
 
 
 
 
 
 
 
Unrealized Gain (Loss) on Securities
 
 
 
 
 
 
 
Net of Income Taxes of $–, $(0.3), $0.1, and $(0.2)
(0.1
)
 
(0.5
)
 
0.1

 
(0.4
)
Unrealized Gain (Loss) on Derivatives
 
 
 
 


 


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

 
(0.1
)
 
0.1

 

Defined Benefit Pension and Other Postretirement Benefit Plans
 
 
 
 
 
 
 
 Net of Income Taxes of $0.2, $0.3, $0.6, and $0.8
0.2

 
0.3

 
0.8

 
1.1

Total Other Comprehensive Income (Loss)
0.2

 
(0.3
)
 
1.0

 
0.7

Total Comprehensive Income
41.8

 
24.9

 
93.3

 
72.4

Less: Non-Controlling Interest in Subsidiaries

 

 
0.4

 

Comprehensive Income Attributable to ALLETE

$41.8

 

$24.9

 

$92.9

 

$72.4

The accompanying notes are an integral part of these statements.


ALLETE, Inc. Third Quarter 2014 Form 10-Q
8


ALLETE
CONSOLIDATED STATEMENT OF CASH FLOWS
Millions – Unaudited

 
Nine Months Ended
 
September 30,
 
2014
 
2013
 
 
 
 
Operating Activities
 
 
 
Net Income

$92.3

 

$71.7

Allowance for Funds Used During Construction – Equity
(5.9
)
 
(3.4
)
Income from Equity Investments, Net of Dividends
(3.0
)
 
(3.1
)
Gains on Sale of Assets / Investments
(0.2
)
 
(2.4
)
Depreciation Expense
99.5

 
86.3

Amortization of Debt Issuance Costs
0.8

 
0.8

Amortization of Power Purchase Agreements
(9.0
)
 

Deferred Income Tax Expense
25.2

 
20.4

Share-Based Compensation Expense
1.7

 
1.8

ESOP Compensation Expense
6.7

 
6.0

Defined Benefit Pension and Postretirement Benefit Expense
9.6

 
16.8

Bad Debt Expense
1.1

 
0.9

Changes in Operating Assets and Liabilities
 
 
 
Accounts Receivable
16.9

 
8.2

Inventories
(9.2
)
 
5.1

Prepayments and Other
8.8

 
4.4

Accounts Payable
(1.2
)
 
3.9

Other Current Liabilities
(12.8
)
 
(8.8
)
Cash Contributions to Defined Benefit Pension and Other Postretirement Benefit Plans

 
(10.8
)
Changes in Regulatory and Other Non-Current Assets
(13.0
)
 
(13.5
)
Changes in Regulatory and Other Non-Current Liabilities
3.8

 
4.6

Cash from Operating Activities
212.1

 
188.9

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

 
15.0

Payments for Purchase of Available-for-sale Securities
(4.3
)
 
(2.8
)
Investment in ATC
(3.1
)
 
(2.3
)
Changes to Other Investments
31.1

 
(10.5
)
Additions to Property, Plant and Equipment
(467.8
)
 
(195.3
)
Acquisition – Net of Cash Acquired
(23.1
)
 

Cash in Escrow for Acquisition
5.4

 

Proceeds from Sale of Assets

 
0.9

Cash for Investing Activities
(458.5
)
 
(195.0
)
Financing Activities
 
 
 
Proceeds from Issuance of Common Stock
128.9

 
63.3

Proceeds from Issuance of Long-Term Debt
375.0

 
150.0

Changes in Restricted Cash
(1.4
)
 

Changes in Notes Payable
2.7

 
1.2

Reductions of Long-Term Debt
(134.1
)
 
(66.2
)
Debt Issuance Costs
(3.1
)
 
(1.3
)
Acquisition of Non-Controlling Interest
(6.0
)
 

Dividends on Common Stock
(62.4
)
 
(57.2
)
Cash from Financing Activities
299.6

 
89.8

Change in Cash and Cash Equivalents
53.2

 
83.7

Cash and Cash Equivalents at Beginning of Period
97.3

 
80.8

Cash and Cash Equivalents at End of Period

$150.5

 

$164.5

The accompanying notes are an integral part of these statements.

ALLETE, Inc. Third Quarter 2014 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, 2013 , 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 September 30, 2014 , are not necessarily indicative of results that may be expected for any other interim period or for the year ending December 31, 2014 . For further information, refer to the consolidated financial statements and notes included in our 2013 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
September 30,
2014

 
December 31,
2013

Millions
 
 
 
Fuel

$16.8

 

$13.1

Materials and Supplies
54.8

 
46.2

Total Inventories

$71.6

 

$59.3


Prepayments and Other Current Assets
September 30,
2014

 
December 31,
2013

Millions
 
 
 
Deferred Fuel Adjustment Clause

$18.5

 

$23.0

Restricted Cash (a)
2.4

 

Other
8.4

 
12.1

Total Prepayments and Other Current Assets

$29.3

 

$35.1

(a)
Restricted Cash related to ALLETE Clean Energy’s wind energy facilities operating expense and capital distribution reserve requirements.

Other Non-Current Assets. As of September 30, 2014 , included in Other Non-Current Assets on the Consolidated Balance Sheet was restricted cash of $4.9 million related to ALLETE Clean Energy’s wind energy facilities debt service and other requirements. As of December 31, 2013 , the Company had restricted cash of $5.4 million related to cash held in escrow pending the closing of the wind energy facilities acquisition, which was completed on January 30, 2014. (See Note 4. Acquisition.)

Other Current Liabilities
September 30,
2014

 
December 31,
2013

Millions
 
 
 
Customer Deposits

$21.2

 

$26.0

Power Purchase Agreements (a)
12.3

 

Other
26.9

 
26.6

Total Other Current Liabilities

$60.4

 

$52.6

(a)
Power Purchase Agreements were acquired in conjunction with the ALLETE Clean Energy wind energy facilities acquisition on January 30, 2014. (See Note 4. Acquisition.)

ALLETE, Inc. Third Quarter 2014 Form 10-Q
10


NOTE 1.  OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Other Non-Current Liabilities
September 30,
2014

 
December 31,
2013

Millions
 
 
 
Asset Retirement Obligation

$94.6

 

$81.8

Power Purchase Agreements (a)
90.5

 

Other
46.5

 
45.4

Total Other Non-Current Liabilities

$231.6

 

$127.2

(a)
Power Purchase Agreements were acquired in conjunction with the ALLETE Clean Energy wind energy facilities acquisition on January 30, 2014. (See Note 4. Acquisition.)


Supplemental Statement of Cash Flows Information.
For the Nine Months Ended September 30,
2014

 
2013

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

$39.4

 

$36.0

Cash Paid During the Period for Income Taxes

$2.8

 

$0.6

Noncash Investing and Financing Activities
 

 
 

Decrease in Accounts Payable for Capital Additions to Property, Plant and Equipment
$(6.5)
 
$(10.0)
Capitalized Asset Retirement Costs

$0.6

 

$1.9

AFUDC – Equity

$5.9

 

$3.4

ALLETE Common Stock Contributed to the Pension Plan

$19.5

 


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.

Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. In July 2013, the FASB issued an accounting standard update on the financial statement presentation of unrecognized tax benefits when an NOL carryforward, a similar tax loss, or a tax credit carryforward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for an NOL carryforward, a similar tax loss, or a tax credit carryforward. To the extent an NOL carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date to settle any additional income taxes that would result from the disallowance of a tax position or the tax law does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. This guidance was adopted in the first quarter of 2014, and did not have a material impact on our consolidated financial position, results of operations, or cash flows.

Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity . In April 2014, the FASB issued an accounting standard update modifying the criteria for determining which disposals should be presented as discontinued operations and modifying the related disclosure requirements. Additionally, the new guidance requires that a business which qualifies as held for sale upon acquisition should be reported as discontinued operations. The new guidance will be effective beginning in the first quarter of 2015, and will apply prospectively to new disposals and new classifications of disposal groups as held for sale. This guidance is not expected to have a material impact on our consolidated financial position, results of operations or cash flows.

ALLETE, Inc. Third Quarter 2014 Form 10-Q
11


NOTE 1.  OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Revenue from Contracts with Customers. In May 2014, the FASB issued amended revenue recognition guidance to clarify the principles for recognizing revenue from contracts with customers. The guidance requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. The guidance also 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 are required regarding customer contracts, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. This accounting guidance is effective for the Company beginning in the first quarter of 2017 using one of two prescribed retrospective methods. Early adoption is not permitted for public companies. The Company is evaluating the impact of the amended revenue recognition guidance on the Company’s consolidated financial statements.


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 Clean Energy, our business which acquired three wind energy facilities in January 2014, and is 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, and ALLETE Properties, our Florida real estate investment. Investments and Other also includes 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.

 
Consolidated

Regulated Operations

Investments and Other

Millions
 
 
 
For the Quarter Ended September 30, 2014
 
 
 
Operating Revenue

$288.9


$255.8


$33.1

Fuel and Purchased Power Expense
88.9

88.9


Operating and Maintenance Expense
105.7

79.4

26.3

Depreciation Expense
33.5

28.5

5.0

Operating Income
60.8

59.0

1.8

Interest Expense
(13.2
)
(11.8
)
(1.4
)
Equity Earnings in ATC
5.3

5.3


Other Income
2.1

2.1


Income Before Non-Controlling Interest and Income Taxes
55.0

54.6

0.4

Income Tax Expense
13.4

13.4


Net Income
41.6

41.2

0.4

Less: Non-Controlling Interest in Subsidiaries



Net Income Attributable to ALLETE

$41.6


$41.2


$0.4



ALLETE, Inc. Third Quarter 2014 Form 10-Q
12


NOTE 2.  BUSINESS SEGMENTS (Continued)

 
Consolidated

Regulated Operations

Investments and Other

Millions
 
 
 
For the Quarter Ended September 30, 2013
 
 
 
Operating Revenue

$251.0


$226.4


$24.6

Fuel and Purchased Power Expense
80.5

80.5


Operating and Maintenance Expense
102.7

78.6

24.1

Depreciation Expense
29.4

27.9

1.5

Operating Income (Loss)
38.4

39.4

(1.0
)
Interest Expense
(12.7
)
(10.4
)
(2.3
)
Equity Earnings in ATC
4.9

4.9


Other Income
3.3

1.2

2.1

Income (Loss) Before Non-Controlling Interest and Income Taxes
33.9

35.1

(1.2
)
Income Tax Expense (Benefit)
8.7

10.5

(1.8
)
Net Income
25.2

24.6

0.6

Less: Non-Controlling Interest in Subsidiaries



Net Income Attributable to ALLETE

$25.2


$24.6


$0.6



 
Consolidated

Regulated Operations

Investments and Other

Millions
 
 
 
For the Nine Months Ended September 30, 2014
 
 
 
Operating Revenue

$846.1


$749.6


$96.5

Fuel and Purchased Power Expense
268.7

268.7


Operating and Maintenance Expense
340.6

258.6

82.0

Depreciation Expense
99.5

86.9

12.6

Operating Income
137.3

135.4

1.9

Interest Expense
(39.5
)
(34.7
)
(4.8
)
Equity Earnings in ATC
15.6

15.6


Other Income
6.0

5.9

0.1

Income (Loss) Before Non-Controlling Interest and Income Taxes
119.4

122.2

(2.8
)
Income Tax Expense (Benefit)
27.1

29.6

(2.5
)
Net Income (Loss)
92.3

92.6

(0.3
)
Less: Non-Controlling Interest in Subsidiaries
0.4


0.4

Net Income (Loss) Attributable to ALLETE

$91.9


$92.6

$(0.7)
 
 
 
 
As of September 30, 2014
 
 
 
Total Assets

$4,067.9


$3,519.9


$548.0

Property, Plant and Equipment – Net

$3,121.5


$2,888.5


$233.0

Accumulated Depreciation

$1,316.6


$1,244.7


$71.9

Capital Additions

$467.6


$452.9


$14.7


ALLETE, Inc. Third Quarter 2014 Form 10-Q
13


NOTE 2.  BUSINESS SEGMENTS (Continued)

 
Consolidated

Regulated Operations

Investments and Other

Millions
 
 
 
For the Nine Months Ended September 30, 2013
 
 
 
Operating Revenue

$750.4


$683.6


$66.8

Fuel and Purchased Power Expense
245.7

245.7


Operating and Maintenance Expense
311.2

243.6

67.6

Depreciation Expense
86.3

81.8

4.5

Operating Income (Loss)
107.2

112.5

(5.3
)
Interest Expense
(37.8
)
(31.5
)
(6.3
)
Equity Earnings in ATC
15.1

15.1


Other Income
7.5

3.4

4.1

Income (Loss) Before Non-Controlling Interest and Income Taxes
92.0

99.5

(7.5
)
Income Tax Expense (Benefit)
20.3

26.5

(6.2
)
Net Income (Loss)
71.7

73.0

(1.3
)
Less: Non-Controlling Interest in Subsidiaries



Net Income (Loss) Attributable to ALLETE

$71.7


$73.0

$(1.3)
 
 
 
 
As of September 30, 2013
 

 

 

Total Assets

$3,463.9


$3,086.3


$377.6

Property, Plant and Equipment – Net

$2,456.1


$2,384.1


$72.0

Accumulated Depreciation

$1,225.3


$1,165.8


$59.5

Capital Additions

$186.4


$177.6


$8.8



NOTE 3.  INVESTMENTS

Investments. At September 30, 2014 , our investment portfolio included 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
September 30,
2014

 
December 31,
2013

Millions
 
 
 
ALLETE Properties

$89.4

 

$89.9

Available-for-sale Securities (a)
19.0

 
17.7

Cash Equivalents (b)
3.7

 
34.2

Other
4.3

 
4.5

Total Other Investments

$116.4

 

$146.3

(a)
As of September 30, 2014 , the aggregate amount of available-for-sale corporate debt securities maturing in one year or less was $0.2 million , in one year to less than three years was $2.1 million , in three years to less than five years was $1.3 million , and in five or more years was $7.1 million .
(b)
During the first quarter of 2014, cash included in Other Investments was transferred to Cash and Cash Equivalents.

ALLETE, Inc. Third Quarter 2014 Form 10-Q
14


NOTE 3.  INVESTMENTS (Continued)

ALLETE Properties
September 30,
2014

 
December 31,
2013

Millions
 
 
 
Land Inventory Beginning Balance

$85.4

 

$86.5

Cost of Sales
(1.1
)
 
(1.5
)
Other
0.5

 
0.4

Land Inventory Ending Balance
84.8

 
85.4

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

 
1.4

Other
3.2

 
3.1

Total Real Estate Assets

$89.4

 

$89.9


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 indicators of impairment on a quarterly basis and no impairments were recorded for the quarter and nine months ended September 30, 2014 ( none for the year ended December 31, 2013 ).

Long-Term Finance Receivables. As of September 30, 2014 , long-term finance receivables were $1.4 million net of an allowance ( $1.4 million net of an allowance as of December 31, 2013 ). 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 September 30, 2014 , we had an allowance for doubtful accounts of $0.6 million ( $0.6 million as of December 31, 2013 ).

 
 
Gross Unrealized
 
Available-For-Sale Securities
Cost
Gain
Loss
Fair Value
Millions
 
 
 
 
September 30, 2014
$19.1
$0.3
$0.4
$19.0
December 31, 2013
$18.3
$0.6
$17.7
 
Net
Gross Realized
Available-For-Sale Securities (Continued)
Proceeds
Gain
Loss
Millions
 
 
 
Quarter Ended September 30,
 
 
 
2014
$0.6
2013
$6.9
$1.4
Nine Months Ended September 30,
 
 
 
2014
$3.3
$0.2
2013
$15.0
$2.2


NOTE 4.  ACQUISITION

On January 30, 2014 , ALLETE Clean Energy acquired wind energy facilities located in Lake Benton, Minnesota ( Lake Benton ), Storm Lake, Iowa ( Storm Lake ) and Condon, Oregon ( Condon ) from The AES Corporation (AES) for $ 26.9  million. ALLETE Clean Energy also has an option to acquire a fourth wind energy facility from AES in Armenia Mountain, Pennsylvania ( Armenia Mountain ), in June 2015. The acquisition supports ALLETE’s strategy to pursue energy-centric initiatives through ALLETE Clean Energy that include less carbon intensive and more sustainable energy sources.

Lake Benton, Storm Lake and Condon have 104 MW, 77 MW and 50 MW of generating capability, respectively. Lake Benton and Storm Lake began commercial operations in 1998, while Condon began operations in 2002. All three wind energy facilities have PPAs in place for their entire output, which expire in various years between 2019 and 2032. Pursuant to the acquisition agreement, ALLETE Clean Energy has an option to acquire the 101  MW Armenia Mountain wind energy facility in June 2015. Armenia Mountain began operations in 2009.

ALLETE, Inc. Third Quarter 2014 Form 10-Q
15


NOTE 4.  ACQUISITION (Continued)

ALLETE Clean Energy acquired a controlling interest in the limited liability company (LLC) which owns Lake Benton and Storm Lake, and a controlling interest in the LLC that owns Condon. 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. In connection with finalizing purchase price accounting, the Company recorded minor adjustments to certain assets and liabilities in the second quarter of 2014, which are reflected in the table below. These adjustments had no impact on the results of operations. Fair value measurements were valued primarily using the discounted cash flow method.


Millions
 
Assets Acquired
 
Cash and Cash Equivalents

$3.8

Other Current Assets
14.3

Property, Plant and Equipment – Net
156.9

Other Non-Current Assets (a)
7.5

Total Assets Acquired

$182.5

Liabilities Assumed
 
Other Current Liabilities (b)

$15.2

Long-Term Debt Due Within One Year
2.2

Long-Term Debt
21.1

Power Purchase Agreements
99.4

Other Non-Current Liabilities
10.6

Non-Controlling Interest (c)
7.1

Total Liabilities and Non-Controlling Interest Assumed
155.6

Net Identifiable Assets Acquired

$26.9

(a)
Included in Other Non-Current Assets was $0.3 million for the option to purchase Armenia Mountain in 2015, and goodwill of $2.9 million; for tax purposes, the purchase price allocation resulted in no allocation to goodwill.
(b)
Other Current Liabilities included $12.4 million related to the current liabilities portion of the Power Purchase Agreements.
(c)
The purchase price accounting valued the non-controlling interest relating to Lake Benton, Storm Lake and Condon at fair value using the discounted cash flow method. The non-controlling interest related to Lake Benton and Storm Lake was subsequently purchased by ALLETE Clean Energy.

ALLETE Clean Energy incurred $1.4 million after-tax of acquisition-related costs during the first quarter of 2014, which were expensed when incurred and were recorded in Other Expenses on the Consolidated Statement of Income. The results of operations of this business from its acquisition date are included in the Investments and Other segment. The pro forma impact of this acquisition was not significant to the results of the Company for the quarter and nine months ended September 30, 2014 or September 30, 2013.

On February 11, 2014, ALLETE Clean Energy purchased the non-controlling interest related to Lake Benton and Storm Lake for $6.0 million. This was accounted for as an equity transaction, and no gain or loss was recognized in net income or other comprehensive income.



ALLETE, Inc. Third Quarter 2014 Form 10-Q
16


NOTE 5. DERIVATIVES

We have one 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 which represents approximately 5 percent of the Company’s outstanding long-term debt, including long-term debt due within one year, as of September 30, 2014 . (See Note 9. Short-Term and Long-Term Debt.) The Swap has an effective date of August 25, 2014, and matures on August 25, 2015. The Swap involves the receipt of the one-month LIBOR in exchange for fixed interest payments over the life of the agreement at 0.75 percent without an exchange of the underlying notional amount. Cash flows from the Swap are expected to be highly effective. If it is determined that the Swap ceases to be effective, we will prospectively discontinue hedge accounting. When applicable, we use the shortcut method to assess hedge effectiveness. If the shortcut method is not applicable, we assess effectiveness using the “change-in-variable-cash-flows” method. Our assessment of hedge effectiveness resulted in no ineffectiveness recorded for the quarter and nine months ended September 30, 2014. As of September 30, 2014 , the fair value of the Swap was a $0.4 million liability which was included in Other Current Liabilities on the Consolidated Balance Sheet. The fair value as of December 31, 2013 , included an additional variable to fixed interest rate swap that expired on August 26, 2014, with an aggregate fair value at December 31, 2013 of $0.6 million of which $0.3 million was included in Other Non-Current Liabilities and $0.3 million was included in Other Current Liabilities on the Consolidated Balance Sheet. Changes in the fair value of the Swap were recorded in Accumulated Other Comprehensive Loss on the Consolidated Balance Sheet. Cash flows from the Swap are presented in the same category as the hedged item on the Consolidated Statement of Cash Flows. Amounts recorded in Other Comprehensive Income related to the Swap will be recorded in earnings when the hedged transaction occurs or when it is probable it will not occur. Gains or losses on the interest rate hedging transaction are reflected as a component of Interest Expense on the Consolidated Statement of Income.


NOTE 6. 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 10. Fair Value to the consolidated financial statements in our 2013 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 September 30, 2014 , and December 31, 2013 . 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 is excluded from the recurring fair value measures in the tables below.

ALLETE, Inc. Third Quarter 2014 Form 10-Q
17


NOTE 6. FAIR VALUE (Continued)

 
Fair Value as of September 30, 2014
Recurring Fair Value Measures
Level 1

 
Level 2

 
Level 3

 
Total

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

$8.3

 

 

 

$8.3

Available-for-sale – Corporate Debt Securities

 

$10.7

 

 
10.7

Cash Equivalents
3.7

 

 

 
3.7

Total Fair Value of Assets

$12.0

 

$10.7

 

 

$22.7

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Deferred Compensation (b)

 

$16.2

 

 

$16.2

Derivatives – Interest Rate Swap (c)

 
0.4

 

 
0.4

Total Fair Value of Liabilities

 

$16.6

 

 

$16.6

Total Net Fair Value of Assets (Liabilities)

$12.0

 
$(5.9)
 

 

$6.1

(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 Current Liabilities - Other on the Consolidated Balance Sheet.


 
Fair Value as of December 31, 2013
Recurring Fair Value Measures
Level 1

 
Level 2

 
Level 3

 
Total

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

$7.9

 

 

 

$7.9

Available-for-sale – Corporate Debt Securities

 

$9.8

 

 
9.8

Cash Equivalents
34.2

 

 

 
34.2

Total Fair Value of Assets

$42.1

 

$9.8

 

 

$51.9

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Deferred Compensation (b)

 

$16.8

 

 

$16.8

Derivatives – Interest Rate Swap (c)

 
0.6

 

 
0.6

Total Fair Value of Liabilities

 

$17.4

 

 

$17.4

Total Net Fair Value of Assets (Liabilities)

$42.1

 
$(7.6)
 

 

$34.5

(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 Current Liabilities - Other and Other Non-Current Liabilities on the Consolidated Balance Sheet.

There was no activity in Level 3 during the quarters and nine months ended September 30, 2014 and 2013 .

For the quarters and nine months ended September 30, 2014 and 2013 , 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 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
 
 
 
September 30, 2014
$1,374.5
 
$1,465.0
December 31, 2013
$1,110.2
 
$1,131.7

ALLETE, Inc. Third Quarter 2014 Form 10-Q
18


NOTE 7.  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.

FERC-Approved Wholesale Rates. Minnesota Power’s non-affiliated municipal customers consist of 16 municipalities in Minnesota. SWL&P, a wholly-owned subsidiary of ALLETE, is a private utility in Wisconsin and also a customer of Minnesota Power. In April 2014, Minnesota Power amended its formula-based wholesale electric sales contract with the Nashwauk Public Utilities Commission, extending the term through June 30, 2026. The electric service agreements with the remaining 15 Minnesota municipal customers and SWL&P are effective through June 30, 2019. The rates included in these agreements 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 formula-based rate 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 Nashwauk Public Utilities Commission agreement, no termination notice may be given prior to July 1, 2023. Under the agreements with the remaining 15 municipal customers and SWL&P, no termination notices may be given prior to June 30, 2016.

2012 Wisconsin Rate Case.   SWL&P’s current 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.

Transmission Cost Recovery Rider. Minnesota Power has an approved cost recovery rider in place for certain transmission investments and expenditures. In November 2013, the MPUC approved Minnesota Power’s updated billing factor 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. We filed a petition on April 24, 2014, to include additional transmission investments and expenditures in customer billing rates.

Renewable Cost Recovery Rider. The Bison Wind Energy Center in North Dakota currently consists of 292 MW of nameplate capacity and was completed in various phases through 2012. Customer billing rates for our Bison Wind Energy Center were approved by the MPUC in a December 2013 order. Construction of Bison 4, a 205 MW wind project in North Dakota, which is an addition to our Bison Wind Energy Center, commenced and is expected to be completed by the end of 2014. The total project investment for Bison 4 is estimated to be approximately $345 million , of which $288 million was spent through September 30, 2014 . On January 17, 2014, the MPUC approved Minnesota Power’s petition seeking cost recovery for investments and expenditures related to Bison 4. We included Bison 4 as part of our renewable resources rider factor filing along with the Company’s other renewable projects in a filing on April 29, 2014, which, upon approval, will authorize updated rates to be included on customer bills.

Minnesota Power has also filed a petition on July 3, 2014 with the MPUC seeking cost recovery for investments and expenditures related to the restoration and repair of Thomson which was damaged during 2012. The total project investment for Thomson is estimated to be approximately $90 million , of which $80 million , net of insurance, was spent through September 30, 2014. (See Note 15. Commitments, Guarantees and Contingencies.)

Integrated Resource Plan. In a November 2013 order, the MPUC approved Minnesota Power’s 2013 Integrated Resource Plan which 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. Significant elements of the “EnergyForward” plan include major wind investments in North Dakota, installation of emissions control technology at Boswell Unit 4, planning for the proposed GNTL, conversion of Laskin from coal to natural gas in the second quarter of 2015 and retiring Taconite Harbor Unit 3 in the second quarter of 2015.

ALLETE, Inc. Third Quarter 2014 Form 10-Q
19


NOTE 7. REGULATORY MATTERS (Continued)

Boswell Mercury Emissions Reduction Plan. Minnesota Power is implementing a mercury emissions reduction project for Boswell Unit 4 in order to comply with 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 Act 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 approximately $250 million of which $120 million was spent through September 30, 2014 . In November 2013, the MPUC issued an order approving the Boswell Unit 4 mercury emissions reduction plan and cost recovery, establishing an environmental improvement rider. Also in November 2013, environmental intervenors filed a petition for reconsideration with the MPUC which was subsequently denied in an order dated January 17, 2014. Intervenors have appealed this order and the Company has filed a response to the appeal. The Minnesota Court of Appeals heard oral argument in September 2014 with a decision expected before the end of 2014. In December 2013, Minnesota Power filed a petition with the MPUC to establish customer billing rates for the approved environmental improvement rider based on actual and estimated investments and expenditures, which was approved in an order dated July 2, 2014.

Great Northern Transmission Line (GNTL) . Minnesota Power and Manitoba Hydro have proposed construction of the GNTL, an approximately 220 -mile 500  kV transmission line, between Manitoba and Minnesota’s Iron Range. The GNTL is subject to various federal and state regulatory approvals. In October 2013, a Certificate of Need application was filed with the MPUC with respect to the GNTL. In an order dated January 8, 2014, the MPUC determined that the Certificate of Need application was complete and referred the docket to an administrative law judge for a contested case proceeding. On April 15, 2014, Minnesota Power filed a route permit application with the MPUC and a request for a presidential permit to cross the U.S.-Canadian border with the U.S. Department of Energy. In an order dated July 2, 2014, the MPUC determined the route permit application to be complete. Manitoba Hydro must also obtain regulatory and governmental approvals related to new transmission line and hydroelectric generation development in Canada. Upon receipt of all applicable permits and approvals, construction of the GNTL is anticipated to begin in 2016, and to be completed in 2020.

Conservation Improvement Program (CIP). Minnesota has enacted legislation establishing an annual energy-savings goal for each utility of 1.5 percent of annual retail energy sales. On April 1, 2014, Minnesota Power submitted its 2013 CIP filing that requested a CIP financial incentive of $8.7 million based upon MPUC procedures. The requested CIP financial incentive was approved by the MPUC in a hearing held on July 24, 2014, and was recorded as revenue and as a regulatory asset. The approved financial incentive will be recovered through customer billing rates in 2014 and 2015. In 2013, the CIP financial incentive of $7.1 million was recognized in the fourth quarter. CIP financial incentives are recognized in the period in which the MPUC approves the filing.

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. 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. Third Quarter 2014 Form 10-Q
20


NOTE 7. REGULATORY MATTERS (Continued)

Regulatory Assets and Liabilities
September 30,
2014

 
December 31,
2013

Millions
 
 
 
Current Regulatory Assets (a)
 
 
 
Deferred Fuel

$18.5

 

$23.0

Total Current Regulatory Assets
18.5

 
23.0

Non-Current Regulatory Assets
 
 
 
Defined Benefit Pension and Other Postretirement Benefit Plans (b)
158.6

 
164.1

Cost Recovery Riders (c)
54.5

 
39.6

Income Taxes
37.9

 
35.3

Asset Retirement Obligations
17.2

 
16.0

PPACA Income Tax Deferral
5.0

 
5.0

Other
3.9

 
3.8

Total Non-Current Regulatory Assets
277.1

 
263.8

Total Regulatory Assets

$295.6

 

$286.8

 
 
 
 
Non-Current Regulatory Liabilities
 
 
 
Plant Removal Obligations

$22.7

 

$19.7

Wholesale and Retail Contra AFUDC
37.6

 
19.7

Income Taxes
17.6

 
17.0

Defined Benefit Pension and Other Postretirement Benefit Plans (b)
15.1

 
16.3

Other
10.1

 
8.3

Total Non-Current Regulatory Liabilities

$103.1

 

$81.0

(a)
Current regulatory assets are included in Prepayments and Other on the Consolidated Balance Sheet.
(b)
Defined benefit pension and other postretirement items included in our Regulated Operations, which are otherwise required to be recognized in accumulated other comprehensive income, are recognized as regulatory assets or regulatory liabilities on the Consolidated Balance Sheet. (See Note 14. Pension and Other Postretirement Benefit Plans.)
(c)
The cost recovery rider regulatory asset is primarily due to capital expenditures related to our Bison Wind Energy Center and is recognized in accordance with the accounting standards for alternative revenue programs.


NOTE 8.  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 based on a FERC-approved 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 September 30, 2014 , our equity investment in ATC was $120.7 million ( $114.6 million at December 31, 2013 ). In the first nine months of 2014 , we invested $3.1 million in ATC, and on October 30, 2014 , we invested an additional $0.8 million . We do not expect to make any additional investments in 2014 .

ALLETE’s Investment in ATC
 
Millions
 
Equity Investment Balance as of December 31, 2013

$114.6

Cash Investments
3.1

Equity in ATC Earnings
15.6

Distributed ATC Earnings
(12.6
)
Equity Investment Balance as of September 30, 2014

$120.7



ALLETE, Inc. Third Quarter 2014 Form 10-Q
21


NOTE 8.  INVESTMENT IN ATC (Continued)

ATC’s summarized financial data for the quarter and nine months ended September 30, 2014 and 2013 , is as follows:
 
Quarter Ended
 
Nine Months Ended
ATC Summarized Financial Data
September 30,
 
September 30,
Income Statement Data
2014
 
2013
 
2014
 
2013
Millions
 
 
 
 
 
 
 
Revenue
$163.6
 
$160.5
 

$487.0

 

$464.3

Operating Expense
76.6
 
77.6
 
229.6

 
217.2

Other Expense
21.4
 
20.2
 
65.1

 
62.6

Net Income
$65.6
 
$62.7
 

$192.3

 

$184.5

ALLETE’s Equity in Net Income

$5.3

 
$4.9
 

$15.6

 

$15.1


In November 2013, several customer groups located within the MISO service area filed a complaint with the FERC requesting, among other things, a reduction in the base return on equity used by MISO transmission owners, including ATC, to 9.15 percent . ATC's current authorized return on equity is 12.2 percent . Any change to ATC's return on equity and capital structure could result in lower equity earnings in ATC and dividends from ATC in the future. We own approximately 8 percent of ATC and estimate that for every 50  basis point reduction in ATC’s allowed return on equity our equity earnings in ATC would be impacted annually by approximately $0.5 million on an after-tax basis.


NOTE 9.  SHORT-TERM AND LONG-TERM DEBT

Short-Term Debt. As of September 30, 2014 , total short-term debt outstanding was $88.0 million ( $27.2 million as of December 31, 2013 ) and consisted of long-term debt due within one year and notes payable.

Long-Term Debt. As of September 30, 2014 , total long-term debt outstanding was $1,289.2 million ( $1,083.0 million as of December 31, 2013 ). In conjunction with ALLETE Clean Energy’s January 30, 2014 wind energy facilities acquisition, ALLETE Clean Energy assumed $ 23.3 million of long-term debt, including $ 2.2 million due within one year. (See Note 4. Acquisition.)

During the first nine months of 2014, we issued $375.0 million of ALLETE first mortgage bonds (Bonds) in the private placement market as shown below:

Issue Date
Maturity Date
Principal Amount
Interest Rate
March 4, 2014
March 15, 2024
$60 Million
3.69%
March 4, 2014
March 15, 2044
$40 Million
4.95%
June 26, 2014
July 15, 2022
$75 Million
3.40%
June 26, 2014
July 15, 2044
$40 Million
5.05%
September 16, 2014
September 15, 2021
$60 Million
3.02%
September 16, 2014
September 15, 2029
$50 Million
3.74%
September 16, 2014
September 15, 2044
$50 Million
4.39%

The Company has the option to prepay all or a portion of the Bonds at its discretion, subject to a make-whole provision; however, each series of bonds is redeemable at par, including, in each case, accrued and unpaid interest, six months prior to the maturity date. The Bonds are subject to additional terms and conditions which are customary for these types of transactions. The Company intends to use the proceeds from the sale of the Bonds to refinance debt, fund utility capital expenditures 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 institutional accredited investors.

ALLETE, Inc. Third Quarter 2014 Form 10-Q
22


NOTE 9.  SHORT-TERM AND LONG-TERM DEBT (Continued)

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 September 30, 2014 , 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 September 30, 2014 , ALLETE was in compliance with its financial covenants.


NOTE 10.  OTHER INCOME (EXPENSE)

 
 
Quarter Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2014

 
2013

 
2014

 
2013

Millions
 
 
 
 
 
 
 
 
AFUDC – Equity
 

$2.1

 

$1.2

 

$5.9

 

$3.4

Gain on Sale of Available-for-sale Securities
 

 
1.4

 
0.2

 
2.2

Investments and Other Income (Expense)
 

 
0.7

 
(0.1
)
 
1.9

Total Other Income
 

$2.1

 

$3.3

 

$6.0

 

$7.5



NOTE 11.  INCOME TAX EXPENSE
 
 
Quarter Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2014
 
2013
 
2014
 
2013
Millions
 
 
 
 
 
 
 
 
Current Tax Expense (Benefit)
 
 
 
 
 
 
 
 
Federal (a)(c)
 

 

 

 

State (b)(c)
 
$1.8
 
$(0.1)
 
$1.9
 
$(0.1)
Total Current Tax Expense (Benefit)
 
$1.8
 
$(0.1)
 
$1.9
 
$(0.1)
Deferred Tax Expense (Benefit)
 
 
 
 
 
 
 
 
Federal
 

$11.2

 

$7.3

 

$20.4

 

$15.5

State
 
0.7

 
1.7

 
5.4

 
5.5

Investment Tax Credit Amortization
 
(0.3
)
 
(0.2
)
 
(0.6
)
 
(0.6
)
Total Deferred Tax Expense
 
11.6

 
8.8

 
25.2

 
20.4

Total Income Tax Expense
 

$13.4

 

$8.7

 

$27.1

 

$20.3

(a)
For the quarter and nine months ended September 30, 2014 , the federal current tax expense of zero reflected the utilization of NOL carryforwards from prior periods. The federal NOLs remaining after utilization in 2014 will be carried forward to offset future taxable income.
(b)
For the quarter and nine months ended September 30, 2014 , the state current tax expense reflected initiatives implemented on the 2013 federal and state tax returns to utilize tax carryforwards that may have expired due to NOL carryforwards from prior periods. State NOL and alternative minimum tax carryforwards remaining after utilization in 2014 will be carried forward to offset future income.
(c)
For the quarter and nine months ended September 30, 2013 , the state current tax benefit was due to federal and state NOLs which resulted from the bonus depreciation provision of the American Taxpayer Relief Act of 2012.


For the nine months ended September 30, 2014 , the effective tax rate was 22.7 percent ( 22.1 percent for the nine months ended September 30, 2013 ). The effective tax rate deviated from the statutory rate of approximately 41 percent primarily due to deductions for AFUDC–Equity, investment tax credits, production tax credits and depletion.

ALLETE, Inc. Third Quarter 2014 Form 10-Q
23


NOTE 11.  INCOME TAX EXPENSE (Continued)

Uncertain Tax Positions. As of September 30, 2014 , we had gross unrecognized tax benefits of $2.0 million ( $1.2 million as of December 31, 2013 ). Of the total gross unrecognized tax benefits, $0.3 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. 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 is no longer subject to federal examination for years before 2011, or state examination for years before 2005.

In September 2013, the U.S. Treasury issued final regulations addressing the tax consequences associated with the acquisition, production and improvement of tangible property. The regulations are generally effective for tax years beginning January 1, 2014. As ALLETE has adopted certain utility-specific guidance for deductible repairs previously issued by the IRS, the final regulation did not have a material impact on our consolidated financial statements.


NOTE 12. RECLASSIFICATIONS OUT OF ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

Changes in accumulated other comprehensive loss, net of tax, for the quarters ended September 30, 2014 and 2013 , were as follows:
 
Unrealized Gains and Losses on Available-for-sale Securities
Defined Benefit Pension, Other Postretirement Items
Gains and Losses on Cash Flow Hedge
Total
Millions
 
 
 
 
For the Quarter Ended September 30, 2014
 
 
 
 
Beginning Accumulated Other Comprehensive Income (Loss)
$0.1
$(16.1)
$(0.3)
$(16.3)
Other Comprehensive Income (Loss) Before Reclassifications
(0.1
)
(0.1
)
0.1

(0.1
)
Amounts Reclassified From Accumulated Other Comprehensive Income

0.3


0.3

Net Other Comprehensive Income (Loss)
(0.1
)
0.2

0.1

0.2

Ending Accumulated Other Comprehensive Loss

$(15.9)
$(0.2)
$(16.1)
 
 
 
 
 
For the Quarter Ended September 30, 2013
 
 
 
 
Beginning Accumulated Other Comprehensive Loss

$(20.7)
$(0.3)
$(21.0)
Other Comprehensive Income (Loss) Before Reclassifications
$0.3

(0.1
)
0.2

Amounts Reclassified From Accumulated Other Comprehensive Income (Loss)
(0.8)
0.3

(0.5)
Net Other Comprehensive Income (Loss)
(0.5)
0.3
(0.1)
(0.3)
Ending Accumulated Other Comprehensive Loss
$(0.5)
$(20.4)
$(0.4)
$(21.3)


ALLETE, Inc. Third Quarter 2014 Form 10-Q
24


NOTE 12. RECLASSIFICATIONS OUT OF ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) (Continued)

Reclassifications from accumulated other comprehensive loss for the quarters ended September 30, 2014 and 2013 , were as follows:

Quarter Ended
Quarter Ended
Amount Reclassified from Accumulated Other Comprehensive Loss
September 30,
September 30,
 
2014
2013
Millions
 
 
Unrealized Gains on Available-for-sale Securities (a)

$1.4
Income Taxes (b)

(0.6
)
Total, Net of Income Taxes

$0.8
 
 
 
Amortization of Defined Benefit Pension and Other Postretirement Items
 
 
Prior Service Costs (c)
$0.1
$0.1
Actuarial Gains and Losses (c)
(0.6
)
(0.7
)
Total
(0.5
)
(0.6
)
Income Taxes (b)
0.2

0.3

Total, Net of Income Taxes
$(0.3)
$(0.3)
Total Reclassifications
$(0.3)
$0.5
(a)
Included in Other Income (Expense) – Other on the Consolidated Statement of Income.
(b)
Included in Income Tax Expense on the Consolidated Statement of Income.
(c)
Defined benefit pension and other postretirement benefit items excluded from our Regulated Operations are recognized in accumulated other comprehensive loss and are subsequently reclassified out of accumulated other comprehensive loss as components of net periodic pension and other postretirement benefit expense. (See Note 14. Pension and Other Postretirement Benefit Plans.)


Changes in accumulated other comprehensive loss, net of tax, for the nine months ended September 30, 2014 and 2013 , were as follows:
 
Unrealized Gains and Losses on Available-for-sale Securities
Defined Benefit Pension, Other Postretirement Items
Gains and Losses on Cash Flow Hedge
Total
Millions
 
 
 
 
For the Nine Months Ended September 30, 2014
 
 
 
 
Beginning Accumulated Other Comprehensive Loss
$(0.1)
$(16.7)
$(0.3)
$(17.1)
Other Comprehensive Income Before Reclassifications
0.2

(0.1
)
0.1

0.2

Amounts Reclassified From Accumulated Other Comprehensive Income (Loss)
(0.1
)
0.9


0.8

Net Other Comprehensive Income
0.1

0.8

0.1

1.0

Ending Accumulated Other Comprehensive Loss

$(15.9)
$(0.2)
$(16.1)
 
 
 
 
 
For the Nine Months Ended September 30, 2013
 
 
 
 
Beginning Accumulated Other Comprehensive Loss
$(0.1)
$(21.5)
$(0.4)
$(22.0)
Other Comprehensive Income Before Reclassifications
0.9



0.9

Amounts Reclassified From Accumulated Other Comprehensive Income (Loss)
(1.3
)
1.1


(0.2
)
Net Other Comprehensive Income (Loss)
(0.4
)
1.1


0.7

Ending Accumulated Other Comprehensive Loss
$(0.5)
$(20.4)
$(0.4)
$(21.3)

ALLETE, Inc. Third Quarter 2014 Form 10-Q
25


NOTE 12. RECLASSIFICATIONS OUT OF ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) (Continued)

Reclassifications from accumulated other comprehensive loss for the nine months ended September 30, 2014 and 2013 , were as follows:
 
Nine Months Ended
Nine Months Ended
Amount Reclassified from Accumulated Other Comprehensive Loss
September 30,
September 30,
 
2014
2013
Millions
 
 
Unrealized Gains on Available-for-sale Securities (a)
$0.2
$2.2
Income Taxes (b)
(0.1
)
(0.9
)
Total, Net of Income Taxes
$0.1
$1.3
 
 
 
Amortization of Defined Benefit Pension and Other Postretirement Items
 
 
Prior Service Costs (c)
$0.3
$0.2
Actuarial Gains and Losses (c)
(1.8
)
(2.1
)
Total
(1.5
)
(1.9
)
Income Taxes (b)
0.6

0.8

Total, Net of Income Taxes
$(0.9)
$(1.1)
Total Reclassifications
$(0.8)
$0.2
(a)
Included in Other Income (Expense) – Other on the Consolidated Statement of Income.
(b)
Included in Income Tax Expense on the Consolidated Statement of Income.
(c)
Defined benefit pension and other postretirement benefit items excluded from our Regulated Operations are recognized in accumulated other comprehensive loss and are subsequently reclassified out of accumulated other comprehensive loss as components of net periodic pension and other postretirement benefit expense. (See Note 14. Pension and Other Postretirement Benefit Plans.)



NOTE 13.  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, performance share awards granted under our Executive Long-Term Incentive Compensation Plan and common shares under the forward sale agreement (described below). For the quarters and nine months ended September 30, 2014 and 2013 , zero options to purchase shares of common stock were excluded from the computation of diluted earnings per share.

 
 
 
2014