ALLETE
ALLETE INC (Form: 10-Q, Received: 08/03/2016 06:02:53)



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, 2016

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,
49,379,945 shares outstanding
as of June 30, 2016





Index
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2016 and December 31, 2015
 
 
 
 
 
 
 
 
Quarter and Six Months Ended June 30, 2016 and 2015
 
 
 
 
 
 
 
 
Quarter and Six Months Ended June 30, 2016 and 2015
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2016 and 2015
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

ALLETE, Inc. Second Quarter 2016 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. and its subsidiaries
ALLETE Properties
ALLETE Properties, LLC and its subsidiaries
ALLETE Transmission Holdings
ALLETE Transmission Holdings, Inc.
ATC
American Transmission Company LLC
Basin
Basin Electric Power Cooperative
BNI Energy
BNI Coal, Ltd. d/b/a BNI Energy
Boswell
Boswell Energy Center
Cliffs
Cliffs Natural Resources Inc.
CO 2
Carbon Dioxide
Company
ALLETE, Inc. and its subsidiaries
CSAPR
Cross-State Air Pollution Rule
DC
Direct Current
EIS
Environmental Impact Statement
EPA
United States Environmental Protection Agency
ESOP
Employee Stock Ownership Plan
Essar
Essar Steel Minnesota LLC
FASB
Financial Accounting Standards Board
FERC
Federal Energy Regulatory Commission
Form 10-K
ALLETE Annual Report on Form 10-K
Form 10-Q
ALLETE Quarterly Report on Form 10-Q
GAAP
Generally Accepted Accounting Principles in the United States of America
GHG
Greenhouse Gases
GNTL
Great Northern Transmission Line
IBEW
International Brotherhood of Electrical Workers
IRP
Integrated Resource Plan
Invest Direct
ALLETE’s Direct Stock Purchase and Dividend Reinvestment Plan
Item ___
Item ___ of this Form 10-Q
kV
Kilovolt(s)
kW / kWh
Kilowatt(s) / Kilowatt-hour(s)
Laskin
Laskin Energy Center
MACT
Maximum Achievable Control Technology
Magnetation
Magnetation, LLC
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.
Montana-Dakota Utilities
Montana-Dakota Utilities Co., a division of MDU Resources Group, Inc.
MPCA
Minnesota Pollution Control Agency

ALLETE, Inc. Second Quarter 2016 Form 10-Q
3




Abbreviation or Acronym
Term
MPUC
Minnesota Public Utilities Commission
MW / MWh
Megawatt(s) / Megawatt-hour(s)
NAAQS
National Ambient Air Quality Standards
NDPSC
North Dakota Public Service Commission
NOL
Net Operating Loss
NO 2
Nitrogen Dioxide
NO X
Nitrogen Oxides
Northshore Mining
Northshore Mining Company, a wholly-owned subsidiary of Cliffs
Note ___
Note ___ to the Consolidated Financial Statements in this Form 10-Q
NPDES
National Pollutant Discharge Elimination System
Oliver Wind I
Oliver Wind I Energy Center
Oliver Wind II
Oliver Wind II Energy Center
Palm Coast Park District
Palm Coast Park Community Development District in Florida
PolyMet
PolyMet Mining Corp.
PPA
Power Purchase Agreement
PPACA
Patient Protection and Affordable Care Act of 2010
PSCW
Public Service Commission of Wisconsin
SEC
Securities and Exchange Commission
Shell Energy
Shell Energy North America (US), L.P.
Silver Bay Power
Silver Bay Power Company, a wholly-owned subsidiary of Cliffs
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 District
Town Center at Palm Coast Community Development District in Florida
United Taconite
United Taconite LLC, a wholly-owned subsidiary of Cliffs
U.S.
United States of America
U.S. Water Services
U.S. Water Services Holding Company and its subsidiaries
USS Corporation
United States Steel Corporation



ALLETE, Inc. Second Quarter 2016 Form 10-Q
4




Forward-Looking Statements

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

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

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



ALLETE, Inc. Second Quarter 2016 Form 10-Q
5




Forward-Looking Statements (Continued)

Additional disclosures regarding factors that could cause our results or performance to differ from those anticipated by this report are discussed in Part 1, Item 1A, under the heading “Risk Factors” beginning on page 25 of our 2015 Form 10-K. Any forward-looking statement speaks only as of the date on which such statement is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which that statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for management to predict all of these factors, nor can it assess the impact of each of these factors on the businesses of ALLETE or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statement. Readers are urged to carefully review and consider the various disclosures made by ALLETE in this Form 10-Q and in other reports filed with the SEC that attempt to identify the risks and uncertainties that may affect ALLETE’s business.

ALLETE, Inc. Second Quarter 2016 Form 10-Q
6




PART I.  FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS
ALLETE
CONSOLIDATED BALANCE SHEET
Millions – Unaudited
 
June 30,
2016
 
December 31,
2015
 
 
 
 
Assets
 
 
 
Current Assets
 
 
 
Cash and Cash Equivalents

$91.9

 

$97.0

Accounts Receivable (Less Allowance of $1.5 and $1.0)
113.6

 
121.2

Inventories
110.4

 
117.1

Prepayments and Other
38.4

 
35.7

Total Current Assets
354.3

 
371.0

Property, Plant and Equipment – Net
3,631.3

 
3,669.1

Regulatory Assets
359.1

 
372.0

Investment in ATC
129.0

 
124.5

Other Investments
72.3

 
74.6

Goodwill and Intangible Assets – Net
212.7

 
215.2

Other Non-Current Assets
98.9

 
68.1

Total Assets

$4,857.6

 

$4,894.5

Liabilities and Equity
 
 
 
Liabilities
 
 
 
Current Liabilities
 
 
 
Accounts Payable

$64.8

 

$88.8

Accrued Taxes
37.7

 
44.0

Accrued Interest
17.8

 
18.6

Long-Term Debt Due Within One Year
64.5

 
35.7

Notes Payable
0.9

 
1.6

Other
85.9

 
86.1

Total Current Liabilities
271.6

 
274.8

Long-Term Debt
1,498.9

 
1,556.7

Deferred Income Taxes
595.1

 
579.8

Regulatory Liabilities
94.6

 
105.0

Defined Benefit Pension and Other Postretirement Benefit Plans
204.5

 
206.8

Other Non-Current Liabilities
340.8

 
349.0

Total Liabilities
3,005.5

 
3,072.1

Commitments, Guarantees and Contingencies (Note 13)

 

Equity
 
 
 
ALLETE’s Equity
 
 
 
Common Stock Without Par Value, 80.0 Shares Authorized, 49.4 and 49.1 Shares Outstanding
1,283.5

 
1,271.4

Accumulated Other Comprehensive Loss
(24.2
)
 
(24.5
)
Retained Earnings
592.8

 
573.3

Total ALLETE Equity
1,852.1

 
1,820.2

Non-Controlling Interest in Subsidiaries

 
2.2

Total Equity
1,852.1

 
1,822.4

Total Liabilities and Equity

$4,857.6

 

$4,894.5

The accompanying notes are an integral part of these statements.

ALLETE, Inc. Second Quarter 2016 Form 10-Q
7




ALLETE
CONSOLIDATED STATEMENT OF INCOME
Millions Except Per Share Amounts – Unaudited
 
Quarter Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2016
2015
 
2016
2015
 
 
 
 
 
 
Operating Revenue

$314.8


$323.3

 

$648.6


$643.3

Operating Expenses
 
 
 
 
 
Fuel and Purchased Power
78.1

80.1

 
155.0

166.1

Transmission Services
16.1

11.3

 
32.9

26.2

Cost of Sales
33.4

52.3

 
66.7

83.5

Operating and Maintenance
82.0

85.4

 
160.1

165.1

Depreciation and Amortization
48.7

41.3

 
96.8

80.3

Taxes Other than Income Taxes
14.3

13.4

 
28.1

26.2

Total Operating Expenses
272.6

283.8

 
539.6

547.4

Operating Income
42.2

39.5

 
109.0

95.9

Other Income (Expense)
 
 
 
 
 
Interest Expense
(17.4
)
(16.2
)
 
(34.3
)
(31.3
)
Equity Earnings in ATC
4.1

4.7

 
8.9

8.6

Other
0.6

0.7

 
1.6

1.8

Total Other Expense
(12.7
)
(10.8
)
 
(23.8
)
(20.9
)
Income Before Non-Controlling Interest and Income Taxes
29.5

28.7

 
85.2

75.0

Income Tax Expense
4.7

6.4

 
14.0

12.6

Net Income
24.8

22.3

 
71.2

62.4

Less: Non-Controlling Interest in Subsidiaries

(0.2
)
 
0.5


Net Income Attributable to ALLETE
$24.8

$22.5

 

$70.7


$62.4

Average Shares of Common Stock
 
 
 
 
 
Basic
49.3

48.6

 
49.2

47.7

Diluted
49.5

48.7

 
49.3

47.8

Basic Earnings Per Share of Common Stock

$0.50


$0.46

 

$1.44


$1.31

Diluted Earnings Per Share of Common Stock

$0.50


$0.46

 

$1.43


$1.30

Dividends Per Share of Common Stock

$0.52


$0.505

 

$1.04


$1.01

The accompanying notes are an integral part of these statements.

ALLETE, Inc. Second Quarter 2016 Form 10-Q
8




ALLETE
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
Millions – Unaudited
 
Quarter Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
Net Income
$24.8
 

$22.3

 

$71.2

 

$62.4

Other Comprehensive Income
 
 
 
 
 
 
 
Unrealized Gain on Securities
 
 
 
 
 
 
 
Net of Income Taxes of $0.3, $–, $–, and $0.1
0.4

 

 

 
0.1

Unrealized Gain on Derivatives
 
 
 
 


 


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

 

 

 
0.1

Defined Benefit Pension and Other Postretirement Benefit Plans
 
 
 
 
 
 
 
Net of Income Taxes of $0.1, $0.2, $0.2, and $0.4
0.1

 
0.4

 
0.3

 
0.7

Total Other Comprehensive Income
0.5

 
0.4

 
0.3

 
0.9

Total Comprehensive Income
25.3

 
22.7

 
71.5

 
63.3

Less: Non-Controlling Interest in Subsidiaries

 
(0.2
)
 
0.5

 

Total Comprehensive Income Attributable to ALLETE

$25.3

 

$22.9

 

$71.0

 

$63.3

The accompanying notes are an integral part of these statements.


ALLETE, Inc. Second Quarter 2016 Form 10-Q
9




ALLETE
CONSOLIDATED STATEMENT OF CASH FLOWS
Millions – Unaudited
 
Six Months Ended
 
June 30,
 
2016
 
2015
 
 
 
 
Operating Activities
 
 
 
Net Income

$71.2

 

$62.4

Allowance for Funds Used During Construction – Equity
(1.2
)
 
(1.6
)
Income from Equity Investments – Net of Dividends
(2.9
)
 
(2.3
)
Gain on Sales of Investments

 
(0.1
)
Depreciation Expense
94.2

 
78.7

Amortization of Power Purchase Agreements
(11.1
)
 
(11.0
)
Amortization of Other Intangible Assets and Other Assets
5.0

 
2.9

Deferred Income Tax Expense
13.8

 
12.3

Share-Based Compensation Expense
1.3

 
1.3

ESOP Compensation Expense
0.9

 
4.9

Defined Benefit Pension and Postretirement Benefit Expense
2.6

 
7.7

Bad Debt Expense
1.1

 
0.3

Changes in Operating Assets and Liabilities
 
 
 
Accounts Receivable
6.5

 
17.3

Inventories
6.7

 
(13.4
)
Prepayments and Other
(0.8
)
 
4.2

Accounts Payable
1.3

 
(25.6
)
Other Current Liabilities
(18.5
)
 
47.4

Changes in Regulatory and Other Non-Current Assets
(21.0
)
 
(9.6
)
Changes in Regulatory and Other Non-Current Liabilities
(2.9
)
 
6.5

Cash from Operating Activities
146.2

 
182.3

Investing Activities
 
 
 
Proceeds from Sale of Available-for-sale Securities
1.4

 
0.7

Payments for Purchase of Available-for-sale Securities
(1.2
)
 
(0.8
)
Acquisitions of Subsidiaries – Net of Cash Acquired

 
(214.4
)
Investment in ATC
(1.6
)
 
(0.8
)
Changes to Other Investments
2.1

 
(0.4
)
Additions to Property, Plant and Equipment
(74.8
)
 
(140.5
)
Cash in Escrow for Acquisition

 
(15.0
)
Proceeds from Sale of Property, Plant and Equipment
0.2

 

Cash for Investing Activities
(73.9
)
 
(371.2
)
Financing Activities
 
 
 
Proceeds from Issuance of Common Stock
15.2

 
148.2

Proceeds from Issuance of Long-Term Debt
2.2

 
15.0

Changes in Restricted Cash
(2.0
)
 
(2.9
)
Changes in Notes Payable
(0.7
)
 
(3.7
)
Repayments of Long-Term Debt
(32.1
)
 
(3.4
)
Acquisition of Non-Controlling Interest
(8.0
)
 

Acquisition-Related Contingent Consideration Payments
(0.7
)
 

Debt Issuance Costs
(0.1
)
 

Dividends on Common Stock
(51.2
)
 
(49.5
)
Cash from (for) Financing Activities
(77.4
)
 
103.7

Change in Cash and Cash Equivalents
(5.1
)
 
(85.2
)
Cash and Cash Equivalents at Beginning of Period
97.0

 
145.8

Cash and Cash Equivalents at End of Period

$91.9

 

$60.6

The accompanying notes are an integral part of these statements.

ALLETE, Inc. Second Quarter 2016 Form 10-Q
10




ALLETE
CONSOLIDATED STATEMENT OF EQUITY
Millions – Unaudited
 
Total
Equity
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss)
Common
Stock
Non-Controlling Interest in Subsidiaries
 
 
 
 
 
 
Balance as of December 31, 2015

$1,822.4


$573.3

$(24.5)

$1,271.4


$2.2

Comprehensive Income
 
 
 
 
 
Net Income
71.2

70.7

 
 
0.5

Other Comprehensive Income – Net of Tax
 
 
 
 
 
Defined Benefit Pension and Other Postretirement Plans – Net of Tax
0.3

 
0.3

 
 
Total Comprehensive Income
71.5

 
 
 
 
Common Stock Issued
17.4

 
 
17.4

 
Dividends Declared
(51.2
)
(51.2
)
 
 
 
Acquisition of Non-Controlling Interest
(8.0
)
 
 
(5.3
)
(2.7
)
Balance as of June 30, 2016

$1,852.1


$592.8

$(24.2)

$1,283.5


The accompanying notes are an integral part of these statements.

ALLETE, Inc. Second Quarter 2016 Form 10-Q
11




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – UNAUDITED

The accompanying unaudited Consolidated Financial Statements have been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X and do not include all of the information and notes required by GAAP for complete financial statements. Similarly, the December 31, 2015 , Consolidated Balance Sheet was derived from audited financial statements, but does not include all disclosures required by GAAP. In management’s opinion, these unaudited financial statements include all adjustments necessary for a fair statement of financial results. All adjustments are of a normal, recurring nature, except as otherwise disclosed. Operating results for the six months ended June 30, 2016 , are not necessarily indicative of results that may be expected for any other interim period or for the year ending December 31, 2016 . For further information, refer to the Consolidated Financial Statements and notes included in our 2015 Form 10-K.


NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

Inventories. Inventories are stated at the lower of cost or market. Inventories in our Regulated Operations and ALLETE Clean Energy segments are carried at an average cost or first-in, first-out basis. Inventories in our U.S. Water Services and Corporate and Other segments are carried at an average cost, first-in, first-out or specific identification basis.
Inventories
June 30,
2016

 
December 31,
2015

Millions
 
 
 
Fuel (a)

$49.2

 

$58.1

Materials and Supplies
49.8

 
49.1

Raw Materials
2.8

 
2.7

Work in Progress
0.6

 

Finished Goods
8.3

 
7.5

Reserve for Obsolescence
(0.3
)
 
(0.3
)
Total Inventories

$110.4

 

$117.1

(a)
Fuel consists primarily of coal inventory at Minnesota Power.
Prepayments and Other Current Assets
June 30,
2016

 
December 31,
2015

Millions
 
 
 
Deferred Fuel Adjustment Clause

$14.5

 

$10.6

Restricted Cash (a)
7.5

 
5.6

Other
16.4

 
19.5

Total Prepayments and Other Current Assets

$38.4

 

$35.7

(a)
Restricted Cash includes collateral deposits required under ALLETE Clean Energy’s loan agreements and cash pledged as collateral for U.S. Water Services’ standby letters of credit.

Other Non-Current Assets. As of June 30, 2016 , included in Other Non-Current Assets on the Consolidated Balance Sheet was restricted cash related to collateral deposits required under ALLETE Clean Energy’s loan agreements and PPAs of $8.2 million ( $8.1 million as of December 31, 2015 ). Also included in Other Non-Current Assets on the Consolidated Balance Sheet as of June 30, 2016 , was a $31 million contract payment made to Cliffs as part of a long-term power sales agreement between Minnesota Power and Silver Bay Power. (See Note 13. Commitments, Guarantees and Contingencies.) The contract payment will be amortized over the term of the sales agreement.
Other Current Liabilities
June 30,
2016

 
December 31,
2015

Millions
 
 
 
Customer Deposits

$13.4

 

$15.1

Power Purchase Agreements
23.9

 
23.3

Other
48.6

 
47.7

Total Other Current Liabilities

$85.9

 

$86.1



ALLETE, Inc. Second Quarter 2016 Form 10-Q
12




NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Other Non-Current Liabilities
June 30,
2016

 
December 31,
2015

Millions
 
 
 
Asset Retirement Obligation

$135.2

 

$131.4

Power Purchase Agreements
125.9

 
138.1

Contingent Consideration (a)
37.3

 
36.6

Other
42.4

 
42.9

Total Other Non-Current Liabilities

$340.8

 

$349.0

(a)
Contingent Consideration relates to the estimated fair value of the earnings-based payment resulting from the U.S. Water Services acquisition. (See Note 3. Acquisitions and Note 5. Fair Value.)

Supplemental Statement of Cash Flows Information.
Six Months Ended June 30,
2016

 
2015

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

$32.9

 

$30.0

Cash Paid During the Period for Income Taxes

$0.4

 

$1.0

Noncash Investing and Financing Activities
 

 
 

Decrease in Accounts Payable for Capital Additions to Property, Plant and Equipment
$(24.4)
 
$(25.5)
Capitalized Asset Retirement Costs

$2.3

 

$7.8

AFUDC–Equity

$1.2

 

$1.6

Contingent Consideration

 

$35.7


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.

Amendments to the Consolidation Analysis. In February 2015, the FASB issued revised guidance which changes the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. The new standard affects (1) limited partnerships and similar legal entities, (2) evaluating fees paid to a decision maker or a service provider as a variable interest, (3) the effect of fee arrangements on the primary beneficiary determination, (4) the effect of related parties on the primary beneficiary determination, and (5) certain investment funds. This guidance was adopted in the first quarter of 2016 and did not have a material impact on our Consolidated Financial Statements.

Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent). In May 2015, the FASB issued an accounting standard update which removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share (or its equivalent) practical expedient. The guidance applies to investments for which there is not a readily determinable fair value (market quote) or the investment is in a mutual fund without a publicly available net asset value. This guidance was adopted in the first quarter of 2016 and did not have a material impact on our Consolidated Financial Statements.

Presentation of Debt Issuance Costs. In April 2015, the FASB issued revised guidance addressing the presentation requirements for debt issuance costs. Under the revised guidance, all costs incurred to issue debt are to be presented on the Consolidated Balance Sheet as a direct deduction from the carrying amount of that debt liability. This guidance was adopted in the first quarter of 2016 resulting in the reclassification of unamortized debt issuance costs from Other Non-Current Assets to Long-Term Debt on the Consolidated Balance Sheet. The effect of the adoption decreased Total Assets and Total Liabilities on ALLETE's Consolidated Balance Sheet by $12.6 million as of December 31, 2015 .


ALLETE, Inc. Second Quarter 2016 Form 10-Q
13




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

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

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. The guidance is effective for the Company beginning in the first quarter of 2018 with early adoption permitted. The Company is evaluating the impact of the amended revenue recognition guidance on the Company’s Consolidated Financial Statements.


NOTE 2. INVESTMENTS

Investments. As of June 30, 2016 , the investment portfolio included the legacy real estate assets of ALLETE Properties, debt and equity securities consisting primarily of securities held in other postretirement plans to fund employee benefits, the cash equivalents within these plans, and other assets consisting primarily of land in Minnesota.
Other Investments
June 30,
2016

 
December 31,
2015

Millions
 
 
 
ALLETE Properties

$47.8

 

$50.1

Available-for-sale Securities (a)
18.4

 
18.5

Cash Equivalents
2.3

 
2.0

Other
3.8

 
4.0

Total Other Investments

$72.3

 

$74.6

(a)
As of June 30, 2016 , 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 $2.5 million , in three years to less than five years was $5.0 million , and in five or more years was $3.3 million .

Land Inventory. Land inventory is accounted for as held for use and is recorded at cost, unless the carrying value is determined not to be recoverable in accordance with the accounting standards for property, plant and equipment, in which case the land inventory is written down to estimated fair value. Land values are reviewed for indicators of impairment on a quarterly basis and no impairments were recorded for the quarter and six months ended June 30, 2016 .



ALLETE, Inc. Second Quarter 2016 Form 10-Q
14




NOTE 3. ACQUISITIONS

The acquisitions below are consistent with ALLETE’s stated strategy of investing in energy infrastructure and related services businesses to complement its core regulated utility, balance exposure to business cycles and changing demand, and provide potential long-term earnings growth. The pro forma impact of the following acquisitions was not significant , either individually or in the aggregate, to the results of the Company for the six months ended June 30, 2016 and  2015 .

2016 Activity.

Acquisition of Non-Controlling Interest. On April 15, 2016 , ALLETE Clean Energy acquired the non-controlling interest in the limited liability company that owns its Condon wind energy facility for $8.0 million . This transaction was accounted for as an equity transaction, and no gain or loss was recognized in net income or other comprehensive income. As a result of the acquisition, the Condon wind energy facility is now a wholly-owned subsidiary of ALLETE Clean Energy.

2015 Activity.

U.S. Water Services. In February 2015 , ALLETE acquired U.S. Water Services . Total consideration for the transaction was $202.3 million , which included payment of $166.6 million in cash and an estimated fair value of earnings-based contingent consideration of $35.7 million , as estimated at the date of acquisition, to be paid through 2019. The contingent consideration is presented within Other Non-Current Liabilities on the Consolidated Balance Sheet. The Consolidated Statement of Income reflects 100  percent of the results of operations for U.S. Water Services since the acquisition date as the Company has acquired 100  percent of U.S. Water Services.

The acquisition was accounted for as a business combination and the purchase price was allocated based on the estimated fair values of the assets acquired and the liabilities assumed at the date of acquisition. The purchase price accounting, which was finalized in 2015, is reflected in the following table. Fair value measurements were valued primarily using the discounted cash flow method.
Millions
 
Assets Acquired
 
Cash and Cash Equivalents

$0.9

Accounts Receivable
16.8

Inventories (a)
13.4

Other Current Assets (b)
5.3

Property, Plant and Equipment
10.6

Intangible Assets (c)
83.0

Goodwill (d)
122.9

Other Non-Current Assets
0.2

Total Assets Acquired

$253.1

Liabilities Assumed
 
Current Liabilities

$19.2

Non-Current Liabilities
31.6

Total Liabilities Assumed

$50.8

Net Identifiable Assets Acquired

$202.3

(a)
Included in Inventories was $2.7 million of fair value adjustments relating to work in progress and finished goods inventories which were recognized as Cost of Sales within one year from the acquisition date.
(b)
Included in Other Current Assets was $1.6 million relating to the fair value of sales backlog. Sales backlog was recognized as Cost of Sales within one year from the acquisition date. Also included in Other Current Assets was restricted cash of $2.1 million relating to cash pledged as collateral for standby letters of credit.
(c)
Intangible Assets include customer relationships, patents, non-compete agreements, and trademarks and trade names. (See Note 4. Goodwill and Intangible Assets.)
(d)
For tax purposes, the purchase price allocation resulted in $2.9 million of deductible goodwill.

Acquisition-related costs of $3.0 million after-tax were expensed as incurred during the first quarter of 2015 and recorded in Operating and Maintenance on the Consolidated Statement of Income.

ALLETE, Inc. Second Quarter 2016 Form 10-Q
15




NOTE 3. ACQUISITIONS (Continued)
2015 Activity (Continued)

Chanarambie/Viking. In April 2015 , ALLETE Clean Energy acquired 100 percent of wind energy facilities in southern Minnesota ( Chanarambie/Viking ) from EDF Renewable Energy, Inc. for $48.0 million .

The facilities have 97.5 MW of generating capability and are located near ALLETE Clean Energy’s Lake Benton facility. The wind energy facilities began commercial operations in 2003 and have PPAs in place for their entire output, which expire in 2018 ( 12 MW) and 2023 ( 85.5  MW).

The acquisition was accounted for as a business combination and the purchase price was allocated based on the estimated fair values of the assets acquired and the liabilities assumed at the date of acquisition. The purchase price accounting, which was finalized in 2015, is reflected in the following table. Fair value measurements were valued primarily using the discounted cash flow method.
Millions
 
Assets Acquired
 
Current Assets

$4.8

Property, Plant and Equipment
103.0

Other Non-Current Assets (a)
1.0

Total Assets Acquired

$108.8

Liabilities Assumed
 
Current Liabilities (b)

$6.7

Power Purchase Agreements
49.0

Non-Current Liabilities
5.1

Total Liabilities Assumed

$60.8

Net Identifiable Assets Acquired

$48.0

(a)
Included in Other Non-Current Assets was $0.3 million of goodwill. For tax purposes, the purchase price allocation resulted in no allocation to goodwill.
(b)
Current Liabilities included $5.9 million related to the current portion of PPAs.

Acquisition-related costs of $0.2 million after-tax were expensed as incurred during the second quarter of 2015 and recorded in Operating and Maintenance on the Consolidated Statement of Income.

Armenia Mountain. In July 2015 , ALLETE Clean Energy acquired 100 percent of a wind energy facility located near Troy, Pennsylvania ( Armenia Mountain ) from The AES Corporation (AES) and a minority shareholder for $111.1 million , plus the assumption of existing debt.

The facility has 100.5 MW of generating capability, began commercial operations in 2009, and has PPAs in place for its entire output, which expire in 2024.

The acquisition was accounted for as a business combination and the purchase price was allocated based on the estimated fair values of the assets acquired and the liabilities assumed at the date of acquisition. The purchase price accounting, which was finalized in 2015, is reflected in the following table. Fair value measurements were valued primarily using the discounted cash flow method.

ALLETE, Inc. Second Quarter 2016 Form 10-Q
16




NOTE 3. ACQUISITIONS (Continued)
2015 Activity (Continued)
Millions
 
Assets Acquired
 
Current Assets (a)
$9.0
Property, Plant and Equipment
156.2

Other Non-Current Assets (b)
14.4

Total Assets Acquired

$179.6

Liabilities Assumed
 
Current Liabilities

$2.9

Long-Term Debt Due Within One Year
5.9

Long-Term Debt
55.0

Other Non-Current Liabilities
4.7

Total Liabilities Assumed
$68.5
Net Identifiable Assets Acquired

$111.1

(a)
Included in Current Assets was $1.0 million related to the current portion of PPAs and $6.0 million of restricted cash related to collateral deposits required under its loan agreement.
(b)
Included in Other Non-Current Assets was $8.2 million related to the non-current portion of PPAs, $6.1 million of restricted cash related to collateral deposits required under its loan agreements, and an immaterial amount of goodwill. For tax purposes, the purchase price allocation resulted in no allocation to goodwill.

Acquisition-related costs of $1.6 million after-tax were expensed as incurred throughout the second and third quarters of 2015, and recorded in Operating and Maintenance on the Consolidated Statement of Income.

A and W Technologies. In November 2015 , U.S. Water Services acquired 100 percent of A and W Technologies, Inc. (AWT). Total consideration for the transaction was $9.3 million , which included payment of $8.3 million in cash and a $1.0 million payment due in April 2017. AWT, similar to U.S. Water Services, is an integrated water management company and was acquired to expand U.S. Water Services’ regional footprint in the Southeastern United States.

The acquisition was accounted for as a business combination and the purchase price was allocated based on the estimated fair values of the assets acquired and the liabilities assumed at the date of acquisition. The purchase price accounting, which was finalized in 2015, is reflected in the following table. Fair value measurements were valued primarily using the discounted cash flow method.
Millions
 
Assets Acquired
 
Current Assets
$1.0
Property, Plant and Equipment
0.1
Intangible Assets (a)
3.9

Goodwill (b)
4.4

Total Assets Acquired

$9.4

Liabilities Assumed
 
Current Liabilities

$0.1

Total Liabilities Assumed
$0.1
Net Identifiable Assets Acquired

$9.3

(a)
Intangible Assets include customer relationships and non-compete agreements. (See Note 4. Goodwill and Intangible Assets.)
(b)
For tax purposes, the purchase price allocation resulted in $4.4 million of deductible goodwill.

Acquisition-related costs were immaterial, expensed as incurred during the fourth quarter of 2015 and recorded in Operating and Maintenance on the Consolidated Statement of Income.



ALLETE, Inc. Second Quarter 2016 Form 10-Q
17




NOTE 4. GOODWILL AND INTANGIBLE ASSETS

The aggregate carrying amount of goodwill was $130.6 million as of June 30, 2016 , and December 31, 2015 . There have been no changes to goodwill by reportable segment for the six months ended June 30, 2016 .

Balances of intangible assets, net, excluding goodwill as of June 30, 2016 , are as follows:
 
December 31,
2015

 
 Amortization
 
June 30,
2016

Millions
 
 
 
 
 
Intangible Assets
 
 
 
 
 
Definite-Lived Intangible Assets
 
 
 
 
 
Customer Relationships
$60.8
 
$(2.1)
 

$58.7

Developed Technology and Other (a)
7.2
 
(0.4)
 
6.8

Total Definite-Lived Intangible Assets
68.0

 
(2.5)
 
65.5

Indefinite-Lived Intangible Assets
 
 
 
 
 
Trademarks and Trade Names
16.6

 
n/a
 
16.6

Total Intangible Assets

$84.6

 
$(2.5)
 

$82.1

(a)
Developed Technology and Other includes patents, non-compete agreements and land easements.

Customer relationships have a remaining useful life of approximately 22 years and developed technology and other have remaining useful lives ranging from approximately 3 years to approximately 13 years (weighted average of approximately 8 years). The weighted average remaining useful life of all definite-lived intangible assets as of June 30, 2016 , is approximately 20 years.

Amortization expense of intangible assets for the six months ended June 30, 2016 , was $2.5 million . Accumulated amortization was $6.6 million as of June 30, 2016 ( $4.1 million as of December 31, 2015 ). The estimated amortization expense for definite-lived intangible assets for the remainder of 2016 is $2.6 million . Estimated annual amortization expense for definite-lived intangible assets is $5.0 million in 2017 , $4.7 million in 2018 , $4.4 million in 2019 , $4.2 million in 2020 and $44.6 million thereafter .


NOTE 5. FAIR VALUE

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). We utilize market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. We primarily apply the market approach for recurring fair value measurements and endeavor to utilize the best available information. Accordingly, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. These inputs, which are used to measure fair value, are prioritized through the fair value hierarchy. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). Descriptions of the three levels of the fair value hierarchy are discussed in Note 10. Fair Value to the Consolidated Financial Statements in our 2015 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 June 30, 2016 , and December 31, 2015 . Each asset and liability is classified based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment, which may affect the valuation of these assets and liabilities and their placement within the fair value hierarchy levels. The estimated fair value of Cash and Cash Equivalents listed on the Consolidated Balance Sheet approximates the carrying amount and therefore is excluded from the recurring fair value measures in the following tables.

ALLETE, Inc. Second Quarter 2016 Form 10-Q
18




NOTE 5. FAIR VALUE (Continued)
 
Fair Value as of June 30, 2016
Recurring Fair Value Measures
Level 1

 
Level 2

 
Level 3

 
Total

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

$7.4

 

 

 

$7.4

Available-for-sale – Corporate Debt Securities

 

$11.0

 

 
11.0

Cash Equivalents
2.3

 

 

 
2.3

Total Fair Value of Assets

$9.7

 

$11.0

 

 

$20.7

 
 
 
 
 
 
 
 
Liabilities (b)
 
 
 
 
 
 
 
Deferred Compensation

 

$15.9

 

 

$15.9

U.S. Water Services Contingent Consideration

 

 

$37.3

 
37.3

Total Fair Value of Liabilities

 

$15.9

 

$37.3

 

$53.2

Total Net Fair Value of Assets (Liabilities)

$9.7

 
$(4.9)
 
$(37.3)
 
$(32.5)
(a)
Included in Other Investments on the Consolidated Balance Sheet.
(b)
Included in Other Non-Current Liabilities on the Consolidated Balance Sheet.
 
Fair Value as of December 31, 2015
Recurring Fair Value Measures
Level 1

 
Level 2

 
Level 3

 
Total

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

$7.6

 

 

 

$7.6

Available-for-sale – Corporate Debt Securities

 

$10.9

 

 
10.9

Cash Equivalents
2.0

 

 

 
2.0

Total Fair Value of Assets

$9.6

 

$10.9

 

 

$20.5

 
 
 
 
 
 
 
 
Liabilities (b)
 
 
 
 
 
 
 
Deferred Compensation

 

$16.1

 

 

$16.1

U.S. Water Services Contingent Consideration

 

 

$36.6

 
36.6

Total Fair Value of Liabilities

 

$16.1

 

$36.6

 

$52.7

Total Net Fair Value of Assets (Liabilities)

$9.6

 
$(5.2)
 
$(36.6)
 
$(32.2)
(a)
Included in Other Investments on the Consolidated Balance Sheet.
(b)
Included in Other Non-Current Liabilities on the Consolidated Balance Sheet.

The Level 3 activity in the preceding tables is the result of the February 2015 acquisition of U.S. Water Services. Changes in the fair value of U.S. Water Services’ Contingent Consideration for the six months ended June 30, 2016 , are primarily due to accretion expense.

For the six months ended June 30, 2016 , and the year ended December 31, 2015 , 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 Long-Term Debt Due Within One Year
 
 
 
June 30, 2016
$1,575.2
 
$1,647.6
December 31, 2015
$1,605.0
 
$1,676.0


ALLETE, Inc. Second Quarter 2016 Form 10-Q
19




NOTE 5. FAIR VALUE (Continued)

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis. Non-financial assets such as equity method investments, goodwill, intangible assets, and property, plant and equipment are measured at fair value when there is an indicator of impairment and recorded at fair value only when an impairment is recognized. For the six months ended June 30, 2016 , and the year ended December 31, 2015 , there were no indicators of impairment for these non-financial assets.


NOTE 6.  REGULATORY MATTERS

Regulatory matters are summarized in Note 5. Regulatory Matters to our Consolidated Financial Statements in our 2015 Form 10-K, with additional disclosure provided in the following paragraphs.

Electric Rates. Entities within our Regulated Operations segment file for periodic rate revisions with the MPUC, 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. Subsequent to this order, and as authorized by the MPUC, Minnesota Power also recognizes revenue under cost recovery riders for environmental, renewable and transmission investments. (See Transmission Cost Recovery Rider, Renewable Cost Recovery Rider and Boswell Mercury Emissions Reduction Plan .) Revenue from cost recovery riders was $48.9 million for the six months ended June 30, 2016 ( $44.9 million for the six months ended June 30, 2015 ).

Energy-Intensive Trade-Exposed (EITE) Customer Rates. The state of Minnesota enacted an EITE customer ratemaking law in June 2015 which established that it is the energy policy of the state to have competitive rates for certain industries such as mining and forest products. In November 2015, Minnesota Power filed a rate schedule petition for EITE customers and a corresponding rider for EITE cost recovery with the MPUC. The rate proposal was revenue and cash flow neutral to Minnesota Power. In an order dated March 23, 2016, the MPUC dismissed the petition without prejudice, providing Minnesota Power the option to refile the petition with additional information or file a new petition. On June 30, 2016, Minnesota Power filed a revised EITE petition with the MPUC, which includes additional information on the net benefits analysis, limits on eligible customers and term lengths for the EITE discount.

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

In April 2015, Minnesota Power amended its formula-based wholesale electric sales contract with the Nashwauk Public Utilities Commission, extending the term through June 30, 2028. The electric service agreements with SWL&P and one other municipal customer are effective through June 30, 2019. The rates included in these three contracts are set each July 1 based on a cost-based formula methodology, using estimated costs and a rate of return that is equal to Minnesota Power’s authorized rate of return for Minnesota retail customers (currently 10.38 percent ). The formula-based rate methodology also provides for a yearly true-up calculation for actual costs incurred.

In September 2015, Minnesota Power amended its wholesale electric contracts with 14 municipal customers, extending the contract terms through December 31, 2024. These contracts include fixed capacity charges through 2018; beginning in 2019, the capacity charge will not increase by more than two percent or decrease by more than one percent from the previous year’s capacity charge and will be determined using a cost-based formula methodology. The base energy charge for each year of the contract term will be set each January 1, subject to monthly adjustment, and will also be determined using a cost-based formula methodology.

In January 2016, one of Minnesota Power’s municipal customers provided notice of its intent to terminate its contract effective June 30, 2019. Minnesota Power currently provides approximately 29 MW of average monthly demand to this customer. Under the Nashwauk Public Utilities Commission agreement, no termination notice may be given prior to June 30, 2025. Under the agreement with SWL&P, no termination notice may be given prior to July 31, 2016. The remaining 14 municipal customers may not give termination notices prior to December 31, 2021.


ALLETE, Inc. Second Quarter 2016 Form 10-Q
20




NOTE 6.  REGULATORY MATTERS (Continued)

2016 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. On June 28, 2016, SWL&P filed a rate increase request with the PSCW requesting an average overall increase of 3.1 percent for retail customers (a 3.5 percent increase in electric rates, a 1.3 percent decrease in natural gas rates and a 7.8 percent increase in water rates). The rate filing seeks an overall return on equity of 10.9  percent, based on a capital structure consisting of approximately 55 percent equity and 45 percent debt. On an annualized basis, the requested rate increase would generate approximately $2.7 million in additional revenue. Hearings are expected to be scheduled in late 2016. The Company anticipates new rates will take effect during the first quarter of 2017. We cannot predict the level of rates that may be approved by the PSCW.

Transmission Cost Recovery Rider. Minnesota Power has an approved cost recovery rider in place for certain transmission investments and expenditures. In an order dated February 3, 2016, 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. As a result of the MPUC approval of the certificate of need for the GNTL in June 2015, the project is eligible for cost recovery under the existing transmission cost recovery rider. Minnesota Power anticipates including its portion of the investments and expenditures for the GNTL in future transmission factor filings to include updated billing rates on customer bills.

Renewable Cost Recovery Rider. Minnesota Power has an approved cost recovery rider in place for investments and expenditures related to the 497 MW Bison Wind Energy Center in North Dakota and the restoration and repair of Thomson. Updated customer billing rates for the renewable cost recovery rider were approved by the MPUC in an order dated March 9, 2016, allowing Minnesota Power to charge retail customers on a current basis for the costs of constructing certain renewable investments plus a return on the capital invested. While approving the updated customer billing rates for the renewable cost recovery rider, the MPUC also allowed Minnesota Power additional time to submit support for its position on its utilization of North Dakota investment tax credits.

Minnesota Power accounts for North Dakota investment tax credits based on long-standing regulatory precedents of stand-alone allocation methodology of accounting for income taxes. The stand-alone method provides that income taxes (and credits) are calculated as if Minnesota Power was the only entity included in ALLETE’s consolidated federal and unitary state income tax returns. Minnesota Power has recorded a regulatory liability for North Dakota investment tax credits generated by its jurisdictional activity and expected to be realized in the future. North Dakota investment tax credits attributable to ALLETE’s apportionment and income of ALLETE’s other subsidiaries are included in the ALLETE consolidated group. The Minnesota Department of Commerce (Department) has inquired about our use of the North Dakota investment tax credits, taking the position that all North Dakota investment tax credits generated from the Bison Wind Energy Center should be credited to Minnesota Power ratepayers. The MPUC did not come to a decision on this issue in its order dated March 9, 2016, but requested that Minnesota Power provide further support on its position which was submitted on April 8, 2016. On April 22, 2016, the Department submitted additional comments restating its position that the tax credits should be credited to ratepayers.

The amount of North Dakota investment tax credits recognized by ALLETE as of June 30, 2016 , total approximately $8 million , which represents the amount of North Dakota investment tax credits that the Department believes should be refunded to ratepayers. Minnesota Power will appropriately consider all avenues of appeal should an adverse decision be issued by the MPUC.

Annual Automatic Adjustment (AAA) of Charges. In an order dated June 2, 2016, the MPUC approved Minnesota Power’s AAA filings made in 2012 and 2013, and deferred action for 90 days on the AAA filing made in 2014 pending review and confirmation of coal transportation costs and terms of service. Minnesota Power’s AAA filings made in 2014 and 2015 are pending MPUC approval, and represent approximately $350 million in retail fuel cost recovery collected, but subject to refund. Minnesota Power currently expects full recovery of amounts represented by each AAA filing, although we cannot predict the outcome of the MPUC’s review of our pending filings.


ALLETE, Inc. Second Quarter 2016 Form 10-Q
21




NOTE 6.  REGULATORY MATTERS (Continued)

Integrated Resource Plan (IRP). In a November 2013 order, the MPUC approved Minnesota Power’s 2013 IRP which detailed its EnergyForward strategic plan, announced in January 2013. Significant elements of the EnergyForward plan include major wind investments in North Dakota completed in the fourth quarter of 2014, the installation of emissions control technology at Boswell Unit 4 completed in December 2015, planning for the proposed GNTL, the conversion of Laskin from coal to natural gas completed in June 2015 and the retirement of Taconite Harbor Unit 3 completed in May 2015. In September 2015, Minnesota Power filed its 2015 IRP with the MPUC which includes an analysis of a variety of existing and future energy resource alternatives and a projection of customer cost impact by class. The 2015 IRP also contains the next steps in Minnesota Power’s EnergyForward plan including the economic idling of Taconite Harbor Units 1 and 2 in the fall of 2016, the ceasing of coal-fired operations at Taconite Harbor in 2020, and the addition of between 200 MW and 300 MW of natural gas-fired generation in the next decade.

In an order dated July 18, 2016, the MPUC approved Minnesota Power’s 2015 IRP with modifications. The order accepts Minnesota Power’s plans for Taconite Harbor, directs Minnesota Power to retire Boswell Units 1 and 2 no later than 2022, requires an analysis of generation and demand response alternatives to be filed with a natural gas resource proposal and requires Minnesota Power to conduct request for proposals for additional wind, solar and demand response resource additions subject to further MPUC approvals. Minnesota Power’s next IRP must be filed by February 1, 2018.

Boswell Mercury Emissions Reduction Plan. Minnesota Power has an approved environmental improvement rider in place for investments and expenditures related to the implementation of the Boswell Unit 4 mercury emissions reduction plan completed in 2015. Customer billing rates for the environmental improvement rider were approved by the MPUC in August 2015. In September 2015, Minnesota Power filed an updated environmental improvement factor filing which included updated costs associated with Boswell Unit 4. Upon approval of the filing, Minnesota Power will be authorized to include updated billing rates on customer bills.

Boswell Remaining Life Petition. In November 2015, Minnesota Power filed a petition with the MPUC for approval to extend Boswell’s remaining life to 2050 for all units and utilize the existing environmental improvement rider to credit a portion of the depreciation expense savings to customers. The extension request is based on the significant multi-emissions retrofit work done at Boswell Unit 3 and Boswell Unit 4.

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 which was approved in a June 2015 order. Based on this order, Minnesota Power’s portion of the investments and expenditures for the project are eligible for cost recovery under its existing transmission cost recovery rider and are anticipated to be included in future transmission factor filings. In a December 2015 order, the FERC approved our request to recover on construction work in progress related to the GNTL from Minnesota Power’s wholesale customers. In April 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 April 11, 2016, the MPUC approved the route permit which largely follows Minnesota Power’s preferred route, including the international border crossing. A final decision on the presidential permit by the U.S. Department of Energy is expected in the third quarter of 2016. Manitoba Hydro must also obtain regulatory and governmental approvals related to a new transmission line in Canada. In September 2015, Manitoba Hydro submitted the final preferred route and EIS for the transmission line in Canada to the Manitoba Conservation and Water Stewardship for regulatory approval. Construction of Manitoba Hydro’s hydroelectric generation facility commenced in 2014. Upon receipt of all applicable permits and approvals, construction of the GNTL is expected to begin by 2017 and to be completed in 2020.

Conservation Improvement Program (CIP). Minnesota requires electric utilities to spend a minimum of 1.5 percent of net gross operating revenues from service provided in the state on energy CIPs each year. On June 1, 2016, Minnesota Power submitted its CIP triennial filing for 2017 through 2019 with the Minnesota Department of Commerce, which outlines Minnesota Power’s CIP spending and energy-saving goals for 2017 through 2019. A decision on the CIP triennial filing by the Minnesota Department of Commerce is expected in the fourth quarter of 2016.

On April 1, 2016, Minnesota Power submitted its 2015 CIP consolidated filing, which detailed Minnesota Power’s CIP program results and requested a CIP financial incentive of $7.5 million based upon MPUC procedures. In an order dated July 19, 2016, the MPUC approved Minnesota Power’s CIP consolidated filing, including the requested CIP financial incentive. CIP financial incentives are recognized in the period in which the MPUC approves the filing.


ALLETE, Inc. Second Quarter 2016 Form 10-Q
22




NOTE 6. REGULATORY MATTERS (Continued)

MISO Return on Equity Complaints. In November 2013, several customer groups located within the MISO service area filed complaints with the FERC requesting, among other things, a reduction in the base return on equity used by MISO transmission owners, including ALLETE and ATC, to 9.15 percent . In December 2015, a federal administrative law judge ruled on the November 2013 complaint proposing a reduction in the base return on equity to 10.32 percent , subject to approval or adjustment by the FERC. A final decision from the FERC on the administrative law judge’s recommendation is expected in 2016.

In February 2015, an additional complaint was filed with the FERC seeking an order to further reduce the base return on equity to 8.67 percent . On June 30, 2016, a federal administrative law judge ruled on the February 2015 complaint proposing a further reduction in the base return on equity to 9.70 percent , subject to approval or adjustment by the FERC. A final decision from the FERC on the administrative law judge’s recommendation is expected in 2017. On January 6, 2015, the FERC approved an incentive adder of up to 50 basis points on the allowed base return on equity for our participation in a regional transmission organization, subject to the outcome of the return on equity complaints.

Minnesota Solar Energy Standard. In May 2013, legislation was enacted by the state of Minnesota requiring at least 1.5 percent of total retail electric sales, excluding sales to certain customers, to be generated by solar energy by the end of 2020. At least 10  percent of the 1.5 percent mandate must be met by solar energy generated by or procured from solar photovoltaic devices with a nameplate capacity of 20 kW or less. Minnesota Power has two solar projects under development. In August 2015, Minnesota Power filed for MPUC approval of a 10 MW utility scale solar project at Camp Ripley, a Minnesota Army National Guard base and training facility near Little Falls, Minnesota. In an order dated February 24, 2016, the MPUC approved the Camp Ripley solar project as eligible to meet the solar energy standard and for current cost recovery, subject to certain compliance requirements. In September 2015, Minnesota Power filed for MPUC approval of a community solar garden project in Duluth, Minnesota, which is comprised of a 1 MW solar array to be owned and operated by a third party with the output purchased by Minnesota Power and a 40 kW solar array that will be owned and operated by Minnesota Power. In an order dated July 27, 2016, the MPUC approved the community solar garden project and cost recovery, subject to certain compliance requirements. Minnesota Power believes these projects will meet approximately one-third of the overall mandate. Additionally, on June 1, 2016, Minnesota Power filed a proposal with the MPUC to increase the amount of solar rebates available for customer-sited solar installations and recover costs of the program through Minnesota Power’s renewable cost recovery rider. If approved, Minnesota Power expects the projects to meet part of the mandate related to solar photovoltaic devices with a nameplate capacity of 20 kW or less.

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

ALLETE, Inc. Second Quarter 2016 Form 10-Q
23




NOTE 6. REGULATORY MATTERS (Continued)
Regulatory Assets and Liabilities
June 30,
2016

 
December 31,
2015

Millions
 
 
 
Current Regulatory Assets (a)
 
 
 
Deferred Fuel Adjustment Clause

$14.5

 

$10.6

Total Current Regulatory Assets
14.5

 
10.6

Non-Current Regulatory Assets
 
 
 
Defined Benefit Pension and Other Postretirement Benefit Plans (b)
215.0

 
219.3

Income Taxes (c)
64.7

 
64.2

Cost Recovery Riders (d)
47.2

 
58.0

Asset Retirement Obligations (e)
23.5

 
21.6

PPACA Income Tax Deferral
5.0

 
5.0

Other
3.7

 
3.9

Total Non-Current Regulatory Assets
359.1

 
372.0

Total Regulatory Assets

$373.6

 

$382.6

 
 
 
 
Non-Current Regulatory Liabilities
 
 
 
Wholesale and Retail Contra AFUDC (f)

$57.0

 

$58.0

Plant Removal Obligations
14.4

 
22.1

Income Taxes (c)
5.4

 
6.1

Defined Benefit Pension and Other Postretirement Benefit Plans (b)

 
0.9

Other
17.8

 
17.9

Total Non-Current Regulatory Liabilities

$94.6

 

$105.0

(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 as actuarial gains and losses as well as prior service costs and credits, are recognized as regulatory assets or regulatory liabilities on the Consolidated Balance Sheet. The asset or liability will decrease as the deferred items are amortized and recognized as components of net periodic benefit cost. (See Note 12. Pension and Other Postretirement Benefit Plans.)
(c)
These assets and liabilities are offsets to deferred income taxes recognized on certain regulatory temporary differences, which will reverse over the remaining lives of those temporary differences.
(d)
The cost recovery rider regulatory assets are revenues not yet collected from our customers primarily due to capital expenditures related to the Bison Wind Energy Center, investment in CapX2020 projects, and the Boswell Unit 4 environmental upgrade and are recognized in accordance with the accounting standards for alternative revenue programs. The cost recovery rider regulatory assets as of June 30, 2016 , will be recovered over the next two years.
(e)
Asset retirement obligations will accrete and be amortized over the lives of the related property with asset retirement obligations.
(f)
Wholesale and Retail Contra AFUDC represents the regulatory offset to AFUDC Equity and Debt recorded during the construction period of our cost recovery rider projects prior to placing the projects in service. The regulatory liability will decrease over the remaining depreciable life of the related asset.


NOTE 7. INVESTMENT IN ATC

Our wholly-owned subsidiary, ALLETE Transmission Holdings, owns approximately 8 percent of ATC, a Wisconsin-based utility that owns and maintains electric transmission assets in parts of Wisconsin, Michigan, Minnesota and Illinois. We account for our investment in ATC under the equity method of accounting. As of June 30, 2016 , our equity investment in ATC was $129.0 million ( $124.5 million at December 31, 2015 ). In the first six months of 2016 , we invested $1.6 million in ATC, and on July 29, 2016 , we invested an additional $1.9 million . We expect to make additional investments of approximately $2.7 million in 2016 .
ALLETE’s Investment in ATC
 
Millions
 
Equity Investment Balance as of December 31, 2015

$124.5

Cash Investments
1.6

Equity in ATC Earnings
8.9

Distributed ATC Earnings
(6.0
)
Equity Investment Balance as of June 30, 2016

$129.0




ALLETE, Inc. Second Quarter 2016 Form 10-Q
24




NOTE 7. INVESTMENT IN ATC (Continued)

Our equity earnings in ATC continue to be impacted by reductions for estimated refunds related to complaints filed with the FERC by several customer groups located within the MISO service area. (See Note 6. Regulatory Matters.) ATC's current authorized return on equity is 12.2 percent . 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 after-tax ( $0.9 million pre-tax).


NOTE 8. SHORT-TERM AND LONG-TERM DEBT

The following tables present ALLETE’s short-term and long-term debt as of June 30, 2016 and December 31, 2015 .
June 30, 2016
Principal

 
Unamortized Debt Issuance Costs
 
Total

Millions
 
 
 
 
 
Short-Term Debt (a)

$66.0

 
$(0.6)
 

$65.4

Long-Term Debt
1,510.1

 
(11.2)
 
1,498.9

Total Debt

$1,576.1

 
$(11.8)
 

$1,564.3

(a)
Consisted of long-term debt due within one year and notes payable.
December 31, 2015
Principal

 
Unamortized Debt Issuance Costs
 
Total

Millions
 
 
 
 
 
Short-Term Debt (a)

$37.9

 
$(0.6)
 

$37.3

Long-Term Debt
1,568.7

 
(12.0)
 
1,556.7

Total Debt

$1,606.6

 
$(12.6)
 

$1,594.0

(a)
Consisted of long-term debt due within one year and notes payable.

No long-term debt was issued in the first six months of 2016 .

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, 2016 , our ratio was approximately 0.46 to 1.00 . Failure to meet this covenant would give rise to an event of default if not cured after notice from the lender, in which event ALLETE may need to pursue alternative sources of funding. Some of ALLETE’s debt arrangements contain “cross-default” provisions that would result in an event of default if there is a failure under other financing arrangements to meet payment terms or to observe other covenants that would result in an acceleration of payments due. As of June 30, 2016 , ALLETE was in compliance with its financial covenants.



ALLETE, Inc. Second Quarter 2016 Form 10-Q
25




NOTE 9. INCOME TAX EXPENSE
 
 
Quarter Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2016
 
2015
 
2016
 
2015
Millions
 
 
 
 
 
 
 
 
Current Tax Expense (a)
 
 
 
 
 
 
 
 
Federal
 

 

 

 

State
 

$0.1

 
$0.2
 

$0.2

 
$0.3
Total Current Tax Expense
 

$0.1

 
$0.2
 

$0.2

 
$0.3
Deferred Tax Expense
 
 
 
 
 
 
 
 
Federal
 
$2.1
 

$3.9

 
$6.7
 

$8.7

State
 
2.7

 
2.5

 
7.5

 
4.0

Investment Tax Credit Amortization
 
(0.2
)
 
(0.2
)
 
(0.4
)
 
(0.4
)
Total Deferred Tax Expense
 
$4.6
 

$6.2

 
$13.8
 

$12.3

Total Income Tax Expense
 
$4.7
 

$6.4

 
$14.0
 

$12.6

(a)
For the six months ended June 30, 2016 and 2015 , the federal and state current tax expense was minimal due to NOLs which resulted from the bonus depreciation provisions of the Protecting Americans from Tax Hikes Act of 2015, the Tax Increase Prevention Act of 2014 and the American Taxpayer Relief Act of 2012.

The Company's tax provision for interim periods is determined using an estimate of its annual effective tax rate, adjusted for discrete items arising in that quarter. In each quarter, the Company updates its estimate of the annual effective tax rate, and if the estimated annual effective tax rate changes, the Company would make a cumulative adjustment in that quarter.
Reconciliation of Taxes from Federal Statutory
 
 
Rate to Total Income Tax Expense
 
 
Six Months Ended June 30
2016

2015

Millions
 
 
Income Before Non-Controlling Interest and Income Taxes

$85.2


$75.0

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

$29.8


$26.3

Increase (Decrease) in Tax Due to:
 
 
State Income Taxes – Net of Federal Income Tax Benefit
5.0

2.8

Production Tax Credits
(20.5
)
(20.8
)
Regulatory Differences for Utility Plant
(0.1
)
(0.4
)
Other
(0.2
)
4.7

Total Income Tax Expense

$14.0


$12.6


For the six months ended June 30, 2016 , the effective tax rate was 16.4 percent ( 16.8 percent for the six months ended June 30, 2015 ).

Uncertain Tax Positions. As of June 30, 2016 , we had gross unrecognized tax benefits of $2.2 million ( $2.4 million as of December 31, 2015 ). Of the total gross unrecognized tax benefits, $0.5 million represents the amount of unrecognized tax benefits included on the Consolidated Balance Sheet that, if recognized, would favorably impact the effective income tax rate. The unrecognized tax benefit amounts have been presented as reductions to the tax benefits associated with NOL and tax credit carryforwards on the Consolidated Balance Sheet.

ALLETE and its subsidiaries file a consolidated federal income tax return as well as combined and separate state income tax returns in various jurisdictions. ALLETE is no longer subject to federal or state examination for years before 2012.



ALLETE, Inc. Second Quarter 2016 Form 10-Q
26




NOTE 10. RECLASSIFICATIONS OUT OF ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

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

For the quarter and six months ended June 30, 2016 and 2015, reclassifications out of accumulated other comprehensive income for the Company were not material. Changes in accumulated other comprehensive loss for the six months ended June 30, 2016 , are presented on the Consolidated Statement of Equity.


NOTE 11. EARNINGS PER SHARE AND COMMON STOCK

We compute basic earnings per share using the weighted average number of shares of common stock outstanding during each period. The difference between basic and diluted earnings per share, if any, arises from outstanding stock options, non-vested restricted stock units, performance share awards granted under our Executive Long-Term Incentive Compensation Plan and common shares under the forward sale agreement entered into in February 2014. For the six months ended June 30, 2016 and 2015 , no options to purchase shares of common stock were excluded from the computation of diluted earnings per share.
 
 
 
2016
 
 
 
 
 
2015
 
 
Reconciliation of Basic and Diluted
 
 
Dilutive
 
 
 
 
 
Dilutive
 
 
Earnings Per Share
Basic
 
Securities
 
Diluted
 
Basic
 
Securities
 
Diluted
Millions Except Per Share Amounts
 
 
 
 
 
 
 
 
 
 
 
Quarter ended June 30,
 
 
 
 
 
 
 
 
 
 
 
Net Income Attributable to ALLETE

$24.8

 
 
 

$24.8

 

$22.5

 
 
 

$22.5

Average Common Shares
49.3

 
0.2

 
49.5

 
48.6

 
0.1

 
48.7

Earnings Per Share

$0.50

 
 
 

$0.50

 

$0.46

 
 
 

$0.46

Six Months Ended June 30,
 

 
 
 
 

 
 
 
 
 
 
Net Income Attributable to ALLETE

$70.7

 
 
 

$70.7

 

$62.4

 
 
 

$62.4

Average Common Shares
49.2

 
0.1

 
49.3

 
47.7

 
0.1

 
47.8

Earnings Per Share

$1.44

 
 
 

$1.43

 

$1.31

 
 
 

$1.30



NOTE 12. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
 
Pension
 
Other
Postretirement
Components of Net Periodic Benefit Expense (Income)
2016
 
2015
 
2016
 
2015
Millions
 
 
 
 
 
 
 
Quarter Ended June 30,
 
 
 
 
 
 
 
Service Cost

$2.1

 

$2.5

 

$1.0

 

$1.1

Interest Cost
8.1

 
7.4

 
1.8

 
1.8

Expected Return on Plan Assets
(10.7
)
 
(10.1
)
 
(2.8
)
 
(2.8
)
Amortization of Prior Service Costs (Credits)

 
0.1

 
(0.8
)
 
(0.7
)
Amortization of Net Loss
2.5

 
4.5

 
0.1

 
0.1

Net Periodic Benefit Expense (Income)

$2.0

 

$4.4

 
$(0.7)
 
$(0.5)
 
 
 
 
 
 
 
 
Six Months Ended June 30,
 
 
 
 
 
 
 
Service Cost

$4.1

 

$5.0

 

$2.0

 

$2.2

Interest Cost
16.2

 
14.9

 
3.7

 
3.6

Expected Return on Plan Assets
(21.3
)
 
(20.3
)
 
(5.6
)
 
(5.5
)
Amortization of Prior Service Costs (Credits)

 
0.1

 
(1.5
)
 
(1.5
)
Amortization of Net Loss
4.9

 
9.0

 
0.1

 
0.2

Net Periodic Benefit Expense (Income)

$3.9

 

$8.7

 
$(1.3)
 
$(1.0)

ALLETE, Inc. Second Quarter 2016 Form 10-Q
27




NOTE 12.  PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS (Continued)

Employer Contributions. For the six months ended June 30, 2016 and 2015 , no contributions were made to our defined benefit pension plan; we expect to make $2.0 million in contributions to our defined benefit pension plan in 2016 . For the six months ended June 30, 2016 and 2015 , we made no contributions to our other postretirement benefit plan; we do not expect to make any contributions to our other postretirement benefit plan in 2016 .


NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES

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

Our PPAs are summarized in Note 12. Commitments, Guarantees and Contingencies to our Consolidated Financial Statements in our 2015 Form 10-K, with additional disclosure provided in the following paragraphs.

Square Butte PPA. Minnesota Power has a PPA with Square Butte, a North Dakota cooperative corporation, that extends through 2026 (Agreement). Minnesota Power is obligated to pay its pro rata share of Square Butte’s costs based on its entitlement to the output of Square Butte’s 455 MW coal-fired generating unit. Minnesota Power’s output entitlement under the Agreement is 50  percent for the remainder of the Agreement, subject to the provisions of the Minnkota Power sales agreement described below. Square Butte’s costs consist primarily of debt service, operating and maintenance, depreciation and fuel expenses. As of June 30, 2016 , Square Butte had total debt outstanding of $361.9 million . Fuel expenses are recoverable through Minnesota Power’s fuel adjustment clause and include the cost of coal purchased from BNI Energy under a long-term contract.

Minnesota Power’s cost of power purchased from Square Butte during the six months ended June 30, 2016 , was $37.7 million ( $39.5 million for the six months ended June 30, 2015 ). 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 $4.8 million during the six months ended June 30, 2016 ( $5.0 million for the six months ended June 30, 2015 ). 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. Minnesota Power has a power sales agreement with Minnkota Power, which commenced June 1, 2014. Under the power sales agreement, Minnesota Power is selling a portion of its entitlement from Square Butte to Minnkota Power, resulting in Minnkota Power’s net entitlement increasing and Minnesota Power’s net entitlement decreasing until Minnesota Power’s share is eliminated at the end of 2025. Of Minnesota Power’s 50 percent output entitlement, it sold to Minnkota Power approximately 28 percent in 2016 and in 2015 .

Silver Bay Power Sales Agreement . On May 23, 2016, Minnesota Power and Silver Bay Power entered into a long-term power purchase agreement through 2031. Silver Bay Power supplies approximately 90 MW of load to Northshore Mining which has been served predominately through self-generation by Silver Bay Power. In the years 2016 through 2019, Minnesota Power will supply Silver Bay Power with at least 50 MW of energy and Silver Bay Power will have the option to purchase additional energy from Minnesota Power as it transitions away from self-generation. On December 31, 2019, Silver Bay Power will cease self-generation and Minnesota Power will supply the entire energy requirements for Silver Bay Power.

Shell Energy PPA. In June 2016, Minnesota Power and Shell Energy signed a PPA that provides for Minnesota Power to purchase 50 MW of energy at fixed prices. The PPA begins in January 2017 and expires in December 2019.

Coal, Rail and Shipping Contracts. Minnesota Power has coal supply agreements providing for the purchase of a significant portion of its coal requirements through December 2016 and a portion of its coal requirements through December 2021. Minnesota Power also has coal transportation agreements in place for the delivery of a significant portion of its coal requirements through December 2018. The minimum annual payment obligation under these supply and transportation agreements is $17.7 million for the remainder of 2016 , $27.9 million in 2017 , $27.0 million in 2018 , $1.8 million in 2019 and none thereafter. The delivered costs of fuel for Minnesota Power’s generation are recoverable from Minnesota Power’s utility customers through the fuel adjustment clause.


ALLETE, Inc. Second Quarter 2016 Form 10-Q
28


NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (Continued)

Leasing Agreements. BNI Energy is obligated to make lease payments for a dragline totaling $2.8 million annually for the lease term, which expires in 2027. BNI Energy has the option at the end of the lease term to renew the lease at fair market value, to purchase the dragline at fair market value, or to surrender the dragline and pay a $3.0 million termination fee. We also lease other properties and equipment under operating lease agreements with terms expiring through 2022. The aggregate amount of minimum lease payments for all operating leases is $14.0 million in 2016 , $12.6 million in 2017 , $11.1 million in 2018 , $9.9 million in 2019 , $6.9 million in 2020 and $23.2 million thereafter.

Transmission. We continue to make investments in transmission opportunities that strengthen or enhance the transmission grid or take advantage of our geographical location between sources of renewable energy and end users. These include the GNTL, investments to enhance our own transmission facilities, investments in other transmission assets (individually or in combination with others), and our investment in ATC.
 
Our transmission investments are summarized in Note 12. Commitments, Guarantees and Contingencies to our Consolidated Financial Statements in our 2015 Form 10-K, with additional disclosure provided in the following paragraphs.

Great Northern Transmission Line (GNTL). As a condition of the long-term PPA signed in May 2011 with Manitoba Hydro, construction of additional transmission capacity is required. As a result, Minnesota Power and Manitoba Hydro proposed construction of the GNTL, an approximately 220 -mile 500  kV transmission line between Manitoba and Minnesota’s Iron Range in order to strengthen the electric grid, enhance regional reliability and promote a greater exchange of sustainable energy.

The GNTL is subject to various federal and state regulatory approvals. In October 2013, a certificate of need application was filed with the MPUC which was approved in a June 2015 order. Based on this order, Minnesota Power’s portion of the investments and expenditures for the project are eligible for cost recovery under its existing transmission cost recovery rider and are anticipated to be included in future transmission factor filings. (See Note 6. Regulatory Matters.) In a December 2015 order, the FERC approved our request to recover on construction work in progress related to the GNTL from Minnesota Power’s wholesale customers. In April 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 April 11, 2016, the MPUC approved the route permit which largely follows Minnesota Power’s preferred route, including the international border crossing. A final decision on the presidential permit by the U.S. Department of Energy is expected in the third quarter of 2016. Manitoba Hydro must also obtain regulatory and governmental approvals related to a new transmission line in Canada. In September 2015, Manitoba Hydro submitted the final preferred route and EIS for the transmission line in Canada to the Manitoba Conservation and Water Stewardship for regulatory approval. Construction of Manitoba Hydro’s hydroelectric generation facility commenced in 2014. Upon receipt of all applicable permits and approvals, construction of the GNTL is expected to begin by 2017 and to be completed in 2020. Total project cost in the U.S., including substation work, is estimated to be between $560 million and $710 million . Minnesota Power is expected to have majority ownership of the transmission line.

Environmental Matters.

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

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

We review environmental matters on a quarterly basis. Accruals for environmental matters are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated based on current law and existing technologies. Accruals are adjusted as assessment and remediation efforts progress or as additional technical or legal information becomes available. Accruals for environmental liabilities are included in the Consolidated Balance Sheet at undiscounted amounts and exclude claims for recoveries from insurance or other third parties. Costs related to environmental contamination treatment and cleanup are charged to expense unless recoverable in rates from customers.

ALLETE, Inc. Second Quarter 2016 Form 10-Q
29




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

Air. The electric utility industry is regulated both at the federal and state level to address air emissions. Minnesota Power’s generating facilities mainly burn low-sulfur western sub-bituminous coal. All of Minnesota Power’s coal-fired generating facilities are equipped with pollution control equipment such as scrubbers, baghouses and low NO X technologies. Under currently applicable environmental regulations, these facilities are substantially compliant with emission requirements.

New Source Review (NSR). In August 2008, Minnesota Power received a Notice of Violation (NOV) from the EPA asserting violations of the NSR requirements of the Clean Air Act at Boswell and Laskin Unit 2 between the years of 1981 and 2001. Minnesota Power received an additional NOV in April 2011 alleging that two projects undertaken at Rapids Energy Center in 2004 and 2005 should have been reviewed under the NSR requirements and that the Rapids Energy Center’s Title V permit was violated. Minnesota Power reached a settlement with the EPA regarding these NOVs and entered into a Consent Decree which was approved by the U.S. District Court for the District of Minnesota (Court) in September 2014. The Consent Decree provided for, among other requirements, more stringent emissions limits at all affected units, the option of refueling, retrofits or retirements at certain small coal units, and the addition of 200 MW of wind energy. Provisions of the Consent Decree require that, by no later than December 31, 2018, Boswell Units 1 and 2 must be retired, refueled, repowered, or emissions rerouted through existing emission control technology at Boswell. Minnesota Power estimates that if the units are not retired, capital expenditures could range between $20 million and $40 million . Minnesota Power’s 2015 IRP filed with the MPUC on September 1, 2015, outlined Minnesota Power’s preferred option to reroute emissions from Boswell Units 1 and 2 through existing emission control technology at Boswell Unit 3. We are required to notify the EPA no later than December 31, 2016, whether we will retire, refuel, repower or reroute Boswell Units 1 and 2. We believe that future capital expenditures or costs to retire would likely be eligible for recovery in rates over time subject to regulatory approval in a rate proceeding.

Cross-State Air Pollution Rule (CSAPR). The CSAPR requires a total of 28 states in the eastern half of the United States, including Minnesota, to reduce power plant emissions that contribute to ozone or fine particulate pollution in other states. The CSAPR does not require installation of controls; rather it requires that facilities have sufficient allowances to cover their emissions on an annual basis. These allowances are allocated to facilities from each state’s annual budget and can be bought and sold.

In December 2014, the EPA distributed the CSAPR allowances to CSAPR-subject units for the Phase I years (2015 and 2016). Phase II allowances (2017 and beyond) for 2017 and 2018 were distributed on June 29, 2016. Based on our review of the NO x and SO 2 Phase I and Phase II allowances already issued, and Phase II allowances not yet issued, we currently expect projected generation levels and emission rates will result in compliance in both Phase I and Phase II.

Mercury and Air Toxics Standards (MATS) Rule (formerly known as the Electric Generating Unit Maximum Achievable Control Technology (MACT) Rule). Under Section 112 of the Clean Air Act, the EPA is required to set emission standards for hazardous air pollutants (HAPs) for certain source categories. The EPA published the final MATS rule in the Federal Register in February 2012, addressing such emissions from coal-fired utility units greater than 25 MW. There are currently 187 listed HAPs that the EPA is required to evaluate for establishment of MACT standards. In the final MATS rule, the EPA established categories of HAPs, including mercury, trace metals other than mercury, acid gases, dioxin/furans, and organics other than dioxin/furans. The EPA also established emission limits for the first three categories of HAPs, and work practice standards for the remaining categories. Affected sources were required to be in compliance with the rule by April 2015. States had the authority to grant sources a one-year extension. The MPCA approved Minnesota Power’s request for an extension of the date of compliance for the Boswell Unit 4 environmental upgrade to April 1, 2016. Construction on the project to implement the Boswell Unit 4 mercury emissions reduction plan was completed in 2015. Boswell Unit 3 is also subject to the MATS rule; however, investments and compliance work completed at Boswell Unit 3, including the emission reduction investments completed in 2009, meet the requirements of the MATS rule. The conversion of Laskin Units 1 and 2 to natural gas in June 2015 positioned those units for MATS compliance.

In June 2015, the U.S. Supreme Court reversed and remanded an earlier U.S. Court of Appeals for the D.C. Circuit decision on the MATS rule. The U.S. Supreme Court ruled that it was unreasonable for the EPA to deem cost of compliance irrelevant in determining that regulation of emissions of hazardous air pollutants from power plants was “appropriate and necessary” under Section 112 of the Clean Air Act. The MATS rule remains in effect until the U.S. Court of Appeals for the D.C. Circuit acts on the remand. In December 2015, the U.S. Court of Appeals for the D.C. Circuit rejected a motion by utilities and states to vacate the MATS rule, instead ordering the rule to remain in effect while the EPA completes its review. On April 15, 2016, the EPA announced its determination that the MATS rule is appropriate and necessary, even after considering cost of compliance. The outcome of these proceedings is not expected to have a material impact on Minnesota Power generation due to emission reduction obligations under the Minnesota Mercury Emissions Reduction Act and the Consent Decree. (See New Source Review. )


ALLETE, Inc. Second Quarter 2016 Form 10-Q
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NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (Continued)
Environmental Matters (Continued)

Minnesota Mercury Emissions Reduction Act/Rule. In order to comply with the 2006 Minnesota Mercury Emissions Reduction Act, which was incorporated into rules promulgated by the MPCA in September 2014, Minnesota Power was required to implement a mercury emissions reduction project for Boswell Unit 4 by December 31, 2018. The Boswell Unit 4 environmental upgrade discussed above (see Mercury and Air Toxics Standards (MATS) Rule ) fulfills the requirements of the Minnesota Mercury Emissions Reduction Act.

EPA National Emission Standards for Hazardous Air Pollutants for Major Sources: Industrial, Commercial and Institutional Boilers and Process Heaters. A final rule issued by the EPA for Industrial Boiler MACT became effective in December 2012. Major existing sources had until January 31, 2016, to achieve compliance with the final rule and July 29, 2016, to perform initial compliance demonstrations. Minnesota Power’s Hibbard Renewable Energy Center and Rapids Energy Center are