ALLETE
ALLETE INC (Form: 10-Q, Received: 11/01/2017 06:01:54)


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

FORM 10-Q
(Mark One)
x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended September 30, 2017
or
¨
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from ______________ to ______________
Commission File Number 1-3548
ALLETE, Inc.
(Exact name of registrant as specified in its charter)
Minnesota
 
41-0418150
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification No.)

30 West Superior Street
Duluth, Minnesota 55802-2093
(Address of principal executive offices)
(Zip Code)

(218) 279-5000
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x Yes    ¨ No

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

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

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

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

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

Common Stock, without par value,
51,039,658 shares outstanding
as of September 30, 2017




Index
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

ALLETE, Inc. Third Quarter 2017 Form 10-Q
2



Definitions

The following abbreviations or acronyms are used in the text. References in this report to “we,” “us” and “our” are to ALLETE, Inc., and its subsidiaries, collectively.
Abbreviation or Acronym
Term
AFUDC
Allowance for Funds Used During Construction – the cost of both debt and equity funds used to finance regulated utility plant additions during construction periods
ALLETE
ALLETE, Inc.
ALLETE Clean Energy
ALLETE Clean Energy, Inc. and its subsidiaries
ALLETE Properties
ALLETE Properties, LLC and its subsidiaries
ALLETE Transmission Holdings
ALLETE Transmission Holdings, Inc.
ASC
Accounting Standards Codification
ATC
American Transmission Company LLC
Bison
Bison Wind Energy Center
BNI Energy
BNI Energy, Inc. and its subsidiary
Boswell
Boswell Energy Center
Camp Ripley
Camp Ripley Solar Array
CO 2
Carbon Dioxide
Company
ALLETE, Inc. and its subsidiaries
CIP
Conservation Improvement Program
Cliffs
Cleveland-Cliffs Inc.
CSAPR
Cross-State Air Pollution Rule
DC
Direct Current
EIS
Environmental Impact Statement
EPA
United States Environmental Protection Agency
ERP Iron Ore
ERP Iron Ore, LLC
ESOP
Employee Stock Ownership Plan
FASB
Financial Accounting Standards Board
FERC
Federal Energy Regulatory Commission
Form 10-K
ALLETE Annual Report on Form 10-K
Form 10-Q
ALLETE Quarterly Report on Form 10-Q
GAAP
Generally Accepted Accounting Principles in the United States of America
GHG
Greenhouse Gases
GNTL
Great Northern Transmission Line
Invest Direct
ALLETE’s Direct Stock Purchase and Dividend Reinvestment Plan
IRP
Integrated Resource Plan
Item ___
Item ___ of this Form 10-Q
kV
Kilovolt(s)
kW / kWh
Kilowatt(s) / Kilowatt-hour(s)
Laskin
Laskin Energy Center
MACT
Maximum Achievable Control Technology
Magnetation
Magnetation, LLC
Manitoba Hydro
Manitoba Hydro-Electric Board
MATS
Mercury and Air Toxics Standards
Mesabi Metallics
Mesabi Metallics Company, LLC (formerly Essar Steel Minnesota, LLC)
Minnesota Power
An operating division of ALLETE, Inc.
Minnkota Power
Minnkota Power Cooperative, Inc.

ALLETE, Inc. Third Quarter 2017 Form 10-Q
3



Abbreviation or Acronym
Term
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
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
Northern States Power
Northern States Power Company, a subsidiary of Xcel Energy Inc.
Northshore Mining
Northshore Mining Company, a wholly-owned subsidiary of Cleveland-Cliffs Inc.
Note ___
Note ___ to the Consolidated Financial Statements in this Form 10-Q
NPDES
National Pollutant Discharge Elimination System
Oliver Wind I
Oliver Wind I Energy Center
Oliver Wind II
Oliver Wind II Energy Center
Palm Coast Park District
Palm Coast Park Community Development District in Florida
PolyMet
PolyMet Mining Corp.
PPA / PSA
Power Purchase Agreement / Power Sales Agreement
PPACA
Patient Protection and Affordable Care Act of 2010
PSCW
Public Service Commission of Wisconsin
SEC
Securities and Exchange Commission
Silver Bay Power
Silver Bay Power Company, a wholly-owned subsidiary of Cleveland-Cliffs Inc.
SIP
State Implementation Plan
SO 2
Sulfur Dioxide
Square Butte
Square Butte Electric Cooperative, a North Dakota cooperative corporation
SWL&P
Superior Water, Light and Power Company
Taconite Harbor
Taconite Harbor Energy Center
Tenaska
Tenaska Energy, Inc. and Tenaska Energy Holdings, LLC
Thomson
Thomson Energy Center
Tonka Water
Tonka Equipment Company
Town Center District
Town Center at Palm Coast Community Development District in Florida
UPM Blandin
UPM, Blandin Paper Mill owned by UPM-Kymmene Corporation

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



ALLETE, Inc. Third Quarter 2017 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. Third Quarter 2017 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 ALLETE’s 2016 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. Third Quarter 2017 Form 10-Q
6



PART I.  FINANCIAL INFORMATION

ITEM 1.  CONSOLIDATED FINANCIAL STATEMENTS

ALLETE
CONSOLIDATED BALANCE SHEET
Unaudited
 
September 30,
2017

 
December 31,
2016

Millions
 
 
 
Assets
 
 
 
Current Assets
 
 
 
Cash and Cash Equivalents

$104.4

 

$27.5

Accounts Receivable (Less Allowance of $2.1 and $3.1)
136.7

 
122.5

Inventories – Net
102.6

 
104.2

Prepayments and Other
44.2

 
40.3

Total Current Assets
387.9

 
294.5

Property, Plant and Equipment – Net
3,746.3

 
3,741.2

Regulatory Assets
310.6

 
330.1

Investment in ATC
146.0

 
135.6

Other Investments
55.8

 
55.6

Goodwill and Intangible Assets – Net
228.9

 
213.4

Other Non-Current Assets
103.0

 
106.5

Total Assets

$4,978.5

 

$4,876.9

Liabilities and Shareholders’ Equity
 
 
 
Liabilities
 
 
 
Current Liabilities
 
 
 
Accounts Payable

$75.3

 

$74.0

Accrued Taxes
51.8

 
46.5

Accrued Interest
14.6

 
17.6

Long-Term Debt Due Within One Year
64.1

 
187.7

Other
84.7

 
73.7

Total Current Liabilities
290.5

 
399.5

Long-Term Debt
1,444.6

 
1,370.4

Deferred Income Taxes
592.9

 
554.6

Regulatory Liabilities
111.5

 
125.8

Defined Benefit Pension and Other Postretirement Benefit Plans
195.2

 
210.9

Other Non-Current Liabilities
301.1

 
322.7

Total Liabilities
2,935.8

 
2,983.9

Commitments, Guarantees and Contingencies (Note 13)

 

Shareholders’ Equity
 
 
 
Common Stock Without Par Value, 80.0 Shares Authorized, 51.0 and 49.6 Shares Issued and Outstanding
1,394.3

 
1,295.3

Accumulated Other Comprehensive Loss
(26.9
)
 
(28.2
)
Retained Earnings
675.3

 
625.9

Total Shareholders’ Equity
2,042.7

 
1,893.0

Total Liabilities and Shareholders’ Equity

$4,978.5

 

$4,876.9

The accompanying notes are an integral part of these statements.

ALLETE, Inc. Third Quarter 2017 Form 10-Q
7



ALLETE
CONSOLIDATED STATEMENT OF INCOME
Unaudited
 
Quarter Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2017
2016
 
2017
2016
Millions Except Per Share Amounts
 
 
 
 
 
Operating Revenue
 
 
 
 
 
Utility

$277.6


$253.3

 

$824.1


$740.5

Non-utility
84.9

96.3

 
257.3

257.7

Total Operating Revenue
362.5

349.6

 
1,081.4

998.2

Operating Expenses
 
 
 
 
 
Fuel, Purchased Power and Gas – Utility
93.5

91.7

 
283.2

250.6

Transmission Services – Utility
18.9

16.6

 
53.1

49.5

Cost of Sales – Non-utility
36.1

45.7

 
106.1

108.5

Operating and Maintenance
80.0

80.8

 
248.2

240.9

Depreciation and Amortization
50.9

48.9

 
151.5

145.7

Taxes Other than Income Taxes
14.1

12.5

 
42.7

40.6

Total Operating Expenses
293.5

296.2

 
884.8

835.8

Operating Income
69.0

53.4

 
196.6

162.4

Other Income (Expense)
 
 
 
 
 
Interest Expense
(16.6
)
(18.7
)
 
(50.5
)
(53.0
)
Equity Earnings in ATC
5.9

6.1

 
17.3

15.0

Other
0.8

1.2

 
2.0

2.8

Total Other Expense
(9.9
)
(11.4
)
 
(31.2
)
(35.2
)
Income Before Non-Controlling Interest and Income Taxes
59.1

42.0

 
165.4

127.2

Income Tax Expense
14.2

1.7

 
34.6

15.7

Net Income
44.9

40.3

 
130.8

111.5

Less: Non-Controlling Interest in Subsidiaries


 

0.5

Net Income Attributable to ALLETE

$44.9


$40.3

 

$130.8


$111.0

Average Shares of Common Stock
 
 
 
 
 
Basic
51.0

49.4

 
50.7

49.3

Diluted
51.2

49.5

 
50.9

49.4

Basic Earnings Per Share of Common Stock

$0.88


$0.82

 

$2.58


$2.25

Diluted Earnings Per Share of Common Stock

$0.88


$0.81

 

$2.57


$2.25

Dividends Per Share of Common Stock

$0.535


$0.52

 

$1.605


$1.56

The accompanying notes are an integral part of these statements.

ALLETE, Inc. Third Quarter 2017 Form 10-Q
8



ALLETE
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
Unaudited
 
Quarter Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2017
 
2016
 
2017
 
2016
Millions
 
 
 
 
 
 
 
Net Income
$44.9
 

$40.3

 

$130.8

 

$111.5

Other Comprehensive Income (Loss)
 
 
 
 
 
 
 
Currency Translation Adjustments
0.1

 

 
(0.1
)
 

Unrealized Gain on Securities
 
 
 
 
 
 
 
Net of Income Tax Expense of $0.1, $0.2, $0.6, and $0.2
0.1

 
0.3

 
0.8

 
0.3

Defined Benefit Pension and Other Postretirement Benefit Plans
 
 
 
 
 
 
 
Net of Income Tax Expense of $0.1, $0.1, $0.4, and $0.3
0.2

 
0.2

 
0.6

 
0.5

Total Other Comprehensive Income
0.4

 
0.5

 
1.3

 
0.8

Total Comprehensive Income
45.3

 
40.8

 
132.1

 
112.3

Less: Non-Controlling Interest in Subsidiaries

 

 

 
0.5

Total Comprehensive Income Attributable to ALLETE

$45.3

 

$40.8

 

$132.1

 

$111.8

The accompanying notes are an integral part of these statements.


ALLETE, Inc. Third Quarter 2017 Form 10-Q
9



ALLETE
CONSOLIDATED STATEMENT OF CASH FLOWS
Unaudited
 
Nine Months Ended
 
September 30,
 
2017
 
2016
Millions
 
 
 
Operating Activities
 
 
 
Net Income

$130.8

 

$111.5

AFUDC – Equity
(0.7
)
 
(1.7
)
Income from Equity Investments – Net of Dividends
(3.8
)
 
(5.8
)
Change in Fair Value of Contingent Consideration
(0.4
)
 

Gain on Sales of Investments and Property, Plant and Equipment
(0.2
)
 
(5.3
)
Depreciation Expense
147.4

 
141.8

Amortization of PSAs
(17.7
)
 
(16.7
)
Amortization of Other Intangible Assets and Other Assets
7.6

 
8.1

Deferred Income Tax Expense
34.3

 
15.5

Share-Based and ESOP Compensation Expense
5.0

 
3.6

Defined Benefit Pension and Postretirement Benefit Expense
7.6

 
3.9

Bad Debt Expense
0.5

 
2.5

Changes in Operating Assets and Liabilities
 
 
 
Accounts Receivable
(9.6
)
 
10.6

Inventories
5.3

 
9.7

Prepayments and Other
2.1

 
(0.7
)
Accounts Payable
(2.6
)
 
0.6

Other Current Liabilities
2.7

 
(23.0
)
Cash Contributions to Defined Benefit Pension Plans
(1.7
)
 
(6.3
)
Changes in Regulatory and Other Non-Current Assets
24.1

 
(18.3
)
Changes in Regulatory and Other Non-Current Liabilities
(23.5
)
 
7.8

Cash from Operating Activities
307.2

 
237.8

Investing Activities
 
 
 
Proceeds from Sale of Available-for-sale Securities
5.2

 
6.8

Payments for Purchase of Available-for-sale Securities
(5.9
)
 
(7.2
)
Acquisitions of Subsidiaries – Net of Cash Acquired
(17.4
)
 

Investment in ATC
(6.6
)
 
(3.5
)
Changes to Other Investments
2.1

 
2.5

Additions to Property, Plant and Equipment
(130.3
)
 
(119.5
)
Proceeds from Sale of Property, Plant and Equipment
1.2

 
0.2

Cash for Investing Activities
(151.7
)
 
(120.7
)
Financing Activities
 
 
 
Proceeds from Issuance of Common Stock
80.5

 
27.0

Proceeds from Issuance of Long-Term Debt
131.5

 
2.2

Changes in Restricted Cash
(4.3
)
 
2.1

Changes in Notes Payable

 
(1.6
)
Repayments of Long-Term Debt
(183.6
)
 
(50.7
)
Acquisition of Non-Controlling Interest

 
(8.0
)
Acquisition-Related Contingent Consideration Payments
(19.7
)
 
(0.8
)
Dividends on Common Stock
(81.4
)
 
(77.0
)
Other Financing Activities
(1.6
)
 
(0.1
)
Cash for Financing Activities
(78.6
)
 
(106.9
)
Change in Cash and Cash Equivalents
76.9

 
10.2

Cash and Cash Equivalents at Beginning of Period
27.5

 
97.0

Cash and Cash Equivalents at End of Period

$104.4

 

$107.2

The accompanying notes are an integral part of these statements.

ALLETE, Inc. Third Quarter 2017 Form 10-Q
10



ALLETE
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
Unaudited
 
Total Shareholders’
Equity
Retained
Earnings
Accumulated
Other
Comprehensive
Loss
Common
Stock
Millions
 
 
 
 
Balance as of December 31, 2016

$1,893.0


$625.9

$(28.2)

$1,295.3

Comprehensive Income
 
 
 
 
Net Income
130.8

130.8



Other Comprehensive Income – Net of Tax
 
 
 
 
Currency Translation Adjustments
(0.1
)

(0.1
)

Unrealized Gain on Securities
0.8


0.8


Defined Benefit Pension and Other Postretirement Plans
0.6


0.6


Total Comprehensive Income
132.1

 
 
 
Common Stock Issued
99.0



99.0

Dividends Declared
(81.4
)
(81.4
)


Balance as of September 30, 2017

$2,042.7


$675.3

$(26.9)

$1,394.3

The accompanying notes are an integral part of these statements.

ALLETE, Inc. Third Quarter 2017 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, 2016 , 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 nine months ended September 30, 2017 , are not necessarily indicative of results that may be expected for any other interim period or for the year ending December 31, 2017 . For further information, refer to the Consolidated Financial Statements and notes included in our 2016 Form 10-K.

NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

Inventories – Net. Inventories are stated at the lower of cost or net realizable value. 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 segment and Corporate and Other operations are carried at an average cost, first-in, first-out or specific identification basis.
Inventories – Net
September 30,
2017

 
December 31,
2016

Millions
 
 
 
Fuel (a)

$39.6

 

$43.9

Materials and Supplies
48.2

 
48.7

Raw Materials
2.9

 
2.9

Work in Progress
3.5

 
1.0

Finished Goods
9.4

 
8.6

Reserve for Obsolescence
(1.0
)
 
(0.9
)
Total Inventories – Net

$102.6

 

$104.2

(a)
Fuel consists primarily of coal inventory at Minnesota Power.
Prepayments and Other Current Assets
September 30,
2017

 
December 31,
2016

Millions
 
 
 
Deferred Fuel Adjustment Clause

$20.2

 

$18.6

Restricted Cash
6.5

 
2.2

Other
17.5

 
19.5

Total Prepayments and Other Current Assets

$44.2

 

$40.3

Other Non-Current Assets
September 30,
2017

 
December 31,
2016

Millions
 
 
 
Contract Payment

$28.0

 

$29.6

Finance Receivable
11.0

 
11.5

Restricted Cash
8.6

 
8.6

Other
55.4

 
56.8

Total Other Non-Current Assets

$103.0

 

$106.5



ALLETE, Inc. Third Quarter 2017 Form 10-Q
12



NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Other Current Liabilities
September 30,
2017

 
December 31,
2016

Millions
 
 
 
PSAs

$24.8

 

$24.6

Other
59.9

 
49.1

Total Other Current Liabilities

$84.7

 

$73.7

Other Non-Current Liabilities
September 30,
2017

 
December 31,
2016

Millions
 
 
 
Asset Retirement Obligation

$157.4

 

$136.6

PSAs
95.3

 
113.8

Contingent Consideration (a)
5.6

 
25.0

Other
42.8

 
47.3

Total Other Non-Current Liabilities

$301.1

 

$322.7

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

Supplemental Statement of Cash Flows Information.
Nine Months Ended September 30,
2017

 
2016

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

$51.4

 

$54.9

Cash Paid During the Period for Income Taxes

$0.4

 

$0.5

Noncash Investing and Financing Activities
 

 
 

Increase (Decrease) in Accounts Payable for Capital Additions to Property, Plant and Equipment
$1.2
 
$(19.5)
Capitalized Asset Retirement Costs

$19.7

 

$3.7

AFUDC–Equity

$0.7

 

$1.7

ALLETE Common Stock Contributed to the Pension Plans

$13.5

 

ALLETE Common Stock Received for Land Inventory

 

$8.0

Long-Term Finance Receivable for Land Inventory

 

$12.0


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

New Accounting Pronouncements.

Recently Adopted Pronouncements

Simplifying the Measurement of Inventory. In 2015, the FASB issued an accounting standards update which requires entities that measure inventory using the first-in, first-out or average cost methods to measure inventory at the lower of cost or net realizable value. Net realizable value is defined as estimated selling price in the ordinary course of business less reasonably predictable costs of completion, disposal and transportation. This accounting guidance was adopted in the first quarter of 2017 and did not have a material impact on our Consolidated Financial Statements.

Improvements to Employee Share-Based Payment Accounting.  In March 2016, the FASB issued guidance to simplify the accounting for share-based payment transactions by requiring all excess tax benefits and deficiencies to be recognized in income tax expense or benefit in earnings, thus eliminating the requirement to classify the excess tax benefit and deficiencies as additional paid-in capital. Under the new guidance, an entity makes an accounting policy election to either estimate the expected forfeiture awards or account for forfeitures as they occur. This accounting guidance was adopted in the first quarter of 2017. The adoption of this guidance is expected to result in a less than $1 million impact to income tax expense (benefit) annually.

ALLETE, Inc. Third Quarter 2017 Form 10-Q
13



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

Clarifying the Definition of a Business. In January 2017, the FASB issued clarifying guidance on the definition of a business and provided additional guidance to assist with evaluating whether transactions are to be accounted for as an acquisition or disposal of a group of assets or a business. The clarifying guidance will also impact other areas including the accounting for goodwill and consolidation. This accounting guidance was adopted in the first quarter of 2017 and did not have an impact on our Consolidated Financial Statements.

Stock Compensation: Scope of Modification Accounting. In May 2017, the FASB issued additional clarifying guidance regarding circumstances where changes to the terms or conditions of share-based payment awards require an entity to apply modification accounting under ASC 718. The guidance provides specific situations that would be excluded from effects of a modification including if the fair value, vesting conditions, and classification are the same before and after modification. The amendments in this update will be applied prospectively to awards modified on or after adoption. This accounting guidance was adopted by the Company in the second quarter of 2017 and did not have an impact on our Consolidated Financial Statements.

Recently Issued Pronouncements

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

Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. In March 2017, the FASB issued guidance to improve the presentation of net periodic pension and postretirement benefit costs. Under the revised guidance of ASC 715, an entity shall present the service cost component of the net periodic benefit cost in the same income statement line as other employee compensation costs arising from services rendered during the period. The guidance also allows only the service cost component of the periodic cost to be eligible for capitalization. The standard will be applied retrospectively for income statement presentation, and prospectively for capitalization of service cost components. We do not expect there to be a material impact on the Consolidated Financial Statements with the adoption of the updated guidance which is effective for the Company beginning in the first quarter of 2018.

Revenue from Contracts with Customers. In 2014, the FASB issued amended revenue recognition guidance that clarifies the principles for recognizing revenue from contracts with customers by providing a single comprehensive model to determine the measurement of revenue and timing of recognition. The guidance requires an entity to recognize revenue in a manner that depicts the transfer of goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled 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. As of September 30, 2017, the Company has reviewed all of its revenue streams and contracts for its regulated businesses, completing the preliminary evaluations of the impact of this guidance. Based on this review, the Company does not expect the guidance to materially affect the results of its regulated operations, which represent the majority of revenue. Our review and analysis of the Company’s energy infrastructure and related services and corporate and other businesses is in progress and we similarly do not expect the guidance to impact the results of these businesses. Management continues to evaluate the need for additional disclosures to meet the requirements of the new standard following adoption. The Company will adopt and implement the new guidance on a modified retrospective basis which requires application of standards to all contracts with customers effective January 1, 2018, with the cumulative impact on contracts with performance obligations not yet satisfied as of December 31, 2017, recognized as an adjustment to retained earnings on the Consolidated Balance Sheet.


ALLETE, Inc. Third Quarter 2017 Form 10-Q
14



NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
New Accounting Pronouncements (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. We are currently evaluating the impact of the revised lease guidance on our Consolidated Financial Statements.

Financial Instruments . In January 2016, the FASB issued an accounting standard update which requires entities to measure their investments at fair value and recognize any changes in fair value in net income unless the investments qualify for the practicability exception. The practicability exception will be available for equity investments that do not have readily determinable fair values. The updated guidance is effective for the Company beginning in the first quarter of 2018 and will result in a cumulative‑effect adjustment to retained earnings on the Consolidated Balance Sheet in the fiscal year of adoption. We have performed a preliminary evaluation of the impact of this update, and based on that evaluation, we do not expect the adoption of the update to have a material impact on our Consolidated Financial Statements.

Classification of Certain Cash Receipts and Cash Payments. In August 2016, the FASB issued an accounting standard update which addresses the following eight specific cash flow issues: debt prepayment or debt extinguishment costs; settlement of zero‑coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (including bank-owned life insurance policies); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. This accounting guidance is effective for the Company beginning in the first quarter of 2018. We do not expect the adoption of the update to have a material impact on our Consolidated Statement of Cash Flows.

Statement of Cash Flows: Restricted Cash. In November 2016, the FASB issued an accounting standard update related to the presentation of restricted cash in the Company’s Consolidated Statement of Cash Flows. The update requires that the Consolidated Statement of Cash Flows explain the change during the period in cash, cash equivalents and restricted cash. Restricted cash should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the Consolidated Statement of Cash Flows. This accounting guidance is effective for the Company beginning in the first quarter of 2018 and will be applied retrospectively to all periods presented. The guidance will result in changes to the Company’s Consolidated Statement of Cash Flows such that restricted cash amounts will be included in the beginning-of-period and end‑of‑period cash and cash equivalents totals when adopted for our fiscal year beginning January 1, 2018. We do not expect the adoption of the update to have a material impact on our Consolidated Statement of Cash Flows.

Revision of Prior Balance Sheet. During the first quarter of 2017, the Company identified an error related to the deferred income tax treatment associated with its Wholesale and Retail Contra AFUDC Regulatory Liability. The Company evaluated the materiality of the error and concluded that it was not material to any previously issued historical financial statements. The Company has revised its Consolidated Balance Sheet as of December 31, 2016, by decreasing Regulatory Assets and Deferred Income Taxes by $29.5 million . The correction had no impact on our Consolidated Statement of Income.

Reclassification of Prior Income Statement. Beginning with the second quarter of 2017, the Company enhanced its presentation of Operating Revenue and certain Operating Expenses on the Consolidated Statement of Income by presenting the caption Operating Revenue separately as Operating Revenue – Utility and Operating Revenue – Non-utility. In conformity with the current presentation, we now present $253.3 million and $740.5 million of Operating Revenue as Operating Revenue – Utility for the quarter and nine months ended September 30, 2016, respectively, as it is generated from our regulated utility operations. Non-utility revenue of $96.3 million and $257.7 million for the quarter and nine months ended September 30, 2016, respectively, is now presented as Operating Revenue – Non-utility. In addition, the captions Fuel and Purchased Power and Cost of Sales have been updated to Fuel, Purchased Power and Gas – Utility and Cost of Sales – Non-utility. As a result, we have reclassified $0.7 million relating to the cost of gas sales at SWL&P from the historic caption Cost of Sales to Fuel, Purchased Power and Gas – Utility for the quarter ended September 30, 2016, and $4.6 million for the nine months ended September 30, 2016.



ALLETE, Inc. Third Quarter 2017 Form 10-Q
15



NOTE 2. INVESTMENTS

Investments. As of September 30, 2017 , 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
September 30,
2017

 
December 31,
2016

Millions
 
 
 
ALLETE Properties

$28.8

 

$31.7

Available-for-sale Securities (a)
21.0

 
18.8

Cash Equivalents
2.2

 
1.3

Other
3.8

 
3.8

Total Other Investments

$55.8

 

$55.6

(a)
As of September 30, 2017 , the aggregate amount of available-for-sale corporate and governmental debt securities maturing in one year or less was $1.1 million , in one year to less than three years was $3.2 million , in three years to less than five years was $4.2 million and in five or more years was $1.6 million .

Land Inventory. Land inventory is accounted for as held for use and is recorded at cost, unless the carrying value is determined not to be recoverable in accordance with the accounting standards for property, plant and equipment, in which case the land inventory is written down to estimated fair value. Land values are reviewed for indicators of impairment on a quarterly basis and no impairment was recorded for the quarter and nine months ended September 30, 2017, and 2016 .

Available-for-Sale Securities.   We account for our available-for-sale securities portfolio in accordance with the guidance for certain investments in debt and equity securities. Our available-for-sale securities portfolio consisted primarily of securities held in other postretirement plans to fund employee benefits.

Gross realized and unrealized gains and losses on our available-for-sale securities were immaterial for the quarter and nine months ended September 30, 2017, and 2016 .


NOTE 3. ACQUISITIONS

The following acquisitions are consistent with ALLETE’s stated strategy of investing in energy infrastructure and related services businesses to complement its regulated businesses, balance exposure to business cycles and changing demand, and provide potential long-term earnings growth. The pro forma impact of the following acquisitions was not significant, either individually or in the aggregate, to the results of the Company for the nine months ended September 30, 2017, and 2016 .

2017 Activity.

Tonka Water. On September 1, 2017, U.S. Water Services acquired 100 percent of Tonka Water . Total consideration for the transaction was $19.4 million , including a preliminary working capital adjustment. Consideration of $19.0 million was paid in cash on the acquisition date with an estimated payment of $0.4 million to be made in the fourth quarter of 2017 with the finalization of the working capital adjustment. Tonka Water is a supplier of municipal and industrial water treatment systems and will expand U.S. Water Services’ geographic and customer markets.

The acquisition was accounted for as a business combination and the purchase price was allocated based on the preliminary estimated fair values of the assets acquired and the liabilities assumed at the date of acquisition, as shown in the following table. The allocation of the purchase price is subject to judgment and the preliminary estimated fair value of the assets acquired and the liabilities assumed may be adjusted when the valuation analysis is complete in subsequent periods. Preliminary estimates subject to adjustment in subsequent periods relate primarily to working capital; subsequent adjustments could impact the amount of goodwill recorded. Fair value measurements were valued primarily using the discounted cash flow method and replacement cost basis.

ALLETE, Inc. Third Quarter 2017 Form 10-Q
16



NOTE 3. ACQUISITIONS (Continued)
2017 Activity (Continued)
Millions
 
Assets Acquired
 
Cash and Cash Equivalents

$1.6

Accounts Receivable
5.1

Other Current Assets
4.4

Trade Names (a)
0.9

Goodwill (a)(b)
18.5

Other Non-Current Assets
0.2

Total Assets Acquired

$30.7

Liabilities Assumed
 
Current Liabilities

$10.6

Non-Current Liabilities
0.7

Total Liabilities Assumed

$11.3

Net Identifiable Assets Acquired

$19.4

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

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

2016 Activity.

Acquisition of Non-Controlling Interest. In April 2016 , ALLETE Clean Energy acquired the non-controlling interest in the limited liability company that owns the 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 became a wholly-owned subsidiary of ALLETE Clean Energy.

WEST. In October 2016 , U.S. Water Services acquired 100 percent of Water & Energy Systems Technology of Nevada, Inc. (WEST). Total consideration for the transaction was $6.7 million . Consideration of $5.9 million was paid in cash on the acquisition date, working capital adjustments of $0.2 million were paid in the first six months of 2017 and a $0.6 million payment is due in April 2018. WEST is an integrated water management company and was acquired to expand U.S. Water Services’ regional footprint in the Southwestern 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 the second quarter of 2017, is shown in the following table. Fair value measurements were valued primarily using the discounted cash flow method and replacement cost basis.

ALLETE, Inc. Third Quarter 2017 Form 10-Q
17



NOTE 3. ACQUISITIONS (Continued)
2016 Activity (Continued)
Millions
 
Assets Acquired
 
Cash and Cash Equivalents

$0.1

Other Current Assets
1.0

Customer Relationships (a)
2.8

Goodwill (a)(b)
4.2

Other Non-Current Assets
0.1

Total Assets Acquired

$8.2

Liabilities Assumed
 
Current Liabilities

$0.3

Non-Current Liabilities
1.2

Total Liabilities Assumed

$1.5

Net Identifiable Assets Acquired

$6.7

(a)
Presented within Goodwill and Intangible Assets – Net on the Consolidated Balance Sheet. (See Note 4. Goodwill and Intangible Assets.)
(b)
For tax purposes, the purchase price allocation resulted in no allocation to goodwill.

Acquisition-related costs were immaterial, expensed as incurred during 2016 and recorded in Operating and Maintenance on the Consolidated Statement of Income.


NOTE 4. GOODWILL AND INTANGIBLE ASSETS

The aggregate carrying amount of goodwill was $149.9 million as of September 30, 2017 ( $131.2 million as of December 31, 2016 ). Changes to goodwill for the nine months ended September 30, 2017 , relate to U.S. Water Services’ acquisition of Tonka Water and the finalization of purchase price accounting for U.S. Water Services’ acquisition of WEST.

Balances of intangible assets, net, excluding goodwill as of September 30, 2017 , are as follows:
 
December 31,
2016

 
Additions (a)
 
 Amortization
September 30,
2017

Millions
 
 
 
 
 
 
Intangible Assets
 
 
 
 
 
 
Definite-Lived Intangible Assets
 
 
 
 
 
 
Customer Relationships
$59.3
 

 
$(3.4)

$55.9

Developed Technology and Other (b)
6.3
 

$0.9

 
(0.7)
6.5

Total Definite-Lived Intangible Assets
65.6

 
0.9

 
(4.1)
62.4

Indefinite-Lived Intangible Assets
 
 
 
 
 
 
Trademarks and Trade Names
16.6

 

 
n/a
16.6

Total Intangible Assets

$82.2

 

$0.9

 
$(4.1)

$79.0

(a)
Additions resulting from the September 1, 2017, acquisition of Tonka Water. (See Note 3. Acquisitions.)    
(b)
Developed Technology and Other includes patents, non-compete agreements, land easements and trade names.

Customer relationships have a remaining useful life of approximately 20 years, and developed technology and other have remaining useful lives ranging from approximately 1 year to approximately 11 years (weighted average of approximately 7 years). The weighted average remaining useful life of all definite-lived intangible assets as of September 30, 2017 , is approximately 19 years.

ALLETE, Inc. Third Quarter 2017 Form 10-Q
18



NOTE 4. GOODWILL AND INTANGIBLE ASSETS (Continued)

Amortization expense for intangible assets was $1.3 million and $4.1 million for the quarter and nine months ended September 30, 2017 , respectively ( $1.3 million and $3.8 million for the quarter and nine months ended September 30, 2016 , respectively). Accumulated amortization was $13.4 million as of September 30, 2017 ( $9.3 million as of December 31, 2016 ). The estimated amortization expense for definite-lived intangible assets for the remainder of 2017 is $1.5 million . Estimated annual amortization expense for definite-lived intangible assets is $5.3 million in 2018 , $4.9 million in 2019 , $4.7 million in 2020 , $4.6 million in 2021 and $41.4 million thereafter .


NOTE 5. FAIR VALUE

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). We utilize market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated or generally unobservable. We primarily apply the market approach for recurring fair value measurements and endeavor to utilize the best available information. Accordingly, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. These inputs, which are used to measure fair value, are prioritized through the fair value hierarchy. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). Descriptions of the three levels of the fair value hierarchy are discussed in Note 9. Fair Value to the Consolidated Financial Statements in our 2016 Form 10-K.

The following tables set forth by level within the fair value hierarchy our assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2017 , and December 31, 2016 . 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.
 
Fair Value as of September 30, 2017
Recurring Fair Value Measures
Level 1

 
Level 2

 
Level 3

 
Total

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

$10.9

 

 

 

$10.9

Available-for-sale – Corporate and Governmental Debt Securities

 

$10.1

 

 
10.1

Cash Equivalents
2.2

 

 

 
2.2

Total Fair Value of Assets

$13.1

 

$10.1

 

 

$23.2

 
 
 
 
 
 
 
 
Liabilities (b)
 
 
 
 
 
 
 
Deferred Compensation

 

$18.7

 

 

$18.7

U.S. Water Services Contingent Consideration

 

 

$5.6

 
5.6

Total Fair Value of Liabilities

 

$18.7

 

$5.6

 

$24.3

Total Net Fair Value of Assets (Liabilities)

$13.1

 
$(8.6)
 
$(5.6)
 
$(1.1)
(a)
Included in Other Investments on the Consolidated Balance Sheet.
(b)
Included in Other Non-Current Liabilities on the Consolidated Balance Sheet.

ALLETE, Inc. Third Quarter 2017 Form 10-Q
19



NOTE 5. FAIR VALUE (Continued)
 
Fair Value as of December 31, 2016
Recurring Fair Value Measures
Level 1

 
Level 2

 
Level 3

 
Total

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

$7.1

 

 

 

$7.1

Available-for-sale – Corporate and Governmental Debt Securities

 

$11.7

 

 
11.7

Cash Equivalents
1.3

 

 

 
1.3

Total Fair Value of Assets

$8.4

 

$11.7

 

 

$20.1

 
 
 
 
 
 
 
 
Liabilities (b)
 
 
 
 
 
 
 
Deferred Compensation

 

$16.0

 

 

$16.0

U.S. Water Services Contingent Consideration

 

 

$25.0

 
25.0

Total Fair Value of Liabilities

 

$16.0

 

$25.0

 

$41.0

Total Net Fair Value of Assets (Liabilities)

$8.4

 
$(4.3)
 
$(25.0)
 
$(20.9)
(a)
Included in Other Investments on the Consolidated Balance Sheet.
(b)
Included in Other Non-Current Liabilities on the Consolidated Balance Sheet.

The Level 3 liability in the preceding tables is the result of the 2015 acquisition of U.S. Water Services. Changes in the U.S. Water Services Contingent Consideration can result from modifications to the shareholder agreement, changes in discount rates, timing of milestones that trigger payment, or the timing and amount of earnings estimates. The following table provides a reconciliation of the beginning and ending balances of the U.S. Water Services Contingent Consideration measured at fair value using Level 3 measurements as of September 30, 2017 . Management analyzes the fair value of the contingent liability on a quarterly basis and makes adjustments as appropriate.
Recurring Fair Value Measures
 
Activity in Level 3
 
Millions
 
Balance as of December 31, 2016

$25.0

Accretion
0.7

Payments (a)
(19.7
)
Changes in Cash Flow Projections (a)
(0.4
)
Balance as of September 30, 2017

$5.6

(a)
Payments and changes in cash flow projections reflect the impact of a modification to the shareholder agreement in the first quarter of 2017 which provided participants a one-time election to sell shares at a determined price. Participants representing approximately half of the outstanding contingent consideration shares made the election, and were paid in the first half of 2017.

For the nine months ended September 30, 2017 , and the year ended December 31, 2016 , there were no transfers in or out of Levels 1, 2 or 3.

Fair Value of Financial Instruments. With the exception of the item listed in the following table, the estimated fair value of all financial instruments approximates the carrying amount. The fair value for the item listed in the following table was based on quoted market prices for the same or similar instruments (Level 2).
Financial Instruments
Carrying Amount
 
Fair Value
Millions
 
 
 
Long-Term Debt, Including Long-Term Debt Due Within One Year
 
 
 
September 30, 2017
$1,519.0
 
$1,627.9
December 31, 2016
$1,569.1
 
$1,653.8

ALLETE, Inc. Third Quarter 2017 Form 10-Q
20



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 quarter and nine months ended September 30, 2017 , and the year ended December 31, 2016 , there were no triggering events or indicators of impairment for these non-financial assets.


NOTE 6. REGULATORY MATTERS

Regulatory matters are summarized in Note 4. Regulatory Matters to our Consolidated Financial Statements in our 2016 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, FERC or PSCW.

2010 Minnesota General Rate Case. Minnesota Power’s current retail rates are based on a 2011 MPUC retail rate order that allows for a 10.38 percent return on common equity and a 54.29 percent equity ratio. As authorized by the MPUC, Minnesota Power also recognizes revenue under cost recovery riders for transmission, renewable, and environmental investments and expenditures. (See Transmission Cost Recovery Rider, Renewable Cost Recovery Rider and Environmental Improvement Rider .) Revenue from cost recovery riders was $23.1 million and $71.7 million for the quarter and nine months ended September 30, 2017 , respectively ( $25.1 million and $73.9 million for the quarter and nine months ended September 30, 2016 , respectively).

2016 Minnesota General Rate Case. In November 2016, Minnesota Power filed a retail rate increase request with the MPUC seeking an average increase of approximately 9 percent for retail customers. The rate filing seeks a return on equity of 10.25  percent and a 53.81 percent equity ratio. On an annualized basis, the requested final rate increase would have generated approximately $55 million in additional revenue. In December 2016, Minnesota Power filed a request to modify its original interim rate proposal reducing its requested interim rate increase to $34.7 million from the original request of approximately $49 million due to a change in its electric sales forecast. In December 2016 orders, the MPUC accepted the November 2016 filing as complete and authorized an annual interim rate increase of $34.7 million beginning January 1, 2017.

On February 23, 2017, Minnesota Power filed an additional request to further reduce its requested interim rate increase. In an order dated April 13, 2017, the MPUC approved Minnesota Power’s updated retail rate request resulting in a reduction in the annual interim rate increase to $32.2 million beginning May 1, 2017. As a result of working with intervenors and further developments as the rate review has progressed, Minnesota Power’s final rate request is approximately $49 million on an annualized basis. A report and recommendation from the administrative law judge is scheduled to be issued in November 2017, with a final decision from the MPUC expected in January 2018. Management has evaluated the need for a reserve for interim rate refunds and concluded that a reserve is not necessary as of September 30, 2017 . Management evaluates the need for reserves for interim rates each reporting period.
 
As part of its 2016 general rate case and through its 2017 remaining life depreciation petition filed on February 1, 2017, Minnesota Power is seeking an extension of the recovery period for Boswell to better reflect recent environmental investments at the facility and mitigate rate increases for our customers. If the requested recovery period extension is approved, annual depreciation expense will be reduced by approximately $25 million . If not approved, we would expect final rates to be increased by a similar amount, subject to regulatory approval. We cannot predict the level of final rates that may be authorized by the MPUC.

Energy-Intensive Trade-Exposed (EITE) Customer Rates. The Minnesota Legislature enacted EITE customer ratemaking law in 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 2015, Minnesota Power filed a rate schedule petition with the MPUC for EITE customers and a corresponding rider for EITE cost recovery. In a March 2016 order, the MPUC dismissed the petition without prejudice, providing Minnesota Power the option to refile the petition with additional information or file a new petition. In June 2016, Minnesota Power filed a revised EITE petition with the MPUC which included additional information on the net benefits analysis, limits on eligible customers and term lengths for the EITE discount. The rate adjustments are intended to be revenue and cash flow neutral to Minnesota Power. The MPUC approved a reduction in rates for EITE customers in a December 2016 order and subsequently approved cost recovery in an order dated April 20, 2017; collection of the discount was subject to the MPUC’s review of Minnesota Power’s compliance filing implementing approval of a recovery mechanism. On September 29, 2017, Minnesota Power informed its EITE customers that it has suspended the EITE discount due to a concern it is not revenue and cash flow neutral to Minnesota Power based on an MPUC decision at a hearing on September 7, 2017, as well as the interim rate reduction and upcoming decisions in its 2016 general rate case.

ALLETE, Inc. Third Quarter 2017 Form 10-Q
21



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

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

Minnesota Power’s wholesale electric contract with the Nashwauk Public Utilities Commission is effective through December 31, 2032, subject to bankruptcy court approval. No termination notice may be given for this contract prior to June 30, 2025. The wholesale electric service contracts with SWL&P and another municipal customer are effective through October 31, 2020, and June 30, 2019, respectively. Under the agreement with SWL&P, no termination notice may be given prior to October 31, 2017. The other municipal customer provided termination notice for its contract in June 2016. Minnesota Power currently provides approximately 29 MW of average monthly demand to this customer. The rates included in these three contracts are set each July 1 based on a cost-based formula methodology, using estimated costs and a rate of return that is equal to Minnesota Power’s authorized rate of return for Minnesota retail customers (currently 10.38 percent ). The formula-based rate methodology also provides for a yearly true-up calculation for actual costs incurred.

Minnesota Power’s wholesale electric contracts with 14 municipal customers are effective through December 31, 2024. No termination notices may be given prior to December 31, 2021. 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.

Transmission Cost Recovery Rider. Minnesota Power has an approved cost recovery rider in place for certain transmission investments and expenditures. In a February 2016 order, the MPUC approved Minnesota Power’s updated customer billing rates 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 2015, the project is eligible for cost recovery under the existing transmission cost recovery rider. Minnesota Power is funding the construction of the GNTL with a subsidiary of Manitoba Hydro (see Great Northern Transmission Line ), and anticipates including its portion of the investments and expenditures for the GNTL in future transmission cost recovery filings.

Renewable Cost Recovery Rider. Minnesota Power has an approved cost recovery rider in place for investments and expenditures related to Bison and the restoration and repair of Thomson. The cost recovery rider allows Minnesota Power to charge retail customers on a current basis for the costs of constructing certain renewable investments plus a return on the capital invested. Updated customer billing rates for the renewable cost recovery rider were approved by the MPUC at a hearing on September 28, 2017.

In a November 2016 order, the MPUC directed Minnesota Power to attribute all North Dakota investment tax credits realized from Bison to Minnesota Power regulated retail customers. As a result of the adverse regulatory outcome, Minnesota Power recorded a regulatory liability and a reduction in operating revenue of approximately $15 million in the third quarter of 2016. The North Dakota investment tax credits previously recognized as income tax credits in Corporate and Other were reversed in 2016 resulting in an approximately $9 million charge to net income in the third quarter of 2016. In December 2016, Minnesota Power submitted a request for reconsideration with the MPUC. In an order dated February 14, 2017, the MPUC decided to reconsider its November 2016 order.

At a hearing on September 28, 2017, the MPUC modified its November 2016 order to allow Minnesota Power to account for North Dakota investment tax credits based on the long‑standing regulatory precedents of stand-alone allocation methodology of accounting for income taxes. As a result of the favorable regulatory outcome, Minnesota Power recorded a reduction in its regulatory liability and an increase in operating revenue of approximately $14 million in the third quarter of 2017. The North Dakota investment tax credits were reestablished as income tax credits in Corporate and Other, resulting in an approximately $8 million increase to net income in the third quarter of 2017.

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 Corporate and Other operations.

ALLETE, Inc. Third Quarter 2017 Form 10-Q
22



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

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

Environmental Improvement Rider . Minnesota Power has an approved environmental improvement rider in place for investments and expenditures related to the implementation of the Boswell Unit 4 mercury emissions reduction plan completed in 2015. Updated customer billing rates for the environmental improvement rider were approved by the MPUC in a December 2016 order; however, in an order dated March 22, 2017, the MPUC approved a request by Minnesota Power to delay implementation of the updated rates until resolution of its 2016 general rate case. (See 2016 Minnesota General Rate Case.)

Fuel Adjustment Clause Reform Pilot . At a hearing on October 19, 2017, the MPUC adopted a three-year pilot program to implement certain procedural reforms to the Minnesota utilities’ automatic fuel adjustment clause (FAC) for fuel and purchased power. The decision, subject to an MPUC order, would change the method of accounting for all Minnesota electric utilities to a monthly budgeted, forwarded‑looking FAC with a subsequent prudence review and true-up to actual allowed costs on an annual basis. The annual budget projection filing would also include an adjustment to the base cost of fuel. The MPUC will seek input from the utilities and other stakeholders on the detailed implementation steps and transition accounting needed to adopt the change in regulatory accounting method from the current FAC. Transition considerations would need to include the recovery of the current regulatory asset for deferred fuel costs consistent with other regulatory accounting transition precedents for similar matters. Other details of the transition including budgeting methodology and approval, tracker accounting for the differences between actual costs and the budgeted amounts, and the annual true-up and collection or refund process to customers will be determined by the MPUC upon consideration of each utility’s compliance filings. Based on the discussion at the October 19, 2017 hearing, this pilot is not expected to start until mid-2019.

2016 Wisconsin General Rate Case. In June 2016, SWL&P filed a rate increase request with the PSCW requesting an average increase of 3.1 percent for retail customers. The filing sought an overall return on equity of 10.9 percent and a 55 percent equity ratio. In an order dated August 9, 2017, the PSCW approved SWL&P’s rate increase request allowing for a 10.5 percent return on common equity and a 55 percent equity ratio. The order authorizes SWL&P to collect on average a 2.9 percent increase in rates for retail customers ( 3.8 percent increase in electric rates; 4.8 percent decrease in natural gas rates; and 9.8 percent increase in water rates). Final rates became effective on August 14, 2017. On an annualized basis, SWL&P will collect additional revenue of approximately $2.5 million .

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

On July 28, 2017, Minnesota Power submitted a resource package to the MPUC requesting approval of PPAs for the output of a 250 MW wind energy facility and a 10 MW solar energy facility as well as approval of a 250 MW natural gas energy PPA. These agreements will be subject to MPUC approval of the construction of a 525 MW to 550 MW combined-cycle natural gas-fired generating facility which will be jointly owned by Dairyland Power Cooperative and a subsidiary of ALLETE. Minnesota Power would purchase approximately 50 percent of the facility's output starting in 2025. In an order dated September 19, 2017, the MPUC approved Minnesota Power’s request to extend the next IRP filing deadline until October 1, 2019, and Minnesota Power’s request that approval for the natural gas energy PPA be decided through an administrative law judge process. The administrative law judge is expected to provide a recommendation by July 2018, and the Company anticipates a MPUC decision in the second half of 2018. The MPUC did not take any action regarding the wind and solar energy PPAs which will be refiled separately from the natural gas energy PPA.


ALLETE, Inc. Third Quarter 2017 Form 10-Q
23



NOTE 6. REGULATORY MATTERS (Continued)

Great Northern Transmission Line . 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. In 2015, a certificate of need was approved by the MPUC. Based on this approval, Minnesota Power’s portion of the investments and expenditures for the project are eligible for cost recovery under its existing transmission cost recovery rider and are anticipated to be included in future transmission cost recovery filings. (See Transmission Cost Recovery Rider .) Also in 2015, the FERC approved our request to recover on construction work in progress related to the GNTL from Minnesota Power’s wholesale customers. In an April 2016 order, the MPUC approved the route permit for the GNTL which largely follows Minnesota Power’s preferred route, including the international border crossing, and in November 2016, the U.S. Department of Energy issued a presidential permit to cross the U.S.-Canadian border, which was the final major regulatory approval needed before construction in the U.S. could begin. Site clearing and pre-construction activities commenced in the first quarter of 2017 with construction expected to be completed in 2020. Total project cost in the U.S., including substation work, is estimated to be between $560 million and $710 million , of which Minnesota Power’s portion is expected to be between $300 million and $350 million ; the difference will be recovered from a subsidiary of Manitoba Hydro as contributions in aid of construction. Total project costs of $66.9 million have been incurred through September 30, 2017 , of which $36.8 million has been recovered from a subsidiary of Manitoba Hydro.

Manitoba Hydro must obtain regulatory and governmental approvals related to a new transmission line in Canada. In 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.

Conservation Improvement Program. Minnesota requires electric utilities to spend a minimum of 1.5 percent of gross operating revenues from service provided in the state on energy CIPs each year. On April 3, 2017, Minnesota Power submitted its 2016 CIP consolidated filing, which detailed Minnesota Power’s CIP program results and requested a CIP financial incentive of $5.5 million based upon MPUC procedures. In an order dated June 22, 2017, the MPUC approved Minnesota Power’s CIP consolidated filing, including the requested CIP financial incentive which was recorded as revenue and as a regulatory asset in the second quarter of 2017. The approved financial incentive will be recovered through customer billing rates in 2017 and 2018. In 2016, the CIP financial incentive of $7.5 million was recognized in the third quarter. CIP financial incentives are recognized in the period in which the MPUC approves the filing.
MISO Return on Equity Complaints. In 2013, several customer groups located within the MISO service area filed complaints with the FERC requesting, among other things, a reduction in the base return on equity used by MISO transmission owners, including ALLETE and ATC, to 9.15 percent . In 2015, a federal administrative law judge ruled on the complaint proposing a reduction in the base return on equity to 10.32 percent , or 10.82 percent including an incentive adder for participation in a regional transmission organization. In September 2016, the FERC issued an order affirming the administrative law judge’s recommendation.

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

Minnesota Solar Energy Standard. In 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 40 kW or less. In a February 2016 order finalized in December 2016, the MPUC approved Camp Ripley, a 10 MW utility scale solar project at the Camp Ripley Minnesota Army National Guard base and training facility near Little Falls, Minnesota, as eligible to meet the solar energy standard and for current cost recovery. Camp Ripley was completed in the fourth quarter of 2016. In a July 2016 order, the MPUC approved a community solar garden project in northeastern 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 is owned and operated by Minnesota Power. Minnesota Power believes Camp Ripley and the community solar garden project will meet approximately one-third of the overall mandate. Additionally, in an order dated February 10, 2017, the MPUC approved Minnesota Power’s proposal to increase the amount of solar rebates available for customer-sited solar installations and recover costs of the program through Minnesota Power’s renewable cost recovery rider. This proposal to incentivize customer‑sited solar installations is expected to meet a portion of the required mandate related to solar photovoltaic devices with a nameplate capacity of 40 kW or less.

ALLETE, Inc. Third Quarter 2017 Form 10-Q
24



NOTE 6. REGULATORY MATTERS (Continued)

Regulatory Assets and Liabilities. Our regulated utility operations are subject to accounting guidance for the effect of certain types of regulation. Regulatory assets represent incurred costs that have been deferred as they are probable for recovery in customer rates. Regulatory liabilities represent obligations to make refunds to customers and amounts collected in rates for which the related costs have not yet been incurred. The Company assesses quarterly whether regulatory assets and liabilities meet the criteria for probability of future recovery or deferral. No regulatory assets or liabilities are currently earning a return. The recovery, refund or credit to rates for these regulatory assets and liabilities will occur over the periods either specified by the applicable regulatory authority or over the corresponding period related to the asset or liability.
Regulatory Assets and Liabilities
September 30,
2017

 
December 31,
2016

Millions
 
 
 
Current Regulatory Assets
 
 
 
Deferred Fuel Adjustment Clause

$20.2

 

$18.6

Total Current Regulatory Assets
20.2

 
18.6

Non-Current Regulatory Assets
 
 
 
Defined Benefit Pension and Other Postretirement Benefit Plans
221.4

 
226.1

Income Taxes (a)
35.7

 
33.8

Asset Retirement Obligations
29.8

 
26.0

Cost Recovery Riders
5.2

 
30.5

PPACA Income Tax Deferral
5.0

 
5.0

Conservation Improvement Program
4.9

 
4.0

Other
8.6

 
4.7

Total Non-Current Regulatory Assets
310.6

 
330.1

Total Regulatory Assets

$330.8

 

$348.7

 
 
 
 
Non-Current Regulatory Liabilities
 
 
 
Wholesale and Retail Contra AFUDC

$57.0

 

$56.8

Plant Removal Obligations
19.2

 
19.1

Income Taxes
18.6

 
19.1

North Dakota Investment Tax Credits
13.9

 
28.2

Other
2.8

 
2.6

Total Non-Current Regulatory Liabilities

$111.5

 

$125.8

(a)
See Note 1. Operations and Significant Accounting Policies – Revision of Prior Balance Sheet.


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 September 30, 2017 , our equity investment in ATC was $146.0 million ( $135.6 million at December 31, 2016 ). In the first nine months of 2017 , we invested $6.6 million in ATC, and on October 31, 2017 , we invested an additional $1.2 million . We do not expect to make any additional investments in 2017 .
ALLETE’s Investment in ATC
 
Millions
 
Equity Investment Balance as of December 31, 2016

$135.6

Cash Investments
6.6

Equity in ATC Earnings
17.3

Distributed ATC Earnings
(13.5
)
Equity Investment Balance as of September 30, 2017

$146.0


In September 2016, the FERC issued an order reducing ATC’s authorized return on equity to 10.32 percent , or 10.82 percent including an incentive adder for participation in a regional transmission organization. Prior to this order, ATC had been allowed a return on equity of 12.2 percent which had been impacted by reductions for estimated refunds related to complaints filed with the FERC by several customers located within the MISO service area.

ALLETE, Inc. Third Quarter 2017 Form 10-Q
25



NOTE 7. INVESTMENT IN ATC (Continued)

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


NOTE 8. SHORT-TERM AND LONG-TERM DEBT

The following tables present the Company’s short-term and long-term debt as of September 30, 2017 , and December 31, 2016 :
September 30, 2017
Principal

 
Unamortized Debt Issuance Costs
 
Total

Millions
 
 
 
 
 
Short-Term Debt

$64.6

 
$(0.5)
 

$64.1

Long-Term Debt
1,454.4

 
(9.8)
 
1,444.6

Total Debt

$1,519.0

 
$(10.3)
 

$1,508.7

December 31, 2016
Principal

 
Unamortized Debt Issuance Costs
 
Total

Millions
 
 
 
 
 
Short-Term Debt

$188.3

 
$(0.6)
 

$187.7

Long-Term Debt
1,380.8

 
(10.4)
 
1,370.4

Total Debt

$1,569.1

 
$(11.0)
 

$1,558.1


On June 1, 2017, ALLETE issued $80.0 million of its senior unsecured notes (the Notes) to certain institutional buyers in the private placement market. The Notes were issued in reliance on an exemption from registration under Section 4(a)(2) of the Securities Act of 1933, as amended, to institutional accredited investors. The Notes bear interest at 3.11 percent and mature on June 1, 2027. Interest on the Notes is payable semi-annually on June 1 and December 1 of each year, commencing on December 1, 2017. ALLETE has the option to prepay all or a portion of the Notes at its discretion, subject to a make-whole provision. The Notes are subject to additional terms and conditions which are customary for these types of transactions. Proceeds from the sale of the Notes may be used to redeem debt, fund corporate growth opportunities and for general corporate purposes.

On August 25, 2017, ALLETE entered into a $40.0 million term loan agreement (Term Loan). The Term Loan is an unsecured, single draw loan that is due on August 25, 2020, and may be prepaid at any time subject to a make-whole provision. The interest rate on the Term Loan is equal to LIBOR plus 1.025 percent . Proceeds from the Term Loan will be used for general corporate purposes.

Financial Covenants. Our long-term debt arrangements contain customary covenants. In addition, our lines of credit and letters of credit supporting certain long-term debt arrangements contain financial covenants. Our compliance with financial covenants is not dependent on debt ratings. The most restrictive financial covenant requires ALLETE to maintain a ratio of indebtedness to total capitalization (as the amounts are calculated in accordance with the respective long-term debt arrangements) of less than or equal to 0.65 to 1.00 , measured quarterly. As of September 30, 2017 , our ratio was approximately 0.42 to 1.00 . Failure to meet this covenant would give rise to an event of default if not cured after notice from the lender, in which event ALLETE may need to pursue alternative sources of funding. Some of ALLETE’s debt arrangements contain “cross-default” provisions that would result in an event of default if there is a failure under other financing arrangements to meet payment terms or to observe other covenants that would result in an acceleration of payments due. As of September 30, 2017 , ALLETE was in compliance with its financial covenants.



ALLETE, Inc. Third Quarter 2017 Form 10-Q
26



NOTE 9. INCOME TAX EXPENSE
 
 
Quarter Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2017
 
2016
 
2017
 
2016
Millions
 
 
 
 
 
 
 
 
Current Income Tax Expense (a)
 
 
 
 
 
 
 
 
Federal
 

 

 

 

State
 

$0.1

 

 

$0.3

 
$0.2
Total Current Income Tax Expense
 

$0.1

 

 

$0.3

 
$0.2
Deferred Income Tax Expense
 
 
 
 
 
 
 
 
Federal
 
$9.2
 

$0.4

 
$20.3
 

$7.1

State
 
5.0

 
1.4

 
14.5

 
8.9

Investment Tax Credit Amortization
 
(0.1
)
 
(0.1
)
 
(0.5
)
 
(0.5
)
Total Deferred Income Tax Expense
 
$14.1
 

$1.7

 
$34.3
 

$15.5

Total Income Tax Expense
 
$14.2
 

$1.7

 
$34.6
 

$15.7

(a)
For the quarter and nine months ended September 30, 2017, and 2016 , 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.
 
Quarter Ended
Nine Months Ended
Reconciliation of Taxes from Federal Statutory
September 30,
September 30,
Rate to Total Income Tax Expense
2017
 
2016
2017
 
2016
Millions
 
 
 
 
 
 
Income Before Non-Controlling Interest and Income Taxes

$59.1

 

$42.0


$165.4

 

$127.2

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

$20.7

 

$14.7


$57.9

 

$44.5

Increase (Decrease) in Income Tax Due to:
 
 
 
 
 
 
State Income Taxes – Net of Federal Income Tax Benefit
3.3

 
0.9

9.6

 
5.9

Production Tax Credits
(10.4
)
 
(14.0
)
(33.4
)
 
(34.5
)
Other
0.6

 
0.1

0.5

 
(0.2
)
Total Income Tax Expense

$14.2

 

$1.7


$34.6

 

$15.7


For the nine months ended September 30, 2017 , the effective tax rate was 20.9 percent ( 12.3 percent for the nine months ended September 30, 2016 ).

Uncertain Tax Positions. As of September 30, 2017 , we had gross unrecognized tax benefits of $1.9 million ( $2.0 million as of December 31, 2016 ). Of the total gross unrecognized tax benefits, $0.7 million represents the amount of unrecognized tax benefits included on the Consolidated Balance Sheet that, if recognized, would favorably impact the effective income tax rate. The unrecognized tax benefit amounts have been presented as reductions to the tax benefits associated with NOL and tax credit carryforwards on the Consolidated Balance Sheet.

ALLETE and its subsidiaries file a consolidated federal income tax return as well as combined and separate state income tax returns in various jurisdictions. ALLETE has no open federal or state audits, and is no longer subject to federal examination for years before 2013, or state examination for years before 2012.



ALLETE, Inc. Third Quarter 2017 Form 10-Q
27



NOTE 10. RECLASSIFICATIONS OUT OF ACCUMULATED OTHER COMPREHENSIVE LOSS

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

For the quarter and nine months ended September 30, 2017 , and 2016, reclassifications out of accumulated other comprehensive loss for the Company were not material. Changes in accumulated other comprehensive loss for the nine months ended September 30, 2017 , are presented on the Consolidated Statement of Shareholders’ Equity.


NOTE 11. EARNINGS PER SHARE AND COMMON STOCK

We compute basic earnings per share using the weighted average number of shares of common stock outstanding during each period. The difference between basic and diluted earnings per share, if any, arises from outstanding stock options, non-vested restricted stock units and performance share awards granted under our Executive Long-Term Incentive Compensation Plan. For the nine months ended September 30, 2017, and 2016 , no options to purchase shares of ALLETE common stock were excluded from the computation of diluted earnings per share.
 
 
 
2017
 
 
 
 
 
2016
 
 
Reconciliation of Basic and Diluted
 
 
Dilutive
 
 
 
 
 
Dilutive
 
 
Earnings Per Share
Basic
 
Securities
 
Diluted
 
Basic
 
Securities
 
Diluted
Millions Except Per Share Amounts
 
 
 
 
 
 
 
 
 
 
 
Quarter ended September 30,
 
 
 
 
 
 
 
 
 
 
 
Net Income Attributable to ALLETE

$44.9

 
 
 

$44.9

 

$40.3

 
 
 

$40.3

Average Common Shares
51.0

 
0.2

 
51.2

 
49.4

 
0.1

 
49.5

Earnings Per Share

$0.88

 
 
 

$0.88

 

$0.82

 
 
 

$0.81

Nine Months Ended September 30,
 

 
 
 
 

 
 
 
 
 
 
Net Income Attributable to ALLETE

$130.8

 
 
 

$130.8

 

$111.0

 
 
 

$111.0

Average Common Shares
50.7

 
0.2

 
50.9

 
49.3

 
0.1

 
49.4

Earnings Per Share

$2.58

 
 
 

$2.57

 

$2.25

 
 
 

$2.25


Contributions to Pension. For the nine months ended September 30, 2017 , we contributed 0.2 million shares of ALLETE common stock to our defined benefit pension plans, which had an aggregate value of $13.5 million when contributed ( no shares were contributed to the defined benefit pension plans for the nine months ended September 30, 2016 ). These shares of ALLETE common stock were contributed in reliance upon an exemption available pursuant to Section 4(a)(2) of the Securities Act of 1933, as amended.



ALLETE, Inc. Third Quarter 2017 Form 10-Q
28



NOTE 12. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
 
Pension
 
Other
Postretirement
Components of Net Periodic Benefit Cost (Income)
2017
 
2016
 
2017
 
2016
Millions
 
 
 
 
 
 
 
Quarter Ended September 30,
 
 
 
 
 
 
 
Service Cost

$2.6

 

$2.0

 

$1.1

 

$1.0

Interest Cost
8.1

 
8.2

 
2.0

 
1.9

Expected Return on Plan Assets
(10.6
)
 
(10.7
)
 
(2.6
)
 
(2.8
)
Amortization of Prior Service Credits

 

 
(0.5
)
 
(0.7
)
Amortization of Net Loss
2.5

 
2.4

 

 

Net Periodic Benefit Cost (Income)

$2.6

 

$1.9

 

 
$(0.6)
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
 
 
 
 
 
 
Service Cost

$7.7

 

$6.1

 

$3.3

 

$3.0

Interest Cost
24.4

 
24.4

 
5.8

 
5.6

Expected Return on Plan Assets
(31.8
)
 
(32.0
)
 
(7.9
)
 
(8.4
)
Amortization of Prior Service Credits

 

 
(1.5
)
 
(2.2
)
Amortization of Net Loss
7.4

 
7.3

 
0.2

 
0.1

Net Periodic Benefit Cost (Income)

$7.7

 

$5.8

 
$(0.1)
 
$(1.9)

Employer Contributions. For the nine months ended September 30, 2017 , we contributed $1.7 million in cash and $13.5 million in ALLETE common stock to the defined benefit pension plans ( $6.3 million in cash for the nine months ended September 30, 2016 ); we do not expect to make additional contributions to our defined benefit pension plans in 2017 . For the nine months ended September 30, 2017, and 2016 , we made no contributions to our other postretirement benefit plans; we do not expect to make any contributions to our other postretirement benefit plans in 2017 .


NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES

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

Our PPAs are summarized in Note 11. Commitments, Guarantees and Contingencies to our Consolidated Financial Statements in our 2016 Form 10-K, with additional disclosure provided in the following paragraphs.

Square Butte PPA. Minnesota Power has a PPA with Square Butte that extends through 2026 (Agreement). Minnesota Power is obligated to pay its pro rata share of Square Butte’s costs based on its entitlement to the output of Square Butte’s 455  MW coal‑fired generating unit. Minnesota Power’s output entitlement under the Agreement is 50  percent for the remainder of the Agreement, subject to the provisions of the Minnkota Power PSA. (See Minnkota Power PSA .) Square Butte’s costs consist primarily of debt service, operating and maintenance, depreciation and fuel expenses. As of September 30, 2017 , Square Butte had total debt outstanding of $309.3 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 nine months ended September 30, 2017 , was $60.6 million ( $56.8 million for the nine months ended September 30, 2016 ). 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 $7.1 million ( $7.2 million for the same period in 2016 ). Minnesota Power’s payments to Square Butte are approved as a purchased power expense for ratemaking purposes by both the MPUC and the FERC.

Minnkota Power PSA. Minnesota Power has a PSA with Minnkota Power, which commenced in 2014. Under the PSA, Minnesota Power is selling a portion of its entitlement from Square Butte to Minnkota Power, resulting in Minnkota Power’s net entitlement increasing and Minnesota Power’s net entitlement decreasing until Minnesota Power’s share is eliminated at the end of 2025. Of Minnesota Power’s 50 percent output entitlement, it sold to Minnkota Power approximately 28 percent in 2017 and in 2016 .

ALLETE, Inc. Third Quarter 2017 Form 10-Q
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NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (Continued)
Power Purchase Agreements (Continued)

Tenaska PPA. On May 10, 2017, Minnesota Power and an affiliate of Tenaska signed a long-term PPA that provides for Minnesota Power to purchase the energy and associated capacity from a 250 MW wind energy facility in southwest Minnesota for a 20 -year period beginning in 2020. This agreement is subject to MPUC approval of the construction of a 525 MW to 550 MW combined‑cycle natural gas-fired generating facility which will be jointly owned by Dairyland Power Cooperative and a subsidiary of ALLETE, and a wind energy facility. (See Note 6. Regulatory Matters.) The agreement provides for the purchase of output from the facility at fixed energy prices. There are no fixed capacity charges, and Minnesota Power will only pay for energy as it is delivered.

Coal, Rail and Shipping Contracts. Minnesota Power has coal supply agreements providing for the purchase of a significant portion of its coal requirements through December 2018 and a portion of its coal requirements through December 2021. Minnesota Power also has coal transportation agreements in place for the delivery of a significant portion of its coal requirements through December 2018. The minimum annual payment obligation under these supply and transportation agreements is $7.2 million for the remainder of 2017 , $29.0 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.

Leasing Agreements. BNI Energy is obligated to make lease payments for a dragline totaling $2.8 million annually during the lease term, which expires in 2027. BNI Energy has the option at the end of the lease term to renew the lease at fair market value, to purchase the dragline at fair market value, or to surrender the dragline and pay a $3.0 million termination fee. We also lease other properties and equipment under operating lease agreements with terms expiring through 2023. The aggregate amount of minimum lease payments for all operating leases is $3.4 million