ALLETE(ALE) - 2019 Q2 - Quarterly Report

Part I. Financial Information Item 1. Consolidated Financial Statements The unaudited consolidated financial statements for the period ended June 30, 2019, show a net income of $104.7 million for the six-month period, a significant increase from $82.3 million in the prior year, largely driven by a gain on the sale of U.S. Water Services, with total assets remaining stable at $5.18 billion and cash from operating activities decreasing to $95.2 million from $194.4 million year-over-year due to customer refunds Consolidated Balance Sheet As of June 30, 2019, total assets were $5.177 billion, a slight increase from $5.165 billion at year-end 2018, with notable changes including a significant increase in Cash and Cash Equivalents to $203.1 million from $69.1 million, a decrease in Goodwill and Intangible Assets to $1.1 million from $223.3 million primarily due to the sale of U.S. Water Services, and Total Shareholders' Equity increasing to $2.205 billion Balance Sheet Highlights (Millions) | Balance Sheet Highlights (Millions) | June 30, 2019 | Dec 31, 2018 | | :--- | :--- | :--- | | Assets | | | | Cash and Cash Equivalents | $203.1 | $69.1 | | Total Current Assets | $397.3 | $334.3 | | Property, Plant and Equipment – Net | $4,062.9 | $3,904.4 | | Goodwill and Intangible Assets – Net | $1.1 | $223.3 | | Total Assets | $5,176.5 | $5,165.0 | | Liabilities & Equity | | | | Total Current Liabilities | $296.6 | $405.1 | | Long-Term Debt | $1,505.9 | $1,428.5 | | Total Liabilities | $2,971.5 | $3,009.2 | | Total Shareholders' Equity | $2,205.0 | $2,155.8 | Consolidated Statement of Income For the six months ended June 30, 2019, ALLETE reported a net income of $104.7 million, up from $82.3 million in the prior-year period, primarily driven by a $20.6 million pre-tax gain on the sale of U.S. Water Services, despite total operating revenue decreasing to $647.6 million from $702.3 million due to the divestiture, resulting in diluted earnings per share rising to $2.02 from $1.60 Income Statement (Millions, except EPS) | Income Statement (Millions, except EPS) | Q2 2019 | Q2 2018 | Six Months 2019 | Six Months 2018 | | :--- | :--- | :--- | :--- | :--- | | Total Operating Revenue | $290.4 | $344.1 | $647.6 | $702.3 | | Operating Income | $36.2 | $36.5 | $93.0 | $93.9 | | Gain on Sale of U.S. Water Services | $0.5 | — | $20.6 | — | | Net Income | $34.2 | $31.3 | $104.7 | $82.3 | | Diluted EPS | $0.66 | $0.61 | $2.02 | $1.60 | Consolidated Statement of Cash Flows For the six months ended June 30, 2019, cash from operating activities significantly decreased to $95.2 million from $194.4 million in the prior year, primarily due to refunds for interim rates and tax reform, while investing activities provided $46.0 million in cash, a sharp reversal from a $138.5 million use of cash in 2018, driven by the $264.2 million net proceeds from the sale of U.S. Water Services, which offset increased capital expenditures Cash Flow Summary (Millions) | Cash Flow Summary (Millions) | Six Months 2019 | Six Months 2018 | | :--- | :--- | :--- | | Cash from Operating Activities | $95.2 | $194.4 | | Cash from (for) Investing Activities | $46.0 | $(138.5) | | Cash for Financing Activities | $(13.6) | $(33.2) | | Change in Cash | $127.6 | $22.7 | - The primary driver for the positive cash flow from investing activities was the $264.2 million in net proceeds from the sale of U.S. Water Services[12] Notes to Consolidated Financial Statements The notes detail significant accounting policies, including the adoption of a new lease standard in Q1 2019, and provide further information on the sale of U.S. Water Services for $270 million, which resulted in an after-tax gain of $11.1 million, also covering regulatory matters, debt, commitments, and segment performance, highlighting the removal of goodwill and intangible assets associated with the divested business - On March 26, 2019, ALLETE completed the sale of U.S. Water Services for a cash purchase price of $270 million, recognizing an after-tax gain of $11.1 million[30] - The company adopted a new lease accounting standard in the first quarter of 2019, resulting in the recognition of right-of-use assets and lease liabilities of $31.2 million on the balance sheet[22][24] - As a result of the sale of U.S. Water Services, goodwill of $148.5 million and significant intangible assets were removed from the balance sheet[47] Net Income (Loss) by Segment (Millions) | Net Income (Loss) by Segment (Millions) | Six Months 2019 | Six Months 2018 | | :--- | :--- | :--- | | Regulated Operations | $81.8 | $69.9 | | ALLETE Clean Energy | $7.7 | $14.9 | | U.S. Water Services | $(1.1) | $(1.2) | | Corporate and Other | $16.3 | $(1.3) | | Total Net Income | $104.7 | $82.3 | Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management attributes the year-over-year increase in net income for the first six months of 2019 primarily to the $11.1 million after-tax gain from the sale of U.S. Water Services, with Regulated Operations seeing higher net income due to lower operating expenses and favorable rate adjustments, while ALLETE Clean Energy's net income declined due to lower wind resources and the absence of prior-year retrospective production tax credits, as the company reiterates its long-term objective of 5% to 7% average annual EPS growth and outlines significant capital expenditure plans, primarily for the Regulated Operations and ALLETE Clean Energy segments Comparison of Financial Results For the six months ended June 30, 2019, Regulated Operations net income rose to $81.8 million from $69.9 million YoY, driven by lower operating expenses and higher cost recovery rider revenue, while ALLETE Clean Energy's net income fell to $7.7 million from $14.9 million, impacted by lower wind resources and the non-recurrence of a $2.6 million tax credit benefit from 2018, and Corporate and Other net income was $16.3 million, compared to a loss of $1.3 million, boosted by the gain on the sale of U.S. Water Services - Regulated Operations' net income increased due to lower operating and maintenance expenses, higher cost recovery rider revenue, and favorable timing of fuel adjustment clause recoveries[117] - ALLETE Clean Energy's net income decreased due to lower wind resources, lower non-cash amortization, and the absence of $2.6 million in retrospective production tax credits recognized in 2018[118] - Corporate and Other net income was significantly higher due to the $11.1 million after-tax gain on the sale of U.S. Water Services[120] Regulated Utility kWh Sold (Millions) | Regulated Utility kWh Sold (Millions) | Six Months 2019 | Six Months 2018 | % Variance | | :--- | :--- | :--- | :--- | | Retail and Municipal | 5,224 | 5,322 | (1.8)% | | Other Power Suppliers | 1,536 | 2,008 | (23.5)% | | Total | 6,760 | 7,330 | (7.8)% | Outlook ALLETE maintains its long-term annual EPS growth target of 5% to 7%, planning to remain predominantly a regulated utility, with Regulated Operations expected to contribute approximately 80% of consolidated net income in 2019, and significant investments are planned, including the Great Northern Transmission Line (GNTL) and multiple wind energy projects through ALLETE Clean Energy, such as the newly acquired 300 MW Diamond Spring project, while Minnesota Power anticipates filing a new rate case in late 2019 - The company has a long-term objective of achieving 5% to 7% average annual earnings per share growth[157] - Regulated Operations are expected to comprise approximately 80% of total consolidated net income in 2019[158] - Minnesota Power plans to file a new rate case in the fourth quarter of 2019[159] - ALLETE Clean Energy acquired the ~300 MW Diamond Spring wind project and expects construction to be completed in the second half of 2020[31][196] - The company's effective tax rate for 2019 is expected to be a benefit in the range of 5% to 10%, primarily due to federal production tax credits from wind energy generation[204] Liquidity and Capital Resources As of June 30, 2019, ALLETE had a strong liquidity position with $203.1 million in cash and $350.7 million in available credit lines, with the debt-to-capital ratio stable at 41%, and capital expenditures are projected to be approximately $695 million in 2019 and $495 million in 2020, an increase from previous forecasts, mainly to fund the Diamond Spring wind project, with proceeds from the U.S. Water Services sale to be reinvested into growth initiatives Capital Structure (Millions) | Capital Structure (Millions) | June 30, 2019 | % of Total | | :--- | :--- | :--- | | Shareholders' Equity | $2,205.0 | 59% | | Long-Term Debt | $1,543.0 | 41% | | Total Capitalization | $3,748.0 | 100% | - Projected capital expenditures have increased to approximately $695 million for 2019 and $495 million for 2020, primarily due to the Diamond Spring wind energy facility[215] - On March 26, 2019, Moody's downgraded ALLETE's issuer rating to Baa1 from A3, citing the 2018 rate case outcome and debt coverage ratios[213] Item 3. Quantitative and Qualitative Disclosures about Market Risk The company's primary market risks include commodity price risk, power marketing credit risk, and interest rate risk, with commodity price risk for its regulated utilities significantly mitigated through regulatory recovery mechanisms like fuel adjustment clauses, and interest rate risk managed by limiting variable rate debt, where a hypothetical 100 basis point increase in rates would impact pre-tax interest expense by approximately $0.5 million annually - Commodity price risk for regulated operations is largely mitigated by the ratemaking process, which allows for the recovery of fuel and purchased power costs[220] - A hypothetical 100 basis point (1%) increase in interest rates would impact annual pre-tax interest expense by approximately $0.5 million, based on variable rate debt outstanding at June 30, 2019[223] Item 4. Controls and Procedures Management, including the CEO and CFO, evaluated the company's disclosure controls and procedures and concluded they were effective as of June 30, 2019, with no material changes to internal control over financial reporting identified during the most recent fiscal quarter - The principal executive officer and principal financial officer concluded that the company's disclosure controls and procedures were effective as of the end of the period[224] - There were no changes in internal control over financial reporting during the quarter that materially affected, or are reasonably likely to materially affect, internal controls[225] Part II. Other Information Item 1. Legal Proceedings The company refers to disclosures in Notes 2 and 7 of the financial statements for information regarding material legal and regulatory proceedings, incorporating them by reference - Information regarding material legal and regulatory proceedings is incorporated by reference from Note 2 (Regulatory Matters) and Note 7 (Commitments, Guarantees and Contingencies)[226] Item 1A. Risk Factors There have been no material changes from the risk factors previously disclosed in the company's 2018 Form 10-K - No material changes to the risk factors disclosed in the 2018 Form 10-K were reported[227] Item 4. Mine Safety Disclosures Information related to mine safety violations and other regulatory matters as required by the Dodd-Frank Act is included in Exhibit 95 of this Form 10-Q - Mine safety disclosures required by the Dodd-Frank Act are provided in Exhibit 95 to the Form 10-Q[228]