ALLETE Inc (ALE) 2006 Q3 法說會逐字稿

Good day and welcome everyone to this conference call announcing ALLETE's third-quarter 2006 financial results. Today's call is being recorded. Your line will be muted for the presentation. Then we will conduct a question-and-answer period. (OPERATOR INSTRUCTIONS)

This conference may contain forward-looking statements within the meaning of the federal securities laws, including statements concerning business strategies and their intended results, and similar statements concerning anticipated future events and expectations that are not historical facts. These forward-looking statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

The forward-looking statements in the earnings release distributed this morning reflect management's best judgment at this time, but all such statements are subject to numerous risks and uncertainties which could cause actual results to differ materially from those expressed in or implied by the statement therein. Additional information concerning potential factors that could affect future financial results is included in the Company's annual report, and from time to time in the Company's filings with the SEC.

At this time, I would like to introduce the Chairman, President and Chief Executive Officer, Mr. Donald J. Shippar. Please go ahead, sir.

Thank you, and thank you for joining us this morning. Mark Schober, our Chief Financial Officer, is with me this morning and he will provide the quarterly financial details in a few moments. This morning we reported our third-quarter earnings, which were $0.78 per share from continuing operations compared with $0.58 in the third quarter of 2005. This represents an increase of 34%, with both of our core businesses having good quarters. We now expect that our year-end earnings per share from continuing operations will be near the upper end of their guidance range, which is 15 to 20% growth over last year.

During the quarter, we continued investing in the American Transmission Company. As of September 30th, we had a total investment of $35.2 million. By year-end we expect to have about $60 million invested in ATC.

With respect to our environmental emission reduction projects, in May the Minnesota Public Utilities Commission approved our filing for recovery of cost for our Arrowhead Regional Emission Abatement plan or AREA. Minnesota Power will be able to recover approved costs for the AREA plan outside of a rate case. We estimate the cost for the AREA plan will be about $60 million.

Last Friday we submitted a filing to the Minnesota Pollution Control Agency for approval of the Boswell Unit 3 emission reduction plan. In approximately 60 days, we expect to make a filing to the Minnesota Public Utilities Commission for approval of the related expenditures for this project, which we estimate will be approximately $200 million.

Minnesota legislation allows for cost recovery and returns on these investments without a rate proceeding. MPUC approval would authorize a cash return on construction work in progress during the construction phase, and allow recovery for a return on investment, depreciation and incremental operation and maintenance expenses once the project is placed in service.

Now I'll turn the call over to Mark who will give you some of the financial highlights for the quarter. Mark.

Good morning. Our income from continuing operations increased by $6.1 million this quarter, compared to the third quarter of 2005. And both of our core businesses had double-digit percentage increases. I'll go through the significant events that influenced the quarter, and I refer you to our 10-Q which was filed this morning for additional information.

Income from our energy business which is comprised of the Regulated Utility, Nonregulated Energy Operations, and investment in ATC segments, was up $3.2 million or 26% over last year's third quarter. Most of this increase came from sales in margins in the Regulated Utility segment. Retail and municipal kilowatt-hour sales were up 3%, reflecting another strong quarter of sales to our industrial customers, and increases in our residential, commercial and municipal classes due to the very warm summer season. For the quarter, revenue at our energy business was up $17.9 million, while fuel and purchase power expenses were up $14.1 million. Other operation and maintenance expenses are about the same year-over-year.

We also recorded $600,000 of equity income from our investment in ATC. At the end of the quarter, we had a total of $35.2 million invested. Income at the real estate business was $5.1 million compared to $4 million during last year's third quarter, or an increase of 28%. We closed on 556 residential units for $6.8 million, or an average of over $12,000 per unit; and 114,300 square feet of commercial property for $3.6 million, or an average of $31.50 per square foot. Additionally, we closed on sales of 242 acres of non-project land for $4.9 million or an average of over $20,000 an acre.

Income from our real estate business varies from quarter to quarter based on the timing and mix of land sale transaction closings and from percentage of completion accounting for our development projects. At the end of the quarter, we had $114.5 million of pending land sales contracts. You can see a summary of these contracts by project in the 10-Q. Prices on these contracts range from $20 to $50 per commercial square foot, $8600 to $34,000 per residential unit, and $11,000 to $1 million per acre for all other properties.

Some of these contracts allow us to receive participation revenue, which would be in addition to the contract prices I just mentioned. These contracts are expected to close over the next several years.

In the other segment, income was up $1.8 million over the third quarter of 2005. Higher interest rates resulted in higher earnings on our invested cash. We also recorded some tax benefits during the quarter. Our balance sheet remains solid. We have $173 million of cash and short-term investments, which is down from $206 million in the beginning of the year. The reduction is mainly due to our investment in ATC. Our debt to capital ratio is 37%.

Thanks, Mark. I'm very pleased with our financial performance this year. We will report our year-end results in mid-February, at which time we will be providing our earnings guidance for 2007. Even though we will not be providing 2007 earnings guidance until then, I'd like to make a few general observations. At our energy business, the earnings contribution from our investment in ATC will grow as we anticipate beginning this year -- or beginning that year with an approximately $60 million investment.

We should also see the initial returns from our investments in our environmental initiatives next year, and we expect continued load growth. Our real estate business, ALLETE Properties, is well-positioned to continue year-over-year earnings growth. We have $114.5 million of pending contracts scheduled to close over the next several years.

We have a diversified mix of property under contract and for sale -- residential, commercial and industrial. I'd like to point out that the rapid residential growth over the past few years in our markets has created a steady demand for our commercial properties. Once the Ormond Crossings DRI is approved, we will increase the amount of entitled property available for sale. The long-term growth indicators for Florida real estate remain very strong. We like the future prospects for both of our core businesses.

Now before we take your questions, I'd like to mention that we will host a tour of our Town Center and Palm Coast project on November 15th. We hope those of you who are interested will take advantage of this opportunity to see the progress being made at this development. If you plan to attend but haven't registered yet, please contact our Vice President of Investor Relations, Tim Thorp, to make arrangements.

Now we'd like to take your questions.

(OPERATOR INSTRUCTIONS) Todd Vencil with BB&T Capital Markets.

Good morning, thanks a lot. You mentioned Ormond. Can you just update us on when you expect to get approval on that project?

Our schedule shows that we do expect approval by the end of this year. Probably be late in the year, but we do expect the approval by the end of 2006.

Okay. So that is unchanged from the last time we talked about that, I think?

Yes.

Can you -- you talk about the fact that you are well-positioned to continue to grow, which I would agree with. Can you talk, though, about the current sort of state of demand? I mean, housing in particular has slowed down really in most markets across the country, and I think parts of Florida have been hit particularly hard. Could you tell us what you are hearing from people who are looking to buy land?

Well, we would agree with you that the housing sales have slowed down and, of course, you read the reports about the inventory growing. We still have interest, obviously. As we mentioned, we have over $114 million of sales under contract, which include certainly residential commercial also. And also we mentioned that the commercial market remains strong.

The residential side, we are not in the home building business, so we're not as close to the actual homebuilders themselves and how much -- in particular, they are looking at how long this may last or when there will be a "recovery", if you will, in some of the housing sales. But we still continue to see interest in our lands and we expect that will continue. We think Florida certainly is still a great place to be. Long-term certainly we don't see any change in the trends in Florida with the influx of people moving to the state, the population growth, the business climate, etc.

So we obviously will go through some ups and downs from time to time. We still think Florida is a great place to be, and particularly in Northeast Florida where we think there is still a lot a potential for growth, population growth, growth in residential, commercial, growth in those areas.

Okay. It looks on the sales that you reported specifically for Palm -- and again, I'm thinking residential, just focusing on that a little bit. The average price of sales was down pretty significantly just on the sales that actually occurred in the quarter at both Town Center and Palm Coast Park.

Can you talk about what kind of units those were; price point and I guess profile of the units?

Yes, the decline in the units was due to sales at our Town Center project. And, Todd, that is due to mix. So the mix of what we sold this quarter, there was more hotel units, assisted living units, which are lower value than we closed in both Q2 of this year and also in '05. So it's strictly due to mix.

Okay. That is fair. Then in terms of your backlog -- and again, I'm thinking specifically residential here, can you just tell us whether you've had conversations with customers that are currently in your backlog looking to modify the terms of their contracts to take down land?

Yes, we're always having discussions with our customers, and that is ongoing. We obviously are watching what is going on with the market, but at this point in time we haven't had any material changes to any of our contracts, and our guidance for the year is not changing.

Okay, thanks very much.

Eric Beaumont with Copia Capital.

Good morning, guys. Congratulations on the quarter. Just a couple quick housekeeping on the energy side. Obviously, $260 million total for the environmental between Boswell and Arrowhead. Just taking a quick look, recovery in cash and balance sheet, I'm assuming are you planning basically -- should we assume 50-50 debt equity for the funding for contributions going forward for our estimates?

Yes, we are.

Okay. Then on ATC, kind of same thing. You're obviously flush with cash so all the investments aren't going to -- doesn't look like there is any need for equity. But in going forward basis, ATC has talked about basically kind of $250 million on costs going forward starting kind of next year. Assuming the 50/50, that's about 125 million in equity at your 9% pro rata. Should we kind of assume 11 to $12 million annually invested unless [languid] changes out of ATC from you guys?

Yes, I think that is a reasonable assumption. We will have by the end of the year about 9% ownership with our $60 million investment.

And again, unless something changes, which obviously you would most likely want to take the full 9% pro rata for everything given, barring anything changing we should just assume whatever we hear on ATC you will take your 9% stake in carryforwards?

I think at this point, based on your qualifiers, that is a good assumption.

Just wanted to double-check. Thanks for your time.

[Yiktak Fung] with Zimmer Lucas Partners.

Good morning, gentlemen. Just one question regarding the real estate purchases; I think there was about $1.4 million of land that was purchased during the quarter. Can you talk a bit about that? I see this on page 14 of your 10-Q.

Yes, we purchased a small piece of land, primarily driven by tax strategies to reinvest proceeds.

Where is this land located?

It is in southeast Florida.

Are there any plans to make more substantial purchases in your future, given the softening in the real estate markets?

Well, we continue to look in Florida and in other areas of the Southeast, Southern Georgia, to acquire additional pieces of property. We are always involved with looking and evaluating and investigating. So, yes, we still have a strong interest and desire to acquire more property in Florida in that area, and to build our inventory.

I see. Regarding the pending contracts, I see that the amount of commercial square feet that is under contract for Town Center has diminished as sales closed, and also for the acreage and other land. But somehow, the residential units, the number of contracts as named for those has actually increased. Does this mean that basically you are signing more contracts for these units at Town Center as you move forward?

Yes, the primary driver is incremental sales -- or incremental contracts at Town Center.

Do you expect, I guess, substantial increases in the amount of pending contracts going forward through the end of this year?

Increases in?

In the amount of commercial square feet, residential units and acreage under contract?

Sure. We will continue to market. We will bring more Town Center to market as we move into '07, so we certainly expect increases both at Town Center and our Palm Coast project as we move into '07.

I see. And this is part of the first phase still at Town Center?

Really the second phase.

So the second phase has begun?

Minimally.

Okay, minimally. When would that start to really kick in?

In 2007.

2007, okay. In terms of the O&M, I see that this quarter the O&M figure is quite a bit less than the, I guess, around 75 million that I saw in the first two quarters of this year. Why was there this decrease?

In the first and second quarter of this year is when we had our largest generating unit was down for maintenance and generator rewind, so our outage expenses were significantly higher than Q1 and Q2.

I see. And finally the tax benefits, just want to clarify, that is more or less a onetime item, correct?

It's a combination, but there is some onetime in there. The onetime in there is about $600,000.

So netting that out, what would the effective tax rate be, more or less?

More or less, it would probably be up around 40% -- 39, 40%.

Okay. That is basically all my questions for this morning. Thank you very much, and congratulations on a great quarter.

Thanks.

James Bellessa with D.A. Davidson & Co.

Good morning. The tax benefit that was just discussed was $1.5 million, or was that something different; and then the onetime aspect of that is $600,000?

You've got it.

And so what is the other $900,000, what would the benefits be from?

They are due to a variety of things, Jim, investment tax credit, depletion allowances, Medicare. And then some of our state planning initiatives that we put in place, those are ongoing.

So that is worth $0.05 a share, but most of that is non-recurring or is just the 600,000?

Just the 600,000.

There is the other income line item there, $1.7 million. Can you explain that?

Mostly what is in the other income is the returns on our cash and our short-term investments.

And did you have that --?

And last year if you are comparing year-to-year, what we had in there last year, especially when you look at the year-to-date numbers for '05, is when we wrote off the remainder of our emerging technology investments or the privately held.

And did you have a prepayment penalty there? If so, what line item does that hit for this bond issue?

That would be in the other two, and that was a few hundred thousand after tax.

And in the Nonregulated Energy operations, the amount of interest expense doubled from the first and second quarters. Can you explain that?

Interest is related to -- or allocated to BNI. I'm not aware of any reason why that would have increased during the third quarter. We'd have to check on that for you.

And do you know of any reason why it should change from where it was in the most recent quarter of --?

No, that should be an ongoing rate.

Okay. Thank you very much.

David Thickens with Deephaven Capital Management.

Good morning. Can you talk a little bit about all the various different industrial expansion projects on the range and how you are planning for those from a resource perspective?

Sure. Well, as you know, we had moved Taconite Harbor into our regulated business from the unregulated beginning this year. So in 2010, that will give us in essence another 225 megawatts of generation that is available for our regulated segment. We also have entered into a 50 megawatt purchase agreement with Manitoba Hydro that carries us out for several years. And then beyond 2010 as we look at the 2015 timeframe approximately, we have another 200 megawatt need. And we are currently evaluating alternatives for how we will address that; what type of generation, location, etc.

So with moving Taconite Harbor into the retail segment, that certainly gives us a big advantage, if you will, or headstart for the next several years, but then we will have to look at another resource addition around the 2015 time period.

With so many of these projects moving forward but not definite and the outcomes being binary on fairly large blocks of power, if these move forward just in the short-term if you end up getting -- or we end up getting projects that move forward that are greater than what is available before 2010 with Taconite Harbor and the contracts with Manitoba Hydro, do you plan on just feeling need with local -- I'm sorry, with additional purchase power contracts coming out of the north, or just reducing all system sales or what?

Well, we would have to look at filling in with purchase power contracts for those interim periods, which we think would be relatively short. And where they would be sourced, obviously, we are not sure at this point. We have -- through the MISO market, we have access to a lot of different sourcing opportunities. We would have to look at filling those interim needs primarily through the market.

Can you talk about what the loads would be on a number of these potential projects? You know, the popular present stuff we see talks about dollar value, but it talks about them being very large consumers of electricity. But can you put some numbers around that?

Yes, the Mesabi Nugget project is about 15 megawatts.

1-5?

Yes, 1-5. The Polymed project, depending on the phase, but the early phase is probably going to be some are around 70 megawatts roughly, 65, 70 megawatts. The Blendon expansion would be probably somewhere around 100 megawatts. And the MSI project, which is certainly the largest of them -- again, depending on the timing and there'd be a startup, but the final phase could be as much as 450 to 500 megawatts.

What is the timing on that project?

Well, I think the MSI project is somewhere off in late 2008, 2009.

Okay, thank you much.

If I could just make a follow-up comment on the interest expense. The interest expense for the non-regulated group is down year-over-year, both for the quarter and nine months ended, and that is simply due to the reclass at Tac Harbor when we reclassed the Tac Harbor facility up to regulated in 2006 business. For 2005, it is still a non-regulated, and that is where the interest expense has been.

(OPERATOR INSTRUCTIONS) Vedula Murti with Tribeca Global Management.

Good morning. I was wondering, can you remind us right now what you're currently earning on a regulated basis at the utility operations; you're authorized in any potential regulatory activities?

Our authorized rates of return are 11.6, and we continue to earn right around at 11 6. There is no rate activity in our Minnesota jurisdiction at this point in time. We have filed a rate case in Superior for Superior Water, Light and Power. We expect that rate case to be final here around the first of the year. We asked for a 5% increase or about $3 million on our $50 million rate base at Superior.

All right, thank you very much.

(OPERATOR INSTRUCTIONS) James Bellessa with D.A. Davidson & Co.

You were identifying the potential projects in your region and you mentioned MSI. What would MSI stand for?

Minnesota Steel Industries; it's a project to take taconite and then produce direct reduced iron right on the site in the form of steel slabs that would then be shipped to the market.

Yes. And then there was a comment here just recently about the interest expense in Nonregulated Energy operations. I do recognize that they were down year-over-year, but sequentially they were up from $0.5 million in the first and second quarter. So I am just asking, what made the jump on a going-forward basis?

Okay. We will get back to you on that, Jim.

Thank you.

John Hanson with [Prosidies].

Good morning. Just one more follow-up on the real estate. Q2 you had an amount under contract of like 129, and then this quarter it is 114 million. Is there some seasonality to that, or what kind of -- what would cause that to be a little bit less this time than before?

There is no seasonality to it. It's just simply as contracts come to closure and new contracts are signed, it's just an ordinary course of business that it declined from Q2 to Q3.

Okay, thank you.

There are no further questions at this time. I'd like to turn the call back over to Mr. Shippar for any additional or closing remarks.

Thank you, and thank you for joining us this morning. We look forward to reporting our year-end results and our 2007 earning guidance in mid February, and look forward to talking to you then. Good morning.

That does conclude today's conference call. Thank you for your participation. You may disconnect at this time.