ALLETE Inc (ALE) 2007 Q3 法說會逐字稿

Good day, everyone, and welcome to the conference call announcing Allete's third quarter 2007 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 Managers' 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 effect 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'd like to introduce the, Chairman, President and Chief Executive Officer, Mr. Donald J. Shippar. Please go ahead, sir.

Thank you. And good morning, everyone. For the third quarter, Allete earned $0.58 per share versus $0.78 per share last year. Year to date we have recorded earnings per share of $2.31 compared with $1.95 for the first three quarters in 2006. When I spoke to you last quarter, I said we expected earnings from our Real Estate Business would be lower in the second half of 2007 due to the difficult market conditions in Florida. As you can see from our quarterly results, that was the case and we expect the weak market conditions to continue through the rest of this year.

We project total year end net income from our real estate business will be in the $16 million to $18 million range, which is less than 2006, the highest earnings year ever at Allete Properties, but in line with historical performance. Based on our consolidated year-to-date results on expectations for the fourth quarter, we still anticipate earnings per share will be within the $3 to $3.05 range for 2007. At this time, I'll call on, Chief Financial Officer, Mark Schober to provide you with the financial highlights for the quarter. And then I'll make some additional comments before we take your questions. Mark?

Thanks, Don. As Don mentioned, we reported quarterly earnings of $0.58 per share compared with $0.78 per share during the third quarter of 2006. Net income was $16.5 million versus $21.8 million a year ago. Income from our Energy Business segment was in total about the same as last year's third quarter, while income for our Real Estate Business was down $4.5 million. Let me give you some detail for each of our businesses, with comparisons to last year's third quarter.

Our three Energy Business segments earned a combined $15.5 million, which was about the same as last year. At the Regulated Utility, kilowatt hour sales to residential and commercial customers were lower this year due to warmer summer we experienced in 2006, but were offset by increased kilowatt hour sales to our municipal customers. Kilowatt hour sales to our industrial customers were down about 3% due to an idle production line at one of our Taconite customers. That line was idled in February and resumed production in September. Total kilowatt hour sales were down about 2%.

Electric operating revenue was up because of increased fuel cost recoveries that resulted from higher purchase power expenses due to generating plant outages. Operating and maintenance expenses increased this year due to these outages, higher labor expense, and storm restoration expense. Income taxes for this business were down about $3 million, largely due to a reduced effective tax rate, which I will touch on in a moment. The net income contribution from our investment in ATC increased because of this year's higher investment balance. At the end of the quarter, we had a total investment of $65 million in ATC.

Income from our Real Estate business was $600,000 compared with $5.1 million last year. Keep in mind that income from this business varies quarter-to-quarter based on the timing and amount of contract closings. Also this quarter, some contracts that were originally expected to close were deferred to future periods as we discussed in our last conference call. In addition, five contracts which were signed earlier this year totaling $6.9 million were canceled during the third quarter. During the quarter, we also signed $4.8 million of new pending contracts and closed $4.8 million of other contracts. At the end of September, we had $73.2 million of pending contracts, which are scheduled to close over the next few years. I refer you to our 10Q which we filed this morning for additional detail regarding our real estate inventory, pending contracts, average prices, and other information.

On a consolidated basis, our effective tax rate for the quarter was about 33% and we projected at year end it will be between 35% and 36%, down from the 37% estimate at the end of June. The reason for the decrease in the annual rate is due to higher expected taxes on interest, a higher projected domestic manufacturing deduction due to increased generation capital expenditures and other tax planning initiatives.

Turning to the balance sheet, cash and short-term investments were $132 million at the end of the quarter, down from $159 million at the end of June. The lower cash balance is reflective of our continued capital spending. Our debt to total capital ratio stands at 38%. Don?

Thanks, Mark. The Florida real estate market has deteriorated during 2007 and we do not see any improvement through the end of this year. Going forward, we're unable to project when real estate markets will begin to improve, but I want to emphasize that this business is and will continue to be a profitable business for us. Even though the current market is very weak, we cannot foresee any scenario where our real estate operations would be unprofitable or where we would have to record impairment charges. This business owns a valuable portfolio of assets due to the mixed use nature of our inventory. The fact that our property for sale is already entitled and our belief that the Palm Coast area will continue to experience above average demand for residential and commercial property over the long-term.

Additionally, the book cost basis of our land inventory is very low. We expect our real estate business will remain a significant contributor to Allete's ongoing earnings stream. We will be providing 2008 earnings guidance when we report our year end results in February 2008.

Switching to our Energy Business, Minnesota Power will continue to significantly increase its rate-based assets over the next several years. Our investments in environmental upgrades in renewable energy assets are recoverable on a current basis through state-authorized cost recovery mechanisms. For other capital expenditures and cost increases, Minnesota Power intends to file a wholesale rate case with the Federal Energy Regulatory Commission by the end of this year, or early in 2008. We also anticipate that retail rate filings in Minnesota and Wisconsin will be made in 2008 or 2009. On another note, the Minnesota Public Utilities Commission unanimously approved Minnesota Power's cost recovery petition for the Boswell 3 environmental improvement plan. We are now able to recover the approximately $200 million cost of the unit 3 improvements through a rate rider beginning January 1st, 2008. That concludes my comments and we'll ask the operator now to open up the lines for your questions.

Thank you. (OPERATOR INSTRUCTIONS) We'll go first to [Larry Solo] with [CGAS] Securities.

Hi, good morning.

Hi, Larry.

Can you just briefly discuss on the regular utilities side your fuel and purchase power costs, which were about in line sequentially with last quarter, even though I thought that a couple, some of the planned outages were actually-- some of these plants were actually back up and running this quarter. What's the dynamic there?

What happens, Larry, is these units were down typically at the end of the first quarter and then into the second quarter. And then we have a lag before that runs through our fuel cost to our customers.

Okay.

And that lag is two to three months, so that's what you're seeing. The units are back and running, but with-- the costs are running to our customers then in the Q3.

Got you, so we should expect that to be, the lag, by the fourth quarter, you would expect this to come back down somewhat?

Yes, sir, you got it.

Right. And then I guess on the operating, on the operating maintenance expense, that was clearly down because you're not doing as much maintenance on these plants that are back up and running?

Yes.

All right. Then just switching gears to the rate case, the wholesale, is that basically just to get Taconite under regulation, the Taconite plant?

No, the, the FERC rate cases are wholesale customers, which is-- the Taconite that you're talking about is retail. So we'll capture those in our retail filings (inaudible) will be later next year, so these are our municipals customers and our other wholesale customers.

Okay, great. Thank you.

We'll go next to Grant Hopkins with Ferris Baker, Watts.

Good morning, gentlemen.

Good morning.

My first question relates to the rate cases you expect to file. What's the timing between the filing and approval, if it is approved, and the time you start to recognize a rate increase?

A couple things happen, and they're different, depending whether we talk FERC or our retail filing. Now, with our FERC rate case that-- before we implement interim rates is -- there's a couple of options here, but we're assuming now it's about a seven month lag before we get interim rates in effect. And then we'd have final rates in effect probably four or five months after that, so the whole process is about a year. On our retail rate filings with the state of Minnesota, the lag between the filing date and interim rate is two months, with filing rates in place typically 10 to 12 months after the filing date.

Okay. Thank you very much. My next question relates to some of the canceled contracts that you mentioned in the Q. These are small numbers now, but do you expect anything more to come, or are there any indications for larger contracts to be canceled?

Not at this point, but that's always a possibility. The contracts that canceled this quarter were all signed earlier in the year. So they were -- they were signed towards the peak in the market. We work closely with all of our customers. We're not aware of anything that will cancel today or is eminent, but that could certainly change depending on where the market goes in the future here.

Because they were signed I guess this year, would that mean that they had less vested into the contracts, so it was easier for them to cancel it back out?

Yes, and the majority of them were in the due diligence process, so they hadn't even gone out hard on their deposit. So they were able to walk. Most of our pending contracts, as we talked before, the $73 million are mature contracts. Those folks have deposits that have gone hard, typically 1% to 2% cash down, but then also have more time into the investment, as you mentioned.

Okay, great. And my last question relates to the one production line of the Taconite facility. Was that just a maintenance issue? Was there a decrease in demand or anything else that drove that?

That's a U.S. steel and they have a, what they call a third production line, that they've sort of used to balance their inventory with. So they will, from time-to-time, run that line and not run it just to balance out their inventory of pallets that they're shipping to their steel mills.

Okay, so it can be on or off, depending-- ?

Yes, that's not the-- it's typically that they run it for several months and then they don't run it for several months. So that's, that's pretty normal operation for them.

All right. Well, thank you. That's it for now.

Thank you.

We'll go next to Bob Chewning with Davenport & Company.

Good morning.

Good morning, Bob.

I guess first is a follow-up on the Taconite. Can you give us some sort of color as to the, the demand outlook for Taconite and whether that's changed over the last quarter or so?

No, I think the demand is still strong. The plants are running pretty much at their total capacity capabilities and we don't, we don't have any indication or see that changing as we look out in the future. I think the, certainly the demand for steel is still quite high. The prices have held up very well, and so we see all of those producers in our region continuing to produce at their, at the levels they have for the, probably the last couple of years, which is pretty much at capacity.

Okay, and with regard to your guidance, which you maintained, you indicated $16 million to $18 million from Real Estate, and I assume that's a reduction from what you had assumed on Real Estate prior. Can you give us any sense as to what you previously expected to get from Real Estate this year.

Yes, our previous guidance, as we started 2007, we expected our real estate earnings to be a bit better than they were last year, which was our best year ever, and that was right around $23 million. As the market continued to deteriorate, our disclosure at the second quarter is that earnings would be under that. So they've continued to decline and then coming into the third quarter, what's pulled us back even a little bit farther was these contract cancellations.

Okay, and with regard to the contract cancellations, $6.9 million, I guess, was that all expected to close in 2007?

Yes, it was.

Okay. Great. Thank you.

Okay. Thanks, Bob.

We'll go next to James Bellessa with D.A. Davidson.

Good morning, Don and Mark.

Good morning, Jim.

Good morning.

The cancellations that you've cited, $6.9 million, would you characterize why they are canceling and what's the theme, what's the motivation?

Yes, I really can't give you a lot of detail on that, Jim. I would tie it all back to market conditions. These folks, as I mentioned, signed contracts, are in the middle of their due diligence period, so there may be other drivers there, but I'm -- we're assuming that it's just a soft market and they signed at prices that they thought were, that they thought were high and decided to pull out of those agreements. So the message here though is that they're all signed this year, so they were set contracts that were signed at the peak of the market and the rest of our contracts, at least at this point, look pretty solid.

Taking the mid-point of your guidance that you've just come forth with of $16 million, $18 million, this is lower than I have built in my model, so is suggesting that other segments might be doing better than I had thought for the fourth quarter?

Yes, there's a couple things going on, it's primarily within the Energy segment, or within the Regulated Utility. As you're aware, we've had a very strong first half of the year, primarily driven by weather, in the early part of the year. That's a piece of it. Couple of other important pieces are our tax rate is going to be under what we originally planned due to the reasons that I mentioned, and then the other big item is our incentive compensation expenses are going to be lower than what we expected. And the final piece is in the third quarter, or I'm sorry, in the second quarter, we talked about some of these unique events, which was the state tax audit settlement we had with the state of Minnesota. We had a guarantee with Northwest Airlines that we didn't have to make good on that we had reserved, so you kind of add all these together, they're offsetting then the drop off in Real Estate earnings that we expect for this year.

This Northwest Airlines situation, has that already gone through your income statement?

Yes, that was a Q2 event.

Okay. So I'm looking forward into the fourth quarter then, and so my question, can you tell us about the Non-Regulated Energy operation and how that might be going in the fourth quarter?

That's a pretty small segment, and there's nothing unusual there. It was a little weaker this quarter because some of those units were down for maintenance in our Non-Regulated group, so we had more maintenance expenses and fewer sales, but they're back online, so there should be nothing unusual there. It's primarily within the Regulated Utility.

Your change in ATC investment then materially increased during the quarter. Do you see yourself adding significantly the remainder of the year to that investment, and therefore increasing that line item's earnings per share contribution?

No. The only thing that will be increasing during Q4 will be reinvested dividends. There won't -- we're not anticipating any capital calls during the remainder of '07.

And so the remainder goes back onto the, to make the change to get back to your guidance range of $3.00 to $3.05. The Regulator Utility needs to be better than perhaps I'd built into my model. Can you tell us a little about the forward look in this quarter?

And that's what we just went through, Jim, was the taxes and some of our lower incentive comp expenses going into Q4.

And the incentive comps, why are they changing?

It's just because our performance is not where we expected it to be. Primarily it's a real estate group.

Very good. Thank you very much.

You bet.

We'll go next to (inaudible) with Zimmer-Lucas Partners.

Hi, good morning.

Good morning.

I guess my first question is with regards to the FERC rate, wholesale rate case, is that for generation or transmission?

It's from everything (inaudible). We're an integrated utility participant, generation transmission.

So is there any sort of estimate from-- I guess, I guess why is the Company going in for a rate case, by how much are you under earning on this portion?

Yes, we don't have those numbers yet. I will certainly share those with you as we get closer to our filing date, but what's driving it in general is the growth in our rate base. And on the wholesale side, we don't -- we do not get current cost recovery like we do retail for our environmental and renewable upgrades. And then just general O&M increases. It's been 10 to 15 years is the last time we've been in for a FERC rate case, so it's just general cost increases.

What's the total rate base for a company in which portion in wholesale and which portion's retail?

Our total rate base for Minnesota Power is between $600 million to $650 million, and I'd say about 15% of that is related to the wholesale side of the business.

Okay. Going back to the tax rate, can you explain, again, why the tax rate has been lowered?

And if we're looking just at the quarter, because as we came out of the second quarter, we projected a tax rate of around 37%. We're now down to 35% to 36%. It gets into the biggest driver is the, the deduction that I mentioned, the, the manufacturer's deduction, which has to do with the growth in our generation plant. We get a deduction for that and what is new there, what's driving that, is our-- we started construction here for our Taconite Ridge Wind Facility, a $50 million facility, so because of that, that deduction is going up this year, which will reduce our tax rate about a point more than what we anticipated at the end of the second quarter.

I see. So is this deduction, I guess, ongoing?

Yes, it is.

Okay, great. That's basically all my questions for today. Thank you.

Okay, thank you.

We'll go next to Brian Janson with SAC Capital.

Good morning. It's actually Jay Hatfield. How are you doing?

Good morning, Jay.

Good morning.

How have you been? I just have two quick questions. The first with regard to the rate case, the state rate case is that mostly, I know it's hard to characterize it generally, but is that mostly related to just increased rate base from customer hookups, or are there other elements?

Again, there's two drivers there. The big one is our growth in rate base. Some of the numbers we've shared with you-- our capital expenditure budget this year is about $220 million, and it will be running at that rate going forward. About half of that we get current cost recovery. The other half we need to go into our regulator to get cost recovery on it. So that's one of the drivers. And the other is just general cost increases throughout the Minnesota Power system, whether it's distribution generation, O&M increases, labor increases, benefit increases, but just a whole mix.

Yes, our last retail rate case was in 1994, so it's been in essence 13 years since we've had to go in for any kind of a rate case.

And you'd mentioned this run rate on the Real Estate business of $16 million to $18 million a year?

No, that's our guidance for this year.

Oh, guidance for this year. Okay.

Yes, we have not given any guidance for '08 and that's what we'll do, we will do that at our February conference call.

Okay, and so -- but if we were going to try to estimate that now, I guess is there -- is your backlog of contracts, is that going -- are you signing other contracts that offset the ones that have been canceled? Is that going up?

No. Well, the number did come down. If you look forward -- or look back to where we were at the end of Q2, our pending contracts was $79 million, $80 million. We're now sitting at about $73 million. We did add contracts during the quarter. We added about $4.5 million, and we closed about $4.5 million. So we are, there are sales, but there's not a lot of sales. The market has not improved during the quarter, so we, we have not made, or we will be making projections then as we get into-- at the February conference call for '08.

Yes we're, we're working on our budgets now and obviously we'll be pulling those together in late January, and approving those and giving guidance. So we really can't give any outlook, if you will, on that until that time.

Great. Thank you very much.

Thank you.

(OPERATOR INSTRUCTIONS) We'll go next to Grant Hopkins with Ferris Baker, Watts.

Hi, just a quick follow-up just to Jim's question. For ATC, I think they've identified about $3 billion in CapEx over the next decade. What are the expectations for capital calls the next two or three years in the short-term?

Well, they've given us a forecast of what they expect to do, and I don't have the details of that in front of me. And it really varies heavily on when they're able to permit their projects and get, get all the approvals they need to begin construction. They currently have several projects that they're in the permitting stages for in Southern Wisconsin, but until they get those projects to the point where they actually need the capital to start the actual construction, they don't do any capital calls typically. So those, again, are very dependent on their construction schedule and that right now is not firm enough to comment on what we expect those next year or following year capital calls to be.

Okay, but assuming the permits that do go through, there could be stuff in '08, or could be capital calls in 2008?

Yes, there certainly could be.

Okay. That's it for me. Thank you very much.

Thanks, Grant.

And it appears we have no further questions at this time. I'd like to turn the call back over to Mr. Shippar for any additional or closing remarks.

Well, thank you, and thank you for joining us this morning. We look forward to speaking to you again in February, at which time we'll report our year end 2007 results and provide you with an outlook for 2008. Thank you.

And once again, that does conclude today's call. We do appreciate your participation. You may disconnect at this time.