ALLETE Inc (ALE) 2007 Q4 法說會逐字稿

Good day, and welcome everyone to this conference call announcing Allete's fourth quarter 2007 financial results. Today's call is being recorded. Your line will be muted for the presentation then we will conduct a question an answer period. (OPERATOR INSTRUCTIONS)

This conference may contain forward-looking statements within the meaning of 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 this Earnings Release distributed this morning reflects Managements best judgment at this time but all such statements are subject to numerous risks an uncertainties which could cause actual results to differ materially from those expressed in or implied by the statements 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 good morning, everyone. Today we announced our fourth quarter 2007 earnings of $0.77 per diluted share. For the year, we earned $3.08 per diluted share, an 11% increase over 2006. We're pleased to report these results especially when considering the difficult market conditions our Real Estate business operated in during the year. Our fourth quarter earnings were slightly higher than we had anticipated primarily due to colder than normal weather in December, which caused increased electric sales to our residential and commercial customers. Our Real Estate business earned $2.5 million for the quarter and ended the year with a $17.7 million of net income which was at the high end of the guidance range we gave you in the fourth quarter. We've been in the Florida Real Estate business since 1991 and 2007 was its third highest earnings year ever.

In a moment, Chief Financial Officer, Mark Schober will go through the financial details but first I'd like to update you on a few new developments. Last Friday, the Federal Energy Regulatory Commission approved the wholesale rate increase request we had filed in December. The request applies to Minnesota Power's 16 wholesale municipal customers and two private utilities in Wisconsin, including Superior Water, Light & Power Company. The FERC made no adjustments to our request which included an 11.25% return on equity on a 59% equity ratio. The rate increase on an annual basis will generate approximately $7.5 million of additional revenue. The new wholesale rates will go into effect March 1st of this year.

Also last week, the Minnesota Public Utility Commission voted to approve Minnesota Power's Electric Service agreement with Mesabi Nugget. Mesabi Nugget would be a new industrial customer for Minnesota Power and plans to begin production later this year. They would initially be a 15 megawatt customer with potential for growth. We expect to receive the formal written order from the MPUC soon.

United States Steel recently announced its intent to restart a pellet line at its Keewatin Taconite processing facility. This line which has been idle since 1980 would be updated and restarted as part of a $300 million investment by U.S. Steel. It's anticipated to require an additional 30 megawatts and bring about 3.6 million tons of additional Taconite pellet making capability to the Minnesota Iron Range by 2011. All of these new developments bode well for our future earnings growth. At this time I'd like to turn the call over to Mark Schober and then I'll follow-up with some additional remarks about the outlook for Allete. Mark?

Thanks, Don. Net income from continuing operations was $87.6 million in 2007 compared to $77.3 million in 2006, an increase of $10.3 million. As Don said, our diluted earnings per share from continuing operations were up 11% year-over-year, from $2.77 to $3.08. I refer you to our Form 10-K we filed this morning for the details of our financial performance, but I'd like to summarize the major factors impacting earnings for the year. The three segments in our Energy Business recorded a combined income of $65.9 million in 2007 compared to $52.4 million in 2006. While income from the Non-Regulated Energy operation segment was slightly less in 2007, income from both the Regulated Utility and investment in ATC segments were higher. In 2007, income from the Regulated Utility segment increased by $8.1 million compared to the prior year. Residential and commercial sales and margins increased primarily due to colder temperatures in the first and fourth quarters of 2007. Demand revenues from industrial customers were also higher in 2007 than in 2006.

We also added two new full or municipal full requirement customers during the year. Superior Water, Light & Power had higher rates beginning in January of 2007. Additionally, we commenced current cost recovery on environmental capital expenditures during the year and had higher earnings from the allowance for funds used during the construction related to our capital expenditure program. These increases more than offset higher operating and maintenance expenses in 2007 which included those related to outages, storms, and salary and wage increases. The Regulated Utility also benefited from a lower effective tax rate during 2007 primarily due to higher allowance for funds used during construction. Income from our investment in ATC rose by $5.6 million as our 2007 investment balance was much larger than in 2006. We began investing in ATC in May 2006 and reached our approximate 8% ownership level in February of 2007. Our current investment in ATC is approximately $66 million.

Our Real Estate segment contributed income of $17.7 million in 2007 versus $22.8 million in 2006. The decrease was due to a challenging Real Estate market. On the positive side, Allete Properties closed two significant sales in the second quarter of 2007 which included a large Non-Residential tract in the first phase of the Sawmill Creek project at Palm Coast Park. The Other segment recorded income of $4 million in 2007 compared to $2.1 million in 2006. The increase in 2007 included a State tax audit settlement and the release from a loan guarantee for Northwest Airlines.

Turning to the balance sheet, our cash, cash equivalents and short-term investment balances were about $100 million lower at the end of 2007, compared to 2006, reflecting our significant capital investment program. Also at year end, the debt to total capital ratio was at 36% highlighting our additional debt capacity. Finally, in relation to our statement of cash flows I do want to point out our continued strong cash flow from operating activities, approximately $123 million in 2007. Don?

Thanks, Mark. Allete is committed to earning a financial return that rewards our shareholders, allows for reinvestment in our businesses and sustains our growth. Recently, opportunities have arisen which we believe will allow us to achieve our long term earnings growth goals through our existing businesses. Therefore, we will now focus or business development activities on growth opportunities within our complimentary to our Energy and Real Estate businesses. At Allete Properties we believe that current market conditions will present an opportunity to add to our portfolio of properties for sale. We expect net income from our Real Estate business will be approximately 10% to 20% of total consolidated net income over the next several years. This is a significant return when you consider our book basis of land is only about $63 million.

Within our Energy Business, Minnesota Power expects significant rate base growth over the next several years as it anticipates making approximately $1.5 billion in capital investments by 2012. About half of these expenditures are for environmental, renewable energy, or transmission investments that will be recovered through current cost recovery riders outside of a rate case. In addition, Minnesota Power will be making significant investments in its low cost, generation fleet. We consider the ownership of low cost generation to be a competitive advantage. We will also look for transmission opportunities that the strengthen and enhance the regional transmission grid and take advantage of our geographic location between sources of renewable energy and growing energy markets.

Several natural resource base companies have been making significant progress developing new projects in Northeastern Minnesota. Besides Mesabi Nugget, these include PolyMet Mining which has executed an electric service agreement with us and is awaiting environmental permits. Minnesota Steel Industries and the expansion project at Keewatin Taconite also are projects on the horizon. If some or all of these projects are completed, Minnesota Power could serve between 100 megawatts and 400 megawatts of new electric load.

We also expect to make additional investments in the American Transmission Company to fund our prorata share of ATC's capital investment program. I mentioned that our capital investments are expected to be about $1.5 billion through 2012. I refer you to a table in the capital requirements section of our 10-K for a detailed projection for each year. Now, we intend to finance about 1/2 of this program from internally generated funds, about 1/3 with incremental debt, and the remainder with additional equity. As you can see, we have a lot of growth opportunities within our core businesses. The Board of Directors and Management of Allete are excited about our future prospects. Our Boards confidence was underscored with its recent action to raise our common dividend by 5%.

Let me now turn to the expectations for this year. We expect Allete's 2008 diluted earnings per share will be in the range of $2.70 to $2.90. This guidance reflects the following: At Minnesota Power the new FERC approved wholesale rates will be in effect beginning March 1st. Minnesota Power also intends to file a retail rate case with the Minnesota Public Utilities Commission in mid-2008 with interim rates in effect 60 days after the filing. Minnesota Powers current industrial customers comprise about 50% of its kilowatt hour sales. We anticipate these industrial customers will continue to operate at a historically high levels in 2008. Minnesota Taconite production is projected to be about 41.5 million tons compared with 39 million tons in 2007. In addition, our paper and pulp customers are expected to run near capacity and our pipeline customers are forecast to operate at record pumping levels in 2008.

We expect increased revenue from current cost recovery riders related to the Company's investment in renewable and environmental initiatives. As we grow, we expect increased operating and maintenance expenses and increased financing costs. With respect to our investment in ATC, we anticipate investing an additional $5 million to $7 million during 2008. At our Real Estate business, we expect that a continuation of difficult market conditions will cause its net income for 2008 to be less than in 2007. Now this is the primary reason for Allete's projected lower earnings per share for 2008. Beyond 2008 we see continued earnings growth because of rate base growth, additional investments in ATC and increased electric-- electricity sales to current and new customers. We also expect that market conditions for our Real Estate business will improve over time. At this time I'll ask the Operator to open up the line for your questions.

Thank you, ladies and gentlemen. (OPERATOR INSTRUCTIONS). We'll go first to Todd Vencil with Davenport.

Hi, guys.

Good morning, Todd.

Looks like you had some cancellations in the Real Estate business in the quarter. Can you-- am I looking at that right and if I am, can you talk about those?

Yeah, we had a-- year-to-date we had cancellations of about $22 million. They started in the third quarter so we talked a little bit about it in the third quarter and then we had an incremental $15 million that cancelled in Q4. So really not surprising, kind of as we expected as the market conditions continued to deteriorate. Most of these were signed relatively at the peak of the market, late '05 into '06, so it simply comes back into our inventory, couple of them did have down payments, 1% to 2% we keep that but it comes back in the inventory and we'll be remarketing it at a later date.

We talking about primarily residential or commercial here ?

A mix.

A mix. If I do the quick math though it looks like it may have been weighted toward the residential is that fair?

That's fair, yes.

Okay. And was this in the development projects or other land?

Most of them were in the development projects.

Okay. Was that-- was [Loe] in among them there?

No.

Okay, fair to say probably smaller developers?

It's a variety. I don't have the names in front of me, Todd, but it would be our typical customers that we've used-- we've had in the past.

Okay.

But none of the large ones, no, it's not [Loe].

Okay, can you talk about how prices have been trending on the commercial property there?

We have not, prices continue to be soft both on commercial and residential, but very few buyers. So priced at this point the way I look at it is really not the issue. Just people are not investing at Real Estate at this point in time, so we are holding our prices at this point, looking for buyers but very very few buyers, very little traffic in our communities down in Florida.

Okay, and then let's talk about the opportunity that you guys mentioned in this market. I mean how-- are you guys looking at purchases of land in Florida as well as other places?

Yes. We continue to look in certain parts of Florida, not all over the state but certain areas we think still have opportunities in the future and we're also looking primarily into-- in primarily in the North Carolina area.

Okay. And how close do you think you might be to taking some action there?

Well, it's really hard to predict. I mean, we've looked at a lot of different parcels and a lot of different opportunities. We just haven't found anything that we feel is priced appropriately relative to where the market is today.

Okay and final question I guess. How much are you thinking if you have an idea of putting to work on purchases of land sort of going forward?

We really haven't set aside our earmark if you will any specific amounts. I think we would be looking at typically maybe property sizes I don't know, several hundred acres, maybe around 1,000 acres would be the typical kind of projects we'd be pursuing.

Okay, thanks a lot.

You bet.

Thank you. And we'll go next to Grant Hopkins with Ferris, Baker Watts.

Good morning.

Good morning, Grant.

My first question, your commercial Real Estate square footage was up pretty substantial year-over-year, up 77%, is that the timing of projects or is that indicative of some I guess relative strength in commercial square foot?

You're looking at the sales for the year?

Just looking at the-- yeah, not even the sales, just the square foot sold.

Yeah, the square foot sold those are the two-- really the two large transactions that we closed in Q2.

No I'm talking about fourth quarter in particular.

For fourth quarter those were very small sales, at Town Center I think there's a movie theatre that we closed there, but they were relatively small.

Okay so it was just the timing of projects?

It's just the timing, yes, yes.

Okay you gave your break down of how you're going to finance your CapEx over the next few years. What's your target capitalization rate going to end up being and how that relates to how much you can-- how much more Real Estate you can purchase?

Our Cap structure is really driven by what happens within the Regulated Utility. We have a very low debt ratio and as I mentioned in my comments that will be coming up as the utility grows but we'll be pretty close to a debt level of a little bit higher than 40% as we move forward so we have very little leverage down at the Real Estate side of the business so we do have ample room to look for funds, both using debt or equity if there's a significant Real Estate acquisition.

Okay. Well that's it for me. I think everything was pretty straight forward, thank you.

Okay, thank you.

Thank you. And we'll go next to Larry Solow with CJS Securities.

Good morning. Just a couple questions on the rate case. First of all on the FERC rate that was already approved since you weren't getting cost recovery on that, can we expect relative to the Minnesota Power rate a good amount of that actually to flow to the bottom line, because you are-- assuming that you already had some of those costs related to that increased revenue from the increased pricing?

Yeah, some of those costs we're all ready incurring. It captures a series of costs, Larry. The capital cost, the financing cost, the incremental O&M and then our general cost increases since like '95 that we were incurring, so you're right. You need to after tax it and a good portion of it will flow through to the bottom line.

Right and then considering your outlook for basically 200 million plus or 100 million if you just take the half of the, that's not being cost recovery for over the next five years can we expect rate increase or filings like every other year or something? Would that the be an appropriate assumption?

The timing of our rate cases with the MPUC are driven by our capital cost that we don't get current cost recovery on, so you're right, we're looking at going in some time in mid-'08 and then it depends on when we incur these other base capital costs, that will drive the timing of the future rate cases. There will be future rate cases. I'm not real sure of what the timing will be, but there will be another one out in the probably 2010/2011 time frame.

Okay, and then just looking just briefly on the Real Estate side, I know you guys, you're somewhat opportunistic and you're out there looking for sort of cheaper land, so you would-- do I read in between the lines that you think maybe there's still another, something another leg to drop before you really get out there and get active in purchasing stuff? Do you think the price still has more to come down?

Well, again, we've looked at several different opportunities down there, parcels, et cetera, and based on just our analysis related certainly price is a big factor but also, how the land is currently permitted for development, whether it's residential, commercial, a combination, those kind of things, those all factor into our decision on whether or not we think it's attractive enough. So as I said , we really haven't-- even though we've looked at several of them in various locations, we simply haven't found anything that's either priced right or has the right development order associated with it that we feel will be good for us and obviously provide earnings in the next several years.

Okay, and then just a quick housekeeping type of question. I see that a 1.4 in Other income and Real Estate, what was that for the quarter?

What we have in the Other Real Estate segments is our earnings on our couple of things, on our finance receivables is in there and also the earnings on our shopping center that we have in Winter Haven.

Okay.

Bulk of that.

Has that normally been-- that's normally been in that same line item?

Yes.

Okay, great. Okay, thank you.

Thanks.

Thank you. We'll move next to James Bellessa with D.A. Davidson & Co.

Good morning.

Good morning.

Good morning.

Follow-up on that other income question. By my calculation, perhaps $0.06 of your positive variance was explained by that in the two segments that you called out at being better than expected, the Regulated Utility and the Real Estate, so could you just explain Other income that what's in that bucket for Real Estate, can you explain why you had a $1.4 million Other income item for the year in Real Estate? That's the only time it hit any quarter.

No, the Other income in Real Estate, as I just mentioned, that is the ongoing or the run rate where we have for those two items for both the receivables and the shopping center. The Other income if you look at the consolidated Other income, there's some unusual events in there. That's where we did record our tax benefit back in Q2, we talked about this where we had a resolution of a State tax issue and then we also had our resolution of our Northwest Airlines is in the Other income but that's in the Other income-- or the Other segment. Within Real Estate it's primarily driven by the shopping center and our finance receivables.

And yet in the previous quarters of the last two years, '06 and '07 you had not had any Other income and then all of a sudden in the fourth quarter you get this Other income.

Yeah, I have to look into the details, Jim. I guess I don't know exactly what that would be there.

And then on the Regulated Utilities side, you called out that there was colder temperatures in December but also there was a swing there of Other income. Is there an explanation for that?

The Other income, what's in the utility? That's primarily now driven by some of our tax benefits that I talked to, I believe.

And that perhaps bolstered the fourth quarter?

Yeah, so that's where-- the Other income is really coming from our AFUDC that's related to our capital expenditures, so that's recorded in Other income for the utility. That's the primary change year-over-year, and you'll see that running into '08 too, because of our capital expenditure program continues to run at a higher level.

Okay, and then you've given a range for guidance for '08 of $2.70 to $2.90, and then you've given yourself a band for what the Real Estate might be able to produce 10% to 20% of the total. When I look at the potential for the Real Estate, the band there is wider, $0.30 between upper and lower end. The band there is wider than in your overall guidance. Can you comment on that?

Well, I think largely, it's just the uncertainty in the Real Estate market. I mean, we obviously aren't predicting that we are going to have any kind of a broad recovery this year. We certainly expect to be profitable but it's really hard to forecast when any kind of recovery will occur, and obviously how quickly that will happen and how quickly buyers will come back into the market. As Mark mentioned we haven't seen buyers and the traffic's been reduced significantly so that's really the driver for the wider outlook there.

Thank you very much.

Thank you. We'll move next to Bob Chewning with Davenport & Co.

Good morning.

Hi, Bob.

With regard to the Minnesota rate case, will you intend to use 2008 test year as you did with FERC on that?

Our test year for the-- our 2008 rate case for Minnesota will be a split test year so as we look forward it depends on when we file, but would be a portion of 2008 and a portion of 2009.

Okay. Well, if one were to extrapolate, if you had requested 7.5 in the FERC case and they're roughly 15% of assets, should we imply, what gets in the way of that? I know that half of your CapEx is being recovered through causes but how should we be looking at that?

You really can't extrapolate that and you've touched on the biggest reason. A big chunk of the 7.5 has to do with our current cost recovery that we do not get on the wholesale side of the business, that we do have already in our rates for the retail side of the business. So you really can't extrapolate that and make any assumptions on our level of success on an MPUC rate case.

Okay. And when you file a rate case with the MSPC, does it also include recovery of what you're already getting under the clauses and so it's removed out of the clause, if you understand what I'm saying?

At the end of the day, yes. Those will, the-- we get current cost recovery for them, as we go in for a rate case, the Commission will be looking at those expenditures and build those capital costs into our base rates once the final order comes out some time in mid-'09 then.

Okay. But you would be putting the revenues into effect basically under bond pending final outcome?

Yeah, interim rates would go into effect 60 days after the filing date, yes subject to a review and refund based on the final order.

Okay, all right, thank you.

(OPERATOR INSTRUCTIONS). We'll go next to Yiktat Fung with Zimmer Lucas Partners.

Good morning, gentlemen and congratulations on a terrific year.

Thank you.

My first question, can you comment on the outlook for the major industries in Minnesota to which the Company is sensitive? And also, can can you also comment on how sensitive the Company's revenue is to sales volumes or is-- or are the sales to initial customers under more fixed and variable rates?

Well as we mentioned the outlook for the large industrial customers, namely the Taconite, the papers and the pipeline companies is very bullish. They continue to project record production levels and also several of them are making capital investments, longer term capital investments, we referred to the Keewatin Taconite, the U.S. Steel (inaudible) plant that they're proposing to invest $300 million into. There's also investments for expansion going on at [Cliffs Nordstrom] Mining project, so from the perspective of those customers, what their projections are continuing to be very strong and bullish. Our contracts with them do have a certain amount of do or take or pay based-- baked into their agreement. In other words they pay us X amount regardless of their operating commissions. But the majority of their electric usage and obviously, cost if you will associated with that is tied to their production, so there is an element of take or pay but it's small overall and the majority of their costs are related to their level of production for those plants.

And my second question pertains to the FERC rate case that was just approved. Was the timing of this approval I guess ahead of Company expectations when you first issued 2008 guidance in the fourth quarter?

No, that was really baked into our guidance. We anticipated the changes we anticipated we'd get interim rates, but what happened is the FERC now gave us a final rate order that came out so it's really just a matter of final rates versus interim rates. So the overall impact on earnings is negligible. The key point here though is that that regulatory risk is now gone. We've got a final rate order from the FERC and we can move on and focus on our Minnesota case now.

And my final question, regards to the fourth quarter results, it seems to me there's a pretty significant pick up in gross margins at the Regulated Utility. Can you comment a bit on that? Was that mainly weather driven or usage driven?

Yeah, the primary driver in Q4 as we had touched on as we went through our comments was the-- we had some really, really cold weather in the beginning of December, so our sales were up substantially to our residential and commercial and even a little bit into our municipal customers, so that was the biggest driver.

Thank you.

And with no further questions I'd like to turn the conference back over to Mr. Shippar for any additional or closing remarks.

Well thank you all for joining us this morning. And for those of you who are unable to join us at our analyst lunch next Tuesday in New York, I invite you to listen to the webcast replay which will be posted on our website, www.allete.com. We look forward to speaking to you again when we report our first quarter earnings results in 2008. Thank you.

Thank you. Once again, ladies and gentlemen, that will conclude today's conference. We do thank you for your participation and you may disconnect at this time.