ALLETE Inc (ALE) 2008 Q2 法說會逐字稿

Good day, and welcome, everyone, to this conference call announcing Allete's second quarter 2008 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 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 the 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.

Good morning, and thank you for joining us. This morning, we reported our second quarter results of $0.37 per share. Year to date, we have earned $1.19 per share, and we are on track to meet our year-end earnings guidance of between $2.70 and $2.90 per share.

Our Chief Financial Officer, Mark Schober, will go through the financial details in a few moments.

There are a few recent developments that I'd like to share with you. As you know, Minnesota Power filed for a $45 million retail rate increase in early May. The Minnesota Public Utilities Commission has issued an order authorizing interim rates, and they go into effect today. We expect to have final rates in place during mid-2009.

Superior Water, Light, and Power also filed a rate increase request during the second quarter. On an annualized basis, the rate increase would generate approximately $4 million of additional revenue. We anticipate that the rates, if approved by the Public Service Commission of Wisconsin, will be effective in January 2009.

In May, we announced plans to develop several hundred megawatts of wind energy in North Dakota and purchase an existing direct-current transmission line to transport this wind energy to customers. This project, which will take several years to complete, will allow us to meet our mandated state renewable energy supply requirements. We expect to execute a definitive agreement in the third quarter and close on the transmission line purchase in early 2009.

And while I'm on the subject of wind energy, I'd like to mention that our 25-megawatt Taconite Ridge wind facility, located in Northeastern Minnesota, became operational in July.

At our Allete Properties real estate business, the $29 million contract with Lowe Enterprises was terminated in July, and Lowe forfeited a $600,000 deposit. We are currently reviewing the best options to proceed with this property. We believe this property, along with all remaining property at our development projects, holds long-term value for Allete.

At this time, I'll turn the call over to Mark, and then we'll take your questions. Mark?

Thanks, Don.

Our earnings performance for the quarter and for the year to date is in line with our expectations. As Don mentioned, our year-end earnings guidance remains unchanged at $2.70 to $2.90 per share. I encourage you to refer to the 10-Q we filed this morning for the complete details for the quarter.

The Regulated Utilities segment earned $5.2 million for the quarter, down $900,000 from the second quarter a year ago.

Retail and municipal electricity sales were up about 2% over the same period last year. In addition, we had higher wholesale rates in place, which resulted in an additional $2.1 million of revenue and increased revenue from cost recovery riders of $4.8 million compared to 2007.

Offsetting these, we realized $7.6 million less revenue from sales to other power suppliers than the second quarter last year due to contract expirations.

On the expense side, regulated utility operating and maintenance expenses were $2.2 million higher because of increases in purchased gas costs and salaries and wages.

Depreciation and interest expenses increased by a combined $1.4 million as a result of our significant capital expenditure program.

Don mentioned that interim retail rates will go into effect today. These higher rates will begin to offset the impact of these rising expenses and reduce sales to other power suppliers. For 2008, we expect incremental revenue from both the new wholesale rates and the interim retail rates of approximately $20 million.

Income in our real estate business was $2.5 million for the quarter, compared to $11.5 million a year ago. Last year's second quarter earnings were unusually large, primarily due to two very large property sales.

In the second quarter this year, we recorded the sale of the Winter Haven Shopping Center for an after-tax gain of approximately $3 million.

As of June 30, we had $2.7 million of pretax deferred profit on sales of real estate on our balance sheet, which we expect to recognize by year-end. Our real estate business will be profitable this year, although net income will be less than in 2007.

Income from the "Other" segment was $2.7 million less than the same period a year ago. This year, we had lower earnings on cash and short-term investments due to lower balances, and in 2007, we recorded the release from a Northwest Airlines loan guarantee and a positive state income tax audit settlement.

The effective tax rate for the quarter was 36.5%, compared to about 32% a year ago. Last year's rate was lower due to the state income tax audit settlement I just mentioned.

Don?

Thanks, Mark. And at this time, I'll ask the operator to open up the line for your questions.

Thank you, Mr. Shippar. (OPERATOR INSTRUCTIONS)

We'll take our first question from Larry Solow with CJS Securities.

Yes, good morning, gentlemen. This is actually [Fred Bonacore] calling in for Larry.

Hi, Fred.

Hi. One quick thing I wanted to ask about. We realize it's just a one-month delay, but does the rate increase going into effect at Minnesota Power August 1 instead of July 1 have any sort of negative impact, albeit slight, on your '08 outlook versus your prior guidance?

No, it really doesn't, and, Fred, with a couple things going on. You're right; we're about a month behind schedule as far as getting our interim rate in effect. However, offsetting that, our overall revenue requirements are a bit higher than we anticipated, but those two guys really do net each other out. So the overall impact from the retail rate filing here in Minnesota will be about $13 million increase in revenue this year.

Okay, excellent. Great. I got that.

And then in terms of weather, did you have any unusual weather impacting the second quarter, or were there any unusual weather impacts in the prior-year quarter?

No, nothing of significance. We've had a couple of storms here that have bumped our O&M expenses a little bit, but nothing of major significance.

Great. And then, clearly, there are significant investment opportunities on the utilities side of the business, and that really appears to be your focus, as we believe it should be. But just touching on real estate a bit, do you expect to make any opportunistic real estate investments in -- additional investments in Florida or perhaps moving up the Coast into Georgia or the Carolinas?

Well, we continue to look in Florida and primarily in North Carolina and parts of South Carolina for further investments in real estate. Again, we're looking in certain specific areas which we think have long-term potential, and we're looking for what we would consider very -- very attractive opportunities to buy additional property during this downturn in the market.

Outstanding. And then, just finally, wanted to touch on mining activity. Any update on potential expansion in mining activity or operations from new or existing customers?

Well, Northshore Mining just completed an expansion -- or actually brought a production line that had been idle for several years back online.

U.S. Steel is in the midst of doing the same at their Keewatin taconite plant.

There's also an expansion that's being scoped out at another one of [Cliff's] operations up in [Forbes] or Eveleth, Minnesota.

So the mining industry on the taconite side, the iron mining side, continues to be very, very strong, and the steel customers are looking for every possible way they can increase their production of pellets.

PolyMet Mining, which, of course, is the copper and nickel company that's in the process of seeking permits, continues to make progress. They're expecting sometime late this summer or early in the fall to receive their first indication from their environmental impact statement. There are also several other firms that are very interested in the copper nickel precious metals mining area, but our view is they're all watching PolyMet to see how that whole process comes together.

Excellent. That's very helpful. Thank you very much.

Thank you.

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And we'll go to James Bellessa with Davidson and Company.

Good morning.

Morning, Jim.

Now, if Lowe forfeited their $600,000 contract deposit, what does that mean about their ownership of this land in, I think, small -- is it Sawmill Creek project?

Correct. What that means, Jim, is that that $600,000 deposited that they forfeited is -- will be recognized or was recognized as income for us in the quarter. Lowe already had a take-down last year. They continue to own that land and can move forward to develop it. The remaining land, however, is -- remains in our inventory. So as far as the future of Sawmill Creek, that's something that we continue to explore opportunities with or without Lowe on what we can do to develop Palm Coast Park, where Sawmill Creek sits.

Property that they purchased last year, is that the sweet spot of that territory and, therefore, you're left with the residual properties and it's going to be harder to develop for you?

Well, actually, what they bought, Jim, is mostly the layout for the golf course that they were planning there. So it was primarily the golf course and land around the golf course. So there's still -- again, all the land around the perimeter of the particular property belongs to us.

We continue to work with Lowe to try to find the best way, if you will, for us to separate and divide that property so that it maximizes our potential for future development, and should they decide to develop their parcel at some time, also to it is a better situation for them.

Is it inconceivable that they might want to sell this property back to you?

Well, we don't think it's inconceivable, no. I mean certainly that hasn't been anything that we've entertained yet, but again, we don't know that.

If you could guy it pennies on the dollar from what they bought it from you at and then have a better -- a larger piece to work with, I'm just asking if that could be a conceivable approach.

I see where you did sell the Winter Haven, and it sold for about $20 million, but I don't see that kind of magnitude of revenues in the real estate business, so what -- how does it get recorded?

What's recorded, Jim, if you look at in the revenue line, that's -- the net pretax gain is included in that line item, and it's about $4.5 million, and that's in the revenue line item for real estate.

And that's -- other revenue is 5.3, and you're saying 4 point, what was it?

4.5 million.

4.5 million, okay. I'm going to ask a couple other questions [inaudible] and just move to my spreadsheet for a second.

On the "Other" business, you in the first quarter didn't have any interest expense, and now you have interest expense of $1.5 million in the "Other" segment. What changed there? What would have caused interest expense this quarter versus --

Yes, it's really just -- overall interest expense is right where we expect it, Jim. What you're talking about is really just how we look at interest expense and how we allocate it across our business unit.

We did make a change this year. We did not go back and restate for '07, and really looking at each one of the operating business units and allocating interest to them based on rate base and capital invested with the remainder at "Other." So you're seeing a little bit of an increase in overall interest expense at "Other," and we made that adjustment in this year, '08 business.

Your non-regulated energy business improved about double the earnings of last year. Were the earnings of last year just Lowe and, therefore, you're just getting back to normal operations there or?

Yes, on the non-regulated side last year, we had some real estate sales, then this year, there are Minnesota real estate sales. We'll probably have some in there later this year.

BNI is performing a little bit better. Our coal mine is in that line item, too, so earnings from BNI are up. That's probably the primary driver that you're seeing.

You said that other power supply sales were down, and you said that that was due to an expiration of a contract or contracts.

Yes.

Do you see any renewal of those kinds of contracts going forward or [inaudible - technical difficulty] long-term contracts that expire and no promise of being replaced?

Yes, those contracts were contracts that we had in place. There are several of them that expired with the first of the year here. That energy now is being moved back and serves our retail load. So, no, we're not going to be re-entering into long-term contracts, and that's really one of the primary drivers then for our Minnesota rate case.

The tax rate at the utility was higher than I would've expected. Was there anything abnormal there?

No, not for the utility.

Thank you very much.

Okay, thanks, Jim.

And we'll now go to [Bernard Horn], Polaris Capital.

Good morning.

Morning.

Just two questions. I wasn't quite sure on the regulated rate increases. It looks like in the press release it talks about it going into effect today. I wasn't quite sure. I just came in a little bit late, so I was a little unclear about the prior comment that it was going to be a month delayed. Are you talking about two different things or one?

No, that is the same issue we originally anticipated, that the interim rates would go into effect July 1.

So it was coming into effect today?

Yes.

Okay. And then the other question, again, you may have covered it before I jumped on, but the commercial business looks like it was down a bit. Could you just bring up to date? And it sounds like your industrial business is still moving along reasonably well.

Yes, we've looked hard at that, too. If you look at our overall kilowatt-hour sales now, we're doing very well, our residential and our industrial. The municipals, there's really -- is also doing very well. When we look at the commercial, there's really nothing specific there. We're thinking it may have something to do with just the overall economy, and the slowdown is maybe pulling our energy sales down a little bit, but there's nothing specific that jumps out or is concerning us at this point in time.

What is in the commercial? I'm not quite sure how that distinguishes itself from the industrial.

Well, it'd just be your small businesses --

Okay.

-- like malls, department stores, those kinds of things.

Okay. And the pricing and so forth wouldn't have changed in those different markets?

No.

No.

Okay. Thanks a lot.

[Thank you.]

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And we'll go to Bob Chewning, Davenport and Company.

Good morning.

Hi, Bob.

Morning, Bob.

Re your guidance, you indicated real estate would be positive, but could you give us some sort of range as to the amount of earnings that could potentially be out of real estate that are in that 2.70 to 2.90 guidance?

Yes, you're well aware, Bob, that we don't give individual guidance out by our business segments. Last year, real estate came in at about $17 million. They certainly are going to be less than that this year. I think you could look at where they are year to date, and you look at, as I mentioned, the deferred profit that we'll be taking into income by the end of the year, you'll come pretty close to what we expect for full-year earnings.

Okay. And if I look at the real estate segment, the first quarter, you had operating revenues of 2.7 million. If you take out the $4.5 million gain, it looks like 3.4 million of revenues. And your operating costs in both periods were around $3.8 million. Should we be looking at 3.8 as more or less close to a quarterly operating expense level?

No, that would be high. That's pretax expense. That would be high for an annual basis. I think there may be some selling costs in there for the shopping center that are one-timers. Our overall expenses for that business on an after-tax basis probably run around 4 to 5 million a year.

4 to 5 on an after-tax basis?

After-tax annually, yes.

Okay. All right. Okay, thank you very much.

You bet.

And we have a follow-up from James Bellessa, again with Davidson and Company.

You had some formal comments about the purchase of this D.C. transmission line from North Dakota to Minnesota. Would you go through that again? What -- the purchase date, did it get pushed back a little into the future? Could it have been done by year-end and now it's the end of the '09?

Well, we were projecting the end of 2008, early 2009. Now, as we continue to work with Minnkota and Square Butte, which is -- [Jaxi] is the owner of the assets -- we're thinking it's more likely that that's going to close in early 2009, after we, of course, make all of our filings, get approvals, etcetera. So it's probably a little later than we first expected but not significantly later.

Does this delay, therefore, the rate basing of that property? Is it pushed out past the middle of '09?

No. So the way we look at it, Jim, we'll complete the purchase in Q1 of '09. We're working with our regulators on exactly how we want to get that into our rate base and start earning on it. When we look at '09 in total, it really is about a push. We're increasing our rate base because of this 80 million, but our costs from Square Butte will also come down. So we may simply then, because of that, address it in a future rate filing.

Thank you very much.

Okay.

And we'll go back to Bernard Horn with Polaris Capital.

Yes, hi again. The industrial business, I know you've got a lot of exposure to the taconite mines and so forth. We've been seeing some reports out of non-U.S. companies that steel prices have been falling somewhat dramatically. And I was just wondering to what degree you have any longer-term view, or are the companies just so positively affected by the weak dollar that it doesn't really matter what's going on? Do you have any sense for how far in advance you can see their business?

Well, just based on conversations with the customers again, the steel companies, the mine owners, they continue to feel very strong about the outlook for the taconite pellets, if you will, whether that -- and, obviously, as you know, the vast majority almost totally of that -- of those pellets go to the U.S. markets.

So they're continuing to look at expansion and continuing to look at getting all the production they can out of those facilities. The prices have clearly gone up significantly in the last several months for pellets on the -- as far as the per-ton cost. So from their perspective, we've gotten no indications whatsoever that they see anything but a very positive outlook.

Okay. And the rate increase that goes in August 1, how much is that, the interim rate?

The overall rates that we're repressing are 45 million. The interim rate increase is 35, so the impact on '08 is about $13 million in increased revenue.

And is that across the board or just a regulated utility?

It's across the board to our retail customers, but, yes, the regulated utility.

Okay, but it would be all categories in that regulated utility. I know you break that down among a number of different types of customers.

Except for the municipals. The municipals are regulated by the Federal Energy Regulatory Commission, and we just completed that rate case earlier this year.

Okay. And will there be any relief on that coming up?

That's already in the estimates that we gave you. Overall, that's about a $7.5 million rate increase on an annual basis that went into effect on March 1.

Okay. And when you tell us that it's 45, 35, and so forth, what are you basing -- is that a fixed-dollar amount, or is it a per-kilowatt hour?

It's an overall blended or average increase for all of our customer classes, the 35 million.

It's about a 7.5% increase on a kilowatt-hour basis.

Okay, but it's -- so what happens if for some reason -- you know, if the economy slows down, kilowatt-hour use goes way down. How does that affect your ability to attain that dollar amount of revenue increase?

In the short term, that overall amount would then be decreased.

So it's a per-kilowatt-hour --

Yes.

-- increase, and that's about 7.5% or -- did you say?

Yes. And that would then drive our overall returns, and that would -- obviously then, we'd factor that in. We'd look at our rate case strategy, and in a worse case, if the numbers were significant, would drive future rate filings.

Okay. So in terms of how we would think about the sensitivity of your -- so if for some reason your fuel bill or other bills go up and that's a fixed amount and then your kilowatt-hour usage declines, even though you've got a rate relief on the -- because you're getting -- you're selling less kilowatt hours, you're still going to have a squeeze on margins if that would be the case.

There would be, but our fuel and purchase power costs here in Minnesota, we have a fuel adjustment clause -- those could always run through to our customers.

The other thing to remember, too, is about 55% of our revenue comes from our industrial class.

Right.

And those customers are under contracts for a certain amount of take --

Yes.

-- or demand. So, really, in the short term, if you will, a slowdown in the economy would more than likely affect the residential and the commercial, which, in our case, is a pretty small segment, about 30%.

Okay.

All of our large customers have individual contracts with us that they nominate demand and energy requirements on a periodic basis.

Yes. And then do you talk about what those contracts, like the minimum/maximum loads, and revenues that those contracts specify to you?

Yes, that's all included in our 10-K.

Okay, I'll have to look at that. Okay, thanks very much.

There's a table there that gives each one of our large power customers, amount of what we have under contract, and the length of that contract, too.

Okay, great. Thanks.

You bet.

And, Mr. Shippar, with no further questions, I'd like to turn it back to you for any additional or closing remarks.

Thanks for your questions this morning. At the halfway point of 2008, our year-to-date earnings are on track to meet our year-end expectation of between $2.70 and $2.90 per share.

We're managing our way through a very difficult environment for our real estate business, and while its earnings contribution will certainly be less than it was in 2007, it will be profitable this year. I think that's a noteworthy accomplishment given the current state of the real estate market. This business represents long-term value for Allete given our low-cost basis and the location of our properties in Florida.

Our energy business is in the midst of a period of substantial growth. Minnesota Power's rate base will more than double over the next five years as a result of our capital investment program. These capital investments will be recovered through a combination of current cost recovery riders and anticipated increased electric base rates. Our industrial customers within the taconite mining industry are also in the midst of substantial capital investments to meet growth and demand for their product.

During 2008, our customers have announced more than $450 million of new investments in their facilities that would result in an approximate 10% increase in production capabilities.

In addition, we could experience between 100 to 400 megawatts of additional growth from several potential new industrial customers planning projects within our service area.

One such example is Mesabi Nugget, whose new facilities are currently under construction. We expect Mesabi Nugget will begin production in 2009 and initially be a 15-megawatt customer with potential for future growth.

Our investment in the American Transmission Company will also grow as we participate in capital calls over the next several years.

All of us at Allete are excited about the prospects for our Company going forward. Thanks again for your time this morning, and I look forward to speaking to you in October, when we release our third quarter results, and again in December, when we disclose our outlook for 2009.

Ladies and gentlemen, that does conclude today's conference. You may now disconnect.