ALLETE Inc (ALE) 2008 Q3 法說會逐字稿

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

Thank you. Good morning.

Earlier today, we announced our third-quarter earnings results $0.85 per share, compared to $0.58 per share a year ago. For the year, we have earned $2.04 per share, and we expect to close 2008 within our previously stated earnings guidance range of $2.70 to $2.90 a share.

Before we go through the quarterly financial results, I will update you on a few new developments. In September, Cliff Natural Resources, formerly known as Cleveland Cliff, and Minnesota Power signed new contracts for service to two of our industrial customers, Hibbing Taconite Company and United Taconite LLC. These agreements extend the existing contract terms to at least December 31, 2015.

Now, on a related note, last Tuesday, Cliff Natural Resources announced that, in order to bring production levels in line with demand, it will temporarily idle two small pellet furnaces at North Shore Mining, and one small pellet furnace at United Taconite. Due to the smaller size of these facilities and their contractual obligations to Minnesota Power, we believe the financial impact of these temporary shutdowns will be immaterial to our earnings in 2008. We are actively involved in ongoing discussions with our large industrial customers who indicate that, while changes are occurring rapidly in their markets, they are bullish on their long-term outlooks.

Turning back to the subject of contracts, as of September 30, Minnesota Power has signed new contracts with 15 of its Minnesota wholesale customers and 2 private utilities in Wisconsin, including Superior Water, Light And power. The new contracts transition each customer to formula-based rates, which means they can be adjusted annually based on changes in cost. All of these contracts are regulated by the Federal Energy Regulatory Commission.

With respect to our retail rate case filed with the Minnesota Public Utilities Commission, new interim rates representing a 7.5% increase went into effect on August 1. The rate case schedule was approved in August, and all scheduled public hearings were held in September and October. The final rate order is expected during the second quarter of 2009.

Last quarter, we announced plans to develop several hundred megawatts of wind energy in North Dakota and purchase an existing 250 kV DC transmission line to transport this wind energy to our service territory. This project will allow us to meet and even exceed our state-mandated renewable energy supply requirements.

In September, we signed a definitive agreement to purchase the transmission line for approximately $80 million. This transaction is subject to regulatory approvals and is expected to close in 2009.

At this time, our Chief Financial Officer, Mark Schober, will provide some of the financial details for the quarter, after which we will take your questions. Mark?

Thanks, Don, and good morning, everyone. I'd like to spend a few minutes to highlighting the major financial contributors for the quarter, and I refer you to our third-quarter 10-Q for complete details for the period.

As Don mentioned, for the quarter, we earned $0.85 per share, compared to $0.58 during the third quarter of 2007. The $0.27 per share improvement was comprised of $0.13 from the regulated utility, $0.02 from our investment in the American Transmission Company, and $0.15 in our Other segment. These are offset by a $0.03 decline from our remaining businesses, including dilution because of the increase in shares outstanding.

The regulated utility business recorded net income of $16.7 million during the quarter, up $3.7 million from a year ago. Revenue from increased wholesale rates, new interim retail rates in effect since August 1, and current cost recovery riders, was up $11.3 million compared to last year. Offsetting these items were lower revenue from sales to other power suppliers and higher operating and maintenance, depreciation, and interest expenses.

Kilowatt hour sales to retail and municipal customers increased by 2% over the third quarter of 2007, mainly due to a 4% increase in sales to industrial customers.

Income from our investment in ATC was up $600,000 from last year, due to our larger investment balance this year. As of the end of September, we had an equity investment balance in ATC of $73.9 million. For your information, today we are investing another $2.3 million into ATC, bringing year-to-date investment to $7.5 million.

We recorded $200,000 of net income at our real estate business during the quarter, down $400,000 from the same period a year ago. As of the end of the quarter, we had approximately $800,000 of deferred profit on a balance sheet, which we expect to recognize as income during the fourth quarter.

This has been a difficult year for the real estate market. We think it's quite an accomplishment to show profitability during this challenging period.

Income from the Other segment was $4 million higher than last year's third quarter. This quarter, we recognized a $2.4 million tax benefit on a previously uncertain tax position due to the closing of a tax year and a $2.9 million tax benefit due to the completion of an IRS review. These resulted in an effective tax rate of about 25% for the quarter, compared to 33% last year. Our effective tax rate year-to-date is 32%, and we expect it will be around 34% at the end of the year.

Turning to the balance sheet, we are in a favorable position with $78 million of cash and a debt-to-capital ratio of 41%. In addition, we've committed lines of credit of $150 million, which we have not tapped. With respect to cash flow needs, we believe we are very well positioned and project sufficient capital availability in the immediate term.

Don?

Thanks, Mark.

Before we take your questions, a couple of additional comments -- as Mark said, believe we are well positioned to meet our cash flow needs. Most of you are aware that Allete is in the midst of a significant capital investment program and that, over the next five years, we plan to finance approximately half of it with internally generated cash and the remainder with a combination of debt and equity. We also have flexibility in the portion of our capital investment program that deals with and addresses future years' renewable energy initiatives.

At this time, we will take your questions. I will turn it back to the operator.

Thank you. The question-and-answer session will be conducted electronically. (Operator Instructions). Larry Solow, CJS Securities.

Can you just maybe, on your guidance, I hate to nitpick, but considering their wide range would be like 66 to 86 for Q4, if you just plot that into your full-year guidance, do you think maybe we can kind of assume it's going to be mid to upper end of that guidance, or why would there be such a wide range for Q4 then?

Yes, there are a couple of things that are going on Larry, and why we didn't take our range and we are going to leave it at the $2.70 to $2.90 -- is a couple of things that are happening in the quarter, and Don touched on the first one -- just a bit of the uncertainty in the taconite market and the impact on our industrial customers.

Then also, we do have some transactions in our real estate business that are scheduled for close later this year. Again, due to the uncertainty in the real estate market, they may or may not close. So that's why we are leaving it at that range, and we realize it's relatively wide but that's just the best we can do as of this point.

I got you. Then on ATC, I understand, I fully understand how it's going up because of your increased investment, but it seems to even take a little further leg up. You have kind of been tracking up $100,000 a quarter and it went up like $400,000 sequentially. Is this kind of a sustainable level, or do you think it would maybe tailback a little bit next quarter?

Are you looking at the investment (multiple speakers)?

(multiple speakers) net income.

Net income -- no, it will continue to trend up like that. It just simply bumps -- you'll see increases as we make our investment. So we will have, like I say, the money we are putting in today, that will certainly increase earnings then for Q4. But we will have a better idea then once we get information from ATC on '09. So it's probably a typical trend.

I got you. Then lastly, on real estate, looking out, I know you're not giving '09 guidance yet, but just assume you had no sales. It's like revenue was basically close to 0. What would your kind of potential loss be in that segment?

Yes, we've talked a little bit about this before, realizing that we have a couple of events in 2008 that will not be re-occurring. Our deferred profit will be all recognized by the end of the year, and we will not be, obviously, selling another shopping center, Winter Haven. So if we look at the business, assuming no sales and assuming we do nothing to manage our carry costs down, the total amount is about probably around $5 million after-tax. A big chunk of that is obviously property taxes and assessments on our real estate in Florida. But that is something that we are looking at and certainly working to minimize those costs to the extent we can.

I got it, okay, great. Thanks a lot.

Bob Chewning, Davenport & Co.

Good morning. First of all, on the guidance, the $2.70 to $2.90, is that a GAAP or an operating EPS number? Does that include the $0.15 gain from the tax items in the quarter?

Yes, it's GAAP. That will be our reported results for the year. Yes, it does include both of the tax items that I commented on a few minutes ago.

Okay. Secondly, can you give us some sort of sense in terms of regulated utility margin? How much of that is coming from the taconite sector?

It's typical. As we've talked in the past, Bob, we are kind of a unique utility with our revenues and our margin. We are almost half of -- on the regulated utilities side of the business come from our large industrial customers.

Okay, but that would include other sectors as well and number of products, etc.?

That's energy from our regulated utility -- about 540, close to 50% of it comes from our 12 industrial customers.

You're right, Bob. It includes paper customers as well as taconite producers.

All right. Lastly, can you give us -- given that you all are going to be going to external financing market, debt markets, can you give us any sense today as to what you're seeing as a current new issuance cost?

Yes, we are looking at issuing some additional debt by the end of the year, and then obviously some more into '09. The numbers we are seeing range probably between 8% to 9%, 9 .5%.

Okay, and that's a long-term maturity?

We are looking at 5 to up to 20 Years, depending on what those rates look at. We haven't decided on what terms or the length of the bonds that we want to put out, looking at what will fit into our current debt maturity.

For your information, we have no debt maturities until 2013, so we certainly have some room here to --.

Right. Okay, all right. Thanks a lot.

(Operator Instructions). Eric Beaumont, Copia Capital.

You know, one of the questions was answered; it was just the tax thing. But one thing I really -- it's pretty easy -- you know, this quarter it was nice to see how the [MURP] and the other mechanisms really fed into utility earnings. I think that with the rate increase, we could really see the strength of utility, where we expect it to be. We can all make our assumption in real estate and ATC.

One thing I want to know, though, is you've had a very strong year in the Other category, both from the tax benefits and the gains on the short-term investments you had earlier in the year.

Correct.

I'm trying to understand how I should normalize that, going forward, and think about the "Other" category. You know, these tax reversals, is there anything that is kind of an ongoing mechanism, or tax change is going to be carrying forward? How should we think about kind of the short-term investment gains you had earlier in the year (multiple speakers) how that goes?

Yes, all those are not recurring, so as you start looking forward, you need to take out the gains that we had in Q1 from the grantor trust, and then both of these tax benefits that I mentioned which are about $5 million. So those are not recurring.

Okay. Just otherwise as far as -- you know, obviously, you've touched on capital markets, but given you have a little bit of a slowdown in the tax (inaudible), it might -- is anticipated just to be short-term. Do you have any expectation shifting on any of the capital expenditures you have outlaid for '09, or is that still pretty much as expected?

Well, I think what we're looking at and we've got flexibility built in, is some of the staging of our renewable projects. We've got, as you know, several renewable projects, particularly wind development, that we're looking at in the next several years. So we have some options and flexibility in how we can stage those projects. I don't know those are the kind of things we are looking at. We do plan though to complete some of our environmental projects that are, for example, at our Boswell station, are in year three of a three-year plan, so we will complete that and some other CapEx, maintenance CapEx operations obviously. But the real flexibility we have is in some of those renewables, and we can expand those out, if necessary.

Okay, I appreciate it. Thanks. Oh, and one last thing -- when should we be expecting '09 guidance out of you?

We will be issuing '09 guidance sometime in early December.

Great, thank you.

James Bellessa, DA Davidson & Co.

Good morning. The tax issues that you've already called out this morning -- did you know about those going into the quarter? If you knew about them, they were significant enough for the quarter, why wouldn't you call them out earlier?

We knew those issues were out there, Jim, but it's beyond our control as far as when they would be dealt with by the tax authorities, so we didn't know when they were going to be addressed. As a matter of fact, they are a little bit earlier than we anticipated. We anticipated one of them would've been dealt with in 2009, and we don't know which way our regulators are going to go. So the actual amount and timing are beyond our control. That's why we couldn't give any additional guidance.

Don, in your narrative, you indicated something about a different profit to be posted in the fourth quarter, I think the real estate. Can you go over that again, please?

That was Mark, and Mark will go over that.

What we have left on our balance sheet, Jim, is our deferred profit from prior sales at real estate. We can't recognize that until we complete development obligations. Right now, we are completing those development obligations and plan on completing them by the end of the year. So that remaining $800,000 of deferred profit that's on the Q3 balance sheet will come through the income statement, and we will recognize it in Q4 -- or at real estate.

The tax rate is up 34% for the full year. Is that unlikely to be that low going forward? What might be a good expectation for '09?

I don't have that number yet. It would be higher than that. I would guess 35%, 36%. But that's a number we will give you when we give our '09 guidance here in December, Jim.

Do you see any pushback in this transmission line negotiations and finalization of that, and regulatory approvals? You are now saying "expected to close in 2009". Originally it said it could have been the end of '08/early '09 and now you're just saying '09.

No, we don't see any change at all. We continue to work with the Square Butte Group and with Minnkota on that, and things are moving ahead. The timing is more around when we would file that for approval and when we expect to get approval and ultimately close it. So that really drives the ultimate closing. But no, there's no changes in direction or negotiation. Everything is moving ahead.

Thank you very much.

Bernard Horn, Polaris Capital.

Good morning. Three questions -- first, on the taconite producers, how quickly do you know or how much can you forecast ahead their demand? Will it affect your ability to optimize the utility generation so that you can try to balance offloads and so forth?

The second question is, how do you think about the CapEx staging that you were talking about with respect to your alternative and wind projects? I mean, are you -- I guess my question is really how do you think about the real economic value of those projects, as opposed to the tax benefit you get from them? Is it likely that, with current fossil fuel prices, that those projects just don't make economic sense any more, despite the tax benefits, and so you'll wait for the oil price to get to a certain level before it makes sense to go ahead with them?

The third thing is just an observation, generally speaking. On this question of disclosure on the tax issues, I guess, as an owner or shareholder of the Company, if you do know something, it's better I think for shareholders to at least disclose it and say "Hey, look, and here's the issue, here's how much it might impact us, and by the way, we don't know which way it's going to go or when it's going to happen, but at least knowing it is better than being surprised by it." So, that's just an observation.

So I will let you answer the questions.

Okay. Well, on the taconite side, these customers typically nominate in increments, if you will, of what they expect to do in going-forward periods. typically, those are broken out in four-month periods. So we would know, at the point in time when they nominate for that next period, what their plans are, production plans are during that time period. They make certain commitments for that time period that, if they are to change or to not run at those levels, then they are obligated under the contracts to still pay us for some portion of that demand revenue. So, that's typically how that is laid out along those periods.

Of course, we have access to the MISO market and obviously we can sell energy into the MISO market. We can do that either in the real-time market, day-ahead market, or the longer-term if we obviously have an indication that we're going to be surplus, if you will, for several weeks or several months. So that's typically how those transactions are noted and how they are put together.

On the wind initiative, all of the issues you raised I think kind of are into that, and additional issues, such as under the mandate in Minnesota, we have to have 25% renewable energy by 2025. There are certain milestones or steps we have to make along the way, so that, for example, by 2015, we have to be at a certain percentage; by 2018, we have to be at a higher percentage. So we have to phase into that and be at those certain points as we move towards that 2025 date. We are currently at about 11% renewables, so we are in a pretty good position, relative to the mandate and where we stand, so that's where some of that flexibility comes in where, if we feel the need to delay some of these projects, obviously we won't make as much progress, but we still don't feel like we will be vulnerable, if you will, to not making those milestones.

Your point about the production tax credits is important also in that, as you know, they've only been extended for this year. Hopefully, our expectation ,I'm sure along with many others, is that there is an extension of those into the future, because they are an important part of this whole economics of the wind energy. I don't know if, Mark, you have any other comments on the tax issue.

No. The only other thing I would really call your attention to -- and I know it's difficult reading, but we do talk about our tax positions in our income tax note, and do talk about these uncertain positions, but it's a thick read, but the information is in there. But we will look at enhancing (multiple speakers).

I will look at that.

Okay.

Just on the taconite, going back to taconite to follow-up, where are we in this four-month nomination period? Are you coming to the end of it or is it rolling?

We will come to the end of one here I think this calendar year, and they will be nominating then sometime in November for the next period.

Okay, but as far as you can tell up to this point and looking out between now and the end of the year, have they started reducing their -- I mean it's clear that steel consumption around the world is starting to throttle back quite hard. My guess is that they would probably be affected by that somehow. I'm just questioning how you can -- you can give us any guidance as to which way they are looking right now?

Well, the only guidance we can give you is what they've told us, and that's, to this point, has been what Cliffs has communicated to us, which of course we just talked about here in our guidance. Again, we don't have any other -- I want to say upfront information until they actually have to make those nominations and inform us of what their intentions are.

Then on the wind, and then I will stop, but how does the wind energy -- I mean, if you get 11% from renewables right now, how does that affect your generation cost? How should we think about your profitability going forward? Now, let's suppose you do go right up to 25%. Does that mean that you're going to become less profitable because of this, given alternative energy costs?

No. Really, I look at it the same as any other utility investment. Our plans at this point for the wind are to own those assets, rate-base those assets so that they become a regulated asset, so our profitability would be based on the rate of return we get from our regulators.

Even -- but if you had two generation assets, you put them both into the rate base and you get a return on that --

Correct.

Doesn't it -- doesn't your profitability also depend on how profitable those -- how efficient those units are? You could be ultimately more profitable with one type of energy generation versus another.

No, because it's ultimately based on your regulated rate of return and your revenue requirements, and what you need, what your regulators grant you.

(multiple speakers)

It's really a matter of cost, I think what you're driving at.

So in other words, if you're given a rate of return on something and it costs more to do it, does that mean that everybody just pays more for their electricity?

In essence, that's it, yes. As the cost of those resources go up, they go into the rate base and then everybody's costs track that (multiple speakers).

Somehow the efficiency of that generation winds up becoming embedded in the costs; it's not just a capital, a return on capital?

That's where the earnings come from. The actual costs then, if you look at whether it's fuel for our generators, that flows through our fuel adjustment clause out to our customers, versus wind, we will have a higher capital cost but lower or nil.

Operating costs.

Yes. Variable costs, correct.

Okay.

Yes. We don't want to leave the impression that the wind certainly is more costly in all cases than fossil fuel. I mean, I think if you look at the cost of new coal generation for example, wind is a pretty attractive cost relative to building new coal generation.

Okay, that's helpful. Yes, that's good to know, because I'm assuming that, in some ways, the cost of wind is inherently more expensive, so that's good to know. Thanks very much.

Todd Vencil, Davenport.

A quick question on the real estate segment -- maybe I missed it, but I didn't see the backlog information in the Q.

Yes, it's still in there.

It's still in there, okay. Well can you just give me the bottom line number at the end of the quarter?

Oh, I don't have that with me, but we can get it to you, Todd. But it is in the Q.

Alright, I will just dig through. Can you talk about what you might have seen in the quarter, in terms of contract renegotiations or delays?

Well, there was minimal activity during the quarter, no incremental cancellations. We didn't sign anything new, either.

Perfect. Thanks a lot.

So, minimal changes.

Okay, thanks.

[Brendan Nice], [Levin] Capital.

It's actually Neil Stein. I just had one question, and it might be a little bit repetitive so bear with me.

If you look at your guidance, the $2.70 to $2.90 for this year, can you just summarize these sort of nonrecurring type items that are in there? I guess there's a small sale. You know that for sure can't happen again next year. Then there are these tax items as well, which I guess are around $0.15.

Yes, the items that are nonrecurring -- in real estate, on the real estate segment, there's two. One is the sale of our Winter Haven shopping center, and also deferred profit that was on our balance sheet that has come through income during the year.

How much do those add up to in EPS?

I don't have it in EPS. Looking at it from a net income standpoint, I believe the shopping center was probably about $3 million. I think deferred profit was probably about $2 million.

$3 million, okay.

Then in the "Other" segment, there are two items. One is the sale of some of our investments that you talked about, and that's about $4.5 million.

Right.

And then these tax benefits, the two of them that we talked about that were both recognized here in Q3, and those total about $5 million, net.

Okay. I'm looking here. Yes, I guess you have a round 30 million shares outstanding so I'm just doing --.

Right in there, yes.

So there was $4.5 million related to what?

That $4.5 million related to -- that's again in the "Other" segment. That's assets that we had in a benefit plan trust earlier in the year that was really out of sync with our allocation. We liquidated those assets and reinvested to meet defined allocation criteria. That happened in Q1, so you see details for that earlier in the year.

Okay, oh, and then there's also the tax items?

Yes.

Okay, so these add up to about $0.50 a share. So, it seems like maybe a good baseline to think about when we are forecasting into '09 would be maybe staying closer to, like, $2.30 or $2.35?

I haven't looked at '09 yet, but those are the five items that you would have to factor in as nonrecurring. Correct.

I got it. Okay, well thanks very much for clarifying.

Larry Solow.

Just quickly, you talked about [you'd steal] unrelated taconite. Have you heard anything else from any of your other customers, your large customers, any indications of cuts in production?

Not at this point, as far as being formally notified that they have. I mean, we certainly know and I think as the steel companies' earnings releases this past week, they indicate they are looking at their production levels, etc. But at this point, we've not received any formal notifications of any cutbacks other than what we've talked about from Cliffs.

I got you. Then just assuming that there's some modest cuts, there would be a good likelihood that you would be able to just -- I don't know if it would be at a little bit of a loss, but you would be able to just turn around and sell that into -- through MISO into the wholesale market, correct?

Yes. That's important, that the energy that is not needed to serve those customers, we certainly would look to the market to sell that energy. Of course, the market has been a pretty strong market for energy and through MISO. So yes, that would be our effort that we would look to.

Okay. Then in your CapEx plans, I think you guys outlaid in a recent slide showed that I had seen kind of like $325 million number for '08 or $323 million to be exact. That would kind of imply like $%115 million in capital expenditure in Q4. Are you still on target for that, or --?

Yes, yes.

Great. Then last question -- ATC, did they recently have a rate case over the last 12 months, or that 11% number? Or are they up for a rate case, or what's the status there?

No, ATC really has -- their rates are set on a forward-looking basis (inaudible) with a true-up at the end of the year. That's the arrangement they have under the FERC regulation.

Okay. Okay, great. Thank you.

Todd Vencil.

I found the backlog information. Sorry, I hadn't seen that before.

Yes, Page 34.

Yes, I found it. Here's my issue, though. I'm looking at the number and it looks like there's $12 million -- $12.4 million of backlog. I believe that number was about $22.5 million last quarter. It appears that there was a pretty significant fallout in commercial square-foot [town center] if my Q2 numbers are right. Am I remembering that right?

I don't remember from the quarter. I know the big one that fell out was our [low] transaction that came out last quarter. That was the big one.

This was about 260,000 square feet commercial and about $8 million.

Yes, I would have to look back, Todd. I don't recall what dropped out during the quarter.

Okay, thanks a lot then. I'll follow up offline.

James Bellessa.

Yes, with the macroeconomic conditions like they are, I wouldn't be betting that anybody is believing real estate is going to turn up anytime soon. What can you tell us about your business there down in Florida, and what can you tell us about your strategy to look for other real estate elsewhere?

Yes, I would tend to agree with you, Jim. We are not expecting any kind of a rapid turnaround, certainly in real estate. There is nothing to indicate that that's likely to happen and certainly not next year.

We are assessing where we are in Florida obviously, and we continue to assess that. We still continue to look for some opportunities in Florida as well as the Carolinas to buy. These would be relatively small types of opportunities. We think that, with some of the settling out of some of these, in some of these developments, we feel ultimately will have to be sold or somehow liquidated that there may be some very attractive buying opportunities for us. So that is why we continue to look for those and will continue to look for those in the next year.

Thank you.

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

Well, before we conclude the call, I want to let you know that our next planned conference call will be in February when we release our year-end 2008 earnings. Also, we plan to issue an 8-K and press release in early December in which we will initiate our 2009 earnings guidance. We will advise you when we set these dates.

So, thanks for joining us and I look forward to speaking again with you in February.

Ladies and gentlemen, that does conclude today's conference. We appreciate your participation. You may disconnect at this time.

Okay, thanks a lot then. I will follow-up off-line.