ALLETE Inc (ALE) 2017 Q2 法說會逐字稿

Good day, and welcome to the ALLETE Second Quarter 2017 Financial Results Call. Today's call is being recorded.

Certain statements contained in this conference call that are not descriptions of historical facts are forward-looking statements, such as terms defined in the Private Securities Litigation Reform Act of 1995. Because such statements can include risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements. Factors that could cause results to differ materially from those expressed or implied by such forward-looking statements, include, but are not limited to, those discussed in filings made by the company with the Securities and Exchange Commission. Many of those factors that will determine the company's future results are beyond the ability of management to control or predict. Listeners should not place undue reliance on forward-looking statements, which reflect management's views only as the date hereof. The company undertakes no obligation to revise or update any forward-looking statements or to make any other forward-looking statements, whether as a result of new information, future events or otherwise.

For opening remarks and introductions, I would now like to turn the conference over to the ALLETE President and Chief Executive Officer, Alan R. Hodnik. Please go ahead.

Good morning, everyone, and thanks for joining us today. With me are ALLETE's Senior Vice President and Chief Financial Officer, Bob Adams; and ALLETE's Vice President, Controller and Chief Accounting Officer, Steve Morris.

This morning, we reported second quarter 2017 financial results of $0.72 per share on net income of $36.9 million. When compared to the second quarter of 2016, our favorable results reflect interim rates associated with Minnesota Power's rate review, strong industrial customer demand and a timing-related but still very positive regulatory outcome associated with our Conservation Improvement Program, or CIP, financial incentive. With more than half of the year behind us, we now expect our full-year earnings to be in a range of $3.15 per share to $3.40 per share.

Before Steve and Bob go through the financials related to the quarter and share more details on our earnings guidance for the year, I would like to highlight several positive developments from the quarter. In June, we were pleased to announce that Minnesota Power's most recent initiative in support of its EnergyForward strategy. After much discussion and analysis, Minnesota Power brought forward a proposal which would, in total, add over 500 megawatts of renewable energy and renewable-enabling natural gas supply to its increasingly diverse and more balanced portfolio of generation. This proposal includes a $350 million investment opportunity that will allow Minnesota Power to add more renewable energy, while still adhering to key EnergyForward principles of affordability, reliability and environmental stewardship.

Minnesota Power and Superior Water, Light and Power's respective rate reviews have continued to advance. In working closely with the Wisconsin Public Service Commission, we are pleased to report that the SWL&P review was recently concluded with a 10.5% return on equity, a 55% cap structure and approval of all of SWL&P's recommended infrastructure improvements, including automated meter reading and gas distribution pipeline upgrades. The final order is expected in August of this year, at which time final rates will go into effect.

As we have emphasized in past quarters, one of ALLETE's strategic objectives for its regulated enterprises is to earn a fair return on investments made to serve respective customers. To date, we have worked diligently with regulators in Minnesota and Wisconsin to supply them with requested information that details the cost of service provided to customers, including compensation to our investors, who provide the needed financing in support of these essential services. ALLETE Clean Energy is making significant progress with its multifaceted growth strategy. The ACE strategy includes optimizing its existing 535-megawatt fleet of contracted renewable generation as well as expanding its national renewable generation presence with its $100 million investment in production tax credit-qualified turbines. Specifically, the ACE PTC strategy includes refurbishing qualified facilities within its existing wind portfolio, building new projects for quality off-takers with long-term power sales agreements, executing build-own-transfer projects for others and acquiring existing renewable energy projects from others, some with potential PTC-related refurbishment opportunities.

As disclosed in our 10-Q this morning, ALLETE Clean Energy has plans to refurbish 385 wind turbines at 3 wind farms in Minnesota and Iowa. This approximately $80 million reinvestment initiative will improve the turbine performance and reliability, generate federal production tax credits at each site and support the renewal of power sales agreements at the Storm Lake sites. Two previously announced projects that will provide future significant earnings and cash flow for ALLETE Clean Energy include the expansion of up to 50 megawatts of wind energy facility for Montana-Dakota utilities, and a new 100-megawatt wind energy facility to be built and operated by the ACE team to service a long-term power sales agreement with Northern States Power, a subsidiary of Xcel Energy.

The NSP Xcel initiative is still subject to final regulatory approval, which is proceeding well at the moment. I am pleased to report that Minnesota Power's taconite customers continue to operate at full production levels, and we are optimistic that market conditions will remain favorable for these customers into the foreseeable future. David Burritt, CEO of United States Steel, which owns and operates Minntac and Keetac iron ore facilities in Northeastern Minnesota, during the recent USS earnings call expressed optimism about the future and about likely Trump administration actions related to steel dumping. Minnesota senators Amy Klobuchar and Al Franken, along with Congressman Rick Nolan, continue to provide strong leadership in this area. We support the federal government's continued work to address unfair trade practices that result in excessive levels of imported steel coming into U.S. markets.

Meanwhile, during Cliffs Resources' recent earnings call, CEO Lourenco Goncalves expressed confidence in the iron ore industry. Goncalves highlighted a 15% year-over-year increase in revenues and also spoke about a sizable investment in next-generation iron ore products. Cliffs is investing approximately $700 million in a hot-briquetted iron, or HBI, facility in Toledo, Ohio. We are pleased for Cliffs and their investment in the Great Lakes region. As you know, most of Minnesota's taconite is utilized within the Great Lakes region and this upgrade in technology bodes well for Cliffs and for its iron ore mining operations in Minnesota. Minnesota Power is the electric service provider to all of Cliffs' operations here in Minnesota.

I will provide some additional thoughts on what lies ahead for the remainder of the year in a moment. But first, I will ask Steve and Bob to go through the financial details. Steve?

Thanks, Al, and good morning, everyone. I would like to remind you that we filed our 10-Q this morning and encourage you to refer to it for more details on the quarter. For the second quarter of 2017, ALLETE reported earnings of $0.72 per share on net income of $36.9 million and operating revenue of $353.3 million, compared to $0.50 per share on net income of $24.8 million and operating revenue of $314.8 million for the second quarter of 2016. Earnings were diluted by $0.03 for the second quarter of 2017 due to additional shares of common stock outstanding as of June 30, 2017.

Operating revenue from ALLETE's Regulated Operations segment, which includes Minnesota Power; Superior Water, Light and Power; and the company's investment in the American Transmission Company, increased $30 million or 13% from 2016. The increased revenue was primarily due to higher fuel adjustment clause recoveries, interim retail rates, financial incentives under the conservation improvement program and higher kilowatt-hour sales. Fuel adjustment clause recoveries increased $8.5 million due to higher fuel and purchased power costs attributable to retail and municipal customers.

Interim retail rates for Minnesota Power, which are subject to refund, were approved by the Minnesota Public Utilities Commission and became effective January 1, 2017, resulting in revenue of $7.8 million in the second quarter of 2017. We have evaluated the need for a reserve for interim retail rates and concluded that a reserve is not necessary as of June 30, 2017. We evaluate the need for reserves for interim rates each reporting period.

Financial incentives under the Minnesota Conservation Improvement program increased $5.5 million from the second quarter of 2016 due to timing of the Minnesota Public Utilities Commission approval. In 2016, the financial incentive of $7.5 million was recognized in the third quarter of 2016, upon approval by the Commission. Revenue from kilowatt-hour sales increased $4.7 million from 2016, primarily due to higher sales to industrial customers. Sales to industrial customers increased 20% due to increased taconite production and the commencement of a long-term power supply agreement with Silver Bay Power in June of 2016. Sales to residential, commercial and municipal customers decreased 3% due to warmer temperatures in 2017. Heating degree days in Duluth, Minnesota were approximate 5% lower in the second quarter of 2017 compared to the same period in 2016. Sales to other power suppliers decreased 15.3% from 2016 as a result of increased sales to industrial customers. On the expense side, fuel, purchased power and gas expense increased $14.1 million or 18% from 2016, due to increased kilowatt-hour sales and higher fuel costs. Fuel and purchased power expense related to our retail and municipal customers is recovered through the fuel adjustment clause.

Operating and maintenance expense increased $2.8 million or 5% from 2016, primarily due to higher salary and benefit expenses and a $1.3 million increase in Conservation Improvement Program expenses in 2017. Equity earnings in our investment in the American Transmission Company increased $1.2 million or 29% from 2016, due to additional capital contributions and period-over-period changes in ATC's estimate of a refund liability related to MISO return-on-equity complaints. ALLETE Clean Energy's net income increased $1.2 million, due to higher operating revenue and lower operating and maintenance expense compared to the same period in 2016. U.S. Water Services recorded net income of $600,000 for the second quarter of 2017 versus net income of $1 million for the second quarter of 2016. The decrease in net income was primarily due to higher operating expenses, partially offset by higher operating revenue. Bob will have a few more comments on U.S. Water Services' results for the quarter in a moment.

Our Corporate and Other segment, which includes BNI Energy and ALLETE Properties, included net income of $100,000 for the quarter compared to a net loss of $1.4 million in 2016. The change is primarily due to a lower accretion expense, related to the contingent consideration liability and lower interest expense. Net income at BNI Energy was $2 million in the second quarter of 2017 compared to $1.8 million for the same period in 2016. ALLETE Properties recorded a net loss of $400,000 in the second quarter of 2017 compared to a net loss of $500,000 for the same period in 2016.

ALLETE's effective tax rate for the second quarter of this year was 16.5% compared to 15.9% for the same period in 2016. We expect our annual effective tax rate in 2017 to be higher than 2016 due to higher pretax income. ALLETE's financial position is supported by increased cash flow and a strong balance sheet. Cash from operating activities was $184.4 million year-to-date and our debt-to-capital ratio was 43% as of June 30, 2017.

I will now hand it off to Bob for additional highlights and an update on our 2017 earnings guidance and outlook. Bob?

Thanks, Steve, and good morning, everyone. Last December, we initiated our 2017 earnings guidance at a range of $3.10 to $3.50 per share. As Al mentioned earlier, with more than half of the year now behind us, we have narrowed our earnings guidance range to $3.15 to $3.40 per share. Our updated guidance range reflects the additional dilutive impact from the shares already issued in the first quarter of 2017 to prefund ALLETE Clean Energy's previously announced growth initiatives using the $100 million investment in production tax credit-qualified turbines. In addition, lower heating degree days in Minnesota Power's service territory has impacted revenue from our original expectations with heating degree days approximately 8% below normal. We now expect capital expenditures for the Great Northern Transmission Line to be approximately $60 million for 2017, down from our earlier estimate of $120 million, impacting current cost recovery revenue in 2017. The reduction in 2017 is partially weather-related and later-than-planned completion of the transmission structure design phase of the project, which, of course, needs to be -- occur before the materials are ordered. We still anticipate the Great Northern Transmission Line expenditures to be approximately $300 million to $350 million in total and to be completed by 2020. Our guidance continues to include Minnesota Power's interim rate request of $32.2 million. The high end of our guidance range continues to assume the positive impact on depreciation expense for the Boswell Energy Center life extension request. At this point, we have not recorded any benefit of the Boswell Life Extension in our 2017 earnings, as we work with our regulators on approval of our life extension request.

As our rate case and the 2017 depreciation docket moves forward, we will evaluate the amount and timing of any depreciation expense reduction to be recorded. Minnesota Power's rate review continues to move ahead on schedule. Working with intervenors and further developments as the rate review has progressed, we now expect our final rate request to be approximately $49 million on an annualized basis. Minnesota Power participated in settlement conference meetings last week. We did not reach a settlement at that time, but will continue to work with intervenors in our rate review. Rate case settlements are not common in Minnesota, but we believe the constructive nature of the Minnesota regulatory environment supports reasonable outcomes. Next week includes evidentiary hearings with the administrative law judge. The administrative law judge report and recommendation are due in November. We continue to work with our intervenors and regulators to achieve a reasonable outcome in our rate filing and are committed to earn our allowed rate of return in the future.

As Al indicated, Superior Water, Light and Power's rate case has been completed in a manner that continues to illustrate Wisconsin's constructive regulatory environment. The filing concluded with an overall return on equity of 10.5% and a 55% equity ratio. On an annualized basis, we expect additional revenue of approximately $2.5 million. We anticipate new rates will take effect in the third quarter of 2017 upon receipt of the final rate order.

At our Energy Infrastructure and Related Services businesses, our earnings in total for the quarter were slightly higher than in 2016. ALLETE Clean Energy posted strong financial and operating results with higher revenue in the quarter, while keeping operating and maintenance expenses lower than in 2016. U.S. Water Services results for the quarter were impacted by weather conditions in the Northern and Western United States. Cooler weather impacted chemical sales for cooling towers found in industrial and building HVAC systems in the Northern United States. In addition, heavy rain delayed crop harvest and demand for product supply to food processing facilities in the Central Valley of California.

Also during the quarter, U.S. Water Services deployed resources and investment to support entry into the waste treatment and water safety application markets. Overall, our deal pipelines remain very robust for these segments, and we expect to grow these businesses in a disciplined manner in support of ALLETE's earnings and dividend growth objectives.

I remain excited about the future for ALLETE Clean Energy and U.S. Water Services. As demonstrated with ALLETE Clean Energy already gaining significant momentum with its strategy, these businesses will provide future earnings growth and strong cash flow for ALLETE. We remain committed to creating shareholder value with these businesses, focused on complementary earnings through our regulated businesses and cash flow in support of our dividend growth. Al?

Steve and Bob, thank you for the financial update. ALLETE is a growing energy company with a family of businesses that are well positioned to capture value. This, as we answer our nation's call to transform its energy and water landscape. We have a significant and stable foundation of regulated businesses, complemented by our growing Energy Infrastructure and Related Services businesses. I would like to share a few details on our latest initiatives.

Minnesota Power's positioning with its transformational EnergyForward strategy is progressing nicely. On July 28, Minnesota Power submitted a resource package to the Minnesota Public Utilities Commission, requesting approval for a 250-megawatt wind energy power purchase agreement, a 10-megawatt solar energy power purchase agreement and a 250-megawatt ALLETE-owned natural gas-fired generation investment opportunity. Minnesota Power also requested a delay relative to a filing deadline of its next Integrated Resource Plan submittal until February 2019. Minnesota Power is also making progress on its plan to move carbon-free hydro generation from Canada into its service territory with the Great Northern Transmission Line. Site clearing and preconstruction activities commenced in the first quarter of 2017 and Minnesota Power expects the line to be completed in 2020. Minnesota Power's portion of this investment is expected to be approximately $300 million to $350 million and is eligible for current cost recovery. Total project costs of $61.1 million have been incurred through the end of June on its portion of the line, which runs approximately 220 miles to the Canadian border.

Minnesota Power's taconite mining customers continue to operate at full production levels and incrementally higher than where they were at this time last year. Supporting further strength for the future is the Trump administration's focus on protecting our domestic steel markets by considering a number of options, including tariffs and quotas on imported steel. We applaud the attention given to address excessive levels of imported steel that negatively impact our customers and undermine our national security. PolyMet's proposed copper, nickel and precious metal mining operation in Northeastern Minnesota has completed its formal permit applications and has reported that the permit application review process is proceeding well. Minnesota Power could supply between 45 to 50 megawatts of new load under a 10-year power supply contract upon startup of the mining operation. Given it is first-of-a-kind nonferrous mining operation in Minnesota history, state regulators have been very deliberate. But PolyMet anticipates completing the needed land exchange and expects to receive final permit decisions later this year and into early 2018.

As anticipated in comments from our last conference call in early June, a federal bankruptcy judge approved a plan led by Chippewa Capital Partners LLC. The plan calls for Chippewa Capital Partners to take control of the former Essar project, now named Mesabi Metallics, subject to certain stipulations and timelines as part of a reorganization plan. Over $1 billion have been spent to date on the site, and startup of this operation could generate significant new wholesale load for Minnesota Power. Chippewa Capital Partners LLC has stated it plans to not only mine and process ore, but also to produce hot-briquetted iron, or HBI, which would be used in the fast-growing electric arc mini-mill steel segment of the steel industry.

Shifting gears from regulated operations, let me share a few thoughts on ALLETE's Energy Infrastructure and Related Services businesses. ALLETE Clean Energy is firing on all cylinders as it is becoming an established and respected project developer and operator of renewable energy facilities across the United States. ALLETE Clean Energy operates a significant portfolio of approximately 535 megawatts of wind generation and has a robust pipeline of other renewable projects it is currently weighing. As I mentioned earlier, ALLETE Clean Energy has plans to refurbish 385 wind turbines at 3 wind farms in Minnesota and Iowa. The approximately $80 million project involves installing select blades, gearboxes and generators on existing turbines at the Lake Benton wind site in Minnesota as well as the Storm Lake 1 and 2 wind sites in Iowa. The project will improve turbine performance and reliability, generate federal production tax credits at each site and support the renewal of power sales agreements at the Storm Lake sites. In sum total, the $80 million ACE investment could generate approximately $180 million in production tax credits, positively contributing to ALLETE earnings. This strategic investment will sustain ALLETE Clean Energy's position in the marketplace. The investment preserves earnings growth over the life of the 10-year production tax credits at a fraction of the cost of new development opportunities.

Already announced and discussed on our last call was the new wind energy facility of up to 50 megawatts to be built for Montana-Dakota utilities under a 25-year power sales agreement. The agreement includes an option for Montana-Dakota utilities to purchase the facility upon completion for a development fee. Construction preplanning and associated regulatory processes are proceeding well. And ALLETE Clean Energy expects to begin construction on the project in 2018. In March, ALLETE Clean Energy announced it would build, own and operate a separate 100-megawatt wind energy facility, pursuant to a 20-year power supply agreement with Northern States Power. Construction on this project is also expected to begin in 2018, subject to regulatory approvals. Our newest business to the ALLETE family, U.S. Water Services, provides integrated water management for industry by combining chemicals, equipment, and engineering for customized solutions to industrial and commercial customers in North America. We continue to believe in the nexus of energy and water and that U.S. Water Services, already a recognized nationwide solutions provider, is well-positioned to take advantage of the opportunities.

The ALLETE team continues to execute its strategy and remains focused on answering our nation's call, while growing ALLETE. ALLETE offers a strong value proposition for investors. We thank you for your continued confidence and investment with us.

At this time, I will ask the operator to open up the line for your questions.

(Operator Instructions) And we have a question from the line of Chris Ellinghaus from Williams Capital.

As far as CIP recognition goes, how should we think about that going forward? Is the second quarter now the operative quarter or is it still going to vacillate in the back end of the year?

Yes, Chris, Steve Morris. Second quarter was earlier than normal. We budget for it in the third quarter. Third quarter is, I'd say, typical, but it could slide into the fourth quarter, but I think you should stick with the third quarter.

Okay. O&M was pretty benign for the quarter. Can you sort of describe what the back end of the year sort of shape of O&M looks like? Are there any significant outages or anything?

No. I'd say we're on plan for O&M this year, and we don't see any significant timing differences with that.

Okay. I think you gave us the interim revenue increase for the quarter. Can you talk about what the impact of taconite was in the second quarter, in terms of maybe an aftertax benefit year-over-year or something like that?

Chris, we haven't disclosed that.

Okay. As far as the guidance range change, you were talking about weather and Great Northern sort of being a little bit delayed. Can you break that out? How much of that $0.10 reduction in the upper end of the range was the weather? And is that first and second quarter kind of combined?

So, Chris, Bob Adams here. So weather was about $0.07 in total. And the Great Northern was about $0.07 as well.

Okay. And as far as the delay in the Great Northern sort of capital plan, do you plan on picking some of that up in 2018, sort of that discrepancy?

Chris, this is Al. We got a little bit of a late start, of course, because the Presidential permit was issued so late in the year last year. So that was part of the cause here in terms of some of the delay. But we have every plan right now to stay on track to get the project done by 2020. We have contingencies built in for good weather and for bad weather, and right now I'm still fully confident we will get the project done on time with maybe some variations in capital, like you're seeing this year.

But that $60 million difference from the plan, does that get caught up in '18 or does that spread out over multiple years?

Likely to get spread out, Chris, over the subsequent years.

(Operator Instructions) We have another question from the line of Paul Ridzon from KeyBanc.

Is there another opportunity for settlement discussions in Minnesota? Or is this -- should we think about this it's going to go the fully litigated route?

So, Paul, this is Bob. You should think about it in this manner. We -- that would be the -- for the week that we plan settlement. So we're moving forward now next week with evidentiary hearings and ALJ in November.

Okay. Then the -- I think you have 100 megawatts of winds in kind of -- or turbines in storage, kind of what's the timeline look like for when some of the things you've bid into could be awarded? And are you anticipating if your IRP is accepted, that ACE could be a player in that?

This is Al, Paul. We see ACE participating more on projects across the nation, so -- not dependent on Minnesota Power, if you will, broadly speaking. So in terms of the pipeline, think more broadly outside the family, if you will, than dependency on Minnesota Power. With respect to the pipeline, nothing new to report other than very robust conversations about power sales extensions, as I said, relative to Storm Lake 1 and 2 with the refurbishment strategy. And then there's just a series of RFPs out there right now from a variety of companies. They themselves looking at the PTC issues and kind of their load growth, their kind of diversity of generation portfolio and kind of where they want to take their business, and so we see opportunities for ACE. We're not ready to disclose anything further at this point in time.

And the CIP was $5.5 million, pretax?

That's correct, pretax.

Yes.

So we should just put a 62% tax rate on that in order to get an EPS impact?

Yes, it's about $0.06.

And we have no further questions at this time. I would like to turn the call back over to Mr. Hodnik for closing remarks.

Bob, Steve and I thank you for being with us this morning, and we thank you for your investment in ALLETE. We look forward to seeing many of you this fall as we travel, and certainly we'll see most of you at the EEI Financial Conference in November. Thanks for your time this morning and your investment in ALLETE.

This concludes today's conference call. You may now disconnect.