ALLETE, Inc.
Q4 2008 Earnings Call Transcript

Published: 13 Feb 2009

[Operator:]

Good morning ladies and gentlemen and welcome to the ALLETE Fourth Quarter 2008 Earnings Results Conference Call. (Operator Instructions) This conference may contain forward-looking statements within the meaning of the Federal Securities Laws including statements concerning business strategies and their intended results and similar statements concerning anticipated future events and expectations that are not historical facts. These forward-looking statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. The forward-looking statements in the earnings release distributed this morning reflects managements 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 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.

[Donald Shippar:]

Thank you and thanks for joining us this morning. With me is our Chief Financial Officer Mark Schober. Today we reported our fourth quarter and year-end financial results. For the year we earned $2.82 per share, which was within the guidance range we issued in December of 2007. I’m pleased that we were able to meet our financial expectations despite the difficult economic environment. At this time I will ask Mark to provide you with the financial details for the year, and then I will make some comments about our outlook for 2009 before we take your questions. Mark?

[Mark Schober:]

Thanks, Don. Before I get to the financial results for the year, I want to review changes we have made to our business segment. Effective with fourth quarter year-end reporting we have combined the regulated utility and investment in ATC segments into one, regulated operations. In addition, we combined the non-regulated energy, real estate, and other segments into the investments and other segment. These changes are reflective of how we manage our businesses and also take into account the anticipated, reduced relative earnings contribution from our real estate business going forward. My comments today will reflect our new segment reporting structure and I encourage you to refer to the 10-K we filed this morning for complete details. As Don mentioned earlier, we reported earnings per share of $2.82 for 2008, versus $3.08 in 2007. Earnings per share decreased about $0.08 from 2007 as a result of additional common shares issued during 2008 as we pre-fund our capital expenditure program. Net income decreased $5.1 million in 2008 from 2007. Regulated operations net income was up $5.5 million or $0.19 per share, while net income from investments and other declined $10.6 million, or $0.37 per share, year-over-year. Let me give you some details for each segment. The increase in earnings from regulated operations is primarily the result of higher rates and also higher income from our investment in ATC. As you know, we received a wholesale rate increase on March 1 and a retail interim rate increase, which is subject to refund, went into affect on August 1. In addition, we recorded current cost recovery revenue on our environmental retrofit projects. Total incremental revenue from rate increases and environmental current cost recovery was $40 million in 2008. Retail and municipal kilowatt-hour sales increased 2% for the year primarily due to an increase in sales to industrial customers. Overall kilowatt-hour sales were down 2% from 2007 because of a decrease in sales to other power suppliers due to the expiration of two sales contracts. We also experienced increases in operating and maintenance expenses, depreciation, and interest expense during the year. Much of this increase is directly related to the increasing size of our asset base. Within regulated operations, net income from our investment in ATC grew about $1.5 million or $0.05 per share over 2007. At the end of 2008 our investment balance in ATC was about $77 million. The 2008 decrease in net income from the investments and other segments was primarily due to a $15.9 million reduction in net income from ALLETE Properties. In spite of an extremely difficult market environment, ALLETE Properties was profitable in 2008, with net income of $1.8 million. During the year we recorded the recognition of deferred profit from prior year sales and the sale of a shopping center. This decrease was partially offset by a $4 million after tax gain on the sale of securities in the first quarter and the recognition of about $5 million in tax benefits in the third quarter. Our effective tax rate for 2008 was 34% and we expect it will be about 36% in 2009. Our balance sheet remains very healthy with $102 million of cash and cash equivalents at year-end and a 42% debt to capital ratio. We have had continued access to the capital markets and successfully issued equity and debt during 2008. Between December 15 and January 15 we issued $80 million of first mortgage bonds and three series coupon rates of 6.94% to 8.17%. Additionally, we have an unused $150 million committed, syndicated line of credit available. We are very well positioned for our cash flow needs. Don?

[Donald Shippar:]

Thanks Mark. At this point I would like to make some comments regarding our prospects for 2009. In early December we initiated our 2009 earnings guidance of a range between $2.10 and $2.35 per share on net income of between $67 and $75 million. Our guidance range includes a number of assumptions for the year which I will summarize. To begin, the current difficult economic climate has had its impact on ALLETE and its customers. Because of the slow down in domestic steel making, we expect a decline in taconite production in Northeastern Minnesota for 2009. As a result demand nominations for power from our taconite customers are expected to be lower by at least 25% than 2008 levels. In an effort to mitigate the earnings impact of these lower retail sales, we intend to remarket any available power to other power suppliers. In fact, this year we have already sold power at similar pricing levels which will largely offset the effect of the taconite reductions to date. We do expect, however, that we will have additional power to sell in 2009 if our taconite customers further reduce their demand. We will strive to continue to mitigate the earnings impact of this reduced demand, but we are unable to predict pricing levels on such sales at this time. In addition, we have begun to implement various expense reductions and will continue to do so as the economic conditions dictate. We will also closely manage our capital investment program and we do have flexibility with the timing of certain investments. We will not alter any capital expenditures that would result in a negative impact on our system reliability. We expect to receive an order on our retail rate case, now before the Minnesota Public Utility Commission in April. While we are unable to determine what the final rates will be, for the purpose of providing 2009 earnings guidance, we have assumed rates equivalent to the current interim rates of $36 million. Once the retail rate case has been completed we will adjust our earnings outlook, if need be, based on the impact of final approved rates, which may be higher or lower than interim rates now being collected. Our earnings guidance includes the impact of the January 1st Superior Water, Light and Power retail rate increase and assumes a rate increase for Minnesota Power’s wholesale customers beginning in the first quarter. We expect Minnesota Power will begin selling electricity to a new industrial customer, Mesabi Nugget in the second half of 2009. Mesabi Nugget has signed and the Public Utility Commission has approved a 15 megawatt contract with potential for growth. ALLETE expects the increase earnings from its investment in ATC due to a higher invested balance. We expect to invest another $5 to $7 million in ATC during 2009. Moving to our Real Estate business, ALLETE expects little or no earnings contribution from ALLETE Properties this year. Going forward our strategy will be to complete and maintain key entitlements and infrastructure improvements, which enhance values without requiring significant additional investment. We’ll manage the current property portfolio for maximization of value and cash flow. Our capital expenditure plan calls for about $300 million of new investment this year, approximately $100 million of which will be for current cost recovery eligible projects. We will continue to finance these projects with a combination of internally generated cash, debt issuances and our ongoing equity and issuance programs. As Mark mentioned, our balance sheet and liquidity are in great shape as we continue with our capital expenditure plan. By the end of this year we will have received the final order from the MPUC for our retail rate case. Mesabi Nugget should be in operation, our investment in ATC will have grown and we expect to have closed on the $80 million purchase of the DC line which will enable us to transport wind generated energy in North Dakota into our service territory. With regards to this initiative, we recently signed contract with Siemens to purchase turbans for the initial 75 megawatt phase of this project. Beyond 2009 and longer term we seek continued rate base goals as a result of our capital expenditure program including investments in renewable generation such as our North Dakota Wind initiative. We plan to make initial investments in ATC and expect increased electricity and real estate sales when economic conditions improve over time. This sort of power also has the potential to serve additional industrial customers which would result in significant growth. At this time we will ask the operator to open up the lines for your questions.

[Operator:]

(Operator Instructions) Your first question comes from Lawrence Solow with CJS Securities.

[Lawrence Solow:]

On the timeline for the current rate case on the retail side, I know you’ve mentioned you expect an order in mid-April.

[Mark Schober:]

Yes, that’s correct.

[Lawrence Solow:]

Wasn’t there some type of administrative lower jug report recommendation of some sort due out some time this month? Or maybe give an inkling of what was going to come out in April?

[Mark Schober:]

Yes, the administrative law judge will be making his recommendation to the commission late in February, but again that’s only a recommendation.

[Lawrence Solow:]

Is that recommendation made public though or?

[Mark Schober:]

It will be public information, yes.

[Lawrence Solow:]

Okay, so but, and that recommendation kind of could go either way from what the actual final outcome is or?

[Mark Schober:]

Yes. It is just a recommendation.

[Lawrence Solow:]

Okay and Don you mentioned there was actually another wholesale increase going into effect in January of this year. Was that on top of the one from last year?

[Donald Shippar:]

Yes, that’s correct. We file with [FIRK] to raise our wholesale rates and that is currently in front of [FIRK] and we expect a decision sometime in the next few weeks.

[Mark Schober:]

So it will go into affect, Larry in Q1. It is likely not going to be affective January.

[Lawrence Solow:]

Got it and then just looking out a bit, do you have any expectations for additional retail rate case filings?

[Mark Schober:]

That’s something we continue to look at and prepare for, especially looking at where our capital spend programs, so it is likely we’ll be filing with them in the next couple of years, but the actual dates have not been blocked in yet.

[Lawrence Solow:]

I know nominations are coming out in March or April of the next third of the year, right?

[Donald Shippar:]

Right, they have to notify us by March 1 for the period that will begin May through August.

[Lawrence Solow:]

Okay and have you gotten any indications from them anecdotally, at least, where levels are going to be coming down? It sounds like taconite may be coming down a little more, at least for the risk for that, but any more color to that or anything outside of taconite from your other industrial customers?

[Donald Shippar:]

No, there is no more color to it. Again, we’ll know by March 1. They have to obviously notify us by then and that will be their formal notification to us. As far as the other industrial customers, they continue to operate pretty much the same as they were last year. The papers, the pipelines, are very similar to what we saw last year.

[Lawrence Solow:]

Okay, great. Thanks guys, we’ll see you next week.

[Operator:]

Your next question comes from Adam Weissman with [Luminous].

[Adam Weissman:]

I just wanted to talk a bit about the CapEx program. It seems like looking at the K that you filed this morning there is a pretty big push out of the current cost recovery CapEx and it seems like there is, in the near term, a slight increase in the base CapEx. So it would seem as if it is probably going to be less CapEx that you guys can earn on immediately. Can you guys just talk about that and what that push out is about?

[Mark Schober:]

Sure. If you’re looking at the K you can see our CapEx that we put in there for the next five years versus where we were in ’07 is down a couple hundred million dollars. What we’re doing there is primarily pushing out some of our wind initiative so we continue to move on acquiring the DC line and that’s what you see in the base. It is included in the base for 2009. But then the actual putting in of the wind farms we have 75 megawatts that are scheduled in 2010, 2011 and that’s about it. The rest of it we’ve pushed out post 2013. We are still moving on it, the strategy is still in place, but based on where the economy is and where capital markets are we’re just being very conservative on our use of cash and as we again, as Don alluded to, we’re being very careful as we manage our capital spend program.

[Adam Weissman:]

Is it not possible to push out some of the other base and still grow the wind as the wind would be able to be recovered immediately?

[Mark Schober:]

Well we are looking at some of our base, but we’re in the midst of a fairly sizable conversion at one of our power plants, so we’ll obviously be completing that. We’re also involved in several duty cycle preservation projects. I think the other issue with the wind is our load growth has obviously been throttled back a little bit with the economy so when we looked at this six, nine months ago, we saw load growth that was quite a bit higher, primarily from some industrial projects that now we think is probably going to be moved out farther also. So that ties into the wind development also is just not having the kind of load growth that we saw, as I said, about six, nine months or a year ago.

[Adam Weissman:]

Okay my last question is on the dribble program and the equity. How is that going? How much do you anticipate needing and how much is already done?

[Mark Schober:]

We continue to issue through our dribble program. We plan on renewing that here with the board and continuing to issue it through 2009. Overall probably issuing similar levels to what we have last year. I think last year in 2008 was about $60 million. Our overall cash needs though, a significant chunk of them will be financed by internal cash flow, especially as we reduce our capital spends here.

[Adam Weissman:]

Okay great. Thanks and congratulations on a good quarter.

[Operator:]

Your next question comes from James Bellessa with D. A. Davidson & Co.

[James Bellessa:]

What is your best guess on the $80 million transmission line finalization and when might it be going into rate base?

[Donald Shippar:]

We plan on filing that for regulatory approval here in the next probably month or so, so then it’s really up to our commission when they approve that. We’re assuming that we’ll get the approval by the end of the year and we’ll be in rate base effective early in 2010.

[James Bellessa:]

Are you glad that the actual consummation of the deal and the perhaps rate basing has been pushed out? Or would you have preferred it to go quicker?

[Donald Shippar:]

Well, I mean the reason we’re a little farther out than we expected is, again, trying to get the final terms and all of the negotiations completed with [Menkota] so that’s just taken a little bit longer than we expected, but we’re there now, in essence and so that’s really the issue that’s pushed it out for us.

[James Bellessa:]

I believe you said your tax rate was going to be 36% estimated for 2009?

[Mark Schober:]

Right.

[James Bellessa:]

Is that down from 2008 and why is it down?

[Mark Schober:]

It’s going to be up a little bit from 2008 and the primary reasons are those tax benefits that we recognized in Q3. We recognized about $5 million in tax benefits as it will not be reoccurring in 2009, so that’s why we’re up a couple of percent.

[James Bellessa:]

And I assume there has been a reclassification of last years ’07 results, I should say, between the interest expense and O&M can you explain that?

[Mark Schober:]

Just a minor re-class. As we have looked at our expenses in prior years, just a better presentation we thought. So yes, there is a couple of million dollar re-class from interest expense to O&M and so now everything that you see in the case reflects that re-class, so 2008, 2009 are consistent.

[Operator:]

Your next question comes from Bernard Horn with Polaris Capital Management.

[Bernard Horn:]

I just need some clarification on your guidance where you talked about the taconite producers. Our current estimates, it sounds like, is that they will use about 25% lower power. You said that you were able to remarket the power. Does that mean that you have already remarketed the entire 25% reduction that you’re forecasting from them at the rates that you would have sold it to them at?

[Donald Shippar:]

Well yes. Just to clarify that, they nominate on four month blocks. So, we know what the nominations are for the period of January through April and through that point we have remarketed that power at pricing similar to what we would have gotten from those customers. Because we don’t know what the nominations are yet for the last two, four month blocks in 2009, we’re not able, at this point, to remarket that power in the market until we get those nominations.

[Bernard Horn:]

Okay so if assuming that they don’t come back for the rest of the year, you’ll still have another two month blocks of 25% that you have to market and then it will be just a question of… Do you have any read on the futures markets for power going from that month 5 to 12?

[Donald Shippar:]

Well, we’ve only got forecasts, again, of what that is. I think the other issue is we are selling some of that energy into the day ahead real time market, but the majority of what we’ve done so far is being sold to other utilities, so they tend to be longer sales in the terms of months, for example, versus the next day or for a week. It is a combination of those types of sales. Some will be reflected of what the market prices are, obviously, and some will be subject to negotiations with other power suppliers.

[Bernard Horn:]

Okay and I know there have been some announcements that, let’s say some of the Midwestern utilities were experiencing some declines in their demand. Assuming that you cannot sell the rest of the power for the last eight months, what impact would that have in terms of the amount of power that you’ll be selling and the potential revenue effect?

[Donald Shippar:]

Well I think the issue is not so much that we couldn’t sell it, because our cost basis is quite low, even relative to other utilities because of the nature of the generation. The real vulnerability is the pricing and whether that pricing replicates what we would get from those retail customers or is somewhat less than that or could be substantially less than that. We just don’t know on that, but I think the market would have to really deteriorate before we wouldn’t be able to sell power, because again, our cost basis for our particular generation is low.

[Bernard Horn:]

All right, but if we were to just say today we want to offload that power, what price, based on any futures market or any other contracts that you have, would you be able to sell it at relative to what the contracts dictate?

[Donald Shippar:]

Well today we still feel it would be relatively close.

[Bernard Horn:]

Okay. My other question I have is, you were talking about the CapEx program where you’re going to continue the DC line extensions. I’m assuming that you mean out to the potential wind farm locations. Is that the transmission line that you’re talking about?

[Mark Schober:]

What that means is, that is when purchasing an existing transmission line. We plan on purchasing that transmission line for about $80 million and we’re planning on completing that acquisition in 2009.

[Bernard Horn:]

Oh, okay. I though you were talking about that as an indirect relation to the wind.

[Mark Schober:]

And that’s the transmission line we will use then to ship our new generation from the wind farms we plan on putting up in North Dakota into our service territory. But they are related.

[Bernard Horn:]

Just as a capital budgeting question. When you decide to put either a whole farm up or a particular wind tower, are you assuming that you can sell that at whatever prices are required to give you the rate of return that you’re getting on your regulated assets?

[Mark Schober:]

Yes, the 75 megawatts that we’re moving on now, we’re asking for regulatory approval for. We’ll move forward as we get regulatory approval and that will become part of our rate base. So these are regulated assets that we’re moving on today. We’ll get what ever our allowed rate of return is from our regulators on those assets.

[Bernard Horn:]

And what is the margin on that, relative to the actual cost of construction and amortize over some reasonable life?

[Mark Schober:]

It will be what ever the allowed rate of return that we get from our regulators is.

[Bernard Horn:]

Okay so if it costs twice as much as it would to generate power from your other fossil fuel assets, the regulators would approve a double rate in order to allow you to get that rate of return?

[Mark Schober:]

As long as the costs are prudently incurred, they would approve the capital costs that we’ve put in the ground and then you have to take our capital structure and our load ROE against that to get what the incremental earnings would be.

[Donald Shippar:]

We expect what they will do is they will compare the projected costs we have for the wind energy compared to what they think is prudent and would be a substitute for that, because again, this is renewable that we’re compelled to do under the Minnesota renewable mandate program. So the comparison will really be against other renewable options or opportunities. Whether they come from us or from somebody else and that will be their decision on whether that project is appropriate.

[Bernard Horn:]

Right and if the ultimate cost to the consumer is twice as much per kilowatt hour as it would be from all your other generation, so be it, then they’ll let you charge that to get your acquired rate of return, is that right?

[Donald Shippar:]

That is right.

[Bernard Horn:]

Okay, because there have been some discussion about like in Spain and so forth where the government has promised those kinds of things and now with the difficulties in budgets and so forth, they’re backing off on those promises and I’m just wondering, do you feel that that is a risk? And, has that entered into your decision to defer the wind asset investments at this point?

[Donald Shippar:]

Well again, under this scenario we won’t go ahead with the project until we get approval. It’s all contingent on the commission approving this project as being prudent and telling us that they’ve approved it to be put into our rate base as it’s built and completed.

[Bernard Horn:]

Last question then, was there anything in the new stimulus programs in Washington that will help or hurt your business?

[Donald Shippar:]

Well we think the production tax credit will be helpful for the wind projects. The ongoing accelerated depreciation for projects will be helpful. Beyond that we haven’t thoroughly looked at all the other issues, but we don’t see anything specifically that would be of a great benefit to us beyond those two items.

[Bernard Horn:]

Alright, thank you very much.

[Operator:]

At this time there appears to be no further questions in the queue. I would like to turn the conference back over to our presenters for any closing remarks.

[Donald Shippar:]

Thank you and thanks everyone for joining us this morning. For those of you who are unable to join us on our analyst breakfast meeting next Thursday in New York, I invite you to listen to the web cast 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. Thanks.

[Operator:]

That does conclude our teleconference for today. We would like to thank everyone for your participation and have a wonderful day.