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ALLETE, Inc. (NYSE:ALE)

Q4 2009 Earnings Call Transcript

February 12, 2010 10:00 am ET

Executives

Donald Shippar – Chairman and CEO

Mark Schober – SVP and CFO

Al Hodnik – President

Analysts

Larry Solow – CJS Securities

Vedula Murti – CDP

Eric McCarthy – Praesidis Asset Management

Neil Stein – Levin Capital

Operator

Good day, and welcome to the ALLETE fourth quarter 2009 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 the 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 the 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 view 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 openings remarks and introduction, I would now like turn the conference over to ALLETE Chairman and CEO, Donald Shippar. Please go ahead, sir.

Donald Shippar

Good morning, and thanks for joining us today. With me are ALLETE President, Al Hodnik; and, Chief Financial Officer, Mark Schober. Early this morning, we reported our 2009 year-end financial results. Excluding a $0.15 after tax charge for rate refunds related to 2008, we are in $2.04 per share, which is within our previously stated guidance range of $1.95 to $2.05.

While ALLETE's financial performance for 2009 was certainly below the expectations we had at the beginning of the year, I would like to point out a number of accomplishments and successes that did occur. In December, we closed on the purchase of the direct current transmission line that extends from Center, North Dakota to Duluth. We view this line as a tremendous strategic asset that gives us the ability to transport electricity from wind generation we are beginning to develop in North Dakota to our service territory here in Minnesota. Al Hodnik will comment on our wind development plans later on this morning.

Also in late 2009, a new industrial customer for Minnesota Power, Mesabi Nugget, began operations. Mesabi Nugget is our first quarter new industrial customer in many years, and is operating under a take-or-pay contract with Minnesota Power through 2017.

During the year, we completed the significant environmental retrofitter at our Boswell 3 generating station. The emission control project, which will help Minnesota Power meet environmental mandates began in 2006, and required nearly $15 billion of capital investment. In late October, we entered into a 10-year agreement to sell 100 megawatts of capacity and energy with Basin Electric Power Cooperative. The transaction is scheduled to begin in May.

2009 was a difficult year. Given the cards that were dealt, the significant decline in sales to our taconite customers, less than favorable rate case outcomes in Minnesota, and a weak Florida real estate market, I'm proud of how our company handled the challenges of 2009. Taken into account the accomplishments I mentioned earlier, a better market for our taconite customers, in our belief that we will receive a more reasonable final decision with the current Minnesota Power retail rate filing. The stage is set for an improved 2010.

Now at this time, Mark will provide you some of the financial details.

Mark Schober

Goods morning. Before I begin, I'd like to note that we filed our 2009 10-K this morning. I encourage you to refer to it for the financial details of the year. For the year, ALLETE earned $1.89 per share and net income of $61 million, compared to earnings per share of $2.82 and net income of $82.5 million in 2008. There are four items that make up the majority of the $0.93 per share year-over-year decrease.

First, during 2009, we recorded $4.9 million after tax or $0.15 per share charged for the 2008 portion of customer refunds related to the 2008 rate case. This charge was excluded in our 2009 earnings guidance. Second, we had $0.19 of dilution in 2009 from the issuance of common stock during the year as we funded our utility capital expenditure program. Third, in 2008, we recorded net income of $9.6 million or $0.33 per share for tax benefits and a gain on sale of securities that did not reoccur in 2009. And fourth, in 2008, our ALLETE Properties business earned $1.8 million, which included the sale of a shopping center and the recording of deferred profit from prior year sales. This year, ALLETE Properties had a net loss of $4.7 million. The year-over-year difference was a $6.5 million decrease for $0.22.

Let me now provide some details about our business segments. Regulated operations, which includes Minnesota Power; Superior Water, Light, and Power; and, our investment in the American Transmission Company earned $65.9 million in 2009, which was $2 million lower than last year.

Total kilowatt-hour sales were down 4% from a year ago, and included a 38% decrease in sales to industrial customers. Sales to our taconite customers decreased substantially in 2009 as they curtailed production during the year. These customers produced about 18 million tons of taconite in 2009, compared to virtually full capacity of 40 million tons in 2008. We were able to offset most of the loss margins that resulted from the lower industrial sales by selling the available electricity to other power suppliers.

Total operating revenue decreased $30.4 million or 4% from 2008 due to lower kilowatt-hour sales; lower fuel and purchase power recovery; lower gas revenue at Superior Water, Light, and Power; and, the 2008 rate case related refund. These are partially offset by higher FERC approved wholesale municipal rates and increased rider recovery revenue.

Fuel purchase power expense decreased $26.1 million, compared to 2008 as a result of lower kilowatt-hour sales and lower wholesale electricity prices. Operating and maintenance expense was $3.5 million less than last year. Lower natural gas costs to Superior Water, Light, and Power were partially offset by higher salaries, benefits, rate case, and plant maintenance expenses. Depreciation expense was $9.5 million higher than 2008 as a direct result of increases in property, plant, and equipment. Interest expense was $4.3 million higher due to additional long term debt issuances as we funded capital investment programs.

Earnings through our investment in ATC grew by $1.4 million after tax, compared to last year, as the investment balance increased. The investments in other segments recorded a net loss of $4.9 million, compared to net income of $14.6 million a year ago. The year-over-year decrease is primarily from the items I mentioned earlier, the non-recurring gain on the sale of securities and tax benefits in 2008, and a net loss from our ALLETE Properties business in 2009.

Our year-end diluted average share balance used for calculating earnings per share increased by 2.9 million shares as we issued equity in 2009 to help fund our capital expenditures. As I mentioned before, the increase shared balance resulted in $0.19 per share dilution.

At this time, I'll turn the call over to Al Hodnik.

Al Hodnik

Thank you, Mark, and good morning, everyone. I'd like to first provide our earnings outlook for 2010, and then talk about ALLETE's longer term strategy as we move forward.

For 2010, we anticipate our earnings per share will be within a range of $2.05 to $2.35, a net income of $73 million to $83 million. This outlook is based on a number of expectations. To begin, we expect retail electric sales, particularly those who are taconite customers, will improve in 2010. We estimate domestic steel producers will operate at approximately 60% capacity this year versus about 50% in 2009, which will translate into an increase in taconite production, compared to last year. In addition, we will have a full year of sales to our new industrial customer, Mesabi Nugget. Also, we expect about $55 million in margins from sales to other power suppliers, the majority of which are already under contract for the year.

As for rates, in January, a new $10 million annual increase for our wholesale municipal customers went into effect under a Federal Energy Regulatory Commission approved formula-based rate provision.

On the retail side, while we are disappointed in the Minnesota Public Utility Commission's decision with regard to intern rates related to our current rate filing, we believe a more reasonable final decision will be rendered once the commission reviews the full record.

Our earnings guidance provides for a range of potential regulatory outcomes. O&M depreciation and interest expenses will increase in 2010 as a result of capital investments we've made to meet environmental and renewable mandates.

Turning to our investment in ATC, we expect to invest approximately $2 million during 2010 as we continue to fund our pro-rata share of ATC's capital expansion program. We anticipate the reinvested portion of our earnings from ATC will be around $3 million. So in total, our investment balance will grow by about $5 million this year.

We expect few, if any, Florida real estate sales in 2010, and anticipate a net loss of approximately $5 million at ALLETE Properties. I will make some additional comments about this business in a few moments.

In 2010, we expect to invest $250 million in our ongoing capital investment program. $156 million of this total is for base capital expenditures, and is included in the test year of our current retail rate filing. $88 million of the total is for current cost recovery eligible investments, the majority of which is for renewable energy projects. Our capital investments will be funded with a combination of cash from operations, debt, and equity issuances, with the equity issuances impacting our year-end earnings per share calculation.

Now I'd like to comment on ALLETE's strategic direction before we take your questions. ALLETE is an energy company committed to earning its authorized rate of return in our regulated businesses while we continue to pursue growth initiatives in renewable energy, transmission, and other energy-centric businesses.

With regard to our regulated operations, Minnesota Power's long term strategy is to maintain its competitively-priced production of energy, reduce customer concentration exposure, comply with environmental permit conditions and renewable requirements, and earn its allowed rate of return. Keeping the production of energy competitive enables Minnesota Power to effectively compete in the wholesale power markets and minimizes retail rate increases to help maintain the viability of its customers. As communicated in the integrated resource plant filing it made last October, Minnesota Power intends to reshape its generation portfolio over time to reduce its reliance on coal and provide more diversity and flexibility in this generation mix.

We intend to reduce our customer concentration exposure to cyclical industries. This may include additional sales to other regional power suppliers, restructuring customer contracts, and the reshaping of our power supply to be more flexible to swings in customer demand. In addition, we will comply with environmental permit conditions and renewable requirements. However, we will monitor and review environmental proposals, and may challenge mandates that have considerable cost with limited environmental benefit.

Current economic conditions require a very careful balancing of the benefit of further environmental controls with the impacts of the associated costs on our customers as well as on our company and our competitive position. We plan to pursue current cost recovery riders to recover any new environmental and renewable investments. And we'll work with our legislators and regulators to earn a fair on them.

Shifting to our longer term growth initiative, we believe that over the long term, wind energy will play an increasingly important role in the nation's energy mix. As such, we intend to pursue the establishment of renewable energy business focused initially on developing wind assets in North Dakota and the upper Midwest. We have over 50,000 acres of land under lease in North Dakota and the recently acquired DC transmission line. We are currently developing wind resources there not only to satisfy the 25% by 2025 renewable mandate in Minnesota, but also to be marketed to others.

We also plan to make investments in upper Midwest transmission opportunities that strengthen or enhance the regional transmission grid. Minnesota Power is already participating with other regional utilities in the CapEx 2020 initiative. We will also take advantage of our geographical location between sources of renewable energy and end users. And we plan to continue to make additional investments to fund of our pro-rata share of ATC's future capital expansion program.

Finally, we are continuing to explore the possibility of making additional energy-centric investments. These may include investments in renewable energy like we are doing with our wind energy initiative or in transmission, such as ATC investment and CapEx 2020 participation. We will also explore possible investments in environmental control or energy efficiency opportunities.

Moving to our real estate business, ALLETE intends to sell its Florida land assets at reasonable prices over time or in bulk transactions as opportunities arise, and reinvest the proceeds in energy-centric growth initiatives. ALLETE Properties does not intend to acquire additional real estate.

We, at ALLETE, are enthused about our future and our prospects. And we commit ourselves to earning a financial return that rewards our shareholders, allows a reinvestment in our businesses, and sustains our growth. At this time, Don, Mark, and I will be happy to answer any questions that you may have.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We'll pause for a moment to assemble the queue. We'll take our first question from Larry Solow with CJS Securities.

Larry Solow – CJS Securities

Hi. Good morning.

Donald Shippar

Hi, Larry.

Larry Solow – CJS Securities

Al, congratulations to you. And Don, I guess, we'll congratulate you, too.

Donald Shippar

That didn't sound very sincere.

Larry Solow – CJS Securities

No, that was very sincere.

Al Hodnik

Thank you, Larry.

Larry Solow – CJS Securities

The first question I have is, on the – dependent on the temporary – excuse me, on the pending rate case and the shortfall of what you were expecting and what you're going to get, at least that's rectified at the end of the case. Is there any way you can make up that revenue? It doesn't seem like you can. So how would you hit the high to mid-to-high end of your guidance if you can?

Mark Schober

Yes, Larry. This is Mark. There're a lot of things that are in play right now. And we're really in the first stages of this rate case. So we continue to work with our regulators to address what we see as a shortfall. As we look forward, if you just took the shortfall in the interim rates and looked at that alone, it would probably push us down towards the lower end of the range. But we're going to continue to work with our regulators to address that and look for opportunities to hopefully recoup some of that, if not some time during the year as Don alluded to, at least in final rates then.

Larry Solow – CJS Securities

Now is there – I know that in the legislation of the way the laws are written that you can – the customers can get a refund. But is it written that if the final rate is determined to be higher than the interim rate, you can get a recovery? Or will it have to be some type of new legislation or a special type of–?

Mark Schober

I don't believe, typically, there is an opportunity to reach back. So typically, it would be prospective.

Larry Solow – CJS Securities

And then, in terms of timeline of events, what're the next key dates we should be focusing on?

Mark Schober

Right now, what – a lot of activities going on with the rate case as data requests are coming in from the various parties. The next real key event is probably the end of Q2 here in August when we get the administrative (inaudible) report. So that's due some time in August. And then we anticipate that we'll have a final order probably some time in November as what the current timeline is.

Larry Solow – CJS Securities

Okay. And just last question on the real estate, part of the loan, you said you are no longer pursuing any real estate purchases. I know you have been looking at maybe adding – I know it's a small part of your business anyhow, but maybe adding some stuff up along the Atlanta Coast. That's no longer in your plans?

Mark Schober

That's correct. I think the last time we talked, Larry, we had talked about – or that we may acquire additional real estate that's contiguous to our existing assets in Florida. We are no longer looking at adding to those assets.

Larry Solow – CJS Securities

Got it. Okay. Great. Thanks.

Operator

For our next question, we'll go to Vedula Murti with CDP.

Vedula Murti – CDP

Good morning.

Donald Shippar

Good morning.

Al Hodnik

Good morning.

Vedula Murti – CDP

Just so I make sure I heard it properly, the lower end of your range is based on the interim rates being basically the final outcome.

Donald Shippar

Again, if you'd looked at – the way I characterize it, if you looked at the interim rate order, to understand the loan basis, that would push us down to that – to the lower end of the range. But again, it's only February. There're a lot of other items the company is looking at that could impact our operations, taconite nominations, whether – where we end up with our regulators. We continue to work on interim rates. So that's why we're comfortable with the overall guidance. But again, if you looked at the interim rate order, on stand-alone basis and considered nothing else, we'd be towards the lower end, yes.

Vedula Murti – CDP

Okay. And secondarily, you mentioned the $250 million of CapEx for this year. And in terms of the financing requirement, can you breakdown between debt and equity? How much you feel like to finance? And if you go – further go out another year or two, can you talk about, at least, what CapEx looks like, whether we'd expect it to be going up or whether it starts coming down?

Mark Schober

Yes. I'll refer you to our – as far as the CapEx number, to our 10-K that we filed this morning. It has the details in there for the next five years. That's $250 million this year. And then it will be trending down a bit as we go forward. As far as financing needs, we've addressed a lot of that already. We've put up a lot of financing in place as we issued equity throughout 2009. We'll be issuing some debt here shortly in the next couple of weeks. But a lot of that we have behind us. As we look forward then for any additional issuances, they'd be small issuances of debt and equity. And really, I'd tie it back to our cap structure, which is about 45% debt, 55% equity. That's what we track to.

Vedula Murti – CDP

Okay. So we should assume that acquisitions in the future will be done consistent with how they've been – being handled here more recently and there's probably not a need for a public offering?

Mark Schober

That's absolutely true. So as you look forward then, the equity we'll be issuing this year, 2010, will be less than we did last year, but will be the same manners. We'll issue it through what we call our internal periodic issuance of equity program, and also our dividend reinvest program.

Vedula Murti – CDP

Okay. And can you give us a sense, roughly, about what the – what you would view as the fully diluted year-end share count for 2010?

Mark Schober

As I mentioned in my comments, we issued a couple of million shares late or throughout 2009. And then we gave you the numbers, or Al gave you the numbers as far as EPS and net income, so you can do that math. But it's probably – in total year-over-year, the change is about 2.9 million.

Vedula Murti – CDP

Okay. Thank you very much.

Operator

(Operator Instructions) Our next question comes from Eric McCarthy with Praesidis Asset Management.

Eric McCarthy – Praesidis Asset Management

Hi. Good morning.

Donald Shippar

Good morning.

Al Hodnik

Good morning.

Eric McCarthy – Praesidis Asset Management

Most of my questions have been answered. But I suppose on the real estate side, what can you tell me about traffic that you're seeing? Or is there any other activity down in that region of the country in terms of other comparable sales happening? Is there any other activity going on?

Donald Shippar

Well I think the traffic is – been through 2009 has been very low. And we're not expecting or forecasting that it's going to change much or it's going to remain – in other words, it's going to remain low, certainly, through 2010. We don't see any signs that there's going to be any kind of a significant recovery virtually in Florida, and particularly also in the areas that we have properties in the northeast part of Florida. I guess to answer you question, it's been low and we expect it'll stay that way at least through this year.

Eric McCarthy – Praesidis Asset Management

Okay. And any nearby comparable development that they're seeing any activity or sales?

Donald Shippar

From the knowledge we have and from our folks in Florida, it's pretty much across the state that the activity is very similar to what we're seeing in our – on our properties.

Eric McCarthy – Praesidis Asset Management

And in the K, you mentioned that your taconite customers are going to be operating about 60% of capacity for 2010. Is that right?

Donald Shippar

Yes, that's the forecast that we're working with right now, correct.

Eric McCarthy – Praesidis Asset Management

Okay. And what would either raise or lower that? What would bring them closer to full capacity? Or what would pull that back closer to zero? What can we watch for?

Donald Shippar

Well I think, clearly, the health of the steel industry, and then the steel production, obviously, is the biggest indicator of that because that's where those pellets go in the steel production, so. Demand for steel and steel pricing is really the key indicators.

Eric McCarthy – Praesidis Asset Management

Is there any particular price point that you watch that would really raise capacity?

Al Hodnik

We don't particularly watch a price point. I think we pretty much watch blast furnace capacity, blast furnace utilization in the lower Great Lakes. And that's usually a good reference point for you or others.

Eric McCarthy – Praesidis Asset Management

All right. Thanks.

Donald Shippar

Good.

Operator

(Operator Instructions) We'll take our next question from Brandon Nace [ph] with Levin Capital.

Neil Stein – Levin Capital

Yes. Hi. It's actually Neil Stein from Levin Capital. Good morning.

Donald Shippar

Good morning, Neil.

Al Hodnik

Hi, Neil.

Neil Stein – Levin Capital

Just going back to your guidance, and I just wanted to clarify your – when you originally gave guidance, I guess you – you're assuming the full amount of interim that you normally add historically? Is that correct?

Mark Schober

For our guidance, we assumed a range of potential rate case outcomes. And I say that and you can look at – when you look at $2.05 to $2.35, that's why it's a much wider range for ALLETE than we've typically given in the past.

Neil Stein – Levin Capital

Now you're saying, to the extent, do you think that's the full amount of interim that puts you to the bottom end? But then you're mentioning there are certain actions you could take that maybe would mitigate that shortfall?

Mark Schober

Oh yes, exactly. What I'm saying is that we're only in February of the year – of this year. And we're still working with our regulators in the rate order. And there're a lot of things that can happen during the year. So yes, I've mentioned that weather certainly impacts taconite nominations, taconite loads impact us. If you just looked at the interim rate order as a discrete item, it would pull us down. But there are other items that go the other way. So that's why we're very comfortable with our overall range at this point in the year.

Neil Stein – Levin Capital

So I guess one of them is – you say you're working with your regulators, you mean maybe to hope you could get a better interim order or–?

Mark Schober

That's a possibility, or certainly get a better final rate order, too.

Neil Stein – Levin Capital

And I'm just trying to think of the other items that could push you from the bottom end of the range, I guess one of them is weather. You mentioned that taconite–

Mark Schober

Taconite nominations would impact us. Real estate transactions could impact us.

Neil Stein – Levin Capital

Anything else in the absence of that or you're – in contemplating any cost reductions or anything that can make you come out a little better?

Mark Schober

Yes. We always look at our overall expense streams, anything we can do to be more efficient. So we'll certainly be looking at that, but I don't envision anything dramatic, no.

Neil Stein – Levin Capital

Okay. Yes, I guess for the moment that's it. So thank you very much.

Donald Shippar

Thank you.

Al Hodnik

Okay. Thank you.

Operator

And it does appear that there are no further questions at this time. I'd now like to turn the conference back over to Mr. Shippar.

Donald Shippar

Well thank you. Earlier this week, we issued a press release announcing my upcoming retirement. After 33 years I've been in power in ALLETE, I will retire as Chief Executive Officer on April 30th. I will continue to serve as Chairman of ALLETE's Board of Directors. And Al Hodnik will succeed me as Chief Executive Officer.

Certainly, over my career, I've seen both our company and the electric utility industry undergo significant transformations. I've enjoyed the opportunity to lead ALLETE and will miss the relationships I've been fortunate to have made with many of our stakeholders, including many of you. I have every confidence that Al and the management team of ALLETE will successfully lead the company while delivering long term value to its shareholders. Thanks for joining us this morning, and we'll see you later on the year.

Operator

Once again, that does conclude our call today. Thank you again for your participation.

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