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ALLETE Inc. (NYSE:ALE)

Q1 2010 Earnings Call

April 30, 2010 10:00 am ET

Executives

Donald Shippar - President and CEO

Al Hodnik - President

Mark Schober - SVP and CFO

Analyst

Larry Solow - CJS Securities

Neil Stein - Levin Capital

James Bellessa - D.A. Davidson

Operator

Good day and welcome to the ALLETE first quarter 2010 financial results call. Today's call is being recorded. Certain statements contained in this conference call that are not description 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 other factors that will determine the company's future result are beyond the ability of management's control or predict. Listeners should not place undue reliance on forward-looking statements which reflects management's views only as of date hereof. The company undertakes no obligations 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'd now like to turn the conference over to ALLETE' Chairman and CEO, Donald Shippar. Please go ahead.

Donald Shippar

Good morning and thanks for joining us today. With me are ALLETE President Al Hodnik and Chief Financial Officer Mark Schober. As you know this morning we reported our first quarter earnings of $0.68 per share compared to $0.55 per share a year ago. The year-over-year comparison was impacted by a couple of non-recurring items which we will explain in a few moments.

During the quarter we received higher nominations from our taconite customers, a rating agency raised its (inaudible) look on our corporate debt and we made regulatory progress with regard to our North Dakota Wind Development initiative.

Last week we rededicated our 380 megawatt Boswell 3 generating station which just completed its start updates following the completion of a $240 million environmental project. This very successful project has resulted in mercury reductions of 94%, SO2 reductions of 99% and nitrous oxide reductions of 91%. More than 2 million man hours were required to complete this project. It's a source of great pride for me to see what our organization can accomplish while at the same time reflecting our commitment to our core values of environmental (inaudible) and safety. Now we'd like to turn the call over the Al who'll provide several updates, Al.

Al Hodnik

Thanks Don and good morning everyone I'd like to take a few moments to comment on some of the least significant events for the quarter. To begin in early March we received demand nominations from our industrial customers for the May to August timeframe. Total nominations increased as our taconite customers plan to return to near full capacity during the summer months and were higher than original expectation. Industry observers knowledge fact that domestic fuel producers will operate at 70% capacity for 2010 which is up from our original forecast of 60% and up from about 45% for 2009. We will receive demand nominations for these September to December period on August 1.

Turning to our lend development initiative, we are continuing these site preparation for our Bison I wind energy project in North Dakota. Construction will begin this year and we expect to have about half of the 75 megawatt project in service by year-end with the remaining completed in 2011.

Last the year the Minnesota Public Utilities Commission approved our petition seeking current cost recovery related to this project and this March, we filed a petition with the Minnesota Public Utilities Commission to establish the customer billing rates.

In a related development, the North Dakota Public Service Commission recently authorized construction of a 22-mile transmission line that will connect Bison I to the DC transmission line we acquired at the end of 2009.

Two weeks ago, we were informed by Standard & Poor's that they had affirmed their bond ratings including the corporate credit rating of BBB plus and revised their outlook from negative to stable. We are pleased that S&P acknowledged the improving outlook for our company.

Finally, with regard to our current retail increase request before the Minnesota Public Utilities Commission, the public hearing phase has just been completed. The evidence we are hearing phase with testimony will occur next month and the administrative law judges' report and recommendation is scheduled for mid August. We expect the commission will deliberate in early October with a written order due in November.

Also for your information, yesterday we filed our rebuttal testimony. In it, we have lowered our increased request from $81 million to about $72 million due to adjustments for known and measurably events that have occurred since we originally filed. The largest of these adjustments is related to the increased sales to our industrial customers. At this time, I will turn the call over to Mark, and then I will make additional comments before we take your question, Mark?

Mark Schober

Good morning. Before I begin, I would like to remind you that we filed our 10-Q this morning and I encourage you to refer to it for the quarterly detail.

For the first quarter ALLETE reported earnings per share of $0.68 on net income of $23 million. The quarterly results include a $4 million after tax or $0.12 per share charge due to a provision in the patient protection and affordable care act of 2010 that eliminated the tax deduction for expenses reimbursed under Medicare Part D. As we go forward, we will exclude this non-recurring charge from our 2010 earnings guidance.

Last year's first quarter reported earnings per share was $0.55 a net income of $16.09 million. Included in those results was a $3.2 million after-tax or $0.10 per share accrual for the 2008 portion of interim rig refunds recorded in 2009. ALLETE's regulated operation segment includes results from our regulated utilities, Minnesota Power and superior Water, Light and Power and from our investment in the American transmission company. Net income further segment was 24.9 million for the quarter compared with $17.7 million a year ago. Retail and municipal kilowatt sales were up 3.5% due to the year-over-year increase in production levels for our taconite customers.

Offsetting this increase were sales to other power suppliers which were down 12.3% from last year. In total kilowatt hour sales were 1% below the first quarter of 2009.

Total regulated operating revenue increased $35 million compared to last year due to a number of factors including, approved wholesale rate increases, authorized inner retail rates which are subject to refunds sending the final order. The absence of 2010 of (inaudible) for interim rate refunds that occurred in 2009, higher deal and purchase power recovery, increased sales to retail and municipal customers and increase transmission revenue related to the DC line we purchased at the end of last year.

Revenues from sales to other parts suppliers decreased in 2010 versus 2009, regulated operating expenses increased $18.9 million year-over-year, in 2010 we incurred higher fuel and purchase power expenses and operating and maintenance expenses including those for transmission and employee benefit.

Depreciation expenses have also increased because of higher property plant and equipment placed into service over the past year as a result of our capital expenditure program. Income tax expense for the regulated operations segment rose by $8.9 million due to higher pretax income as well as $3.6 million of the non-recurring charge as a result of the healthcare act I already mentioned.

Those included in our regulated operations earning from our investment in ATC rose by $3,000 from the same period last year as the investment balance grew to $90.3 million. Investment in other segment incurred a net loss of $1.9 million during the first quarter compared to a net loss of $800,000 in 2009. Included in this year's result is a slightly larger net loss properties and $400,000 as a non recurring Heath Care Act charge. A lease quarterly earnings per share included $0.06 of dilution due to the increased number of shares outstanding as we fund our capital expenditure program. Looking ahead, we continue to expect our year-end earnings per share to be between $2.05 and $2.35 excluding the $0.12 per share impact from a Health Care act charge.

Our guidance provides for a range of potential regulatory outcomes. We expect operating expenses to increase during the year partially due to Boswell 3 returning to full service and scheduled unit outages this fall. Our investment balance in ATC is on track to grow by about $5 million this year and we continue to anticipate a $5 million net loss at ALLETE properties. We also expect to invest $250 million in our on ongoing capital investment program to support a regulated operations. About $160 million of this is for basic capital expenditures and approximately $90 million is for current cost recovery eligible investment, a majority of which is for renewable energy projects. Al?

Al Hodnik

Thank you Mark. Overall I am pleased with the start we have had for 2010. It was good news for Northern Minnesota to have its major industry taconite mining return to higher production levels due in the summer. Through prospects for the industry look encouraging, we won't receive our industrial customer's final four months nominations until August. A lease strategy for Minnesota power is to maintain its competitively priced production of energy, reduce customer concentration exposure, comply with environmental permit conditions and meet renewable requirements for earning our allowed rate of returns.

We believe our regulators will treat us fairly when our rate increase request is ultimately considered and the decision is rendered. As we go forward, we will continue our longer term growth initiatives establishing a renewable energy business focus initially on developing wind assets in North Dakota and the Upper Midwest. Investing in Upper Midwest transmission opportunities that strengthen or enhance the regional transmission grid and exploring the possibility of making additional energy centric investments.

Before we take your questions, I'd like to say a few words about Don Shippar, his legacy and leadership. As many of you already know, today is Don's last day on the job as he steps out of his CEO role. He will continue to serve ALLETE as Chairman of the Board and I'd like to personally thank Don for leading ALLETE to a period of transition and fundamental changes since he became CEO in 2004.

During his tenure, he guided the company through a time of dramatic asset growth, a dreadful global economic downturn, a sorted regulatory and legislative challenges and considerable work for his transition. His principle leadership style and steady hand were invaluable as we have navigated through these events and doing so without compromising our core values.

ALLETE is well positioned strategically, financially and from a human resource and talent readiness perspective as a result of Don's leadership. It is from that sound platform that we move forward from today with our firm commitment to providing investors with the return that they expect. Thank you Don and best wishes to you in path in your new adventures ahead.

Donald Shippar

Well, thanks for the kind words Al. I certainly have enjoyed my time with ALLETE Minnesota Power over the past 33 years. I'm proud of how our company has performed during my years as CEO and the many successes we have accomplished fused from economically difficult times. It's gratifying to see the outlook brightening as I handover the reins to Al.

I am definitely excited about ALLETE's prospects into the future. I'll miss the many associations I have made during my career with employees, customers and other stakeholders including the lead investors such as those of you whom I have had the pleasure to meet on many occasions. Thank you for support of our company.

At this time Al, Mark and I will take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Larry Solow from CJS Securities.

Larry Solow - CJS Securities

Hi. Good morning. First of all, Don, best of luck to you in your future endeavors, and obviously, you're still Chairman, so hopefully we'll still hear from you every now and then.

Donald Shippar

Thanks Larry.

Larry Solow - CJS Securities

In terms of the first quarter, is it fair to assume that the customer's ultimately used more electricity than they initially nominated for?

Mark Schober

A couple of industrial customers took a bit more than they nominated for, but Q1 they are pretty close to what we expected.

Larry Solow - CJS Securities

And then I know you haven't adjusted guidance, but if you can just give us a little more color on the moving parts? Because obviously you are not going to hear much regarding the rate case until for the end of the year. So can you say sort of what is the midpoint of your range? Does that assume you get what you're asking for and then plus or minus is part of the difference in your range or are there obviously other variables? But can you just give us a little more color on that?

Al Hodnik

Sure we've talked out before we're reaffirming our guidance and that encompasses a range of potential rate case outcomes, so that's obviously a big driver. Another big driver Larry that we need to keep an eye on is what the Q4 nominations are (inaudible) customers. They are running very strong over the summer, what we don't know yet where they'll be in the final four months of the year and then with Boswell 3 coming online, our O&M expenses will be increasing as we move through the rest of the year and we had two of our major units that are down this far at (inaudible) and Boswell and there will be a significant ramp up in our O&M expenses because of that and also the uncertainty that goes along with those outages. So those are the variables that we're keeping our eye on that pushing us to just maintain our guidance at this point at the 205 to 235.

Larry Solow - CJS Securities

That the 70% capacity utilization assumption for taconite for the full year. Does that assume that nomination sort of tailback a little bit in the last 30 year?

Al Hodnik

Yes, really what we've done to increase the 70% is bring them up to a pretty much full capacity through the summer season and back to our original expectations for the last quarter.

Larry Solow - CJS Securities

And then in terms of rate case, it seems like the next sort of key event or milestone to look for would be the ALJs report mid August. Is that a good assessment?

Al Hodnik

Yes, that's correct. We have the evidence hearings will be happening in the middle of May here and then the report out in August that would be the next key date.

Larry Solow - CJS Securities

I know the Attorney General and the Office of Energy Security; they've put out their reports. I know they are usually protecting the people, election-type. So obviously some ulterior motives there, but I didn't actually see those reports. Were they in line with your expectations or anything extraordinary, in either of the reports?

Al Hodnik

I don't think so Larry really typical challenging of the cost and revenues that we have in our rate case. Now the biggest issue obviously we need to do is with our revenue levels especially as the tax managers starting to improve here. But no real surprises there. We continue to work this through with the regulators and the process is pretty much going as we expected so far.

Larry Solow - CJS Securities

Okay. Any update on the real estate and then on obviously the environment, maybe you're taking improving a little bit. Are you guys seeing anymore activity?

Al Hodnik

There is probably bit more activity at our sites down in Florida but we still don't anticipate any sales this year and the activities that are taking place typically at distress prices so the market is certainly not back to normal and still has ways to go. So we are still anticipating about $5 million loss for our real estate operation.

Operator

Our next question comes from the line Bradon May from Levin Capital.

Neil Stein - Levin Capital

Hi. It's actually Neil Stein. Good morning.

Donald Shippar

Good morning Neil.

Neil Stein - Levin Capital

I had a question about the share counts. In your 10-K it says that the year-end 2009 share count was 35.2 million shares, but the average share count for the first quarter, as per your release says 33.8 million? So I'm kind of confused as to how the share count might have gone down from year-end.

Mark Schober

Yeah, I think what you're probably looking at the unallocated (inaudible) of share I think Neil, for our outstanding shares, our diluted shares that we use for the calculation are not going down. We anticipate issuing about another million shares this year by the end of the year that our total outstanding average share will be above 35 million. So I think it's (inaudible) you're looking at an incorrect number.

Neil Stein - Levin Capital

It doesn't annotate it or give any caveat, it just says in the K, 35.2 million shares at year-end. You're saying there's a portion of that, that doesn't get included in the EPS calculation?

Mark Schober

If you look at the 10-Q and then the 10-K, our unallocated (inaudible) shares are not included in the EPS calculation, correct.

Neil Stein - Levin Capital

Okay, got it. What about with respect to the status of the share repurchases you are doing for this year? Within your guidance, I think that reflected a 2.9 million increase in the diluted share count?

Mark Schober

Yeah there's a couple of things that are going on. As you looked at our share count, one is we issued a substantial amount of shares late in 2009 for those are already issued chairs that will be included in our average count as we go through the year. Actual new issue shares in 2010, probably around in million shares is what we're finding right now and we'll continue to issue those internally through our periodic issuance program.

Neil Stein - Levin Capital

Are you planning on doing those, say during the first half of the year or do you want to…

Mark Schober

The best where to look at that would be ratably through the year. And we do give the details in the Q of what we issued in Q1.

Neil Stein - Levin Capital

Okay. With respect to real estate. I saw in the Q that there was a 22-acre land sale. Was that just opportunistic?

Mark Schober

You must be looking at last year and there could be…

Neil Stein - Levin Capital

Oh, was that last year? I thought that was…

Mark Schober

Yeah, we have not had any real estate sales this year.

Neil Stein - Levin Capital

And the loss was, it's a little bit higher run rate, than would be suggested by the $5 million net income target I believe?

Mark Schober

That would just be signing where we're comfortable that will be right around $5 million by the time it gets to the end of year, assuming that we have no sale transactions.

Operator

Our next question comes from James Bellessa from D.A. Davidson

James Bellessa - D.A. Davidson

The Boswell number 3 start up and the scheduled unit outages, how much push up in the O&M might that cause?

Al Hodnik

Well the Boswell 3 startup of course is difficult to predict on reagent cost and reagent use, we're learning to operate that unit as Don Shippar, his comments were seeing some favorable emission reduction so we're still working through that so its hard to place a number on that Jim and with regard to the fall outages and pushing up expenses, its again hard to put a range on that as well with in terms of when you of course have a planned outage you expect certain expenses but you might encounter other things along the way, so its hard to place current dollar figure on what that will be.

James Bellessa - D.A. Davidson

The amount of depreciation for the regulated segment went up materially in the quarter. In the fourth quarter, you had a $17.9 million depreciation expense, and then a jump to $20 million. Can you explain what happened there, and is this going to be maintained at this level?

Mark Schober

It will continue to grow Jim as plant and service comes online. So, that's simply matching the growth in our capital expenditure. So there is nothing unusual there. So it will be at that $20 million level and we'll continue to go through the year matching our growth in our capital spend.

Operator

(Operator Instructions). And I am showing no further questions.

Al Hodnik

All right, well thank you for your time and attention this morning. We look forward to speaking to you again this summer after our second quarter results have been released. Have a good day.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may all disconnect. Everyone have a great day.

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