ALLETE, Inc. Q2 2010 Earnings Call Transcript

Aug. 4.10 | About: ALLETE, Inc. (ALE)

ALLETE, Inc. (NYSE:ALE)

Q2 2010 Earnings Call

August 04, 2010 10:00 a.m. ET

Executives

Alan Hodnik - President & CEO

Mark Schober - CFO

Analysts

Larry Solow - CJS Securities

James Bellessa - D.A. Davidson & Co.

Neil Stein - Levin Capital

Operator

Good day and welcome to the ALLETE Second 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 of the factors that will determine the company's future result are beyond the ability of management to 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 now turn the conference over to ALLETE' President and Chief Executive Officer, Alan R. Hodnik. Please go ahead.

Alan Hodnik

Thank you. Good morning and thanks everyone for joining us today. With me is ALLETE Chief Financial Officer, Mark Schober. This morning we reported second quarter earnings per share of $0.57 compared with $0.29 a year ago. The year-over-year increase was driven by a number of factors including a return to strong production levels by our taconite mining customers. Mark will go through the financial details in a few moments but first let me recap some of the highlights for the quarter

Earlier this week we received demand nominations from our industrial customers for the last four months of 2010. The total nomination level is similar to that of the May through August time period and it indicates that total demand from our industrial customer class in 2010 will be quite a turn around from 2009 levels.

Turning to another topic, construction work is progressing nicely on the first portion of our North Dakota wind initiative. The 75 megawatt Bison I project located near the 250 kilowatt DC line we purchased in 2009 Bison alone will consist of 33 wind turbines with the first half placed into service late this year.

The total project is estimated to cost $177 million and as of June 30 we have spent about $63 million. On a related note in July the Minnesota public utilities commission approved our partition to begin billing customers for the project.

Our retail rate increased request before the Minnesota public utilities commission continues to proceed according to schedule.

As you may know in April we filed our rebuttal testimony in which we lowered our increased request from $81 million to approximately $72 million due to adjustments for known and measurable events that occurred since the original filing.

The largest of these adjustments relates to increased sales to our industrial customers and in addition we lowered our return on equity request from 11.5% to 11.25%. In mid-august, we expect to report in recommendations on the administrative law judge. The commission's oral deliberations should begin and be held sometime in October and the written order is due November 2nd.

I will now ask Mark to provide the financial details for the quarter. Mark?

Mark Schober

Good morning, before I begin I encourage you to refer to the 10Q we filed this morning for complete details of our quarterly results.

For the second quarter of 2010 ALLETE earned $0.57 per share on net income of $19.4 million compared to $0.29 per share, a net income of $9.4 million in the second quarter if 2009. Last year's results included $1.5 million after tax accruals or rate refund related to the 2008 case.

Both excluding it the second quarter of 2009 earned $0.34 per share a net income of $10.9 million. Our regulated operations which includes Minnesota Power; Superior Water, Light and Power and our investment in the American transmission company recorded a net income of 18.2 million for the quarter compared to 10.7 million a year ago.

As I mentioned $1.5 million of the increase is due to the refunds related to the 2008 rate case which we recorded in 2009. Retail and municipal kilowatt hour sales were 50% higher than last years second quarter primarily due to a 98% increase in industrial sales.

There was a corresponding decrease in sales to other power suppliers which were 33% lower this quarter than in 2009. In total, kilowatt hour sales were 17% higher in the second quarter of 2010 compared to 2009.

Last year sales were impacted by dramatic downturn in production levels from our taconite mining customers. Total regulated operations revenue increased 45 million compared to last year due to a number of factors.

Including the significantly increase in retail and municipal sales authorized interim retail rates which are subject to refund pending a final order. The absence in 2010 of the 2008 interim rate refund accruals that occurred last year.

Higher fuel and purchase power recoveries and increased transmission revenue related to the DC Line we purchased in late 2009. Revenue from sales to other power suppliers decreased in 2010 versus 2009.

Fuel and purchase power expense was $18 million higher than last year due to increased coal generation, higher coal prices and related transportation and increased kilowatt hour purchases combined with higher market prices.

The $12 million increase in regulated operating and maintenance expense reflected additional transmission expenses related to the DC line, higher generating plant operating and maintenance expenses and increased employee benefit costs.

Depreciation expense increased $4 million and interest expense $1 million both directly attributable to our capital investment program. Income from our investment in ATC was a $100,000 higher this quarter than in the same period in 2009.

In the second quarter, ALLETE's Investments and Other segment are in $1.2 million this year versus a net loss of $1.3 million last year.

The largest contributor to this increase was a result of a Minnesota income tax audit settlement and related interest from a previous year in the amount of $1.1 million. No land sales were made at ALLETE properties during the second quarter of either 2010 or 2009 and results of the BNI Coal were similar to last year.

ALLETE's quarterly earnings per share also included $0.04 of delusion due to the increased number of shares outstanding as we fund our capital investment program.

Our earnings expectation for 2010 remains at $2.05 to $2.35 per share excluding the $0.12 per share charge related to the health care act in the first quarter. Our guidance provides for a range of potential regulatory outcomes and takes into account the recent demand nomination from our industrial customers.

For the second half of the year we expect increasing operating and maintenance expenses and in part due to a plan maintenance outage at the Boswell 4 unit. In addition, we expect increasing depreciation and interest expenses as a direct result of our ongoing capital investment program.

Our investment balance in ATC is expected to grow by $5 million over the last year and we continue to expect that ALLETE properties will record a net loss of about $5 million in 2010. Al?

Alan Hodnik

Thanks Mark. I am very pleased how the company has performed both financially and operationally through the first half of 2010. We've made progress with the beginning phase of our North Dakota wind initiative and we are certainly encouraged to see our industrial customers production levels rise from the dreadful conditions they faced in 2009. As Mark mentioned, we are on track to meet our earnings expectations for the year.

We are also on track with our capital investment program, a combination of base capital cost and expenditures to meet renewable mandates. We are in a good position with our cash balance and our debt-to-capital ratio is a strong 42%.

ALLETE is an energy company committed to earning a financial return that rewards our shareholders, allows for reinvestment in our businesses and sustains growth. We will take actions necessary to earn our allowed rate of return in our regulated businesses while we pursue longer term growth initiatives in renewable energy, transmission and other energy centric businesses and I'm enthused about our prospects for the future.

At this time I will ask the Operator to open the lines for your questions.

Question-and-Answer Session

Operator

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

Larry Solow - CJS Securities

Hi, good morning.

Alan Hodnik

Good morning Larry.

Mark Schober

Good morning Larry.

Larry Solow - CJS Securities

Notwithstanding the several variables that go into your guidance, which I know are moving around constantly but just based on the strong performance in the quarter and nominations looking pretty good or as good as this prior four-month period, is it fair to say that you are tracking towards the high end of your guidance or any reason why you'd leave such a wide gap, especially considering it looks like things are relatively positive?

Mark Schober

Yeah Larry, our guidance remains the same, 205 to 235 and as we issued that guidance and as we reaffirm that guidance coming out of Q1, we expect the nominations to be strong through the remainder of the year. So the fact that nominations came in near full production levels for the remainder of the year, that's not going to change our guidance.

The big drivers, as we look towards the end of the year and we've kind of touched on those during the call here is that we expect O&M expense to be back ended this year. So you will see a significant ramp up, primarily driven by our Boswell 4 outage and also increasing cost at our Boswell 3 unit due to the news cover that we put in there and continuing increases in our depreciation expense and interest expense because of the capital spend.

So, I'm really not surprised that those are all factored into the guidance and then ultimately the big one is where we end up in this rate case and that's why we're maintaining the guidance with such a wide range.

Larry Solow - CJS Securities

Right. And with the rate case itself, in terms of -- what is in your guidance for the rate case? I mean you won't get the approval, assuming things go without a hitch, it wouldn't happen until, I guess November, right? So your guidance assumes interim rates for that November/December period too or do you assume you'd get a little bit --

Mark Schober

Yeah, nothing has changed since when we issued guidance in November of last year. Guidance has provided for a range of regulatory outcomes. We do expect the commission to have an order issued in November and we do anticipating recording that order in 2010 business. So that again is why the range remains so wide.

Larry Solow - CJS Securities

Okay. And then I guess in terms of milestones to look for, so the ALJ report comes out -- is there a specific date for that or is it just around mid August?

Alan Hodnik

We're just thinking it will be around mid August at this point.

Larry Solow - CJS Securities

Okay, so there's no actual, like drop-dead deadline or whatever where it has to be submitted or what have you?

Alan Hodnik

No.

Larry Solow - CJS Securities

And correct me if I'm wrong but I believe they usually -- these are obviously for the people or for the government. So it's generally more of a critical Devil's Advocate point of view versus not necessarily the final outcome. It's more of a conservative view?

Alan Hodnik

It's just a view Larry. It's a recommendation by the ALJ based on their analysis of the record at that point in time to the MPUC.

Larry Solow - CJS Securities

Right. So I know you don't want to comment on it, but qualitatively, generally speaking, it doesn't necessarily -- be the final decision. There are some gives and takes there and I believe, in your last rate case the ALJs was lower than you actually ended up getting, is that right?

Alan Hodnik

That's correct for the last rate case but again it's a recommendation to the MPUC and its, and I'm not going to….

Larry Solow - CJS Securities.

Yeah, I don't want you to comment. I fully understand that. Okay. Great. Thanks, I appreciate it, guys.

Alan Hodnik

Thanks Larry

Mark Schober

Thanks Larry

Operator

Our next question comes from James Bellessa of D.A. Davidson & Co.

James Bellessa - D.A. Davidson & Co.

Good morning.

Alan Hodnik

Good morning Jim.

James Bellessa - D.A. Davidson & Co.

The Boswell 4 outage, when does that occur and how long will it be out?

Alan Hodnik

Boswell 4 outage begins in the middle of August here and it's scheduled to be about an eight or nine week outage Jim.

James Bellessa - D.A. Davidson & Co.

So it will stretch into the next quarter, from the third into the fourth quarter.

Alan Hodnik

Right and when you include start up issues always following the big outage like that.

James Bellessa - D.A. Davidson & Co.

You indicated that you had a state income tax audit refund. Did you say $1.1 million?

Mark Schober

Yeah, that's an audit that we completed this quarter Jim and we recorded, the fact that we completed that audit in the bank it was $1.1 million. Yes.

James Bellessa - D.A. Davidson & Co.

And that's about $0.03 a share. Would that be about right?

Mark Schober

That's about right, $0.03 to $0.04, yes.

James Bellessa - D.A. Davidson & Co.

We see evidently in the ALLETE Properties, received a property and you must have put that back on your books as a gain, right?

Mark Schober

Yeah, what happened at ALLETE properties, we had a note receivable with a customer that had gone through bankruptcy? What we did then was take that property back on to our books. So when you look at the numbers in the 10-Q that they'd show the units and acreages, that's what it is. It's simply taking that property back on our books. And your right, when you take that property back on, you take it on a fair market value. We have that real estate appraised and we recognize a gain in that transaction at ALLETE properties in the amount of about $700,000.

James Bellessa - D.A. Davidson & Co.

And if I heard in the narrative correctly, in Minnesota you received a June decision that allows you to start collecting on Bison I. Are you already collecting or will you be collecting?

Mark Schober

Bison I, we just received the commission approval to do that here in July. So those buildings will -- those costs will start appearing on customer bills here at August 1st.

James Bellessa - D.A. Davidson & Co.

Thank you very much.

Alan Hodnik

Bison I was a current cost recovery writer eligible project.

James Bellessa - D.A. Davidson & Co.

Thank you.

Mark Schober

Thanks Jim.

Alan Hodnik

Thanks Jim.

Operator

(Operator Instructions). Our next question comes from Brendan Naeve with Levin Capital.

Neil Stein - Levin Capital

Hi, it's actually Neil Stein from Levin Capital. How are you this morning?

Mark Schober

We're good.

Alan Hodnik

Hi Neal.

Neil Stein - Levin Capital

The question I had is just looking at the level of taconite sales and the recovery there has been really impressive, but I was wondering how that compares to what you filed in your rate case and might you need to make an amendment to that filing to take up that level or will the commission take into account the current level of sales?

Mark Schober

We've already made that adjustment Neil to our rate care. If you recall when we filed we originally filed for about $81 million back in November of 2009. Earlier this year we adjusted that amount down to $72 million and the biggest driver of that was the increase in the sales to our industrial customer. So we've captured that in a rate case already and yes, the commission will look at that as we move forward in the process.

Neil Stein - Levin Capital

It's somewhat confusing, the model on a quarter-to-quarter-basis but how we think about the margin associated with selling to these taconite customers versus if you didn't have that demand and you were selling into the market. I imagine it varies quarter-to-quarter?

Mark Schober

If we don't sell to our taconite customers, it will vary substantially quarter-to-quarter. As we've discussed we're confident we can take that power to market. It's really a volume hedge but it's not a price hedge. So those margins could and do change dramatically based on market prices at the time we take it to market.

Neil Stein - Levin Capital

In the third quarter are you able to satisfy this incremental demand with your own generation or do you actually need to go into the market to buy power to satisfy the incremental taconite demand?

Alan Hodnik

No, we're able to satisfy this increased demand with our existing generating suite.

Neil Stein - Levin Capital

I guess though, maybe on a year-over-year basis, the opportunity cost of not selling in the market is maybe a bit higher. Maybe if that's the way to think about it? Lower in the shoulder quarters so you're -- it's much better maybe to sell to the taconite customers but maybe to the extent prices are much higher in the third quarter, it would have better to sell into the market? Is that a way to think about it?

Mark Schober

Again, it comes back to what those market prices are. And those market prices have been soft for the past several months. We would much rather have the certainty of selling to our taconite customers versus having to take that power to the market.

Neil Stein - Levin Capital

And then maybe just a bigger picture question. How sustainable is this taconite demand? Is this just temporary inventory restocking and things we're going to see sort of fade away or fade back to kind of where it was or do you think it's a little bit more -- a sign that we should expect to last?

Alan Hodnik

Well as we have said, a good proxy to watch or look at, one we look at is the blast furnace utilization rates in the Great Lakes and of course that rises and falls also with the U.S. economy and so depending on your views of the U.S. economy and where its at on recovery mode here and where that utilization rate is, you can kind of predict on your own where taconite might be at. We're encouraged where we are today. We encouraged with the nominations here for the next four months and we're not going to trying to predict necessarily where '11 and '12 might be going.

Neil Stein - Levin Capital

Okay. Thanks very much.

Mark Schober

Thanks Neil

Alan Hodnik

Thanks Neil

Operator

I'd like to turn the conference back over to Alan Hodnik for closing comments.

Alan Hodnik

Well, that concludes our call for today. I look forward to announcing third quarter results this fall. Thanks for joining us this morning and I wish everyone listening an enjoyable rest of the summer.

Operator

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the conference. You may now disconnect. Good day.

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