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ALLETE (NYSE:ALE)

Q3 2010 Earnings Call

October 29, 2010 10:00 am ET

Executives

Al Hodnik - President and CEO

Mark Schober - CFO

Analysts

Larry Solow - CJS Securities

James Bellessa - D.A. Davidson Company

Eric Jacobsohn - Columbia Wanger

Operator

Good day and welcome to the ALLETE third quarter 2010 financial results call. Today's call is being recorded. Certain statements contained in the conference call that are not descriptions of historical facts are forward looking statements such as such as terms defined in the Private Securities Litigation Reform Act of 1995. Because such statements 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 the management's reviews 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.

I would now like turn the conference over to your host for today Mr. Al Hodnik, President and CEO. Sir you may begin.

Al Hodnik

Good morning everyone and thank you for joining us. With me on the call today is ALLETE's Chief Financial Officer Mark Schober. I am pleased to report that ALLETE recorded quarterly earnings per share of $0.56 compared to $0.49 last year. Year-to-date ALLETE has earned $1.93 per share excluding a $0.12 one time item. Mark will go over the financial details shortly. Before he does that, I would like to update you on some significant events that occurred during the quarter.

I mentioned it on the last call, but I think its worth repeating. In early August, Minnesota Power received demand nominations for the last four months of 2010 from its industrial customers. The total nomination level was similar to the preceding four month period which is near full capacity. Our industrial customers have had quite a turnaround in 2010 compared to 2009. We are pleased that economic improvement was seen by our customers this year which is not only good for them but for the entire North Eastern Minnesota region.

On the renewable energy front, we continue to make progress with our North Dakota wind initiative as construction has been completed on the first phase of our Bison 1 Wind Project. The first 16 wind turbines are now in position and will be phased into service through the end of this year. The remaining turbines will be installed in 2011. In addition, we have completed construction of a 22 mile, 230 kilovolt transmission line that not only physically connects the Bison 1 Wind Project farm, but also a broader areas of lease lands we hold that are part of our wind development strategy to the DC line we purchased late last year.

The total project is estimated to cost $177 million and through September 30th, we have spent $101 million. The Minnesota public utilities commission has already approved our petition to begin bailing our customers for this project effective August 1st. Minnesota Power's retail rate increased request also continues to progress. On September 29th, the Minnesota Public Utilities Commission considered and decided upon over 50 different issues contained in the request. We estimate that the Minnesota Public Utilities Commission will order an overall retail related rate increase of approximately $54 million when it issues a formal written order by November 22nd.

The Minnesota Public Utilities Commission approved a 10.38% return on equity and a 54.29% equity ratio. We will continue to collect interim rates from our customers until the new rates go into effect which will be after a reconsideration period has expired. And after all compliance filings are completed and accepted. We estimate the new rates will go in to effect early next year.

Last spring, I announced our plan to participate in additional phases of CapEx 20-20 a Minnesota initiative to ensure Electric transmission reliability well into the future. We initially intend to invest between 100 and $125 million through 2015. For transmission lines between Fargo and North Dakota and Monticello, Minnesota as well as between and Grand Rapids, Minnesota. The first segment, a line between Monticello and St. Cloud Minnesota, was granted a (inaudible) permit from the Minnesota Public Utilities Commission in July. Construction of this line is expected to be complete by late 2011. And yesterday, the Minnesota Public Utilities Commission approved the road permit for the (inaudible) to Grand Rapids line. We expect construction of that line will begin sometime in 2011. The CapEx 2020 project costs are eligible for current cost recovery and we have petitioned that Minnesota Public Utilities Commission to recover the cost under a writer.

CapEx 2020 participants are also currently researching and st7udying additional reliability upgrades. Our lead continues to make progress as we pursue our various energy centric initiatives. I look forward to sharing additional updates with you as we move forward.

At this time, I will ask Mark to go through the financial details and then I will provide a few more comments before we take your questions. Mark.

Mark Schober

Good morning. Before I began I encourage you to refer to 10Q we filed this morning for complete details of our quarterly results. For the quarter of 2010 ALLETE earned $0.56 per share a net income of $19.6 million compared to $0.49 per share a net income of %16 million in third quarter of 2009.

A regulated operations which includes Minnesota Power, Superior Water, Light and Power and our investment in the American transmission company reported net income of $22.1 million of the quarter compared to $16.6 million a year ago.

Retail and municipal kilowatt-hour sales were 48% higher then last years third quarter primarily due to an 83% increase in industrial sales. Offset in the increase of industrial sales was a 40% decrease in sales to other power suppliers compared to the same quarter in 2009.

In total regulated and utility kilowatt-hour sales were 16% higher in the third quarter of 2010 compared with the 2009.

Last years sales were impacted by a dramatic drop in production levels by taconite customers. Total regulated operations revenue increased $45 million compared to third quarter due to the significant increase in retail and municipal kilowatt-hour sales.

Up rise interim retail rates which are subject to refund depending the final order, higher fuel and purchase power recoveries in an increase in transmission revenue related to the DC transmission line we purchased last December.

The increase in revenue from industrial sales was partially offset by lower sales to other power suppliers in 2010 versus 2009. Fuel and purchase power expense was $9 million higher then last year due to increase call generation higher coal prices in related transportation and increased kilowatt-hour purchases partially offset by lower market prices.

Regulated operations operating in maintenance expense increased $20 million or 40% over 2009. The increase reflects higher reagent and contractor expenses at out power plants of $8 million. Increase labor and benefit costs of $5 million and $3 million additional MISO expenses related to the DC transmission line.

Depreciation expense increased $4 million and interest expense was up $1 million both directly attributable to the capital investment program at our regulated operation.

Income from our investment in ATC was $100,000 higher this quarter then in the same period in 2009.

ALLETE investments in segment reported a net loss of $2.5 million in the third quarter compared to net loss of $600,000 last year. The increase losses primarily due to higher non-regulated operating and maintenance expenses compared with the third quarter of 2009.

Loss of contributing to the increased loss was the impact of transferring a small generating facility to regulated operations in November of 2009.

No land sales were made at ALLETE Properties during the third quarter of the year 2010 or 2009 and result of BNI Coal were similar to last year. ALLETE quarterly earnings per share also included $0.04 of dilutions due to increased number of shares outstanding as we fund our capital investment program.

We expect 2010 earnings to come in between $2.25 and $2.35 per share, excluding the $0.12 in non-recurring charge we took at the first quarter as a result of the patient protection in affordable care act. As mentioned in past quarter we anticipate increasing operating and maintenance expenses and higher depreciation and interest expenses into to the end of year.

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.

Al Hodnik

Thank you Mark, this year we decided to hold up issuing our 2011 earning guidance until mid December for a couple of reasons. First we have not yet received the formal written order from the Minnesota Power Commission for our retail rate increase the quest and we are unable to predict if there will be any re-consideration request.

We will have more clarity on that issue towards the end of the year. And secondly we prefer to wait until we receive our industrial customers demand nominations which are due on December 1st. When we provide guidance it will take into account a number of assumptions that include our expectations for final rates and industrial customer demands in 2011.

In addition our guidance was included the expectation of continued progress was our investment in wind generation and in North Dakota and transmission expansion in Minnesota through our participation CapEx 20-20. Our investment balance in ATC will continue to grow and lastly as Mark mentioned earlier we also expect continued increases in O&M depreciation and interest expenses. Now I will ask the operators to open the lines and Mark and I can take your questions.

Operator

(Operator Instructions). And our first question comes from the line of Larry Solow from CJS Securities.

Larry Solow - CJS Securities

Mark in terms of your guidance I guess the variance is that obviously you've narrowed it a lot, but still $0.10 from the last quarter I mean the variance is mostly just how much you ramp up on the O&M expenses or.

Mark Schober

It would be a combination of things Larry. We take that guidance from the last time we spoke because of the clarity we have on our raid case and the fact that two of our major unit outages are winding down so we have clarity there but as we get into the fourth quarter we certainly have the potential for weather, additional maintenance issues, potential for reconsideration issues in the raid case, resulting at our Florida real estate operations so there's some items that could swing it.

Larry Solow - CJS Securities

Okay. And then just in terms of the operating and maintenance expenses, I know you guys have been sort of warning that they will be ramping up, and they have been pretty flat the last three quarters, around 70 million. In terms of ramping up, is this going to be something like a 10 million type ramp up, is that like a good ballpark number, just sequentially? Would it go up that much?

Mark Schober

I don't have a number right now Larry. You will continue to see our ramp up again as we finish some of our maintenance projects. You will see reagents expenditures increasing over above which it seemed year-to-date at our power plant. So you will see increases very similar at Square Butte as they've put a new environmental upgrade there, expenses will be increasing too so those are the numbers that we are working through as we speak and as we give 2011 guidance here in mid-December, I will be able to provide you more clarity on the numbers.

Larry Solow - CJS Securities

Got it. And just to clarify, Al said that some of the variables for 2011, he mentioned your investments in transmission, the transmission expansion and the wind initiatives. Does he mean that you'll have more expenses toward that or you will actually start seeing revenue from it?

Mark Schober

Both. All of these are recoverable to get approval from the Minnesota Public Utility Commission to construct. You will see revenues starting to come through and if they go into service like Bison going into service late this year you will see expenses starting to run through so you will see both sides ramping up.

Larry Solow - CJS Securities

Okay then on the ATC side, I know obviously utility expansion has been a little bit slower across the country, and these guys I think are no different, any outlook, I mean do you expect to continue to invest next year, or I guess that's sort of not in your hands? Any do you have any better grasp of that?

Mark Schober

No the only numbers that we have from ATC is that they look longer term, they've updated some of their long term capital spend plans, I think they are up above 3 billion all over the next 10 years but I don't have a feel yet for what our investment in 2011 will be and again we will have more clarity on that as we give guidance here in December.

Operator

Thank you. Our next question comes from the line of James Bellessa from D. A. Davidson & Co.

James Bellessa - D.A. Davidson Company

Now I'm looking at the guidance. Was there anything special in the fourth quarter last year when you reported $0.56?

Mark Schober

The only unusual item that we recorded in the fourth quarter of 2009, Jim was, on our wholesale customers, if you recall our wholesale customers have a, we build them, actually expense with a true-up. We did record a true-up of about $6 million or $7 million in Q4 of ’09. This year we have been spreading that amount and trying to capture it during 2010. So that would be the only unusual item, the other item that you will see though as I’ve mentioned O&M expenses will be up quarter-over-quarter.

James Bellessa - D.A. Davidson Company

Okay. So if I look at the guidance of $2.20 to $2.35, and you said that you have $1.93 under your belt already, you are suggesting a fourth quarter number of $0.27 to $0.42. This for true-up you talked about, is that enough to, let me quick, I guess I have to tax affect that, would I not? To get it to a per share basis?

Mark Schober

Yes you would.

James Bellessa - D.A. Davidson Company

So let's say its $4 million divided by [2.5] that's about $0.12 a share. So last year was maybe $0.12. We'll have to recalculate that but that would make the quarter $0.44. So you're talking about a down quarter comparison. Is that fair?

Mark Schober

That’s fair.

James Bellessa - D.A. Davidson Company

Then another couple of checks, you indicated that there was total CapEx of $177 million so far. I think Bison 1 and the transmission system, or just Bison I?

Alan Hodnik

Those projects are combined and the total value or cost of the project is 177 million. We have sent around a 100 million to-date.

James Bellessa - D.A. Davidson Company

Okay. And then when O&M was described there three items that changed and I didn't catch them. I wasn't able to write them fast enough. Would you go over that, Mark, again?

Mark Schober

Well as we look forward you mean? Yeah we are expecting

James Bellessa - D.A. Davidson Company

No, no. In the most recent quarter, you described like reagent expenses and so forth.

Mark Schober

There is couple of things that way we are going on. Reagent contractor expense that add our power plant, due to primarily driven by some of the large maintenance outages we have. They are up about $8 million

Increased labor and benefit costs are up about $5 million and then our MISO expenses related to the DC line, that’s up about $3 million and then the last ones I mentioned were depreciation and interest together are up about $5 million and that’s again directly attributable to the growth in our property plant and equipment.

Operator

(Operator Instructions) And we have a follow up from Larry Solow from CJS Security

Larry Solow - CJS Security

Not to beat this, it's very trivial, but the wholesale true-up are at $6 million in Q4 of last year. This year it is basically, I don't know if the true-up is in the same ballpark, but assuming it is it would have been like $1.5 million a quarter? Is that basically what's happening?

Mark Schober

We spread it through out the year and the true-up this year and I don’t have a number handy but its going the other way.

Larry Solow - CJS Security

Okay, so that could vary a lot.

Mark Schober

Yes because it has taconite customers have come back so much (multiple speakers) going back we built that into our quarterly result so you won’t see anything large in the quarter

Larry Solow - CJS Security

Got you. So you basically assume it's flat. So that -- normally it wouldn't -- it's sort of a nonrecurring thing that was -- so that really was a $0.12 impact last year. And to clarify, your guidance now is $2.20 or $2.25, I thought, right? $2.25 is the low end?

Mark Schober

225 and 235

Larry Solow - CJS Security

So it is $0.32 to $0.42 essentially is what it implies in Q4.

Mark Schober

Yes

Operator

Thank you our next question comes from Eric Jacobsohn of Columbia Wanger, your line is open.

Eric Jacobsohn - Columbia Wanger

Quick question. Just what percentage of your rate base right now is coming from transmission? And then can you kind of talk what it would be in, let's say, 2015?

Alan Hodnik

Yes its difficult to predict what it would be right now, our transmission rate base is around 15% or so and depending on the growth and transmission out of retirement where policy makers take transmission which is unclear at this time we like transmission we will continue to invest in transmission it would be difficult to predict any uncertainty where we would be in 2025

Eric Jacobsohn - Columbia Wanger

I mean, with what you guys have announced, would you -- do you have a sense of what it ramps to, just with what you have approvals for?

Alan Hodnik

I don’t have that with me today no

Eric Jacobsohn - Columbia Wanger

Okay.

Alan Hodnik

But the number is as I would throw it – its 100-125 million that for the CapEx project there will be other minor items within Minnesota power but then you also look at our investment in American transmission company to that’s an investment in transmission too.

Eric Jacobsohn - Columbia Wanger

Thank you. Wait, I'm sorry. The 15 is including ATC stuff?

Mark Schober

It is not

Eric Jacobsohn - Columbia Wanger

It is not. Okay. Great. Thank you.

Operator

Thank you I show no questions in the queue I would like to turn the conference back to Mr. Alan Hodnik for closing remarks.

Alan Hodnik

Thank you and that ramps up our call for today and we look forward to seeing you all at the EEI financial conference next week. Thanks for joining us and have a good day.

Operator

Ladies and gentlemen thank you for your participation in today’s conference this thus concludes the program and you may all disconnect for this time.

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