May 13, 2008
Executives
Donald J. Shippar – Chairman of the Board, President & Chief Executive Officer Mark A.
Schober – Chief Financial Officer & Senior Vice President
Analysts
Lawrence Solow – CJS Securities Todd Vencil – Davenport & Co. Robert Chewning – Davenport & Co.
James Bellessa – D. A.
Davidson & Co.
Operator
Good day everyone and welcome to this conference call announcing Allete’s first quarter 2008 financial results conference call. Just as a reminder, today’s call is being recorded.
You’re line will be muted for today’s presentation. Then, we will conduct a question and answer session.
(Operator Instructions) This conference may contain forward-looking statements within the meaning of federal securities laws including statements concerning business strategies and/or 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 Privates Securities Litigation Reform Act of 1995.
The forward-looking statements in the earnings release distributed this morning reflect management’s 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 there in. 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’d like to introduce the Chairman, President and Chief Executive Officer Mr. Donald J.
Shippar. Please go ahead sir.
Donald J. Shippar
Good morning everyone. Earlier today we reported first quarter earnings per share of $0.82.
These results keep us on track to meet our total year earnings guidance of between $2.70 and $2.90 per share. Before we get to the details of the quarter I’d like to take a moment to update you on a couple of new developments.
First, you may have noticed that this morning we filed a $45 million rate increase request with the Minnesota Public Utilities Commission. If approved, this increase in base rates would be the first for our retail customers in 14 years.
Interim rates will go in to effect on July 1st and we expect final rates will be in place in mid 2009. Also yesterday Allete Properties closed on the sale of its Winter Haven Shopping Center for $20 million.
We determined that the shopping center which is the only shopping center we own was not a strategic part of our real estate business. The expectation of a sale was included in our initial 2008 earnings guidance.
We will record an after tax gain of about $3 million with this transaction in our second quarter results. At this time I’ll turn the call over to Chief Financial Officer Mark Schober.
Mark A. Schober
Good morning. Our quarterly results were in line with our expectations and I encourage you to refer to the 10Q we filed this morning for complete details.
However, I’d like to highlight a few items for you. Our regulated utilities segment earned $700,000 after tax or $0.02 less than the first quarter a year ago primarily because of higher expenses.
Operation and maintenance expenses were about 10% higher than a year ago. This year we incurred increased cost of labor, benefits and materials.
Some of these costs are related to our recent environmental retrofit project which are recovered through riders. We also incurred higher depreciation and interest expense related to our capital investment program.
Operating revenue for the regulated utility was up about 7% from last year and reflected a number of factors. Cooler than normal weather helped drive a 3% increase in residential, commercial and municipal sales, our most weather sensitive customer classes.
Fuel cost recoveries were higher than last year as was current cost recovery revenue related to our environmental projects. Also, on March 1st, higher wholesale electric rates went in to effect.
Revenue of gas sales at Superior Water Light & Power were higher this year, another result of colder weather. These increases in revenue were partially offset by a decrease in revenue from sales to other power suppliers due to contract expirations at the end of 2007.
As Don mentioned, we have filed a retail rate increase with the Minnesota Public Utilities Commission. The filing requests an average rate increase of about 10% and seeks an overall return on equity of 11.15% and a capital structure consisting of about 55% equity and 45% debt.
The filing addresses increases in operating and maintenance costs, increases in depreciation and interest expense related to our capital investment program and the expiration of off systems sales contracts. Additionally, we will incorporate to base rates some of the costs that are being collected through riders.
The total requested annualized increase if $45 million and we expect the final rate order from the commission in mid 2009. We requested an interim rate increase of $36 million to go in to effect July 31st this year.
We estimate incremental revenue from both the wholesale rate increase and the expected interim rate increase to be about $20 million in 2008. Net income from the non-regulated energy segment was down about $2 million after tax or $0.07 per share.
In 2007 we recorded a large sale of property in Minnesota and this year we incurred higher operating expenses and less revenue due to a planned outage at one of our non-regulated generating facilities. Income from our investment in the American Transmission Company grew slightly year-over-year due to our larger investment balance.
Income from this investment will continue to grow as we participate in capital calls. At the end of the quarter we had about $67 million invested in ATC and in 2008 we expect to invest an additional $5 to $7 million.
In April we participated in the capital call of $2.8 million which will be reported in our second quarter financial statements. Our real estate business recorded a $500,000 net loss or $0.02 per share during the quarter.
Land sales were lower than the first quarter last year consistent with real estate market conditions across the country. I’d like to remind you that no matter what the market conditions are, income from this business naturally varies from quarter-to-quarter due to the scheduled timing of contract closings and other factors.
Even though we recorded a small loss during the quarter we anticipated another profitable year for this business in 2008 but, as we stated in our previous guidance, a lower earnings contribution than in 2007. Don mentioned the gain on the sale of the shopping center which will be recorded in the second quarter and as of March 31st we also have $2.7 million of pre-tax deferred profits on the books which we expect to recognize during 2008.
Our other business segment earned $3.4 million or $0.12 per share more than in 2007. During the quarter we recorded gains on available for sales securities that are held for employee benefits.
These gains were triggered where securities were sold to reallocate investment to met defined allocations based upon an approved investment strategy. Our effective tax rate was 36.6% for the quarter, down slightly from 37.9% during the same period a year ago.
So, in summary the quarter ended up where we had anticipated and we remain on course to achieve our earnings per share expectation of between $2.70 and $2.90 per share.
Donald J. Shippar
Before we go to your questions I’d like to make a few comments about Allete as we look forward. Within our regulated utility business, Minnesota Power is in the midst of its most significant rate base growth ever as it anticipates making approximately $1.5 billion in capital investments by 2012.
About half of these expenditures are needed to comply with renewable energy requirements and environmental mandates. In addition, Minnesota Power will be making significant investments in its low cost generation fleet.
We will also look for transmission opportunities that strengthen and enhance the regional transmission grid and take advantage of our geographic location between sources of renewable energy and growing energy markets. Our capital investments will be recovered through a combination of current cost recovery riders and anticipated increased electric rates.
We expect growth in electric sales to our existing customers and may have additional load growth from potential new industrial customers in our service territory. Net income from our investment in ATC will grow as we increase our investment in that segment.
In short, we are seeing growth and opportunity in this business that we haven’t seen in decades. We believe our substantial capital investment program will benefit our customers and shareholders for years to come.
This is truly an exciting time in the history of our company. At this time I’ll ask the operator to open up the line for your questions.
Operator
(Operator Instructions) Your first question comes from the line of Lawrence Solow – CJS Securities.
Lawrence Solow – CJS Securities
Can you just confirm on the rate case, you get the 8% interim and assuming the rates go through in July 09 there would be I guess a back pay of the additional incremental difference?
Mark A. Schober
No. We anticipate interim rates going in to effect July 1st.
Those rates we anticipate being as I mentioned just about $14 million on the retail side and those are certainly subject to refund based on what our final rate order will say that comes out some time mid 09.
Lawrence Solow – CJS Securities
Just an update on I know you get current or cost recovery I guess on Boswell [inaudible] as the actual programs are complete or as the plants are up and running?
Mark A. Schober
The big one on Boswell, the environmental retro fit there, we do get cash return on [quip] because that’s such a long term project. The other smaller ones, the area project and some of our renewable those costs run through to our customers as the project goes in to service.
Lawrence Solow – CJS Securities
Then just turning to real estate where there any cancellations in the quarter?
Mark A. Schober
There haven’t been any cancellation during the quarter but we have updated the disclosure in our Q, I’d encourage you to take a look at that. But, we are working with all of our customers that have pending contracts due to the slowdown in the market and working with them trying to move these contracts to closure.
No guarantee that they will close but there hasn’t been any cancellations during the quarter.
Lawrence Solow – CJS Securities
Then you said the shopping center was a $20 million net sale?
Mark A. Schober
Yes, the sales price was $20 million and the after tax gain on the transaction that we will record in the second quarter is $3.3 million.
Lawrence Solow – CJS Securities
And that was included in your 2008 guidance?
Mark A. Schober
Yes, that was included in our guidance.
Lawrence Solow – CJS Securities
So it’s like a $0.10 after tax gain per share?
Mark A. Schober
Yes.
Operator
Your next question comes from the line of Todd Vencil – Davenport & Co.
Todd Vencil – Davenport & Co.
Just on that, did you say $3.3 million was the gain?
Mark A. Schober
On the Winter Haven Shopping Center, yes that’s what it was.
Todd Vencil – Davenport & Co.
Can you tell me how much Winter Haven represented on your balance sheet? I’m looking at an other asset line there in real estate of $13.5 million.
Mark A. Schober
That’s it.
Mark A. Schober
There’s some other finance receivables in there but that’s pretty much it, right around $13 million, $13 or $14 million.
Todd Vencil – Davenport & Co.
Was there any debt associated with it?
Mark A. Schober
Yes. We paid it off so the cash on the transaction is $5 to $6 million, there was about a $11 million note on it I believe that we have to pay off.
Todd Vencil – Davenport & Co.
When you say you’re working with the customers in your backlog there on the real estate to bring things to closing, as you go through that process are you delaying or changing, renegotiating the price?
Mark A. Schober
All those are possible. Again, that’s why I encourage you to look at the Q.
But, there’s going to be because of market conditions likely delays on some of those closings but there certainly could also be price adjustments or outright cancellations are possible too as we experience late in 07.
Donald J. Shippar
And there were extensions. Obviously, we’re working to try to extend and work with the customers but again, in this market there’s no guarantees of course that we’ll be able to successfully do that in call cases.
Todd Vencil – Davenport & Co.
Does any of that potentially affect that $2.7 million of deferred profit or do you think you’re pretty well locked in to that?
Mark A. Schober
That will come through our income statement as we complete some development obligations down in Florida. And, we anticipate completing them during the year so no, that should not impact that.
Todd Vencil – Davenport & Co.
Last question, just sort of more broadly, what are the guys down there thinking about sort of the timing on these market conditions? Do they have any idea and I’m assuming it’s not 08, but what are their thoughts as to when we might see this market beginning to improve a little bit?
Donald J. Shippar
I think there’s a variety of opinions on that depending on who you talk to as you well know. But, we would tend to agree with you, we’re not expecting any significant change this year.
We’re hoping there’ll be some improvement starting to show up next year probably later in the year and by 2010 see some significant improvement but again, that’s pure speculation on our behalf and their behalf as you well know.
Operator
Your next question comes from the line of Robert Chewning – Davenport & Co.
Robert Chewning – Davenport & Co.
I don’t want to appear confused but with regard to the rate increase the $45 million, is that inclusive or in addition to the increases that you will get via current cost recovery?
Mark A. Schober
That $45 million includes some of the revenue that we’re already collecting through our riders for our environmental projects. So, what happens is you go in to a rate case, we’re moving some of the completed construction from the revenue riders in to our base rates and that’s why when we look at 2008 as I discussed on the call a few minutes ago that the incremental revenue both on our Ferc rate case and the Minnesota rate case is incremental over and above what we’re recovering through the riders is about $20 million of revenue for 2008.
Robert Chewning – Davenport & Co.
$20 million incremental above the riders?
Mark A. Schober
Yes sir.
Robert Chewning – Davenport & Co.
That are currently in place?
Mark A. Schober
Yes sir.
Robert Chewning – Davenport & Co.
So if we were to look at the rate case the test year that you were using reflects what period?
Mark A. Schober
The test year is July 1st this year through 6/30 next year.
Robert Chewning – Davenport & Co.
So you’re using an average test year between those periods?
Mark A. Schober
Yes.
Robert Chewning – Davenport & Co.
Could you just give us some sense outside of the current cost recovery cap ex how much of the other cap ex is going to be included in that filing?
Mark A. Schober
Maybe just to give you some numbers, I like to look at it from a rate base standpoint. Looking at the test year which is July of 08 through June of 09, our total rate base for that period is right around $1 billion and the Minnesota jurisdictional piece is just about $900 million.
So, that’s what we’re going in for. The next piece, and it does get complicated, you also need to back out the rate base with some of these riders.
So the net rate base for this rate case is about $714 million.
Robert Chewning – Davenport & Co.
So net $714 then plus the cap ex that relates to the current cost recovery?
Mark A. Schober
Yes.
Operator
Your next question comes from the line of James Bellessa – D. A.
Davidson & Co.
James Bellessa – D. A. Davidson & Co.
The interim rate that goes in to effect on July 1st is $20 million?
Mark A. Schober
No. The interim rate that goes in to effect, this is what we’re requesting so again it’s up to the commission, the $20 million has to do with that’s the total incremental revenue from both the Minnesota rate case and the Ferc rate case.
So the piece, the incremental revenue related strictly to the retail or the Minnesota rate case is about $14 million.
James Bellessa – D. A. Davidson & Co.
So you’re going to ask for an interim increase of $14 out of a total of $45 million that you’re asking for.
Mark A. Schober
That’s the incremental revenue that we expect, yes. Remember that $45 million also includes some that we’re already recovering through our riders.
James Bellessa – D. A. Davidson & Co.
When you gave the guidance $2.70 to $2.90 did you have an anticipation that you were going to get this gain from the sale of investments in the first quarter?
Mark A. Schober
Yes, we did. When you step back and look at the results for the quarter it’s pretty much exactly in line with what we expected for the year.
There are no surprises in the first quarter.
James Bellessa – D. A. Davidson & Co.
So when you gave the guidance did you expect to have a down utility quarter?
Mark A. Schober
Yes, we did.
James Bellessa – D. A. Davidson & Co.
Why did you expect it? Why did it come out as being down?
Mark A. Schober
We knew it was going to be down and it did come out down about $700,000 and there’s a couple of primary drivers. One, is the increase in our OEM expense as we talked about.
And, we also had contracts in place that expired in 2007 and that energy now is being sold to our retail load. So, we knew that those margins were going to be down on the wholesale contracts and that we make those up or replace them as we’re selling to our retail load and that’s one of the drivers for the retail rate increase here.
James Bellessa – D. A. Davidson & Co.
Of course, we all know the timing of real estate varies from quarter-to-quarter but did you expect when you started the quarter that you’d have a loss of $500,000?
Mark A. Schober
We really don’t look at our real estate business quarter-to-quarter. Again, it varies so much.
We look at it on an annual basis and it’s in line with what we expected for the full year. And, that’s the way we’ve run the real estate business since we’ve been involved since 1991.
You really can’t take a lot of these transactions that we’re anticipating and peg them in to a month or in to q quarter.
Operator
At this time there appears to be no further questions in the queue. I would like to turn the conference back over to Mr.
Shippar for any closing remarks.
Donald J. Shippar
Thank you and thanks for joining us this morning. We look forward to talking to you again at the end of the second quarter where we’ll be reporting our second quarter earnings.
Thanks for participating and good morning.
Operator
That does conclude our teleconference for today. We’d like to thank everyone for your participation and have a wonderful day.