May 8, 2013
Executives
Alan Hodnik – Chairman, President and CEO Mark Schober – SVP and CFO
Analysts
Chris Ellinghaus – Williams Capital Paul Ridzon – KeyBanc Brian Russo – Ladenburg Thalmann
Operator
Good day and welcome to ALLETE First Quarter 2013 Financial Results Call. Today’s call is being recorded.
Certain statements contained in this conference call that are not discussions of historical fact are forward-looking statements such as terms defined in the Private Securities Litigation Reform Act of 1995. Because such statement can include risks and uncertainties, such actual results may differ materially from those expressed or implied by such forward-looking statements.
Factors that can cause results to differ materially from those expressed or implied by such forward-looking statements include but are not limited to those discussed in the 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 at the date hereof. The company undertakes no obligation to revise or update any forward-looking statements or to make any other forward-looking statement whether as a result of new information, future events or otherwise.
For opening remarks and introduction, I would now like to turn the conference over to ALLETE’s President and Chief Executive Officer, Alan R. Hodnik.
Please go ahead.
Alan Hodnik
Good morning, everyone, and thank you for joining us. With me on today’s call is Mark Schober, ALLETE’s Chief Financial Officer.
Earlier this morning, we reported ALLETE’s first quarter earnings of $0.83 per share which were in line with our expectations. Based on our quarterly results and expectations for the remainder of the year, we are reaffirming our earnings guidance of $2.58 to $2.78 per share for 2013.
Mark will provide an analysis of our quarterly earnings performance in a few moments. In addition to a strong quarter financially, we also made progress on our multifaceted, multi-year growth strategies.
In late January, Minnesota Power announced its Energy Forward plan, an energy vision designed to assure reliability, protect affordability, while further improving an already strong record of environmental stewardship. Energy Forward initiatives are subject to regulatory approval and we’re included in Minnesota Power’s 2013 Integrated Resource Plan which was filed with the Minnesota Public Utility Commission on March 1st.
Our Energy Forward plan provides the foundation for the various capital investments we plan to make related to further environmental upgrades, renewable energy, and transmission reliability; initiatives that we have been sharing with you for some time. I will provide updates on these initiatives later on in this call.
Let me turn now to organic growth and new customer developments in mineral-rich northeastern Minnesota. Two significant milestones were reached during the first quarter relating to the Essar Steel Minnesota project, which is served by one of Minnesota Power’s municipal customers, the City of Nashwauk.
First, installation of all-related transmission assets was completed and those assets were placed into service on April 1st. This marked the beginning of the new electric service agreements with Nashwauk and Essar Steel and a new stage in our relationship with both parties.
Billings to Essar to recover our transmission investments began in April and at even greater consequence, Essar Steel signed a 10-year off-take agreement with ArcelorMittal, the largest steel maker in the world. Under terms of the agreement, Essar will supply 3.5 million tons of pellets annually to Arcelor to 2024.
Essar is expected to begin blasting, mining and commissioning of equipment during the second half of 2013 and the early portion of 2014, which required insignificant electric power. As a result and as we’ve included in our earnings guidance, we expect minimal impact on our results on operations from electric sales to Essar in 2013.
Essar Steel is expected to begin increasing at the electric power requirement as production ramps up in 2014. The Taconite portion of this Essar steel project will ultimately result in approximately 110 megawatts of additional load from Minnesota Power.
Another new customer Magnetation which started two new facilities in Minnesota Power service territory last year is currently undergoing a $20 million expansion at its 5 megawatt mining resources facility. The expansion underway at mining resources, a shared facility between Magnetation and steel dynamics is expected to go online this summer and will increase concentrate output and also electric load by the additional 3 megawatts to 5 megawatts.
On the non-ferrous mining front, PolyMet mining has recently announced a new financing plan under which it will receive $60 million in cash and $20 million short-term loan from Glencore. Glencore has an ownership stake in PolyMet and is its concentrates marketing and financing partner.
PolyMet has indicated that the proceeds will be used in part to help complete the environmental review and permitting process and for detailed engineering cost in preparation for the start of project construction. The PolyMet supplemental draft environmental impact statement, or SDEIS, is now expected to be completed in the third quarter, but the possibility of final permits being issued in early 2014.
Given a 12 to 16 months construction timeline, PolyMet could be online by early 2015 if 40 to 70 megawatts load already under-contract with Minnesota Power. We have had a good start to 2013, and I look forward to reporting continued progress during the year.
At this time, I will turn the call over to Mark for a review of our financials. But later, I will have some additional comments before we take your questions.
Mark?
Mark Schober
Thanks, Al, and good morning everyone. I would like to remind you that we filed our 10-Q this morning, and I encouraged you to refer to us for more details.
For the first quarter, ALLETE earned $0.83 per share and net income of $32.5 million and operating revenues of $263.8 million. Compared to $0.66 per share, a net income of $24.4 million and operating revenue of $240 million in 2012.
Earnings from ALLETE’s regulated operation segment, which includes Minnesota Power, Superior Water, Light and Power and our investment in the American transmission company grows from $24.4 million in 2012 to $32.1 million in 2013 and the increase of 32%. Operating revenue increased $22.8 million or 10% from 2012.
Kilowatt hour sales to Minnesota Power customers rose by about 3% over the same quarter last year resulting in a $5.3 million increase due to a combination of seasonally warm weather experienced in the first quarter of 2012 and the 14% increase in sales to other power suppliers. In 2013, heating degree days in Duluth, Minnesota were approximately 27% higher than the same period in 2012.
Fuel adjustment clause recoveries were up $7.2 million over the same quarter last year due to higher fuel in purchases power costs attributable to our retail and municipal customers because of the increase kilowatt hour sales. Cost recovery rider revenue grew by $4.9 million from 2012 as the Bison 2 and 3 wind generating facilities were on service for the full quarter of 2013.
We also had higher revenue due to increase investment in our CapEx 2020 projects. Gas sales with Superior Water, Light and Power rose by $1.9 million from 2012, also as a result of unseasonably warm weather during the first quarter last year.
Turning to the expense side, regulated operations operating expenses increased $17.1 million or 10% over the same quarter in 2012. Most of this change was due to a $9.4 million increase in fuel and purchased power expense from 2012 due to higher kilowatt hour sales sold and purchased power prices.
Operating and maintenance expense increased $4.1 million or 5% from 2012. Purchased gas expenses, which are recovered during an adjustment clause increased with higher sales at Superior Water, Light and Power.
Higher taxable plant and rates resulted in higher property tax expense compared with last year. Depreciation expense increased $3.6 million and interest expense was up $1.1 million for the quarter both directly attributable to the capital investment program at our regulated operations.
Earnings from our investment in ATC were slightly higher than the same quarter of 2012. The income tax expense decreased $2.2 million from 2012 primarily due to higher federal production tax credits in 2013 related to the Bison 2 and 3 wind-generating facilities.
ALLETE investment in other segment, which includes results from BNI Coal, ALLETE properties, ALLETE clean energy and other corporate income and expenditures reported $400 in net income for the quarter compared to known net income for the same quarter in 2012. Out effective tax rate in the first quarter of 2013 was 19% compared to 25% for the same period of last year.
We anticipate the effective tax rate for 2013 will be approximately 20%. We generated $58 million in cash from operating activities and carry 45% debt to capital ratio at quarter end 2013.
In summary, we are pleased that their financial results in the first quarter and we are confident in our prospects for the full year. As Al mentioned, our first quarter result were consistent with our expectations and we reaffirm our full year guidance range of $2.58 to $2.78 per share.
Al?
Alan Hodnik
Thank you, Mark. ALLETE is an energy company with multifaceted multiyear earnings growth opportunities.
Organic growth within mineral rich Northeastern Minnesota such as the projects I mentioned earlier will continue to drive top line revenue increases. We have identified significant capital investment opportunities that will provide per rate base growth throughout the decade.
We also remain very disciplined and very focused. This is we analyze potential energy-centric investment prospects.
Before we take your question, I would like to update you on the progress of some of our capital investment opportunities beginning with our renewable energy development. As we disclosed in our 10-K filing last February, our current five-year capital expenditure plan includes $226 million for about 100 megawatts of additional wind development in North Dakota over the 2016 to 2017 timeframe.
However, with the expansion of the federal production tax credit, Minnesota Power is currently evaluating an acceleration of those expenditures to commence in 2013 as well as increasing size of this project. And we have been very busy all winter and now have 130,000 acres of land under lease out in North Dakota.
We are currently in a final stage of evaluation on this process and expect to be able to announce the filing with the Minnesota Public Utility Commission, the size timing and estimated investment for this additional wind energy development presently. ALLETE Clean Energy is also a way the production tax credit extension impacts as it evaluates various projects and partnership opportunities out in North Dakota.
Similarly, we hope to be in a position very soon to provide additional detail regarding our plans for the Great Northern transmission line. As you probably know, we, along with Manitoba Hydro has proposed construction of a 500 kilovolt transmission line between Manitoba and Minnesota’s iron range with a target in-service date of 2020.
Additionally, Minnesota Power and ATC are evaluating the joint development of a 345 kilovolt transmission line from the Iron Range to Duluth as part of the great northern transmission line project. Total project cost, ownership shares, and cost allocations are still to be determined.
We are expecting a decision from the Minnesota Public Utility Commission some time during the later part of 2013 regarding the estimated $350 million to $400 million Boswell Unit 4 Mercury Emission Reduction Project. On March 1st, the Minnesota Pollution Control Agency issued a report in support of our plan and recommended that the Minnesota Public Utility Commission accept the Minnesota Pollution Control Agency findings.
The project is designed to comply with new rules issued by the EPA which requires all coal units to be in compliance by April 2015. To achieve both EPA and State of Minnesota mercury requirements and deadlines, and to do so in a cost-effective manner for rate payers, Minnesota Power must commence with this project during 2013, something we fully expect to do.
So with that, I will now ask the operator to open up the lines for your questions.
Operator
(Operator instructions) Our first question is from Chris Ellinghaus from Williams Capital.
Chris Ellinghaus – Williams Capital
Hey, guys, how are you?
Alan Hodnik
Good morning, Chris.
Chris Ellinghaus – Williams Capital
Were there any unusual items in the quarter?
Alan Hodnik
None at all, pretty clean quarter for us, Chris.
Chris Ellinghaus – Williams Capital
Okay, what does the weather look like versus normal?
Alan Hodnik
The (inaudible) were p as I mentioned in the call about 20% so we’re closer to normal in the first quarter here of 2013 versus last year which was quite warm.
Chris Ellinghaus – Williams Capital
Okay. Did you?
Alan Hodnik
So that’s –
Chris Ellinghaus – Williams Capital
Did you?
Alan Hodnik
Go ahead.
Chris Ellinghaus – Williams Capital
Did you quantify what the weather benefit versus last year was?
Alan Hodnik
Yeah, if we go through the 10-Q we do include it in there. It’s about a bump of about $5 million in revenue.
Chris Ellinghaus – Williams Capital
Okay. And just getting to the guidance, I mean, it’s a huge quarter for you for the first quarter.
Are there any notable drags or timing issues on expenses that play out throughout the rest of the year?
Alan Hodnik
Yeah, really two things going on. So we reaffirm our guidance, so what you’re seeing a piece of that is the timing of O&M expenses, so that is included in there.
And you have to recall, remember that we always have a bit of seasonality too, so our strong quarters are Q1 and Q4. We tail a little bit in the middle quarter, so that’s a piece of it too.
But for the full year we’re right where we need to be.
Chris Ellinghaus – Williams Capital
One last thing, Bison 2 and 3, they came online pretty late in the fourth quarter last year if I recall, is that true?
Alan Hodnik
Yeah. They came in in November, December of last year.
Chris Ellinghaus – Williams Capital
Okay. Thanks a bunch.
Alan Hodnik
Okay. Thanks, Chris.
Mark Schober
Thanks, Chris.
Operator
Our next question is from Paul Ridzon from KeyBanc. Your line is open.
Paul Ridzon – KeyBanc
Good morning. Congratulations on a solid quarter.
Mark Schober
Good morning, Paul.
Alan Hodnik
Thank you.
Paul Ridzon – KeyBanc
I just had a question on, your RFP, I’m trying to interpret what you said, does it – has Minnesota Power won the RFP or is it down to a short list?
Mark Schober
Yeah, there’s a process, a fairly lengthy process that Minnesota Power goes through. So we put out an RFP for up to 200 megawatts of new wins.
MP obviously bid into that. So the evaluation of all of those bids is what’s going on as we speak.
And we use an independent third-party there to evaluate those responses [ph] to make sure that what we file with our commission is in the best interest of our rate payers. So that’s the process that’s going on right now.
Once that process is complete, as Al mentioned, we will then prepare our filing. And as we have with the prior Bison projects, that’s when we – once we make that filing, that’s when we’d announce to you the size and scope of that project.
Paul Ridzon – KeyBanc
And that are in PPAs [ph]?
Mark Schober
Yes, yes.
Paul Ridzon – KeyBanc
Okay. And we should be a few weeks or – well, what’s the time I think we’ll get at that regulatory filing?
Mark Schober
Yeah, what we anticipate as making that filing right around mid-year so close to the end of the quarter. So it’s a very similar timeline to what we used with Bison 3 last year.
So we need to make the filing by the middle of the quarter and get regulatory approvals to meet the IRS regs there where we need to start construction by the end of 2013 if we win that RFP to take advantage of the production tax credits.
Alan Hodnik
That’s been the other issue, Paul, is waiting for IRS guidance which they’ve just issued here recently with respect to the PTC extension, and in this case, unlike last year where we were concerning ourselves more with a end date; this time around we’re more concerned with the definitions for what start [ph] means, and so we finally go to those guidelines as well. So we’re working through the process.
Paul Ridzon – KeyBanc
And you indicated that you now had 130,000 under lease in North Dakota, was the previously 80,000?
Alan Hodnik
It was something like 65,000 to 70,000; we’ve now boosted that to 130,000 acres. Yes, so we continue to be busy all winter acquiring land and working with the land owners to obtain leases.
Minnesota Power has a very good reputation and so does ALLETE Clean Energy out in North Dakota. And of course, North Dakota wind is sort of the Saudi Arabia wind, vey superior wind compared to other locations.
We we’re – yes, we’ve been very busying out there acquiring more land.
Paul Ridzon – KeyBanc
How far along are your discussions at ACE [ph] with regards to maybe partnerships or projects?
Alan Hodnik
Well, again, there is a – ACE is continuing to work with developers that might have an interest for one cause or another in additional renewable. And certainly with the PTC extension, it makes the story and the economics around wind even more enhanced if you will.
So I would just say they’ve had a variety of conversation with the people out in the western part of North Dakota and also in other parts of the upper mid-west. That’s where I could leave it at this point in time.
Paul Ridzon – KeyBanc
Great. Thank you very much.
Alan Hodnik
Thank you, Paul.
Operator
(Operator instructions) Our next question is from Brian Russo from Ladenburg. Your line is open.
Brian Russo – Ladenburg Thalmann
Can you hear me?
Alan Hodnik
Yeah, got you, Brian.
Mark Schober
Good morning, Brian.
Brian Russo – Ladenburg Thalmann
Okay. I’m just curious, did ALLETE Clean Energy bid into the RFP?
Alan Hodnik
No.
Brian Russo – Ladenburg Thalmann
No?
Alan Hodnik
No.
Brian Russo – Ladenburg Thalmann
Okay. And you may have mentioned this before and I missed it but Bison 2 and 3 went through a similar RFP, correct?
Alan Hodnik
Yes, they did.
Brian Russo – Ladenburg Thalmann
Okay. And assuming ALLETE wins or Minnesota Power wins the RFP, how should we profile the spending.
It will have to start in ‘13. I would assume there’s very little CapEx at the end of ‘13 but we assume construction cycle of about a year, so full year of operation in ‘15.
Alan Hodnik
That’s exactly what we’re looking at as part of this process, Bryan. We need to start construction to meet the IRS regs and I think that number is 5% needs to be in the ground of the project by the end of the year and then you need to have continuous construction.
So that’s what we’re looking at and I won’t know that until we make our filing closer to the middle of the year where I can give you some of the metrics when we anticipate bringing it into service. I can envision scenarios where it does all come in to service at the end of 2014 but I could also envision scenarios where some of this will move into 2015 too.
A lot of it, especially if we go to 200 megawatts, a lot of turbines that need to be put up and then you got winter weather in North Dakota. So it would be a lot of work to get done in a short period of time.
Mark Schober
Brian, just as a point of clarification, we had originally done Bison 1 and we had conducted an RFP at that time for our regulators. And then with the production tax credit expiration date looming, our regulators themselves had asked about building additional wind, Bison 2 and Bison 3.
And so in that particular instance, we work with our regulators and using the RFP outcomes for Bison 1, the regulators were satisfied with our Bison 2 and Bison 3 likely cost. And so we moved forward in that case based on that sort of Bison 1 RFT.
But enough time has passed at this point in time that we know on working with our regulators that they would and we would on behalf of our rate payers expect in our peer [ph] a fresh RFP. So I just wanted to put that subtlety in there just to make sure that we are clear about how these RFPs actually work but we continue to have a very good working relationship with our regulators and we expect to bring similar products forward to them that would meet their standards.
Brian Russo – Ladenburg Thalmann
Okay, great. And the additional wind form, you mentioned the new acreage that you secured.
But aren’t these wind projects being built on the Bison site?
Mark Schober
Well, it’s all sort of euphemistically you sort of universally call Bison, but just start thinking about all that territory west of Central North Dakota. And so, any proposed projects by Minnesota Power called Bison 4 or 5 harbor we described, or even something that ALLETE Clean Energy might do is all sort of in that central or western part of North Dakota.
We all call it sort of euphemistically the "Bison territory."
Brian Russo – Ladenburg Thalmann
Okay. Is there access to transmission already?
Or would you need to construct something?
Mark Schober
Well, we continue to build 230 kV transmission out from our DC line. We call, first of all, the great advantage that ALLETE has and being able to move quickly with wind on behalf of our customers is that we already have the DC line in service.
So far we’ve built about 23 to 30 miles of 230 kV line further to the west, and we would continue to add about another 20 to 25 miles of 230 kV line to go to the west to do all that. So that is implicit in any sort of continued wind expansion, but all very doable, all very sort of rudimentary, if you will, in terms of all that we’ve been doing so far.
Brian Russo – Ladenburg Thalmann
Okay. And just remind me of the mechanics of the cost recovering mechanism.
Do you get cost recovery as you spend or do you get a few DC and then cost recovery return of it on when the project actually goes into service?
Alan Hodnik
Yes, we’ll be recording AFUDC once we get the project approval from the MPUC and then the process we go through is to file what we call a factor filing which will take several more months. And once we get approval of that, then we can actually start running those cost through our right peers and the cash flow will start.
Brian Russo – Ladenburg Thalmann
Okay. And can you –
Alan Hodnik
And that’s an annual filing, so we update those numbers on an annual basis typically.
Brian Russo – Ladenburg Thalmann
Can you remind us of your dividend policy?
Alan Hodnik
Our dividend policy continues to be as we spoke before, Brian. We want to be consistent with our peers.
We know dividends are important to our investors and we look at payouts in the range of our plus or minus 70% that look typical for our peers.
Brian Russo – Ladenburg Thalmann
Okay. And have the assumptions in our guidance remain the same in terms $0.10 to $0.15 of ETS dilution for higher share count?
Mark Schober
Yes, nothing has changed from the original guidance that we issued in December of last year.
Brian Russo – Ladenburg Thalmann
Okay. And has there been any movement on the potential for an Essar Steel mill which would require a new combustion turbine of about 300 megawatts?
Alan Hodnik
No not at this point, Brian. Essar is wholly focused right now on finishing up construction of their Taconite facility.
We expect relatively robust construction into the summer and fall and their focus right now is really getting the Taconite portion up and running.
Brian Russo – Ladenburg Thalmann
Okay. Thanks very much.
Alan Hodnik
Thank you.
Mark Schober
Okay.
Operator
Thank you. (Operator Instructions) We have a follow up from Paul Ridzon from KeyBanc.
Your line is open.
Paul Ridzon – KeyBanc
Thank you. [Inaudible] kind of what’s going to drive whether the projects are done in ‘14 or ‘15, is it to protect the balance sheet, the equity issuance or how are you thinking about financing?
Mark Schober
Well, what’s going to drive the timeline is certainly the IRS reg, so we need to get a better understanding of what continuous construction means. And then it’s more of an operational standpoint than a financing standpoint.
We’re very comfortable that we can finance this through a mix of debt and equity as we have in the past fall.
Paul Ridzon – KeyBanc
Just changing gears, anywhere out of Pittsburgh on the US deal conversion?
Alan Hodnik
Yes, John Tamara was just on a quarterly call himself, of course, with regards to US deals earnings. John indicated a couple of things in there that I thought were interesting.
One is that the KeyTech or KTech expansion has been delayed, or postponed, if you will. But implicit in that is that the US deal has worked out an agreement with the State of Minnesota to extend their permit.
And so the permit associated with construction carry forth, and that was very good news. And he also further indicated in there that US deal continues to evaluate this whole emergent side of the business directly to standards.
I spoke about this in New York when I was out there with you all. But directly to this iron or directly through Nuggets if you will, our products, it has ALLETE products.
So we’re really have becoming more involved because of low natural gas pricing and all the rest. And so, while I wasn’t at the meeting, I didn’t sit in the call, a follow up was clear that US deal is sort of slow down the "Taconite expansion," have maintained their permits going forward and continue to evaluate the role DRI might be able to play no in any sort of mining and processing operations for US deal on the iron range.
Paul Ridzon – KeyBanc
Thank you.
Mark Schober
Very good. Thanks, Paul.
Operator
(Operator Instructions) We have no more questions at this time. I would like to turn the conference back to our president and CEO, Hodnik, for closing remarks.
Alan Hodnik
So thank you for your continued interest in ALLETE and we look forward to reporting our continued progress on our multifaceted multiyear growth plans as the year continues to unfold. Thank you and have a very good day.
Operator
Ladies and gentlemen, this does conclude today’s conference. You may now disconnect.