Aug 1, 2008
Operator
Good day and welcome everyone to this conference call announcing Allete’s second quarter 2008 financial results. Today’s call is being recorded.
You're line will be muted for the presentation. Then, we will conduct a question-and-answer period.
(Operator Instructions) This conference may contain forward-looking statements within the meaning of Federal Securities Laws including statements concerning business strategies and there 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 the 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 Shippar
Good morning and thank you for joining us. This morning we reported our second quarter results of $0 37 per share.
Year-to-date, we are reporting $1.19per share and we are on track to meet our year end earnings guidance of between $2.70 and $2.90 per share. Our Chief Financial Officer, Mark Schober, will go through the financial details in a few moments.
There are few recent development that I like to share with you. As you know Minnesota Power filed for a $45 million retail rate increase in early May.
The Minnesota Public Utilities Commission has issued an order authorizing interim rates and they go into effect today. We expect to have final rates in place during mid 2009.
Superior Water, Light and Power also filed a rate increase request during the second quarter. On an annualized basis, the rate increase will generate approximately $4 million of additional revenue.
We anticipate that the rates, if approved by the Public Service Commission in Wisconsin will be effective in January 2009. In may, we announced plans to develop several 100 megawatts of wind energy in North Dakota and purchase an existing direct current transmission line to transport this wind energy to customers.
This project which will take several years to complete will allow us to meet our mandated state renewal energy supply requirements. We expect to execute a definitive agreement in the third quarter and close on the transmission line purchase in early 2009.
In bottom line, on subject to wind energy, I’d like to mention that our 25 megawatt Taconite Ridge wind facility located in North Eastern Minnesota became operational in July. Under our lease property real estate business, the $29 million contract with low enterprises was terminated in July and low inaudible] of $600,000 deposit.
We are currently reviewing the best options to proceed with this property. We believe this property along with all remaining property at our development projects holds long-term value for Allete.
At this time I'll turn the call over to Mark and then we will take your questions. Mark?
Mark A. Schober
Thanks Don. Our earnings performance for the quarter and for the year-to-date is in line with our expectations.
As Don mentioned, our year end earnings guidance remained unchanged at $2.70 to $2.90 per share. I encourage you to refer to the 10-Q we filed this morning for the complete detail for the quarter.
The regulated utility segment, earned $5.2 million for the quarter down $900,000 from the second quarter a year ago. Retail and municipal electricity sales were up about 2% over the same period last year.
In addition, we have higher wholesale rates in place, which resulted in an additional $2.1 million of revenue. An increase revenue from cost recovery riders of $4.8 million compared to 2007.
Offsetting these, we realize $7.6 million less revenue from sales to other power suppliers in the second quarter last year due to contract expirations. On the expense side, regulated utility operating and maintenance expenses were $2.2 million higher because of increases in purchased gas costs and salaries and wages.
Depreciation and interest expenses increased by a combined $1.4 million, as a result of our significant capital expenditure program. Don mentioned that interim retail rates were going to effect today.
These higher rates will begin to offset the impact of these rising expenses and reduce sales to other power suppliers. For 2008, we expect incremental revenue from both the new wholesale rates and the interim retail rates of approximately $20 million.
Income in our real estate business $2.5 million for the quarter compared to $11.5 million a year ago. Last year's second quarter earnings were unusually large, primarily due to two very large property sales.
In the second quarter this year, we recorded the sales of Winter Haven Shopping Centre on an after-tax gain of approximately $3 million. As of June 30th, we had $2.7 million of pretax deferred profit on sales of real estate on our balance sheet, which we expect to recognize by year-end.
Our real estate business will be profitable this year, our net income will be less than in 2007. Income from the other segment was $2.7 million less than the same period a year ago.
This year we have lower earnings on cash in short-term investments due to lower balances and in 2007 we recorded the release from a North-west airlines loan guarantee and a positive state income tax audit settlement. Effective tax rate for the quarter was 36.5% compared to about 32% a year ago.
Last year's rate was lower due to the state income tax audit settlement I just mentioned. Don?
Donald Shippar
Thanks Mark. At this time, I will ask the Operator to open up the line for your questions.
Operator
Thank you, Mr. Shippar.
Ladies and gentlemen the question-and-answer session will be conducted electronically. Operator Instructions] We will take our first question from Lawrence Solow with CJS Securities.
Fred Buonocore
Yes, good Morning gentlemen. This is Fred Buonocore calling in for Larry
Donald Shippar
Hello Fred
Fred Buonocore
Hi, one quick thing I wanted to ask about, we realized its just a one month delay, but does the rate increase going into effect at Minnesota power August 1st, instead of July 1st have any sort of negative impact obvious slide on your '08 outlook versus your prior guidance?
Mark Schober
No it really doesn’t, I will tell you there are couple of things going on here. You are right, we are about a month behind schedule as far as giving our interim rates in effect.
However offsetting that our overall revenue requirements are bit higher than we anticipated, so those two guys really do net each other out so the overall impact on the retail rate filing here in Minnesota will be about $13 million increase in revenue this year.
Fred Buonocore
Okay. Excellent, great, I got that and then, in terms of weather, did you have any unusual weather impacting the second quarter or were there any unusual weather impacts in the prior year quarter?
Mark Schober
No, nothing of significance. We’ve had a couple of storms here that have bumped our OEM expenses a little bit but nothing of major significance.
Fred Buonocore
Great, and then, clearly there is significant investment opportunities on the utility side of the business and that really appear to be your focus as, and we believe it should be, but just touch me on the real estate a bit. Do you expect to make any opportunistic real estate investment and additional investment in Florida or perhaps moving up the cost into Georgia or the Carolina’s?
Mark Schober
Well we continue to look in Florida and primarily in North Carolina and parts of South Carolina for further investments in real estate. Again we're looking in certain specific areas, which we think have long-term potential, and we are looking we would consider very, very attractive opportunities to buy additional property during this downturn in the market.
Fred Buonocore
Outstanding. And then, just finally wanted to touch on miming activity.
Any update on potential expansion in miming activity or operations from new or existing customers?
Mark Schober
Well, Northshore mining just completed a expansion or actually broaden up production line has been ideal for several years back on line. US steels is in the midst of doing the same at there Q1 Taconite plant.
There is also a expansion that's been scoped out at another one at Cliff operations] up in (inaudible) Minnesota, so the mining industry, and the Taconite site, the iron mining site continues to be very, very strong and the steel, or customers are looking for every possible way they can increase their production at Allete. PolyMet mining, which of course is the copper and nickel company that's in the process of seeking permits, continues to make progress.
They're expecting sometime late this summer, early in the fall to receive there first indication from their environmental impacts they have met on. There is also several other firms that are very interested in the copper nickel precious metals mining area.
But our view is that they are all watching PolyMet to see how that whole process comes together.
Fred Buonocore
Excellent, that’s very helpful. Thank you very much.
Mark Schober
Thank you.
Operator
Operator Instructions]. And we'll go to James Bellessa with Davidson & Co.
James Bellessa
Good morning.
Mark Schober
Morning James.
James Bellessa
If Lowe forfeited their $600,000 contract deposit, what does that mean about their ownership of this land in I think Sawmill Creek project.
Mark Schober
Correct, what that means Jim is that that $600,000 deposit that they forfeited will be recognized, or was recognized as income for us in the quarter. Lowe's already had a take down last year.
They continue to own that land and can move forward to develop the remaining land. However, it remains in our inventory.
So as far as the future of Sawmill Creek, that's something that we continue to explore opportunities with them or without Lowe and what we can do to develop the Palm Coast Park where Sawmill Creek is.
James Bellessa
Property that they purchase last year, is that the sweet spot of that territory and therefore you're left with the residual properties, and it's going to be harder to develop for you?
Mark Schober
Well, actually what they bought Jim is mostly the layout for the golf course that they were planning there. So it was primarily the golf course and land around the golf course.
So there is still, again all the land are on the perimeter of the particular property belong to us. We continue to work with Lowe to try to find the best way if you will for us to separate and divide that property so that it maximizes our potential for future development.
And so they decide to develop their parts at sometime and also is a better situation for them.
James Bellessa
And so, the inconceivable that they might want to sell this property back to you?
Mark Schober
Well, we don't think it's inconceivable. No, I mean certainly that hasn't been anything that we want to change yet, but again we don't know that.
James Bellessa
If it's, you could buy pennies on the dollar from what they bought it from US and then have a better larger piece to work with, I’m just asking that it could be a conceivable approach. I see where, you did sell the Winter Haven and it sold for about $20 million, but I don’t see that kind of magnitude of revenues in the real estate business, so what how does it get recorded?
Mark Schober
What's recorded Jim, if you look at in the revenue line that’s net pre-tax is included in that line item and it's above $4.5 million, and that's in the revenue line item for real estate
James Bellessa
And that other revenue is 5.3 and your saying 4 poin, what was it?
Mark Schober
4.5 million.
James Bellessa
Okay. I am going to ask a couple other questions here right and just move to the, my spread sheet for a second.
On the other business, you in the first quarter didn’t have any interest expense and now you have interest expense of $1.5 million in the other segment, what changed there, what would have caused interest expense this quarter versus--?
Mark Schober
This is really just, overall interest expense is right where we expected Jim. What you're talking about is really just how we look at interest expense, and how we allocate it across our business units.
We did make a change this year, we did not go back and restate for '07. And really looking at a each one of the operating business units, and allocating interest to them based on a rate base and capital invested with the remainder at other.
So you're seeing a little bit of increase in overall interest expense at other. And we made that adjustment in this year '08 business.
James Bellessa
Non-regulated energy business improved about double earnings than last year, where the earnings last year just low and therefore you just getting back to normal operations there?
Mark Schober
Yeah, on the non-regulated side, the last year we had some real estate sales and then at this year Minnesota real estate we will probably have someone there later this year. BNI is performing a little bit better.
Our coal mine is in that line item too, so earnings from BNI that's probably the primary driver that you are seeing.
James Bellessa
You said that other power supply sales were down, and you said that that was due to an expiration on the contract or contracts?
Mark Schober
Yeah.
James Bellessa
Do you see any of the renewal of those kinds of contracts going forward or if long-term contracts are expire and no promise of being replaced?
Mark Schober
Yeah those contract or contracts that we had in place, they all, there are several other that expired with the first of the year here, that energy now is being move back and faired a retail low. So no, we are not going to be reentering in the long-term contracts and that's really one of the primary drivers into our Minnesota rate case.
James Bellessa
Tax rate at the utility was higher than I would have expected, was there anything abnormal there?
Mark Schober
No, not for the utility.
James Bellessa
Thank you very much.
Mark Schober
Okay. Thanks Jim.
Operator
And we'll now go to Bernard Horn, Polaris Capital.
Bernard Horn
Hi, good morning.
Mark Schober
Good morning.
Bernard Horn
Just two questions, I wasn't quite sure on the regulated rate increases. It looks like in the press release it talks about it going into effect today, and I wasn't quite sure.
I just came little bit late, so I was a little unclear about the prior comment that it was going to be a month delayed. Are you talking about two different things or one?
Mark Schober
No, that is the same issue we have originally anticipated that the interim rates would go into effect July 1st.
Bernard Horn
So it's going into effect today.
Mark Schober
Yeah.
Bernard Horn
Okay and then the other question, again you may have covered it before I jumped on but the commercial business, looks like it was down a bit. Could you just bring up-to-date, and it sounds like your industrial business is still moving on reasonably well.
Mark Schober
Yeah, we have looked hard at that too, as we look at our overall towards our sales, and we are doing very well, residential and our industrial. The municipals, they should really, is also doing very well.
When we look at the commercials, there is really nothing specific there. We are thinking it may have something to do with just the overall economy and the slowdown.
This may be pulling our energy sales down a little bit but there is nothing specific that jumps outs or is concerning at this point in time.
Bernard Horn
What is in the commercial? I am not quite sure how that distinguishes itself from the industrial.
Mark Schober
Just the small businesses, like malls, department stores, those kinds of things.
Bernard Horn
Okay. And the pricing and so forth.
This wouldn’t have changed in those different markets?
Mark Schober
No.
Bernard Horn
Okay. Thanks a lot.
Mark Schober
Yes.
Operator
Operator Instructions] And we will go to Bob Chewning, Davenport & Company.
Bob Chewning
Good Morning
Mark Schober
Good Morning Bob.
Donald Shippar
Hey Bob.
Bob Chewning
Your guidance, you indicated real estate would be positive. But, could you give us some sort of range as to the amount of earnings that could potentially be out of real estate that are in that 270-290 guidance?
Mark Schober
You are well aware, Bob that we don’t give individual guidance by our business segments. Last year real estate came in at about $17 million.
This is certainly going to be less than that this year. I think if you look at where they are year-to-date and you look at, as I mentioned the deferred profit that will be taking into income by the end of the year.
You will come pretty close to what we expect for our portfolio earnings.
Bob Chewning
Okay. And as I look at the real estate segment, first quarter you had operating revenue is of $2.7 million, if you take out the $4.5 million gain, it looks like you've $3.4 million of revenues and your operating cost in both periods were around $3.8 million.
Should we be looking at 3.8 is more or less close to a quarterly operating expense level?
Mark Schober
No that would be high, that's pre-tax expense that would be high for an annual basis. I think there maybe some selling cost in there for the shopping center that are one timers.
Our overall expenses for that business on an after-tax basis probably round about 5 million -- 4 to 5 million a year,
Bob Chewning
4 to 5 on an after-tax?
Mark Schober
After-tax annually, yes
Bob Chewning
Okay, all right. Okay, thank you very much
Mark Schober
You bet.
Operator
And we have a follow up from James Bellessa again with Davidson & Co
James Bellessa
You had some formal comments about the purchase of this DC transmission line from North Dakota to Minnesota, would you go through that again? What's the purchase date, did it get push back a little into the future, could it have been done by year end and now to into this '09?
Mark Schober
Well we were projecting the end of 2008 early 2009, now as we continue to work with Minnkota and Square Butte, which actually is the owner of the assets, we are thinking it's more likely that that's going to close in early 2009, after we of course make all of our filling get approvals etc. So its probably a little later than we first expected, but not significantly later
James Bellessa
Does this delay therefore the rate basing of that property? Is it pushed out past middle of '09?
Mark Schober
No. The way we look at it Jim, we complete the purchases in Q1 of '09, we're working with our regulators on exactly how we want to get that into our weak base to start earning on.
When we look at '09 in total, it really is about a push, because we were increasing our rate base because of this 80 million, but our cost from Square Butte will also come down. So we make simply them because that will address in a future rate filing.
James Bellessa
Thank you very much.
Mark Schober
Okay.
Operator
And we'll go back to Bernard Horn with Polaris Capital.
Bernard Horn
Yeah. Hi, again.
The industrial business, I know you've got a lot of exposure to Taconite mines and so forth. We have been seeing some reports out of non-US companies that steel prices have been falling some what dramatically and I was just wondering to what degree you have any longer term view or the companies just so positively effected by the weak dollar that it doesn't really matters what's going on?
Do you have any sense of how far and advance you can see their business?
Mark Schober
Well, just based on conversations with the customers again on the steel companies, the mine owners, they continue to feel very strong about the outlook for the Taconite palettes, if you have ordered that. And obviously as you know, the vast majority, almost totally that all those palettes go to the US markets.
And so they are continuing to look at expansion and continuing to look at getting all the production they can to all facilities. The prices have clearly gone off significantly in the last several months for palettes on as far as per ton cost.
So from their perspective, we've got no indications what so ever that they see anything but a very positive outlook.
Bernard Horn
Okay. And the rate increase goes in August 1st, how much is that?
The interim rate?
Mark Schober
The overall rates that we are repressing are $45 million. The interim rate increase is 35, so the impact on '08 is about $13 million in the increase revenue.
Bernard Horn
And is that across the board or just the regulated utility?
Mark Schober
Across the board to our retail customers, but yes the regulated utility.
Bernard Horn
Okay. But it would be all categories in that regulated utility and now you break that down among other different types of customers.
Mark Schober
Except for the municipals, the municipals are regulated by the Federal Energy Regulatory Commission and we just completed that rate case earlier this year.
Bernard Horn
Okay and will it be any release on that coming up?
Mark Schober
That's already in the estimates that we gave you. Overall, that's about $7.5 million rate increase on annual basis that went into effect on March 1st.
Bernard Horn
Okay. And when you tell us it is 45, 35 and so forth, what are you basing -- is that a fixed dollar amount or is it per kilowatt-hour?
Mark Schober
It's an overall blended or average increase for all of our customer classes, up to 35 million.
Donald Shippar
It's about 7.5% increase on kilowatt-hour basis.
Bernard Horn
Okay, but it's… so what happens if for some reason, if the economy slows down, kilowatt-hour use goes way down. How does that affect your ability to obtain that dollar amount of revenue increase?
Mark Schober
In the short term, that overall amount would then be decreased.
Bernard Horn
So, it's a per kilowatt-hour increases, that's about 7.5% or what did you say?
Mark Schober
Yeah, and that would drive our overall returns and that would obviously then we factor that and we look at our rate case strategy and in the worse case, if the numbers are significant, we would drive future rate filings.
Bernard Horn
Okay, so in terms of how we would think about the sensitivity of your, so if for some reason your fuel bill or bills go up and that's a fixed amount and then your kilowatt hour usage decline even though you have got a rate relief on the kilo, because you're getting less, you're selling less kilowatt hours, you still going to have a squeeze on margins, if that were the case?
Mark Schober
There would be, but our fuel and purchase power cost here in Minnesota, we have a fuel adjustment clause. Both the dollars run through to our customers.
Donald Shippar
The only thing to remember is about 55% of our revenue comes from our industrial class.
Bernard Horn
Right
Donald Shippar
Those customers are under contacts for a certain amount of take for demand, so really in the short term if you will slowdown on the economy would more than likely affect the residential and the commercial, which in our case in a pretty small segment about 30%
Bernard Horn
Okay
Donald Shippar
All of our large customers have individual contracts. That they nominate the man and energy requirements on a periodic basis.
Bernard Horn
Yeah, and then do you talk about what those contracts like the minimum, maximum loads and revenues with those contracts specified to you?
Mark Schober
Yes that's all included in our 10-K
Bernard Horn
Okay, I will look at that, okay thanks very much.
Mark Schober
There is a table there that gives you each one of our large power customer, amount what we had under contract and the length of the contract too.
Bernard Horn
Okay great thanks
Mark Schober
You bet.
Operator
And Mr. Shippar, we have no further question, I would like to turn it back to you for any additional or closing remarks.
Donald Shippar
Thanks for your question this morning. At the half way point of 2008, our year-to-date earnings are on track to meet our year end expectation of between $2.70 and $2.90 per share.
We are managing our way through a very difficult environment for our real estate business and while its earnings contribution will certainly be less than it was in 2007. It will be profitable this year.
I think that's a note worthy accomplishment given the current state of the real estate market. This business represents long-term value for Allete, given our low cost basis and the location of our properties in Florida.
Our energy business is in the midst of the period of substantial growth. Minnesota Powers rate base will more than double over the next five years as a result of our capital investment program.
These capital investments will be recovered through a combination of current cost recovery riders and anticipated increased electric base rates. Our industrial customers within the Taconite mining industry are also in the midst of substantial capital investments to meet growth and demand for their product.
During 2008, our customers have announced more than $450 million of new investments in their facilities that would result in an approximate 10% increase in production capabilities. In addition, we could experience between 100 to 400 megawatts of additional growth from several potential new industrial customers, planning projects within our service area.
One such example is the Mesabi Nugget, whose new facilities are currently under construction. We expect Mesabi Nugget will begin production in 2009 and initially be of 15 megawatt customer with potential for future growth.
Our investment in the American Transmission Company will also grow as we participate in capital calls over the next several years. All of us at Allete are excited about the prospects for our company going forward.
Thanks again for your time this morning. And I look forward to speaking to you in October when we release our third quarter results and again in December when we disclose our outlook for 2009.
Operator
Ladies and gentlemen that does conclude today's conference. You may now disconnect.