WEC Energy Group, Inc.
Q2 2008 Earnings Call Transcript

Published: 1 Aug 2008

[Operator:]

Good afternoon, and welcome to Wisconsin Energy’s 2008 second quarter conference call. Before the conference call begins, I will read the forward-looking language. All statements in this presentation, other than historical facts, are forward-looking statements that involve risks and uncertainties which are subject to change at any time. Such statements are based on management’s expectations at the time they are made. In addition to the assumptions and other factors referred to in connection with the statements, factors described in the company’s latest Form 10-K and subsequent reports filed with the Securities and Exchange Commission could cause actual results to differ materially from those contemplated. During the discussion, referenced earnings per share will be based on diluted earnings per share unless otherwise noted. This conference is being recorded for re-broadcast and all participants are in a listen-only mode at this time. After the presentation, the conference will be open to analysts for questions and answers. Conjunction with this call, Wisconsin Energy has posted on its website a package of detailed financial information on its 2008 second quarter results at www.wisconsinenergy.com. A replay of our remarks will be available approximately 2 hours after the conclusion of this call. And now, I would like to introduce Mr. Gale Klappa, Chairman of the Board, President and Chief Executive Officer of Wisconsin Energy Corporation.

[Gale Klappa:]

Aileen [ph], thank you. Good afternoon everyone. We appreciate you joining us on our conference call to review the company’s 2008 second quarter results. Let me begin as always by introducing the members of the Wisconsin Energy management team who are here with me today. We have Rick Kuester, President and CEO of Regeneration; Allen Leverett, our Chief Financial Officer; Jim Fleming, General Counsel; Jeff West, our Treasurer; and Steve Dickson, Controller. I’m pleased to report that we reached another milestone in the second quarter, as our customers began realizing the benefits of two major elements of our Power the Future plan. In May, our generating capability increased with the startup of the second natural gas-fueled unit in our Port Washington site and with the commercial operation of 88 wind turbines at our Blue Sky Green Field wind farm. Allen will review our financial results in detail in just a moment. And as you saw from our new release this morning, we reported net income from continuing operations of $0.49 a share in the second quarter of 2008 versus $0.49 a share last year. The last year’s second quarter as you recall, included a total of $0.08 per share from the settlement of a billing dispute with one of our major customers and a gain on the sale of land. Now I’d like to spend just a moment on our continuing efforts to upgrade the energy infrastructure in Wisconsin. Our Power the Future plan is fundamental to the principle of energy’s self-sufficiency. The components of our focus on self-sufficiency include investing in two combined cycle natural gas-fired units at Port Washington, just north of Milwaukee, the construction of two super-critical coal-fired units at Oak Creek, which is south of the city, and our plans to build a significant amount of new wind generation. Back in November of 2002, as you may recall, the Wisconsin Public Service Commission approved the construction of two natural gas-fired units at our Port Washington site. First unit at Port Washington went into service in July of 2005 on time and on budget. Now we’re pleased to report that Port Washington Unit 2 was completed and began commercial service on May 23, 2008. The project was finished on time and on budget, and the total investment for Unit 2 will be approximately $335 million. Now let’s turn to the status of the two new coal-fired units at Oak Creek. As we discussed in our previous calls, last November, December, January, and February were difficult months for construction in Wisconsin. Although Bechtel has been working to make up for lost time at Oak Creek, they’re now forecasting that the completion of Unit 1 and the common facilities will be delayed by 3 months beyond the guaranteed in-service date of September 29, 2009. Bechtel has also advised us that they expect Unit 2 at Oak Creek to be completed one month earlier than its guaranteed in-service date of September 29, 2010. Bechtel is citing a number of factors that they believe are causing the changes to the schedule. The factors include weather conditions and the two most recent winters, heavy rains this spring, and what Bechtel believes to be changed is the local labor conditions. Bechtel is still analyzing the impact of these factors and they expect to submit claims for scheduled extensions and cost relief by the end of this year. Once we receive those requests, along with the required justification, we will determine whether Bechtel is entitled to any scheduled and/or cost relief. Claims would ultimately be subject to binding arbitration if we do not reach agreement with Bechtel. Since we haven't received the claims, it really is impossible to provide you with any specifics on what the financial impacts could be. However, I believe there are several very key points to keep in mind. The first relates to the impact of the in-service date on our reported earnings for 2009 and 2010. We estimate that a one-month movement in the in-service date for Unit 1 will result in a change of $0.03 a share in earnings. A 1-month movement for Unit 2 has a somewhat smaller impact. We estimate that to be $0.02 per share. So, if Bechtel's new forecast comes to pass of three months in for Unit 1, our earnings in 2009 would be reduced by $0.09 a share compared to what they otherwise would have been. If Bechtel's forecast comes to pass of a 1 month early finish for Unit 2, our earnings in 2010 would increase by $0.02 a share. Of course and this is very important to point out, I believe, the ultimate earning power of the assets in 2011 and beyond are unaffected by the specific dates of the units placed into service in 2009 and 2010. The next key point relates to cash flow. Under the terms of the lease agreement between Wisconsin Electric and Wind Power, we are recovering, based on a mix of debt and equity. Our capital carrying costs as construction continues on the Oak Creek Project, and we’re allowed to recover our carrying costs up to the total budget for the project which has got approved by the Wisconsin Commission. So while reported earnings in 2009 and 2010 would be affected slightly by a change in the in-service dates, our ability to recover cash carrying costs will be largely unaffected. Final point I'd like to make relates to the ultimate recovery of any potential cost increases. We have several important layers of protection, and let me give you some specifics. We conclude that the additional cost is not ultimately recoverable. You would have to believe that the cost will not qualify for recovery and there are at least four opportunities that are clearly outlined in the Commission's order. First, the remaining contingency in the project is not sufficient to offset the cost. Second, that the cost would fall outside the 5% band that the Commission has deemed as reasonable for prudent costs above the approved project allowed. Third, that the cost was not caused by a (inaudible) as defined by the lease agreement. And finally, after an opportunity to demonstrate prudency, that the cost would be ultimately deemed improved. Although we have not received the detailed claims from Bechtel, we believe we have several layers of protection in place. Of course, we will provide updates for any significant developments in our SEC filings and on our schedule earnings calls. At the end of July, based on Bechtel's revised schedule and a new forecast of the labor hours that will be required to complete the project, Oak Creek was approximately 56% complete. Unit 1 and the common facilities were 68% complete and Unit 2 was 24.5% complete. More than 3000 workers are currently on the site and we do know that in the past two months, they’ve made more progress than during any other two-month period since construction began three years ago. As you know, there are four major permits needed to build the facilities at Oak Creek. These include an air permit, a wetlands permit, a permit from the US Army Corps Engineers and finally, a water pollution discharge elimination permit. We received all of these permits and each of them remains in effect unless it is overturned by a court or an administrative law judge. In September of 2005, we resolved all legal challenges to the air permit. Also in February of 2006, we resolved the outstanding legal challenges to the wetlands permit. Our permit from the US Army Corps Engineers was received in May of 2005. This permit relates solely to the construction of facilities that are now complete. And to date, no appeals have been launched against this permit. And the last permit, the Wisconsin Pollution Discharge Elimination System permit or WPDES. They’ve been involved, as you may recall since early 2006, in litigation with two environmental groups, who oppose the water intake system that was approved for Oak Creek. Now today, we have several major developments to report to you. In early May, the State Department of Natural Resources issued a new draft permit and concluded in that permit that the water intake system we built is the best technology available for a new unit at the Oak Creek site. A public hearing was held in June, and the public comment period is now closed. The Federal Environmental Protection Agency has notified the Department of Natural Resources here in the state that it will not object to the issuance of the new permit. And this morning, jus this morning, the DNR issued a final modified permit, which fully support the use of the water intake system at the site at Oak Creek. As you know, we’ve always believed that the water intake structure we built is the best environmental solution, as it minimizes the impact on the lake and results in lower air emissions, less use of coal and less use of Lake Michigan water than other types of cooling systems. So, we are very pleased to receive this new permit. Also, in another breaking development, shortly after 11 o’clock this morning, we and the other two owners of the expansion units at Oak Creek reached an agreement with Clean Wisconsin and Sierra Club, the groups that have been opposing the water intake permit. Here the settlement agreement, the environmental groups will withdraw their opposition and this should bring to a close the ongoing litigation and administrative challenges to the permit. The terms of the settlement agreement will be announced jointly by the parties next week. Certain elements of the agreement will be subject to review and approval by the Wisconsin Public Service Commission. Again, we view this as a very positive step forward. And now I would like to update you on our Blue Sky Green Field wind project. In February of 2007, the Wisconsin Commission approved the project as a traditional utility rate-based investment. Late March of last year, we signed an agreement with Vestas Wind Systems for 88 turbines. Each of the 88 turbines has a capacity of 1.65 megawatts. The budget for this project was approximately $300 million, excluding capitalized carrying costs. Construction began at the site literally a year ago, in June of 2007. First wind turbine produced electric power for the first time on February 09 of this year and we achieved commercial operation of the entire wind farm on May 19. The project, which is the largest wind farm to date in the State of Wisconsin, was completed under budget and ahead of schedule. Now as you know, Wisconsin has in place, a renewable portfolio standard increases from 5% in 2010 to 10% in 2015 at the state-wide level. The standard sets targets for each of the utilities of the state using an historical base line. Using that base line, approximately 8.5% of our retail electricity sales must come from renewable sources in 2015. Meeting this more aggressive 2015 target will require several additional projects. So, to keep moving forward, we recently completed the acquisition of a new wind project site that is located in Colombia County in Central Wisconsin. We expect the site to accommodate somewhere between 100 megawatts and 200 megawatts of new capacity depending upon the final site layout and the turbine equipment we select. Permitting process will begin later this year and the projected in-service date at this point is late 2010 or 2011. Finally, I have one other positive development to report to you. On July 10, the Wisconsin Public Service Commission issued a final decision allowing us to build wet flue gas desulfurization and selective catalytic reduction facilities at the four existing units at Oak Creek. The Commission authorized an investment of up to $830 million, including allowance for funds used during construction. Building of these emission controls has now begun and we expect the installation will be completed in the year 2012. I should note that yesterday, the Citizens Utility Board and Clean Wisconsin, two groups to oppose this environmental upgrade, petitioned the Commission for reconsideration. We do not believe their arguments to have merits. Now I will turn the call over to Allen, who will give you more details on our financial performance in the second quarter. Allen?

[Allen Leverett:]

Thank you, Gale. As Gale mentioned earlier, our 2008 second quarter earnings from continuing operations were $0.49 per share. Now, I will focus on operating income by segment and then touch on other income statement items. I will also discuss cash flows for the quarter and briefly review our earnings guidance for 2008 as well as the third quarter. Our consolidated operating income was $108 million as compared to $105 million in the second quarter of 2007, for an increase of $3 million. Operating income in our Utility Energy Segment totaled $90 million for a decrease of $5 million versus last year. Before I discuss the primary drivers, I would like to remind you of a couple of developments that caused significant changes in individual items in the income statement. First, in September of 2007 we sold our Point Beach nuclear plant and entered into a long-term power purchase agreement with the new owner. Since we no longer own Point Beach, our results this year do not include operating or maintenance costs related to the facility, nor do we incur any depreciation or decommissioning costs associated with the plant. However, our fuel and purchased power costs this year have increased as a result of the power purchase agreement we now have. Also, as we mentioned in our February and April conference calls, we expect to see a different quarterly distribution of costs and earnings this year as a direct result of the power purchase agreement. Our income statement this quarter reflects $87 million of gain amortization relating to the gain on the Point Beach sale that is being used for the benefit of customers. We issued this gain in the form of bill credits to our customers. I would like to briefly expand on this item. The January 2008 Wisconsin rate order resulted in about a 17% increase in electric rates. This increase was needed to recover higher costs associated with transmission expense and environment expenditures, as well as the lease payments and O&M costs associated with our new power plants and our continued investment in renewables. However, our customers as a group will only see about a 3% rate increase in 2008 from this rate order as the balance is being funded through bill credits resulting from the gain on the sale of Point Beach. While we look at the bill credits as a form of revenue, GAAP requires us to record the bill credits as part of the amortization of the gain because we are collecting the cash from the restricted cash accounts and not the customers. However, once all the Point Beach gain has been returned to customers, the full 17% increase will be paid by customers and at that point reflected in operating revenues. Now with this as background, I would like to address the primary drivers in our utility operating income for the second quarter of 2008. First, price increases to our retail and wholesale customers resulted in a $41 million increase in revenues. However, the mild weather in the quarter reduced operating income $70 million. In addition, the conversion of the Point Beach nuclear plant from being an asset owned by Wisconsin Electric to an owned by FPL Energy with an associated power purchase agreement, reduced income $9 million. The settlement of a billing dispute in the second quarter of 2007 resulted in a $9 million reduction this year. Additional planned operations and maintenance expenses in our power plants decreased income $10 million. Other items reduced income a total of $1 million. Operating income in the non-utility energy and corporate and other income segments, which primarily includes We Power, was up $8 million. The key drivers of this increase were the new coal handling facility at the Oak Creek expansion, which was placed into service last October and the earnings from Unit-II at Port Washington, from the time it began commercial operation in late May. Taking the changes for each of these segments brings you back to the $3 million increase in operating income for the second quarter of 2008. Other income was down $10 million in the second quarter 2008, the largest negative change relates to a $7 million gain on sale of property that was in last year’s results. Additionally, we experienced lower carrying charges on regulatory assets. In connection with the January 2008 rate order, we stopped accruing carrying charges on several regulatory assets as these assets were now considered part of rate base and setting rates, and now we are allowed to (inaudible) return on them. Earnings from our investment in the American Transmission Company are also included in other income. These earnings were up almost $2 million for the quarter. Total interest expense was down $7 million. This decrease was driven by lower interest rates and our ability to capitalize an additional $4 million in interest related to construction activity. Consolidated income tax expense was level as compared to 2007. I expect that our effective tax rate this year will be between 36% and 38%. Adding these items brings you to $58 million of net income from continuing operations for the second quarter 2008 or earnings of $0.49 a share. Turning now to cash flow. During the first six months of 2008, we generated $574 million of cash from operations on a GAAP basis, which is up $118 million from the same period in 2007. This increase was driven by the implementation of new prices and reduced cash taxes, offset in part by the earlier timing of a contribution through our pension trust this year. On an adjusted basis, cash from operations totaled $728 million. The adjusted number includes the $154 million of cash impact of the bill credits and the one-time amortization of the gain. Under GAAP, the cash from the bill credits is reflected in the change in restricted cash, which GAAP defines as an investing activity. From a management standpoint, we consider this as a source of cash as it directly relates to the bill credits and the one-time amortization. In 2008, we will continue to provide both GAAP and adjusted measures of cash flow. We believe the adjusted measure is more representative of the company’s ability to generate cash from operations for two reasons. First, the customer credits are being funded from the proceeds of the Point Beach sale that are set aside in a restricted cash account as opposed to from operations; and second, once all of the Point Beach proceeds have been returned to customers, our prices and hence customer bills will reflect the full cost of electricity without any credits. Capital spending was approximately $642 million in the first half of 2008, which is $70 million higher than the first half of 2007 but on track with our annual estimate. We expect to spend nearly $1.2 billion of capital this year to support our Power the Future construction program, the addition of wind generation, and ongoing utility infrastructure improvements. We also paid $63 million in common dividends in the first half of 2008. On a GAAP basis, our debt to capital ratio was 57.8% as of June 30, and we were at 54.6% on an adjusted basis. This is down from our December 31, 2007 levels of 58.6% and 55.3% adjusted. The adjusted amounts treat half of our hybrid securities as common equity, which is the approach used by the majority of the rating agencies. Given the continued high level of capital spending in 2008 and the fact that no significant asset sales are planned this year, I would expect our debt to capital ratio to increase slightly as of December 31, 2008, as compared to December 31, 2007. Our goal now is to maintain our adjusted debt to capital ratio at no more than 60% during the period we are constructing our new gas and coal fire generation. We are using cash to satisfy any shares required for our 401K plan, options, and other programs. Going forward, we do not expect to issue any additional shares. Given the expected reduction in capital expenditures next year, we believe that we will begin to have more room for dividend payments in our financial plan. As a result, we plan on reviewing our dividend policy again this year for a potential change in 2009. Now before I move to earnings guidance, I would like to update you on our Wisconsin fuel filing and the status of potential changes in Wisconsin fuel rules. On March 13, we filed a request to increase our fuel recovery rate. This was driven by large increases in the price of natural gas and the price of diesel fuel used to transport coal by rail. Commission approved an interim annual increase of $76.9 million effective April 15. A settlement was reached in case earlier this month. Based in actual results through May and projected natural gas and fuel oil prices for the remainder of this year, the final annual increase was set at $118.9 million. We implemented rates of July 8 based on this final mail. We expected that the final fuel rate would reflect actual year to date result through May and the most up-to-date fuel prices at the time of the decision. So, an annual increase that was $42 million above the interim rate was not a surprise. Given the continued volatility in the fuel markets, our projected under-recovery of fuel cost in Wisconsin remains at $20 million to $40 million for calendar year 2008. Now moving to potential changes in the Wisconsin fuel rules. In June of 2006, the commission opened a docket to consider revisions to the existing fuel rules. This month, the commission ordered a second comment period on a revised rule. The hearing is to be held in August. The current recommendation calls for modifying the rules to allow for annual plans and reconciliation filings of fuel cost by each utility. In the period between plan and reconciliation escrow accounting would be used to record fuel cost outside a plus or minus 2% annual band of the total fuel costs allowed in rates. The proposed rule further recommends that the escrow balance be trued-up annually following the end of each calendar year. The commission proposed a new rule to become effective in January of 2009. The commission expressed its intent to send a revised rule to the legislature to follow the statutory review process by September of this year. Now I would like to wrap things up with a review of our earnings guidance for 2008 as well as the third quarter. Based on our results in the first half of our year, and our forecast for the remainder of the year, we are on track with our financial plan. So, our full year guidance remains in the range of $2.80 to $2.90 a share. Looking to outlook for the third quarter, this will be the first full year that we will be operating with the power purchase agreement in Point Beach. As a result, we anticipate the quarterly distribution of earnings will be quite different in 2008 as compared to 2007. Because the power purchase agreement is designed to resemble the change in market prices through the year and those market prices are usually highest during the summer months, we expect the cost of the power purchase agreement will be highest in the third quarter. This factor alone would decrease earnings by approximately $0.20 per share in the third quarter relative to the same period in 2007. As a result, I expect earnings to be down relative to the third quarter of last year because of the shape of the power purchase payments related to Point Beach. At this point, our expectation of earnings in the third quarter is $0.53 per share to $0.57 per share versus $0.70 per share in 2007. So in summary, while we are very pleased with our results to date, our annual guidance remains unchanged at $2.80 per share to $2.90 per share. So with that, I will turn the call back over to Gale.

[Gale Klappa:]

Allen, thank you very much. I think you can see from our report that we really made tremendous progress in the last three or four months on a number of very important fronts. We are on track and focused on delivering value for our customers and stockholders. Now I’ll ask our operator to set up the question-and-answer period.

[Operator:]

(Operator instructions) We'll go first to Greg Gordon with Citigroup.

[Gale Klappa:]

Afternoon, Greg.

[Greg Gordon:]

Hello, guys. How are you?

[Gale Klappa:]

Good, how you doing?

[Greg Gordon:]

So, (inaudible) there is no longer any opposition to the method of environmental controls at the new coal plants?

[Gale Klappa:]

It really would not be the environmental controls, Greg, it’s the water intake system.

[Greg Gordon:]

Sorry, the water intake system, I apologize.

[Gale Klappa:]

I think that is an accurate statement, yes.

[Greg Gordon:]

There is no existing party we’re aware of that would at this point pursue an appeal of the revised issued permit?

[Gale Klappa:]

Greg, there is no existing party that we’re aware of, there’s no party that’s been involved in any of this litigation that is not party to the settlement. And now, let me give you additional detail that may be helpful. The final permit that was in question that we received this morning from the Department of Natural Resources, there is a 60-day period in which an administrative appeal could be lodged against that permit. After the 60 days, if there is no appeal to that permit, then there can be no further appeal. So we have 60 days in front of us, but all the parties who have been active in appealing this permit so far or challenging this permit so far are signatories to the settlement.

[Greg Gordon:]

On the three-months delay of the one unit, at this point, are we looking at a slippery slope where we have the potential for further delay beyond the three months or have they come to you, do you think with a really firm assessment of where they’re at and we can count on three months being the outside edge of this?

[Gale Klappa:]

Well clearly, Bechtel is a very professional organization, as you know. They’ve taken a very long, hard look at what they think the work is remaining in front of them coming out of the winter, and they’ve given us their best estimate. Now, if something crazy happens, if something unforeseen happens, certainly we can’t guarantee that this is the schedule, but with Bechtel having taken a very hard look at what their new plan looks like, what work they have in front of them, what productivity they think they can achieve, we think that is a pretty good schedule.

[Greg Gordon:]

Thank you, gentlemen.

[Gale Klappa:]

Thanks, Greg.

[Operator:]

Thank you. We’ll go next to Paul Ridzon with KeyBanc.

[Paul Ridzon:]

Around of the annual fuel recovery, does this mean that you are no longer going to have to absorb any excess cost that you could have actually gone through true-up?

[Gale Klappa:]

And again, all these rules are just being put in place. So, they're the final – as Allen described, they’re the final set of hearings and the final rule that has to be put in place by the Commission. As we understand their current proposal, there would be the 2% bandwidth that Allen described, though our ultimate exposure would be 2% of our fuel costs, plus or minus. And then we also understand there would be an opportunity mid-year for all the Wisconsin utilities to adjust, seek an adjustment to the fuel-recovery rate and anything above or below the 2% would go into escrow. Those are kind of the three major elements. In essence, the first step would be once the fuel rules as we understand them would go into place, but all the utilities would come in, in the fourth quarter of a given calendar year, project their fuel cost for the next calendar year, the Commission would then review that and set a fuel recovery rate that would go into effect in January. It would have the 2% bandwidth exposure plus or minus and an opportunity for a refresher, if you will, at mid-year. That’s our current understanding of the proposal and please note that this is still in the final stages of development, so this could change slightly, but the Commission’s had a long time to look at the manner in which they might want to change the fuel rules and I think we’re headed for implementation sometime around the first of the year.

[Allen Leverett:]

And Paul, just to be clear, for calendar year 2008, we’re going to be under the existing fuel rules.

[Paul Ridzon:]

The short answer is you’ve still got the 2% exposure that you could keep or eat?

[Gale Klappa:]

That is correct.

[Paul Ridzon:]

With no opportunity to go in ask for recovery of that?

[Gale Klappa:]

Well, again, there would be a mid-year refresher; and that is under the new rule. The existing rules are as we described and where we have this year we believe a $20-40 million exposure.

[Allen Leverett:]

And under the existing rules, Paul, you could very easily find yourself in a situation where you under-recover by more than 2%, because you can’t implement a new rate if you go in and file and you have to under-recover on an actual basis before you can make that filing for perspective relief.

[Paul Ridzon:]

You can only file once you hit 2% and then you got some lag until new rates are implemented and commodity prices can still change further?

[Gale Klappa:]

Under the current rule, that’s right.

[Allen Leverett:]

That’s right, Paul.

[Gale Klappa:]

But we think the shape of the rules as they’re beginning to develop the new rules there would be some improvements going forward.

[Paul Ridzon:]

What happened with fuel under or over-recovery this quarter relative to last quarter? I guess if you have the absolute terms, that would be very helpful.

[Allen Leverett:]

Yes, in terms of absolute under-recovery in the second quarter of 2008, I believe we were $6 million under-recovered in the second quarter of 2008. In terms of absolute under-recovery in the second quarter of 2007, we were approximately $18 million under-recovered in the second quarter of 2007.

[Paul Ridzon:]

So you saw a $12 million pick-up?

[Allen Leverett:]

In terms of fuel, in terms of relative recovery, that’s right; but remember also, the timing within the year of fuel recoveries is very different, because of the Point Beach PTA.

[Paul Ridzon:]

And what, do you have the 3Q07 over and under-recovery?

[Allen Leverett:]

The 3Q07 over/under was we were about $2.5 million under-recovered in the third quarter of ’07.

[Paul Ridzon:]

But that’s.

[Allen Leverett:]

But I guess, the nice thing will be in 2009, you have a lot comparability because you do have the Point Beach PTA throughout all of calendar ’08 and then we expect all of calendar 2009.

[Gale Klappa:]

I think Paul, Allen’s making a good point. 2008 quarter-to-quarter fuel under-recovery versus the prior year may not be as straightforward as you think because of the shape of the purchase power of payments under the Point Beach agreement. It’s a big swing factor, each quarter that was not there last year.

[Paul Ridzon:]

And as we look at the third quarter, the other things that we need to consider are, you’re going to have Port Washington too? Will you have last year’s, is that correct?

[Gale Klappa:]

That is correct, in-service and earning the returns.

[Paul Ridzon:]

And the coal? Is the coal –.

[Allen Leverett:]

The coal facility went in I believe right at the end of October of 2007. So that will be a full quarter pick up as well. So those are – you’ve got it I mean, the two key drivers in terms of earnings, growth if you will, would be the second unit at Port and the coal-handling and then we have this other difference that’s introduced because of the timing of fuel recoveries.

[Paul Ridzon:]

Let's go back to Bechtel. You mentioned the guaranteed in-service date. What does the guarantee mean, I guess is the question.

[Gale Klappa:]

Well, the guaranteed in-service date is just that, that they guarantee the in-service date beyond which there would be potential liquidated damages if the in-service date was not met. Now, having said that, remember we have a turn-key contract here with certain very limited exceptions. One of those exceptions could be for example a weather that impeded construction, weather that Bechtel could not have reasonably foreseen. That’s for example one potential force measure event, that would allow some leeway in the guaranteed in-service date and some exception, if you will, to liquidate damage payments. Rick, anything to add on that? One point that Rick made to me as we were moving from call to call, in fact to Greg’s question on the schedule at Oak Creek and how does that look now that Bechtel has re-forecasted the work? One of the things that clearly impacted Bechtel’s progress was that nearly 100 inches of snow that we had over the course of this past winter. Future winter conditions should have far less impact on the schedule going forward, because Unit 1 will be completely enclosed well before this next winter. As Unit-I and Unit-II at the site were not enclosed, given the construction progress at that point as we went into last winter. The Unit-I will be fully enclosed by well before this winter. So that should be a material plus to continue the kind of progress that Bechtel has made in the last couple of months at the site.

[Paul Ridzon:]

So who is on the hope for the labor? Is that still Bechtel?

[Gale Klappa:]

Yes, there is one exception. Again, I mentioned the turn key project with certain limited exceptions. Each of one risk has a limited exception that basically said if you look at the wage rates of the skilled craft at the site, has anything above average annual 4% growth in the scheduled wage rates, we would take the risk on that. Anything else would be Bechtel’s risk. So, at the moment, the wage rates are very trackable, we don’t see that being a significant issue as it relates to the craft labor wage rates at the site.

[Paul Ridzon:]

Jim, just one last question. As you go forward, you mentioned looking at the dividend for ’09. What would envision as the dividend policy. Jim Fleming We will get there before ’09 and we’ll let you know. We’re still taking a hard look at that. We obviously want to have all the flexibility that we can to deliver as much shareholder value as we can and we will give you a very clear revised dividend policy in the not too distant future.

[Paul Ridzon:]

Thank you very much.

[Gale Klappa:]

More than welcome.

[Operator:]

Thank you. We’ll go next to Alex Cunningham [ph] with Merrill Lynch.

[Gale Klappa:]

Hey, Alex, how’re you doing?

[Alex Cunningham:]

Hey, great, thanks very much. On the settlement, I was wondering if you’ve actually established the date next to when you’re going to come to terms with that. Or is it a little up in the air at this point?

[Gale Klappa:]

We just really literally signed all the settlement agreements at 10.30 this morning. The folks in the environmental groups and our folks will be getting together working on a joint announcement. It will be certainly before the end of next week, but we haven’t set a specific date.

[Alex Cunningham:]

Okay, great. The other question which has come, the fuel under-recoveries for this year, I was just looking at where natural gas is right now and comparing it to where gas was I guess based on the interim when it was filed in April, and it’s a little bit higher than where it was in April but that is certainly a lot lower than where it was, I guess, during your first quarter earnings call, and I was just wondering how come that 10% or so decline isn’t necessarily making you feel any better about getting towards the lower end of that under-recovery?

[Gale Klappa:]

If you recall, the basic rate that is now set in our fuel-recovery cause, was tied to the latest natural gas strip. It really was for June I believe, because the order was in early July. To get the proper comparison, you really need to look at the natural gas strip was going forward for the remainder of the year before the end of June, or at the end of June. And clearly, given what has happened in the last couple of weeks to natural gas prices, the current natural gas prices are better than that, so that’s helpful. But if you look at the volatility and if just look at the plant outages that we have in terms of maintenance going forward, I think Allen’s current view and mine, is $20-40 million under-recovered and that’s a pretty good range. And really it hasn’t changed from where we thought it was, I mean, and of course as we go forward now, with more hedging in place and the number of months that we have behind us in the year, the volatility should decrease a little bit. But right now, we think that’s a good estimate and that lines up with our $2.80-2.90 a share annual guidance.

[Alex Cunningham:]

Okay, great. Thanks.

[Gale Klappa:]

Thank you.

[Operator:]

Thank you. We’ll go next to Maurice May with Power Insights.

[Gale Klappa:]

Hi, Maurie, how you doing today?

[Maurice May:]

Okay. How’re you folks?

[Gale Klappa:]

Doing good.

[Maurice May:]

A couple of questions. First of all on the new fuel rule for 2009; you termed them, Gale, a quote some improvement, and I don’t understand that improvement. I know you have the mid-year update on the one hand, but on the other hand, shareholders will still eat that first 2% under recovery, will they not, and that won’t be subject to the mid-year update.

[Gale Klappa:]

Well, the mid-year update could certainly help mitigate the 2%.

[Maurice May:]

It can.

[Gale Klappa:]

But the element, Maurie, that I think is important here, right now, your fuel recovery rate, as it exists, has to stay in place until you trip the bandwidth and actually experience and project a more than 2% under-recovery in fuel, okay?

[Maurice May:]

Okay.

[Gale Klappa:]

The improvements that I see here is that the Commission will allow all the Wisconsin utilities to submit a filing in the fourth quarter of the calendar year, projecting their next calendar year fuel costs, and then theoretically, have a reasonable projection of those costs in place on January 1. So that should help mitigate the exposure to the 2%.

[Maurice May:]

Okay, but there is a mid-year update. Mid-year implying..

[Gale Klappa:]

There is a mid-year refresher exactly how it will work, no one is sure yet, because all of this has to be finalized, out in place and administered, so we’re at the very beginning of a change here.

[Allen Leverett:]

And Maurie, as you know, from a practical standpoint, you kind of look at our situation this year. If we have these new rules in place this year, our maximum potential exposure would be approximately $20 million. Well, because we’re under the existing rules, we’re sitting here today telling you exposure to be as much as $40 million. So from a practical standpoint, I think it really supports the statement that Gale was making about the fact that this would be a step in the right direction in terms more reasonable set of fuel rules.

[Maurice May:]

Okay, so just as an example, if by mid-year, you are 1.5% under-recovered, you can ask for that adjustment?

[Gale Klappa:]

Again, we’re not exactly sure how the mid-year will work, the Commission hasn’t defined that yet, we can certainly ask for an adjustment.

[Maurice May:]

Okay, okay, good. And then moving on to the dividend review, I thought earlier this was supposed to be an undertaking in 2009 and now you’re talking about a review in the second half of 2008 to become effective in 2009. I noticed that the last five years, you’ve boosted your dividends in either January or by February. So what you’re saying is you won’t give up a new dividend sometime in the second half of 2008 that would become effective probably with the first quarter of ’09. Is that correct?

[Allen Leverett:]

Well, we didn’t say when we would announce the new dividend policy. I mean jus to be clear, what we said was we will review the dividend policy in 2008 for a potential change in 2009. Now typically Maurie, what we do is, whatever the dividend is going to be for the current year, usually we make that announcement in February of that year. So if we follow with that pattern, we do our review with the Board say in the fourth quarter, and then in February of ’09 we would to the extent there are any changes in the dividend policy, we would announce those say in about February of 2009, but that policy we would expect to be implemented for a full calendar year in 2009. And Gale, anything you want to add to that?

[Gale Klappa:]

That’s exactly correct.

[Maurice May:]

This policy would be in terms of what, like a payout ratio target?

[Gale Klappa:]

We’ll provide you all the specific details as soon as we have them worked out.

[Maurice May:]

Okay. I appreciate it. Thank you very much folks.

[Gale Klappa:]

Welcome Maurie.

[Operator:]

Thank you, we’ll go next to Nathan Judge with Atlantic Equities.

[Gale Klappa:]

Nathan, you’re on almost the same time zone.

[Nathan Judge:]

Good afternoon. We are. It’s easier to do it at 2.00 PM than it is at 7.00. With regard to sales, noticed that there is an acceleration and sales decline when you’re nearing the second quarter. Could you just give us an update on how much of the decline was related to weather and how much that was related to perhaps conservation in the slowing economy?

[Gale Klappa:]

I’ll be happy to. First of all, I think that the lion’s share of the decline was really due to the fact that we really had almost no air-conditioning demand at all in the month of June. We have not yet had in this part of the Midwest, we have not had a 90 degree day yet this summer. So we really didn’t see any air-conditioning demand in the month of June at all this year. So the lack of residential demand from air-conditioning, I think played a big role in the decline in electricity sales for the quarter. We are seeing in terms of the economy Nathan, we’re clearly seeing a slowdown in the rate of household formation. Our customer growth, just looking back over the last five years, the customer growth we’re seeing this year is about half of the customer growth we were seeing on a percentage basis is in the prior five years. So from an economic standpoint, I think the first thing we’re seeing in the slowdown in customer growth or slowdown in household formation. The industrial side of the economy is actually holding up reasonably well. Where we are seeing spots of weakness are in paper production and in automotive parts and automotive manufacturing. For example, steel production, the iron-ore mines in the upper plains of Michigan, very strong. So we’re seeing some real pockets of strength in the economy here that are largely offsetting the weakness from paper production and the automotive sector. And again, we have a lot of industrial companies here in our region that we serve, that are very tied to the export market. So they’re also doing very well. That’s kind of a snapshot for you, but I think a large chunk of what we saw in the second quarter was clearly tied, in terms the decline in energy sales, it is clearly tied to the lack of air-conditioning demand. Now it is supposed to be 95 a month and let’s hope that turns around.

[Nathan Judge:]

If residential continues to grow less quickly or perhaps even see a decline, let’s say, and industrial begins to outpace in terms of growth, is there any impact on your margin that you could potentially see if this was an elongated effect?

[Gale Klappa:]

Certainly, you could see some impacts on margins from the declining residential and commercial, really. The declining residential would probably have a greater impact on the margins than declining commercial. But again, we are not seeing negative household growth. We are still seeing growth in the customer base just not at the same rate that we saw, say on average over the past five years. Things never got from an economic standpoint, things never got as exuberant here as perhaps they did in some other states and on the coasts. So, I just don’t see at the moment the kind of precipitous decline for our region that some may be starting to experience.

[Nathan Judge:]

I wanted to also ask about the new potential wind site and how that could potentially affect future CapEx plans. When would those sites be a potentially viable (inaudible) and when would you look to try to build new wind in the future?

[Gale Klappa:]

As we mentioned, we just concluded the exercise of an option that we had negotiated with FPL as part of all the possessions surrounding the sale of the Point Beach nuclear plant. We negotiated an option with FPL for the purchase of a fully permitted wind site and we just closed on that option just a matter of couple of weeks ago. As I mentioned in the script, it is in North East Columbia County in Central Wisconsin. Very good wind site and we think again, depending upon the equipment we select and the final layout of the turbines, it could be somewhere between a 100 megawatt and 200 megawatt wind site. We will begin the permit process immediately and we are thinking late 2010 or 2011 when that wind site could go into service. That would be the first step there toward the additional renewables that we think we will need.

[Allen Leverett:]

But in terms of the three-year capital outlook that we’ve been providing, we included in the outlook capital in 2009 and 2010 associated with wind projects. So, essentially what you are seeing is some specificity now of where that capital is likely to be deployed. However, I would say in those capital outlooks that we gave before, the working assumption that we made was that the capital cost would be in the range of $2000 a KW. I think based on what’s been happening, since even we did those forecasts last fall we are seeing some significant inflation in the cost per KW. So, what before we felt was we might be able to do say, 2000 a KW should be as much as $2500 a KW. So, you could see the numbers come up slightly because of that , you know, Gale, anything you’d like to add?

[Gale Klappa:]

No, you get it Allen. But the large amount of the capital, perhaps not a 100% of it, but the lion’s share of the capital for our next wind project is, as Allen said, in the capital forecast.

[Nathan Judge:]

All right, thank you. And then my final question is, coming back to the delay at Oak Creek, and bear with me, perhaps fingering on this topic, but what actual costs do you incur related to the delay. That would cost $0.03 a quarter, is it fuel cost? I obviously understand the cost to carry, but you do get that part, as I understand, get that back. So, what other additional costs do you incur?

[Gale Klappa:]

And I let you Allen give you some more detail as well. But the real driver in terms of, say a one-month delay in 2009 in the in-service state of Unit 1 at Oak Creek. That $0.03 decline in projected earnings or a one-month delay is really tied to the fact that we cannot put into reported earnings the actual earnings on the project until the project is commercial. So, in essence the cash continues to come in. The cash will continue to be put until the unit is commercial in the deferred revenue account. We will earn through customer rates the cash carrying costs. But it simply can’t be put into earnings and reported in earnings until the unit is declared commercial. Allen?

[Allen Leverett:]

Yes. So, Nathan, you sort of asked, as Gale mentioned. Going one way or sort of a reduction in earnings, if you will is relative to a situation when you put the unit in service you are not able to recognize the release time as Gale mentioned. You are also not able to begin recognizing the amortization of the deferred revenue that’s already built up. So, those are two negative factors if you will, two factors that could push it back the other way somewhat. You don’t begin recognizing depreciation of course until the plant goes into service. You do have the continued ability to capitalize interest. So, a net of all those four factors combined together brings you to that $0.03 per share per month rule of thumb that Gale mentioned in the script.

[Gale Klappa:]

And Nathan, that’s for Unit 1. For Unit 2, as you recall, Bechtel is now forecasting one month early. And because all the positive factors that Allen mentioned because those would go into the income statement a month early, band [ph] on Unit 2 would represent a $0.02 a share pick up a month in 2010.

[Allen Leverett:]

Is that – while we haven’t received a calming, that will be subject to negotiation. If there are LDs, the LDs don’t go to the benefit of the shareholder, they go to the benefit of the customer.

[Nathan Judge:]

Cash wise, there would be a little impact then, if I understand all of that?

[Gale Klappa:]

I think that’s a fair assessment. Yes.

[Nathan Judge:]

Okay. Thank you very much.

[Gale Klappa:]

You are more than welcome, Nathan.

[Operator:]

Thank you. We will go next to Michael Lapides with Goldman Sachs.

[Michael Lapides:]

Hi guys. Congratulations on reaching an agreement with Clean Wisconsin. Couple of questions. One, little bit –

[Gale Klappa:]

We are doing okay with the environmental groups, but the breadth [ph] part of thing, we have to get under control.

[Michael Lapides:]

You know, it’s those Mississippi guys, Allen and Gale. What can you do about them, right?

[Allen Leverett:]

Just to be clear Michael, there was nothing in my earnings forecast for severance –

[Michael Lapides:]

That’s right. Or to pay him to bring him back. Couple of questions. First of all, in the first quarter, besides the amortization gain that you took with Point Beach, you also had, I think it was like $41 million in change on deferred fuel cost and $43 million, $44 million related to deferred bad debt cost. How does that get treated when I think about you guidance for the year?

[Allen Leverett:]

In terms of earnings guidance?

[Michael Lapides:]

Yes, just thinking about your EPS guidance for the year.

[Allen Leverett:]

In terms of the earnings guidance those particular items that you mentioned would have no impact at all on reported earnings because you have a regulatory asset on your balance sheet that you no longer have. So, that would have been $85 million in total deferred fuel costs and deferred bad debt costs. So, that $85 million reg asset goes away. But at the same time we’ve discharged $85 million towards the regulatory liability associated with sale of Point Beach. And those two from an earnings standpoint, just offset each other. However, from a cash standpoint, obviously that’s $85 million pre-tax that comes under the company.

[Michael Lapides:]

Understood. Okay, few other questions. Haven’t heard anybody talk lately about growth projects at ATC. Can you talk about – and I know you are not a majority owner, can you talk about what major projects ATC either has underway right now under construction or that its petitioning to build over the next couple of years, I’m going to say major, kind of greater than the $7500 million range?

[Allen Leverett:]

The two biggest ones, there was one project that was approved very recently may have – if for some reason you are reading some of the local papers here that refer to as (inaudible) sales project which essential is another timeline, if you will, to Illinois. That’s about $100 million project, Michael. That was just approved by the commission and that will be under construction soon. The other big items that’s out there, there are a number of projects that are being considered in Dane County around Madison. That could easily be $200 million plus, but that’s something that is yet to come before the commission. So, there are certainly some big projects that are underway, some others that are potentially will come underway, but it will take the commission quite a while with the Dane County one. Everything else I would say is generally well below your $100 million threshold. And in terms of overall capital spending at ATC, and it could be certainly be a number of years, (inaudible) you look at Michael, anywhere from $300 million to $400 million a year. So, there are still looking at very significant capital program at least the next four or five years, and probably beyond.

[Michael Lapides:]

Got it. Final question. A little bit unrelated, and Gale, just coming back to the winds plant development. I want to make sure I understand, so you’ve got the site from FPL, and I may have misheard. Are you saying that there is another site as well that you are considering a plant in addition to the one on the FPL side, or is that all one and the same item?

[Gale Klappa:]

Well, at the moment that’s one and the same item. Now we do have as I mentioned, we do have a pretty steep curve coming down the road here to get to the renewable mandate for 2015. So, Rick and his team are really going to be developing a significant plan going forward here, and a lot of that work on that plan will be coming in the next six to seven to eight months. But it would be a broader look at how are we going to get precisely to where we need to be by 2015. But what we talked about so far, the next step is the filing for the regulatory approvals now that we have obtained the site, the fully permitted site from FPL in Central Wisconsin.

[Michael Lapides:]

Actually I apologize. I have a follow on and it is almost a legal or regulatory one. As I understand Wisconsin state law, the environmental regulations for mercury and I think for Sox are not by (inaudible) have to be more stricter than federal ones. With Care & Kramer [ph] now cost by the US circuit court of appeals, how does that impact the regulation in Wisconsin that would have – that is driving you to put the scrubbers on the south Oak Creek side?

[Gale Klappa:]

The scrubbers on the south Oak Creek side really are in the requirement for that is separate and apart from the mercury rule or the Care & Kramer. The requirement for the scrubbers on the NOx controls at the existing Oak Creek units is driven by our consent decree with the EPA that was signed back in 2003. So those must go forward. And I am confident they will go forward with the authority we now got from the commission. In terms of the mercury rule itself that you mentioned, the Wisconsin governor does want a mercury rule that is stricter than the federal rule and regardless of the what goes on at the federal level, we are in the final process of – the state is in the final process of really getting approved a new mercury rule that we think will give us some flexibility in terms of meeting the higher standards.

[Michael Lapides:]

Got it. Okay, thank you guys. And once again congratulations.

[Gale Klappa:]

More than welcome. Thank you, Michael.

[Operator:]

And we got time for one more question. That will come from Paul Patterson [ph].

[Gale Klappa:]

Greetings Paul. How are doing?

[Paul Patterson:]

Hi, how are doing.

[Gale Klappa:]

I am good.

[Paul Patterson:]

Did you guys actually give a number on the cost of the overrun that Bechtel is going to have?

[Gale Klappa:]

First of all, Bechtel has not made any specific claims as of yet. I don’t believe we will get any specific claims from Bechtel in terms of their quantification, probably till the end of the year. And then as I mentioned on the call, we think we have several important layers of protection in place. And so now there is no quantification at this point at all.

[Paul Patterson:]

I don’t. Actually, I think everything else has been asked. Thank you. Thanks a lot guys. Congratulations on the settlement. By the way, is there anything that you guys are giving up in the settlement or anything that – you said you have to get approval from the Wisconsin Public Service Commission, correct?

[Gale Klappa:]

There are certain elements of the settlement agreement that will have to be reviewed and approved by the Wisconsin Commission. Again, I view this settlement as a positive set forward for us, and you will be apprised of all the details in the joint announcement with the environmental groups next week.

[Paul Patterson:]

Okay great. Thanks a lot.

[Gale Klappa:]

You are more than welcome. That I believe concludes our conference call for today. Ladies and gentlemen, we appreciate your participating. If you have any other questions, the famous Colleen Henderson will be available in our investor relations office at 414-221-2592. Thank you much. Good afternoon everybody.