Wisconsin Energy Corporation Q3 2009 Earnings Call Transcript

Oct.29.09 | About: Wisconsin Energy (WEC)

Wisconsin Energy Corporation (NYSE:WEC)

Q3 2009 Earnings Call

October 29, 2009 2:00 pm ET

Executives

Gale Klappa – President & CEO

Allen Leverett – CFO

Rick Kuester - President & CEO of We Generation

Steve Dickson - Controller

Analysts

Dan Jenkins – State of Wisconsin Investment Board

Leslie Rich – Columbia Management

James Dobson - Wunderlich Securities

Michael Lapides - Goldman Sachs

Greg Gordon - Morgan Stanley

Paul Ridzon - Keybanc Capital Markets

Andrew Levy – Incremental Capital

Paul Patterson – Glenrock Associates

Operator

Good afternoon ladies and gentlemen, and welcome to Wisconsin Energy's conference call to review our third quarter 2009 results. (Operator Instructions) 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, reference to earnings per share will be based on diluted earnings per share unless otherwise noted. After the presentation the conference will be open to analysts for questions and answers.

In conjunction with this call Wisconsin Energy has posted on its website a package of detailed financial information on its' 2009 third quarter results at www.wisconsinenergy.com. A replay of our remarks will be available approximately two 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

Good afternoon everyone. Thank you for joining us on our conference call to review the company's third 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 We Generation; Allen Leverett, our Chief Financial Officer; Jim Fleming, our venerable General Counsel; Jeff West, Treasurer; and Steve Dickson, Controller.

Allen of course will review our financial results in detail in just a moment but as you saw from our news release this morning we reported earnings from continuing operations of $0.50 for the third quarter of 2009. This compares with $0.64 a share for the same period in 2008.

Now I’d like to spend just a moment on our continuing effort to upgrade the energy infrastructure in Wisconsin. Our power of the future plan is fundamental to the principal of energy self-sufficiency. Key components of our focus on self efficiency include investing in two combined cycle gas-fired unit at Port Washington, north of Milwaukee, the construction of two super critical pulverized coal units at Oak Creek, which is south of the city, and building a significant amount of renewable generation.

Let’s turn now quickly to the status of the two new coal fired units at Oak Creek, unit one and the common facilities are now more then 96% complete and I’m pleased to report that a number of major milestones have been achieved in the past three months.

You may recall that on July 23, the main unit one boiler was fired successfully for the first time using natural gas. Since then our contractor Bechtel completed the steam blows, that’s the process necessary to clean the thousands of feet of piping in the unit.

Bechtel then connected the boiler to the steam turbine and on October 1 we rolled the turbine up to its full operating speed. On October 3 Bechtel successfully fired the unit on coal for the first time. The unit was synchronized to the grid on October 6 and generated its first power for export on October 7.

During the past two weeks Bechtel has been tuning and testing the unit up to 150 megawatts or about 25% of full capacity. Now Bechtel is preparing to increase the load to over 300 megawatts and that milestone is expected to occur in the next few days.

Looking forward Bechtel will continue to increase the unit load up to its full design capacity of 615 megawatts. The schedule then calls for performance testing during the month of December. These tests will demonstrate the unit’s ability to meet the guaranteed efficiency rate, capacity, and reliability metrics as well as compliance with various environmental standards.

As for unit two, I’m pleased to report that progress during the past three months has been significant. Unit two at Oak Creek is now approximately 74% complete. This represents an advancement of nearly 20 percentage points since my last report to you at the end of July.

The unit two boiler has also successfully passed its first pressure test and Bechtel’s near-term goals for unit two are to complete the remaining piping and exhaust gas path on through the air quality control equipment.

As the work continues Bechtel is targeting commercial operation of unit one by the end of December this year and unit two by the end of August, 2010. Bechtel is slightly behind these target dates but they continue to optimize their work schedule and believe that the target dates are still achievable.

Of course as we get closer to commercial operation, each day of the schedule becomes more critical. Now as you know Bechtel filed a formal claim last December seeking relief under the construction contract. Bechtel cited a number of factors including weather conditions in the winters of 2006 and 2007, heavy rains in the spring of 2008 and what Bechtel believes to be changes in local labor conditions.

The claim for the schedule and cost relief related to these factors totaled $413 million. Bechtel also stated its belief that the weather events constitute a force majeure. Now as I’ve mentioned on our previous calls, we simply don’t believe there is a contractual basis for some of the claims that Bechtel submitted.

For example, we disagree that Bechtel is entitled to cost or schedule relief as a result of alleged changes in the labor market. Further we do not believe that Bechtel complied with the contractual requirements for filing the claims and we disagree with a number of Bechtel’s factual assertions.

Bechtel also filed a $72 million claim for the alleged effects of changes and delays prior to the issuance of the full notice to proceed back in July of 2005. We believe this claim is without merit and that Bechtel was fully compensated for any and all impacts of the delayed start.

Finally Bechtel has asked for six months of relief from liquidated damages beyond the September 29, 2009 guaranteed date for unit one and three months of relief from liquidated damages beyond the September 29, 2010 guaranteed date for unit two.

We have as you know been unable to resolve our differences with Bechtel in non-binding mediation. So as reported to you last quarter we initiated binding arbitration which is the final stage of the dispute resolution process called for under the contract.

These three-member arbitration panel is now in place and the parties are engaged in discovery. The arbitration is likely to be concluded in 2010 or early 2011. As we assess these developments I believe there are several key points to keep in mind.

First we are still recovering carrying costs associated with the construction of these units. Under the terms of the lease agreements between Wisconsin Electric and WE Power we are recovering based on a mix of debt and equity our capital carrying costs as construction continues on the Oak Creek projects.

We are allowed to recover our carrying costs up to the total budget for the project that has been approved by the Wisconsin Commission so we believe our ability to recover cash carrying costs should be largely unaffected by a slight change in the construction schedule.

I would also like to reiterate an important point about the ultimate recovery of any potential cost increases. We believe we have several layers of protection for recovery of our costs. So to conclude that an additional cost is not ultimately recoverable, you would have to believe that the costs will not qualify for recovery under several opportunities.

First that any remaining contingency on the project is not sufficient to offset the cost. Second that the cost would fall outside the 5% ban that the Commission had deemed reasonable for prudent costs above the approved amount for the project.

And then even if the cost is above the 5% ban, that the cost was not caused by a force majeure event as defined in the lease agreements. And one more important point, liquidated damage payments will be due from Bechtel on unit one unless its determined that any days granted to Bechtel for schedule relief are equal to or exceed the delay in the schedule.

Of course as we move forward we’ll provide you with updates on any major developments through our SEC filings and on our scheduled earnings calls. Now turning to renewables, the State of Wisconsin as you have heard has a renewable portfolio standard in place that increases from 5% in 2010 to 10% in 2015 at a statewide level.

The standard sets targets for each of the utilities using an historical baseline. Using that baseline approximately 8.27% of our retail electricity sales must come from renewable sources in the year 2015. Meeting the aggressive 2015 target will likely require a mix of additional projects and short-term purchase power agreements.

Of course with the completion of our Blue Sky Green Field Wind Farm last year, we took a major step forward toward meeting Wisconsin’s goal to reduce its carbon footprint. With a total of 88 turbines, each with a capacity of 1.65 megawatts, Blue Sky Green Field is the largest wind farm to date in the State of Wisconsin. It was completed under budget and ahead of schedule.

Last summer we also completed the purchase from FPL Energy of a new wind farm development site in East Central Wisconsin. This site is called the Glacier Hills Wind Park. In October of last year we filed for approval to build on the site and our application was deemed complete in January of this year. That started a 360-day review process by the Public Service Commission.

In May we also announced a conditional agreement with Vestas Wind Systems at an attractive price for wind turbines capable of producing approximately 162 megawatts. Last month the Wisconsin Commission issued the final environmental impact statement for the project. Technical hearings are now set to be held next week, November 2, in Madison and public hearings are set for November 4.

A final decision by the Commission of our request for a certificate of public convenience and necessity should be made in January, 2010. Assuming Commission approval the first full year of operation for Glacier Hills is projected to be 2012.

Then in September we also announced our plans to build a biomass-fueled power plant at a paper mill site in Northern Wisconsin. The paper mill is owned and operated by Domtar Corporation. Wood, wood waste and sawdust will be used to produce 50 megawatts of electricity. We’re fortunate to be close to significant forestlands that could be harvested in a sustainable manner.

These forests have large amounts of wood waste that we can purchase to fuel the plant. And as compared to wind, the clear benefit from an operational standpoint is that we will be able to dispatch the biomass unit. Our gross investment in this project is projected to be approximately $250 million with a targeted in-service date of 2013.

We’re also considering a second project with similar size and timing. As you may know the tax law provides through 2013 an investment tax credit of 30%. That would bring the net investment we would make for each plant to about $175 million.

We also plan to invest approximately $85 million to $90 million in 12.5 megawatts of solar with a target in-service date for the initial solar project of 2013. Of course the proposed biomass and solar projects are subject to Public Service Commission review and approval.

And as you know construction is also underway on a major upgrade of the air quality controls at the existing coal-fired units at Oak Creek. We expect the cost of this facility will be $960 million including allowance for funds used during construction for the installation of wet flue gas to sulfurization and selective catalytic reduction facilities. These controls are scheduled to be completed in 2012.

Now I’d like to cover the status of our various rate filings, the Wisconsin review of our electric, gas, and steam rates is nearing the deliberation phase for the Public Service Commission. At the time of our last conference call our electric rate request stood at $126 million. However during the staff audit, the projection of our fuel costs for next year dropped by approximately $30 million.

We agree with these new fuel estimates and this reduced our updated request in July to approximately $96 million or an overall 3.7% increase as compared to the rates that were in effect at the beginning of this year.

The Commission staff is now estimating a 2010 revenue deficiency for our electric company of $62 million, again using that same lower fuel forecast. Then for our Wisconsin Electric gas utility, the staff is recommending a $1.2 million increase or about a quarter of percent and for our Wisconsin Gas gas utility, the staff position calls for a $10.1 million increase or about one and a quarter percent.

The staff also recommended a range for the return on equity of 10% to 10.75% and used 10.75% to determine the revenue requirement for all the utilities. The staff further recommended a financial common equity range for Wisconsin Electric that was unchanged, a range of 48.5% to 53.5% with a test year average of 51%.

For Wisconsin Gas the Commission staff recommended that the financial common equity range remain again unchanged at 45% to 50% with a 47.5% used for determining the revenue requirement. In September and October public and technical hearings took place on these cases. Briefings were completed actually this week.

The next step in the process is Commission deliberations and an oral decision which will be followed by a final written order. We continue to expect a decision and a written order this year with new rates to be effective January 1, 2010.

Turning now to our Michigan case, in July we filed a request to increase electric rates in Michigan by approximately $42 million. This request was driven primarily by the need to recover our investment and our operating costs associated with the new Oak Creek units.

We’re proposing to implement this request in three phases. The first phase is for approximately $22 million and primarily reflects the commercial operation of the first Oak Creek unit. This increase is expected to occur in conjunction with the commercial operation of unit one.

The second phase would occur when the Michigan Commission issues its decision for the 2010 test year, which is I expect it to be in July of 2010. Assuming our request is approved, this amounts to an additional $16 million. Finally if our request is approved when the second Oak Creek unit enters commercial service, the final amount, approximately $4 million would become effective.

In Michigan of course, any amounts that we would self-implement are subject to refund with interest. Our filing which was submitted on July 3 was deemed complete on August 3. Under Michigan law the Commission must then issue a final order within one year of a complete filing or the requested rates go into effect. This morning a limited hearing took place to discuss our implementation plan.

And finally, I’d like to briefly review a development that we announced literally just a few hours ago. Wisconsin Energy has reached a definitive agreement to sell Edison Sault Electric Company, one of our regulated utility subsidiaries, to Cloverland Electric Cooperative of Dafter, Michigan for approximately $61.5 million.

Under the agreement the ownership share of American Transmission Company currently held by Edison Sault, will be retained by Wisconsin Energy. The purchase price of $61.5 million represents a premium of about $2 million as compared to the adjusted net book value of Edison Sault’s assets excluding the ATC ownership share.

Then to assure a continuing reliable source of energy for Edison Sault’s customers, the existing wholesale power arrangement between Wisconsin Electric and Edison Sault will be extended by another 12 years to the year 2030.

I believe this agreement is a positive step forward for the customers of Edison Sault as well as our stockholders. The service areas of Cloverland and Edison Sault are contiguous. Both organizations know each other well and work together in fact on a daily basis.

As a result they’ll be able to gain efficiencies that will benefit customers across this region of Northern Michigan. Edison Sault by the way has not requested a base rate increase in almost 25 years. Without this transaction Edison Sault would have needed to request higher retail rates in the not too distant future.

The combination of these two utility operations should allow these increases to be mitigated. The sale of course is subject to approval by Cloverland’s membership and is subject to normal regulatory approvals and customary closing conditions. Assuming timely reviews the transaction could be completed by midyear 2010.

And now I’ll turn the call over to Allen who is fresh from a personal appearance in Lansing for more details on our financial performance for the third quarter.

Allen Leverett

Thank you Gale, as Gale mentioned earlier our third quarter 2009 earnings from continuing operations were $0.50 per share. Now I will focus on operating income by segment, and then I’ll touch on other income statement items. I will also discuss cash flows for the first nine months, and discuss our earnings guidance for the remainder of the year.

Our consolidated operating income was $105 million as compared to $138 million in the third quarter of 2008 for a decrease of $33 million. Operating income in our utility energy segment totaled $75 million which is $37 million lower then the third quarter of 2008.

The most significant factors reducing our utility operating income were an unseasonably cool summer which reduced electric margins by approximately $22 million. In addition we estimate that the economic slowdown lowered electric margins by $14 million and the timing of fuel recoveries reduced electric margins by $19 million.

On the positive side our utility O&M was $11 million lower, other pricing items contributed $4 million, and all other items totaled a net $3 million. When we net all other factors together we come to utility operating income that was $37 million lower then the third quarter of 2008.

Our non-utility operating income was up $4 million. The key driver of this increase related to a full quarter’s earnings from the water intake system at Oak Creek that was placed into service in January of this year. Corporate and other affiliates had an operating loss of $3 million in 2009 as well as in 2008.

Taking the changes for each of these segments together, brings you back to the $33 million decrease in operating income for this quarter. During the third quarter of 2009 earnings from our investment in the American Transmission Company increased almost $1 million and all other income increased slightly because of higher AFUDC and interest income.

Interest expense decreased $1 million. Consolidated income tax expense declined by approximately $12 million primarily because of lower pre-tax earnings. I expect that our annual effective tax rate in 2009 will be in the range of 35% to 37%.

Combining all of these items brings you to $59 million of net income from continuing operations for the third quarter of 2009 or earnings of $0.50 per share. During the first nine months of 2009 we generated $437 million of cash from operations on a GAAP basis, which is down from the $643 million generated during the same period in 2008.

While our net income and depreciation expenses were up, our cash flows from operations were down primarily because of the $289 million contribution to our benefit plans in January of 2009 which was discussed in prior conference calls.

On an adjusted basis, our cash from operations totaled $587 million as compared to $924 million in the first nine months of 2008. The adjusted number includes $150 million of cash impact from the bill credits in 2009 and $281 million in bill credits and refunds in 2008.

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 a source of cash as it directly relates to customer bill credits refunds and the one-time amortization of costs in 2008.

Our total capital expenditures were approximately $556 million in the first nine months of 2009 which is down from $889 million in the first nine months of 2008. On an annual basis we expect our capital expenditures to be $250 million to $275 million lower then 2008 capital expenditures as we move closer to the completion of our power of the future construction program.

On a GAAP basis our debt to capital ratio was 58.1% as of September 30, 2009 and we were at 55.1% on an adjusted basis. This is essentially flat compared to our December 31, 2008 levels even when considering the $289 million contribution to our benefit plans in January of this year.

I would expect our debt to capital ratio to increase slightly by the end of this year as compared to last year. We are using cash to satisfy any shares required for our 401-K plan, options, and other programs. Going forward we do not expect to issue any additional shares.

And in the third quarter we continued to see the economic recession impact our electric sales. However, we have seen some stabilization of the decline in the third quarter. Our service territory has a well-diversified industrial and commercial mix that helps mitigate the impact of most economic downturns.

However in this economy we continue to see large impacts in four sectors; iron ore mining, paper production, primary metals, as well as the automotive parts sector. As we look at our large commercial and industrial group, we see a 13.6% decline in third quarter sales compared to the third quarter of 2008.

However this decline is smaller then what we saw in the first and second quarters. In addition when we look at large commercial and industrial sales on a quarter over quarter basis we clearly see some positive news.

In 2009 we saw a 12.9% increase in third quarter sales over the second quarter. In 2008 the comparable data for the third quarter showed an increase of only 2.2%. So while our sales are still down significantly from historical levels, we do see some strong evidence of stabilization in our service area.

During our first and second quarter calls we provided guidance on our annual 2009 electric sales forecast. I would like to comment on where we see our annual sales in light of the third quarter results.

On a weather-normalized basis, our third quarter sales came in slightly better then forecast. Retail sales came in about 6.4% less then the third quarter of 2008. We had expected a 7.7% decline. We also saw a slight improvement in our third quarter electric sales to our large commercial and industrial classes, excluding our largest customer the iron ore mines.

While these results are promising they are not so significant to adjust our annual sales forecast. We are maintaining our prior outlook for electric sales that called for an 8.5% decline in kilowatt-hour sales in 2009 as compared to 2008.

In light of our actual results through nine months, we are keeping our earnings guidance for 2009 in the range of $3.05 to $3.15 per share. As we look back over the first nine months we are coming in within our targeted range.

While the economy turned out worse then we originally forecast, and we were hurt by the cool summer, we were helped by a strong first quarter heating season and our fuel recoveries are better than budget.

We have also implemented strong cost containment measures during the year including a hiring freeze and a reprioritization of work projects. If you take our actual year to date earnings per share from continuing operations of $2.24 and look at our annual guidance you will come up with a fourth quarter earnings range of $0.81 to $0.91 per share which compares with actual 2008 fourth quarter earnings of $0.85 per share.

So with that I will turn things back over to Gale.

Gale Klappa

Allen, thank you very much. Overall we’re on track and focused on delivering value for our customers and our stockholders.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Dan Jenkins – State of Wisconsin Investment Board

Gale Klappa

Good afternoon Dan. Dan you know its Halloween coming up and I heard this rumor that they already had an arrest warrant made out in your name on [Mithlin] Street, so you know, kind of good luck with that.

Dan Jenkins – State of Wisconsin Investment Board

No, I’m leaving town so they can’t pin that on me.

Gale Klappa

Probably a good move Dan. How can we help you today.

Dan Jenkins – State of Wisconsin Investment Board

Just a few things, first I was curious, I missed a couple of the numbers when you were going through the effect of the various changes like the cool summer and the various cost savings and so forth. I was wondering if you could give me the breakdown again.

Gale Klappa

That’s never happened to you before Dan but we’ll be happy to go over the numbers.

Allen Leverett

Yes and Dan, on page eight of the earnings package if you could refer to that. Retail sales as it relate to weather, that was a negative effect 2008 versus 2009, so that was $22 million. Fuel recoveries was a negative swing of $19 million and then our estimate of the economic, the change in the economy, our estimate of that effect on retail sales was a $14 million swing, again negative.

The other single largest item that was actually going the other way positive item, related to O&M reductions, so that was $11 million. So really the big three negative factors were weather, economy, fuel recoveries and again that fuel recovery is more of a timing within the year but a difference nonetheless.

And then finally O&M reductions were an $11 million positive swing.

Dan Jenkins – State of Wisconsin Investment Board

Okay on the O&M part of that, how sustainable are those savings going forward or are they more, how much of, just deferral type items.

Gale Klappa

There’s a combination, obviously we have taken as Allen mentioned earlier, we’ve taken very seriously the downturn and reprioritized a number of the work projects. Some of those work projects will have to be done eventually, there’s no question about that.

But I would say this, a large percentage of the O&M savings that we’ve achieved this year has really come from headcount reduction. In fact if you just look at the end of the third quarter a year ago and compare that with the end of the third quarter this year, our full time equivalent headcount is down 2.4% and we’ve really reduced our headcount by gosh, almost 1,000 people in total over the last five years.

So we continue to get productivity gains. We continue to get O&M savings. Some of the deferral of maintenance work though will have to be at some point addressed later down the road. And the other thing that Rick is pointing out to me and he’s absolutely right, the decline in wholesale power market prices has allowed us to do things like not work overtime at the plants if we have a scheduled outage.

So some of the savings that we’ve I think intelligently reaped here in O&M have been taking advantage of lower market prices in [inaudible].

Dan Jenkins – State of Wisconsin Investment Board

And I was wondering if you could update us on the amortization of the gains on the Point Beach, is that, is next year the final year of that and is it, you kind of look at the long-term and short-term restricted cash, is that kind of the extent of what that amortization will be going forward.

Gale Klappa

Let me first mention to you our proposal that is in our current rate case before the Wisconsin Commission would have all the remaining Point Beach credits delivered to customers during 2010. The current situation if the Commission does not adopt our proposal would be that the bulk of the credits would be delivered in 2010 with the remainder in 2011.

My guess is the Commission will agree with us, that all the remaining credits should be delivered in 2010.

Allen Leverett

And from a cash standpoint, restricted cash if you will that will yet to go back to customers, roughly $240 million worth of credits or restricted cash if you will, that we would expect to go back to customers and as Gale mentioned, some of that will be in the fourth quarter of this year obviously as we continue to give credits and we would expect the remainder of those credits at least if the Commission in Wisconsin follows our proposal to go back in 2010.

Now all of the FERC credits are done. We provided all of those last year. There’s about $2.16 million worth of credits that are remaining in Michigan that I would expect will go back in 2010.

Dan Jenkins – State of Wisconsin Investment Board

And speaking in the rate case, given items that you’ve agreed with the staff on and like fuel and so forth, how far apart are you and the staff now going into the end of this case.

Gale Klappa

Well basically the staff is at about $62 million in terms of their recommendation to the Commission. Our ask is at $96 million, so about a $30 million difference.

Dan Jenkins – State of Wisconsin Investment Board

And what’s the primary reason for that.

Gale Klappa

Well there are a couple of things, one is clearly on O&M. The other is on, in terms of O&M spending how much does the Commission think we should be increasing our O&M spending next year compared to what we have proposed. That’s the biggee.

There’s another one and that relates to the settlement that we reached, oh gosh, a year ago with the environmental groups over the water intake permit at Oak Creek. As you may recall we agreed with the environmental groups that we would fund some Lake Michigan water quality improvement projects if you will.

Such as working on reduction of invasive species in the lake, in return for the environmental groups’ dropping all litigation against the water intake permit. That agreement would call for spending $4 million a year only if the Commission so approves.

The staff has recommended zero so there is a $4 million annual issue as well right there. But the big two or three would be on how much additional O&M should be spent particularly on network projects and plant operations and maintenance and then another one would be the $4 million a year related to this environmental settlement.

Operator

Your next question comes from the line of Leslie Rich – Columbia Management

Leslie Rich – Columbia Management

I wondered if you could review again the liquidated damages portion of the Bechtel claim and how that likely plays out. You went through that sort of quickly. Like the liquidated damage payments would be due on unit one under what set of circumstances and on unit two under what set of circumstances.

Gale Klappa

We’ll be happy to do that and if I miss a detail, Rick Kuester will add in his thoughts as well. Essentially the, as you know we signed a fixed price turnkey guaranteed contract with Bechtel. And in that contract Bechtel guaranteed that they would deliver both unit one and unit two to us by a given date. The date for unit one that was guaranteed in the contract is September 29, 2009.

Under the contract if they don’t make September 29, 2009, which they’ve obviously not done, they would owe us $250,000 a day in liquidated damages unless there was schedule relief granted to them for any number of very specific reasons.

So essentially unless there is schedule relief granted at the end of this entire process, then Bechtel would owe $250,000 a day. Now as you know they’ve made a case for relief because of severe weather. Frankly we think there is some merit, they clearly were up against for example almost 100 inches of snow two winters ago and I think both Rick and I and all of our experts agree that there may be some schedule relief and therefore relief from some specific number of days of liquidated damages due to them, but all of that will get worked out during the arbitration process.

Rick Kuester

Just to remind you what Gale had mentioned earlier is that Bechtel has asked for six months of relief so that would put them at the end of the first quarter of next year for unit one and three months’ relief which would put them at the end of the year next for unit two. And those final determination of what is granted will be part of what is being arbitrated right now.

Leslie Rich – Columbia Management

I see so that cash won’t actually exchange hands if any, until the whole issue is resolved.

Gale Klappa

That is our current belief. That is correct.

Operator

Your next question comes from the line of James Dobson - Wunderlich Securities

James Dobson - Wunderlich Securities

Allen question for you, tax rate, you indicated it was 35% to 37% for full year 2009. When I look back at my notes that was a hard 37% in the second quarter. Can you help me understand what’s moving that around in the balance for second half of this year.

Allen Leverett

Why don’t I ask Steve Dickson our Controller to give you little more light on that.

Steve Dickson

As you know the effective tax rate takes into consideration the permanent differences and as pre-tax income may change, that may change the effective rate. There’s nothing significant. We’ve got many tax years that are outstanding and some items may settle, but it’s a lot of small items and we just thought 35% to 37% made more sense then a hard number.

James Dobson - Wunderlich Securities

Would you expect that to pop back, because when I look back historically you’ve been closer to 37%, would you expect 2010 is more like a 37% year because it is sort of like a $0.10 benefit or so if we take you all the way to 35%.

Steve Dickson

Keep in mind though, one of the things that’s impacting our ETR right now and will continue to impact the effective tax rate are the production tax credits associated with the wind projects. Now what happens under regulation effectively we’re given those credits back so on a net impact I wouldn’t expect an impact on the company but if you just look at the ETR the ETR would be slightly less then maybe what you’ve seen historically.

James Dobson - Wunderlich Securities

On O&M I was wondering going back to Dan’s question if you couldn’t put a couple of numbers around that and that’s really to say what were the O&M cuts you would be able to quantify that comes from hiring freeze and your activities to manage costs for the first nine months of the year and then if you can, obviously not maybe a dollar number but a percentage of those that would be sustainable and those that might not and I’m understanding that the majority of them are sustainable.

Gale Klappa

Just to frame it for you a little bit, our O&M for the third quarter of 2009 was 5% below Q3 of 2008 and for the year to date, for the first nine months of 2009, we’ve reduced O&M by 7.5% compared to the comparable nine months in 2008. Those are very significant numbers. Much of that as I mentioned to you is coming from basically headcount savings because we have materially, we have frozen our hiring except for absolute critical positions and we’re at a point where I have to personally approve any headcount addition.

So we have been very firm about controlling and reducing our O&M and gaining some productivity. But as we look forward, we have, 2010 is a very different year from an O&M standpoint then 2009 because we’ll be bringing on two new major coal-fired units. We’re going to have $20 million or more ammonia costs to operate the scrubbers at Oak Creek that we do not experience today.

Rick Kuester

We’re adding scrubbers. We’ve added them at Pleasant Prairie, we’re adding them at South Oak Creek and we’ve obviously, will have them at [Bergs], the Oak Creek expansion.

Gale Klappa

So 2010 will look a good bit different simply because we’re bringing in major addition of capacity and comes with that several hundred well paid, highly trained technicians and operators to operate the new Oak Creek units and then you have basically the commodities like ammonia that you have to have to operate, another catalyst that you have to have to operate the air quality control equipment.

And we’re also starting to hire people now, we will in our plan for later next year, to operate the air quality controls that will be coming in on the existing Oak Creek units. So we have to make considerable adjustments in 2010. Having said that I do think we will continue to be very, very judicious about headcount additions other than the people that we absolutely need to operate the units and the new air quality controls. I hope that’s helpful to some degree. Its just not an apples to apples comparison going forward.

James Dobson - Wunderlich Securities

No, that’s fair. And then last question on the Edison Sault sale, I assume since that’s right at book after-tax proceeds will be right about $61.5 million.

Steve Dickson

There is a book tax basis difference so after-tax proceeds on a cash basis probably closer I would say $45 to $50 million.

Operator

Your next question comes from the line of Michael Lapides - Goldman Sachs

Michael Lapides - Goldman Sachs

If I take the midpoint between what you’ve requested and the [Webco] and Wisconsin gas rate cases, and where staff or intervener testimony is right now, can you earn your ROE in 2010 with a number like that and then furthermore if you’re not getting a second increase in 2011 can you earn your ROE just at the core utility, not at PTF in 2011.

Gale Klappa

Instinctively I would say no, because of the normal disallowances that any Commission will apply. For example any bonuses, the cost of any stock options, would always be disallowed in most every rate case anywhere in the country and that would certainly apply here.

So I would think it would be if indeed our sales forecast is correct, I think it would be somewhat difficult to get right on top of the allowed rates of return at the utilities themselves.

Allen Leverett

That’s exactly right.

Michael Lapides - Goldman Sachs

Do you know, and does that become, assuming a slight uptick in 2011 from 2010 demand, does that problem exacerbate in 2011 due to lag.

Gale Klappa

No, I don’t think so.

Allen Leverett

I wouldn’t say so. I would hope that we would start seeing an improvement in the top line in electric sales in 2011 and as you always try to do, continue to improve your cost position, so I would hate, hope to be in a better position all things being equal on our ability to earn our allowed return in 2011 as compared to 2010.

Gale Klappa

I absolutely agree with that.

Operator

Your next question comes from the line of Greg Gordon - Morgan Stanley

Greg Gordon - Morgan Stanley

Just had question as to what you are assuming for the sales outlook for next year given that you’ve kind of seen the stabilization in the sales this past quarter. Do you expect to see more deterioration or more of a flattish outlook.

Allen Leverett

Its really the latter being a flattish outlook and I’ve really have that view very consistently. We’re looking at what we believe is a flat outlook for electric sales in 2010 as compared to 2009.

Gale Klappa

Weather-normalized.

Allen Leverett

So still flattish.

Greg Gordon - Morgan Stanley

And then on the Michigan rate case the three steps that you outlined for us, does that reflect self-implementation as well or would those numbers move around if you chose to self implement.

Gale Klappa

The three phases, phase one would be basically a self implementation in conjunction with the commercial operation of unit one at Oak Creek and then phase two, again because of the way the new Michigan rules work, the Michigan Commission has a full year to decide appropriate test year expenses and make a decision on the rate case.

So the way we have chosen to propose a phasing in of our request would be self-implementation for the first phase which is about as I recall $22 million in conjunction with operation of unit one at Oak Creek. And then in approximately July of 2010 we would think the Commission would decide on phase two as well as then the phase three which would be about $4 million when the second unit at Oak Creek would come into service in the second half of 2010.

So only one phase of the three would clearly be self-implementation.

Operator

Your next question comes from the line of Paul Ridzon - Keybanc Capital Markets

Paul Ridzon - Keybanc Capital Markets

What was the absolute fuel recovery in the quarter as opposed to just the quarter over quarter.

Steve Dickson

In the third quarter typically its where we under recover because the incremental cost of fuel is higher. So in the third quarter of this year we had about $22 million of under recovery compared to last year it was about $3 million. So that’s where you get the $19 million variance third quarter year over year.

Paul Ridzon - Keybanc Capital Markets

And what’s your forecast now for full year fuel recovery.

Gale Klappa

Positive over recovery of $15 to $20 million.

Paul Ridzon - Keybanc Capital Markets

Over recovery.

Steve Dickson

Yes, positive recovery position.

Paul Ridzon - Keybanc Capital Markets

And Gale, do you like the night before calls think about what you’re going to say to Dan.

Allen Leverett

No actually, I can attest, he makes it up on the call.

Gale Klappa

I think Dan practices his response over night though.

Operator

Your next question comes from the line of Andrew Levy – Incremental Capital

Andrew Levy – Incremental Capital

Actually the questions have been asked but I didn’t hear the answer, just can you just real quickly on the over and under recovery of the fuel for the third quarter and for the fourth quarter and what the expectations are and what it was.

Gale Klappa

You remind me of [Karnack], you devine the answer without knowing the question. We’ll ask Steve to go over that again very quickly.

Steve Dickson

Third quarter this year under recovered by about $22 million, third quarter last year we under recovered by about $3, so its $19 million. As we look at the fourth quarter it will probably be about $5 million worse as compared to last year if we’re looking at the fourth quarter standalone.

Andrew Levy – Incremental Capital

So total under recovery for the two quarters is about $27 million or so.

Gale Klappa

And remember what really happened, 2009 second and third quarters, well actually third quarter was the mirror image reverse of last year. We had just come off of getting a fuel cost recovery increase in July of 2008 and we have just reduced fuel rates and those reduced rates were in effect for the third quarter of 2009.

Andrew Levy – Incremental Capital

You reduced them like March 31 or something like that.

Gale Klappa

So its just kind of a reverse in the timing of fuel recovery swung the numbers.

Operator

Your final question comes from the line of Paul Patterson – Glenrock Associates

Paul Patterson – Glenrock Associates

I’m afraid I got on just a little bit late and I did hear the comments about how the, that you thought the economy was stabilizing there, I was just wondering if you and I apologize if you’ve already gone over this but what do you see for 2010 when you speak to your customers, your larger customers, what your expectations are for 2010.

Gale Klappa

We’ll be happy to answer that, I think the fundamental bottom line is when we talk to customers and we do every day they are very cautious about the outlook for 2010 and that has led us to basically assume a flat compared to 2009 weather normalized sales year.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Gale Klappa

That does conclude our conference call for today. Thank you so much for participating. If you have any other questions Colleen Henderson is ready and willing in our Investor Relations office at 414-221-2592. Thank you again, bye.

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