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Executives

Gale Klappa - Chairman and CEO

Analysts

Steve Fleishman - Wolfe Research

Wisconsin Energy Corporation (WEC) 2013 Wolfe Research Power and Gas Leaders Conference Call September 25, 2013 10:15 AM ET

Steve Fleishman - Wolfe Research

Okay next panel is titled Growing the Rate Base, and we are really happy to have these two gentlemen here, I know, I am sure, we will have a good discussion, probably not including me. But first off will be John Russell, who is the Chairman and CEO of CMS Energy, and then we have got Gale Klappa, who is the Chairman and CEO of Wisconsin Energy.

Gale Klappa

Thank you. Actually as you can see, John has done a great job with CMS. He has been a terrific CEO and has been a real contributor in our industry, and delighted to be with you today, and with the talkative analyst here. As always, we are going to provide you with a good bit of forward-looking information, and as they say at the Environmental Protection Agency, your results may vary.

Just a very brief snapshot of our investment thesis. First of all, I think we are the only major utility, electric utility and gas utility in the United States with positive free cash flow. We will talk more about that. We define positive free cash flow as cash flow after our capital spending program, and after our dividend policy is fully implemented. So, we have a fair amount of financial flexibility given the fact that one of our distinctions is positive free cash flow. We are targeting earnings per share growth after our Power the Future plan is complete, which it now is 4% to 6% annually.

In addition to that, we believe we are going to be able to provide you with best in class dividend growth. Our Board has adopted a dividend policy, where we are going to move our payout ratio to 65% to 70% of earnings by 2017. We will talk more about that in a minute. In fact, if you were a shareholder last September in Wisconsin Energy and our shareholder this September, your dividend is 27% higher today than it was in September of a year ago.

In addition to that, we have a $300 million share buyback authorized by our Board of Directors that is through 2013, and I think a proven management team that has delivered strong financial results, and as John said, predictable, consistent, excellent performance.

So that's basically a summary of our investment thesis. For those of you who have followed us, you know that we are the largest electric and gas utility in the state of Wisconsin. We touch about one out of every two customers in the state. We are on the theme of consistency, the only company in any of these major utility indices; the S&P Electric Index, the S&P Utilities Index, the Philadelphia Utility Index, or the Dow Utilities Average. The only company that has grown earnings per share and dividends per share every year since 2003.

Our total shareholder return over the 10-year period, I think, has been one of the things we are the proudest of. You can see on the screen here, the 10-year total shareholder return performance of the major utility and market indices, ranging from the Dow Industrials to the S&P 500 to the S&P Electric Index; and you can see over the 10 years, if you have invested in one of those indices, your returns would have ranged from 98% up to about 167% or an investment in the companies in the S&P Electrics Index, by comparison, Wisconsin Energy's total shareholder return, 285.2%.

Looking forward now, one of our major objectives is to build on our record of reliability, and I am very pleased to reiterate with you that Wisconsin Energy has been named the most reliable utility in the Midwest, eight times in the past 11 years, and I am hopeful that in a month or so, it will be nine times in the last 12 years.

This particular honor is given to the company in the Midwest that has the best outage performance and the best outage restoration performance, and of course customer satisfaction at its core for our industry is built on reliability. So, we are very proud of that track record.

We have also -- as John is doing, we also focus very, very strongly on customer satisfaction. In fact, during 2012, we achieved the highest customer satisfaction ratings that we have achieved in the past decade, probably the best ever, and I just saw an external survey just the other day of business customers in the United States, business customer satisfaction with their utilities, we were number one in the Midwest, and number four in the United States. So, we continue to focus like a laser beam on customer satisfaction, because that's the core of our franchise, that's what makes our franchise enduring, long lasting, and successful.

Most of you know that the earnings growth we have achieved over the course of the last decade has been fueled by a couple of really [better] (ph) company projects, and I am pleased again that we were able to deliver those projects on time, on budget, and they are now fully reflected in customer rates.

The first was our new natural gas fired units just north of Milwaukee in a city called Port Washington, and if you look at the bottom of the slide, you can see that we brought the two natural gas fired units in Port Washington into service for about $609 per unit of capacity. We are very pleased with that because today if you are to try to build a natural gas combined-cycle unit anywhere in the U.S., chances are it would cost you at least $1,000 per unit of capacity. But these units, which have the best heat rate, the best efficiency rate if you will in the Midwest right now; and among the best in the country will serve our customers very, very well for many years to come.

And then the centerpiece of our Power the Future plan was two new clean burning coal-fired units just south of Milwaukee, in a city called Oak Creek. This in total was a $2.3 billion project. We have a couple of small partners in the project, and we completed these Power the Future units -- these coal-fired units at Oak Creek for about $1,950 per unit of capacity. Our friends at Duke Energy last year brought on a unit at Cliffside in North Carolina using exactly the same technology. Their cost per unit of capacity was $2,500; and today, according to the Energy Information Administration of the Federal Government, if you could get a coal-fired unit permitted today, which is highly doubtful, it would cost at least $3,000 per unit of capacity, and that would be without any carbon capture.

Our environmental performance as a result of the significant investments that we have made over the course of the past decade is really a dramatically improved story. In essence, what we have been able to accomplish between 2000 and the end of 2012 is we have added 50% more production capacity to our system. So, we have 50% more power production capacity on our system today than we had in the year 2000, but look at the results from an environmental standpoint. Our emissions of nitrogen oxide, sulfur dioxide, mercury, and particulate matter have all declined by 80% or more; 50% more capacity, 80% less emission, and our CO2 emissions are actually down by more than 20%.

So where do we go from here? Well, we call it delivering the future. For the five-year period, this year through 2017, our plan is to invest about $3.5 billion in many of the same types of projects that John has engaged in investing in. Projects that will upgrade our aging distribution infrastructure, add clean renewable energy to our fleet, and of course meet new environmental standards, and I will quickly walk through some of the details for you.

We are just about finished now in Northern Wisconsin with a new biomass fueled power plant. Wisconsin of course has a renewable portfolio standard, about 10% of all electricity sales in the state of Wisconsin at retail, must come by law from renewable sources by the year 2015. We have already built the two largest wind farms in Wisconsin. We have a third wind farm that we own. We have got power purchase agreements for other wind energy, but we felt under the banner of fuel diversity being important. We felt it was really imperative that we have a diverse portfolio of renewable sources with which to meet the state standard. So we received approval for building this new biomass fueled plant, and it is now virtually complete. We expect to bring it into service by the end of this year, and in fact we hit a major milestone yesterday, for the first time, we synchronized the unit to the grid and produced energy from this unit for the grid. So we have met our major milestone on-time and on budget.

This 50 megawatt plant will use wood waste. Northern Wisconsin is heavily populated with forests. 100% of the forestry and logging activity that takes place in Northern Wisconsin has been certified as using sustainable forestry practices, and that's a very big deal. So, we are able to use wood waste from the Northern Wisconsin forest. Tree-tops, tree trunks, bark, branches, wood chips as the fuel for this plant. The beauty of this plant, which we project to cost just under $270 million, is that we can dispatch the unit.

With wind, in Wisconsin in Midwest in particular, the wind is most prevalent at night and in the winter time, when you need the energy the least. This unit will produce reliable energy in terms of renewable energy, and we can dispatch the unit whenever we need it. So that should be in service by the end of this year.

We are also beginning to make very firm plans to rebuild the power house at one of our hydroelectric dams in the far Northern part of Wisconsin and Michigan. It's called Twin Falls. This hydroelectric dam was actually built way back in the early 1900s. It still produces energy very well, but the foundation of the powerhouse is beginning to crumble. So, we have received approval from the Wisconsin Public Service Commission already. We are expecting a license amendment literally any day now from the Federal Energy Regulatory Commission, and we will be spending $60 million to $65 million in rebuilding this powerhouse and actually expanding the amount of hydroelectric energy that we can produce from this particular facility.

We are also seeking approval to convert the last operating power plant inside the city of Milwaukee from coal to natural gas. We would expect to spend $65 million to $70 million on this project, and hope to have it completed by late 2015 or early 2016.

I mentioned the focus on upgrading our aging distribution networks, and here is exactly what we plan to do. We will rebuild more than 2,000 miles of electric distribution lines that today are more than 50 years old. We are going to replace more than 18,500 power poles. Some of them long pecked by woodpeckers. 20,000 transformers will be replaced, and literally hundreds and hundreds of substation components.

On the natural gas distribution side of our business, it's very much the same story, replacing over 1,250 miles of aging gas mains replacing 83,000 individual gas distribution lines. For those of you, the lines that come off the street and go straight to your home and replacing almost a quarter of a million meter sets.

We are also expecting approval and we have asked for approval from the Wisconsin Commission to build a major expansion of our natural gas distribution network into the western part of the state of Wisconsin. We see increasing demand from customers in the Western part of the state for two reasons; one, customers wanting to switch from propane to natural gas. In fact, seven communities have now petitioned us to expand our natural gas distribution network into their communities, and from the increase in the mining of sand for fracking. Wisconsin apparently has the perfect molecule for fracking. The rounder the molecule, the heavier and coarse the molecule; the better the molecule works in the fracking process in the field. Wisconsin in the shaded area that you see here has great prevalence of sand for fracking.

We have several other investment opportunities that we are working on right now, ranging from fuel blending, at our new Oak Creek units, to major transmission projects that have been proposed by American Transmission Company in the middle west, but outside of our footprint, and the possibility of purchasing energy assets that are currently operated and known today by the state of Wisconsin. We can talk more about that in the Q&A.

Having said all that, we expect even after we complete all of that, to have about $500 million of free cash after the capital spending and after our dividend policy is completely in place, about $500 million of free cash between now and 2017. That is helping us to have, what I would call industry-leading dividend growth. As you can see, the history in the chart here of our dividend payments, going up every year since 2003.

In the first quarter of this year, we raised the dividend and then in the third quarter of this year, we raise the dividend again. As I mentioned, you put the two dividend increases together, and your September dividend payment this year was 27% higher than our September dividend payment a year ago.

On our share repurchase plan, we have been, I think, very prudent in how we purchase the shares. Our stock today is just about $41 a share. We have completed two-thirds through June of our share repurchase plan, at an average purchase price of $34.57 a share. We are very pleased with how we have managed that.

So to summarize, our Power the Future plan is now complete, providing us with highly visible earnings and strong cash flow. All regulatory approvals and construction are complete on Power the Future and rates are in place. We think we have well managed utilities with visible, significant, low risk rate based growth. We think we have additional investment opportunities through our 26% ownership in American Transmission Company, and I really believe that we are positioned to deliver, among the very best risk adjusted returns that the industry can offer in the next five to 10 years. Or, just to summarize, as that great American philosopher Maria Muldaur said in the 1970s; when it's midnight at the oasis and you are putting your camel to bed, we want you to sleep well with Wisconsin Energy Stock. Thank you.

Steve Fleishman - Wolfe Research

You guys make this look so easy. I am assuming, not exactly that easy, to manage the business this way. Is it -- maybe you can just give us a little sense of just how hard it is to manage costs like this? Hit the numbers, and let's say you are a big utility with a lot of nuclear plants. Does it help to kind of be too big, not have nuclear -- I am not that certain of a good -- but just give some perspective on -- how much is it just -- management team what you are doing versus being right sized and not having the right assets? How do you manage?

Gale Klappa

John makes some great points. I think Steve, kind of maybe taking a little different take on it. But I agree with everything John said. It's really all about execution. I am not sure it's harder to do it, I mean, I was with Southern for 29 years. I don't think it's about size. Certainly if you have a more balanced mix of assets, and you are not exposed to certain nuclear risks, it may be easier. But I don't think it's about size, it's all about focus and execution. We have been very fortunate, we have spent $8.3 billion in infrastructure projects since 2003. Some of them in a little, but worse than the budget. Some of them a little better than budget, but net-net, we put $8.3 billion worth of infrastructure in place on time and on budget. That gives you credibility with the regulator, and that takes a lot of pressure off of it. If you can deliver what you said you are going to deliver, then do it consistently. If you do it consistently, you can satisfy customers. I think that's the magic formula.

Steve Fleishman - Wolfe Research

Question, little more for Michigan, but it's broader than that, because cash in power prices are slow, particularly in Midwest. I assume, there is some pressure to say hey, should we look at deregulated market, maybe customers in kind of a facility here, kind of cheaper power, just how much of a pressure is that, and where do you think things may be play out in Michigan first, and can we see it in Wisconsin?

Gale Klappa

It is an important piece, and I can elaborate on one piece of that, to Wisconsin. There is very little discussion about opening the markets in Wisconsin. There are some industrial customers have said, well gosh, I could get this in New Jersey or whatever. But I think the general sense is that if MISO, Midcontinent Independent System Operator, that their projections are anywhere close to accurate. That reserve margins are going to tighten materially in the Midwest in the next four or five years. That's the long time to open up the market. The Midwest independent system operator is saying that with the retirement, the post retirement of older less efficient, coal-fired power plants in the Midwest, they are seeing even if we have 1% demand growth each year between now and 2016, and MISO is likely to have single digit reserve margin by 2016 or 2017. That's not that far off.

And the last thing you want to do is, is suddenly open markets when capacity is tight, and I think a lot of customers understand the (inaudible) P&Ls. You understand where the [pump] is going, and realize that we have put assets in the ground at a very good price. So we will serve customers as well for the long term.

Related to customer choice in Michigan, we've just lost the iron ore mine -- two iron mines in the Upper Peninsula, and John's point resonated with me, because the mines are receiving the same electricity, from the same plant, with the same electrons today, just the financial contract difference, than they would forward, and the way the alternative energy supplier can make that work, is they believe and they are probably right. So we have a [much strong] unit up there. We have a [much strong] plan, and so we can't -- normally, a normal business would say, okay, well we have lost that customer, so we need to balance our supply with the demand. Well we are not supplying that customer anymore, so we would shut down these five units that are older units in the Upper Peninsula of Michigan. We would shut them down. We don't need that any more. We have actually applied to MISO to shut down those units. We are going to get an answer back from MISO by the end of October we are told, but I believe the answer will be, not only no, but hell no.

The lights are going to go out, if you shut down those five units, and therefore, they would designate we think, our units as they call them something else, but you will be familiar with the term, reliability must run, and then customers across Wisconsin and Michigan will have to pay for the O&M of the plant; because, the physical mechanics are not changing. This alternative energy supplier could not meet those applications of this contract with the iron ore mines if we didn't run that plant, and someone has to cover the cost of running their plant.

I think what we are seeing, and we are seeing this in many states, is these experiments of hybrid markets are deregulation. They have really uncovered serious flaws, and I think John and certainly the governor of Michigan and his policy advisors are beginning to realize that something needs to change for the long run benefit of Michigan.

Steve Fleishman - Wolfe Research

I will ask one more and then we will open to the audience. Just thoughts on M&A, both for your own companies, or maybe more broadly for the sector, how much is potentially a key component going forward?

Gale Klappa

Steve was urging me to get showgirls for our next annual meeting from Las Vegas. We gave it a shot. We have, as many of you are aware, we have three very specific criteria that have been in place at our company, who have been there, that our senior team believes in, to evaluate any potential opportunities. And the criteria are very straightforward and very simple, but I think they are important; because if you don't follow the criteria, and I will lay them out quickly in a second. If you don't find a criteria, my own view is you are not creating shareholder value. So the criteria are simple; we would have to believe to acquire another utility, that we could make the acquisition accretive to earnings per share by the end of year one, after the acquisition.

Number two, it would have to be largely credit neutral, and what I mean by that is, would be willing for short term to go from an A to an A- rating, yeah. Would be willing to go to (inaudible) category in ratings, no. So largely credit neutral.

And then the third and very important, is that for significant due diligence, we would have to really believe that the longer term growth rate of whatever we would acquire, would be at least as good as our standalone growth rate. So that's the length through which we look at anything that might be an actionable opportunity. And as all of you know, when you look at those three criteria and then you apply those three criteria, very little fit the criteria. So it's not something that we focus on every day, because its mostly not actionable.

Now having said that, if we find something that we think is actionable, and really does meet those criteria, we would certainly take it seriously.

Question-and-Answer Session

Steve Fleishman - Wolfe Research

Questions from the audience?

Unidentified Analyst

Steve, you put on quite a show. You are so attuned to each other and your beliefs are the impressions of it, I think that Gale, you ought to check out the statistics for John, and maybe there is an M&A opportunity there? You know, this morning, I saw the EVP of (inaudible) and CFO, and talking to the EVPs (inaudible) southern company, and requested to come to these meetings, one of the things is to see who talks to whom, because they are laying down a plot to make a transmission line from New York City to Georgia, so they can use all that nuclear power. John, do you expect at this time, actually with the subject matter that Steve had given you of growing ratebase and managing costs, I wondered now there seems to be -- outside the utility industry, there seems to be some emphasis that the SEC on executive costs versus workers costs, and in your case, it was how we translate that to customer costs or executive salaries. Can you talk at all about how your personal and senior staff compensation relates to what you pay your workers down, who you have cut so deeply in the last few years?

Gale Klappa

I agree with John, and just a slightly different take on that. We both run very flat organizations, and I believe that, both from a standpoint of effectiveness, but also from just the standpoint of sheer costs. We have done a look at -- look at in terms of consumer impact, and I think the number will shock you. If our entire senior team at Wisconsin Energy worked for free, if all of our senior officers worked for free for the entire year, for free, the typical residential customer would save, I think $1.30 on their electric bill, less than $2 a year on their electric bill. So that I think gives you a sense of -- paying in our industry is not driving electric rates or natural gas rates. In fact, many people forget that the single biggest element of an electric bill, it's not fuel, it's not O&M costs, it’s the cost of capital. So you can have a senior team that can deliver project on time and on budget, and have enough confidence in the market that you can get low cost of capital. That's the real key. Executive pay is really meaningless, in terms of the customer's bill.

John's right. I mean, if you think about compensation, cost of stock options, the cost of restricted stock, any bonuses, none of that was paid for by the customer.

Steve Fleishman - Wolfe Research

Any other evening questions?

Unidentified Analyst

So just wanted to get both your perspectives. We have heard some different opinions on how pipelines (inaudible) as a market, what are your (inaudible) in terms of coal plant retirement, gas fields, and then potential pressure on the grid from different little pockets (inaudible)?

Gale Klappa

MISO every fall does a rolling projection of its reserve margins, so they will be updating that again in the next couple of months. But I just had a meeting with the senior MISO people last Friday, and I will tell you the foremost thing on their minds, is their belief that a seriously shrinking reserve margin and potential reliability issues by 2016. Their underlying forecast, as I mentioned, excuse me, calls for (inaudible). Their underlying forecast is only 1% annual demand growth. They have been informed by regulation of which plants are going to come out of either [tighter] in the Midwest. So they have got that list of all the megawatts that are coming out of service. They are assuming that they said 1% load growth, and they are also assuming, that there may be some restrictions in terms of delivery of natural gas for gas fired generation at certain times. Those are kind of the treaty assumptions that they are putting into their models. But I have not seen the MISO folks be this concerned about reserve margins in the 2016-2017 timeframe, as they are today. They believe there is going to be a serious concern.

And none of us win, and I want to go back to something. MISO obviously has been all of the market -- all the market monitors do this. They only give you a certain percentage of your installed wind capacity. They only count on a certain percentage in their calculation of reserve margins. I think the last time I looked, if you have -- pick a number, get a 100 megawatt wind farm, that would give you 20 megawatt installed capacity. So about 20%.

I want to take you back to July 5th of 2012. Myself and a couple of our senior folks were standing in our control rooms were really, really getting concerned. July 5, 2012, you got to 103 degrees on the lake front in Milwaukee, and it was over 100 everywhere in the Midwest. We were running, we were told by MISO to run everything we could run. Now we were going into the summer, thinking we had a 25% plus reserve margin. We had nothing de-rated. We had everything up. MISO was telling us to run everything. At our newest units, we were asked to run above their rated capacity, for hours on them. Why? Well, we had some minor units go out in other parts of the Midwest. But in 103 degrees on the lakefront, and humid is all to get out, there was no wind.

Back then one afternoon, that afternoon, I think of all of our installed wind capacity, we got six megawatts of actual wind production. So I think MISO is also somewhat concerned, if you hit the right atmospheric conditions and heat conditions, how much they can really count on the installed base of wind capacity. Their 20% credit was way overstated on July 5, 2012.

Unidentified Analyst

All right, just a quick follow-up, I mean, if all that -- the way that you see there has been -- I mean, I know John (inaudible), why aren't more plants being built to solve those?

Gale Klappa

The price signals just don't support it.

It would be astronomical. And I think that gets to the question that John reposed earlier -- I think I have come to the conclusion that I think John has, there are some things that are true monopolies and should be regulated, and to me, this industry is a classic example of that. These experiments in hybrid and deregulated markets, and the movies are not ending well, and I fear, as we start -- and the fact that there has been excess capacity, and we have had a significant recession, has messed some of these problems. But if we start getting into tight markets and you don't have time to build the plant, reliability issues are going to surface. I am a big believer in this industry remaining fully integrated and fully regulated, because I think that's the best service model for the customer.

Unidentified Analyst

Maybe a question on price. Just in all this sort of view, in general that regulated utilities have sort of been opposed to, or would not want a robust capacity market in MISO, but it seems like that would be, the way to get proper price signals and economic incentives for newbuilds? Is that --?

Gale Klappa

And I think, the difference between say PJM and the MISO market is, the MISO market was populated with mostly regulated utilities, and I will tell you that certainly Michigan and Wisconsin and in Illinois and other places, the state regulators don't want the ability to make that capacity decision taken away from them. So it’s the difference between serving mostly deregulated markets, and MISO which is serving mostly regulated markets. And again, I think the states really want us to have -- they don't want that ability to say yes or no to capacity taken away.

Steve Fleishman - Wolfe Research

We can [work on] what you guys thought all day. But we do need to end. So thank you John and Gale.

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