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Wisconsin Energy Corporation (NYSE:WEC)

Q1 2010 Earnings Call Transcript

May 4, 2010 2:00 pm ET

Executives

Gale Klappa, Chairman, President and CEO

Allen Leverett – EVP and CFO

Steve Dickson – VP and Controller

Analysts

Bill Appicelli – Morgan Stanley

Michael Lapides – Goldman Sachs

Paul Ridzon – KeyBanc

Leon Dubov – Catapult Capital Management

Vedula Murti – CDP

Reza Hatefi – Decade Capital

Phyllis Gray – Dwight Asset Management

Dan Jenkins – State of Wisconsin Investment Board

Operator

Good afternoon. Thank you for holding ladies and gentlemen, and welcome to Wisconsin Energy Corporation conference call to review 2010 first quarter results. This conference is being recorded for re-brought cast and all participants are in a listen-only only mode at this time.

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 discussions, referenced earnings per share will be based on diluted earnings per share unless otherwise noted.

After the prepared remarks, 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 2010 first quarter results at www.wisoncsinenergy.com. A replay of our remark will be available at 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

Thank you. Good afternoon everyone, we appreciate you taking part in our conference call today to review the company's 2010 first quarter results. Let me begin as always by introducing the members of the Wisconsin Energy management team who are here with me. We have Rick Kuester, President and CEO of V-Generation, Allen Leverett our Chief Financial Officer, Jim Fleming our General Counsel, Jeff West Treasure and Steve Dickson, Controller. Allen will review our financial results in detail in just a moment, as you saw from our News Release this morning we reported earnings from continuing operations of $1.10 a share for the first quarter 2010. This compares with $1.20 a share for the first quarter 2009. As we mentioned on our conference call back in February, we expected our first quarter to be lower than last year because of fuel recoveries.

Fuel recoveries caused a negative swing for $0.26 share for the quarter but on the other side of the ledger we benefited from earnings related to the first expansion unit at Oak Creek, which was placed into commercial service one minute after midnight on February 2. Overall, we're pleased with our first quarter's results.

Now, I'd like 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 principle of energy self sufficiency. Key component on our focus of self-sufficiency include investing in two combined cycle natural gas fired unit at Port Washington, North of Milwaukee. The construction of two super critical plant arise cold unit at Oak Creek which is south of the City and building a significant amount of renewable generation. As we discussed on previous calls, both unit at Port Washington are in service, construction was completed on time and on three budgets. The units are among the most efficient in the mid-west market, they're operating well and our customers are now benefiting from the low price of natural gas that fuels these units.

Turning now to the status of the two new coal fired units at Oak Creek. Unit one passed all of its performance tests was placed into commercial service as I mentioned on February 2 and is currently on-line. Since early February, Bechtel has been addressing a number of punch list items and resolving several warranty issues that were identified after the turnover. This type of activity is quite normal for a major new generating unit in its first year of operation. We're very optimistic about the long-term performance of the Oak Creek expansion units. The demonstrated heat rate for unit one is outstanding. And based on that data, we believe that the Oak Creek expansion will rank among the 4 or 5 most efficient coal fired power plants in the country.

We also made significant progress on the construction of unit two during the quarter. In fact, the first fire of unit two with natural gas was successfully achieved on April 20. Bechtel is now working on steam blows, a process used to clean scale and debris from the thousands of feet of tubes and pipes in the unit. Once steam blows are complete the unit will be re-configured so that steam can be directed to the high pressure turbine. The unit will then be fired again on natural gas and the turbine generator will be synchronized to the grid for the first time this is scheduled to occur by the end of June or early July, we then expect the boiler to be fired on full for the first time. From there we will follow a routine similar to the commissioning schedule we saw in unit one. Testing and tuning will be conducted, as the output of the unit is gradually raised from 0 to 100% capacity. The final step will be a series of rigorous performance tests.

Now there's no question that we're benefiting from the lessoned learns on unit one. As a result, we expect the unit two at Oak Creek to have a smoother and shorter time line for commissioning. The guaranteed turnover date as you recall, for unit two, which was set as part of the settlement agreement with Bechtel is November 28 of this year. Now, as we first reported to you last December, we have settled all claims with Bechtel that were raised in the arbitration proceeding. Through its claim Bechtel was seeking additional construction costs of $517 million and scheduled relief of seven months and 4 months for the completion of units 1 and Unit 2 respectively.

Our settlement includes the following elements. We agreed to pay Bechtel $72 million or about $0.14 on the dollar. Including $55 million, that has been paid to date and $17 million to be paid in five additional installments that are tied to specific milestone at the site, as one of the three co-owners of the Oak Creek we're responsible for approximately 85% of these amounts. Bechtel received 120 days of scheduled relief for unit 1 and 60 days of scheduled relief for unit two. This extended the guaranteed turnover date for unit two to November 28, 2010. And finally Bechtel released us from all matters related to their claims in the arbitration and we leased Bechtel from all matters related to our clams in the arbitration.

As we move forward now, we'll continue to update you on the progress of unit two, as well as the recovery of any costs that might be incurred above the improved amount. In other developments in the first quarter, we reached an agreement to sell to a live energy our 25% interest in Edgewater unit five. Edgewater five is an existing 380 megawatt coal fired unit in eastern Wisconsin. The 95 megawatts capacity that we own at Edgewater will be sold for our net book value including working capital. As a result, we did not expect any book gain or loss on this transaction. And a lint, which already owns 75% of the plant's capacity will then become the plant's 100% owner.

The sale is subject to the course to customer regulatory reviews including Wisconsin and Michigan commissions. If approved, we expect the sale to close by the end of this year. Pre-tax proceeds should be in the range of $40 to $45 million depending on the final working capital balances. This proposed sale of our minority interest in Edgewater five is a result of our normal ongoing review and analysis of the assets in our generation portfolio. I should also point out that today, this morning actually we closed on the sale of our Edison Sault utility in Sault Ste in Marie Michigan; we expect the final pretax proceeds from the sale to be approximately $61.5 million.

Turning now to other developments, the Wisconsin state legislature completed its session for the five-year – I'm sorry for the year and adjourned on April 23. In our most recent call I had mentioned a bill being debated that was intended to address climate change. It did not receive a vote in either house. As a result, the current renewable portfolio standards in Wisconsin remain in effect and remain unchanged. To refresh your memory, the standards call for an increase in the amount of electricity we supply with renewable sources from 5% in 2010 to 10% in 2015 at a statewide level. The standard set targets for each of the Wisconsin utilities using an historical baseline. Using that baseline, approximately 8.25% of our retail electricity sales must come from renewable by the year 2015.

With the completion of our Blue Sky Green Field wind farm in 2008, we took a major step toward meeting Wisconsin's goal to reduce its carbon footprint. With a total of 88 turbines each with the capacity of 1.65 megawatts. Blue Sky Greenfield is the largest wind farm to date in Wisconsin's he was completed under budget and on time and actually ahead of schedule as well. Also in 2008 you may recall we purchased a new wind farm development site approximately 45 miles Northeast of Madison. The site was purchased from FPL Energy as part of the point beach transaction. This site, which we call the Glacier Hills Wind Park, is one the best location for a wind farm in the state. On January 22 of this year, the Wisconsin commission approved our request for a certificate of public convenience and necessity to build up to 90 wind turbines at Glacier Hills and in March we finalized an agreement with vest as wind systems for the delivery of 1.8 megawatt turbines by mid 2011. The initial order was issued for 81 turbines with the expectation of up to nine additional turbines will be added when all turbine placements have been finalized at the site.

If 90 turbines are finally installed, Glacier Hills will have a generating capacity of 162 megawatts, we're pleased to be moving forward on what certainly will be a new sizable new wind farm the first year full year of operation for Glacier Hills is projected to be 2012 and our current estimate for capital cost for Glacier Hills is approximately $367 million, against assuming 90-best turbines are installed. This estimate does not include any allowance for funds used during construction or reimbursable transmission costs.

Now as you may recall last fall we also announced our plans to build a 50-megawatt biomass fuel power plant at a paper mill site in Morgan was Wisconsin. The paper mill is own and operated by Domtar Corporation, we're fortunate to be close to significant forest lands that can be harvested and are being harvested in a sustainable manner. These forests have large amounts of wood waste that can be purchased to fuel the plant. Diversification of our renewable energy supply is one of our very important goals, as compared to wind; the clear benefit from an operational stand point is that we will be able to dispatch the biomass unit. Our investment in this project is projected to be approximately $255 million without an allowance the fund used during construction.

On March 15, we filed an application for approval of this project with the Wisconsin commission. We expect the commission to make a decision by year-end the targeted in service date would be late 2013. Construction is also underway on a major upgrade of the air quality controls for the existing units at Oak Creek. We plan to invest approximately $950 million including allowance for funds used during construction, for the installation of wet-flue gas desulfurization and selective catalytic reduction facilities; we expect these controls to be completed in 2012. Construction is actually progressing very well. The project is about 30% complete as we speak today and we're on time and on budget.

Turning now to our Michigan operations. On December 16, last year the Michigan public service commission approved ourselves implementation plant to raise electric rates by approximately $12 million or 9.5% effective with the commercial operation of unit one of the Oak Creek expansion. This rate increase is subject to refund with interest, depending on the final decision by the Michigan commission on the company's overall rate requests for $42 million annually. The commission staff has filed testimony supporting an increase of approximately $28 million. Right now, the case is before the administrative law judge. After the law judge issues his opinion, the case will then move to the commission. We expect a final order from the commission in July of this year.

Now, before I turn the call over to Allen, I'd like to touch briefly on the direction of the economy in our region. We are beginning to see modest improvement in economic activity. The impact of the recession in our service area was deep. But thankfully in terms of unemployment levels it was not as painful as many other regions of the country experienced and for now it certainly appears that the worst is behind us. Specifically, we're seeing three sectors of the economy showing some strength. Iron ore mining. Specialty steel, paper production and printing and now with more detail on or first quarter and our outlook for the remainder of 2010. Here's Allen.

Allen Leverett

Thank you, Gale. Now, as Gale mentioned earlier, our 2010 first quarter earnings from continuing operations were $1 and $0.10 a share I will focus on operating income by segment and then touch on other income statement items. I will also discuss cash flows in the quarter. Our consolidated operating income in the first quarter of 2010 was $230 million, as compared to $243 million in 2009, a decline of $13 million. Now, as expected, our utility operating earnings were lower because of fuel recoveries, but earnings from our non-utility energy segment were up with a commercial operation of the first unit at Oak Creek.

Operating income in our utility energy segment totaled $179 million for a decrease of $37 million versus 2009. On the positive side, our electric revenues excluding fuel collections were up $43 million. This increase is primarily related to our Wisconsin electric retail rates that were effective January 1st. You may remember we received a 3.4% increase in Wisconsin retail electric rates, which included a 13.8% decrease in fuel related revenues. Also, our utility depreciation expense was $15 million lower in the first quarter as we implemented new depreciation rates in connection with the new electric rates. Finally, last year we had a $10 million reduction in revenues related to my so-charges. We did not have a similar charge in 2010.

On the negative side, our fuel recoveries were $52 million lower as compared to the first quarter of 2009. In the first quarter 2010, we under recovered our fuel costs by $24 million. In the same period in 2009, we had a favorable recovery of fuel costs totaling $28 million. This represents a $52 million negative swing when we compare 2010 versus 2009. In addition, our utility owned and cost increase by $28 million in the first quarter, because of increased costs to run the new coal unit, recoveries of regulatory amortization associated with the power to future release, as well as deferred bad debt cost these increased costs were considered when setting our 2010 rates.

Finally we estimate that weather had a $23 million negative impact on operating income. During the first quarter of 2010 we experienced weather that was slightly warmer than normal. Last year, we had a colder than normal winter. In addition to these items, the net of all other factors was $2 million, which leads to the $37 million reduction in utility operating income in the first quarter. Also, on March 25th of this year, we received rate relief under the current fuel rules. Pending our final review of our fuel rate, the revenue collected are subject to refund. With the new fuel recovery rate in place, I expect we will under recover our fuel costs by approximately $20 million for the full calendar year.

Operating income in the non-utility energy segment, which primarily includes We-Power, was up $24 million because of the commercial operation of unit one at Oak Creek on February 2, now in 2011 when all of the plants are expected to be operating for a full year, we expect the total earnings contribution of the four units that We-Power will be $1.03 per share. After allocating $375 million of holding company debt. Taking the changes for each of these segments together and rounding brings you back to the $13 million decrease in operating income for the first quarter of 2010. During the first quarter of 2010 earnings from our investment in the American Transmission Company totaled $15 million, which was a slight increase over 2009.

Net interest expense increased by $8 million, primarily because of interest expense associated with unit one at Oak Creek. In February, we issued $530 million of long-term debt to replace short-term debt used to finance the construction of unit one. In addition, once unit, one achieved commercial operation; we stopped capitalizing interest on the construction in progress. In the first quarter of 2009, we capitalized $11.2 million of interest related to unit one. We also expect increases in interest expense when unit two achieves commercial operation. Consolidated income tax expense decreased by approximately$9 million because of the lower pretax earnings and a slightly lower effect of tax rate.

Our effective tax rate for2010 is expected to be – between 35 and 36%. Combining all of these items brings you to $130 million of net income from continuing operations, for the first quarter of 2010 or earnings of $1.10 per share. During the first quarter, we generated $304 million of cash from operations on a GAAP basis, which is up $284 million from the same period in 2009. As we discussed, on prior conference calls, we contributed $289 million to our benefit trusts, in January of 2009. No contributions are expected this year. On an adjusted basis, our cash from operations totaled $347 million. The adjusted number includes $43 million of cash impacts from the point each bill credits. Under GAAP the cash from the bill credits is reflected as a change in restricted cash which GAAP defines as an investing activity.

From a management stand point however we consider this as a source of cash. Our total capital expenditures were approximately $195 million in the first quarter of 2010. About $131 million of this was dedicated to our utility businesses and the balance was primarily associated with the generating units being constructed, as part of our power of the future plan. This year, our total capital budget is approximately $950 million. $815 million of this is in your utility operations. And about $135 million is for our Power the Future program. Of the $815 million in utility spending, nearly $100 million is for renewables and $300 million is for environmental upgrades at our power plants.

We also paid $47 million in common dividends in the first quarter of 2010, which was an 18% increase over the same period last year.

On a GAAP basis, our debt-to-capital ratio was 57.2% and we were at 54.3% on an adjusted basis. These ratios are slightly better than our December 31, 2009, levels. The adjusted amount treats half of our hybrid securities as common equity. 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.

Now, as shown in the earnings package we posted on our website this morning, our actual first quarter retail sales of electricity increased 0.3%, as compared to 2009. On a weather normalized basis, first quarter retail electric sales increased 2.2%.

Excluding the sales for our largest customer, the iron ore mines on a weather normalized basis, retail sales decreased 0.4%, which is in line with our first quarter projection of a declining of 0.6%.

Consumption by our residential customers declined in the first quarter by 3.6%. This was driven by the mild winter weather. Our small commercial and industrial class declined by 3.3%, due in part to the mild winter as well as continued difficult economic conditions.

On a weather normalized basis, both of these classes performed better than our first quarter projection. Sales to the large commercial and industrial class increased 7.8%, for the first quarter of 2010 over 2009. Excluding the sales to the iron ore mines the large commercial and industrial class increased 0.6%. Overall, sales are tracking well against forecasts.

In February, we completed the permanent debt financing for the first in unit at Oak Creek. We issued a total of $530 million of senior notes in two tranches. The first tranche was a $255 million note with a coupon rate of approximately 5.2% and a final maturity of February 11, 2030.

The second tranche was a $275 million note with a coupon rate of 6.09% and a final maturity of February 11, 2040. We use the net proceeds to repay debt incurred to finance the construction of Unit 1 at Oak Creek. We anticipate that the permanent debt financing for Unit 2 at Oak Creek will occur this fall.

On a consolidated basis, we have approximately $1.6 billion of available undrawn credit facility that expire in March and April of 2011. We anticipate renewing and downsizing our credit facilities later this year before they expire in 2011.

Our earnings guidance remains the same as what we provided to you in our February conference call. We expect our earnings for 2010 to be in the range of $3.65 to $3.75 per share.

Now before I turn things back over to Gale, I would like to briefly discuss our earnings outlook for the second quarter. Now let me start by saying that we project our second quarter earnings to be above the $0.54 per share we earned in the second quarter of 2009.

Now, as you may remember from our second quarter call last year, our 2009 second quarter earnings benefited by $0.05 per share because of an issue stemming from refund of credits relating to MISO. We will not have this benefit in the second quarter of 2010. So the adjusted 2009 base, if you will, is $0.49 per share.

And as we look to this year, the key positive driver is the full quarter's contribution from Oak Creek Unit 1. I expect this will add $0.11 per share. Note that this also includes an increase in net interest expense because of the reduction in capitalized interest associated with the Unit.

I also expect that fuel recovery will be a very slight positive versus last year. Although, we project that the company will under recover fuel cost in the second quarter, we are currently projected to have less of an under recovery than last year.

At this point, we cannot say how much of an earnings driver weather will be. April weather was mild. However, whether in the second quarter of 2009 was also mild.

So to summarize, if you start with a $0.54 per share from last year, subtract $0.05 for the 2009 MISO item and then add $0.11 per share for Oak Creek Unit 1 you get a good starting point of $0.60 per share for your second quarter earnings estimate.

So with that, I'll 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. And now, we'll head for the Q&A section of our call. I bet our operator is standing by.

Question-and-Answer Session

Operator

(Operator Instructions) We'll take our first question from Bill Appicelli with Morgan Stanley.

Bill Appicelli – Morgan Stanley

Hi. Good morning.

Gale Klappa

Good morning, Bill.

Bill Appicelli – Morgan Stanley

Good. How are you?

Gale Klappa

We’re doing good. You got Greg under control.

Bill Appicelli – Morgan Stanley

Yeah. He's down in Florida, but under control last time I checked.

Gale Klappa

Well, I keep an eye on him.

Bill Appicelli – Morgan Stanley

Thanks. Just to rehash in the large C&I, it sounded like the bulk of that was driven by the operations coming back at the mines? Is that correct?

Gale Klappa

Yeah. That's very much so. We had a double-digit increase in energy usage by the iron ore mines. They have had a very rapid return to virtually full production coming out of the recession. But we're also seeing, some puts and some pluses as you would expect.

The other two sectors as we mentioned, the other two sectors that are really beginning to see some material increase are the specialty steel production. In fact, I talked to the largest specialty steel producer in Wisconsin I talked to the CEO and COO yesterday. And they are very optimistic, their order book is full for the remainder of the year, and then paper production and printer is beginning to show some signs of life after really getting hit very hard during the last 18 months. Allen?

Bill Appicelli – Morgan Stanley

Okay. So, it sounds like then, this sounds like the production coming back from the mines in some of these specialty steels has the outlook of being sustainable for the foreseeable future, we would hope?

Gale Klappa

Certainly from our conversations with those customers, I think the remainder of the year looks pretty solid for those two sectors.

Bill Appicelli – Morgan Stanley

Okay. Great. And then, the second question is regarding the 2011 guidance. I know it's still at $4 and I think, if you can just kind of walk me through the changes in the buckets. I know the outlook for Power the Future has increased from $1.14 to $1.33. While the earnings contribution from the electric and gas utilities has declined from, by about $0.22.

I assume that's, you're now assuming a lower dollar ROE at the utilities, and is the Power the Future step up because of all in cost, the ultimately expect to reflect in rates at that point to be higher?

Allen Leverett

So, Bill, let me make sure. This is Allen to make sure you're asking for a comparison between 2010 and 2011.

Bill Appicelli – Morgan Stanley

No. I'm sorry just to clarify. The 2011 just kind of looking at slides from maybe in the fall to what you're last presentation was, it's usually the buckets that are adding up to the $4, so it's 2011 versus 2011, but just the breakout of how you get to there?

Allen Leverett

Yeah. That's right. If you look looked at the presentation, say, that we would have done in September of last year, a couple of, actually two conferences in September, we still have the $4 number for 2011, that's exactly right. But the electric utilities were slightly higher than what you would see today.

So for right now, my outlook for 2011 for the utilities is $2.61. It was slightly higher back in September and really the differential between the two is the, the allowed rates of return at the utilities.

So they're down somewhat because remember in September that's before we got the outcome and the rate case. And the Power the Future earnings contribution is up slightly. I think the ATC contribution was about the same, Bill, if you looked at the September version versus the current version. But bottom line, our expectation is still for at least $4 a share in 2011.

Bill Appicelli – Morgan Stanley

Okay. And then, but the driving the higher assumption on Power the Future would be just the assumption that the cost maybe a little bit higher than what was initially out there when you had the $1.14 or?

Allen Leverett

Well, remember, there were really, at least two big uncertainties when we were doing the presentations back in September. One, we didn't know the outcome of the rate cases, and two, we didn't know the outcome of the Bechtel settlement. We were yet to get either of those resolved.

So in the former, the allowed return ended up being a bit less than what I would expected back in September, and in the latter case, the Bechtel settlement was a positive surprise.

Bill Appicelli – Morgan Stanley

Okay. So driven most part by the Bechtel, okay. And then, the $1.33 which should be the assumed kind of run rate going forward until you hit the kind of five-year escalator, assuming that, the, there's no equity issuance during that time, is that a fair, in terms of price…

Allen Leverett

That's right. Yeah. We would expect, if you look for a full year in 2011, a $1.33. So that assumes all four units online for a full year and no equity issue answer at all.

Bill Appicelli – Morgan Stanley

Okay. Great. Thank you very much.

Gale Klappa

Thank you, Bill.

Allen Leverett

Yeah. And then, the – basically what will happen after five years with the lease payments on the coal units. There will be a step up in the lease, in the payment, so that will affect cash, certainly.

But in terms of the way the revenues get spread over the term of the lease, if you take deferred revenue plus current revenues those all get levelized over the term of lease.

Bill Appicelli – Morgan Stanley

Okay.

Allen Leverett

There's book accounting impact for that. That makes sense?

Bill Appicelli – Morgan Stanley

Yeah. Thank you.

Allen Leverett

Okay. All right.

Gale Klappa

Good to hear you call, Bill.

Operator

Moving onto Michael Lapides with Goldman Sachs.

Gale Klappa

Hi, Michael. How are you doing?

Michael Lapides – Goldman Sachs

I’m fine, Gale. How are you?

Gale Klappa

Yeah. We are hanging in there. We are doing all right.

Michael Lapides – Goldman Sachs

A couple questions for you. What's in your guidance? What's the assumption in guidance for the Michigan rate case outcome?

Gale Klappa

I believe the, I'm not sure that we have an actual, I mean…

Allen Leverett

That's not something that we...

Gale Klappa

Yeah.

Allen Leverett

It’s not something…

Gale Klappa

It’s not something that we've talked about.

Allen Leverett

Yeah. I don’t, it's not something that we've specifically broken out, Michael. But as we talked about on the February earnings call, what's sort of baked in behind that $3.70, we're in the midpoint of the guidance range, is 10% earned…

Gale Klappa

Return…

Allen Leverett

… ROE, for Wisconsin Electric Power Company, but we've never talked specifically about the Michigan outcome.

Michael Lapides – Goldman Sachs

Got it. Okay. And the other thing you talked a little bit about some D&A changes per the rate agreement. Can you go into a little bit more detail, I apologize, I didn't catch that?

Allen Leverett

Yeah. The, what happened in connection with the rate case, we did a new depreciation study. And based on the results of depreciation study, which we had to file the new study as a part of the rate case, it basically supported, lengthening if you will the depreciable life of lives of the assets. And I believe that our total utility level you’ll see, that results in about a $60 million reduction in depreciation expense.

So that's, and so that was reflected of course in rates, Michael. So it's a variance. Your actual, actual but it was reflected when we set rates or when the commission set rates, rather last year.

Gale Klappa

It was all part of the review of the entire business that gets conducted during a rate case.

Michael Lapides – Goldman Sachs

And at $60 million annualized across Webco, Inc. and Wisconsin Gas, is there any way to break that in half, I mean, by sub?

Allen Leverett

We can certainly.

Gale Klappa

We can try.

Allen Leverett

We can breakdown for you late, but it’s, but to tell you the truth, we’re going to – we've applied to merge Wisconsin Gas with Wisconsin Electric here pretty soon, so it will be one big number soon anyway, Michael.

Michael Lapides – Goldman Sachs

Got it. Thank you. Thanks, guys.

Gale Klappa

Take care, Michael.

Operator

Moving onto Paul Ridzon with KeyBanc.

Gale Klappa

Good afternoon, Paul. How are you, today?

Paul Ridzon – KeyBanc

Fine. Yourself.

Gale Klappa

We are doing well.

Paul Ridzon – KeyBanc

When we look at second quarter with $0.60 at starting point, when you think about the rate case, the depreciation study, I guess…

Gale Klappa

We've baked all that into what Allen mentioned to you is a good starting point.

Allen Leverett

Well, in term of when we set, well, the guidance for the year for the utilities is, Paul, is for it to be flat, the utilities to be flat, that's our guidance, in terms of earnings, if that's your question for the year.

Paul Ridzon – KeyBanc

Does your $0.60 second quarter starting point contemplate the new rates that took effect January 1?

Gale Klappa

Yeah.

Allen Leverett

Yeah.

Gale Klappa

Absolutely.

Paul Ridzon – KeyBanc

And what was whether versus normal?

Allen Leverett

The weather in the first quarter of this year was warmer than normal. I think in terms of heat and degree days, we were probably about 100 heating degree days, below normal on or unfavorable on degree days.

In terms of margin, I think, we broke that out in the factors, we were about $23 million in total. You want to break that out for us Steve?

Steve Dickson

Yeah. 23 in total, the electric we were – had about $9 million and the gas was about 14. Again, as Allen said in, the first quarter, it was mild. It was about 6% warmer than normal. Last year, it was colder, so that's the swing.

Allen Leverett

Yeah. There was a big swing, Paul, in part because we had a mild, as Steve is indicating a mild winter this year, a very, very cold winter in the prior year. So the bigger swing than just the change in degree days to normal might indicate.

Gale Klappa

You have margin versus normal? How much is 23ish residual from last year rolling off?

Allen Leverett

Well, if you look at maybe we'll just talk you through it. In the first quarter of 2009, Paul, it was better than normal from the standpoint of weather and if you measure that in terms of margin, that was about a $15.5 million pickup versus normal weather in, in 2009. Then in 2010, as, as Steve mentioned, as I mentioned, that was worse than normal, unfavorable versus normal and that was $7.5 million. So $15.5 million benefit from weather versus normal in the first quarter of '09, $7.5 million going the other way in 2010 for a total swing of 23.

Gale Klappa

23.

Allen Leverett

Does that help?

Paul Ridzon – KeyBanc

Yes.

Allen Leverett

Yep.

Paul Ridzon – KeyBanc

Then the depreciation study, that had a dollar for dollar offset in the revenue requirement, isn’t that?

Allen Leverett

Absolutely.

Gale Klappa

Absolutely right.

Paul Ridzon – KeyBanc

So that's earnings neutral that depreciation study?

Allen Leverett

That's right.

Gale Klappa

That's correct.

Paul Ridzon – KeyBanc

Okay. Thank you very much.

Gale Klappa

Thank you, Paul.

Operator

Our next question will come from Leon Dubov.

Leon Dubov – Catapult Capital Management

Hi. Good afternoon.

Colleen Henderson

Hi Leon, how are you today?

Leon Dubov – Catapult Capital Management

I just wanted to check for your 2011 guidance; I think you guys have baked in some, I guess, some fuel variability in Wisconsin. I'm wondering if this new bill that's based there, is that kind of give you a little bit more comfort around that or how does that affect it?

Gale Klappa

Well go ahead.

Allen Leverett

Generally, generally when we do guidance, particularly for a period as far hard as 2011 we just assume that fuel is a neutral. So you know, we haven't made any, sort of assumption that we'll be over or under collected in 2011. So that's, as it relates to guidance. Now, Gale, if you want to amplify that anymore.

Gale Klappa

I'll be happy to. Again, simply because of the way fuel recoveries work, as Allen said, when you go out farther, it's really not possible to pinpoint precisely what our fuel recovery situation is going to look like, so on our farther out years we do assume neutral fuel recovery. You're correct that a bill passed the legislature this past session. That would in essence be an improvement in the way the recovery mechanism works. In that the commission would be allowed under this piece of legislation that passed to basically ask all the utilities to project their annual fuel costs in the fall of the year prior to the New Year.

So for example, the commission could ask the utilities to come in, in October or November, with a pretty firm projection of their fuel costs for the following calendar year. And then theoretically after a hearing, the commission could set a new fuel rate that would be effective January 1. If that should occur, it would obviously damp even and reduce the volatility in our fuel recovery. We think that would be a positive improvement. The bill ended up being very non-controversial, which was a very good thing. It actually passed the state Senate on a voice vote and was supported by all the parties involved.

The Wisconsin commission testified on behalf of the bill, the consumers utility board and the industrial groups, the industrial owner groups testified on behalf of it. The utilities were obviously in favor of it. So it was a, it was a well supported piece of legislation. And the remaining step is, the governor would need to sign the bill and we'll, we'll be able to determine whether that happens over the course of the next 20 days.

Leon Dubov – Catapult Capital Management

Okay. Does that change anything for 2010 guidance?

Gale Klappa

No. No. Because it would take a while for the commission to put all the rules in place for this new recovery mechanism and I wouldn't expect assuming the governor does sign the bill, I would not expect that mechanism to be in place probably until the start of 2011.

Leon Dubov – Catapult Capital Management

Got it. Thank you very much.

Gale Klappa

Thank you.

Operator

We'll now hear from Vedula Murti with CDP.

Gale Klappa

Rock-and-roll, Vedula, how are you?

Vedula Murti – CDP

I'm well. Thank you. Good afternoon.

Gale Klappa

Good afternoon.

Vedula Murti – CDP

I would see – if I recall from your last call, I think when you set up the outlook for the year-end, particularly the 10% earned return assumption. You talked about the challenges in terms of I think the sales forecasts versus, you know, what you were thinking as well as cost challenges that were, that you were facing versus what was provided for, in the last rate outcome. Could you talk about a little bit how the first quarter tracked versus that and kind of what you're seeing either things that are moving in your favor or things that might be incremental headwinds versus your comments from the last quarterly call, if I'm phrasing that properly?

Gale Klappa

I'll be happy to, Vedula, and Allen can join in with whatever thoughts he has. I think the key variables, the key factors that could swing, obviously, first related to the economy and whether our sales forecast was on target. And as Allen mentioned during his remarks, we're actually tracking just slightly better overall than our sales forecast. So at the moment – on a weather normalized basis, so at the moment, our sales forecast seems to be holding up well.

Allen Leverett

Now that's versus our financial forecasts, Vedula, which you'll remember that the sales forecast that we bake, that was used for our financial forecast was not quite as rosy as what the commission used to set rate. So when Gale talks about how we're doing versus sales, it's versus the sales that are in our financial forecast.

Vedula Murti – CDP

Okay.

Gale Klappa

Okay. And secondly, always a big variable for every utility is weather. And weather clearly did not cooperate in the first quarter of this year. We also had a very mild April. It was the second mildest April on record since weather records began here in Milwaukee. So weather remains a variable and clearly we'll see how the summer goes, but it certainly has been a very warm spring.

And then the third is obviously is obviously cost control and I'm very pleased with where we are on, on our managing the costs in our business. We continue to track slightly under the budget on our O&M expenses and that was helpful to us in Q1 when the weather was not.

So the three big variables, I think, we clearly have – strong effective cost controls in place. We'll see how the weather pans out, and of course, the fuel volatility in the first quarter. Allen mentioned on the call that we do have interim fuel rate in place and we expect to still be under recovered for the year but hopefully, hopefully with the new fuel recovery in place, which is much more reflective of what we're seeing in the wholesale power and natural gas markets, hopefully that won't materially get worse as we end the year.

Allen Leverett

Yes. Vedula, there's one other factor that we did discuss back in February and that was the Michigan REIT case and, we, we don't have an outcome in that. Of course, we're waiting for a proposal for decision from the ALJ, that should be any day. And then the commission, I believe, they have to rule in July. So that's something we, don't yet know what the final outcome of that's going to be, of course.

Vedula Murti – CDP

All right. Thank you very much.

Allen Leverett

Thanks, Vedula.

Operator

Reza Hatefi with Decade Capital has the next question.

Gale Klappa

Hi, Reza.

Reza Hatefi – Decade Capital

Thank you. Hi, guys, how are you?

Gale Klappa

We're great. How you doing?

Reza Hatefi – Decade Capital

Pretty good. Sorry, if I missed this earlier, but what's the ROE embedded in the 2011 utility guidance?

Allen Leverett

Well, basically, you know, 2010 just to remind everybody is about 10%. And then the assumption that we're making in 2011 is about the same, you know, going back to the question that I got. I can't remember who it was from. Earlier on the call, but when we're looking at the 2011 numbers, the 261 that we had in our – our analyst presentation for 2011 for the electric and gas utilities, the return is just under 10%. So about 10% this year and just under 10% next year.

Reza Hatefi – Decade Capital

So a little, little degradation because you're in between rate cases? I mean, it's sort of like you're in middle year?

Allen Leverett

Yes. And obviously we'll seek to do better than that because we would aspire always to earn our allowed returns but right now our forecast is for something little less than 10% in 2011.

Reza Hatefi – Decade Capital

But, of course, as you build more including the HUCS, the Oak Creek HUCS and these other large projects, you're earning some (inaudible) on that in '11 that, you know, then gets rate based in 2012. Is that the best way to think about it?

Allen Leverett

Right.

Gale Klappa

Right.

Allen Leverett

So basically as we spend the dollars on renewables so glacier hills and south Oak Creek, we spend the dollars and then those earnings go ahead and manifests themselves below the line as AFUDC and then we would, we would seek to put them into rates into 2012.

Reza Hatefi – Decade Capital

Okay. Thank you very much.

Gale Klappa

You're welcome, Reza. Thank you

Operator

We'll now here with Phyllis Gray with Dwight Asset Management.

Phyllis Gray – Dwight Asset Management

Good afternoon.

Gale Klappa

Welcome. How are you?

Phyllis Gray – Dwight Asset Management

I’m well. How are you?

Gale Klappa

We're doing well.

Phyllis Gray – Dwight Asset Management

I wondered, if you had received any additional information from Moody’s regarding the potential change in equity credit allocated to hybrid securities?

Allen Leverett

Yeah. My – of course, they put out their proposed changes comment. I'm not sure exactly, Phyllis, when the comments are due back. But they – they put those out for comment. If, unless they change the – the way they're headed, the hybrids that we have under the Moody’s sort of scheme if you will, instead of having a 50% credit, they'd have 25% equity credit. So if they do that, sort of interesting result of one agency Fitch they will treat them at 75% equity. S&P would treat them as 50% and Moody's would treat them at 25. So I guess everybody has to be different, so they all the way across on the scale on the equity credit. But Phyllis from a practical standpoint, we're not going to change anything about our financing plan, right. Based on what Moody's does or doesn't do with the equity credit of the hybrids.

Gale Klappa

The arithmetic average is still 50%, even if they go down to 25.

Allen Leverett

Right. Is that responsive to your question, Phyllis?

Phyllis Gray – Dwight Asset Management

Yes. It is. Thank you.

Operator

Our next question will come from Dan Jenkins with State of Wisconsin Investment Board.

Gale Klappa

Dan.

Dan Jenkins – State of Wisconsin Investment Board

Hi.

Gale Klappa

Hello.

Dan Jenkins – State of Wisconsin Investment Board

Good afternoon.

Gale Klappa

Good afternoon. Did you survive the Mifflin Street block party?

Dan Jenkins – State of Wisconsin Investment Board

Barely.

Gale Klappa

Barely. Yeah. You didn't see any vans, black vans sitting there smoking or anything. Did you Dan?

Dan Jenkins – State of Wisconsin Investment Board

No, I'm getting ready to send all those folks your way in a couple weeks so.

Gale Klappa

Yeah. Okay. Well, what's on your mind today, Dan?

Dan Jenkins – State of Wisconsin Investment Board

First of all, I just wanted to make sure I understood your addendum on the retail sales to try to adjust for the normalization.

Gale Klappa

Okay.

Dan Jenkins – State of Wisconsin Investment Board

So I guess the lower right corner with the – that’s the Original forecast assuming normalized weather for the first quarter? Is that correct?

Allen Leverett

That's right.

Gale Klappa

Yes.

Allen Leverett

So you are looking just to be clear. You're looking at page 11, Dan?

Dan Jenkins – State of Wisconsin Investment Board

Right.

Allen Leverett

Yep.

Dan Jenkins – State of Wisconsin Investment Board

So based on that, so I guess it's right that the residential and small commercial industrial and mines did better on a normalized basis than you expected but the large commercial industrial X mines did a little worse.

Gale Klappa

That's accurate.

Allen Leverett

That's exactly right.

Gale Klappa

Yep.

Dan Jenkins – State of Wisconsin Investment Board

Okay. So what's, I guess I'm curious, what was the discrepancy in the large commercial industrial X mines since it's fairly sizable difference there?

Gale Klappa

Actually, if you look at all the major sectors that we look at in terms of our customer segments, it was really, it was really a lot of puts and takes. There were a couple of sectors like for example, other utilities, I mean, we have a very large water utility system here in the Milwaukee region that was very under in term of its, its expected electricity usage, but there really wasn't one single pattern. We had the three sectors that we talked about that were definitely going in the right direction and not – and then a lot of little movement back and forth among all the other sectors. So nothing really stood out other than perhaps other utilities and MMSD, the Metropolitan Milwaukee Sewerage District really stood out to me but nothing material and it is interesting, though at least to me, the largest energy users are beginning to show growth. Our normal largest consumers are, our normal largest industrial customers are beginning to show growth, what's lagging is the smaller – the smaller customers within that large segment.

Dan Jenkins – State of Wisconsin Investment Board

Okay. You mentioned that you targeting maybe fall for the financing of the Oak Creek two, would that be similar sized to what you did for Oak Creek one or how should we think about the size of that financing?

Allen Leverett

Well, in total, we're looking at doing a total of $950 million worth of financing to the two units combined this year. So we did $530 million back in February, so we'd do the balance of $420 million roughly with the second unit and Dan, in terms of timing, essentially what we would do is do the financing contemporaneous with the commercial operation of the second plan.

Dan Jenkins – State of Wisconsin Investment Board

Okay. Then on page seven, you mentioned part of the O&M cost, year-over-year comparison was due to the new coal unit being in effect. Is that correct?

Gale Klappa

Yes. I mean, obviously once the unit goes into, goes into service you have thing like ammonia costs to run the scrubbers, you have personnel costs, et cetera.

Dan Jenkins – State of Wisconsin Investment Board

Yeah.

Gale Klappa

That's a big factor. And I think we've done a specific breakdown for you.

Allen Leverett

Yeah. About six of the $28 million was O&M for the power of the future units, Dan.

Gale Klappa

You have to remember that's only for two of the three months of the quarter.

Dan Jenkins – State of Wisconsin Investment Board

Okay. So that should be something that will continue then throughout the rest of the year, would it be that similar rate about $3 million a month?

Allen Leverett

Yeah. But just keep in mind, of course, that was reflected when we, when the commission set rates.

Dan Jenkins – State of Wisconsin Investment Board

Right. But I'm just, when we look at year over year –

Allen Leverett

Yeah.

Gale Klappa

GAAP results.

Allen Leverett

That's what you'll see in the account.

Dan Jenkins – State of Wisconsin Investment Board

So I guess the another thing I'm, I want to try to understand, how is it that, – those costs are up in the utility, but then you have the benefit of $24 million in the non-utility, is that like a pass-through?

Gale Klappa

Dan. The way the lease works is basically the utility, remember now, We Power, which is our subsidiary of the parent, designed and built the unit and is leasing the unit for a set period of time approved by the commission, leasing the units of the utility. But the utility is responsible for operation and the utility's responsible for all the associated O&M cost. And the utility is also responsible for a lease payment each month to We Power for leasing the unit. So that's why you're seeing the O&M in the utility, in the utility statements and why you're seeing the result of the lease payment in We Power's income statement.

Dan Jenkins – State of Wisconsin Investment Board

Okay. As part of the cost of the utility's paying being reflected in other, in like say fuel and other parts to them?

Gale Klappa

Oh, sure. The fuel costs would be part of our normal fuel recovery rate. That's part of the electric bill and part of the utility's costs.

Dan Jenkins – State of Wisconsin Investment Board

Okay. And then last –

Gale Klappa

Fuel and all operation and maintenance expense, or the power of the future units are responsibilities and are reflected in the utility statements.

Dan Jenkins – State of Wisconsin Investment Board

Is the lease payment, is that included in O&M or is that included in (inaudible).

Gale Klappa

The answer is yes. Steve, go ahead.

Steve Dickson

Yeah. Dan, I just want to summarize what Gale had said, as the utility is responsible for operating the plant, but the fuel cost associated with the new units, the O&M costs for running the day-to-day, the day-to-day operations, those are included in utility's income statement. In addition, the utility is making a lease payment for the right to use that unit. The lease payment is also in the utility O&M, but the lease payment is reflected as revenue in the We Power in the non-regulated segment. So if you think, if you carve out the lease payment that's in O&M, that amount matches the revenue that's being recorded in the non-regulated energy sent. Does that make sense?

Dan Jenkins – State of Wisconsin Investment Board

Right. Yeah. I was just trying to make sure I understood how that was working across.

Steve Dickson

Okay. And then on a consolidated basis, then that lease payment gets eliminated against the revenue that We Power. So that gets eliminated in consolidation.

Dan Jenkins – State of Wisconsin Investment Board

Okay.

Gale Klappa

Does that makes sense Dan.

Dan Jenkins – State of Wisconsin Investment Board

Yeah. That makes sense.

Steve Dickson

Good.

Dan Jenkins – State of Wisconsin Investment Board

The last question I had was you mentioned the new units go into service that you consider revising your dividends to reflect that. What's your ideas as far as the timing that when that might be reflected?

Gale Klappa

We have, as you may know, Dan, a stated policy that our board has approved related to the dividend. In an essence it's in two pieces, right now. And the first is we would pay out 40 to 45% of our earnings in dividends, this year and 2011. And then after 2011, we're proposing to raise the payout ratio, again, from 40 to 45% currently to 45 to 50%. So that would be effective based on our policy in 2012.

Dan Jenkins – State of Wisconsin Investment Board

Okay. Thank you. That's all I have.

Gale Klappa

You are more than welcome. Hang in there Dan.

Dan Jenkins – State of Wisconsin Investment Board

Okay. You too.

Operator

We'll take a follow-up from Paul Ridzon.

Paul Ridzon – KeyBanc

Do you have any for Medicare D or Cadillac health plans?

Gale Klappa

No. We don't, and I'm not sure whether we were brilliant or lucky, but when we did the assumptions associated with the future costs of our health plans, we realized that the subsidy under the current law, not related to the new healthcare legislation, but the subsidy under the law then in effect, in essence went away at the end of the 2013.

We have several different plans that we offer to our retirees. And we assume that with the subsidy going away that that particular plan that was the beneficiary of the subsidies, we assumed that plan wouldn't be economic anymore. And so we wouldn't keep any of our retirees on that plan. So we didn't, we didn't basically take into account any benefits to the corporation for the subsidy beyond 2013 and therefore, no accounting charge was needed.

Paul Ridzon – KeyBanc

So you mentioned, though the word Cadillac and so were you asking, so Gale, gave a very good answer to this, the drug subsidy issue, because the tax deductibility of the drug subsidy is changing, no longer, no longer deductible. So that's one issue. And Gale answered that question. Were you asking a different question, because you said the word Cadillac, which is a – it's a longer term issue about excise tax.

Gale Klappa

That's a longer term, were you wanting to know about that Paul?

Paul Ridzon – KeyBanc

Apparently, I guess actuarials have started to dig deeper into that and it may be a bigger issue than the people thought at first glance.

Gale Klappa

On the Cadillac?

Paul Ridzon – KeyBanc

Yes.

Gale Klappa

Well, we do know that the Cadillac plans are under the current law. So the excise tax on the "Cadillac plans", don't kick until 2018. So at the moment I think a lot of people are going to be digging into that and looking at that. I believe to be very candid, that all of our plans, if you look at all of our plans, which I don't view as Cadillac plans. By the year 2018, just given inflation that's expected in medical care costs, all of our plans would be deemed Cadillac by 2018. My guess is that virtually every company's plan would be deemed Cadillac by 2018. So at the moment, we'll just have to see as that unfolds

Allen Leverett

Yeah. And I guess from an actuarial standpoint, there is this remeasurement concept, Paul, that you may have heard people talk about, and I certainly don't expect remeasurements to be required this year yet. But we will have to do a remeasurement of the FAS 106 liabilities in 2011. And we'll see what impact if any potential excise taxes in the future might have on that remeasurement, but I wouldn't expect a remeasurement in '10, but I would expect almost assuredly you'll have do some remeasurement in 2011. But there are a lot of uncertainties, I mean for example, Paul, Apparently HHS has to promulgate quite a bit – They have to did a lot of rule makings and depending on where they hit on some of that rule making, that could also have effect.

Paul Ridzon – KeyBanc

Absolutely.

Allen Leverett

Good or bad, on your retirees as well as our active medical experience.

Gale Klappa

Allen is right, Paul. The first set of rules were theoretically to be delivered by HHS in 90 days, after the date of passage of the legislation. We haven't hit the 90-day mark yet. There's some discussion that perhaps a lot of those rules won't be promulgated in 90 days. I think we've got a long way to go to work our way through this ticket.

Paul Ridzon – KeyBanc

I just hope they don't go after my Yugo plan. Where does, where does the Point Beach, bill credit stand?

Gale Klappa

Well, we're cranking the Point Beach bill credits every month on schedule and under the current, the commission's current rate order, those Point Beach bill credits for retail customers in Wisconsin would basically run through all of calendar 2010 and then be completed.

Allen Leverett

Yeah. And of course the Michigan credits are done and the FERC credit, there were no bill credits there, there was just a lump sum that was handed over to the customers back in 2007, I believe.

Gale Klappa

So all of the bill credits essentially from the Point Beach transaction will be dealt with, by the end of 2010 and the remaining jurisdiction is just Wisconsin.

Paul Ridzon – KeyBanc

Thank you very much.

Gale Klappa

Thank you, Paul. And take care wherever you go.

Operator

Mr. Klappa, we have no further questions. So I'll turn it back over to you for closing, sir.

Gale Klappa

Thank you very much. This concludes our conference call for today. If you have any other questions, please don't hesitate to call Colleen Henderson in our investor relations office and she's available at 414-221-2592. Thank you very much.

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Source: Wisconsin Energy Corporation Q1 2010 Earnings Call Transcript
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