威斯康辛能源 (WEC) 2004 Q1 法說會逐字稿

Good afternoon and welcome to the Wisconsin Energy 2004 first quarter earnings conference call. Before the conference call begins, I will read the forward-looking language.

All statements in this presentation, other than historical facts or forward-looking statements 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, a reference to earnings per share will be based on diluted earnings per share unless otherwise noted.

This call is being recorded for re-broadcast and all participants are in a listen-only mode at this time. After the presentation, the conference will be open to analysts for questions and answers. In conjunction with this call, Wisconsin Energy has posted on its website a package of detailed financial information on its 2004 first quarter and year-end performance 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 Gale Klappa, Chairman, President, and Chief Executive Officer of Wisconsin Energy Corporation. Please go ahead.

Thank you. Good afternoon everyone. We appreciate you joining us as we review our first quarter results for 2004.

Let me begin by introducing the members of the Wisconsin Energy management team that are here with me in the room today. We have Allen Leveret, Chief Financial Officer, Rick Kuester, President and CEO of W.E. Generation, Larry Salustro, Senior VP and General Council, Jeff West, Treasurer, and Steve Dickson, Controller. Any of us will be available to respond to your questions after our prepared remarks.

As you saw in our news release this morning, our first quarter earnings on a GAAP basis came in at 76 cents a share compared with 79 cents for the first quarter of 2003. When you look inside the numbers I think you will see we delivered a pretty solid quarter.

We took a 3 cent a share charge for the redemption of trust preferred securities at Wisconsin Energy. And warmer weather as compared to last year, was a drag of about 5 cents a share. Our earnings from normal operations came in at about 79 cents a share and weather in this year's first quarter was pretty normal compared with the blistering cold in the first quarter of a year ago.

Now, I would like to update you on the progress of our power of the future plan. Last call as you may recall the Public Service Commission approved the construction of two 615 megawatt coal fired units at our Oak Creek site south of Milwaukee. The first of these base load units is scheduled to go into service in 2009 and the second in 2010. I expect that Wisconsin Energy will own 84% of this capacity, or about 1030 megawatts, and invest approximately $1.8 billion.

As you know, we are also building two new gas-fired units, each with the capacity of 545 megawatts north of Milwaukee in Port Washington.

As we anticipated, there are legal challenges to the commission's decisions on these projects, and environmental permits that we need to obtain for the Oak Creek project. Here are the latest developments.

On April 16, a Wisconsin circuit court judge dismissed the first appeal of the Public Service Commission's order for the Port Washington gas fired plant. The judge had previously remanded the case to the commission, asking whether a comprehensive environmental impact statement should have been prepared by the commission. The commission provided additional information supporting its conclusion that an environmental impact statement was not required and the commission reauthorized our project. So the case is now closed. No further proceedings are expected on this first appeal.

But there is a second appeal filed by the same petitioner, challenging the commission's reauthorization of our project. It is now pending before a separate Wisconsin circuit court judge. Although the nature of the second appeal is substantially the same as the first, we are currently unable to determine the outcome.

In the meantime, construction on the first Port Washington unit is now approximately 30% complete. We are pleased to report that the plan is on schedule and on budget. We expect it to be in service in July of 2005. It is very critical that we bring this plant online for the summer of '05 in order to meet the Public Service Commission's requirement for an 18% reserve margin. Without the plant or without significant additional power purchases which would be difficult given the transmission system in the state, our reserve margin would drop to 7.6%.

Our next step is to provide the commission with an update of the state's capacity and demand situation before we begin construction of the second unit at Port Washington. We expect to file this updated data this month. Our latest model runs show that the need for capacity is as great if not greater than when the commission reviewed the situation back in 2002.

Switching to the status of the new coal units at our Oak Creek site. The authorizations for the coal units are the subject of 6 appeals, primarily raising environmental issues. All of the cases regarding the coal units have been consolidated into a single judicial proceeding in Dane county circuit court in Madison. We should receive an initial determination on these appeals before the end of this year.

Another key step in the process is obtaining all the major environmental permits for the coal units. We received the air permit from the Wisconsin State Department of Natural Resources in January. We are also working on permits for wetlands and water intake requirements. The major permits are likely to be contested and there are no statutory deadlines here, but we do anticipate final decision on the environment permits this year.

In a very positive development regarding the Oak Creek site, we signed a comprehensive EPC contract, effective April 9, with [Bechtel] Power Corporation for the construction of the new coal units at Oak Creek. The contract is essentially a fixed price turn key arrangement where Bechtel will provide engineering, procurement, and construction services. The contract is a standard power industry agreement, including the ability for us to cancel for cause or for convenience.

Now, subject to the issuance of permits and satisfactory progress on the litigation, we expect to complete some site preparation activities in late 2004 and begin construction in ernest at our Oak Creek site in early 2005.

Switching gears now to our regulatory developments. In July of last year we filed an application with the Public Service Commission asking for an increase in base rates of approximately $90 million. With $64 million being for our electric and steam business and $26 million for our natural gas business.

In March, we received approval for the gas price increase which was primarily related to the cost of constructing our new [Axonia] gas lateral. Just recently in April, the commission approved an increase in electric and steam rates of approximately $59 million. We anticipate an order in just a few days allowing us to begin billing the base rate increase.

Moving now to our nuclear units at Point Beach. On April 4, we began the regularly scheduled refueling outage at unit one.

We just very recently within the last day or so, completed the unit one reactor vessel head inspection and identified one penetration nozzle that needs repair. The repair consists of the cutting and removing the associated thermal sleeve, machining and welding the penetration nozzle, and installing a new thermal sleeve in the unit. This repair will begin later this week and is expected to extend the outage by 5 to 7 days at an additional O&M cost of $2 million to $2.5 million. The nozzle was still intact. It has not experienced any leakage of reactor coolant system water at all. We understand that in the industry, 65 similar repairs have been made at 12 different sites. This expense, of course, will hit the second quarter earnings.

We expect this won't be an issue for the long-term or beyond this quarter as we will be replacing the reactor vessel heads in both units at Point Beach during next year's spring and fall refueling outages.

In February, we applied to extend the license for both Point Beach units and that application was submitted to the NRC. The current licenses expire in 2010 and 2013. The NRC's first public meeting regarding license renewal was held at the end of March to provide information about the license renewal process to the public. The entire license renewal effort is expected to cost approximately $22 million and will take up to 18-24 months to complete.

Now, in February as you know, we also announced an agreement to sell our manufacturing business to [Pentair] for $850 million in cash. Pentair will also assume approximately $25 million of debt. The transaction is expected to result in after-tax proceeds of $740 million. The sale, of course, is subject to standard regulatory approvals. Under the Hart-Scott-Rondino Act, each party filed a notification with the Federal Trade Commission and with the U.S. Department of Justice.

As is customary in transactions of this size, the Federal Trade Commission has begun an inquiry. We are complying with the FTC's request for information and expect to close the transaction pending FTC approval in the third quarter of this year. I will turn the call over to Allen, who will give you an in depth look at our first quarter performance. Allen.

Thanks Gale. As Gale mentioned, we are we earned 76 cents per share for the quarter versus 79 cents in the same period last year and this includes 69 cents from continuing operations and 7 cents from our manufacturing business, which is accounted for as a discontinued operation as result of the pending sale to Pentair.

I'm going to start my review of the earnings by discussing the drivers of operating income and then will move down the income statement to the items below the operating income line. Once we have gone through the earnings for the quarter, I'll provide you some additional detail on cash flow as well as current view of earnings for the full year. It may be helpful for you to refer to page 8 of the earnings package we posted on the website this morning as I make my remarks on earnings.

On a consolidated basis our operating income from continuing operations was up $10 million for the quarter.

Operating income for our utilities segment was $187 million. Which is up $7 million from the first quarter of 2003.

The improved operating income reflects a higher fuel recovery rate and normal growth, partially offset by warmer weather and increased benefits cost. In March of the last year we received an interim increase of $55.1 million annually to recover higher fuel and purchase power costs. We received an additional $6.1 million in the final order in September.

These increases added $13 million to operating income. Normal growth added another $10 million of operating income. Weather relative to last year reduced operating income by $10 million dollars for our combined electric and natural gas businesses. As measured by heating degree days the first quarter was 5.1% warmer than the same period last year.

Higher employee benefit costs reduced operating income another $8 million for the quarter.

Netting the impact of the positive and negative drivers I just reviewed plus another $2 million in net increases from other items, brings you to the $7 million increase in the utilities segment operating income for the first quarter.

The nonutility segment recognized $3 million of operating losses in the first quarter of this year as compared to $6 million of losses in the same period last year. The majority of this improvement is due to the elimination of operating costs associated with a 500 megawatt natural gas power island which was sold in the fourth quarter of 2003. Taking these two segments together brings you back to the $10 million increase in operating income for the quarter.

Other income for the first quarter of 2004 was $4 million, or $4 million less than 2003. This decrease is primarily due to costs of approximately $6 million associated with the early redemption of our trust preferred securities in March.

During the first quarter financing costs were up $3 million, due in large part to the issuance of intermediate and long-term debt securities. The proceeds from these issuances were used primarily to reduce short-term borrowings.

Taxes were $3 million higher relative to last year. Our first quarter 2004 effective tax rate was 37.7%. Which was more than the annual rate of 35.9% for 2003. This increase reflects the ability to use state operating net operating losses in 2003 and a reduction in tax credits. For the full year 2004, I expect that our effective tax rate will be approximately 37.5%.

These items below the operating income line exactly offset the $10 million increase on operating income which brings us to the $83 million in income from continuing operations in the first quarter. Net income in our manufacturing business, which is accounted for as a discontinued operation, was $8 million which is down $1 million from last year.

Now, I want to point out here, that the discontinued operations segment only includes interest expense on the debt which is to be assumed by Pentair as a part of the transaction.

Adding this to the income from continuing operations brings you to our $91 million in net income for the quarter versus $92 million last year. Before the increase in shares outstanding relative to last year, earnings per share were down 1 cent. The additional shares outstanding reduced earnings per share another 2 cents.

Now let's spend a moment on cash flow. We generated $386 million of funds from continuing operations during the first three months of 2004. Also during the first quarter of 2004, we repurchased approximately 367,000 shares of our common stock at a cost of $12 million. Our financing plan calls for another $38 million in share repurchases this year, and as we repurchase these shares, we will retire them.

In addition, we are going to use cash to satisfy any shares required for our 401(k) plan, options, and other programs. In short, going forward we do not expect to issue any additional shares.

On the usage side, we had capital expenditures of $134 million during the first three months of 2004, with $83 million of this dedicated to our utility businesses, and $49 million for our Port Washington generating station. In addition we paid $24 million in dividends. And in March, we redeemed $200 million of trust preferred securities.

At the end of the first quarter of 2004, our debt to capital ratio was 62.7% compared to 64.4% at the end of 2003. Once the sale of the manufacturing business is completed, we expect that our debt to capital ratio will decline to at least 61.5% at the end of 2004.

Let me move now to earnings guidance for 2004. Our earnings guidance for the year remains at $2.33 to $2.43 per share. This includes manufacturing earnings for a full year in 2004, and excludes the 3 cent charge for the redemption of the trust preferred securities that we took in the first quarter. It also excludes the net gain we expect to record on the sale of the manufacturing business. And remember that net gain already reflected the cost associated with the redemption of the trust preferred securities.

Although we will not be giving guidance for second quarter earnings, I do want to remind you that we are refueling one of our nuclear units in the second quarter. Last year we did not have a refueling outage in the second quarter. I would expect that the additional O&M costs will run $16 million or 8 cents a share.

In addition, our fuel and purchase power costs are expected to be at least $16 million to $20 million or 8 to 10 cents per share higher during this refueling outage.

To summarize, I believe we had a good first quarter and are on track for the year. With that, I'll turn things back over to Gale.

Allen, thank you.

Our year really is off to a good start. We're making solid progress on our business plan, and we're beginning to see real signs of economic recovery in our region.

With that, we'll now be happy to answer any questions that you might have.

Thank you. If you are using a speaker phone pick up the handset before pressing any numbers. To ask a question, press star one on your telephone. Should you wish to withdraw your question press star two. Your question will be taken in the order it is received. Please stand by for your first question. Our first question comes from Andy Levy with Bear Wagner. Please state your question.

Hi, guys, how are you doing?

Doing good. How about you Andy?

Doing all right. I would rather be in Florida, but I left that to somebody else.

We would rather be in Milwaukee right where we need to be.

A good thing. A quick question on what Allen mentioned on the quarter. Just to understand, it's 8 cents for the refueling and then another 8 -- incremental 8-10 cents for the purchase power relating to the refueling.

That's right. About 8 cents for the O&M associated with the refueling outage itself, plus another 8-10 cents for the fuel and purchase power costs associated.

What are some possible offsets just in any other parts of your business on that? Because I'm looking at first call consensus and trying to figure out.

In terms of the second quarter, you know, we already built into our budget the fact that we're going to have a refueling outage, so there is already a base level of O&M included in this year's budget for refueling outage, and the purchase power cost and fuel cost budget that we did for the year.

I'm thinking more just for the second quarter, Allen.

Andy, there is not much of anything for the second quarter. To put it in perspective, we had -- we had a fall outage at one of our two normal refueling outage at one of the two nuclear units last year, so the expenses that were recorded for the fueling outage, the natural normal evolution in the fall of last year, will not repeat themselves in the fall of next year. This is a timing issue by and large.

Basically it hurts you in the second quarter and you get it back in the third quarter.

Fourth. The fourth quarter outage began in the fourth quarter last year. We will take substantial costs because of refueling outage that were not evident in the second quarter last year but won't be evident in the fourth quarter this year.

Thank you very much. Perfect. Good luck for the rest of the year.

Thanks so much Andy.

I the next question is from Doug Fischer with A.G. Edwards. Please state your question.

Thank you. Two questions really. Remind me with the fuel case the surcharge that you filed for last year, remind me when that was effective last year? And isn't it the case that you made up some of the ground that you lost in the first quarter later in the year? Refresh my memory on that. And then I have a second question about the fall outage refueling outage, whether the numbers were similar for that outage that you are anticipating, you know, both O&M and fuel and purchase power that you are anticipating for the second quarter of this year. How closely do they match up?

Doug, while we're look up the exact month when we got the fuel order it was March of last year.

Mid- March I'm trying to remember?

21st of March. That was an interim fuel order, and then we got the final fuel order, as Allen mentioned, with an additional amount added, because of the continuing increase in the price of natural gas. We did make up some ground. Your memory is very good we did make up some ground toward the end of the year. No question about that.

Any additional amount was $6 million on an annualized basis? Did I hear that right?

The March increase was $55.1 million and the additional amount in September was $6.1 million. And both of those are on an annualized basis.

Okay. Thank you. And then about the outage, just, you know, and I hate to ask these questions about these interquarter stuff but just so we are getting realistic numbers out there. Is the third quarter outage in terms of O&M and the year-ago fourth quarter outage in terms of O&M and fuel and purchase power, were those dollar amounts roughly the same as what you expect in this second quarter of this year?

Doug, this is Gale. The -- I would expect that the costs of the outage this year as compared to last year will be slightly higher because we did not have any repair that had to be done to the reactor vessel head in the other unit last year. And as Allen mentioned, those repair costs may be as much as $2.5 million, plus the fact that these repairs will extend the outage 5 to 7 days. I would expect we are going to see somewhat higher costs for this refueling outage simply because of this one issue related to a minor repair that has to be made in the vessel head.

And then that $2 million to $3 million was both the O&M and replacement power?

The $2.5 million on O&M is strictly related to the additional costs required to fix the nozzle and then we'll have to incur the additional power purchase costs on top of that.

Okay. Thank you.

You're welcome, Doug.

The next question is from Jeff Gildersleeve with Millenium Partners. Please state your question.

My question was answered. Thanks.

Thank you, Jeff.

Our next question comes from Paul Patterson with Glenrock Associates. Please state your question.

Good afternoon guys.

How are you doing, Paul?

All right. Just to clarify a few things, weather was normal this quarter?

January was slightly colder and March slightly warmer. You look at the quarter as a whole, about dead on normal.

In the income statement looks like depreciation was lower quarter over quarter, yet property taxes went up. You look at the income statement was 81 versus 77 I think is what it is.

We're taking a quick look and Allen will give you his view.

It is a bit lower. It went from, just to make sure we are talking about the same numbers, on page four of the earnings package, depreciation went down from about $81 million to $77 million.

Right.

That is what you're looking at. That is really the net of a couple of things. You did have an increase in property plant and equipment. A little bit of increased depreciation there, but then netted against that were some credits that we were able to take, because we had to rebalance our nuclear decommissioning [trusts]. And we had to rebalance to a 60% equity, and we recognize really effectively some gains when you do that, and those gains get offset in the income statement against depreciation.

You benefited by how much from that?

I would say let me start with decommissioning. Decommissioning probably got about a $7 million pretax pickup from that. And then you had about a $3 million increase in other depreciation.

Okay. So that would explain so that would be 4 so that explains okay. So you guys basically got about a $7 million pretax benefit from that.

Yeah.

Does that continue going forward?

No, we rebalance only when the funds gets out of whack in terms of the targeted percentage of the fund invested in equities.

How long did it take for that to happen?

Happened pretty quickly in 2003. The market had a good year and we are invested in by and large large cap equities in that fund. And, of course, the S&P 500 had a very good year and under state law, we do have to rebalance. So that is what we did in the first quarter and Allen described to you the pretax.

He did. Thank you. This happens every year at the beginning of the year pretty much?

Only happens again -- only happens when the balance of the allocation moves, you know, away from the targeted allocation. In other words, if we're targeted, and I'm picking a number out of the air, if we're targeted to have 60% of the trust in equities, and if a market runup takes the equity percentage of the allocation to say 65%, then we will make the adjustment. So we look at this each quarter and make an adjustment when it was is appropriate.

Would S&P 500 in looking at that performance just give us an idea of how that might show up in the future? Is that a good proxy for how much your equity might go up?

A reasonable proxy but we have some equity exposure to small cap. It is not simply just in the S&P 500.

Then I guess which is [Wisk Park] performance, what was that quarter over quarter?

Basically is flat. I think we only did $3 million worth of asset sales in the quarter. So basically level versus the first quarter of last year, and then very minimal asset sales that occurred in the portfolio.

Great.

That was as expected.

Thanks a lot, guys.

Thank you.

Thank you, the next question comes from Vic Katan with Deutsche Asset Management. Please state your question.

Thank you, Gale and Allen. looks like back to southern company more there.

Slightly more northern location.

Right.

Although I must tell you in honor of Rick and Allen being here their first winter it was mild.

It was not a surprise I hope not.

The weather or Rick and Allen? [ LAUGHTER ]

You mentioned about par for the future you gave update on that one but the -- could you remind us, when does the earnings start benefiting from this par in the future, I think it starts with '05 and '06 and continues in '09 and '10?

The first gas unit goes in mid year July 2005 so basically a half year's contribution in 2005 and a full year contribution from that unit in '06, and we expect the net income for the first full year of the gas unit to be $17 million.

Then you would have another gas unit slotted in mid year 2008 and a full year contribution in 2009. The first coal unit mid year 2009 and would have a full year contribution of $65 million, because you have all the common facility costs loaded into that one. The second coal unit mid year 2010 and a full year contribution for that would be $35 million.

Add at all together we would expect in the first full year of operation after all the units are in service our net income to increase by approximately $134 million with no additional shares.

That is great. The other question related to the coal units, remind me a little bit about the fuel price, coal price might be going up and how are you protected against coal price?

I will give you a little flavor and then I will ask Rick Kuester to add anything he would like to add. Clearly, we have all seen, and this is a fairly recent phenomenon over the last few months, across the industry certainly spot prices for coal, but for the first time long-term coal contract prices edging up.

It wouldn't surprise me, based on the data I've seen, that renewals of long-term coal contracts may see a 30, 35, even 40% increase in price compared to some of the legacy contracts that we have here.

We are completely hedged this year and slightly less hedged the following two years but we have the majority of our coal over the next three years locked up in long-term contracts, but there will be a considerable amount of contract activity that we have to engage in next year. Rick?

I think you said it well. We don't expect any impact this year, but will start seeing some impact next year. And it will be some what exacerbated by the fact we have two nuclear outages next year, so we will be burning more coal, and we also and those will be a little longer because they have the reactor vessel head replacement going on. We expect a ramp up over the next few years starting next year.

From everything we can tell it appears there is a huge demand for anything that comes close to -- metallurgical coal from China. As long as the China boom stays intact, it looks like there's going to be some upward pressure on coal prices. This is the first time the industry has seen this in a very long time.

What happens to 2009 and 2010 when the coal units start coming in?

I would expect if coal prices are substantially higher in '09 and '10 that we would obviously have to apply for an increase in our -- in our fuel clause. But I can't imagine, you know, never say never, but I cannot imagine that anything we're seeing today relating to coal prices, would do anything but reinforce the wisdom of building those coal units. Because coal prices have run up some but nothing like natural gas prices have run up.

One last question for either you or Allen about this 2004 guidance. If we were to pro forma that adjusted for the sale of the manufacturing part of the business and the nonrecording stuff, what would be the good operating base for '04 going into '05?

Yeah, in fact, we probably the best number to use if you look at say '05 and assume you had no contribution whatsoever from the manufacturing business,and on the positive side you have the shares that we going to buy back with some of that cash.

We have debt that we are going to pay down with some of that the cash so you have the interest savings, and then we have the loss of the operating earnings.

When you put all those together, you're looking at a 13-15 cent per share impact reduction in earnings per share.

I think probably a reasonable thing for you to do when you do your modeling is look at your base of earnings in 2004 and back out between 13-15 cents a share to sort of pro forma out, if you will, the effects of the fewer shares, reduced interest costs and the elimination of the manufacturing earnings.

And then of course Vic you would add your own estimate of our utility and power the future earnings growth for '05.

Thank you so much.

Take care, Vic.

Yep.

Thank you. The next question comes from Aaron Vaughan with Robert W. Baird. Please state your question.

Good afternoon.

Hi, Aaron.

You mentioned the discontinued operations the change there. Go over that again and then just tell us what the revenues were for the quarter and the drivers that affected that income?

Let me get to that piece there. On discontinued operations, we had $8 million of earnings at the manufacturing business, which is down $1 million from last year. Again, all these values are after tax. I'm going to ask Steve Dickson to go through the revenues on manufacturing side.

Thanks Gale. On the manufacturing side for the revenues, they had about $192 million for the first quarter which is about $14 million higher than last year. So they experienced pretty good growth between 7-8%. About 2.5-3% of that is foreign currency related.

They had an increase in the gross margin level but they got hit in the operating expenses and this is why the operating income is down a little bit. They had higher customer rebate costs. Higher insurance costs and higher benefits costs. The sales look strong. They are close to plan on that. But any had some blips in one-time costs associated with customer rebates and some higher insurance costs.

Great, thanks.

Thank you.

Thank you. The next question comes from Michael Lepetis with Hibernia. Please state your question.

A couple of questions. One, the balance sheet target debt to total cap you mentioned the number earlier. Could repeat that, and give a little guidance on what the long-term meaning in the next few years debt to total cap target is?

My expectation pro forma for the sale of the manufacturing business, given that closes and then look at a year end debt to cap ratio for the business, I would see it being no more than 61.5% debt to cap.

In terms of a long run target, I think we will stay close to that level of debt, certain no more than, over this entire construction period. So go out to 2010 which is when you get the second coal unit on line. I see it staying at that 61.5%, no more than that. Longer term I would like to see it below 60%.

For the foreseeable future, at least 6-7 years, it will be at about that 65.1%, cyclical with the year with the way our inventory works, primarily for the gas business. If you look at year end targets I would expect about 61.5%.

And we think that is achievable. We really do.

One other question and this is sorry to get kind of nitty gritty on this one but on page 7 of the earnings release packet and the cash flow kind of the consolidated condensed statement of cash flows, you talk about cash at beginning period of $28 million, but I don't know if that syncs up or maybe I'm not looking at that correctly, with what is in the K, the $53.5 million at the end of the Q4 '03.

We will ask Steve Dickson to give you a very specific answer on that.

Your observations are entirely correct and the difference is that in the first quarter we took the manufacturing operations and all the assets of the manufacturing operations are net assets held for sale and the liabilities are liabilities held for sale. The difference in the cash between the 12/31 10-K and what we show in the earnings release here is the cash associated with the manufacturing group.

That sounds fine. Thank you.

Thank you, the next question comes from Seth Pennant with J.P. Morgan. Please state your question.

Hi, how are you doing?

Fine thanks, how are you?

Good. I was looking in terms of the sales numbers on page nine. I see retail sales up 1.2% year-over-year but total sales up 3.3%. Give a little color on what is the difference there? Like the other retail muni stock and wholesale?

The largest increase is in our wholesale sales. Sales to other utilities in the state, but we did see for the first time just a bit of an uptick in our sales to large manufacturing customers. We are not quite back yet to in terms of industrial consumption of electricity in our region. We are not quite yet back to the year 2000 levels but in the first quarter of this year, we got pretty close.

That was driven by and large, by foundries, steel manufacturers, so we thought -- we began to see some heartbeat in terms of the industrial sector of our economy which was encouraging.

Commercial continues to be pretty strong but the biggest driver of the increase that you saw in the first quarter was wholesale sales of energy to other utilities. Allen?

And those were strictly opportunity sales if you will. A couple of the other utilities in the state had bad experience with their conventional, you know, with the coal units.

But a good experience with our energy.

Right, but a good experience with our energy so we were able to increase our opportunity sales somewhat in the first quarter.

Okay. Thanks.

You're welcome.

Thank you. Our next question from Brian Olsen with L Pat Management.

Congratulations guys. Could you break out what earnings were from ETC in the quarter and if you could talk to what those should look like going forward.

In terms of the change of earnings or quarter-to-quarter at ATC it was $800,000 after tax. In terms of the absolute numbers in each quarter and Steve do you want to hit that?

The earnings in the first quarter for the ATC on a consolidated basis, which is Wisconsin Energy and Edison Sault and [Spec 2] was about $9.2 million. And the balance is about $800,000 higher than last year after-tax. Because the increased investment base that ATC has, we expect the earnings to continue throughout the year at that level.

Do do have what the targets should be '04 and '05 and going out further who were -- how much bigger the investment base will be there? What kind of earnings you will see.

I wouldn't hang out a target for 2005 but let me talk about what we expect long-term at ATC. If you look at the end of 2002, I believe their total FERK rate base was $800 million and over the next 10 years their target at least is to add $2.8 billion to the investment of that company. So nearly a quadrupling in the FERK rate base if you look out 10 years. That is very much back-end loaded because you're bringing the very large investments, you know, the transmission lines online at the latter part of the decade.

In terms of our ownership of that company, we're about 39% and I would expect at the end of the decade to be closer to 31 or 32% of that total company. And that is being driven by fact that WPS, Wisconsin Public Service in Green Bay is putting in all the equity for the Arrowhead Western line, so in effect, the other members ownership will go down a bit, but a really big increase in rate base and you know will be roughly a one third owner or 31-32% owner of that company.

Great, thank you.

Thank you.

Thank you. Thank you. Our next question comes from Zack Shriber with Due Cane. Please state your question.

Hi guys. How are you?

Doing great.

I'm not the expert on you guys so I apologize if it is an ill-informed question. On the coal hedging, it is my vague recollection, in Wisconsin there was a fuel clause but you can only trigger it if you have fuel expenses that increase or decrease by plus or minus 5% above the sort of projected fuel expense over any given sort of rolling 12 month forward basis. Number one, is that the structure?

And number two, if that is the structure how does this kind of coal hedging and hedge rolloff fit into that structure and how do you sort of ensure it is not an issue for us to worry about and sort of all prudent and so forth?

Good question because the Wisconsin fuel clause does work a little bit differently than fuel clauses in most states. We do have a bandwidth above and below the targeted fuel recovery rate and that has to be by and large pierced before you can get fuel recovery for higher or lower fuel costs. And we will let Allen describe how that works specifically in terms of the bandwidth and our filing for higher costs when needed.

First, Zack, on the when can you go in for a new fuel case, outside of a general rate case, okay so if you are outside that sort of regime which is where we are right now, if you have an actual underrecovery in a month of at least 10%, then you get to do an annual test. So say, for example you are in February which is sort of the situation we were in last year, and you were more than 10% underrecovered for the month, then you get to do an annual test. So for that calendar year, you then do an annual test and if you're going to fall outside that plus or minus 3% band on a projected basis that Gale talked about, you can go in and request that new fuel rates be set.

Um-h'm.

I should mention that the fuel rules are expected to change somewhat in 2006. And the -- they will actually tighten the band some. Instead of plus or minus 3, it will be plus or minus 2, and instead of plus or minus 10, it will be plus or minus 8. And they are actually going to sub divide fuel costs into the volatile and nonvolatile components. For example things that you wouldn't expect to change on a month-in month-out basis, or to be very predictable, like a purchase power payment ,they will put those in the nonvolatile bucket and look at the plus or minus 8% on the more volatile things like natural gas prices and spot coal and the like.

The plus and minus 3% going 2% is on a full year basis and plus or minus 10% to 8% is on a.

Monthly.

Monthly basis.

That's right.

And just from a procedural perspective, for you to file for a higher fuel rate based on this sort of structural change in coal pricing, do you have to pierce the band and incur the pain first or can you do it just prospectively on what is known and measurable and anticipated.

Outside of a general rate case we would have to do it only once we experience the increase. However, we will have a general rate case coming up in all probability in the second half of '05 with new rates being set January 1, '06. So, in the context of a general rate case, you can review this and what the impacts may be going out in the future prospectively.

Got it.

Depends upon which kind of situation we find ourselves in and right now since we are in basically the third year of a rate freeze we have to pierce the band first. But I must say this commission has been very responsive when we pierce the band. Allen mentioned to you that last February because of the.

Right.

Runup and high spike in natural gas prices we pierced the 10% band in February, we filed immediately and got emergency interim relief in March. The commission I think understands the need for us to recover as quickly as possible our actual fuel costs.

And is there still a prohibition against retroactive rate making in the state.

There certainly is.

The only exposure is for some sort of stub period in the second half of '05, come '06 any lag if there is any at all is done?

Well, I guess, I mean by and large I think you are right. Assume, for example that there was some kind of huge runup in oil or natural gas prices in the fall, this is a possibility certainly we could pierce the 10% band quickly. Quickly and have to go in immediately and file for a rate increase. I don't expect that but I wouldn't rule it out.

Okay. You're bringing it all back for me, Gale, thank you.

You're more than welcome.

Once again, ladies and gentlemen, if you do have a question, please press star one on your push button telephone at this time. The next question comes from Vidullah Merti with Zimmer Lucas Partners.

Good afternoon.

Hi Vidullah, how are you.

Fine, Thank you.

Are you hanging in New York?

Hanging back at home base. Doing okay.

All right.

Can you remind us again, I apologize, in terms of the factors that pushed up the O&M by $12 million here in the quarter?

Sure, we will be happy to go over that with you. One of the major increases, as Allen described in his comments, was benefit costs. And we are getting to that section right now so we can give you a breakdown.

That was $8 million of the $12 million so almost all is benefits costs.

Is that a timing issue or will that kind of be continuing quarterly going forward?

I expect annual benefits costs compared this year to last to be up. But if you look specifically at the $8 million within the quarter and sort of looked at, you know, quarter over quarter, about $5 million of the $8 million was pension costs and the rest was employee medical. Some retiree and some active so I certainly would expect benefit costs in 2004 to be higher for the year than they were in 2003.

But at the moment we are not seeing benefit costs do anything other than what we thought they would do from a budget standpoint.

Yes.

We're not surprised by what happened in the quarter.

So but I mean I guess the benefits were $3 million of the $8 million. What about the pension going forward?

Pension was $5 million of the $8 million and medical was $3 million of the $8 million. And so I think largely the $5 million of additional pension was really rolling off some good years and now having to average in some bad years of experience. You know, the way the FAS 87 sort of rules work.

All right, so then, I think what you're indicating here is that this increase will be is fairly representative of what we will see in the next three quarters over the rest of the year?

I think that is reasonably the case. Yes. And as Allen said, this is not -- what happened with benefits and pension costs in the first quarter was not a surprise and we have taken into account this and our budgeted projection and we are still clearly within our $2.33 to $2.43 earnings guidance range.

Okay. I'm wondering with regards to the coal costs, can you perhaps be a little bit more specific in terms of, you know, the volumes that you currently use and how does rolloff over the next couple of years? And when you say you are he is seeing pricing up 35-40% potentially, can you kind of give us some baselines for you guys as to, you know, kind of where your starting points are?

I'm not sure we have those specific numbers in the room with us and I would rather not speculate. But we can get back to you offline with general response to that question if you would like.

That would be great. Okay, thank you very much.

You're more than welcome.

Thank you. Our next question comes from Doug Fischer with AG Edwards. Please state your question. Mr. Fisher your line is live, sir.

Yes. Sorry. Just a follow-up on the coal issue. Remind us where you get your coal, how much is western coal and are you seeing this runup in the western coal?

Let's see, we are wanting to give you some specific numbers here. Our [Preskyle] power plant up in the U.P of Michigan, is fueled almost exclusive by Powder River basin western coal and I believe, that our Oak Creek and Pleasant Prairie plants, try to say that five times fast, are by and large fueled by Eastern coal.

Oak Creek and Pleasant Prairie are Wyoming mine.

Oak Creek and Pleasant Prairie are Wyoming?

Pleasant Prairie is Wyoming mine, it's Powder River basin coal.

I guess I'm a little puzzled because my understanding is that the Powder River basin coal was up much less than the Eastern coal. But your concern is that we're going to see the long-term contracts of that go up on the percentage range that you are talking about?

That is the concern. Now, you know, we may well be able to do better than that but we are seeing, I mean as you know, once a significant portion of the fuel market rises.

Yes.

Other types of fuels tend to rise in concert. We may well be able to do better than that.

I hope we are able to do better than that and we do have some flexibility in terms of types of fuels on the new plants we are bringing on, but we wanted to warn that there could be a fairly significant increase in the contract price for coal. Even Western coal.

Okay, thank you, Gale.

You're welcome, Doug.

If there are no further questions I will turn the conference back to management for final remarks.

Thank you very much. That concludes our conference call for today. We appreciate very much you participating.

If you have additional questions, Colleen Henderson will be available at the Investor Relations hotline at (414)221-2592. Thank you very much, folks. Bye bye.

If you wish to access a replay you may dial 1-800-428-6051 with ID# 347078. This concludes the conference for today, thanks for participating. Have a great day. All parties may now disconnect.