威斯康辛能源 (WEC) 2006 Q1 法說會逐字稿

Good afternoon and welcome to the Wisconsin Energy 2006 first-quarter conference call. Before the conference call begins, I will read the forward-looking language. All statements in this presentation other than historical facts are forward-looking statements that involve risks and uncertainties, which are subject to change at anytime. Such statements are based on management's expectations at the time they are made.

In addition to the assumption and other factors referred to in connection with these 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. This conference is being recorded for rebroadcast and all participants are in a listen-only mode at this time. After the presentation, the conference will be opened 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 2006 first-quarter results at www.WisconsinEnergy.com. A replay of our remarks will be available approximately two hours after the conclusion of this call.

And now I would like to introduce Gale Klappa, Chairman of the Board, President and Chief Executive Officer of Wisconsin Energy Corporation.

Good afternoon, everyone and thank you for joining us on our conference call to review the Company's 2006 first-quarter results. Let me begin as always by introducing the members of the Wisconsin Energy management team who are here with me today. We have Rick Kuester, President and CEO of We Generation; Allen Leverett, our Chief Financial Officer; Jim Fleming, General Counsel; Larry Salustro, Executive Vice President; Jeff West, our Treasurer and Steve Dickson, Controller.

Overall, I am very pleased with our first-quarter results. Allen will review our performance in detail in just a moment. As all of you saw from our news release this morning, we achieved earnings from continuing operations of $0.88 a share in the first quarter of 2006. This compares with earnings from continuing operations of $0.76 a share in the first quarter of last year.

Now I would like to spend just a moment on our continuing effort to upgrade the energy infrastructure in Wisconsin. Our Power the Future plan is fundamental to the principle of energy self-sufficiency. To better serve our customers and ensure the economic future of the state, we need to have a modern efficient fleet of generating units that use a diverse mix of fuels, including nuclear, coal, natural gas and renewables.

Key components of our focus on self-sufficiency include investing in two combined cycle gas-fired units at Port Washington, north of Milwaukee, the construction of two supercritical pulverized coal units at Oak Creek, which is south of the city, and our proposal to build approximately 200 megawatts of new wind generation.

Let me begin with our Port Washington project. Back in November of 2002, the Public Service Commission approved the construction of two 545 megawatt natural gas-fired units at our Port Washington site. On July 16 of last year, the first Port Washington unit went into commercial service on time and on budget. Construction of the second unit now is well underway. Site preparation, including removal of the old coal units at the site, was completed early this year and most of the major components have been procured for Port Washington Unit 2. The unit is expected to begin commercial service in time for the peak summer season in 2008.

Now let's turn to the status of our two coal-fired units at Oak Creek. Activity at the site began in earnest as you know last summer following the Wisconsin Supreme Court ruling that allowed us to move forward. Since that time, the major focus has been site excavation, drilling of the down shafts in Lake Michigan for the water intake structure and building the necessary foundations in various areas around the site.

Bechtel Power Corporation, our major contractor, has excavated about 5 million cubic yards of material so far. That is about 90% of the amount expected for the entire project. Bechtel reached final grade for the Unit 1 boiler building earlier this year and has begun pouring foundations in that area. The first shipment of structural steel for the Unit 1 boiler has arrived at the site and erection is scheduled to begin next month.

Two downshafts have been completed for the water intake structure and the remaining two downshafts are scheduled to be built this summer. Drilling of the water intake tunnel is also scheduled to begin in the next few months.

Engineering for the Oak Creek project is now about 64% complete. Procurement of the engineered equipment and supplies is approximately 85% complete and overall project completion stands at approximately 8%. We're very satisfied with the progress so far.

As you also know, there are four major permits needed to construct these facilities. These include an air permit, a wetlands permit, a pollution discharge and elimination permit and finally a permit from the U.S. Army Corps of Engineers. We have received all of these permits and each of the permits remains in effect unless and until it is overturned by a court or an Administrative Law Judge.

Last September, we resolved all legal challenges to the air permit. Also in February, we resolved the outstanding legal challenges to the wetlands permit. On the third permit, the Wisconsin pollution discharge and elimination system permit, a contested case hearing was held in March. We expect a decision by the Administrative Law Judge later in the year.

The final permit from the U.S. Army Corps of Engineers was received in May of 2005. To date, no appeals have been lodged against this permit. Our plan remains as it has been to have the first unit at Oak Creek in service in the summer of 2009. The second unit is scheduled to follow one year later in 2010.

Now turning to the subject of renewable energy. In March, the state of Wisconsin passed new legislation that requires 10% of our state's electricity to be supplied by renewable sources by the year 2015 and 5% by 2010. To meet this mandate, we must obtain approximately 200 megawatts -- I'm sorry 210 megawatts of additional renewables by 2010 and another 610 megawatts of renewables by 2015.

The new law does allow the Public Service Commission to delay implementation of the renewable portfolio standard if it becomes too expensive, lessons reliability or cannot be permitted on a timely basis. We have already started developing new sources of renewable energy to work toward complying with the 2010 requirement of 5%.

Last year, we purchased the development rights to two windfarm projects and we plan to build wind turbines with a generating capacity of up to approximately 200 megawatts. We currently have a request for proposal out for equipment and after we analyze the results, we will finalize the capacity, the cost and the schedule. As I said, the project could be sized up to 200 megawatts with a cost of approximately $360 million, including capitalized carrying cost during construction.

We filed for a certificate of public convenience of necessity with the Public Service Commission in March. The turbines are expected to be placed into service in either 2007 or 2008 depending upon equipment availability and receipt of the necessary regulatory approvals. If the project is approved, we expect it will be a traditional utility rate-based investment.

Now turning to our nuclear operations. In 2005, we completed refueling outages and replacement of the reactor vessel heads for both Unit 1 and Unit 2 at Point Beach. We also received approval from the Nuclear Regulatory Commission for 20-year license extensions for both units. The operating licenses for Unit 1 and Unit 2 are now extended to the years 2030 and 2033 respectively.

As we mentioned on our last conference call, we have begun to conduct a formal review of our operations for the ownership and operation of Point Beach. The range of options that we are evaluating includes continued operation by NMC, a third-party operator other than NMC, a return to in-house operation of the plant by Wisconsin Electric and a sale of the Point Beach facility. We will be thorough and deliberate in carrying out this review during 2006. We will provide you with an update when we've reached our conclusions in the fourth quarter.

In other developments, last Friday, Wisconsin Energy and a subsidiary of WPS Resources closed on the sale of their respective one-third interests in the Guardian pipeline to Northern Border Partners. We each received $38.5 million for our interests. In our case, this represents about a $3.5 million pre-tax gain and that gain will be booked in the second quarter.

We expect that Northern Borders will expand the transmission capacity and extend the existing pipeline to bring improved gas transportation capability to the eastern half of Wisconsin.

And finally we were pleased to learn in March of this year that for the fifth time in a row Wisconsin Energy has received a perfect 10, the highest possible score from Governance Metrics International, a corporate governance research and ratings agency. Wisconsin Energy is one of only six companies worldwide and one of only three U.S. companies to have consistently received GMI's highest rating for corporate governance practices.

And with that, I'll turn the call over to Allen, who will give you more details on our financial performance in the first quarter of this year.

Thanks, Gale. I'm going to focus my remarks this afternoon on earnings from continuing operations. Information regarding earnings from discontinued operations is included however in the earnings package that we provided on our website. It may be helpful for you to refer to pages 6 to 8 of the earnings package as I review our results.

Earnings from continuing operations were $0.88 per share for the first quarter versus $0.76 per share in the first quarter of 2005. On a consolidated basis, our operating income was $192 million versus $167 million in 2005 for an increase of $25 million. Operating income for the Utility Energy segment, which is comprised of Wisconsin Electric, Wisconsin Gas and Edison Sault was $186 million compared to $171 million in 2005 for an increase of $15 million.

Positive earnings drivers in the first quarter included improved recovery of fuel cost and the contribution from increased natural gas distribution rates that were put into place on January 26. Fuel cost recovery represented a $39 million positive swing. In the first quarter of 2005, we had an $11 million fuel cost underrecovery. While during this quarter, we were in a positive recovery position of $28 million. The increased gas rates net of lower normalized usage per customer contributed $10 million. These two positive drivers totaled $49 million.

The primary negative driver in the first quarter related to the mild winter weather we experienced. This was a $17 million drag on operating income as compared to 2005. Additional planned maintenance on our fossil units reduced operating income $5 million. Other negative factors related to increased bad debt cost of $4 million and other items in total representing $8 million. All of these negative drivers combined totaled $34 million.

Now netting the impact of the positive and negative factors I just reviewed brings you to the $15 million increase in the Utility segment's operating income for the first quarter.

Operating income in the Non-utility energy and Corporate and Other Income segments, which primarily includes We Power, was up $10 million. This amount is almost exclusively related to operating income from the new Port Washington plant that was placed into service in July of 2005.

Taking the changes for each of these segments together brings you back to the $25 million increase in operating income for 2006. Other income was up $3 million in the first quarter due in large part to increased capitalized carrying costs on construction work in progress as well as deferred costs. Total interest expense increased by $2 million in the first quarter and this was driven by both higher, short-term interest rates, as well as increased debt balances, including the $155 million of debt associated with Port Washington Unit number 1.

Income tax expense was up $11 million in the first quarter. Part of this was due, of course, to the higher income as compared to 2005, but the effective tax rate was also slightly higher. Adding these items brings you to the $105 million of net income from continuing operations for the first quarter of 2006 versus $90 million of net income from continuing operations last year. In earnings per share terms, this equates to $0.88 per share in the first quarter of 2006 versus $0.76 per share in the same period last year.

Let me turn now to cash flow. During the first quarter of 2006, we generated $340 million of cash from continuing operations. This compares to $377 million in 2005. The decline in cash flow from operations was caused by a combination of factors, including a lower-than-expected withdrawal of natural gas and storage due to the mild weather and increased accounts receivable balances.

We had capital expenditures of $215 million in the first quarter. $116 million of this was dedicated to our utility and other businesses and $99 million was from the generating units being constructed as a part of our Power the Future plan.

In addition, we paid $27 million in dividends. At the end of the first quarter, our debt to capital ratio was 58% as compared to 57.5% at the end of the first quarter of 2005. As I mentioned on our last earnings call, our capital spend this year is expected to be approximately $1 billion. As a result, we expect that our debt to capital ratio will increase somewhat over the course of the year.

However, as we have stated in the past, our goal is to maintain our debt to capital ratio at no more than 61.5% during the period we are constructing our new gas and coal-fired generation. This would exclude any environmental trust financing that we might complete since the bonds issued under this structure would not be our obligation. We are using cash to satisfy any shares required for our 401(k) plan, options and other programs. So going forward, we do not expect to issue any additional shares.

I would now like to turn to our earnings guidance for 2006. Now as we discussed on our last earnings call back in February, the anticipated earnings drivers for the year fall into four groups. They included price increases, changes in sales volume, nonfuel cost increases at our utilities and finally increased earnings contribution from the first unit at Port Washington.

As we look at the quarter, the impact of price increases and the earnings contribution from Port Washington were in line with our financial plan. Due primarily to the mild weather, the sales volume was below plan. Fuel recoveries were better than planned due to very good operating experience at our power plants and lower-than-expected natural gas prices.

Let me remind all of you that based on the fuel recovery rules that apply to Wisconsin Electric in 2006, we will refund any overcollection of fuel costs for the calendar year as a whole. While we were in a $28 million positive fuel cost recovery position in the first quarter, I still expect that we will be slightly underrecovered on an annual basis. In fact, I expect that the amount of underrecovery in the fourth quarter of this year will be almost exactly the same magnitude as the positive recovery that we experienced in the first quarter.

We also have a nuclear refueling outage planned, as well as a planned outage at one of our largest coal units in the last half of the year. Given that it is so early in the year and that there is still significant uncertainty about fuel costs, our guidance range for 2006, excluding any gain on the sale of our Guardian pipeline interest that will be booked in the second quarter, remains at $2.47 to $2.57 per share. The gain on the Guardian sale would add approximately $0.02 per share to this range.

Although we will not be giving guidance for the second quarter, I did want to give you a feel for the earnings drivers that I expect compared to the second quarter of 2005. Adjusted earnings from continuing operations were $0.34 per share in the second quarter of 2005. Two factors are expected to increase earnings in the second quarter of 2006 relative to the 2005 level.

First, we expect to see a contribution from Port Washington Unit number 1 in the second quarter; whereas we did not last year. Also, one of the Point Beach units was out for almost the entire second quarter last year due to a planned refueling outage. No outage is planned for the second quarter this year. These two drivers should bring our earnings in the second quarter significantly above those in last year's second quarter. So with that, I'll turn things back over to Gale.

Allen, thank you very much. Overall, we are on track and focused on continuing to deliver value for our customers and stockholders.

(OPERATOR INSTRUCTIONS). Doug Fischer, A.G. Edwards.

I just wanted to review that the overrecovery was $29 million on fuel in the first quarter.

428 million, yes.

$28 million. And so then over the second half of the year, we are expecting difficult comparisons it looks like at this point or would you comment on that?

Yes. Let me take you through in terms of the quarterlies. Obviously as we talked about, Q1 -- now comparing Q1 '06 to Q1 '05 -- that certainly was a positive. I would also expect Q2 to be a positive. Then Q3 would be neutral to slightly negative quarter-over-quarter and then as I mentioned, Q4 would be significantly negative as compared to Q4 of '05 on fuel. So for the year, if you recall when we did our earnings guidance for the year, Doug, we said that we expected to be somewhere between $10 million underrecovered and say neutral on the fuel clause for the calendar year. And that is still the range that I would expect to be in for the year.

Once again, your guidance still assumes normal weather for the year even though you are in the hole some in the first quarter?

Normal for the remainder of the year. That's correct.

For the remainder of the year or for the entire year as a whole?

I guess it's fair to say it's probably for the year as a whole. It's probably more accurate.

I think it is important to point out, because not everyone is familiar with the fuel recovery rules here, now obviously the Commission sets a fixed rate for fuel recovery and that is applied to every unit of sales. And quarter-to-quarter, depending upon gas prices, depending upon demand, depending upon our planned outage schedule and maintenance schedule, you're going to swing quarter-to-quarter. In this particular quarter, it was a positive swing. But as Allen said, just given what we see in front of us, particularly in the fourth quarter with additional planned outages, we will see it swing the other way. And overall, as Allen said, we still expect a slight underrecovery for the year again depending upon all those factors, but that is our current outlook.

Thank you, Gale. Then how would you -- what kind of net proceeds after-tax are you getting from Guardian?

I would expect -- pretax, it was like $38.5 million. After-tax, I would expect somewhere in the range of $34 million.

And what kind of tax rate do you expect for the year as a whole? You mentioned the effective rate was up slightly -- up some in the first quarter.

I would expect the effective rate to be between 37% and 38% for the year and I believe for the first quarter, we were like 37.6%.

Okay. Thank you.

Paul Patterson, Glenrock Associates.

I wanted to ask some basic questions. The weather versus normal, you gave it to us for the last year, but versus normal, I was wondering what that was?

Let me just take you through that quickly. In the first quarter of 2005, at the margin level, if you take electric and gas combined, it was about $1.3 million better than normal. And then if you look at the first quarter of 2006, there was a $17 million swing. So you were about $15.7 million below normal or worse than normal weather in the first quarter this year. So you swung from about $1.3 million better in '05 to $15.7 million worse in the first quarter of '06.

Okay. And then the regulated ROE for the last 12 months at the utility.

Well, the regulated ROE for the last 12 months is not very instructive really for two reasons. Number one, you're coming off a period where last year for part of the year you were able to in effect keep the benefit of the cost synergies between the WICOR and Wisconsin Energy merger and we also, as we have been talking, were in a very large positive recovery position for fuel. So as I look at -- what would be more instructive is prospectively for this calendar year for Wisconsin Electric Power Company, the allowed return on equity is 11.2% and I expect that we will be very, very close to that level. So that is the Wisconsin Electric Power Company.

For Wisconsin Gas, I would expect our regulated return to be closer to 7%. So those I think are the more instructive numbers.

And that is because of the weather pretty much at the gas?

Both weather and a little bit of conservation. In fact, we have some interesting numbers for you because we were looking to see how much conservation effect there might be in light of the run-up of natural gas prices and underlying our first-quarter numbers, if you look at weather normalized use per residential customer and again the single biggest gas usage in the state of Wisconsin is for residential heating, so if you look at weather normalized use per residential customer for the 12 months ended March of '06, so that would include the entire winter season, it's about 801 therms consumed per residential customer on a weather normalized basis. That is down from 861 terms for the 12 months ended March of '05. So about a 7% decline on a weather normalized basis and we would say that that is very much the result of customer conservation.

Now having said that, given that it was the warmest January since 1891, it was a pretty easy year to dial down the thermostat. So we will see if that continues to hold, but definitely we saw conservation and in terms of residential usage, about 7% on a weather normalized basis. I hope that helps.

Good. That's very helpful. In fact, I was going to ask you about that. What was the price increase that your customers had seen? What was -- if we can just get an elasticity ID here. How much of a price had they seen as a result in that period?

For this winter season, about 19% increase in price compared to the prior winter season.

Okay. But they had lower bills because -- they had bills that weren't fully impacted by that because the weather was warmer and yet we're still seeing a 7% weather normalized decline?

No, the 19% included the warmer weather. That is based on actual consumption.

Okay. So that is an increase -- a 19% increase in bills.

That is correct.

But how much -- how much per Mcf -- how much per volume -- do you see what I'm saying? How much on a unit basis had it gone up?

On a unit basis, it was probably closer to 28% to 30%.

And then the bad debt expense, is that -- again you had warmer weather so you would have thought that wouldn't have gotten worse; yet it did. On the other hand, you've got higher prices. What is causing that to go up?

Yes, let me take you through that. Remember for us, bad debt -- you really need to think of it in two components. The first component is what is actually recognized on the income statement in the current period. The second component is deferred because remember we have the accounting treatment here that to the extent that your actual bad debt experience is above the level that's included -- now this is just for residential customers -- above the level that is included in rates, it gets deferred the difference.

So for example, if you look at the year in 2005, we recognized about $28 million to the income statement, deferred $17 million. Total expense was $45 million and in total, I expect we will be at about that level this year, but if you look within those two buckets between what is recognized on the income state versus what is deferred, I would expect to recognize probably around $43 million in the income statement this year and defer say roughly $3 to $4 million for a total of about $46 million.

So then as you look at the first quarter, you saw that $4 million increase in bad debt expenses. Well, almost all of that, roughly $3.5 million, was just because you now have a higher rate recovery for bad debt expense and therefore defer less. So $3.5 of the $4 million was for that and about $0.5 million was actual increased bad debt experience if you will.

That's really helpful. And just finally on the electric side, is there any elasticity that you're seeing there?

To be honest with you, not a lot. In fact, one of the conclusions I came to after looking at our first-quarter numbers -- if you think about it in general, the first quarter of this year was about 10.5% warmer than last year and yet we only saw a 1/10 of 1% reduction in residential use of electricity and commercial actually was up. So we haven't seen a significant amount on the electric side of any kind of reaction to the run-up in prices driven by the cost of natural gas generation.

The other encouraging sign related to your question on bad debt -- when you look at our arrears, our arrears greater than 60 days are lower today than they were at the end of the first quarter a year ago. So all in all, I think we're in a pretty good position.

Paul Ridzon, Keybanc.

Just a question, on your last call, you indicated that indications were such that first quarter would be up modestly versus '05. Where was the upside, unless this is modest, in which case I am very impressed?

Well, the upside is clearly in two areas -- actually three. The first, as Allen described in detail, we were at a fuel underrecovered position in the first quarter of last year. We are in a positive position on fuel recovery first quarter of this year. So that swing from underrecovery to positive recovery was a huge element in the 2006 results.

The second is that our first unit at Port Washington, the new combined cycle gas-fired unit at Port Washington was not in service in the first quarter of last year. It is this year. So we had an earnings contribution there that we did not have in the first quarter of 2005.

And then one thing that we continue to watch and discuss is customer growth. Our customer growth has been very strong. If you look at the electric and gas businesses combined, we are serving about 1.2% more customers at the end of the first quarter this year than at the end of the first quarter last year. So those were some of the big positive elements.

And I guess I would -- just as a point of clarification, some of those factors were baked into the guidance. So we believe that we would -- going into the first quarter, we thought we would be in a positive recovery position in the first quarter and we expected to have an earnings contribution from Port Washington 1. I think the positive surprise if you will, going back to what I was saying on '06 earnings guidance, fuel recoveries were better than planned due to the very good experience that we had with the power plants, as well as honestly the much lower spot prices for natural gas than we expected.

So just the magnitude of the positive recovery was a bit of a positive surprise. And then also on the O&M side, although O&M was up -- we talked about bad debt as manifested to the income statement, we talked about fossil O&M, we did do better than planned on O&M in other parts of the business. I think the thing that took us from modest to your point to maybe more than modest would have been those two things.

We went from modest to reasonable.

Now for the second quarter, you expect significant -- I'm on the edge of my seat on this one.

I think going back again to what I was saying about fuel cost recovery. We had -- I think one of the Point Beach units was out from April 2 all the way past June 30. So you had a nuclear unit that was out for basically the whole second quarter. That is not expected to happen again.

You also should have much better position on fuel recovery, the fuel recovery rates and also you have got the roughly $0.035 a share from Port Washington 1.

On Point Beach, as I recall last year, you were deferring your placement power by eating O&M or do I have it backwards?

Well, we certainly have to expense all of the O&M related to the outages and those outages were longer than normal last year because we were replacing the reactor vessel heads. As it related to fuel costs, to the extent that the outage of the first unit was more than about 59 days as I recall, to the extent that it was more than 59 days and it was -- it was actually 99 days in the final analysis -- for that 40-day period, we were able to defer the additional fuel cost for that 40-day period and that was -- I think roughly we deferred about $25 million for that.

And that was second quarter, yes.

Right, in the second quarter. So it was a mix of current versus deferred on fuel. Hopefully that wasn't clear as mud.

Just a clarification. The expected fuel underrecovery , did you say for the full year, you expect the underrecovery to equal the first-quarter overrecovery or basically that the first-quarter overrecovery plan is to get overrecovery down to about zero by the end of year?

You are exactly right, what you said at the end there. For the full year -- so if you take all four calendar -- the quarters combined, we still expect to be in that range that I talked about at the very beginning of the year, which was from roughly $10 million under to a neutral position. That is for the entire year.

The point that I was making on the quarters -- if you look at the positive recovery position in the first quarter of this year and look at what I would project for the underrecovery in the fourth quarter, ironically the magnitude of those two are the same and the point we're trying to get across there with that is the quarter-to-quarter swings that you can see on fuel recovery is partly because you're charging an average rate throughout the year, but also as you see just the outages, planned and otherwise, in our generation fleet.

In light of what we're describing here, these quarter-to-quarter swings on fuel recovery, I think it is very important not to get overexuberant about one quarter because we are still, as Allen said, projecting a slight underrecovery in fuel for the year despite the very positive experience in the first quarter.

And then by definition, even if we did have let's say positive experience that was outside of planned, by definition you cannot overrecover fuel costs this year because any overrecovery for the calendar year will go back to the customers.

Michael Lapides, Goldman Sachs.

One or two very easy ones, just on the difference in O&M year-over-year, which is about $40 million. Can you break that down?

Sure. I'd be happy to. Of the $40 million, about say $17 million of the -- or actually about $20 million of the $40 million is related to reduced -- we have costs that were previously being deferred that now are recovered in current rates. So you see that $20 million go through the income statement as O&M, but you also up the income statement, have revenues to offset it.

So roughly say $20 million of that $40 million are for items of that type. Then we had $5 million that was from the fossil O&M that I talked about, which is just doing more maintenance work this year as compared to last, about $4 million bad debt and we went through that in detail with Paul Patterson. So those are some other items. We had some other cats and dogs that were about $5 million and then we had some other amortizations of some deferred items related to PTF that were about $12 million. So the bulk of this really were related to either amortization of deferreds or recovery of costs in the current period that last year were not being recovered.

When I think of 2005's O&M cost and then going forward for the next two to three years, what should I be thinking about in terms of where you think your annual O&M trends will be through '07, '08?

Well, I'll take a shot at it as Allen is thinking as well. There will be some of the factors that Allen just described to you. Coming out of our rate case, there will be costs that were deferred prior to the rate decision that are now going through O&M. But when you strip out those factors, certainly for this year I would expect pretty flat O&M compared to last year and then flat to very modest increase in the following year.

And can you talk a little about the things you're doing because lots of other companies are facing O&M increases primarily tied to wage inflation. What are you doing differently?

Well, I think there are three things that we're pretty focused on. The first is we are looking in every area of the Company for additional productivity and additional cost savings and finding some very good experience there. The second that is helping us considerably this year is on medical coverage costs. We negotiated a new contract with the healthcare provider that is giving us steeper discounts on healthcare costs and that, as you know, in terms of employee benefit costs, the healthcare component has really been significantly increasing year-over-year.

This year, we expect to have a much more favorable experience in terms of very low single digit increases in healthcare costs. So the fact that we're really focused on productivity savings, the fact that we are able to negotiate a favorable healthcare coverage with a new provider that is working out very well and then thirdly, we are seeing some really good results from a lot of the work that Rick and his team are doing on powerplant availability and that is helping us considerably as well.

One final question. Just want to make sure I understood. For Port Washington 1, the other income, non-regulated energy operating income year-over-year for the quarter was a difference of about $10 million. And I thought that the total annual contribution from Port Washington 1 was expected to be in the, if I remember correctly, the $14 million to $17 million range for a full year. Why so front-end loaded for the quarter?

Well the $10 million is pretax operating income. The $17 million is an after-tax net income.

Okay.

So you have interest and taxes.

You're right. Thank you.

David [Grumhaus], Copia Capital.

Good afternoon, guys. Congrats on a nice quarter. Just on the fuel recovery, just to make sure I'm totally clear on this, last year, you underrecovered by $36 million, correct?

No, last year, we -- well, for the full year, yes. $11 million in the quarter.

Okay. So even though your fuel recovery for the year, you are still expecting it negative 10 to neutral, that will be an improvement of 26 to 36 over last year.

That's correct. You have got it nailed.

Good. Given how the plants ran in the first quarter and given that you did get a little bit of a break on gas prices, although it is hard to say that given where gas is at, you still feel like though you will underrecover by 10 million to neutral. You don't have any more confidence that you're going to be more in the neutral range than the negative $10 million range?

In fact, you have said it exactly. We still believe we will be modestly underrecovered and I think one of the factors that we have to look at is what is going to happen with our maintenance schedule in the fourth quarter. Allen mentioned that he was expecting about as much of an underrecovery in the fourth quarter of this year as we had in overrecovery in the first quarter of this year.

Largely, that is because of the fact that we will have a planned nuclear refueling outage in the fourth quarter and one of our very large coal-fired units at Pleasant Prairie will be out for a longer than normal time because we're tying in a scrubber that we're completing and adding to that plant. So there are a number of operating factors underlying all of this that we have to take properly into account to give you an accurate projection and our best projection at this point in time is still a slight underrecovery.

And then on Wisconsin Gas, Allen, I think you said you are expecting prospectively a 7% ROE?

Yes, for the calendar year. Right.

And you all had talked about I think on the fourth-quarter call about you were going to be underearning there and about when you might be able to get rate relief. Any further thinking on that? Is it likely not to be at the beginning of '08 or is there a chance you may do some interim recovery that would allow you to get closer to your allowed?

I think the more likely scenario, and again nothing is quite set in g concrete yet on that question, but I think the more likely scenario would be the beginning of '08 to be able to really fix the problem.

If you bring in -- say you do a rate case mid '07, the rates would then be applied prospectively starting in January 2008.

[Hassan Doza], Luminous Management.

Based on the original guidance you gave last couple of months ago, you expected the nonfuel costs to reduce the EPS by $0.25 to $0.27 per share? Do you still expect that to be the case for the full year?

Well, given that we're only about four months of the way through, that is still the range that I would expect, somewhere in that range.

Given the savings program you just discussed about Medicare costs and etc., do you expect that to change?

No, in the original guidance, all the things that Gale talked about in response to I believe Michael Lapides' question, all of those things were baked in to our guidance for the year. Savings from those programs.

On the customer growth side, you had strong customer growth this quarter. On a percentage basis, what was that like?

Well, for an annual -- the numbers I was giving you were for the 12 months ended March and that was a 1 -- just slightly above a 1.2% growth. On the gas side of the business, we are seeing about 1.4% annual customer growth and about 1.1% to 1.2% on the electric side. That is very good growth.

[Reza Hatefi], Zimmer Lucas Partners.

I was wondering could you guys give us a little flavor on potential '07 or '08 CapEx and I think I asked you guys this question on the fourth-quarter call, any update on the windfarm project?

Well, let me -- while Allen is pulling up his chart, let me -- Allen has already pulled it up. Let me give you the windfarm update. We talked about it in the script itself. We purchased the development rights, as I mentioned in the script, last year to two windfarm projects in Fond du Lac County, which is northwest of Milwaukee. And we filed with the Public Service Commission in March for a certificate of public convenience and necessity to build the windfarm project.

Right now, as we're out for equipment bids, we're finalizing all the important details about the windfarm project, but it could be sized up to 200 megawatts and the cost could be up to about $360 million. In-service dates, '07 or'08 depending upon equipment availability and regulatory approvals and this all would fit into the new state mandate that basically has put an increased renewable portfolio standard in effect in Wisconsin.

10% of all the electricity we sell at retail needs to be from renewable resources by 2015 and 5% by 2010. So this particular project would take us a long way toward the 2010 requirement. Rick, anything to add?

I just might mention that when we first stepped into the shoes of the developer, we were looking at 160 megawatt project. As we looked at this harder and we saw the renewable portfolio standard past and we looked at technology, there is more of a case to be made to upsize it. So that is why we have moved from talking around 160 megawatts to 200. Now that will depend on the equipment bids and what we get, but we are trying to take advantage of the site that we can add additional megawatts to rather than future development of those megawatts.

As we look at this particular site in Fond du Lac County, it is one of the better remaining windfarm sites in Wisconsin. So Rick's thinking I think is absolutely correct that, if possible, we should maximize the output from this particular site because we think the capacity factor there will be as good or better than any of the other sites still remaining in the state.

But I think all this will be dependent on what we get from the market in terms of equipment bids. As you know, it is a very active market right now and where we would fit in manufacturing slots may determine the ultimate best economic decision for our customers.

And in terms of the capital spending, what I would estimate this year, right at $1 billion, a $1.20 billion to be precise. '07, we would estimate to be $1.125 billion and then 2008 would be $975 million.

The '07 number, excluding this windfarm project?

The numbers that I just quoted include a certain amount for the wind turbines and what we baked in to the financial projections was more of a middle of the road scenario on the windfarm. So right at a $270 million installation. So to the extent we do an installation that is larger in megawatts, as Rick and Gale were describing, we would add a bit to the capital spending over the next three years. To the extent that it is more than $270 million would certainly -- if you went to the 200 megawatts, you would have something -- a fair amount above $270 million.

And Commission approval could come at what point, just like a ballpark, fourth quarter this year?

Probably fourth quarter this year or first quarter of next year.

Dan Jenkins, State of Wisconsin Investment Board.

Dan, how did you enjoy that Mifflin Street block party in Madison over the weekend?

I missed it.

You missed it. So that wasn't you I saw being arrested. I'm glad to hear that.

Nope.

What is your question today, Dan?

You mentioned what was driving the change in the working capital and I got the lower withdrawal of gas from storage, but what was the second item?

The higher receivables and that is largely because you're billing it at higher rates obviously than last year.

Those were the two items. Lesser reduction in gas in storage and then because of the higher gas bills for the winter heating season, slightly higher receivables.

Okay. And then I was curious on the cash flow statement, you show that you were able to reduce debt by $130 million in the quarter. Do you expect -- what do you expect for the year? Do you expect that will reverse as the CapEx cranks up?

I do because, as I was mentioning in response to a previous question, we'll spend right at $1 billion this year. Last year, we spent about $750 million. So we are going to spend quite a bit more this year than last largely driven by -- now we're getting into the high spending for the coal units.

That's all I had. Thanks.

[Ashar Khan], SAC Capital.

My questions have been answered. Thank you.

Paul Ridzon, Keybanc.

Assuming the alternative you choose is a disposition of the nuclear assets, does that necessarily trigger a rate case or how do you anticipate that unfolding?

No, I would not anticipate that it would trigger a separate rate case. Certainly we would have to have significant discussions with the Commission and we would do so. But I would not expect it would trigger a separate full-blown rate case, no.

And is your view that any potential gain would go 100% to your rate payers?

Well, again, it is really too early to tell because we have not made up our mind to sell the unit. We're doing a very thorough study, as I mentioned, and we would have to have significant discussions with the Commission.

Margaret Jones, Citigroup.

I'm sorry if you have covered this, but I had a question about your latest thinking on how these construction expenditures would leave your balance sheet at the end of the construction period after 2008. I think you've previously talked about how you could maintain the debt ratio no higher than 61.5% without new equity issuance. And I just wondered where you're coming out with that now?

Well, a couple of things and I will let Allen give his view as well. But first of all, our peak spending years will be 2006, 2007 and 2008. Remember the second unit at Oak Creek will not be online until 2010. So there will be some continuing spending, albeit in lesser amounts, in '09 and '10. And as Allen and I have looked at the situation, we really have no change. We really believe, based on everything we are seeing, that we will maintain our debt to total capital at or below 61.5% through the construction period. Allen.

That is exactly right. Our goal would be to maintain that debt to capital ratio at no more than 61.5%, as Gale mentioned, and that would exclude, to the extent that we do any of these environmental trust financing bonds, that would exclude anything from that since those would be issued in a structure that would cause them not to be the obligations of either Wisconsin Electric Power Company or Wisconsin Energy. So to summarize, really no change in the outlook for capital structure.

And sorry if I missed it, but when is the most likely time that you would you do the environmental trust financing?

I think if we did it, it would be more likely that we would do it either late this year or early next year.

And why would you not do it?

Why would we not do it? Well, at this point, we are looking at, very seriously, at doing it. So I think it is more a matter of timing really because when you do it, although in the long term it certainly represents a savings for customers, in the short term, it is a price increase. So we will --.

One of the things we've looked at is when would be the optimal timing for an environmental trust bond issuance. If you think about the work Rick is completing right now and working on, one of the major expenditures, and that is on the scrubber installation at Pleasant Prairie, that should be completed right towards the end of this year, that first scrubber installation. So it is beginning to be clearer that that may be a very good time, as Allen said, late this year or early next year for any TF issuance and I think he is right. The answer is really more when as opposed to if.

And are you actually required to do the issuance at the time that you are installing the scrubber?

No, we have the flexibility to do it at the time that makes the most sense for our customers.

Maurice May, Power Insights.

I'm glad you made it back from London.

That has been a while.

It has been a while.

Time to go again. At any rate, looking very long term as far as your generation needs and beyond Power the Future and even beyond the renewable mandates from the state, what are the possibilities for additional generation to meet future needs?

Well, certainly we continue to look at our generation models and we continue to look at when the next significant capacity additions would be needed. Right now, based on the models we're looking at, I would expect the next baseload need would be in the 2015 range, out in that time frame. That may seem like a long way away, but given the time it takes to permit and approve a baseload capacity, it is not all that far out. And then there will be some additional peaking along the way. Rick?

Gale or Rick, what would be your thoughts on fuel?

Well, I think for baseload generation, we would still look at coal-fired generation and we would look at -- we would be looking and seeing what the maturity is of IGCC technology. We had proposed that the last time around. The Commission made a decision it wasn't ready. There is a lot of people looking at it now, not a lot of real on the ground construction yet. So I would like to see some real operating experience. But clearly that would be something that we'd take a good hard look at it. Peaking obviously would be gas. Combined cycle would be intermediate.

Michael Lapides, Goldman Sachs.

One quickie follow-up and just wanted to doublecheck some rate-based numbers. I have got a WEPCO total rate base including all the steam of about $3.3 billion. Just tell me if that's way off base or not and a Wisconsin Gas that is about $580 million.

Rolling 12 month at Wisconsin Electric Power Company, the total -- so this would be at the end of March, so March 31 -- I have got right at $3.5 billion of total rate base. And that is across electric gas. And then if you look at Wisconsin Gas, it is right at $600 million.

And then what is Edison Sault?

About $44 million.

And those three things would comprise all of your rate base outside of ATC?

Yes, and outside of course of the new units, the new gas and coal units.

Understood.

That concludes the question-and-answer session. I would like to turn the conference back to Mr. Klappa for concluding remarks.

Well, that does conclude our conference call for today. We really appreciate you participating. If you have any other questions, Colleen Henderson will be available in our investor relations office and that direct line phone number is 414-221-2592. Again, 414-221-2592. Thank you again. Have a good day.

There will be a replay of this conference call starting at 4 PM Central time and running until midnight Central time on May 8. You may listen to the replay by dialing 888-203-1112 if in the U.S. or 719-457-0820 outside of the U.S. The access code will be 5637924. Thank you for joining us today. You may disconnect your line now.