威斯康辛能源 (WEC) 2008 Q3 法說會逐字稿

Good afternoon and welcome to Wisconsin Energy's 2008 third 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 any time. Such statements are based on management's expectations at the time they are made. In addition to the assumptions and other factors referred to in connection with the statements, factors described in the Company's latest Form 10-K and subsequent reports filed with the Securities and Exchange Commission could cause actual results to differ materially from those contemplated.

During the discussions, referenced earnings per share will be based on diluted earnings per share unless otherwise noted. 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 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 2008 third quarter results at www.wisconsinenergy.com. A replay of our remarks will be available approximately two hours after the conclusion of this call.

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

Thank you, Colleen. Good afternoon, everyone. Thank you for joining us on our conference call to review the Company's 2008 third quarter results. Let me begin, as always, by introducing the members of the Wisconsin Energy management team who are here with me today. We have [Rick Kester], President and CEO of (inaudible) Generation, Allen Leverett, our Chief Financial Officer, Jim Fleming, our General Counsel, Jeff West, Treasurer, and Steve Dickson, our Controller. Allen, of course, will review our financial results in detail in just a moment.

As you saw from our news release this morning, we reported net income from continuing operations of $0.65 a share in the third quarter of 2008. This compares with $0.70 a share last year. Earnings were down, largely because of the shape of our power purchase payments for the energy we buy from the Point Beach nuclear units. As we discussed in our last earnings call, the power purchase agreement is designed to reflect the change in market prices for the curve through the year and market prices are usually higher during the summer months. However, the $0.65 a share we're reporting is clearly better than our financial plan in large part because of lower than expected costs for diesel and natural gas during the quarter.

Our service area has a well diversified industrial base which tends to help mitigate the impact of an economic downturn. However, in the quarter we did see a slight drop in electric sales and that has continued into October. The largest declines have occurred in two sectors where we've seen significant declines over the past several years, automotive and paper production. At the same time, we've seen sales increases in other areas, namely chemicals, mining, and parts of the service sector.

As you would expect, we're also experiencing a slight increase in past due receivables driven by a combination of higher prices and slower payments. Of course we currently have some protection in Wisconsin. The residential bad debt that exceeds the level provided for in rates is deferred for future recovery. We're actively monitoring our past due accounts and working with customers on payment plans. One other positive development I would expect that energy assistance funds for our residential customers will increase by at least 10% for this heating season. We continue to see positive customer growth in our region, although at a slower pace than in previous years. At the end of September, our customer count was one-half of 1% higher than a year ago, and one other interesting statistic that I would like to share with you on the natural gas side of our business, conversions, largely from propane, are accounting for more than a third of the customer growth on the gas distribution side.

Now I would like to switch gears and spend just a moment with you 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. 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 plans to build a significant amount of new renewable generation. Of course, both of the units at Port Washington are now in service. Construction was completed on time and on budget for both unit 1 and unit 2.

Now let's turn to the status of the two new coal-fired units at Oak Creek. As you may recall, in late July, we and the other two owners of the expansion units at Oak Creek reached an agreement with Clean Wisconsin and the Sierra Club, the groups that had been actively opposing our water intake permit. Under the settlement agreement, the environmental groups withdrew their opposition and this brought to a close the ongoing litigation and administrative challenges to the permit. In addition, the deadline for appealing the water intake permit has now passed, so I can report to you that all litigation surrounding the permits for the Oak Creek expansion is resolved.

On the construction front, based on Bechtel's revised schedule, the Oak Creek project overall was approximately 65% complete at the end of September. Unit 1 and the common facilities are 76% complete and unit 2 is approximately 30% complete. Bechtel continues to make progress on the project. Currently, there are more than 2700 workers on the site. And a significant milestone was achieved just last week with the successful completion of the hydrostatic test of the unit 1 boiler. Progress also continues on the site for winterizing many of the structures, including the unit 1 boiler and turbine generator building to help minimize the impacts of the upcoming winter.

As we discussed on our last call, Bechtel is forecasting that completion of unit 1 and the common facilities will be delayed by three months beyond the guaranteed in-service date of September 29, 2009. Bechtel also advised us, as we reported last time, that they expect unit 2 to be completed one month earlier than the guaranteed in-service date of September 29, 2010. So assuming Bechtel maintains its current forecast, unit 1 and the common facilities would begin commercial operation at the end of December '09, unit 2 would be in service at the end of August 2010.

Bechtel is citing a number of factors that they believe have caused a change in the schedule. The factors include weather conditions of the two most recent winters, heavy rains this past spring, and what Bechtel believes to be changes in labor conditions.

Bechtel is still analyzing the impact of these factors. They have advised us that they expect to submit claims for schedule and cost relief by the end of this year. We don't believe there is a contractual basis for some of the claims that Bechtel may submit. For example, we disagree that Bechtel is entitled to cost or schedule relief as a result of changes in the labor market. To address this and other issues, we have invoked the contract dispute resolution clause. The first step called for management meetings to see if we could reach a resolution. This step has been completed and we were unable to resolve our differences with Bechtel. So the next step is non-binding mediation followed by binding arbitration, if necessary.

Obviously, it's not possible at this stage to provide you with any specifics on what the financial impact of any claims by Bechtel could be. However, I believe there are several key points to keep in mind. The first relates to the impact of the in-service dates on our reported earnings for 2009 and 2010. As I mentioned on our last call, we estimate that a one-month movement in the in-service date for unit 1 would result in a change of $0.03 a share in earnings. A one-month movement for unit 2 has a somewhat smaller impact. We estimate this to be $0.02 per share.

So, for example, if Bechtel's forecast of a three-month delay for unit 1 comes to pass, our earnings in '09, as we reported to you previously, would be reduced by $0.09 a share compared to what they otherwise would have been. If Bechtel's forecast of a one-month earlier finish for unit 2 comes to pass, then our earnings in 2010 would increase by $0.02 a share. Of course the ultimate earning power of the assets in 2011 and beyond is unaffected by the specific dates that the units will be placed in service in '09 and '10.

The next key point relates to cash flow. Under the terms of the lease agreements between Wisconsin Electric and We Power, we are recovering based on a mix of debt and equity our capital carrying costs as construction continues on the Oak Creek project. And we're allowed to recover our carrying costs up to the total budget for the project that has been approved by the Wisconsin commission. So while reported earnings in 2009 and '10 would be affected slightly by a change in the in-service dates, our ability to recover cash carrying costs should be largely unaffected.

I would also like to repeat the point I made last quarter about the ultimate recovery of any potential cost increases. We have several important layers of protection. To conclude that an additional cost is ultimately -- not ultimately recoverable, you would have to believe that the cost would not qualify for recovery under at least four opportunities that are clearly outlined in the commission's order.

First, that the remaining contingency in the project is not sufficient to offset the cost. Second, that the cost would fall outside the 5% bandwidth that the commission has deemed to be reasonable for prudent costs above the approved amount for the project. Third, that the cost was not caused by a force majeure event, as defined by the lease agreements. Finally, after an opportunity to demonstrate prudency, that the cost would be ultimately deemed imprudent. So although we have not yet received any detailed claims or resolved the disputed issues, we believe we have significant layers of protection in place. Of course we'll provide you with any updates on major developments in our SEC filings and on our scheduled earnings calls.

Now, as you know, Wisconsin has in place a renewable portfolio standard that increases from 5% in 2010 to 10% in 2015 at a statewide level. The standard sets targets for each of the utilities using an historical baseline. Using that baseline, approximately 8.5% of our retail electricity sales must come from renewable sources in 2015. Meeting the aggressive 2015 target will of course require several additional projects. With the completion of our Blue Sky Green Field wind farm on May 19, we took a major step towards meeting Wisconsin's goal to reduce its carbon footprint. With a total of 88 turbines, each with a capacity of 1.65 megawatts, Blue Sky Green Field is the largest wind farm to date in the state of Wisconsin. It was completed under budget and ahead of schedule.

To continue on a path toward carbon reduction, we recently completed the acquisition of a new wind site located in Columbia County in east central Wisconsin about 45 miles from Madison. We signed an option to buy this site from FPL Energy in conjunction with the sale last year of our Point Beach nuclear plant. And this week we filed for approval to build the new wind project, which is called the Glacier Hills Wind Park. We expect the site to accommodate between 100 and 200 megawatts of new capacity, depending on the final layout and the turbine equipment that we select. The permitting process is scheduled to begin later this year and the first full year of operation is expected to be 2012.

One other development of note from the past quarter, on July 10 the Wisconsin commission authorized an investment of up to $830 million, including allowance for funds used during construction, for the installation of wet flue gas desulfurization and selective catalytic reduction facilities at the four existing units at Oak Creek. The commission subsequently denied a petition for reconsideration from the two groups who oppose this environmental upgrade. We expect the new controls to be completed in 2012.

One other note, yesterday afternoon, we were notified that Wisconsin Energy stock will be included in the S&P 500 index, and that inclusion will be effective after the close of trading on Thursday.

And finally, Wisconsin Energy has once again been recognized for excellence in corporate governance. For the 15th consecutive time, we've received a perfect 10, the highest possible score from Governance Metrics International in that agency's latest evaluation. Wisconsin Energy is one of only four companies worldwide that have been consistently rated a 10 by GMI. Our Board of Directors has clearly established high standards for how we manage our Company and conduct our business and GMI's independent review confirms that Wisconsin Energy ranks among the best in the world in our corporate governance practices.

Now I'll turn the call over to Allen, who will give you more details on our financial performance for the third quarter of 2008. Allen.

Thank you, Gale. As Gale mentioned earlier, our 2008 third quarter earnings from continuing operations was $0.65 per share. I will focus on operating income by segment and then touch on other income statement items. I will also discuss cash flows for the year to date and update our earnings guidance for the full year.

Our consolidated operating income was $139 million as compared to $153 million in the third quarter of 2007, a decrease of $14 million. Operating income at our utility energy segment totaled $113 million, a decrease of $24 million versus last year. Now, before I discuss the primary drivers, I would like to remind you of a couple of developments that caused significant changes in individual items in the income statement.

First, in September of 2007, we sold our Point Beach nuclear plant and entered into a long-term power purchase agreement with the new owner. Since we no longer own Point Beach, our results this year do not include operating or maintenance costs related to the facility nor do we incur any depreciation or decommissioning costs associated with the plant. Of course, our fuel and purchase power costs this year have increased as a result of the power purchase agreement we now have.

Also, as we mentioned at our quarterly conference calls this year, we expect to see a different quarterly distribution of costs and earnings this year as a direct result of the power purchase agreement. Our income statement this quarter reflects $157 million of gain amortization relating to the gain on the Point Beach sale that is being used for the benefit of our customers. This includes a one-time refund of $62.5 million to our FERC wholesale customers with the remainder issued in the form of bill credits to our Wisconsin Electric retail customers.

I would now like to briefly expand on this item. The January 2008 Wisconsin rate order resulted in about a 17% increase in electric rates. This increase was needed to recover higher costs associated with transmission expense and environmental expenditures as well as the lease payments and O& M costs associated with our new power plants and our continued investment in renewables. However, our customers as a group have seen only about a 3% rate increase in 2008 from this rate order as the balance is being funded through bill credits from the gain on the sale of Point Beach.

While we look at the bill credits as a form of revenue, GAAP requires us to record the bill credits as part of the amortization of the gain because we are collecting the cash from the restricted cash accounts and not from customers. As we have previously discussed, once all the Point Beach gain has been returned to customers, the full 17% increase will be paid by customers and at that point, reflected in operating revenues.

With this as background, I would like to address the primary drivers in our operating utility income for the third quarter of 2008. First, price increases to our retail and wholesale customers resulted in a $57 million increase in revenues. However, the mild weather in the quarter reduced operating income $13 million.

In addition, the conversion of the Point Beach nuclear plant from being an asset owned by Wisconsin Electric to one owned by FPL Energy with an associated power purchase agreement reduced income $60 million. Additional planned operations and maintenance expenses at our power plants decreased income $8 million.

Operating income in the non-utility energy segment, which primarily includes We Power, was up $16 million. The key drivers of this increase were the new coal handling facility at the Oak Creek expansion which was placed into service in October of 2007 at a cost of approximately $175 million and the earnings from unit 2 at Port Washington, which was placed into service in May of this year. WISPARK had lower operating income of $6 million driven by reduced land sales as compared to the third quarter of 2007. Making the changes for each of these segments together brings you back to the $14 million decrease for the third quarter 2008.

During the third quarter, our earnings from our investment in the American Tranmission Company grew by $3 million. Other income declined $7 million because of lower carrying costs and regulatory assets. These regulatory assets are now a component of rate base, so the carrying costs are included in revenues instead of other income. Total interest expense was down $4 million. This decrease was driven by lower short-term interest rates.

Consolidated income tax expense declined by approximately $8 million because of lower pre-tax earnings. I expect that our effective tax rate this year will be between 36% and 38%. Adding these items brings you to $77 million of net income from continuing operations to the third quarter of 2008, or earnings of $0.65 per share.

Let me now turn to cash flow. During the first nine months of 2008 we generated $644 million of cash from operations on a GAAP basis which is up $11 million from the same period of 2007. This increase was driven by the implementation of new prices and reduced cash taxes offset in part by the earlier timing of a contribution to our pension trust this year. On an adjusted basis, our cash from operations totaled $924 million. The adjusted number includes the $281 million of cash impact from the bill credits and the one-time amortization of the gain.

Under GAAP, the cash from the bill credits is reflected in the change in restricted cash which GAAP defines as an investing activity. From a management standpoint, we consider this a source of cash as it directly relates to the bill credits and the one-time amortization. As long as the bill credits continue, we plan to provide both GAAP and adjusted measures of cash flow.

We believe the adjusted measure is more representative of the Company's ability to generate cash from operations for two reasons. First, the customer credits are being funded from the proceeds of the Point Beach sale that are set aside in a restricted cash account. And, second, once all of the Point Beach proceeds have been returned to customers, our prices and, hence, customer bills, will reflect the full cost of electricity without any credits.

Now, given the events of the past few weeks, I also wanted to expand more on our liquidity situation. On a consolidated basis, we have $1.61 billion of available undrawn credit facilities that expire in 2011. This amount excludes the $80 million of committed credit that we lost as a result of the Lehman bankruptcy. Of this, $856 million is at the Wisconsin Energy level and the remainder, or $758 million, is at our utilities. Our actual commercial paper balances at September 30 were $541 million and $296 million at the Wisconsin Energy and Wisconsin Electric levels respectively. We also had $78 million of commercial paper outstanding at Wisconsin Gas. However, we closed on a $300 million bond financing at Wisconsin Electric on October 1. The proceeds from this transaction were used to repay commercial paper.

Pro forma for the impact of these repayments are commercial paper balances at the end of September would have been about $391 million at Wisconsin Energy and $148 million at Wisconsin Electric. These balances are well within the limits of our credit facilities. The commercial paper at the Wisconsin Energy level is primarily being used to provide construction financing for the Oak Creek units while the CP at the utilities is used to provide working capital.

Our financing plan for the remainder of 2008 and all of 2009 calls for approximately $800 million in term financing. $300 million of this is expected to be at Wisconsin Energy and the remaining $500 million is projected to be at Wisconsin Electric. I would stress the plan calls for these financings over the course of the next 14 months and that we have a fair amount of flexibility in terms of timing within that window. So I believe we are currently in good shape from a liquidity standpoint.

Now I would like to move to uses of cash in the first nine months of the year. Capital spending was approximately $889 million in the first nine months of 2008, which is $47 million higher than the comparable period in 2007, but on track with our annual estimate. We expect to spend nearly $1.2 billion in capital this year in support of our power of the future construction program, the addition of wind generation and ongoing utility and infrastructure improvements. We also paid $95 million in common dividends in the first nine months of 2008.

On a GAAP basis, our debt to capital ratio was 58.1% as of September 30 and we were at 54.9% on an adjusted basis. This is down from our December 31, 2007, levels of 58.6% and 55.3% adjusted. The adjusted amount treats half of our hybrid securities as common equity, which is the approach used by the majority of the rating agencies. Given the high level of capital spending in 2008 and the fact that no significant asset sales are planned this year, I would expect our debt to capital ratio to increase slightly as of December 31, 2008, as compared to December 31, 2007.

Our goal is to maintain our adjusted debt to capital ratio at no more than 60% during the period we are constructing our new coal fire generation. We are using cash to satisfy any shares required for our 401(k) plan, options and other programs. Going forward, we do not expect to issue any additional shares. Given the expected reduction in capital expenditures next year, we believe that we will begin to have more room for dividend payments in our financial plan. We certainly recognize the increased importance of dividends given the current market conditions. As a result, the Board of Directors plans on reviewing our dividend policy at their meeting on December 4 for a potential change to the dividend in 2009.

Now, I would like to update you on our electric fuel cost recovery position in Wisconsin. On July 31, during our second quarter conference call, we discussed our expectation regarding electric fuel cost recovery. At that time, we projected that under recoveries would be between $20 million to $40 million for 2008. Our expectation has now changed because of the substantial drop in natural gas and diesel prices in the past few months and the impact of cooler than normal summer weather in the third quarter. We now expect to be close to a fully recovered position on our fuel costs for 2008.

Now I would like to wrap things up with a review of our earnings guidance for 2008. Based on our results in the first nine months of the year and our forecast for the remainder of the year, we're slightly ahead of our financial plan. However, weather and economic uncertainty remain in the fourth quarter. As a result, we are moving our full year guidance to the upper end of our previous range of $2.80 to $2.90 a share, so our new guidance for 2008 is now $2.90 per share. So with that, I will turn things back to Gale.

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

(OPERATOR INSTRUCTIONS) We'll take our first question from Greg Gordon with CitiGroup.

Thanks. Hello, Gale.

Hi, Greg. How are you today?

Doing alright. I wish Brett wouldn't throw so many interceptions, but otherwise it's okay here in New York.

It will be a thrill a minute, Greg.

Two questions. One is as you look at the dividend policy of the Company, you did state pretty much the same philosophy on your second quarter call as you're stating now as far as what you're recommending to the Board. Has your point of view on what a reasonable level of dividend policy in '09 should look like changed at all in the last three months, given how much tighter the market conditions have gotten on credit?

Greg, not really. We tend to look at things in three- to five-year increments to the degree that we have certainty. And we really are making a dividend decision and recommendation to the Board based on not just the six-month look or not just a one-year look, but on how we see the business evolving over the next three to five years. So, if anything, we've been boringly consistent about that. But in terms of -- I mean clearly we have -- we've taken into account what we're seeing in the credit markets but, as Allen mentioned to you during his portion of the call, our liquidity situation is in good shape. We have some flexibility in terms of the next 14 months and the debt offerings. We don't need to issue any additional equity, so certainly we've taken a look at it and factored in the current credit conditions, but it has not changed our long-term three- to five-year view.

Okay. So all things being equal, the payout ratio that you would have thought appropriate in August is the same payout ratio you would recommend today if you were going to the Board with that recommendation?

That is exactly right, Greg.

Thanks. The second question for Allen, can you reiterate what you said about where you thought you would be on fuel recovery going into the summer and where you think you'll be now? And can you tell us whether the majority of that benefit has already occurred in the peak summer months, and how much of that you think is going to the flow through into Q4 given the decline in gas prices?

Sure, I would be happy to. Just by way of context, again, on the July 31 call, at that point, Greg, we expected our under recovery for the calendar year 2008 to be between $20 million and $40 million. And we now, sitting here today, our latest projection would be essentially to be in a fully recovered position for calendar year 2008. And that was very much driven really by three things. First, the move in the natural gas strip. I think it was approximately $14 per million back in July when we did that projection. It's about half that, or $7 per million now. Fuel oil went from roughly $4 a gallon in July to roughly $2 now. And we also, over the course of the summer because of the mild weather, just from a volume standpoint, we burned much less natural gas than we expected. So that's really what moves you from the 20 to 40 to the roughly fully recovered.

In terms of the timing, Greg, within the year, in -- if you look through the end of the third quarter, say year to date, and look at your fuel recovery situation, we were approximately $24.1 million under recovered on fuel year to date through the end of September, so at September 30, under recovered $24 million. So essentially when you look at the fourth quarter, we would expect to have that turn and come to roughly a neutral position by the end of the year.

Greg, Allen's exactly right. And one other point that might be helpful, we have an agreement in place for this calendar year with the Wisconsin Public Service Commission that if, if fuel prices were to stay very low and we somehow made up all of the deficit on fuel recovery and over recovered, we would return to customers the over recovery. So anything above fully recovered would not flow through to earnings, would instead flow back to customers next year.

Okay, so you wouldn't keep the benefit inside the dead band then?

We would keep the benefit up to fully recovered.

Right.

Anything above full recovery, there would be no dead band this year, if you will. It would all above fully recovered go back to customers.

Right. My understanding of the new rules is that there's a 2% bandwidth.

Well, there's a 2% bandwidth in place today.

Right.

And the new rules are really not in a position to become new rules yet. I think the Wisconsin commission has now decided to step back, take another look and perhaps seek some guidance from the legislature. But there is a 2% bandwidth of sorts in effect today.

Okay. So the proposed changes in the fuel rules that we were looking at potentially getting codifided this year are now sort of been put on hold?

That is correct.

And in their place, you have a short-term patch which basically says if you get back to fully recovered, that's where you stay?

For this calendar year, that is correct.

And Greg, maybe one other point of background. If you look at the fourth quarter of '07 and compare it on a really consistent basis to what we would expect in '08, it's a pretty similar pattern. So we would see on an apples to apples about a $20 million turn last year in the fourth quarter and we're expecting about that kind of swing in the fourth quarter this year to bring us back to that hopefully fully recovered position for the calendar year.

Thank you, gentlemen.

Thank you, Greg. Appreciate the questions.

And we'll move on to our next question from Michael Lapides from Goldman Sachs.

Hey, Mike.

Hi, guys, how are you?

Doing good.

I actually have two questions. On the south Oak Creek environmental CapEx, are there any challenges left over related to that or any rumblings of any of the parties potentially appealing the PSCW opinion or order?

Good question, Michael. The answer is no. There was an environmental group that opposed the upgrade. They asked the commission for reconsideration, but the commission denied that reconsideration and I believe all is clear and there is nothing pending whatsoever in terms of any legal challenges.

Okay, and Allen, on the short-term debt balance, and I apologize, you talked about it in your prepared remarks and I'm not sure I captured it all. Can you talk a little bit about plans for treating the $914 million under short-term debt over the next 12 to 14 months? Apologize if it's repeat stuff.

No, no, that's quite all right, Michael. You're right. On an actual basis, we were at approximately $914 at the end of the third quarter. However, on the very next day after the end of the quarter, on October 1, we closed on $300 million worth of term financing at Wisconsin Electric and we used that to pay down commercial paper. So if you looked at our pro forma balances, if you will, on September 30, so pro forma for that security issuance, Michael, we were at $391 million at Wisconsin Energy and $148 million at Wisconsin Electric which, if you look at that on a percentage of the debt that we had outstanding at September 30, we had roughly $4.6 billion worth of debt outstanding.

So those pro forma CP balances would represent about 13.5% of our outstanding debt and roughly 8% of our total capitalization. In terms of security issuances that I would expect for the remainder of 2008 and 2009 combined, we would hope to do on the order of another $300 million of term financing at the holding company and another $500 million of term financing at Wisconsin Electric. But I would just stress, Michael, that that's over a 14-month period that we would be looking at doing those financings, and we really have a fair amount of flexibility in terms of when we time those within that 14-month window. Is that helpful?

No, that's, that's extremely helpful. I greatly appreciate that. Last question, pension, cash requirements for the next 12 to 14 months?

Yes, and maybe just to sort of put that in context. We made a contribution in January of this year to the qualified plans, $48 million, so that's a gross of tax benefit figure of $48 million contribution. As I sit here today, I would expect in calendar 2009 that we would make approximately a $180 million contribution. So up quite a bit in '09 as compared to '08. However, I would just re-[emphasize what Gale already said in his response to the dividend question that Greg Gordon asked, we look at pension contributions as well as dividend decisions over a multi-year basis, so you should not conclude that because we've had a big tickup in the projected pension contribution in '09 as compared to '08 that that somehow impacts our dividend decision.

Allen is exactly right. We are looking at this, as we mentioned, on a three to five-year basis. I mean clearly the market conditions are such that many, many companies are going to have to make significant cash contributions to their pension plans next year. By the way, Michael, your buddy, Drew Brees, looked pretty good in London over the weekend.

You know, it's kind of funny, I'm not a native west Tennessean but a former New Orleans resident. I'm not actually that big of a fan of the Saint's, although if Archie Manning were still quarterbacking, maybe I would change that opinion.

There you go.

Thanks, guys. Y'all have a good one.

Take care, Michael.

And we'll move on to our next question from Paul Ridzon with KeyBanc Capital Markets.

Good afternoon, Paul.

Good afternoon. How are you?

Fine. How are you doing?

I had a question, you gave I think $0.53 to $0.57 guidance for the third quarter. Was -- could you just outline kind of the deltas versus plan? I realize fuel must be a big piece of that.

Fuel's the biggest piece.

Yes, almost all of the swing, Paul, as we sort of said, plan would be $0.53 to $0.57. Almost all of the swing between the $0.53 to $0.57 and the $0.65 actual is what happened with fuel, because we had a very pleasant surprise, I guess if you will, on fuel recovery, but it was a surprise, nonetheless.

And clearly none of us anticipated the incredible volatility in the fuel markets, particularly with the crash of natural gas prices. The two things that helped us the most really were the huge declines in the natural gas strip and the fact that the diesel fuel surcharges that were being passed through to us from the railroads for moving coal to our power plants, those diesel fuel charges really declined as well as oil prices declined. So a very positive surprise and our units operated quite well during the summer. So put those together and we had a very positive movement in fuel recovery.

What was the delta in the 3Q fuel balance?

I'm sorry, Paul. Say again?

How much did the fuel balance change in the third quarter?

From the end of the second quarter?

Yes.

We were about $3 million. We were actually -- we were expecting much less -- we were expecting a greater under recovery in the third quarter. I think we ended Q2 at about $21 million of fuel under recovery for the year to date. We're now at $24.1.

Right, and the projected under recovery for the quarter was much, much greater.

Much greater, yes.

Than that. One other maybe point of background, Paul, I don't know if it would be helpful or not. Of course the weather was milder than normal in the third quarter. That certainly helped fuel recovery, as we mentioned, but obviously adversely impacts margin otherwise. But we were able to offset that with better experience than we expected on O&M. So the O&M and the weather effects were almost neutral when taken together. And then the big swing that you're left with is fuel recovery.

And, Paul, the other reason that we were projecting a much larger under recovery for Q3, again, as we mentioned earlier in the script, it was because of the shape of our power purchase payments for the Point Beach units. If you turn back the clock a year ago, we still owned the Point Beach units. This year, we have a power purchase agreement after the sale of the units and, as I mentioned, the shape of that power purchase agreement, purchase agreement has us paying higher purchase power costs in the summer than in the shoulder period.

You actually absorbed fuel under recovery in the third quarter, but to a lesser extent than planned?

That's a good way to describe it.

And do you use five-year pension smoothing or how do you -- what is your smoothing method?

For funding purposes when we determine the actuarial value of assets, I believe we use two-year smoothing when we look at the actuarial value of assets for the purpose of funding. Now, when you look at, say, FAS 87 expenses, which would be more of a GAAP treatment, you would do smoothing of gains and losses and so if you're in a position where in a year you earn more than your actuarial return assumption or you earn less, you then smooth that into income over four years, but for the purposes of funding and the actuarial value of assets, you do that over two years. Does that help?

Yes, it does. Those are my questions. Thank you.

Great. Thank you, Paul.

And we'll take our next question from Gary Linhoff with Iron Works Capital.

Hi, Gary. How are you doing?

I'm fine. Thanks. Thanks for taking the question. You may have addressed this before and I just missed it, but can you tell us as of the most recent date you have, what the performance of pension assets has been?

Sure.

Sure.

In fact, we have that right here in the room with us.

Yes, Gary, I tend to get a report every day on this. Through the end of yesterday, we -- our return was minus 26.7%, so the asset return was minus 26.7% through the end of yesterday. And maybe as some additional context, Michael Lapides asked me about the funding assumption for next year, and that funding assumption of $180 million was based on the assumption that we would experience a minus 25% return this year, but that the liability discount rate would be 6.5%. So although our experience year to date is just a little more negative than minus 25%, if we were going to run the numbers today in terms of the appropriate liability discount rate, the liability discount rate would be closer to 7%, which would reduce the present value of your liabilities. So net-net, even with the performance through today, or through yesterday rather, I would expect that we will still be looking at about a $180 million contribution.

Okay. So if I, if I'm thinking about this correctly, the value of the assets is down about $250 million which, at your expected return assumption, is about $20 million, $21 million or so of pension, additional pension expense, if we thought about it on a cash basis.

On a cash basis, yes.

Okay. That's helpful. Thanks very much.

Okay. Thank you so much.

And we'll take our next question from Ted Heyn with Catapult Capital.

Good afternoon, Ted, how are you doing?

Good, how are you?

Fine. You headed for Phoenix next week?

Yes, hope to see everyone down there. Good. Had a few quick questions. First just on weather year to date. Where are you guys ahead or behind kind of compared to normal?

For the summer, while Allen looks at his numbers, let me mention one thing to you about the summer. We had a cool summer this year, fairly normal summer last year, but to put this summer's experience in perspective, we did not have one single 90-degree day in Wisconsin the entire summer. So you've heard of the endless summer. Well, this was the summer that never started.

Wow.

Allen, do we have nine months?

Yes, in terms of -- if you look at the margin level, Ted, which is probably the most relevant for your purposes, if you look nine months ended September 30, we were about $7 million below normal on margin. Or in other words, if we had experienced normal weather through the end of September, we would have expected our margins to have been about $7 million higher than normal and -- than actual. Through the end of September of '07, so September 30, '07, it was essentially normal. So if you're looking at either a comparison to last year's weather or a comparison to normal, it's about a $7 million negative swing.

Okay. So compared to plan at the guidance at the beginning of the year, you're just slightly behind and you're obviously making that up with better fuel recoveries.

That's correct, yes.

And better O&M.

Yes.

And better O&M. Secondly, Allen, I know you mentioned at some previous conferences you expected to be $15 million under recovered in 2009. Is that kind of still where you expect to be or has your outlook changed on that?

At the moment, Ted, that's still the number we're using for planning purposes, but I would add one thing. Our fuel clause next year will be in the neighborhood of $1.3 billion, so to be any more precise than $15 million current projected under recovery for our base plan, we're not going to get any more precise than that and it will change 15 million times between now and next year. Again, because of the volatility of the fuel markets and the size of our fuel clause.

Okay. But the $15 million bogey's still the best one to use at this point?

That's unchanged from what Allen mentioned back in September, yes.

We still view that as a reasonable planning assumption, Ted.

Great. Okay. Thanks a lot, guys. I appreciate it.

See you next week, Ted.

Yes, you, too.

And we'll take our next question from Dan Jenkins with State of Wisconsin Investment Board.

Dan, good afternoon. How are you?

Good.

I have a question for you.

Sure, what?

I was watching television last night, and was that you I saw with Joe the plumber with that wrench?

No, must have been my twin brother, I guess.

He had a great wrench, really did. I would advise you to get a new tool belt then.

Oh, okay.

Dan, I wouldn't put up with this kind of abuse.

How are you, Dan?

Pretty good. Just a few questions here. First, I forget, could you remind me, when does the amortization of the gain end? Does that end at the end of this year or does it still have another year to run after that?

Just quick review on that, we're essentially providing credits, if you will, in three jurisdictions, Wisconsin, Michigan and FERC. Michigan and FERC are done now and I would not expect -- well, there won't be any more credits in Michigan and FERC related to Point Beach. So the only credits that would remain would be in the Wisconsin jurisdiction and those were the bulk of the credits. So sitting here today, Dan, I would expect that really you would continue to see credits for the remainder of this year as well as calendar '09, '10, and there could be a very tiny amount that would lapse over into the early part of 2011. But I certainly would expect to see credits for the remainder of this year '09 and '10.

That is exactly what the Wisconsin Commission envisioned, at least the three-year amortization, if you will, of the credits on to customer bills, and I think Allen is right. We may see some additional small amount of credit move in to 2011depending on energy sales and depending upon the interest that's earned in this restricted account, but certainly for three years, '08, '09, '10, and maybe a chunk into '11.

Okay, and that's pretty much like a straight line amortization.

No. It follows -- well, the amount of credit obviously is based on energy usage, so you can get variability there.

Right.

But also there is a -- even at target, even at the budget, if you will, on energy sales, or at least the budget that they set rates based on, there was a downward pattern in credits as you go over that roughly four-year period.

The biggest credit amounts will be this year and then it will step down next year and there will be another stepdown in 2010.

Okay. It was front end loaded, then.

Exactly.

To some degree, yes.

Okay. On the financing needs, I know you have $320 million that matures in December and it sounds like you used your -- that $300 million you issued in -- at the first of this month to pay down short-term debt. Would you anticipate returning to the market or taking short-term debt back up, or how would you manage that maturity?

Well, at this point looking at the financing plan over the next 14 months, $300 million at the Holdco, $500 million term financing at the utility have a fair amount of flexibility within that 14-month window. So we'll look at conditions and pick what we think are appropriate timing for those offerings, although my philosophy is sort of a dollar/cost average. I certainly wouldn't expect to go out and do all of the $800 million within a very compacted period of time. I think we would try to spread it out a bit more over the period because, candidly, I don't know which way spreads or treasury yields are heading.

Okay. And then on your cash flow statement, what was going on with the deferred taxes and the working capital changes from this year versus last year's? Is the deferred taxes related to the amortization of the --?

In terms of cash taxes, let me address that and then I'm going ask Steve Dickson to talk about the working capital component of it, Dan. But on the cash taxes question, what's really our deferred taxes, which is, of course, related to cash taxes, we had a lower cash tax rate in '08 because we were able to recognize quite a bit of -- we were able to go ahead and expense for tax purposes items that previously would have been depreciated for tax purposes over a longer period of time. So another way to think about that is we basically were able to advance some deductions for tax purposes. That reduces cash taxes and then, of course, results in a buildup in the deferred tax liability.

This was the result of a very thorough tax depreciation study that we completed.

And, Dan, as you look at the consolidated, condensed statement of cash flows, I assume the line item you're looking at is working capital and other.

Right.

Looks like it increased about $226 million between years. The two biggest drivers relate to deferred costs and then deferred revenue. On the deferred costs, last year we were in a position where we incurred high fuel costs and we deferred them on our balance sheet at the request of the recovery of those. So that was a cash outflow. This year, with a new rate order, we are amortizing a lot of those costs. So the swing related to deferred costs is about $130 million this year compared to last year. The second largest component relates to the deferred revenue. As Allen and Gale mentioned, we're collecting cash carry costs in the power of the future plans and as the construction work in progress balances grow, the amount of cash we collect increases and that amount is about $33 million. So those were the two largest items in that account.

Okay, and then it sounds like since the recovery on the fuel costs will kind of reverse in the fourth quarter, would you expect to see that then expand even more in the fourth quarter?

No, I think that -- two different things. Allen was talking about the ongoing fuel costs. The costs we deferred last year did not go through fuel expense, so that was not in the calculation last year. What we would expect to see in the fourth quarter is a continued amortization of the regulatory assets and so that's a non-[cash item which will increase cash flow, and I don't think we had significant deferred items in the fourth quarter last year. So we won't see a huge change.

Okay. Then the last thing I was wondering about is on your sales numbers for the third quarter, you actually had negative revenues from wholesale/other, which seems somewhat unusual. I was wondering if you could explain.

Steve has got that detail.

Dan, as Allen mentioned in his discussion, in the third quarter we made a one-time refund to our FERC wholesale customers and that was for their share of the amortization of the gain and that was $62.5 million. Where that was reflected on our income statement was we reduced our revenues, our wholesale revenues by $62.5 million and then we increased the amortization of the gain. So on the income statement, it was neutral, but GAAP requires us to show refunds as a reduction of revenues and so that's why we have -- it looks like negative revenues for that customer class.

Okay. That makes sense. Thanks.

Terrific.

And we'll take our next question from Steve Gambuzza with Longbow Capital.

Good afternoon.

Hi, Steve, how are you today?

Good, thanks. Question on the pension funding, how does that $180 million compare to the amount of kind of non-cash accrued pension expense embedded in your rate? Because I would imagine that it's really the differential between those two numbers that is really kind of the outflow on the cash flow statement, is that right?

I believe the pension expense that was in the last rate case was probably on the order of $30 million.

Okay. So that's how much is noncash accrual is in your rate structure, and so--

That's how much is included in rates and, therefore, you recover in cash.

Right.

So that's the $30 million. And then the deficit that you in effect are having to fund above that is the difference between the $180 and the $30 or $150 million, if I'm following you.

Yes, okay. Thanks very much.

You're welcome, Steve.

And of course you know this, Steve, but to remind everybody on the call, the $180 is tax deductible, so I take gross $180 and then will tax benefit that $180, so I'll get a deduction for $180 on the tax refund.

Thanks very much.

Take care, Steve.

And we'll move to our next question from Maurice May with Power Insights.

Yes, good afternoon, folks. How are you?

Good, how are you?

Okay. I'm old fashioned and I have another question on dividends. Your previous comment, I recall, as being a dividend payout target of some 50% to 60%, is that what it was?

What we've said is that we have a near-term policy which we are now revisiting, and that near-term policy basically is tied to what we believe we can afford during this period of heavy construction spending, and that is trying to grow the dividend about half the rate of earnings per share growth. Now we're revisiting that, but we have not yet publicly discussed what the new dividend payout ratio range would look like. That's something we're going to have a very thorough discussion with our Board about in early December and hope to communicate with you after that.

Okay, good. Thank you very much.

You're welcome.

We'll take our next question from Alex Kania with Merrill Lynch.

Greetings, Alex.

Hi, good afternoon. Just some thoughts I would like to hear from you guys on just the breakdown between, on your retail sales about how you think weather versus some of the economic factors, and if you -- it's been a pretty quick, crazy quarter with respect to weather, but your thoughts generally on fundamental demand and trends you've been seeing recently.

Sure, I would be happy to discuss that. First of all, in general terms, just to kind of set the playing field, manufacturing demand for electricity is not very weather sensitive. You heard us talk earlier about some of the pluses and minuses we're seeing in our base of manufacturing customer. So in looking at roughly 37%, 38% of our total retail sales being to manufacturing customers, we are only down about 1% so far this year in terms of energy consumption by our manufacturing base. Clearly, paper production and automotive and automotive parts are deteriorating no question about that. But we've seen other bright spots and we continue to see interesting growth in the commercial or non-manufacturing segment of our customer base. There's a significant expansion here in healthcare. We have several new hospitals, several new medical research centers being built. So we really see some interesting expansion that has offset some of the weakness in the non-manufacturing base. So it's down about 1% on the manufacturing side so far.

In the commercial or non-manufacturing side, a little more weather-sensitive, but we're seeing some growth offset other weakness and then residential really is tied to two things. Your household formation and customer growth and the weather. And the residential obviously swings very much with the weather. I mentioned earlier that we're still seeing positive customer growth. That is not the case in other parts of the country, but we're still seeing, slower, but positive customer growth, about up one-half of 1% over the last 12 months, and a fair amount of conversions from the natural gas side from propane to natural gas. So I would look at the weakness that we saw so far this year, particularly this summer, in residential demand as purely weather driven.

Okay, great. Thank you, guys.

You're welcome.

And we'll take our next question from Paul Patterson with Glenrock Associates.

How are you today, Paul?

All right, good afternoon. Almost all my questions have been asked, but the only thing I wanted to follow up with, Greg, when you were talking to Greg about the legislature, looking at the new fuel rules, or I guess the PSE going to the legislature, could you just elaborate a little bit more about what that looks like now? Is there a bill, or when would that happen, or --?

Well, I'll be happy to elaborate. The answer is we're not certain. The commission is still considering what path to take and what specific actions to move forward on. My sense is, although the commission has not made a final decision, that there is some uncertainty about whether the commission has the administrative authority under Wisconsin law to change the fuel rules, and in light of that uncertainty, they may submit to the legislature a proposed change in the fuel rules for the legislature to vote on. That's the current discussion by the commission.

Does the commission have the legislative authority under the law to make an administrative change in the fuel rules or not? So I would expect that if the commission makes a final decision that they need to go to the legislature for a change in the fuel rules that they would probably propose a change to the legislature in the form of a bill or part of an energy package that might be submitted in the spring. That's my current guess, but no final decision has yet been made by the commission.

Okay. So it's, so it's going to be some time before it's resolved, it sounds like.

I would think we would see some resolution next year. If I were a betting man, that would be my bet.

Okay, great. Thanks a lot, guys.

You're welcome.

And we'll take our next question from Vedula Murti with Duff Capital Advisors.

Good afternoon. How are you doing?

We're doing great. How about you?

Doing fine. Thank you. Different topic. Can you update us on the carbon capture pilot that's going on at your coal plant?

Sure. We'll be happy to give you the data we have at the moment. Really, we have a one-year experiment here. The manufacturer has some technical difficulty in the early stages with some aspects of the technology, particularly the chilled ammonia piece, and that has now been rectified and data collection is under way and, Rick, I would expect some time early next year we'll see some specific data, but I understand they have been reasonably pleased with the performance.

Yes, I think that's right, Gale. And, of course, this is being funded by a consortium and that data probably will take a while to work its way through before it becomes public.

We will certainly, as part of our commitment, the group of utilities through the Electric Power Research Institute and Alstom, which is the manufacturer, we will make a public report on this data as we collect the data and as we understand the efficiencies of the technology and the effectiveness of capturing the carbon with this chilled ammonia process.

Okay, so is basically that beginning problem, because I think last call or one of the more recent times you had indicated about this time you would have a much better sense, so it seems like there might be a two, three-month delay in that.

You're exactly right. There was about a two to three-month delay in getting consistent operation of the technology in light of some of the startup issues they have had, but they have overcome those issues and, again, the sense we get is they are pretty pleased with the performance, but we'll know a lot more I'm sure early next year.

All right. Thank you very much.

You're more than welcome. Thank you.

And we'll take our next question from Greg Gordon with CitiGroup.

Greg, you have the honor of being the first and last.

Fantastic. Pension, you've told us about your projected cash obligations. You have $30 million in rates in in rates in terms of operating expenses from the last rate plan.

Right.

If I look at FAS 87, what would you project to be your increase in, if any, in FAS 87 pension expense next year as you look at it today and as the regulatory mechanism that mitigates the impact on earnings between rate cases?

Well, certainly to start with, the second question first, we run a two-year cycle so in Wisconsin your pension expense is sort of is what it is, the one included in rates, and there is no true-up or anything. If you have a big increase or a big decrease, that's just something that you have to plan around as a company, so there's not any true-up mechanism.

Not between rate cases.

Not between rate cases, but obviously when you file a rate case say next spring, you put in your latest projection for '10 and '11 and then they will set rates on that. And in terms of an annual increase because of the smoothing, I don't know, Steve, did you want to take a crack at that, at what that increase might be?

There's so many factors that go into pension expense, smoothing in the return, balancing the asset, discount rates, change in the service clause. This year we think we'll have about $22 million, $24 million pension expense. Next year we expect to see an increase, but at this time we're not in a position to say.

And there's one big variable obviously, Greg, in addition to the asset returns, is where that liability discount rate turns out, and so you can get moves, very big moves in pension expense based on what happens to that liability rate. So it's a little hard -- I'll be certainly happy when we do our February call to talk about what we project and what the key assumptions are then, but it's still a little early.

Right now, as I think Allen mentioned earlier, if the year were to end today, we would actually be helped a little bit by the difference in our assumption on the discount rate versus where the discount rate really appears to be. So we will, we will be happy to discuss in great detail with you on the call but, at the moment, we're not panicking over this, because, again, I think we have some conservative assumptions and that discount rate could make a huge difference.

My understanding is you would amortize the under recovered balance, you're saying, over a -- is it a four-year period?

Four-year smoothing of the asset return, yes.

But that to the extent your discount rate goes up, that reduces the projected benefit obligation by a pretty meaningful amount and that's an offsetting factor in the impact on earnings, correct?

Absolutely right.

And how does that offset -- is that also smoothed over a four-year period, or is that booked in -- is that offsetting reduction in the PBO booked just in the period?

Off the top of my head, I don't know the period over which you do the liability -- liability smoothing. I think it's more than four years, though, Greg.

Okay, but that's a big mitigating factor to the extent interest rates stay high?

You are correct.

You have to be careful what you hope for, but that's right if you have high interest rate.

Okay, thank you, guys.

Thank you, Greg. Well, that concludes our conference call for today, ladies and gentlemen. We appreciate you participating. If you have any other questions, Colleen Henderson will be available at our Investor Relations office, 414-221-2592. Thank you again. Good afternoon everybody.

This concludes today's conference call. Thank you for joining, and have a great day.