威斯康辛能源 (WEC) 2011 Q1 法說會逐字稿

Good afternoon. Thank you for holding, ladies and gentlemen, and welcome to Wisconsin Energy's conference call to review 2011 first quarter results. This conference is being recorded for rebroadcast, and all participants are in a listen-only mode at this time.

Before the conference call begins, I will read the forward-looking language. All statements in this presentation, other than historical facts, are forward-looking statements that involve risks and uncertainties which are subject to change at any time. Such statements are made based on management's expectations at the time they are made. In addition to the assumptions and other factors referred to in connection with the statements, factors described in the Company's latest Form 10-K and subsequent reports filed with the Securities and Exchange Commission could cause actual results to differ materially from those contemplated. During the discussions, referenced earnings per share will be based on diluted earnings per share, unless otherwise noted. After the 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 2011 first quarter results at www.WisconsinEnergy.com. A replay of our remarks will be available approximately two hours after the conclusion of the 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.

Elaine, thank you. Good afternoon, everyone. We appreciate you joining us on our call to review the Company's 2011 first quarter results.

As always, let me begin by introducing the members of the Wisconsin Energy management team who are here with me today. We have Rick Kuester, our Chief Financial Officer; Allen Leverett, President and CEO of We Generation; Jim Fleming, our venerable General Counsel; Steve Dickson, our Controller; and Pat Keyes, who has joined the Company as our new Treasurer. Pat, of course, is taking the reins from Jeff West, and as many of you know, Jeff retired at the end of April after 41 years of service. I understand that Jeff is on his favorite lake today, trying out a brand new rod and reel, and we hope the fish are biting.

Rick will review our financial results in detail in just a moment. But as you saw from our news release this morning, we reported earnings from continuing operations of $0.72 a share for the first quarter of 2011. This compares with $0.55 a share for the first quarter a year ago. The uplift in earnings for this year's first quarter was driven by the commercial operation of the second expansion unit at Oak Creek, which, as you know, was placed in service in the early morning hours of January 12. Across our utility operations, we experienced improved fuel recovery in the first quarter and colder winter weather. Overall, we're off to a solid start for the year.

Now, I would like to briefly touch on the state of the economy across our service area. Overall, electric sales to large commercial and industrial customers rose just 0.4% over the first quarter of 2010. But a deeper look inside the numbers will give you a more complete picture. First, as you may remember, a Chrysler engine plant in Kenosha, Wisconsin, shut down last year, and that is a permanent shutdown. This plant was one of our larger customers, and we had factored this closing into our 2011 forecast. In addition, on February 2 of this year, we experienced a blizzard that shut down much of the region for a good couple of days. If you exclude these two items, growth and energy use by our large commercial and industrial customers would have been in the 2% to 3% range, which is right in line with our forecast. We are seeing strength in iron ore mining, especially steel production, and printing; and we're cautiously optimistic that the recovery will continue throughout 2011.

Now, as I mentioned on our February call, we reached a milestone event in the first quarter, as construction was completed on our Power the Future Plan. More than 10 years ago, we developed a road map that we called Power the Future. It was fundamental to the principle of energy self-sufficiency. Key components of achieving self-sufficiency include investing in 2 combined-cycle gas-fired units at Port Washington, which is north of Milwaukee; and the construction of 2 super critical pulverized coal units at Oak Creek, which is south of the city; and building a significant amount of renewable generation. With the commercial operation of Unit 2 at Oak Creek, we have now completed the last of the 4 major units that were designed to provide our customers with a state-of-the-art generation fleet, and provide clean, reliable energy for many years to come. The 2 natural gas-fired units and the 2 coal-fired units required a total investment of more than $2.6 billion, and we're very pleased with the efficiency and the environmental performance of these units. Our customers are now receiving the operational benefits of these plants, and our patient stockholders are beginning to realize the full benefit of their investment.

While we've largely completed our Power the Future effort, there is clearly much more work to be done and more value to be created. We have several major projects underway and in the pipeline. To help us meet the state's renewable energy standard, we're building the Glacier Hills Wind Park on more than 17,000 acres of rolling farmland approximately 45 miles northeast of Madison. When completed, this will be the largest wind project in the state of Wisconsin. It will consist of 90 turbines, with a total generating capacity of 162 megawatts, or about 1.8 megawatts per wind site. Construction began at Glacier Hills about a year ago, and we're currently on track to begin full operation by the end of 2011. The total cost of the project is expected to be approximately $360 million, excluding allowance for funds used during construction and reimbursable transmission costs.

Now, as you know, we've also proposed a 50 megawatt co-generation plant, to be fueled with biomass at a paper mill site in northern Wisconsin that is owned by the Domtar Corporation. This site, as I've mentioned, is close to significant forest lands that are harvested in a sustainable manner, yielding the wood waste that would power the plant. We've received all of the local permits necessary to move forward, and last week, the Wisconsin Public Service Commission held an open meeting on the matter. The commissioners expressed concern about the overall cost of the project, and asked if Domtar would be willing to bear a greater share of the cost by paying more for the steam that the plant would produce. We and Domtar have filed a joint response, actually, just at noon today, and we expect a final decision from the Commission in the next week or so. And I believe that response you will find to be a very positive response.

Finally, on the construction front, we continue to make excellent progress on a major upgrade of the air quality controls for the older coal-fired units at Oak Creek. We're investing approximately $900 million, and, I might add, this is the second-largest construction project in the history of the Company. Approximately $900 million, including allowance for funds used during construction for the installation of wet flue gas desulfurization and selective catalytic production facilities. We expect these controls to be completed in 2012. As we speak, the project is more than 75% complete, and again, we're on time and on budget.

In other developments during the first quarter, we completed the sale to Alliant Energy of our 25% interest in Edgewater Unit 5. Edgewater 5 is an existing 380-megawatt coal-fired unit in eastern Wisconsin. We sold the 95 megawatts of capacity that we owned at Edgewater for approximately $38 million. The sale price reflected our net book value, including working capital, so as a result, we did not record any book gain or any book loss.

Turning to regulatory matters, I would like to briefly touch on 2 items for you. First, late last week, the Wisconsin Public Service Commission approved a rate adjustment of less than 1%, related to the higher fuel and purchase power costs that we're incurring this year. In our last general rate case, you may recall, we were allowed to file for our projected fuel and purchase power costs for the year 2011, and we filed for that increase back in September of 2010. Commission action on our request was delayed, but we're pleased that an appropriate fuel recovery rate is now in place. As a result of the delay, however, we expect to undercollect our fuel costs by between $20 million and $25 million this year. But under the new fuel rules that went into effect this year, we estimate that our financial exposure will be limited to about $16 million, which would be the Wisconsin share, and the $16 million is already factored into our guidance. The second regulatory matter is our upcoming rate filing. We expect to present a new rate proposal to the Wisconsin Commission within the next month.

Finally, Wisconsin Governor Scott Walker recently appointed a new Public Service Commissioner to fill a vacancy that occurred this spring when Commissioner Myers' 6-year term came to an end. The new Commissioner and the new Commission Chairman is Phil Montgomery. Phil brings a wealth of experience to the position, having worked on utility, energy, and telecommunication issues while serving for 12 years as a Wisconsin state legislator. For a number of those 12 years, Mr. Montgomery was Chairman of the Assembly Committee on Energy and Utilities. A confirmation hearing for Commission Chairman Montgomery is expected to take place in the State Senate in May. However, he may act with full authority prior to the confirmation. Needless to say, we're pleased that the Commission is back at full strength.

In summary, with the completion of our Power the Future Plan, the Company is at a very positive inflection point. We expect to have approximately $600 million of free cash flow from 2011 through 2015, and that's after retirement of $450 million of holding company debt. Along with a stronger balance sheet, we've clearly lowered the risk profile of this Company. The majority of our construction risk is now behind us, and when the Point Beach units were sold in 2007, we put nuclear operating and regulatory risk behind us, as well. We're turning our efforts now to our renewable and environmental projects, and continuing to upgrade the energy infrastructure of the region. We're planning a capital budget of up to $3.4 billion over the next 5 years, or about $1.9 billion to $2 billion of net rate base growth after ongoing depreciation expense. And by mid-year, we plan to announce a revised dividend policy, debt reduction, share repurchases, or a combination of all three, with internally-generated cash.

Now, with more details on our first quarter and our outlook for the remainder of 2011, here is a familiar face but in a slightly different chair, our new Chief Financial Officer, Rick Kuester.

Rick?

Thank you, Gale.

Before I discuss our first quarter operating results, I would like to remind you that our 2-for-1 stock split was effective on March 1, 2011. As a result of the split, we have changed the reporting of all prior earnings per share to reflect a new number of shares outstanding, so the $1.10 a share that we reported in the first quarter of 2010 is now $0.55 a share after the split. As Gale mentioned, our 2011 first quarter earnings from continuing operations were $0.72 a share, as compared to $0.55 a share in 2010. I will focus on the earnings drivers at the operating income level by segment, and then touch on the other income statement items. I will also discuss cash flows in the quarter.

Our consolidated operating income in the first quarter of 2011 was $296 million, as compared to $228 million in 2010; an increase of $68 million. As expected, our utility operating earnings were higher because of favorable fuel recoveries, as compared to 2010; and earnings from our non-utility energy segment were up with the commercial operation of the second unit at Oak Creek, and a full quarter of earnings from the first Oak Creek unit. Operating income in our utility energy segment totaled $213 million, an increase of $35 million versus 2010. On the positive side, our revenues associated with the recovery of fuel and purchase power costs were up $24 million when compared to the first quarter of 2010. Last year, we undercollected fuel and purchase power costs by $23 million. During the first quarter this year, we were in a slightly favorable position. We also experienced a significantly colder first quarter this year, and we estimate that our electric and gas margins were up $22 million as compared to last year.

On the negative side, our utility O&M costs increased $10 million, due to additional Power the Future costs, the timing of outages at our power plant, and increased work on our distribution network. Operating income in the non-utility energy segment, which consists primarily of the Power the Future units, was up $32 million. Unit 2 at Oak Creek was placed in service on January 12, 2011, and we realized a full quarter's earnings on Unit 1. Last year, we only realized a partial quarter's earnings on Unit 1, as it was placed into service on February 2, 2010. Taking the changes for each of these segments together, with a small increase in our corporate and other segment, brings you back to the $68 million increase in operating income for the first quarter of 2011.

During the first quarter of 2011, earnings from our investment in the American Transmission Company increased just slightly over 2010. Net interest expense increased by $14 million, primarily because of interest expense associated with Unit 2 at Oak Creek. When we placed the unit into service, we stopped capitalizing interest associated with the construction of the plant. We also issued $420 million of long-term debt, and used the net proceeds to repay short-term debt incurred to finance the construction of Unit 2, and for other corporate purposes. Consolidated income tax expense increased by approximately $18 million because of the higher pre-tax earnings, offset in part by a slightly lower effective tax rate. Our effective tax rate for 2011 is expected to be between 34% and 35%. Combining all of these items brings you to $171 million of net income from continuing operations for the first quarter of 2011, or earnings of $0.72 per share.

During the first quarter, we generated $391 million of cash from operations, which is up $87 million from the same period in 2010. Our cash earnings, which we define as net income plus depreciation and amortization, plus deferred income taxes, increased by $120 million as compared to the first quarter of 2010. In addition to higher net income, we deferred more income tax as a result of bonus depreciation and increased depreciation expense associated with the new coal units. The largest change in our uses of operating cash flows relates to our benefit plans. From the first quarter of 2011, we contributed $122 million to our qualified benefit plans. No such contributions were made in 2010.

Our total capital expenditures decreased by approximately $59 million in the first quarter of 2011, as compared to the first quarter of 2010, because of the completion of the Oak Creek units. However, for the year, we expect to see capital expenditures of approximately $950 million, which is about $150 million more than our 2010 expenditures. Over the next 9 months, we should see higher capital spending related to our air quality control system at south Oak Creek and the Glacier Hills Wind Farm. As Gale mentioned earlier, we received approximately $38 million from the sale of Edgewater 5 in March 2011. We also paid $61 million in common dividends in the first quarter of 2011, which was a 30% increase over the same period last year. The first quarter dividends equate to an annual dividend rate of $1.04 a share.

Our adjusted debt to cap ratio was 53.7% as of March 31, 2011. Our adjusted calculation treats half of our hybrid securities as common equity, which is consistent with past presentation. We used $223 million of cash on hand at March 31, 2011, to retire long-term debt that matured on April 1, 2011. Adjusting for the use of cash on hand, our adjusted debt to total capital ratio was 52.5%. We are very pleased with our efforts to strengthen our balance sheet. 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.

As shown in the earnings package that we posted on our website this morning, our actual first quarter retail sales of electricity increased 1.4% as compared to 2010. Our residential sales were helped by a colder than normal winter, and our large commercial and industrial customers are slightly below forecast because of the February 2 blizzard. We see some decline in average use by our residential customers. We believe this is a result of conservation efforts. But overall, our electric sales are in line with our annual forecast. As we look at our natural gas sales, we saw 11.4% increase in sales, primarily because of the cold winter. We are also seeing our weather-normalized natural gas sales in line with our annual forecasts.

As we mentioned on the February call, when the second unit at Oak Creek was placed into service, we issued $420 million of senior notes in two tranches. The first tranche was a $205 million note, with a coupon rate of 4.673%, and a final maturity in 2031. The second tranche was a $215 million note, with a coupon rate of 5.848%, and a final maturity in 2041. We used the net proceeds to repay debt incurred to finance the construction of Unit 2 at Oak Creek, and for other corporate purposes. As discussed earlier, on April 1, 2011, we retired $450 million of long-term debt with $223 million of existing cash in commercial paper borrowings. Later this year, we expect Wisconsin Electric to issue approximately $300 million of long-term debt to help fund its construction program. Our 2011 earnings guidance remains the same as what we provided to you on our February conference call. We expect our earnings for 2011 to be in the range of $2.05 to $2.10 per share. While our first quarter earnings exceeded our forecast range because of favorable weather, we still have 9 more months of weather ahead of us.

Before I turn things back over to Gale, I would like to briefly discuss our earnings outlook for the second quarter. As a starting point, our 2010 second quarter earnings from continuing operations were $0.37 a share, adjusted for the 2-to-1 stock split. When we look at our utility earnings, we expect to see a decline in operating income on a quarter-over-quarter basis because of favorable weather in 2010 and higher O&M costs in 2011. Last year, we had an early summer and benefited from some cooling load in June. This year, our forecast assumed normal weather. However, we expect increased earnings from the second Oak Creek unit to offset the lower earnings from our utility in the second quarter. In the past, we said that Unit 2 should contribute $0.02 a month pre-split, or $0.01 a month post-split. As a result, we are expecting second quarter 2011 earnings to be in the $0.36 per share to $0.39 per share range, or flat with the prior year.

With that, I will turn things back over to Gale.

Rick, thanks very much. Overall, we're on track and focused on delivering value for our customers and our stockholders.

And now, we would like to take your questions. (Operator Instructions).

Your first question comes from the line of Andy Levy with Caris & Company. Please state your question.

Gentlemen, how are you?

How are you doing, Andy?

I'm doing all right. Just two very quick questions. And I may have missed the first one. O&M was down a lot for the quarter. What was the reason why?

Well, actually, and we can let Rick and Steve get into the mechanics if you would like, but if you really look at utility O&M, it was up about $10 million in the quarter. The remaining impact of the O&M that you see on the income statement is really because of some -- because of the way the mechanics of the lease payments work between the utility and We power. I think because of this year, we are going to have an unusual year. The one thing you really need to focus on is the utility at the -- or the O&M at the utility.

Steve, do you want to give us a little more on that?

Yes. Thanks, Gale.

And as you point out, overall on the consolidated level, our O&M is down about $22 million. And as Gale said, at the utility, it is up about $10 million. The difference, which is about $30 million, a decline, relates to the elimination of inter-Company revenues and expense. And as you remember, at We power, We power bills the utility for the lease payment, so We power records revenue, and the utility records expense. This year We power, with Unit 2 coming online, had about $30 million more of revenue, and therefore on the consolidation entries, we eliminated $30 million more revenue at We power and $30 million more expense on a consolidated basis.

So it is an accounting anomaly which shows why the O&M is down. Does that make sense, Andy?

Sure does. Thank you very much.

And I had another quick question.

Andy, the lesson for everyone here, for this year, if you want to look at the O&M trends, really look, and we will break this out for you each quarter, really look at the utility O&M.

Got it.

And then on the stock buyback and/or dividend increase and/or, I guess, what is it? Debt paydown, was that the third thing that you were talking about?

Yes.

Just timing on that, as far as hearing from you guys on that, will that be in the second quarter call? Or could that come before? What are you guys thinking?

It will definitely come by June. And we're working through, obviously, all of our final analysis. We obviously also want to have our regularly scheduled Board meetings, and so you will expect an answer from us by June.

And when is your Board meeting in June? Is that something you can share with us today?

Well, we have a Board meeting coming up soon. We also need, by the way, a final decision on our proposed biomass investment in Rothschild, the Domtar investment, so that's another factor that we're waiting for. But you will be hearing from us in the not too distant future.

Got it. Thank you.

Thanks, Andy.

Your next question comes from the line of Brian Russo with Ladenburg Thalmann.

Hi, Brian. How are you doing today?

Good, thanks.

Would you mind elaborating a little more on the joint filing with the PSCW related to the Domtar biomass costs? I apologize, but I haven't had a chance to read the filing.

Sure. In essence, the filing that we made at noon -- I understand why you wouldn't have had a chance to read it, it was noon Central time --the filing, in the filing, Domtar has agreed to, in essence, pay more for the steam that would be produced by the units. And for background, this would be a 50-megawatt plant. The plant would produce both steam to power Domtar's paper mill operations and renewable electricity for the grid. And one of the major questions that the commissioners had during their open meeting last week was, could there be a different allocation of costs between the costs that go to electric customers and the costs that Domtar would accept for the production of steam. And so Domtar has agreed to what we think is a very major price change, and we'll let Allen cover the details for you.

Yes, Brian. To put some numbers around it, what Domtar agreed to was a 20% increase in the rate that they pay for steam. Now, when you sort of track that through, the implication then for our customers, that translates into about a 7% reduction in the cost of the project to our customers. And we believe that, based on the conversation at the commission last week, we believe this puts the cost of the project, as compared to a wind project, within a range that at least one of the commissioners was looking for.

So as Gale mentioned, you know, we would expect a decision in the near future from the commission, but from a practical standpoint, we really need a decision by May 15 if we're going to move forward with the project. That's a high level summary, Gale.

Allen is exactly right. We actually need an order by May 15. In that, we obviously have -- if we're going to go forward with this project, we have a construction schedule that we have to meet and federal production tax credits related to biomass that right now, at any rate, expire at the end of 2013. And if we don't qualify, if we couldn't get the plant online by the end of 2013, and if we couldn't therefore qualify for the production tax credits, it obviously changes the economics of the plant and not for the better. So we think the commission understands that. And we're looking for a decision here in the very near future.

Okay. Great.

And then the $600 million of accumulating free cash flow through 2014, does that assume the biomass plant moves forward and the expenditures are included in the CapEx calculation there, or would that price of the biomass plant eat into the $600 million?

Rick?

No, Brian, the $600 million assumes that we build the biomass project. If we don't build it, that would be additional equity available. That's a total $255 million investment, so about $125 million of additional cash flow would be available.

Thank you very much.

You're welcome. And that is because, obviously, of the 50/50 capital structure.

Your next question comes from the line of Steve Fleishman of Bank of America.

The last time I saw you, you were really on jet lag. Have you recovered?

That's right. That's right.

Couple of questions. First on the Chrysler plant shutdown, do you have a sense, if we excluded just that plant, kind of what all industrial sales would have done, you know, without that impact?

Yes, as a matter of fact, I do. Very good question.

Let me give you a little bit of analysis. We had -- the analysis I have looks at the four major -- and not all of them were major, but we had four plant shutdowns that we believe are going to be reasonably permanent shutdowns. There was the Chrysler engine plant in Kenosha. Then we had the Delphi automotive operations in Oak Creek. We had White Pine up in the Upper Peninsula of Michigan, which was a copper refiner. And then we had the NewPage paper mills, paper mills owned in northern Wisconsin by NewPage. All four of those shutdowns and closings we have factored into our forecast.

Now, looking at how that relates, about 25% of our industrial demand and some of our largest customers are, in the first quarter of this year, their usage is above pre-recession levels. The remaining 75% of our industrial grouping of customers, if you take out those four shutdowns, they're about 5% below as a group, about 5% below pre-recession levels. So coming back, but that's kind of the picture, and we have obviously factored in the shutdowns in our 2011 forecast.

Okay.

A couple of other questions. The $16 million of net drag on fuel from the delay on the fuel case, was that in your initial guidance, or is that kind of incremental to your initial guidance?

We had assumed there would be some drag, because of the delay in getting an order from the commission. So it is really not incremental.

Okay.

And then I know you had mentioned one potential use of cash might be, for example, the fact that the state may be looking to sell some of their power assets.

Yes.

Is there any update on that issue?

Very good question, Steve. And that is a potential use of cash.

The state of Wisconsin has -- well, the Walker administration has expressed an interest in selling a number of the plants and steam heating power islands that currently are operated by the state of Wisconsin, across college campuses, and the biggest, obviously, would be the UW campus in Madison. It will require, for the state to move forward with any sale, a piece of legislation would be required to be passed by both the state Senate and the Assembly. And my understanding is that the Walker administration is hoping to introduce that legislation sometime this summer. So there won't be any immediate movement until a piece of legislation is passed and signed by the governor. But our understanding is the Walker administration would like to move forward with the sale of those assets.

Okay.

One last question. Just your take on the EPA-proposed air toxics rules and how that affects your capital plan for the remaining kind of non-cleaned up coal plants and the like?

Sure. Absolutely. In fact, I will ask Allen to add his thoughts on this as well.

Some background, Steve, might be very helpful. We really see very little impact on customer electric rates or our capital plan between now and 2015 as a result of all of the new EPA regulations that have been proposed. And that may surprise you, because so many utilities are indicating that they are going to see huge capital increases and huge cost increases from the need to comply with these proposed rules. But there are three very good reasons why we do not see that kind of impact.

Allen?

Yes, and just as background, Steve, of course, 10 years ago, the first reason is 10 years ago, the Company made the decision to retire old coal, build new natural gas plants, build new coal plants. So, of course, those are the Port Washington plants and the Oak Creek plant. So that is the first driver of why we are where we are.

Second, you may remember in 2003, we entered into a consent decree with the EPA which drove controls at many of our other major plants. And then finally, we as a Company, unlike many others, we don't have ash impoundments. We have 100% beneficial reuse of the ash that comes from the combustion of the coal. So we don't really see much of any impact from EGU MACT or IB MACT on the Company. The only three plants that we see, you know, there might be impacts on down the road, you've heard us talk about our Valley and our Milwaukee County power plants, which are actually co-gen plants that produce steam as well as electricity, and an electric plant that we have in the U.P. We see little impact on those units.

There could be a small amount of investment at those units because of the EGU and/or IB MACT. But the bigger impacts, if there are going to be impacts at those plants, would be out in the 2017 time frame. They wouldn't be driven by MACT They would be driven by NAAAQS, the National Ambient Air Quality Standard for SO2 and particulate matter, but again, we wouldn't see impacts there, if any, until 2017. So that is probably more than you wanted to know but that is kind of where we see ourselves positioned.

And Steve, speaking of more than you wanted to know, you're probably seeing some of the national studies that have been done now that would indicate that the average price of electricity in the country may be going up by as much as 20% because of these proposed EPA rules. We might see a 1% to 2% increase, our best guess. So that gives you an example of how well we're positioned from the environmental standpoint in terms of complying with even the new proposed rules. So I think this is going to materially help our competitive position.

Great. Thank you.

Thanks, Steve.

Your next question comes from the line of Michael Lapides with Goldman Sachs.

Hi, guys.

Hi, Michael. How are you doing today?

I'm okay, guys. Thank you.

The return on capital -- you're waiting on Domtar, and we're in kind of a period where things are getting better, but things are not perfect. I'm going to ask a question I think your entire investor base probably won't love, which is what is the rush?

Well, I don't feel like we're in a rush. I really don't. We've taken, I think, very good time to do the proper analysis. We will have, sooner or later, within the next week or two, I believe, a decision from the Wisconsin Commission on Domtar. We've laid out a $3.4 billion, or up to $3.4 billion capital plan for the next five years.

So Michael, I think all of the elements are in place for us to really have a very good understanding of what our earnings potential, our investment opportunities, and our cash flows look like. So I don't sense that we're in a rush at all.

I would just add something to that, Michael. Another way to interpret your question would be, why now? And what has happened in the first part of this year is that we've gotten more clarity on the EPA rules. So we kind of know what the exposure is there. We sold Edgewater 5, which was going to be an investment that was going to be required to be made from an air quality control standpoint, so that is no longer an uncertainty out there. And we finished the last unit at Oak Creek. So we've got a number of things resolved. So I think the timing actually is pretty good, if you look at the issues that we were facing a few months ago versus the issues that we are facing now, in terms of capital expenditure.

Got it. One other --

Michael, one other point to add on to what Rick said. I personally think it is important for our investor base to understand very clearly where we -- what our philosophy is on our dividend payout ratio as well. I mean, we're entering a, as I mentioned in our -- in the earlier comments, I think the Company is at a very positive inflection point. But clearly our dividend payout ratio is below our peers, and I think it is important to clarify for our investors going forward at a minimum what our goals are, related to our dividend payout ratio.

And that makes a ton of sense. And honestly, over the last five to seven, five to 10 years, you guys have been among the best in terms of stewards of shareholder and bondholder capital.

One follow-up unrelated to capital structure, but just in general, in your discussions with the new Chairman, what are you getting in terms of potential direction for state energy policy in Wisconsin for the next three to five years?

Really, Phil has just gotten in the chair. And I think he's been pretty busy trying, with the other commissioners, to work off the backlog of items that they had really built up when they were short a commissioner. So I don't think Phil has had a great opportunity yet to sit down and think about energy policy for the state.

He did say, though, during the last open meeting, that he was part of the crafting of the renewable energy standard for 2015 and supports that standard. So I think the first and only comment that we have really seen from Phil so far is his support for the 2015 energy standard -- renewable energy standard.

What does that then mean if Domtar doesn't get approved?

Well, that's when we will have some conversations and try to seek some guidance from the commissioners. Because the truth of the matter is, if Domtar is approved, it will get us to where we need to be for 2015 and 2016. That would be the last major investment we would need to make in the near term in renewables to meet that 2015, 2016 standard.

Without that, then we've got some decisions to make, and our first step, if they decide that Domtar is just too expensive a proposal, our next step would be to sit down and work with the commissioners and get some guidance. And frankly, work with the Walker administration as well. I know that the governor would want to have some say in that thinking.

Got it. Okay. Thank you, guys. Much appreciated.

You're more than welcome, Michael. Take care.

Your next question comes from the line of Jay Dobson with Wunderlich Securities.

Rock and roll Jay, how are you?

Very well, Gale. How are you?

Doing fine.

I was hoping we could continue on the Domtar topic, and I know it is timely, we will have a decision here shortly, but I didn't hear the commentary that the PSC made. But just judging from your reaction, you took some solace in the fact that they -- with the price cut, they would compare that, or it would look economically similar to a wind asset. And I was just hoping you could elaborate on that solace, simply because it seemed as if a lot of the desire for wind in the state, quite frankly, lost a lot of its backing with the new governor. So I'm just wondering if that is economics we ought to feel more comfortable with, or that is something that, you know, obviously will be determined in the ultimate decision. But just tell us how, you know, the wind economics, or the comparison with wind economics makes you feel more comfortable.

Well, I think there is one very clear reason why it makes me feel more comfortable, and that is the former Chairman and current Commissioner, Eric Callisto, during the open discussion with the other commissioners, said that he would like to be able to see this renewable alternative, meaning the Domtar plant, the Domtar co-generation plant that we are proposing. He was concerned that it looked like, based on staff analysis, that this proposal was more expensive than generic wind. And he said, gosh, if -- he would feel more comfortable, he said, if we could have some kind of, as he put it, wind bogey against which to compare.

Now, when we look at the staff's assumption on generic wind and the cost of generic wind, there are a couple of items here that I think are worth pointing out. The staff's analysis on the cost of generic wind assumed that the federal production tax credit for wind would go on for a very long time. We don't think it is prudent to make that assumption, because under the current law, the federal production tax credit for wind expires at the end of 2012. And then, when you factor that into the fact that generic wind may not represent the real cost of building wind in Wisconsin, in light of the flux that the state is in regarding the siting rules, I mean, we think the real generic cost of wind can be materially higher than what the staff indicated. And then if you couple that with the price reduction that Allen described from what Domtar and we filed at noon today, you get much, much closer -- in fact, we think we -- and hope we've achieved what Commissioner Callisto was looking for, which was a proposal that would be quite close to the cost of generic wind.

Guys, would you like to add anything?

No, I think you covered it, Gale. If you kind of stand back and look at it, it is not really possible to build the generic wind project that we're being compared to, because -- if it is a greenfield project, because one, siting rules aren't clear, two, the production tax credit expires one year earlier than biomass. So I think by bringing the numbers closer, we've been responsive to the commission.

There is another factor here. The area where we're proposing to build the biomass plant, which is a suburb of Wausau in northern Wisconsin, like all areas, that area can benefit from jobs, and there is a very strong job protection and job creation story associated with this plant that we think should also play into the mix here.

That's very helpful. Maybe seizing on an asset question a different way, you indicated if it doesn't go forward, you would like to have discussions with the Walker administration. Where do you think their desires might be on, you know, where you might fill, if need be, and you certainly would have to under the renewable standard, where he would like you to sort of focus?

I would hate to prejudge what the governor might say on this. But clearly, in the past, he has focused on -- particularly in this kind of economic climate, he has focused on near-term cost to the customer. So one option -- and I'm not suggesting this would be the option, we would have to get the proper input --but one option, which is allowed under the law, is the filing of an off-ramp. And the law says that if it is practically -- if it is not practical or if it is excessive in cost to meet the 2015 standard, then a utility could file for an off-ramp. None have done so at this point. And we certainly would not need to do so, assuming we could move forward with the Rothschild/Domtar biomass project.

Got you.

And last question on Domtar. How much is in the CapEx budget for '11? I think you answered that question, and it just went by me too quick.

About $100 million this year. A total of $255 million.

Great.

Then Rick, last question, on the undercollection, the fuel underrecoveries for the balance of this year, how do they flow over the remaining three quarters, understanding it is just about $16 million of financial exposure?

And we're about even now on fuel recovery going into Q2. Steve or Rick, do you have that flow for the final three quarters?

Yes, well, we expect to, as Gale said, we basically -- our cost of fuel was right on top of our collection rate in the first quarter. As Gale said, we expect to be $16 million, we expect to hit the threshold. If you look the next couple of years, I mean the next couple of quarters, we expect to underrecover in the second, but most of it would be in the third quarter. That's probably when we would exceed the $16 million amount and start to edge up toward the $20 million to $25 million that Gale mentioned. And then in the fourth quarter, we typically claw back some of that that we've lost in the third quarter, because of the higher cost of power during the summer. So at the end of the year, we expect to be in that $20 million to $25 million range, undercollected, but we're capped at $16 million based on how the fuel rules work.

Absolutely. And how much would be in that 36 to 39 you gave, Rick, for the second quarter? It is probably a pretty small number, I know.

Yes, basically -- this is Steve Dickson. On the fuel recoveries, we will undercollect anywhere from $5 million to $7 million in the second quarter, and that amount is comparable to 2010. So we don't expect an earnings variance in 2010 to 2011 related to fuel.

Got you.

In Q2.

Perfect. Right. Thank you so very much.

More than welcome, Jay. Take care.

Your next question comes from the line of Ted Heyn with Catapult.

Good afternoon.

How are you doing?

Good. How are you doing?

Fine. You want to try to double down, make any of your money back?

No, I'm not making any more bets with you, Gale.

I had a few quick questions. Just I guess first, just on the underrecoveries, so the $16 million represents the -- basically the 2% bandwidth, the $16 million is kind of the cap of the earnings exposure?

Yes. You've nailed it, Ted.

Okay.

And then just quickly on weather, how much above normal was it this quarter? And how much did it contribute?

In terms of average temperatures, Q1 was about 10% colder than last year, and Steve, how much colder than normal?

6%.

6% colder than normal. Last year was 4% warmer than normal.

Okay. And so how much -- do you have a dollar or gross margin impact from being above normal?

Yes, on the electric side, we think that, compared to normal, our electric margins, which is revenues minus fuel, were helped by about 7 -- $7 million. On the gas side, our gas margins were helped by about $8 million. So in total, about $15 million.

So $15 million ahead, but you also have the $16 million of fuel underrecovery, so net-net on a normalized basis, you're kind of --

No, no. The $16 million of fuel underrecovery was already in our guidance.

Okay.

And we fully collected on fuel this quarter. We won't see that $16 million actually flow through until the third quarter.

Okay. I guess I was thinking as -- when I do a bridge from '11 to '12, those two things should wash each other out.

Yes, that's right.

From '11, to '12, yes. Exactly.

Got you.

And then on Domtar, the filing mentioned that they increased their capital allocation by $22 million. Does that change the amount of dollars you would spend?

No, no. All it does, and again, you need to think about this as about a $255 million capital investment. And then the question becomes, what share of that -- what share of the cost of that investment and what share of the operating costs would be allocated to Domtar for taking the steam for their paper mill operations, and what share would go to electric customers for the renewable electricity that would go to the grid?

Okay.

This is all a question about allocation of the total cost, not about change of total cost.

Got you. Okay. So if this -- if your revised proposal was approved, the spend would still be $255 million.

You got it.

It is just the rate that they pay for the steam.

It is just the rate. Okay.

And just finally, I think that there is some movement to try to change the RPS standard to allow hydro power from Manitoba to potentially count. If that were to happen, could you talk about maybe how -- what the investment opportunities would be for you there?

Well, I'm not sure there is an investment opportunity there, in terms of that change, for any Wisconsin utility. Because what is being proposed is -- particularly by one other Wisconsin utility, is that, in essence, they would sign a purchase power agreement for a new hydro power that would be developed in Canada to be imported into Wisconsin. Now, so there is no real construction investment opportunity there for the hydro power itself. But as Rick is pointing out, there may be a transmission opportunity in this.

Okay. So maybe ATC would have some opportunity.

That is entirely possible.

But that is probably longer term in nature?

Yes, Ted, I would be thinking this is a post-2015 type of matter. Because first of all, the hydro -- the new hydro facilities aren't even built yet.

Got you. Okay. Thanks a lot for all of the help.

Thank you. Take care, Ted.

You too. Bye-bye.

Your next question comes from the line of Sarah Akers with Wells Fargo.

Good afternoon.

Welcome, Sarah. How are you today?

Good, thank you.

I just had a quick clarification question on the $600 million of free cash flow. First, does that include the sale proceeds from Edgewater 5? And second, does it include the impact of the DOE settlement, which I believe was about $45 million?

Yes and no.

Yes and no. Okay.

It includes the Edgewater sale proceeds, but the proceeds from our settlement with the federal government regarding the extra cost we incurred at Point Beach on spent nuclear fuel, those dollars are in an Al Gore lock box down the street in a bank, and those dollars will be completely returned to customers over time, and so they're not counted in our cash flow assumptions.

Got it. Okay. Thank you very much.

You're welcome, Sarah.

Your next question comes from the line of Dan Jenkins with State of Wisconsin Investment Board.

Dan.

Hi, good afternoon.

Dan, do you have things back under control up there?

Well, it is a little cold today. So you know, tomorrow it is supposed to warm up, so who knows.

You didn't take any sick days or anything now, Dan, did you?

No, I'm not a teacher, so.

Well, just checking. Always worried about you, Dan.

Okay. Just to follow up on what you just talked about with Sarah there, so is that the $45 of restricted cash then that we're seeing on the balance sheet?

Yes.

$45 million.

$45 million, yes.

$45 million, yes, I'm sorry.

And then, while we're on the balance sheet, and I notice that the material supplies inventory are about $100 million lower, which I assume it is also then part of the working capital gain that we're seeing on the cash flow statement. I was wondering if you could talk about what is going on with that?

That is gas and coal inventories. Steve can talk about that.

Yes, the balance sheet is comparing December 31 to March 31. And at the end of December, we had a significant amount of gas in storage. And we pulled that out at the end of the year. So we had the same decline last year. The number this year is about $50 million more because March was significantly colder, so we went through more in gas in storage in this, and we were able to reduce coal inventories down. So those are the two big drivers.

Okay. Is there anything else then that is driving that working capital gain of $150 million on the cash flow statement?

Well, the bonus depreciation is having an effect on that, Dan.

The increase in the deferred taxes.

Right, yes. What is that, $60-odd million, Steve?

Yes.

Okay.

And then I think you mentioned that you're expecting to file a rate, for a rate increase in the next month or so.

That is correct.

And I was curious what your current ROE, earned ROE is, and then, are there any other items driving that, that you expect that will drive that request beyond the ROE impact?

Well, for all of 2010, our earned ROE was very close to the allowed ROE at the utility. So again, we performed very close to the allowed ROE at the utility last year. And of course, the way Wisconsin regulation works, the commission uses and asks us to file a two-year forward-looking test year. We project our expenses, our O&M expenses, our fuel expenses, our capital costs for, in this case, 2012 and 2013. And the big driver of the rate proposal that we will file is really completing construction and placing into service about $1.2 billion of new assets that have already been approved by the commission. In specific, the two large projects that would be the big drivers would be the completion of the air quality controls at the older existing Oak Creek units -- remember, I mentioned that is a $900 million capital expenditure -- and then the completion later this year, we believe, of the Glacier Hills Wind Park, which is another $360-ish million.

Between $360 million and $370 million.

So you put those two together, and that's $1.2 billion of new capital that, once placed into service, needs to be reflected in customer rates. So that would be the big driver of our rate proposal that we expect to file in the next few weeks.

Okay.

And then the last thing I was curious is, it looks like the residential usage was up about 1.5% and the commercial was up about -- small commercial was up about 2.5%. If you strip out the weather impact, what would those have looked like?

Okay. You strip out the weather impact, against 20-year average weather, you would see residential actually being down slightly. You would see small commercial and industrial up about 0.5%. You would see large commercial and industrial about flat and total large commercial and industrial up about 0.4%.

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

Dan, one other thing. On the $45 million that's restricted cash from the DOE settlement, that will be returned to customers net of the cost to achieve. That was about a 10-year process where we were suing the federal government. So there are costs that are associated with that. So just a point of clarification.

What's the time frame for returning that?

That will be dealt with -- actually, we will make that -- it is certainly up to the commission when they would like to have and over what time frame they would like to have those dollars flow back to customers, but we will propose an option for the commission in this next rate filing.

Okay. Thank you.

You're more than welcome, Dan. Hang in there.

Your next question comes from the line of Michael Lapides with Goldman Sachs.

Hi, guys.

Rick, a modeling question, real quickly. What is left in 2011 in terms of deferred income tax, or really bonus depreciation for to you take, and even deferred income taxes separate from bonus depreciation, meaning the deferred income tax benefit you get from Oak Creek?

We said all along we've got about $100 million worth of bonus depreciation impacts in 2011.

Most of that is to come this year yet.

Got it. Okay. Meaning very little of that is what showed in the first quarter?

Well, about $60 million showed in the first quarter, I believe.

Okay. So another $40 million for the rest of the year.

All right, Michael. Thank you.

Thanks, guys. Much appreciated.

You're more than welcome.

At this time, there are no further questions.

Very good. Well, that concludes our conference call for today. We really appreciate you taking part in all of the great questions you asked today. If you have any other questions, Colleen Henderson is ready and waiting in our Investor Relations office, and that number is 414-221-2592. Thank you very much. Have a good day, everybody.