威斯康辛能源 (WEC) 2011 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for waiting, and welcome to Wisconsin Energy's quarterly conference call. 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 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 at www.WisconsinEnergy.com. A replay of our remarks will be available approximately 2 hours after the conclusion of this call. I now 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. And thank you for joining us as we review the Company's 2011 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 Allen Leverett, President and CEO of We Generation, Rick Kuester, our Chief Financial Officer, Jim Fleming, General Counsel, Pat Keyes, our Treasurer, and Steve Dickson at the controls.

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 $1.69 a share for the first 9 months of this year. That compares with earnings of $1.39 a share from continuing operations for the first 9 months of 2010. For this year's third quarter, our earnings from continuing operations came in at $0.55 a share, up from $0.47 a share in the third quarter a year ago.

Now, compared to our forecast, 2 factors influenced our positive results in the latest quarter. The first was weather. The Midwest recorded warm temperatures and high humidity this summer, which led to strong demand for air conditioning. It literally was a hot town in the summer, summer in the city, during much of July and August. In fact, the peak demand on our system rose to within 2.5% of our all-time record 1-hour demand. We also saw slightly stronger growth across the commercial sector of the region.

When we compare our numbers to the prior-year third quarter, we realized higher earnings from our Power the Future assets, driven by our investment in the second expansion unit at Oak Creek. We also benefited from booking higher allowance for funds used during construction at Wisconsin Electric as we continued to invest in utility projects that have been approved by the Wisconsin Public Service Commission. Overall, we're pleased with our third quarter and our year-to-date performance.

Now I'd like to focus for a few minutes on the economy across our service area. After a nearly double-digit increase and rebound in 2010, electric sales to our large commercial and industrial customers rose by a little less than 1% in the first 3 quarters of 2011. When we take a closer look inside the numbers, we see that the demand destruction from 5 large plant closings during the Great Recession is now being largely offset by modest growth and recovery in other sectors of the region's economy. For example, we're seeing strength in iron ore mining, in specialty steel and metal fabrication, paper and printing, and in the production of industrial machinery. And from talking with our largest customers, we're cautiously optimistic that the recovery will continue.

Next, I'd like to update you on the 3 significant construction projects we have under way. The 50-megawatt biomass plant in Northern Wisconsin, the Glacier Hills Wind Park northeast of Madison, and the air quality control upgrade at the original Oak Creek units. You may recall last quarter we announced that construction was under way on a 50-megawatt co-generation plant to be fueled with biomass at a paper mill owned by Domtar Corporation in Northern Wisconsin. Good progress has been made on critical underground work and on the foundation for the boiler. On August 25, 1,700 cubic yards of concrete was continuously delivered and poured for the foundation.

Of course, the biomass plant will help us diversify our renewable energy portfolio. We will be able to dispatch the unit and the efficient technology that will be used to produce steam will clearly benefit the existing paper mill. Our investment in the biomass plant is expected to total between $245 million and $255 million, excluding allowance for funds used during construction. We're on schedule and on budget to meet a completion date by the end of 2013.

The other large renewable project in our pipeline of course is the Glacier Hills Wind Park. A 162-megawatt energy center located on more than 15,000 acres of rolling farmland about 45 miles northeast of Madison. Ironically, higher than normal winds in late spring and early summer slowed our construction, but we're on track now and making excellent progress. As of yesterday, 88 of the 90 wind turbines planned for the site have been erected and approximately half of the turbines are already producing power for the grid. We're scheduled to complete the project on time and on budget by the end of this year. Our current estimate of the capital cost for the Glacier Hills site is $361 million. This estimate does not include allowance for funds used during construction or reimbursable transmission costs.

The biomass project and the Glacier Hills Wind Park are key components that will position us to meet Wisconsin's renewable portfolio standard for the year 2015. To refresh your memory, the standard calls for an increase in the amount of electricity produced from renewable sources from 5% in 2010, to 10% in 2015 at a state-wide level. The standard sets targets for each of the Wisconsin utilities, using an historical baseline. Using that baseline, approximately 8.25% of our retail electricity sales must come from renewable sources in 2015. When we complete the 2 large projects we have underway, we will be on target to meet the 2015 standard. I should point out, however, that we expect to deplete our bank of renewable credits, and as a result, we project a need for additional credits by the year 2017.

Finally, we're making excellent progress on the air quality control upgrade at the original coal fired units at the Oak Creek site. These units are among the most efficient base load units in the Midwest, so the economic solution for our customers was to invest approximately $900 million, including allowance for funds used during construction, for the installation of wet scrubbers and selective catalytic reduction facilities. As of today, the project is about 90% complete. Our project team is now finalizing an extensive testing protocol, which is a key step of course in the final stages of construction. And once again, we're on time and on budget. We expect the new controls at Oak Creek to be completed during 2012.

Now I'd like to switch gears and briefly review where we stand on the regulatory fronts, in both Wisconsin and Michigan. As you know, on October 6, the Wisconsin Public Service Commission approved our creative approach to keep base rates flat for customers as the economy continues to recover. We were pleased that the Commission found value for customers in our proposed plan, and in this fragile economy, our customers now have certainty on the cost of electricity for the year ahead, with base rates to remain at 2011 levels through 2012.

The rate plan also authorizes us to suspend the amortization of $148 million of regulatory assets in 2012. Then, the plan authorizes us to recover $148 million of carrying costs and depreciation for the air quality controls at Oak Creek and the Glacier Hills Wind Park. In addition, we have filed a fuel cost plan for the year 2012. Finally, as part of that fuel cost plan, we will provide customers with a 1-time credit of $26 million. The credit stems from Wisconsin Electric's settlement of spent nuclear fuel litigation with the US Department of Energy. We expect an order on our fuel cost recovery plan in January 2012. It's also important to note that we have the authority to file a full rate case next year, for new rates to be effective in January of 2013.

Turning now to our Michigan operations, you'll recall that earlier this year, we filed a request with the Michigan Public Service Commission for a rate increase of $17.5 million annually. We're seeking to recover from Michigan customers their pro rata share of renewable generation, environmental controls, and costs associated with unit 2 of Oak Creek. As provided for under Michigan law, we plan to self-implement $7.7 million of our request in January of 2012, and that would represent a 4.4% rate increase. If the Commission accepts our proposal, that amount would be partially offset by the Michigan portion of the DOE settlement, so the net result would be an interim rate increase for customers of 2.8%. We expect the Michigan Commission to rule on the entire request by July of 2012.

Another important topic, the Environmental Protection Agency issued on August 8th its final cross state air pollution rule, commonly known as CASPR. Earlier this month the EPA announced a plan to revise CASPR with a provisional hearing set for tomorrow, actually, October 28 in Washington. We believe that our additional cost to comply with CASPR will be far less than many of our peers because of the investments we've made in air quality control technology, investments that are complete or nearing completion at our older coal fired units and because of the new state-of-the-art generation we've built through our Power the Future plan.

However, we do have some concerns about CASPR as it relates to the upper peninsula of Michigan. Based on our analysis, we believe that the EPA has failed to allocate sufficient allowances to support minimum levels of generation at our Presque Isle power plant. Operations at the Presque Isle facility are necessary to maintain system reliability in what has historically been a very constrained region. We have filed petitions with both the EPA and the Washington, DC Circuit Court of Appeals supporting our position. Our preferred approach is simply to have 1 assurance area for our integrated combined system. EPA's current approach is to have separate and distinct assurance areas for Wisconsin and for Michigan.

Finally, I'd like to address our share repurchase plan and our dividend policy. To maintain appropriate financial strength and provide value to our stockholders, we have implemented a share repurchase plan, scheduled to run through the end of 2013, that calls for us to buy back up to $300 million of Wisconsin Energy common stock, through open market purchases or privately-negotiated transactions. Through today we have repurchased approximately 2.5 million shares at an average price of $30.32. Earlier this year, we also announced that our Board of Directors approved a dividend policy that calls for a payout ratio of 60% of earnings in the year 2015. Trending toward a 60% payout ratio will allow us to be more competitive with the dividend policies of other regulated utilities across the industry, and as a first step in implementing our new dividend policy, I'm pleased to report that management will recommend to the Board a dividend increase in the range of 13% to 15% for the year 2012.

In summary, with 3 quarters of this year already in the books, the Company continues to perform at a high level and our Power the Future investments are providing tangible benefits for our customers and our stockholders, and now with more details on the third quarter and our outlook for the remainder of 2011, here's our Chief Financial Officer, Rick Kuester. Rick?

Thank you, Gale. As Gale mentioned earlier, our 2011 third-quarter earnings from continuing operations were $0.55 a share. The results were better than our plan because of hotter than normal summer weather, a slightly better than expected growth in commercial sales, and a continued emphasis on cost management. I will focus my comments on operating income from continuing operations by segment and then touch on other income statement items. I will also discuss year-to-date cash flows and earnings guidance for the full year.

Our consolidated operating income in the third quarter of 2011 was $224 million, as compared to $203 million in last year's third quarter, an increase of $21 million. We clearly benefited from the second expansion unit at Oak Creek. Operating income in our utility energy segment totaled $136 million, which is up $2 million from the prior year. When we look at our electric margins, we see a $2 million improvement. When we break down the components of our electric margin, we see that weather had a negative impact of $9 million in 2011.

While this summer was significantly hotter than normal, it was not as hot as the prior year. We estimate that weather helped our margins this quarter by approximately $21 million. However, we estimate that last year's hot summer helped our margins by $30 million. Offsetting this impact was a stronger than expected growth in electric sales to our commercial sector, and an increase in electric demand in our industrial segment. We estimate that these 2 items helped our margins by approximately $10 million, as compared to the third quarter of 2010. When you look at the rest of the detail of our utility operating income, you see several small items that net to a positive impact of approximately $1 million.

Our operating income in the non-utility energy segment, which includes We Power, came in as expected and was consistent with prior quarters. We saw higher operating income of $21 million that was driven by the commercial operation of unit 2 at Oak Creek. Unit 2 achieved commercial operation in January of this year, so we did not have any earnings associated with unit 2 in the prior years. Taking the changes for these 2 segments together, along with corporate charges and other miscellaneous items, you arrive at the $21 million increase in operating income for the third quarter of 2011.

During the third quarter of 2011, earnings from our investment in American Transmission Company totaled nearly $16 million. Other income increased by $6 million, because of higher allowance for funds used during construction for AFUDC on our utility construction projects, primarily the air quality control system for the older Oak Creek units, and the Glacier Hills Wind Park. AFUDC, of course, allows us to earn a return on these approved utility projects during construction.

Our net interest expense increased by $4 million, primarily because of interest expense associated with the second unit at Oak Creek. In January, we issued $420 million of long-term debt to replace short-term debt used to finance the construction of unit 2. In addition, once unit 2 achieved commercial operation, we no longer capitalized interest on the construction work in progress. While we saw increased interest expense at the We Power level, our holding Company interest expense declined as we retired $450 million of 6.5% long-term debt on April 1st of this year. In addition, we were able to take advantage of the low interest rate environment in September, when our Wisconsin Electric subsidiary issued 10 year bonds with a coupon rate below 3%.

Consolidated income tax expense increased by approximately $6 million because of higher pre-tax earnings, offset by slightly lower effective tax rate. For the year, we expect our effective tax rate to be between 34% and 35%. Combining all of these items brings you to $130 million of net income from continuing operations for the third quarter of 2011, or earnings of $0.55 per share. During the first 9 months of 2011, we generated $828 million of cash from operations on a GAAP basis, which is up $174 million from the same period in 2010. On an adjusted basis, our cash from operations increased by $5 million. The adjustments relate to how GAAP treats changes in restricted cash as an investing activity, while we look at this as an operating item.

Our strong cash flows were driven by higher net income and higher non-cash charges, related to depreciation and deferred income tax benefits as a result of bonus depreciation. Our 2011 operating cash flows were reduced by $257 million, because of contributions to our qualified benefit plans. We made $122 million contribution to our benefit plans in January, and another $135 million contribution in September. No such contributions were made in 2010.

Our total capital expenditures were approximately $612 million in the first 9 months of 2011, and we are forecasting annual capital expenditures this year of approximately $900 million, which is below our plan of $950 million. The reduction is primarily related to the timing of expenditures on the biomass project, given a later start date than originally planned. The majority of our capital expenditures are in the utility business, and the largest projects are the air quality control system on the original Oak Creek units and the Glacier Hills Wind Park.

We also paid $182 million in common dividends for the first 9 months of 2011, which was a 30% increase over the same period last year. On a GAAP basis, our debt to cap at the end of the third quarter was at 56.5%, and we were at 53.7% on an adjusted basis. These ratios are a slight improvement over our December 31, 2010 levels of 56.9%, and 54.1% respectively. The adjusted amount treats half of our hybrid securities as common equity. We may see a slight uptick in these ratios by the end of the year, as we fulfill our capital budget commitments and repurchase shares. Consistent with our past practice, 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 shares, any additional shares.

As we discussed in the past, our Board of Directors authorized a share repurchase program, that allows us to repurchase up to $300 million of our common stock through 2013. As Gale noted, through today, we have repurchased approximately 2.5 million common shares at an average price of $30.32 a share. Year-to-date, our weather-normalized retail sales have grown by 1.2% compared to 2010. Excluding sales to our largest customer, the iron ore mines, year-to-date normalized sales increased by 0.6%, compared to 2010. These results, excluding the iron ore mines, are about 0.5% better than our original forecast due to modest economic recovery and delay in some customer-owned generation projects.

I will now discuss our earnings guidance. We are raising our guidance for 2011 from a range of $2.10 a share -- excuse me, $2.10 to $2.14 a share, to a revised range of $2.13 to $2.16 a share from continuing operations. We are comfortable raising the range because of our strong results for the first 9 months of the year, which were driven by cold winter weather, hot summer weather, improved electric sales and effective cost controls. With that. I will turn things back over to Gale.

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

Now, we would like to take your questions. (Operator Instructions). Your first question comes from the line of Greg Gordon with ISI Group.

Hey, Greg, how about those Jets?

Hi, we had a good game going in the bye week. So I'm hopefully maybe we'll get that Green Bay Jets matchup this year that we almost got last year. Hopefully we'll get that match up.

That would be cool.

That would be super cool. So anyway, listen, your shareholders I'm sure are ecstatic that you've decided to increase the trajectory of the dividend come next year from your prior guidance, of I think it was 8%, 8% to 9% to the level you've just articulated. Can you talk through what is going on in terms of the cash flow profile of the Company that -- and the credit quality of the Company that gave your Board comfort that was a rational move and can you talk about whether you think there's more upside in your payout ratio relative to the industry average or if you think you're getting close to the point of equilibrium?

Very good question, Greg. Let me first back up and talk about the policy that our Board has adopted. As you recall, our payout ratio, because we had such a very solid use for our cash generation in investing in the Power the Future units, our payout ratio among utilities that do pay a dividend is, and remains, one of the lowest payout ratios in the industry. Clearly now, as Power the Future is behind us, we want to become more competitive with our peers, in terms of the dividend payout ratio. So as we looked at our earnings profile and our cash generation over the next 5 years in our analysis, we believed we could afford, while maintaining very solid credit ratings, we could afford to move to a roughly 60% payout ratio and trend toward that 60% payout ratio by the year 2015. In our analysis, we said that would support roughly an 8% to 9% annual dividend increase every year between now and 2015.

Clearly, our cash generation is better this year than we projected. As you saw in Rick's numbers on our debt to total cap, we continue to improve, and it was pretty clear to us that we could afford to move a little quicker in implementing that policy. So the policy remains the same right now, of moving toward a 60% and trending toward a 60% payout ratio in 2015. It's just we can move quicker with the strength of the underlying cash flows and the strength of the underlying earnings. And so we will recommend to the Board a 13% to 15% dividend increase for 2012, and then beyond that, we still believe we can support a roughly 8% annual dividend increase through 2015. I hope that responds to your question, Greg.

That's crystal clear. Can I ask on a separate subject, are you -- now that you've got the regulatory deal in Wisconsin, do you feel that you're on track? Do you feel that you're on track to get the costs out of the Company that you need to, to meet your end of the bargain and still earn at the level of return that you're earning into 2012?

Very good question, Greg. We had mentioned in previous calls and in one-on-one conversations that we would have to reduce O&M expenses in many parts of the business next year to basically come close to earning our allowed rate of return at -- and still have flat base rates for our customers. And yes, we have worked diligently to put those O&M plans in place and I think we're on track to deliver our end of the bargain.

Great. Great. But with weather having been so strong this year, are there other offsetting drivers that are going to help you get to that return, because that's clearly going to be a headwind?

There are a couple of offsetting drivers. 1 of course is we had a very good handle on how much O&M we were going to have to reduce and we have -- we are putting and finalizing the plans to do so, and the second of course is with the shape of the plan that we put in place, and we're basically going to get recovery on the $1.3 billion of new utility investment that will be coming into service next year. So those 2 drivers I think are very important drivers to us achieving close to our allowed rate of return.

Great. Thanks, Gale.

You're welcome, Greg. Take care.

Your next question comes from the line of Jim von Riesemann with UBS.

Jim, how you doing?

I'm great, how are you?

Hanging in there, we're doing all right.

I hear Rogers is the real deal.

Amen, he is the real deal. I think actually, Jim, he is the most intelligent quarterback in the NFL, bar none. He really is the real deal.

Wow. A couple of questions for you. The first one is on CapEx. Your disclosures throughout the year, you've talked about declining CapEx trends through 2013. But as you look out towards, say, 2014 and beyond, what do you see as the general trend there?

Well, we have -- as you know, we made public I believe our specific capital expenditure program for 2012 and I think Rick for 2013 as well.

Right. That's correct.

You can see in the public material our specific 2012 and 2013. For 2014 and 2015, obviously we are still putting the final details in place and working through our specific capital spend plan for 2014 and 2015, but we have said that 2011 through 2015 is about a $3.4 billion capital spending at our Company.

So basically there's no change. We can expect maybe 725 in a rounded figure for 2014 and 2015; correct?

Well, I'll let you do the math.

Okay.

I think you're pretty well l right on.

Okay. Second question is kind of as a follow-up to Greg's question, can you talk a little bit more about your philosophy on how you think about your cash reinvestment? So if you would, could you frame your response, how you think about rate base investments, dividends and buybacks, and what makes you buy back stock at, say, 2 times book value versus redeploying it elsewhere?

Very good question, Jim. And we look at it really very simply and that is, what is the best after tax return for our shareholders? What is the best use of our cash? And the answer to that is what provides the best after tax return for our shareholders.

So clearly, the number 1 priority would be to invest in solid utility projects where there is a need. I mean, clearly we cannot, should not and will not propose a utility project that's not needed for reliability or for customer growth or for safety and regulation and continued safe operation of the system. But as you can see, we have about $3.4 billion of those kinds of utility projects on the horizon between 2011 and 2015. So number 1 use of the cash is to continue to be the most reliable utility in the country.

Second then after that is asking the same question. What is the best after tax return for our shareholders? Within the parameters of maintaining our credit ratings. And we simply drive our decisions off of that question. Right now, at the share price that we've been able to buy back shares so far, Rick mentioned $30, $32 a share on average, that still provides a better after tax return than paying a premium to lower our debt levels.

So we continue to look for appropriate utility projects. And as you know, we have a list of other projects that we have on the horizon that we're looking at, some of them would be outside the utility, for example, if the state decided to try to put up for sale some of the state owned power plants. We would view that as a potential solid utility investment, perhaps outside the rate base. In general terms, Jim, that's how we look at the business and how we try to deploy the cash.

Thanks.

You're welcome.

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

Hi, guys. Congrats on the quarter and the dividend.

Thank you. How you doing, Mike?

I'm okay. Can you, Rick -- can you walk us through the various items from the regulatory portion of this call. Increases and decreases in the line items impacted for next year. I'm not asking for guidance. I'm just -- you talked through a number of regulatory moving parts, the amortization suspension, that type of stuff, the Michigan potential rate increase. Can you just walk us through which line items get impacted by each of those items and just kind of rehash a little bit what those items were?

We'll give it a shot.

We'll give it a shot, Michael. For part of that, I'll ask Steve Dickson, our Controller, to take the first shot at it here.

Mike, as we talk about the $148 million for the State of Wisconsin, the way I look at that is if you just look at our income statement, whatever you forecast for 2011, and use that as a base, the first thing that will happen is within our O&M, there's $148 million of amortizations. That will stop. So everything else being equal, our O&M should be $148 million better. In addition, right now, we are accruing AFUDC on the projects. And once those projects go into service, the AFUDC will stop. So those are 2 items that will stop that will be reduced as compared to our forecast for 2011.

Then what we will have when the plants go into service, we will have additional depreciation on those units, and so our depreciation costs will go up. So our O&M should go down. Our depreciation will go up. Our AFUDC, which is in other income will go down. Net, net, net, if everything else is equal, our net income should be up and in effect that reflects the recovery of the carrying -- recovery of the plants that will go into service.

And a key point here is that revenues, everything else being equal, will not change. Our customers will not pay any additional amounts. Revenues are flat. Does that make sense?

I think that makes sense. How should we think about how much the AFUDC change will be becomes it's hard to disaggregate the AFUDC that's being tied to things like Glacier Hills or being tied to things like Domtar versus what's at Oak Creek.

Go ahead, Steve.

I would say this year, if you look at our AFUDC, the 2 big items relate to the air quality control system and Glacier Hills. Glacier Hills, I think Gale said, should be in at the have beginning of the year so we should have no AFUDC on that and then the air quality will be going in, in early 2012. I can't give you an exact amount of this but there will be a significant reduction in AFUDC, and on top of that, we will have additional AFUDC at Domtar.

Domtar started, Michael, in the middle of the year, I think originally we had planned on spending $100 million. We ended up spending -- expect to spend close to $60 million this year. The effect on AFUDC from Domtar is relatively minor compared to the other 2 projects.

The guys are right, Michael, all but about $50 million or $60 million, in that range, of the AFUDC you're seeing on the income statement is attributable to projects that will be going into service next year.

So is the best way to think about it revenues -- the only revenue change besides load growth and besides changes in fuel costs or purchase power costs is Michigan.

Right.

And then O&M declined by 148. Higher D&A as the assets go into service. Lower AFUDC by a significant amount as Glacier Hills and South Oak Creek go into service.

You're right. There's 1 other category of revenue change, it is modest, that will be from our wholesale business. That's the FERC-regulated business.

What is it you're expecting out of there? I'm just -- is that just a change due to pricing change or is that a contract that is new that didn't exist?

It's just formula rights, Michael. It's under contracts.

So it's an annual formula rate change.

Have you guys quantified that?

Not yet.

Okay.

It's significant, we just didn't want you to completely ignore it.

Okay. And last question, can you -- I apologize. I may have missed it because I was hopping on a little bit late. The amount of the Michigan rate increase?

Sure. Let me get back to that specific number for you. The interim, the self-implement that we would propose to self-implement in January is $7.7 million on an annual basis. The total rate increase filing is 17.5.

And when would you -- when would -- I guess the question, if you do the interim January, when do you get the remainder portion?

By law, the Michigan Commission is obliged to make a decision in July, early July of 2012.

Got it. Guys, thank you. Congratulations again. Much appreciated.

You're more than welcome, Michael. See you soon.

See you in a couple weeks.

Your next question comes from the line of Paul Ridzon with KeyBanc.

Paul, how are you?

I'm okay. Yourself?

You're a little echoey, Paul.

Yes. I'm on a cell phone, sorry. What are you targeting for the O&M reductions 2012 versus 2011?

I'm sorry, did you say what are we planning for O&M reductions 2012 versus 2011?

Yes.

There will be the adjustment that Steve just talked about, when the rate plan goes into effect. But in terms of strict operational O&M, we probably have to pull more than $20 million of O&M costs out of the Company next year, compared to this year's O&M spend in order to reach our close to our ROE target.

Where's the spend getting pulled out of? You're doing a fantastic job year-to-date.

We have -- we really have a really solid management team focused on effective cost controls, and it is 100 little things across virtually every aspect of the Company. There's not one big item. But we are just being more productive, and more effective in our spending, and literally it's across every area of the Company.

Okay. Good enough. And what on an absolute and relative basis, was the swing in fuel recoveries?

Steve, for the third quarter, was pretty -- not much change, was there.

You're absolutely right. Absolutely flat this year third quarter compared to third quarter in 2010.

What about on an absolute basis?

Recovery itself for Q3.

It was just right at $34 million both quarters.

$31 million over or under recovery.

$34 million.

$34 million under recovery.

$34 million under.

Okay. And given you're more optimistic about the dividend hike, any chance that you could have a similar thought around the share repurchase?

That we would accelerate the share repurchase or increase it?

Or upsize it.

No, at the moment we -- at the moment, we will stick with our up to $300 million through 2013.

Okay. Thank you very much.

You're welcome, Paul.

Your next question comes from the line of Travis Miller with Morningstar.

Good afternoon, Travis, how are you today?

Good afternoon. Good. Similar weather down here in Chicago, very beautiful. I'm sure you're enjoying that as well. Quick question, on the preferreds, given the financing moves that you've made, I know it's a small amount, but what's the chance you would address those preferred and what factors are you thinking about when you think about those preferred stock issues?

You're not talking about our hybrids but you're talking about the amount of preferreds that remain outstanding?

Yes, down at the utility, right.

At the utility. At the moment, we don't have any plan to try to retire or recall those at all.

Is that because of regulatory structure? Is there something else that you would consider?

Because of the effectiveness and we'll let Pat Keyes answer this, but my view would be is because it's very cost effective financing for us. Pat?

Because of the age at which we issued those, we have a tax advantage for those preferreds that -- when we look at it, it's just not cost effective for us to take them out.

Even given the rate that you issued the new debt at?

Yes. Yes, even given the rate; correct.

Travis, we look at what is the best use of the funds. As Gale talked earlier and as you know, we took out some holding Company debt earlier this year and we continue to evaluate on an ongoing basis how to optimize the capital structure. We view the preferreds as cost effective financing for us.

Okay. Great. Thanks a lot.

Good question. Thank you, Travis.

Your next question comes from the line of Andy Levi with Caris.

How you doing, Andy?

How you guys doing. Congratulations on your regulatory victory.

I wouldn't call it a victory. I would call it that sense prevailed. Common sense prevailed.

I was surprised. I thought they were going to give you a harder time, so congratulations on that. You did a great job. Couple of very, very quick questions. When do you give 2012 guidance? Would that be on the first quarter call or before that?

Andy, for you, January 2013. No, that's not -- It will be on our first quarter -- it will be on our year-end call in February of 2012.

Okay. Don't give me a hard time here. I work on Wall Street. It's not the panacea it used to be here.

You're already having a hard enough time. You been out in the parks lately?

No, no, but probably will be panhandling there soon. The $2.13 to $2.16, how much of that do we back out to get to our base for 2011?

The base for -- you're talking about our --

you have your guidance at $2.13 to $2.16. Is that kind of a base we grow off of or?

We said, as you know, that we believe we will be able to grow at about 5% average annual EPS growth through 2015 and the base, as Rick and I have emphasized, is really the midpoint of our July guidance, which was $2.12 a share.

That's right.

Got it. Okay. Thank you on that. And last but not least, what are you guys thinking as far as M&A? Is there anything that you can shed the light on there and whether you have any thoughts as far as whether the State of Wisconsin, State of Wisconsin need to consolidate, whether your region, whether you guys think you go it alone here, not go it alone, any type of thoughts you can share. I know it's a tough question but any type of thoughts.

I appreciate the question, Andy. Obviously we are open and continue to look at what might make sense in terms of mergers, acquisitions, consolidation. We have very specific criteria that we believe need to be applied to any particular potential situation and that is that we would want any acquisition that we would make to be credit-neutral, accretive to earnings per share at least by the end of the first year. And have a long-term growth rate at least equal to what we believe our long-term growth rate looks like.

So those are the criteria that we apply and frankly, I think those criteria are very important, because if you don't adhere to those criteria, my own view is, you're not creating shareholder value. So Rick and Allen and I are very wed to those criteria, and then beyond that, there has to be a willing seller and a willing buyer. So we are certainly not for our growth plans and for our continuing effort to deliver shareholder value, we are not counting on any potential merger or acquisition.

Great. Thank you, guys.

Okay. Hang in there, Andy.

Trying.

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

Hi, Jay, how are you today?

Great, Gale, how are you?

Doing well.

Very well. Quick question on Domtar, you indicated that CapEx this year was coming in about $50 million, and I was wondering should we shift that to 2012 or will that be sort of spread between 2012 and 2013 until commercial operation?

I think it would be mostly in 2012, Jay, this is Rick.

Oh, great, hi Rick, how are you?

Good.

Perfect. And then on industrial sales, Gale, I hear what you're saying and sort of weak recovery but when I look at some of the sequential numbers, 1.8% growth in the second quarter, compared with 0.3% in the third quarter, I'm just wondering if you can give us a little better sense of sort of exactly what you're seeing now and then what you expect to see in 2012, again, specifically on the large commercial and industrial segment of your sales?

I'll be happy to, Jay, a very good question. First of all, I would caution you a little bit about looking quarter-to-quarter sequentially because some of our larger customers like for example the iron ore mines, they might have planned outages for their own maintenance at different times in the year. And I know for example Rick and I were talking about this the other day. Our September, individual month of September industrial sales were impacted by the fact that the mines took a planned outage earlier this year than they did last year.

So I think it's more instructive to look at a bit longer period of time, like a half or 3 quarters. And when you look at that, industrial sales -- we were I think appropriately cautious about our projection for growth in industrial sales. But we're not seeing any substantial weakening. And the sectors that I mentioned in the prepared script, iron ore mining, specialty steel and metal fabrication, production of industrial machinery, paper and printing, they're continuing to show some growth.

And then in addition to that, I've been very encouraged. We've had a number of expansion and relocation announcements in the Milwaukee region in the last few weeks, and I know from personal involvement there are more to come. So we see some traction in terms of our -- the industrial sector of the economy here. Again, nothing robust, but steady. Steady and I think cautiously optimistic for continued modest growth.

Got you. So if we were looking out to 2012, and appreciate you haven't given guidance yet but if we're looking for a road map for that, would be using something like that number? I know you're 0.8% year-to-date, if we want to look at it the way you are. Would that be sort of a good guide post to begin thinking about 2012, again, just for the large industrial segment of your sales?

That's probably a decent starting point, and again, we're refining all of that. We'll take our full-blown and fully developed plan to the Board in early December but that's a good starting point, Jay.

Thanks very much for the clarity. Look forward to seeing you in Florida.

Same here. Take care.

Your next question comes from the line of Carl Seligson with Utility Financial.

Hi, Carl. Long time no talk to you.

Hey, Gale. That's right. It has been. How you doing?

Doing well. How about you, Carl?

Very well, thank you. I've got sort of I don't know what you call it question, it's not a quick one. As you do all of your calculations, and ministrations over cutting O&M and where you're putting the money, how you're spending it, et cetera, et cetera, what are you thinking about in terms of rate effect on your customers? In other words, you're adding more high priced -- because I believe renewable is higher price than base load stuff, more high price generation, and you're doing a lot of good things, and I suppose all 3 of you guys have a little black book like you used to have when you were in Atlanta, that tells you all the right answers. Look in there and tell me what are you projecting as far as annual increases to your customers?

That black --

Percentage wise.

Rick had a different black book than I did.

Well, that's right, he did. Sorry.

Well, I think actually there's good news here on the horizon for our customers. We have spent, Carl, since 2003, $7.8 billion on upgrading the energy Infrastructure of this region. It was badly needed and today we have an Infrastructure in place that can actually support economic growth in this state and this region. So that's for starters, and that has driven, that $7.8 billion of spend, has driven about 4% average rate increases for our customers in base rates, forgetting fuel.

Which is not much.

But obviously it has a cumulative impact but you're right. Overall 4% average annual rate increase is not -- I mean, given the spend that we've had, and given the efficiency of what we built for our customers, I think it's going to be huge value down the road. But with much of that spending behind us and even with $3.4 billion ahead of us, I think you're going to see a definite roll-down in the size of the rate increases that we're going to be asking for and I would hope we could do inflation or less in terms of after this next rate case where we have to get $1.3 billion of new plant that will be coming into service, recognized in rates. After that, I think you'll see a substantially less in terms of average annual rate request from us. Rick, your thoughts?

I'd just add 1 other thing, Gale. I think the other thing that's important, part of that $7.8 billion investment was significant investment in air quality control systems and as we look at our position in the industry, we believe that we've got a lot of that spending behind us and as we look forward, while there are impacts from EPA rules such as the CASPR rules or the 316-B rules, we believe that our spending is really going to be relatively modest compared to many in the industry, so I think cost relative to others, other jurisdictions, I think we're in pretty good shape.

Rick's making a great point, Carl. You've seen estimates across the industry of the billions and billions of dollars literally that companies are projecting they're going to have to spend to meet these new EPA regulations. Our estimate is less than $100 million. And it's because we're positioned well. So the trajectory of rate increases by the other utilities, particularly in the eastern US, is going to be far greater than ours.

That's a great point for you. But it's not necessarily a point for the Public Service Commission. The Commissions around the country have been cutting ROEs right and left, as I'm sure you're well aware. The most recent quarter was reported by IRA, the average ROE granted in the proceeding that was 10.2. That's coming down.

It's not going up. There's been some good work done by some of my colleagues in terms of the effect that might have and what does it mean if you get half a percentage point less than your allowed ROE than you did the last time around and that kind of thing. So you're going to have to watch it, obviously and I'm sure you are, because you grew up with watching details very closely, and I'm sure you're maintaining that even though you moved home.

Amen. By the way, when Allen wanted to borrow a black book he borrowed Rick's, not mine.

That's a great line. I'll remember that. I'll see you in Florida.

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

Dan, nothing goofy has been going on in Madison lately. You must have been out of town.

We've had Occupy Madison here for nearly a year. They're just getting started in New York.

Dan, are we going to see you in Florida?

Yes, I'll be down there.

Sounds good. What can we do for you today?

Just curious if you can talk a little about, given your higher dividend guidance and your share buybacks and your CapEx plans, I know you don't have any maturities coming in 2012, but how will all of that affect financing plans in 2012?

Pat, do you want to talk about our financing -- we don't have any real maturities coming due in 2012.

Nothing's coming in. We are working on the plans for next -- we're working on our plans, Dan, still for next year. We will put something out in next time around, we'll have it as set in stone as one can. You're right, we don't have anything urgent coming up next year that's going to force us down a certain path.

Okay. Then, I was just curious on the sales number, the retail sales were marginally down, but the total sales were up 3% in the quarter. Looks like the sales for resale doubled in terms of revenue. Was that just opportunity sales or is there more going on there in wholesale or sales for resale?

Allen, do you want to cover that?

Well, while Allen's looking at something, we've got a second Oak Creek unit going so we've got more base load capacity available to sell in the market.

Steve has got a particular line item he's looking at.

Just supports what Rick said is our sales for resale more than doubled and again, we have the capacity. It was a hot summer. So we were able to sell. But the margin on that is very, very low.

The margin's low but it does speak to the efficiency of those units.

Is that something we can anticipate then going forward?

A lot of it I think -- to some degree, yes because we have this capacity in service but a lot of that was driven by a very hot summer.

All of this really goes to offset costs for customers.

And Dan, just to reinforce what Rick's saying, because those Oak Creek units are dedicated to our retail customer base, if we have any sales from those Oak Creek units to customers other than our retail customers, the margin offsets our fuel costs for retail customers.

And then just on when we think of the revenues going forward, you mentioned the FERC rate order. Where would that tend to show up? Would that show up in wholesale or does that show up in other retail?

I believe that's wholesale. Steve?

That's correct, wholesale customers with FERC.

It would be in the wholesale line.

Okay. That's all I had. Thanks.

You're welcome. See you in Florida.

Okay.

Bring your sun tan lotion.

Or just a big floppy hat.

Either way, Dan.

Okay. Bye.

Take care.

Your next question comes from the line of Ted Heyn with Point State Capital.

It's good to hear from you. How you doing, Ted?

Doing well, how about you?

We're doing fine.

Gale, I wanted to see if I could just ask, try to reconcile 2 comments you made. The first was I think in question that Greg asked, I believe you said that you expected to have to grow the dividend at 8% to 9% off of the 2011 base through 2015 to get to a 60% payout ratio.

That was our original -- yes, when we asked the Board to adopt our dividend policy, the new dividend policy that we've announced, which is trending toward a 60% payout ratio by and in 2015, we said that based on our analysis, that would support average annual dividend increases over the period from 8% to 9%.

Okay. Because if I do that math, if I grow $1.04 at 8.5%, and through 2015, and then apply a 60% payout ratio, that implies an earnings power of around $2.40. And then in a second question I think from Andy, you mentioned that your EPS was more of a 5% growth off of a $2.12.

That is correct.

Which would get you more to like $2.60. I guess I'm trying to figure out is 2015, $2.60 or $2.40 or -- I'm just trying to reconcile those 2.

I appreciate the question, Ted. First of all, you know, we're not prepared today to give you 2015 guidance. But I think we can give you some insight by just kind of recasting our situation. What we have said is we would propose to the Board for 2012 a dividend increase in the range of 13 to 15%. And then we still believe, given our analysis of our financial condition and our cash generation that we could grow the dividend beyond that by about 8% a year for 2013, 2014 and 2015.

Okay.

Does that help, Ted?

That's helpful. Just to clarify what you said to Andy, you did say that you expect to have around 5%-ish growth off of the $2.12 base?

That is correct. That's what Rick keeps telling me. No, no, that's our plan.

Great. Thanks a lot. See you guys down in Florida.

Look forward to it, Ted.

Thank you, bye-bye.

Your next question comes from the line of Paul Patterson with Glenrock Associates.

Greetings, Paul.

How are you?

We're fine.

I wanted to --

I'm still looking for Allen and Rick's black book here.

There might be a lot of money in that. What I wanted to ask you guys --

Never mind. I was going to say --

What was your question, Paul?

There are a bunch of transmission projects that are obviously happening in Wisconsin and 1 of them, the Prairie to Zion, I forget the actual name of it but there's one that goes from southeastern Wisconsin to Illinois.

It's Pleasant Prairie to Zion.

I was wondering, with -- I know all the stuff is interconnected, if you guys have any sense as to what we might be seeing in terms of basis differential or opportunities for off-system sales or what have you into Illinois or potential price impacts you might see all things being equal between the 2 areas?

We're going to let Allen take a shot a at that.

I don't have any forecast for you Paul, specifically if you put that 345 KV segment in and it's a relatively short transmission segment. I certainly don't have any specific forecast of what that would do to basis differential. It is forecasted to go into service I believe in 2014.

Yes, 2013, 2014 I think, yes.

So that sort of time frame. But I do think based on the forecast that I've seen that we would see and always depends on what actual market conditions are, but the long run models would indicate that there would be a pretty quick payback for our customers in terms of fuel savings for the investment that's going into that line. So it's a relatively modest cost. I would expect a very quick payback. But I don't have anything that would say okay, in terms of dollar per megawatt hour differential change, I don't have anything of that nature, Paul.

Just to sort of elaborate a little on the fuel savings for customers. Could you just say, in terms of, that would basically mean you were able to sell power for -- you would have more opportunity to sell power into Illinois.

That's right. What happens often now because of limitations in the transmission system, in effect you sort of get shut in. You can't run the units up to where they otherwise would have been without transmission constraints and so kind of bridging back to Steve Dickson's response to I think, maybe Dan's question, Dan Jenkins' question, we would hope to be able to do more sales, off-system sales, get a little more margin then go against retail customer fuel cost.

Any sense as to the volume of megawatts that could show up in the Illinois area as a result of what you guys -- because of this line, or anything else?

I really don't have anything.

I just thought I'd ask. All my other questions have been answered. Thanks a lot, guys.

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

All right, Michael.

Hey, guys. My apologies. 1 or 2 quick follow-ups. First of all. Residential demand what are you seeing, and how much is -- have you tried to aggregate or tried to break out what's economic and what's energy efficiency?

We try but that's -- that is more of an art than a science, as you know, Michael. I will say this. We're beginning to see 2 distinct patterns develop here this year. 1 is residential electricity use, particularly in the shoulder months, where it is much more convenient if you will to conserve. We're beginning to see more conservation than one had expected in the past in those shoulder months, and so residential demand for electricity in terms of kilowatt hour sales is down more than we projected it to be, but the other offsetting pattern has been the stronger use in the commercial sector, in offices, stores and other non-manufacturing firms. So when you put the 2 together, the upside in commercial and the down side in residential, they have about offset each other in terms of our forecast.

And we're still seeing modest or very slight customer growth in the retail sector too. I think somewhere -- we used to grow about 1% a year. We're probably 0.1%, something like that now.

Okay. And your comments on small commercial are interesting, just because a lot of companies including some of the large ones in the southeast have actually seen small commercial demand weakness and I'm just curious, is there something that's impacting the Wisconsin economy that's significantly different than some of the other regions?

That's a really good question. We have scratched our head about the stronger than expected growth in commercial. The only thing I can point to is that the unemployment rate in Wisconsin and in Metro Milwaukee, as of the latest data is 7.6%. And as you know, with unemployment below the national average, that differential between where we are in the national average is probably made up of a lot of small businesses. So I think we've got a little bit more employment level here in our small businesses, given the lower unemployment rate than perhaps some other regions.

Got it. Last question. Just which quarter do you expect South Oak Creek online?

It will come through the -- you're talking about the air quality controls?

Yes.

It will come through -- it has to be in by the end of 2012 but it will be in pieces throughout the year. Rick or Allen?

The first unit tie-in starts this year. We've got a fairly major outage this year to tie the first unit in and then it's over the first half of next year. So the unit will be coming in service I would say roughly half would be in April, half would be in June.

July or June.

June, July.

If I think about the AFUDC it takes a partial dip at the beginning of the year and the end of 2011, and another dip midway through the year when the second unit comes online.

Reasonable assumption, yes.

Thanks guys. Much appreciated.

You're welcome, Michael.

Your last question comes from the line of Scott Senchak with Decade Capital.

Good afternoon, Scott, how are you today?

Good, how are you guys?

We're doing fine.

Great. You've shown us a slide before with your projected 2012 and 2013 rate base. Given the reduction in amortization from the rate agreement, should we now assume that that 2013 rate base should be $145 million higher?

Steve?

I think the amortizations relate to the regulatory assets and I'm not sure they're factored into the rate base.

Okay. Sorry, go ahead.

The answer is probably not.

So rate base -- so your earning rate base would not go higher. Got you. Thank you very much.

You're welcome.

There are no further questions. Do you have any closing remarks?

Well, that does conclude our conference call for today. Thank you again for taking part. If you have any other questions, Colleen Henderson will be available. I'm told she has her own version of the black book, at 414-221-2592. Thanks everybody. See you soon.