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Earnings Conference Call - First Quarter 2005

by Larry L. Weyers
Chairman, President, and Chief Executive Officer

Joseph P. O'Leary
Senior Vice President and Chief Financial Officer

and

Mark A. Radtke
President - WPS Energy Services and WPS Power Development

Good afternoon. Welcome to the quarterly earnings conference call for WPS Resources Corporation. I'm Larry Weyers, Chairman, President, and Chief Executive Officer for WPS Resources Corporation. With me today is Joe O'Leary, our Senior Vice President and Chief Financial Officer; Phil Mikulsky, our Executive Vice President - Development; and Mark Radtke who is President of our nonregulated subsidiaries, WPS Energy Services and WPS Power Development.

We are here today to discuss our earnings for the first quarter of 2005 and what you can expect from us in the future.

WPS Resources' common stock is traded on the New York Stock Exchange under the ticker symbol WPS. Earlier today we issued a press release containing our earnings information. If you haven't seen the release, you might want to get it. It is available on our Web site. Once you are at the site, select Investor Information, select Financial News, select Earnings, and finally select the release from today, May 4, 2005.

Before we begin, I need to point out that this presentation contains forward-looking statements within the definition of the Securities and Exchange Commission's safe harbor rules including projected results for 2005 for WPS Resources and its subsidiaries. Forward-looking statements are beyond the ability of WPS Resources to control and, in many cases, WPS Resources cannot predict what factors would cause actual results to differ materially from those indicated by forward-looking statements. I refer you to the forward-looking statement section of today's press release and to our filed Securities and Exchange Commission disclosure documents for further information.

Now, back to the business at hand…

Let's begin with a couple of highlights.

Joe O'Leary will now discuss some details relating to our financial results.

The Senior Vice President and Chief Financial Officer speaks.

Thanks, Larry.

WPS Resources Corporation's income available for common stock shareholders was 65.9 million dollars for the quarter ended March 31, 2005, compared with 42.6 million dollars for the quarter ended March 31, 2004. This resulted in basic earnings per share of $1.74 for the first quarter of 2005, compared with $1.15 in the first quarter of 2004. Income from continuing operations was 62.5 million dollars, or $1.63 in basic earnings per share, for the first quarter of 2005, compared with 46.4 million dollars, or $1.23 in basic earnings per share, for the first quarter of 2004.

Our electric utility margin increased 13.0 million dollars, or 8.7 percent, in the first quarter of 2005, compared with the first quarter of 2004, mostly due to an increase in Wisconsin Public Service's electric margin, which primarily resulted from a retail electric rate increase authorized by the Public Service Commission of Wisconsin that was effective January 1, 2005. Included in the rate increase was recovery of costs such as those associated with the Fox Energy Center contract, which begins June 1, 2005. The recovery of the contract costs will occur throughout the year, but no costs will be incurred until June 1. The revenue related to the recovery of these costs contributed to the increase in first quarter margin, however, there will be a negative impact to third and fourth quarter margin as the costs incurred will exceed the revenue collected in these periods.

The natural gas utility margin increased 1 million dollars, or 2.2 percent, for the first quarter of 2005, compared to the first quarter of 2004, mostly due to a rate increase that was partially offset by a decrease in overall natural gas throughput volumes.

WPS Energy Services' electric margin decreased 2.7 million dollars, or 17.2 percent, for the first quarter of 2005, compared with the first quarter of 2004. The margin on wholesale electric operations decreased 1.4 million dollars, mostly as a result of a decrease in the margin contributed by portfolio optimization strategies. The retail electric margin decreased 1.3 million dollars primarily due to a 3.1 million dollar decrease in margins from retail electric operations in Michigan, which was partially offset by positive results from Advantage Energy.

The natural gas margin at WPS Energy Services increased 2.3 million dollars, or 12.9 percent, for the first quarter of this year, compared with the first quarter of 2004. The retail natural gas margin increased 6.6 million dollars, mostly due to improved supply management for Ohio customers and higher sales volumes because of new customers in Ohio. Wholesale natural gas margins decreased 4.3 million dollars mostly due to a decrease in margin related to the natural gas storage cycle and a decrease in margin from other structured wholesale natural gas transactions.

Excluding discontinued operations, WPS Power Development's margin for the first quarter of 2005 increased 5.7 million dollars, or 135.7 percent, compared to the first quarter of 2004. Mark-to-market gains on oil options utilized to protect the value of a portion of WPS Power Development's Section 29 federal tax credits accounted for 2.8 million dollars of the increase. Operations at three of our generating facilities, Niagara, Westwood, and Stoneman, resulted in a combined margin improvement of 2 million dollars. Niagara and Westwood benefited from higher tolling values, and Niagara also reduced the per ton cost of fuel utilized in its generation process as a result of using more tire-derived fuel. The Stoneman facility's increased margin was due to a new power sales agreement.

WPS Resources' consolidated operating and maintenance expenses increased 1.7 million dollars for the first quarter of 2005, compared with the first quarter of 2004, primarily due to a 2.7 million dollar increase in charges from the American Transmission Company for Wisconsin Public Service's electric transmission costs. WPS Power Development's operating expenses were down 900 thousand dollars due to repair and maintenance expenses associated with the unplanned outage at Beaver Falls in the first quarter of 2004.

WPS Resources' consolidated miscellaneous income increased by 2.9 million dollars for the first quarter of 2005, compared to the first quarter of 2004, partially due to an increase in earnings on decommissioning trust assets. Also contributing to the increase in miscellaneous income were a 1.5 million dollar increase in equity earnings from our investments in American Transmission Company and a write-off in the first quarter of 2004 of previously deferred financing costs associated with the redemption of our trust preferred securities.

Although our results for the first quarter have been extremely good, as compared to last year, there were a few things that occurred that will not reoccur in the remainder of the year.

First, the return on equity component for Kewaunee was included in our results for the first quarter. Assuming Kewaunee is sold in the second quarter, you can expect that our investment in Kewaunee and its related earnings will not be a part of our results in the second half of 2005.

Second, we entered into financial transactions in March and April to manage the risk relating to the value of Section 29 tax credits due to the rising price of oil. Our results for the first quarter included a gain on the mark-to-market of the options in March. As the options expire, the cost of the options will be recognized. There also will be mark-to-market earnings fluctuations relating to the value of these options until they expire.

Third, in the first quarter of 2005, we have already recognized the benefit of 12.8 million dollars of Section 29 federal tax credits. For the year ended December 31, 2005, we expect to recognize the benefit of Section 29 federal tax credits totaling approximately 24 million dollars. Therefore, the Section 29 federal tax credits will not be recognized evenly throughout the year.

Fourth, our authorized utility rate increases allow for revenue to be collected throughout the year, but expenses are not necessarily incurred and recognized that way. A good example relates to planned maintenance on a facility. The expense would be recognized in the period when the maintenance procedures are performed, but the expenses are recovered in rates more evenly throughout the year.

Finally, for the utility, the first quarter of any given year is when we typically have more earnings resulting from the heating cycle. The second quarter earnings generally are less than the first quarter because of less heating and minimal air conditioning load. The third quarter earnings typically pick up again, depending on how warm the summer is because of air conditioning load. And then the fourth quarter earnings are usually less, because the air conditioning load decreases and the heating load has not fully kicked in. This can be considered the typical utility earnings cycle, and it is highly dependent on weather.

Please refer to our press release issued this morning for more information about our financial results.

Now I'll review our utility rate situation. On December 21, 2004, the Public Service Commission of Wisconsin authorized Wisconsin Public Service to increase Wisconsin retail electric rates by 60.7 million dollars, or 8.6 percent; and Wisconsin retail natural gas rates by 5.6 million dollars, or 1.1 percent. These rates were effective January 1, 2005, and were calculated using an 11.5 percent return on common equity and a 57.35 percent regulated common equity ratio.

Wisconsin Public Service filed its 2006 rate case with the Public Service Commission on April 1. We requested an 89.7 million dollar, or 11.4 percent, increase in retail electric rates, and a 10 million dollar, or 2.09 percent, increase in retail natural gas rates. A schedule for this case will be set later, but it is likely that public hearings will be conducted in early fall. The Commission has determined that costs associated with the fall 2004 extended outage of Kewaunee, which had been deferred, will be addressed in this rate case.

Factors impacting our requested 2006 rate increase include costs of transmission, costs associated with the planned Kewaunee refueling outage in spring 2006, costs for the construction of Weston 4, and increased purchased power costs. The Commission's approval of the Kewaunee plant sale could reduce the requested 2006 rate increase. The level of decrease that could be involved will depend on how the Commission chooses to handle the release of the nonqualified decommissioning fund for rate purposes.

We also filed for and received approval to defer replacement power and operating and maintenance costs for Wisconsin retail customers due to the Kewaunee forced outage this spring. Under the formula rate mechanism, generally recovery of costs for our wholesale market based rate customers follows the Wisconsin retail methodology.

We plan to request approval from the Federal Energy Regulatory Commission to defer the costs for purchased power, fuel, operations and maintenance relating to the Kewaunee forced outage. For our Michigan retail customers, fuel costs are recovered through a pass through fuel adjustment clause.

The Public Service Commission of Wisconsin allows Wisconsin Public Service to adjust prospectively the amount billed to Wisconsin retail customers for fuel and purchased power if costs are in excess of plus or minus 2 percent from approved levels on an annualized basis. At March 31, 2005, excluding the impact of the deferred Kewaunee outage costs, Wisconsin Public Service was experiencing actual fuel and purchased power costs that were more than 2 percent lower than the currently approved level. As a result, the Public Service Commission reopened Wisconsin Public Service's 2005 rate case for the refund of these costs on April 14, 2005. Therefore, revenues collected after that date are subject to refund pending a review of projected fuel costs for 2005. Rates will be adjusted downward for the balance of the year if projected costs are deemed to be more than 2 percent less than the amount allowed in the 2005 rate case.

Lastly, under a settlement agreement approved by the Michigan Public Service Commission, Upper Peninsula Power Company will withdraw the rate case filed earlier in the year and not re-file a new rate case before January of 2006. In exchange, Upper Peninsula Power is allowed to retain 100 percent of the gains relating to the planned sale of certain lands owned by Upper Peninsula Power, up to 18.5 million dollars, and 73 percent of any gains over that amount.

I also want to mention that under WPS Resources' existing shelf registration statement, we have the ability to issue up to 176.9 million dollars of debt or equity. We have also filed a new shelf registration statement that will replace the existing shelf and will authorize issuance of up to 450 million dollars of debt and equity, which includes the existing 176.9 million dollars. Wisconsin Public Service also has an existing shelf registration statement for 375 million dollars of debt. During 2005, we plan to issue new common equity to fund our utility capital expenditures. The size and timing of the offering is dependent on the successful sale of Kewaunee and Sunbury and the capital needs for constructing Weston 4.

Now I'll turn the conference call over to Larry Weyers.

The Chairman, President, and Chief Executive Officer speaks.

Thanks, Joe.

The energy environment is constantly changing and evolving. On April 1, 2005, WPS Resources' affiliates began operating in the Midwest Independent Transmission System Operator (MISO) financial energy marketplace. This market is intended to create a competitive market for wholesale electricity that better uses the transmission system to access low cost generation.

WPS Resources has been instrumental in the development of this market to date through the involvement of a number of our employees, consultants, and attorneys. So far, this involvement has paid off since the operating and dispatch systems are functioning reasonably well. But there are still market issues that must be resolved.

The new market is based on a locational marginal pricing system, which is similar to that used by the successful Pennsylvania, New Jersey, Maryland regional transmission organization.

This pricing mechanism expands the existing market from a physical one to also include financial implications and is intended to send price signals to stakeholders where generation or transmission system expansion is needed. This methodology is consistent with and responsive to the FERC direction over the past four years to develop a standard competitive generation market.

MISO Day 2 has the potential to significantly impact the cost of transmission for eastern Wisconsin and the Upper Peninsula of Michigan system, including Wisconsin Public Service and Upper Peninsula Power, as well as our marketing affiliates in the MISO footprint, such as WPS Energy Services. Under this market-based approach where there is abundant transmission capacity, costs should be less due to the ability to access cheaper generation from across the MISO footprint. For areas with a shortage of transmission capacity, such as Wisconsin and the Upper Peninsula of Michigan, costs could be higher due to the congestion and marginal losses components. Mechanisms have been deployed to offset these potential increased costs in the first five years of the Day 2 market. If this system works appropriately, even in the short term with the current transmission congestion, the costs to WPS Energy Services, excluding the Seams Elimination Cost Adjustment, should be similar to the pre-Day 2 market costs. Any incremental costs to Wisconsin Public Service and Upper Peninsula Power would be recoverable from our customers under existing tariffs.

Now I'll discuss how our operating segments fared and what you can expect in the future.

The Kewaunee nuclear power plant was shut down in late February to resolve an identified weakness in the protection of pumps in an auxiliary back-up emergency system. We expect the plant to return to service by the end of May, but this is dependent upon the timing of the Nuclear Regulatory Commission's review of information submitted to it by the Nuclear Management Company.

The Public Service Commission of Wisconsin approved the sale of Kewaunee to Dominion Energy Kewaunee, Inc. on March 17 and issued their written order April 21. We are working with Dominion to close the sale when the plant is back in service. The major benefits of the sale for Wisconsin Public Service include shifting financial risk from utility customers and shareowners to Dominion, greater certainty of future power costs, and the return of approximately 128 million dollars, pre-tax, of decommissioning funds to our customers.

Construction of Weston 4 continues to go well. We began construction in October and are on track for completion of the construction work by June 2008, when the 500-megawatt plant is scheduled to be in service. In January, we filed with the Public Service Commission of Wisconsin for approval to complete the sale of 30 percent of Weston 4 to Dairyland Power Cooperative. We don't anticipate any problems obtaining that approval and expect to close on this ownership arrangement sometime in 2005 or 2006, provided certain contingencies are met, including financing, transmission, and Commission approval. We believe the air permit for Weston 4 is among the most stringent in the country, however it has been challenged, and we will participate in the Wisconsin Department of Natural Resources' rehearing process. We are allowed to and intend to continue with construction while the contested case proceedings occur.

In May 2004, we announced that we were planning to build a 500-megawatt base load electric plant with Alliant Energy Corporation. We are nearing the completion of preliminary siting studies and supporting feasibility studies. We expect that this second baseload plant will be ready for commercial operation near the summer of 2011.

Construction of a 220-mile, 345-kilovolt Wausau, Wisconsin, to Duluth, Minnesota, transmission line began in the first quarter of 2004 in Minnesota and was completed earlier this year. Construction in Wisconsin is scheduled to begin in August 2005.

Wisconsin Public Service is managing construction of the project and is responsible for obtaining private property rights in Wisconsin necessary for construction. Various permit related decisions made by the Wisconsin Department of Natural Resources are currently the subject of a contested case hearing in Wisconsin. A decision on the contested case is expected in the third quarter of 2005.

In December 2003, the PSCW issued an amended Certificate of Public Convenience and Necessity, which was appealed to Dane County Circuit Court, and the court affirmed the PSCW's decision. Project opponents have not appealed that decision and the time to appeal has now expired.

WPS Resources committed to fund 50 percent of total projected costs incurred up to 198 million dollars. We currently own about 25 percent of the American Transmission Company, and we will receive additional equity in ATC in exchange for a portion of the project funding. We have the option to terminate funding if the project extends beyond January 1, 2010. The line is expected to be complete in 2008. WPS Resources has the right, but not the obligation, to provide additional funding in excess of 198 million dollars. For the period 2005 through 2008, we expect to fund up to approximately 179 million dollars for our portion of the line. Our commitment to this project could decrease if another entity exercises its option to fund a portion of the project.

Now, let's take a closer look at our nonregulated operations. Here to tell us about this is Mark Radtke, President of WPS Energy Services and WPS Power Development.

The President of WPS Energy Services and WPS Power Development speaks.

Thanks, Larry.

First of all, I want to mention that we are continuing the process of bringing together WPS Energy Services and WPS Power Development to maximize the synergies of our respective core competencies. An organizational step this past quarter was the March 1st move making WPS Power Development an LLC subsidiary of WPS Energy Services. While we have more work to do, we are seeing the benefits of this close collaboration in responding more quickly to opportunities, managing operational risks, and gaining efficiencies.

WPS Power Development is continuing its efforts to sell Sunbury. The process is taking a little longer than previously projected, in part because of the introduction of additional interested parties. Potential buyers are currently doing due diligence and we are progressing with the sale process. We anticipate being able to complete the sale of Sunbury in 2005.

I also have an update on a few of our other plants. Our Niagara Falls generating facility in New York returned to service on January 21, after a forced outage that began last December 19, due to a generator breaker failure. The unit has run great since returning to service, and with the exception of those first 21 days; the capacity factor for the quarter was 77 percent—a percentage point improvement over the first quarter in 2004. Sunbury 4 returned to service on February 14, after the generator stator and rotor were repaired. Like Niagara, Sunbury had a great run for the quarter, with the plant output routinely above 300 megawatts. However, our Syracuse generating facility in New York recently had a blade failure in the compressor section of the turbine and has been out of service since the end of March. We have insurance on the equipment, and are in the midst of assessing the extent of damage and the likely return to service date.

On the wholesale natural gas front, we began our northeast market entry this past quarter. These wholesale transactions enable deliverability that supports our entry into the retail natural gas markets. You will recall that we intend to introduce a retail natural gas offering to our growing New York customer base acquired with last year's addition of Advantage Energy.

On the electric side, our wholesale customer origination efforts are gaining traction with the completion of structured power transactions with municipal customers in the northeast. These are usually one- to three-year deals, but some are in the four- to five-year range.

Turning to the retail business, Larry mentioned operating in the MISO Day 2 marketplace is going reasonably well. An important open issue involves the uncertainty around resource adequacy requirements for load serving entities. This uncertainty arises because the MISO has not yet settled on the provisions of its Business Practices Manual relative to this issue. We believe that we are currently in compliance with resource adequacy requirements. In addition, the issue is a transitional one, as the objective of MISO is to implement a separate capacity market in the second quarter of 2006. In light of current resource adequacy requirements and the future capacity market, we are prudently including a capacity component in pricing new and renewal customer agreements.

We are also challenged by the Seams Elimination Cost Adjustment or SECA issue. SECA is a transitional charge that was ordered to be effective December 1, 2004, and is scheduled to extend through March 2006. While we are participating at the Federal Energy Regulatory Commission in the extensive review process of SECA implementation, we do not know the final impact of SECA on 2005 and 2006 business, but the cost could be significant. Based on information from MISO, the maximum exposure to WPS Energy Services is estimated to be approximately 15 million dollars, of which about 13 million dollars is Michigan market exposure. Generally, our customer contracts give us the ability to pass through these costs, which reduces the exposure. However, competitive forces dictate that we seek only a partial pass through of these costs, which we have begun. We are also accruing an estimate of our liability to date and will continue to do so. Given our early stage involvement and experience with similar market transitions elsewhere, we believe we are prudently managing the transitional risks that MISO Day 2 presents.

Adding new business or recontracting existing business has been a challenge in the Michigan and Ohio electric markets. Regulatory changes have reduced the savings available to customers who purchase their electricity from a competitive supplier rather than a regulated utility, and when the utility offering is not priced at the current market, rising wholesale prices combine to make a competitive supply alternative less attractive to customers. Interestingly, customer expectations on savings do move with the market derived opportunity, and it is not uncommon for a customer to choose WPS Energy Services even if there are no savings compared to the utility. That is a demonstration of our value proposition being more extensive than simply price.

WPS Power Development is part owner of a synthetic fuel producing facility that generates Section 29 tax credits, which are subject to phase-out if domestic crude oil prices reach certain levels. To manage our risk if oil prices increase, in March and April we mitigated approximately 95 percent of our 2005 Section 29 tax credit exposure, 60 percent of our 2006 exposure, and 40 percent of our 2007 exposure by entering into derivative contracts. These contracts involve purchased and written call options that provide for net cash settlement at expiration based on the average New York Mercantile Exchange (NYMEX) trading price of oil in relation to the strike price of each option.

Now, I'll turn the call back to Larry.

The Chairman, President, and Chief Executive Officer speaks.

Thanks, Mark.

Our long-term basic earnings per share growth rate target remains at 6 to 8 percent on an average annualized basis, with fluctuations in any given year above or below that targeted range. We are reducing our 2005 basic earnings per share guidance range for income from continuing operations to between $3.62 and $3.86, assuming normal weather, availability of our generation units, the sale of the Kewaunee plant, and our planned land sales. This reduction reflects the impact of the Kewaunee sale and the costs related to protecting our Section 29 tax credits. Earnings per share guidance does not reflect the cumulative effect adjustment that may be required upon our adoption of Financial Accounting Standards Board Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations, which is effective December 31, 2005. We have not provided earnings per share guidance for discontinued operations. Although we remain committed to the sale of Sunbury and are working with several interested parties, we are not currently able to predict the ultimate sale price.

In 2005, we will continue to seek a balanced portfolio of utility and nonregulated growth, with an emphasis on regulated growth. This strategy allows us to participate in, learn from, and be prepared to take advantage of nonregulated opportunities with an acceptable risk profile when those opportunities are available.

Also, our asset management strategy will support delivery of our predicted shareholder return and help maintain our outstanding dividend record. We plan to continue delivering value to our investors for many years to come.

Please remember our three key points for today:

Now, Joe, Phil, Mark, and I are available to answer your questions about our financial picture and plans for the future.

Thank you for being a part of our first quarter earnings conference call. A replay of this conference call will be available through May 18 by dialing 866-416-8341.

The text for today's presentation is available on our Web site. Just select Investor Information and then Presentations.

If you have additional questions, you may contact Joe O'Leary at 920-433-1463 or Donna Sheedy at 920-433-1857.