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Earnings Conference Call - Second Quarter 2002

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

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

Good afternoon. Welcome to the second quarter 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.

We are here today to discuss our earnings for the second quarter of 2002 and to discuss what the future has in store for us.

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 also available on our Internet site. Once you are at the site, select Financial Information, select Financial News, select Earnings, and finally select the release from today, July 23.

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 the realization of projected results for 2002 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.

WPS Resources' consolidated net income increased by 10 million dollars during the second quarter 2002 when compared with 2001. Basic earnings per share were 68 cents for the second quarter in 2002 compared with 41 cents for the same period in 2001. However, the 68 cents for 2002 included recognition of 32 cents of the one-time deferred gain on WPS Power Development's 2001 sale of part of its synthetic fuel operation, resulting in earnings from ongoing operations of 36 cents per share during the second quarter.

Consolidated net income increased by 85 percent during the second quarter of 2002 when compared with the same period in 2001, largely as a result of WPS Power Development's 11.9 million dollar increase in net income. Meanwhile, our regulated electric utility segment had a 30 percent decrease in net income in the second quarter of 2002 when compared with 2001, and our nonregulated energy services segment had a 20 percent decrease in net income in the second quarter of 2002 when compared with the same period in 2001.

Margins increased for most business segments this quarter. Our electric utility segment increased its margin by almost 15 million dollars, but our electric sales volumes and the sales mix between higher margin and lower margin customers did not generate enough revenue to cover our higher electric utility operating expenses. As a result, electric utility net income decreased 30 percent.

Our second quarter heating season was 35 percent cooler than last year and 14 percent cooler than normal. Meanwhile, our second quarter cooling season was 18 percent warmer than last year and 22 percent warmer than normal. Our earnings increased by approximately 7 cents this quarter as a result of this weather variation from the same period in 2001.

Now Joe O'Leary will discuss the details behind these financial results.

The Senior Vice President and Chief Financial Officer speaks.

Thanks, Larry.

Utility segment revenues increased by 24 million dollars, or 11 percent, in the second quarter of 2002. Our electric utility segment generated 17.8 million dollars of additional revenue over the second quarter of 2001, and our gas utility segment generated 6.2 million dollars of additional revenue over the second quarter of 2001. This was largely the result of a Public Service Commission of Wisconsin interim rate order authorizing Wisconsin Public Service to increase its retail electric rates by 10.3 percent and its retail natural gas rates by 4.7 percent in Wisconsin effective January 1, 2002. In late June, Wisconsin Public Service received the Public Service Commission's final 2002 rate order, which authorized a 10.9 percent increase in retail electric rates and a 3.9 percent increase in retail natural gas rates in Wisconsin effective June 22.

WPS Energy Services' revenues decreased by 21 million dollars, or 6 percent, during the second quarter of 2002 when compared with 2001 primarily as a result of lower natural gas prices in the second quarter of 2002 than in 2001.

We were able to improve our margins during the second quarter of 2002 when compared with the same period in 2001. Our utility margin increased by almost 18 million dollars. In the nonregulated arena, WPS Power Development increased its margin by almost 6 million dollars and WPS Energy Services increased its net margin by 9 hundred thousand dollars.

Our electric utility margin increased by more than 14 million dollars due to the electric rate increase and 7 percent higher overall electric sales volumes at Wisconsin Public Service. While sales volumes increased to most classes of customers, the volume mix hurt us. Volumes were up 26 percent for lower-margin wholesale customers, but sales to higher-margin residential customers and commercial and industrial customers were up only 5 percent and 3 percent. Our second quarter heating season was 35 percent cooler than last year and 14 percent cooler than normal, while our second quarter cooling season was 18 percent warmer than last year and 22 percent warmer than normal. Both of these weather variances had a positive impact on the electric utility margin in the second quarter.

Our gas utility margin increased by more than 3 million dollars this quarter when compared with the same period in 2001 due to Wisconsin Public Service's higher retail natural gas rates and a 14 percent increase in overall natural gas throughput volumes. Cooler weather during the second quarter's heating season contributed to the greater gas usage and throughput.

WPS Energy Services increased its gas margin by almost 5 million dollars through better management of its retail gas procurement and volume risk processes. However, lower market prices on peak demand reserve power sales decreased its electric margin by nearly 4 million dollars.

WPS Power Development increased its margin by nearly 6 million dollars mainly due to meeting Sunbury's firm contracts at a lower cost as a result of lower spot market power purchases and the change in accounting from consolidation to the equity method as a result of the sale of a portion of its interest in its synthetic fuel facility.

Operating expenses increased nearly 19 million dollars this quarter. Our utility segment was responsible for almost 17 million of the increased expenses that resulted from:

Operating expenses also increased at our nonregulated segments. WPS Energy Services reported 1.5 million dollars of additional operating expenses, mostly as the result of higher broker fees and additional write-offs of uncollectible accounts.

Depreciation expense increased by more than 2 million dollars this quarter when compared to 2001 as a result of Wisconsin Public Service's additional plant assets at the Kewaunee plant—primarily the two new steam generators and our increased ownership in the plant's other assets.

A one-time pretax tax gain of 16.7 million dollars related to WPS Power Development's sale of part of its synthetic fuel operation in 2001 was the primary reason for the 15 million dollar increase in miscellaneous income in the first quarter of 2002 when compared with 2001. We had deferred a portion of the gain in 2001, pending the satisfaction of certain contingencies. One of the contingencies for gain recognition was resolved in April of 2002 when the IRS issued a favorable Private Letter Ruling to the buyer of the facility.

Power Development also recorded 1.8 million dollars of increased tax credits as a result of increased sales at the synthetic fuel facility.

Now, let's take a look at how we performed during the first six months of 2002.

WPS Resources' consolidated net income increased by almost 15 million dollars during the first six months of 2002 when compared with the same period in 2001. This resulted in basic earnings per share in 2002 of $1.58 compared with $1.28 in 2001.

Consolidated utility revenue decreased by almost 24 million dollars, or 4.5 percent, as a result of lower gas prices in 2002.

Electric utility segment revenue increased by 25 million dollars, or 7.7 percent, as a result of the interim rate order from the Public Service Commission of Wisconsin. Meanwhile, gas utility segment revenue decreased by 48.5 million dollars, or 22.7 percent, as a result of lower gas prices.

Our utility heating season for the first six months of 2002 was 1.2 percent warmer than last year and 2.8 percent warmer than normal. Meanwhile, our cooling season for the first six months of 2002 was 18 percent warmer than last year and 22 percent warmer than normal.

Consolidated nonregulated revenue decreased by 300 million dollars, or almost 29 percent, during the first six months of 2002 when compared with the same period in 2001.

WPS Energy Services' revenue decreased by more than 286 million dollars, or 29.5 percent, as a result of lower natural gas prices during the first six months of 2002.

WPS Power Development's revenue decreased by almost 15 million dollars, or almost 20 percent, primarily as a result of the sale of a portion of its ownership interest in its synthetic fuel facility, which resulted in a change in accounting from consolidation to the equity method. Revenues from steam sales also decreased.

Our utility margin increased by almost 43 million dollars during the first six months of 2002 compared with the same period in 2001. Our electric utility segment margin increased by almost 31 million dollars as a result of Wisconsin Public Service's retail electric rate increase and a 5 percent higher overall electric sales volume. WPS's electric sales volumes were up 21 percent for lower-margin wholesale customers while sales to higher-margin residential customers and commercial and industrial customers each increased by only 1 percent. Our gas utility segment margin increased by almost 12 million dollars as a result of Wisconsin Public Service's retail natural gas rate increase and a 17 percent overall increase in natural gas throughput volumes. The increased throughput volumes were the result of Wisconsin Public Service's acquisition of Wisconsin Fuel and Light Company in April of 2001.

WPS Energy Services had an 11 million dollar increase in gas margin during the first six months of 2002 as a result of better management of its retail gas procurement and volume risk processes, partially offset by lower wholesale business. However, Energy Services' electric margin decreased by 2 million dollars because of lower market prices received from the sale of its reserve power.

WPS Power Development's margin increased by more than 9 million dollars largely due to lower spot market power purchases at Sunbury and additional margin from the Combined Locks Energy Center, which became operational in 2002.

Consolidated operating expenses increased by more than 39 million dollars in the first six months of 2002 when compared with the same period in 2001. Utility operating expenses represented more than 34 million dollars of the increased expenditures as the result of:

In the nonregulated arena, operating expenses increased by more than 5 million dollars due to business expansion and higher write-offs of uncollectibles at WPS Energy Services and accelerated maintenance during the first quarter of 2002 at WPS Power Development's Sunbury generation plant.

Depreciation expense increased by more than 9 million dollars during the first six months of 2002 when compared with 2001 due to additional plant assets at Wisconsin Public Service resulting primarily from the two new steam generators and the increased ownership interest at Kewaunee plant.

Rounding out the first six months was a 17.9 million dollar pretax gain related to WPS Power Development's 2001 sale of a portion of its synthetic fuel facility.

The weighted average number of common stock shares outstanding increased by 4.1 million shares primarily as a result of:

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

The Chairman, President, and Chief Executive Officer speaks.

Thanks, Joe. That gives you some background on our earnings story for the second quarter and the first six months. Now I'll discuss how our operating segments fared and what you can expect in the future. I'll begin with our regulated utilities.

Wisconsin Public Service operated under an interim rate order from the Public Service Commission of Wisconsin that was granted in December 2001 for the year 2002 until June 22, 2002 when the final rate order was issued. Wisconsin Public Service had filed for additional rate relief in April of 2001 but, due to several delays in the process, also filed an interim rate request in September of 2001. The interim order, which was subject to refund, granted a 10.3 percent, or 55.5 million dollar, annualized increase in electric rates and a 4.7 percent, or 11.2 million dollar, annualized increase in natural gas rates effective January 1, 2002. The interim order continued the 12.1 percent return on 55 percent equity, which was increased from 54 percent. The final rate order granted a 10.9 percent, or 58.6 million dollar, annualized increase in retail electric rates and a 3.9 percent, or 10.6 million dollar, annualized increase in retail natural gas rates. The order also granted a 12.3 percent return on 55 percent equity. Because the final retail natural gas rates were less than those granted under the interim order, Wisconsin Public Service is required to refund about 420 thousand dollars to customers who were charged the higher rate since January.

Even with this rate increase, Wisconsin Public Service's rates remain among the lowest in Wisconsin and the nation. In fact, in 2001, WPS's electric rates were 29 percent below average rates across the nation, 17 percent less than the average rates in the East North Central Region, and 15 percent below the average rates of major Wisconsin utilities. So, even with the 10.9 percent increase granted for 2002, Public Service's electric rates remain low.

On March 28 of this year, Wisconsin Public Service filed a request to modify electric and natural gas rates for its Wisconsin customers in 2003 and 2004. This rate filing is necessary under a Wisconsin regulatory requirement that calls for biennial filing for rates. Our request included an 8.3 percent increase in electric rates and a 2.7 percent increase in natural gas rates for 2003. We hope to receive a Wisconsin rate order on our 2003 rate request in December to be effective January 1, 2003.

The measures WPS is taking to ensure reliable energy are a primary reason for the requested rate relief.

Wisconsin Public Service strives to remain one of the lowest-priced energy service providers in the Midwest. Even with these proposed increases, WPS's rates will compare favorably with those of other utilities in the Midwest.

Upper Peninsula Power, our electric utility in Michigan, has not had a rate increase since 1994 and needs to increase its rates to cover the increased costs of its operations and enable it to earn a reasonable return on equity. We expect to file for a rate increase in the third quarter and hope to receive an order to be effective January 1, 2003.

WPS has signed definitive agreements to purchase Calpine's 180-megawatt De Pere Energy Center located in De Pere, Wisconsin for 120.4 million dollars. The agreement includes termination of the existing power purchase agreement. WPS expects to pay 72 million dollars at close and 48.4 million dollars near year-end 2003. WPS also entered into a power purchase agreement for up to 235 megawatts of capacity and energy for 10 years, beginning in 2005, from Calpine's proposed Sherry Energy Center, which will be located near Marshfield, Wisconsin. The cost of the capacity purchase will be approximately 250 million dollars, and WPS will be responsible for supplying the fuel for the energy it receives from the Sherry Energy Center.

This is a good deal for WPS and its customers because it will give us a better mix of resources and will mean lower rates for our customers. By terminating the existing power purchase agreement, WPS will be able to take advantage of changes in technology to provide lower-cost options for meeting the increasing demands of its customers.

WPS is also moving forward with preliminary work on the proposed 220-mile Wausau, Wisconsin, to Duluth, Minnesota, transmission line. We recently received a favorable ruling from Marathon County Circuit Court allowing us access to approximately 90 parcels of private land to do survey work in preparation for design and construction of the line. This project is needed in Wisconsin to provide adequate power to the north central portion of the state. This favorable ruling was a necessary step to ensure that the line can be constructed in a timely manner.

We were also pleased when the United States Senate voted to establish Yucca Mountain as the national nuclear waste repository site. The Kewaunee Nuclear Power Plant currently has enough on-site storage to last until the end of its current license in 2013, but the approval of the site is a step in the right direction for the entire nation.

Now let me bring you up-to-date on the operations of our two nonregulated subsidiaries. I'll begin with WPS Power Development.

We own 503 megawatts of generation capacity in Pennsylvania, which consists of 473 megawatts from our Sunbury and 30 megawatts from our Westwood facilities. These plants supply the Pennsylvania, New Jersey, and Maryland energy marketplace. Most of the output from these facilities is under off-take contracts that we've hedged for the next two years. Going forward, we plan to operate Sunbury as a merchant plant.

We also own 69 megawatts of generation in Maine and New Brunswick, Canada. Unfortunately, these hydro facilities have suffered for the last two years from lack of rain and snow—unusual occurrences in that part of the country. The drought conditions persisted through the spring. Fortunately, there has been more rain in late June and July, allowing us to make up some of the lost generation. We still expect that the annual production will be below normal due to the drought conditions that existed in the winter and spring.

In June, WPS Power Development completed its purchase of CH Resources, Inc. whose primary assets are three upstate New York power plants. The plants have a combined capacity of 257 megawatts. The 60 million dollar transaction includes certain transmission contracts and emission allowances. The relatively new generating facilities are expected to sell power into the New York bulk power market through bilateral agreements or into the wholesale and retail open markets using WPS Energy Services as the marketer for the power. The addition of these plants brings the electric generating capacity of WPS Power Development to 930 megawatts. In June, we conducted a successful operational test on the New York plants. Since that time, we have been dispatching the units based on market conditions. The units have operated well and we are pleased with their operations so far.

WPS Power Development continues to work on its plan to construct a 250-megawatt, coal-fueled electric generating power facility in western Wisconsin. The facility will be constructed as a redevelopment project of the existing 53-megawatt Stoneman Power Plant that was purchased in 1996. The plan calls for construction of an additional 200 megawatts of electrical capacity integrated with the existing 53-megawatt Stoneman Plant. We expect to complete this redevelopment project around 2006. WPS Power Development owns two-thirds of the Stoneman Power Plant.

WPS Power Development completed construction of a 50-megawatt simple cycle combustion turbine facility in Combined Locks, Wisconsin, in November of 2001 and completed construction of the cogeneration phase in the second quarter of 2002. The facility is now operational. Overall, the facility's operation has been acceptable; however, we have had some early operational issues, which are normally expected in this type of power plant. We are addressing these issues and are confident that the unit will perform well in the future.

Our synthetic fuel operation in Kentucky has been operating flawlessly. We continue to maintain a one-third share in the facility. In April, the Internal Revenue Service issued a favorable Private Letter Ruling relating to the facility. As a result of receiving the Private Letter Ruling, Power Development recognized in the second quarter of 2002 a one-time pretax gain of 16.7 million dollars associated with this sale, which was completed in 2001. The rest of the gain, about 20 million dollars, will be recognized during 2002 and 2003 as the remaining contingencies expire.

Additional acquisition and development projects continue to be evaluated.

WPS Power Development has been facing bearish market conditions. Power prices are significantly depressed compared with previous years and are not expected to generate the improved margins we had anticipated. Sunbury's change in operational strategy has been helpful in mitigating the effects of the weak market. Sunbury's availability has been good since completing our maintenance schedules, and we have also made progress with improved fuel costs. Coordination between WPS Energy Services and WPS Power Development to optimize trading revenues associated with the plant has also improved.

WPS Power Development is an important part of our earnings growth projections. In addition to expecting profitable operations from its existing diversified asset portfolio, we're expecting to make new investments of about 150 to 200 million dollars per year on an average annualized basis with a return that is commensurate with the assessed risks.

Now, let's take a closer look at WPS Energy Service's operations.

We have enjoyed tremendous growth over the last 6 years, and we expect it to continue expanding in the northeastern quadrant of the United States.

We participate in the electric and gas markets where our sales commitments have back-to-back transactions that allow us to effectively manage risk. Where possible, the transactions are backed by WPS Power Development's generation assets or by assets that we control through contract.

Energy Services' returns from sales of electricity have generally been better than the returns on natural gas sales, and we are continuing to grow Energy Services' electric business. We have also made changes in the way this business manages its retail gas procurement and volume risk processes. All of these efforts are expected to yield improved margins in the future.

WPS Energy Services has a 3-year contract to serve northern Maine's electric market, a 5-year electric contract to serve the municipal aggregation program for the City of Cleveland, Ohio, a 4-year contract to serve six communities surrounding Toledo, Ohio, who participate in an aggregated buying group, and recently added an aggregated buying group around Euclid, Ohio. It also contracted with Cleveland Heights, Ohio, to provide gas aggregation services to the city. This is a two-year contract.

WPS Energy Services owns a 3 billion cubic foot gas storage field in Michigan, which became operational in February. The facility interconnects with the ANR Pipeline, which directly connects to the Michigan Consolidated Gas Company and the natural gas trading hub of Dawn in Ontario, Canada. The facility has access to both the Great Lakes Gas Transmission and Vector Pipeline gas transmission systems. The storage field allows for increased reliability and greater flexibility in meeting customers' peak day energy requirements.

Round-trip trades are the hot topic with many investors today. Let me assure you that we have not been, are not currently, nor do we intend to be involved in round-trip trading. WPS Energy Services' traders are incented to produce margin and profit. WPS Energy Services does not use internally generated price curves but uses external sources in its mark-to-market evaluation. Further protection is provided through our WPS Resources corporate Risk Administration area, which monitors trading activities at Energy Services on a daily basis and assures that they are appropriately hedged.

As far as the market conditions facing WPS Energy Services, it is definitely a less liquid market than it was a year ago—before Enron's demise. Many of the major market makers are either gone or have greatly reduced their activity. This has not caused many problems for Energy Services. With Energy Services' good reputation in the marketplace and the quality credit rating of WPS Resources, Energy Services has not had difficulty in finding counterparts to transact business. The biggest impact we are seeing is not directly from Enron's collapse but from other companies that are experiencing credit downgrades and/or stock price issues. A lot of customers being served by these companies have asked Energy Services to start serving them or we see companies pulling out of regional market areas, leaving opportunities for us to pick up these customers.

Energy Services is continuing to maintain a balance of retail and wholesale gas and electric business in the northeast quadrant of the United States, utilizing WPS Power Development's assets where applicable.

Finally, I'll turn to WPS Resources.

In December, we announced the initiation of our asset management strategy. Our strategy calls for the disposition of assets that are no longer required for operations in a manner that allows recognition of profits over the next 5 to 7 years. Land, buildings, and other facilities at our subsidiaries are a part of this strategy. We are expecting an average annualized impact of 15 to 25 cents per share through 2007 from our asset management strategy.

We expect that our utility, Wisconsin Public Service, will require debt financing in the third or fourth quarter and expect it to be in the form of fading lien notes in the amount of 125 to 175 million dollars. The financing is needed relative to our acquisition of the De Pere Energy Center and to retire 50 million dollars of debt coming due in October.

We expect WPS Resources to require debt financing in the third or fourth quarters and expect it to be in the form of unsecured senior notes in the amount of 100 to 150 million dollars. The funds will be used to meet the capital needs of our subsidiaries.

We are continuing to work hard to maintain our quality credit ratings that give us access to the capital markets at reasonable rates.

We may also issue common stock in the fourth quarter. A common stock issue this year is contingent on the level of future investment activity by our subsidiaries.

We recently announced a dividend increase on our common stock. We are proud to say that this is the 44th consecutive year we have increased our dividend. The 53-1/2 cent dividend is payable on September 20 to shareholders of record on August 30.

Investors and analysts have had a tough six months in attempting to identify quality companies. Both investors and analysts are recognizing that WPS Resources' conservative nature has served it well throughout the years. Our core competencies are in energy and energy related businesses. We intend to stay in those businesses. Our electric and gas utility has served northeastern Wisconsin for over 119 years. We understand the energy business and have developed a business plan that capitalizes on that understanding. Our utility base is solid and our nonregulated energy businesses are focused. We've rewarded our shareholders with 44 consecutive years of dividend increases. We mitigate and minimize risk. We work hard to maintain quality credit ratings. Finally, we deliver value to our customers and our shareholders. We plan to continue delivering value for many years to come!

Now for our earnings forecast, we are adjusting our 2002 earnings guidance to between $2.40 and $2.70 from ongoing operations, plus approximately 59 cents from a one-time gain. This is due in part to the economy recovering at a slower pace than we anticipated. As it has done in the first six months, we expect the sluggish economy to continue impacting our earnings from utility operations. Market prices for energy have also been a problem for our nonregulated business in the first half of the year, and we expect this to continue. Although we've improved our operations at WPS Power Development, we don't expect market prices for energy to generate the improved margins we had anticipated. As a result, we are lowering our estimate for annual earnings. Our target continues to be 8 to 10 percent annualized growth in earnings per share.

Assuming normal weather, availability of our generating units, a pick-up in the recovery of the economy, improvement in the market price for energy, and successful execution of cost control initiatives, we expect that ongoing operations can deliver basic earnings per share of between $2.40 and $2.70 with the likelihood of a one-time gain from the sale of a portion of our synthetic fuel facility adding approximately 59 cents per share by year-end. That will provide total earnings per share of between $2.99 and $3.29. We are also expecting our nonregulated subsidiaries to continue working to improve profitability so that they can, in the future, contribute 15 to 20 percent of our income from ongoing operations, even if they are not able to reach the 15 to 20 percent goal this year.

As you can see, we are still expecting a good year in 2002. We plan to continue delivering shareholder value through our strong utility foundation, focused nonregulated energy and energy-related businesses, achieving our projected annualized earnings per share growth of 8 to 10 percent, and maintaining our outstanding dividend record.

Now, I'd like to take time to answer some of your questions about our financial picture and plans for the future.

Thank you for being a part of our second quarter earnings conference call. A replay of this conference call will be available through August 6 by dialing 800-294-4340. The text for today's presentation is available on our Web site>. Just select Financial Information and then Presentations.

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