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Earnings Conference Call - Second Quarter 2006

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

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

Mark A. Radtke
President - WPS Energy Services

and

Donna M. Sheedy
Manager - Investor Relations

The Manager Investor Relations speaks.

Good afternoon. Welcome to WPS Resources Corporation's 2006 second quarter earnings conference call. With me today are Larry Weyers, Chairman, President, and Chief Executive Officer of WPS Resources Corporation; Joe O'Leary, our Senior Vice President and Chief Financial Officer; Phil Mikulsky, our Executive Vice President - Development; and Mark Radtke, President of our nonregulated subsidiary, WPS Energy Services.

We are here to discuss our second quarter results, as well as what you can expect from us in the future. Today, Larry Weyers will provide highlights on the quarter. Then Joe O'Leary will discuss our financial results. Larry will then provide an operational update on our regulated utilities. This will be followed by an operational update on WPS Energy Services from Mark Radtke. At the end of our prepared remarks you will have an opportunity to ask questions.

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 2006 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.

I will now turn the call over to Larry Weyers.

Larry Weyers - Chairman, President, and Chief Executive Officer

Thank you, Donna. Good afternoon, everyone, and thanks for your continued interest in WPS Resources. Let's begin with a few highlights.

Before I turn the call over to Joe, I want to bring up a few of our recent milestones.

Joe O'Leary will now discuss our financial results. Joe…

Joe O'Leary - Senior Vice President and Chief Financial Officer

Thanks, Larry.

Before I begin, let me refer everyone to our press release and Form 10-Q that we filed earlier today with the Securities and Exchange Commission for details of our second quarter financial results. I will review the major financial and segment highlights for the quarter.

As Larry said, we produced earnings of 34.9 million dollars during the second quarter, which includes the following items:

Now let's move on to our regulated operations. Cooler than normal weather resulted in a 1 percent decline in electric volumes compared to the second quarter last year. Although we experienced a decline in residential demand versus last year, our wholesale volumes were up 4.5 percent. Electric utility margins declined 10.8 percent in the second quarter of 2006 to 143.6 million dollars. However, this included 24.3 million dollars in fixed payments to Dominion Energy Kewaunee under a power purchase agreement associated with our sale of Kewaunee last year. Excluding the impact of this payment, margin increased 6.9 million dollars due to fuel and purchased power costs that were less than what was recovered in rates during the quarter. This was partially offset by the impact of unfavorable weather conditions. Fuel and purchased power costs are expected to be greater than what will be recovered in rates in the second half of the year, which should negatively impact margins during that period.

With the sale of Kewaunee, the related operating expenses at Kewaunee are no longer reflected in our results, resulting in lower operating expenses. Overall, earnings at our electric utility rose 12 percent to 23.4 million dollars in the second quarter of 2006 from 20.9 million dollars in the comparable quarter last year.

Throughput in our natural gas utility operations rose 19.9 percent, due to our newly acquired natural gas distribution operations in Michigan. By way of size, Michigan Gas Utilities accounted for roughly a third of our regulated utilities' natural gas throughput during the quarter. Although throughput increased on an overall basis, Wisconsin Public Service's volume declined 20.7 percent during the quarter compared with last year. Most of the decline in throughput was related to an 85 percent drop in volumes sold to our electric utility in last year's second quarter for peaking demand. Residential and commercial and industrial volumes were also down by 7.7 percent due to weather and conservation efforts. Despite the drop in volume, Wisconsin Public Service's gas utility margins came in roughly flat with last year's results. This is because the lost sales volume to the electric utility had very thin margins. In addition, there was a rate increase at Wisconsin Pubic Service that helped to partially mitigate the retail and commercial volume decline. Michigan Gas Utilities contributed 9.8 million dollars in margin. In aggregate, our gas utility segment margin increased by 10 million dollars for the second quarter to 33.6 million dollars. Overall, our combined natural gas utility's operating and maintenance expenses were approximately 33 million dollars, which includes 4.1 million dollars of pre-tax transition costs associated with the acquisition of natural gas distribution operations in Michigan and Minnesota. Together they resulted in a net loss in our natural gas utility operations of 7.5 million dollars, compared to a loss of 1.9 million dollars last year.

Turning to our nonregulated operations, WPS Energy Services posted income of 13.4 million dollars, an increase of 9.8 million dollars from a year ago. These results include a 5.4 million dollar after-tax gain on the sale of the Kimball natural gas storage field, as well as a 5.6 million dollar after-tax loss in discontinued operations associated with our Sunbury generation operations. Margins rose by 22 million dollars, led by strong performance in wholesale electric operations. The margin increase was partially offset by a 2.7 million dollar decrease in recognized synfuel tax credits and a 5.4 million dollar increase in operating expenses, primarily due to higher payroll and benefit costs associated with our continued business expansion. A detailed breakdown of WPS Energy Services' margin growth can be found in our Form 10-Q.

Finally, in our Holding Company and Other operations, we reported earnings of 5.6 million dollars, up from 1.3 million dollars last year. This includes approximately 3.8 million dollars of after-tax gain from the sale of our interest in Guardian Pipeline. Our after-tax equity earnings from American Transmission Company were 5.9 million dollars for the quarter, up from 3.5 million dollars last year.

Now, I would like to discuss a few other financial related issues that will have an impact on our future results.

On June 27, 2006, Upper Peninsula Power Company received approval to increase its overall electric base rates by 4.8 percent, or 3.8 million dollars, effective June 28, 2006, with a 10.75 percent return on equity, and a regulatory capital structure that allows 54.9 percent equity. This is expected to increase net income by about 2.5 million dollars annually.

Hearings are scheduled in September 2006 for the 2007 electric and natural gas rate case that Wisconsin Public Service filed with the Public Service Commission of Wisconsin. The filing requests a 125.1 million dollar, or 14.4 percent, increase in Wisconsin retail electric rates, and a 22.6 million dollar, or 3.9 percent, increase in Wisconsin retail natural gas rates. We anticipate that the Public Service Commission of Wisconsin will provide a ruling on the rate case by the end of 2006, which would allow the new rates to become effective on January 1, 2007. In order to provide greater rate certainty for our customers through 2008, Wisconsin Public Service filed a biennial rate proposal with the Public Service Commission of Wisconsin on July 1, 2006. The rate proposal includes a revenue stabilization mechanism, which is designed to reduce over and under collections of Wisconsin Public Service's gross margin caused by variations in customer usage, including the impacts of conservation and weather. Wisconsin Public Service expects that the Public Service Commission will act upon this proposal as part of the 2007 rate case.

On July 26, 2006, we completed the sale of our Sunbury generation facility. Gross proceeds were about 34.6 million dollars. The total estimated pre-tax gain on that transaction is expected to be about 19 million dollars, which will be reported in our third quarter results in discontinued operations. We also anticipate 14 million dollars in cash tax benefits that will be realized within the next few years, with the timing subject to the use of alternative minimum tax credits.

Now, I would like to give you an update on our anticipated capital expenditures. We intend to invest about 900 million dollars in capital expenditures between 2006 and 2008 for Wisconsin Public Service, with about 300 million dollars being spent each year. The majority of expenditures will be invested in our regulated utility operations with the largest project being Weston 4.

Depreciation for those years for Wisconsin Public Service is expected to be about:

Wisconsin Public Service is currently allowed almost 60 percent equity in its regulated capital structure and a return on equity of 11 percent. So, incremental net income could be about 12 to 13 million dollars per year.

Anticipated capital expenditures at Upper Peninsula Power for 2006 through 2008 will be about $48 million and depreciation is estimated to be about $17 million for those years.

We anticipate that capital expenditures net of depreciation are not going to be significant for the Michigan Gas Utilities and Minnesota Energy Resources utility operations through 2008.

Anticipated nonregulated capital expenditures for the same period are not significant when compared with the expected regulated expenditures.

WPS Resources expects capital calls from the American Transmission Company relating primarily to transmission line projects to total about 164 million dollars for the years 2006 through 2009, with about 61 million dollars relating to the Wausau, Wisconsin, to Duluth, Minnesota, transmission line. This assumes that Allete contributes 60 million dollars toward the Wausau to Duluth capital calls in 2006. ATC is currently allowed a return on equity of 12.2 percent through 2012.

With regard to issuing equity and debt, WPS Resources has previously described plans to issue additional common equity and debt during the latter part of 2006 to fund the acquisition of the Michigan and Minnesota natural gas distribution operations from Aquila and other capital requirements. We previously communicated expectations to issue equity in the range of 250 million dollars to 300 million dollars and long-term debt in the 350 million dollar to 400 million dollar range with the potential to displace part of the equity and debt with certain hybrid securities that are treated by credit rating agencies as a blend of debt and equity. Given the proposed merger with Peoples Energy Corporation and the announced asset management review of certain businesses in connection with the merger, the timing, size, and mix of the WPS Resources financing may change. We continue to plan for WPS Resources financing later this year. Our regulated utility, Wisconsin Public Service, plans to issue long-term debt in the 100 million dollar to 150 million dollar range to provide funds for capital growth of utility operations.

Finally, as Larry mentioned earlier regarding our earnings per share guidance, we are raising our guidance. We now anticipate that our 2006 diluted earnings per share guidance will range between $3.64 and $4.12, compared with our previously released guidance range of $3.54 and $3.98, including about 14 million dollars of pre-tax transition costs we anticipate expensing in 2006 related to the acquisitions of natural gas distribution operations in Michigan and Minnesota. It also includes about 6.4 million dollars of increased purchased power costs for WPS Energy Services relating to an 8.2 million dollar pre-tax gain recognized in 2005 from the liquidation of a supply contract for Maine customers. The guidance also includes the impact of our asset management sales and discontinued operations; including the estimated 19 million dollar pre-tax gain from the sale of the Sunbury generation facility, as well as that facility's operating results.

Since many of you often request information relating to notable items included in our 2006 diluted earnings per share guidance, we have provided details in a page attached to the text of this presentation which is available on our Web site. We also included information relating to notable items included in our 2005 diluted earnings per share. We expect that you will find this information useful in analyzing the possible rate of growth in diluted earnings per share in 2006 as compared to 2005.

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

The Chairman, President, and Chief Executive Officer speaks.

Thanks, Joe.

Let's look at the capital projects we have underway.

Construction of Weston 4, our 500-megawatt pulverized coal plant in Wausau, Wisconsin, continues on schedule and on budget. The plant is scheduled to begin commercial operation by June 2008.

Construction of the 220-mile, 345-kilovolt Duluth, Minnesota, to Wausau, Wisconsin, ATC transmission line is well underway. Construction of the Wisconsin portion of the line is progressing on schedule for a second quarter 2008 completion. A 142-mile portion of the Wisconsin line is scheduled to be in service by the end of this year, at which time, 70 percent of the line will be complete.

Now, let's take a closer look at our nonregulated operations. Here to discuss this is Mark Radtke, President of WPS Energy Services. Mark…

Mark Radtke, the President of WPS Energy Services speaks.

Thanks, Larry.

Let's start by taking a quick look at our plants. Although we completed a slightly longer spring maintenance outage this year versus last year at our Niagara Falls solid fuel plant, our improved operating performance led to a capacity factor of 59 percent, an increase of 5 percentage points compared to the second quarter of 2005. We also finished testing the use of tire derived fuel at Niagara, successfully sustaining blends of 65 to 70 percent tire derived fuel. We believe this clears the way for permitting normal operation at those higher levels. As I've noted in the past, this effort not only provides a beneficial use for old tires, it lowers our total fuel cost at the plant where we have been using between 20 to 25 percent tire derived fuel in recent quarters.

Westwood's capacity factor dropped 11 percentage points to 61 percent due to a couple of boiler tube leaks, which were repaired during our spring maintenance outage. The unit is also de-rated a couple of megawatts as we lower the boiler operating temperature. Engineering analysis is underway to determine modifications to avoid excessive boiler component wear while operating at full capacity. The solution may not be implemented until next spring's maintenance outage.

Given the improved spark spreads in New York, our Syracuse natural gas plant dispatched 13 percent of the time — 20 days in the month of June alone, compared to not dispatching during the second quarter of 2005. Beaver Falls continues to be unavailable since its June 26, 2005, first stage turbine blade failure. Given improvements in long-term market fundamentals, it is probable that we will repair the unit.

Over the past 18 to 24 months, we have been adding significant business origination and support resources to focus on organic growth of our customer based natural gas and electric business. That focus is continuing to generate results that can be seen in this quarter's growth of forward contract business volume, or business backlog as it is sometimes referred to. Our natural gas forward contract volume increased 35 percent compared to June 30, 2005. That growth is more heavily weighted to our retail business than our wholesale business and is even stronger in future years than for the next 12 months. Our electric business grew even more with an 85 percent increase in forward contracted business, again heavier in future years than in the next 12 months.

As you may know, we have started operating in Texas. In accordance with our plans, we began delivering physical electricity to retail customers on July 1. Our infrastructure is operational, and customer response has been very positive. This enhanced infrastructure will be leveraged in our other markets as well.

In addition to our Texas expansion, we are seeing good organic growth in existing markets, including the Midwest, New England, and Canada. During the second quarter, we added almost 1 million megawatt-hours of contracted retail customer sales volumes across our markets.

We are continuing to innovate around product offerings to wholesale and retail customers, enabling load response capability for customers that can proactively participate in the market's supply/demand balance.

Last quarter I mentioned the expansion of our natural gas mass-market business, which has been primarily residential and small commercial customers in Ohio, and we are now adding service to small commercial customers in Michigan. This market expansion leverages our experience and analytics developed and demonstrated in the Ohio market, and resulted in growing our mass market business by about 15 percent.

Our synthetic fuel tax credit phase-out risk management continues to work well. We were able to produce an additional 264,000 tons of synthetic fuel during the quarter, and protect against economic harm should oil prices continue to remain high in the phase-out range during 2006. An entity that previously entered into a monetization agreement has given notice that they will discontinue taking production after the third quarter of 2006. This represents a potential pre-tax reduction of 4.2 million dollars we expected in 2007 from the sell down, and we are working on strategies to compensate for that shortfall from plan.

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

The Chairman, President, and Chief Executive Officer speaks.

Thanks, Mark.

We have tremendous opportunities ahead of us at WPS Resources. On July 10, 2006, we announced the merger agreement with Peoples Energy. As we outlined in our press release and presentation, we see tremendous opportunities for merging our two organizations. As we mentioned, assuming the merger closes, we intend to increase the company's dividend to 66 cents per quarter, which represents a 14.8 percent increase from the company's recently increased dividend level. We have also identified approximately 94 million dollars in potential annual cost savings at a one-time cost of approximately 186 million dollars. On August 2, WPS Resources and Peoples Energy filed a joint application seeking expedited approval of the merger with the Illinois Commerce Commission. As we move forward, we will keep you informed of the progress we make in merging these organizations.

Although we have identified substantial synergies associated with our merger with Peoples Energy, we will continue our cost reduction initiative called Competitive Excellence. It is a process approach that gives employees the tools and knowledge to eliminate waste and work more efficiently. We expect this focus will allow us to further lower our costs for many activities.

We continue to target a 6 to 8 percent long-term earnings per share growth rate on an average annualized basis, with annual fluctuations that may be above or below that target.

To recap key points of today's earnings conference call:

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 second quarter earnings conference call. A replay of this conference call will be available through August 17, 2006, by dialing toll free 800 406-7489.

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.

Diluted Earnings Per Share Information

    Potential 2006 EPS Ranges
  Actual 2005 High Scenario Low Scenario
Diluted EPS from continuing operations $3.87 $3.90 $3.49
Diluted EPS from discontinued operations $0.24 $0.22 $0.15
Diluted EPS from cumulative effect of change in accounting principle ($0.04) ----- -----
Total Diluted EPS $4.07 $4.12 $3.64
Notable Items Information:
Notable items and their financial impact on the 2006 diluted earnings per share from continuing operations guidance and the actual 2005 diluted earnings per share from continuing operations are as follows:
Asset Management      
    Other asset sales ($0.10) $0.22 $0.22
    Land sales $0.15 $0.10 $0.10
      Total asset management and land sales $0.05 $0.32 $0.32
Estimated MERC and MGUC earnings ----- ($0.06) ($0.06)
Writeoff of Kewaunee deferred 2004 outage costs ($0.12) ----- -----
ESI power contract in Maine liquidated in 2005 $0.13 ($0.10) ($0.10)
Synfuel - primarily realized and unrealized oil option gains, tax credits, production costs, premium amortization, deferred gain recognition, and royalties $0.84 $0.39 $0.37
Weather impact - regulated utilities (As compared to normal weather)      
    Electric impact $0.18 ($0.07) ($0.07)
    Gas impact ($0.07) ($0.09) ($0.09)
      Total weather impact $0.11 ($0.16) ($0.16)