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Earnings Conference Call - October 18, 2001

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

Good afternoon. Welcome to the third 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 are Joe O'Leary, our Senior Vice President and Chief Financial Officer; Ralph Baeten, our Senior Vice President - Finance and Treasurer; and Diane Ford, our Vice President - Controller and Chief Accounting Officer.

We are here today to discuss our earnings for the third quarter of 2001 and to take a look at 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, October 18.

Before we begin, I need to point out that this presentation contains forward-looking statements within the definition of the Security and Exchange Commission's safe harbor rules regarding the realization of projected results for 2001 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 8.9 million dollars during the third quarter of 2001 when compared with the same period in 2000. This resulted in earnings per share of 76 cents for the quarter compared with 49 cents in 2000.

Impacting our earnings this quarter was warmer than normal weather, efficient and reliable plant operations, reasonable energy costs when energy purchases were necessary, and the seventh consecutive quarter of profitability by our nonregulated subsidiaries, WPS Power Development and WPS Energy Services.

Revenues from utility operations grew by over 14 million dollars and net income increased by 3.5 million dollars this quarter when compared with the same period in 2000. Wisconsin Public Service achieved higher margins as a result of a 5.4 percent increase in Wisconsin retail electric rates and a 1.5 percent increase in retail gas rates that were effective on January 1, 2001. This was coupled with higher sales volumes to most classes of customers at our utilities and summer weather that was 76 percent warmer than the third quarter of 2000 and 20 percent warmer than normal.

WPS Energy Services, our energy supply and services company, has grown its revenues by more than 41 million dollars when compared with the same quarter in 2000. Its net income increased by 800 thousand dollars as a result of increased sales volumes in both existing and newly-entered retail electric markets and increased activity in the wholesale gas market.

With revenues growing by approximately 5 million dollars this quarter compared with the same period in 2000, WPS Power Development increased its net income by 1.1 million dollars this quarter over the same period in 2000 as a result of increased generation and production of syn fuel.

Consolidated operating expenses increased by 11.6 million dollars this quarter. The bulk of the increase, 7.9 million dollars, was at the utility. Increased maintenance associated with the refueling outage at our nuclear plant that began on September 23, increased expenses associated with the formation of the American Transmission Company, increased energy conservation payments, and increased write-offs for uncollectible accounts contributed to the higher operating expenses. Nonregulated segments also incurred 4.1 million dollars in increased operating expenses as a result of business expansion that included new offices and staff additions, increased payroll expenses, increased project development costs, and costs associated with WPS Power Development's Westwood generation plant which was acquired in September of 2000.

Lower earnings from the nuclear decommissioning fund resulted in a 3 million dollar reduction in depreciation expense at Wisconsin Public Service while higher earnings on equity investments increased income for WPS Resources. We also experienced a small marked-to-market expense this quarter on an electric energy contract we entered into as a hedge against potential summer energy price spikes this summer compared with a pre-tax 3.9 million dollar marked-to-market expense in the third quarter of 2000.

Now, let's look at our performance for the year to date.

For the nine months ended September 30, earnings per share were $2.04 compared with $2.02 in 2000.

Revenues at each of our major segments increased over 2000. Our utility segment grew its revenues by over 127 million dollars, while our nonregulated segments grew their revenues by over 733 million dollars.

All of our generating units—utility and nonregulated—were available for dispatch this summer.

When comparing nine-month data for 2001 with the same period in 2000, net income increased by 1.8 million dollars at WPS Energy Services and 1.5 million dollars at WPS Power Development, but was partially offset by an 800 thousand dollar decrease in net income from utility operations.

Our utility segment shows a decrease in net income for the nine months of 2001 when compared with the same period in 2000 because of the one-time gain of 3.8 million dollars that was recorded in 2000 for the sale of the combustion turbine to Madison Gas and Electric.

WPS Energy Services' revenue for the nine months of 2001 of over 1 billion 240 million dollars surpassed all of its revenue for last year, which had amounted to 956 million dollars. Energy Services' margins increased for the nine months of 2001 to 21 million dollars compared with 13 million dollars for the first nine months of last year.

WPS Power Development's tax credits increased by over 7 million dollars during the first nine months of 2001 over the same period in 2000.

So, what does our year look like? Our third quarter was strong which pushed our year-to-date earnings per share to $2.04 compared with $2.02 for the same period in 2000. Last year, we achieved earnings per share of 51 cents during our fourth quarter. But our fourth quarter this year is providing some unique challenges. As a result, we are adjusting our annual earnings per share forecast to be between $2.50 and $2.55. The reasons for this adjustment include:

There are also opportunities and, in some cases, additional challenges in achieving targeted earnings.

It is the beginning of the heating season for Wisconsin Public Service, so our gas deliveries should increase. We should also realize increased gas revenues because of the merger with Wisconsin Fuel and Light Company that was closed in April.

The Kewaunee Nuclear Power Plant was taken down for refueling on September 23 and is expected to be out of service for 73 days while the steam generators are replaced during this outage.

WPS Energy Services was awarded electric contracts in Ohio earlier this year, which are adding to our increased earnings. We now have about 600 megawatts of electric load.

We continue to expect WPS Energy Services and WPS Power Development together to contribute more than 15 percent to our earnings in 2001.

That gives you some background on what has increased our earnings so far this year. Now I'll discuss our operating segments. I'll begin with our regulated utilities.

Wisconsin Public Service established new peak demands on our electric system on July 9 and again on July 31 and approached peak sendout on several days in early August. We were able to meet the demand comfortably because there was sufficient market supply available, so we did not need to run our higher-cost generating units.

Providing reliable power is extremely important to us because for the sixth consecutive year, Wisconsin Public Service reached a new peak for summer electricity use. On July 31, the electricity demand on our utility system increased to 2,173 megawatts—exceeding last year's summer peak by 124 megawatts—and doing so without requiring the implementation of our load reduction programs.

The Public Service Commission of Wisconsin approved the 250-mile electric transmission line that will stretch from Wausau, Wisconsin, to Duluth, Minnesota, by a 3 to 0 vote on August 17. The joint project of Wisconsin Public Service and Minnesota Power was originally announced on April 15, 1999. The Minnesota portion of the project was approved in March. This is a key step in improving the reliability of a fragile transmission system. Currently, we are not always able to either import necessary power into the state nor are we able to move bulk amounts of power within the state to where it is needed.

As a result of contributing the transmission assets of Wisconsin Public Service and Upper Peninsula Power to American Transmission Company, we are approximately a 15 percent owner in the company. When we complete the construction of the proposed Weston to Arrowhead transmission line, our ownership is expected to increase to about 25 percent.

The Kewaunee Nuclear Power Plant was taken down for refueling on September 23. At the same time, work was begun on a 100-million-dollar project to replace the plant's two steam generators. This project will allow Kewaunee to produce competitively priced, reliable and clean electricity at least through the end of its current license in 2013.

Upper Peninsula Power completed the replacement of its 42-year-old pipeline or penstock at its Victoria Hydro facility near Rockland. The 6,050-foot long wooden stave pipeline had reached the end of its lifespan and was replaced with a 9 and 1/2 foot diameter spiral-welded steel pipeline. The 6 million dollar project was completed on schedule and confirms our commitment to renewable energy sources.

In April, Wisconsin Public Service filed a request to increase its electric rates by 16 percent and its gas rates by 4.5 percent. We're investing in service, reliability, and infrastructure that our customers require for the future. We're doing what California didn't do so that we can avoid the problems they have experienced.

Improvements to the Kewaunee plant accounted for 45 percent of the electric rate increase request. Installation of the new steam generators and upgrades to the plant will ensure its reliability through the life of its license.

The second largest component of the request—26 percent—is related to the normal growth of our customer base and systems.

Another 20 percent of the increase requested is related to the American Transmission Company that began operating in 2001 to coordinate the transmission systems of eastern Wisconsin and the Upper Peninsula of Michigan. All participating utilities, including Public Service, transferred their transmission assets to the American Transmission Company and now pay a fee to that company to transmit power over those lines. To arrive at one system transmission rate, the American Transmission Company averaged the existing transmission rates of all participating utilities. Because Public Service had the lowest transmission rate in the state, the averaged rate is higher than what we had in the past. The current system rate is approximately 30 percent more than before. Like any business, we need to recover these increased costs.

The final component of the rate request—14 percent—is related to a requested increase in the return on equity to 12.6 percent, an increase in the equity component to 55 percent, upgrades to computer systems such as the installation of automated meter reading technology, and upgrading our billing and mapping systems.

In spite of these rate increases, our rates will remain competitive with rates in the upper Midwest.

We had hoped to receive the order for this rate request this December and that the new rates would take effect on January 1. However, it now appears that we will not see an order until the beginning of the second quarter. As a result, Wisconsin Public Service is requesting interim electric and natural gas rate increases from the Public Service Commission of Wisconsin. The interim request seeks an 11.5 percent electric and 4.3 percent natural gas rate increase. The interim increase request is based on a 12.3 percent return on equity with 55 percent equity. We anticipate the Commission will make a ruling on the interim rates in late December.

Wisconsin Public Service also joined other state investor-owned utilities in seeking to recover costs resulting from the changes to the state's electric transmission system. So that the transmission cost issues would not have to be presented individually before the Commission in separate utility rate cases, the companies agreed to a joint filing. Wisconsin Public Service has also included 20 million dollars in its electric rate case filing with the Public Service Commission of Wisconsin in April. If the costs are recovered through this generic case, the costs will be removed from the 2002 rate case.

Upper Peninsula Power Company also had a rate case pending before the Michigan Public Service Commission since October of 2000. In August, Upper Peninsula Power withdrew its rate case. The primary reason for the rate increase was to cover the 20 million-dollar-cost of major safety modifications to its hydro plants which were mandated by the Federal Energy Regulatory Commission. Upper Peninsula Power intends to submit a new rate case in 2002 that will be based on the latest data. Upper Peninsula Power has not had a rate increase since 1994 and its customers received a rate decrease in 1995. The case was withdrawn because the filed data was outdated given the delay caused by interveners who were expecting a significant cost savings for transmission when Upper Peninsula Power joined the American Transmission Company.

Our utilities are projecting capital expenditures of nearly 500 million dollars over the next three years. The steam generator replacement that is currently taking place at the Kewaunee Nuclear Plant is expected to cost about 66 million dollars. The replacement of equipment at Upper Peninsula Power's hydro facilities and substations will account for 30 million dollars. Completion of our automated meter reading project will be in the range of 65 million dollars. The equity commitment for construction of the Weston to Arrowhead transmission line will require about 60 million dollars. Software upgrades at our utilities could be as much as 150 million dollars. This demonstrates our desire to make significant investments in the continued growth of our utilities.

Now I would like to address the expected operations of our two nonregulated companies. I'll begin with WPS Power Development.

Our synthetic fuel operation in Kentucky seems to draw attention. The mines in the area have an abundant supply of feed stock. The equipment has plenty of operational capacity—in fact, significantly greater than what has been produced to date. Its output capability is not a limiting factor in achieving significant tax credits.

We became involved in this project as a way of maximizing our cash flows through the use of tax credits. What we've discovered is that the operation has tax credit potential that exceeds our needs. Because our appetite for tax credits is limited, we are continuing to negotiate with a potential partner.

We cannot discuss more specific confidential information such as cost of production, specific quantities of production, the market price of the syn fuel, and the company's appetite for tax credits.

We own 503 nominal megawatts of generation capacity in Pennsylvania, which is made up of 473 megawatts from our Sunbury and 30 megawatts from our Westwood facilities. We purchased Sunbury in November of 1999 and Westwood in September of 2000. These plants performed reasonably well during this summer's hottest months. This type of reliability is very important in the liquid Pennsylvania, New Jersey, Maryland energy marketplace. Most of the output from these facilities is under off-take contracts for the next two years.

In September, WPS Power Development announced plans to construct a nominal 250-megawatt, coal-fueled electric generating power facility in Cassville, Wisconsin. The Cassville Energy Center would 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 in about 2005. WPS Power Development owns two-thirds of the Stoneman Power Plant.

WPS Power Development will also require capital for expenditures associated with the new 50-megawatt cogeneration facility at the Appleton Coated Papers' mill located in Combined Locks, Wisconsin. Additional acquisition and development projects continue to be evaluated. Sierra Pacific Resources has submitted our proposal for upgrading certain generating units at the Tracy/Pinon Power Station as part of its Electric Resource Plan to the Nevada Commission.

WPS Power Development is an important part of our earnings growth projections. In addition to expecting continuing profitable operations from its existing diversified asset portfolio, we're expecting to make new investments of about 150 to 200 million dollars per year.

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

WPS Energy Services has enjoyed tremendous revenue growth over the last 6 years, and we expect it to continue expanding in the northeastern portion of the United States.

Energy Services is growing its electric sales volume, yielding greater margins than its natural gas segment historically has. We're expecting to see continually improving margins from Energy Services, with expanded sales a key contributor to that improvement.

WPS Energy Services' participates in the electric 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.

An example of this is our 3-year contract in northern Maine's electric market to provide the Standard Offer Service to retail customers. The retail marketing efforts of our office in Maine are generating electric revenues for WPS Energy Services while securing a market for the output of WPS Power Development's generation assets. Because we were established in northern Maine, Energy Services is successfully expanding its retail business into southern Maine. As a result, our total sales within Maine now exceed our own generation capacity in the region by a factor of six. Energy Services has fully secured capacity to cover the increased sales volume from reliable local generators and creditworthy power marketers that control physical assets.

WPS Energy Services also has a 5-year electric contract to serve the municipal aggregation program for the City of Cleveland, Ohio, and is serving over 100,000 residential and commercial customers in Cleveland who were previously served by First Energy.

WPS Energy Services was recently selected by the Northwest Ohio Aggregation Coalition to serve 35,000 electric residential customers in six communities surrounding Toledo who participate in the aggregated buying group.

In September, WPS Energy Services completed construction of a 3 billion cubic foot gas storage field in the Township of Kimball, Michigan, and began injecting natural gas into the facility. The rapid-withdrawal facility will improve the region's energy delivery infrastructure, lowering energy costs and enhancing the reliability of energy supplies in the region. 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 Great Lakes Gas Transmission and Vector Pipeline gas transmission systems. Michigan's geology allowed for the cost-effective construction of this storage facility. The design of the system will allow for increased reliability and greater flexibility in meeting customers' peak day energy requirements.

More good news came our way when WPS Energy Services was recently named the number one rated gas marketer in the country in terms of overall customer satisfaction as measured by Mastio and Company in its 2001 survey.

In regard to our financing plans, in the fourth quarter, we plan to issue between 50 and 100 million dollars of common stock to provide the equity commitment for the capital expenditure projects at all of our subsidiaries. We are closely watching national developments in response to the terrorism attacks. The financial market's reaction and potential stock market volatility may impact our decision of when we come to market with the issuance.

The opportunities and challenges I just discussed lead us to believe that we can achieve the $2.50 to $2.55 earnings per share this year.

We should have a good year in 2002. The Wisconsin rate case will be settled. The sell down of our synthetic fuel facility should be settled. And, we hope to have an Upper Peninsula Power rate case filed and settled as well.

We are currently putting our budgets together, so it's a little early to give an earnings per share range for 2002. But, I will say that we expect to exceed our 8 to 10 percent growth rate. We had previously said that year-to-year growth would vary. We expect 2002 to be one of those years when we achieve higher growth.

Standard & Poor's indicated that they have reviewed the credit ratings of the Wisconsin utilities. They have indicated that their methodology first looks at the holding company and then, because of Wisconsin regulation, rates the utility one notch higher than the holding company.

They have indicated that there is no regulation currently that would merit more than a one notch differential.

We believe that Wisconsin regulation clearly is distinct in its separation of regulated and nonregulated businesses. Affiliated interest rules, dividend requirements, frequent rate reviews with reasonable allowed returns on a significant common equity factor, and continuous oversight of operations more than justifies a spread of more than one notch.

In our case, Standard & Poor's has determined that WPS Resources Corporation is highly leveraged for it to retain an AA- rating. Standard & Poor's rated the senior unsecured debt an A+ given WPS Resources Corporation capitalization mix and the impact of the commitment to the nonregulated growth business.

Wisconsin Public Service Corporation first mortgage bonds are rated AA-. Commercial paper ratings are A-1 for WPS Resources Corporation and A1+ for Wisconsin Public Service Corporation.

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

A replay of this conference call will be available through November 1 by dialing 800-925-2059.