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Earnings Conference Call - Third 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

Donna M. Sheedy
Manager - Investor Relations

Good afternoon. Welcome to WPS Resources Corporation's 2006 third 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.

Today we will discuss our third quarter results, as well as what you can expect from us in the future. We will start with Larry Weyers, who will discuss the highlights of the quarter. Then Joe O'Leary will review our financial results. Mark Radtke will then give us an operational update on WPS Energy Services. 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 news 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 joining us on the call today. In an effort to put at your fingertips detailed quarterly statistics, we included a supplemental financial highlights table in the news release we issued this morning. We thought that with the increased level of asset management and corporate development activities, additional disclosure would be beneficial. As you review that information, please let us know if it was helpful. Now, let's begin with the third quarter strategic highlights.

Now on to our third quarter financial results:

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

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

Thanks, Larry.

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

As Larry said, we produced earnings of 39.5 million dollars during the third quarter, which included 11.5 million dollars from discontinued operations, of which 12.7 million dollars related to the gain on the sale of the Sunbury facility. Our income from continuing operations was 28.7 million dollars or 65 cents per diluted share. In our news release we have included non-GAAP financial information related to adjusted diluted earnings per share from continuing operations. We believe that adjusted diluted EPS from continuing operations is a useful measure for providing investors with additional insight into our operating performance because it eliminates the effects of certain items that are not comparable from one period to the next. The items in the third quarter of 2006 that are not comparable include:

Taking into consideration the items that we've identified as non-comparable for year-over-year comparison, our adjusted diluted earnings per share from continuing operations were 81 cents for the 2006 third quarter compared to 84 cents last year.

Turning to our segment results, our regulated electric utility margins increased 2 percent in the third quarter of 2006 to 151.5 million dollars. The main contributor to this improvement was the implementation of approved retail electric rate increases at Wisconsin Public Service and Upper Peninsula Power. Our sales volume was up a modest 0.3 percent. We saw strength in our commercial and industrial and wholesale volumes, which rose 1.2 percent versus last year. However, this was offset by a 3.0 percent decline in residential volumes, which were negatively impacted by cooler summer weather conditions as compared with last year. Overall, earnings at our electric utility rose 11 percent in the third quarter of 2006.

At our regulated natural gas utility operations, throughput more than doubled due to our newly acquired natural gas distribution operations in Michigan and Minnesota, which added about 167 million therms. Although throughput increased on an overall basis, Wisconsin Public Service's volume declined 15.7 percent during the quarter compared with last year. Most of this decline was related to a 64.5 percent drop in volumes sold to our electric utility in this year's third quarter relating to a decrease in generation required for peaking demand. Residential volumes were also down by 11.3 percent, due to conservation efforts.

Margins rose 71.9 percent in our gas utility operations to 33.0 million dollars. Our Minnesota and Michigan operations contributed basically all of the incremental increase in margin or approximately 14 million dollars. Our combined natural gas utility's operating and maintenance expenses increased approximately 14 million dollars to 31 million dollars and included 2.3 million dollars of pre-tax external transition costs associated with the acquisition of natural gas distribution operations in Michigan and Minnesota. Overall, our gas utility operations produced a net loss of 11 million dollars during the seasonally weak third quarter.

Turning to our nonregulated operations, WPS Energy Services posted income of 21.1 million dollars, a 1.1 million dollar decrease versus last year's third quarter results. Margins declined by 25.9 million dollars during the third quarter this year compared to last year's third quarter, driven largely by a 28.9 million dollar quarter over quarter decrease in the value of derivative instruments used to protect the value of our Section 29 tax credits in 2006 and 2007. A detailed breakdown of WPS Energy Services' margin variances can be found in our Form 10-Q, which was filed with the Securities and Exchange Commission this morning. As you may know, we are required to mark-to-market certain options and hedging instruments at the end of each accounting period. Unfortunately, this can cause some volatility in our quarterly results when there is volatility in commodity prices. In particular, the third quarter of 2006 witnessed a fairly sharp decline in natural gas and oil prices, and as a result, we were required to mark down the value of our derivatives to reflect this change. On the other hand, during the third quarter last year, we recognized significant mark-to-market gains on derivatives due to rising prices for natural gas and oil as a result of hurricanes Katrina and Rita. Please keep in mind that derivative mark-to-market adjustments are unrealized. When netted against the physical transaction related to the derivative contract, the intrinsic value is not affected by the current period's mark-to-market adjustment.

The results at our nonregulated operations included after-tax income of 0.3 million dollars from synthetic fuel activity (including the negative impact of mark-to-market losses on derivative instruments used to protect our Section 29 tax credits) and 11.5 million dollars in after-tax income from discontinued operations virtually all related to the sale of the Sunbury generation facility.

Finally, in our Holding Company and Other operations, we reported a net loss of 1.6 million dollars compared with income of 1.5 million dollars last year. The decrease in earnings was due in part to an 8.9 million dollar increase in interest expense associated with increased borrowing levels that resulted from the acquisition of our natural gas distribution operations in Michigan and Minnesota. Our investment in the American Transmission Company continues to perform well. During the third quarter, the investment generated after-tax equity earnings of 6.1 million dollars, up from 4.0 million dollars last year.

Now, I would like to give you an update on our anticipated capital expenditures. We intend to invest about 840 million dollars in capital expenditures between 2006 and 2008 for Wisconsin Public Service, with about 280 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 11 to 12 million dollars per year.

At Upper Peninsula Power we now anticipate our total capital expenditures for 2006 through 2008 will be about 48 million dollars, and depreciation is estimated to be about 17 million dollars for those years.

We anticipate that total capital expenditures for the Michigan Gas Utilities and Minnesota Energy Resources utility operations for 2006 through 2008 will be about 72 million dollars and depreciation is estimated to be about 45 million dollars for those years.

When compared with the expected regulated capital expenditures, nonregulated expenditures for the same period are not anticipated to be significant.

WPS Resources expects capital calls from the American Transmission Company relating primarily to transmission line projects to total about 168 million dollars for the years 2006 through 2009, with about 78 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. ATC is currently allowed a return on equity of 12.2 percent through 2012.

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

During September we participated in the technical hearings for the 2007 electric and natural gas rate case that Wisconsin Public Service filed with the Public Service Commission of Wisconsin. Our 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 7, 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 actual sales volumes as compared to forecasted sales volumes. Wisconsin Public Service expects that the Public Service Commission will act upon this proposal as part of the 2007 rate case. At this time we cannot predict whether or not the Commission will approve the proposal.

With regard to issuing equity and debt, we continue to plan for WPS Resources financing later this year. We estimate that we will need to raise approximately 300 million dollars, most likely with hybrid debt securities that are treated by credit agencies as a blend of debt and equity. Our regulated utility, Wisconsin Public Service, plans to issue new long-term debt of approximately 125 million dollars to provide funds for capital growth of utility operations.

Finally, we are narrowing our guidance. We anticipate that our 2006 diluted earnings per share guidance will range between $3.73 and $3.95, compared with our previously released guidance range of $3.64 and $4.12, including about 12.4 million dollars of pre-tax external transition costs we anticipate expensing in 2006 related to the acquisitions of natural gas distribution operations in Michigan and Minnesota. We also included about 2.8 million dollars of pre-tax external transition costs we anticipate expensing for our pending merger with Peoples Energy. We assumed normal weather for the remainder of 2006. The guidance 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 12.7 million dollar after-tax gain from the sale of the Sunbury generation facility, as well as that facility's operating results. This guidance is outlined in the news release we issued this morning. Also included in the news release is the projected guidance range for 2006 diluted earnings per share from continuing operations adjusted, which is anticipated to increase to between $3.15 and $3.36 in 2006 from $3.04 in 2005. Diluted earnings per share from continuing operations adjusted include special items that are not comparable from one period to the next. See our news release for further details relating to the special items.

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

The Chairman, President, and Chief Executive Officer speaks.

Thanks, Joe.

Now I would like to ask Mark Radtke, President of WPS Energy Services to discuss our nonregulated operations. Mark…

Mark Radtke, the President of WPS Energy Services speaks.

Thanks, Larry.

Let me start by saying that WPS Energy Services' third quarter financial results masked a very good operating quarter for the company. One full year after the severe production disruptions in the gulf, the energy complex has finally experienced meaningful price declines. This market descent contributed to our operating success this quarter and bodes well for improved opportunities in future quarters. An irritation resulting from this price decline is that it caused our reported financial results to be negatively impacted by mark-to-market adjustments on our hedging instruments that do not qualify for hedge accounting. The year-over-year comparison is further aggravated by last year's sharp price rise in the market largely reflecting the impact of Hurricanes Katrina and Rita. Within our retail business, when commodity prices decline, as they did during the third quarter of 2006, the mark-to-market value of our non-qualifying hedging instruments will also decline, which results in an unrealized loss, dragging WPS Energy Services' margins down. The opposite is true in a rising market like we experienced last year. Nevertheless, once the contracts are fulfilled, we will realize the positive value that was originally anticipated. In the mean time, we will experience fluctuations in our results as commodity prices vary.

More importantly, this price moderation has been good for our customers. Customers have been able to lock in these more reasonable prices over their planning horizon, resulting in a rise in our transaction volume and duration.

Not only is the market improving, we are benefiting from the moves we made into various markets. As you may recall, we began delivering physical electricity in Texas on July 1. Looking forward, we see tremendous opportunities ahead of us in Texas, and we are experiencing organic growth in existing markets, including the Midwest, New England, and Canada.

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 34 percent compared to September 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. In our forward contracted volumes table provided in the 10-Q, you will see a sharp rise in electric wholesale forward contract volume. That could be misunderstood, as we entered into a significant number of contracts during the quarter to reduce the risk in our trading portfolio. About 40 percent of that volume supports originated wholesale customer business contracted during the third quarter. Our retail electric business also grew nicely, with a 21 percent increase in forward contracted business, and like natural gas, heavier in future years than in the next 12 months.

Our business growth has not been at the expense of business quality. Our realized per unit margin for retail electric has returned to the mid 4 dollars per megawatt-hour range while our growing forward contracted sales margins are in the lower 3 dollars per megawatt-hour range. We expect our future margins to trend toward our higher actual experience as we gain critical mass in newly entered markets. Our realized per unit margin for natural gas is between 13 and 15 cents per MCF and our forward contracted margin is consistent with past experience at about 8 cents. Through physical supply optimization we expect to achieve about the same realized per unit margin upon delivery.

Now let's take a quick look at our plants.

At Westwood, the capacity factor dropped 12 percentage points to 89 percent. As I mentioned last quarter, the unit has been de-rated a couple of megawatts as we lowered the boiler operating temperature. Engineering analysis is underway to determine modifications to avoid excessive boiler component wear while operating at full capacity.

Also like last quarter, our Syracuse natural gas plant dispatched 13 percent of the time in an improved spark spread environment. It had not dispatched in the third quarter of 2005 because it was down for repair of damage caused by a blade failure.

During the third quarter, we made the decision to repair the Beaver Falls natural gas generation plant, which has not been operational since June 2005. We anticipate that the repairs will cost approximately 5.2 million dollars and will be completed by June 2007.

And finally, the active management of our synthetic fuel tax credit phase-out risk continues to work well. During the quarter we chose to add to our production while hedging its tax credit value. The decline in crude oil market prices also reduces the cost of implementing the balance of our 2007 hedging strategy, where we have yet to hedge about 54 percent of expected production.

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

The Chairman, President, and Chief Executive Officer speaks.

Thanks, Mark.

As I discussed earlier, we have tremendous opportunities ahead of us at WPS Resources including our merger with Peoples Energy, our construction projects, and the expansion of our nonregulated operations in Texas and Illinois.

Our targeted long-term earnings per share growth rate is between 6 percent and 8 percent 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 third quarter earnings conference call. A replay of this conference call will be available through November 16, 2006, by dialing toll free 800 284-7024.

The text for today's presentation is available on our Web site at www.integrysgroup.com. 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.