Gale E. Klappa - Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of Wisconsin Electric Power Company, Chairman of Wisconsin Gas LLC, Chief Executive Officer of Wisconsin Electric Power Company, Chief Executive Officer of Wisconsin Gas LLC, President of Wisconsin Electric Power Company and President of Wisconsin Gas LLC James Patrick Keyes - Chief Financial Officer and Executive Vice President Allen L. Leverett - Executive Vice President, Chief Executive Officer of WE Generation Operations, President of WE Generation Operations and Executive Vice President of Wisconsin Electric Power Company Stephen P. Dickson - Principal Accounting Officer, Vice President and Controller

Greg Gordon - ISI Group Inc., Research Division Jonathan P. Arnold - Deutsche Bank AG, Research Division James D. von Riesemann - CRT Capital Group LLC, Research Division James D. von Riesemann - UBS Investment Bank, Research Division Julien Dumoulin-Smith - UBS Investment Bank, Research Division Andrew Bischof - Morningstar Inc., Research Division Paul T. Ridzon - KeyBanc Capital Markets Inc., Research Division Michael J. Lapides - Goldman Sachs Group Inc., Research Division

Good afternoon, ladies and gentlemen. Thank you for waiting and welcome to Wisconsin Energy's conference call to review 2013 second quarter results. This conference call is being recorded for rebroadcast. [Operator Instructions] Before the conference call begins, I will read the forward-looking language. All statements in this presentation, other than historical facts, are forward-looking statements that involve risks and uncertainties which are subject to change at any time. Such statements are based on management's expectations at the time they are made. In addition to the assumptions and other factors referred to in connection with the statements, factors described in the company's latest Form 10-K and subsequent reports filed with the Securities and Exchange Commission could cause actual results to differ materially from those contemplated. During the discussions, referenced earnings per share will be based on diluted earnings per share unless otherwise noted. After the presentation, the conference will be open to analysts for questions and answers. In conjunction with this call, Wisconsin Energy has posted a package of detailed financial information on its website at www.wisconsinenergy.com. A replay of our remarks will be available approximately 2 hours after the conclusion of this call. And now, it's my pleasure to introduce Mr. Gale Klappa, Chairman of the Board, President and Chief Executive Officer of Wisconsin Energy Corporation.

Thank you, Colleen. Good afternoon, everyone, and thank you for joining us as we review our 2013 second quarter results. Let me begin, as always, by introducing the members of the Wisconsin Energy management team who are here with me today. We have Allen Leverett, President and Chief Executive of We Generation; Pat Keyes, our Chief Financial Officer; Susan Martin, General Counsel; Steve Dickson, our Controller; and Scott Lauber, our newly named Treasurer. Effective tomorrow, Allen will officially assume the role of President of Wisconsin Energy. Allen, of course, has been a key contributor to our success over the past decade, and this promotion recognizes his leadership skills and the broader operational role that he currently plays in the company. I will continue to serve as Chairman and Chief Executive. Allen, congratulations. Pat Keyes will be reviewing our financial results in detail in just a moment. But as you saw from our news release this morning, we're reporting earnings from continuing operations of $0.52 a share for the second quarter of 2013. This compares with earnings from continuing operations of $0.51 a share for the second quarter of 2012. Our earnings were boosted by stronger natural gas sales during a cooler and longer-than-normal spring, a slight uptick in earnings at We power and our share repurchase program. However, the cooler temperatures in June significantly reduced consumption of electricity, particularly for air-conditioning. Turning now to the economy of our region, Wisconsin's unemployment rate declined to 6.8% in June, well below the national average. However, in forecasting our second quarter sales for this year, we did anticipate some continued sluggishness in the regional economy. And that sluggishness was clearly evident in the numbers you saw this morning. Energy sales to our large commercial and industrial customers, excluding the iron ore mines, were…

Thank you, Gale. As Gale mentioned, our 2013 second quarter earnings from continuing operations were $0.52 a share, compared with $0.51 a share for the same quarter in 2012. Results were slightly better than last year, primarily because of increased natural gas sales, the positive impact of our share repurchases and increased earnings at We power. Our consolidated operating income for the second quarter was $229.5 million as compared to $222.6 million in 2012, an increase of $6.9 million. Starting with the Utility Energy segment, you will see that operating income in the second quarter of 2013 totaled $138.9 million, an increase of $5.3 million over the second quarter of 2012. Our second quarter earnings were helped by $15.4 million due to the pricing increases that went into effect January 1 of this year. We also experienced $5.5 million of favorable fuel recoveries as compared to the second quarter last year. Our earnings were hurt by $6.3 million because of the increased depreciation expense, largely driven by the environmental projects at the older Oak Creek units that were completed last year. Finally, we estimate that weather reduced our operating income by $13 million as compared to the second quarter of last year. Overall, these were the primary factors that netted to a $5.3 million improvement in utility operating income. I would also like to remind you of one item that is affecting our quarterly earnings. As I mentioned last quarter, we expect to receive a federal tax grant when we complete our new biomass facility later this year. Our customers are currently receiving the benefits of this grant through bill credits. However, accounting rules do not allow us to recognize the grant income until the plant is placed into service. We estimate that our second quarter earnings would have been…

Thank you very much. Overall, we're on track and focused on delivering value for our customers and our stockholders.

[Operator Instructions] Greg Gordon with ISI Group.

Quick and simple question. You've obviously tightened your earnings guidance range. You've raised the lower end of the range. That's good, but it seems to me, if my memory is correct, that your sales growth is trailing behind what your beginning of the year budget expectation was. So can you tell us what you've done in terms of a midcourse correction to stay on track to have such a good year?

I appreciate it, Greg. Well, the first thing is, the bill wasn't too bad at Catch 35. It's a little inside joke, folks. At any rate, if you look at our natural gas sales projections, remember our natural gas distribution business is about 20% of our total business. And then, you look at our electric sales projections. You put it all in one pot and we're about on target with where we thought we would be overall for energy consumption. So there's not been a big deviation up to this point, through the first 6 months of this year, against our sales growth forecast when you put the whole group of companies together.

Got you. So I was focused on the electric numbers, and -- but the gas numbers are ahead of plan?

Exactly.

Your next question comes from the line of Jonathan Arnold with Deutsche Bank.

On the state power plants, the timeframe, Gale, I think you laid out was probably a little longer than we might have thought. Maybe we were too optimistic or it there some extra steps that have to go through here? And just could you update on how you see that process playing out?

Happy to, Jonathan. The truth of the matter is, the state has not announced -- or the Department of Administration, on behalf of the state, has not announced a formal timetable. We know that this is something that they are planning, that they are putting together a process to move forward with. But they've not announced a formal timetable. So the information we gave you in the prepared remarks, it was a sale that would be perhaps a 2014 or early 2015 event, that's our best guess at this stage of the game because they've not announced a timetable. But I don't sense any slippage in their desire to try to put a process together and move forward. It's just we don't have a very good handle, because no one has talked about a specific timetable at this stage of the game. On the other hand, the governor has said publicly how he would like to use the proceeds from the sale if a sale takes place. So there's no lack of attention at the state in terms of trying to put together a process. I hope that helps, Jonathan.

That's very helpful. And the other thing on timing, it seems like kind of you're now expecting not to start the Twin Falls construction until next year, rather than later this year. Is that just -- but you're still on track for 2016. What's going on there?

You're correct. We would plan to start next year. Allen?

That's right, in the spring of 2014. So we need one last permit from the Wisconsin Department of Natural Resources, and then, the final approval from FERC. So we expect to get those well before year end, which will allow us to -- when the construction season starts in Michigan, to do the construction starting in spring of '14.

You were saying fall of '13, last quarter. I was just wondering, what's taken longer?

Well, that DNR permit that we need, we have to have that Wisconsin DNR permit before the FERC will act. So it's taken us a bit longer to get that Wisconsin DNR permit than we had hoped. Because part of what's happening with this project, Jonathan, this might be too much detail, but we're literally moving the powerhouse from the Michigan side of the river to the Wisconsin side of the river. And because of that, even though it's the same river, the Wisconsin regulators have to weigh in. So that's taking a little longer than we expected.

Thank you for the question. We don't, by the way, think anything is off track here. It's just a matter of working through the permitting process, and that's taking just a hair longer.

Your next question comes from the line of Jim von Riesemann with CRT Capital.

I wanted to move to a strategic line of questioning, if you don't mind.

We'd be happy to talk strategy.

Okay. So as we know, this back-to-basic strategy emerged in earnest in, call it 2005. It was centered on rate-based growth and cost containment efforts. So with that backdrop, let me look at the cost side of the ledger, if you don't mind. One of the key themes this earnings season has been containing costs, yet with 7 to 8 years of cost-reduction efforts already underway, I'm having a tough time reconciling how much fruit might be left on a proverbial tree, so to speak. So the question to you is, could you shed some light on how Wisconsin balances your -- Wisconsin Energy that is, balances your near-term cost containment efforts without triggering a potentially longer-term negative impact on the business, be it earnings or reliability issues and the like? And importantly, how we should think about where the future cost savings could come from?

Sure, I'll give it a shot, and we'll be happy to ask Pat and Allen to pitch in as well. Let me start with kind of our approach, because I think that if we talk in some detail about our approach, it might help shed light on the other aspects of your question. Our approach, essentially, can be broken down into 2 pieces. Piece 1 is we are -- and I think you saw this reflected in a lot of what we talked about in terms of the capital projects, particularly on the generation side of the business. Our first approach is to look for and carry out investment opportunities that can actually lower O&M costs and lower cost for customers. So if we can make a capital investment that actually takes our O&M costs down, that gives us an investment opportunity, but it also directly benefits customers. And we have a couple of very specific projects along those lines that we touched on, and I'll ask Allen just to briefly touch again. That would be Valley and our Oak Creek fuel flexibility initiative. Allen?

Yes, and just on that note, Jim, in the case of Valley, that's a fuel-switching project. So there, what we propose to do is switch from coal to natural gas. Of course, when you go away from solid fuel for this kind of plant, much lower level of employment at the plant, the great deal of expenses and capital investments that will just go away because you're no longer handling solid fuel and handling the combustion byproducts that come along with solid fuel. So as Gale mentioned in the prepared remarks, that could be up to a $20 million-a-year savings. On sort of the fuel flexibility front, Gale also mentioned the project at the Oak Creek expansion plan where we're -- want to make investments to be able to burn a blend of bit and sub-bit coal. Depending on what we're able to do in terms of an ultimate level of sub-bituminous coal, we could be looking at $50 million a year in savings. Now, of course, those aren't O&M savings. They're fuel savings. But that still serves, I mean because ultimately, customers don't discriminate between O&M and fuel, they're just looking at their total bill. So that, certainly, is another source of savings. And I know, in other areas, Pat, we're looking at things.

Yes, that's kind of piece 1, Jim. And as Allen said, and we're going to ask Pat to comment here, on the nongeneration side of our business, we believe there are numerous opportunities to invest in automation and process improvement to take O&M out of the business. And Pat can give you a couple examples of that. And then, I'll come back with a third piece after Pat can give you a couple of examples of how we can automate our processes, use IT technology to cut O&M. Pat?

Sure, be glad to, Gale. So Jim, I think as Gale alluded to, at the core of this are lots of small initiatives where we identify where our process inefficiencies are, where we have a lot of hand-offs, where we have a lot of people pushing paper and not thinking in effect, and figuring out how we can better automate them. And that's not any one big project. That's a series of several that we will do year-on-year-on-year. So that's kind of the core example. But there's other more tactical examples. And let me use customer service as one of them. There are segments of our customers, generally speaking the younger folks, that don't really like the whole experience of calling into a call center. So the more functionality or more ways of interacting with us that we can make available on the web or on mobile apps, those customers would prefer to shift to that channel of interaction. And that is a win for them, it's also a win for us because that's a lower-cost channel for them to interact with than picking up the phone. So we've got several ideas that we continue to roll out applications in that area. Another area we're looking at is in parts of our service territory. That is, universities where we've got high volumes of people going on and off during move season, would there be an advantage to put remote disconnect technology in those areas so that we don't have to send people out every spring and every fall to disconnect and reconnect the meter? Again, we're still evaluating it. May roll that out over time. But that's another example of a place we still have opportunity for cost take-out. So with that, Gale, I'll turn it back to you.

Terrific. And you may be getting more detail than you want here, Jim. But there's a third piece and that's what I generally call line losses. And that's been one of our focuses over time, in terms of how do you reduce line losses. And there are all kinds of ways, both from a process standpoint and a technical standpoint on line losses. And we've been pretty successful at actually reducing our line losses over time. We were able to do that in England. We've been able to do that here. So there's just hundreds of little initiatives, all focused on process improvement, automation and investment that can take O&M out of the business over time. I hope that helps, Jim.

Yes, it is. So the bottom line is that you replace OpEx with CapEx, you keep your cost structure relatively flat by automating stuff, and that your earnings growth prospectively isn't predicated on job cuts or major cost-reduction initiatives. Is that right, the way I think about it?

I think you've nailed it.

Your next question comes from the line of Julien Dumoulin-Smith with UBS.

So going back to one of the little details there on Michigan, I'd be curious, what caused the switching decision now, of any period? And frankly, you alluded to the mines being an exception. Are all the customers here mines that you're talking about? And perhaps, what are the alternative solutions, if you will, that you're evaluating potentially?

Okay, sure. Well, the 2 major customers, obviously, are the iron ore mines. We really don't know what motivated them. I mean they have been eligible to switch, I believe since 2002, when that First Choice law was introduced in Michigan. And the last amendment to the law in which they received the -- well, actually, the Choice was introduced in Michigan in 2002. There was a 2008 amendment to the Choice law that specifically exempted the mines from the cap. So they've been eligible to switch for -- well, ever since 2008. What specifically motivated them at this stage of the game, we really don't know for certain. But again, I think there's some internal dynamics up there at the 2 mines, the Empire Mine and the Tilden Mine. Those are the names of the 2 mines. One of the dynamics, certainly, that we expected was that the Empire Mine, based on their public announcements, is going to close for good at the end of 2014. And we're not certain, based on the information they've given us, just how much they intended to produce out of that mine anyway in 2014. So the switch of the Empire Mine may have had something to do with the final stages of its life. Well, I'm speculating though, we just don't know for certain what motivated the particular timing for their switch. The other customers that have switched so far -- I might add, by the way, that we are the last utility that I'm aware of in Michigan to see customer switching. From 2002 up until June of this year, we hadn't lost a single customer in the Upper Peninsula. But the other customers who are switching are, by and large, very small customers. I know of a paint store, I know of a bank branch. Very, very small customers. So I hope that helps.

Absolutely. And just in the remarketing, I mean, if you can give us some sense of a net impact. It's probably fairly modest, but ...

Well, I think in terms of remarketing, and certainly, we have some opportunities for serving some other customers, but also, we simply have to look at -- as we have been looking at, we simply have to look at the future of the Presque Isle Power Plant up in the Upper Peninsula. Normally, if you lost -- if you were in a normal business and you lost a significant customer load, even though it may or may not have been particularly profitable, you would look at, well, what capacity do I still need? So one of the things we obviously have to reexamine is the future of the Presque Isle Power Plant. It's all very early days and we will work our way through this; having active discussions internally, obviously, and with the Michigan Public Service Commission. And we'll just step-by-step, methodically, logically and productively work our way through this.

Your next question comes from the line of Andy Bischof with Morningstar.

A quick clarifying question on the share buyback. What was the average purchase price in the quarter? And I apologize, I missed the total shares since program initiation?

We have that in the script, and we'll go back to the page here in terms of the total number of shares for the program.

So Andy, this is Pat. For the program, it was 5.974 million shares at around $206 million, so an average share price of $34.57. For the quarter, we purchased just over 1 million shares for just over $43 million.

And one other question. You've talked in detail about your growth opportunities, which was much appreciated. In the past, you've highlighted the additional opportunities at ATC, not only within Wisconsin, Michigan, but outside that footprint. Any update on those additional opportunities or is this announcement still pretty out in the future?

I think all of the information we provided you over time about the 10-year growth forecast for American Transmission Company still applies today. They, as you probably remember, Andy, they do a rolling 10-year forecast that's updated every autumn. And I believe it's October.

It's done in October, Andy. This is Allen. Yes.

So nothing different. Still on track and a new update coming in October.

Your next question comes from the line of Paul Ridzon with KeyBanc Capital Markets.

What was the fuel cover on an absolute basis? I know it was $5 million relative to last year.

The famous Steve Dixon is turning to that page right now.

Yes, our fuel recovery, we are above the 2% band, so we are deferring everything about the 2% band. And through the 6 months, we're at about $16.6 million, which is where the band is, and we're a little bit above that. We're at $19.7 million, so we deferred the amount above $16 million. Does that make sense?

So $3 million?

$3 million is what we've deferred.

What we've deferred. Yes, so in other words, we're allowed to keep for our shareholders anything up to 2% above the target amount or our shareholders have to eat anything below the 2% target amount. And what Steve is saying is, we were just above the 2% target amount. So what you saw in our earnings was the amount up to the 2% target. The remaining over recovery, we've deferred. And if that holds, that will go back to customers.

So you ate $2 million last year, is that the right way to think about it, to get to $5 million this year?

Yes, that is correct.

Okay. And just because you mentioned it about line losses, what are you doing with conservation voltage regulation? What's the opportunity there?

Well, obviously, there's a lot of work going on around the industry related to that. I know EPRI has a project related to that. Some utilities are looking at it. We're looking at it, but nothing definitive yet.

Okay. So your work so far has been on the utility side of the meter?

That is largely correct, yes.

Your last question comes from the line of Michael Lapides with Goldman Sachs.

Natural gas demand. We've seen in a handful of utilities, I think you guys as well, what is a little bit of a pickup in weather-normalized demand for natural gas from utilities to their customers. Could you just comment on that? What are the trends you're seeing, whether you think it's a short-term blip or whether it's something structural? After all, if you look at like 10, 20, 30-year cycles of natural gas demand served by utilities, it had actually been on a downward slope. So just curious if this is a short-term thing or something else to look out for?

Good question, Michael, and I'll give you my theory, for what it's worth. First of all, I think you're right. Here and across the country, we've seen a little change in terms of the historic past 20 years where usage per customer was going down at a slow, but reasonably steady rate. And clearly -- well, let's start with demand. Most of the demand for natural gas in a state like Wisconsin is coming from residential and small commercial customers. In fact, about 2/3 of the natural gas historically consumed in the state of Wisconsin is consumed by residential and small commercial customers. So there, very weather-dependent, obviously, year to year, but when you try to weather normalize, the big change has been the efficiency of furnaces. So if, for example, you replaced a 20-year-old gas-fueled furnace with a brand new one, you would get a significant percentage pickup in efficiency. And I think -- and it's that way with virtually every natural gas appliance in your home. The new appliances are simply much, much more efficient. So I believe that was the big factor driving this kind of slow but steady decline year after year in usage, natural gas usage per customer. Now the last couple of years as natural gas prices have really been low and have stayed low, we have seen a break in that pattern. And you can see it in the numbers we reported today. Couple of things going on. First of all, you know when it costs you less per term and your wife is cold, you know you're going to turn it up. So I think that's piece 1. The second piece is -- so I think there's not as much price disincentive to being more comfortable and to using more natural gas. So that may be one structural change. I think the second is we're seeing an uptick again in conversions. If you look at the price spread in most parts of the country between propane and natural gas, there's still a very significant price spread that incentivizes customers to switch from the use of propane to the use of natural gas. In fact, I think I mentioned during my prepared remarks that we've gotten authorizations and requests now from 7 smaller communities in the western part of Wisconsin, asking us to begin providing natural gas distribution service so that their residents have the opportunity to switch from either oil, propane baseload heat to natural gas. So I think that the pricing of natural gas today is causing a changed behavior in the marketplace, driving more customer connections, driving a move away from propane. And that is mitigating, I think, the increased efficiency that customers are seeing when they upgrade their equipment. So I hope that helps.

It helped. How do you think about what -- you've talked at length about what's kind of in guidance or in your views about weather-normalized electricity demand. What's in your views for weather-normalized gas demand?

Well, until we see -- I'll be honest with you. Until we see more of a pattern here, I'm not sure we're ready to declare it a structural change. But we're obviously taking a very hard look at it, and if we see enough evidence that there's a structural change, it will change our long-term forecast. For now, candidly, the weather has been so abnormal, either abnormally warm or abnormally cold in the last 2 or 3 winters, and you know, I've talked about the limitations of the weather normalization techniques. I think we need to see a little more data and hopefully, more normal weather so that we can really understand whether the weather is driving some of this change, and our weather normalization techniques are limited, which they are, or whether there's true structural change. So I don't mean to give you a vague answer at all, but I think in another 24 months, I hope we would have a better answer for you because we'll have more data.

Your next question is a follow-up question from the line of Jim von Riesemann with CRT Capital.

Going back strategically, under what conditions do you think the board or what conditions would be ripe for the board to raise your payout ratio above 70%?

Well, I can tell you about how Allen and I both look at it. And our board would certainly have a view, but they tend to follow our logic very well in terms of the financial structure. If you step back and you say, "All right, there are several components of the business that we want to make sure all fit together." All right? So the first thing we look at is what is our cash need? And that's driven by what is our investment opportunity. And as we said, for the next several years, 2013 through 2017, we expect an investment opportunity ranging from $3.2 billion to $3.5 billion. So that's Step 1. We identify our investment opportunities and our cash needs. Step 2 is we know that we want to maintain a strong A-category credit rating. So we know what debt-to-total capital and equity-to-total capital, we know what that needs to look like on a percentage basis. And then, thirdly, we don't really want to be forced -- unless there's an incredible opportunity that we didn't see, we don't want to be forced into issuing equity. And so you put all that together and out falls a sustainable medium-term dividend payout ratio. We really look at it systematically, block by block, in terms of the components of the business. And so I think logically, to directly answer your question: What would motivate the board to materially increase the payout ratio? It would be if we thought there was just simply a derth of investment opportunities where you simply -- you didn't have a productive use for that cash. Allen, anything you'd like to add?

No, I don't think so, Gale. But you always go through those 3 parts, Jim, that Gale enumerated.

All right. Well, ladies and gentlemen, we appreciate you taking part in the call today. That concludes our conference call for this afternoon. Again, thank you so much for participating. If you have any other questions, the famous Colleen Henderson will be available in our Investor Relations office, and her direct line (414)221-2592. Thanks again, everybody. Take care.