WEC ENERGY GROUP, INC. quarterly report, Q2 FY2009

Business context and reporting period

Wisconsin Energy Corporation (the registrant named in the filing; the request metadata identifies WEC Energy Group) filed this unaudited Form 10-Q for the quarter ended June 30, 2009. It operates regulated electric, natural gas and steam utilities, alongside non-utility energy businesses, principally We Power. Results are compared with 2008; interim results are seasonal and are not necessarily indicative of full-year performance.

Financial performance

Amounts are in millions of dollars, except per-share figures and where stated otherwise.

Metric	Q2 2009	Q2 2008	Six months 2009	Six months 2008
Operating revenue	$842.5	$945.4	$2,238.7	$2,376.5
Operating income	$119.2	$107.9	$362.2	$325.4
Income from continuing operations	$63.4	$58.2	$204.9	$181.2
Net income	$63.7	$58.0	$205.2	$181.2
Diluted EPS	$0.54	$0.49	$1.74	$1.53

• Revenue fell 10.9% in Q2 and 5.8% for the first half, while net income rose 9.8% and 13.2%, respectively. Lower gas prices and weaker electric sales reduced revenue; lower fuel and gas costs, improved non-utility earnings and other factors supported earnings.
• Q2 utility gross margin was $483.0, up $24.1 year over year; gas gross margin was $79.5, down $0.7. First-half utility gross margin was $1,108.4, up $116.4; gas gross margin was $263.8, down $6.2.
• Electric sales volumes declined 12.6% in Q2 and 9.2% in the first half; management attributed the weakness chiefly to economic conditions, particularly lower commercial and industrial demand. First-half gas margin also faced pressure from milder weather and weaker economic conditions.
• Operating cash flow was $232.4 for the first half, versus $573.7 in 2008. The principal drag was $289.3 of benefit-plan contributions, compared with $48.4 a year earlier. Capital expenditures were $365.1, down from $642.0; investing cash use was $306.3. Financing provided $53.9, including a net debt increase.
• At June 30, cash and cash equivalents were $12.5; current assets were $1,300.1 and current liabilities $1,821.0. Long-term debt including current maturities was $4,093.1, and short-term debt was $780.2. Reported debt to total capitalization was 58.2% (55.2% on management’s adjusted basis for the junior notes).
• Common-equity dividends were $0.3375 per share for Q2 and $0.6750 for the first half, up from $0.27 and $0.54, respectively, in 2008.

Material changes and unusual items

• Operating income increased despite lower revenue, in part because utility fuel and purchased-power recoveries improved; management cautioned that a substantial portion of the favorable first-half fuel recoveries was expected to reverse by year-end following a rate reduction.
• The Point Beach sale gain is being amortized as customer bill credits are issued: $55.1 in Q2 and $119.3 in the first half of 2009, versus $87.0 and $246.0 in 2008. The lower 2009 amortization reflects, among other factors, a one-time $85.0 million 2008 entry.
• Wisconsin Energy sold its water utility to the City of Mequon on April 30, 2009, for approximately $14.5 million; its results are presented as discontinued operations. The filing reports no material subsequent events through August 4, 2009.
• Non-utility operating income rose to $30.8 in Q2 from $20.0, and to $58.7 for the first half from $34.2, mainly reflecting PWGS 2 and the Oak Creek water intake system entering service.

Outlook, risks and contingencies

• Management forecast a 2009 annual effective tax rate of 35%–37%. It expected to meet remaining 2009 capital needs primarily with internally generated funds and short-term borrowings, with debt issuance depending on market conditions. The 2009 capital expenditure budget was approximately $875 million.
• Management said it had approximately $1.6 billion of available, undrawn bank credit lines at June 30, excluding an $80 million commitment from a Lehman affiliate; $780.2 million of short-term debt was outstanding. It stated that it believed liquidity was adequate for the foreseeable future, while noting continued credit-market uncertainty.
• For 2010, Wisconsin Electric and Wisconsin Gas sought rate increases in Wisconsin; Wisconsin Electric later raised its electric request to $126.0 million, with lower sales also creating $24.0 million of additional Point Beach bill credits. Wisconsin Electric also filed a $42 million Michigan rate request. Outcomes remained subject to regulators.
• Bechtel sought approximately $413 million for alleged weather and labor impacts and approximately $72 million for alleged owner-directed changes and delays on the Oak Creek expansion. The company said it believed the claims were without merit; mediation failed and binding arbitration was underway, with a conclusion anticipated in 2010. Unit 1 was forecast three months later than its guaranteed date, and unit 2 one month earlier, but the contractor had not fully kept pace with its revised schedule.
• Oak Creek air-control project cost estimates increased to approximately $800 million, or $960 million including AFUDC, from $750 million, or $830 million including AFUDC. Completion was expected in 2012. The company also cited possible material cost and operational effects from future greenhouse-gas and other environmental rules; such costs and rate recovery could not yet be quantified.
• FERC proceedings concerning MISO revenue-sufficiency-guarantee charges and refunds remained unresolved, and their net effects were uncertain. A retiree lawsuit alleging underpayment of cash-balance pension lump sums was filed June 30; the company said it believed the plan calculations were correct but could not predict the outcome or impact.
• The company could not determine whether it was the primary beneficiary of two purchased-power/tolling variable-interest entities; it did not consolidate them and disclosed approximately $446.2 million of required payments over the remaining contract terms.

Most important facts to verify

1. Whether electric demand and industrial sales stabilize, and how the 2009 fuel-rate decrease and expected reversal of favorable fuel recoveries affect earnings.
2. Progress and final cost/timing of the Oak Creek expansion and environmental controls, and the outcome of Bechtel’s arbitration claims.
3. Regulatory decisions on the 2010 Wisconsin and Michigan rate requests, and the eventual impact of MISO/FERC refund and cost-allocation proceedings.
4. Liquidity and refinancing capacity, including short-term borrowings, undrawn facilities and credit-rating outlook changes.
5. Environmental compliance exposure, pension-plan lawsuit risk, and the company’s ability to recover related costs in regulated rates.