XEL

Business Context and Reporting Period

Company: Northern States Power Company (NSP), a Minnesota corporation, and its subsidiaries (collectively NSP), including Northern States Power Company (Wisconsin), NRG Energy, Inc., Viking Gas Transmission Company, Cenerprise, Inc., and Eloigne Company.

Reporting Period: Fiscal year ended December 31, 1996.

Operations: NSP is a regulated public utility generating, transmitting, and distributing electricity in Minnesota, North Dakota, and South Dakota, and transporting/distributing natural gas in Minnesota, Wisconsin, and North Dakota. It also operates significant non-regulated energy businesses through NRG Energy, Inc. and affordable housing investments through Eloigne Company.

Key Event: NSP is in the process of a "merger-of-equals" transaction with Wisconsin Energy Corporation (WEC) to form Primergy Corporation. As of the filing date, the merger had not been completed pending regulatory approvals, though shareholder approval was obtained in 1995.

Key Financial Metrics (1996)

Liquidity: Cash and cash equivalents totaled $51.1 million at year-end. The company maintained a AA- bond rating (S&P) and A1 (Moody's). The pretax interest coverage ratio was 3.7x.

Material Changes vs. Prior Period

• Revenue Growth: Utility operating revenues increased 3.3% to $2.65 billion. Electric revenues decreased slightly ($15 million) due to lower sales to other utilities and weather impacts, while gas revenues increased significantly ($101 million) driven by higher purchased gas costs passed through to customers and increased sales volumes.
• Earnings: Total EPS decreased slightly to $3.82 from $3.91, primarily due to the absence of a $30 million non-recurring gain from a contract termination in 1995. However, EPS from ongoing operations increased 3.5% to $3.82.
• Non-Regulated Results: Non-regulated operating revenues decreased 3% to $303.9 million, largely due to the curtailment of Cenerprise's gas trading activities. Non-regulated earnings per share from ongoing operations were 24 cents in 1996 compared to 28 cents in 1995.
• Debt Levels: Short-term debt increased significantly to $368 million from $216 million to finance capital expenditures and working capital needs. Long-term debt increased modestly.
• Capital Spending: Total utility capital expenditures remained relatively flat at $387 million, while investments in non-regulated projects increased to $157 million in 1996 (including equity investments) compared to $54 million in 1995.

Guidance, Outlook, and Risks

Merger with Wisconsin Energy Corporation (WEC)

NSP and WEC are pursuing regulatory approvals to complete a merger forming Primergy Corporation. The transaction is subject to numerous conditions, including approvals from the FERC, SEC, NRC, and state commissions (Minnesota, Wisconsin, North Dakota, Michigan). While Michigan and North Dakota have approved, proceedings in Minnesota and Wisconsin are ongoing with potential delays due to legal challenges and legislative reviews. The merger is expected to result in $2 billion in cost savings over 10 years and a proposed 1.5% electric rate reduction followed by a four-year rate freeze.

Outlook and Guidance

• Capital Expenditures: Estimated at $420 million for 1997 and $2.0 billion for the five-year period 1997-2001 for utility operations. Non-regulated capital requirements are estimated at $310 million for 1997 and $940 million for 1997-2001.
• Dividends: NSP has increased dividends for 22 consecutive years. The payout ratio was 71.5% in 1996, within the target range of 65-75%.
• Rate Regulation: The company anticipates continued regulatory scrutiny regarding rate cases, particularly in Minnesota and Wisconsin, where restructuring and competition are being considered.

Risks and Contingencies

• Regulatory Risk: Uncertainty regarding the timing and terms of the WEC merger approval. Potential divestiture of gas or non-regulated assets under the Public Utility Holding Company Act (PUHCA).
• Nuclear Fuel Storage: The Department of Energy (DOE) has not met its statutory obligation to accept spent nuclear fuel by 1998. NSP is pursuing interim storage solutions and has filed lawsuits against the DOE. Uncertainty exists regarding the availability of permanent storage.
• Environmental Liabilities: NSP faces potential costs for site remediation (estimated at $18 million for four unremediated sites) and compliance with the Clean Air Act. Asbestos removal costs are estimated at $47 million.
• Competition: Increased competition in wholesale and retail electricity markets due to the Energy Policy Act of 1992 and FERC Orders 888 and 889. Loss of wholesale customers has impacted revenues.
• Year 2000 Compliance: Estimated costs of $20-$25 million to modify computer systems for the Year 2000, potentially higher if the merger is not completed.

Investor Verification Checklist

• Merger Status: Verify the current status of regulatory approvals for the NSP/WEC merger, specifically in Minnesota and Wisconsin, and any new conditions imposed by regulators.
• Nuclear Fuel Disposal: Monitor the outcome of the lawsuits against the DOE regarding the 1998 deadline for spent fuel acceptance and the progress of interim storage facilities.
• Non-Regulated Performance: Review the performance of NRG Energy's international projects (e.g., Germany, Australia, Bolivia) and the impact of natural gas price volatility on Cenerprise's earnings.
• Environmental Costs: Track the finalization of remediation costs for the Ashland, Wisconsin site and other PRP sites, and the impact of new environmental regulations on capital expenditures.
• Rate Case Outcomes: Monitor the results of pending rate cases in Minnesota and Wisconsin, particularly regarding the proposed rate reductions and freezes associated with the merger.