WEC ENERGY GROUP, INC. annual report, FY2012

WEC Energy Group, Inc. (Wisconsin Energy Corporation) — 2012 Form 10-K

Reporting period: Fiscal year ended December 31, 2012. The filing’s registrant is Wisconsin Energy Corporation; the requested “2012 Q4” is covered within this annual report. Amounts are in U.S. dollars.

Business context and reporting period

The company operates regulated electric, natural-gas and steam utilities in Wisconsin and Michigan, primarily through We Energies, alongside We Power’s long-term generation leases and a smaller non-utility business. The utility served about 1.126 million electric customers and 1.074 million gas customers at year-end. All four Power the Future generation plants were in service.

Financial performance and liquidity

Metric	2012	2011
Operating revenue	$4,246.4 million	$4,486.4 million
Operating income	$1,000.3 million	$887.3 million
Net income	$546.3 million	$526.2 million
Diluted EPS	$2.35	$2.24 total; $2.18 continuing operations
Operating cash flow	$1,173.9 million	$993.4 million
Capital expenditures	$707.0 million	$830.8 million

Revenue declined about 5.4%, while operating income rose about 12.7% and net income about 3.8%. Continuing-operations income was $546.3 million, up from $512.8 million; 2011 also included $13.4 million of discontinued-operations income.
Utility operating income rose to $647.7 million from $544.8 million, mainly because of lower operation and maintenance and fuel/purchased-power costs. Non-utility operating income increased to $358.8 million from $348.9 million.
Electric gross margin was $2,103.6 million versus $2,052.1 million. Gas gross margin fell to $416.8 million from $452.5 million, primarily due to warmer winter weather and lower retail deliveries. Lower natural-gas commodity costs reduced reported gas revenue and gas cost of sales.
Cash used in investing activities was $729.6 million; cash used in financing was $422.8 million. Year-end cash and cash equivalents were $35.6 million.
Year-end long-term debt, including current maturities, was $4,865.9 million; short-term debt was $394.6 million. Debt to total capitalization was 55.8% on the company’s GAAP presentation (53.2% on its rating-agency-adjusted presentation). Current liabilities exceeded current assets by about $129.4 million, including $412.1 million of current long-term debt maturities.
Available undrawn credit facilities were approximately $1.2 billion, supporting $394.6 million of commercial paper. The company reported compliance with credit-facility covenants.
Fourth quarter: Revenue was $1,071.2 million versus $1,113.2 million in Q4 2011; operating income was $201.4 million versus $193.0 million; continuing-operations income was $98.8 million versus $114.1 million; diluted EPS was $0.43 versus $0.49.

Material changes versus the prior comparable period

Higher 2012 earnings reflected utility cost reductions, including a one-year suspension of $148 million in amortization of certain regulatory assets authorized in the 2012 rate arrangement. Management expected the amortization to resume in 2013.
Electric sales fell 3.4% overall; retail sales were nearly flat. Warmer weather, lower wholesale/resale activity, a planned outage at a major iron-ore customer and two large customers’ move to self-generation affected sales and revenue.
Gas utility revenue fell to $962.6 million from $1,181.2 million, while deliveries increased 3.2% to 2,222.0 million therms, largely reflecting increased transported gas for electric generation.
Depreciation and amortization increased to $364.2 million from $330.2 million as more utility assets entered service. Net interest expense rose to $248.2 million from $235.8 million, partly because less interest was capitalized after projects entered service.
Capital spending declined as Oak Creek air-control equipment entered service. Year-end construction work in progress fell to $315.9 million from $921.3 million.

Outlook, commentary, risks and contingencies

Management forecast 2013 non-utility segment operating income of $360 million to $365 million and total capital expenditures of $692.7 million. It expected the 2013 effective tax rate to be 37%–38%.
Management forecast annual retail electric sales growth of 0.5%–1.0% over five years, excluding the two iron-ore mines, assuming normal weather and economic improvement; retail gas deliveries were forecast to remain flat over five years.
The PSCW-approved 2013 Wisconsin rates included a net $70 million (2.6%) non-fuel electric rate increase, offset in part by anticipated biomass grant proceeds; forecast fuel recovery added about $44 million. Wisconsin gas rates decreased for both Wisconsin Electric and Wisconsin Gas. The order retained allowed returns on equity of 10.4% and 10.5%, respectively.
The Rothschild biomass project was targeted for completion by year-end 2013, at an estimated $245 million–$255 million excluding AFUDC. The company expected a roughly $72 million federal grant; the rate order incorporated anticipated grant proceeds, making timing and eligibility important.
Planned conversion of Valley Power Plant from coal to natural gas was estimated at $60 million–$65 million, subject to approvals, with completion expected by late 2015 or early 2016. A western Wisconsin gas lateral was estimated at $150 million–$170 million, with regulatory approval anticipated to be sought in 2013.
Environmental regulation remains a significant uncertainty, including air-emissions, water-discharge and coal-combustion-product rules. The company estimated $8.0 million–$12.5 million to comply with the Mercury and Air Toxics Standards, with expected PIPP work to be funded by Wolverine under a proposed joint-ownership arrangement subject to approvals.
Paris Generating Station units 1 and 4 were ordered out of service following a January 2013 environmental notice and order; management expected them to remain unavailable until at least 2014 and said fines or penalties were possible. The company was evaluating replacement generation and reliability effects.
At the Oak Creek site, a 2011 bluff collapse was reconstructed and stabilized, and WDNR closure was received for related storm-water work. The Wisconsin DOJ was considering alleged storm-water and solid-waste violations, and management anticipated possible fines. The WDNR’s groundwater study was inconclusive about the source of nearby impacts.
Other risks include weather and demand variability, fuel and purchased-power costs, rate-case outcomes and regulatory recovery, project delays, labor negotiations (all labor agreements were scheduled to expire in 2013), pension funding, capital-market access, cyber threats and credit-rating changes. Estimated collateral or termination payments under certain agreements following a downgrade below specified investment-grade thresholds were $225.7 million.
Management stated it believed liquidity was adequate and environmental remediation costs beyond accrued/disclosed amounts were not expected to be material based on available information. Manufactured-gas-plant investigation and remediation costs were estimated at $16 million–$62 million over ten years, with $38.2 million reserved at year-end.
The independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting.

Important facts for investors to verify

Whether the biomass facility was completed on schedule and the expected grant was received, and how customer bill credits affected earnings and rates.
Actual 2013 rate-case recovery, especially resumption or extension of regulatory-asset amortization and fuel-cost recovery.
Resolution of the Paris units’ outage, environmental proceedings and any replacement-power costs or penalties.
Approvals, financing and cost allocation for the PIPP environmental-control joint ownership and the Valley Power Plant conversion.
Cash flow, debt maturities, credit-facility availability and any changes in collateral requirements or ratings.
Developments in environmental rules, remediation exposures, pension assumptions and labor negotiations that could change costs or capital requirements.