WEC Energy Group, Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. Financial results exclude Integrys, acquired June 29, 2015; the balance sheet includes Integrys. Comparisons therefore do not reflect the enlarged company’s operating results. The filing presents unaudited pro forma results as if the acquisition had occurred January 1, 2014.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Operating revenue | $991.2 million | $1,043.7 million | $2,379.1 million | $2,738.7 million |
| Operating income | $165.8 million | $240.7 million | $524.6 million | $622.5 million |
| Net income | $80.9 million | $133.0 million | $276.7 million | $340.6 million |
| Diluted EPS | $0.35 | $0.58 | $1.21 | $1.50 |
| Operating margin | 16.7% | 23.1% | 22.0% | 22.7% |
Operating margins are calculated as operating income divided by operating revenue. Q2 revenue fell 5.0% and net income fell 39.2%; six-month revenue declined 13.1% and net income declined 18.8%. These reported comparisons are affected by acquisition expenses and other unusual items.
- Drivers: Q2 utility segment operating income declined $14.8 million year over year, including lower gas margin amid warmer weather, higher operating and maintenance costs, and lower Treasury Grant income. The six-month gas margin decline was $15.5 million, primarily reflecting weather-related lower retail volumes. Lower natural gas prices also reduced reported gas revenues and gas costs; those pass-through revenue changes are not equivalent to margin changes.
- Acquisition and unusual items: Integrys acquisition costs were $66.7 million in Q2 and $75.5 million in the first half; after-tax costs were $53.9 million ($0.24 per share) and $62.3 million ($0.28 per share), respectively. A $20.8 million gain on the sale of Minergy LLC and remaining financial assets partly offset expenses. A $10.4 million one-time state deferred-tax remeasurement charge increased the tax rate.
- Pro forma context: Unaudited pro forma Q2 revenue and net income were $1,629.2 million and $159.1 million, versus $1,879.5 million and $143.2 million in Q2 2014. First-half pro forma revenue and net income were $4,180.1 million and $488.7 million, versus $5,208.2 million and $499.5 million. These illustrative figures exclude potential synergies and transaction costs and are not forecasts.
Cash flow, debt and liquidity
- First-half operating cash flow was $715.9 million versus $721.3 million. Capital expenditures were $356.5 million; operating cash flow less capital expenditures was $359.4 million.
- Investing cash outflow was $1.679 billion, including $1.329 billion for the acquisition, net of cash acquired. Financing cash inflow was $1.116 billion. Cash ended the period at $214.4 million.
- At June 30, total debt was approximately $9.98 billion, including $8.548 billion of long-term debt, $608.4 million due currently, and $826.3 million of short-term debt. Debt to total capitalization was 53.9% (50.7% on the company’s adjusted basis for rating-agency treatment of junior notes). Long-term debt carrying value, including current maturities, was $9.118 billion.
- Current liabilities exceeded current assets by $663.5 million. Management said it expected no liquidity impact, citing approximately $2.3 billion of available undrawn credit facilities and capital-market access. Commercial paper outstanding was $826.3 million.
- Moody’s and Fitch lowered certain WEC Energy Group debt ratings in connection with the acquisition; the disclosed outlooks were stable. The company noted that downgrades could affect access to capital and borrowing costs.
Acquisition, outlook, risks and contingencies
- WEC acquired all Integrys shares on June 29 for total consideration of $5.583 billion, including approximately 90.2 million newly issued shares and cash. The combined company serves approximately 1.6 million electric and 2.8 million gas customers and owns approximately 60% of ATC. ATC remains accounted for as an equity-method investment, not consolidated.
- Acquisition goodwill was preliminarily valued at $2.945 billion and is not tax-deductible; total goodwill was $3.387 billion. The purchase-price allocation and segment allocation of goodwill remained preliminary.
- Management expected the acquisition to be accretive to EPS in 2016, based on preliminary estimates. The company forecast a 2015 effective tax rate of 38%–39%, including the one-time deferred-tax adjustment. No specific full-year earnings guidance is provided in the supplied filing text.
- The quarterly dividend rate increased 8.3% to $0.4575 per share, or $1.83 annualized, effective with the September 2015 payment.
- Regulatory approval conditions include three-year earnings-sharing mechanisms for Wisconsin Electric and Wisconsin Gas beginning in 2016, and a two-year base-rate freeze for Illinois gas utilities PGL and NSG. After quarter-end, parties asked the ICC to rehear its acquisition approval; the ICC had until August 13, 2015 to act.
- Illinois regulators and the state Attorney General were investigating allegations concerning PGL’s Accelerated Natural Gas Main Replacement Program; investigations were ongoing and the company planned an independent review. Environmental remediation reserves and related regulatory assets for manufactured-gas-plant sites were $608.6 million and $670.7 million, respectively; balances increased primarily due to Integrys.
- Environmental compliance, including emissions and cooling-water requirements, could require future operating changes or capital spending; the filing states some impacts remained uncertain. Other risks include acquisition integration, failure to realize expected synergies, goodwill impairment, utility regulation, weather, fuel and power costs, litigation, and access to capital.
Important facts for investors to verify
- How Integrys’s actual post-close results, integration costs, and realized cost savings compare with the preliminary expectation of 2016 EPS accretion.
- The final purchase-price allocation, goodwill allocation, and any impairment indicators for the $2.945 billion of acquisition goodwill.
- The outcome of the ICC rehearing request and the PGL program investigations, including any resulting regulatory or financial effects.
- Cash generation, capital spending, debt maturities, credit ratings, and available liquidity as the combined company begins reporting consolidated operations.
- Progress on Wisconsin and Illinois regulatory conditions, environmental compliance obligations, and the sustainability of the higher dividend.