WEC

Business Context and Reporting Period

Company: Wisconsin Energy Corporation (WEC Energy Group, Inc.)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2005
Business Overview: A diversified holding company operating primarily in two segments: Utility Energy (electric and gas distribution/generation in Wisconsin and Michigan) and Non-Utility Energy (development of new generation capacity via "Power the Future" strategy). The company divested its manufacturing segment in 2004 and its Calumet facility in 2005, classifying them as discontinued operations.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total operating revenues increased 12.0% to $3,815.5 million, driven by a 12.3% increase in Utility Energy revenues ($3,793.0 million) due to favorable weather (summer cooling) and rate increases approved by regulators.
• Profitability: Net income from continuing operations rose 38.3% to $303.6 million. This was primarily due to higher utility operating income ($542.4 million vs. $528.6 million) and a significant reduction in the effective tax rate (33.0% vs. 37.7%) following a $16.3 million reversal of valuation allowances on state net operating losses.
• Cost Pressures: Fuel and purchased power costs for electric utilities increased by $260.8 million (32.1%) due to higher natural gas prices, reduced nuclear generation availability (two refueling outages vs. one in 2004), and coal delivery shortages. The company deferred $72.8 million of these costs for future rate recovery.
• Capital Expenditures: Total capital expenditures increased to $745.1 million (from $636.5 million), with significant investment in the "Power the Future" strategy, including the completion of the first natural gas unit at Port Washington Generating Station (PWGS) in July 2005.
• Discontinued Operations: Income from discontinued operations dropped significantly to $5.1 million (from $86.8 million in 2004) as the 2004 figure included a large gain on the sale of the manufacturing segment.

Guidance, Outlook, and Risks

• Power the Future Strategy: The company is investing approximately $2.6 billion to add 2,120 megawatts of new generation capacity. The first PWGS unit is operational; the second is expected in 2008. Two coal units at Oak Creek are under construction, with service expected in 2009 and 2010.
• Rate Outlook: The Public Service Commission of Wisconsin (PSCW) approved rate increases effective January 26, 2006, totaling approximately $222.0 million for electric and $21.4 million for gas to recover fuel costs and infrastructure investments.
• Key Risks:
  • Commodity Prices: Continued volatility in natural gas and coal prices impacts working capital and margins. The company utilizes hedging programs to mitigate gas price risk.
  • Regulatory: Recovery of deferred costs (fuel, transmission, MISO market costs) is subject to regulatory approval. New federal regulations (Energy Policy Act of 2005) require FERC authorization for leasing new generation units.
  • Construction: Risks associated with the schedule and cost of the Oak Creek and PWGS projects, including potential cost overruns not recoverable in rates.
  • Environmental: Significant capital expenditures required for EPA consent decree compliance (estimated $600 million over 10 years) and potential future costs for mercury and carbon emissions.

Investor Verification Checklist

• Deferred Cost Recovery: Verify the status of the $72.8 million in deferred fuel costs and $169.4 million in deferred transmission costs awaiting regulatory approval for rate recovery.
• Power the Future Costs: Monitor construction progress and cost adherence for the Oak Creek coal units and PWGS Unit 2, specifically regarding the 5% cost overrun cap for Oak Creek.
• Nuclear Operations: Review the impact of the Point Beach nuclear plant refueling outages and the ongoing review of ownership/operation options announced in February 2006.
• Environmental Liabilities: Assess the progress and cost implications of the EPA consent decree and the remediation of manufactured gas plant sites (estimated future costs $25-$50 million).
• Dividend Policy: Note the 4.5% dividend increase announced in January 2006 to $0.23 per share, and monitor the company's ability to maintain this payout given high capital expenditure requirements.