ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INTEGRYS ENERGY GROUP
G. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Notes to the Consolidated Financial Statements that follow include consolidated Integrys Energy Group footnotes and certain combined footnotes for both Integrys Energy Group and its wholly owned subsidiary registrant, WPSC. WPSC's financial statements also include supplemental footnotes related to WPSC. Refer to Item 8, Section P for a listing of the combined footnotes included in the Integrys Energy Group notes and the supplemental footnotes that are applicable to WPSC.
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Nature of Operations--Integrys Energy Group is a holding company with wholly owned primary subsidiaries at December 31, 2006 including WPSC, UPPCO, MGUC, MERC, and Integrys Energy Services. Of these subsidiaries, four subsidiaries are regulated utilities and one subsidiary, Integrys Energy Services, is a nonregulated energy marketer. WPSC is an electric and natural gas utility that purchases, generates, and distributes electric power and purchases and distributes natural gas to its franchised service territory in northeastern Wisconsin and an adjacent portion of the Upper Peninsula of Michigan. UPPCO is an electric utility that supplies and distributes electric energy to a portion of the Upper Peninsula of Michigan. MGUC is a natural gas utility that supplies and distributes natural gas to cities and communities primarily throughout Otsego, Grand Haven, and Monroe counties in Michigan. MERC, also a natural gas utility, supplies and distributes natural gas to various cities and communities including Grand Rapids, Pine City, Rochester, and Dakota County in Minnesota. The nonregulated subsidiary, Integrys Energy Services, offers nonregulated natural gas, electric, and alternative fuel supplies, as well as energy management and consulting services, to retail and wholesale customers. Integrys Energy Services also owns several merchant electric generation plants, primarily in the Midwest and Northeastern United States and adjacent portions of Canada.
The term "utility" refers to the regulated activities of WPSC, UPPCO, MGUC, and MERC while the term "nonutility" refers to the activities of WPSC, UPPCO, MGUC, and MERC that are not regulated. The term "nonregulated" refers to activities other than those of WPSC, UPPCO, MGUC, and MERC.
The line item on the Consolidated Statements of Income "Income available for common shareholders," is net income.
(b) Consolidation Basis of Presentation--The Consolidated Financial Statements include the accounts of Integrys Energy Group and all majority owned subsidiaries, after eliminating significant intercompany transactions and balances, and proportionate shares of jointly owned utility facilities. If a minority owner's equity is reduced to zero, our policy is to record 100% of the subsidiary's losses until the minority owner makes capital contributions or commitments to fund its share of the operating costs. The cost method of accounting is used for investments when Integrys Energy Group owns less than 20% of the voting equity of the company, unless other evidence indicates we have significant influence over the operating and financial policies of the investee. Investments in businesses not controlled by Integrys Energy Group, but over which we have significant influence regarding the operating and financial policies of the investee, are accounted for using the equity method. For additional information on our equity method investments see Note 10, "Investments in Affiliates, at Equity Method."
The assets and liabilities, results of operations, and cash flows of MGUC and MERC were included in Integrys Energy Group's consolidated financial statements effective April 1, and July 1, 2006, respectively. See Note 6, "Acquisitions and Sales of Assets," for more information.
For all periods presented, certain assets and liabilities of Sunbury and Niagara have been reclassified as held for sale and Sunbury's and Niagara's results of operations and cash flows have been reclassified as discontinued operations. Refer to Note 4, "Discontinued Operations," for more information.
(c) Use of Estimates--We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America. We make estimates and assumptions that affect reported amounts. These estimates and assumptions affect assets, liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from these estimates.
(d) Cash and Cash Equivalents--We consider short-term investments with an original maturity of three months or less to be cash equivalents.
Cash paid for taxes during 2006, 2005, and 2004, was $37.7 million, $50.4 million, and $37.0 million, respectively. During 2006, 2005, and 2004, cash paid for interest totaled $87.6 million, $59.6 million, and $54.4 million, respectively.
Significant non-cash transactions were as follows:
(Millions) | | 2006 | | 2005 | | 2004 | |
| | | | | | | | |
| Weston 4 construction costs funded through accounts payable | | $ | 32.0 | | $ | 33.7 | | $ | 22.6 | |
Purchase price adjustments related to the acquisition of MGUC funded through accounts payable | | | 0.8 | | | - | | | - | |
Transaction costs related to the merger with Peoples Energy funded through other current liabilities | | | 8.1 | | | - | | | - | |
| Debt assumed in Integrys Energy Services New York acquisition | | | - | | | - | | | 3.2 | |
(e) Revenue and Customer Receivables--Revenues are recognized on the accrual basis and include estimated amounts for electric and natural gas services rendered but not billed. Currently there are no customers or industries that account for more than 10% of Integrys Energy Group's revenues.
WPSC and UPPCO use automatic fuel and purchased power adjustment clauses for the Michigan retail electric portions of their business. WPSC also uses automatic fuel and purchased power adjustment clauses for its FERC wholesale electric business. At UPPCO, most wholesale electric contracts have no automatic fuel and purchased power adjustment clauses. The Wisconsin retail electric portion of WPSC's business uses a "cost variance range" approach, based on a specific estimated fuel and purchased power cost for the forecast year. If WPSC's actual fuel and purchased power costs fall outside this range, the PSCW can authorize an adjustment to future rates. Decreases to rates can be implemented without a hearing, unless requested by WPSC, PSCW staff, or interveners, while increases to rates are generally subject to a hearing.
Billings to UPPCO's customers under the MPSC's jurisdiction include base rate charges and a power supply cost recovery factor. Power supply cost recovery factors are established annually to recover projected power supply costs approved by the MPSC. The MPSC reconciles these factors to actual costs annually and permits 100% recovery of allowed power supply costs. UPPCO recognizes any over or under recovery currently in its revenues, and the payable or receivable is recognized on the balance sheet until settlement. The deferrals are relieved with additional billings or refunds.
The PSCW approved a modified one-for-one gas cost recovery plan for WPSC. This plan allows WPSC to pass changes in the cost of natural gas on to system natural gas customers, subject to regulatory review by the PSCW for reasonableness.
The MPUC approved a modified one-for-one gas cost recovery plan for MERC. This plan allows MERC to pass changes in the cost of natural gas on to system natural gas customers, subject to regulatory review by the MPUC for reasonableness.
The MPSC has approved one-for-one recovery of prudently incurred natural gas costs for WPSC and MGUC, subject to regulatory review. The MPSC also approved a natural gas cost recovery factor adjustment mechanism for WPSC for the period November 2006 through October 2007. This adjustment mechanism allows WPSC to adjust the maximum natural gas rates that can be charged to customers in Michigan based on upward or downward changes to the NYMEX natural gas futures price without further MPSC action.
WPSC, UPPCO, MGUC, and MERC are required to provide service and grant credit to customers within their service territories. The companies continually review their customers' credit-worthiness and obtain or refund deposits accordingly. The utilities are precluded from discontinuing service to residential customers during winter moratorium months.
For Integrys Energy Services' merchant electric generation plants, electric power revenues related to fixed-price contracts are recognized at the lower of amounts billable under the contract or an amount equal to the volume of the capacity made available or the energy delivered during the period multiplied by the estimated average revenue per kilowatt-hour per the terms of the contract. Under floating-price contracts, electric power revenues are recognized when capacity is provided or energy is delivered.
For its nonregulated business of supplying energy, management, and consulting services to retail and wholesale customers, Integrys Energy Services accrues revenues in the month that energy is delivered and/or services are rendered. Revenues related to derivative instruments classified as trading are reported net of related cost of sales for all periods presented.
(f) Inventories--Inventories consist of natural gas in storage and fossil fuels, including coal. Average cost is used to value fossil fuels and natural gas in storage for our regulated segments. Inventories at Integrys Energy Services are valued at the lower of cost or market unless hedged pursuant to a fair value hedge, in which case inventory is marked to the spot rate.
(g) Risk Management Activities--As part of our regular operations, Integrys Energy Group enters into contracts, including options, swaps, futures, forwards, and other contractual commitments, to manage market risks such as changes in commodity prices and interest rates.
Integrys Energy Group accounts for its derivative contracts in accordance with SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended and interpreted. SFAS No. 133 establishes accounting and financial reporting standards for derivative instruments and requires, in part, that we recognize certain derivative instruments on the balance sheet as assets or liabilities at their fair value. Subsequent changes in fair value of the derivatives are recorded currently in earnings unless certain hedge accounting criteria are met. If the derivatives qualify for regulatory deferral subject to the provisions of SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation," the derivatives are marked to fair value pursuant to SFAS No. 133 and are offset with a corresponding regulatory asset or liability.
Integrys Energy Group classifies mark-to-market gains and losses on derivative instruments not qualifying for hedge accounting or regulatory deferral as a component of revenues.
(h) Emission Allowances--Integrys Energy Services accounts for emission allowances as an intangible asset, with cash inflows and outflows related to purchases and sales of emission allowances recorded as investing activities in the Consolidated Statements of Cash Flows. Integrys Energy Services uses the guidance in SFAS No. 144, "Accounting for the Impairment and Disposal of Long-Lived Assets," to test allowances for impairment. The utilities generally do not purchase or sell emission allowances, but account for allowances as inventory. Emission allowances granted to WPSC are recorded at zero cost
and, thus, no charge results when zero cost allowances are utilized in operating the utilities' generation plants.
(i) Property, Plant, and Equipment--Utility plant is stated at the original cost of construction including an allowance for funds used during construction. The cost of renewals and betterments of units of property (as distinguished from minor items of property) is capitalized as an addition to the utility plant accounts. Except for land, no gain or loss is recognized in connection with ordinary retirements of utility property units. Maintenance, repair, replacement, and renewal costs associated with items not qualifying as units of property are considered operating expenses. The utility charges the cost of units of property retired, sold, or otherwise disposed of, less salvage, to the accumulated provision for depreciation. The cost of removal associated with the retirement is charged to a regulatory liability.
We record straight-line depreciation expense over the estimated useful life of utility property and include amounts for estimated removal and salvage. The PSCW approved new depreciation rates for WPSC effective January 1, 2005, which have not had a material impact on annual depreciation expense. Depreciation rates for UPPCO were approved by the MPSC effective January 1, 2002. Depreciation rates for MGUC and MERC were approved by the MPSC and MPUC effective April 1, 2006, and July 1, 2006, respectively. Annual utility composite depreciation rates are shown below.
Annual Utility Composite Depreciation Rates | | 2006 | | 2005 | | 2004 | |
| | | | | | | | |
| WPSC - Electric | | | 3.36 | % | | 3.65 | % | | 3.65 | % |
| WPSC - Natural Gas | | | 3.57 | % | | 3.61 | % | | 3.65 | % |
| UPPCO | | | 2.90 | % | | 2.85 | % | | 2.84 | % |
MGUC(1) | | | 2.06 | % | | - | | | - | |
MERC(2) | | | 1.76 | % | | - | | | - | |
(1) Composite depreciation rate for 9 months of the year
(2) Composite depreciation rate for 6 months of the year
Interest capitalization is applied to nonutility property during construction, and gain and loss recognition occurs in connection with retirements. Currently, nonutility property at WPSC and UPPCO consists primarily of land.
Nonregulated plant is stated at cost, which includes capitalized interest, or estimated fair value at the time of acquisition. The costs of renewals, betterments, and major overhauls are capitalized as an addition to plant. The gains or losses associated with ordinary retirements are recorded in the period of retirement. Maintenance, repair, and minor replacement costs are expensed as incurred.
Most of the nonregulated subsidiaries compute depreciation using the straight-line method over the following estimated useful lives:
| Structures and improvements | 15 to 40 years |
| Office and plant equipment | 5 to 40 years |
| Office furniture and fixtures | 3 to 10 years |
| Vehicles | 5 years |
| Computer equipment | 3 to 8 years |
| Leasehold improvements | Shorter of: life of the lease or life of the asset |
The Combined Locks Energy Center uses the units of production depreciation method for selected components of equipment having defined lives stated in terms of hours of production.
Integrys Energy Group capitalizes certain costs related to software developed or obtained for internal use and amortizes those costs to operating expense over the estimated useful life of the related software, which is usually three to eight years.
(j) Capitalized Interest and Allowance for Funds Used During Construction--Our nonregulated subsidiaries capitalize interest for construction projects, while our utilities use an allowance for funds used during construction (AFUDC) calculation, which includes both a debt and an equity component as required by regulatory accounting.
Approximately 50% of WPSC's retail jurisdictional construction work-in-progress expenditures are subject to AFUDC, except on specific projects approved by the PSCW. For 2006, WPSC's AFUDC retail rate was 8.82%. A current return for construction funds related to Weston 4 is being recovered in rates as incurred.
WPSC's construction work-in-progress AFUDC debt and equity percentage formula for the wholesale jurisdiction is specified in the FERC's Uniform System of Accounts. The 2006 average AFUDC wholesale rate was 8.14%.
WPSC's allowance for equity funds used during construction for 2006, 2005, and 2004 was $0.6 million, $1.5 million, and $2.0 million, respectively. WPSC's allowance for borrowed funds used during construction for 2006, 2005, and 2004 was $0.2 million, $0.4 million, and $0.7 million, respectively.
UPPCO did not record AFUDC for 2006, 2005, or 2004, as UPPCO did not have significant construction projects during these years. In addition, MGUC and MERC did not record AFUDC for 2006 because they did not have any significant construction projects during the year.
Our nonregulated subsidiaries calculate capitalized interest on long-term construction projects for periods during which financing is provided by Integrys Energy Group through interim debt. The interest rate capitalized is based upon the monthly short-term borrowing rate Integrys Energy Group incurs for such funds. The amount of interest capitalized during 2006, 2005, and 2004 was not significant.
(k) Asset Impairment--We review the recoverability of long-lived tangible and intangible assets in accordance with SFAS No. 144. This Statement requires review of assets when circumstances indicate that the carrying amount may not be recoverable. The carrying amount of assets held and used is not recoverable if it exceeds the undiscounted sum of cash flows expected to result from the use and eventual disposition of the asset. If the carrying value is not recoverable, the impairment loss is measured as the excess of the asset's carrying value over its fair value. The carrying value of assets held for sale is not recoverable if it exceeds the fair value less cost to sell the asset. An impairment charge is recorded for any excess of the carrying value over the fair value less cost to sell. If events or circumstances indicate the carrying value of investments accounted for under the equity method of accounting may not be recoverable, potential impairment is assessed by comparing the fair value of these investments to their carrying values as well as assessing if a decline in fair value is temporary. If an impairment is indicated, a charge is recognized equal to the amount the carrying value exceeds the investment's fair value. Impairment charges are recorded if the carrying value of such assets exceeds the future anticipated cash flows. See Note 4, "Discontinued Operations," for information related to the impairment charge recorded at Sunbury in 2005.
(l) Regulatory Assets and Liabilities--WPSC, UPPCO, MGUC, and MERC are subject to the provisions of SFAS No. 71. Regulatory assets represent probable future revenue associated with certain incurred costs that will be recovered from customers through the ratemaking process. Regulatory liabilities represent amounts that are refundable in future customer rates. Based on a current evaluation of the various factors and conditions that are expected to impact future cost recovery, we believe that future recovery of our regulatory assets is probable. If at any reporting date a previously recorded regulatory asset is no longer probable of recovery, the regulatory asset is reduced to the amount considered probable of recovery with the reduction charged to current expense.
(m) Goodwill and Other Intangible Assets--In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," goodwill and other assets with indefinite lives are not amortized, but are subject to annual impairment tests. WPSC performs its impairment test during the second quarter of each year, while Integrys Energy Services performs its impairment test annually during the third quarter. Impairment tests were performed at the time of acquisition for both MGUC and MERC. Going forward, MGUC and
MERC will perform annual impairment tests during the second quarter. The impairment tests are updated whenever events or changes in circumstances indicate that the assets might be impaired. Based upon the results of testing, no impairments were noted in 2006, 2005, or 2004.
Other intangible assets with definite lives consist primarily of emission allowances and customer related intangible assets, and have weighted-average amortization periods of approximately five years. For more information on Integrys Energy Group's intangible assets, see Note 11, "Goodwill and Other Intangible Assets."
(n) Retirement of Debt--Premiums, discounts, and expenses incurred with the issuance of outstanding long-term debt are amortized over the terms of the debt issues. Any call premiums or unamortized expenses associated with refinancing higher-cost debt obligations used to finance regulated assets and operations are amortized consistent with regulatory treatment of those items, where appropriate.
(o) Research and Development--Electric research and development expenditures for WPSC totaled $0.3 million, $0.7 million, and $0.7 million, in 2006, 2005, and 2004, respectively. No other research and development expenditures were significant.
(p) Asset Retirement Obligations-- Integrys Energy Group applies SFAS No. 143, "Accounting for Asset Retirement Obligations." Under this accounting standard, Integrys Energy Group recognizes, at fair value, legal obligations associated with the retirement of tangible long-lived assets that resulted from the acquisition, construction or development, and/or normal operation of the assets. The asset retirement obligations are accreted using a credit-adjusted risk-free interest rate commensurate with the expected settlement dates of the asset retirement obligations. The associated retirement costs are capitalized as part of the related long-lived assets and are depreciated over the useful lives of the assets.
Integrys Energy Group adopted Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations," as of December 31, 2005. Interpretation No. 47 clarifies that conditional asset retirement obligations are within the scope of SFAS No. 143. Therefore, a liability must be recorded for these obligations as long as the fair value can be reasonably estimated, even if the timing or method of settling the obligation is unknown. Asset retirement obligations included within the scope of Interpretation No. 47 are calculated and recorded utilizing the methodology in SFAS No. 143. See Note 1(u), "Cumulative Effect of Change in Accounting Principles," and Note 15, "Asset Retirement Obligations," for additional information regarding SFAS No. 143 and Interpretation No. 47.
(q) Income Taxes--We account for income taxes using the liability method as prescribed by SFAS No. 109, "Accounting for Income Taxes." Under this method, deferred income taxes have been recorded using currently enacted tax rates for the differences between the tax basis of assets and liabilities and the basis reported in the financial statements. Due to the effects of regulation on WPSC, UPPCO, MGUC, and MERC, certain adjustments made to defer income taxes are, in turn, recorded as regulatory assets or liabilities.
Investment tax credits, which have been used to reduce our federal income taxes payable, have been deferred for financial reporting purposes. These deferred investment tax credits are being amortized over the useful lives of the property to which they relate.
Integrys Energy Group files a consolidated United States income tax return that includes domestic subsidiaries of which its ownership is 80% or more. Integrys Energy Group and its consolidated subsidiaries are parties to a tax allocation arrangement under which each entity determines its income tax provision on a stand-alone basis. In several states, combined or consolidated filing is required for certain members of the Integrys Energy Group doing business in that state. The tax allocation arrangement equitably allocates the state taxes associated with these combined or consolidated filings.
Integrys Energy Group and its subsidiaries have routinely been subject to examination by various taxing jurisdictions, including the Internal Revenue Service (IRS), Wisconsin Department of Revenue, and other
state and local taxing jurisdictions. At any given time there might be several of these audits open covering multiple tax years. Management has not been informed by any taxing jurisdictions of any material adjustment to any filed or proposed tax position as a result of the on-going examinations, except as described below. The following jurisdictions are currently under audit: Integrys Energy Group and consolidated subsidiaries - Federal 2005; WPSC - Wisconsin 1996 through 2000; Integrys Energy Services of Canada Corp. - Quebec 2002 through 2004; WPS Power Development - Oregon 1998 through 2001; WPS Canada Generation, Inc. - Canada 2003 and 2004 transfer pricing.
(r) Taxes other than income--Integrys Energy Group presents revenue net of pass-through taxes on the Consolidated Statements of Income.
(s) Guarantees--FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees Including Indirect Guarantees of Indebtedness of Others," requires that the guarantor recognize, at the inception of the guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. See Note 18, "Guarantees," for additional information on Interpretation
No. 45.
(t) Stock-Based Employee Compensation--Integrys Energy Group has stock-based employee compensation plans, which are described more fully in Note 22, "Stock-Based Compensation." Prior to January 1, 2006, Integrys Energy Group accounted for these plans under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly, Integrys Energy Group provided pro forma disclosure amounts in accordance with SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," as if the fair value method defined by SFAS No. 123, "Accounting for Stock-Based Compensation," had been applied.
The following table illustrates the effect on income available for common shareholders and earnings per share if Integrys Energy Group had applied the fair value recognition provisions of SFAS No. 123:
(Millions, except per share amounts) | | 2005 | | 2004 | |
| | | | | | |
Income available for common shareholders | | | | | | | |
| As reported | | $ | 157.4 | | $ | 139.7 | |
Add: Stock-based compensation expense using the intrinsic value method - net of tax | | | 2.0 | | | 1.4 | |
Deduct: Stock-based compensation expense using the fair value method - net of tax | | | (1.9 | ) | | (1.1 | ) |
| Pro forma | | $ | 157.5 | | $ | 140.0 | |
| | | | | | | | |
Basic earnings per common share | | | | | | | |
| As reported | | $ | 4.11 | | $ | 3.74 | |
| Pro forma | | | 4.11 | | | 3.74 | |
| | | | | | | | |
Diluted earnings per common share | | | | | | | |
| As reported | | $ | 4.07 | | $ | 3.72 | |
| Pro forma | | | 4.07 | | | 3.72 | |
Effective January 1, 2006, Integrys Energy Group adopted the fair value recognition provisions of SFAS No. 123R, "Share-Based Payment," using the modified prospective transition method. Under this transition method, prior periods' results are not restated. Stock-based compensation cost for 2006 includes compensation cost for all stock-based compensation awards granted prior to, but not yet fully vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, adjusted for estimated future forfeitures. The fair values of stock-based compensation awards granted after January 1, 2006 were estimated in accordance with the provisions of SFAS No. 123R. There was no material cumulative effect of a change in accounting principle recorded upon adoption of SFAS No. 123R. The implementation of SFAS No. 123R had an immaterial impact on cash flows from operations and cash flows from financing activities.
(u) Cumulative Effect of Change in Accounting Principles--The adoption of Interpretation No. 47 on December 31, 2005, resulted in a $1.6 million after-tax cumulative effect of change in accounting principle, decreasing income available for common shareholders, related to recording a liability for asbestos remediation at certain of Integrys Energy Services' generation plants. Approximately $1.4 million of the after-tax cumulative effect of change in accounting principle recorded in 2005 related to Sunbury. For more information on Sunbury, see Note 4, "Discontinued Operations." For the utility segments of Integrys Energy Group, we concluded it was probable that any differences between expenses under Interpretation No. 47 and expenses currently recovered through customer rates will be recoverable or refundable in future customer rates. Accordingly, the adoption of Interpretation No. 47 had no impact on the utility segments' income, as its effect is offset by the establishment of regulatory assets or liabilities pursuant to SFAS No. 71.
(v) Reclassifications--We reclassified certain prior year financial statement amounts to conform to the current year presentation. Except for those reclassifications recorded to report assets and liabilities as held for sale and results of operations and cash flows as discontinued, no reclassifications made to the prior year financial statements were material.
(w) New Accounting Pronouncements-- In June 2006, the FASB ratified the consensus reached by the EITF on Issue No. 06-3, "How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation)." The Issue applies to taxes directly imposed on revenue-producing transactions and excludes from its scope taxes assessed on an entity's activities over time, such as gross receipts taxes. Issue No. 06-3 concludes that the presentation of taxes on either a gross (i.e., included in revenues and costs) or net (i.e., excluded from revenues) basis is an accounting policy decision. It does not require an entity to reevaluate its existing classification policies related to these taxes, but it does require additional disclosures regarding which presentation is selected. In addition, for any such taxes that are reported on a gross basis, the guidance requires an entity to disclose the amounts of those taxes in interim and annual financial statements for each period for which an income statement is presented. Issue No. 06-3 is effective January 1, 2007, for Integrys Energy Group. We do not expect this guidance to have a significant impact on our financial statements.
In July 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes," to provide guidance on how to reflect uncertain tax positions in an enterprise's financial statements. The Interpretation applies to all tax positions and will affect all circumstances in which an entity is uncertain as to whether a tax position will ultimately be sustained as filed in its tax return. In order to recognize a tax benefit in the financial statements, an entity must determine that it is "more likely than not" that the tax benefit will be realized. The amount of the tax benefit to be recognized is the largest amount that is greater than 50% likely to be realized upon ultimate settlement with the taxing authority. The Interpretation is effective for Integrys Energy Group on January 1, 2007. We do not expect the implementation of Interpretation No. 48 to have a significant impact on our financial statements.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." SFAS No. 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and states that a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. The Standard eliminates the current requirement for deferring "day one" gains on energy contracts that are not evidenced by quoted market prices or other current market transactions. The standard will be effective for Integrys Energy Group beginning January 1, 2008. We are currently evaluating the impact that SFAS No. 157 will have on our financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities." This standard permits entities to choose to measure many financial instruments and certain other items at fair value, following the provisions of SFAS No. 157. Included within the scope of the standard are all recognized financial assets and financial liabilities, except consolidated investments,
consolidated interests in a variable interest entity, obligations for pension and certain other benefits, leases, and financial instruments that are classified as a component of shareholder's equity. Also included in the scope of the standard are firm commitments that would otherwise not be recognized at inception and that involve only financial instruments, nonfinancial insurance contracts and warranties that the insurer can settle by paying a third party to provide those goods or services, and host financial instruments resulting from separation of an embedded nonfinancial derivative instrument from a nonfinancial hybrid instrument. SFAS No. 159 is effective for Integrys Energy Group beginning January 1, 2008. We are currently evaluating the impact that SFAS No. 159 will have on our financial statements.
NOTE 2--FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate such value:
Cash, restricted cash, accounts receivable, accounts payable, notes payable, and outstanding commercial paper: The carrying amount approximates fair value due to the short maturity of these investments and obligations.
Long-term debt and preferred stock: The fair values of long-term debt and preferred stock are estimated based on the quoted market price for the same or similar issues or on the current rates offered to Integrys Energy Group for debt of the same remaining maturity.
Risk management activities: Assets and liabilities from risk management activities are recorded at fair value in accordance with SFAS No. 133.
The estimated fair values of our financial instruments as of December 31 were:
(Millions) | | 2006 | | 2005 | |
| | | Carrying Amount | | Fair Value | | Carrying Amount | | Fair Value | |
| | | | | | | | | | |
| Cash and cash equivalents | | $ | 23.2 | | $ | 23.2 | | $ | 27.7 | | $ | 27.7 | |
| Restricted cash | | | 22.0 | | | 22.0 | | | - | | | - | |
| Accounts receivable | | | 1,037.3 | | | 1,037.3 | | | 1,005.6 | | | 1,005.6 | |
| Accounts payable | | | 1,010.4 | | | 1,010.4 | | | 1,078.9 | | | 1,078.9 | |
| Notes payable | | | 160.0 | | | 160.0 | | | 10.0 | | | 10.0 | |
| Commercial paper | | | 562.8 | | | 562.8 | | | 254.8 | | | 254.8 | |
| Long-term debt | | | 1,315.9 | | | 1,323.1 | | | 872.9 | | | 901.7 | |
| Preferred stock | | | 51.1 | | | 48.8 | | | 51.1 | | | 49.0 | |
| Risk management activities - net | | | 110.4 | | | 110.4 | | | 91.7 | | | 91.7 | |
NOTE 3--RISK MANAGEMENT ACTIVITIES
The following table shows Integrys Energy Group's assets and liabilities from risk management activities as of December 31, 2006, and 2005:
| | | Assets | | Liabilities | |
(Millions) | | 2006 | | 2005 | | 2006 | | 2005 | |
Utility Segments | | | | | | | | | |
| Commodity contracts | | $ | 5.9 | | $ | 22.0 | | $ | 12.1 | | $ | - | |
| Financial transmission rights | | | 14.3 | | | 14.5 | | | 2.0 | | | 1.8 | |
Nonregulated Segments | | | | | | | | | | | | | |
| Commodity and foreign currency contracts | | | 1,237.7 | | | 1,058.6 | | | 1,195.4 | | | 971.7 | |
| Fair value hedges - commodity contracts | | | 11.0 | | | 4.2 | | | 0.3 | | | 12.9 | |
| Cash flow hedges | | | | | | | | | | | | | |
| Commodity contracts | | | 107.9 | | | 33.6 | | | 53.3 | | | 50.1 | |
| Interest rate swaps | | | - | | | - | | | 3.3 | | | 4.7 | |
Total | | $ | 1,376.8 | | $ | 1,132.9 | | $ | 1,266.4 | | $ | 1,041.2 | |
Balance Sheet Presentation | | | | | | | | | | | | | |
| Current | | $ | 1,068.6 | | $ | 906.4 | | $ | 1,001.7 | | $ | 852.8 | |
| Long-term | | | 308.2 | | | 226.5 | | | 264.7 | | | 188.4 | |
Total | | $ | 1,376.8 | | $ | 1,132.9 | | $ | 1,266.4 | | $ | 1,041.2 | |
Assets and liabilities from risk management activities are classified as current or long-term based upon the maturities of the underlying contracts.
Utility Segments
The derivatives listed in the above table as "Commodity contracts" include a limited number of electric and natural gas purchase contracts as well as financial derivative contracts (NYMEX futures and options) used by both the electric and natural gas utility segments to mitigate the market price volatility of natural gas. The electric utility segment also uses financial instruments to manage transmission congestion costs, which are shown in the above table as "Financial transmission rights."
The following table shows WPSC's assets and liabilities from risk management activities as of December 31, 2006, and 2005:
| | | Assets | | Liabilities | |
(Millions) | | 2006 | | 2005 | | 2006 | | 2005 | |
WPSC | | | | | | | | | |
| Commodity contracts | | $ | 3.8 | | $ | 22.0 | | $ | 10.2 | | $ | - | |
| Financial transmission rights | | | 13.7 | | | 13.6 | | | 2.0 | | | 1.7 | |
Total | | $ | 17.5 | | $ | 35.6 | | $ | 12.2 | | $ | 1.7 | |
Balance Sheet Presentation | | | | | | | | | | | | | |
| Current | | $ | 17.5 | | $ | 29.3 | | $ | 11.3 | | $ | 1.7 | |
| Long-term | | | - | | | 6.3 | | | 0.9 | | | - | |
Total | | $ | 17.5 | | $ | 35.6 | | $ | 12.2 | | $ | 1.7 | |
Derivative instruments at the utilities are entered into in accordance with the terms of the risk management policies and plans approved by the respective regulatory bodies. Changes in the fair value of derivative instruments are recognized as regulatory assets or liabilities as our regulators have allowed deferral of the mark-to-market effects of derivative instruments at the utilities. Thus, management believes any gains or losses resulting from the eventual settlement of these derivative instruments will be collected from or refunded to customers.
Nonregulated Segments
The derivatives in the nonregulated segments not designated as hedges under generally accepted accounting principles are primarily commodity contracts used to manage price risk associated with natural gas and electric energy purchase and sale activities, and foreign currency contracts used to manage foreign currency exposure related to Integrys Energy Services' Canadian operations. In addition, Integrys Energy Services entered into a series of derivative contracts (options) covering a specified number of barrels of oil in order to manage exposure to the risk of an increase in oil prices that could result in a phase-out of Section 29/45K federal tax credits from Integrys Energy Services' investment in a synthetic fuel production facility for 2007. See Note 1(q), "Income Taxes," and Note 17, "Commitments and Contingencies," for more information. Changes in the fair value of non-hedge derivatives are recognized currently in earnings.
Our nonregulated segments also enter into derivative contracts that are designated as either fair value or cash flow hedges. Fair value hedges are used to mitigate the risk of changes in the price of natural gas held in storage. The changes in the fair value of these hedges are recognized currently in earnings, as are the changes in fair value of the hedged items. Fair value hedge ineffectiveness recorded in nonregulated revenue on the Consolidated Statements of Income was a pre-tax gain of $3.7 million in 2006, a pre-tax loss of $2.5 million in 2005 and was not significant in 2004. Changes in the difference between the spot and forward prices of natural gas were excluded from the assessment of hedge effectiveness and reported directly in nonregulated revenue. During 2006, the amount excluded was not significant. During 2005, the amount excluded was a pre-tax loss of $5.2 million. During 2004, the amount excluded was a pre-tax gain of $2.0 million.
Commodity contracts that are designated as cash flow hedges extend through March 2011 and are used to mitigate the risk of cash flow variability associated with the future purchases and sales of natural gas and electricity. To the extent they are effective, the changes in the values of these contracts are included in other comprehensive income, net of taxes. Cash flow hedge ineffectiveness recorded in nonregulated revenue on the Consolidated Statements of Income related to commodity contracts was a pre-tax gain of $8.6 million in 2006, a pre-tax loss of $2.6 million in 2005 and was not significant in 2004. When testing for effectiveness, no portion of the derivative instruments was excluded. Amounts recorded in other comprehensive income related to these cash flow hedges will be recognized in earnings as the related contracts are settled or if it is probable that the hedged transaction will not occur. During 2006, 2005, and 2004, we reclassified pre-tax gains of $2.1 million, $5.2 million, and $3.2 million, respectively, from other comprehensive income into earnings as a result of the discontinuance of cash flow hedge accounting for certain hedge transactions. In the next 12 months, subject to changes in market prices of natural gas and electricity, we expect that a pre-tax gain of $17.0 million will be recognized in earnings as contracts are settled. We expect this amount to be substantially offset by settlement of the related nonderivative contracts that are being hedged.
In the second quarter of 2005, a variable rate non-recourse debt instrument used to finance the purchase of Sunbury was restructured to an Integrys Energy Group variable rate obligation. An interest rate swap used to fix the interest rate on the Sunbury non-recourse debt was previously designated as a cash flow hedge. As a result of the debt restructuring, the hedged transaction was probable of not occurring. Subsequent to the restructuring, the interest rate swap was re-designated as a cash flow hedge, along with an additional interest rate swap, to fix the interest rate on the Integrys Energy Group obligation. Since the redesignation of these contracts as cash flow hedges, the changes in the fair value of the effective portion of these swaps are included in other comprehensive income, net of deferred taxes, while the changes related to the ineffective portion are recorded in earnings. During the years ended December 31,
2006 and 2005, cash flow hedge ineffectiveness recorded in earnings related to these swaps was not significant. Amounts recorded in other comprehensive income related to these swaps will be recognized as a component of interest expense as the interest becomes due. In the next 12 months, we expect to recognize a $0.8 million pre-tax reduction to interest expense related to these swaps, assuming interest rates comparable to those at December 31, 2006. We did not exclude any component of the derivative instruments' change in fair value from the assessment of hedge effectiveness.
In the first quarter of 2006, Integrys Energy Group entered into a forward-starting interest rate swap with a notional amount of $200 million to hedge a portion of the interest rate risk associated with the planned issuance of fixed-rate, long-term debt securities in 2006. The swap had a ten-year term beginning in August 2006 and a mandatory early termination date of August 31, 2006. The swap was used to protect against the risk of changes in future interest payments resulting from changes in benchmark rates between the date of hedge inception and the earlier of the date of the debt issuance or the date of the swap termination. The swap was designated as a cash flow hedge, and changes in its fair value were recorded through other comprehensive income, net of taxes. In the third quarter of 2006, the issuance of the related debt securities was delayed, and it became probable that the first forecasted interest payment would not occur within the specified time period. Integrys Energy Group terminated the original swap and entered into a new swap with a ten-year term beginning in December 2006. Integrys Energy Group reclassified a pre-tax $0.4 million gain from other comprehensive income to interest expense related to the original swap.
The second swap also qualified for cash flow hedge treatment. As a result, changes in the fair value of the swap were recorded in other comprehensive income, net of taxes. In November 2006, the second swap was terminated in conjunction with the issuance of the related debt securities. Cash flow hedge ineffectiveness recorded in earnings related to the swap was not significant for the year ended December 31, 2006. Amounts remaining in accumulated other comprehensive income are being reclassified to interest expense over a ten-year period beginning in December 2006 to correspond with the first ten years of interest on the related debt.
NOTE 4--DISCONTINUED OPERATIONS
WPS Niagara Generation, LLC
In January 2007, Integrys Energy Services completed the sale of WPS Niagara Generation, LLC, which owned a 50-megawatt merchant generation facility located near Niagara Falls, New York, for approximately $31 million, subject to post closing adjustments. The pre-tax gain recorded in the first quarter of 2007 was approximately $25 million, approximately $15 million after-tax, and will be included as a component of discontinued operations in the first quarter of 2007. This facility sold power on a wholesale basis when market conditions were economically favorable. Integrys Energy Services had received an unsolicited offer to purchase the facility and believed the price being offered was above the value Integrys Energy Services would realize from continued ownership of the facility.
At December 31, 2006, and 2005, the assets and liabilities associated with Niagara that were transferred in the sale have been classified as held for sale in accordance with SFAS No. 144. No adjustments to write down the Niagara assets were required during the year ended December 31, 2006 and 2005. The major classes of assets held for sale at December 31, 2006 and 2005 for Niagara were as follows:
(Millions) | | 2006 | | 2005 | |
| Inventories | | $ | 0.4 | | $ | 0.4 | |
| Property, plant, and equipment, net | | | 4.6 | | | 4.1 | |
| Other assets | | | 1.1 | | | 1.0 | |
| Total assets held for sale | | $ | 6.1 | | $ | 5.5 | |
A summary of the components of discontinued operations recorded in the Consolidated Statements of Income related to Niagara for the year ended December 31 were as follows:
(Millions) | | 2006 | | 2005 | | 2004 | |
| Nonregulated revenue | | $ | 19.3 | | $ | 21.8 | | $ | 14.5 | |
| Operating expenses | | | | | | | | | | |
| Nonregulated cost of fuel, natural gas, and purchased power | | | 12.9 | | | 12.2 | | | 10.0 | |
| Operating and maintenance expense | | | 5.3 | | | 4.9 | | | 4.6 | |
| Depreciation expense | | | 0.4 | | | 0.3 | | | 0.2 | |
| Taxes other than income | | | 0.3 | | | 0.2 | | | 0.3 | |
| Miscellaneous income (expense) | | | 0.2 | | | - | | | (0.2 | ) |
| Income (loss) before taxes | | | 0.6 | | | 4.2 | | | (0.8 | ) |
| Income tax provision (benefit) | | | 0.2 | | | 1.8 | | | (0.4 | ) |
| Discontinued operations, net of tax | | $ | 0.4 | | $ | 2.4 | | $ | (0.4 | ) |
Sunbury Generation, LLC
In July 2006, Integrys Energy Services completed the sale of Sunbury Generation, LLC to Corona Power, LLC. Sunbury Generation's primary asset was the Sunbury generation plant located in Pennsylvania. The gross proceeds received in the transaction were $33.6 million and the pre-tax gain recorded in 2006 was $20.2 million ($12.5 million after taxes). In conjunction with the sale, the company also anticipates accelerating approximately $13 million in cash tax benefits that will be realized within the next few years, with the timing subject to the use of alternative minimum tax credits. This facility sold power on a wholesale basis when market conditions were economically favorable. Integrys Energy Services had been evaluating Sunbury's future since 2004, after an agreement to sell Sunbury was terminated. The sale of Sunbury allows Integrys Energy Services to better focus on its existing competitive energy business, while continuing to evaluate other strategic opportunities to add to and optimize the value of its generation fleet.
The assets and liabilities associated with Sunbury that were transferred to Corona Power, LLC have been classified as held for sale in accordance with SFAS No. 144. The major classes of assets and liabilities related to Sunbury classified as held for sale at December 31, 2005 were as follows:
(Millions) | | | |
| Inventories | | $ | 6.6 | |
| Other current assets | | | 5.0 | |
| Property, plant, and equipment, net | | | 1.3 | |
| Other assets (includes emission credits) | | | 1.9 | |
| Assets held for sale | | $ | 14.8 | |
| | | | | |
| Other current liabilities | | $ | 1.0 | |
| Asset retirement obligations | | | 5.6 | |
| Liabilities held for sale | | $ | 6.6 | |
A summary of the components of discontinued operations recorded in the Consolidated Statements of Income for the years ended December 31 related to Sunbury were as follows:
(Millions) | | 2006 | | 2005 | | 2004 | |
| Nonregulated revenue | | $ | 69.2 | | $ | 115.4 | | $ | 60.2 | |
| Nonregulated cost of fuel, natural gas, and purchased power | | | 61.6 | | | 68.7 | | | 56.1 | |
| Operating and maintenance expense | | | 17.9 | | | 27.5 | | | 24.4 | |
| Gain on Sunbury sale | | | (20.2 | ) | | - | | | - | |
| Depreciation and decommissioning expense | | | 0.3 | | | 0.2 | | | - | |
| Gain on sale of emission allowances | | | - | | | (86.8 | ) | | - | |
| Impairment loss | | | - | | | 80.6 | | | - | |
| Taxes other than income | | | 0.3 | | | 0.4 | | | - | |
| Miscellaneous income | | | - | | | - | | | 4.3 | |
| Interest expense | | | - | | | (10.4 | ) | | (5.7 | ) |
| Income (loss) before taxes | | | 9.3 | | | 14.4 | | | (21.7 | ) |
| Income tax provision (benefit) | | | 2.4 | | | 5.3 | | | (8.3 | ) |
| Discontinued operations, net of tax | | $ | 6.9 | | $ | 9.1 | | $ | (13.4 | ) |
The after-tax gain from the sale of Sunbury included in discontinued operations for the year ended December 31, 2006 was $12.5 million and is reflected in the table above. Interest recorded for the year ended December 31, 2006 was not significant. For the year ended December 31, 2005, interest expense of $9.1 million was recognized related to the termination of an interest rate swap pertaining to Sunbury's non-recourse debt obligation in addition to the recognition of interest expense on the non-recourse debt prior to the restructuring of this debt in the second quarter of 2005. The restructuring of the Sunbury debt to an Integrys Energy Group obligation in June 2005 triggered the recognition of interest expense equivalent to the mark-to-market value of the swap at the date of restructuring. Other than the interest expense related to the interest rate swap, interest expense in the table above represented the non-recourse loans directly related to Sunbury. During 2005 and 2004, cash paid for interest associated with the non-recourse debt related to Sunbury was $4.1 million and $5.4 million, respectively.
NOTE 5--PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment in service at December 31 consists of the following utility, nonutility, and nonregulated assets:
(Millions) | | 2006 | | 2005 | |
| Electric utility | | $ | 2,181.7 | | $ | 2,108.3 | |
| Natural gas utility | | | 1,129.6 | | | 548.5 | |
| Total utility plant | | | 3,311.3 | | | 2,656.8 | |
| Less: Accumulated depreciation | | | 1,366.2 | | | 1,054.7 | |
| Net | | | 1,945.1 | | | 1,602.1 | |
| Construction in progress | | | 444.9 | | | 286.6 | |
| Net utility plant | | | 2,390.0 | | | 1,888.7 | |
| | | | | | | | |
| Nonutility plant | | | 21.0 | | | 19.9 | |
| Less: Accumulated depreciation | | | 6.5 | | | 5.9 | |
| Net nonutility plant | | | 14.5 | | | 14.0 | |
| | | | | | | | |
| Electric nonregulated | | | 161.0 | | | 160.7 | |
| Natural gas nonregulated | | | 1.1 | | | 6.7 | |
| Other nonregulated | | | 21.9 | | | 20.1 | |
| Total nonregulated property, plant, and equipment | | | 184.0 | | | 187.5 | |
| Less: Accumulated depreciation | | | 53.7 | | | 46.2 | |
| Net nonregulated property, plant, and equipment | | | 130.3 | | | 141.3 | |
| Total property, plant, and equipment | | $ | 2,534.8 | | $ | 2,044.0 | |
The increase in the natural gas utility assets in 2006 is due to MGUC and MERC's acquisition of natural gas distribution operations in Michigan and Minnesota. See Note 6, "Acquisitions and Sales of Assets" for more information. The increase in construction in progress in 2006 is mainly due to the construction of Weston 4. The above table does not include net electric nonregulated property, plant, and equipment of $4.6 million classified as held for sale at December 31, 2006.
NOTE 6--ACQUISITIONS AND SALES OF ASSETS
Merger with Peoples Energy Corporation
On February 21, 2007, the previously announced merger with Peoples Energy Corporation was consummated. In connection with the merger, the company changed its name from WPS Resources Corporation to Integrys Energy Group, Inc. The merger will be accounted for under the purchase method of accounting with Integrys Energy Group treated as the acquirer. Pursuant to the merger, shareholders of Peoples Energy will receive 0.825 shares of WPS Resources common stock, $1 par value, for each share of Peoples Energy common stock, no par value, that they held immediately prior to the merger. The estimated total purchase price of the merger is approximately $1.6 billion.
On February 7, 2007, the ICC approved the merger by accepting an agreed upon settlement among the parties to the merger case. The order included Conditions of Approval regarding commitments by the applicants to provide certain reports, perform studies of the Peoples Gas system, promote and hire a limited number of union employees in specific areas, make no reorganization-related layoffs or position reductions within the Peoples Gas union workforce, maintain Peoples Gas and North Shore Gas' operation and maintenance and capital budgets at recent levels, file a plan for formation and implementation of a services company, accept certain limits on the merger-related costs that can be recovered from ratepayers, and not seek cost recovery for any increase in deferred tax assets that may result from the tax treatment of the Peoples Gas and North Shore Gas storage gas inventory in connection with closing the merger. The Conditions of Approval also include commitments by the company with respect to the upcoming rate cases of Peoples Gas and North Shore Gas. These are the inclusion of merger synergy savings of $13.1 million in the proposed test year, the recovery of $7.0 million of the merger-related costs in the test year (reflecting recovery of $35.0 million of costs over 5 years), proposing a $7.5 million energy efficiency program which will be contingent on receiving cost recovery in the rate case orders, and filing certain changes to the small volume transportation service programs. Finally, the order provides authority for Peoples Gas and North Shore Gas to record a regulatory asset for up to $44.9 million of merger costs that may be recovered from ratepayers.
The PSCW approved the merger as of February 16, 2007. The merger approval order contains several conditions. One condition is that WPSC will not have a base rate increase prior to January 1, 2009. Under this condition, WPSC will be allowed to adjust rates effective January 1, 2008, for changes in fuel costs due to changes in the NYMEX natural gas futures prices, coal prices and transportation costs for coal. While WPSC had asked for authority to also adjust rates effective January 1, 2008, for the change in transmission costs from 2007 to 2008, the PSCW did not provide that authority in this order. Other conditions imposed in the order include no recovery of transaction costs, recovery of transition costs in 2009 and later years limited to the verified synergy savings in those years, a requirement that WPSC seek approval for the formation of a services company within 120 days of the closing of the merger, WPSC holding ratepayers harmless from any increase in interest costs due to the merger, and WPSC not paying a dividend greater than 103% of the prior year's dividend.
Peoples Energy is a diversified energy company consisting of three primary business segments: natural gas distribution, oil and natural gas production, and energy marketing. The regulated business of Peoples Energy (the natural gas distribution business segment), stores, distributes, sells, and transports natural gas to about one million customers in the city of Chicago and 54 communities in northeastern Illinois. The nonregulated energy marketing business sells natural gas and power to more than 25,000 customers and provides a portfolio of products to manage energy needs of commercial, industrial, and residential customers. The oil and natural gas production business segment of Peoples Energy acquires, develops,
and produces oil and natural gas reserves in selected onshore basins in the United States through direct ownership in oil, natural gas and mineral leases.
On February 21, 2007, subsequent to the merger with Peoples Energy Corporation, Integrys Energy Group announced its commitment to the sale of Peoples Energy Corporation's oil and natural gas production business. SFAS No. 141, "Business Combinations," states that assets acquired in a business combination that will be sold should be recognized at fair value less costs to sell in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 requires that long-lived assets classified as held for sale be measured at the lower of their carrying amount or fair value, less costs to sell, and to cease depreciation, depletion and amortization. At the date of merger, the assets and liabilities of the oil and natural gas production business were classified as held for sale and results of operations and related cash flows occurring subsequent to the merger will be reported as discontinued operations. Integrys Energy Group selected a financial advisor for this transaction and anticipates the divestiture to be complete by the end of 2007.
Sale of Kimball Storage Field
In April 2006, Integrys Energy Services sold WPS ESI Gas Storage, LLC, which owned a natural gas storage field located in the Kimball Township, St. Clair County, Michigan. Integrys Energy Services utilized this facility primarily for structured wholesale natural gas transactions as natural gas storage spreads presented arbitrage opportunities. Integrys Energy Services was not actively marketing this facility for sale, but believed the price being offered was above the value it would realize from continued ownership of the facility. Proceeds received in April from the sale of WPS ESI Gas Storage, LLC, and other related assets were $19.9 million, which resulted in a pre-tax gain of $9.0 million in the second quarter of 2006.
Sale of Guardian Pipeline
In April 2006, WPS Investments, LLC, a subsidiary of Integrys Energy Group, completed the sale of its one-third interest in Guardian Pipeline, LLC to Northern Border Partners, LP for $38.5 million. The transaction resulted in the recognition of a pre-tax gain of $6.2 million in the second quarter of 2006.
Purchase of Aquila's Michigan and Minnesota Natural Gas Distribution Operations
Michigan
On April 1, 2006, Integrys Energy Group, through its wholly owned subsidiary MGUC, completed the acquisition of natural gas distribution operations in Michigan from Aquila. The Michigan natural gas assets provide natural gas distribution service in 147 cities and communities primarily throughout Otsego, Grand Haven, and Monroe counties. The assets operate under a cost of service environment and are currently allowed an 11.4% return on equity on a 45% equity component of the regulatory capital structure.
Integrys Energy Group paid total consideration of $344.2 million for the Michigan natural gas distribution operations, which included closing adjustments related primarily to purchased working capital. This transaction is still subject to certain post closing adjustments. The transaction was initially funded with commercial paper borrowings supported by a revolving credit agreement entered into with JP Morgan Chase Bank, N.A. and Bank of America, N.A. (see Note 13 "Short-Term Debt and Lines of Credit" for more information on the revolving credit agreement). Permanent financing for the acquisition will include a combination of common equity, long-term debt instruments, and hybrid securities. The transaction was accounted for under the purchase method of accounting. The purchase price ($344.2 million, subject to post closing adjustments) was allocated based on the estimated fair market value of the assets acquired and liabilities assumed. The excess cost of the acquisition over the estimated fair value of the tangible net assets acquired was allocated to identifiable intangible assets with the remainder then allocated to goodwill. The results of operations were included in the accompanying consolidated financial statements since the date of acquisition. The following table shows the preliminary allocation of the purchase price to
the assets acquired and liabilities assumed at the date of the acquisition. When the purchase price allocation is finalized, adjustments to goodwill may result.
(Millions) | | | |
| Accounts receivable, net | | $ | 28.4 | |
| Accrued unbilled revenues | | | 15.6 | |
| Inventories | | | 23.9 | |
| Other current assets | | | 3.3 | |
| Property plant and equipment, net | | | 137.1 | |
| Regulatory assets | | | 56.5 | |
| Other long-term assets | | | | |
| Goodwill | | | 122.9 | |
| Intangibles - trade name | | | 5.2 | |
| Other long-term assets | | | 4.2 | |
| Total Assets | | | 397.1 | |
| | | | | |
| Other current liabilities | | | 6.1 | |
| Regulatory liabilities | | | 1.2 | |
| Environmental remediation liabilities | | | 24.9 | |
| Pension and postretirement benefit obligations | | | 20.5 | |
| Other long-term liabilities | | | 0.2 | |
| Total Liabilities | | | 52.9 | |
| Net assets acquired | | $ | 344.2 | |
Minnesota
On July 1, 2006, Integrys Energy Group, through its wholly owned subsidiary, MERC, completed the acquisition of natural gas distribution operations in Minnesota from Aquila. The Minnesota natural gas assets provide natural gas distribution service in 165 cities and communities including Eagan, Rosemount, Rochester, Fairmount, Bemidji and Cloquet, and Dakota County. The assets operate under a cost of service environment and are currently allowed an 11.71% return on equity on a 50% equity component of the regulatory capital structure.
Integrys Energy Group paid total consideration of $315.9 million for the Minnesota natural gas distribution operations, which included closing adjustments related primarily to purchased working capital. This transaction is still subject to certain post closing adjustments. The transaction was initially funded with commercial paper borrowings supported by a revolving credit agreement entered into with JP Morgan Chase Bank, N.A. and Bank of America, N.A. (see Note 13 "Short-Term Debt and Lines of Credit," for more information on the revolving credit agreement). Permanent financing for the acquisition will include a combination of common equity, long-term debt instruments, and hybrid securities. The transaction was accounted for under the purchase method of accounting.
The purchase price was allocated based on the estimated fair market value of the assets acquired and liabilities assumed. The excess cost of the acquisition over the estimated fair value of the tangible net assets acquired is allocated to identifiable intangible assets with the remainder then allocated to goodwill. The results of operations were included in the accompanying consolidated financial statements from the date of acquisition. The fair values set forth below are preliminary and are subject to adjustment as additional information is obtained. The following table shows the preliminary allocation of the purchase price to the assets acquired and liabilities assumed at the date of the acquisition.
(Millions) | | | |
| Accounts receivable, net | | $ | 5.5 | |
| Accrued unbilled revenues | | | 3.4 | |
| Inventories | | | 6.9 | |
| Other current assets | | | 1.9 | |
| Property plant and equipment, net | | | 157.6 | |
| Regulatory assets | | | 15.2 | |
| Other long-term assets | | | | |
| Goodwill | | | 144.6 | |
| Customer list - non-utility | | | 5.0 | |
| Other long-term assets | | | 2.3 | |
| Total Assets | | | 342.4 | |
| | | | | |
| Other current liabilities | | | 2.5 | |
| Regulatory liabilities | | | 4.6 | |
| Pension and postretirement benefit obligations | | | 17.1 | |
| Other long-term liabilities | | | 2.3 | |
| Total Liabilities | | | 26.5 | |
| Net assets acquired | | $ | 315.9 | |
The following table provides supplemental pro forma results of operations for Integrys Energy Group for the year ended December 31, 2006 and 2005, as if the acquisition of both the Michigan and Minnesota natural gas distribution operations from Aquila had been completed at the beginning of 2006 and 2005, respectively. Pro forma results are presented for informational purposes only, assume commercial paper was used to finance the transaction, and are not necessarily indicative of the actual results that would have resulted had the acquisitions actually occurred on January 1, 2006, and January 1, 2005.
| | Pro Forma for the Year Ended December 31 |
(Millions) | 2006 | 2005 |
| Net revenue | $7,162.9 | $7,380.5 |
| Income available for common shareholders | $166.1 | $167.7 |
| Basic earnings per share | $3.93 | $4.38 |
| Diluted earnings per share | $3.92 | $4.33 |
Sale of UPPCO Lands
DPC
In November 2005, WPSC and DPC closed a transaction in which DPC acquired a 30% ownership interest in Weston 4. Under terms of the agreement, WPSC received $95.1 million in cash from DPC for its share of the costs through the date of the closing. DPC is remitting payments to WPSC for its 30% share of the remaining costs to complete the construction of Weston 4 and will reimburse WPSC for its share of operating costs after the plant is completed and operational, which is anticipated by June 2008.
Kewaunee
On July 5, 2005, WPSC completed the sale of its 59% ownership interest in Kewaunee to Dominion Energy Kewaunee, LLC, a subsidiary of Dominion Resources, Inc. At the same time, Wisconsin Power and Light Company sold its 41% ownership interest in Kewaunee to Dominion.
WPSC's share of the cash proceeds from the sale was $112.5 million. Dominion received the assets in WPSC's qualified decommissioning trust and assumed responsibility for the eventual decommissioning of Kewaunee. These trust assets had a pre-tax fair value of $243.6 million at closing. The sale of Kewaunee resulted in a loss of $12.5 million, which includes the proceeds from the sale less the net assets sold, adjusted by several additional items. The most significant of these adjustments is the fair value of an indemnity issued to cover certain costs Dominion may incur related to the recent unplanned outage (see Note 18, "Guarantees," for more information). In addition, the adjustments include certain costs related to the termination of the plant operating agreement and withdrawal from Integrys Energy Group's investment in the Nuclear Management Company, which served as the licensed operator of Kewaunee.
As part of the sale, WPSC retained ownership of the assets contained in its nonqualified decommissioning trust. Proceeds received from the liquidation of the nonqualified decommissioning trust were $127.1 million and are being refunded to ratepayers. See Note 23, "Regulatory Environment," for details regarding regulatory treatment of the proceeds received from the nonqualified decommissioning trust and the loss on the sale of Kewaunee.
At the closing date, WPSC's share of the carrying value of the assets and liabilities that were included within the sale agreement, or that were otherwise eliminated pursuant to the sale, were as follows:
(Millions) | | July 5, 2005 | |
| | | | |
| Qualified decommissioning trust fund | | $ | 243.6 | |
| Other utility plant, net | | | 165.4 | |
| Other current assets | | | 5.5 | |
| Total assets | | $ | 414.5 | |
| | | | | |
| Regulatory liabilities | | $ | (72.1 | ) |
| Accounts payable | | | 2.5 | |
| Asset retirement obligations | | | 376.4 | |
| Total liabilities | | $ | 306.8 | |
Upon the closing of the sale, WPSC entered into a long-term power purchase agreement with Dominion to purchase energy and capacity consistent with volumes available when WPSC owned Kewaunee. The power purchase agreement extends through 2013 when the plant's current operating license will expire. The costs of power under the power purchase agreement approximate the expected costs had WPSC continued to own the plant. Therefore, management believes that the sale of Kewaunee and the related power purchase agreement provide more price certainty for WPSC's customers and reduces WPSC's risk profile. In April 2004, WPSC entered into an exclusivity agreement with Dominion. Under this agreement, if Dominion decides to extend the operating license of Kewaunee, Dominion can negotiate only with WPSC during the exclusivity period for 59% of the plant output under a new power purchase agreement that would extend beyond Kewaunee's current operating license termination date. The exclusivity period started on the closing date of the sale, July 5, 2005, and extends through December 21, 2011, after which Dominion can negotiate with other parties.
Sale of Peshtigo River Lands
On October 5, 2004, WPSC sold at auction 279 acres of Peshtigo River development lands located in Wisconsin for $12.2 million. Under terms of a multi-phase agreement reached with the WDNR in 2001 related to lands near the Peshtigo River, the WDNR bought more than 5,000 acres of land for $13.5 million in 2001. In December 2003, WPSC sold an additional 542 acres of land to the WDNR for $6.5 million. WPSC completed the multi-phase agreement with the sale of 179 acres for $5.0 million to the WDNR on December 9, 2004. Following the close of this final phase of the WDNR agreement, WPSC donated an additional 5,176 acres to the state of Wisconsin.
Integrys Energy Services of New York, Inc.
On July 1, 2004, Integrys Energy Services acquired all of the outstanding stock of Integrys Energy Services of New York, a New York based energy-marketing company. On the date of acquisition, Integrys Energy Services of New York served approximately 8,200 residential and commercial customers with a peak load of approximately 275 megawatts. Consideration for the purchase consisted of an initial cash payment for the tangible and intangible net worth of the company and an earn-out with a maximum cap and a declining percentage to the seller.
ECO Coal Pelletization #12
At December 31, 2006, Integrys Energy Services holds a 70% ownership interest in ECO Coal Pelletization #12, LLC, which holds an equity method investment in an entity that produces synthetic fuel for tax credits under Section 29/45K of the Internal Revenue Code.
On December 19, 2002, Integrys Energy Services sold approximately 30% interest in ECO #12 to a third party. The buyer purchased the Class A interest in ECO #12, giving the buyer a preferential allocation of tons of synthetic fuel produced and sold annually. The buyer may be allocated additional tons of synthetic fuel if Integrys Energy Services makes them available, but neither party is obligated beyond the required annual allocation of tons. The buyer's share of operating losses generated from the synthetic fuel operation, $3.8 million, $4.7 million, and $3.4 million, in 2006, 2005, and 2004, respectively, are recorded as minority interest in the Consolidated Statements of Income.
Integrys Energy Services received consideration of $3.0 million cash, as well as a fixed and variable note for this sale transaction. Payments under the variable note are contingent upon the achievement of specified levels of synthetic fuel production by the facility. In conjunction with the sale, Integrys Energy Services agreed to make certain payments to a third-party broker, consisting of an up-front payment of $1.5 million (which was paid at the time of closing), $1.4 million in 2003, $1.9 million in 2004, and $0.5 million in 2005. A deferred gain of $2.3 million, $4.6 million, and $6.9 million was reflected on Integrys Energy Services' balance sheet at December 31, 2006, 2005, and 2004, respectively. This deferred gain represents the present value of future payments under the fixed note and the up-front cash payments net of transaction costs. It does not include an amount for the variable note, which is contingent upon the synthetic fuel production. Payments on the variable note are a function of fuel production and recognized as a component of the gain when received. Pre-tax gains of $6.4 million, $7.1 million, and $7.5 million were recognized as a component of miscellaneous income in 2006, 2005, and 2004, respectively, related to the 2002 transaction. See Note 17, "Commitments and Contingencies," for more information on Integrys Energy Services' investment in the synthetic fuel production facility.
NOTE 7--JOINTLY OWNED UTILITY FACILITIES
WPSC holds an ownership interest in certain jointly owned electric-generating facilities. WPSC is entitled to shares of the generating capability and output of each equal to its respective ownership interest and also pays its ownership share of additional construction costs, fuel inventory purchases and operating expenses unless specific agreements have been executed to limit certain joint owners' maximum exposure to additional costs. WPSC's share of significant jointly owned electric-generating facilities as of December 31, 2006, is as follows:
(Millions, except for percentages and megawatts) | West Marinette Unit No. 33 | Columbia Energy Center | Edgewater Unit No. 4 |
Ownership | 68.0% | 31.8% | 31.8% |
WPSC's share of plant nameplate capacity (megawatts) | 56.8 | 335.2 | 105.0 |
Utility plant in service | $18.8 | $155.5 | $32.6 |
Accumulated depreciation | $ 9.0 | $ 94.1 | $20.1 |
In-service date | 1993 | 1975 and 1978 | 1969 |
WPSC's share of direct expenses for these plants is included in the corresponding operating expenses in the Consolidated Statements of Income. WPSC has supplied its own financing for all jointly-owned projects.
NOTE 8--NUCLEAR DECOMMISSIONING TRUST
In conjunction with the sale of Kewaunee in July 2005 (see Note 6, "Acquisitions and Sales of Assets," for details regarding the sale of Kewaunee), the qualified decommissioning trust assets were transferred to Dominion and WPSC liquidated the assets contained in the nonqualified decommissioning trust. Proceeds received from the liquidation of the nonqualified decommissioning trust are being refunded to ratepayers. See Note 23, "Regulatory Environment," for details regarding regulatory treatment of the proceeds received from the nonqualified decommissioning trust.
Decommissioning costs collected in customer rates and charges for realized earnings from the trusts were included in depreciation expense. Realized after-tax trust earnings totaled $41.0 million in 2005 as the trust assets were liquidated due to the sale of Kewaunee. Realized after-tax trust earnings totaled $5.5 million in 2004.
NOTE 9--REGULATORY ASSETS AND LIABILITIES
The following regulatory assets and liabilities are reflected in our Consolidated Balance Sheets as of December 31:
Integrys Energy Group's Regulatory Assets/Liabilities (Millions) | | 2006 | | 2005 | |
| | | | | | |
Regulatory assets | | | | | |
| Pension and post-retirement benefit related items | | $ | 158.7 | | $ | 32.6 | |
| Environmental remediation costs (net of insurance recoveries) | | | 102.7 | | | 73.6 | |
| Deferred nuclear costs | | | 45.3 | | | 63.8 | |
| De Pere Energy Center | | | 40.5 | | | 42.9 | |
| Deferred MISO costs | | | 20.8 | | | 21.2 | |
| Derivatives | | | 14.1 | | | 1.8 | |
| Reserve for uncollectible accounts | | | 7.0 | | | 8.5 | |
| Reduced coal deliveries | | | 6.6 | | | 6.4 | |
| Income tax related items | | | 4.6 | | | 6.8 | |
| Asset retirement obligations | | | 4.2 | | | 3.8 | |
| Other | | | 13.3 | | | 10.6 | |
Total | | $ | 417.8 | | $ | 272.0 | |
| | | | | | | | |
Regulatory liabilities | | | | | | | |
| Cost of removal reserve | | $ | 206.4 | | $ | 190.7 | |
Non-qualified decommissioning trust | | | 55.9 | | | 126.9 | |
| Derivatives | | | 16.1 | | | 36.4 | |
| Income tax related items | | | 9.7 | | | 8.8 | |
| Deferred ATC and MISO costs | | | 4.2 | | | 3.8 | |
| Pension and post-retirement benefit related items | | | 3.6 | | | - | |
| Other | | | 5.8 | | | 6.6 | |
Total | | $ | 301.7 | | $ | 373.2 | |
Our utility subsidiaries expect to recover their regulatory assets and return their regulatory liabilities through rates charged to customers based on specific ratemaking decisions or precedent for each item over periods specified by the regulators or over the normal operating period of the assets and liabilities to which they relate. Except for amounts expended for manufactured gas plant remediation, WPSC is recovering carrying costs for all regulatory assets. Historically, WPSC has recognized carrying costs at its weighted average cost of capital; however, pursuant to PSCW order, carrying costs related to some
regulatory assets such as the 2005 Kewaunee outage and MISO costs are being recovered based on the composite short-term debt rate. UPPCO is recovering carrying costs on environmental regulatory assets. Both MGUC and MERC are authorized to recover all regulatory assets. Based on prior and current rate treatment for such costs, we believe it is probable that WPSC, UPPCO, MGUC, and MERC will continue to recover from customers the regulatory assets described above.
Pension and post-retirement benefit related items at December 31, 2006 include all initial adjustments made to implement SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R)" at its implementation date of December 31, 2006 and pension and post-retirement obligations assumed from the purchase of MGUC and MERC. Pension and post-retirement benefit related items at December 31, 2005 include minimum pension liability adjustments.
See Note 3, "Risk Management Activities"; Note 6, "Acquisitions and Sales of Assets"; Note 15, "Asset Retirement Obligations"; Note 17, "Commitments and Contingencies"; Note 19, "Employee Benefit Plans," and Note 23, "Regulatory Environment," for more information on some of the more significant regulatory assets and liabilities listed in the above table.
NOTE 10--INVESTMENTS IN AFFILIATES, AT EQUITY METHOD
Investments in corporate joint ventures and other companies accounted for under the equity method at December 31, 2006, and 2005 follow.
(Millions) | | 2006 | | 2005 | |
| ATC | | $ | 231.9 | | $ | 186.1 | |
| Guardian Pipeline | | | - | | | 30.8 | |
| Wisconsin River Power Company | | | 8.9 | | | 10.1 | |
| Other | | | 3.2 | | | 3.0 | |
| Investments in affiliates, at equity method | | $ | 244.0 | | $ | 230.0 | |
Investments in affiliates under the equity method are a component of other assets on the Consolidated Balance Sheets, and the equity income is recorded in miscellaneous income on the Consolidated Statements of Income. We are taxed on ATC's equity income, rather than ATC, due to the tax flow through nature of ATC's business structure. Accordingly, the provision for income taxes includes our taxes on this equity income.
ATC
WPS Investments, LLC, a consolidated subsidiary of Integrys Energy Group, had a 30.65% ownership interest in ATC at December 31, 2006. ATC is a for-profit, transmission-only company. It owns, maintains, monitors, and operates electric transmission assets in portions of Wisconsin, Michigan, and Illinois. Its assets previously were owned and operated by multiple electric utilities serving the upper Midwest, all of which transferred their transmission assets to ATC in exchange for an ownership interest. A Wisconsin law encouraged utilities in the state to transfer ownership and control of their transmission assets to a state-wide transmission company. The MISO directs ATC's operation of the transmission system.
During 2003, WPSC transferred its interest in the Wausau, Wisconsin, to Duluth, Minnesota, transmission line to ATC. In addition, Integrys Energy Group committed to fund 50% of total project costs incurred up to $198 million and will receive additional equity in ATC in exchange for the project funding. See Note 17, "Commitments and Contingencies," for more information on these transactions.
WPSC and UPPCO record related-party transactions for services and construction provided to and network transmission services received from ATC. The charges to ATC for services and construction provided by WPSC were $124.1 million, $70.2 million, and $19.5 million in 2006, 2005, and 2004, respectively. UPPCO charged $2.4 million, $2.7 million, and $6.7 million in 2006, 2005, and 2004, respectively for services and construction provided. Network transmission service costs paid to ATC by WPSC were $59.4 million, $50.8 million, and $42.6 million in 2006, 2005, and 2004, respectively. UPPCO recorded network transmission service costs of $3.9 million, $3.4 million, and $4.0 million in 2006, 2005, and 2004, respectively.
Integrys Energy Group recorded dividends received of $29.7 million, $17.8 million, and $11.7 million from ATC in 2006, 2005, and 2004 respectively.
Guardian Pipeline
Guardian Pipeline owns a natural gas pipeline, which began operating in 2002, that stretches about 140 miles from near Joliet, Illinois, into southern Wisconsin. It can transport up to 750 million cubic feet of natural gas daily. WPS Investments, LLC, a consolidated subsidiary of Integrys Energy Group, purchased a 33% ownership interest in Guardian Pipeline, LLC on May 30, 2003. In April 2006, WPS Investments completed the sale of its one-third interest in Guardian Pipeline to Northern Border Partners, LP. See Note 6 "Acquisitions and Sales of Assets," for more information related to the sale.
Integrys Energy Services recorded related party transactions for purchases from Guardian Pipeline. These purchases amounted to $0.9 million, $0.6 million, and $0.4 million in 2006 through the date of sale, 2005 and 2004, respectively.
Wisconsin River Power Company
WPSC owns 50% of the voting stock of Wisconsin River Power Company (WRPC), which operates two hydroelectric plants on the Wisconsin River and an oil-fired combustion turbine. Two-thirds of the energy output of the hydroelectric plants is sold to WPSC, and the remaining one-third is sold to Wisconsin Power and Light. The electric power from the combustion turbine is sold in equal parts to WPSC and Wisconsin Power and Light.
WPSC records related party transactions for sales to and purchases from WRPC. Revenues from services provided to WRPC were $1.5 million, $0.7 million, and $1.1 million for 2006, 2005, and 2004, respectively. Purchases of energy from WRPC by WPSC were $4.1 million, $4.3 million, and $4.6 million for 2006, 2005, and 2004, respectively. WPSC receives net proceeds from sales of energy into the MISO market from WRPC. These net proceeds were $4.2 million and $3.1 million for 2006 and 2005, respectively.
WPSC recorded dividends received of $4.2 million, $7.8 million, and $6.0 million from Wisconsin River Power in 2006, 2005, and 2004 respectively.
Of Integrys Energy Group's equity in net income disclosed below, $3.2 million, $4.9 million, and $6.2 million relates to WPSC's investment in Wisconsin River Power in 2006, 2005, and 2004 respectively.
Other Investments
Other investments accounted for under the equity method include various investments and are not significant at December 31, 2006.
Financial Data
Combined financial data of ATC and WRPC are included in the table below for 2006. Combined financial data of ATC, WRPC, and Guardian Pipeline are included in the table below for 2005 and 2004. The financial data of Guardian Pipeline is not included in the 2006 information, as Integrys Energy Group sold this investment in April 2006 and the financial information from January 1, 2006 through the date of sale was not significant.
(Millions) | | 2006 | | 2005 | | 2004 | |
Income statement data | | | | | | | |
| Revenues | | $ | 347.5 | | $ | 339.8 | | $ | 305.2 | |
| Operating expenses | | | (184.3 | ) | | (189.4 | ) | | (180.6 | ) |
| Other expense | | | (34.9 | ) | | (37.8 | ) | | (29.8 | ) |
| Net income | | $ | 128.3 | | $ | 112.6 | | $ | 94.8 | |
| | | | | | | | | | | |
| Integrys Energy Group's equity in net income | | $ | 40.6 | | $ | 31.8 | | $ | 23.9 | |
| | | | | | | | | | | |
Balance sheet data | | | | | | | | | | |
| Current assets | | $ | 36.2 | | $ | 40.3 | | $ | 44.2 | |
| Non-current assets | | | 1,872.4 | | | 1,791.8 | | | 1,444.5 | |
| Total assets | | $ | 1,908.6 | | $ | 1,832.1 | | $ | 1,488.7 | |
| | | | | | | | | | | |
| Current liabilities | | $ | 306.4 | | $ | 158.5 | | $ | 209.1 | |
| Long-term debt | | | 648.9 | | | 796.9 | | | 610.8 | |
| Other non-current liabilities | | | 128.2 | | | 102.4 | | | 9.2 | |
| Shareholders' equity | | | 825.1 | | | 774.3 | | | 659.6 | |
| Total liabilities and shareholders' equity | | $ | 1,908.6 | | $ | 1,832.1 | | $ | 1,488.7 | |
NOTE 11--GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill recorded by Integrys Energy Group was $303.9 million at December 31, 2006, and $36.8 million at December 31, 2005. At December 31, 2006, $144.6 million of goodwill was related to the acquisition of the natural gas distribution operations in Minnesota, $122.9 million of goodwill was related to the acquisition of the natural gas distribution operations in Michigan, and $36.4 million related to WPSC's 2001 acquisition of Wisconsin Fuel and Light. In conjunction with the acquisition of the natural gas distribution operations in Michigan, a $5.2 million indefinite lived intangible asset was recorded related to the MGUC trade name. At December 31, 2005, goodwill consisted of $36.4 million related to WPSC's natural gas utility business, with the remaining $0.4 million related to Integrys Energy Services.
Identifiable intangible assets other than goodwill are included as a component of other assets within the Consolidated Balance Sheets. Information in the tables below relates to purchased identifiable intangible assets for the periods indicated.
(Millions) | | December 31, 2006 | | December 31, 2005 | |
Asset Class | | Gross Carrying Amount | | Accumulated Amortization | | Net | | Gross Carrying Amount | | Accumulated Amortization | | Net | |
Emission allowances(1) | | $ | 5.0 | | $ | (0.8 | ) | $ | 4.2 | | $ | 39.3 | | $ | (22.2 | ) | $ | 17.1 | |
Customer related | | | 12.2 | | | (4.3 | ) | | 7.9 | | | 10.2 | | | (5.6 | ) | | 4.6 | |
Other | | | 3.9 | | | (0.8 | ) | | 3.1 | | | 4.2 | | | (0.9 | ) | | 3.3 | |
Total | | $ | 21.1 | | $ | (5.9 | ) | $ | 15.2 | | $ | 53.7 | | $ | (28.7 | ) | $ | 25.0 | |
(1) Emission allowances have a weighted-average amortization period of approximately 5 years which could vary based upon plant production and trading activity.
Customer related intangible assets at December 31, 2006, are primarily related to customer relationships associated with MERC's non-utility home services business. The remaining weighted average amortization period for customer related intangible assets is approximately five years.
Intangible asset amortization expense, in the aggregate, for the years ended December 31, 2006, 2005, and 2004, was $2.1 million, $2.2 million, and $1.5 million, respectively and relates primarily to emission allowances at Integrys Energy Services. Most of the emission allowances on hand at December 31, 2005, had been purchased to operate the Sunbury plant prior to the sale of this facility, which occurred in July 2006. These emission allowances were not included as held for sale at December 31, 2005, because they did not transfer to Corona Power, LLC in the sale. Integrys Energy Services utilized the majority of the emission allowances it had on hand at December 31, 2005, to operate its Sunbury plant prior to the sale. The amortization of these emission allowances is included in discontinued operations, as a component of nonregulated cost of fuel, natural gas, and purchased power. See Note 4, "Discontinued Operations" for more information.
Amortization expense for the next five fiscal years is estimated as follows:
Estimated Amortization Expense: | |
| | |
| For year ending December 31, 2007 | $2.1 million |
| For year ending December 31, 2008 | 1.9 million |
| For year ending December 31, 2009 | 1.7 million |
| For year ending December 31, 2010 | 1.4 million |
| For year ending December 31, 2011 | 1.2 million |
NOTE 12--LEASES
Integrys Energy Group leases various property, plant, and equipment. Terms of the operating leases vary, but generally require Integrys Energy Group to pay property taxes, insurance premiums, and maintenance costs associated with the leased property. Many of Integrys Energy Group's leases contain one of the following options: (a) Integrys Energy Group can, at the end of the lease term, purchase the property at the current fair market value or (b) exercise a renewal option, as set forth in the lease agreement. Rental expense attributable to operating leases was $7.0 million, $6.6 million, and $5.7 million in 2006, 2005, and 2004 respectively. Future minimum rental obligations under non-cancelable operating leases, are payable as follows:
Year ending December 31 (Millions) | | | |
| | | | |
| 2007 | | $ | 5.6 | |
| 2008 | | | 4.9 | |
| 2009 | | | 4.1 | |
| 2010 | | | 3.8 | |
| 2011 | | | 3.5 | |
| Later years | | | 6.8 | |
| Total payments | | $ | 28.7 | |
NOTE 13--SHORT-TERM DEBT AND LINES OF CREDIT
In June 2006, Integrys Energy Group entered into an unsecured $500 million 5-year credit agreement. This revolving credit facility replaced the $300 million bridge credit facility discussed below and is in addition to the previously existing credit line facility which also has a borrowing capacity of $500 million, bringing Integrys Energy Group's total borrowing capacity under its general credit agreements to $1 billion. Both credit lines back Integrys Energy Group's commercial paper borrowing programs and letters of credit. The first $500 million credit line was entered into in June 2005, and is an unsecured 5-year credit agreement. In June 2005, WPSC also entered into a 5-year credit facility for $115 million to replace its
former 364-day credit line facility for the same amount. This credit line is used to back 100% of WPSC's commercial paper borrowing programs and letters of credit for WPSC. As of December 31, 2006, there was a total of $520.1 million available under Integrys Energy Group's general credit lines, including $73.2 million available under WPSC's general credit line.
In November 2005, Integrys Energy Group entered into two unsecured revolving credit agreements of $557.5 million and $300 million with JP Morgan Chase Bank, N.A. and Bank of America, N.A. As discussed above, the $500 million 5-year credit agreement entered into in June 2006 replaced the $300 million bridge credit facility. The $557.5 million credit facility is a bridge facility intended to back commercial paper borrowings related to the purchase of the natural gas distribution operations in Michigan and Minnesota. The capacity under the $557.5 million bridge facility is reduced by the amount of proceeds from any long-term financing Integrys Energy Group completes, with the exception of proceeds received from the November 2005 equity offering. On March 31, 2006, Integrys Energy Group issued $269.5 million of commercial paper supported by the $557.5 million bridge facility to purchase the natural gas distribution operations in Michigan. On May 10, 2006, as a result of Integrys Energy Group's physical settlement of its forward equity agreement (and issuing 2.7 million shares of common stock upon settlement), the $557.5 million facility was reduced to $417.9 million. The $417.9 million credit agreement matures on September 5, 2007, and has representations and covenants that are similar to those in Integrys Energy Group's general credit facilities. On June 30, 2006, Integrys Energy Group issued $288.0 million of commercial paper supported by the remainder of the $417.9 million credit facility and the general credit facilities, to purchase the natural gas distribution operations in Minnesota. Working capital and other post closing adjustments related to the acquisitions were funded by commercial paper supported by the general credit facilities. On December 1, 2006, Integrys Energy Group issued $300 million of junior subordinated notes, reducing the $417.9 million credit facility to $121 million. See Note 6, "Acquisitions and Sales of Assets," for more information related to the acquisitions of the natural gas distribution operations in Michigan and Minnesota.
The increase in short-term notes payable outstanding relates primarily to a $150 million credit agreement that Integrys Energy Services entered into in April 2006 to finance its margin requirements related to natural gas and electric contracts traded on the NYMEX and the ICE, as well as the cost of natural gas in storage and for general corporate purposes. As of December 31, 2006, Integrys Energy Services utilized all $150 million of its borrowing capabilities under this agreement.
The information in the table below relates to Integrys Energy Group's short-term debt and lines of credit for the years indicated.
(Millions, except for percentages) | | 2006 | | 2005 | | 2004 | |
| | | | | | | | |
As of end of year | | | | | | | |
| Commercial paper outstanding | | $ | 562.8 | | $ | 254.8 | | $ | 279.7 | |
| Average effective rate on outstanding commercial paper | | | 5.51 | % | | 4.54 | % | | 2.46 | % |
| Short-term notes payable outstanding | | $ | 160.0 | | $ | 10.0 | | $ | 12.7 | |
| Average interest rate on short-term notes payable | | | 5.64 | % | | 4.32 | % | | 2.52 | % |
| Available (unused) lines of credit | | $ | 520.1 | | $ | 249.1 | | $ | 161.9 | |
| | | | | | | | | | | |
For the year | | | | | | | | | | |
| Maximum amount of short-term debt | | $ | 1,085.6 | | $ | 310.7 | | $ | 312.5 | |
| Average amount of short-term debt | | $ | 678.8 | | $ | 174.4 | | $ | 75.3 | |
| Average interest rate on short-term debt | | | 5.34 | % | | 3.21 | % | | 1.82 | % |
The commercial paper had varying maturity dates ranging from January 2, 2007, through February 1, 2007.
NOTE 14--LONG-TERM DEBT
At December 31 (Millions) | | 2006 | | 2005 | |
First mortgage bonds - WPSC | | | | | |
| | | Series | | Year Due | | | | | |
| | | | 6.90 | % | | 2013 | | $ | 22.0 | | $ | 22.0 | |
| | | | 7.125 | % | | 2023 | | | 0.1 | | | 0.1 | |
| | | | | | | | | | | | | | |
Senior notes - WPSC | | | | | | |
| | | | Series | | | Year Due | | | | | | | |
| | | | 6.125 | % | | 2011 | | | 150.0 | | | 150.0 | |
| | | | 4.875 | % | | 2012 | | | 150.0 | | | 150.0 | |
| | | | 4.80 | % | | 2013 | | | 125.0 | | | 125.0 | |
| | | | 3.95 | % | | 2013 | | | 22.0 | | | - | |
| | | | 6.08 | % | | 2028 | | | 50.0 | | | 50.0 | |
| | | | 5.55 | % | | 2036 | | | 125.0 | | | - | |
| | | | | | | | | | | | | | |
| First mortgage bonds - UPPCO | | | | | | |
| | | | Series | | | Year Due | | | | | | | |
| | | | 9.32 | % | | 2021 | | | 13.5 | | | 14.4 | |
| | | | | | | | | | | | | | |
Unsecured senior notes - Integrys Energy Group | | | | | | |
| | | Series | | | Year Due | | | | | | | |
| | | | 7.00 | % | | 2009 | | | 150.0 | | | 150.0 | |
| | | | 5.375 | % | | 2012 | | | 100.0 | | | 100.0 | |
| | | | | | | | | | | | | | |
| Junior subordinated notes - Integrys Energy Group | | | | | | |
| | | | Series | | | Year Due | | | | | | | |
| | | | 6.11 | % | | 2066 | | | 300.0 | | | - | |
| | | | | | | | | | | | | | |
| Unsecured term loan due 2010 - Integrys Energy Group | | 65.6 | | | 65.6 | |
Term loans - nonrecourse, collateralized by nonregulated assets | | 13.7 | | | 16.4 | |
| Other term loan | | 27.0 | | | 27.0 | |
| Senior secured note | | 2.0 | | | 2.4 | |
| Total | | 1,315.9 | | | 872.9 | |
| Unamortized discount and premium on bonds and debt | | (2.2 | ) | | (1.8 | ) |
| Total debt | | 1,313.7 | | | 871.1 | |
| Less current portion | | (26.5 | ) | | (4.0 | ) |
| Total long-term debt | $ | 1,287.2 | | $ | 867.1 | |
WPSC's long-term first mortgage bonds and senior notes are subject to the terms and conditions of WPSC's First Mortgage Indenture. Under the terms of the indenture, substantially all property owned by WPSC is pledged as collateral for these outstanding debt securities. All of these debt securities require semi-annual payments of interest. Principal payments are due on the maturity date of each series. WPSC senior notes become non-collateralized if WPSC retires all of its outstanding first mortgage bonds and no new mortgage is put in their place.
On December 14, 2006, the Village of Weston, Wisconsin, issued $22.0 million of 3.95% Pollution Control Refunding Revenue Bonds. The proceeds from the sale of the bonds were loaned to WPSC. In return, WPSC issued $22.0 million of 3.95% senior notes to the Village of Weston. At December 31, 2006, the $22.0 million of proceeds were classified as restricted cash. In January 2007, WPSC used these proceeds to repay the outstanding principal balance of the 6.90% first mortgage bonds in the above table.
WPSC issued $125.0 million of 5.55% 30-year senior notes on December 1, 2006. The net proceeds from the issuance of the senior notes were used for general corporate purposes, including funding construction costs and capital additions and reducing short-term indebtedness.
Under the terms of UPPCO's First Mortgage Indenture, substantially all property owned by UPPCO is pledged as collateral for this outstanding debt series. Interest payments are due semi-annually on May 1 and November 1 with a sinking fund payment of $900,000 due each November 1. The final sinking fund payment due November 1, 2021, will completely retire the series.
On December 1, 2006, Integrys Energy Group issued $300 million of junior subordinated notes. Due to certain features of these notes, rating agencies consider them to be hybrid instruments with a combination of debt and equity characteristics. These notes have a 60-year term and rank junior to all current and future indebtedness of Integrys Energy Group, with the exception of trade accounts payable and other accrued liabilities arising in the ordinary course of business. Interest is payable semi-annually at the stated rate of 6.11% for the first ten years, but the rate has been fixed at 6.22% through the use of forward-starting interest rate swaps described more fully in Note 3, "Risk Management Activities." The interest rate will float for the remainder of the term. The notes can be prepaid without penalty after the first ten years. Integrys Energy Group has agreed, however, in a replacement capital covenant with the holders of Integrys Energy Group's 5.375% unsecured senior notes due December 1, 2012, that it will not redeem or repurchase the junior subordinated notes on or prior to December 1, 2036 unless such repurchases or redemptions are made from the proceeds of the sale of specific securities considered by rating agencies to have equity characteristics equal to or greater than those of the junior subordinated notes.
On June 17, 2005, $62.9 million of non-recourse debt at Integrys Energy Services collateralized by nonregulated assets was restructured to a five-year Integrys Energy Group obligation as a result of the sale of Sunbury's allocated emission allowances. In addition, $2.7 million drawn on a line of credit at Integrys Energy Services was rolled into the five-year Integrys Energy Group obligation. The floating interest rate on the total five-year Integrys Energy Group obligation of $65.6 million has been fixed at 4.595% through two interest rate swaps. See Note 3, "Risk Management Activities," for additional information.
Borrowings by Integrys Energy Services under term loans and collateralized by nonregulated assets totaled $13.7 million at December 31, 2006. The assets of WPS New England Generation, Inc. and WPS Canada Generation, Inc., subsidiaries of Integrys Energy Services, collateralize $4.0 million and $9.7 million, respectively, of the total outstanding amount. Both loans have semi-annual installment payments, interest rates of 8.75%, and maturity dates in May 2010.
In April 2001, the Schuylkill County Industrial Development Authority issued $27.0 million of refunding tax-exempt bonds. The proceeds from the bonds were loaned to WPS Westwood Generation, LLC, a subsidiary of Integrys Energy Services. This loan is repaid by WPS Westwood Generation to Schuylkill County Industrial Development Authority with monthly payments that have a floating interest rate that is reset weekly. At December 31, 2006, the interest rate was 3.92%. The loan is to be repaid by April 2021. Integrys Energy Group agreed to guarantee WPS Westwood Generation's obligation to provide sufficient funds to pay the loan and the related obligations and indemnities.
Upper Peninsula Building Development Corporation has a senior secured note of $2.0 million as of December 31, 2006, which requires semi-annual payments at an interest rate of 9.25%, and matures in 2011. The note is secured by a first mortgage lien on the building they own, which is also leased to UPPCO for use as their corporate headquarters.
At December 31, 2006, Integrys Energy Group and its subsidiaries were in compliance with all covenants relating to outstanding debt. A schedule of all principal debt payment amounts, including bond maturities and early retirements, for Integrys Energy Group is as follows:
Year ending December 31 (Millions) | | | |
| 2007 | | $ | 26.5 | |
| 2008 | | | 5.1 | |
| 2009 | | | 155.6 | |
| 2010 | | | 69.2 | |
| 2011 | | | 151.4 | |
| Later years | | | 908.1 | |
| Total payments | | $ | 1,315.9 | |
NOTE 15--ASSET RETIREMENT OBLIGATIONS
Under the provisions of SFAS No. 143, "Accounting for Asset Retirement Obligations," and Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations," Integrys Energy Group has recorded liabilities for legal obligations associated with the retirement of tangible long-lived assets. The utility segments identified asset retirement obligations primarily related to asbestos abatement at certain generation facilities, office buildings, and service centers; disposal of PCB-contaminated transformers; and closure of fly-ash landfills at certain generation facilities. Additional asset retirement obligations related to asbestos abatement were recorded in connection with the acquisition of the natural gas distribution operations in Michigan and Minnesota. In accordance with SFAS No. 71, the utilities establish regulatory assets and liabilities to record the differences between ongoing expense recognition under SFAS No. 143 and Interpretation No. 47, and the rate-making practices for retirement costs authorized by the applicable regulators. Asset retirement obligations identified at Integrys Energy Services relate to asbestos abatement at certain generation facilities. All asset retirement obligations are recorded as other long-term liabilities in the Consolidated Balance Sheets of Integrys Energy Group.
As discussed in Note 6, "Acquisitions and Sales of Assets," the sale of Kewaunee to Dominion was completed on July 5, 2005. As a result of the sale, Dominion assumed the asset retirement obligation related to Kewaunee. As discussed in Note 4, "Discontinued Operations," Integrys Energy Services completed the sale of Sunbury to Corona Power, LLC in July 2006, which included the transfer of asset retirement obligations related to Sunbury.
Changes to Asset Retirement Obligation Liabilities
The following table shows changes to the asset retirement obligations of Integrys Energy Group through December 31, 2006.
(Millions) | | Utilities | | Integrys Energy Services | | Total | |
| Asset retirement obligations at December 31, 2003 | | $ | 344.0 | | $ | 2.1 | | $ | 346.1 | |
| Accretion | | | 20.4 | | | 0.1 | | | 20.5 | |
| Asset retirement obligations at December 31, 2004 | | | 364.4 | | | 2.2 | | | 366.6 | |
| Accretion | | | 12.4 | | | 0.2 | | | 12.6 | |
| Asset retirement obligation transferred to Dominion | | | (376.4 | ) | | - | | | (376.4 | ) |
| Adoption of Interpretation No. 47 | | | 8.2 | | | 3.9 | | | 12.1 | |
| Asset retirement obligations at December 31, 2005 | | | 8.6 | | | 6.3 | | | 14.9 | |
Asset retirement obligations from acquisition of natural gas operations in Michigan and Minnesota | | | 0.3 | | | - | | | 0.3 | |
| Asset retirement obligations transferred in sales | | | - | | | (5.8 | ) | | (5.8 | ) |
| Accretion | | | 0.5 | | | 0.2 | | | 0.7 | |
Asset retirement obligations at December 31, 2006 | | $ | 9.4 | | $ | 0.7 | | $ | 10.1 | |
NOTE 16--INCOME TAXES
The principal components of our deferred tax assets and liabilities recognized in the balance sheets as of December 31 are as follows:
(Millions) | | 2006 | | 2005 | |
| | | | | | |
Deferred tax assets: | | | | | |
| | | | | | |
| Tax credit carryforwards | | $ | 105.3 | | $ | 65.6 | |
| Plant related | | | 61.3 | | | 56.7 | |
| Employee benefits | | | 54.8 | | | 34.7 | |
| Regulatory deferrals | | | 27.7 | | | 31.3 | |
| State capital and operating loss carryforwards | | | 14.0 | | | 13.1 | |
| Deferred income and deductions | | | 2.8 | | | 21.2 | |
| Other | | | 4.1 | | | 2.5 | |
| Total deferred tax assets | | | 270.0 | | | 225.1 | |
| | | | | | | | |
Valuation allowance | | | (1.8 | ) | | (2.5 | ) |
| Net deferred tax assets | | $ | 268.2 | | $ | 222.6 | |
| | | | | | | | |
Deferred tax liabilities: | | | | | | | |
| Plant related | | $ | 277.7 | | $ | 252.6 | |
| Regulatory deferrals | | | 49.5 | | | 17.2 | |
| Risk management activities, net | | | 35.0 | | | 15.6 | |
| Deferred income and deductions | | | 3.7 | | | 3.5 | |
| Employee benefits | | | - | | | 3.2 | |
| Other | | | 3.0 | | | 2.8 | |
| Total deferred tax liabilities | | $ | 368.9 | | $ | 294.9 | |
| | | | | | | | |
Consolidated Balance Sheet Presentation: | | | | | | | |
| Current deferred tax liabilities | | $ | 3.1 | | $ | - | |
| Current deferred tax assets | | | - | | | 7.3 | |
| Long-term deferred tax liabilities | | | 97.6 | | | 79.6 | |
| Net deferred tax liabilities | | $ | 100.7 | | $ | 72.3 | |
Consistent with ratemaking treatment, certain temporary differences, in which the offsetting amount is recorded as a regulatory assets or liability, are presented net in the table above.
Deferred tax credit carryforwards include $99.0 million of alternative minimum tax credits related to tax credits available under Section 29/45K of the Internal Revenue Code. These alternative minimum tax credit carryforwards can be carried forward indefinitely. Carryforward periods for state capital and operating loss carryforwards vary, but in the majority of states in which we do business, the period is 15 years or more, the majority of which begin to expire in 2013. The balance of the carryforwards of state net operating losses is $251.0 million for all states. Valuation allowances have been established for certain state operating and capital loss carryforwards due to the uncertainty of the ability to realize the benefit of these losses in the future.
The following table presents a reconciliation of federal income taxes (which are calculated by multiplying the statutory federal income tax rate by book income before federal income tax) to the provision for income taxes reported in the Consolidated Statements of Income for the periods ended December 31.
(Millions, except for percentages) | | 2006 | | 2005 | | 2004 | |
| | | Rate | | Amount | | Rate | | Amount | | Rate | | Amount | |
| | | | | | | | | | | | | | |
| Statutory federal income tax | | | 35.0 | % | $ | 68.8 | | | 35.0 | % | $ | 66.8 | | | 35.0 | % | $ | 65.5 | |
| State income taxes, net | | | 6.5 | | | 12.8 | | | 4.3 | | | 8.2 | | | 3.7 | | | 7.0 | |
| Foreign income taxes, net | | | - | | | - | | | (0.1 | ) | | (0.2 | ) | | (0.5 | ) | | (0.9 | ) |
| Plant related | | | - | | | - | | | 0.3 | | | 0.6 | | | - | | | 0.1 | |
| Benefits and compensation | | | (2.5 | ) | | (4.8 | ) | | (2.6 | ) | | (4.8 | ) | | (2.0 | ) | | (3.7 | ) |
| Investment tax credit | | | (0.4 | ) | | (0.8 | ) | | (0.9 | ) | | (1.7 | ) | | (0.8 | ) | | (1.5 | ) |
| Federal tax credits | | | (15.8 | ) | | (30.2 | ) | | (14.1 | ) | | (26.9 | ) | | (15.3 | ) | | (28.6 | ) |
| Other differences, net | | | 0.1 | | | (0.8 | ) | | (1.1 | ) | | (2.4 | ) | | (3.8 | ) | | (7.5 | ) |
Effective income tax | | | 22.9 | % | $ | 45.0 | | | 20.8 | % | $ | 39.6 | | | 16.3 | % | $ | 30.4 | |
| | | | | | | | | | | | | | | | | | | | |
Current provision | | | | | | | | | | | | | | | | | | | |
| Federal | | | | | $ | 21.1 | | | | | $ | 13.1 | | | | | $ | 20.3 | |
| State | | | | | | 6.2 | | | | | | 14.3 | | | | | | 11.6 | |
| Foreign | | | | | | 5.3 | | | | | | 3.2 | | | | | | 0.4 | |
Total current provision | | | | | | 32.6 | | | | | | 30.6 | | | | | | 32.3 | |
| Deferred provision | | | | | | 11.4 | | | | | | 13.0 | | | | | | 1.3 | |
| Net operating loss carryforwards | | | | | | 1.8 | | | | | | (2.3 | ) | | | | | (1.7 | ) |
| Investment tax credit | | | | | | (0.8 | ) | | | | | (1.7 | ) | | | | | (1.5 | ) |
Total income tax expense | | | | | $ | 45.0 | | | | | $ | 39.6 | | | | | $ | 30.4 | |
Foreign income before taxes was $24.5 million in 2006, $10.2 million in 2005, and $8.3 million in 2004.
As the related temporary differences reverse, WPSC, UPPCO, MGUC, and MERC are prospectively refunding taxes to customers for which deferred taxes were recorded in prior years at rates different than current rates. The regulatory liability for these refunds and other regulatory tax effects totaled $9.7 million and $8.8 million as of December 31, 2006 and 2005, respectively.
NOTE 17--COMMITMENTS AND CONTINGENCIES
Commodity and Purchase Order Commitments
Integrys Energy Group routinely enters into long-term purchase and sale commitments that have various quantity requirements and durations. The commitments described below are as of December 31, 2006.
Integrys Energy Services has unconditional purchase obligations related to energy supply contracts that total $3.1 billion. Substantially all of these obligations end by 2008, with obligations totaling $175.7 million extending from 2010 through 2018. The majority of the energy supply contracts are to meet Integrys Energy Services' obligations to deliver energy to its customers.
WPSC has obligations related to coal, purchased power, and natural gas. Obligations related to coal supply and transportation extend through 2016 and total $443.2 million. Through 2016, WPSC has obligations totaling $1.3 billion for either capacity or energy related to purchased power. Also, there are natural gas supply and transportation contracts with total estimated demand payments of $102.6 million through 2017. WPSC expects to recover these costs in future customer rates. Additionally, WPSC has contracts to sell electricity and natural gas to customers.
UPPCO has made commitments for the purchase of commodities, mainly capacity or energy related to purchased power, which total $31.5 million and extend through 2010.
MGUC has obligations related to natural gas contracts totaling $85.5 million, substantially all of which end by 2009.
MERC has obligations related to natural gas contracts totaling $154.9 million, substantially all of which end by 2013.
Integrys Energy Group also has commitments in the form of purchase orders issued to various vendors. At December 31, 2006, these purchase orders totaled $434.0 million and $319.6 million for Integrys Energy Group and WPSC, respectively. The majority of these commitments relate to large construction projects, including construction of the 500-megawatt Weston 4 coal-fired generation facility near Wausau, Wisconsin.
Environmental
EPA Section 114 Request
In December 2000, WPSC received from the EPA a request for information under Section 114 of the Clean Air Act. The EPA sought information and documents relating to work performed on the coal-fired boilers located at WPSC's Pulliam and Weston electric generation stations. WPSC filed a response with the EPA in early 2001.
On May 22, 2002, WPSC received a follow-up request from the EPA seeking additional information regarding specific boiler-related work performed on Pulliam Units 3, 5, and 7, as well as information on WPSC's life extension program for Pulliam Units 3-8 and Weston Units 1 and 2. WPSC made an initial response to the EPA's follow-up information request on June 12, 2002, and filed a final response on June 27, 2002.
In 2000 and 2002, Wisconsin Power and Light received a similar series of EPA information requests relating to work performed on certain coal-fired boilers and related equipment at the Columbia generation station (a facility located in Portage, Wisconsin, jointly owned by Wisconsin Power and Light, Madison Gas and Electric Company, and WPSC). Wisconsin Power and Light is the operator of the plant and is responsible for responding to governmental inquiries relating to the operation of the facility. Wisconsin Power and Light filed its most recent response for the Columbia facility on July 12, 2002.
Depending upon the results of the EPA's review of the information provided by WPSC and Wisconsin Power and Light, the EPA may issue "notices of violation" or "findings of violation" asserting that a violation of the Clean Air Act occurred and/or seek additional information from WPSC and/or third parties who have information relating to the boilers or close out the investigation. To date, the EPA has not responded to the filings made by WPSC and Wisconsin Power and Light. In addition, under the federal Clean Air Act, citizen groups may pursue a claim. WPSC has no notice of such a claim based on the information submitted to the EPA.
In response to the EPA's Clean Air Act enforcement initiative, several utilities have elected to settle with the EPA, while others are in litigation. In general, those utilities that have settled have entered into consent decrees which require the companies to pay fines and penalties, undertake supplemental environmental projects, and either upgrade or replace pollution controls at existing generating units or shut down existing units and replace these units with new electric generating facilities. Several of the settlements involve multiple facilities. The fines and penalties (including the capital costs of supplemental environmental projects) associated with these settlements range between $7 million and $30 million. The regulatory interpretations upon which the lawsuits or settlements are based may change based on future court decisions that may be rendered in the pending litigations.
If the federal government decided to bring a claim against WPSC and if it were determined by a court that historic projects at WPSC's Pulliam and Weston plants required either a state or federal Clean Air Act permit, WPSC may, under the applicable statutes, be required to:
| · | shut down any unit found to be operating in non-compliance, |
| · | install additional pollution control equipment, |
| · | pay a fine, and/or |
| · | pay a fine and conduct a supplemental environmental project in order to resolve any such claim. |
Pulliam Air Permit Violation Lawsuit
On October 19, 2005, the Sierra Club Inc. and Clean Wisconsin Inc. filed a complaint against WPSC in the Eastern District of Wisconsin pursuant to the citizen suit provisions of the Clean Air Act. The complaint alleged various violations at the 373-megawatt J.P. Pulliam Plant located in Green Bay, Wisconsin, including opacity exceedances, opacity monitoring violations, and other violations of limitations in the facility's Clean Air Act operating permit. On January 10, 2007, the court entered a Consent Decree based on the stipulated agreement of the parties, settling the litigation. Under the terms of the Consent Decree, WPSC is to pay the plaintiffs attorneys fees, fund $500,000 of environmental projects through the Wisconsin Energy Conservation Corporation, and perform upgrades on the precipitators and other environmental control equipment at Pulliam. For one year after the improvements are completed (January 1 through December 1, 2008), WPSC's performance will be evaluated and, depending upon that performance, WPSC may be required to make additional contributions to energy efficiency projects. WPSC will implement environmental control upgrades on Pulliam Units 5, 6, 7, and 8 and continue to operate those units. In lieu of upgrading the precipitators for Pulliam Units 3 and 4 (both are 30-megawatt units), WPSC has elected to shut down these units by December 31, 2007. Since WPSC expects the 500-megawatt Weston 4 plant to come on line in 2008, we anticipate no electric supply shortfalls as there will be power available to replace these small units.
Weston 4 Air Permit
On November 15, 2004, the Sierra Club filed a petition with the WDNR under Section 285.61, Wis. Stats., seeking a contested case hearing on the WDNR construction permit issued for the Weston 4 generation station (the “Weston 4 air permit”). In February 2006, the Administrative Law Judge affirmed the Weston 4 air permit with changes to the emission limits for sulfur dioxide and nitrogen oxide from the coal-fired boiler and particulate from the cooling tower. The changes have now been incorporated into a proposed permit by the WDNR issued on January 18, 2007. The proposed permit imposes limits that are more stringent than those originally set by the WDNR. The public comment period on the draft language has closed, and WPSC anticipates that the WDNR will issue the final language shortly.
In 2006, the Sierra Club and WPSC filed petitions for judicial review of the Administrative Law Judge's decision with the circuit court. On August 7, 2006, WPSC withdrew its petition for judicial review and sought dismissal, without prejudice, of Sierra Club's petition as premature. On October 12, 2006, the court granted the motion to dismiss and the Sierra Club filed a petition for appeal of the circuit court's dismissal with the Wisconsin Court of Appeals. The petition has now been fully briefed by the parties. These activities did not stay the construction of the Weston 4 facility or the Administrative Law Judge's decision on the Weston 4 air permit. WPSC believes that it has substantial defenses to Sierra Club's appeal of the circuit court's decision and does not expect these actions to stop construction. Until the WDNR issues the final revised air permit consistent with the Administrative Law Judge's decision, and Sierra Club's administrative challenge is finally resolved, Integrys Energy Group will not be able to make a final determination of the probable cost impact, if any, of compliance with the revised Weston 4 air permit on its future operating or construction costs.
Weston Facility Modeling
In early November 2006, it came to the attention of WPSC that the ambient air quality computer modeling done by the WDNR and used as the basis for the Weston 4 air permit did not take into account the emissions from the existing Weston 3 facility for purposes of evaluating air quality increment consumption under the required Prevention of Significant Deterioration (PSD) analysis. WPSC also performed its own computer modeling in support of the Weston 4 air permit application, on a basis consistent with the WDNR modeling. For the PSD analysis, a baseline of emissions was established in each area of the country which meets National Ambient Air Quality Standards, with a corresponding allowable increment of additional emissions for each regulated pollutant which, if permitted, would still ensure that the air quality in the area will not be degraded below the National Standard. Each new air permit issued by the WDNR then uses up part of the available increment for specific pollutants, and once, and so long as the total increment for any pollutant is exhausted, the WDNR cannot issue air permits for any additional sources of that pollutant.
WPSC believes that based on the facts known to the company today, it can demonstrate compliance by making minor revisions to the air permits applicable to the Weston facility, and it will not be required to make significant changes to any of the units at the Weston facility or material changes in operations. WPSC also believes that based upon the facts known to the company today, there are procedures available for the WDNR to revise the permits applicable to the Weston facility. The WDNR also has the authority to suspend, revoke or withdraw a permit to assure compliance with applicable requirements. However, WPSC believes that the WDNR will not suspend, revoke or withdraw the Weston 4 air permit or any other permit for the Weston site in this situation, where the issue can be addressed by permit limit modifications. WPSC understands from discussions with the WDNR that the agency has never revoked a construction permit under similar circumstances. WPSC is still investigating the situation and is continuing to work with the WDNR to revise the appropriate permits. Although Integrys Energy Group currently is not able to make a final determination of the probable timing or cost impact of this issue, if any, on construction of Weston 4, it does not believe there will be any affects which will materially impact the construction or future operations of Weston 4.
Weston 4 Discovery Complaint
On December 16, 2005, the Sierra Club filed a complaint with the PSCW alleging that WPSC failed to respond accurately and completely to a PSCW staff request for information about air pollution control technology available for the Weston 4 electric generation facility, the construction of which was authorized by the PSCW in October 2004. Following an informal investigation, the PSCW determined that, although the alleged failure to provide the information did not adversely affect the outcome of the case, WPSC may not have fully complied with the PSCW's procedural rules. Based on this determination, the PSCW referred the matter to the Wisconsin Attorney General for investigation and potential enforcement action. WPSC does not believe that it violated the PSCW's procedural rules. Moreover, both the PSCW and the WDNR determined that any error by WPSC would not have impacted the outcome of the cases involved. On August 29, 2006, the Attorney General issued an order reflecting a settlement with WPSC on this issue. The order required certain penalties, fees, and contributions to local entities for charitable purposes, none of which were material to WPSC.
Weston Site Operating Permit
On April 18 and April 26, 2005, Integrys Energy Group notified the WDNR that the existing Weston facility was not in compliance with certain provisions of the "Title V" air operating permit that was issued to the facility in October 2004. These provisions include: (1) the particulate emission limits applicable to the coal handling equipment; (2) the carbon monoxide limit for Weston combustion turbines; and (3) the limitation on the sulfur content of the fuel oil stored at the Weston facility. On July 27, 2005, WPSC received a notice of violation (NOV) from the WDNR asserting that the existing Weston facility is not in compliance with certain provisions of the permit. In response to the NOV, a compliance plan was submitted to the WDNR. Subsequently, stack testing was performed, which indicated continuing exceedances of the particulate limits from the coal handling equipment. On January 19, 2006, WPSC received from the
WDNR a Notice of Noncompliance (NON) seeking further information about the alleged non-compliance event. WPSC provided a response to the WDNR and is in the process of seeking to have the permit revised. On February 20, 2006, the WDNR issued an NOV which incorporated most of the alleged noncompliance events described above (the alleged exceedances of the carbon monoxide limit was not included) and added issues relating to opacity monitoring and the operation of a particulate source for three days without a functioning baghouse. Under the WDNR's stepped enforcement process, an NOV is the first step in the WDNR's enforcement procedure. If the WDNR decides to continue the enforcement process, the next step is a "referral" of the matter to the Wisconsin Attorney General's Office. In addition, citizen groups may seek to initiate enforcement prior to the filing of any lawsuit by the Wisconsin Attorney General's Office or may seek to intervene in the Title V operating permit revision process. WPSC is seeking to amend the applicable permit limits and is taking corrective action. At this time, WPSC believes that its exposure to fines or penalties related to this noncompliance would not have a material impact on its financial results.
Mercury and Interstate Air Quality Rules
On October 1, 2004, the mercury emission control rule became effective in Wisconsin. The rule requires WPSC to control annual system mercury emissions in phases. The first phase will occur in 2008 and 2009. In this phase, the annual mercury emissions are capped at the average annual system mercury emissions for the period 2002 through 2004. The next phase will run from 2010 through 2014 and requires a 40% reduction from average annual 2002 through 2004 mercury input amounts. After 2015, a 75% reduction is required with a goal of an 80% reduction by 2018. The State of Wisconsin is in the process of adopting a rule consistent with the federal requirements. However, the State of Wisconsin has filed suit against the federal government along with other states in opposition to the rule. WPSC estimates capital costs of approximately $15 million to achieve the proposed 75% reductions. The capital costs are expected to be recovered in a future rate case.
In March 2005, the EPA finalized the mercury "maximum achievable control technology" standards and an alternative mercury "cap and trade" program, Clean Air Mercury Rule, modeled on the Clear Skies legislation initiative. The EPA also finalized the Clean Air Interstate Rule (formerly known as the Interstate Air Quality Rule), which will reduce sulfur dioxide and nitrogen oxide emissions from utility boilers located in 29 states, including Wisconsin, Michigan, Pennsylvania, and New York.
The final mercury rule establishes New Source Performance Standards for new units based upon the type of coal burned. Weston 4 will install and operate mercury control technology with the aim of achieving a mercury emission rate less than that in the final EPA mercury rule.
The final mercury rule establishes a mercury cap and trade program, which requires a 21% reduction in national mercury emissions in 2010 and a 70% reduction in national mercury emissions beginning in 2018. Based on the final rule and current projections, WPSC anticipates meeting the mercury rule cap and trade requirements and does not anticipate incurring costs beyond those to comply with the Wisconsin rule.
Integrys Energy Services expects no significant capital costs for compliance with the 70% reduction requirement.
The final Clean Air Interstate Rule requires reduction of sulfur dioxide and nitrogen oxide emissions in two phases. The first phase requires about a 50% reduction beginning in 2009 for nitrogen oxide and beginning in 2010 for sulfur dioxide. The second phase begins in 2015 for both pollutants and requires about a 65% reduction in emissions. The rule allows the affected states (including Wisconsin, Michigan, Pennsylvania, and New York) to either require utilities located in the state to participate in the EPA's interstate cap and trade program or meet the state's emission budget for sulfur dioxide and nitrogen oxide through measures to be determined by the state. Wisconsin’s rule, which is anticipated to be final in June 2007, incorporates the cap and trade approach.
Currently, WPSC is evaluating a number of options that include using the cap and trade program and/or installing controls. For planning purposes, it is assumed that additional sulfur dioxide and nitrogen oxide
controls will be needed on existing units or the existing units will need to be converted to natural gas by 2015. The installation of any controls and/or any conversion to natural gas will need to be scheduled as part of WPSC's long-term maintenance plan for its existing units. As such, controls or conversions may need to take place before 2015. On a preliminary basis and assuming controls or conversion are required, WPSC estimates capital costs of $229 million in order to meet an assumed 2015 compliance date. This estimate is based on costs of current control technology and current information regarding the final EPA rule. The costs may change based on the requirements of the final state rules.
Integrys Energy Services is evaluating the compliance options for the Clean Air Interstate Rule. Additional nitrogen oxide controls on some of Integrys Energy Services' facilities may be necessary, and would cost approximately $0.3 million. Integrys Energy Services will evaluate a number of options including using the cap and trade program, fuel switching, and/or installing controls.
Clean Air Regulations
Most of the generation facilities owned by Integrys Energy Services are located in an ozone transport region. As a result, these generation facilities are subject to additional restrictions on emissions of nitrogen oxide and sulfur dioxide. In future years, Integrys Energy Services expects to purchase sulfur dioxide and nitrogen oxide emission allowances at market rates, as needed, to meet its requirements for its generation facilities.
Spent Nuclear Fuel Disposal
The federal government is responsible for the disposal or permanent storage of spent nuclear fuel. The DOE is currently preparing an application to license a permanent spent nuclear fuel storage facility in the Yucca Mountain area of Nevada. Spent nuclear fuel is currently being stored at the Kewaunee Nuclear Power Plant formerly owned by WPSC.
The United States government through the DOE was under contract with WPSC for the pick up and long-term storage of Kewaunee's spent nuclear fuel. Because the DOE failed to begin scheduled pickup of the spent nuclear fuel, WPSC incurred costs for the storage of the spent nuclear fuel. WPSC is a participant in a suit filed against the federal government for breach of contract and failure to pick up and store the spent nuclear fuel. The case was filed on January 22, 2004, in the United States Court of Federal Claims. The case has been temporarily stayed until June 29, 2007.
In July 2005, WPSC sold Kewaunee to a subsidiary of Dominion Resources, Inc. Pursuant to the terms of the sale, Dominion has the right to pursue the spent nuclear fuel claim and WPSC will retain the contractual right to an equitable share of any future settlement or verdict. The total amount of damages sought is unknown at this time.
Manufactured Gas Plant Remediation
WPSC continues to investigate the environmental cleanup of ten manufactured gas plant sites. Cleanup of the land portion of the Oshkosh, Stevens Point, Green Bay, Manitowoc, Menominee, and two Sheboygan sites in Wisconsin are substantially complete. Groundwater treatment and/or monitoring at these sites will continue into the future. Cleanup of the land portion of three sites will be addressed in the future. River sediment remains to be addressed at sites with sediment contamination, and priorities will be determined in consultation with the EPA. The additional work at the sites remains to be scheduled.
In May 2006, WPSC transferred six sites with sediment contamination formally under WDNR jurisdiction to the EPA Superfund Alternatives Program. In January 2007, a seventh site in Sheboygan was transferred to the EPA Superfund Alternatives Program. Under the EPA's program, the remedy decision will be based on risk-based criteria typically used at Superfund sites. A schedule has been agreed to under which on-site investigative work will commence in 2007. WPSC estimated the future undiscounted investigation and cleanup costs as of December 31, 2006, to be approximately $67.8 million. WPSC may adjust these estimates in the future, contingent upon remedial technology, regulatory requirements,
remedy determinations, and the assessment of natural resource damages. WPSC expects to recover actual cleanup costs, net of insurance recoveries, in future customer rates. Under current PSCW policies, WPSC will not recover carrying costs associated with the cleanup expenditures. WPSC has received $12.7 million in insurance recoveries, which were recorded as a reduction in the regulatory asset as of December 31, 2006.
MGUC, which acquired retail natural gas distribution operations in Michigan from Aquila in the second quarter of 2006, is responsible for the environmental impacts at 11 manufactured gas plant sites. Removal of the most contaminated soil has been completed at seven sites. Future investigations are needed at many of the sites to evaluate on-site, off-site, and sediment impacts.
MGUC has estimated future investigation and remediation costs of approximately $25 million as of December 31, 2006. The MPSC has historically authorized recovery of these costs. An environmental liability and related regulatory asset were recorded at the date of acquisition to reflect the expected investigation and clean-up costs relating to these sites and the expected recovery of these costs in future rates.
As these 11 sites are integrated into the corporate gas plant site management program, cost estimates may change. We will also evaluate the feasibility of transferring the MGUC sites into the EPA Superfund Alternatives Program.
MERC, which acquired retail natural gas distribution operations in Minnesota from Aquila in the third quarter of 2006, is not responsible for any manufactured gas plant sites, and thus, no environmental investigations are needed.
Flood Damage
On May 14, 2003, a fuse plug at the Silver Lake reservoir owned by UPPCO was breached. This breach resulted in subsequent flooding downstream on the Dead River, which is located in Michigan's Upper Peninsula near Marquette, Michigan.
A dam owned by Marquette Board of Light and Power, which is located downstream from the Silver Lake reservoir near the mouth of the Dead River, also failed during this event. In addition, high water conditions and siltation resulted in damage at the Presque Isle Power Plant owned by Wisconsin Electric Power Company. Presque Isle, which is located downstream from the Marquette Board of Light and Power dam, was ultimately forced into a temporary shutdown.
The FERC's Independent Board of Review issued its report in December 2003 and concluded that the root cause of the incident was the failure of the design of the fuse plug to take into account the highly erodible nature of the fuse plug's foundation materials and spillway channel, resulting in the complete loss of the fuse plug, foundation, and spillway channel. This caused the release of Silver Lake far beyond the intended design of the fuse plug. The fuse plug for the Silver Lake reservoir was designed by an outside engineering firm.
UPPCO has worked with federal and state agencies in their investigations. UPPCO is still in the process of investigating the incident. Integrys Energy Group maintains a comprehensive insurance program that includes UPPCO and which provides both property insurance for its facilities and liability insurance for liability to third parties. Integrys Energy Group is insured in amounts that it believes are sufficient to cover its responsibilities in connection with this event. Deductibles and self-insured retentions on these policies are not material to Integrys Energy Group.
As of May 13, 2005, several lawsuits were filed by the claimants and putative defendants relating to this incident. The suits that have been filed against UPPCO, Integrys Energy Group, and WPSC include the following claimants: Wisconsin Electric Power Company, Cleveland Cliffs, Inc., Board of Light and Power of the City of Marquette, the City of Marquette, the County of Marquette, Dead River Campers, Inc., Marquette County Road Commission, SBC, ATC, and various land and home owners along the
Silver Lake reservoir and Dead River system. In May 2005, UPPCO filed a suit against the engineering company that designed the fuse plug (MWH Americas, Inc.) and the contractor who built it (Moyle Construction, Inc.). UPPCO has reached a confidential settlement with Wisconsin Electric Power Company resolving Wisconsin Electric Power Company's claims. The settlement payment has been reimbursed by Integrys Energy Group's insurer and, therefore, did not have a material impact on the Consolidated Financial Statements. Integrys Energy Group has also settled several small claims with various landowners that are also covered by insurance. Integrys Energy Group is defending the remaining lawsuits and is seeking resolution of all claims and litigation where possible. A trial date in October 2007 has been set for the remaining cases.
In November 2003, UPPCO received approval from the MPSC and the FERC for deferral of costs that are not reimbursable through insurance or recoverable through the power supply cost recovery mechanism. Recovery of costs deferred will be addressed in future rate proceedings.
UPPCO has announced its decision to restore Silver Lake as a reservoir for power generation pending approval of a license amendment and an economically feasible design by the FERC. The FERC has required that a board of consultants evaluate and oversee the design approval process. UPPCO is developing a timeline for the project, provided the FERC approves an economically feasible design. Once work is done, Silver Lake is expected to take approximately two years to refill, based upon natural precipitation.
Other Environmental Issues
Groundwater testing at a former ash disposal site of UPPCO indicated elevated levels of boron and lithium. Supplemental remedial investigations were performed, and a revised remedial action plan was developed. The Michigan Department of Environmental Quality approved the plan in January 2003. UPPCO received an order from the MPSC permitting deferral and future recovery of these costs. A liability of $1.3 million and an associated regulatory asset of $1.3 million were recorded at December 31, 2006, for estimated future expenditures associated with remediation of the site. In addition, UPPCO has an informal agreement, with the owner of another landfill, under which UPPCO has agreed to pay 17% of the investigation and remedial costs. It is estimated that the cost of addressing the site over the next year will be $2.4 million. UPPCO has recorded $0.4 million of this amount as its share of the liability as of December 31, 2006.
There is increasing concern over the issue of climate change and the effect of emissions of greenhouse gases. Integrys Energy Group is evaluating both the technical and cost implications, which may result from a future greenhouse gas regulatory program. This evaluation indicates that it is probable that any regulatory program that caps emissions or imposes a carbon tax will increase costs for Integrys Energy Group and its customers. At this time, there is no commercially available technology for removing carbon dioxide from a pulverized coal-fired plant, but significant research is in progress. Efforts are underway within the utility industry to develop cleaner ways to burn coal. The use of alternate fuels is also being explored by the industry, but there are many cost and availability issues. Based on the complexity and uncertainty of the climate issues, a risk exists that future carbon regulation will increase the cost of electricity produced at coal-fired generation units. However, we believe the capital expenditures we are making at our generation units are appropriate under any reasonable mandatory greenhouse gas program. Integrys Energy Group will continue to monitor and manage potential risks and opportunities associated with future greenhouse gas regulatory actions.
Stray Voltage Claims
The PSCW has established certain requirements regarding stray voltage for all utilities subject to its jurisdiction. The PSCW has defined what constitutes "stray voltage," established a level of concern at which some utility corrective action is required, and set forth test protocols to be employed in evaluating whether a stray voltage problem exists. However, in 2003, the Supreme Court of Wisconsin ruled in Hoffmann v. WEPCO that a utility could be found liable for damage from stray voltage even though the utility had complied with the PSCW's requirements and no stray voltage problem existed as defined by the
PSCW. Consequently, although WPSC believes it abides by the applicable PSCW requirements, it is not immune from stray voltage lawsuits.
From time to time, WPSC has been sued by dairy farmers who allege that they have suffered loss of milk production and other damages due to "stray voltage" from the operation of WPSC's electrical system. Past cases have been resolved without any material adverse effect on the financial statements of WPSC. Two stray voltage cases are now pending. The first case, Allen v. WPSC, resulted in a June 2003 jury verdict in the plaintiff's favor. Both parties appealed. In February 2005, the court of appeals affirmed the damage verdict but remanded to the trial court for a determination of whether a post-verdict injunction was warranted. WPSC paid the damages verdict. On August 31, 2006, the parties settled the injunction issues. This settlement does not resolve the entire case, because the plaintiff has been permitted to file an amended complaint seeking money damages suffered since June 2003. The expert witnesses retained by WPSC do not believe that there is any scientific evidence of a "stray voltage" problem caused by WPSC on the plaintiff's land from June 2003 to the present. Accordingly, WPSC intends to contest the plaintiff's claim for money damages. Trial is set for September 2007. The second case, Wojciehowski Brothers Farms v. WPSC, was brought in Wisconsin in Marinette County. The case is currently in discovery, and WPSC is vigorously defending the case. No trial date has been set.
Two cases have been recently resolved. The first of these cases, Schmoker v. WPSC was brought in Wisconsin state court in Winnebago County. This case has been settled well within WPSC's self insured retention. The second of these cases, Seidl v. WPSC, is also no longer pending. That case was dismissed on June 21, 2005, when the trial judge granted WPSC's motion for a directed verdict. The Seidl plaintiffs appealed that dismissal. On July 18, 2006, the Court of Appeals affirmed the trial judge's ruling. The plaintiffs chose not to ask the Wisconsin Supreme Court to review the case, so the dismissal is now final.
WPSC has insurance coverage for these pending claims, but the policies have customary self-insured retentions per occurrence. Based upon the information known at this time and the availability of insurance, WPSC believes that the total cost to it of resolving the pending actions will not be material.
Wausau, Wisconsin, to Duluth, Minnesota, Transmission Line
Construction of the 220-mile, 345-kilovolt Wausau, Wisconsin, to Duluth, Minnesota, transmission line began in the first quarter of 2004 with the Minnesota portion completed in early 2005. Construction in Wisconsin began on August 8, 2005.
ATC has assumed primary responsibility for the overall management of the project and will own and operate the completed line. WPSC received approval from the PSCW and the FERC and subsequently transferred ownership of the project to ATC. WPSC will continue to manage obtaining the private property rights, design, and construction of the Wisconsin portion of the project.
The Certificate of Public Convenience and Necessity and other permits needed for construction have been received and are final. In addition, on August 5, 2005, the new law allowing condemnation of county land for transmission lines approved by the PSCW became effective.
Integrys Energy Group committed to fund 50% of total project costs incurred up to $198 million and will receive additional equity in ATC in exchange for the project funding. Under its agreement, Integrys Energy Group invested $22.4 million in ATC for this project in 2006, bringing Integrys Energy Group's investment in ATC related to the project to $109.0 million since inception. Integrys Energy Group may terminate funding if the project extends beyond January 1, 2010. On December 19, 2003, WPSC and ATC received approval from the PSCW to continue the project at a revised cost estimate of $420.3 million to reflect additional costs for the project resulting from time delays, added regulatory requirements, changes and additions to the project, and ATC overhead costs. Integrys Energy Group has the right, but not the obligation, to provide additional funding in excess of $198 million for up to 50% of the revised cost estimate. However, Integrys Energy Group's future funding of the line will be reduced by the amount funded by Allete, Inc. Allete exercised its option to fund $60 million of future capital calls for the portion of
the Wausau to Duluth transmission line and had completed funding the $60 million as of February 2007. During 2007 through the completion of the line in 2008, Integrys Energy Group expects to fund up to approximately $57 million for the Wausau to Duluth transmission line.
Beaver Falls
Integrys Energy Services' Beaver Falls generation facility in New York has been out of service since late June 2005. An unplanned outage was caused by the failure of the first stage turbine blades. The decision to repair the plant was made in late August 2006 and the dismantling and repair process has begun. The facility is expected to be available for service in June 2007. Repairs to the facility continue to be on track and, inclusive of insurance recoveries, Integrys Energy Services estimates that out-of-pocket costs to repair the turbine and replace the damaged blades will be approximately $5.8 million. An analysis of the expected undiscounted future cash flows of the Beaver Falls facility demonstrates that the carrying value of the plant and related assets is recoverable.
Revenue Sufficiency Guarantee Charges
On April 25, 2006, the FERC issued an order regarding MISO's "Revenue Sufficiency Guarantee" charges (RSG charges). RSG charges are collected by MISO from Load Serving Entities in order to compensate generators that are standing by to supply electricity when called upon by MISO. MISO's business practice manuals and other instructions to market participants have stated, since the implementation of market operations on April 1, 2005, that RSG charges will not be imposed on offers to supply power not supported by actual generation (also known as virtual supply offers). However, some market participants raised questions about the language of MISO's tariff concerning that issue and in October 2005, MISO submitted to the FERC proposed tariff revisions clarifying its tariff to reflect its business practices with respect to RSG charges, and filed corrected tariff sheets exempting virtual supply from RSG charges. In its April 2006 decision, the FERC interpreted MISO's tariff to require that virtual supply offers must be included in the calculation of the RSG charges and that to the extent that MISO did not charge virtual supply offers for RSG charges, it violated the terms of its tariff. The FERC order then proceeded to require MISO to recalculate the RSG charges back to April 1, 2005, and to make refunds to customers, with interest, reflecting the recalculated charges. In order to make such refunds, it is likely that MISO will attempt to impose retroactively RSG charges on those who submitted virtual supply offers during the recalculation period. Integrys Energy Services and our electric utility segment made virtual supply offers in MISO during this period on which no RSG charges were imposed, and thus may be subject to a claim for refunds from MISO (which claim will be contested). The electric utility segment will be eligible for the refund discussed above, which is expected to more than offset any charges that will be imposed on the electric utility segment. Integrys Energy Services is eligible for offsetting refunds; however, the amount of estimated refund will not offset charges incurred from virtual supply offers. The FERC's April 2006 order has been challenged by MISO and other parties, including Integrys Energy Group, and the eventual outcome of these proceedings is unclear. As such, no amounts have been recorded for the potential RSG charges in Integrys Energy Group's financial statements.
On October 26, 2006, the FERC issued a rehearing order on its April 25, 2006, RSG order granting rehearing on the RSG refunds for virtual transactions. Although this rehearing order does reaffirm the FERC's original order on the need for virtual transactions to pay RSG charges prospectively, it eliminates the original requirement that MISO provide refunds and potential re-billings of virtual transactions back to April 1, 2005. The rehearing order does require refunds back to April 1, 2005, for market participants that were charged RSG for imports but the FERC does not specify how those refunds will be funded. Since the refunds are for less frequent transactions, the total potential costs to WPSC, UPPCO, and Integrys Energy Services will be insignificant. A number of parties have asked for clarifications and rehearing of this FERC rehearing order and it is also subject to court challenge and so far one party has filed a court challenge of the order. In addition, there are requests for a stay or delay in any refunds and resettlements until the rehearing requests are resolved to minimize resettlements.
Synthetic Fuel Production Facility
Background
We have significantly reduced our consolidated federal income tax liability through tax credits available to us under Section 29/45K of the Internal Revenue Code for the production and sale of solid synthetic fuel produced from coal. These tax credits are scheduled to expire at the end of 2007 and are provided as an incentive for taxpayers to produce fuel from alternate sources and reduce domestic dependence on imported oil. This incentive is not deemed necessary if the price of oil increases sufficiently to provide a natural market for the fuel. Therefore, the tax credits in a given year are subject to phase-out if the annual average reference price of oil within that year exceeds a minimum threshold price set by the Internal Revenue Service (IRS) and are eliminated entirely if the average annual reference price increases beyond a maximum threshold price set by the IRS. The reference price of a barrel of oil is an estimate of the annual average wellhead price per barrel for domestic crude oil, which has in recent history been approximately $6.50 below the NYMEX price of a barrel of oil. The threshold price at which the credit begins to phase-out was set in 1980 and is adjusted annually for inflation; the IRS releases the final numbers for a given year in the first part of the following year.
Information Related to Section 29/45K Federal Tax Credits
In order to mitigate exposure to the risk of an increase in oil prices that could reduce the amount of Section 29/45K federal tax credits that could be recognized, Integrys Energy Services entered into derivative (option) contracts, beginning in the first quarter of 2005, covering a specified number of barrels of oil. If no phase-out had occurred in 2006, Integrys Energy Services would have recognized approximately $44 million of Section 29/45K federal tax credits both from its ownership interest in a synthetic fuel production facility and additional tons of synthetic fuel it was able to procure from its synthetic fuel partners, who curtailed their production in the third and fourth quarters of 2006 when oil prices were increasing. Integrys Energy Services elected to take, and economically hedged, the risk associated with the additional production its synthetic fuel partners curtailed. As of December 31, 2006, based upon 2006 actual oil prices, Integrys Energy Services estimated that approximately 33% of the $44 million of 2006 tax credits that otherwise would be available from the production and sale of synthetic fuel would be phased out, resulting in the recognition of $29.5 million of Section 29/45K tax credits in 2006. Inception-to-date, gains on oil option contracts utilized to economically hedge the 2006 tax credits added an additional $2.1 million of pre-tax income, consisting of a $4.0 million pre-tax gain in 2005 and a $1.9 million pre-tax loss in 2006. Although 2006 oil prices are known at December 31, 2006, the final reference price and inflation factor published by the IRS (discussed above) will not be available until April 2007. However, based upon the accuracy of past estimates we do not believe the published reference price and inflation factor will differ significantly from our December 31, 2006 assumptions and, therefore, should not have a material impact on Section 29/45K federal tax credits recognized in 2006. At December 31, 2006, Integrys Energy Services had derivative (option) contracts that mitigated approximately 75% of its volumetric exposure to Section 29/45K phase-outs in 2007.
In addition to exposure from federal tax credits, Integrys Energy Services has also historically received royalties tied to the amount of synthetic fuel produced, as well as variable payments from a counterparty related to Integrys Energy Services' 2002 sale of 30% of its interest in ECO Coal Pelletization #12. While variable payments were received by Integrys Energy Services quarterly, royalties are a function of annual synthetic fuel production and are generally not received until later in the year. Because Integrys Energy Services' partners in the synthetic fuel facility curtailed their synthetic fuel production throughout 2006 and at least one counterparty elected not to take any production in 2007, Integrys Energy Services did not realize any royalty income in 2006 and does not anticipate receiving any royalty income in 2007, compared to $3.5 million and $4.1 million of pre-tax royalty income that was realized in 2005 and 2004, respectively. Integrys Energy Services realized pre-tax income related to variable payments from the 2002 sale of $3.2 million through the first nine months of 2006, but did not realize any income from variable payments in the fourth quarter of 2006 and does not expect to realize any income from variable payments for the year ended December 31, 2007, primarily because Integrys Energy Services will take this counterparty's
production in 2007. In comparison, Integrys Energy Services realized pre-tax income of $3.6 million and $3.5 million related to the variable payments in 2005 and 2004, respectively.
Impact of Synthetic Fuel Activities on Results of Operations
The following table shows the impact that Integrys Energy Services' investment in the synthetic fuel production facility and procurement of additional tons, including derivative (option) contract activity, had on the Consolidated Statements of Income.
Amounts are pre-tax, except tax credits (millions) | | Income (loss) | |
| | | 2006 | | 2005 | | 2004 | |
| Provision for income taxes: | | | | | | | | | | |
| Section 29/45K federal tax credits recognized | | $ | 29.5 | | $ | 26.1 | | $ | 27.8 | |
| | | | | | | | | | | |
| Nonregulated revenue: | | | | | | | | | | |
| Net realized gains on 2005 oil options | | | - | | | 0.3 | | | - | |
| Mark-to-market (losses) gains on 2006 oil options | | | (4.0 | ) | | 4.0 | | | - | |
| Net realized gains on 2006 oil options | | | 2.1 | | | - | | | - | |
| Mark-to-market (losses) gains on 2007 oil options | | | (0.5 | ) | | 4.4 | | | - | |
| | | | | | | | | | | |
| Miscellaneous income: | | | | | | | | | | |
| Operating losses - synthetic fuel facility | | | (23.9 | ) | | (16.8 | ) | | (14.1 | ) |
| Variable payments received | | | 3.2 | | | 3.6 | | | 3.5 | |
| Royalty income recognized | | | - | | | 3.5 | | | 4.1 | |
| Deferred gain recognized | | | 2.3 | | | 2.3 | | | 2.3 | |
| Interest received on fixed note receivable | | | 0.9 | �� | | 1.2 | | | 1.7 | |
| | | | | | | | | | | |
| Minority interest | | | 3.8 | | | 4.7 | | | 3.4 | |
NOTE 18--GUARANTEES
As part of normal business, Integrys Energy Group and its subsidiaries enter into various guarantees providing financial or performance assurance to third parties on behalf of certain subsidiaries. These guarantees are entered into primarily to support or enhance the creditworthiness otherwise attributed to a subsidiary on a stand-alone basis, thereby facilitating the extension of sufficient credit to accomplish the subsidiaries' intended commercial purposes.
Most of the guarantees issued by Integrys Energy Group include inter-company guarantees between parents and their subsidiaries, which are eliminated in consolidation, and guarantees of the subsidiaries' own performance. As such, these guarantees are excluded from the recognition and measurement requirements of FASB Interpretation No. 45, "Guarantors' Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others."
Corporate guarantees issued in the future under the Board of Directors authorized limits may or may not be reflected on Integrys Energy Group's Consolidated Balance Sheet, depending on the nature of the guarantee.
At December 31, 2006, 2005, and 2004, outstanding guarantees totaled $1,659.0 million, $1,310.6 million, and $977.9 million, respectively, as follows:
Integrys Energy Group's Outstanding Guarantees (Millions) | | December 31, 2006 | | December 31, 2005 | | December 31, 2004 | |
| Guarantees of subsidiary debt | | $ | 178.3 | | $ | 27.2 | | $ | 27.2 | |
| Guarantees supporting commodity transactions of subsidiaries | | | 1,314.0 | | | 1,154.7 | | | 863.9 | |
| Standby letters of credit | | | 155.3 | | | 114.3 | | | 80.9 | |
| Surety bonds | | | 1.2 | | | 0.8 | | | 0.6 | |
| Other guarantees | | | 10.2 | | | 13.6 | | | 5.3 | |
| Total guarantees | | $ | 1,659.0 | | $ | 1,310.6 | | $ | 977.9 | |
| | | | | | | | | | | | |
Integrys Energy Group's Outstanding Guarantees (Millions) Commitments Expiring | | Total Amounts Committed At December 31, 2006 | | Less Than 1 Year | | 1 to 3 Years | | 4 to 5 Years | | Over 5 Years | |
| Guarantees of subsidiary debt | | $ | 178.3 | | $ | 150.0 | | $ | - | | $ | - | | $ | 28.3 | |
| Guarantees supporting commodity transactions of subsidiaries | | | 1,314.0 | | | 1,050.1 | | | 216.5 | | | 5.3 | | | 42.1 | |
| Standby letters of credit | | | 155.3 | | | 153.1 | | | 2.2 | | | - | | | - | |
| Surety bonds | | | 1.2 | | | 1.2 | | | - | | | - | | | - | |
| Other guarantees | | | 10.2 | | | - | | | 10.2 | | | - | | | - | |
| Total guarantees | | $ | 1,659.0 | | $ | 1,354.4 | | $ | 228.9 | | $ | 5.3 | | $ | 70.4 | |
At December 31, 2006, Integrys Energy Group had outstanding $178.3 million in corporate guarantees supporting indebtedness. Of that total, $150.0 million supports an Integrys Energy Services 364-day credit agreement entered into in April 2006, to finance its margin requirements related to natural gas and electric contracts traded on the NYMEX and the ICE, as well as the cost of natural gas in storage and for general corporate purposes. Borrowings under this agreement are guaranteed by Integrys Energy Group and are subject to the aggregate $1.65 billion guarantee limit authorized for Integrys Energy Services by Integrys Energy Group's Board of Directors (discussed below). At December 31, 2006, the entire $150.0 million has been borrowed by Integrys Energy Services, leaving no availability on the existing credit agreement. The remaining $28.3 million of guarantees support outstanding debt at Integrys Energy Services' subsidiaries, of which $1.0 million is subject to the $1.65 billion limit and the remaining $27.3 million received separate authorization from Integrys Energy Group's Board of Directors. The underlying debt related to these guarantees is reflected on Integrys Energy Group's Consolidated Balance Sheet.
Integrys Energy Group's Board of Directors has authorized management to issue corporate guarantees in the aggregate amount of up to $1.65 billion to support the business operations of Integrys Energy Services. Integrys Energy Group primarily issues the guarantees to counterparties in the wholesale electric and natural gas marketplace to provide them assurance that Integrys Energy Services will perform on its obligations and permit Integrys Energy Services to operate within these markets. At December 31, 2006, Integrys Energy Group provided parental guarantees subject to this limit in the amount of $1,201.4 million, reflected in the above table for Integrys Energy Services' indemnification obligations for
business operations, in addition to $8.1 million of guarantees that received specific authorization from Integrys Energy Group's Board of Directors and are not included in the $1.65 billion general authorized amount. Of the parental guarantees provided by Integrys Energy Group, the current amount at December 31, 2006, which Integrys Energy Group would be obligated to support, is approximately $520.5 million.
Another $3.2 million of corporate guarantees support energy and transmission supply at UPPCO and are not reflected on Integrys Energy Group's Consolidated Balance Sheets. In February 2005, Integrys Energy Group's Board of Directors authorized management to issue corporate guarantees in the aggregate amount of up to $15.0 million to support the business operations of UPPCO.
Corporate guarantees in the amount of $75.0 million and $125.0 million have been authorized by Integrys Energy Group's Board of Directors to support MGUC and MERC, respectively. MGUC and MERC had $40.2 million and $61.1 million, respectively, of outstanding guarantees related to natural gas supply at December 31, 2006.
At Integrys Energy Group's request, financial institutions have issued $155.3 million in standby letters of credit for the benefit of third parties that have extended credit to certain subsidiaries. Of this amount, $150.3 million has been issued to support Integrys Energy Services' operations. Included in the $150.3 million is $2.5 million that has specific authorization from Integrys Energy Group's Board of Directors and is not included in the $1.65 billion guarantee limit. The remaining $147.8 million counts against the $1.65 billion guarantee limit authorized for Integrys Energy Services. If a subsidiary does not pay amounts when due under a covered contract, the counterparty may present its claim for payment to the financial institution, which will request payment from Integrys Energy Group. Any amounts owed by our subsidiaries are reflected in Integrys Energy Group's Consolidated Balance Sheet.
At December 31, 2006, Integrys Energy Group furnished $1.2 million of surety bonds for various reasons including worker compensation coverage and obtaining various licenses, permits, and rights-of-way. Liabilities incurred as a result of activities covered by surety bonds are included in the Integrys Energy Group's Consolidated Balance Sheet.
A guarantee of $4.9 million listed in the above table under other guarantees was issued by WPSC to indemnify a third party for exposures related to the construction of utility assets. This amount is not reflected on Integrys Energy Group's Consolidated Balance Sheet, as this agreement was entered into prior to the effective date of FASB Interpretation No. 45.
In conjunction with the sale of Kewaunee, WPSC and Wisconsin Power and Light Company agreed to indemnify Dominion for 70% of any and all reasonable costs asserted or initiated against, suffered, or otherwise existing, incurred or accrued, resulting from or arising from the resolution of any design bases documentation issues that are incurred prior to completion of Kewaunee's scheduled maintenance period for 2009 up to a maximum exposure of $15 million for WPSC and Wisconsin Power and Light Company combined. WPSC believes that it will expend its share of costs related to this indemnification and, as a result, recorded the fair value of the liability, or $8.9 million, as a component of the loss on the sale of Kewaunee. WPSC has paid a total of $3.6 million to Dominion related to this guarantee, reducing the liability to $5.3 million as of December 31, 2006.
Under the agreements related to the sales of Sunbury, the Kimball storage field, and Niagara, Integrys Energy Services agreed to indemnify the buyers for losses resulting from potential breaches of Integrys Energy Services' representations and warranties thereunder. Integrys Energy Services believes the likelihood of having to make any material cash payments under these sales agreements as a result of breaches of representations and warranties is remote, and as such, has not recorded any liability related to these agreements.
NOTE 19--EMPLOYEE BENEFIT PLANS
Integrys Energy Group has a non-contributory qualified retirement plan covering substantially all employees. Integrys Energy Group also sponsors several nonqualified retirement plans, which are not funded.
Integrys Energy Group also currently offers medical, dental, and life insurance benefits to employees and their dependents. We expense these items for active employees as incurred. We fund benefits for retirees through irrevocable trusts as allowed for income tax purposes.
The net periodic benefit cost associated with the plans is allocated among Integrys Energy Group's subsidiaries. Actuarial calculations are performed (based upon specific employees and their related years of service) in order to determine the appropriate benefit cost allocation.
The costs of pension and postretirement benefits are expensed over the period in which the employee renders service. The transition obligation for postretirement benefits of current and future retirees is being recognized over a 20-year period beginning in 1993. Integrys Energy Group uses a December 31 measurement date for all of its plans.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act) provides a prescription drug benefit under Medicare Part D as well as a federal subsidy to sponsors of certain retiree health care benefit plans. In May 2004, the FASB staff issued FSP 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003." Integrys Energy Group and its actuarial advisors determined that benefits provided by Integrys Energy Group's plan as of the date of enactment were at least actuarially equivalent to Medicare Part D, and, accordingly, Integrys Energy Group is entitled to the federal subsidy. The effect of the subsidy served to reduce the net postretirement benefit cost by $6.4 million, $6.5 million, and $2.6 million for Integrys Energy Group for the years ended December 31, 2006, 2005, and 2004, respectively.
Plan Information
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R)." SFAS No. 158 requires employers to recognize a defined benefit postretirement plan's funded status in the Consolidated Balance Sheets effective December 31, 2006, and recognize changes in the plan's funded status in comprehensive income in the year in which the changes occur. Integrys Energy Group's regulated utilities record changes in the funded status to regulatory asset or liability accounts, pursuant to SFAS No. 71. The following table shows the incremental effects of applying SFAS No. 158 on individual line items on Integrys Energy Group's Consolidated Balance Sheet at December 31, 2006.
(Millions) | | Before Application of Statement 158 | | Adjustments | | After Application of Statement 158 | |
| Regulatory assets | | $ | 307.7 | | $ | 110.1 | | $ | 417.8 | |
| Other assets | | | 371.3 | | | (1.7 | ) | | 369.6 | |
| Total assets | | | 6,753.3 | | | 108.4 | | | 6,861.7 | |
| Other current liabilities | | | 137.9 | | | 4.0 | | | 141.9 | |
| Regulatory liabilities | | | 298.0 | | | 3.7 | | | 301.7 | |
| Pension and postretirement benefit obligations | | | 80.5 | | | 108.1 | | | 188.6 | |
| Noncurrent deferred income taxes | | | 100.5 | | | (2.9 | ) | | 97.6 | |
| Common stock equity | | | 1,538.1 | | | (4.5 | ) | | 1,533.6 | |
| Total liabilities and shareholders' equity | | | 6,753.3 | | | 108.4 | | | 6,861.7 | |
The following tables provide a reconciliation of the changes in the plans' benefit obligations and fair value of assets during 2006, 2005, and 2004, as well as a statement of the funded status as of December 31.
| | | Pension Benefits | | Other Benefits | |
(Millions) | | 2006 | | 2005 | | 2004 | | 2006 | | 2005 | | 2004 | |
Reconciliation of benefit obligation (qualified and non-qualified plans) | | | | | | | | | | | | | |
| Obligation at January 1 | | $ | 727.8 | | $ | 720.7 | | $ | 637.2 | | $ | 286.9 | | $ | 294.7 | | $ | 281.6 | |
| Service cost | | | 24.2 | | | 23.9 | | | 20.5 | | | 7.1 | | | 8.0 | | | 7.5 | |
| Interest cost | | | 42.1 | | | 40.3 | | | 39.8 | | | 17.3 | | | 16.5 | | | 16.9 | |
| Plan spin off - Kewaunee sale | | | - | | | (25.7 | ) | | - | | | - | | | (13.3 | ) | | - | |
| Plan acquisitions - MGUC and MERC | | | 60.8 | | | - | | | - | | | 23.0 | | | - | | | - | |
| Actuarial (gain) loss - net | | | (19.5 | ) | | 8.2 | | | 62.0 | | | (33.1 | ) | | (9.6 | ) | | (3.4 | ) |
| Net benefit payments | | | (48.1 | ) | | (39.6 | ) | | (38.8 | ) | | (9.1 | ) | | (9.4 | ) | | (7.9 | ) |
| Obligation at December 31 | | $ | 787.3 | | $ | 727.8 | | $ | 720.7 | | $ | 292.1 | | $ | 286.9 | | $ | 294.7 | |
| | | | | | | | | | | | | | | | | | | | |
Reconciliation of fair value of plan assets (qualified plans) | | | | | | | | | | | | | | | |
| Fair value of plan assets at January 1 | | $ | 583.0 | | $ | 588.9 | | $ | 569.9 | | $ | 183.0 | | $ | 170.9 | | $ | 149.7 | |
| Actual return on plan assets | | | 67.3 | | | 39.7 | | | 54.5 | | | 16.5 | | | 11.3 | | | 12.9 | |
| Employer contributions | | | 25.3 | | | 8.2 | | | 1.6 | | | 17.9 | | | 20.4 | | | 16.2 | |
| Plan spin off - Kewaunee sale | | | - | | | (15.5 | ) | | - | | | - | | | (10.4 | ) | | - | |
| Plan acquisitions - MGUC and MERC | | | 45.0 | | | - | | | - | | | 5.4 | | | - | | | - | |
| Net benefit payments | | | (46.6 | ) | | (38.3 | ) | | (37.1 | ) | | (10.0 | ) | | (9.2 | ) | | (7.9 | ) |
Fair value of plan assets at December 31 | | $ | 674.0 | | $ | 583.0 | | $ | 588.9 | | $ | 212.8 | | $ | 183.0 | | $ | 170.9 | |
| | | Pension Benefits | | Other Benefits | |
(Millions) | | 2006 | | 2005 | | 2006 | | 2005 | |
Funded status of plans | | | | | | | | | |
| Funded status at December 31 | | $ | (113.3 | ) | $ | (144.8 | ) | $ | (79.3 | ) | $ | (103.9 | ) |
| Unrecognized transition obligation | | | - | | | 0.2 | | | - | | | 2.9 | |
| Unrecognized prior-service cost | | | - | | | 39.4 | | | - | | | (17.1 | ) |
| Unrecognized loss | | | - | | | 120.3 | | | - | | | 74.2 | |
| Net asset (liability) recognized | | $ | (113.3 | ) | $ | 15.1 | | $ | (79.3 | ) | $ | (43.9 | ) |
Amounts recognized in Integrys Energy Group's Consolidated Balance Sheets at December 31, 2005 related to the benefit plans consisted of:
(Millions) | | Pension Benefits | | Other Benefits | |
| Accrued benefit cost | | $ | (63.6 | ) | $ | (43.9 | ) |
| Intangible assets | | | 39.7 | | | - | |
| Regulatory asset | | | 32.6 | | | - | |
| Accumulated other comprehensive income | | | | | | | |
| (before tax effect of $2.6 million) | | | 6.4 | | | - | |
| Net asset (liability) recognized | | $ | 15.1 | | $ | (43.9 | ) |
Amounts recognized in Integrys Energy Group's Consolidated Balance Sheet at December 31, 2006 related to the benefit plans consisted of:
(Millions) | | Pension Benefits | | Other Benefits | |
| Current liabilities | | | 3.8 | | | 0.2 | |
| Noncurrent liabilities | | | 109.5 | | | 79.1 | |
| | | $ | 113.3 | | $ | 79.3 | |
The accumulated benefit obligation for all defined benefit pension plans was $700.1 million and $646.5 million at December 31, 2006, and 2005, respectively. Information for pension plans with an accumulated benefit obligation in excess of plan assets is presented in the following table.
| | | December 31, | |
(Millions) | | 2006 | | 2005 | |
| Projected benefit obligation | | $ | 34.3 | | $ | 727.8 | |
| Accumulated benefit obligation | | | 32.2 | | | 646.5 | |
| Fair value of plan assets | | | - | | | 583.0 | |
The following table shows the amounts that have not yet been recognized in Integrys Energy Group's net periodic benefit cost as of December 31, 2006. Amounts related to the nonregulated entities are included in accumulated other comprehensive income, while amounts related to the utilities are recorded as regulatory assets.
(Millions) | | Pension Benefits | | Other Benefits | |
Accumulated other comprehensive income (pre-tax) | | | | | |
| Net actuarial loss | | $ | 9.7 | | $ | 1.7 | |
| Prior service costs (credits) | | | 1.6 | | | (3.1 | ) |
| Total | | $ | 11.3 | | $ | (1.4 | ) |
Net regulatory assets | | | | | | | |
| Net actuarial loss | | $ | 58.6 | | $ | 31.1 | |
| Prior service costs (credits) | | | 32.6 | | | (11.8 | ) |
| Transition obligation | | | - | | | 2.5 | |
| Total | | $ | 91.2 | | $ | 21.8 | |
The estimated net loss and prior service cost for defined benefit pension plans that will be amortized as a component of net periodic benefit cost during 2007 are $6.8 million and $5.1 million, respectively. The estimated net loss, prior service credit, and transition obligation for other postretirement benefit plans that will be amortized as a component of net periodic benefit cost during 2007 are $2.3 million, $(2.2) million, and $0.4 million, respectively.
The following table presents the components of the consolidated net periodic benefit cost for the plans:
| | | Pension Benefits | | Other Benefits | |
(Millions) | | 2006 | | 2005 | | 2004 | | 2006 | | 2005 | | 2004 | |
Net periodic benefit cost | | | | | | | | | | | | | |
| Service cost | | $ | 24.2 | | $ | 23.9 | | $ | 20.5 | | $ | 7.1 | | $ | 8.0 | | $ | 7.5 | |
| Interest cost | | | 42.1 | | | 40.3 | | | 39.8 | | | 17.3 | | | 16.5 | | | 16.9 | |
| Expected return on plan assets | | | (44.2 | ) | | (43.6 | ) | | (45.9 | ) | | (13.5 | ) | | (12.5 | ) | | (11.6 | ) |
| Amortization of transition obligation | | | 0.2 | | | 0.2 | | | 0.2 | | | 0.4 | | | 0.4 | | | 0.4 | |
| Amortization of prior-service cost (credit) | | | 5.1 | | | 5.3 | | | 5.7 | | | (2.2 | ) | | (2.2 | ) | | (2.2 | ) |
| Amortization of net loss | | | 9.8 | | | 8.7 | | | 4.5 | | | 5.3 | | | 5.5 | | | 4.1 | |
| Net periodic benefit cost | | $ | 37.2 | | $ | 34.8 | | $ | 24.8 | | $ | 14.4 | | $ | 15.7 | | $ | 15.1 | |
Assumptions
The weighted average assumptions used at December 31 in accounting for the plans are as follows:
| | | Pension Benefits | | Other Benefits | |
| | | 2006 | | 2005 | | 2004 | | 2006 | | 2005 | | 2004 | |
| Discount rate for benefit obligations | | | 5.87 | % | | 5.65 | % | | 5.75 | % | | 5.87 | % | | 5.65 | % | | 5.75 | % |
| Discount rate for net periodic benefit cost | | | 5.65 | % | | 5.75 | % | | 6.25 | % | | 5.65 | % | | 5.75 | % | | 6.25 | % |
| Expected return on assets | | | 8.50 | % | | 8.50 | % | | 8.75 | % | | 8.50 | % | | 8.50 | % | | 8.75 | % |
| Rate of compensation increase | | | 5.50 | % | | 5.50 | % | | 5.50 | % | | - | | | - | | | - | |
The assumptions used for Integrys Energy Group's medical and dental cost trend rates are shown in the following table:
| | | 2006 | | 2005 | | 2004 | |
| Assumed medical cost trend rate (under age 65) | | | 9.0 | % | | 10.0 | % | | 11.0 | % |
| Ultimate trend rate | | | 5.0 | % | | 5.0 | % | | 5.0 | % |
| Ultimate trend rate reached in | | | 2010 | | | 2010 | | | 2010 | |
| | | | | | | | | | | |
| Assumed medical cost trend rate (over age 65) | | | 11.0 | % | | 12.0 | % | | 13.0 | % |
| Ultimate trend rate | | | 6.5 | % | | 6.5 | % | | 6.5 | % |
| Ultimate trend rate reached in | | | 2011 | | | 2011 | | | 2011 | |
| | | | | | | | | | | |
| Assumed dental cost trend rate | | | 5.0 | % | | 5.0 | % | | 5.0 | % |
| Ultimate trend rate | | | 5.0 | % | | 5.0 | % | | 5.0 | % |
| Ultimate trend rate reached in | | | 2004 | | | 2004 | | | 2004 | |
Assumed health care cost trend rates have a significant effect on the amounts reported by Integrys Energy Group for the health care plans. A 1% change in assumed health care cost trend rates would have the following effects:
(Millions) | | 1% Increase | | 1% Decrease | |
Integrys Energy Group | | | | | | | |
| Effects on total of service and interest cost components of net periodic postretirement health care benefit cost | | $ | 3.4 | | $ | (3.1 | ) |
Effect on the health care component of the accumulated postretirement benefit obligation | | $ | 36.2 | | $ | (32.8 | ) |
Plan Assets
Weighted-average asset allocations of the plans at December 31, 2006, and 2005, are as follows:
| | | Pension Plan Assets
at December 31, | | Postretirement Plan
Assets at December 31, | |
| | | 2006 | | 2005 | | 2006 | | 2005 | |
Asset category | | | | | | | | | |
| Equity securities | | | 60 | % | | 63 | % | | 61 | % | | 62 | % |
| Debt securities | | | 35 | % | | 32 | % | | 39 | % | | 38 | % |
| Real estate | | | 5 | % | | 5 | % | | 0 | % | | 0 | % |
| Total | | | 100 | % | | 100 | % | | 100 | % | | 100 | % |
The Board of Directors has established the Employee Benefits Administrator Committee to manage the operations and administration of all benefit plans and related trusts. The Committee has investment policies for the plan assets that establish target asset allocations for the above listed asset classes as follows: pension plan - equity securities 60%, debt securities 35%, and real estate 5%; postretirement plan - equity securities 65%, and debt securities 35%. Because of market volatility, the Committee periodically reviews the asset allocation and the portfolio is rebalanced when considered appropriate.
Cash Flows
Integrys Energy Group's funding policy is to contribute at least the minimum amounts that are required to be funded under the Employee Retirement Income Security Act, but not more than the maximum amounts that are currently deductible for income tax purposes. We expect to contribute $25.4 million to our pension plans and $15.2 million to our other postretirement benefit plans in 2007.
The following table shows the payments, reflecting expected future service, which Integrys Energy Group expects to make for pension and other postretirement benefits. In addition, the table shows the expected federal subsidies under Medicare Part D, which will partially offset other postretirement benefits, as discussed earlier.
(Millions) | | Pension Benefits | | Other Benefits | | Federal Subsidies | |
| 2007 | | $ | 43.5 | | $ | 13.3 | | $ | (1.3 | ) |
| 2008 | | | 45.0 | | | 14.2 | | | (1.5 | ) |
| 2009 | | | 46.8 | | | 15.2 | | | (1.6 | ) |
| 2010 | | | 49.7 | | | 16.1 | | | (1.7 | ) |
| 2011 | | | 51.0 | | | 16.9 | | | (1.8 | ) |
| 2012-2016 | | | 307.1 | | | 95.3 | | | (10.3 | ) |
Defined Contribution Benefit Plans
Integrys Energy Group maintains a 401(k) Savings Plan for substantially all full-time employees. Employees generally may contribute from 1% to 30% of their base compensation to individual accounts within the 401(k) Savings Plan. Participation in this plan automatically qualifies eligible non-union employees for participation in the Employee Stock Ownership Plan ("ESOP"). The company match, in the form of shares of Integrys Energy Group's common stock, is contributed to an employee's ESOP account. The plan requires a match equivalent to 100% of the first 4% and 50% of the next 2% contributed by non-union employees. Certain union employees receive a contribution to their ESOP account regardless of their participation in the 401(k) Savings Plan. The ESOP held 2.3 million shares of Integrys Energy Group's common stock (market value of $122.9 million) at December 31, 2006. Certain employees participate in a discretionary profit-sharing contribution and/or cash match in place of participation in the ESOP. Total costs incurred under these plans were $9.4 million in 2006, $8.4 million in 2005, and $7.9 million in 2004.
Integrys Energy Group maintains a deferred compensation plan that enables certain key employees and non-employee directors to defer a portion of their compensation or fees on a pre-tax basis. Non-employee directors can defer up to 100% of their director fees. There are essentially two separate investment programs available to plan participants. The first program (Program 1) offers Integrys Energy Group's common stock as a hypothetical investment option for participants; deemed dividends paid on the common stock are automatically reinvested; and all distributions must be made in Integrys Energy Group's common stock. The second program (Program 2) offers a variety of hypothetical investment options indexed to mutual funds, Integrys Energy Group's return on equity, and Integrys Energy Group's common stock. Participants may not redirect investments between the two programs. All employee deferrals are remitted to WPSC and, therefore, the liabilities and costs associated with the deferred compensation plans are included on WPSC's Consolidated Balance Sheet and Consolidated Statement of Income, respectively.
Program 1 distributions are made solely in Integrys Energy Group's common stock; consequently, we classify the deferred compensation arrangement as an equity instrument. Changes in the fair value of the deferred compensation obligation are not recognized. The deferred compensation obligation associated with Program 1 was $19.9 million at December 31, 2006, and $16.1 million at December 31, 2005.
Program 2 permits diversification. As a result, the deferred compensation obligation associated with this program is classified as a liability in the Consolidated Balance Sheets and adjusted, with a charge or credit to expense, to reflect changes in the fair value of the deferred compensation obligation. The obligation classified within other long-term liabilities was $26.8 million at December 31, 2006, and $23.6 million at December 31, 2005. The costs incurred under Program 2 were $3.0 million in 2006, $2.6 million in 2005, and $2.1 million in 2004.
The deferred compensation programs are partially funded through shares of Integrys Energy Group's common stock that is held in a rabbi trust. The common stock held in the rabbi trust is classified as a reduction of equity in a manner similar to accounting for treasury stock. The total cost of Integrys Energy Group's common stock held in the rabbi trust was $13.2 million at December 31, 2006, and $10.9 million at December 31, 2005.
NOTE 20--PREFERRED STOCK OF SUBSIDIARY
WPSC has 1,000,000 authorized shares of preferred stock with no mandatory redemption and a $100 par value. Outstanding shares are as follows at December 31:
| | | | | 2006 | | 2005 | |
(Millions, except share amounts) | | Series | | Shares Outstanding | | Carrying Value | | Shares Outstanding | | Carrying Value | |
| | | | 5.00 | % | | 130,765 | | $ | 13.1 | | | 130,778 | | $ | 13.1 | |
| | | | 5.04 | % | | 29,920 | | | 3.0 | | | 29,920 | | | 3.0 | |
| | | | 5.08 | % | | 49,928 | | | 5.0 | | | 49,928 | | | 5.0 | |
| | | | 6.76 | % | | 150,000 | | | 15.0 | | | 150,000 | | | 15.0 | |
| | | | 6.88 | % | | 150,000 | | | 15.0 | | | 150,000 | | | 15.0 | |
| Total | | | | | | 510,613 | | $ | 51.1 | | | 510,626 | | $ | 51.1 | |
All shares of preferred stock of all series are of equal rank except as to dividend rates and redemption terms. Payment of dividends from any earned surplus or other available surplus is not restricted by the terms of any indenture or other undertaking by WPSC. Each series of outstanding preferred stock is redeemable in whole or in part at WPSC's option at any time on 30 days' notice at the respective redemption prices. WPSC may not redeem less than all, nor purchase any, of its preferred stock during the existence of any dividend default.
In the event of WPSC's dissolution or liquidation, the holders of preferred stock are entitled to receive (a) the par value of their preferred stock out of the corporate assets other than profits before any of such
assets are paid or distributed to the holders of common stock and (b) the amount of dividends accumulated and unpaid on their preferred stock out of the surplus or net profits before any of such surplus or net profits are paid to the holders of common stock. Thereafter, the remainder of the corporate assets, surplus, and net profits shall be paid to the holders of common stock.
The preferred stock has no pre-emptive, subscription, or conversion rights, and has no sinking fund provisions.
NOTE 21--COMMON EQUITY
Shares outstanding at December 31 | | 2006 | | 2005 | |
| Common stock, $1 par value, 200,000,000 shares authorized | | | 43,387,460 | | | 40,089,898 | |
Treasury shares | | | 12,000 | | | 12,000 | |
| Average cost of treasury shares | | $ | 25.19 | | $ | 25.19 | |
| Shares in deferred compensation rabbi trust | | | 311,666 | | | 270,491 | |
| Average cost of deferred compensation rabbi trust shares | | $ | 42.24 | | $ | 40.29 | |
Treasury shares at December 31, 2006, and 2005, relate to our Non-Employee Directors Stock Option Plan. All options under this plan have a ten-year life, but may not be exercised until one year after the date of grant.
We issue common stock under our Stock Investment Plan and under certain of our stock-based employee benefit plans. These stock issuances increased equity $25.0 million, $29.0 million, and $28.3 million in 2006, 2005, and 2004, respectively.
In May 2006, 2,700,000 shares of Integrys Energy Group's common stock were issued relating to the physical settlement of the forward equity agreement with an affiliate of JP Morgan Securities, Inc. (see discussion below) at $53.70 per share and resulted in a net increase in equity of $139.6 million, inclusive of underwriting commissions and other expenses directly related to the issuance.
In November 2005, 1,900,000 shares of Integrys Energy Group's common stock were issued at $53.70 per share and resulted in a net increase in equity of $98.3 million, inclusive of underwriting commissions and other expenses directly related to the issuance.
Reconciliation of Integrys Energy Group's common stock shares | | Common Stock Shares Outstanding | |
| | | | |
| Balance at December 31, 2003 | | | 36,830,556 | |
| Shares issued | | | | |
| Stock Investment Plan | | | 452,471 | |
| Stock Options and Employee Stock Option Plans | | | 126,834 | |
| Long-term Incentive Plan | | | 39,520 | |
| Rabbi trust shares | | | 51,410 | |
| Balance at December 31, 2004 | | | 37,500,791 | |
| Shares issued | | | | |
| Stock Investment Plan | | | 370,928 | |
| Stock Options and Employee Stock Option Plans | | | 218,176 | |
| Common stock offering | | | 1,900,000 | |
| Long-term Incentive Plan | | | 44,538 | |
| Rabbi trust shares | | | 55,465 | |
| Balance at December 31, 2005 | | | 40,089,898 | |
| Shares issued | | | | |
| Stock Investment Plan | | | 406,878 | |
| Stock Options and Employee Stock Option Plans | | | 100,604 | |
| Common stock offering | | | 2,700,000 | |
| Long-Term Incentive Plan | | | 33,788 | |
| Rabbi trust shares | | | 56,292 | |
Balance at December 31, 2006 | | | 43,387,460 | |
Shareholder Rights Plan
In December 1996, we adopted a Shareholder Rights Plan. The rights under this plan expired on their original expiration date of December 11, 2006. The Board of Directors of Integrys Energy Group is focused on maintaining the highest level of corporate governance and believes these rights are no longer needed to protect shareholders.
Dividends
Integrys Energy Group is a holding company and our ability to pay dividends is largely dependent upon the ability of our subsidiaries to pay dividends to us. The PSCW has by order restricted our principal subsidiary, WPSC, to paying normal dividends on its common stock of no more than 103% of the previous year's common stock dividend. The PSCW also requires WPSC to maintain a financial capital structure (i.e., the percentages by which each of common stock equity, preferred stock equity and debt constitute the total capital invested in a utility), which has a common equity range of 50% to 55%. The PSCW has also established a targeted financial common equity ratio at 52% that results in a regulatory common equity ratio of 57.46%. The primary difference between the financial and the regulatory common equity ratio relates to certain off-balance sheet obligations, primarily purchased power obligations, considered by the PSCW in establishing the financial common equity target. Each of these limitations may be modified by a future order of the PSCW. Our right to receive dividends on the common stock of WPSC is also subject to the prior rights of WPSC's preferred shareholders and to provisions in WPSC's restated articles of incorporation which limit the amount of common stock dividends which WPSC may pay if its common stock and common stock surplus accounts constitute less than 25% of its total capitalization. These limitations are not expected to limit any dividend payments in the foreseeable future. At December 31, 2006, WPSC had $317.1 million of retained earnings available for the payment of dividends.
UPPCO's indentures relating to its first mortgage bonds contain certain limitations on the payment of cash dividends on its common stock, which is held solely by Integrys Energy Group. Under the most restrictive of these provisions, $26.1 million of retained earnings were available at December 31, 2006, for the payment of common stock cash dividends by UPPCO.
As of December 31, 2006, MGUC, MERC, and Integrys Energy Services have not made any dividend payments.
At December 31, 2006, Integrys Energy Group had $600.6 million of retained earnings available for the payment of dividends.
Forward Equity Transaction
In November 2005, Integrys Energy Group entered into a forward equity sale agreement with an affiliate of JP Morgan Securities, Inc., as forward purchaser, relating to 2.7 million shares of Integrys Energy Group's common stock. On May 10, 2006, Integrys Energy Group physically settled the forward equity agreement (and, thereby, issued 2.7 million shares of common stock) and received proceeds of $139.6 million. The proceeds were used to pay down commercial paper borrowings originally utilized to finance the acquisition of the natural gas distribution operations in Michigan and for general corporate purposes.
Earnings Per Share
Basic earnings per share are computed by dividing income available for common shareholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share are computed by dividing income available for common shareholders by the weighted average number of shares of common stock outstanding during the period adjusted for the exercise and/or conversion of all potentially dilutive securities. Such dilutive items include in-the-money stock options, performance stock rights, and shares related to the forward equity transaction discussed above. The calculation of diluted earnings per share for the years shown excludes some stock option and performance stock rights that had an anti-dilutive effect. All 215,568 performance shares currently outstanding at December 31, 2006, are anti-dilutive. All stock options granted in the years 2006 and 2005 were also anti-dilutive for the year ended December 31, 2006. A total of 659,724 stock options were outstanding at December 31, 2006, related to all shares granted. See Note 19, "Employee Benefit Plans," for more information on stock options. The following tables reconcile the computation of basic and diluted earnings per share:
(Millions, except per share amounts) | | 2006 | | 2005 | | 2004 | |
| | | | | | | | |
Basic Earnings Per Share | | | | | | | |
| Average shares of common stock outstanding - basic | | | 42.3 | | | 38.3 | | | 37.4 | |
| Income available for common shareholders | | $ | 155.8 | | $ | 157.4 | | $ | 139.7 | |
| Earnings per common share (basic) | | $ | 3.68 | | $ | 4.11 | | $ | 3.74 | |
| | | | | | | | | | | |
Diluted Earnings Per Share | | | | | | | | | | |
| Average shares of common stock outstanding | | | 42.3 | | | 38.3 | | | 37.4 | |
| Effect of dilutive securities | | | | | | | | | | |
| Performance stock rights, restricted stock, and stock options | | | 0.1 | | | 0.4 | | | 0.2 | |
| Average shares of common stock outstanding - diluted | | | 42.4 | | | 38.7 | | | 37.6 | |
| Income available for common shareholders | | $ | 155.8 | | $ | 157.4 | | $ | 139.7 | |
| Earnings per common share (diluted) | | $ | 3.67 | | $ | 4.07 | | $ | 3.72 | |
NOTE 22--STOCK-BASED COMPENSATION
Integrys Energy Group has four stock-based compensation plans: the 2005 Omnibus Incentive Compensation Plan ("2005 Omnibus Plan"), the 2001 Omnibus Incentive Compensation Plan ("2001 Omnibus Plan"), the 1999 Stock Option Plan ("Employee Plan"), and the 1999 Non-Employee Directors Stock Option Plan ("Director Plan"). Under the provisions of the 2005 Omnibus Plan, the number of shares of stock that may be issued in satisfaction of plan awards may not exceed 1,600,000, and no more than 400,000 shares of stock can be granted as performance shares or restricted stock. No additional awards will be issued under the 2001 Omnibus Plan, the Employee Plan, or the Director Plan, although
the plans will continue to exist for purposes of the existing outstanding stock-based compensation. The number of shares issuable under each of the aforementioned stock-based compensation plans, each outstanding award, and stock option exercise prices are subject to adjustment, at the Board of Directors' discretion, in the event of any stock split, stock dividend, or other similar transaction. At December 31, 2006, stock options, performance stock rights, and restricted shares were outstanding under the aforementioned plans.
Stock Options
Stock options are granted by the Board of Directors and may be granted at any time. Under the provisions of the 2005 Omnibus Plan, no single employee who is the chief executive officer of Integrys Energy Group or any of the other four highest compensated officers of Integrys Energy Group and its subsidiaries can be granted options for more than 250,000 shares during any calendar year. No stock options will have a term longer than ten years. The exercise price of each stock option is equal to the fair market value of the stock on the date the stock option is granted. Under the 2005 and 2001 Omnibus Plans and the Employee Plan, one-fourth of the stock options granted vest and become exercisable each year on the anniversary of the grant date. Stock options granted under the Director Plan are immediately vested but may not be exercised until one year after the date of grant. Shares to be delivered under the Director Plan consist solely of treasury shares.
The fair value of stock option awards granted in December 2006 was estimated using a binomial lattice model. The expected term of option awards is calculated based on historical exercise behavior and represents the period of time that options granted are expected to be outstanding. The risk-free interest rate is based on the U.S. Treasury yield curve. The expected dividend yield incorporates the anticipated post-merger dividend rate announced previously as well as historical dividend increase patterns. Integrys Energy Group's expected stock price volatility was estimated using the 10-year historical volatility. The fair values of stock option awards granted in December 2005 and December 2004 were estimated using the Black-Scholes option-pricing model. The following table shows the weighted-average fair values along with the assumptions incorporated into the models:
| | | 2006 | | 2005 | | 2004 | |
| Weighted-average fair value | | $ | 6.04 | | $ | 4.40 | | $ | 4.75 | |
| Expected term | | | 6 years | | | 6 years | | | 10 years | |
| Risk-free interest rate | | | 4.42 | % | | 4.38 | % | | 4.40 | % |
| Expected dividend yield | | | 4.90 | % | | 4.73 | % | | 5.19 | % |
| Expected volatility | | | 17 | % | | 12 | % | | 15 | % |
Total pre-tax compensation cost recognized for stock options during the year ended December 31, 2006, was $1.8 million. The total compensation cost capitalized was immaterial. As of December 31, 2006, $1.8 million of total pre-tax compensation cost related to unvested and outstanding stock options is expected to be recognized over a weighted-average period of 3.1 years.
Cash received from option exercises during the years ended December 31, 2006, 2005, and 2004, was $1.9 million, $5.9 million, and $2.3 million, respectively. The tax benefit realized from these option exercises was immaterial in 2006 and 2004 and was $1.3 million in 2005.
A summary of stock option activity for the year ended December 31, 2006, and the number of outstanding and exercisable stock options by plan at December 31, 2006, is presented below:
| | | Stock Options | | Weighted-Average Exercise Price Per Share | | Weighted-Average Remaining Contractual Life (in Years) | | Aggregate Intrinsic Value (Millions) | |
| Outstanding at December 31, 2005 | | | | | | | | | |
2001 Omnibus Plan | | | 1,194,441 | | $ | 41.72 | | | | | | | |
2005 Omnibus Plan | | | 325,347 | | | 54.85 | | | | | | | |
Employee Plan | | | 156,973 | | | 33.99 | | | | | | | |
Director Plan | | | 12,000 | | | 25.50 | | | | | | | |
| Granted | | | | | | | | | | | | | |
| 2005 Omnibus Plan | | | 334,377 | | | 52.73 | | | | | | | |
| Exercised | | | | | | | | | | | | | |
2001 Omnibus Plan | | | 21,562 | | | 38.59 | | | | | | 0.3 | |
| Employee Plan | | | 32,326 | | | 33.92 | | | | | | 0.6 | |
| Forfeited | | | | | | | | | | | | | |
| 2001 Omnibus Plan | | | 625 | | | 43.38 | | | | | | - | |
| Outstanding at December 31, 2006 | | | | | | | | | | | | | |
2001 Omnibus Plan | | | 1,172,254 | | | 41.78 | | | 6.55 | | | 14.4 | |
2005 Omnibus Plan | | | 659,724 | | | 53.78 | | | 8.93 | | | 0.2 | |
Employee Plan | | | 124,647 | | | 34.01 | | | 3.74 | | | 2.5 | |
Director Plan | | | 12,000 | | | 25.50 | | | 2.98 | | | 0.3 | |
| Exercisable at December 31, 2006 | | | | | | | | | | | | | |
2001 Omnibus Plan | | | 929,153 | | | 40.43 | | | 6.28 | | | 12.6 | |
2005 Omnibus Plan | | | 81,342 | | | 54.85 | | | 8.93 | | | - | |
Employee Plan | | | 124,647 | | | 34.01 | | | 3.74 | | | 2.5 | |
Director Plan | | | 12,000 | | | 25.50 | | | 2.98 | | | 0.3 | |
No modifications were made to previously issued awards, and no options expired during the year ended December 31, 2006.
During the years ended December 31, 2005, and 2004, the intrinsic value of options exercised totaled $3.3 million and $1.1 million, respectively.
The aggregate intrinsic value for outstanding and exercisable options in the above table represents the total pre-tax intrinsic value that would have been received by the option holders had they all exercised their options at December 31, 2006. This is calculated as the difference between Integrys Energy Group's closing stock price on December 31, 2006, and the option exercise price, multiplied by the number of in-the-money stock options.
Performance Stock Rights
A portion of the long-term incentive is awarded in the form of performance stock rights. Performance stock rights vest over a three-year performance period and are paid out in shares of Integrys Energy Group's common stock. No single employee who is the chief executive officer of Integrys Energy Group or any of the other four highest compensated officers of Integrys Energy Group and its subsidiaries can receive a payout in excess of 50,000 performance shares during any calendar year. The number of shares paid out is calculated by multiplying a performance percentage by the number of outstanding stock rights at the completion of the vesting period. The performance percentage is based on the total shareholder return of Integrys Energy Group's common stock relative to the total shareholder return of a peer group of companies. The payout may range from 0% to 200% of target.
The fair values of performance stock right awards granted in December 2005 and December 2004 were estimated using Integrys Energy Group's common stock price on the date of grant, less the present value of expected dividends over the three-year vesting period, assuming a payout of 100% of target. The fair value of performance stock rights granted in December 2006 was estimated using a Monte Carlo valuation model, incorporating the assumptions in the table below. The risk-free interest rate is based on the U.S. Treasury yield curve. The expected dividend yield incorporates the anticipated post-merger dividend rate announced previously as well as historical dividend increase patterns. The expected volatility was estimated using three years of historical data.
| | | 2006 | |
| Expected term | | | 3 years | |
| Risk-free interest rate | | | 4.74 | % |
| Expected dividend yield | | | 4.90 | % |
| Expected volatility | | | 14.40 | % |
Pre-tax compensation cost recorded for performance stock rights for the years ended December 31, 2006, 2005, and 2004 was $2.8 million, $3.4 million, and $2.3 million, respectively. The total compensation cost capitalized during these same years was immaterial. As of December 31, 2006, $3.9 million of total pre-tax compensation cost related to unvested and outstanding performance stock rights is expected to be recognized over a weighted-average period of 2.4 years.
A summary of the activity of the performance stock rights plan for the year ended December 31, 2006, is presented below:
| | | Performance Stock Rights | | Weighted-Average Grant Date Fair Value | |
| Outstanding at December 31, 2005 | | | 211,421 | | $ | 41.93 | |
| Granted | | | 43,147 | | $ | 51.30 | |
| Distributed | | | 37,600 | | $ | 31.60 | |
| Forfeited | | | 1,400 | | $ | 45.96 | |
Outstanding at December 31, 2006 | | | 215,568 | | $ | 45.58 | |
Performance stock rights vested at December 31, 2005, were distributed during the first quarter of 2006 and had a total intrinsic value of $2.4 million. The actual number of shares of Integrys Energy Group's common stock distributed totaled 45,121 based on a payout of 120% of target. The tax benefit realized due to the distribution of performance shares totaled $1.0 million. No performance shares were distributed during the remainder of the year.
Restricted Shares
In December 2006, a portion of the long-term incentive was awarded in the form of restricted shares. These shares have a four-year vesting period, with 25% of each award vesting on each anniversary of the grant date. During the vesting period, award recipients have voting rights and are entitled to dividends in the same manner as other common shareholders. Restricted shares have a value equal to the fair market value of the shares on the grant date. The grant-date fair value of the December 2006 shares was $52.73. In 2006, an immaterial amount of compensation cost was recorded related to restricted share awards. We expect to recognize $2.9 million in pre-tax compensation cost for these awards over a weighted-average period of 3.9 years.
NOTE 23--REGULATORY ENVIRONMENT
Wisconsin
On January 11, 2007, the PSCW issued a final written order authorizing a retail electric rate increase of $56.7 million (6.61%) and a retail natural gas rate increase of $18.9 million (3.77%), effective January 12, 2007. The 2007 rates reflect a 10.9% return on common equity. The PSCW also approved a common equity ratio of 57.46% in its regulatory capital structure. The 2007 retail electric rate increase was required primarily because of increased costs associated with electric transmission, costs related to the construction of Weston 4 and the additional personnel to maintain and operate the plant, and costs to maintain the Weston 3 generation unit and the De Pere Energy Center. The 2007 retail natural gas rate increase was driven by infrastructure improvements necessary to ensure the reliability of the natural gas distribution system and costs associated with the remediation of former manufactured gas plant sites. In order to provide greater rate certainty for our customers through 2008, WPSC filed a biennial rate proposal with the PSCW on July 7, 2006. The PSCW acted upon this proposal as part of the 2007 rate case and approved the biennial rate proposal for 2007 and 2008, but would not agree to WPSC's proposed revenue stability mechanism.
As part of its January 2007 final written order, the PSCW determined that it was reasonable for WPSC to continue to defer the MISO Day 2 charges associated with net congestion and financial transmission rights costs and revenues, and the cost differences between marginal losses and average losses through 2007. At December 31, 2006, WPSC had deferred $20.8 million of costs related to these matters.
On April 25, 2006, WPSC filed with the PSCW a stipulation agreement with various interveners to refund a portion of the difference between fuel costs that were projected in the 2006 Wisconsin retail rate case and actual Wisconsin retail fuel costs incurred from January 2006 through March 2006 as well as the projected fuel savings in April through June 2006. This refund resulted in a credit to customers' bills over the months of May 2006 to August 2006. On October 2, 2006, WPSC filed for an additional refund of $15.6 million to reflect additional fuel cost saving. The PSCW approved this filing and ordered this amount to be refunded based on November and December usage. Customer refunds of $28.6 million were made in 2006, related to the stipulation agreement. An additional refund to customers of $13.4 million was accrued at December 31, 2006. WPSC expects to make a final refund to customers in the spring of 2007.
On December 22, 2005, the PSCW issued a final written order authorizing a retail electric rate increase of $79.9 million (10.1%) and a retail natural gas rate increase of $7.2 million (1.1%), effective January 1, 2006. The 2006 rates reflect an 11.0% return on common equity. The PSCW also approved a common equity ratio of 59.7% in its regulatory capital structure. The 2006 retail electric rate increase was required primarily because of higher fuel and purchased power costs (including costs associated with the Fox Energy Center power purchase agreement), and also for costs related to the construction of Weston 4, higher transmission expenses, and recovery of a portion of the costs related to the 2005 Kewaunee outage. Partially offsetting the items discussed above, retail electric rates were lowered to reflect a refund to customers in 2006 of a portion of the proceeds received from the liquidation of the nonqualified decommissioning trust fund as a result of the sale of Kewaunee. The 2006 retail natural gas rate increase was driven by infrastructure improvements necessary to ensure the reliability of the natural gas distribution system.
In WPSC's 2006 rate case (discussed above), the PSCW ruled that the deferred assets and liabilities related to the Kewaunee matters should be treated separately and determined that Wisconsin retail customers were entitled to be refunded approximately 85% (approximately $108 million of the total $127.1 million of proceeds received) of the proceeds received from the liquidation of the nonqualified decommissioning trust fund over a two-year period beginning on January 1, 2006 (in addition to the refund of carrying costs on the unamortized balance at the authorized pre-tax weighted average cost of capital). In 2005, the MPSC ruled that WPSC's Michigan customers were entitled to be refunded approximately 2% of the proceeds received from the liquidation of the nonqualified decommissioning fund over a 60-month
period. Refunding to Michigan customers began in the third quarter of 2005. In December 2006, the MPSC issued an order authorizing WPSC to amortize the approximately $2 million balance of the Michigan portion of the Kewaunee nonqualified decommissioning trust fund simultaneously with the amortization of approximately $2 million of the 2005 power supply under collections from January 2007 through July 2010. FERC customers will receive approximately 13% of the proceeds received from the liquidation of the nonqualified decommissioning fund.
On August 8, 2005, the FERC accepted the proposed refund plan for filing and implemented the plan effective January 1, 2006, subject to refund upon final resolution. Settlement discussions between WPSC and wholesale parties contesting WPSC's refund plan were held both in the fourth quarter of 2005 and in the first quarter of 2006, and a final agreement was reached with one FERC customer in the second quarter of 2006. A refund of approximately $3 million was made to this customer, offset by a payment received from this customer of approximately $1 million related to both the loss WPSC recorded on the sale of Kewaunee and costs incurred related to the 2005 Kewaunee outage. In the fourth quarter of 2006 a final agreement was reached between WPSC and the remaining FERC customers to resolve all Kewaunee related issues, which included the loss on the sale of Kewaunee, the outage costs related to the 2005 Kewaunee outage, and the refund of the non-qualified decommissioning trust fund. Based upon this resolution, in December 2006, the FERC Administrative Law Judge certified the wind-up plan as uncontested. WPSC expects the FERC to issue a final order approving this settlement in the first quarter of 2007. Pursuant to the settlement, WPSC will be required to make a lump-sum payment to the remaining FERC customers of approximately $14 million representing their contributions to the non-qualified decommissioning trust fund during the period in which they received service from WPSC. The settlement would also require these FERC customers to make two separate lump-sum payments to WPSC with respect to the loss from the sale of Kewaunee and the 2005 Kewaunee power outage. The payments to WPSC total approximately $1 million and $9 million, respectively, and will be netted against the $14 million refund due to these customers within 30 days following the FERC's acceptance of the settlement.
At December 31, 2006, WPSC had recorded a $55.9 million regulatory liability representing the amount of proceeds received from the liquidation of the nonqualified decommissioning trust fund remaining to be refunded in 2007.
The PSCW disallowed recovery of 50% of the 2005 loss on the sale of Kewaunee. The entire loss had previously been approved for deferral, resulting in WPSC writing off $6.1 million of the regulatory asset previously recorded. WPSC petitioned the PSCW for rehearing on this matter; however, the request for rehearing was denied and this decision is now final.
On February 20, 2005, Kewaunee was temporarily removed from service after a potential design weakness was identified in its auxiliary feedwater system. On March 17, 2005, the PSCW authorized WPSC to defer replacement fuel costs related to the outage. On April 8, 2005, the PSCW approved deferral of the operating and maintenance costs, including carrying costs at the most recently authorized pre-tax weighted average cost of capital. In the order granted for WPSC's 2006 rate case, which was finalized on December 22, 2005 (discussed above), the PSCW determined that it was reasonable for WPSC to recover all deferred costs related to the 2005 Kewaunee forced outage over a five-year period, beginning on January 1, 2006, including carrying costs on the unamortized balance at the composite short-term debt rate. Because the PSCW had initially approved deferral of carrying costs based upon the weighted average cost of capital, WPSC was required to write-off $2.2 million of carrying costs in the fourth quarter of 2005. WPSC also filed with the FERC for approval to defer these costs in the wholesale jurisdiction and the issue was resolved as part of the wind-up plan discussed above. For WPSC's Michigan retail customers, fuel costs are recovered through a pass through fuel adjustment clause and no deferral request is needed. At December 31, 2006, $39.4 million was left to be collected from ratepayers and remained recorded as a regulatory asset related to this outage.
In May 2005, WPSC received notification from its coal transportation suppliers that extensive maintenance was required on the railroad tracks that lead into and out of the Powder River Basin. The extensive maintenance ended on November 23, 2005. During the maintenance efforts, WPSC received
approximately 87% of the expected coal deliveries. WPSC took steps to conserve coal usage and secured alternative coal supplies at its affected generation facilities during that time. On September 23, 2005, the PSCW approved WPSC's request for deferred treatment of the incremental fuel costs resulting from the coal supply issues. As of December 31, 2006, $6.6 million was deferred related to this matter. These costs were addressed in WPSC's 2007 retail electric rate case and will be recoverable in 2007 and 2008.
On November 5, 2004, WPSC filed an application with the PSCW to defer all incremental costs, including carrying costs, resulting from unexpected problems encountered in the 2004 refueling outage at Kewaunee. During the refueling outage, an unexpected problem was encountered with equipment used for lifting the reactor vessel internal components to perform a required 10-year inspection. These equipment problems caused the outage to be extended by approximately three weeks. On November 11, 2004, the PSCW authorized WPSC to defer the replacement fuel costs related to the extended outage. On November 23, 2004, the PSCW authorized WPSC to defer purchased power costs and operating and maintenance expenses related to the extended outage, effective from when the problems were discovered, including carrying costs at WPSC's authorized weighted average cost of capital. Kewaunee returned to service on December 4, 2004. In the order granted for WPSC's 2006 rate case, which was finalized on December 22, 2005 (discussed above), the PSCW disallowed recovery of these costs, resulting in the write-off of the $7.6 million regulatory asset WPSC had previously recorded. WPSC petitioned the PSCW for rehearing on this matter; however, the request for rehearing was denied and this decision is now final.
Michigan
On June 27, 2006, the MPSC issued a final written order authorizing a retail electric rate increase for UPPCO of $3.8 million (4.8%), effective June 28, 2006. The 2006 rate reflects a 10.75% return on common equity. The MPSC also approved a common equity ratio of 54.9% in its regulatory capital structure. The retail electric rate increase was required in order to improve service quality and reliability, upgrade technology, and manage rising employee and retiree benefit costs. UPPCO's last retail electric rate increase was in December 2002.
The increased retail electric rate does not reflect the recovery by UPPCO of any deferred costs associated with the Silver Lake incident, which will be addressed in a future proceeding.
On December 8, 2004, UPPCO submitted a request to the MPSC to approve UPPCO's proposed treatment of the pre-tax gains from certain sales of undeveloped and partially developed land located in the Upper Peninsula of Michigan as appropriate for ratemaking purposes. On February 4, 2005, UPPCO submitted an application to the MPSC for a 7.6% increase in retail electric rates ($5.7 million in revenues). UPPCO also requested interim rate recovery of 6.0% ($4.5 million in revenues) to allow UPPCO to recover costs during the time the MPSC was reviewing the full case. On April 28, 2005, the MPSC issued an order authorizing UPPCO to retain 100% of the pre-tax gains on certain lands owned up to $18.5 million and 73% of any pre-tax gains over that amount, and in return UPPCO withdrew its rate increase request.
Federal
Through a series of orders issued by the FERC, Regional Through and Out Rates for transmission service between the MISO and the PJM Interconnection were eliminated effective December 1, 2004. To compensate transmission owners for the revenue they will no longer receive due to this rate elimination, the FERC ordered a transitional pricing mechanism called the Seams Elimination Charge Adjustment (SECA) to be put into place. Load-serving entities paid these SECA charges during a 16-month transition period from December 1, 2004, through March 31, 2006.
For the 16-month transitional period, Integrys Energy Services received billings of $19.2 million for these charges, of which approximately $17 million related to its Michigan retail electric business and $2 million related to its Ohio retail electric business. Integrys Energy Services expensed $14.7 million of the
$19.2 million as it is probable that Integrys Energy Services' total exposure will be reduced by at least $4.5 million due to inconsistencies between the FERC's SECA order and the transmission owners' compliance filings. Integrys Energy Services anticipates settling a significant portion of its SECA matters through vendor negotiations in 2007. Integrys Energy Services has reached settlement agreements with two of its vendors for a combined $1.3 million. The SECA hearing to resolve all issues was held in the spring of 2006. The Administrative Law Judge hearing the case issued an Initial Decision that was in agreement with all of Integrys Energy Services' positions. The Administrative Law Judge certified the Initial Decision to the FERC in mid-September 2006, closing the hearing record. Briefs on Exception to the Initial Opinion were filed with FERC in early September 2006, and Opposing Exceptions were filed on October 10, 2006. The FERC will review the hearing record, the Initial Decision, and the briefs on exception, and issue a Final Order. If the Final Order that follows is consistent with the Initial Decision of the Administrative Law Judge, Integrys Energy Services' total exposure may be reduced by approximately $13 million. The Final FERC Order is subject to rehearing and then court challenges, with final resolution not anticipated until sometime in the first half of 2007. Any refunds to Integrys Energy Services will include interest for the period from payment to refund. Since SECA is a transition charge that ended on March 31, 2006, it does not directly impact Integrys Energy Services' long-term competitiveness because the only unresolved issue is the final FERC Order and pending refund. In addition to potential rehearing and court challenges of the final FERC order in this case, the application and legality of the SECA has been challenged by many load-serving entities, including Integrys Energy Services, and in rehearing requests, which are also subject to court challenges.
The SECA is also an issue for WPSC and UPPCO, who have intervened and protested a number of proposals in this docket because they believe those proposals could result in unjust, unreasonable, and discriminatory charges for customers. It is anticipated that most of the SECA rate charges incurred by WPSC and UPPCO and any refunds will be passed on to customers through rates. WPSC and UPPCO have reached a settlement in principle with American Electric Power and Commonwealth Edison, which was certified by the settlement judge and now awaits approval by the FERC along with dozens of other full and partial settlements. Under the terms of the settlement agreement, American Electric Power and Commonwealth Edison will refund almost $1 million of the approximately $4 million of SECA charges paid by WPSC during the transition period. If FERC does not approve this settlement, which is deemed unlikely, WPSC and UPPCO have reserved their rights to challenge various issues in SECA which were not settled by the hearings. WPSC and UPPCO have also reserved their rights to challenge any briefs on exception to the Initial Decision and FERC's final order in this case if the settlement is not approved.
NOTE 24--VARIABLE INTEREST ENTITIES
The FASB issued Interpretation No. 46R (as revised), "Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51," in order to improve financial reporting by companies involved with variable interest entities. Interpretation No. 46R requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional financial support from other parties. The primary beneficiary is the party that absorbs the majority of the expected losses and/or receives the majority of the expected residual returns of the variable interest entity's activities.
Integrys Energy Group adopted the provisions of Interpretation No. 46R for variable interest entities not defined as special purpose entities effective March 31, 2004. The required adoption had no impact on our Consolidated Financial Statements, as we did not identify significant variable interests in any unconsolidated variable interest entities where we were determined to be the primary beneficiary. The adoption of Interpretation No. 46R also included an analysis of our power purchase and sale agreements. We do not believe that any of our power purchase or sale agreements constitute significant variable interests that would lead us to consolidate entities not currently consolidated or deconsolidate any entities currently consolidated.
NOTE 25--SEGMENTS OF BUSINESS
SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information," requires that companies disclose segment information based on how management makes decisions about allocating resources to segments and measuring their performance.
We manage our reportable segments separately due to their different operating and regulatory environments. At December 31, 2006, Integrys Energy Group reported four segments, which are described below.
Our two regulated segments include the regulated electric utility operations of WPSC and UPPCO, and the regulated natural gas utility operations of WPSC, MGUC, and MERC. WPSC's revenues are primarily derived from the service of electric and natural gas retail customers in northeastern and central Wisconsin and an adjacent portion of Upper Michigan. WPSC also provides wholesale electric service to various customers, including municipal utilities, electric cooperatives, energy marketers, other investor-owned utilities, and a municipal joint action agency. Portions of WPSC's electric and natural gas operations cannot be specifically identified as electric or natural gas and instead are allocated using either actual labor hours, revenues, number of customers, or number of meters. MGUC's revenues are primarily derived from the natural gas distribution service to various cities and communities in lower Michigan, primarily throughout Otsego, Grand Haven, and Monroe counties. MERC's revenues are primarily derived from the natural gas distribution service to various cities and communities in Minnesota including Grand Rapids, Pine City, Rochester, and Dakota County. UPPCO derives revenues from the sale of electric energy in the Upper Peninsula of Michigan.
Integrys Energy Services is our primary nonregulated segment. Integrys Energy Services offers nonregulated natural gas, electric, and alternate fuel supplies as well as energy management and consulting services to retail and wholesale customers in various areas of the United States and portions of Canada. Although Integrys Energy Services has a widening array of products and services, revenues are primarily derived through sales of electricity and natural gas to retail and wholesale customers. Integrys energy Services' marketing and trading operations manage power and natural gas procurement as an integrated portfolio with its retail and wholesale sales commitments. Electricity required to fulfill these sales commitments is procured from both Integrys Energy Services merchant electric power generation and from independent generators, energy marketers, and organized electric power markets. Natural gas is purchased from a variety of suppliers under daily, monthly, seasonal and long-term contracts with pricing delivery and volume schedules to accommodate customer requirements. Integrys Energy Services' customers include utilities, municipalities, cooperatives, commercial and industrial consumers, aggregators, and other marketing and retail entities.
Integrys Energy Services also owns several merchant electric generation plants, primarily in the Midwest and northeastern United States and adjacent portions of Canada. Integrys Energy Services markets power from these plants that is not under contract to third parties. Integrys Energy Services utilizes power from its New England and Canadian assets primarily to serve firm load commitments in northern Maine and certain other sales agreements with customers. For most of the remaining capacity available from these plants, Integrys Energy Services utilizes financial tools, including forwards, options, and swaps to mitigate exposure, as well as to maximize value from the merchant generation fleet. Power purchase agreements are also in place with third-party customers for approximately 95 megawatts of capacity, which includes the Stoneman facility in Cassville, Wisconsin, and the Combined Locks facility in Combined Locks, Wisconsin.
The Holding Company and Other segment, another nonregulated segment, includes the operations of Integrys Energy Group and WPS Resources Capital Corporation as holding companies and the nonutility activities at WPSC, MGUC, MERC, and UPPCO. Equity earnings from our investments in ATC, Wisconsin River Power Company, and Guardian Pipeline, LLC (prior to its sale in 2006) are included in the Holding Company and Other Segment.
The tables below present information for the respective years pertaining to our operations segmented by lines of business.
| | | | | | | | | | | | | | | | |
| | | Regulated Utilities | | Nonutility and Nonregulated Operations | | | | | |
2006 (Millions) | | Electric Utility(1) | | Gas Utility(1) | | Total Utility(1) | | Integrys Energy Services | | Other(2) | | Reconciling Eliminations | | Integrys Energy Group Consolidated | |
| | | | | | | | | | | | | | | | |
Income Statement | | | | | | | | | | | | | | | |
| External revenues | | $ | 1,057.9 | | $ | 676.1 | | $ | 1,734.0 | | $ | 5,151.8 | | $ | 4.9 | | $ | - | | $ | 6,890.7 | |
| Intersegment revenues | | | 41.5 | | | 0.8 | | | 42.3 | | | 7.3 | | | 1.2 | | | (50.8 | ) | | - | |
| Depreciation | | | 66.0 | | | 28.7 | | | 94.7 | | | 10.7 | | | 0.7 | | | - | | | 106.1 | |
| Miscellaneous income | | | 2.6 | | | 1.0 | | | 3.6 | | | (11.4 | ) | | 66.0(3 | ) | | (16.0 | ) | | 42.2 | |
| Interest expense | | | 30.0 | | | 18.1 | | | 48.1 | | | 15.4 | | | 51.7 | | | (16.0 | ) | | 99.2 | |
| Provision for income taxes | | | 48.6 | | | 1.5 | | | 50.1 | | | (5.0 | ) | | (0.1 | ) | | - | | | 45.0 | |
| Income from continuing operations | | | 87.6 | | | (1.3 | ) | | 86.3 | | | 65.0 | | | 0.3 | | | - | | | 151.6 | |
| Discontinued operations | | | - | | | - | | | - | | | 7.3 | | | - | | | - | | | 7.3 | |
| Preferred stock dividends of subsidiary | | | 2.1 | | | 1.0 | | | 3.1 | | | - | | | - | | | - | | | 3.1 | |
| Income available for common shareholders | | | 85.5 | | | (2.3 | ) | | 83.2 | | | 72.3 | | | 0.3 | | | - | | | 155.8 | |
Total assets | | | 2,368.0 | | | 1,483.9 | | | 3,851.9 | | | 2,736.7 | | | 741.5 | | | (468.4 | ) | | 6,861.7 | |
Cash expenditures for long-lived assets | | | 282.1 | | | 54.6 | | | 336.7 | | | 5.5 | | | (0.2 | ) | | - | | | 342.0 | |
| (1) | Includes only utility operations. |
| (2) | Nonutility operations are included in the Other column. |
| (3) | Other miscellaneous income includes $40.6 million of equity income. |
| | | | | | | | | | | | | | | | |
| | | Regulated Utilities | | Nonutility and Nonregulated Operations | | | | | |
2005 (Millions) | | Electric Utility(1) | | Gas Utility(1) | | Total Utility(1) | | Integrys Energy Services | | Other(2) | | Reconciling Eliminations | | Integrys Energy Group Consolidated | |
| | | | | | | | | | | | | | | | |
Income Statement | | | | | | | | | | | | | | | |
| External revenues | | $ | 1,003.6 | | $ | 520.6 | | $ | 1,524.2 | | $ | 5,301.3 | | $ | - | | $ | - | | $ | 6,825.5 | |
| Intersegment revenues | | | 33.5 | | | 1.4 | | | 34.9 | | | 13.6 | | | 1.1 | | | (49.6 | ) | | - | |
| Depreciation and decommissioning | | | 113.4 | | | 17.4 | | | 130.8 | | | 11.2 | | | 0.3 | | | - | | | 142.3 | |
| Miscellaneous income | | | 51.6 | | | 0.5 | | | 52.1 | | | (0.8 | ) | | 39.4(3 | ) | | (4.5 | ) | | 86.2 | |
| Interest expense | | | 27.1 | | | 8.7 | | | 35.8 | | | 4.4 | | | 26.3 | | | (4.5 | ) | | 62.0 | |
| Provision for income taxes | | | 37.0 | | | 7.3 | | | 44.3 | | | (2.4 | ) | | (2.3 | ) | | - | | | 39.6 | |
| Income from continuing operations | | | 66.2 | | | 14.3 | | | 80.5 | | | 64.2 | | | 5.9 | | | - | | | 150.6 | |
| Discontinued operations | | | - | | | - | | | - | | | 11.5 | | | - | | | - | | | 11.5 | |
| Cumulative effect of change in accounting principle | | | - | | | - | | | - | | | (1.6 | ) | | - | | | - | | | (1.6 | ) |
| Preferred stock dividends of subsidiary | | | 2.0 | | | 1.1 | | | 3.1 | | | - | | | - | | | - | | | 3.1 | |
| Income available for common shareholders | | | 64.2 | | | 13.2 | | | 77.4 | | | 74.1 | | | 5.9 | | | - | | | 157.4 | |
Total assets | | | 2,082.3 | | | 660.8 | | | 2,743.1 | | | 2,442.9 | | | 455.4 | | | (178.9 | ) | | 5,462.5 | |
Cash expenditures for long-lived assets | | | 373.9 | | | 36.4 | | | 410.3 | | | 2.7 | | | 0.9 | | | - | | | 413.9 | |
| (1) | Includes only utility operations. |
| (2) | Nonutility operations are included in the Other column. |
| (3) | Other miscellaneous income includes $31.8 million of equity income. |
| | | | | | | | | | | | | | | | |
| | | Regulated Utilities | | Nonutility and Nonregulated Operations | | | | | |
2004 (Millions) | | Electric Utility(1) | | Gas Utility(1) | | Total Utility(1) | | Integrys Energy Services | | Other(2) | | Reconciling Eliminations | | Integrys Energy Group Consolidated | |
| | | | | | | | | | | | | | | | |
Income Statement | | | | | | | | | | | | | | | |
| External revenues | | $ | 875.6 | | $ | 416.4 | | $ | 1,292.0 | | $ | 3,584.1 | | $ | - | | $ | - | | $ | 4,876.1 | |
| Intersegment revenues | | | 21.0 | | | 4.5 | | | 25.5 | | | 15.4 | | | 1.1 | | | (42.0 | ) | | - | |
| Depreciation and decommissioning | | | 79.5 | | | 16.0 | | | 95.5 | | | 10.8 | | | 0.5 | | | - | | | 106.8 | |
| Miscellaneous income | | | 10.4 | | | 0.4 | | | 10.8 | | | (0.3 | ) | | 40.6(3 | ) | | (3.2 | ) | | 47.9 | |
| Interest expense | | | 25.6 | | | 7.7 | | | 33.3 | | | 3.3 | | | 20.8 | | | (3.2 | ) | | 54.2 | |
| Provision for income taxes | | | 39.2 | | | 10.2 | | | 49.4 | | | (15.2 | ) | | (3.8 | ) | | - | | | 30.4 | |
| Income from continuing operations | | | 70.8 | | | 18.4 | | | 89.2 | | | 55.5 | | | 11.9 | | | - | | | 156.6 | |
| Discontinued operations | | | - | | | - | | | - | | | (13.8 | ) | | - | | | - | | | (13.8 | ) |
| Preferred stock dividends of subsidiary | | | 2.0 | | | 1.1 | | | 3.1 | | | - | | | - | | | - | | | 3.1 | |
| Income available for common shareholders | | | 68.8 | | | 17.3 | | | 86.1 | | | 41.7 | | | 11.9 | | | - | | | 139.7 | |
Cash expenditures for long-lived assets | | | 223.0 | | | 62.7 | | | 285.7 | | | 3.8 | | | 0.3 | | | - | | | 289.8 | |
| (1) | Includes only utility operations. |
| (2) | Nonutility operations are included in the Other column. |
| (3) | Other miscellaneous income includes $23.9 million of equity income. |
Geographic Information (Millions) | 2006 | | 2005 | | 2004 |
Revenues | Long-Lived Assets | | Revenues | Long-Lived Assets | | Revenues |
| United States | $4,908.5 | $3,605.1 | | $4,659.8 | $2,691.9 | | $3,749.1 |
Canada(1) | 1,982.2 | 21.0 | | 2,165.7 | 21.7 | | 1,127.0 |
| Total | $6,890.7 | $3,626.1 | | $6,825.5 | $2,713.6 | | $4,876.1 |
| (1) | Revenues and assets of Canadian subsidiaries. |
NOTE 26--QUARTERLY FINANCIAL INFORMATION (Unaudited)
(Millions, except for share amounts) | | Three Months Ended | |
| | | 2006 | |
| | | March | | June | | September | | December | | Total | |
| Operating revenues | | $ | 1,995.7 | | $ | 1,475.3 | | $ | 1,555.1 | | $ | 1,864.6 | | $ | 6,890.7 | |
| Operating Income | | | 95.3 | | | 67.7 | | | 44.5 | | | 42.3 | | | 249.8 | |
| Income from continuing operations | | | 59.3 | | | 41.8 | | | 28.1 | | | 22.4 | | | 151.6 | |
| Discontinued operations, net of tax | | | 1.6 | | | (6.1 | ) | | 12.1 | | | (0.3 | ) | | 7.3 | |
| Preferred stock dividends of subsidiary | | | 0.8 | | | 0.8 | | | 0.7 | | | 0.8 | | | 3.1 | |
| Income available for common shareholders | | | 60.1 | | | 34.9 | | | 39.5 | | | 21.3 | | | 155.8 | |
| | | | | | | | | | | | | | | | | |
| Average number of shares of common stock (basic) | | | 40.3 | | | 42.2 | | | 43.3 | | | 43.5 | | | 42.3 | |
| Average number of shares of common stock (diluted) | | | 40.6 | | | 42.2 | | | 43.4 | | | 43.6 | | | 42.4 | |
| | | | | | | | | | | | | | | | | |
Earnings per common share (basic) (1) | | | | | | | | | | | | | | | | |
| Income from continuing operations | | $ | 1.45 | | $ | 0.97 | | $ | 0.63 | | $ | 0.50 | | $ | 3.51 | |
| Discontinued operations | | | 0.04 | | | (0.14 | ) | | 0.28 | | | (0.01 | ) | | 0.17 | |
| Earnings per common share (basic) | | | 1.49 | | | 0.83 | | | 0.91 | | | 0.49 | | | 3.68 | |
Earnings per common share (diluted) (1) | | | | | | | | | | | | | | | | |
| Income from continuing operations | | | 1.44 | | | 0.97 | | | 0.63 | | | 0.50 | | | 3.50 | |
| Discontinued operations | | | 0.04 | | | (0.14 | ) | | 0.28 | | | (0.01 | ) | | 0.17 | |
| Earnings per common share (diluted) | | | 1.48 | | | 0.83 | | | 0.91 | | | 0.49 | | | 3.67 | |
| | | 2005 | |
| | | March | | June | | September | | December | | Total | |
| Operating revenues | | $ | 1,458.9 | | $ | 1,310.9 | | $ | 1,712.7 | | $ | 2,343.0 | | $ | 6,825.5 | |
| Operating Income | | | 85.2 | | | 5.8 | | | 62.8 | | | 7.7 | | | 161.5 | |
| Income from continuing operations | | | 62.8 | | | 29.5 | | | 43.8 | | | 14.5 | | | 150.6 | |
| Discontinued operations, net of tax | | | 3.9 | | | (4.8 | ) | | 5.1 | | | 7.3 | | | 11.5 | |
| Cumulative effect of change in accounting principle | | | - | | | - | | | - | | | (1.6 | ) | | (1.6 | ) |
| Preferred stock dividends of subsidiary | | | 0.8 | | | 0.8 | | | 0.7 | | | 0.8 | | | 3.1 | |
| Income available for common shareholders | | | 65.9 | | | 23.9 | | | 48.2 | | | 19.4 | | | 157.4 | |
| | | | | | | | | | | | | | | | | |
| Average number of shares of common stock (basic) | | | 37.8 | | | 38.0 | | | 38.2 | | | 39.1 | | | 38.3 | |
| Average number of shares of common stock (diluted) | | | 38.1 | | | 38.4 | | | 38.6 | | | 39.6 | | | 38.7 | |
| | | | | | | | | | | | | | | | | |
Earnings per common share (basic) (1) | | | | | | | | | | | | | | | | |
| Income from continuing operations | | $ | 1.64 | | $ | 0.76 | | $ | 1.13 | | $ | 0.35 | | $ | 3.85 | |
| Discontinued operations | | | 0.10 | | | (0.13 | ) | | 0.13 | | | 0.19 | | | 0.30 | |
Cumulative effect of change in accounting principle | | | - | | | - | | | - | | | (0.04 | ) | | (0.04 | ) |
| Earnings per common share (basic) | | | 1.74 | | | 0.63 | | | 1.26 | | | 0.50 | | | 4.11 | |
Earnings per common share (diluted) (1) | | | | | | | | | | | | | | | | |
| Income from continuing operations | | | 1.63 | | | 0.75 | | | 1.12 | | | 0.35 | | | 3.81 | |
| Discontinued operations | | | 0.10 | | | (0.13 | ) | | 0.13 | | | 0.18 | | | 0.30 | |
Cumulative effect of change in accounting principle | | | - | | | - | | | - | | | (0.04 | ) | | (0.04 | ) |
| Earnings per common share (diluted) | | | 1.73 | | | 0.62 | | | 1.25 | | | 0.49 | | | 4.07 | |
(1) Earnings per share for the individual quarters do not total the year ended earnings per share amount because of changes to the average number of shares outstanding and changes in incremental issuable shares throughout the year.
Because of various factors, the quarterly results of operations are not necessarily comparable.
