WPS RESOURCES CORPORATION AND SUBSIDIARIES
WISCONSIN PUBLIC SERVICE CORPORATION AND SUBSIDIARY
September 30, 2006
NOTE 1--FINANCIAL INFORMATION
We have prepared the condensed consolidated financial statements of WPS Resources and WPSC under the rules and regulations of the SEC.
This Quarterly Report on Form 10-Q is a combined report of WPS Resources and Wisconsin Public Service. These financial statements have not been audited. Management believes that these financial statements include all adjustments (which unless otherwise noted include only normal recurring adjustments) necessary for a fair presentation of the financial results for each period shown. Certain items from the prior period have been reclassified to conform to the current year presentation. The only significant reclassification was related to discontinued operations, which is discussed below. We have condensed or omitted certain financial information and footnote disclosures normally included in our annual audited financial statements. These condensed financial statements should be read along with the audited financial statements and notes included in both our Annual Report on Form 10-K for the year ended December 31, 2005, and our Current Report on Form 8-K dated August 9, 2006, which revised certain sections of WPS Resources' 2005 Form 10-K for the impact of reclassifying certain assets and liabilities of Sunbury as held for sale and Sunbury's results of operations and cash flows as discontinued operations.
The assets and liabilities, results of operations, and cash flows of MGUC and MERC were included in WPS Resources' consolidated financial statements effective April 1, and July 1, 2006, respectively. See Note 5, "Acquisitions and Sales of Assets," for more information.
For all periods presented, certain assets and liabilities of Sunbury have been reclassified as held for sale and Sunbury's results of operations and cash flows have been reclassified as discontinued operations. See Note 4, "Sunbury," for more information.
NOTE 2--CASH AND CASH EQUIVALENTS
Short-term investments with an original maturity of three months or less are reported as cash equivalents.
The following is supplemental disclosure to the WPS Resources and WPSC Condensed Consolidated Statements of Cash Flows:
(Millions) | | Nine Months Ended September 30 | |
| WPS Resources | | 2006 | | 2005 | |
| Cash paid for interest | | $ | 56.6 | | $ | 38.9 | |
| Cash paid for income taxes | | $ | 37.7 | | $ | 47.4 | |
| | | | | | | | |
| WPSC | | | | | | | |
| Cash paid for interest | | $ | 22.8 | | $ | 21.1 | |
| Cash paid for income taxes | | $ | 36.7 | | $ | 39.5 | |
During the nine months ended September 30, 2006, and September 30, 2005, accounts payable related to Weston 4 construction costs increased approximately $2.7 million and $23.6 million, respectively, and accordingly, were treated as non-cash investing activities. Purchase price adjustments totaling $0.8 million related to the acquisition of MGUC were also funded through accounts payable and treated as non-cash investing activities during the nine months ended September 30, 2006.
NOTE 3--RISK MANAGEMENT ACTIVITIES
As part of our regular operations, WPS Resources 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.
WPS Resources 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. WPS Resources classifies mark-to-market gains and losses on derivative instruments not qualifying for hedge accounting as a component of revenues. 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.
The following table shows WPS Resources' assets and liabilities from risk management activities:
| | | Assets | | Liabilities | |
(Millions) | | September 30, 2006 | | December 31, 2005 | | September 30, 2006 | | December 31, 2005 | |
Utility Segments | | | | | | | | | |
| Commodity contracts | | $ | 7.3 | | $ | 22.0 | | $ | 12.5 | | $ | - | |
| Financial transmission rights | | | 21.3 | | | 14.5 | | | 2.6 | | | 1.8 | |
Nonregulated Segments | | | | | | | | | | | | | |
| Commodity and foreign currency contracts | | | 1,268.3 | | | 1,058.6 | | | 1,185.8 | | | 971.7 | |
| Fair value hedges - commodity contracts | | | 7.6 | | | 4.2 | | | 0.9 | | | 12.9 | |
| Cash flow hedges | | | | | | | | | | | | | |
| Commodity contracts | | | 120.6 | | | 33.6 | | | 61.1 | | | 50.1 | |
| Interest rate swaps | | | - | | | - | | | 6.4 | | | 4.7 | |
Total | | $ | 1,425.1 | | $ | 1,132.9 | | $ | 1,269.3 | | $ | 1,041.2 | |
Balance Sheet Presentation | | | | | | | | | | | | | |
| Current | | $ | 1,091.6 | | $ | 906.4 | | $ | 991.8 | | $ | 852.8 | |
| Long-term | | | 333.5 | | | 226.5 | | | 277.5 | | | 188.4 | |
Total | | $ | 1,425.1 | | $ | 1,132.9 | | $ | 1,269.3 | | $ | 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 share of assets and liabilities from risk management activities:
| | | Assets | | Liabilities | |
(Millions) | | September 30, 2006 | | December 31, 2005 | | September 30, 2006 | | December 31, 2005 | |
WPSC | | | | | | | | | |
| Commodity contracts | | $ | 4.0 | | $ | 22.0 | | $ | 10.2 | | $ | - | |
| Financial transmission rights | | | 20.4 | | | 13.6 | | | 2.6 | | | 1.7 | |
Total | | $ | 24.4 | | $ | 35.6 | | $ | 12.8 | | $ | 1.7 | |
Balance Sheet Presentation | | | | | | | | | | | | | |
| Current | | $ | 24.4 | | $ | 29.3 | | $ | 11.2 | | $ | 1.7 | |
| Long-term | | | - | | | 6.3 | | | 1.6 | | | - | |
Total | | $ | 24.4 | | $ | 35.6 | | $ | 12.8 | | $ | 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 ESI's Canadian operations. In addition, ESI 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 that can be recognized from ESI's investment in a synthetic fuel production facility for 2006 and 2007. See Note 11, "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 in the Condensed Consolidated Statements of Income was not significant for the three months ended September 30, 2006 and 2005. Fair value hedge ineffectiveness recorded in nonregulated revenue in the Condensed Consolidated Statements of Income was a pre-tax gain of $3.1 million for the nine months ended September 30, 2006, and was not significant for the nine months ended September 30, 2005. 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 the three months ended September 30, 2006 and 2005, the amounts excluded were not significant. During the nine months ended September 30, 2006, the amount excluded was a pre-tax gain of $1.2 million. During the nine months ended September 30, 2005, the amount excluded was a pre-tax loss of $4.4 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 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 in the Condensed Consolidated Statements of Income related to commodity contracts was a pre-tax gain of $4.9 million for the three months ended September 30, 2006, and was not significant for the three months ended September 30, 2005. Cash flow hedge ineffectiveness recorded in nonregulated revenue in the Condensed Consolidated Statements of Income related to commodity contracts was a pre-tax gain of $9.0 million for the nine months ended September 30, 2006, and was not significant for the
nine months ended September 30, 2005. 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 the three and nine months ended September 30, 2006 and 2005, the amounts reclassified from other comprehensive income into earnings as a result of the discontinuance of cash flow hedge accounting for certain hedge transactions related to commodity contracts were not significant. In the next 12 months, subject to changes in market prices of natural gas and electricity, we expect that an after-tax gain of $13.9 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 a WPS Resources 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 WPS Resources obligation. 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 three and nine months ended September 30, 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 September 30, 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, WPS Resources 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. WPS Resources terminated the original swap and entered into a new swap with a ten-year term beginning in December 2006. WPS Resources reclassified a $0.4 million gain from other comprehensive income to interest expense related to the original swap. We believe that all other hedged forecasted interest payments are probable of occurring.
The new swap also qualifies for cash flow hedge treatment and is considered highly effective in hedging the benchmark interest rate risk on the forecasted debt issuance. As a result, changes in the fair value of the swap are recorded in other comprehensive income, net of taxes. Cash flow hedge ineffectiveness recorded in earnings related to the new swap were not significant during the three and nine months ended September 30, 2006. Amounts included in accumulated other comprehensive income will be reclassified to interest expense as the related interest on the debt becomes due.
NOTE 4--SUNBURY
In July 2006, ESI 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 $34.1 million, subject to post closing adjustments, and the pre-tax gain recorded in the third quarter was $20.8 million. 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. ESI had been evaluating Sunbury's future since 2004, after an agreement to sell Sunbury was terminated. The sale of Sunbury allows ESI 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, "Accounting for the Impairment or Disposal of Long-Lived Assets," in the December 31, 2005 balance sheet. SFAS No. 144 requires that a long-lived asset classified as held for sale be measured at the lower of its carrying amounts or fair value, less costs to sell, and cease being depreciated. No adjustments to write down the Sunbury assets were required during the nine months ended September 30, 2006. The major classes of assets and liabilities classified as held for sale at December 31, 2005 are 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 (excluding the gain on the sale) recorded in the Condensed Consolidated Statements of Income for the three months ended September 30 was as follows:
(Millions) | | 2006 | | 2005 | |
| Nonregulated revenue | | $ | 9.8 | | $ | 37.2 | |
| Operating expenses | | | | | | | |
| Nonregulated cost of fuel, natural gas, and purchased power | | | (11.3 | ) | | (24.0 | ) |
| Operating and maintenance expense | | | (1.2 | ) | | (6.2 | ) |
| Depreciation expense | | | - | | | (0.1 | ) |
| Taxes other than income | | | (0.2 | ) | | (0.2 | ) |
| Income (loss) before taxes | | | (2.9 | ) | | 6.7 | |
| Income tax provision | | | 1.7 | | | (3.2 | ) |
| Discontinued operations, net of tax | | $ | (1.2 | ) | $ | 3.5 | |
A summary of the components of discontinued operations (excluding the gain on the sale) recorded in the Condensed Consolidated Statements of Income for the nine months ended September 30 was as follows:
(Millions) | | 2006 | | 2005 | |
| Nonregulated revenue | | $ | 69.2 | | $ | 75.0 | |
| Operating expenses | | | | | | | |
| Nonregulated cost of fuel, natural gas, and purchased power | | | (61.6 | ) | | (43.8 | ) |
| Operating and maintenance expense | | | (16.8 | ) | | (20.5 | ) |
| Depreciation expense | | | (0.3 | ) | | (0.1 | ) |
| Gain (loss) on sale of emission allowances | | | (0.4 | ) | | 86.8 | |
| Impairment loss | | | - | | | (80.6 | ) |
| Taxes other than income | | | (0.3 | ) | | (0.3 | ) |
| Interest income (expense) | | | 0.1 | | | (10.6 | ) |
| Income (loss) before taxes | | | (10.1 | ) | | 5.9 | |
| Income tax benefit (provision) | | | 4.5 | | | (2.9 | ) |
| Discontinued operations, net of tax | | $ | (5.6 | ) | $ | 3.0 | |
The after-tax gain from the sale of Sunbury included in discontinued operations for the three and nine months ended September 30, 2006, was $12.7 million. Interest recorded for the quarter and nine months ended September 30, 2006 was not significant. For the nine months ended September 30, 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 a WPS Resources 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.
NOTE 5--ACQUISITIONS AND SALES OF ASSETS
Proposed sale of Niagara Generation
In October 2006, ESI entered into an agreement to sell WPS Niagara Generation, LLC, which owns a 53-megawatt merchant generation facility located near Niagara Falls, New York, for approximately $31 million, subject to post closing adjustments. ESI received an unsolicited offer to purchase the facility and believed the price being offered was above the value ESI would realize from continued ownership of the facility. The transaction is anticipated to close in the first quarter 2007, subject to New York State Public Service Commission and FERC regulatory approvals and is expected to generate an approximate $25 million pre-tax gain.
As of September 30, 2006, WPS Niagara Generation, LLC, did not meet the criteria to be reported as held for sale. The major classes of assets associated with the sale agreement are as follows:
(Millions) | | September 30, 2006 | |
| Inventories | | $ | 0.6 | |
| Other current assets | | | 1.1 | |
| Property, plant, and equipment, net | | | 4.3 | |
| Total assets | | $ | 6.0 | |
Proposed merger with Peoples Energy Corporation
On July 10, 2006, WPS Resources and Peoples Energy Corporation announced they had entered into a definitive merger agreement. Upon consummation of the transaction, each common share of Peoples Energy will be converted into 0.825 shares of WPS Resources' common stock and will result in WPS Resources' shareholders owning approximately 58 percent of the combined company, and Peoples Energy shareholders owning approximately 42 percent. The transaction, which was unanimously approved by both companies' Boards of Directors, is subject to receipt of all necessary regulatory
approvals and certain shareholder approvals of both companies. A WPS Resources shareholder meeting will be held on December 6, 2006, to vote on the amendment of the articles of incorporation to change the name of the company to Integrys Energy Group, Inc. and to vote on the issuance of the additional shares of WPS Resources' common stock as contemplated by the merger agreement. The Peoples Energy shareholder meeting is also scheduled for December 6, 2006. Early termination of the Hart-Scott-Rodino waiting period was received on October 25, 2006. Approvals of various state and federal regulatory authorities, including the FERC, PSCW, and ICC are pending. On August 2, 2006, WPS Resources and Peoples Energy (the "Applicants") filed a joint application with the ICC to approve the merger between the Applicants. The Applicants requested an expedited proceeding as WPS Resources believes the ICC to be the critical path to the closing of the merger. Key components of the application include an expected rate filing for Peoples Gas and North Shore Gas in early 2007 based on a 2006 historical test year. The Applicants requested that this filing not include either the costs to achieve or the synergies, but represent a "pre-close" cost of service. Also, the Applicants agreed that Peoples Gas and North Shore Gas would not file another rate case before February 1, 2009. Expedited regulatory approval has been requested from the ICC and a status hearing will take place on November 17, 2006. In August 2006, the PSCW opened a contested case proceeding to investigate the merger. The contested case proceeding is to consider any and all effects the merger would have on WPS Resources' subsidiaries, specifically WPSC. The PSCW subsequently opened a docket requiring approval of both the merger and affiliated interest agreements required to provide services between WPS Resources and its affiliates. In both Illinois and Wisconsin, if WPS Resources is able to negotiate a resolution of issues with the respective commissions and intervenors, such agreements could be approved by the respective commissions before year end. If the parties do not reach a resolution, a fully litigated case could still be completed by the end of the first quarter 2007.
Peoples Energy is a diversified energy company consisting of four primary business segments: natural gas distribution, oil and natural gas production, energy assets 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.
The merger will be accounted for under the purchase method of accounting with WPS Resources treated as the acquirer. The combination of the two companies will create a diversified regulated utility business that will serve about 1.6 million natural gas customers and over 450,000 electric customers.
Sale of Kimball Storage Field
In April 2006, ESI sold WPS ESI Gas Storage, LLC, which owned a natural gas storage field located in the Kimball Township, St. Clair County, Michigan. ESI utilized this facility primarily for structured wholesale natural gas transactions as natural gas storage spreads presented arbitrage opportunities. ESI 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 the Kimball natural gas storage field, 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 WPS Resources, 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
On September 21, 2005, WPS Resources, through wholly owned subsidiaries, entered into two definitive agreements with Aquila, Inc. (Aquila) to acquire its natural gas distribution operations in Michigan and Minnesota for approximately $558 million, exclusive of direct costs of the acquisition. This purchase price excluded adjustments for working capital balances, including accounts receivable, unbilled revenue, inventory, and certain other current assets, and is subject to other closing and post-closing adjustments. WPS Resources did not assume any indebtedness of the seller in the transactions.
Michigan
On April 1, 2006, WPS Resources, through its wholly owned subsidiary MGUC, completed the acquisition of the 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.
WPS Resources paid total consideration of $344.6 million for the Michigan natural gas distribution operations, which included closing adjustments related primarily to purchased working capital, which are still subject to certain post closing adjustments. The transaction was initially funded with commercial paper borrowings supported by the revolving credit agreement entered into with J. P. Morgan Chase Bank, N.A. and Bank of America, N.A. (see Note 7 "Short-Term Debt and Lines of Credit" for more information on the revolving credit agreements). Permanent financing for the acquisition is expected to 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 ($344.6 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 condensed 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 finalized, adjustments to goodwill may result.
(Millions) | | | |
| Accounts receivable, net | | $ | 28.6 | |
| Accrued unbilled revenues | | | 15.6 | |
| Inventories | | | 23.9 | |
| Other current assets | | | 3.3 | |
| Property plant and equipment, net | | | 137.2 | |
| Regulatory assets | | | 25.2 | |
| Other long-term assets | | | | |
| Goodwill | | | 152.6 | |
| Intangibles - trade name | | | 5.2 | |
| Other long-term assets | | | 6.2 | |
| Total Assets | | | 397.8 | |
| | | | | |
| Other current liabilities | | | 6.1 | |
| Regulatory liabilities | | | 1.2 | |
| Environmental remediation liabilities | | | 24.9 | |
| Pension and postretirement benefit obligations | | | 20.8 | |
| Other long-term liabilities | | | 0.2 | |
| Total Liabilities | | | 53.2 | |
| Net assets acquired | | $ | 344.6 | |
Minnesota
On July 1, 2006, WPS Resources, through its wholly owned subsidiary, MERC, completed the acquisition of the natural gas distribution operations in Minnesota from Aquila. The Minnesota natural gas assets provide natural gas distribution service in 165 cities and communities including Grand Rapids, Pine City, Rochester, 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.
WPS Resources paid total consideration of $321.8 million for the Minnesota natural gas distribution operations, which included closing adjustments related primarily to purchased working capital. The transaction was initially funded with commercial paper borrowings supported by the revolving credit agreement entered into with J. P. Morgan Chase Bank, N.A. and Bank of America, N.A. (see Note 7 "Short-Term Debt and Lines of Credit," for more information on the revolving credit agreements). Permanent financing for the acquisition is expected to 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 final purchase price is still subject to post-closing adjustments.
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 condensed 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 | | $ | 7.6 | |
| Accrued unbilled revenues | | | 3.5 | |
| Inventories | | | 6.3 | |
| Other current assets | | | 2.6 | |
| Property plant and equipment, net | | | 158.1 | |
| Regulatory assets | | | 3.2 | |
| Other long-term assets | | | | |
| Goodwill | | | 160.3 | |
| Other long-term assets | | | 2.3 | |
| Total Assets | | | 343.9 | |
| | | | | |
| Other current liabilities | | | 2.5 | |
| Regulatory liabilities | | | 4.6 | |
| Pension and postretirement benefit obligations | | | 13.0 | |
| Other long-term liabilities | | | 2.0 | |
| Total Liabilities | | | 22.1 | |
| Net assets acquired | | $ | 321.8 | |
The following table provides supplemental pro forma results of operations for WPS Resources for the nine months ended September 30, 2006 and 2005 and for the three months ended September 30, 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 Nine Months Ended September 30 | | Pro Forma for the Three Months Ended September 30 | |
(Millions) | | 2006 | | 2005 | | 2005 | |
| Net revenue | | $ | 5,313.1 | | $ | 4,843.9 | | $ | 1,768.8 | |
| Income available for common shareholders | | $ | 144.6 | | $ | 143.6 | | $ | 44.0 | |
| Basic earnings per share | | $ | 3.45 | | $ | 3.78 | | $ | 1.15 | |
| Diluted earnings per share | | $ | 3.44 | | $ | 3.75 | | $ | 1.14 | |
NOTE 6--GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill recorded by WPS Resources was $349.3 million at September 30, 2006, and $36.8 million at December 31, 2005. At September 30, 2006, $160.3 million of goodwill was related to the acquisition of the natural gas distribution operations in Minnesota, $152.6 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. 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 ESI. Also 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.
Identifiable intangible assets other than goodwill are included as a component of other assets within the Condensed Consolidated Balance Sheets. Information in the tables below relates to purchased identifiable intangible assets for the periods indicated.
(Millions) | | September 30, 2006 | | December 31, 2005 | |
Asset Class | | Gross Carrying Amount | | Accumulated Amortization | | Net | | Gross Carrying Amount | | Accumulated Amortization | | Net | |
Emission allowances(1) | | $ | 5.3 | | $ | (0.4 | ) | $ | 4.9 | | $ | 39.3 | | $ | (22.2 | ) | $ | 17.1 | |
Customer related | | | 7.2 | | | (3.6 | ) | | 3.6 | | | 10.2 | | | (5.6 | ) | | 4.6 | |
Other | | | 4.0 | | | (0.8 | ) | | 3.2 | | | 4.2 | | | (0.9 | ) | | 3.3 | |
Total | | $ | 16.5 | | $ | (4.8 | ) | $ | 11.7 | | $ | 53.7 | | $ | (28.7 | ) | $ | 25.0 | |
(1)Emission allowances have a weighted-average amortization period of approximately 1 year.
Intangible asset amortization expense, in the aggregate, for the three months ended September 30, 2006 and 2005, was $0.5 million and $10.1 million, respectively. Intangible asset amortization expense, in the aggregate, for the nine months ended September 30, 2006 and 2005, was $1.6 million and $13.1 million, respectively. 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. ESI 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, "Sunbury," for more information.
Amortization expense for the next five fiscal years is estimated as follows:
Estimated Future Amortization Expense (millions) | | | |
| For three months ending December 31, 2006 | | $ | 0.4 | |
| For year ending December 31, 2007 | | | 1.3 | |
| For year ending December 31, 2008 | | | 1.0 | |
| For year ending December 31, 2009 | | | 0.8 | |
| For year ending December 31, 2010 | | | 0.6 | |
NOTE 7--SHORT-TERM DEBT AND LINES OF CREDIT
In June 2006, WPS Resources 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 WPS Resources' total borrowing capacity under its general credit agreements to $1 billion. Both credit lines back WPS Resources' 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 September 30, 2006, there was a total of $449.5 million available under WPS Resources' general credit lines, including $13.4 million available under WPSC's general credit line.
In November 2005, WPS Resources entered into two unsecured revolving credit agreements of $557.5 million and $300 million with J. P. 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 WPS Resources completes, with the exception of proceeds received from the November 2005 equity offering. On March 31, 2006, WPS Resources 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 WPS Resources' 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 and will be further reduced as permanent or replacement financing is secured. The $417.9 million credit agreement matures on September 5, 2007, and has representations and covenants that are similar to those in WPS Resources' general credit facilities. On June 30, 2006, WPS Resources 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. See Note 5, "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 ESI 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 September 30, 2006, ESI maximized its borrowing capabilities under this agreement.
The information in the table below relates to WPS Resources' short-term debt and lines of credit as of the time periods indicated.
(Millions) | | September 30, 2006 | | December 31, 2005 | |
| Commercial paper outstanding | | $ | 888.3 | | $ | 254.8 | |
| Average effective rate on outstanding commercial paper | | | 5.47 | % | | 4.54 | % |
| Short-term notes payable outstanding | | $ | 168.6 | | $ | 10.0 | |
| Average interest rate on short-term notes payable | | | 5.80 | % | | 4.32 | % |
| Available (unused) lines of credit | | $ | 449.5 | | $ | 249.1 | |
The commercial paper at September 30 had varying maturity dates ranging from October 2 through November 15, 2006.
The information in the table below relates to WPSC's short-term debt and lines of credit as of the time periods indicated.
(Millions) | | September 30, 2006 | | December 31, 2005 | |
| Commercial paper outstanding | | $ | 97.8 | | $ | 75.0 | |
| Average effective rate on outstanding commercial paper | | | 5.45 | % | | 4.54 | % |
| Short-term notes payable outstanding | | $ | 10.0 | | $ | 10.0 | |
| Average interest rate on short-term notes payable | | | 5.35 | % | | 4.32 | % |
| Available (unused) lines of credit | | $ | 13.4 | | $ | 36.2 | |
The commercial paper at September 30 had varying maturity dates ranging from October 2 through October 13, 2006.
NOTE 8--LONG-TERM DEBT
(Millions) | | September 30, 2006 | | December 31, 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 | |
| | | | 6.08 | % | | 2028 | | | 50.0 | | | 50.0 | |
| | | | | | | | | | | | | | |
| First mortgage bonds - UPPCO | | | | | | |
| | | | Series | | | Year Due | | | | | | | |
| | | | 9.32 | % | | 2021 | | | 14.4 | | | 14.4 | |
| | | | | | | | | | | | | | |
| Unsecured senior notes - WPS Resources | | | | | | |
| | | Series | | | Year Due | | | | | | | |
| | | | 7.00 | % | | 2009 | | | 150.0 | | | 150.0 | |
| | | | 5.375 | % | | 2012 | | | 100.0 | | | 100.0 | |
| | | | | | | |
| Unsecured term loan due 2010 - WPS Resources | | 65.6 | | | 65.6 | |
| Term loans - non-recourse, collateralized by nonregulated assets | | 15.2 | | | 16.4 | |
Tax exempt bonds | | 27.0 | | | 27.0 | |
| Senior secured note | | 2.2 | | | 2.4 | |
| Total | | 871.5 | | | 872.9 | |
| Unamortized discount and premium on bonds and debt | | (1.6 | ) | | (1.8 | ) |
| Total debt | | 869.9 | | | 871.1 | |
| Less current portion | | (4.2 | ) | | (4.0 | ) |
| Total long-term debt | $ | 865.7 | | $ | 867.1 | |
NOTE 9--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," WPS Resources 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 ESI relate to asbestos abatement at certain generation facilities. All asset retirement obligations are recorded as other long-term liabilities in the Condensed Consolidated Balance Sheets of WPS Resources and WPSC.
The following table shows all changes to the asset retirement obligation liabilities of WPS Resources.
(Millions) | | Utilities | | ESI | | Total | |
| 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 Sunbury sale | | | - | | | (5.7 | ) | | (5.7 | ) |
| Accretion | | | 0.3 | | | 0.2 | | | 0.5 | |
Asset retirement obligations at September 30, 2006 | | $ | 9.2 | | $ | 0.8 | | $ | 10.0 | |
WPSC's share of the asset retirement obligations in the above table was $8.0 million at September 30, 2006, and $7.7 million at December 31, 2005. Accretion at WPSC for the nine months ended September 30, 2006 was $0.3 million.
NOTE 10--INCOME TAXES
The effective tax rate for the three and nine months ended September 30, 2006, was 1.7% and 26.6%, respectively. The effective tax rate for the three and nine months ended September 30, 2005, was 25.0% and 22.1%, respectively. WPS Resources' and WPSC's provision for income taxes were calculated in accordance with APB Opinion No. 28, "Interim Financial Reporting." Accordingly, our interim effective tax rate reflects our projected annual effective tax rate. The effective tax rate differs from the federal tax rate of 35%, primarily due to the effects of Section 29/45K federal tax credits related to our ownership in a synthetic fuel production facility and state income taxes.
NOTE 11--COMMITMENTS AND CONTINGENCIES
Commodity and Purchase Order Commitments
WPS Resources routinely enters into long-term purchase and sale commitments that have various quantity requirements and durations. The commitments described below are as of September 30, 2006.
ESI has unconditional purchase obligations related to energy supply contracts that total $6.1 billion. Substantially all of these obligations end by 2008, with obligations totaling $804.8 million extending from 2009 through 2018. The majority of the energy supply contracts are to meet ESI's 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 $471.1 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 $107.5 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 $32.6 million and extend through 2010.
MGUC has obligations related to natural gas contracts totaling $69.7 million, substantially all of which end by 2009.
MERC has obligations related to natural gas contracts totaling $177.1 million, some of which extend through 2014.
WPS Resources also has commitments in the form of purchase orders issued to various vendors. At September 30, 2006, these purchase orders totaled $438.0 million and $326.8 million for WPS Resources 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 Company 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 Company, Madison Gas and Electric Company, and WPSC). Wisconsin Power and Light Company 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 Company 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 Company, 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 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 generation 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 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
The Sierra Club and Clean Wisconsin filed a complaint in the Eastern District of Wisconsin on October 19, 2005. The lawsuit was filed pursuant to the citizen suit provisions of the Clean Air Act. The complaint references opacity exceedances reported by the Pulliam facility located in Green Bay, Wisconsin, from 1999 through the first quarter of 2005. The complaint also alleges monitoring violations from 1999 through 2004, exceedances of the Clean Air Act operating permit in 2002, exceedances of the permit issued for eight diesel generators in 2001, and exceedances of the permit for one of the combustion turbines. The lawsuit seeks penalties, injunctive relief, and costs of litigation. WPSC filed an answer to the complaint on March 6, 2006, asserting a number of affirmative defenses. The Sierra Club and Clean Wisconsin have resolved this suit by entering into a Consent Decree on October 25, 2006. WPSC has agreed to pay the plaintiffs' nominal legal fees, fund $500,000 of environmental projects through the Wisconsin Energy Conservation Corporation (WECC), perform upgrades on the precipitators and other environmental control equipment at Pulliam, and make additional payments to WECC for environmental projects if Pulliam exceeds pre-determined limits after implementation and testing of the changes noted above. According to the settlement, WPSC agreed to decide whether to perform the environmental upgrades at its 373-megawatt J.P. Pulliam Plant units in Green Bay, or shut the units down. WPSC has opted to shut down units 3 and 4 (both are 30-megawatt units) at Pulliam on December 31, 2007. WPSC will implement environmental control upgrades on Pulliam units 5, 6, 7, and 8 and continue to operate those units. According to the settlement, WPSC had some time to decide on Pulliam units 3 and 4, but internal studies indicated that it made sense to retire these older units. Since WPSC expects the 500-megawatt Weston 4 plant to come on line in 2008, there are no electric supply concerns 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 air permit issued for the Weston 4 generation station. On December 2, 2004, the WDNR granted the petition and forwarded the matter to the Division of Hearings and Appeals. In its petition, the Sierra Club raised legal and factual issues with the permit and with the process used by WDNR to develop the air emission limits and conditions. Certain issues were decided on summary judgment in favor of WPSC with respect to certain Sierra Club claims consistent with the rulings rendered in Wisconsin Energy's Elm Road proceeding. The contested case hearing in the matter was held during the last week of September 2005. The hearing addressed the remaining issues, which are generally related to the emission limits specified in the permit and the pollution controls to be used to achieve these limits. In February 2006, the Administrative Law Judge affirmed the Weston 4 air permit with modifications to the emission limits for sulfur dioxide and nitrogen oxide from the coal-fired boiler and particulate from the cooling tower. The modifications set limits that are more stringent than those set by the WDNR. 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. These activities did not stay the Administrative Law Judge's decision on the permit. The WDNR intends to revise the air permit consistent with that decision.
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 have 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, WPS Resources 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 (CO) 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 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 CO 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 will 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. Because federal regulations were promulgated in March 2005, we believe the state of Wisconsin will revise the Wisconsin rule to be consistent with the federal rule. 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 future rate cases.
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.
ESI's current analysis indicates that additional emission control equipment on its existing units may be required. ESI estimates the capital costs to be approximately $1 million to achieve a 70% reduction.
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. The states have not adopted a preference as to which option they would select, but the states are investigating the cap and trade program, as well as alternatives or additional requirements. Consequently, the effect of the rule on WPSC's and ESI's facilities is uncertain, since it depends upon how the states choose to implement the final Clean Air Interstate Rule.
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 $278 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.
ESI is evaluating the compliance options for the Clean Air Interstate Rule. Additional nitrogen oxide controls on some of ESI's facilities may be necessary, and would cost approximately $3 million. ESI 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 ESI 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, ESI expects to purchase sulfur dioxide and nitrogen oxide emission allowances at market rates, as needed, to meet 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 has 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 December 31, 2006.
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 is completed. Groundwater treatment and 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. 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 onsite investigative work will commence at two of the sites in 2007. WPSC estimated the future undiscounted investigation and cleanup costs as of September 30, 2006, to be approximately $65 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 has received $12.7 million to date in insurance recoveries. 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.
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. 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 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. WPS Resources 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. WPS Resources 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 WPS Resources.
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, WPS Resources, 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. WPS Resources is defending these lawsuits and is seeking resolution of all claims and litigation where possible. 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 WPS Resource's insurer and, therefore, did not have a material impact on the Condensed Consolidated Financial Statements. WPS Resources has also settled several small claims with various landowners that are also covered by insurance. WPS Resources is defending the remaining lawsuits filed against it and is seeking resolution of all claims and litigations where possible. A trial date in September 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 as of September 30, 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 $1.8 million. UPPCO has recorded $0.3 million of this amount as its share of the liability as of September 30, 2006.
There is increasing concern over the issue of climate change and the effect of greenhouse gas emissions. WPS Resources 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 WPS Resources 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 costs 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. WPS Resources 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. Three 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 present. Accordingly, WPSC intends to contest the plaintiff's claim for money damages.
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. The third case, Schmoker v. WPSC was brought in Wisconsin state court in Winnebago County. The parties are currently engaged in settlement discussions. A fourth case, Seidl v. WPSC, is 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 the 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.
WPS Resources 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, WPS Resources invested $22.4 million in ATC during the nine months ended September 30, 2006, bringing WPS Resources' investment in ATC related to the project to approximately $109 million since the inception of the project. WPS Resources 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. WPS Resources 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. Allete exercised its option to fund a portion of the Wausau to Duluth transmission line. WPSC and Allete agreed that Allete will fund up to $60 million of the future capital calls for the line. Considering this, for the period January 2006 through the anticipated completion of the line in 2008, WPS Resources expects to fund up to approximately $78 million for its portion of the Wausau to Duluth transmission line.
Beaver Falls
ESI's 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. Inclusive of insurance recoveries, ESI estimates that it will cost approximately $5.2 million to repair the turbine and replace the damaged blades. 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. ESI 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. ESI 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 WPS Resources, and the eventual outcome of these proceedings is unclear. As such, no amounts have been recorded for the potential RSG charges in WPS Resources' 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 ESI will be insignificant. This rehearing order is subject to court challenge.
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.
Section 29/45K Federal Tax Credits Related to Our Ownership Interest in a Synfuel Facility
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, ESI entered into a series of derivative (option) contracts, beginning in the first quarter of 2005, covering a specified number of barrels of oil. If no phase-out were to occur in 2006, we would expect to recognize approximately $32 million of Section 29/45K federal tax credits from our ownership interest in a synthetic fuel production facility. Based upon 2006 actual year-to-date and forward oil prices, we are anticipating partial phase-outs of 2006 and 2007 Section 29/45K federal tax credits. However, we cannot predict with certainty the future price of a barrel of oil and, therefore, have no way of knowing what portion of our 2006 and 2007 tax credits will ultimately be phased out. ESI estimates that 2006 Section 29/45K federal tax credits will begin phasing out if the annual average NYMEX price of a barrel of oil reaches approximately $61, with a total phase-out if the annual average NYMEX price of a barrel of oil reaches approximately $75. At September 30, 2006, based upon estimated annual average oil prices, we anticipate that approximately 43% of the 2006 tax credits that otherwise would be available from the production and sale of synthetic fuel would be phased-out. For the year ending December 31, 2006, including the projected tax credit phase-out, we expect to recognize the benefit of Section 29/45K federal tax credits totaling approximately $19 million from our ownership interest in a synthetic fuel production facility. However, the actual amount of tax credits recognized in 2006 could differ substantially from our September 30, 2006 estimate, based upon actual average annual oil prices and fourth quarter production levels.
At September 30, 2006, ESI had derivative (option) contracts that mitigated substantially all of the Section 29/45K tax credit exposure in 2006 and approximately 40% of the exposure in 2007. The derivative contracts involve purchased and written options that provide for net cash settlement at expiration based on the annual average NYMEX trading price of oil in relation to the strike price of each option. Net premiums paid to date for options to mitigate exposure to Section 29/45K federal tax credit phase-outs in 2006 and 2007 related to ESI's ownership interest in a synthetic fuel production facility totaled $17.4 million, all of which are recorded as risk management assets and liabilities on the balance sheet. Essentially, ESI paid $14.1 million for options ($8.5 million after-tax) to protect the value of approximately $32 million of tax credits in 2006 and $3.3 million to protect the value of 40% of the tax credits to be generated in 2007. The derivative contracts have not been designated as hedging instruments and, as a result, changes in the fair value of the options are recorded currently as a component of nonregulated revenue. This results in mark-to-market gains or losses being recognized in earnings in different periods than the tax credits.
In addition to exposure from federal tax credits, ESI has also historically received royalties tied to the amount of synthetic fuel produced as well as variable payments from a counterparty related to ESI's 2002 sale of 30% of its interest in ECO Coal Pelletization #12. While variable payments are received by ESI quarterly, royalties are a function of annual synthetic fuel production and are generally not received until later in the year. Because ESI's partners in the synthetic fuel facility have curtailed their synthetic fuel production throughout 2006, it is unlikely that ESI will realize any royalty income in 2006, compared to $3.5 million of pre-tax royalty income that was realized in 2005. ESI realized pre-tax income related to variable payments from the 2002 sale of $3.2 million in 2006, but does not expect to receive any variable payments in the fourth quarter of 2006 or for the year ended December 31, 2007. In comparison, ESI realized pre-tax income of $3.7 million related to the variable payments in 2005.
Additional Synthetic Fuel Production Procured in 2006
ESI's partners in the synthetic fuel facility curtailed production during the second and third quarters of 2006. In addition to the production ESI is entitled to based upon its ownership interest in the synthetic fuel facility (discussed above), ESI also elected to take, and economically hedge the risk associated with the additional production its synthetic fuel partner curtailed. The following facts are pertinent to understanding the impact these transactions had on results of operations for the nine months ended September 30, 2006, and the impact for the remainder of 2006.
| ● | If no phase-out of Section 29/45k federal tax credits occurs in 2006, the additional production that was procured would result in the recognition of approximately $9 million of tax credits. This is in addition to the $32 million of tax credits (disclosed above) that we would recognize from production procured from our ownership interest in the synthetic fuel production facility. |
| ● | For the year ending December 31, 2006, including the projected 43% tax credit phase-out, we expect to recognize the benefit of Section 29/45K federal tax credits totaling approximately $5 million from the additional production that was procured. This is in addition to the benefit of Section 29/45K federal tax credits totaling approximately $19 million that we expect to recognize from our ownership interest in the synthetic fuel production facility, including the projected 43% tax credit phase-out. |
| ● | For the nine months ended September 30, 2006, compared to the same period in 2005, ESI's share of operating losses from its investment in the synthetic fuel facility increased $6.4 million on a pre-tax basis, which was driven by the additional synthetic fuel production procured. |
| ● | Mark-to-market gains on derivative instruments related to the economic hedging strategies for the additional production that was procured are included in the table below. |
Impact of Synthetic Fuel Activities on Results of Operations
The following table shows the impact that ESI's investment in the synthetic fuel production facility and procurement of additional tons, including derivative (option) contract activity, had on the Condensed Consolidated Statements of Income for the three and nine months ended September 30.
Amounts are pre-tax, except tax credits (millions) | | Income (loss) | |
| | | Quarter Ended | | Nine Months Ended | |
| | | 2006 | | 2005 | | 2006 | | 2005 | |
| Provision for income taxes: | | | | | | | | | |
| Section 29/45K federal tax credits recognized | | $ | 12.4 | | $ | 5.5 | | $ | 20.0 | | $ | 24.1 | |
| | | | | | | | | | | | | | |
| Nonregulated revenue: | | | | | | | | | | | | | |
| Mark-to-market gains on 2005 oil options | | | - | | | 5.1 | | | - | | | 5.3 | |
| Net realized gains (losses) on 2005 oil options | | | - | | | 0.9 | | | - | | | (0.6 | ) |
| Mark-to-market (losses) gains on 2006 oil options | | | (15.8 | ) | | 2.6 | | | 1.9 | | | 5.7 | |
| Net realized gains on 2006 oil options | | | - | | | - | | | 2.0 | | | - | |
| Mark-to-market (losses) gains on 2007 oil options | | | (2.2 | ) | | 2.3 | | | 2.8 | | | 4.4 | |
| | | | | | | | | | | | | | |
| Miscellaneous income: | | | | | | | | | | | | | |
| Operating losses - synthetic fuel facility | | | (5.7 | ) | | (3.8 | ) | | (18.6 | ) | | (12.2 | ) |
| Variable payments received | | | 1.3 | | | 0.9 | | | 3.2 | | | 2.8 | |
| Royalty income recognized | | | - | | | - | | | - | | | - | |
| Deferred gain recognized | | | 0.6 | | | 0.6 | | | 1.7 | | | 1.7 | |
| Interest received on fixed note receivable | | | 0.2 | | | 0.3 | | | 0.7 | | | 1.0 | |
| | | | | | | | | | | | | | |
| Minority interest | | | 1.4 | | | 1.1 | | | 3.8 | | | 3.5 | |
NOTE 12--GUARANTEES
As part of normal business, WPS Resources 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 WPS Resources 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 authorized limits may or may not be reflected on WPS Resources' Condensed Consolidated Balance Sheet, depending on the nature of the guarantee.
At September 30, 2006, and December 31, 2005, outstanding guarantees totaled $1,535.4 million, and $1,310.6 million, respectively, as follows:
WPS Resources' Outstanding Guarantees (Millions) | | September 30, 2006 | | December 31, 2005 | |
| Guarantees of subsidiary debt | | $ | 178.2 | | $ | 27.2 | |
| Guarantees supporting commodity transactions of subsidiaries | | | 1,148.6 | | | 1,154.7 | |
| Standby letters of credit | | | 195.9 | | | 114.3 | |
| Surety bonds | | | 0.9 | | | 0.8 | |
| Other guarantees | | | 11.8 | | | 13.6 | |
| Total guarantees | | $ | 1,535.4 | | $ | 1,310.6 | |
| | | | | | | | | | | | |
WPS Resources' Outstanding Guarantees (Millions) Commitments Expiring | | Total Amounts Committed at September 30, 2006 | | Less Than 1 Year | | 1 to 3 Years | | 4 to 5 Years | | Over 5 Years | |
| Guarantees of subsidiary debt | | $ | 178.2 | | $ | 150.0 | | $ | - | | $ | - | | $ | 28.2 | |
| Guarantees supporting commodity transactions of subsidiaries | | | 1,148.6 | | | 1,027.2 | | | 49.7 | | | 13.6 | | | 58.1 | |
| Standby letters of credit | | | 195.9 | | | 191.4 | | | 4.5 | | | - | | | - | |
| Surety bonds | | | 0.9 | | | 0.9 | | | - | | | - | | | - | |
| Other guarantees | | | 11.8 | | | - | | | - | | | 11.8 | | | - | |
| Total guarantees | | $ | 1,535.4 | | $ | 1,369.5 | | $ | 54.2 | | $ | 25.4 | | $ | 86.3 | |
At September 30, 2006, WPS Resources had outstanding $178.2 million in corporate guarantees supporting indebtedness. Of that total, $150.0 million supports an ESI 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 WPS Resources and are subject to the aggregate $1.5 billion guarantee limit authorized for ESI by WPS Resources' Board of Directors (discussed below). As of September 30, 2006, the entire $150 million has been borrowed by ESI, leaving no availability left on the existing credit agreement. The remaining $28.2 million of guarantees support outstanding debt at ESI's subsidiaries, of which $1.0 million is subject to the $1.5 billion limit and the remaining $27.2 million received separate authorization from WPS Resources' Board of Directors. The underlying debt related to these guarantees is reflected on WPS Resources' Condensed Consolidated Balance Sheet.
WPS Resources' Board of Directors has authorized management to issue corporate guarantees in the aggregate amount of up to $1.5 billion to support the business operations of ESI. WPS Resources primarily issues the guarantees to counterparties in the wholesale electric and natural gas marketplace to provide them assurance that ESI will perform on its obligations and permit ESI to operate within these markets. At September 30, 2006, WPS Resources provided parental guarantees subject to this limit in the amount of $1,079.9 million, reflected in the above table, related to guarantees to ESI's wholesale counterparties. In addition, WPS Resources also provided parental guarantees for ESI of $8.1 million that received specific authorization from WPS Resources' Board of Directors and are not included in the $1.5 billion general authorized amount. Of the parental guarantees provided by WPS Resources, the current amount at September 30, 2006, which WPS Resources would be obligated to support, is approximately $500 million.
Another $2.7 million of corporate guarantees support energy and transmission supply at UPPCO and are not reflected on WPS Resources' Condensed Consolidated Balance Sheet. In February 2005, WPS Resources' 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.
Both MGUC and MERC have been authorized to issue corporate guarantees in the amount of $50 million each to support their business operations. MGUC and MERC had $28.0 million and $29.9 million, respectively, of outstanding guarantees related to natural gas supply at September 30, 2006.
At WPS Resources' request, financial institutions have issued $195.9 million in standby letters of credit for the benefit of third parties that have extended credit to certain subsidiaries. Of this amount, $190.9 million has been issued to support ESI's operations. Included in the $190.9 million is $2.5 million that has specific authorization from WPS Resources' Board of Directors and is not included in the $1.5 billion guarantee limit. The remaining $188.4 million counts against the $1.5 billion guarantee limit authorized for ESI. 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 WPS Resources. Any amounts owed by our subsidiaries are reflected in WPS Resources' Condensed Consolidated Balance Sheet.
At September 30, 2006, WPS Resources furnished $0.9 million of surety bonds for various reasons including worker compensation coverage and obtaining various licenses, permits, and rights-of-way. Of the $0.9 million of surety bonds, $0.3 million supports ESI and is included in the $1.5 billion guarantee limit authorized for ESI. Liabilities incurred as a result of activities covered by surety bonds are included in WPS Resources' Condensed Consolidated Balance Sheet.
A guarantee of $4.3 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 WPS Resources' Condensed 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 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 combined exposure of $15 million for WPSC and Wisconsin Power and Light. 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 $1.4 million to Dominion related to this guarantee, reducing the liability to $7.5 million as of September 30, 2006.
Under the agreements related to the sale of Sunbury and the Kimball storage field, ESI agreed to indemnify the buyers for losses resulting from potential breaches of ESI's representations and warranties thereunder. ESI 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.
NOTE 13--EMPLOYEE BENEFIT PLANS
The following table provides the components of net periodic benefit cost for WPS Resources' benefit plans for the three months ended September 30:
| WPS Resources | | Pension Benefits | | Other Benefits | |
(Millions) | | 2006 | | 2005 | | 2006 | | 2005 | |
Net periodic benefit cost | | | | | | | | | | | | | |
| Service cost | | $ | 6.2 | | $ | 6.0 | | $ | 1.8 | | $ | 2.0 | |
| Interest cost | | | 10.9 | | | 10.0 | | | 4.4 | | | 4.1 | |
| Expected return on plan assets | | | (11.3 | ) | | (10.9 | ) | | (3.5 | ) | | (3.1 | ) |
| Amortization of transition obligation | | | - | | | - | | | 0.1 | | | 0.1 | |
| Amortization of prior-service cost (credit) | | | 1.3 | | | 1.3 | | | (0.6 | ) | | (0.6 | ) |
| Amortization of net loss | | | 2.2 | | | 2.2 | | | 1.4 | | | 1.4 | |
| Net periodic benefit cost | | $ | 9.3 | | $ | 8.6 | | $ | 3.6 | | $ | 3.9 | |
WPSC's share of net periodic benefit cost for the three months ended September 30 is included in the table below:
| WPSC | | Pension Benefits | | Other Benefits | |
(Millions) | | 2006 | | 2005 | | 2006 | | 2005 | |
Net periodic benefit cost | | | | | | | | | |
| Service cost | | $ | 4.6 | | $ | 4.8 | | $ | 1.6 | | $ | 1.9 | |
| Interest cost | | | 8.2 | | | 8.4 | | | 3.6 | | | 3.7 | |
| Expected return on plan assets | | | (9.0 | ) | | (9.6 | ) | | (3.2 | ) | | (3.0 | ) |
| Amortization of transition obligation | | | - | | | - | | | 0.1 | | | 0.1 | |
| Amortization of prior-service cost (credit) | | | 1.2 | | | 1.2 | | | (0.5 | ) | | (0.5 | ) |
| Amortization of net loss | | | 1.7 | | | 1.5 | | | 1.0 | | | 1.2 | |
| Net periodic benefit cost | | $ | 6.7 | | $ | 6.3 | | $ | 2.6 | | $ | 3.4 | |
The following table provides the components of net periodic benefit cost for WPS Resources' benefit plans for the nine months ended September 30:
| WPS Resources | | Pension Benefits | | Other Benefits | |
(Millions) | | 2006 | | 2005 | | 2006 | | 2005 | |
Net periodic benefit cost | | | | | | | | | |
| Service cost | | $ | 18.0 | | $ | 17.9 | | $ | 5.3 | | $ | 6.0 | |
| Interest cost | | | 31.3 | | | 30.2 | | | 12.9 | | | 12.4 | |
| Expected return on plan assets | | | (32.7 | ) | | (32.7 | ) | | (10.1 | ) | | (9.4 | ) |
| Amortization of transition obligation | | | 0.1 | | | 0.1 | | | 0.3 | | | 0.3 | |
| Amortization of prior-service cost (credit) | | | 3.9 | | | 4.0 | | | (1.7 | ) | | (1.6 | ) |
| Amortization of net loss | | | 7.3 | | | 6.5 | | | 4.0 | | | 4.1 | |
| Net periodic benefit cost | | $ | 27.9 | | $ | 26.0 | | $ | 10.7 | | $ | 11.8 | |
WPSC's share of net periodic benefit cost for the nine months ended September 30 is included in the table below:
| WPSC | | Pension Benefits | | Other Benefits | |
(Millions) | | 2006 | | 2005 | | 2006 | | 2005 | |
Net periodic benefit cost | | | | | | | | | |
| Service cost | | $ | 13.8 | | $ | 14.5 | | $ | 4.9 | | $ | 5.6 | |
| Interest cost | | | 24.6 | | | 25.1 | | | 10.7 | | | 11.3 | |
| Expected return on plan assets | | | (27.0 | ) | | (28.7 | ) | | (9.6 | ) | | (9.1 | ) |
| Amortization of transition obligation | | | 0.1 | | | 0.1 | | | 0.3 | | | 0.3 | |
| Amortization of prior-service cost (credit) | | | 3.5 | | | 3.6 | | | (1.5 | ) | | (1.4 | ) |
| Amortization of net loss | | | 5.0 | | | 4.3 | | | 3.0 | | | 3.5 | |
| Net periodic benefit cost | | $ | 20.0 | | $ | 18.9 | | $ | 7.8 | | $ | 10.2 | |
Contributions to the plans are made in accordance with legal and tax requirements and do not necessarily occur evenly throughout the year. For the nine months ended September 30, 2006, $25.3 million of contributions were made to the pension benefit plan, and no contributions were made to the other postretirement benefit plans. WPS Resources expects to contribute an additional $17.9 million to its other postretirement benefit plans and does not expect to contribute any additional amount to its pension plan in the remainder of 2006.
NOTE 14--STOCK-BASED COMPENSATION
WPS Resources 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. No additional awards will be issued under the 2001 Omnibus Plan or the Employee 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 September 30, 2006, only stock options and performance stock rights were outstanding under the aforementioned plans.
Prior to January 1, 2006, WPS Resources accounted for the plans under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly, WPS Resources 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.
Effective January 1, 2006, WPS Resources 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. There was no material cumulative effect of a change in accounting principle recorded upon adoption of SFAS No 123R. Stock-based compensation cost for all awards granted after January 1, 2006, will be recognized based on the grant date fair value estimated in accordance with the provisions 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.
The following table illustrates the effect on income available for common shareholders and earnings per share for the third quarter of 2005, had WPS Resources applied the fair value recognition provisions of SFAS No. 123:
(Millions, except per share amounts) | | Three Months Ended September 30, 2005 | | Nine Months Ended September 30, 2005 | |
| | | | | | |
Income available for common shareholders | | | | | |
| As reported | | $ | 48.2 | | $ | 138.0 | |
| Add: Stock-based compensation expense using the intrinsic value method - net of tax | | | 0.3 | | | 1.6 | |
| Deduct: Stock-based compensation expense using the fair value method - net of tax | | | (0.4 | ) | | (1.1 | ) |
| Pro forma | | $ | 48.1 | | $ | 138.5 | |
| | | | | | | | |
Basic earnings per common share | | | | | | | |
| As reported | | $ | 1.26 | | $ | 3.63 | |
| Pro forma | | | 1.26 | | | 3.64 | |
| | | | | | | | |
Diluted earnings per common share | | | | | | | |
| As reported | | $ | 1.25 | | $ | 3.60 | |
| Pro forma | | | 1.25 | | | 3.62 | |
Stock Options
Under the provisions of the 2005 Omnibus Plan, no single employee who is the chief executive officer of WPS Resources or any of the other four highest compensated officers of WPS Resources and its subsidiaries can be granted options for more than 250,000 shares during any calendar year. Stock options are granted by the Compensation Committee of the Board of Directors and may be granted at any time. 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.
The number of stock options granted under the Director Plan may not exceed 100,000, and the shares to be delivered will consist solely of treasury shares. Stock options are granted at the discretion of the Board of Directors. No additional options may be granted under this plan. All options have a ten-year term, but they may not be exercised until one year after the date of grant. Options granted under this plan are immediately vested. The exercise price of each option is equal to the fair market value of the stock on the date the stock options were granted.
The fair values of stock option awards outstanding at January 1, 2006, were estimated using the Black-Scholes option-pricing model. Stock options granted after the implementation of SFAS No. 123R will be valued using a binomial lattice model. No stock options were granted during the nine months ended September 30, 2006, and no modifications were made to previously issued awards. Total pre-tax compensation expense recognized for stock options during the three and nine months ended September 30, 2006, was $0.2 million and $0.5 million, respectively, of which $0.1 million and
$0.3 million, respectively, relates to WPSC. The total compensation cost capitalized for these same periods was immaterial.
As of September 30, 2006, $1.1 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 2.4 years.
Cash received from option exercises during the three and nine months ended September 30, 2006, was $0.3 million and $0.9 million, respectively. The tax benefit realized from these option exercises was immaterial for the three and nine months ended September 30, 2006.
A summary of stock option activity for the nine months ended September 30, 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 | | | | | | | |
| Exercised | | | | | | | | | | | | | |
2001 Omnibus Plan | | | 19,186 | | | 38.45 | | | | | $ | 0.3 | |
| Employee Plan | | | 4,000 | | | 29.88 | | | | | | 0.1 | |
| Forfeited | | | | | | | | | | | | | |
| 2001 Omnibus Plan | | | 625 | | | 43.38 | | | | | | - | |
| Outstanding at September 30, 2006 | | | | | | | | | | | | | |
2001 Omnibus Plan | | | 1,174,630 | | | 41.77 | | $ | 6.80 | | | 9.2 | |
2005 Omnibus Plan | | | 325,347 | | | 54.85 | | | 9.19 | | | - | |
Employee Plan | | | 152,973 | | | 34.10 | | | 4.02 | | | 2.4 | |
Director Plan | | | 12,000 | | | 25.50 | | | 2.98 | | | 0.3 | |
| Options exercisable at September 30, 2006 | | | | | | | | | | | | | |
2001 Omnibus Plan | | | 692,927 | | | 39.32 | | | 6.30 | | | 7.1 | |
Employee Plan | | | 152,973 | | | 34.10 | | | 4.02 | | | 2.4 | |
Director Plan | | | 12,000 | | | 25.50 | | | 2.98 | | | 0.3 | |
No options expired during the nine months ended September 30, 2006.
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 September 30, 2006. This is calculated as the difference between WPS Resources' closing stock price on September 30, 2006, and the option exercise price, multiplied by the number of in-the-money stock options.
Other Stock-Based Compensation Awards
A portion of the long-term incentive is awarded in the form of performance stock rights. No more than 400,000 of the shares authorized for issuance under the provisions of the 2005 Omnibus Plan can be granted as performance shares. In addition, no single employee who is the chief executive officer of WPS Resources or any of the other four highest compensated officers of WPS Resources and its subsidiaries can receive a payout in excess of 50,000 performance shares during any calendar year. Performance stock rights vest over a three-year performance period and are paid out in shares of WPS Resources' common stock. 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 WPS Resources' 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 outstanding at January 1, 2006, were estimated using WPS Resources' 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 after the implementation of SFAS No. 123R will be estimated using a Monte Carlo valuation model. No performance stock rights were granted during the nine months ended September 30, 2006, and no modifications were made to previously issued awards. Pre-tax compensation expense recorded for performance stock rights for the three months and nine months ended September 30, 2006, was $0.7 million and $2.0 million, respectively. For these same time periods $0.4 million and $1.3 million relate to WPSC. The total compensation cost capitalized was immaterial.
The total intrinsic value of performance shares distributed during the first quarter of 2006 (related to the December 2002 grant) was $2.4 million. The tax benefit realized due to the distribution of performance shares totaled $1.0 million. No performance shares were distributed during the second and third quarters.
As of September 30, 2006, $2.5 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 2.0 years.
A summary of the activity of the performance stock rights plan for the nine months ended September 30, 2006, is presented below:
| | | Performance Stock Rights | | Weighted-Average Grant Date Fair Value | |
| Outstanding at December 31, 2005 | | | 211,421 | | $ | 41.93 | |
| Distributed | | | 37,600 | | $ | 31.60 | |
| Forfeited | | | 1,400 | | $ | 45.96 | |
Outstanding at September 30, 2006 | | | 172,421 | | $ | 44.14 | |
Performance stock rights vested at December 31, 2005, were paid out during the first quarter of 2006. The actual number of shares of WPS Resources' common stock distributed totaled 45,121 based on a payout of 120% of target. None of the stock rights outstanding at September 30, 2006, were exercisable at September 30, 2006.
NOTE 15--COMPREHENSIVE INCOME
SFAS No. 130, "Reporting Comprehensive Income," requires the reporting of other comprehensive income in addition to income available for common shareholders. Total comprehensive income includes all changes in equity during a period except those resulting from investments by shareholders and distributions to shareholders. WPS Resources' total comprehensive income is:
| | | Three Months Ended September 30, | |
(Millions) | | 2006 | | 2005 | |
| Income available for common shareholders | | $ | 39.5 | | $ | 48.2 | |
| Cash flow hedges, net of tax of $(2.4) and $(13.5) | | | (2.6 | ) | | (21.3 | ) |
| Foreign currency translation, net of tax | | | 0.1 | | | 0.4 | |
| Unrealized gain on available-for-sale securities, net of tax | | | (0.3 | ) | | 0.5 | |
| Total comprehensive income | | $ | 36.7 | | $ | 27.8 | |
| | | Nine Months Ended September 30, | |
(Millions) | | 2006 | | 2005 | |
| Income available for common shareholders | | $ | 134.5 | | $ | 138.0 | |
| Cash flow hedges, net of tax of $17.2 and $(20.5) | | | 27.8 | | | (32.0 | ) |
| Foreign currency translation, net of tax of | | | 0.4 | | | 0.1 | |
| Unrealized gain on available-for-sale securities, net of tax | | | (0.3 | ) | | 0.6 | |
| Total comprehensive income | | $ | 162.4 | | $ | 106.7 | |
The following table shows the changes to accumulated other comprehensive income (loss) from December 31, 2005, to September 30, 2006.
(Millions) | | | |
| December 31, 2005 balance | | $ | (10.4 | ) |
| Cash flow hedges | | | 27.8 | |
| Foreign currency translation | | | 0.4 | |
| Unrealized gain on available -for-sale securities | | | (0.3 | ) |
September 30, 2006 balance | | $ | 17.5 | |
NOTE 16--COMMON EQUITY
WPS Resources had the following changes to common stock outstanding for the three and nine months ended September 30, 2006:
WPS Resources' common stock shares, $1 par value | | Three Months Ended September 30, 2006 | | Nine Months Ended September 30, 2006 | |
| | | | | | |
| Common stock outstanding - beginning balance | | | 43,122,346 | | | 40,089,898 | |
| Shares issued | | | | | | | |
| Stock Investment Plan | | | 103,642 | | | 316,096 | |
| Stock options and employee stock option plans | | | 22,942 | | | 59,690 | |
| Physical settlement of equity forward | | | - | | | 2,700,000 | |
| Long-Term Incentive Plan | | | - | | | 33,788 | |
| Rabbi trust shares | | | 3,531 | | | 52,989 | |
| Common stock outstanding - ending balance | | | 43,252,461 | | | 43,252,461 | |
At September 30, 2006, and December 31, 2005, WPS Resources' had 12,000 treasury shares outstanding. The average cost of the treasury shares for both periods was $25.19. At September 30, 2006, WPS Resources' had 308,363 rabbi trust shares with an average cost of $42.12 per share. At December 31, 2005, WPS Resources' had 270,491 rabbi trust shares with an average cost of $40.29 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. The calculation of diluted earnings per share for the periods shown excludes some stock option and performance stock rights that had an anti-dilutive effect. The shares having an anti-dilutive effect are not significant for any of the periods shown. The following tables reconcile the computation of basic and diluted earnings per share:
| | | Three Months Ended
September 30 | | Nine Months Ended
September 30 | |
(Millions, except per share amounts) | | 2006 | | 2005 | | 2006 | | 2005 | |
| | | | | | | | | | |
Basic EPS | | | | | | | | | |
| Average shares of common stock outstanding - basic | | | 43.3 | | | 38.2 | | | 41.9 | | | 38.0 | |
| Income available to common shareholders | | $ | 39.5 | | $ | 48.2 | | $ | 134.5 | | $ | 138.0 | |
| Earnings per common share (basic) | | $ | 0.91 | | $ | 1.26 | | $ | 3.21 | | $ | 3.63 | |
| | | | | | | | | | | | | | |
Diluted EPS | | | | | | | | | | | | | |
| Average shares of common stock outstanding | | | 43.3 | | | 38.2 | | | 41.9 | | | 38.0 | |
| Effect of diluted securities | | | | | | | | | | | | | |
| Performance stock rights and stock options | | | 0.1 | | | 0.4 | | | 0.1 | | | 0.3 | |
| Average shares of common stock outstanding - diluted | | | 43.4 | | | 38.6 | | | 42.0 | | | 38.3 | |
| Income available to common shareholders | | $ | 39.5 | | $ | 48.2 | | $ | 134.5 | | $ | 138.0 | |
| Earnings per common share (diluted) | | $ | 0.91 | | $ | 1.25 | | $ | 3.20 | | $ | 3.60 | |
In November 2005, WPS Resources entered into a forward equity sale agreement with an affiliate of J. P. Morgan Securities, Inc., as forward purchaser, relating to 2.7 million shares of WPS Resources' common stock. On May 10, 2006, WPS Resources 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.
NOTE 17--REGULATORY ENVIRONMENT
Wisconsin
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 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. A current regulatory liability of $7.0 million has been recorded at September 30, 2006, and $8.7 million and $13.3 million was refunded to customers for the three and nine months ended September 30, 2006, respectively, related to the stipulation agreement. 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. Rates remain subject to refund under the agreement through the end of the year.
On March 31, 2006, WPSC filed a request with the PSCW to increase retail electric and natural gas rates 14.4% ($125.1 million) and 3.9% ($22.6 million), respectively for 2007. Since then, WPSC adjusted the request to 15.8% ($136.9 million) due to higher than expected coal costs and Weston 3 maintenance costs. The proposed retail electric rate increase is required because of increased costs associated with electric transmission, (including the recovery of 2007 MISO costs and deferred MISO costs from 2005 and 2006), higher fuel and purchased power costs (including the recovery of deferred costs for reduced coal deliveries in 2005), 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 proposed retail natural gas rate increase is driven by infrastructure improvements necessary to ensure the reliability of the natural gas distribution system and remediation of former manufactured gas plant sites. This filing included an 11.0% return on common equity and a common equity ratio of 60.35% in its regulatory capital structure. Hearings on this request were completed in September 2006, and WPSC expects the new rates to be effective January 1, 2007. 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 rate proposal includes a revenue stabilization mechanism, which is designed to reduce over and under collections of WPSC's gross margin caused by variations in the sales forecast. WPSC expects that the PSCW will act upon this proposal as part of the 2007 rate case.
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.
On June 7, 2005, WPSC filed with the PSCW and the FERC a request for establishment of a cooperative joint proceeding for approval of the Kewaunee wind-up plan. The wind-up plan proposed that the refunds due to both retail and wholesale customers related to proceeds received from the liquidation of the nonqualified decommissioning trust fund be offset by the net loss on the sale of the plant and also by certain costs related to the 2004 and 2005 Kewaunee outages. The wind-up plan proposed to begin the amortization of the net regulatory liability as a credit to customer rates as of the effective date of the PSCW's order (January 1, 2006). The FERC subsequently denied the request for joint proceeding with the PSCW. The wind-up plan was addressed by the PSCW in WPSC's 2006 rate case (discussed above). The PSCW ruled in the 2006 rate case that the deferred assets and liabilities related to the Kewaunee matters should be treated separately and not netted as WPSC initially proposed in its wind-up plan. In the 2006 rate case, the PSCW determined that Wisconsin retail customers were entitled to be refunded approximately 85% of the proceeds received from the liquidation of the nonqualified decommissioning trust fund based on a historical allocation methodology, or approximately $108 million of the total $127.1 million of proceeds received, 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 October 2006, WPSC, the MPSC, and all other interested parties agreed to immediately refund the approximately $2 million balance of the Michigan portion of the Kewaunee nonqualified decommissioning trust fund to offset power supply under collections that occurred in 2005.
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 final resolution was reached between WPSC and one party on this matter. On April 25, 2006, formal settlement discussions were terminated with the remaining parties. On May 19, 2006, WPSC filed a proposed amendment to revise the manner of distributing the value of the non-qualified decommissioning trust related to the Kewaunee plant. Instead of providing refunds as a credit to wholesale customers' future bills, WPSC proposed to refund the value of the non-qualified decommissioning trust based on historical customer payments paid into the trust fund. WPSC also proposed to reduce the amortization period of the refund from five years, as originally proposed, to two years, to be consistent with the PSCW's ruling. In addition, on May 24, 2006, WPSC filed a motion to consolidate the June 2005 proceeding with the instant proceeding for purposes of hearing and decision and to expedite the instant proceeding so that the litigation on both proceedings may be conducted on a timely basis. On June 30, 2006, the FERC accepted WPSC's wind-up plan amendment, and suspended it until August 1, 2006. The FERC also granted WPSC's request for consolidation. On September 5, 2006, WPSC and the Algoma Group reached an agreement in principal to resolve all Kewaunee related issues. FERC approval of a final settlement agreement is expected in the fourth quarter of 2006.
At September 30, 2006, WPSC had recorded an $82.7 million regulatory liability representing the amount of proceeds received from the liquidation of the nonqualified decommissioning trust fund remaining to be refunded to both retail and wholesale customers. Based upon information at this time, it is anticipated
that approximately 100% of the nonqualified decommissioning trust fund will be refunded to Michigan and FERC customers by the end of 2006, and Wisconsin customers by the end of 2007.
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.
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, ESI received billings of $19.2 million for these charges, of which approximately $17 million relates to its Michigan retail electric business and $2 million relates to Ohio retail electric business. ESI expensed $14.7 million of the $19.2 million. It is probable that ESI's 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. ESI anticipates settling a significant portion of its SECA matters through vendor negotiations in 2006 and reached a $1.0 million settlement agreement with one of its vendors in January 2006. 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 ESI's positions. The Administrative Law Judge certified the Initial Decision to the FERC in mid-September, closing the hearing record. Briefs on Exception to the Initial Opinion were filed with FERC in early September, 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, ESI's 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 at least 2007. Any refunds to ESI 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 ESI's 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 ESI, 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 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 18--SEGMENTS OF BUSINESS
We manage our reportable segments separately due to their different operating and regulatory environments. Prior to the fourth quarter of 2005, WPS Resources reported two nonregulated segments, ESI and WPS Power Development. In the fourth quarter of 2005, WPS Resources' Chief Executive Officer and its Board of Directors decided to view ESI and WPS Power Development as one business; therefore, corresponding changes were made to the segment information reported to them. Effective in the fourth quarter of 2005, WPS Resources began reporting to the Chief Executive Officer and Board of Directors one nonregulated segment, ESI. Segment information related to prior periods has been reclassified to reflect this change.
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. As discussed above, ESI is our primary nonregulated segment offering natural gas, electric, and alternate fuel supplies as well as energy management and consulting services to retail and wholesale customers, and marketing power from its generation plants that are not under contract to third parties. The Other segment, another nonregulated segment, includes the operations of WPS Resources and WPS Resources Capital Corporation as holding companies, along with nonutility activities at WPSC, MGUC, MERC, and UPPCO.
| | | Regulated Utilities | | Nonutility and Nonregulated Operations | | | | | |
Segments of Business (Millions) | | Electric Utility(1) | | Gas Utility(1) | | Total Utility(1) | | ESI | | Other(2) | | Reconciling Eliminations | | WPS Resources Consolidated | |
| | | | | | | | | | | | | | | | |
Three Months Ended September 30, 2006 | | | | | | | | | | | | | | | |
| External revenues | | $ | 303.8 | | $ | 91.0 | | $ | 394.8 | | $ | 1,166.0 | | $ | - | | $ | - | | $ | 1,560.8 | |
| Intersegment revenues | | | 11.2 | | | 0.1 | | | 11.3 | | | 0.6 | | | 0.3 | | | (12.2 | ) | | - | |
| Operating Income | | | 58.3 | | | (11.1 | ) | | 47.2 | | | 2.1 | | | (3.7 | ) | | (0.1 | ) | | 45.5 | |
| Income from continuing operations | | | 31.6 | | | (10.9 | ) | | 20.7 | | | 9.6 | | | (1.6 | ) | | - | | | 28.7 | |
| Discontinued operations | | | - | | | - | | | - | | | 11.5 | | | . | | | - | | | 11.5 | |
| Preferred stock dividends of subsidiary | | | 0.6 | | | 0.1 | | | 0.7 | | | - | | | - | | | - | | | 0.7 | |
| Income available for common shareholders | | | 31.0 | | | (11.0 | ) | | 20.0 | | | 21.1 | | | (1.6 | ) | | - | | | 39.5 | |
| | | | | | | | | | | | | | | | | | | | | | | |
Three Months Ended September 30, 2005 | | | | | | | | | | | | | | | | | | | | | | |
| External revenues | | $ | 289.6 | | $ | 71.6 | | $ | 361.2 | | $ | 1,358.6 | | $ | 0.3 | | $ | - | | $ | 1,720.1 | |
| Intersegment revenues | | | 9.0 | | | 0.2 | | | 9.2 | | | 7.7 | | | - | | | (16.9 | ) | | - | |
| Operating income | | | 49.4 | | | (3.9 | ) | | 45.5 | | | 22.0 | | | (2.2 | ) | | - | | | 65.3 | |
| Income from continuing operations | | | 28.4 | | | (3.3 | ) | | 25.1 | | | 18.7 | | | 1.6 | | | - | | | 45.4 | |
| Discontinued operations | | | - | | | - | | | - | | | 3.5 | | | - | | | - | | | 3.5 | |
| Preferred stock dividends of subsidiary | | | 0.4 | | | 0.2 | | | 0.6 | | | - | | | 0.1 | | | - | | | 0.7 | |
| Income available for common shareholders | | | 28.0 | | | (3.5 | ) | | 24.5 | | | 22.2 | | | 1.5 | | | - | | | 48.2 | |
| | | | | | | | | | | | | | | | | | | | | | | |
Nine Months Ended September 30, 2006 | | | | | | | | | | | | | | | | | | | | | | |
| External revenues | | $ | 804.1 | | $ | 379.3 | | $ | 1,183.4 | | $ | 3,857.5 | | $ | - | | $ | - | | $ | 5,040.9 | |
| Intersegment revenues | | | 29.7 | | | 0.4 | | | 30.1 | | | 6.4 | | | 0.9 | | | (37.4 | ) | | - | |
| Operating income | | | 133.7 | | | (5.6 | ) | | 128.1 | | | 89.9 | | | (9.8 | ) | | (0.1 | ) | | 208.1 | |
| Income from continuing operations | | | 71.5 | | | (11.1 | ) | | 60.4 | | | 64.5 | | | 4.8 | | | - | | | 129.7 | |
| Discontinued operations | | | - | | | - | | | - | | | 7.1 | | | - | | | - | | | 7.1 | |
| Preferred stock dividends of subsidiary | | | 1.6 | | | 0.7 | | | 2.3 | | | - | | | - | | | - | | | 2.3 | |
| Income available for common shareholders | | | 69.9 | | | (11.8 | ) | | 58.1 | | | 71.6 | | | 4.8 | | | - | | | 134.5 | |
| | | | | | | | | | | | | | | | | | | | | | | |
Nine Months Ended September 30, 2005 | | | | | | | | | | | | | | | | | | | | | | |
| External revenues | | $ | 757.9 | | $ | 335.7 | | $ | 1,093.6 | | $ | 3,403.1 | | $ | - | | $ | - | | $ | 4,496.7 | |
| Intersegment revenues | | | 25.0 | | | 0.5 | | | 25.5 | | | 10.8 | | | 0.9 | | | (37.2 | ) | | - | |
| Operating income | | | 92.6 | | | 20.0 | | | 112.6 | | | 47.9 | | | (4.7 | ) | | (0.1 | ) | | 155.7 | |
| Income from continuing operations | | | 73.9 | | | 9.4 | | | 83.3 | | | 51.0 | | | 3.0 | | | - | | | 137.3 | |
| Discontinued operations | | | - | | | - | | | - | | | 3.0 | | | - | | | - | | | 3.0 | |
| Preferred stock dividends of subsidiary | | | 1.5 | | | 0.8 | | | 2.3 | | | - | | | - | | | - | | | 2.3 | |
| Income available for common shareholders | | | 72.4 | | | 8.6 | | | 81.0 | | | 54.0 | | | 3.0 | | | - | | | 138.0 | |
| (1) | Includes only utility operations. |
| (2) | Nonutility operations are included in the Other column. |
WPSC's principal business segments are the regulated electric utility operations and the regulated natural gas utility operations.
| | | Regulated Utilities | | | | | | | |
Segments of Business (Millions) | | Electric Utility(1) | | Gas Utility(1) | | Total Utility | | Other(2) | | Reconciling Eliminations | | WPSC Consolidated | |
| | | | | | | | | | | | | | |
Three Months Ended September 30, 2006 | | | | | | | | | | | | | |
| External revenues | | $ | 285.9 | | $ | 49.2 | | $ | 335.1 | | $ | 0.4 | | | ($0.4 | ) | $ | 335.1 | |
| Earnings on common stock | | | 29.3 | | | (4.8 | ) | | 24.5 | | | 1.7 | | | - | | | 26.2 | |
| | | | | | | | | | | | | | | | | | | | |
Three Months Ended September 30, 2005 | | | | | | | | | | | | | | | | | | | |
| External revenues | | $ | 266.7 | | $ | 71.8 | | $ | 338.5 | | $ | 0.4 | | | ($0.4 | ) | $ | 338.5 | |
| Earnings on common stock | | | 26.7 | | | (3.5 | ) | | 23.2 | | | 2.6 | | | (0.1 | ) | | 25.7 | |
| | | | | | | | | | | | | | | | | | | | |
Nine Months Ended September 30, 2006 | | | | | | | | | | | | | | | | | | | |
| External revenues | | $ | 754.2 | | $ | 310.2 | | $ | 1,064.4 | | $ | 1.1 | | | ($1.1 | ) | $ | 1,064.4 | |
| Earnings on common stock | | | 67.1 | | | 3.7 | | | 70.8 | | | 6.7 | | | - | | | 77.5 | |
| | | | | | | | | | | | | | | | | | | | |
Nine Months Ended September 30, 2005 | | | | | | | | | | | | | | | | | | | |
| External revenues | | $ | 705.8 | | $ | 336.2 | | $ | 1,042.0 | | $ | 1.1 | | | ($1.1 | ) | $ | 1,042.0 | |
| Earnings on common stock | | | 69.7 | | | 8.6 | | | 78.3 | | | 6.3 | | | - | | | 84.6 | |
| (1) | Includes only utility operations. |
| (2) | Nonutility operations are included in the Other column. |
NOTE 19--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 WPS Resources. 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 WPS Resources on January 1, 2007. WPS Resources is currently analyzing any impact this guidance may have on its 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 WPS Resources beginning January 1, 2008. We are currently evaluating the impact that SFAS No. 157 will have on our financial statements.
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 an employer to recognize a plan's funded status in its statement of financial position, measure a plan's assets and obligations as of the end of the employer's fiscal year, and recognize the changes in a defined benefit postretirement plan's funded status in comprehensive income in the year in which the changes occur. SFAS No. 158 is effective for WPS Resources on December 31, 2006. We are currently assessing the impact this standard will have on our financial statements.
