<PAGE> 1
WISCONSIN ELECTRIC POWER COMPANY
1996 ANNUAL REPORT TO STOCKHOLDERS
ACCOMPANYING INFORMATION STATEMENT
----------------------------------
TABLE OF CONTENTS
-----------------
ITEM PAGE
---- ----
Business A-2
Market for Common Equity and Related Stockholder Matters A-2
Selected Financial Data A-3
Management's Discussion and Analysis of Financial
Condition and Results of Operations A-4
Income Statement A-32
Balance Sheet A-33
Statement of Cash Flows A-35
Capitalization Statement A-36
Common Stock Equity Statement A-37
Notes to Financial Statements A-38
Directors A-55
Executive Officers A-55
A-1
<PAGE> 2
BUSINESS
Wisconsin Electric Power Company ("WE" or "Wisconsin Electric") is an
electric, gas and steam utility incorporated in the State of Wisconsin in
1896. Effective January 1, 1996, Wisconsin Energy Corporation ("WEC"), WE's
parent company, merged its wholly owned natural gas utility subsidiary,
Wisconsin Natural Gas Company ("WN"), into WE to form a single combined
utility subsidiary. Where applicable, references to WE include WN prior to
the merger. WE's operations are conducted in the following three business
segments.
Electric Operations: The WE electric operations generates, transmits,
distributes and sells electric energy in a territory of approximately 12,000
square miles with a population estimated at 2,300,000 in southeastern
(including the metropolitan Milwaukee area), east central and northern
Wisconsin and in the Upper Peninsula of Michigan.
Gas Operations: The WE gas operations purchases, distributes and sells
natural gas to retail customers and transports customer-owned gas in three
distinct service areas of about 2,800 square miles in Wisconsin: west and
south of the City of Milwaukee, the Appleton area and the Prairie du Chien
area. The gas service territory, which has an estimated population of over
1,100,000, is largely within WE's electric service area.
Steam Operations: The WE steam operations distributes and sells steam
supplied by its Valley and Milwaukee County Power Plants to space heating and
processing customers in the metropolitan Milwaukee area.
For additional financial information about business segments, see "Note L -
Information by Segments of Business" in the NOTES TO FINANCIAL STATEMENTS.
MARKET FOR COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
Cash dividends declared on Wisconsin Electric Power Company's Common Stock
during the two most recent fiscal years are set forth below. Dividends were
paid to WE's sole common stockholder, WEC.
==============================================================================
Quarter Total Dividend *
------- ---------------------------------
1996 1995
---- ----
First $40,455,444 $38,208,667
Second 42,478,000 40,455,444
Third 42,478,000 40,455,444
Fourth 42,478,000 40,455,444
==============================================================================
* Includes dividends paid by Wisconsin Natural Gas Company in 1995.
A-2
<PAGE> 3
WISCONSIN ELECTRIC POWER COMPANY **
SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
(Thousands of Dollars)
Financial 1996 1995 1994 1993 1992
- ---------------------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Year Ended December 31
Earnings available
for common stockholder $ 210,112 $ 239,465 $ 180,403* $ 187,703 $ 170,034
Operating revenues
Electric $1,393,270 $1,437,480 $1,403,562 $1,347,844 $1,298,723
Gas 364,875 318,262 324,349 331,301 283,699
Steam 15,675 14,742 14,281 14,090 13,093
---------- ---------- ---------- ---------- ----------
Total operating revenues $1,773,820 $1,770,484 $1,742,192 $1,693,235 $1,595,515
========== ========== ========== ========== ==========
At December 31
Total assets $4,507,160 $4,318,924 $4,202,193 $4,078,973 $3,623,838
Long-term debt and preferred
stock - redemption required $1,371,446 $1,325,169 $1,257,776 $1,274,476 $1,280,012
- -----------------------------------------------------------------------------------------------
Sales and Customers 1996 1995 1994 1993 1992
- ------------------- ---------- ---------- ---------- ---------- ----------
Electric
Megawatt-hours sold 27,560,428 27,283,869 26,911,363 25,685,436 24,747,581
Customers (End of year) 968,735 955,616 944,855 932,285 919,466
Gas
Therms delivered (Thousands) 936,894 886,729 811,219 809,348 772,036
Customers (End of year) 367,275 357,030 347,080 336,571 327,247
Steam
Pounds sold (Millions) 2,705 2,532 2,395 2,376 2,284
Customers (End of year) 465 473 471 459 472
===============================================================================================
<CAPTION>
QUARTERLY FINANCIAL DATA
(Thousands of Dollars)
March June
Three Months Ended 1996 1995 1996 1995
- ------------------ --------- --------- --------- ---------
<S> <C> <C> <C> <C>
Total operating revenues $ 495,457 $ 471,122 $ 401,686 $ 405,093
Operating income 85,145 84,572 68,382 72,848
Earnings available
for common stockholder 61,703 62,121 44,906 51,249
- -----------------------------------------------------------------------------------------------
<CAPTION>
- -----------------------------------------------------------------------------------------------
September December
Three Months Ended 1996 1995 1996 1995
- ------------------ --------- --------- --------- ---------
<S> <C> <C> <C> <C>
Total operating revenues $ 398,801 $ 426,413 $ 477,876 $ 467,856
Operating income 76,693 80,704 75,624 90,897
Earnings available
for common stockholder 52,392 58,679 51,111 67,416
===============================================================================================
<FN>
Quarterly results of operations are not directly comparable because of seasonal and other factors.
See MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Earnings and dividends per share are not provided as all of Wisconsin Electric Power Company's
("WE") common stock is held by Wisconsin Energy Corporation.
* Includes nonrecurring $73.9 million charge in 1994 ($45 million net of tax) related to WE's
Revitalization program.
** Where applicable, prior year financial and statistical information has been restated to
include Wisconsin Natural Gas Company at historical values.
</TABLE>
A-3
<PAGE> 4
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Wisconsin Energy Corporation ("WEC" or the "Company") is a holding company
whose principal subsidiary is Wisconsin Electric Power Company ("WE"), an
electric, gas and steam utility. As of December 31, 1996, approximately 94%
of WEC's consolidated total assets were attributable to WE. The following
discussion and analysis of financial condition and results of operations
includes both WEC and WE unless otherwise stated.
Wisconsin Electric Revitalization
To better position the Company in a changing energy marketplace, WE
implemented a revitalization program ("Revitalization") in 1994 to increase
efficiencies and improve customer service by reengineering and restructuring
the organization. The new structure consolidated many business functions and
simplified work processes. See "Note K - Benefits Other Than Pensions" in the
NOTES TO FINANCIAL STATEMENTS for additional information.
Mergers
Wisconsin Natural Gas Company: On January 1, 1996, WEC merged its natural gas
utility subsidiary, Wisconsin Natural Gas Company ("WN"), into its electric
and steam utility subsidiary, WE, to form a single combined utility
subsidiary. The merger, which was part of Revitalization, is expected to
improve customer service and reduce operating costs. The accounting treatment
for this merger was similar to that which would result from a pooling of
interests. Where applicable, references to WE include WN's gas operations
prior to the merger.
Northern States Power Company: As previously reported, WEC has entered into an
agreement with Northern States Power Company, a Minnesota corporation ("NSP"),
which provides for a strategic business combination involving the two
companies in a "merger-of-equals" transaction. The future operations and
financial position of the Company will be significantly affected by the
proposed merger. Consummation of the proposed merger is subject to a number
of conditions, including obtaining all required regulatory approvals.
Additional information concerning such agreement and proposed transaction may
be found below under "FACTORS AFFECTING RESULTS OF OPERATIONS - Merger
Agreement with Northern States Power Company", in MARKET FOR REGISTRANT'S
COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - and in "Note B - Mergers" -
"DIVIDEND POLICY OF PRIMERGY" in the NOTES TO FINANCIAL STATEMENTS (including
unaudited pro forma financial information).
Cautionary Factors
When used in this document, "anticipate", "believe", "estimate", "expect",
"objective", "project" and similar expressions are intended to identify
forward-looking statements. Forward-looking statements are subject to certain
risks, uncertainties and assumptions which could cause actual results to
differ materially from those that are described, including the items described
below under "FACTORS AFFECTING RESULTS OF OPERATIONS" and below under
"CAUTIONARY FACTORS".
A-4
<PAGE> 5
RESULTS OF OPERATIONS
The following discussion and analysis of the RESULTS OF OPERATIONS does not
consider the impact of the proposed merger with NSP. See "FACTORS AFFECTING
RESULTS OF OPERATIONS - Merger Agreement with Northern States Power Company"
for information concerning the proposed merger. See "Note L - Information By
Segments of Business" in the NOTES TO FINANCIAL STATEMENTS for additional
information related to WEC's and WE's RESULTS OF OPERATIONS.
Earnings
1996 Compared to 1995: During 1996, WEC's consolidated net income and
earnings per share of common stock were $218.1 million and $1.97 per share
compared to $234.0 million and $2.13 per share during 1995. WE's Net Income
decreased to $210.1 million in 1996 from approximately $239.5 million in 1995.
As described below, WEC's and WE's earnings decreased primarily because 1996
retail electric and gas rate decreases more than offset the favorable impact
of increases in electric sales and gas deliveries and decreases in certain
Operating Expenses.
1995 Compared to 1994: Earnings per share of WEC's common stock in 1995 were
$2.13 compared with $1.67 per share in 1994, an increase of 27.5%. WEC's Net
Income increased by approximately $53.2 million and WE's Net Income increased
$58.9 million in 1995 compared to 1994. WEC's and WE's earnings during 1994
reflect a nonrecurring charge of approximately $73.9 million ($45 million net
of tax, or 42 cents per share) associated with WE's Revitalization program.
The 1994 nonrecurring charge primarily included the costs of early retirement
and severance packages which were elements of Revitalization. The Company has
recovered the 1994 nonrecurring charge in avoided labor costs that would have
been charged to Other Operations and Maintenance expense during 1994 and 1995.
Excluding the Revitalization charge, WEC's 1995 earnings and earnings per
share of common stock were 3.6% and 1.9% greater than 1994 earnings and
earnings per share, respectively. WE's 1995 earnings were 6.2% greater than
1994 earnings excluding the Revitalization charge. The increase in WEC's and
WE's 1995 earnings primarily reflects higher electric sales and gas deliveries
and a decrease in Other Operation and Maintenance expenses.
Electric Revenues, Gross Margins and Sales
The table below summarizes Electric Operating Revenues, gross margins,
megawatt-hour sales and average electric customers for each of the three years
ended December 31, 1996.
A-5
<PAGE> 6
<TABLE>
<CAPTION>
=========================================================================================================
% Change % Change
1995 1994
Electric Operations 1996 1995 to 1996 1994 to 1995
------------------------------ ---------- ---------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Electric Gross Margin ($000's)
Operating Revenues
Residential $ 494,142 $ 507,416 (2.6%) $ 484,627 4.7%
Small Commercial/Industrial 421,511 423,039 (0.4%) 406,043 4.2%
Large Commercial/Industrial 383,047 401,794 (4.7%) 398,179 0.9%
Other-Retail/Municipal 56,318 69,318 (18.8%) 69,258 0.1%
Resale-Utilities 26,372 24,811 6.3% 31,295 (20.7%)
Other Operating Revenues 11,880 11,102 7.0% 14,160 (21.6%)
---------- ---------- ----------
Total Operating Revenues 1,393,270 1,437,480 (3.1%) 1,403,562 2.4%
Fuel & Purchased Power 331,867 345,387 (3.9%) 328,485 5.2%
---------- ---------- ----------
Gross Margin $1,061,403 $1,092,093 (2.8%) $1,075,077 1.6%
========== ========== ==========
Sales (Megawatt-hours)
Residential 6,998,769 7,042,691 (0.6%) 6,670,081 5.6%
Small Commercial/Industrial 7,204,694 7,047,277 2.2% 6,699,073 5.2%
Large Commercial/Industrial 10,785,505 10,639,782 1.4% 10,471,869 1.6%
Other-Retail/Municipal 1,476,999 1,550,937 (4.8%) 1,603,741 (3.3%)
Resale-Utilities 1,094,461 1,003,182 9.1% 1,466,599 (31.6%)
---------- ---------- ----------
Total Electric Sales 27,560,428 27,283,869 1.0% 26,911,363 1.4%
========== ========== ==========
Average Customers
Residential 867,917 857,924 1.2% 846,745 1.3%
Small Commercial/Industrial 91,565 90,386 1.3% 88,765 1.8%
Large Commercial/Industrial 706 679 4.0% 674 0.7%
Other-Retail/Municipal 1,812 1,809 0.2% 1,802 0.4%
Resale-Utilities 20 12 66.7% 9 33.3%
---------- ---------- ----------
Total Average Customers 962,020 950,810 1.2% 937,995 1.4%
========== ========== ==========
=========================================================================================================
</TABLE>
1996 Compared to 1995: Primarily as a result of annualized electric retail
rate decreases effective January 1, 1996 of approximately $33.4 million or
2.8% in Wisconsin and $1.1 million or 3.3% in Michigan, total Electric
Operating Revenues decreased by 3.1% or $44.2 million during 1996 compared to
1995. Also contributing to the 1996 decrease in Electric Operating Revenues
were the effects of renegotiated contracts with various wholesale customers
and with the Empire and Tilden iron ore mines (the "Mines"), WE's two largest
retail customers, as well as continued reductions in sales to Wisconsin Public
Power Inc. SYSTEM ("WPPI") and Upper Peninsula Power Company ("UPPCo"), WE's
largest municipal and utility customer, respectively. The renegotiated
wholesale and mine contracts contain discounts from previous rates charged to
these customers in exchange for contract extensions. A 1.0% 1996 increase in
total electric kilowatt-hour sales was not sufficient to offset the impact on
Electric Operating Revenues of the rate decreases, the renegotiated contracts
and the reduced sales to WPPI and UPPCo.
Between the comparative periods, the gross margin on Electric Operating
Revenues (Electric Operating Revenues less Fuel and Purchased Power expenses)
decreased 2.8% or by approximately $30.7 million. The lower 1996 Electric
Operating Revenues more than offset the lower net 1996 Fuel and Purchased
Power expenses. Fuel expenses declined 2.6% in 1996 primarily due to lower
average coal costs per ton consumed. Between the comparative periods,
Purchased Power expense decreased 13.4% as WE substituted lower cost
generation for power purchases.
A-6
<PAGE> 7
Residential sales declined 0.6%, but Small Commercial/Industrial sales
increased 2.2% during 1996 compared to 1995. A decrease in the average
electric usage per Residential customer as a result of cooler weather during
the summer of 1996 compared to the summer of 1995 was partially offset by the
effect of a 1.2% increase in the average number of Residential customers
during 1996. Average usage per Small Commercial/Industrial customer in 1996
was flat compared to 1995. However, a 1996 increase in the average number of
Small Commercial/Industrial customers caused the increase in electric sales to
this customer class.
Electric energy sales to the Mines increased by 3.2% to approximately
2,369,000 megawatt-hours in 1996 compared to 2,296,000 megawatt-hours in 1995.
Excluding the Mines, sales to Large Commercial/Industrial customers increased
0.9% between the comparative periods.
The 4.8% decrease in 1996 sales to the Other-Retail/Municipal customer class
compared to 1995 is largely due to the reduction in sales to WPPI noted above.
WPPI has been reducing its purchases from WE subsequent to acquiring
generating capacity and expanding use of its existing generating facilities.
Sales of electric energy to other utilities (the Resale-Utilities customer
class), representing 4.0% of total 1996 electric energy sales, increased 9.1%
from 1995 to 1996. This increase is attributed in part to increased
availability during 1996 of WE's lowest cost generating units compared to 1995
and to greater native load demand as a result of the hot weather during the
summer of 1995, allowing for higher opportunity sales by WE to other utilities
in 1996. During 1996, a continued reduction in purchases of electricity by
UPPCo somewhat offset the increase in resale sales to other utilities during
1996. WE expects UPPCo to significantly reduce its purchases of electric
energy from WE when a 65 megawatt ("MW") agreement with WE expires at the end
of 1997.
1995 Compared to 1994: Despite an annualized $16.2 million or 1.3% Wisconsin
retail electric fuel adjustment rate decrease that became effective on
August 4, 1994, total Electric Operating Revenues increased by 2.4% or by
$33.9 million from 1994 to 1995 due to increased 1995 electric sales.
The gross margin on Electric Operating Revenues increased by 1.6% or $17.0
million in 1995 compared to 1994. The gross margin grew because the increased
electric sales were primarily to Residential and Small Commercial/Industrial
customers who contribute higher margins to earnings than other customer
classes. During 1995, Fuel expense increased 6.2% or by approximately $17.7
million in 1995 compared to 1994 as a result of higher electric sales.
Purchased Power expense declined 1.9% or by approximately $0.8 million in 1995
compared to 1994 as a result of decreased marginal generating costs in 1995 at
three of WE's fossil plants and the newly installed peaking capacity at Paris
Generating Station ("Paris"). Lower generating costs at the fossil plants
were due to decreased per unit fuel costs and the benefits of Revitalization,
allowing WE to substitute lower cost generation for power purchases. The
addition of Paris, a natural gas fired peaking unit, in 1995 allowed WE to
eliminate firm power purchase contracts that included fixed demand charges.
Unscheduled or longer than expected outages in 1995 at two of WE's most
efficient power plants, however, offset most of the decrease in Purchased
Power expense as WE purchased nonfirm replacement power on the spot market.
A-7
<PAGE> 8
Total electric sales increased by 1.4% in 1995 compared to 1994. Electric
sales were positively impacted by substantially warmer summer weather
conditions during 1995, resulting in increased use of electricity for air
conditioning and other cooling purposes. As measured by cooling degree days,
the 1995 cooling season (June through August) was 27.7% warmer than the same
period in 1994. During the summer of 1995, WE experienced eight days of
electric peak demands greater than the previous record which had been set in
June 1994. The increase in electric sales also reflects colder winter weather
during the fourth quarter of 1995 and a moderate increase in economic activity
in WE's service area.
The warmer 1995 summer weather increased sales primarily to Residential and
Small Commercial/Industrial customers. These customers are more sensitive to
weather variations than other customer classes. The average number of
customers in the Residential and Small Commercial/Industrial customer classes
increased by 1.3% and 1.8%, respectively, from 1994 to 1995.
Electric energy sales to the Mines decreased by 0.5% to 2,296,000 megawatt-
hours in 1995 compared to 2,308,000 megawatt-hours in 1994. Excluding the
Mines, sales to Large Commercial/Industrial customers increased 2.2%.
The 3.3% reduction in sales to the Other-Retail/Municipal customer class in
1995 compared to 1994 is largely the result of reductions in sales to WPPI
discussed above. WPPI's sales reductions during 1995 did not have a
significant effect on earnings.
Sale of electric energy to the Resale-Utilities customer class declined 31.6%
in 1995 compared to 1994. This decline can in part be attributed to unplanned
or longer than expected outages at two of WE's least cost generating
facilities during 1995 and to increased retail customer load as a result of
the warmer summer of 1995 weather, both of which reduced the opportunity to
sell electric energy to other utilities. Also, as noted above, UPPCo reduced
the amount of energy that it purchased from WE in 1995. The 1995 sales
reductions by UPPCo did not have a significant effect on 1995 earnings.
A-8
<PAGE> 9
Gas Revenues, Gross Margins and Therm Deliveries
The table below summarizes Gas Operating Revenues, gross margins, therm
deliveries and average gas customers for each of the three years ended
December 31, 1996.
<TABLE>
<CAPTION>
=========================================================================================================
% Change % Change
1995 1994
Gas Operations 1996 1995 to 1996 1994 to 1995
------------------------------ ---------- ---------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Gas Gross Margin ($000's)
Operating Revenues
Residential $ 218,811 $ 194,226 12.7% $ 200,824 (3.3%)
Commercial/Industrial 108,100 94,482 14.4% 102,496 (7.8%)
Interruptible 11,531 7,712 49.5% 12,605 (38.8%)
Transported Customer Owned Gas 11,006 12,161 (9.5%) 11,453 6.2%
Other - Interdepartmental 3,775 5,834 (35.3%) 2,907 100.7%
Other Operating Revenues 11,652 3,847 202.9% (5,936) (164.8%)
---------- ---------- ----------
Total Operating Revenues 364,875 318,262 14.6% 324,349 (1.9%)
Cost of Gas Sold 234,254 188,764 24.1% 199,511 (5.4%)
---------- ---------- ----------
Gross Margin $ 130,621 $ 129,498 0.9% $ 124,838 3.7%
========== ========== ==========
Therms Delivered (000's)
Residential 371,990 345,140 7.8% 323,913 6.6%
Commercial/Industrial 225,169 207,358 8.6% 199,206 4.1%
Interruptible 35,869 29,397 22.0% 36,916 (20.4%)
Transported Customer Owned Gas 268,163 261,361 2.6% 235,850 10.8%
Other - Interdepartmental 35,703 43,473 (17.9%) 15,334 183.5%
---------- ---------- ----------
Total Gas Delivered 936,894 886,729 5.7% 811,219 9.3%
========== ========== ==========
Average Customers
Residential 330,153 321,643 2.7% 311,288 3.3%
Commercial/Industrial 29,930 29,228 2.4% 28,439 2.8%
Interruptible 196 203 (3.5%) 198 2.5%
Transportation 230 209 10.1% 202 3.5%
Other - Interdepartmental 8 8 0.0% 7 14.3%
---------- ---------- ----------
Total Average Customers 360,517 351,291 2.6% 340,134 3.3%
========== ========== ==========
=========================================================================================================
</TABLE>
1996 Compared to 1995: Despite an annualized $8.3 million or 2.6% Wisconsin
retail gas rate decrease effective January 1, 1996, total Gas Operating
Revenues increased 14.6% or by $46.6 million and the gross margin on Gas
Operating Revenues (Gas Operating Revenues less Cost of Gas Sold) increased
0.9% or by $1.1 million during 1996 compared to 1995. A 5.7% increase in
total therm deliveries during 1996 more than offset the impact of the rate
decrease on Gas Operating Revenues and on gross margin.
Gross margin was higher in 1996 because the increased therm deliveries were
primarily to Residential and Commercial customers, who contribute higher
margins to earnings than other customer classes. The change in Cost of Gas
Sold increased 24.1% or by approximately $45.5 million in 1996 compared to
1995 due to a higher 1996 per unit cost of purchased gas and to a higher
volume of gas purchases in 1996. WE arranges for its own gas supply contracts
with terms of various lengths. Changes in the cost of natural gas purchased
at market prices are included in customer rates through the purchased gas
adjustment mechanism and do not affect gross margin.
A-9
<PAGE> 10
Total natural gas therm deliveries increased 5.7% or by 50,165,000 therms in
1996 compared to 1995. Of this increase in therm deliveries, Residential and
Commercial/Industrial sales increased by 26,850,000 therms and 17,811,000
therms, respectively, in 1996. These increases are attributed in part to
colder weather and in part to increased customers in these two customer
classes during 1996 compared to 1995. As measured by heating degree days,
1996 was 9.3% colder than 1995 and 6.0% colder than normal. During 1996, the
average number of Residential and Commercial/Industrial customers increased by
2.7% and 2.4%, respectively, compared to 1995.
Other-Interdepartmental therm deliveries decreased 17.9% or by 7,770,000
therms during 1996 compared to 1995. These therm deliveries to WE electric
generating facilities, primarily the natural gas fired peaking units at the
Paris and Concord Generating Stations ("Concord"), are at rates approved by
the Public Service Commission of Wisconsin ("PSCW"). Therm deliveries to
these customers decreased in 1996 as a result of the cooler 1996 summer
weather discussed above in "Electric Revenues, Gross Margins and Sales".
1995 Compared to 1994: Despite an increase in 1995 total gas deliveries,
total Gas Operating Revenues decreased 1.9% or by approximately $6.1 million
in 1995 compared to 1994 as a result of a reduction in the cost of gas, which
is recovered in Gas Operating Revenues through the purchased gas adjustment
clause. The gross margin on Gas Operating Revenues (Gas Operating Revenues
less Cost of Gas Sold) increased 3.7% or by approximately $4.7 million in 1995
compared to 1994. The gross margin was higher because of increased therm
sales to Residential and Commercial customers who contribute higher margins to
earnings than other customer classes. A decrease in the average per unit cost
of purchased gas during 1995 more than offset the effect of the increase in
therm deliveries such that Cost of Gas Sold decreased 5.4% or by $10.7 million
compared to 1994.
Total natural gas therms delivered increased 9.3% or by 75,510,000 therms
between the comparative periods. Colder weather during the fourth quarter of
1995 compared to the fourth quarter of 1994 contributed to net increased
deliveries for 1995. As measured by heating degree days, the fourth quarter
of 1995 was 43.1% colder than the same period in 1994. The colder weather in
the fourth quarter of 1995 especially increased sales to Residential and
Commercial customers. These customers are more sensitive to weather
variations as a result of heating requirements than other customer classes.
Also, the average number of Residential and Commercial/Industrial customers
increased by 3.3% and 2.8%, respectively, in 1995 compared to 1994.
During 1995, Other-Interdepartmental therm deliveries increased 183.5% or by
28,139,000 therms compared to 1994. WE attributes this increase to increased
electric generation peaking requirements of Concord and Paris, especially
given the warmer weather conditions during the summer of 1995 noted above.
All of the gas fired generating units at Concord and Paris were in operation
by the end of the second quarter of 1995 while only the generating units at
Concord were in operation by the end of the second quarter of 1994.
Operating Expenses
1996 Compared to 1995: Other Operation Expenses decreased 0.9% or by $3.7
million during 1996 compared to 1995, primarily due to lower capitalized
conservation, property insurance and pension and benefit expenses, partially
offset by increased uncollectible expenses. Maintenance expense decreased
8.3% or by approximately $9.4 million in 1996 compared to 1995, primarily as a
result of a decrease in costs associated with maintenance of WE's fossil power
A-10
<PAGE> 11
plants. WE attributes the decrease in maintenance to an extended outage at
WE's Pleasant Prairie Power Plant in 1995 as well as to continued efforts to
reduce operating and maintenance costs. Depreciation expense increased 10.3%
or by $18.9 million between the same comparative periods primarily due to
increased nuclear decommissioning expenses and to a lesser extent to higher
depreciable plant balances in 1996.
During 1996, Operating Taxes Other Than Income Taxes increased 4.1% or by $3.1
million compared to 1995 due to tax adjustments related to prior periods.
Total operating income taxes decreased 10.2% or by $14.4 million in 1996
compared to 1995 as a result of lower taxable income.
1995 Compared to 1994: Excluding Depreciation expense, operating income taxes
and the nonrecurring 1994 Revitalization charge, total Operating Expenses
decreased 0.9% in 1995 compared to 1994, reflecting a reduction of 3.1% or
approximately $16 million in Other Operation and Maintenance expenses
primarily attributable to payroll-related savings and efficiencies gained
through WE's Revitalization program. Such reductions were partially offset by
higher costs related to increased generation, the availability of Paris and
unscheduled or longer than expected outages at WE power plants.
In 1995 compared to 1994, total operating income taxes increased 41.4% or by
$41 million due to lower taxable income in 1994 caused by the nonrecurring
Revitalization charge. Deferred Income Taxes-Net increased $22 million or
88.7% primarily due to tax matters related to the timing of payments made in
connection with WE's Revitalization program.
Other Items
Excluding the annual $10.9 million impact of a 1996 change in accounting for
capitalized conservation expenditures at WE, Miscellaneous - Net Other Income
and Deductions increased $14.9 million in 1996 compared to 1995. The change
in accounting more than offset a 1996 increase in non-utility Miscellaneous-
Net Other Income and Deductions of $13.4 million compared to 1995. This $13.4
million increase was primarily due to fair market valuation adjustments of
non-utility investments and the gain recorded on sales of non-utility property
and investments. Miscellaneous-Net Other Income and Deductions decreased $9.8
million in 1995 compared to 1994, due in part to fair market valuation
adjustments of non-utility investments.
Other Interest Charges decreased by approximately $5.0 million in 1996
compared to 1995 due to decreased average outstanding short-term debt balances
during 1996, primarily at WE. Other Interest Charges increased by $4.8
million in 1995 compared to 1994 as a result of increased average short-term
debt balances, primarily at WE, in 1995 compared to 1994.
FACTORS AFFECTING RESULTS OF OPERATIONS
Merger Agreement with Northern States Power Company
On April 28, 1995, Wisconsin Energy Corporation ("WEC") and Northern States
Power Company, a Minnesota corporation ("NSP"), entered into an Agreement and
Plan of Merger, which was amended and restated as of July 26, 1995 ("Merger
Agreement"). The Merger Agreement provides for a strategic business
combination involving WEC and NSP in a "merger-of-equals" transaction
("Transaction"). As a result, WEC will become a registered public utility
holding company under the Public Utility Holding Company Act of 1935, as
A-11
<PAGE> 12
amended ("PUHCA"), and will change its name to Primergy Corporation
("Primergy"). Primergy will be the parent company of WEC's utility
subsidiary, Wisconsin Electric Power Company ("WE", which will be renamed
Wisconsin Energy Company), of NSP (which, for regulatory reasons, will
reincorporate in Wisconsin ("New NSP")), and of the other subsidiaries of WEC
and NSP.
The Transaction is intended to be tax-free for income tax purposes and to be
accounted for as a "pooling of interests". On September 13, 1995, the
stockholders of WEC and NSP voted to approve the proposed Transaction. Under
the provisions of the Merger Agreement, each outstanding share of NSP common
stock will be converted into 1.626 shares of Primergy common stock and each
outstanding share of WEC common stock will remain outstanding as a share of
Primergy common stock.
The Merger Agreement is subject to various conditions, including approval of
various regulatory agencies. The goal of WEC and NSP was to complete the
Transaction by January 1, 1997. However, as discussed below, all necessary
regulatory approvals were not obtained by the end of 1996 and, as a result,
the Transaction was not completed in 1996. WEC and NSP continue to pursue
regulatory approvals, without unacceptable conditions, to facilitate
completion of the Transaction as soon as possible in 1997.
Upon consummation of the Transaction, cost savings are estimated to be
approximately $2 billion over a 10-year period, net of transaction costs
(including fees for financial advisors, attorneys, accountants, consultants,
filings and printing) and net of costs to achieve the savings of approximately
$30 million and $122 million, respectively. The allocation between WEC and
NSP and their customers of the estimated cost savings resulting from the
Transaction, net of costs incurred to achieve such estimated cost savings, is
subject to regulatory review and approval.
WEC and NSP have proposed that, upon consummation of the Transaction, retail
electric rates be reduced by approximately 1.5% and frozen at that level for
four years in the jurisdictions in which they operate. WEC and NSP have also
proposed a four year freeze in their wholesale electric rates. In December
1995, WEC and NSP entered into a settlement agreement with certain Wisconsin
municipal intervenors that ended the latters' participation in the Federal
Energy Regulatory Commission ("FERC") and state merger proceedings. The
settlement agreement, which provides for certain rate reductions on power
sales and transmission services, was approved by the FERC in June 1996. For
retail gas customers, WE and NSP-WI have proposed that Wisconsin Energy
Company implement a $4.2 million reduction in retail gas rates on an
annualized basis and a four year rate freeze for customers in Wisconsin and
Michigan. NSP has proposed a two year gas retail rate freeze in its Minnesota
jurisdiction and a modest gas retail rate reduction and four year gas retail
rate freeze in its North Dakota jurisdiction.
Regulatory authorities may also require the restructuring of electric
transmission system operations or administration. As noted below, WEC and NSP
have proposed an Independent System Operator ("ISO") of their electric
transmission systems in testimony filed with the FERC and the Public Service
Commission of Wisconsin ("PSCW") during merger application hearings. WEC and
NSP currently cannot predict what, if any, restructuring of the transmission
system will be required. In addition, Wisconsin State law limits the total
assets of non-utility affiliates of Primergy, which could affect the amount of
non-regulated operations.
A-12
<PAGE> 13
Securities and Exchange Commission: In April 1996, WEC and NSP submitted the
initial filing with the Securities and Exchange Commission ("SEC") to
facilitate registration of Primergy under the PUHCA. Although WEC and NSP are
working to avoid divestitures, the SEC could require, as a condition of its
approval of the Transaction, that Primergy divest of certain of its gas
utility and/or non-regulated operations within a reasonable time after the
Transaction is consummated. In a few cases, the SEC has allowed the retention
of such properties or deferred the question of divestiture for a substantial
period of time. In those cases in which divestiture has taken place, the SEC
has usually allowed enough time to complete the divestiture so as to allow the
applicant to avoid a "fire sale" of the divested assets. WEC and NSP believe
that strong policy reasons and prior SEC decisions exist which support their
retaining their existing gas utility properties and non-utility ventures, or,
alternatively, which support deferring the question of divestiture for a
substantial period of time. Accordingly, WEC and NSP requested in their April
1996 merger application with the SEC that WEC and NSP be allowed to retain
WEC's and NSP's existing gas utility properties and non-utility ventures.
Federal Energy Regulatory Commission: The FERC held hearings on the merger
application in June 1996. Subject to WEC and NSP meeting eight conditions,
the administrative law judge ("ALJ") in the merger proceeding issued an
initial decision in August 1996 recommending approval of the Transaction. The
ALJ's initial decision included recommendations for a working ISO and
specifically rejected the need for divestiture of any generation or
transmission facilities as a requirement for ensuring open and equal access to
the transmission system. In October 1996, WEC and NSP filed with the FERC a
Unilateral Settlement Offer of the Primergy Merger Applicants ("Settlement
Offer") setting forth a proposed ISO for Primergy. The Settlement Offer
contains all of the elements appropriate to an ISO and addresses all issues
and concerns related to transmission "market power".
In mid-December 1996, the FERC revised and streamlined its 30-year-old policy
for evaluating public utility mergers, with the changes designed to expedite
the processing of merger applications. The new policy primarily focuses on
three factors in reviewing mergers: the effect on competition, rates, and
state and federal regulation. For pending mergers, such as that between WEC
and NSP, the policy will be applied on a case-by-case basis. WEC and NSP
believe the proposed Transaction is consistent with the FERC's revised merger
policy and are hopeful that the FERC will simultaneously rule on the
Settlement Offer and the pending merger application in the first quarter of
1997.
Public Service Commission of Wisconsin: In October 1996, the PSCW commenced
hearings on the merger application, which were completed in November 1996.
In late December 1996, two Wisconsin legislators asked the PSCW to delay
decisions on all pending utility mergers until the Wisconsin Legislature had
an opportunity to consider a bill revising the state's utility merger law,
which the two legislators indicated they would introduce. In early January
1997, the PSCW voted unanimously not to delay its decision. However, later in
January 1997, a Dane County Circuit Court judge ordered the PSCW to delay its
decision on the application, pending the results of an investigation regarding
alleged prohibited conversations between one of the commissioners and WEC
officials. The judge further ordered the PSCW to investigate the allegations.
While WEC cannot predict specifically when the PSCW will resolve the
allegations and proceed with deliberations concerning the merger application,
the Company is hopeful that such investigation might be completed by early in
the second quarter of 1997.
A-13
<PAGE> 14
Minnesota Public Utilities Commission: In June 1996, the Minnesota Public
Utilities Commission ("MPUC") issued an order which established the procedural
framework for the MPUC's consideration of the merger. The issues of merger-
related savings, electric rate freeze characteristics, NSP's pre-merger
revenue requirements, Primergy's ability to control the transmission interface
between the Mid-Continent Area Power Pool and the Wisconsin and upper Michigan
area, and the impact of control of this interface on Minnesota utilities were
set for contested case hearings.
The MPUC completed evidentiary hearings on the merger application in December
1996. In January and February 1997, ALJs in the merger application
proceedings issued their findings and recommendations about the Minnesota
merger application. Among other items, they found that the projected merger-
related cost savings were reasonable, recommended a four-year rate freeze,
with very limited exceptions for rate changes and concluded that the merger
would not provide Primergy with the ability or incentive to negatively impact
competition. The MPUC will consider the ALJs' recommendations along with
other information when they deliberate and decide the case. In late March
1997, the MPUC indicated that in April 1997 it would decide whether to adopt
procedures in connection with its decision on the Transaction that include
additional public hearings as well as additional written comments. If
additional hearings or written comments are necessary, final deliberations in
this matter would be scheduled for late June or early July 1997.
Michigan Public Service Commission: In April 1996, the Michigan Public
Service Commission ("MPSC") approved the merger application through a
settlement agreement containing terms consistent with the merger application.
North Dakota Public Service Commission: In June 1996, the North Dakota Public
Service Commission approved the merger application.
Other Federal Agencies: In the fall of 1995, WEC and NSP filed applications
with the United States Nuclear Regulatory Commission ("NRC") for license
amendments related to the Merger Agreement. The matter is pending. In 1995,
WEC and NSP received a ruling from the United States Internal Revenue Service
indicating that the proposed successive merger transactions included in the
Merger Agreement would not prevent treatment of the Transaction as a tax-free
reorganization under applicable tax law if each transaction independently so
qualified. In December 1996, WEC and NSP filed required notifications with
the Federal Trade Commission and the United States Department of Justice
("DOJ") under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as
amended. In January 1997, the DOJ served a second request for information and
documents. WEC and NSP anticipate responding to the second request in March
1997.
Merger Conditions: Under the Merger Agreement, completion of the Transaction
is subject to several conditions, including but not limited to the prior
receipt of all necessary regulatory approvals without the imposition of
materially adverse terms. In addition, both WEC and NSP have the right to
terminate the Merger Agreement if the Transaction has not been completed by
April 30, 1997, except where on such date all necessary statutory approvals
and third party consents have not been obtained but all other conditions to
closing have been fulfilled or are capable of being fulfilled. Then the
termination date shall be extended to October 31, 1997. WEC continues to work
with NSP to complete the Transaction and believes that fulfillment of the
various conditions to the Transaction within the time frame of the Merger
Agreement is achievable.
A-14
<PAGE> 15
Additional information with respect to the Merger Agreement and the proposed
Transaction, including pro forma combined condensed financial information, may
be found in "Note B - Mergers" in the NOTES TO FINANCIAL STATEMENTS.
Nuclear Matters
Point Beach Nuclear Plant: WE operates two 500 megawatt electric generating
units at Point Beach Nuclear Plant ("Point Beach"). During 1996, Point Beach
accounted for 25.4% of WE's net electric generation. The current operating
licenses for the two units at Point Beach expire in 2010 and 2013 for Units 1
and 2, respectively.
As a result of degradation of tubes within the Unit 2 steam generators at
Point Beach, WE completed replacement of the steam generators in January 1997.
The unit had been operating at 90% of its capacity during the operating cycle
prior to the Unit 2 fall refueling and steam generator replacement outage,
which began in October 1996. Subject to approval by the NRC, WE expects to
restart Unit 2 during the second quarter of 1997. Unit 1 was taken out of
service in February 1997 due to equipment problems. These problems and other
emergent issues associated with this Unit 1 outage were resolved and Unit 1
was scheduled to return to service in March 1997. Unit 1 had been scheduled
to be taken out of service again in early May 1997 to begin an extended
refueling outage. In March 1997, WE reevaluated its generating unit outage
schedule scenarios to optimize the availability of supply resources and has
decided to return Unit 1 to service in early summer 1997, with the refueling
outage currently scheduled to occur from September through October 1997. This
decision allows Point Beach staff to focus their attention on the work
necessary to bring Unit 2 back into service and, secondarily, to allow Unit 1
to be in service during the 1997 summer peak demand months. See "FACTORS
AFFECTING RESULTS OF OPERATIONS - Rates and Regulatory Information" below for
information about a related emergency fuel rate increase request filed with
the PSCW in the first quarter of 1997.
WE anticipates additional power purchases during 1997, in part due to the
extended outages of Point Beach Units 1 and 2. The cost of these additional
power purchases are included in the emergency fuel rate increase request filed
with the PSCW as noted above.
WE completed construction of an Independent Spent Fuel Storage Installation
("ISFSI") in 1995 for dry storage of spent fuel from Point Beach. The ISFSI
was necessary because the spent fuel pool inside the plant is nearly full.
Two storage casks have been loaded with spent fuel and transferred to the
ISFSI. As a result of a hydrogen gas ignition during loading of a third cask
in May 1996, cask loading has been halted until actions are implemented to
prevent recurrence of such an event and until the NRC has reviewed and
accepted these actions. WE hopes to resume loading of the casks in the summer
of 1997.
In December 1996, WE paid the NRC $325,000 in civil penalties for performance
deficiencies and violations of NRC requirements in various plant activities.
In January 1997, the NRC informed WE of additional potential violations
observed during a special inspection that could result in further civil
penalties. Also, the NRC sent a letter on January 27, 1997 notifying WE of a
declining trend in performance at Point Beach based upon these inspections and
other ongoing regulatory interactions. The NRC issues trend letters to
provide early notification of declining performance and to allow a utility,
under the watchfulness of the NRC, to take early corrective actions. The NRC
acknowledged in the letter that WE has made improvements in the identification
and resolution of specific problems.
A-15
<PAGE> 16
See "Note F - Nuclear Operations" in the NOTES TO FINANCIAL STATEMENTS for
further information related to Point Beach, the Unit 2 steam generator
replacement, the ISFSI and NRC matters. See "LIQUIDITY AND CAPITAL
RESOURCES - Investing Activities" below for additional information about the
Unit 2 steam generator replacement project.
Spent Fuel Storage and Disposal: As noted in the preceding section, WE
constructed the ISFSI because its spent fuel pool within Point Beach is nearly
full. Without NRC agreement that WE may resume loading of storage casks, the
pool for spent fuel will be full by 1998. With NRC agreement to resume
loading spent fuel, WE will load up to a total of 12 casks, providing
sufficient storage capacity for spent fuel until the year 2000. WE plans to
file an application with the PSCW later in 1997 for approval to load by the
year 2000 further storage casks in addition to the 12 that were previously
approved.
The temporary dry storage facilities at Point Beach are being used until the
United States Department of Energy ("DOE") takes ownership of and permanently
removes the spent fuel under a contract mandated by the Nuclear Waste Policy
Act of 1982, as amended in 1987 ("Waste Act"). In July 1996, the United
States Court of Appeals for the District of Columbia circuit ruled that the
DOE has an unconditional obligation under the Waste Act to begin accepting
spent fuel by January 31, 1998. However, in December 1996, the DOE notified
owners of commercial nuclear plants that it will not be able to meet its
statutory obligation. The DOE has indicated that it does not expect a
permanent spent fuel repository to be available until at least 2010. On
January 31, 1997, numerous electric utilities filed a petition in the Court of
Appeals for review of the DOE's failure to meet its statutory obligation and
requested, among other things, authority to withhold payments to the DOE for
the permanent disposal program until it begins accepting their spent fuel.
While WE was not a party to the petition, the PSCW has joined other public
utility commissions and states in a similar petition filed on the same day.
At this time, WE is unable to predict when the DOE will actually begin
accepting spent fuel. Until such time, WE expects to continue to rely on
temporary dry storage of its spent nuclear fuel. As another potential
temporary storage option, WE is participating with a consortium of electric
utilities to establish a private facility for interim storage of spent nuclear
fuel. However, the availability of this private facility is uncertain at this
time.
Industry Restructuring and Competition
The electric industry continues a trend towards restructuring and increased
competition, driven by a combination of market forces, regulatory and
legislative initiatives and technological changes. To date, competitive
pressures have been most prominent in the wholesale power market, but are
expected to continue to develop in the electric retail markets. Currently
proposed federal legislation targets electric retail customer choice by the
years 2000 through 2003. Present regulatory restructuring initiatives in
various midwestern states target electric retail customer choice by the years
2000 through 2005. While the Company cannot predict the ultimate timing or
impact of a restructured electric industry, WE has been advocating
restructuring of the electric utility industry and believes that as a low-cost
energy provider, it is well positioned to benefit from such changes. Among
others, the following electric and gas industry restructuring initiatives are
underway in regulatory jurisdictions where WE currently does business.
A-16
<PAGE> 17
PSCW Electric Utility Industry Investigation: The PSCW has conducted an
investigation into the electric utility industry in Wisconsin, particularly
its institutional structure and regulatory regime, in order to evaluate what
changes would be beneficial for Wisconsin. In December 1995, the PSCW decided
the general direction of utility regulation in Wisconsin. This proposed
restructuring of the industry would permit all consumers to choose their
electricity provider by the year 2001 and it would establish a competitive
generation business. The transmission and distribution functions would remain
regulated. In a February 1996 report to the Wisconsin Legislature, the PSCW
identified a 32 step workplan that it would follow for electric utility
restructuring in Wisconsin. During 1996, the PSCW opened dockets on six of
these steps including:
* Required utilities to file plans to functionally segment the business into
generation, transmission, distribution and customer service operations.
Comments were filed on the plans and a technical conference will be held
in early 1997.
* Requested utilities and other interested parties to file comments on the
adoption of affiliated interest standards to prevent unfair competition
and cross-subsidization between affiliated businesses. The PSCW staff
will prepare an initial proposal for comment in the spring of 1997 to be
followed by hearings and rulemaking proceedings in the fourth quarter of
1997.
* Evaluated whether a public benefits policy advisory board should be
created to carry out policies to continue programs, such as conservation
and low-income energy assistance which are best handled by a government
agency as competition is introduced into the industry. Meetings were held
throughout 1996 to discuss recommendations for action. These
recommendations formed a report that will serve as the basis for public
meetings in early 1997. The PSCW is expected to make decisions in April
1997 which will most likely require significant legislation.
* Evaluated what quality of service standards and mechanisms for measuring
and monitoring service quality should be established. Utilities and other
interested parties were requested to comment on ways to generally improve
service rules before moving to a restructured industry. A rulemaking
hearing is planned for early 1997. The PSCW is expected to issue an order
on service quality for legislative review after the hearings.
* Examined the introduction of an ISO in the state of Wisconsin that
effectively separates control and operation of the transmission system
from the ownership of generation. At the request of the PSCW, WE, along
with four other utilities (including NSP) submitted a joint proposal in
May 1996 for an ISO that would have the responsibility for ensuring
transmission service in the state will be conducted fairly and equitably
for all parties. Three other proposals were also filed. In September
1996, the PSCW issued an order setting forth principles for an acceptable
ISO ("ISO Order"). Among the principles are that the ISO would operate
the transmission system, be governed by a Board of Directors not subject
to control by transmission owners and be the principal transmission
planner. The PSCW indicated that the preferred method of transfer of
authority to the ISO is a contract with a minimum length of five years.
The PSCW has indicated that it will consider the principles contained in
its ISO Order as deliberations are held on the Primergy merger
application. As part of the PSCW merger proceeding, WEC and NSP proposed
an ISO consistent with the ISO proposal filed with the FERC in the
Settlement Offer discussed above. See "FACTORS AFFECTING RESULTS OF
OPERATIONS - Merger Agreement with Northern States Power Company" above
for further information about the proposed merger.
A-17
<PAGE> 18
MPSC Electric Utility Industry Investigation: In December 1996, the staff of
the MPSC issued a proposal to restructure that state's electric utility
industry. If adopted, the plan would allow all consumers to be able to choose
their electric supplier by the year 2004. The proposal supports development
of a lower Michigan ISO using FERC principles to ensure non-discriminatory
access and continued reliability. The Michigan ISO could later be involved
with a regional ISO if determined to provide substantive benefit to Michigan
customers. Based upon comments received in January 1997, the MPSC has
requested further input on several implementation issues and will hold
additional public hearings in March and April 1997.
Midwest ISO: WE is one of twenty-five utilities who are participating in the
formation of a Midwest ISO which would be responsible for ensuring
nondiscriminatory open transmission service access and the planning and
security of the combined bulk transmission systems of the utilities. These
utilities are all transmission facility owners within the East Central Area
Reliability Council ("ECAR") or the Mid-America Interconnected Network
("MAIN"). In its Wisconsin statewide ISO Order, the PSCW did not specifically
address how the Wisconsin ISO might be merged into the regional Midwest ISO
once it was formed. Plans for the Midwest ISO are expected to be filed with
the FERC in the summer of 1997 and would be implemented in stages after
acceptance by the FERC.
FERC Open Access Transmission Ruling: As a result of the Energy Policy Act of
1992, the FERC issued in April 1996 two orders relating to open access
transmission service, stranded costs, standards of conduct and open access
same-time information systems. The ruling is intended to create a more
competitive wholesale electric power market.
The first order, Order No. 888, requires public utilities owning, controlling
or operating transmission lines to file non-discriminatory open access tariffs
that offer others the same transmission service provided to themselves and
requires the use of the tariffs for their own wholesale energy sales and
purchases. Order No. 888 also provides for the full recovery of "stranded
costs" that were prudently incurred to serve power customers and that could go
unrecovered if wholesale customers use open access to move to another electric
energy supplier. In July 1996, WE submitted to the FERC a transmission tariff
in connection with Order No. 888. WE's filing includes terms and conditions
of network transmission service and point-to-point transmission service,
including ancillary services. The rate related aspects of the tariff were
accepted by the FERC in a June 1996 settlement agreement regarding WE's
preexisting transmission service tariffs. All other aspects of the tariff
followed the FERC pro-forma tariff and were accepted by the FERC.
The second order, Order No. 889, works to ensure that transmission owners and
their affiliates do not have an unfair competitive advantage in using
transmission to sell power. Order No. 889 establishes standards of conduct
and requires that a public utility's merchant function rely on the same
electronic information network that its transmission customers rely on to
obtain information about its transmission system when buying or selling power.
On March 3, 1997, the FERC reaffirmed and clarified these orders with the
issuance of Order No. 888a.
WE has advocated open access to transmission facilities as a necessary step in
the competitive restructuring of the electric utility industry and does not
believe that the ruling by the FERC will have a detrimental effect on its
financial position or results of operations. The open access transmission
orders became effective in mid-1996.
A-18
<PAGE> 19
In its open access transmission ruling, the FERC encouraged utilities to
consider ISOs such as the Wisconsin statewide and Midwest ISOs noted above as
a tool to meet the demands of a competitive market for electric energy.
Wholesale Competition: Wholesale sales of electric energy accounted for 5.0%,
5.6% and 6.2% of WE's total Electric Operating Revenues in 1996, 1995 and
1994, respectively. WE attributes the decrease over this three year period in
part to the increasingly competitive market for electric wholesale customers.
In response to competition, WE renegotiated long-term power sales contracts
with its municipal and rural electric cooperative wholesale customers during
1995 and 1996. The renegotiated contracts contain discounts from previous
rates charged to these customers in exchange for contract extensions. Two
wholesale customers, representing 24 MW, chose to obtain their power supplies
from other suppliers, with their contracts phasing out between 1997 and 1998.
As a result of the renegotiated and lost contracts, WE anticipates that
electric wholesale revenues will continue to decrease slightly in 1997 and
1998. WE expects to continue to provide transmission service to the customers
who did not renew their contracts.
PSCW Natural Gas Utility Industry Investigation: The PSCW continued a generic
investigation of the natural gas industry in Wisconsin and addressed the
extent to which traditional regulation should be replaced with a different
approach. In response to a November 1996 PSCW order, WE will file a revised
gas cost recovery mechanism ("GCRM") by July 1, 1997. In accordance with that
order, GCRMs must either be an incentive type or modified dollar-for-dollar
type, both of which will include after-the-fact prudence reviews by the PSCW.
After WE files and receives PSCW approval for the new GCRM, WE will be able to
assess the level of risk. The Company does not expect that a major portion of
gas costs that are currently passed through to customers will be subject to
risk under any GCRM that will be filed later this year.
The PSCW has also issued Standards of Conduct applicable to opportunity sales.
Opportunity sales are described as the sales of underutilized capacity and
supply entitlements that become periodically available because of the variable
daily and seasonal needs of customers. These Standards of Conduct are
intended to ensure that all interested market participants have an opportunity
to purchase released capacity and supply and that the releasing utility
receives the highest price for the sale, given the specific circumstances.
Additional restrictions become applicable if a gas utility has a marketing
affiliate.
Electric Sales and Gas Deliveries Outlook
Assuming moderate growth in the economy of its service territory and normal
weather, WE presently anticipates total electric kilowatt-hour sales to grow
at a compound annual rate of approximately 2.1% over the five-year period
ending December 31, 2001. WE forecasts total therm deliveries of natural gas
to grow at a compound annual rate of approximately 1.9% over the same five-
year period. These forecasts are subject to a number of variables, including
among others the economy, weather and the restructuring of the electric and
gas utility industries, which may affect the actual growth in sales. These
estimates do not reflect the operations of NSP, which will become a part of
Primergy after consummation of the Transaction. See "FACTORS AFFECTING
RESULTS OF OPERATIONS - Merger Agreement with Northern States Power Company"
above.
New Gas Service Proposal: On February 14, 1997, WE filed revised plans with
the PSCW to expand natural gas service to more than 4,800 potential customers
in northeastern Wisconsin. The project will involve the installation of more
A-19
<PAGE> 20
than 350 miles of new gas main and is one of the largest proposed new
franchise territory expansion efforts in recent Wisconsin history. Wisconsin
Public Service Corporation ("WPS"), an unaffiliated investor-owned utility in
Green Bay, Wisconsin, filed a competing application to serve a portion of the
area for which WE originally filed. WE and WPS have reached an agreement that
resolves which company will serve in areas that both companies initially filed
to serve. A number of approvals must be granted before the project can
continue, including receiving approval from the PSCW. The Wisconsin Propane
Gas Association has intervened in the case and has requested that the PSCW
hold a hearing. The hearing is scheduled for April 1997. Once all approvals
are received, WE expects to begin contacting potential customers in the second
half of 1997.
Proposed Acquisition of ESELCO, Inc.: ESELCO, Inc., parent company of Edison
Sault Electric Company ("Edison Sault"), and WEC announced on March 25, 1997,
that they had entered into a letter of intent setting forth the preliminary
terms of the potential acquisition of ESELCO, Inc. by WEC. All outstanding
shares of ESELCO, Inc. common stock would be converted into shares of WEC
common stock based on a value of $44.50 for each share of ESELCO, Inc. common
stock in a transaction proposed to be structured as a tax-free reorganization
and accounted for as a pooling of interests. The total purchase price would
be approximately $71 million. The exact number of shares of WEC common stock
to be issued in the transaction would be determined by dividing $44.50 by the
average closing prices of WEC common stock during a specified period prior to
closing.
Consummation of the proposed transaction is contingent upon several conditions
including the negotiation and execution of a definitive agreement, approval by
the Boards of Directors of both companies and the shareholders of ESELCO,
Inc., receipt of all appropriate regulatory approvals, the effectiveness of a
registration statement to be filed with the Securities and Exchange Commission
covering the WEC shares to be issued in the transaction and other customary
conditions. There can be no assurance as to the final terms of the proposed
transaction, or that the conditions will be satisfied, or that the proposed
transaction will be consummated.
Edison Sault is an electric utility which serves approximately 22,000
residential, commercial and industrial customers located in Michigan's eastern
Upper Peninsula. ESELCO, Inc. is traded under the symbol EDSE on the NASDAQ
National Market.
Effects of Weather
By the nature of its utility business segments, WEC's and WE's earnings are
sensitive to weather variations from period to period. Variations in winter
weather affect heating load for both the gas and electric utility. Variations
in summer weather affect cooling load for the electric utility as well as
therm deliveries to gas fired electric generating customers. The table below
summarizes weather in WE's service territory as measured by degree days for
each of the three years ended December 31, 1996.
==============================================================================
% Change % Change
1995 1994
Degree Days 1996 1995 to 1996 1994 to 1995
---------------------- ------ ------ -------- ------ --------
Heating (7,049 Normal) 7,469 6,833 9.3% 6,431 6.3%
Cooling (668 Normal) 608 952 (36.1%) 877 8.6%
==============================================================================
A-20
<PAGE> 21
Effects of Inflation
With expectations of low-to-moderate inflation, the Company does not believe
the impact of inflation will have a material effect on its future results of
operations.
Rates and Regulatory Matters
The table below summarizes the projected annual revenue impact of recent rate
changes authorized by regulatory commissions for the electric, natural gas and
steam utilities of the Company based on the sales projections utilized by
those commissions in setting rates. The PSCW regulates Wisconsin retail
electric, steam and natural gas rates, while the FERC regulates wholesale
power and electric transmission and gas transportation service rates. The
MPSC regulates retail electric rates in Michigan.
The PSCW has discontinued the practice of conducting annual rate case
proceedings, replacing it with a new schedule which calls for future rate
cases to be conducted once every two years. In support of its goal to become
the lowest-cost energy provider in the region and in light of the operating
cost reductions expected from Revitalization discussed above, WE did not seek
an increase in rates for 1994 or 1995. Discussion of rate changes for the
1997 and 1996 test years follow the table.
==============================================================================
Revenue Percent
Increase Change in Effective
Service (Decrease) Rates Date
- ------------------------- ------------ --------- ---------
(Millions) (%)
Retail electric, WI $ (7.4) (0.6) 02/18/97
Retail gas (6.4) (2.0) 02/18/97
Steam heating 0.1 .5 02/18/97
Retail electric, WI (33.4) (2.8) 01/01/96
Retail electric, MI (1.1) (3.3) 01/01/96
Retail gas (8.3) (2.6) 01/01/96
Steam heating (0.8) (5.1) 01/01/96
Fuel electric, WI (16.2)* (1.3) 08/04/94
==============================================================================
* The 8/4/94 fuel credit was eliminated 1/1/96 by PSCW Order.
Under the Wisconsin retail electric fuel cost adjustment procedure, retail
electric rates may be adjusted, on a prospective basis, if cumulative fuel and
purchased power costs, when compared to the costs projected in the retail
electric rate proceeding, deviate from a prescribed range and are expected to
continue to be above or below that range.
Due to extended outages at Point Beach and the Oak Creek Power Plant, WE has
incurred and will continue to incur increased fuel costs beyond those
reflected in its electric rates. In February 1997, WE filed with the PSCW a
request for an increase in its electric rates to cover the increased fuel
costs. The filing was made under the PSCW special rules governing fuel cost
increases. Under these rules, a utility may, if allowed by the PSCW, recover
a portion of the fuel cost increase. The projected fuel cost increase for WE
is estimated at about $67 million of which $53 million is allocated to the
Wisconsin jurisdiction. The portion of the $53 million which WE may be
allowed to recover could depend upon the timing and nature of the PSCW order.
It is expected that WE's rate increase request will be contested.
A-21
<PAGE> 22
In December 1995, the MPSC approved the suspension of the Power Supply Cost
Recovery Clause (fuel adjustment procedure) for a five-year period for
Michigan retail electric customers. In the case of natural gas costs,
differences between the test year estimate and the actual cost of purchased
gas are accounted for through a purchased gas adjustment clause.
1997 Test Year: In an order dated February 13, 1997, the PSCW directed WE to
implement rate decreases for Wisconsin retail electric and gas customers of
$7.4 million or 0.6% and $6.4 million or 2.0%, respectively, on an annualized
basis, and a steam rate increase of $0.1 million or 0.5% on an annualized
basis. The order is effective February 18, 1997 and is based on a regulatory
return on common equity of 11.8%, up from 11.3% authorized since January 1,
1996. The PSCW had determined that it required a special full review of WE's
rates for the 1997 test year in connection with consideration of the
application for approval of the proposed merger of WEC and NSP.
1996 Test Year: In a letter order dated September 11, 1995, the PSCW directed
WE to implement rate decreases for Wisconsin retail electric, gas and steam
customers of $33.4 million or 2.8%, $8.3 million or 2.6% and $0.8 million or
5.1%, respectively, on an annualized basis effective January 1, 1996. The
order is based on a regulatory return on common equity of 11.3%, down from
12.3% authorized since 1993. Also effective January 1, 1996, the MPSC
authorized WE to implement a rate decrease for Michigan non-mine retail
electric customers of $1.1 million or 3.3% on an annualized basis.
Neither the 1997 nor 1996 Test Year changes reflect the proposed retail
electric and gas rate reductions and freezes nor the wholesale rate reductions
and freezes related to the proposed merger with NSP. See "FACTORS AFFECTING
RESULTS OF OPERATIONS - Merger Agreement with Northern States Power Company"
above for a separate discussion of rate actions related to the proposed
Transaction.
Regulatory Accounting: WEC's principal subsidiary, WE, operates under
electric utility rates which are subject to the approval of the PSCW, MPSC and
FERC, and natural gas and steam utility rates that are subject to the approval
of the PSCW (see "Rates and Regulatory Matters" above). Such rates are
designed to recover the cost of service and provide a reasonable return to
investors. Developing competitive pressures in the utility industry may
result in future utility rates which are based upon factors other than the
traditional original cost of investment. In such a situation, continued
deferral of certain regulatory asset and liability amounts on the utility's
books may no longer be appropriate as allowed under Statement of Financial
Accounting Standards No. 71, Accounting for the Effects of Certain Types of
Regulation. At this time, WEC is unable to predict whether any adjustments to
regulatory assets and liabilities will occur in the future. See "Note A -
Summary of Significant Accounting Policies" in the NOTES TO FINANCIAL
STATEMENTS for additional information.
New Accounting Pronouncements
In 1995, the Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standards No. 121, Accounting for the Impairment of Long-
Lived Assets ("FAS 121") and Statement of Financial Accounting Standards
No. 123, Accounting for Stock-Based Compensation ("FAS 123"). FAS 121
requires that long-lived assets be reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. FAS 123 establishes reporting standards and an optional
accounting method for stock-based employee compensation plans. The Company
A-22
<PAGE> 23
adopted both standards prospectively in 1996. Adoption did not have a
material effect on the Company's net income or financial position.
In February 1996, FASB released for comment an exposure draft of a Proposed
Statement of Financial Accounting Standards, Accounting for Certain
Liabilities Related to Closure or Removal of Long-Lived Assets ("Proposed
FAS"). The Proposed FAS, if issued, would require WE to recognize as a
liability the present value of the estimated future total costs associated
with closure or removal of certain long-lived assets and to correspondingly
capitalize those costs. The capitalized costs would be depreciated to expense
over the useful life of the asset. The proposed statement would become
effective in 1998. This Proposed FAS would apply to decommissioning costs for
Point Beach and would result in WE recording a decommissioning liability and
corresponding asset as required by the pronouncement. Currently, nuclear
decommissioning costs are accrued as depreciation expense over the expected
service lives of the two units at Point Beach based on an external sinking
fund method. Any changes in depreciation expense due to differing assumptions
between the Proposed FAS and those currently required by the PSCW are not
expected to be material and would most likely be deferrable and recoverable in
rates. For additional information on the costs of decommissioning Point
Beach, see "Note F - Nuclear Operations" in the NOTES TO FINANCIAL STATEMENTS.
Environmental Matters
Clean Air Act: The 1990 Amendments to the Clean Air Act mandate significant
nation-wide reductions in SO2 and NOx emissions to address acid rain and
ground level ozone control requirements.
WE has completed the installation of continuous emission monitors at all of
its facilities and installed low NOx burners on all boilers at its Oak Creek
and Valley Power Plants. These actions, along with the burning of low sulfur
coal meet the requirements that became effective January 1, 1995. To date,
approximately $47.6 million has been spent on compliance with the 1990
amendments to the Clean Air Act.
WE elected to voluntarily bring the Valley and Port Washington Power Plants
under jurisdiction of the NOx requirements of the Clean Air Act amendments of
1990, five years earlier than mandated. This was possible because these units
already meet the current NOx emissions standards.
WE projects a surplus of SO2 emission allowances during Phase I and a small
shortfall during Phase II, which begins in the year 2000. WE is seeking
additional allowances available as a result of energy conservation programs.
As an integral component of its least-cost plan, WE is active in SO2 allowance
trading. Revenue from the sale of allowances is being used to offset future
potential rate increases.
Additional fuel switching and the installation of NOx controls at various
power plants will be required to meet the second phase of reduction
requirements that become effective January 1, 2000. These costs, along with
additional operating expenses, are not expected to exceed $38.0 million based
on today's costs.
Manufactured Gas Plant Sites: WE is reviewing and addressing environmental
conditions at a number of former manufactured gas plant sites. See "Note M -
Commitments and Contingencies" in the NOTES TO FINANCIAL STATEMENTS for
additional information.
A-23
<PAGE> 24
Ash Landfill Sites: WE aggressively seeks environmentally acceptable,
beneficial uses for its combustion byproducts. However, ash materials have
been, and to some degree, continue to be disposed in company-owned, licensed
landfills. Some early designed and constructed landfills may allow the
release of low levels of constituents resulting in the need for various levels
of remediation. Where WE has become aware of these conditions, efforts have
been expended to define the nature and extent of any release, and work has
been performed to address these conditions. These costs are included in the
environmental operating and maintenance costs of WE.
LS Power Generation Facility
In 1993, a competitive bidding process conducted by the PSCW resulted in the
selection of a proposal submitted by an unaffiliated independent power
producer, LSP-Whitewater L.P. ("LS Power"), to construct a generation facility
to meet a portion of WE's anticipated increase in system supply needs. WE
subsequently signed a long-term agreement to purchase electricity from the
proposed facility. The agreement is contingent upon the facility being
completed and placed into operation. Plant construction is currently on
schedule to meet the planned start-up date of June 1, 1997. See "Note M -
Commitments and Contingencies" in the NOTES TO FINANCIAL STATEMENTS for
additional information about WE's long-term power purchase agreement with LS
Power.
LIQUIDITY AND CAPITAL RESOURCES
Except where specifically noted, the following discussion and analysis of
LIQUIDITY AND CAPITAL RESOURCES does not consider the impact of the proposed
merger with NSP. See "FACTORS AFFECTING RESULTS OF OPERATIONS - Merger
Agreement with Northern States Power Company" above for information about the
proposed merger.
Investing Activities
WEC invested a net total of $1.106 billion in its businesses during the three
years ended December 31, 1996. Investments during this three-year period
included approximately $957 million for construction of new or improved
facilities of which $840 million was for utility projects and approximately
$117 million was for non-utility projects. Additional investments during the
three years ended December 31, 1996 included approximately $76 million for
acquisition of nuclear fuel, $47 million for the eventual decommissioning of
Point Beach and net capitalized conservation expenditures of $18 million.
WEC's non-utility subsidiaries received net proceeds of $31 million during
this three-year period on the disposition of various investments as part of
Other Investing Activities.
Point Beach Unit 2 Steam Generators: In October 1992, WE filed an application
with the PSCW for replacement of the Point Beach Unit 2 steam generators,
which will allow for the unit's operation until the expiration of its
operating license in 2013. In an Interim Order in February 1995, the PSCW
deferred the decision on steam generator replacement until after the refueling
outage in September 1995. However, the PSCW directed WE to make suitable
arrangements with the fabricator of the new steam generators to allow the
fabrication, delivery and replacement to proceed promptly if authorized by the
PSCW. The reasonable costs of such arrangements to maintain a place in line
with the fabricator would be afforded rate recovery. In May 1996, WE received
a written order from the PSCW approving replacement of the steam generators at
A-24
<PAGE> 25
an estimated cost of $96 million. Replacement of the Unit 2 steam generators
was completed in January 1997. Capital expenditures of $41.5 million and
$24.6 million were made in 1996 and 1995, respectively, for replacement of the
Unit 2 steam generators.
Milwaukee County Power Plant: The 11 MW Milwaukee County Power Plant supplies
electricity, steam and chilled water to the hospitals and other member
institutions of the Milwaukee Regional Medical Center, as well as to other
large customers located on land known as the Milwaukee County Grounds. In
December 1995, WE acquired the electric generation and distribution facilities
in the first phase of the acquisition. The capital cost for the electric
facilities was $7 million. These facilities and the new customers associated
with them were integrated into WE's current electric utility operations. In
December 1996, WEC acquired the steam and chilled water production and
distribution facilities to complete the second phase of the purchase. Two
outstanding contingencies were met prior to closing the purchase. The PSCW
approved the purchase of the steam facilities, and the five largest customers
signed steam and chilled water service agreements which obligate them to
purchase their present and future heating and cooling requirements from WEC
for a period of ten years. The capital cost for the steam facilities was
approximately $21 million. WE has integrated these facilities and the
associated customers into its current steam utility operations. The capital
cost for the chilled water facilities was approximately $19 million. A
separate subsidiary of WEC will operate the chilled water facilities as a non-
regulated business.
Paris Generating Station: During 1995, WE placed in service four units, or
approximately 300 megawatts of capacity, at its Paris Generating Station.
This natural gas-fired combustion turbine facility, located near Union Grove,
Wisconsin, is designed to meet peak demand requirements. Capital expenditures
of $6 million, $10 million and $54 million were made during 1996, 1995 and
1994, respectively. The capital costs of the Paris facility totalled
approximately $102 million.
Concord Generating Station: During 1994, WE placed in service the last two
units, or approximately 150 megawatts of capacity, at its Concord Generating
Station. This four unit 300 megawatt natural gas-fired combustion turbine
facility, located near Watertown, Wisconsin, is designed to meet peak demand
requirements. The first two units were completed in 1993. Capital
expenditures of $3 million and $6 million were made during 1995 and 1994,
respectively, for construction of this facility. The capital costs of the
Concord facility totalled approximately $100 million.
Port Washington Power Plant Renovation: Additionally during 1994, WE
completed the $107 million renovation project at its Port Washington Power
Plant. The renovation work, which began in September 1991, included the
installation of additional emission control equipment. Capital expenditures
totaling $12 million were made during 1994 for this project.
Kimberly Cogeneration Facility: Prior to the 1993 selection of the LS Power
generation facility by the PSCW discussed above in "FACTORS AFFECTING RESULTS
OF OPERATIONS - LS Power Generation Facility", WE had proposed to construct
its own 220 megawatt cogeneration facility in Kimberly, Wisconsin, which was
intended to provide process steam to Repap Wisconsin, Inc. ("Repap") starting
in mid-1994. In its order, the PSCW selected the WE project as the second
place conditional project if the LS Power project did not proceed. At
December 31, 1996, a net investment of approximately $65.6 million remains in
Other Deferred Charges and Other Assets for the Kimberly Cogeneration Facility
A-25
<PAGE> 26
equipment (the "Equipment"). This balance represents costs associated with
the procurement of three combustion turbines, one steam turbine and three heat
recovery boilers that were acquired in order to achieve the in-service dates
as agreed to in a steam service contract with Repap. See "Note M -
Commitments and Contingencies" in the NOTES TO FINANCIAL STATEMENTS for
further information concerning disposition of the Equipment.
Non-Utility Investments: WEC's non-utility assets amounted to approximately
$304 million at December 31, 1996. WEC currently anticipates making
additional non-utility investments from time to time. For additional
information, see "Capital Requirements 1997-2001" below and "Note L -
Information by Segments of Business" in WEC's NOTES TO FINANCIAL STATEMENTS.
Minergy Glass Aggregate Plant: Minergy Corp. ("Minergy"), a non-utility WEC
subsidiary, plans to place into operation a $45 million facility in Neenah,
Wisconsin that would recycle paper sludge from area paper mills into two
usable products: glass aggregate and steam. The glass aggregate will be sold
into existing construction and aggregate markets and the steam will be sold to
a local paper mill. The plant will result in substantial environmental and
economic benefits to the area by providing an alternative to landfilling paper
sludge. Minergy commenced construction in July 1996, with commercial
operation scheduled for April 1998. The project is expected to be financed
during construction through short-term borrowings. Capital expenditures
totaling $14 million were made during 1996 for this facility.
Cash Provided by Operating and Financing Activities
During the three years ended December 31, 1996, cash provided by operating
activities totaled $1.308 billion at WEC and $1.310 billion at WE. During
this period, internal sources of funds, after the payment of dividends,
provided 75% of WEC's and 82% of WE's capital requirements.
Financing activities during the three-year period ended December 31, 1996
included the issuance of approximately $506 million of long-term debt by WEC
of which $480 million was issued by WE. The proceeds of these new debt issues
were used to retire or refinance higher coupon debt in the amount of $223
million, to reduce net short-term borrowings in the amount of $138 million and
for other general corporate purposes. WEC added $126 million of common equity
from the issuance of new shares through the Company's stock plans and
purchased or redeemed $5 million of preferred stock. No preferred stock was
issued during this period. Dividends on WEC's common stock were $167 million,
approximately $160 million and approximately $151 million during 1996, 1995
and 1994, respectively. WE paid dividends to WEC of approximately $168
million, $160 million and $151 million during 1996, 1995 and 1994,
respectively, and received a total of $60 million in capital contributions
from WEC during this three-year period.
In December 1996, WE and WISVEST Corporation issued promissory notes in the
amount of $12.05 and $10.95 million, respectively, due 2006. The notes were
issued as part of the transaction to acquire the steam and chilled water
facilities from Milwaukee County. The notes have been discounted to reflect
the difference between the effective interest rate of 6.36% and the stated
rate of 1.93%.
In November 1996, WE issued $200 million of 6 5/8% unsecured debentures due
2006. In December 1995, WE issued $100 million of unsecured One Hundred Year
6 7/8% Debentures due 2095. Proceeds of both issues were added to WE's
general funds and were applied to the repayment of short-term borrowings.
A-26
<PAGE> 27
In August 1995, WE called for optional redemption $98.35 million aggregate
principal amount of fixed rate tax exempt bonds issued by three political
jurisdictions on WE's behalf that were secured by issues of WE's First
Mortgage Bonds with terms corresponding to the tax exempt bonds called for
redemption. During September and October 1995, the three political
jurisdictions issued $98.35 million aggregate principal amount of new tax
exempt bonds on behalf of WE, collateralized by unsecured variable rate
promissory notes issued by WE, maturing between March 1, 2006 and September 1,
2030, with terms corresponding to the respective issues of the refunding tax
exempt bonds. The proceeds were used to finance the optional redemptions.
The WE First Mortgage Bonds, which collateralized the redeemed tax exempt
bonds, have been canceled.
The Merger Agreement, entered into by WEC and NSP, provides for restrictions
on certain transactions by both the Company and NSP, including the issuance of
debt and equity securities. Should circumstances arise to make such
transactions necessary, NSP would need to agree to consent to any such change
in the Merger Agreement.
Capital Structure
WEC's and WE's capitalization at December 31 were:
==============================================================================
WEC WE
---------------- ----------------
1996 1995 1996 1995
------ ------ ------ ------
Common Equity 53.3% 53.8% 51.6% 52.1%
Preferred Stock 0.8 0.9 0.9 1.0
Long-Term Debt
(including current maturities) 44.0 40.8 46.1 42.3
Short-Term Debt 1.9 4.5 1.4 4.6
------ ------ ------ ------
100.0% 100.0% 100.0% 100.0%
====== ====== ====== ======
==============================================================================
Compared to the utility industry in general, the Company has maintained a
relatively high ratio of common equity to total capitalization and low debt
and preferred stock ratios. This conservative capital structure, along with
strong bond ratings and internal cash generation has provided, and should
continue to provide, the Company with access to the capital markets when
necessary to finance the anticipated growth in the Company's utility business.
WE currently has senior secured debt ratings of AA+ by Standard & Poor's
Corporation ("S&P"), Duff & Phelps Inc. and Fitch Investors Service Inc.
("Fitch") and Aa2 by Moody's Investors Service ("Moody's"). WE currently has
unsecured debt ratings of AA by S&P and Duff & Phelps, Inc. and Aa3 by
Moody's.
Following announcement of the Transaction, in May 1995 S&P reported that it
was placing on CreditWatch with negative implications its AA+ senior secured
debt and AA+ preferred stock ratings of WE and its AA senior unsecured debt
rating of Wisconsin Michigan Investment Corporation, a non-utility subsidiary
of WEC. S&P stated that if the Transaction is completed, the likely credit
rating for the senior secured debt of WE is expected to be AA or AA-. As part
A-27
<PAGE> 28
of its rating process, S&P intends to review the financial and operating plans
of the merged utilities. Also in May 1995, citing WE's continued operation as
a separate utility subsidiary after the Transaction, its strength within its
rating category and its strong capital structure, Moody's confirmed its Aa2
first mortgage bond rating of WE. On December 5, 1995, Fitch changed WE's
credit trend from "stable" to "declining" based upon its analysis of cash flow
trends versus its standards for an AA+ rating.
At year-end 1996, WEC had $185 million of unused lines of bank credit and
approximately $11 million of cash and cash equivalents, and WE had $99 million
of unused lines of bank credit and approximately $2 million of cash and cash
equivalents.
Capital Requirements 1997-2001
Construction Expenditures: The Company's construction expenditures for the
period 1997-2001 are estimated to be $1.2 billion. Of this amount,
approximately $992 million represents utility construction expenditures. 1997
utility construction expenditures are estimated to be $250 million, and
include, in addition to the recurring additions and improvements to WE's
distribution and transmission systems, anticipated expenditures associated
with the installation of more than 350 miles of new gas main which will expand
natural gas service to more than 4,800 potential customers, expenditures for
the construction of approximately 250 miles of new distribution system to
improve the reliability of WE's rural electric distribution system,
expenditures for upgrades to environmental equipment at several of WE's fossil
fueled power plants and expenditures related to upgrading computer systems to
improve productivity and customer service.
Retirement of Long-term Debt Securities: The Company's capital requirements
for maturing long-term debt and sinking funds total $173 million in 1997 and
$179 million for the period 1998-2001. Included in the above amounts are WE's
requirements of $167 million and $159 million, respectively. See "Note H -
Long-Term Debt" in the NOTES TO FINANCIAL STATEMENTS for additional
information.
Decommissioning Trust Payments: WE's estimated payments to the Nuclear
Decommissioning Trust Fund ("Fund") for 1997 are $33 million. For the period
1998-2001, the combined estimated payments are $154 million. Payments to the
Fund represent both the amount of annual contribution to external trust funds
and the income earned on the external trust funds. WE expects to contribute
$11 million to the Fund annually. See "Note F - Nuclear Operations" in the
NOTES TO FINANCIAL STATEMENTS for additional information.
PSCW Advance Plans: In December 1995, the PSCW approved WE's Advance Plan 7
filing originally filed in January 1994. In addition to specifying the
expectations of conservation and load management programs, the plan indicates
the need for additional peaking and intermediate load capacity during the 20-
year planning period. WE does not anticipate needing additional base load
generation until after 2010.
In the Advance Plan process, the regulated electric utilities in Wisconsin
file, for planning purposes, long-term forecasts of future resource
requirements along with plans to meet those requirements, including planned
implementation of energy management and conservation programs (demand-side
savings). As a result of the PSCW's industry restructuring initiatives
described above in "FACTORS AFFECTING RESULTS OF OPERATIONS - Industry
A-28
<PAGE> 29
Restructuring and Competition", future Advance Plans will be streamlined to
focus primarily on the need and timing for new generation additions and
transmission facilities. In a February 1997 ruling, the PSCW split the
Advance Plan 8 filing into two phases. In May 1997, Wisconsin utilities will
be filing twenty year forecasts of electricity demand along with data on
existing generation. The PSCW will rule on this in August 1997. Phase two
will be filed in January 1998 and will include generation and transmission
plans. An order on Phase two is expected from the PSCW in August 1998.
Capital Resources
The Company expects internal sources of funds from operations to provide
approximately 73% of the capital requirements for 1997. The remaining cash
requirements for 1997 are expected to be met through short-term borrowings
and/or the issuance of intermediate or long-term debt. Beyond 1997, capital
requirements will be met principally through internally generated funds
supplemented, when required, by debt and equity financing. The specific form,
amount and timing of securities which may be issued have not yet been
determined and will depend, to a large extent, on market conditions and other
factors.
On September 1, 1996, WEC resumed issuing new shares of common stock through
the Company's stock plans. Between January 1, 1996 and August 31, 1996, WEC
purchased shares required for the plans on the open market. From September
1996 through December 1996, WEC issued 859,458 new shares of common stock
through the Company's stock plans and received proceeds of approximately $23
million.
CAUTIONARY FACTORS
This report and other documents or oral presentations contain or may contain
forward-looking statements made by or on behalf of WEC or WE. Such statements
are based upon management's current expectations and are subject to risks and
uncertainties that could cause actual results to differ materially from those
projected in the statements. When used in written documents or oral
presentations, the words "anticipate", "believe", "estimate", "expect",
"objective", "project" and similar expressions are intended to identify
forward-looking statements. In addition to the assumptions and other factors
referred to specifically in connection with such statements, factors that
could cause WEC's or WE's actual results to differ materially from those
contemplated in any forward-looking statements include, among others, the
following:
Operating, Financial and Industry Factors
* Factors affecting utility operations such as unusual weather conditions;
catastrophic weather-related damage; unscheduled generation outages,
maintenance or repairs; unanticipated changes in fossil fuel, nuclear fuel
or gas supply costs or availability due to higher demand, shortages,
transportation problems or other developments; nuclear or environmental
incidents; resolution of spent nuclear fuel storage and disposal and steam
generator replacement issues; electric transmission or gas pipeline system
constraints; unanticipated organizational structure or key personnel
changes; collective bargaining agreements with union employees or work
stoppages; inflation rates; or demographic and economic factors affecting
utility service territories or operating environment.
A-29
<PAGE> 30
* The rapidly changing and increasingly competitive electric and gas utility
environment as market-based forces replace strict industry regulation and
other competitors enter the electric and gas markets resulting in
increased wholesale and retail competition.
* Customer business conditions including demand for their products or
services and supply of labor and materials used in creating their products
and services.
* Regulatory factors such as unanticipated changes in rate-setting policies
or procedures; unanticipated changes in regulatory accounting policies and
practices; industry restructuring initiatives; transmission system
operation and/or administration initiatives; recovery of costs of previous
investments made under traditional regulation; required approvals for new
construction; NRC operating regulatory changes related to Point Beach; or
the siting approval process for new generating and transmission
facilities.
* The cost and other effects of legal and administrative proceedings,
settlements, and investigations, claims and changes in those matters.
* Factors affecting the availability or cost of capital such as changes in
interest rates; market perceptions of the utility industry, the Company or
any of its subsidiaries; or security ratings.
* Federal, state or local legislative factors such as changes in tax laws or
rates; changes in trade, monetary and fiscal policies, laws and
regulations; electric and gas industry restructuring initiatives; or
changes in environmental laws and regulations.
* Certain restrictions imposed by various financing arrangements and
regulatory requirements on the ability of WE to transfer funds to WEC in
the form of cash dividends, loans or advances.
* Authoritative generally accepted accounting principle or policy changes
from such standard setting bodies as the FASB and the SEC.
* Unanticipated technological developments that result in competitive
disadvantages and create the potential for impairment of existing assets.
* Changes in social attitudes regarding the utility and power industries.
* Possible risks associated with non-utility diversification such as
competition; operating risks; dependence upon certain suppliers and
customers; or environmental and energy regulations.
* Other business or investment considerations that may be disclosed from
time to time in WEC's or WE's SEC filings or in other publicly
disseminated written documents.
Business Combination Factors
* Consummation of the Transaction with NSP to form Primergy and Wisconsin
Energy Company, which will have a significant effect on the future
operations and financial position of WEC and WE, respectively. Specific
factors include:
* The ability to consummate the Transaction on substantially the basis
contemplated.
A-30
<PAGE> 31
* The ability to obtain the requisite approvals by all applicable regulatory
authorities without the imposition of materially adverse terms.
* The ability to generate the cost savings to Primergy that WEC and NSP
believe will be generated by the synergies resulting from the Transaction.
This depends upon the degree to which the assumptions upon which the
analyses employed to develop estimates of potential cost savings as a
result of the Transaction will approximate actual experience. Such
assumptions involve judgements with respect to, among other things, future
national and regional economic conditions, national and regional
competitive conditions, inflation rates, regulatory treatment, weather
conditions, financial market conditions, business decisions and other
uncertainties. All of these factors are difficult to predict and many are
beyond the control of WEC and NSP. While it is believed that such
assumptions are reasonable, there can be no assurance that they will
approximate actual experience or that the estimated cost savings will be
realized.
* The allocation of the benefits of cost savings between shareholders and
customers, which will depend, among other things, upon the results of
regulatory proceedings in various jurisdictions.
* The rate structure of Primergy's utility subsidiaries.
* Additional regulation to which Primergy will be subject as a registered
public utility holding company under PUHCA, in contrast to the more
limited impact of PUHCA upon WEC and NSP as exempt holding companies, and
other different or additional federal and state regulatory requirements or
restrictions to which Primergy and its subsidiaries may be subject as a
result of the Transaction (including conditions which may be imposed in
connection with obtaining the regulatory approvals necessary to consummate
the Transaction such as the possible requirement to divest gas utility
properties and possibly certain non-utility ventures).
* Factors affecting the dividend policy of Primergy including results of
operations and financial condition of Primergy and its subsidiaries and
such other business considerations as the Primergy Board of Directors
considers relevant.
WEC and WE undertake no obligation to publicly update or revise any forward-
looking statements, whether as a result of new information, future events or
otherwise.
A-31
<PAGE> 32
<TABLE>
WISCONSIN ELECTRIC POWER COMPANY
INCOME STATEMENT
Year Ended December 31
<CAPTION>
1996 1995 1994
---------- ---------- ----------
(Thousands of Dollars)
<S> <C> <C> <C>
Operating Revenues
Electric $1,393,270 $1,437,480 $1,403,562
Gas 364,875 318,262 324,349
Steam 15,675 14,742 14,281
---------- ---------- ----------
Total Operating Revenues 1,773,820 1,770,484 1,742,192
Operating Expenses
Fuel (Note F) 295,651 303,553 285,862
Purchased power 36,216 41,834 42,623
Cost of gas sold 234,254 188,764 199,511
Other operation expenses 391,520 395,242 399,011
Maintenance 103,046 112,400 124,602
Revitalization (Note K) - - 73,900
Depreciation (Note C) 202,796 183,876 177,614
Taxes other than income taxes 77,866 74,765 76,035
Federal income tax (Note D) 105,656 119,939 104,725
State income tax (Note D) 24,976 28,405 24,756
Deferred income taxes - net (Note D) (1,575) (2,833) (25,095)
Investment tax credit - net (Note D) (2,430) (4,482) (4,625)
---------- ---------- ----------
Total Operating Expenses 1,467,976 1,441,463 1,478,919
Operating Income 305,844 329,021 263,273
Other Income and Deductions
Interest income 13,553 12,850 11,715
Allowance for other funds used during
construction (Note E) 3,036 3,650 4,985
Miscellaneous - net (3,642) 5,677 10,727
Federal income tax (Note D) (631) (535) (1,504)
State income tax (Note D) (570) (370) (589)
---------- ---------- ----------
Total Other Income and Deductions 11,746 21,272 25,334
Income Before Interest Charges 317,590 350,293 288,607
Interest Charges
Long-term debt 100,133 99,727 102,059
Other interest 7,821 11,960 7,610
Allowance for borrowed funds used
during construction (Note E) (1,679) (2,062) (2,816)
---------- ---------- ----------
Total Interest Charges 106,275 109,625 106,853
---------- ---------- ----------
Net Income 211,315 240,668 181,754
Preferred Stock Dividend Requirement 1,203 1,203 1,351
---------- ---------- ----------
Earnings Available for Common
Stockholder $ 210,112 $ 239,465 $ 180,403
========== ========== ==========
<FN>
Note: Earnings and dividends per share of common stock are not applicable because all of Wisconsin
Electric Power Company's common stock is owned by Wisconsin Energy Corporation.
The notes are an integral part of the financial statements.
</TABLE>
A-32
<PAGE> 33
<TABLE>
WISCONSIN ELECTRIC POWER COMPANY
BALANCE SHEET
December 31
ASSETS
<CAPTION>
1996 1995
---------- ----------
(Thousands of Dollars)
<S> <C> <C>
Utility Plant
Electric $4,725,832 $4,531,404
Gas 503,041 489,739
Steam 60,480 40,078
---------- ----------
5,289,353 5,061,221
Accumulated provision for depreciation (2,441,950) (2,288,080)
---------- ----------
2,847,403 2,773,141
Construction work in progress 135,040 78,153
Nuclear fuel - net (Note F) 75,476 59,260
---------- ----------
Net Utility Plant 3,057,919 2,910,554
Other Property and Investments
Nuclear decommissioning trust fund (Note F) 322,085 275,125
Conservation investments (Note A) 92,705 115,523
Other 43,219 36,979
---------- ----------
Total Other Property and Investments 458,009 427,627
Current Assets
Cash and cash equivalents 1,871 19,550
Accounts receivable, net of allowance for
doubtful accounts - $13,264 and $13,400 140,256 144,476
Accrued utility revenues 155,838 140,201
Fossil fuel (at average cost) 113,516 83,366
Materials and supplies (at average cost) 70,900 70,347
Prepayments 55,176 55,147
Other 3,268 4,637
---------- ----------
Total Current Assets 540,825 517,724
Deferred Charges and Other Assets
Accumulated deferred income taxes (Note D) 150,269 136,581
Deferred regulatory assets (Note A) 193,756 193,757
Other 106,382 132,681
---------- ----------
Total Deferred Charges and Other Assets 450,407 463,019
---------- ----------
Total Assets $4,507,160 $4,318,924
========== ==========
<FN>
The notes are an integral part of the financial statements.
</TABLE>
A-33
<PAGE> 34
<TABLE>
WISCONSIN ELECTRIC POWER COMPANY
BALANCE SHEET
December 31
CAPITALIZATION and LIABILITIES
<CAPTION>
1996 1995
---------- ----------
(Thousands of Dollars)
<S> <C> <C>
Capitalization (See Capitalization Statement)
Common stock equity $1,738,788 $1,696,565
Preferred stock 30,450 30,451
Long-term debt (Note H) 1,371,446 1,325,169
---------- ----------
Total Capitalization 3,140,684 3,052,185
Current Liabilities
Long-term debt due currently (Note H) 183,635 51,419
Notes payable (Note I) 45,390 150,694
Accounts payable 145,894 107,115
Payroll and vacation accrued 24,007 26,699
Taxes accrued - income and other 33,581 18,378
Interest accrued 22,500 21,617
Other 32,588 48,762
---------- ----------
Total Current Liabilities 487,595 424,684
Deferred Credits and Other Liabilities
Accumulated deferred income taxes (Note D) 507,845 479,828
Accumulated deferred investment tax credits 87,798 89,672
Deferred regulatory liabilities (Note A) 175,943 167,483
Other 107,295 105,072
---------- ----------
Total Deferred Credits and Other
Liabilities 878,881 842,055
Commitments and Contingencies (Note M)
---------- ----------
Total Capitalization and Liabilities $4,507,160 $4,318,924
========== ==========
<FN>
The notes are an integral part of the financial statements.
</TABLE>
A-34
<PAGE> 35
<TABLE>
WISCONSIN ELECTRIC POWER COMPANY
STATEMENT OF CASH FLOWS
Year Ended December 31
<CAPTION>
1996 1995 1994
-------- -------- --------
(Thousands of Dollars)
<S> <C> <C> <C>
Operating Activities
Net income $211,315 $240,668 $181,754
Reconciliation to cash
Depreciation 202,796 183,876 177,614
Nuclear fuel expense - amortization 21,887 22,324 21,437
Conservation expense - amortization 22,498 21,870 20,910
Debt premium, discount & expense -
amortization 9,762 12,652 14,368
Revitalization - net (942) (5,404) 43,860
Deferred income taxes - net (1,575) (2,833) (25,095)
Investment tax credit - net (2,430) (4,482) (4,625)
Allowance for other funds used
during construction (3,036) (3,650) (4,985)
Change in - Accounts receivable 4,220 (32,639) 7,684
Inventories (30,703) 5,233 11,455
Accounts payable 38,779 16,650 (20,683)
Other current assets (14,297) (4,068) (9,878)
Other current liabilities (2,780) 17,097 9,980
Other 5,816 (29,204) (13,123)
-------- -------- --------
Cash Provided by Operating Activities 461,310 438,090 410,673
Investing Activities
Construction expenditures (319,832) (248,867) (271,448)
Allowance for borrowed funds used
during construction (1,679) (2,062) (2,816)
Nuclear fuel (26,053) (23,454) (26,351)
Nuclear decommissioning trust (26,309) (10,861) (10,138)
Conservation investments - net 319 2,130 (20,823)
Other (8,211) (4,511) (10,205)
-------- -------- --------
Cash Used in Investing Activities (381,765) (287,625) (341,781)
Financing Activities
Sale of long-term debt 230,094 217,453 32,474
Retirement of long-term debt (52,921) (134,172) (35,069)
Change in short-term debt (105,304) (91,811) 49,294
Stockholder capital contribution - 30,000 30,000
Retirement of preferred stock (1) - (5,250)
Dividends on stock - common (167,889) (159,576) (150,951)
- preferred (1,203) (1,203) (1,381)
-------- -------- --------
Cash Used in Financing Activities (97,224) (139,309) (80,883)
-------- -------- --------
Change in Cash and Cash Equivalents $(17,679) $ 11,156 $(11,991)
======== ======== ========
Supplemental information
Cash Paid For
Interest (net of amount capitalized) $ 94,845 $ 99,352 $ 93,383
Income taxes 107,682 149,224 148,552
<FN>
The notes are an integral part of the financial statements.
</TABLE>
A-35
<TABLE> 36
WISCONSIN ELECTRIC POWER COMPANY
CAPITALIZATION STATEMENT
December 31
<CAPTION>
1996 1995
---------- ----------
(Thousands of Dollars)
<S> <C> <C>
Common Stock Equity (See Common Stock Equity Statement)
Common stock - $10 par value; authorized 65,000,000 shares;
outstanding - 33,289,327 shares $ 332,893 $ 332,893
Other paid in capital 280,689 280,689
Retained earnings 1,125,206 1,082,983
---------- ----------
Total Common Stock Equity 1,738,788 1,696,565
Preferred Stock - Cumulative
Six Per Cent. Preferred Stock - $100 par value; authorized
45,000 shares; outstanding - 44,498 and 44,508 shares 4,450 4,451
Serial preferred stock - $100 par value; authorized 2,286,500 shares;
outstanding - 3.60% Series - 260,000 shares 26,000 26,000
---------- ----------
Total Preferred Stock (Note G) 30,450 30,451
Long-Term Debt
First mortgage bonds
Series Due
------ ---
4-1/2% 1996 - 30,000
5-7/8% 1997 130,000 130,000
6-5/8% 1997 10,000 10,000
5-1/8% 1998 60,000 60,000
6-1/2% 1999 40,000 40,000
6-5/8% 1999 51,000 51,000
7-1/4% 2004 140,000 140,000
7-1/8% 2016 100,000 100,000
6.85 % 2021 9,000 9,000
7-3/4% 2023 100,000 100,000
7.05 % 2024 60,000 60,000
9-1/8% 2024 3,443 3,443
8-3/8% 2026 100,000 100,000
7.70 % 2027 200,000 200,000
---------- ----------
1,003,443 1,033,443
Debentures (unsecured)
6-1/8% 1997 25,000 25,000
6-5/8% 2006 200,000 -
9.47% 2006 7,000 7,000
8-1/4% 2022 25,000 25,000
6-7/8% 2095 100,000 100,000
Notes (unsecured)
Variable rate due 2006 1,000 1,000
Variable rate due 2015 17,350 17,350
Variable rate due 2016 67,000 67,000
Variable rate due 2030 80,000 80,000
Due 2006 (Note H) 12,052 -
Obligations under capital lease (Note F) 42,962 43,924
Unamortized discount - net (25,726) (23,129)
Long-term debt due currently (183,635) (51,419)
---------- ----------
Total Long-Term Debt (Note H) 1,371,446 1,325,169
---------- ----------
Total Capitalization $3,140,684 $3,052,185
========== ==========
<FN>
The notes are an integral part of the financial statements.
</TABLE>
A-36
<PAGE> 37
<TABLE>
WISCONSIN ELECTRIC POWER COMPANY
COMMON STOCK EQUITY STATEMENT
<CAPTION>
Common Stock
-------------------------
$10 Par Other Paid Retained
Shares Value In Capital Earnings Total
------ -----------------------------------------------------
(Thousands of Dollars)
<S> <C> <C> <C> <C> <C>
Balance - December 31, 1993 33,289,327 $332,893 $220,689 $ 973,917 $1,527,499
Net income 181,754 181,754
Cash dividends
Common stock (150,951) (150,951)
Preferred stock (1,381) (1,381)
Stockholder capital contribution 30,000 30,000
Other (245) (245)
---------- -------- -------- ----------- -----------
Balance - December 31, 1994 33,289,327 332,893 250,689 1,003,094 1,586,676
Net income 240,668 240,668
Cash dividends
Common stock (159,576) (159,576)
Preferred stock (1,203) (1,203)
Stockholder capital contribution 30,000 30,000
---------- -------- -------- ----------- -----------
Balance - December 31, 1995 33,289,327 332,893 280,689 1,082,983 1,696,565
Net income 211,315 211,315
Cash dividends
Common stock (167,889) (167,889)
Preferred stock (1,203) (1,203)
---------- -------- -------- ----------- -----------
Balance - December 31, 1996 33,289,327 $332,893 $280,689 $1,125,206 $1,738,788
========== ======== ======== =========== ===========
<FN>
The notes are an integral part of the financial statements.
</TABLE>
A-37
<PAGE> 38
WISCONSIN ELECTRIC POWER COMPANY
NOTES TO FINANCIAL STATEMENTS
A - Summary of Significant Accounting Policies
General: The accounting records of Wisconsin Electric Power Company ("WE")
are kept as prescribed by the Federal Energy Regulatory Commission ("FERC"),
modified for requirements of the Public Service Commission of Wisconsin
("PSCW").
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of certain assets and liabilities and
disclosure of contingent assets and liabilities at the date of financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Revenues: Utility revenues are recognized on the accrual basis and include
estimated amounts for service rendered but not billed.
Fuel: The cost of fuel is expensed in the period consumed.
Property: Property is recorded at cost. Additions to and significant
replacements of utility property are charged to utility plant at cost; minor
items are charged to maintenance expense. Cost includes material, labor and
allowance for funds used during construction (see Note E). The cost of
depreciable utility property, together with removal cost less salvage, is
charged to accumulated provision for depreciation when property is retired.
Regulatory Assets and Liabilities: Pursuant to Statement of Financial
Accounting Standards No. 71, Accounting for the Effects of Certain Types of
Regulation, WE capitalizes, as regulatory assets, incurred costs which are
expected to be recovered in future utility rates. WE also records, as
regulatory liabilities, the current recovery in utility rates of costs which
are expected to be paid in the future.
The following deferred regulatory assets and liabilities are reflected in the
Balance Sheet.
==============================================================================
December 31
1996 1995
-------- --------
(Thousands of Dollars)
Deferred Regulatory Assets
Deferred income taxes $154,532 $155,944
Department of Energy assessments 29,022 31,638
Other 10,202 6,175
-------- --------
Total Deferred Regulatory Assets $193,756 $193,757
======== ========
Deferred Regulatory Liabilities
Deferred income taxes $155,720 $163,676
Tax and interest refunds 14,080 -
Other 6,143 3,807
-------- --------
Total Deferred Regulatory Liabilities $175,943 $167,483
======== ========
==============================================================================
A-38
<PAGE> 39
WE directs a variety of demand-side management programs to help foster energy
conservation by its customers. As authorized by the PSCW, WE capitalized
certain conservation program costs prior to 1995. Utility rates approved by
the PSCW provide for a current return on these conservation investments. As
of December 31, 1996 and 1995, there were $92.7 million and $115.5 million of
conservation investments, respectively, on the Balance Sheet in Other Property
and Investments. Through 1995, conservation investments were charged to
operating expense over a ten-year amortization period. Beginning in 1996, the
capitalized conservation balance is charged to operating expense on a straight
line basis over a five-year amortization period.
Statement of Cash Flows: Cash and cash equivalents include marketable debt
securities acquired three months or less from maturity.
B - Mergers
Wisconsin Natural Gas Company: On January 1, 1996, Wisconsin Energy
Corporation ("WEC"), WE's parent company, merged its natural gas utility
subsidiary, Wisconsin Natural Gas Company ("WN") into WE. The accounting
treatment for this merger was similar to that which would result from a
pooling of interests. WE's prior years' financial information has been
restated to include WN at historical values. Where applicable, references to
WE include WN prior to their merger.
Northern States Power Company: On April 28, 1995, WEC and Northern States
Power Company, a Minnesota corporation ("NSP"), entered into an Agreement and
Plan of Merger, which was amended and restated as of July 26, 1995 ("Merger
Agreement"). The Merger Agreement provides for a strategic business
combination involving WEC and NSP in a "merger-of-equals" transaction
("Transaction"). As a result, WEC will become a registered public utility
holding company under the Public Utility Holding Company Act of 1935, as
amended, and will change its name to Primergy Corporation ("Primergy").
Primergy will be the parent company of WE (which will be renamed Wisconsin
Energy Company), of NSP (which, for regulatory reasons, will reincorporate in
Wisconsin ("New NSP")), and of the other subsidiaries of WEC and NSP.
In connection with the Transaction, Northern States Power Company, a Wisconsin
corporation ("NSP-WI"), currently a subsidiary of NSP, will be merged into
Wisconsin Energy Company. At the time of the merger of NSP-WI into Wisconsin
Energy Company, New NSP will acquire from NSP-WI certain gas utility assets in
LaCrosse and Hudson, Wisconsin with a net historical cost at December 31, 1996
of $25.7 million.
The Transaction is intended to be tax-free for income tax purposes and to be
accounted for as a pooling of interests. On September 13, 1995, stockholders
of WEC and NSP voted to approve the Transaction.
The Merger Agreement is subject to various conditions, including the approval
of various regulatory agencies. Two of four state regulatory commissions, the
Michigan Public Service Commission and the North Dakota Public Service
Commission, approved the Transaction during 1996. Also during 1996, the PSCW,
the Minnesota Public Utilities Commission ("MPUC") and the FERC concluded
hearings on the Transaction. WEC and NSP are hopeful that the PSCW, the MPUC
and the FERC will rule on the Transaction in the second quarter of 1997. The
PSCW, which was scheduled to rule on the Transaction in January 1997, has
delayed a decision pending the results of an investigation of alleged
prohibited conversations between one of the PSCW commissioners and WEC
A-39
<PAGE> 40
officials. WEC is unable to predict with certainty when the PSCW will rule on
the Transaction, but is hopeful that the investigation will be completed by
early in the second quarter of 1997. In late March 1997, the MPUC indicated
that in April 1997 it would decide whether to adopt procedures in connection
with its decision on the Transaction that include additional public hearings
as well as additional written comments. If additional hearings or written
comments are necessary, final deliberations in this matter would be scheduled
for late June or early July 1997. Remaining regulatory applications and
filings have either been submitted or approved.
The goal of WEC and NSP was to complete the Transaction by January 1, 1997.
However, because all necessary regulatory approvals were not obtained by the
end of 1996, the Transaction was not completed in 1996. WEC and NSP continue
to pursue regulatory approvals, without unacceptable conditions, to facilitate
completion of the Transaction as soon as possible in 1997.
Filings with regulatory agencies in the states where WEC and NSP provide
utility services and in which such filings are required include a request for
deferred accounting treatment and rate recovery of costs incurred associated
with the Transaction. As of December 31, 1996, WE has deferred $15.0 million
of costs to achieve the merger as a component of Deferred Charges and Other
Assets-Other.
The following summarized Wisconsin Energy Company unaudited pro forma
financial information combines historical balance sheet and income statement
information of WE and NSP-WI to give effect to the Transaction, including the
transfer of the gas assets from NSP-WI to New NSP, and should be read in
conjunction with the historical financial statements and related notes thereto
of WE and NSP-WI. The unaudited pro forma income statement information does
not reflect adjustments for 1996 revenues of $32.5 million and related
expenses associated with the transfer of the gas assets from NSP-WI to New
NSP. A $150 million pro forma adjustment has been made to conform the
presentation of noncurrent deferred income taxes in the summarized unaudited
pro forma combined balance sheet information as a net liability. The
allocation between WEC and NSP and their customers of the estimated cost
savings resulting from the Transaction, net of costs incurred to achieve such
savings, will be subject to regulatory review and approval. None of the
estimated cost savings, the costs to achieve such savings, nor transaction
costs are reflected in the unaudited pro forma financial information. All
other financial statement presentation and accounting policy differences are
immaterial and have not been adjusted in the unaudited pro forma financial
information.
The unaudited pro forma balance sheet information gives effect to the
Transaction as if it had occurred at December 31, 1996. The unaudited pro
forma income statement information gives effect to the Transaction as if it
had occurred at January 1, 1996. The following information is not necessarily
indicative of the financial position or operating results that would have
occurred had the Transaction been consummated on the date or at the beginning
of the period for which the Transaction is being given effect nor is it
necessarily indicative of future operating results or financial position.
A-40
<PAGE> 41
==============================================================================
Wisconsin Energy Company: * Unaudited
WE NSP-WI Pro Forma
(As Reported) (As Reported) Combined**
------------- ------------- -------------
(Millions of Dollars)
As of December 31, 1996
Utility plant-net $ 3,058 $ 665 $ 3,703
Current assets 541 87 646
Other assets 908 57 814
----------- ----------- -----------
Total Assets $ 4,507 $ 809 $ 5,163
=========== =========== ===========
Common stockholder's equity $ 1,739 $ 331 $ 2,070
Preferred stock and premium 30 - 30
Long-term debt 1,372 232 1,604
----------- ----------- -----------
Total Capitalization 3,141 563 3,704
Current liabilities 488 89 577
Other liabilities 878 157 882
----------- ----------- -----------
Total Equity & Liabilities $ 4,507 $ 809 $ 5,163
=========== =========== ===========
For the Year Ended
December 31, 1996
Utility Operating Revenues $ 1,774 $ 466 $ 2,240
Utility Operating Income $ 306 $ 56 $ 362
Net Income, after Preferred
Dividend Requirements $ 210 $ 39 $ 249
==============================================================================
* In connection with the Merger Agreement, WE will be renamed Wisconsin
Energy Company.
** Includes a $150 million pro forma adjustment to conform the presentation
of noncurrent deferred taxes as a net liability and a net $25.7 million
pro forma adjustment for the transfer of selected gas assets from NSP-WI
to New NSP.
Note:Earnings per share of common stock are not applicable because all of
the Wisconsin Energy Company common stock will be owned by Primergy.
C - Depreciation
Depreciation expense is accrued at straight line rates over the estimated
useful lives of the assets. These rates are certified by the PSCW and include
estimates for salvage and removal costs. Depreciation as a percent of average
depreciable utility plant was 4.1% in 1996, 3.8% in 1995 and 3.9% in 1994.
Nuclear plant decommissioning is accrued as depreciation expense (see Note F).
D - Income Taxes
Comprehensive interperiod income tax allocation is used for federal and state
temporary differences. The federal investment tax credit is accounted for on
the deferred basis and is reflected in income ratably over the life of the
related property.
A-41
<PAGE> 42
The following table is a summary of income tax expense and a reconciliation of
total income tax expense with the tax expected at the federal statutory rate.
==============================================================================
1996 1995 1994
-------- -------- --------
(Thousands of Dollars)
Current tax expense $131,833 $149,249 $131,574
Investment tax credit-net (2,430) (4,482) (4,625)
Deferred tax expense (1,575) (2,833) (25,095)
-------- -------- --------
Total Tax Expense $127,828 $141,934 $101,854
======== ======== ========
Income Before Income Taxes
and Preferred Dividend $339,143 $382,602 $283,608
======== ======== ========
Expected tax at federal
statutory rate $118,700 $133,911 $ 99,263
State income tax net of
federal tax benefit 17,624 18,943 14,087
Investment tax credit
restored (4,509) (4,482) (4,625)
Other (no item over
5% of expected tax) (3,987) (6,438) (6,871)
-------- -------- --------
Total Tax Expense $127,828 $141,934 $101,854
======== ======== ========
==============================================================================
Statement of Financial Accounting Standards No. 109, Accounting for Income
Taxes ("FAS 109"), requires the recording of deferred assets and liabilities
to recognize the expected future tax consequences of events that have been
reflected in WE's financial statements or tax returns and the adjustment of
deferred tax balances to reflect tax rate changes. Following is a summary of
deferred income taxes under FAS 109.
==============================================================================
December 31
1996 1995
-------- --------
(Thousands of Dollars)
Deferred Income Tax Assets
Decommissioning trust $ 41,066 $ 43,759
Construction advances 45,906 43,052
Other 63,297 49,770
-------- --------
Total Deferred Income Tax Assets $150,269 $136,581
======== ========
Deferred Income Tax Liabilities
Property related $480,788 $445,878
Conservation investments 16,827 25,775
Other 10,230 8,175
-------- --------
Total Deferred Income Tax Liabilities $507,845 $479,828
======== ========
As detailed in Note A, WE has also recorded deferred regulatory assets and
liabilities representing the future expected impact of deferred taxes on
utility revenues.
A-42
<PAGE> 43
E - Allowance for Funds Used During Construction ("AFUDC")
AFUDC is included in utility plant accounts and represents the cost of
borrowed funds used during plant construction and a return on stockholders'
capital used for construction purposes. On the income statement, the cost of
borrowed funds (before income taxes) is a reduction of interest expense and
the return on stockholders' capital is an item of noncash other income.
As approved by the PSCW, AFUDC was capitalized on 50% of construction work in
progress ("CWIP") at a rate of 10.17% during 1996. Prior to 1996, utility
rates approved by the PSCW provided for a current return on investment for
selected long-term projects included in CWIP. AFUDC was capitalized on the
remaining CWIP at a rate of 10.83% in 1995 and 1994.
F - Nuclear Operations
Point Beach Nuclear Plant: WE operates two 500 megawatt electric generating
units at its Point Beach Nuclear Plant ("Point Beach"). During 1996, Point
Beach accounted for 25.4% of WE's net electric generation. The current
operating licenses for the two units at Point Beach expire in 2010 and 2013
for Units 1 and 2, respectively.
In May 1996, WE received a written order from the PSCW ("PSCW Order")
approving replacement of the Unit 2 steam generators and reaffirming its prior
decision approving WE's construction and operation of an Independent Spent
Fuel Storage Installation ("ISFSI") for dry storage of spent fuel at Point
Beach. In July 1996, the PSCW denied a petition for rehearing filed by
intervenors in the proceeding.
Failure by the PSCW to approve the steam generator replacement and reaffirm
authorization for the ISFSI would have jeopardized the continued operation of
Point Beach. The Unit 2 replacement steam generators were necessary due to
the degradation of tubes within the steam generators and will permit operation
of Unit 2 at least until its current operating license expires. The steam
generator replacement was completed in January 1997. Subject to approval by
the United States Nuclear Regulatory Commission ("NRC"), WE expects to restart
Unit 2 in the second quarter of 1997. The ISFSI provides interim dry storage
of spent fuel from Point Beach until the United States Department of Energy
("DOE") takes ownership of and removes spent fuel under an existing contract
mandated by the Nuclear Waste Policy Act of 1982. The ISFSI is necessary
because the spent fuel pool inside the plant is nearly full. Construction of
the ISFSI was completed in 1995.
In August 1996, a group of intervenors in the PSCW Order proceedings filed in
Dane County Circuit Court a petition for judicial review of the PSCW Order.
The petition seeks reversal of the PSCW Order and a remand to the PSCW
directing it to deny WE's request for authorization to replace the steam
generators and to construct the ISFSI, or in the alternative, to correct the
alleged errors in the PSCW Order. WE has intervened in the proceeding to
vigorously oppose the petition. Final briefs have been filed in the
proceeding, and WE is awaiting a decision by the court on the petition.
Two storage casks have been loaded with spent fuel and transferred to the
ISFSI. During loading of a third cask in May 1996, hydrogen gas was ignited
within the cask. Cask loading has been halted until actions are implemented
by WE to prevent recurrence of such an event and until the NRC has reviewed
and accepted such actions. WE hopes to receive agreement from the NRC that WE
may resume loading of the casks in the summer of 1997.
A-43
<PAGE> 44
In December 1996, WE paid the NRC $325,000 in civil penalties for performance
deficiencies and violations of NRC requirements in various plant activities.
In January 1997, the NRC informed WE of additional potential violations
observed during a special inspection that could result in further civil
penalties. Also, the NRC sent a letter on January 27, 1997 notifying WE of
its assessment that Point Beach has experienced a recent declining trend in
performance based upon these inspections and other ongoing regulatory
interactions. The NRC issues trend letters to provide an early notification
of declining performance and to allow a utility, under the watchfulness of the
NRC, to take early corrective actions. The NRC acknowledged in the letter
that WE has made improvements in the identification and resolution of specific
problems.
In early October 1996, the NRC requested all nuclear reactor licensees in the
United States to describe the processes used to ensure the adequacy and
integrity of the licensees' design bases for their plants and to ensure the
plants continue to be operated and maintained in accordance with the design
bases. WE responded to the NRC in February 1997.
Nuclear Fuel: WE has a nuclear fuel leasing arrangement with Wisconsin
Electric Fuel Trust ("Trust"), which is treated as a capital lease. The
nuclear fuel is leased for a period of 60 months or until the removal of the
fuel from the reactor, if earlier. Lease payments include charges for the
cost of fuel burned, financing costs and management fees. In the event WE or
the Trust terminates the lease, the Trust would recover its unamortized cost
of nuclear fuel from WE. Under the lease terms, WE is in effect the ultimate
guarantor of the Trust's commercial paper and line of credit borrowings
financing the investment in nuclear fuel.
Provided below is a summary of nuclear fuel investment at December 31 and
interest expense for the respective years on the nuclear fuel lease.
==============================================================================
1996 1995 1994
-------- -------- --------
(Thousands of Dollars)
Nuclear Fuel
Under capital lease $100,952 $ 89,840
Accumulated provision for amortization (61,408) (50,532)
In process/stock 35,932 19,952
-------- --------
Total Nuclear Fuel $ 75,476 $ 59,260
======== ========
Interest Expense on Nuclear Fuel Lease $ 2,332 $ 2,401 $ 1,896
==============================================================================
A-44
<PAGE> 45
The future minimum lease payments under the capital lease and the present
value of the net minimum lease payments as of December 31, 1996 are as
follows:
============================================================================
(Thousands of Dollars)
1997 $ 19,141
1998 15,823
1999 7,011
2000 3,356
2001 418
--------
Total Minimum Lease Payments 45,749
Less: Interest (2,787)
--------
Present Value of Net Minimum Lease Payments $ 42,962
========
==============================================================================
The estimated cost of disposal of spent fuel, based on a contract with the
DOE, is included in nuclear fuel expense.
The Energy Policy Act of 1992 establishes a Uranium Enrichment Decontamination
and Decommissioning Fund ("D&D Fund") for the DOE's nuclear fuel enrichment
facilities. Deposits to the D&D Fund are derived in part from special
assessments to utilities. As of December 31, 1996, WE has on its books a
remaining estimated liability equal to the projected special assessments of
$26.8 million. A corresponding deferred regulatory asset is detailed in
Note A.
Effective in 1997, the PSCW has disallowed the recovery of D&D Fund
assessments in Wisconsin utility retail rates as a result of a decision by the
U.S. Court of Federal Claims in "Yankee Atomic Electric Company v. The United
States" ("Yankee Atomic") in which the court ruled that the payments were
unlawful. WE has a similar contract with the DOE. The PSCW expects that the
DOE will eventually refund the D&D Fund assessments paid by the affected
utilities but has stated that it would be appropriate that WE be reimbursed if
the Yankee Atomic decision is overturned or modified. The amount of the
assessments related to the PSCW rate jurisdiction is approximately 85% of the
assessments or $2.6 million in 1997 and will remain as a deferred regulatory
asset. The portion of allowable costs will be amortized to nuclear fuel
expense and included in utility rates over the next 11 years.
Nuclear Insurance: The Price-Anderson Act ("Act") provides an aggregate
limitation of $8.9 billion on public liability claims arising out of a nuclear
incident. WE has $200 million of liability insurance from commercial sources.
The Act also establishes an industry-wide retrospective rating plan under
which nuclear reactor owners could be assessed up to $79.3 million per reactor
(WE owns two), but not more than $10 million in any one year for each reactor,
in the event of a nuclear incident.
An industry-wide insurance program, with an aggregate limit of $200 million,
has been established to cover radiation injury claims of nuclear workers first
employed after 1987. If claims in excess of the available funds develop, WE
could be assessed a maximum of approximately $3.0 million per reactor.
A-45
<PAGE> 46
WE has property damage, decontamination and decommissioning insurance totaling
$1.5 billion for loss from damage at Point Beach with Nuclear Mutual Limited
("NML") and Nuclear Electric Insurance Limited ("NEIL"). Under the NML and
NEIL policies, WE has a potential maximum retrospective premium liability per
loss of $5.4 million and $7.0 million, respectively.
WE also maintains additional insurance with NEIL covering extra expenses of
obtaining replacement power during a prolonged accidental outage (in excess of
21 weeks) at Point Beach. This insurance coverage provides weekly indemnities
of $3.5 million per unit for outages during the first year, declining to 80%
of the amounts during the second and third years. Under the policy, WE's
maximum retrospective premium liability is approximately $7.8 million.
It should not be assumed that, in the event of a major nuclear incident, any
insurance or statutory limitation of liability would protect WE from material
adverse impact.
Nuclear Decommissioning: Subject to resolution of the Point Beach Unit 2
steam generator replacement and ISFSI matters described above, WE expects to
operate the two units at Point Beach to the expiration of their current
operating licenses. The estimated cost to decommission the plant in 1996
dollars is $379 million based upon a site specific decommissioning cost study
completed in 1994. Assuming plant shutdown at the expiration of the current
operating licenses, prompt dismantlement and annual escalation of costs at
specific inflation factors established by the PSCW, it is projected that
approximately $1.7 billion will be spent over a twenty-year period, beginning
in 2010, to decommission the plant.
Nuclear decommissioning costs are accrued as depreciation expense over the
expected service lives of the two units following an external sinking fund
method. In 1996, WE increased its funding levels based on a site specific
estimate as required by the PSCW. It is expected that the annual payments to
the Nuclear Decommissioning Trust Fund ("Fund") along with the earnings on the
Fund will provide sufficient funds at the time of decommissioning. WE
believes it is probable that any shortfall in funding would be recoverable in
utility rates.
As required by Statement of Financial Accounting Standards No. 115, Accounting
for Certain Investments in Debt and Equity Securities, WE's debt and equity
security investments in the Fund are classified as available for sale. Gains
and losses on the Fund were determined on the basis of specific
identification; net unrealized holding gains on the Fund were recorded as part
of accumulated provision for depreciation.
A-46
<PAGE> 47
Following is a summary of decommissioning costs and earnings charged to
depreciation expense and the Fund balance included in accumulated provision
for depreciation at December 31. The Fund balance is stated at fair value.
==============================================================================
1996 1995 1994
-------- -------- --------
(Thousands of Dollars)
Decommissioning costs $ 15,418 $ 3,456 $ 3,456
Earnings 10,891 7,405 6,682
-------- -------- --------
Depreciation Expense $ 26,309 $ 10,861 $ 10,138
======== ======== ========
Total costs accrued to date $261,729 $235,420
Unrealized gain 60,356 39,705
-------- --------
Accumulated Provision for Depreciation $322,085 $275,125
======== ========
==============================================================================
G - Preferred Stock
Serial Preferred Stock authorized but unissued is cumulative, $25 par value,
5,000,000 shares.
In the event of default in the payment of preferred dividends, no dividends or
other distributions may be paid on WE's common stock.
The 3.60% Series Preferred Stock is redeemable in whole or in part at the
option of WE at $101 per share plus any accrued dividends.
In 1994, WE called for redemption all of its 52,500 outstanding shares of
6.75% Series Preferred Stock at a redemption price of par.
H - Long-Term Debt
The maturities and sinking fund requirements through 2001 for the aggregate
amount of long-term debt outstanding (excluding obligations under capital
lease, see Note F) at December 31, 1996 are shown below.
==============================================================================
(Thousands of Dollars)
1997 $166,905
1998 61,905
1999 92,905
2000 1,905
2001 1,905
==============================================================================
Sinking fund requirements for the years 1997 through 2001, included in the
table above, are $9.5 million. Substantially all utility plant is subject to
the applicable mortgage.
A-47
<PAGE> 48
Long-term debt premium or discount and expense of issuance are amortized by
the straight line method over the lives of the debt issues and included as
interest expense. Unamortized amounts pertaining to reacquired debt are
written off currently, when acquired for sinking fund purposes, or amortized
in accordance with PSCW orders, when acquired for early retirement.
The fair value of WE's long-term debt was $1.6 billion and $1.5 billion at
December 31, 1996 and 1995, respectively. The fair value of the first
mortgage bonds and debentures is estimated based upon the market value of the
same or similar issues. Book value approximates fair value for WE's unsecured
notes. The fair value of WE's obligations under capital lease is the market
value of the Trust's commercial paper.
In September and October 1995, WE issued $98.35 million of unsecured variable
rate promissory notes maturing between March 1, 2006 and September 1, 2030.
These notes were issued as a revenue and collateral source for an equal
principal amount of tax exempt Refunding Revenue Bonds issued on WE's behalf
to refund $98.35 million of previously issued tax exempt bonds called for
optional redemption that were secured by WE's First Mortgage Bonds.
In November 1996, WE issued $200 million of 6 5/8% unsecured debentures due
2006. In December 1995, WE issued $100 million of unsecured One Hundred Year 6
7/8% Debentures due 2095. Proceeds from both issues were added to WE's
general funds and were applied to the repayment of short-term borrowings.
In December 1996, WE issued a promissory note in the amount of $12.05 million
due 2006. The note was issued as part of the transaction to acquire the steam
facilities from Milwaukee County. The note has been discounted to reflect the
difference between the effective interest rate of 6.36% and the stated rate of
1.93%. This discount will be amortized over the life of the notes using the
effective interest method.
At December 31, 1996, the interest rate for the $67 million variable rate note
due 2016 was 4.15% and the interest rate for the $98.35 million variable rate
notes due 2006-2030 was 4.20%.
I - Notes Payable
Short-term notes payable balances and their corresponding weighted average
interest rates at December 31 consist of:
==============================================================================
1996 1995
-------------------- ----------------------
Interest Interest
Balance Rate Balance Rate
-------- -------- -------- --------
(Thousands of Dollars)
Banks $ 10,495 5.80% $100,885 5.78%
Commercial paper 34,895 5.59% 49,809 5.88%
-------- --------
$ 45,390 $150,694
======== ========
==============================================================================
A-48
<PAGE> 49
Unused lines of credit for short-term borrowing amounted to $99.3 million at
December 31, 1996. In support of various informal lines of credit from banks,
WE has agreed to maintain unrestricted compensating balances or to pay
commitment fees; neither the compensating balances nor the commitment fees are
significant.
J - Pension Plans
Prior to 1996, WE had several defined benefit noncontributory pension plans
covering all eligible employees. Pension benefits were based on years of
service and the employee's compensation. Effective January 1, 1996, plans
covering all employees were converted to a single defined benefit
noncontributory cash balance plan. Under the cash balance plan, pension
benefits are determined by a combination of annual plan wages, a credit based
upon WE's annual financial performance and individual account-based interest
credits. Lump sum payout at termination of employment or retirement is
available. Each employee's opening account balance was based on accrued
pension benefits as of December 31, 1994 and converted to a lump-sum amount
determined under the prior plan's provisions. The lump-sum amount was
credited for an additional transition credit based on age and years of
service. The cash balance plan includes a grandfather clause, where employees
who retire during the 15 years following January 1, 1996 receive the greater
of pension benefits calculated under their original pension plan or under the
cash balance plan.
The majority of the plans' assets are equity securities; other assets include
corporate and government bonds and real estate. The plans are funded to meet
the requirements of the Employee Retirement Income Security Act of 1974.
In the opinion of WE, current pension trust assets and amounts which are
expected to be paid to the trusts in the future will be adequate to meet
future pension payment obligations to current and future retirees.
A-49
<PAGE> 50
==============================================================================
Pension Cost calculated per FAS 87* 1996 1995 1994
- ---------------------------------- -------- -------- --------
(Thousands of Dollars)
Components of Net Periodic Pension Cost,
Year Ended December 31
Cost of pension benefits earned by
employees $ 9,912 $ 8,985 $ 10,933
Interest cost on projected benefit
obligation 41,454 41,586 38,736
Actual (return) loss on plan assets (85,141) (136,243) 7,634
Net amortization and deferral 34,600 88,493 (52,180)
-------- -------- --------
Total pension cost calculated
under FAS 87 $ 825 $ 2,821 $ 5,123
======== ======== ========
Actuarial Present Value of Accumulated
Benefit Obligation, at December 31
Vested benefits-employees' right to
receive benefit no longer contingent
upon continued employment $560,801 $543,371
Nonvested benefits-employees' right to
receive benefit contingent upon
continued employment 14,741 12,651
-------- --------
Total obligation $575,542 $556,022
======== ========
Funded Status of Plans: Pension Assets and
Obligations at December 31
Pension assets at fair market value $687,482 $637,529
Projected benefit obligation
at present value (601,213) (584,785)
Unrecognized transition asset (19,566) (22,034)
Unrecognized prior service cost 36,027 23,194
Unrecognized net gain (96,344) (54,780)
-------- --------
Projected status of plans $ 6,386 $ (876)
======== ========
Rates used for calculations (%)
Discount rate-interest rate used to
adjust for the time value of money 7.75 7.25 8.25
Assumed rate of increase in
compensation levels 4.75 to 4.75 5.0
5.0
Expected long-term rate of return
on pension assets 9.0 9.0 9.0
==============================================================================
* Statement of Financial Accounting Standards No. 87, Employers' Accounting
for Pensions ("FAS 87").
K - Benefits Other Than Pensions
Postretirement Benefits: Effective in 1993, WE adopted prospectively
Statement of Financial Accounting Standards No. 106, Employers' Accounting for
Postretirement Benefits Other Than Pensions ("FAS 106"), and elected the 20
year option for amortization of the previously unrecognized accumulated
postretirement benefit obligation.
A-50
<PAGE> 51
WE sponsors defined benefit postretirement plans that cover both salaried and
nonsalaried employees who retire at age 55 or older with at least 10 years of
service. The postretirement medical plan provides coverage to retirees and
their dependents. Retirees contribute to the medical plan. The group life
insurance benefit is reduced upon retirement.
Employees' Benefit Trusts ("Benefit Trusts") are used to fund a major portion
of postretirement benefits. The funding policy for the Benefit Trusts is to
maximize tax deductibility. The majority of the Benefit Trusts' assets are
mutual funds.
==============================================================================
Postretirement Benefit Cost
calculated per FAS 106 1996 1995 1994
- ------------------------------------------- -------- -------- --------
(Thousands of Dollars)
Components of Net Periodic Postretirement
Benefit Cost, Year Ended December 31
Cost of postretirement benefits
earned by employees $ 2,436 $ 2,276 $ 2,653
Interest cost on projected
benefit obligation 10,456 10,458 10,148
Actual return on plan assets (5,938) (12,598) (3,893)
Net amortization and deferral 6,745 13,951 5,648
-------- -------- --------
Total postretirement benefit cost
calculated under FAS 106 $ 13,699 $ 14,087 $ 14,556
======== ======== ========
Funded Status of Plans: Postretirement
Obligations and Assets at December 31
Accumulated Postretirement Benefit
Obligation at December 31
Retirees $(92,417) $(92,746)
Fully eligible active plan participants (9,938) (10,304)
Other active plan participants (40,428) (41,732)
-------- --------
Total obligation (142,783) (144,782)
Postretirement assets at
fair market value 49,424 45,086
-------- --------
Accumulated postretirement benefit
obligation in excess of plan assets (93,359) (99,696)
Unrecognized transition obligation 78,239 83,268
Unrecognized prior service cost (1,038) (1,279)
Unrecognized net gain (14,583) (6,102)
-------- --------
Accrued Postretirement Benefit Obligation $(30,741) $(23,809)
======== ========
Rates used for calculations (%)
Discount rate-interest rate used to
adjust for the time value of money 7.75 7.25 8.25
Assumed rate of increase in
compensation levels 4.75 to 4.75 5.0
5.0
Expected long-term rate of return
on postretirement assets 9.0 9.0 9.0
Health care cost trend rate 10.0 declining to
5.0 in year 2002
==============================================================================
A-51
<PAGE> 52
Changes in health care cost trend rates will affect the amounts reported. For
example, a 1% increase in rates would increase the accumulated postretirement
benefit obligation as of December 31, 1996 by $8.4 million and the aggregate
of the service and interest cost components of net periodic postretirement
benefit cost for the year then ended by approximately $1 million.
Revitalization: In the first quarter of 1994, WE recorded a $73.9 million
charge related to its revitalization program. This charge included $37.5
million for Early Retirement Incentive Packages ("ERIP") and $25 million for
Severance Packages ("SP"). These plans were used to reduce employee staffing
levels. ERIP provided for a monthly income supplement ("ERIP Supplement"),
medical benefits and waiver of an early retirement pension reduction. The SP
included a severance payment, medical/dental insurance, outplacement services,
personal financial planning and tuition support. Availability of these plans
to various bargaining units was based upon agreements made between WE and the
bargaining units. These plans were available to most management employees but
not to elected officers.
Under ERIP, 403 employees elected to retire in 1994. Under SP, 651 and 75
employees enrolled in 1994 and 1995, respectively. ERIP Supplement costs are
paid from pension plan trusts and medical/dental benefits from employee
benefit trusts. Remaining ERIP and SP costs are paid from general corporate
funds. The ultimate timing of cash flows for ERIP Supplement costs depends
upon the funding limitations of WE's pension plans. With the exception of
ERIP Supplement costs, approximately $35.8 million have been paid against the
revitalization liability through December 31, 1996 and no liability remains
outstanding at December 31, 1996.
L - Information By Segments of Business
WE is a public utility incorporated in the State of Wisconsin. WE's principal
business segments include electric, gas and steam utility operations. The
electric utility generates, transmits, distributes and sells electric energy
in southeastern (including metropolitan Milwaukee), east central and northern
Wisconsin and in the Upper Peninsula of Michigan. The gas utility purchases,
distributes and sells natural gas to retail customers and transports customer-
owned gas in three service areas in southeastern, east central and western
Wisconsin that are largely within the electric service area. The steam
utility produces, distributes and sells steam to space heating and processing
customers in the Milwaukee area. The following summarizes the business
segments of WE.
A-52
<PAGE> 53
==============================================================================
Year ended December 31 1996 1995 1994
- ---------------------- ---------- ---------- ----------
(Thousands of Dollars)
Electric Operations
Operating revenues $1,393,270 $1,437,480 $1,403,562
Operating income before income taxes 380,376 419,271 329,216
Depreciation 183,159 164,789 159,414
Construction expenditures 272,838 223,723 244,718
Gas Operations
Operating revenues 364,875 318,262 324,349
Operating income before income taxes 47,720 47,022 30,993
Depreciation 18,246 17,722 16,856
Construction expenditures 22,851 24,851 25,481
Steam Operations
Operating revenues 15,675 14,742 14,281
Operating income before income taxes 4,375 3,757 2,825
Depreciation 1,391 1,365 1,344
Construction expenditures 21,651 206 1,213
Total
Operating revenues 1,773,820 1,770,484 1,742,192
Operating income before income taxes 432,471 470,050 363,034
Depreciation 202,796 183,876 177,614
Construction expenditures
(including non-utility) 319,832 248,867 271,448
At December 31
- --------------
Net Identifiable Assets *
Electric $3,646,997 $3,449,822 $3,411,512
Gas 400,582 376,536 357,242
Steam 46,499 25,214 25,315
Non-utility 9,199 5,235 2,779
---------- ---------- ----------
Total Identifiable Assets 4,103,277 3,856,807 3,796,848
Other corporate assets ** 403,883 462,117 405,345
---------- ---------- ----------
Total Assets $4,507,160 $4,318,924 $4,202,193
========== ========== ==========
==============================================================================
* Prior years restated to reflect change in presentation.
** Primarily includes other property and investments, materials and supplies
and deferred charges and other assets.
M - Commitments and Contingencies
Purchase Power Commitment: To meet a portion of WE's anticipated increase in
future system energy supply needs, WE has entered into a 25 year power
purchase contract with an unaffiliated independent power producer, LSP-
Whitewater L.P. ("LS Power"). The contract is contingent upon the generating
facility achieving commercial operation. Plant construction is currently on
schedule to meet the planned start-up date of June 1, 1997. The contract
includes no minimum take provisions for energy. WE's estimated unconditional
obligations under the terms of the contract at December 31, 1996 are:
A-53
<PAGE> 54
============================================================================
(Thousands of Dollars)
1997 $ 17,000
1998 30,000
1999 31,000
2000 32,000
2001 33,000
Later Years 815,000
--------
Total Minimum Obligations 958,000
Less: Interest (569,000)
--------
Total at Present Value $389,000
========
==============================================================================
Kimberly Cogeneration Facility: In 1993, a competitive bidding process
conducted by the PSCW resulted in selection of a proposal submitted by LS
Power to construct the generating facility discussed in Purchase Power
Commitment above. Prior to the 1993 selection of the LS Power generating
facility by the PSCW, WE had proposed to construct its own 220 megawatt
cogeneration facility in Kimberly, Wisconsin, which was intended to provide
process steam to Repap Wisconsin, Inc. ("Repap") starting in mid-1994. In its
order, the PSCW selected the WE project as the second place conditional
project if the LS Power project did not proceed. At December 31, 1996, a net
investment of approximately $65.6 million remains in Other Deferred Charges
and Other Assets for the Kimberly Cogeneration Facility equipment (the
"Equipment"). This balance represents costs associated with the procurement
of three combustion turbines, one steam turbine and three heat recovery
boilers that were acquired in order to achieve the in-service dates as agreed
to in a steam service contract with Repap.
WE is continuing to review other options for use or sale of the Equipment,
which is a technology of natural gas-fired combined cycle generation equipment
that is marketed worldwide. WE is investigating opportunities to sell the
Equipment or to use it in another power project and is currently negotiating a
power project involving the Equipment. At this time, WE does not believe that
disposition of the Equipment will have a material adverse effect on its
financial condition. However, there is a possibility that WE may need to
recognize an impairment of the Equipment in the future should the project
noted above not occur and should no other viable sales opportunities and/or
power projects involving the Equipment be identified.
Manufactured Gas Plant Sites: WE continues a voluntary program to investigate
the remediation of a number of former manufactured gas plant ("MGP") sites.
Approximately $1.7 million has been expended through December 31, 1996 for
such activities. Future remediation costs to be incurred through the year
2001 have been estimated to be $12 million, but the actual costs are uncertain
pending the result of further site specific investigation and the selection of
site specific remediation. In its February 13, 1997 rate order, the PSCW
amplified its position on the recovery of MGP remediation costs. It
reiterated its position that such costs should be deferred and amortized and
recovered, without carrying costs, in future rate cases. Since the timing and
recovery of MGP remediation costs will be affected by the biennial rate case
cycle and WE's proposed merger related rate freeze, the timing and magnitude
of remediation expenditures, and their recovery during the period to 2001, may
be affected.
A-54
<PAGE> 55
N - Transactions with Associated Companies
Managerial, financial, accounting, legal, data processing and other services
may be rendered between associated companies and are billed in accordance with
service agreements approved by the PSCW. WE received from WEC stockholder
capital contributions of $30 million in 1995 and 1994, respectively.
Plans for the construction and financing of future additions to utility plant
can be found elsewhere in this report in MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - "LIQUIDITY AND CAPITAL
RESOURCES - Capital Requirements 1997-2001."
DIRECTORS
The information under "Election of Directors" in Wisconsin Electric's
definitive Information Statement dated April 3, 1997, attached hereto, is
incorporated herein by reference.
EXECUTIVE OFFICERS
(Figures in parenthesis indicate age and years of service with Wisconsin
Electric Power Company as of December 31, 1996)
Richard A. Abdoo (52;21):
Chairman of the Board
and Chief Executive Officer
Richard R. Grigg (48;26):
President, Chief Operating Officer
and Chief Nuclear Officer
David K. Porter (53;27):
Senior Vice President
Calvin H. Baker (53;5):
Vice President-Finance
and Chief Financial Officer
Ann Marie Brady (44;8):
Corporate Secretary
and Vice President-External Affairs
Francis Brzezinski (45;7):
Vice President-
Business Development
Charles T. Govin, Jr. (50;18):
Vice President - Electric & Gas Operations
Kristine M. Krause (42;18):
Vice President - Fossil Operations
Kristine A. Rappe (40;14):
Vice President - Customer Services
Anne K. Klisurich (49;24):
Controller
A-55
<PAGE> 56
Price Waterhouse LLP
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and the
Stockholder of Wisconsin Electric Power Company
In our opinion, the accompanying balance sheet and capitalization statement
and the related statements of income,of common stock equity and of cash flows
present fairly, in all material respects, the financial position of Wisconsin
Electric Power Company at December 31, 1996 and 1995, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/Price Waterhouse LLP
January 29, 1997
A-56
