Integrys Energy Group

Securing the Resources to Stay in the League - September 02, 1999

by Dan Bittner - Vice President and Chief Financial Officer

Financial Condition

To stay in the league, we feel it is very important to maintain a strong financial condition in order to have maximum flexibility for future business initiatives. This is why we continue to maintain a conservative capital structure, aggressive depreciation rates, and an aggressive expense versus capitalization policy. These policies contribute to our strong cash flows, excellent credit ratings, and overall healthy financial condition. Wisconsin Public Service Corporation is one of only two electric companies in the nation that is rated AA+ by Standard & Poors.

The benefit plans at WPS Resources are well funded. At year-end 1998, the Defined Benefit Pension Plan was funded at 150%, and Other Benefit Obligations were funded at 100%. We have also been aggressive in funding future obligations for decommissioning of the Kewaunee Nuclear Plant, and we estimate that liability to be funded currently at 90%.

Our current dividend payout ratio is high compared to our target of 65% to 70%, but we expect to move closer to our target through growth in our business and improved earnings. From a normal earnings level, we expect to increase earnings approximately 4% to 7% per year in the next several years. About 2% of this will come from the utility portion of the business with the balance coming from our nonregulated subsidiaries. Under this scenario, we expect to be in the 70% payout range in 3 to 4 years.

It is our feeling that the dividend is very important to a large portion of our shareholders. WPS Resources is included in Moody's Handbook of Dividend Achievers, which includes just over 300 companies with the strongest dividend records in America. The list is based on the concept that certain equity investments can provide a rising cash return over the long-run, while offering the additional benefit of potential price appreciation. We were also included in their top 20 companies with the highest current yield.

Our nonregulated earnings goal is 10% of total earnings by the year 2000. Progress toward this goal has been slower than anticipated for two major reasons. First, the retail electric market has been slower to deregulate than originally expected, particularly in the areas of the Midwest and Northeast where we have been concentrating our nonregulated marketing efforts. And secondly, our coal briquetting project has not reached its full potential due to both initial operating problems and securing a stable market for the output. The operating problems have been solved and we are now concentrating on securing a firm market for the output. The generation asset acquisitions from Maine Public Service and the Sunbury Plant from Pennsylvania Power & Light will also start contributing to earnings beginning in the 2000 to 2001 time period.

1999 Earnings

Our EPS for WPS Resources were $1.23 for the six months ended June 30, 1999, compared with $1.07 for the same period in 1998. Although it was over 8% colder in this year's heating season compared to last year, it was still almost 10% warmer than normal. This has made it very difficult to maintain an adequate earnings level in the regulated utility, since Wisconsin rates are based on forecasted sales under normal weather conditions. Below normal weather also has a negative impact on the sales made by our nonregulated marketing subsidiary. The other major factor affecting earnings has been the delay in anticipated earnings from the coal briquetting project which I mentioned earlier.

In spite of these factors, we are still comfortable with the overall estimate of earnings for 1999 of $2.25 to $2.35 per share as published by the analysts following our company. With normal weather in the last quarter of 1999, we will probably be closer to the low end of that estimate. Our nonregulated operations will continue to try and balance the development of future projects that provide long-term earnings with the need to maintain an acceptable level of earnings in the short-term.

Rate Case

Our new gas and electric rates for 1999 and 2000 in Wisconsin were effective on January 15 of this year. We considered it a very favorable order. Average electric rates increased 6.3% and gas rates 5.1%. The allowed ROE was set at 12.1% for the two-year period. This is an increase over the 11.8% ROE allowed in the 1997 to 1998 time period.

The order included a rate case reopener for the year 2000 to consider revised cost estimates for a limited number of electric items. The estimated amount of the electric increase in the re-opener is approximately $20 million, a 4% increase. The two major items which account for nearly all of the $20 million are additional fuel and purchased power costs and the Kewaunee Nuclear Plant spring 2000 refueling and steam generator repair costs. The Kewaunee Plant steam generators are anticipated to be replaced during the fall 2001 refueling outage.

The hearing date for the re-opener is set for October 12 with an expected effective date of January 1, 2000 for the new electric rates. Natural gas rates will not be affected by the re-opener.

Our next regularly scheduled full rate case for Wisconsin will be filed, as required, in April of next year for the years 2001 and 2002. Based on the pace of deregulation in Wisconsin, the 2001 - 2002 rate case may be the last one filed under the traditional process used to establish price levels and return levels for a bundled utility product. In the 2001 - 2002 rate case, we will concentrate on cost and price unbundling and establishing the infrastructure needed to position ourselves for the deregulated environment. We will also explore price caps or performance-based rates that capitalize on our low cost status and continuing efforts to increase productivity. We are supportive of performance-based rates in the future regulated functions if they can provide benefits to both customers and stockholders.

Capital Expenditures

Construction expenditures for Wisconsin Public Service Corporation are expected to be in the area of $375 million over the next three years. This includes expenditures for the replacement of the Kewaunee Nuclear Plant's steam generators and construction of a proposed transmission line to strengthen the interface in the northwest part of Wisconsin.

WPS Resources' other utility subsidiary, Upper Peninsula Power Company (UPPCO), will incur construction expenditures of approximately $25 million over the next three years for electric distribution system improvements.

Investment expenditures for nonregulated projects will depend on the timing of either developing new generation projects or acquiring existing generation assets that are being sold by local utility companies. This year, between the generation assets purchased from Maine Public Service and the Sunbury plant in Pennsylvania that should be closed toward the end of this year, our new nonregulated investment will total close to $150 million.

Financing Plans

Financing for part of the nonregulated projects is expected to be through non-recourse debt. For the Maine Public Service generation assets, we expect to secure about 60% of the funding from Bayerische Landesbank on a non-recourse basis. This should be finalized by the end of this month. In spite of the small size of this project, we are very pleased with the terms and conditions obtained on this non-recourse financing. It demonstrates the confidence we have with the economics of the purchase. The non-recourse financing gives us flexibility to use corporate resources for equity and take advantage of additional generation development opportunities.

The equity for these projects and other WPS Resources' needs will mainly be obtained through a subsidiary called WPS Resources Capital Corporation, which was formed earlier this year. It is our intent to utilize the financial strength and high equity levels at WPS Resources to support the planned growth of our nonregulated subsidiaries without significant additional amounts of new common stock. We are currently issuing new shares of common stock for the Stock Investment Plan, but we expect to discontinue issuing new shares for this program at the end of 1999. At this time, based on our current growth plans, we do not anticipate issuing more common stock until sometime in 2001 at the earliest.

In the short-term, WPS Resources will use internally generated funds and short-term borrowings to satisfy most of our capital requirements. We will periodically issue medium-term notes to reduce short-term debt and to maintain desired capitalization ratios. Our current equity level at WPS Resources is 85%, and our target equity level without non-recourse project debt and utility debt is around 65%. Based on discussions with the credit rating agencies, these levels should be sufficient to maintain the high credit quality that we desire for financial flexibility.

For a company our size, and because we haven't used all of our strong equity position, it doesn't take very large new project investments to realize significant earnings growth. For example, new investment in the regulated utility of approximately $100 million per year, along with new annual nonregulated investments of close to the $150 million, which we should accomplish this year, should translate into earnings growth at the high single digit or low double digit rate. This assumes earnings on assets of around 3.5%. Book value in this scenario would increase at about 5% per year. This can be done while maintaining equity levels within our target area to maintain strong financial quality. This potential scenario would involve a small amount of new equity in 2001 to avoid excess leverage.

Conclusion

In summary, we are a financially strong company that is in a position to add long-term value for the shareholder. We also have the flexibility to take advantage of growth opportunities through both additional regulated and nonregulated investments, as well as other strategic alliances that may make sense based on the ever-changing energy business environment. We expect to remain a strong player in the league.