Back to GetFilings.com

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2004

Securities registered pursuant to Section 12 (b) of the Act:    None

Securities registered pursuant to Section 12 (g) of the Act:    None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x     No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes ¨    No x

The aggregate market value of the common equity of Wisconsin Gas LLC held by non-affiliates as of June 30, 2004 was zero. All of the membership interests of Wisconsin Gas LLC are held by Wisconsin Energy Corporation.

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock, as of the latest practicable date (January 31, 2005):

1,125 Common Membership Interests

Documents Incorporated by Reference

None.

Reduced Disclosure Format

The Registrant meets the conditions set forth in General Instructions I(1)(a) and (b) of Form 10-K and is therefore filing with the reduced disclosure format.

2004 Form 10-K

WISCONSIN GAS LLC

FORM 10-K REPORT FOR THE YEAR ENDED DECEMBER 31, 2004

TABLE OF CONTENTS

2004 Form 10-K

PART I

INTRODUCTION

Wisconsin Gas LLC, formerly Wisconsin Gas Company, is a natural gas distribution public utility which serves approximately 577,000 gas customers in Wisconsin. Wisconsin Gas is a single member limited liability company organized under the laws of the state of Wisconsin and is a wholly owned subsidiary of Wisconsin Energy Corporation (Wisconsin Energy). Wisconsin Energy has integrated Wisconsin Gas’ operations with the gas operations and corporate support areas of Wisconsin Electric Power Company (Wisconsin Electric), Wisconsin Energy’s wholly-owned electric, gas and steam utility. In April 2002, Wisconsin Electric and Wisconsin Gas began doing business under the trade name “We Energies”. Unless qualified by their context when used in this document, the terms Wisconsin Gas, the Company, our, us or we refer to Wisconsin Gas.

We maintain our principal executive offices in Milwaukee, Wisconsin. We are the largest natural gas distribution public utility operating throughout Wisconsin. We are subject to the regulation of the Public Service Commission of Wisconsin (PSCW) as to various phases of our operations, including rates, service and issuance of long-term securities.

General Information About our Business: Our business is highly seasonal, particularly as to residential and commercial sales of gas for space heating purposes, with a substantial portion of our sales occurring in the winter heating season. The following table sets forth the volumes of natural gas we delivered to our customers. The sales volumes represent quantities we sold and delivered to customers. The volumes shown as transported represent customer-owned gas that we delivered to customers.

Cautionary Factors: Certain statements contained herein are “Forward-Looking Statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-Looking Statements include, among other things, statements regarding management’s expectations and projections regarding regulatory matters, gas deliveries, remediation costs, environmental and other capital expenditures, liquidity and capital resources and other matters. Also, Forward-Looking Statements may be identified by reference to a future period or periods or by the use of forward looking terminology such as “anticipates,” “believes,” “estimates,” “expects,” “forecasts,” “intends,” “may,” “objectives,” “plans,” “possible,” “potential,” “projects” or similar terms or variations of these terms. Actual results may differ materially from those set forth in Forward-Looking Statements as a result of certain risks and uncertainties, including but not limited to, those risks and uncertainties described under the heading “Cautionary Factors” in Item 7 of this report, as well as other matters described under the heading “Factors Affecting Results, Liquidity and Capital Resources” in Item 7 of this report, and other risks and uncertainties detailed from time to time in our filings with the Securities and Exchange Commission (SEC) or otherwise described throughout this document.

GAS UTILITY OPERATIONS

We are authorized to provide retail gas distribution service in designated territories in the state of Wisconsin, as established by indeterminate permits, certificates of public convenience and necessity, or boundary agreements with other utilities. We also transport customer-owned gas. We are the largest natural gas distribution utility in

2004 Form 10-K

Wisconsin. Our largest concentration of customers is in the City of Milwaukee, Wisconsin and surrounding suburban communities.

Gas Deliveries

Our gas utility business is highly seasonal due to the heating requirements of residential and commercial customers. Annual gas sales are also impacted by the variability of winter temperatures.

See “Results of Operations” in Item 7 for selected gas operating information by customer class during each of the three years in the period ended December 31, 2004.

We delivered approximately 1,233 million therms of gas during 2004, including customer-owned transported gas, a 3.9% decrease compared with 2003. As of December 31, 2004, we were transporting gas for approximately 1,105 customers who purchased gas directly from other suppliers. Transported gas accounted for approximately 39% of the total volumes delivered by us during 2004, 38% during 2003 and 39% during 2002. We had approximately 577,000 customers at December 31, 2004, an increase of approximately 1.3% since December 31, 2003.

Our maximum daily send-out in 2004 was 922,076 dekatherms on January 29, 2004. A dekatherm is equivalent to ten therms or one million British thermal units.

Sales to Large Gas Customers: We provide gas utility service to a diversified base of industrial customers. Major industries served include the paper, food products and fabricated metal products industries.

In late February 2001, Wisconsin Energy filed a petition with the PSCW starting the regulatory review process for a 10-year strategy, originally proposed in September 2000, to improve the supply and reliability of electricity in Wisconsin. As part of Wisconsin Energy’s Power the Future strategy, Wisconsin Energy is investing in new natural gas-fired and coal-fired generating capacity. We expect the natural gas-fired facilities to be transport customers of ours.

Gas Deliveries Growth: We currently forecast our total therm deliveries of natural gas to grow at an annual rate of approximately 4.8% over the next five-years. This forecast reflects a current year normalized sales level and assumes moderate growth in the economy of our service territory, normal weather and incremental Power the Future demand.

Competition

Competition in varying degrees exists between natural gas and other forms of energy available to consumers. Many of our large commercial and industrial customers are dual-fuel customers that are equipped to switch between natural gas and alternate fuels. We offer lower-priced interruptible rates and transportation services for these customers to enable them to reduce their energy costs and use gas rather than other fuels. Under gas transportation agreements, customers purchase gas directly from gas marketers and arrange with interstate pipelines and us to have the gas transported to the facilities where it is used. We earn substantially the same margin (difference between revenue and cost of gas) whether we sell and transport gas to customers or only transport their gas.

Our future ability to maintain our present share of the industrial dual-fuel market (the market that is equipped to use gas or other fuels) depends on our success and the success of third-party gas marketers in obtaining long-term and short-term supplies of natural gas at competitive prices compared to other sources and in arranging or facilitating competitively-priced transportation service for those customers that desire to buy their own gas supplies.

Federal and state regulators continue to implement policies to bring more competition to the gas industry. For information concerning proceedings by the PSCW to consider how its regulation of gas distribution utilities should change to reflect the changing competitive environment in the gas industry, see “Factors Affecting Results, Liquidity and Capital Resources” in Item 7. While the gas utility distribution function is expected to remain a highly regulated, monopoly function, the sales of the natural gas commodity and related services are expected to become increasingly subject to competition from third parties. However, it remains uncertain if and when the current economic

2004 Form 10-K

disincentives for small customers to choose an alternative gas commodity supplier may be removed such that we begin to face competition for the sale of gas to our smaller firm customers.

Gas Supply, Pipeline Capacity and Storage

We have been able to meet our contractual obligations with both our suppliers and our customers despite periods of severe cold and unseasonably warm weather.

Pipeline Capacity and Storage: Our natural gas originates in three major gas producing areas of North America: the Oklahoma and Texas basins, the Gulf of Mexico and western Canada. We have contracted for long-term firm capacity from each of these areas. This strategy reflects management’s belief that overall supply security is enhanced by geographic diversification of the supply portfolios and that Canada represents an important long-term source of reliable, competitively-priced gas. Wisconsin Energy also has a one-third ownership interest in the Guardian Pipeline which receives gas supply in the Joliet, Illinois market hub.

Because of the daily and seasonal variations in gas usage in Wisconsin, we have also contracted for substantial underground storage capacity, primarily in Michigan. Storage capacity enables us to manage significant changes in daily demand and to optimize our overall gas supply and capacity costs. We generally inject gas into storage during the spring and summer months and withdraw it in the winter months. As a result, we can contract for less long-line pipeline capacity than would otherwise be necessary and can purchase gas on a more uniform daily basis from suppliers year-round. Each of these capabilities enables us to reduce our overall costs.

We also maintain high deliverability storage in the mid-continent and Southeast production areas, as well as in our market area. This storage capacity is designed to deliver gas when other supplies cannot be delivered during extremely cold weather in the producing areas, which can reduce long-line supply.

We hold firm daily transportation and storage capacity entitlements from pipelines and other service providers under long-term contracts.

Term Gas Supply: We currently have contracts for firm supplies with terms in excess of 30 days with 12 gas suppliers for gas acquired in the Joliet, Illinois market hub and in the three producing areas discussed above. The pricing of the term contracts is based upon first of the month indices. Management believes that the volume of gas under contract is sufficient to meet our forecasted firm peak day demand.

Secondary Market Transactions: Capacity release is a mechanism by which pipeline long-line and storage capacity and gas supplies under contract can be resold in the secondary market. Local distribution companies, such as us, must contract for capacity and supply sufficient to meet the firm peak day demand of their customers. Peak or near peak demand days generally occur only a few times each year. Capacity release facilitates higher utilization of contracted capacity and supply during those times when the full contracted capacity and supply are not needed by the utility, helping to mitigate the fixed costs associated with maintaining peak levels of capacity and gas supply. Through pre-arranged agreements and day-to-day electronic bulletin board postings, interested parties can purchase this excess capacity and supply. The proceeds from these transactions are passed through to ratepayers, subject to our gas cost incentive mechanism pursuant to which we have an opportunity to share in the cost savings. See “Factors Affecting Results, Liquidity and Capital Resources – Rates and Regulatory Matters” in Item 7 for information on the gas cost recovery mechanism (GCRM) and gas cost incentive mechanism. During 2004, we continued our active participation in the capacity release market.

Spot Market Gas Supply: We expect to continue to make gas purchases in the 30-day spot market as price and other circumstances dictate. We have supply relationships with a number of sellers from whom we purchase spot gas.

Hedging Gas Supply Prices: We have PSCW approval to hedge (i) up to 50% of planned flowing gas supply using NYMEX based natural gas options, (ii) up to 10% of planned flowing gas supply using NYMEX based natural gas future contracts and (iii) up to 33% of planned storage withdrawals using NYMEX based natural gas options. That approval allows us to pass 100% of the hedging costs (premiums and brokerage fees) and proceeds (gains and losses) through our purchase gas adjustment mechanism. Hedge targets (volumes) are provided annually to the PSCW as part of our five-year gas supply plan filing.

2004 Form 10-K

To the extent that opportunities develop and our physical supply operating plans will support them, we also have PSCW approval to utilize NYMEX-based natural gas derivatives to capture favorable forward market price differentials. That approval provides for 100% of the related proceeds to accrue to our GCRM.

Guardian Pipeline: Wisconsin Energy has a one-third interest in a joint venture, Guardian Pipeline, L.L.C. (Guardian). Two unaffiliated companies also have one-third interests. Guardian owns an interstate natural gas pipeline from the Joliet, Illinois market hub to southeastern Wisconsin that is designed to serve the growing demand for natural gas in Wisconsin and Northern Illinois. Guardian began commercial operation in early December 2002. Currently, Guardian has firm precedent agreements to transport 87% of its 750,000 dekatherms per day pipeline design capacity. We have committed to purchase 650,000 dekatherms (approximately 87% of the pipelines total capacity) per day of capacity on the pipeline over a long-term contract that expires in December 2012.

WATER UTILITY OPERATIONS

In November 1998, we entered into the water distribution business to leverage off of operational similarities with our natural gas business. As of December 31, 2004, we served approximately 2,700 water customers in the suburban Milwaukee area compared with approximately 2,600 customers at December 31, 2003. We also provide contract services to local municipalities and businesses within our service territory for water system repair and maintenance. Our water revenues totaled $1.9 million and $1.8 million in 2004 and 2003, respectively.

UTILITY RATE MATTERS

See “Factors Affecting Results, Liquidity and Capital Resources – Rates and Regulatory Matters” in Item 7.

REGULATION

We are subject to the regulation of the PSCW as to retail gas and water rates in the state of Wisconsin, standards of service, issuance of long-term securities, construction of certain new facilities, transactions with affiliates, billing practices and various other matters.

We are also subject to regulations, where applicable, of the United States Environmental Protection Agency (EPA) and the Wisconsin Department of Natural Resources (WDNR).

Gas Cost Recovery: Our rates traditionally contain clauses providing for periodic rate adjustments, with PSCW approval, to reflect changes in purchased gas costs.

The PSCW approved a new performance-based GCRM which became effective April 1, 2001. See “Rates and Regulatory Matters” in Item 7.

Changing Regulatory Environment: The PSCW has instituted generic proceedings to consider how its regulation of gas distribution utilities should change to reflect the changing competitive environment in the natural gas industry. To date, the PSCW has made a policy decision to deregulate the sale of natural gas in customer segments with workably competitive market choices and has adopted standards for transactions between a utility and its gas marketing affiliates. However, work on deregulation of the gas distribution industry by the PSCW is presently on hold. Currently, we are unable to predict the impact of potential future deregulation on our results of operations or financial position.

2004 Form 10-K

ENVIRONMENTAL COMPLIANCE

Environmental Expenditures

For discussion of environmental issues, see “Environmental Matters” in Item 3.

Manufactured Gas Plant Sites

We are reviewing and addressing environmental conditions at a number of former manufactured gas plant sites. See “Note K – Commitments and Contingencies” in the Notes to Financial Statements in Item 8.

OTHER

Research and Development: We had immaterial research and development expenditures in the last three years, primarily for improvement of service. Research and development activities include specific projects performed by employees, consultants and contractors, plus sponsorship of research by industry associations.

Employees: At December 31, 2004, we had 674 total employees, of which 529 were represented under labor agreements.

The employees represented under labor agreements were with the following bargaining units as of December 31, 2004.

During 2004, labor and management successfully negotiated one contract which covered 126 employees.

2004 Form 10-K

We own our principal properties outright except that the major portion of gas utility distribution mains and services are located, for the most part, on or in streets and highways and on land owned by others.

We own a distribution system which, as of December 31, 2004, included approximately 10,400 miles of distribution and transmission mains connected at gate stations to the pipeline transmission systems of ANR Pipeline Company, Guardian, Northern Natural Pipeline Company, Viking Gas Transmission and Michigan Consolidated Gas Company. We have a liquefied natural gas storage plant which converts and stores in liquefied form natural gas received during periods of low consumption. The liquefied natural gas storage plant has a send-out capability of 3,600 dekatherms per day. We also have a propane air system for peaking purposes. This propane air system will provide approximately 2,400 dekatherms per day of supply to the system. Our distribution system consists almost entirely of plastic and coated steel pipe. We own office buildings in certain communities in which it serves, gas regulating and metering stations, peaking facilities and its major service centers, including garage and warehouse facilities.

Where distribution mains and services occupy private property, in some, but not all, instances we have obtained consents, permits or easements for such installations from the apparent owners or those in possession, generally without an examination of title.

In addition to those legal proceedings discussed below, we are currently, and from time to time, subject to claims and suits arising in the ordinary course of business. Although the results of such legal proceedings cannot be predicted with certainty, we believe, after consultation with legal counsel, that the ultimate resolution of these proceedings will not have a material adverse effect on our financial statements.

ENVIRONMENTAL MATTERS

We are subject to federal, state and certain local laws and regulations governing the environmental aspects of our operations. We believe that, perhaps with immaterial exceptions, our existing facilities are in compliance with applicable environmental requirements.

EPA Information Requests: We responded to an EPA request for information pursuant to Comprehensive Environmental Response, Compensation and Liability Act Section 104(e) for the Solvay Coke and Gas Site located in Milwaukee, Wisconsin. All potentially responsive records and corporate legal files have been reviewed and responsive information was provided in October 2004. A predecessor company of ours had a customer and corporate relationship with the entity that owned and operated the site, Milwaukee Solvay Coke Company. Although we have not accepted responsibility for costs of any sort related to the property, remediation cost estimates and reserves continue to be included in the estimated manufactured gas plant values reported in “Note K – Commitments and Contingencies” in the Notes to Financial Statements in Item 8.

See “Manufactured Gas Plant Sites” in Note K – Commitments and Contingencies” in the Notes to Financial Statements in Item 8, which is incorporated by reference herein, for a discussion of matters related to certain manufactured gas plant sites.

UTILITY RATE MATTERS

See “Factors Affecting Results, Liquidity and Capital Resources – Rates and Regulatory Matters” in Item 7 for information concerning rate matters in the jurisdictions where we do business.

Omitted pursuant to General Instruction I(2)(c).

2004 Form 10-K

EXECUTIVE OFFICERS OF THE REGISTRANT

The names, ages at December 31, 2004 and positions of our executive officers are listed below along with their business experience during the past five years. All officers are appointed until they resign, die or are removed pursuant to the Limited Liability Company Operating Agreement. There are no family relationships among these officers, nor is there any agreement or understanding between any officer and any other person pursuant to which the officer was selected. Reference to Wisconsin Gas LLC includes the time spent with its predecessor, Wisconsin Gas Company.

Gale E. Klappa. Age 54.

Charles R. Cole. Age 58.

Stephen P. Dickson. Age 44.

Frederick D. Kuester. Age 54.

Allen L. Leverett. Age 38.

2004 Form 10-K

EXECUTIVE OFFICERS OF THE REGISTRANT – (Cont’d)

Kristine A. Rappé. Age 48.

Larry Salustro. Age 57.

Certain executive officers also hold offices in other of Wisconsin Energy’s subsidiaries.

PART II

We are a wholly-owned subsidiary of Wisconsin Energy and none of our stock is publicly traded. We did not pay any dividends during the three years ended December 31, 2004.

Various financing arrangements and regulatory requirements impose certain restrictions on our ability to transfer funds to Wisconsin Energy in the form of cash dividends, loans or advances. Under Wisconsin law, we are prohibited from loaning funds, either directly or indirectly, to Wisconsin Energy.

Omitted pursuant to General Instruction I(2)(a).

CORPORATE DEVELOPMENTS

INTRODUCTION

The financial statements include the accounts of Wisconsin Gas LLC (Wisconsin Gas or the Company, our, we or us), a wholly-owned subsidiary of Wisconsin Energy Corporation (Wisconsin Energy). We are a public utility engaged in the distribution of natural gas throughout Wisconsin. Most of our revenues are derived from gas delivered in southeastern Wisconsin. In addition, we operate a small water utility that has annual revenues less than $2.0 million.

2004 Form 10-K

Wisconsin Gas and Wisconsin Electric Power Company, (Wisconsin Electric), another wholly-owned subsidiary of Wisconsin Energy, have combined many of their common functions and operate under the trade name “We Energies”.

Prior to July 2004, Wisconsin Gas was a corporation and was a wholly-owned subsidiary of WICOR, Inc. who was a wholly-owned subsidiary of Wisconsin Energy. In July 2004, Wisconsin Gas converted to a Wisconsin single member limited liability company (LLC), and the interest in the LLC was transferred from WICOR to Wisconsin Energy in connection with the redemption of certain shares of WICOR stock.

Cautionary Factors: Certain statements contained herein are “Forward-Looking Statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-Looking Statements include, among other things, statements regarding management’s expectations and projections regarding regulatory matters, gas deliveries, remediation costs, environmental and other capital expenditures, liquidity and capital resources and other matters. Also, Forward-Looking Statements may be identified by reference to a future period or periods or by the use of forward looking terminology such as “anticipates,” “believes,” “estimates,” “expects,” “forecasts,” “intends,” “may,” “objectives,” “plans,” “possible,” “potential,” “projects” or similar terms or variations of these terms. Actual results may differ materially from those set forth in Forward-Looking Statements as a result of certain risks and uncertainties, including but not limited to, those risks and uncertainties described under the heading “Cautionary Factors” in this Item 7, as well as other matters described under the heading “Factors Affecting Results, Liquidity and Capital Resources” in this Item 7, and other risks and uncertainties detailed from time to time in our filings with the Securities and Exchange Commission (SEC) or otherwise described throughout this document.

CORPORATE STRATEGY

Business Opportunities

We are realizing operating efficiencies through the integration of the operations of Wisconsin Electric and Wisconsin Gas. These operating efficiencies should increase customer satisfaction and reduce operating costs.

RESULTS OF OPERATIONS

EARNINGS

2004 vs 2003: We had a net loss of $20.4 million in 2004 compared with net income of $36.8 million during 2003. Our net loss includes an impairment charge of $51 million related to goodwill. A more detailed analysis of financial results follows.

Gas Operating Revenues, Cost of Gas Sold and Gross Margin

Our gas rates allow us to pass on the costs of gas sold on a dollar for dollar basis. As such, we believe that gross margin as a better performance indicator than revenues. The following table compares our gas utility operating revenues and gross margins (total gas operating revenues less cost of gas sold) during 2004, 2003 and 2002.

2004 vs 2003: During 2004, gas operating revenues increased by $15.9 million or 2.2%. This increase in revenues is due primarily to a $25.9 million annual price increase which became effective in February 2004. This increase was partially offset by lower therm deliveries due to less favorable weather and our recognition of $3.0 million less

2004 Form 10-K

in gas cost incentive revenues under our gas cost recovery mechanism. The increase in purchased gas costs is passed on to customers because changes in the cost of gas sold flow through to revenue under the gas cost recovery mechanism (GCRM).

2003 vs 2002: During 2003, gas operating revenues increased by $184.7 million or 35.0%. This increase in revenues is due primarily to a $173.8 million increase in the delivered cost of natural gas, recognition of $3.0 million of increased gas cost incentive revenues under our GCRM and increased deliveries resulting from colder weather during 2003 compared with 2002. The increase in purchased gas costs is passed on to customers because changes in the cost of gas sold flow through to revenue under the GCRM.

Gas Gross Margin and Therm Deliveries

The following table compares gas gross margin and therm deliveries during 2004, 2003 and 2002.

2004 vs 2003: Gas gross margin totaled $215.0 million in 2004, or a $9.8 million improvement from 2003. This increase is due primarily to a $25.9 million annual price increase which became effective in February 2004. This price increase favorably impacted gas revenues by $19.6 million in 2004 as compared to 2003. This price increase was partially offset by lower therm deliveries due to less favorable weather and our recognition of $3.0 million less in gas cost incentive revenues under our GCRM. As measured by heating degree days, 2004 was 5.7% warmer than 2003 and 1.1% warmer than normal. Total therm deliveries of natural gas decreased by 3.9% during 2004, but varied within customer classes. Volume deliveries for the residential and commercial/industrial customer classes decreased by 5.1% and 6.4%, respectively, reflecting warmer winter weather.

2003 vs 2002: Gas gross margin totaled $205.2 million in 2003, or a $10.9 million improvement from 2002. This increase was directly related to a favorable weather-related increase in therm deliveries, especially to residential customers who are more weather sensitive and contribute higher margins per therm than other customer classes. As measured by heating degree days, 2003 was 7.8% colder than 2002 and 5.1% colder than normal. A $3.0 million increase in gas cost incentive revenues during 2003 under our GCRM also contributed to the increased gross margin between the comparative periods. Total therm deliveries of natural gas increased by 4.2% during 2003, but varied within customer classes. Volume deliveries for the residential and commercial/industrial customer classes increased by 4.5% and 6.7%, respectively, reflecting colder weather.

Operation and Maintenance Expenses

2004 vs 2003: Operation and maintenance expenses increased by $9.2 million or 9.5% during 2004 when compared with 2003. This increase was driven by $5.9 million of severance-related costs, primarily due to a

2004 Form 10-K

Voluntary Separation Plan which was offered to certain management employees in the second half of 2004. We also recognized $6.2 million of increased public benefits costs and experienced higher pension and medical costs of $1.1 million. Partially offsetting these increases was a $6.2 million reduction in bad debt costs due to improved collections and the timing of the PSCW’s deferral order authorizing us to defer bad debt costs for collection in future rates.

2003 vs 2002: Other operation and maintenance expenses increased by $13.2 million or 15.8% during 2003 when compared with 2002. The increase was primarily attributable to pension, medical and other benefit costs, which increased by $5.0 million, and a $4.7 million increase in bad debt expenses in large part due to higher gas bills during 2003.

Impairment Charge

2004 vs 2003: The $51.0 million goodwill impairment charge in 2004 was attributable to the difference between the fair value and recorded value of certain deferred tax assets.

2003 vs 2002: As part of the adoption of Statement of Financial Accounting Statement No. 142, Goodwill and Other Intangible Assets, on January 1, 2002, we recorded an impairment charge of $295.0 million which was reflected as a cumulative effect of a change in accounting principle.

Interest Expense

2004 vs 2003: Interest expense increased by $6.6 million during 2004 compared to 2003. This increase reflects the December 2003 issuance of $125 million of unsecured 5.20% Debentures.

2003 vs 2002: Interest expense remained relatively unchanged for 2003 compared to 2002.

Other Income and Deductions

2004 vs 2003: Other income and deductions decreased by $0.9 million in 2004 compared to 2003.

2003 vs 2002: Other income and deductions increased by $4.9 million in 2003 compared to 2002. This increase is due in part to higher returns of $0.7 million associated with other investments. Also, in 2002 we recorded losses on asset sales of $3.2 million.

Income Taxes

During 2004, we recorded a $51.0 million impairment charge, which is a non-deductible cost. Our effective income tax rate, excluding the impact of goodwill impairment charges, was 35.3%, 35.9%, and 37.4% for the three years ended December 31, 2004, 2003 and 2002, respectively. See “Note C – Income Taxes” in the Notes to Financial Statements in this report for additional information.

2004 Form 10-K

LIQUIDITY AND CAPITAL RESOURCES

CASH FLOWS

The following table summarizes our cash flows during 2004, 2003 and 2002:

Operating Activities

During 2004, cash flows from operations increased to $42.1 million compared to $11.7 million in 2003. This increase was primarily attributable to improvements in working capital.

Cash provided by operating activities decreased to $11.7 million during 2003 compared with $26.1 million during the same period in 2002. This decrease was primarily due to an increase in the use of working capital due to higher natural gas prices and higher volumes of natural gas in storage.

Investing Activities

During 2004, we had net cash outflows for investing activities of $44.3 million as compared to net cash outflows of $126.4 million in 2003. This decrease was directly related to construction costs associated with the Ixonia natural gas lateral, which was placed into service in December 2003.

During 2003, we invested a total of $126.4 million, an increase of $84.7 million over the prior year, primarily due to costs for construction of the Ixonia natural gas lateral.

Financing Activities

During 2004, we received $3.7 million from financing activities compared with $114.4 million during 2003. This change is attributed to the December 2003 issuance of $125 million of unsecured 5.20% Debentures.

During 2003, we received $114.4 million from financing activities compared with $13.5 million from financing activities during 2002. In December 2003, we sold $125 million of unsecured 5.20% Debentures due December 1, 2015. The primary use of proceeds for this debt was to finance the Ixonia natural gas lateral.

CAPITAL RESOURCES AND REQUIREMENTS

Capital Resources

We anticipate meeting our capital requirements during 2005 primarily through internally generated funds and short-term borrowings, supplemented by the issuance of intermediate or long-term debt securities depending on market conditions and other factors. Beyond 2005, we anticipate meeting our capital requirements through internally generated funds supplemented, when required, through the issuance of debt securities depending on market conditions and other factors.

We have access to the capital markets and have been able to generate funds internally and externally to meet our capital requirements. Our ability to attract the necessary financial capital at reasonable terms is critical to our

2004 Form 10-K

overall strategic plan. We believe that we have adequate capacity to fund our operations for the foreseeable future through our borrowing arrangements and internally generated cash.

On December 31, 2004, we had approximately $200 million of available unused lines in our bank back-up credit facility and approximately $136.9 million of total short-term debt outstanding on such date.

We review our bank back-up credit facility needs on an ongoing basis and expect to be able to maintain adequate credit facilities to support our operations. The following table summarizes such facility at December 31, 2004:

On June 23, 2004, we entered into an unsecured three year $200 million bank back-up credit facility to replace a $200 million 364 day credit facility that was expiring in 2004. This new facility will expire in June 2007 and may be extended for an additional 364 days, subject to lender agreement.

The following table shows our capitalization structure at December 31:

Access to capital markets at a reasonable cost is determined in large part by credit quality. The following table summarizes the ratings of our debt securities by Standard & Poors Corporation (S&P), Moody’s Investors Service (Moody’s) and Fitch as of December 31, 2004.

Our security rating outlooks assigned by S&P, Moody’s and Fitch are all stable.

In March 2003, S&P lowered its corporate credit rating for us from A to A-. S&P also lowered its rating for our senior unsecured debt from A to A- and lowered our short-term rating from A-1 to A-2.

In October 2003, Moody’s lowered our senior unsecured debt rating from Aa2 to A1 and confirmed our P-1 commercial paper ratings.

In October 2003, Fitch lowered our senior unsecured debt rating from AA- to A+ and lowered our commercial paper ratings from F1+ to F1.

We believe these security ratings should provide a significant degree of flexibility in obtaining funds on competitive terms. However, these security ratings reflect the views of the rating agencies only. An explanation of the significance of these ratings may be obtained from each rating agency. Such ratings are not a recommendation to buy, sell or hold securities, but rather an indication of creditworthiness. Any rating can be revised upward or

2004 Form 10-K

downward or withdrawn at any time by a rating agency if it decides that the circumstances warrant the change. Each rating should be evaluated independently of any other rating.

Capital Requirements

Total capital expenditures are currently estimated to be $37 million during 2005, a decrease of approximately $8.6 million over 2004. We currently expect capital expenditures to be between $35 million and $55 million per year during the next five years.

Investments in Outside Trusts: We have funded our pension and other post-retirement benefit obligations in outside trusts. These investments are subject to the volatility of the stock market and interest rates. For further information see “Note H – Benefits” in the Notes to Financial Statements.

Off-Balance Sheet Arrangements: We may, from time to time, be a party to various financial instruments with off-balance sheet risk as a part of our normal course of business, which may include, from time to time, financial guarantees and letters of credit which support construction projects, commodity contracts and other payment obligations. As of December 31, 2004, we have no financial instruments with off-balance sheet risk.

Contractual Obligations/Commercial Commitments: We have the following contractual obligations and other commercial commitments as of December 31, 2004:

Our obligations for utility operations have historically been included as part of the rate making process and therefore are generally recoverable from customers.

FACTORS AFFECTING RESULTS, LIQUIDITY AND CAPITAL RESOURCES

MARKET RISKS AND OTHER SIGNIFICANT RISKS

We are exposed to market and other significant risks as a result of the nature of our businesses and the environment in which those businesses operate. These risks, described in further detail below, include but are not limited to:

Natural Gas Costs: Natural gas costs have increased significantly because the supply of natural gas in recent years has not kept pace with the demand for natural gas, which has grown throughout the United States as a result of increased reliance on natural gas-fired electric generating facilities. We expect that demand for natural gas will remain high into the foreseeable future and that significant price relief will not occur until additional natural gas is added to the nation’s energy supply mix.

2004 Form 10-K

Higher natural gas costs increase our working capital requirements, resulting in higher gross receipts taxes in the state of Wisconsin. Higher gas costs combined with slower economic conditions also expose us to greater risks of accounts receivable write-offs as more customers are unable to pay their bills. Because federal and state energy assistance dollars have not kept pace with rising natural gas costs, our risks related to bad debt expenses associated with non-paying customers has increased.

As a result of gas cost recovery mechanisms, we receive dollar for dollar pass through on most of the cost of natural gas. However, increased natural gas costs increase the risk that customers will switch to alternative fuel sources, which could reduce future gas margins. For additional information concerning our gas cost recovery mechanism, see “Rates and Regulatory Matters” below.

Weather: Our rates are set by the PSCW based upon estimated temperatures which approximate 20-year averages. Our gas revenues are unfavorably sensitive to above normal temperatures during the winter heating season. A summary of actual weather in our service territory during 2004, 2003 and 2002, as measured by degree-days, may be found above in “Results of Operations”.

Interest Rate Risk: We have various short-term borrowing arrangements to provide working capital and general corporate funds. Borrowing levels under such arrangements vary from period to period depending upon capital investments and other factors. Future short-term interest expense and payments will reflect both future short-term interest rates and borrowing levels.

We performed an interest rate sensitivity analysis at December 31, 2004 of our outstanding portfolio of $136.9 million short-term debt with a weighted average interest rate of 2.34%. A one-percentage point change in interest rates would cause our annual interest expense to increase or decrease by approximately $1.4 million before taxes from short-term borrowings.

Marketable Securities Return Risk: We fund our pension and other post-retirement benefit obligations through various trust funds, which in turn invest in debt and equity securities. Changes in the market price of the assets in these trust funds can affect future pension and other post-retirement benefit expenses. Future contributions to these trust funds can also be affected by changes in the market price of trust fund assets. We expect that the risk of expense and contribution variations as a result of changes in the market price of trust fund assets would be mitigated in part through future rate actions by our utility regulator. However, we are currently operating under a PSCW-ordered, qualified five-year rate restriction period through 2005. For further information about the rate restriction, see “Rates and Regulatory Matters” below.

At December 31, 2004, Wisconsin Energy held on our behalf, the following total trust fund assets at fair value, primarily consisting of publicly traded debt and equity security investments.

Fiduciary oversight of the pension and other post-retirement plan trust fund investments is the responsibility of a Chairman appointed Investment Trust Policy Committee. Qualified external investment managers are engaged to manage the investments. Asset/liability studies are periodically conducted with the assistance of an outside investment advisor. The current study projects long-term, annualized returns of approximately 9%.

Credit Rating Risk: We do not have any credit agreements that would require material changes in payment schedules or terminations as a result of a credit rating downgrade. We do have certain agreements in the form of employee benefit plans that could require, in the event of a credit ratings change to below investment grade, an accelerated payment. At December 31, 2004, we estimate that the potential payments under these agreements that could result from credit rating downgrades totaled approximately $0.8 million.

Inflationary Risk: We continue to monitor the impact of inflation, especially with respect to the rising costs of medical plans, in order to minimize its effects in future years through pricing strategies, productivity improvements

2004 Form 10-K

and cost reductions. Except for continuance of an increasing trend in the inflation of medical costs and the impacts on our medical and post-retirement benefit plans, we have expectations of low-to-moderate inflation. We do not believe the impact of general inflation will have a material effect on our future results of operations.

Economic Risk: We are exposed to market risks in the regional Midwest economy.

For additional information concerning risk factors, including market risks, see “Cautionary Factors” below.

RATES AND REGULATORY MATTERS

The PSCW regulates our retail natural gas and water rates in the state of Wisconsin, while the Federal Energy Regulatory Commission (FERC) regulates interstate gas transportation service rates. Orders from the PSCW can be viewed at http://psc.wi.gov/.

Overview: In the state of Wisconsin, our rates are governed by an order from the PSCW issued in March 2000 in connection with the approval of the WICOR acquisition. Under this order, we are restricted from increasing Wisconsin rates for a five year period ending December 31, 2005, with certain exceptions. We may seek biennial rate reviews during the five-year rate restriction as a result of:

In addition, the PSCW found that gas cost recovery mechanisms would not be subject to the five-year rate restriction period and that it was reasonable to allow us to retain efficiency gains associated with the merger. Under the March 2000 order, a full rate review will be required by the PSCW for rates beginning in January 1, 2006. We expect to make a filing in 2005 in connection with this PSCW review.

In March 2004, the PSCW approved an annual rate increase of $25.9 million due to increased costs associated with the Ixonia lateral and for increased costs associated with low-income energy assistance programs.

Gas Cost Recovery Mechanism: Our GCRM approved by the PSCW includes an incentive mechanism that provides an opportunity for us to increase or decrease earnings within certain limited ranges as a result of gas acquisition activities and transportation costs. The majority of gas costs are passed through to customers under our existing GCRM. We have the opportunity to increase or decrease earnings by up to approximately 2.5% of our total annual gas costs based upon how closely actual gas commodity and capacity costs compare to benchmarks established by the PSCW.

Hedging Gas Supply Prices: We have PSCW approval to hedge (i) up to 50% of planned flowing gas supply using NYMEX based natural gas options, (ii) up to 10% of planned flowing gas supply using NYMEX based natural gas future contracts and (iii) up to 33% of planned storage withdrawals using NYMEX based natural gas options. That approval allows us to pass 100% of the hedging costs (premiums and brokerage fees) and proceeds (gains and losses) through our purchase gas adjustment mechanism. Hedge targets (volumes) are provided annually to the PSCW as part of our five-year gas supply plan filing.

To the extent that opportunities develop and our physical supply operating plans will support them, we also have PSCW approval to utilize NYMEX-based natural gas derivatives to capture favorable forward market price differentials. That approval provides for 100% of the related proceeds to accrue to our GCRM.

Bad Debt Costs: Prior to October 2002, we expensed amounts included in rates for bad debt expense. If actual bad debt costs exceeded amounts allowed in rates, these amounts were deferred as a regulatory asset. Effective October 2002, the PSCW issued an order which eliminated escrow accounting for bad debts. The escrow amount accumulated at September 30, 2002 of approximately $6.9 million is expected to be collected in future rates. In 2003 and 2004, due to a combination of unusually high natural gas prices, a soft economy within our utility service territories, and limited governmental assistance available to low-income customers, we saw a significant increase in residential uncollectible accounts receivable. Because of this, we requested and received a letter from the PSCW which allowed us to defer the costs of residential bad debts to the extent that the costs exceeded the amounts allowed

2004 Form 10-K

in rates. As a result of these letters from the PSCW we deferred approximately $9.4 million and $4.7 million in 2004 and 2003, respectively, related to bad debt costs.

In December 2004, we filed with the PSCW a request to implement a pilot program, which, among other things, is designed to better match our collection efforts with the ability of low income customers to pay their bills. Included in this filing is a request to implement escrow accounting for all residential bad debt costs. In February 2005, the PSCW approved our pilot program and our request for escrow accounting.

ENVIRONMENTAL MATTERS

Consistent with other companies in the energy industry, we face potentially significant ongoing environmental compliance and remediation challenges related to current and past operations. Specific environmental issues affecting us include but are not limited to remediation of former manufactured gas plant sites.

We are currently pursuing a proactive strategy to manage our environmental issues including the clean-up of former manufactured gas plant sites. For further information, see “Note K – Commitments and Contingencies” in the Notes to Financial Statements.

INDUSTRY RESTRUCTURING AND COMPETITION

The PSCW has instituted generic proceedings to consider how its regulation of gas distribution utilities should change to reflect the changing competitive environment in the natural gas industry. To date, the PSCW has made a policy decision to deregulate the sale of natural gas in customer segments with workably competitive market choices and has adopted standards for transactions between a utility and its gas marketing affiliates. However, work on deregulation of the gas distribution industry by the PSCW is presently on hold. Currently, we are unable to predict the impact of potential future deregulation on our results of operations or financial position.

ACCOUNTING DEVELOPMENTS

New Pronouncements: In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 123 (revised 2004), Share-Based Payment (SFAS 123R), which amended SFAS 123, Accounting for Stock-Based Compensation. This statement requires that the compensation costs relating to such transactions be recognized in the consolidated income statement. We are currently evaluating the provisions of SFAS 123R and expect to adopt it on July 1, 2005. We have not yet determined the method of transition. See “Note B – Recent Accounting Pronouncements” in the Notes to Financial Statements in this report for additional information.

CRITICAL ACCOUNTING ESTIMATES

Preparation of financial statements and related disclosures in compliance with generally accepted accounting principles (GAAP) requires the application of appropriate technical accounting rules and guidance, as well as the use of estimates. The application of these policies necessarily involves judgments regarding future events, including the likelihood of success of particular projects, legal and regulatory challenges and anticipated recovery of costs. These judgments, in and of themselves, could materially impact the financial statements and disclosures based on varying assumptions. In addition, the financial and operating environment also may have a significant effect, not only on the operation of our business, but on our results reported through the application of accounting measures used in preparing the financial statements and related disclosures, even if the nature of the accounting policies applied have not changed.

The following is a list of accounting policies that are most significant to the portrayal of our financial condition and results of operations and that require management’s most difficult, subjective or complex judgments.

2004 Form 10-K

Regulatory Accounting: We operate under rates established by a state regulatory commission, which 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 prices, which are based upon factors other than the traditional original cost of investment. In this situation, continued deferral of certain regulatory asset and liability amounts on our books, as allowed under Statement of Financial Accounting Standards No. 71, Accounting for the Effects of Certain Types of Regulation (SFAS 71), may no longer be appropriate and the unamortized regulatory assets net of the regulatory liabilities would be recorded as an extraordinary after-tax non-cash charge to earnings. As of December 31, 2004, we had $68.0 million in regulatory assets and $314.0 million in regulatory liabilities. We continually review the applicability of SFAS 71 and have determined that it is currently appropriate to continue following SFAS 71. See “Note A – Summary of Significant Accounting Policies” in the Notes to Financial Statements for additional information.

Pension and Other Post-retirement Benefits: Our reported costs of providing non-contributory defined pension benefits (described in “Note H – Benefits” in the Notes to Financial Statements) are dependent upon numerous factors resulting from actual plan experience and assumptions of future experience. Pension costs are impacted by actual employee demographics (including age, compensation levels and employment periods), the level of contributions made to plans, and earnings on plan assets. Changes made to the provisions of the plans may also impact current and future pension costs. Pension costs may also be significantly affected by changes in key actuarial assumptions, including anticipated rates of return on plan assets and the discount rates used in determining the projected benefit obligation and pension costs.

In accordance with Statement of Financial Accounting Standard No. 87, Employers’ Accounting for Pensions (SFAS 87), changes in pension obligations associated with these factors may not be immediately recognized as pension costs on the income statement, but generally are recognized in future years over the remaining average service period of plan participants. As such, significant portions of pension costs recorded in any period may not reflect the actual level of cash benefits provided to plan participants.

As of December 31, 2004 approximately 73% of our pension plan assets were invested in equity securities. Remaining plan assets were invested primarily in corporate and government bonds. During 2004, the funded status of our plans remained close to the 2003 levels and is $73.0 million over-funded.

The following chart reflects pension plan sensitivities associated with changes in certain actuarial assumptions by the indicated percentage. Each sensitivity reflects a change to the given assumption, holding all other assumptions constant.

In addition to pension plans, we maintain other post-retirement benefit plans which provide health and life insurance benefits for retired employees (described in “Note H – Benefits” in the Notes to Financial Statements). We account for such plans in accordance with Statement of Financial Accounting Standards No. 106, Employers’ Accounting for Post-retirement Benefits Other Than Pensions (SFAS 106). Our reported costs of providing these post-retirement benefits are dependent upon numerous factors resulting from actual plan experience including employee demographics (age and compensation levels), our contributions to the plans, earnings on plan assets and health care cost trends. Changes made to the provisions of the plans may also impact current and future post-retirement benefit costs. Other post-retirement benefit costs may also be significantly affected by changes in key actuarial assumptions, including anticipated rates of return on plan assets and the discount rates used in determining the post-retirement benefit obligation and post-retirement costs. Our other post-retirement benefit plan assets are primarily

2004 Form 10-K

made up of equity and fixed income investments. Fluctuation in actual equity market returns, as well as changes in general interest rates, may result in increased or decreased other post-retirement costs in future periods. Similar to accounting for pension plans; our regulators have adopted SFAS 106 for rate making purposes.

The following chart reflects other post-retirement benefit plan sensitivities associated with changes in certain actuarial assumptions by the indicated percentage. Each sensitivity reflects a change to the given assumption, holding all other assumptions constant.

Goodwill and Other Intangible Assets: We adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS 142) on January 1, 2002 and are required to perform annual assessments of our goodwill for impairment by applying fair-value-based tests. To perform our annual test of goodwill, we are required to make various assumptions including assumptions about our future profitability as compared to published projections for other similar businesses, capital expenditures, discount rate and growth rate. We assess the fair value by considering future discounted cash flows. This analysis is supplemented with a comparison of fair value based on public company trading multiples and merger and acquisition transaction multiples for similar companies. A significant change in these markets or a difference between actual results and our projections could result in an impairment loss related to a decrease in the goodwill asset.

We performed the annual assessment of our goodwill for impairment by applying fair value based tests as of August 31, 2004. In conjunction with the change in tax basis of our assets (see “Note A – Summary of Significant Accounting Policies” in the Notes to Financial Statements), we recorded a deferred tax asset at the undiscounted estimated future tax cash benefits in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. In determining our fair value for the annual goodwill impairment testing, the estimated future cash flows including tax benefits were discounted to arrive at our estimated fair value. A $51 million goodwill impairment charge recorded in the third quarter of 2004 resulted primarily from the impact of recording the deferred tax asset. Since the goodwill is not amortizable for tax purposes, there is no related tax benefit recorded on the goodwill impairment charge.

Unbilled Revenues: We record operating revenues when gas is delivered to our customers. However, the determination of gas sales to individual customers is based upon the reading of their meters, which occurs on a systematic basis throughout the month. At the end of each month, we estimate the amount of gas delivered to customers since the date of their last meter reading and these estimated volumes are allocated to our customer classes. The unbilled revenue is estimated each month based upon throughput volumes, recorded sales, estimated customer usage by class, weather factors and applicable customer rates. Significant fluctuations in gas demand for the unbilled period or changes in the composition of customer classes could impact the accuracy of the unbilled revenue estimate. Total gas operating revenues during 2004 of $729 million included unbilled revenues of $79.3 million at December 31, 2004.

CAUTIONARY FACTORS

This report and other documents or oral presentations contain or may contain forward-looking statements made by us or on our behalf. These statements are based upon management’s current expectations and are subject to risks and

2004 Form 10-K

uncertainties that could cause our actual results to differ materially from those contemplated in the statements. Readers are cautioned not to place undue reliance on the forward-looking statements. When used in written documents or oral presentations, the terms “anticipates,” “believes,” “estimates,” “expects,” “forecasts,” “intends,” “may,” “objectives,” “plan,” “possible,” “potential,” “projects” and similar expressions are intended to identify forward-looking statements. In addition to the assumptions and other factors referred to specifically in connection with these statements, factors that could cause our actual results to differ materially from those contemplated in any forward-looking statements or otherwise affect our future results of operations and financial condition include, among others, the following:

2004 Form 10-K

We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

See “Factors Affecting Results, Liquidity and Capital Resources – Market Risks and Other Significant Risks” in Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations in this report for information concerning potential market risks to which we are exposed.

2004 Form 10-K

WISCONSIN GAS LLC

INCOME STATEMENTS

Year Ended December 31

The accompanying Notes to Financial Statements are an integral part of these financial statements.

2004 Form 10-K

WISCONSIN GAS LLC

STATEMENTS OF CASH FLOWS

Year Ended December 31

The accompanying Notes to Financial Statements are an integral part of these financial statements.

2004 Form 10-K

WISCONSIN GAS LLC

BALANCE SHEETS

December 31

ASSETS

The accompanying Notes to Financial Statements are an integral part of these financial statements.

2004 Form 10-K

WISCONSIN GAS LLC

BALANCE SHEETS

December 31

CAPITALIZATION AND LIABILITIES

The accompanying Notes to Financial Statements are an integral part of these financial statements.

2004 Form 10-K

WISCONSIN GAS LLC

STATEMENTS OF CAPITALIZATION

December 31