Fellow Shareowners

In today’s complex electric utility arena, returning to our roots is the best path to continued growth.

This year UIL Holdings took a number of steps designed to shape a promising future for the corporation by building on its strong roots in the electric utility industry. We believe that focusing on our utility business, The United Illuminating Company (UI), is the best way to increase shareowner value and serve our customers and communities. This focus allows us to take full advantage of our core capabilities and seize opportunities that have emerged in today’s utility environment.

This strategy originated with UIL’s previous Chief Executive Officer (CEO), Nathaniel D. Woodson. Nat led the corporation through years of sweeping changes in American business, the energy industry and the global economy. In recent years, the company saw the need to revamp the philosophy and direction that UIL had been pursuing aggressively since the late 1990s. Since becoming CEO of UIL Holdings in July 2006, I have worked with our talented leadership team to advance this strategy from concept to reality, to the benefit of
our customers, shareowners and employees.

We are making excellent progress. As you’ll read in this report, we’ve taken a number of important steps in a variety of areas. All contributed to key goals of:

• Enhancing our returns by investing in the growth area of electric transmission.
• Strengthening our core utility business through capital investments in distribution and transmission infrastructure to maintain safe and reliable service.

 

Here are some highlights of actions taken this year.

Redirecting Our Resources
We made the decision to focus our energy, attention and resources on UI in the operational areas of distribution and transmission services. Transmission, in particular, will be the major driver of growth for the corporation.

Our experience in this field is increasingly valuable in a world eager for better ways to deliver electricity efficiently, reliably and cost-effectively. To improve the financial position of UI and execute our new strategic direction, we divested our non-utility businesses. The sales of our interests in Bridgeport Energy and Cross Sound Cable were completed in the first quarter of 2006. Xcelecom’s entire systems integration business and a portion of the electrical contracting business were sold in September. The balance of that company was essentially divested by the end of the fourth quarter. This effectively completed the repositioning of our business focus to that of a transmission and distribution utility.

The financial community responded favorably to these structural changes within UIL. In July, we split UIL stock five-for-three, making the company more attractive to retail investors seeking a quality growth stock at a reasonable price. This, combined with our realignment to core competencies, contributed to a very strong year for the company. For the year 2006, UIL’s total shareowner return (including dividend reinvestment) was 60.4% to its shareowners, placing the company as the premier financial performer when compared to other electric utilities in the Edison Electric Institute Index. Additionally, I am proud of the fact that we continued our consistent dividend policy for more than twelve years, returning an annual dividend of $1.728 per share.

Investing in Transmission
To ensure that we are positioned to capture the opportunities available in meeting the need for new transmission, we created an entirely new, dedicated business unit in 2006. The UI Transmission Business Unit explores future local and regional transmission opportunities and creates value by vigorously pursuing incentives put forth by the Federal Energy Regulatory Commission (FERC), bringing our utility perspective to bear on ISO-New England’s (ISO-NE) planning process, and overseeing all of UI’s transmission infrastructure projects.

The new business unit’s principal responsibility right now is the successful construction and energizing of the largest transmission infrastructure project in the company’s history: the Middletown to Norwalk (MN) Project.

UI has committed nearly $260 million to this 345 kilovolt (kV) transmission project, which is our latest and most aggressive entry into the transmission arena. UI’s portion of this 69-mile project includes a state-of-the-art, gas insulated 345 kV substation capable of addressing a variety of transmission requirements, and a six-mile segment of high-voltage cable that will be laid underground through a highly developed area in Southwestern Connecticut. The project represents some of the most ambitious work of its type in the country. We broke ground for the cable in September 2006 and have begun construction of the substation, which is located in Bridgeport, Connecticut. The project is scheduled for completion in 2009 and is expected to grow our transmission rate base by between $255 million and $285 million.

The MN Project represents a significant milestone in the financing of transmission construction. It is the first UI project ever to have 50% of construction work in progress (CWIP) permitted in its rate base. And there
may be more milestones to come. The FERC issued a ruling on July 20, 2006, which will allow UI to apply for additional incentives such as 100% of CWIP in its rate base and a higher return on equity (ROE). These new parameters would increase the financial value of transmission to UIL. The Transmission Business Unit has followed this matter closely, and UI is preparing to file for 100% of CWIP and higher ROE for the MN Project.

On October 31, 2006, the FERC issued a final decision authorizing an ROE for transmission owners of the ISO-NE transmission grid, including an incentive rate to encourage transmission expansion and ensure grid reliability in the New England region. Looking forward, the ROE on new transmission investment is at least 12.4%. These are among the recent changes that underscore the wisdom of investing in transmission.

Rates: A Significant Challenge
The year began with the successful completion of UI’s complex distribution rate case. Importantly, in their decision, the Connecticut Department of Public Utility Control (DPUC) endorsed UI’s capital improvement budget and fully supported our plan to address the aging infrastructure of our distribution system. This complex and extensive program is required to maintain system reliability at UI’s traditionally high levels. The DPUC also recognized the staffing levels required by the company in order to operate successfully in a challenging environment.

Towards year end, an important milestone in the process of establishing a new supply contract was reached when the company filed proposed new Generation Service Charge rates with the DPUC. Effective for a six-month period starting January 1, 2007, these rates reflect a major increase in the price of electricity since the time of UI’s last procurement in 2003. With residential customers experiencing rates 48% higher than in 2006 and commercial and industrial customers even more — rates that we believe are not warranted or reflective of the cost of electricity — we recognize that rate-related issues will dominate both regulatory and legislative discussion regarding operations at UI.

Functioning as a true distribution and transmission company with no owned generation, UI is in the challenging situation of having to collect and reconcile this supply-side increase. We believe it vital to the company’s long-term well-being that UI assume a leadership role in working to correct the financial hardship that deregulation has placed on our customers. Our legislative team is focused on taking this issue forward with Connecticut legislative leaders charged with  addressing this critical issue. Likewise, we continue to communicate with customers about the importance of controlling their energy costs by utilizing the many conservation and energy efficiency programs offered by UI.

UI: Positioned for Performance
UI began the year on solid ground, with the successful outcome of its distribution rate case and a six-year union contract that ensures labor stability into 2011. With these issues settled, the company was able to focus on meeting challenging regulatory requirements and improving efficiency and cost-effectiveness. Initiatives pursued this year targeted optimizing resources and applying leading-edge technologies to control costs and streamline processes. Other major projects included infrastructure assessment and the development of new ways to help customers get the most from their energy dollars.

UI’s operations and field staff performed admirably as Connecticut experienced one of its worst summer and winter storm seasons of the last decade. While service disruptions did occur, UI field crews worked diligently in restoring service to the vast majority of customers in a timely manner.

Rooted in Values
I feel fortunate to have joined UIL at such a pivotal moment in its evolution, and I am proud to be part of this extraordinary organization. UIL’s culture reflects a unique combination of attributes. It is an organization that prizes tradition and innovation, service and achievement, local engagement and global perspective.
These attributes were also prized by Nat Woodson during his tenure here at UIL. His work reflected a commitment to this company, its heritage and the future generations that it would serve. His dedication to these ideals will be missed by those who worked with him through difficult and often trying times.

UI will remain a keystone in the energy future of Connecticut. We will continue to deliver a fundamental service and vital product required by residents and businesses to prosper. I am sure of this because of the talented and dedicated people who come to work every day committed to doing their very best for shareowners, customers and one another, and who give back to our communities in countless ways. These are the people who have made UIL the strong, forward-thinking company it is today. It is their dedication, effort and vision that will keep this company strong and successful as we travel down this new path together.

James P. Torgerson
President and Chief Executive Officer

 

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