EXELON CORP annual report, FY2016

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Business context and reporting period

Exelon Corporation’s Form 10-K covers the fiscal year ended December 31, 2016; it is an annual report, not a standalone fourth-quarter filing. Exelon combines competitive power generation through Exelon Generation with regulated electric and gas delivery businesses, including ComEd, PECO, BGE and the newly acquired Pepco Holdings (PHI). PHI was acquired on March 23, 2016, so Exelon’s 2016 results include PHI from March 24 onward and are not directly comparable with 2015.

Key financial metrics

  • Revenue: $31.36 billion, up $1.91 billion (6.5%) from $29.45 billion. The increase primarily reflects PHI’s inclusion and higher utility distribution and transmission revenues.
  • Profit: Operating income was $3.11 billion, down from $4.41 billion. Net income attributable to common shareholders was $1.13 billion, versus $2.27 billion; diluted GAAP EPS was $1.22, versus $2.54. Approximate operating margin declined to 9.9% from 15.0%, and common-shareholder net margin to 3.6% from 7.7%.
  • Adjusted earnings: Management’s non-GAAP adjusted operating earnings were $2.49 billion, or $2.68 per diluted share, compared with $2.23 billion, or $2.49 per share, in 2015. This measure excludes specified items and is not GAAP.
  • Cash flow: Operating cash flow was $8.45 billion, up from $7.62 billion. Investing cash outflow was $15.50 billion, including $6.6 billion for the PHI acquisition; capital expenditures were $8.55 billion. Financing cash inflow was $1.19 billion.
  • Liquidity: Year-end cash and cash equivalents were $635 million, down from $6.50 billion; the 2016 cash flow statement includes a $1.25 billion IRS deposit. Current assets were $12.41 billion and current liabilities $13.46 billion. Credit facilities totaled $9.5 billion, with about $7.9 billion available.
  • Debt: Long-term debt, including debt to financing trusts, was $32.22 billion, compared with $24.29 billion in 2015. Year-end short-term borrowings were $1.27 billion and current maturities of long-term debt were $2.43 billion.
  • Generation and nuclear: Generation’s revenue was $17.75 billion, operating income $836 million and net income attributable to membership interest $496 million; the respective 2015 figures were $19.14 billion, $2.28 billion and $1.37 billion. Nuclear fleet capacity factor was 94.6%, versus 93.7%.

Material changes versus the prior comparable period

  • PHI’s acquisition added regulated utility operations serving Exelon’s expanded customer base. The purchase price was approximately $7.1 billion and the preliminary purchase accounting recorded $4.0 billion of goodwill.
  • GAAP operating income and net income attributable to common shareholders fell despite higher revenue. Key pressures included increased operating and maintenance expense, depreciation and amortization, interest expense, and weaker Generation results. Generation’s mark-to-market economic hedging results shifted from a $257 million gain in 2015 to a $41 million loss in 2016.
  • Exelon recorded $513 million of pre-tax PHI merger commitments, including customer credits and energy efficiency and infrastructure-related commitments. Exelon also reported higher merger and integration costs; it estimated total PHI acquisition and integration costs of about $700 million, excluding merger commitments.
  • Generation’s June 2016 decision to retire Clinton and Quad Cities was reversed after Illinois enacted the Future Energy Jobs Act (FEJA) in December. The original decision produced accelerated depreciation and other charges; the company restored expected economic lives through 2027 for Clinton and 2032 for Quad Cities.

Outlook, management commentary, risks and unusual items

  • Strategy and investment: Management emphasizes regulated utility growth, reliable service and capital discipline, with competitive Generation cash flow supporting utility investment and debt reduction. Exelon forecast approximately $25 billion of utility infrastructure investment over five years, expected to increase rate base by about $9 billion by the end of 2021. Projected 2017 capital expenditures were $8.25 billion.
  • Cost savings and dividends: A cost-management program targets about $350 million of annual operating and maintenance savings and $50 million of capital-cost savings. Management reported approximately 35% of targeted run-rate savings achieved by the end of 2016, expected about 60% by the end of 2017 and full realization in 2018. Exelon’s stated dividend policy called for 2.5% annual increases for three years beginning with the June 2016 dividend.
  • Power-market exposure: Management cited sustained low wholesale power prices, subdued demand, renewable generation growth and competitive retail pressure as risks to Generation’s earnings and cash flow. Expected generation was 91%–94% hedged for 2017, 56%–59% for 2018 and 28%–31% for 2019.
  • Policy and plant risk: FEJA’s Illinois zero-emission credits and New York’s Clean Energy Standard (CES) support certain nuclear plants, but their legal and regulatory status and treatment in capacity markets remain uncertain. An expanded minimum offer price rule could reduce capacity-market revenues. Three Mile Island was identified as Generation’s greatest early-retirement risk; FitzPatrick acquisition closing remained subject to NRC approval.
  • Tax dispute: The Tax Court rejected Exelon’s 1999 like-kind-exchange tax position and found a penalty applicable. Exelon recorded tax, penalty and interest charges and planned to appeal. It estimated approximately $1.4 billion payable when filing the appeal in the second quarter of 2017; about $1.25 billion had been deposited with the IRS. Management estimated net cash outflow of approximately $1.0 billion after an expected tax benefit, with about $300 million attributable to ComEd under Exelon’s hold-harmless agreement.
  • Other contingencies: Generation’s nuclear decommissioning ARO was $8.7 billion; nuclear decommissioning trust funds were valued at approximately $11.1 billion. Environmental remediation, spent nuclear fuel storage and disposal, nuclear insurance, regulatory rate proceedings, cybersecurity, severe weather and pension funding remain material areas of risk. Management estimated NRC-related Fukushima-response costs for Generation in 2017–2019 at $75–$100 million of capital and $15 million of operating expense; impacts of later NRC actions were unclear.
  • Reporting and controls: The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting. Management concluded that disclosure controls and internal controls were effective; ConEdison Solutions was excluded from the internal-control assessment following its 2016 acquisition.

Important facts investors should verify

  • Track the like-kind-exchange appeal, final IRS calculation, remaining payment and expected timing of the tax benefit and any refund.
  • Confirm implementation and legal durability of FEJA and the New York CES, and monitor FERC proceedings on potential capacity-market mitigation of supported nuclear plants.
  • Verify NRC approval and final economics of the FitzPatrick acquisition, including refueling, operating costs and purchase accounting.
  • Assess Generation’s unhedged exposure after 2017, low-price sensitivity, and the outlook for Three Mile Island and other potentially uneconomic plants.
  • Monitor PHI integration, remaining acquisition costs, delivery of merger commitments and realization of targeted cost savings.
  • Review debt maturities, available credit capacity, collateral requirements, and cash needs for capital spending, dividends, pensions and nuclear decommissioning.
  • Follow utility rate-case outcomes and the recoverability of regulatory assets, including BGE cost disallowances and DPL provisional rates subject to refund.