FIRSTENERGY CORP quarterly report, Q1 FY2016

FirstEnergy Corp. (FE) — Q1 2016 Form 10-Q

Reporting period: Three months ended March 31, 2016; filed April 26, 2016. The combined filing also reports FirstEnergy Solutions Corp. (FES), a wholly owned subsidiary. FirstEnergy operates regulated electric distribution and transmission businesses and competitive generation and energy-supply businesses.

Financial performance

FirstEnergy consolidated	Q1 2016	Q1 2015	Change
Revenue	$3.869 billion	$3.897 billion	Down 1%
Operating income	$776 million	$594 million	Up 31%
Operating margin	20.1%	15.2%	Up 4.9 percentage points
Net income	$328 million	$222 million	Up 48%
Diluted EPS	$0.77	$0.53	Up $0.24
Operating cash flow	$638 million	$193 million	Up $445 million

• Net margin was approximately 8.5%, versus 5.7% a year earlier. Declared dividends were $0.72 per share in both periods.
• Cash and cash equivalents were $146 million at March 31, versus $131 million at year-end 2015. Investing used $865 million, primarily for property additions and nuclear fuel; financing provided $242 million, including $425 million of net short-term borrowing and $152 million of dividends paid.
• At March 31, current liabilities were $6.389 billion and current assets $3.230 billion. Management attributed the working-capital deficit largely to current maturities of long-term debt and short-term borrowings. Short-term borrowings were $2.125 billion, up from $1.708 billion at year-end; currently payable long-term debt was $1.355 billion.
• Long-term debt and other long-term obligations were $18.878 billion, compared with $19.099 billion at December 31. Total available liquidity, including $3.821 billion available under revolving facilities and $146 million cash, was reported as $3.967 billion. The company said existing liquidity should be sufficient for anticipated needs.

Material changes and segment results

• Competitive Energy Services (CES) net income improved by $152 million year over year, to $144 million. Higher capacity revenue and commodity-contract mark-to-market gains, together with lower fuel, purchased-power and transmission expenses, outweighed lower contract sales volumes. Lower operating costs also reflected the absence of prior-year coal-contract termination and settlement costs.
• Regulated Distribution net income fell $43 million, to $165 million, reflecting weaker weather-related volumes and $51 million of regulatory charges associated with Ohio’s ESP IV order. Distribution deliveries fell 7.8%; heating degree days were 25% below the prior-year quarter and 11% below normal.
• Regulated Transmission net income rose $2 million, to $74 million, as higher rate base and revenue requirements were partly offset by higher expenses and financing costs.
• Overall revenue edged lower despite a $37 million increase in transmission revenue: CES revenue declined $131 million and Regulated Distribution declined $41 million. Total operating expenses fell $210 million, led by lower CES costs.
• FirstEnergy reported $638 million of operating cash flow, compared with $193 million in Q1 2015. Management cited higher transmission and capacity revenues, distribution rate increases, lower fuel and purchased-power disbursements, and lower collateral postings.

FES subsidiary

FES revenue was $1.199 billion, down from $1.377 billion. Net income was $131 million, versus a $3 million loss, and operating income was $226 million, versus $12 million. Operating cash flow was $228 million, compared with $105 million. FES had $2 million cash, $49 million short-term borrowings from affiliates, $549 million currently payable long-term debt, and $2.480 billion of long-term debt and other long-term obligations.

Outlook, management commentary and key risks

• Ohio ESP IV and PPA: The PUCO approved the eight-year ESP IV, with modifications, on March 31; it was scheduled to take effect June 1, 2016. FES and the Ohio Companies signed the associated eight-year PPA on April 1, after quarter-end. It covers 3,241 MW of facilities, with FES selling their output to the Ohio utilities at a negotiated rate intended to cover operating costs and capital investment. Management expects the agreement to provide FES more stable cash flow. FERC and court challenges could impair or invalidate it; management warned this could materially harm FE and FES results, financial condition and credit ratings. The filing provides no firm earnings or EPS guidance.
• Generation and market exposure: Management said competitive power prices remained depressed and CES continued to review generation operations, capital spending and costs. For April–December 2016, CES expected generation supply, including committed purchases, to be fully hedged against committed sales under normal weather conditions. From 2017, FES expected to hedge 70%–80% of generation output, including the ESP IV PPA, subject to its effectiveness.
• Capital investment: The Energizing the Future transmission plan calls for $4.2 billion of investment from 2014–2017; $2.4 billion had been spent through 2015, and approximately $1 billion of 2016 spending was projected. Management cited at least $15 billion of identified transmission opportunities over time. Planned 2016 spending in other segments remained subject to greater clarity on the ESP IV PPA and related FERC complaints.
• Ohio and other rate matters: The Ohio order includes customer bill limits in the first two years, restrictions on recovery of certain retirement costs, and assigns PPA capacity-performance penalties to the Ohio Companies. Proposed distribution revenue increases included approximately $142 million for JCP&L and a combined approximately $439 million for four Pennsylvania utilities; these were planned filings, not approved increases.
• Environmental and legal exposure: FirstEnergy had accrued approximately $123 million for environmental remediation, including $87 million for New Jersey sites expected to be recovered through a customer surcharge. A Fort Martin water-discharge permit could require $150–$300 million of initial capital investment; the appeal was unresolved. Coal-transportation arbitrations following plant deactivations could materially affect results, with no loss estimate available; FES had paid about $70 million in 2014 liquidated damages. Other material uncertainties include California refund claims, recovery of certain transmission costs, and potential future environmental-compliance costs.
• Other financial risks: Guarantees and other assurances totaled approximately $3.7 billion. A downgrade or other specified credit event could trigger up to $406 million of additional collateral obligations under listed contractual provisions. A 10% increase in commodity prices was estimated to reduce net income by about $22 million over the next 12 months. FirstEnergy had a $381 million minimum 2016 qualified pension funding obligation and had contributed $160 million by quarter-end.
• Management set a goal to reduce CO₂ emissions 90% below 2005 levels by 2045. The Davis-Besse license was renewed through April 22, 2037; the company reported that shield-building cracking remained structurally safe, while planning a license-amendment application in 2016.

Most important facts for investors to verify

• Whether the ESP IV order and PPA withstand FERC, judicial and other challenges, and whether the agreement delivers the anticipated cash flow and credit benefits.
• Whether the pronounced earnings improvement—particularly CES gains from capacity revenue and mark-to-market items—is sustainable under depressed wholesale energy prices.
• How FirstEnergy funds substantial transmission investment, debt maturities, pension contributions and dividends while managing short-term borrowings and its working-capital deficit.
• The outcome and potential cost of coal-transportation disputes, environmental compliance matters, transmission cost-allocation proceedings and other unresolved claims.
• Whether proposed utility rate increases and transmission-asset transfers receive required regulatory approvals and achieve expected cost recovery.