FirstEnergy Corp. (NYSE: FE) — Q3 2015 Form 10-Q
Business context and reporting period. This combined, unaudited filing covers the three and nine months ended September 30, 2015, with comparisons to 2014. FirstEnergy operates regulated distribution and transmission businesses and competitive energy services (CES), serving approximately six million customers. Its wholly owned subsidiary FirstEnergy Solutions Corp. (FES) is also a reporting registrant in the filing.
Financial performance
| FirstEnergy consolidated | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $4.123B | $3.888B | $11.485B | $11.566B |
| Operating income | $908M | $716M | $2.056B | $1.399B |
| Net income | $395M | $333M | $804M | $605M |
| Diluted EPS | $0.93 | $0.79 | $1.90 | $1.44 |
| Operating margin | 22.0% | 18.4% | 17.9% | 12.1% |
For the first nine months, operating cash flow was $2.317B, up from $1.737B; property additions were $2.025B. Cash was $86M at September 30. Dividends declared were $0.72 per share for Q3 and $1.44 for the first nine months, unchanged from 2014.
At September 30, FirstEnergy reported $1.933B of short-term borrowings, $1.148B of currently payable long-term debt and $19.093B of long-term debt and other long-term obligations. Current assets of $3.833B were below current liabilities of $5.876B. Available liquidity, including committed revolving facilities and cash, was reported at $4.080B; facility borrowers were in compliance with debt-to-capitalization covenants. The filing identifies $4.2B of stand-alone holding-company long-term debt, 28% of which had variable interest rates.
FES reported Q3 revenue of $1.338B and net income of $120M, versus $1.521B and $44M in Q3 2014. For the first nine months, FES revenue was $3.834B and net income was $96M, versus $4.802B and a $30M net loss in 2014. FES operating income was $252M for the nine months, compared with an operating loss of $209M in 2014.
Material changes and management commentary
- Q3 revenue rose 6%, principally from regulated distribution rate changes and weather-related usage, partly offset by lower CES contract sales. Nine-month revenue fell 1% as CES sales declined, partly offset by regulated growth.
- FirstEnergy’s nine-month operating income increased 47%, as operating expenses fell 7%. CES results improved with higher capacity revenues, lower purchased-power and other costs, and the absence of 2014’s extreme market conditions and unplanned outage costs. Regulated transmission benefited from ATSI’s forward-looking rate structure. Corporate/Other results declined, including from higher interest and environmental remediation costs and lower tax benefits.
- Management is shifting investment toward regulated operations and reducing CES exposure to weather-sensitive retail loads. CES reported 2015–2017 committed sales of approximately 72, 59 and 36 million MWh, respectively; its stated target is 65–75 million MWh of annual contract sales. These are operating targets, not earnings guidance.
- FirstEnergy forecast approximately $2.9B of 2015 capital expenditures. Its Energizing the Future plan calls for $4.2B of transmission investment from 2014–2017; management cited at least $15B of potential incremental transmission opportunities. The 2015 transmission capital forecast was $970M, of which $781M had been spent through September.
- The cash-flow improvement plan targeted savings of approximately $58M in 2015, $155M in 2016 and $240M annually by 2017. Management said existing liquidity was expected to cover anticipated obligations, while noting reliance on operating cash flow and external financing.
Outlook, risks and unusual items
- No consolidated EPS or revenue guidance is provided in the supplied filing text. The Ohio Companies’ proposed ESP IV, including a proposed 15-year power-purchase arrangement and retail rate-stability rider, remained pending; a PUCO decision was expected in early 2016. The proposed transmission-asset transfer to MAIT also awaited regulatory approvals.
- Environmental rules and associated investment could materially affect costs and operations. Estimated MATS compliance capital costs were $370M through 2018, with $176M spent by September 30. The filing also describes potential material costs for wastewater controls and a possible $150M–$300M Fort Martin water-treatment investment.
- Coal transportation arbitrations concern contracts extending through 2025; potential losses were not estimable. FES had paid approximately $70M in liquidated damages for 2014 delivery shortfalls. Other material uncertainties include regulatory proceedings, transmission cost allocation, PJM capacity-market reforms and environmental litigation.
- FirstEnergy recorded $70M of investment impairments in the first nine months, including $60M more OTTI than in the comparable 2014 period, and a $31M impairment of non-core long-lived assets. A separate $24M pretax charge arose from extending a guarantee for Global Holding’s term loan. The 2014 comparison included an after-tax gain from hydroelectric asset sales; no such discontinued-operations income was recorded in 2015.
- Management estimated a possible year-end 2015 pretax pension and OPEB mark-to-market loss of approximately $250M–$450M, based on specified discount-rate and asset-return assumptions. Pension assets had lost approximately 3.5% through September versus a 7.75% expected annual return.
- Credit downgrades could increase collateral requirements: disclosed contingent collateral exposure was up to $387M under specified ratings scenarios. The filing also reports $3.7B of guarantees and other assurances and approximately $1B in present-value sale-and-leaseback operating lease commitments, net of trust investments.
Important facts for investors to verify
- Progress and final terms of Ohio ESP IV, including whether the proposed rate-stability rider and long-term power agreement are approved.
- Whether transmission investment, rate recovery and the proposed MAIT transfer proceed on schedule and on acceptable terms.
- CES performance against its sales and risk-reduction targets, and the effect of PJM capacity prices, wholesale power prices and capacity-performance obligations.
- Actual environmental compliance spending and outcomes of coal-transportation, wastewater, CCR and other material proceedings; several potential losses were not estimable.
- Cash generation, short-term debt refinancing, covenant headroom, liquidity and any resulting collateral needs, particularly under adverse credit-rating scenarios.
- Year-end pension/OPEB remeasurement and NDT investment performance, which may affect future expense, funding needs and reported earnings.