SCE-PG

Business Context and Reporting Period

Company: Southern California Edison Company (SCE)
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Three and six months ended June 30, 2004
Business Overview: SCE is an investor-owned utility regulated by the California Public Utilities Commission (CPUC) and the Federal Energy Regulatory Commission (FERC), providing electricity to retail customers in central, coastal, and southern California.

Key Financial Metrics

Note: Operating margins improved significantly in 2004 due to regulatory adjustments. Net income available for common stock increased 7.6% for the six-month period compared to the prior year.

Material Changes vs. Prior Period

• Revenue Decline: Operating revenue decreased by 8.8% (three months) and 7.8% (six months) compared to 2003. This was primarily due to a CPUC-approved customer rate reduction plan effective August 2003, decreased sales volume as the California Department of Water Resources (CDWR) supplied more energy, and the absence of a 2003 surcharge revenue recognized in 2004.
• Profitability Increase: Despite lower revenue, Net Income increased. This was driven by a $180 million pre-tax credit from regulatory adjustments related to the 2003 General Rate Case (GRC) decision and improved operating results, which offset the expiration of the San Onofre Nuclear Generating Station incentive pricing plan.
• Expense Fluctuations:
  • Fuel Expense: Increased due to the consolidation of variable interest entities (VIEs) and higher coal generation at Mohave.
  • Purchased Power: Decreased due to VIE consolidation and a $66 million credit from the El Paso Natural Gas settlement.
  • Regulatory Adjustments: Decreased significantly due to the collection of the Procurement-Related Obligations Account (PROACT) balance and the implementation of the rate-reduction plan.
• Cash Flow: Operating cash flow decreased from $1.4 billion to $981 million (six months) primarily due to the absence of overcollections in 2003 used to recover PROACT. Investing cash outflows increased to $1.0 billion due to $721 million in property additions and $285 million for the Mountainview acquisition.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• General Rate Case (GRC): The CPUC authorized a $73 million annual base rate increase retroactive to May 2003. SCE expects to record an additional $55 million pre-tax gain in Q3 2004 from a memorandum account and $48 million related to 1997-1998 capital additions.
• Capital Expenditures: Projected 2004 capital expenditures are $1.9 billion, including the Mountainview project ($600 million).
• Liquidity: SCE maintains a $700 million credit facility (unused except for $2 million in letters of credit). Credit ratings are BBB (S&P) and Baa3 (Moody's), with Moody's reviewing for a possible upgrade.

Risks and Contingencies

• Performance Incentive Rewards (PBR) Investigation: An internal investigation revealed deliberate alteration of customer satisfaction survey data by at least 36 employees. SCE proposed refunding $14 million in rewards. Investigations into service reliability and employee safety data are ongoing, with potential refunds or penalties for rewards totaling up to $35 million ($20M safety received, $15M pending; $8M reliability received, $5M pending).
• Mohave Generating Station: Uncertainty regarding post-2005 coal and water supply prevents $1.1 billion in investments (SCE share $605 million). A decision is not expected before November 2004. A temporary shutdown of at least three years is likely even if supply issues are resolved.
• San Onofre Steam Generators: Replacement costs are under review. The CPUC denied a request for a memorandum account to pre-fund fabrication costs, potentially delaying the project beyond the 2009 target.
• Legal Proceedings:
  • Navajo Nation Litigation: Claims for damages exceeding $1 billion related to coal supply agreements. Discovery continues through December 2004.
  • Environmental Remediation: Recorded liability is $88 million, but costs could exceed this by up to $131 million.
• Accounting Changes: Effective March 31, 2004, SCE consolidated four variable interest entities (VIEs) partially owned by a related party. This changed the classification of certain operating costs and revenues.

Investor Verification Checklist

• Regulatory Recovery: Verify the timing and certainty of the $103 million in expected pre-tax gains from the GRC memorandum account and capital additions in Q3 2004.
• PBR Refunds: Monitor the CPUC's final determination on the $14 million proposed refund for customer satisfaction rewards and the outcome of the ongoing safety/reliability data investigations.
• Mohave Viability: Track the November 2004 CPUC decision on Mohave Generating Station, as the outcome dictates the necessity of a $605 million investment or potential shutdown.
• San Onofre Timeline: Assess the impact of the CPUC's denial of the memorandum account on the steam generator replacement schedule and associated costs.
• Market Settlements: Confirm the final allocation and customer refund mechanisms for the Duke Energy, Dynegy, and Williams settlements (totaling over $200 million in refunds to SCE).