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, 2003
Business Overview: SCE is a regulated public utility providing electricity to retail customers in central, coastal, and southern California. The company operates under the oversight of the California Public Utilities Commission (CPUC) and the Federal Energy Regulatory Commission (FERC).

Key Financial Metrics

Note: Operating margins declined significantly due to higher purchased power costs and regulatory adjustments, despite revenue growth.

Material Changes vs. Prior Period

• Earnings Decline: Net income available for common stock decreased by approximately 61% year-over-year ($327 million vs. $841 million). Management attributes this primarily to the absence of a $480 million one-time gain related to the Utility Retained Generation (URG) decision recorded in 2002.
• Revenue Growth: Operating revenue increased by $176 million (4.4%) driven by higher wholesale revenue from reselling excess energy and increased retail revenue from the amortization of a temporary surcharge collected in 2002.
• Expense Increases: Purchased power expenses rose significantly ($1,174 million vs. $835 million) due to higher spot natural gas prices and increased costs for qualifying facilities (QFs). Provisions for regulatory adjustment clauses increased to $811 million (from $314 million) due to the reestablishment of regulatory assets.
• Cash Flow Improvement: Net cash provided by operating activities turned positive ($1.4 billion) compared to a negative $747 million in the prior year, largely due to the timing of cash receipts and the repayment of past-due obligations in March 2002.
• Accounting Change: Effective January 1, 2003, SCE adopted new accounting standards for Asset Retirement Obligations (ARO), resulting in a $354 million after-tax gain deferred as a regulatory liability and a reclassification of nuclear decommissioning obligations.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Rate Reductions: SCE fully recovered its $3.6 billion Procurement-Related Obligations Account (PROACT) in July 2003. Consequently, a CPUC-approved rate reduction plan effective August 1, 2003, will reduce annual rates by $1.2 billion (no impact on earnings), lowering bills by 8% for residential and up to 19% for large business customers.
• Capital Structure: As of June 30, 2003, the common equity to total capitalization ratio was approximately 64%, exceeding the CPUC-authorized level of 48%. SCE plans to rebalance this via dividends to its parent, Edison International, and debt issuance.
• Procurement: SCE resumed procurement of its residual net short on January 1, 2003. The company expects to recover reasonable power procurement costs through customer rates via regulatory mechanisms.

Material Risks and Contingencies

• CPUC Litigation Settlement: A federal appeals court certified questions regarding the validity of the $3.6 billion settlement agreement to the California Supreme Court. A decision is expected by August 25, 2003. While SCE believes recovery is probable, the outcome remains uncertain.
• FERC Investigations: The FERC issued orders requiring SCE to show cause regarding potential market manipulation and gaming during 2000-2001. Remedies could include disgorgement of unjust profits. Under the CPUC settlement, 90% of refunds would go to ratepayers and 10% to shareholders.
• Mohave Generating Station: Uncertainty regarding coal and water supply post-2005 prevents SCE from making approximately $605 million in necessary investments. No substantive CPUC decision has been made.
• Environmental Remediation: Recorded liability is $101 million, but costs could exceed this by up to $277 million due to uncertainties in site contamination and cleanup methods.
• Electric Line Maintenance: A CPUC administrative law judge fined SCE $576,000 for maintenance violations. Both SCE and the CPUC's Consumer Protection and Safety Division have appealed the decision.

Investor Verification Checklist

• PROACT Recovery Status: Verify the final status of the $3.6 billion procurement cost recovery and the implementation of the August 2003 rate reductions.
• California Supreme Court Ruling: Monitor the expected August 25, 2003, decision on the validity of the CPUC settlement agreement.
• FERC Enforcement Outcomes: Track the resolution of FERC show-cause orders regarding market manipulation and potential financial penalties.
• Mohave Station Viability: Assess the likelihood of extending Mohave operations past 2005 and the associated $605 million investment requirement.
• Capital Structure Rebalancing: Confirm the timing and magnitude of dividends to Edison International and new debt issuances to align with the 48% equity target.
• Environmental Liabilities: Review updates on the $101 million recorded environmental remediation liability and potential exposure up to $277 million.