Southern Company — Q1 2016 Form 10-Q
Business context and period. Unaudited results cover the three months ended March 31, 2016, compared with Q1 2015. Southern Company is a regulated Southeastern electric utility holding company, with traditional utilities and wholesale generation business Southern Power. The combined filing also reports separately for Alabama Power, Georgia Power, Gulf Power, Mississippi Power, and Southern Power.
Key financial metrics
| Southern Company consolidated | Q1 2016 | Q1 2015 |
|---|---|---|
| Operating revenue | $3.965 billion | $4.183 billion |
| Operating income | $933 million | $957 million |
| Net income attributable to Southern Company | $485 million | $508 million |
| Diluted EPS | $0.53 | $0.56 |
| Operating margin | 23.5% | 22.9% |
| Operating cash flow | $865 million | $913 million |
| Cash at March 31 | $754 million | $1.112 billion at March 31, 2015 |
| Cash dividends paid | $497 million | $478 million |
Operating margin is calculated as operating income divided by operating revenue. Consolidated comprehensive income attributable to Southern Company was $371 million, down from $493 million, reflecting a larger loss on qualifying hedges.
- Cash flow and investment: Investing cash outflow was $2.197 billion, primarily for construction and property additions; financing cash inflow was $682 million. Property additions were $1.872 billion.
- Debt and liquidity: At March 31, reported long-term debt was $26.091 billion, securities due within one year were $2.392 billion, and notes payable were $1.195 billion. These balance-sheet items total approximately $29.7 billion, versus approximately $28.7 billion at year-end 2015. Current liabilities exceeded current assets by $2.4 billion, primarily reflecting debt due within a year. The company reported $6.412 billion of unused committed bank credit and $754 million of cash.
- Margins and earnings drivers: Revenue fell 5.2% and attributable net income fell 4.5%. Retail revenue declined $165 million, with milder weather and lower fuel-cost recovery partly offset by rate increases and sales growth. Lower fuel expense was largely offset in earnings through regulated fuel-recovery mechanisms. Depreciation rose $54 million and the Kemper estimated-loss charge increased to $53 million from $9 million.
Material changes and subsidiary performance
- Alabama Power: Net income after preferred and preference dividends was $155 million, down from $169 million, mainly due to milder weather, higher interest expense, and lower AFUDC.
- Georgia Power: Net income after preferred and preference dividends was $268 million, up from $236 million, supported by higher base rates and lower non-fuel expenses. Its Q1 operating cash flow was $563 million, compared with $363 million.
- Gulf Power: Net income after preference dividends was $29 million, down from $37 million. The expiration of Plant Scherer Unit 3 wholesale contracts is expected to materially reduce Gulf Power earnings in 2016; from June 2016 through 2019, remaining contracted sales cover about 24% of the unit.
- Mississippi Power: Net income was $11 million, down from $35 million, principally reflecting Kemper charges. Operating cash flow was negative $25 million, versus positive $204 million.
- Southern Power: Net income attributable to Southern Power rose to $50 million from $33 million, chiefly due to renewable-energy tax benefits and new renewable sales. Revenue fell to $315 million from $348 million, while operating and maintenance and depreciation expenses increased.
Outlook, risks, contingencies, and unusual items
- Kemper IGCC: Mississippi Power estimated total project cost at approximately $6.58 billion, including $5.35 billion subject to the cost cap, and expected the remaining project to enter service in Q3 2016. It recorded a $53 million pre-tax Q1 loss and had cumulative pre-tax charges of $2.47 billion through March 31. Mississippi Power says it will not seek recovery of costs above the $2.88 billion cap, subject to stated exclusions. An extension beyond September 30, 2016 was estimated to add $25 million to $35 million in base costs monthly, plus other costs. The company received approximately $137 million in additional DOE grants on April 8, 2016, after quarter-end, expected to reduce future customer rate impacts. Cost estimates, completion, and rate recovery remain uncertain.
- Kemper legal and regulatory exposure: The SEC was conducting a formal investigation relating to project cost and schedule estimates, accounting, disclosures, and controls. Mississippi Power was cooperating and said the investigation was not expected to materially affect its financial statements. A separate civil complaint filed April 26 sought damages and an injunction against charging Kemper costs to customers; the company said it would defend the case. The ultimate outcomes of rate recovery and related proceedings could materially affect Mississippi Power and Southern Company.
- Plant Vogtle: Georgia Power’s updated in-service capital cost forecast for Units 3 and 4 was $5.44 billion, with estimated in-service dates of June 30, 2019 and June 30, 2020. Estimated construction-period financing costs were approximately $2.4 billion; Georgia Power reported about $3.7 billion of project CWIP at March 31. The contractor settlement included approximately $350 million payable by Georgia Power based on its ownership share, of which about $241 million had been paid by quarter-end. Cost prudence, regulatory review, contractor performance, licensing, and schedule remain material risks.
- Merger and financing: Southern Company proposed acquiring AGL Resources for approximately $8.0 billion in cash consideration and expected about $8.2 billion of cash needs including transaction and financing costs; it would also assume AGL debt. Management expected to issue at least $8.0 billion of debt before closing and at least $1.2 billion of equity during 2016, and had an $8.1 billion bridge facility available if long-term financing was unavailable. The merger remained subject to outstanding approvals and closing conditions. Q1 merger-related external costs were approximately $20 million. Southern Company also agreed to acquire PowerSecure for approximately $431 million, with closing expected in May 2016.
- Capital program and regulation: System construction spending was estimated at $7.3 billion for 2016, $5.2 billion for 2017, and $5.5 billion for 2018. Georgia Power filed to reduce fuel rates by 15% effective June 1, 2016, expected to lower annual billings by about $313 million; the outcome was pending. Management cited weather, demand, fuel prices, regulatory cost recovery, construction execution, environmental compliance, financing conditions, and credit ratings as risks. No specific consolidated earnings guidance is stated in the supplied filing text.
- Other developments: Gulf Power retired Plant Smith coal units on March 31 and sought regulatory recovery of their approximately $60 million net book value. Mississippi Power reported that CO2 purchasers had termination rights after missed delivery obligations, with low oil prices and regulatory developments posing additional risks. The filing states that disclosure controls were effective and that there were no material Q1 changes in internal controls over financial reporting.
Most important facts for investors to verify
- Progress against Kemper’s Q3 2016 expected in-service date, revised completion costs, and the remaining cost exposure and recovery decisions.
- Vogtle schedule and cost updates, regulatory findings on prudence and the contractor settlement, and any further financing requirements.
- Plant Scherer replacement sales or regulatory treatment and the resulting effect on Gulf Power earnings after contract expirations.
- Merger approval status, transaction funding needs, planned debt and equity issuance, and the impact of assumed AGL indebtedness.
- Liquidity and refinancing needs, including near-term maturities, construction spending, and Mississippi Power’s funding needs.