SOUTHERN CO quarterly report, Q3 FY2012

Business context and reporting period

Southern Company’s combined, unaudited Form 10-Q covers the quarter and nine months ended September 30, 2012, with comparisons to 2011. The filing includes Southern Company and its regulated utilities, Southern Power, and other subsidiaries. Results are seasonal and are not necessarily indicative of full-year performance.

Financial performance and liquidity

Southern Company paid $0.49 per common share in third-quarter dividends, up from $0.4725 in 2011. Management described financial condition as stable. Total current assets were $6.70 billion and current liabilities $6.57 billion at quarter-end. The company reported $5.17 billion of committed bank credit arrangements, of which $5.17 billion was unused.

Material changes versus the prior comparable period

• Lower retail and wholesale revenues reflected milder weather, lower customer usage, and lower fuel-cost recovery billings. Fuel and purchased-power costs also fell; these costs and related revenues generally offset under regulated recovery mechanisms and do not materially affect earnings.
• Quarterly net income increased mainly because of lower non-fuel operating expenses, partly offset by weaker retail revenue. Nine-month net income rose modestly, but diluted EPS declined from $2.26 to $2.23, with higher average shares outstanding.
• Operating cash flow declined year over year, while property additions increased to $3.56 billion from $3.12 billion. Utility property, plant, and equipment increased $2.3 billion during the first nine months.
• Long-term debt increased to $18.96 billion from $18.65 billion at year-end 2011; securities due within one year rose to $2.43 billion from $1.72 billion. Southern Company issued $3.11 billion of long-term debt and redeemed $2.10 billion during the period.
• Southern Company repurchased approximately 2.6 million shares for $117 million, intended to partially offset employee and director plan issuances.

Outlook, commentary, risks, contingencies, and unusual items

• Kemper IGCC: Mississippi Power’s current cost estimate reached the $2.88 billion construction cap, including a $40–$50 million contingency; this excludes specified items such as the lignite mine and CO2 pipeline. Approximately $2.1 billion had been spent by September 30. The project was expected to enter service in May 2014, but management acknowledged potential further cost increases or delays; costs above permitted cap exceptions or disallowed by regulators could result in material charges. Recovery of requested construction financing costs was disputed, and the SMEPA 15% ownership sale remained conditional.
• Plant Vogtle Units 3 and 4: The contractor asserted a proposed Georgia Power cost adjustment of approximately $425 million (in 2008 dollars), which the owners disputed and litigated. The owners were reassessing whether the 2016 and 2017 commercial-operation dates remained appropriate. The filing cites a certified total cost of approximately $6.1 billion, including projected construction-period financing costs.
• Environmental spending: Southern Company estimated MATS compliance investment of about $1.8 billion for 2012–2014 and potential investment of about $500 million for proposed water and coal-combustion-byproduct rules. Total compliance costs through 2021 were estimated at the low end of $13–$18 billion, subject to final rules, legal challenges, and recovery through rates.
• Leveraged lease: One lessee’s operating and credit performance raised uncertainty over its December 2012 rent payment. Southern Company stopped recognizing income on the investment effective July 2012. If restructuring failed and the project were abandoned, the potential after-tax impairment was about $90 million; successful restructuring could require up to $20 million of lower lease income in fourth-quarter 2012.
• Regulatory and market outlook: Management identified weather, economic recovery, customer demand, fuel costs, cost recovery, wholesale-market profitability, construction execution, and environmental requirements as key factors affecting earnings and cash flow. Georgia Power requested a further fuel-rate reduction effective January 2013; the outcome was pending. DOE loan guarantees for Vogtle and Kemper were not assured.
• Other notable matters: Mississippi Power’s ratings outlook was negative following 2012 downgrades by Fitch and Moody’s. Hurricane Isaac restoration costs for Mississippi Power were estimated at $9.7 million. The filing reported various environmental and other legal proceedings whose outcomes could not be determined. Management stated it did not expect unreported current proceedings to have a material effect. Disclosure controls were deemed effective, with no material third-quarter changes to internal control over financial reporting.

Most important facts for investors to verify

1. Whether Kemper remains within its construction cap and on schedule, and whether rate recovery, tax credits, DOE support, and the SMEPA transaction proceed as expected.
2. The outcome and potential cost or schedule effects of the Vogtle contractor dispute, and whether the planned in-service dates change.
3. Whether the leveraged-lease lessee pays rent or completes a restructuring, and whether an impairment or reduced lease income is recorded.
4. How final environmental rules, litigation, and regulatory decisions affect compliance capital spending and timely recovery from customers.
5. Whether operating cash flow and access to capital remain adequate amid heavy construction needs and approximately $2.43 billion of securities due within one year.
6. Whether customer demand, weather, and retail/wholesale sales recover; the filing provides no specific consolidated earnings guidance.