Business context and reporting period
FirstEnergy Corp. filed this unaudited combined Form 10-Q for the three months ended March 31, 2011. The filing also covers FirstEnergy Solutions and several utility subsidiaries. FirstEnergy closed its merger with Allegheny Energy on February 25, 2011; consequently, reported results include Allegheny only from the merger date and are not directly comparable with 2010. The combined company serves approximately 6 million customers and reports Regulated Distribution, Regulated Independent Transmission, and Competitive Energy Services segments.
Financial performance and condition
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Revenue | $3.576 billion | $3.299 billion | Up 8.4% |
| Operating income | $315 million | $416 million | Down $101 million |
| Net income | $45 million | $149 million | Down $104 million |
| Earnings available to FirstEnergy | $50 million; $0.15 per share | $155 million; $0.51 per share | Down $105 million; EPS down $0.36 |
| Operating margin | Approximately 8.8% | Approximately 12.6% | Lower |
| Cash from operations | $491 million | $506 million | Down $15 million |
| Property additions | $449 million | $508 million | Down $59 million |
| Cash and cash equivalents at March 31 | $1.101 billion | $310 million at March 31, 2010 | Higher |
Investing activities provided $141 million, including $590 million of cash received in the Allegheny merger; financing activities used $550 million. The company declared dividends of $0.55 per share, unchanged from Q1 2010.
At March 31, total assets were $47.866 billion, up from $34.805 billion at year-end, primarily reflecting the merger. Cash was $1.101 billion; current assets were $4.646 billion versus current liabilities of $5.162 billion, a reported working-capital deficit that management attributed principally to debt classification. Long-term debt and other obligations were $17.535 billion, currently payable long-term debt was $1.385 billion, and short-term borrowings were $486 million. The filing reports carrying value of long-term debt and other long-term obligations of $18.743 billion, including amounts assumed in the merger.
As of April 25, available liquidity was reported at $4.839 billion, comprising $3.705 billion of available credit-facility capacity and $1.134 billion of cash. Management said existing liquidity sources should be sufficient for anticipated obligations. FirstEnergy expected approximately $1.8 billion of property additions and capital-lease requirements for the remaining nine months of 2011, including about $90 million of nuclear fuel expenditures.
Material changes versus the prior comparable period
- Revenue rose mainly because Allegheny was consolidated from February 25 and Competitive Energy Services gained direct and government-aggregation sales. Higher revenue did not translate into higher earnings.
- Earnings available to FirstEnergy fell to $50 million from $155 million. Management’s EPS bridge identified merger-related costs as a $0.34-per-share headwind, lower revenues as a $0.26 headwind, and additional shares issued in the merger as a $0.06 headwind. Fuel and purchased-power costs, regulatory amortization, and mark-to-market adjustments partly offset declines.
- Competitive Energy Services earnings fell to $5 million from $69 million, primarily due to transmission expense, inventory valuation adjustments, asset impairments, and mark-to-market effects. Regulated Distribution earnings were $96 million versus $103 million; Regulated Independent Transmission earnings were $13 million versus $12 million.
- Distribution deliveries at pre-merger companies increased 2.4%, reflecting colder weather and improved industrial demand, while customer shopping reduced regulated utilities’ retail generation sales.
- Reported results include only a partial quarter of Allegheny operations. Unaudited pro forma Q1 results assuming the merger occurred January 1 were revenue of $4.786 billion and net income attributable to FirstEnergy of $137 million, versus $4.685 billion and $255 million in 2010; pro forma EPS was $0.33 versus $0.61.
Outlook, commentary, risks, contingencies, and unusual items
- Merger and unusual charges: FirstEnergy recorded $82 million of merger transaction costs, $75 million of integration costs, and $24 million of merger-settlement charges in Q1. Integration costs included a $67 million inventory valuation adjustment. It also recorded impairments of approximately $25 million for the Fremont Energy Center and peaking facilities. Allegheny’s post-merger results included $437 million of revenue and a $46 million net loss, including $52 million of after-tax merger costs.
- Assets and financing plans: FirstEnergy agreed to sell Fremont Energy Center for approximately $485 million, subject to approvals, with closing targeted for July 2011. Management expected to pursue up to $1.0–$1.5 billion of debt reductions during the rest of 2011, subject to market conditions and liquidity needs. Additional pension contributions planned for the remaining three quarters of 2011 were $220 million to qualified pension plans and $6 million to postretirement plans.
- Transmission projects: PJM placed the PATH project in abeyance pending further need analysis and directed sponsors to suspend development work. The TrAIL project was expected to be completed by June 2011. ATSI’s planned move from MISO to PJM was scheduled for June 1, 2011; related rate, exit-fee, and cost-allocation proceedings remained unresolved.
- Environmental and regulatory exposure: The combined fleet was approximately 62% coal-fired, increasing exposure to emissions and coal-ash rules. Proposed air and water regulations could require substantial capital spending or affect plant operations. FirstEnergy cited potential costs exceeding $150 million for controls related to Hatfield’s Ferry water limits; costs at Fort Martin could be higher, but were not clearly quantified. Probable environmental remediation liabilities accrued were approximately $104 million.
- Nuclear matters: The filing identified an approximately $92.5 million decommissioning-funding shortfall for Beaver Valley Unit 1 and Perry; FENOC agreed to increase its parental guarantee to $95 million. Davis-Besse license-renewal hearings were granted, and NRC actions following the Fukushima incident could require additional expenditures or delay relicensing.
- Contingencies and collateral: Outstanding guarantees and other assurances totaled approximately $3.8 billion. Maximum collateral exposure under downgrade or material-adverse-event provisions was $557 million, rising to $623 million under stress assumptions. FirstEnergy also disclosed significant Clean Air Act, water-quality, transmission-rate, and other proceedings with outcomes it said could not be predicted. On May 2, 2011, after quarter-end, a court entered a $104 million verdict for AE Supply and MP in a coal-supply dispute; post-trial challenges and appeal remained possible.
- Market and integration risks: Management highlighted commodity prices and replacement-power costs, customer demand and weather, regulatory rate recovery, credit ratings and capital-market access, pension and trust values, environmental compliance, and execution of merger integration and expected synergies. Moody’s placed FES ratings under review for possible downgrade. No consolidated EPS guidance is clearly provided in the filing text.
Most important facts an investor should verify
- Separate underlying operating trends from merger effects and one-time charges; review pro forma results and segment performance.
- Confirm the final purchase-price allocation, acquired debt, goodwill, and intangible-asset valuations, which were preliminary and subject to change.
- Track liquidity, debt maturities, refinancing and credit ratings, including the planned debt reductions and replacement credit facilities.
- Assess whether customer shopping, competitive sales growth, commodity costs, and rising transmission expenses affect future margins.
- Monitor PATH and ATSI/PJM developments, environmental compliance costs, nuclear relicensing and decommissioning funding, and material litigation outcomes.