FirstEnergy Corp. — Q2 2011 Form 10-Q
Business context and reporting period. This combined quarterly filing covers FirstEnergy Corp. and specified utility and generation subsidiaries for the three and six months ended June 30, 2011. FirstEnergy is an electric utility and competitive generation company serving about 6 million customers. Allegheny Energy merged into FirstEnergy on February 25, 2011; its results are included only from that date, making year-over-year comparisons materially affected by the acquisition. The interim financial statements are unaudited.
Key financial metrics
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Total revenue | $4.060 billion in 2011; $3.139 billion in 2010 | $7.636 billion in 2011; $6.438 billion in 2010 |
| Operating income | $486 million; $526 million in 2010 | $801 million; $942 million in 2010 |
| Net income | $171 million; $256 million in 2010 | $216 million; $405 million in 2010 |
| Earnings available to FirstEnergy | $181 million; $265 million in 2010 | $231 million; $420 million in 2010 |
| Basic and diluted EPS | $0.43; $0.87 in 2010 | Basic $0.61 and diluted $0.61; 2010 basic $1.38 and diluted $1.37 |
| Operating margin | About 12.0%; about 16.8% in 2010 | About 10.5%; about 14.6% in 2010 |
| Operating cash flow | Not separately stated in the supplied filing text | $1.031 billion; $858 million in 2010 |
| Capital additions | Not separately stated in the supplied filing text | $1.018 billion; $997 million in 2010 |
Balance sheet and liquidity at June 30, 2011: Cash and cash equivalents were $476 million, down from $1.019 billion at December 31, 2010. Current assets were $4.118 billion versus current liabilities of $5.544 billion, a working-capital deficit of approximately $1.426 billion; management attributed the deficit principally to classification of variable-rate bonds and short-term borrowings as current. Total assets were $47.596 billion and total equity was $12.950 billion. Long-term debt and other long-term obligations were $16.491 billion; current debt payable was $2.058 billion and short-term borrowings were $656 million. FirstEnergy reported $5.236 billion of available liquidity as of July 29, including $4.650 billion of available revolving credit and $586 million of cash. Its credit-facility debt-to-capitalization ratio was 56.9%, below the 65% covenant ceiling.
First-half financing cash outflow was $1.039 billion, including $420 million in common-stock dividends; investing cash outflow was $535 million. The company declared dividends of $0.55 per share in the first half of 2011.
Material changes versus the prior comparable period
- Revenue rose 29% in Q2 and 19% for the first half, substantially reflecting the addition of Allegheny results and higher unregulated business revenue. Reported earnings available to FirstEnergy fell 32% in Q2 and 45% for the first half; EPS also declined, while weighted-average shares rose following issuance of 113 million shares in the merger.
- Competitive Energy Services earnings fell to $12 million from $121 million in Q2 and to $17 million from $190 million for the first half. Management cited lower sales margins, mark-to-market effects, non-core asset impairments and merger-related inventory adjustments. Regulated Distribution earnings increased to $184 million from $132 million in Q2 and to $280 million from $235 million for the first half. Regulated Independent Transmission earnings were $31 million in Q2 and $44 million for the first half, benefiting from TrAIL and PATH results.
- Operating cash flow increased by $173 million year over year for the first half, despite lower net income. The filing attributes the improvement largely to non-cash adjustments and working-capital changes, including increased customer collections; pension contributions of $262 million partially offset cash generation.
- Assets and debt expanded with the merger: total assets increased to $47.596 billion from $34.805 billion at year-end 2010, and total goodwill rose to $6.456 billion from $5.575 billion.
Outlook, management commentary, risks and unusual items
- Merger and savings: The merger consideration was $4.354 billion, primarily FirstEnergy shares. Management said it expects to achieve its 2011 merger-benefits target of $210 million annually; initiatives completed through June represented approximately $132 million of annualized pretax savings, or 63% of the target. The filing records $89 million of merger transaction costs, $85 million of integration costs and $32 million of merger-settlement charges in the first half. A $67 million pretax inventory valuation adjustment was recorded in Q1 ($42 million after tax).
- Near-term spending and debt: Second-half 2011 property additions and capital-lease requirements were expected to be about $1.2 billion, including $122 million for nuclear fuel. FirstEnergy said it may pursue $1.0–$1.5 billion of debt reductions during the remainder of 2011, subject to market conditions, liquidity needs, asset sales and other factors. It also planned additional pension and postretirement contributions of $116 million and $2 million, respectively.
- Market and operating exposure: Management cited weather, customer demand and shopping, commodity prices, fuel and coal-transportation costs, generating-unit availability, replacement-power costs, interest rates, collateral requirements and access to capital markets as risks. An adverse 10% commodity-price move was estimated to reduce net income by about $31 million pretax ($20 million after tax) over the next 12 months. A credit downgrade or material adverse event could trigger up to $625 million of collateral or accelerated-payment exposure, rising to $666 million under specified stress conditions.
- Regulatory and environmental matters: The PATH transmission project was suspended pending PJM’s reassessment of need, leaving timing and related capital spending uncertain. ATSI joined PJM on June 1, and TrAIL entered service May 19. Potential environmental compliance costs—including air emissions, water intake, wastewater and coal-combustion residual rules—could be substantial, but the filing does not provide a clear consolidated estimate. FirstEnergy had accrued approximately $133 million for environmental remediation liabilities.
- Legal and nuclear contingencies: Met-Ed and Penelec are challenging a ruling denying recovery of approximately $254 million of historical marginal transmission losses; customer refunds were underway while appeals proceeded. A CERCLA matter prompted a $29 million Q2 expense. A coal-supply litigation verdict awarded AE Supply and MP $104 million, but post-trial proceedings and potential appeals remained. A decommissioning funding report identified a $92.5 million shortfall for Beaver Valley Unit 1 and Perry; a $95 million parental guarantee was submitted for NRC approval. The Davis-Besse license renewal faces a hearing, including challenges concerning alternatives and severe-accident mitigation.
- Unusual tax and asset items: A second-quarter IRS settlement generated approximately $30 million of income-tax benefits, including $5 million favorable to the effective tax rate. The filing also reports a $21 million first-half impairment charge for certain peaking facilities and an $11 million Q1 impairment on Fremont Energy Center; the Fremont sale closed July 28 for $510 million, subject to a possible price adjustment of up to $16 million.
- Guidance: The supplied filing text does not state a specific full-year earnings or EPS forecast.
Most important facts for investors to verify
- How much of revenue growth and balance-sheet expansion reflects the Allegheny acquisition, and how comparable post-merger operating performance is.
- Whether the $210 million annual merger-benefits target is achieved, and the remaining integration, transaction and settlement costs.
- Competitive Energy Services’ margins and cash generation, including effects from market prices, hedging, customer mix and commodity contracts.
- Liquidity and refinancing exposure from current debt classifications, variable-rate pollution-control bonds, collateral triggers and planned debt reductions.
- Outcomes and potential costs of the $254 million transmission-loss recovery dispute, environmental proceedings, coal-supply litigation and nuclear licensing and decommissioning matters.
- Actual capital spending, pension funding and environmental compliance requirements compared with management’s stated expectations.