SOUTHERN CALIFORNIA EDISON Co quarterly report, Q3 FY2010

Business context and reporting period

Southern California Edison Company (SCE), a wholly owned subsidiary of Edison International, is a regulated electric utility serving central, coastal and southern California. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2010; comparisons are with the corresponding 2009 periods unless noted.

Financial performance and position

Operating margin was approximately 22.5% for Q3 2010 versus 22.7% a year earlier, and 19.7% for the nine-month period versus 20.7%. These are calculated as operating income divided by revenue. SCE reported non-GAAP core earnings of $352 million for Q3, up $52 million, and $802 million year to date, up $95 million.

At September 30, 2010, cash and equivalents were $857 million; cash plus short-term investments were approximately $861 million. Current assets of $3.228 billion exceeded current liabilities of $3.160 billion. Long-term debt was $7.626 billion, with no current portion shown; debt including current maturities was $7.6 billion. Total assets were $36.227 billion and total equity was $9.133 billion. SCE had $2.883 billion available under credit facilities and a debt-to-total-capitalization ratio of 0.46, below its 0.65 covenant limit.

Material changes versus prior periods

• Quarterly common earnings rose $48 million, while nine-month common earnings fell $195 million. The year-to-date decline reflects, in part, a smaller Global Settlement tax benefit than in 2009 and a $39 million 2010 non-cash charge related to health-care legislation.
• Core earnings increased in both periods, primarily from higher authorized revenue supporting rate-base growth and higher capitalized financing costs. Year-to-date improvement also reflected lower income tax expense, partly offset by higher operating costs.
• Nine-month operating cash flow declined $625 million, principally because tax receipts were lower following the Global Settlement and because of working-capital timing. Investing cash outflow increased to $2.883 billion, driven largely by higher capital expenditures.
• Revenue was nearly flat year to date despite higher rates: retail billed and unbilled revenue increased with rate changes, while lower sales volume from milder weather and economic conditions partially offset the increase.
• SCE adopted revised VIE consolidation guidance in 2010 and deconsolidated four qualifying-facility projects prospectively, with no gain or loss. This affects comparability with 2009; the filing reports $90 million of 2009 nine-month net income attributable to noncontrolling interests.

Outlook, commentary, risks and unusual items

• Capital program: Management projected 2010 capital investments of $3.3–$4.0 billion and $18–$21.5 billion for 2010–2014. Investments during the first nine months were $2.4 billion including accruals. Funding is expected from operating cash, debt and preferred equity.
• Rate proceedings: SCE expected to file its 2012 General Rate Case application by year-end 2010, requesting a $6.3 billion 2012 base-rate revenue requirement, a proposed $903 million increase over projected 2011 base-rate revenue. The CPUC’s eventual decision and timing are uncertain. The 2010 FERC rate case remains subject to refund; a final decision was expected in the second half of 2011.
• Tax items: 2010 included a $95 million earnings benefit from the California impact of the federal Global Settlement and a $40 million benefit from a tax-accounting-method change for asset-removal costs. The 2009 nine-month period included a $300 million Global Settlement benefit. The filing also records a $39 million non-cash 2010 charge from health-care legislation. SCE estimated accelerated depreciation could provide $250–$300 million of additional 2010 cash flow.
• San Onofre: Unit 2 returned to service on April 11, 2010 after an extended outage and additional work. Unit 3 steam-generator installation began in October, with service expected in early 2011. The NRC identified continuing corrective-action and performance issues; SCE said added management attention and operating costs would continue beyond 2010, and unresolved issues could materially adversely affect SCE.
• Environmental and regulatory risks: Proposed California requirements for 33% renewable electricity by 2020 and once-through-cooling rules could require substantial infrastructure, capital spending or affect generation availability. Greenhouse-gas regulation is subject to legal challenges and future compliance costs are uncertain.
• Contingencies: SCE recorded a $38 million minimum liability for 23 environmental-remediation sites and said costs could exceed that amount by up to $228 million; recovery through rates is expected for much of the cost. The Navajo Nation litigation seeks at least $600 million plus interest and at least $1 billion in punitive damages; SCE cannot predict the outcome. The DOE appealed a $142 million spent-nuclear-fuel damages award, and any recovery would benefit ratepayers. A Coastal Commission notice alleged unauthorized vegetation removal; no settlement terms had been proposed. SCE also cited potential nuclear-insurance assessments and other environmental, legal, tax and regulatory exposures.
• Collateral and market exposure: SCE reported $18 million of collateral posted and $201 million of incremental requirements if its credit rating fell below investment grade. Its net derivative liability increased to $1.262 billion from $251 million at year-end; under regulatory mechanisms, derivative gains and losses are generally recorded in regulatory assets or liabilities rather than earnings, but can affect cash flows.

Important facts for investors to verify

• Progress and final cost-recovery treatment for the San Onofre steam-generator work, and the NRC’s assessment of outstanding safety and performance actions.
• CPUC decisions on the proposed 2012 rate case and energy-efficiency incentive payment; FERC decisions on rates and transmission-related amounts subject to refund.
• Whether capital spending, financing needs and cash generation remain consistent with management’s investment plans.
• Developments in environmental rules, remediation estimates and the Navajo Nation, spent-fuel and Coastal Commission proceedings.
• Effects of tax settlements and accounting benefits on reported earnings, and the cash-flow implications of derivative valuations and collateral requirements.