Business context and reporting period
Southern Company’s combined Form 10-Q covers the quarter and nine months ended September 30, 2016, and includes the parent, four regulated electric utilities, and Southern Power. Southern Company Gas has been consolidated since the July 1, 2016 merger; its results therefore contribute only three months to 2016 results, limiting direct comparability with 2015. Southern Company also acquired PowerSecure in May 2016.
Key financial metrics
Amounts are in U.S. dollars; financial results below are consolidated Southern Company results.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Operating revenues | $6.264 billion | $5.401 billion | $14.715 billion | $13.921 billion |
| Operating income | $1.917 billion | $1.649 billion | $4.042 billion | $3.704 billion |
| Consolidated net income attributable to Southern Company | $1.130 billion | $959 million | $2.226 billion | $2.096 billion |
| Diluted EPS | $1.16 | $1.05 | $2.36 | $2.30 |
| Cash dividends per common share | $0.5600 | $0.5425 | $1.6625 | $1.6100 |
- Calculated operating margin was approximately 30.6% in Q3 2016 versus 30.5% in Q3 2015, and 27.5% for the first nine months versus 26.6%. Net income attributable to Southern Company was about 18.0% of revenue in Q3 and 15.1% year to date in both years.
- Q3 revenue increased 16.0% and attributable net income increased 17.8%. For the first nine months, revenue rose 5.7% and attributable net income rose 6.2%.
- Operating cash flow was $4.262 billion for the first nine months, down from $5.088 billion. Investing used $16.640 billion, principally reflecting the Gas merger, utility construction, and Southern Power investments; financing provided $13.643 billion. Cash and cash equivalents ended September at $2.669 billion, versus $1.109 billion a year earlier.
- At September 30, total assets were $106.362 billion, total liabilities $80.015 billion, and stockholders’ equity $26.180 billion. Long-term debt was $41.550 billion, with $2.254 billion of securities due within one year and $1.670 billion of notes payable. Debt rose substantially from year-end, primarily reflecting the merger and related financing.
- Current liabilities exceeded current assets by approximately $0.9 billion. The company reported $8.445 billion of committed bank credit arrangements, of which $8.281 billion was unused.
Material changes versus the prior comparable period
- Reported revenue and balance-sheet growth reflect the July 2016 acquisition of Southern Company Gas and May 2016 acquisition of PowerSecure, as well as organic changes. Gas contributed $518 million of reported natural gas revenue in the income statement; merger-related costs were $104.1 million year to date.
- Management attributed improved earnings mainly to warmer Q3 weather, electric base-rate increases, lower fuel costs and tax benefits at Southern Power, and lower Q3 Kemper loss charges. Higher interest expense, depreciation, and certain operating costs partly offset those benefits.
- Retail electric revenue was nearly flat year to date ($11.932 billion versus $11.958 billion). Rates and pricing added $379 million, while lower fuel and other cost-recovery billings reduced revenue by $473 million; these recovery mechanisms generally offset related expenses and primarily affect cash flow.
- Interest expense, net of capitalized amounts, rose to $374 million in Q3 from $218 million and to $913 million year to date from $612 million, primarily due to higher debt, including merger financing.
Outlook, risks and unusual items
- Kemper IGCC: Mississippi Power’s estimated total project cost was approximately $6.82 billion, including $5.52 billion subject to the cost-cap category, against a $2.88 billion cost cap (subject to specified exclusions and grants). The company said it would not seek recovery of costs above the cap, subject to the stated exceptions. Southern Company had recorded $2.63 billion of cumulative pre-tax estimated-loss charges through September 30; 2016 charges were $222 million year to date. The remaining facility’s expected in-service date was revised to December 31, 2016 following start-up and ash-removal problems. Further cost changes could be material; a post-December 2016 delay was estimated to add $25 million to $35 million in monthly base costs, plus specified uncapped costs.
- Kemper rate recovery and prudence remain unresolved. Mississippi Power expects to file its next rate request by June 3, 2017 and anticipates potentially material operating costs above current rates pending a final recovery approach. Two lawsuits include allegations concerning project disclosures and a $100 million claim relating to a cancelled CO2 contract. The SEC is conducting a formal investigation concerning Kemper cost and schedule estimates and related accounting and controls; management said it did not expect a material financial-statement impact, but the outcome is uncertain.
- Plant Vogtle Units 3 and 4: Georgia Power and Georgia PSC Staff reached a cost/prudence settlement on October 20, subject to PSC approval. It proposed a $5.680 billion in-service capital-cost forecast for Georgia Power, revised return treatment, and an estimated $325 million reduction in revenue ($115 million in net income) over 2016–2020 if approved. Unit 3 faced an estimated three-to-four-month schedule pressure; current target in-service dates were June 2019 for Unit 3 and June 2020 for Unit 4. Delays, contractor performance, licensing issues, and cost recovery remain risks.
- Southern Company’s system construction program was estimated at $10.2 billion for 2016 and $8.9 billion for 2017. Management cautioned that estimates may change and that full recovery of capital costs is not assured. Southern Power’s growth strategy also entails significant acquisition and construction spending.
- Other notable items include Hurricane Matthew restoration costs estimated at $130 million to $155 million for Georgia Power, with costs expected to be charged to capital or the storm reserve; Gulf Power’s loss of significant Plant Scherer Unit 3 wholesale contracts and pending $106.8 million retail rate request; and credit-rating downgrades for Southern Company and Mississippi Power in May 2016.
- Southern Company expects a consolidated tax net operating loss for 2016, affecting the timing of tax-credit and bonus-depreciation cash benefits. Approximately $370 million of expected tax benefit was dependent on Kemper being placed in service by December 31, 2016. The filing states that failure to meet that date could require Mississippi Power to repay approximately $250 million of tax benefits already received through estimated tax payments.
- Management described financial condition as stable and said it intends to use operating cash flow, credit facilities, and capital markets to meet needs. Risks include regulation and cost recovery, construction execution, weather and demand, fuel and natural-gas markets, environmental requirements, interest rates, counterparty performance, and post-merger integration.
Important facts for investors to verify
- Whether Kemper achieved sustained integrated operation by the revised December 31, 2016 date, and the final project cost, remaining losses, and recoverable cost amount.
- Mississippi PSC findings on Kemper prudence and rates, the outcome of related litigation and the SEC investigation, and any additional post-in-service costs.
- Georgia PSC action on the Vogtle settlement, updated schedule and cost forecasts, and the effect of the proposed return and rate treatment on Georgia Power earnings.
- How much of reported growth reflects the Southern Company Gas and PowerSecure acquisitions, and the acquired businesses’ subsequent contribution to earnings and cash flow.
- Debt, maturities, liquidity, credit ratings, and access to capital as the company funds large construction and acquisition commitments.
- Whether Southern Company realizes expected tax benefits and whether environmental, storm, and other capital costs are recovered promptly through rates.