Business context and reporting period
The Southern Company filed this unaudited combined Form 10-Q for the quarter and six months ended June 30, 2012. Southern Company is a holding company for four regulated electric utilities and Southern Power, a wholesale generation business. The filing also contains separate financial statements and disclosures for those subsidiaries; figures below are primarily consolidated Southern Company amounts.
Financial performance and position
Amounts are in millions of dollars except per-share data. Comparisons are with the same periods in 2011.
| Metric | Q2 2012 | Q2 2011 | First half 2012 | First half 2011 |
|---|---|---|---|---|
| Operating revenue | $4,181 | $4,521 | $7,785 | $8,533 |
| Operating income | $1,143 | $1,136 | $1,909 | $1,990 |
| Consolidated net income | $639 | $620 | $1,023 | $1,058 |
| Net income after subsidiary preferred/preference dividends | $623 | $604 | $991 | $1,026 |
| Diluted EPS | $0.71 | $0.70 | $1.13 | $1.20 |
| Operating margin | 27.3% | 25.1% | 24.5% | 23.3% |
Consolidated net income rose 3.1% in Q2 but declined 3.4% for the first half. Operating margin increased in both comparisons, helped by lower fuel costs; revenue fell faster than operating income in Q2. The first-half decline in earnings reflected milder weather, higher operations and maintenance and depreciation, increased interest expense, and lower Southern Power energy revenues. Q2 earnings benefited in part from a $19 million net insurance recovery related to the MC Asset Recovery litigation settlement.
- Revenue drivers: Retail revenue fell 6.4% in Q2 and 7.6% year to date, mainly because lower fuel-cost recovery reduced billed revenue and milder weather reduced sales. Fuel-cost changes generally flow through regulated recovery mechanisms and ordinarily have limited net-income effect. Weather-adjusted residential and commercial sales increased modestly across the system; industrial trends varied by utility.
- Cash flow: First-half operating cash flow was $1,757, down from $2,389. Investing cash use was $2,791, including $2,356 of property additions; financing provided $378. Cash and cash equivalents declined to $659 from $1,315 at year-end 2011.
- Debt and liquidity: At June 30, long-term debt was $19,459, up from $18,647 at year-end; securities due within one year were $2,075. Cash was $659, current assets $6,373, and current liabilities $6,088. The system reported $5,164 of committed bank credit arrangements, of which $5,159 was unused. Management said it remained in compliance with credit covenants.
- Capital returns: Common dividends paid were $0.49 per share in Q2, versus $0.4725 a year earlier; first-half dividends were $0.9625 per share. Southern Company issued about 9.7 million shares through employee and director plans during the first half.
Material changes and subsidiary developments
- Georgia Power and Alabama Power earnings after subsidiary stock dividends declined year to date; Gulf Power and Mississippi Power earnings increased. Southern Power’s first-half net income declined 7.8%, principally because of lower non-affiliate energy and capacity revenues, partly offset by lower fuel and interest expense.
- Georgia Power’s fuel recovery rates were reduced 19%, lowering annual billings by $567 million effective June 1. Gulf Power’s base-rate decision authorized a $64 million permanent annual increase effective April 11, plus a $4 million step increase planned for January 2013; its fuel rates were also reduced effective July 2.
- Mississippi Power’s Kemper IGCC construction drove substantial capital spending: $1.7 billion had been spent by June 30, including mine and pipeline costs. The current project estimate was $2.88 billion, including contingency; the certified estimate of $2.4 billion excluded the mine and CO2 pipeline and was net of DOE grants. Commercial operation was expected in May 2014, subject to significant regulatory, construction, and financing risks.
- Georgia Power’s Plant Vogtle Units 3 and 4 contractor asserted a proposed adjustment of about $425 million attributable to Georgia Power (in 2008 dollars). Georgia Power disputed responsibility and amount; negotiations continued, and owners were assessing whether the scheduled 2016 and 2017 in-service dates remained appropriate.
- Southern Power acquired a 90% interest in a 20-MW Nevada solar project for $102 million cash consideration, with some consideration contingent on milestones. The facility declared commercial operation in July 2012.
Outlook, risks, contingencies, and unusual items
- No earnings guidance: The filing provides no specific full-year EPS or earnings forecast. Management says results depend on weather, electricity demand and economic recovery, fuel prices, regulatory cost recovery, and wholesale-market conditions.
- Environmental spending: Southern Company revised estimated 2012–2014 incremental spending to about $1.8 billion for the EPA’s MATS rule and about $500 million for proposed water and coal-combustion-byproduct rules. Through 2021, combined compliance costs were estimated at the low end of a $13–$18 billion range, assuming coal ash remains classified as non-hazardous solid waste. Final rules, litigation, timing, and recovery in rates could change these estimates.
- Kemper regulatory and funding exposure: Mississippi regulators denied the proposed CNP-A construction financing recovery and 2012 rate filings pending litigation; the Mississippi Supreme Court later denied interim rates under bond while considering the appeal. SMEPA’s $150 million deposit is refundable under specified conditions, and its proposed purchase share was reduced from 17.5% to 15%, subject to approvals. DOE loan guarantees were not assured.
- Other contingencies: A Southern Company leveraged-lease investment was placed on nonaccrual beginning July 2012 because of the lessee’s and generation assets’ performance; an unsuccessful restructuring could result in an estimated after-tax impairment of about $90 million. The EPA’s motion to vacate a judgment in Alabama Power’s New Source Review case remained unresolved. The Hurricane Katrina climate case was dismissed and appealed. Management said other current proceedings were not expected to have a material effect, while noting outcomes could not be predicted.
- Credit and construction risks: Mississippi Power’s credit ratings were downgraded by Fitch on July 3, 2012, with a negative outlook. Construction estimates and schedules for major projects may change; cost recovery is not assured. The filing also notes potential collateral requirements following rating downgrades and seasonal working-capital needs.
- Tax cash-flow benefit: Bonus depreciation was expected to provide Southern Company an estimated $535–$725 million positive cash-flow benefit in 2012, although timing of tax-credit utilization affects the benefit.
Most important facts for investors to verify
- Whether the decline in first-half earnings and operating cash flow persists, and how much reflected weather, fuel-recovery timing, taxes, or other working-capital movements.
- Kemper’s final cost, schedule, regulatory rate recovery, DOE financing, and completion of SMEPA’s proposed ownership purchase; also monitor the $150 million refundable deposit.
- Vogtle’s disputed contractor claim, any schedule or certified-cost changes, and the status of licensing and construction matters.
- Actual environmental compliance expenditures, final EPA rules and legal outcomes, and the extent and timing of recovery through customer rates.
- The leveraged-lease restructuring and whether the potential $90 million after-tax impairment becomes probable or is recorded.
- Debt maturities, liquidity access, credit ratings, and any collateral demands or changes in financing costs.