Exelon Corp. 10-Q Summary: Period Ended September 30, 2006
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2006, for Exelon Corporation and its subsidiaries: Commonwealth Edison Company (ComEd), PECO Energy Company (PECO), and Exelon Generation Company, LLC (Generation). Exelon operates as a utility services holding company with three reportable segments: ComEd (electricity delivery in northern Illinois), PECO (electricity and gas delivery in southeastern Pennsylvania), and Generation (electric generation and wholesale marketing). The filing highlights significant regulatory developments in Illinois affecting ComEd's future rates and the termination of Exelon's proposed merger with PSEG.
Key Financial Metrics (Nine Months Ended Sept 30, 2006)
| Metric | 2006 (in millions) | 2005 (in millions) |
|---|---|---|
| Operating Revenues | $11,960 | $11,519 |
| Operating Income | $2,458 | $3,140 |
| Net Income | $1,000 | $1,760 |
| Diluted EPS | $1.48 | $2.60 |
| Operating Cash Flow | $3,505 | $1,546 |
| Capital Expenditures | $(1,752) | $(1,521) |
| Total Assets | $41,648 | $42,449 |
| Total Debt (Long-term + Current) | $10,302 | $9,563 |
Note: Debt figures derived from Balance Sheet line items for Long-term debt, Long-term debt due within one year, and Commercial paper/notes payable.
Material Changes vs. Prior Period
- Net Income Decline: Net income decreased by $760 million (43%) compared to the prior year. This was primarily driven by a $776 million non-cash goodwill impairment charge recorded by ComEd due to the negative impact of the Illinois Commerce Commission (ICC) rate order on future cash flows.
- Merger Termination Costs: Exelon recorded a pre-tax charge of approximately $55 million to write off capitalized costs associated with the terminated merger with PSEG.
- Operating Expenses: Operating and maintenance expenses increased by $213 million, driven by higher severance costs, storm damage costs in PECO's territory, and increased stock-based compensation expenses following the adoption of SFAS No. 123-R.
- Segment Performance:
- ComEd: Reported a net loss of $325 million (vs. $403 million income in 2005) largely due to the goodwill impairment.
- Generation: Reported net income of $1,163 million (vs. $951 million in 2005), benefiting from higher wholesale margins and lower purchased power costs.
- PECO: Reported net income of $320 million (vs. $405 million in 2005), impacted by higher competitive transition charge (CTC) amortization and storm costs.
Guidance, Outlook, and Risks
- Illinois Regulatory Risk: The most significant risk involves the post-2006 rate environment for ComEd. The ICC approved a reverse-auction process for electricity procurement starting in 2007. However, proposed legislation to extend the rate freeze could force ComEd to purchase power at auction prices higher than the rates it is allowed to charge customers. Management estimates this could result in operating losses of approximately $1.4 billion in 2007 and potentially lead to a Chapter 11 bankruptcy filing.
- Credit Ratings: On October 5, 2006, Standard & Poor's downgraded ComEd's senior unsecured debt to BB+ (below investment grade) due to political risk regarding the rate freeze. Moody's and Fitch also downgraded ComEd's ratings earlier in the quarter. Exelon, PECO, and Generation ratings were affirmed but placed on Credit Watch with negative implications.
- Generation Market Exposure: With the expiration of the ComEd Power Purchase Agreement (PPA) at the end of 2006, Generation will face increased exposure to wholesale market price volatility and counterparty credit risk, particularly regarding ComEd and Ameren.
- Environmental Liabilities: Ongoing litigation and remediation costs related to tritium leaks at the Braidwood Nuclear Generating Station and other environmental sites remain a contingency.
Investor Verification Checklist
- ComEd Goodwill Impairment: Verify the assumptions used in the fair value assessment that led to the $776 million impairment charge and the potential for further impairments.
- Illinois Rate Freeze Legislation: Monitor the status of House Bill 5766 and Senate Bill 1714, as their enactment would materially alter ComEd's financial viability and liquidity.
- Credit Facility Covenants: Confirm compliance with debt covenants, particularly the cash flow to interest expense ratios, given the recent credit rating downgrades.
- Generation Hedging Strategy: Review the extent of Generation's hedging for 2007 and beyond to mitigate the risk of selling power at market rates post-PPA expiration.
- Dividend Policy: Note that ComEd suspended dividend payments during the nine months ended September 30, 2006, due to regulatory uncertainty and capital needs.