Business context and reporting period
FirstEnergy Corp. filed this combined Form 10-Q with its wholly owned competitive-generation subsidiary, FirstEnergy Solutions Corp. (FES), for the quarter ended September 30, 2016. FirstEnergy serves approximately 6 million customers through 10 utilities and reports Regulated Distribution, Regulated Transmission, and Competitive Energy Services (CES). Management’s stated strategy is to shift toward a fully regulated business profile.
Key financial metrics
| FirstEnergy, $ millions except per-share data | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | 3,917 | 4,123 | 11,187 | 11,485 |
| Operating income | 861 | 908 | 662 | 2,056 |
| Net income (loss) | 380 | 395 | (381) | 804 |
| Diluted EPS | $0.89 | $0.93 | $(0.90) | $1.90 |
| Operating cash flow | Not separately provided | Not separately provided | 2,580 | 2,317 |
- For the nine months, cash used in investing was $2.476 billion, including $2.156 billion of property additions. Cash provided by financing was $316 million. Cash and cash equivalents were $551 million at September 30, versus $131 million at year-end 2015.
- At September 30, FirstEnergy reported $2.975 billion of short-term borrowings, $1.216 billion of currently payable long-term debt, and $18.532 billion of long-term debt and other long-term obligations. Its reported working-capital deficit was largely due to short-term borrowings and current debt.
- Available liquidity as of November 1 was $3.702 billion, including $3.491 billion of undrawn revolving facilities and $211 million of cash. The facilities total $6.0 billion and generally have a 65% debt-to-capitalization covenant for relevant borrowers.
- Common dividends declared were $0.72 per share for Q3 and $1.44 for the first nine months, unchanged from 2015 comparable periods.
- Separately, FES reported Q3 revenue of $1.100 billion and net income of $40 million, versus $1.338 billion and $120 million a year earlier. Nine-month revenue was $3.401 billion and net loss was $267 million, versus revenue of $3.834 billion and net income of $96 million.
Material changes versus the prior comparable period
- Q3 FirstEnergy revenue declined 5% and net income declined $15 million. Higher regulated distribution and transmission earnings were more than offset by lower CES earnings.
- Nine-month FirstEnergy results swung to a $381 million net loss from $804 million of income. The main driver was $1.447 billion of CES asset impairments and plant-exit charges, compared with $24 million of impairments in 2015.
- The 2016 charges included an $800 million non-cash goodwill impairment, a $647 million non-cash impairment for planned generation exits, and approximately $58 million of coal-contract termination and settlement costs. A $159 million valuation allowance was also recorded against state and local net operating loss carryforwards.
- Revenue from regulated transmission increased year to date, while CES revenue declined as FirstEnergy reduced contract sales to better align sales with generation. FirstEnergy’s nine-month operating cash flow increased $263 million year over year.
- Short-term borrowings rose $1.267 billion from December 31, 2015. FirstEnergy said approximately $400 million of short-term investments at September 30 were redeemed in early October to reduce borrowings.
Guidance, management commentary, risks, contingencies, and unusual items
- Management is reviewing strategic alternatives for competitive generation, including sales of gas and hydroelectric units and options for remaining FES and AE Supply assets. It targeted implementation within 12–18 months; outcomes could cause additional material impairments.
- Planned capital expenditures are $2.925 billion in 2016, $2.790 billion in 2017, and $2.695 billion in 2018. Regulated transmission investment is forecast at $1.0 billion annually in 2017–2018, with $800 million–$1.2 billion annually expected in 2018–2021. Management also expects possible equity issuance of up to $500 million annually in 2017–2019, subject to market conditions.
- FirstEnergy expects CES to generate sufficient operating cash flow to fund anticipated capital spending in 2017–2018 under current market forwards, but identified significant market, liquidity, and refinancing risks. FES subsidiary maturities include $130 million in 2017 and $515 million in 2018. Management warned that adverse contract outcomes, refinancing difficulties, or unsuccessful strategic alternatives could lead to debt restructuring, asset sales, further plant deactivations, or bankruptcy protection; a FES bankruptcy could trigger defaults under FirstEnergy debt agreements.
- After the quarter, Moody’s and S&P further downgraded FES on November 4. The filing reports potential collateral obligations of up to $355 million for CES under specified conditions, including $81 million at then-current ratings. FirstEnergy also disclosed $3.4 billion of aggregate guarantees and other assurances.
- Ohio’s October 12, 2016 PUCO order approved a Distribution Modernization Rider expected to provide approximately $204 million annually, grossed up for taxes, for three years with a possible two-year extension. Continued recovery is subject to conditions, and the order remained subject to rehearing and appeal. The ESP IV power purchase agreement with FES had been suspended following FERC action.
- Material unresolved matters include disputes over long-term coal transportation contracts, with potential losses not estimable; environmental compliance and permitting risks; and regulatory disputes over transmission costs and rates. Environmental liabilities accrued were approximately $121 million. The Fort Martin water permit could require $150 million–$300 million of initial capital investment, but the outcome of the related appeal was uncertain.
- FirstEnergy’s planned deactivations include 720 MW at W.H. Sammis by May 31, 2020 and 136 MW at Bay Shore by October 1, 2020. Q3 also included a $32 million FES customer-contract termination charge. A $21 million reduction in depreciation related to prior periods was recorded in Q3; management considered it immaterial.
- Management stated that disclosure controls were effective and that there were no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the Ohio Distribution Modernization Rider survives rehearing or appeal and whether its conditions are met.
- FES’s liquidity, collateral calls, credit ratings, and ability to refinance upcoming maturities, including the possible effects on FirstEnergy’s credit covenants.
- Progress and terms of the competitive-generation strategic review, including any asset sales, further deactivations, or additional impairment charges.
- Outcomes of coal transportation disputes and other material regulatory or environmental proceedings, including potential costs not currently estimable.
- Execution of planned regulated capital spending, financing and equity plans, and whether operating cash flow supports dividends and pension contributions.