Southern Company — 2016 Second-Quarter Form 10-Q
Business context and reporting period
Combined quarterly filing for Southern Company and its electric utility and power subsidiaries. Results cover the three and six months ended June 30, 2016, compared with 2015; amounts are in U.S. dollars. Southern Company’s principal business was regulated electric service, alongside wholesale generation and related businesses. Southern Company Gas was acquired on July 1, 2016, after the reporting date, so its results are not included.
Key financial metrics
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Operating revenues | $4.459B | $4.337B | $8.451B | $8.520B |
| Operating income | $1.185B | $1.098B | $2.125B | $2.055B |
| Net income attributable to Southern Company | $612M | $629M | $1.097B | $1.138B |
| Diluted EPS | $0.65 | $0.69 | $1.18 | $1.25 |
- Cash flow: First-half operating cash flow was $2.115B (versus $2.107B); investing cash flow was negative $12.675B (versus negative $2.766B), largely reflecting merger-related restricted cash and higher property additions; financing cash flow was $11.053B (versus $762M).
- Debt and liquidity: At June 30, long-term debt was $35.368B, up from $24.688B at year-end 2015; current securities due within one year were $2.724B. Cash and cash equivalents were $1.897B, plus $7.963B of restricted cash designated for the merger. Current assets exceeded current liabilities by $6.6B including restricted cash; excluding it, current liabilities exceeded current assets by $1.3B.
- Dividends: Cash dividend was $0.56 per share for Q2, compared with $0.5425 a year earlier; first-half dividends were $1.1025 per share.
- Operating performance: Q2 operating income rose despite slightly lower attributable net income. First-half revenue and attributable net income declined. The filing does not provide a clear consolidated gross-margin measure.
Material changes versus the prior comparable period
- Q2 attributable net income fell 2.7%; first-half attributable net income fell 3.6%. Management cited higher interest expense, depreciation and amortization, and Kemper cost-estimate charges; first-half results also reflected milder weather. Rate increases and Southern Power tax benefits partly offset these pressures.
- First-half retail revenue decreased $132M, mainly from lower fuel-cost recovery and milder weather, partly offset by rate and pricing increases. Fuel and purchased-power expense declined with lower fuel prices; these costs are generally recovered through regulatory mechanisms and typically do not materially affect earnings.
- Interest expense, net of capitalization, rose to $539M for the first half from $393M, primarily reflecting merger-related borrowing and higher debt balances and rates.
- Southern Power attributable net income increased to $139M for the first half from $79M, mainly from federal solar investment and wind production tax credits and increased renewable sales.
Outlook, major projects, and risks
- Kemper IGCC: Mississippi Power estimated total project cost at approximately $6.68B, including $5.43B subject to the construction cost cap. Southern Company had recorded cumulative pre-tax charges of $2.55B through June 30; $134M of charges were recorded in the first half. The remaining facility was expected in service by October 31, 2016; initial syngas production began July 14. The company does not intend to seek recovery of costs above the applicable $2.88B cap, subject to stated exceptions. Further delay beyond October could add an estimated $25M–$35M monthly in base costs, plus additional uncapped costs. Cost recovery and completion remain uncertain.
- Plant Vogtle Units 3 and 4: Georgia Power’s forecast in-service capital cost was $5.44B; its construction work in progress was $3.7B at June 30. Estimated in-service dates were June 2019 and June 2020. Construction, licensing, contractor performance, cost prudence and regulatory review could affect timing, cost recovery and tax-credit eligibility.
- Merger and other transactions: Southern Company completed its approximately $8.0B Southern Company Gas acquisition on July 1; merger financing included $8.5B of parent senior notes and a common-stock offering. On July 10, it agreed to acquire a 50% interest in Southern Natural Gas for approximately $1.5B, subject to regulatory requirements. The filing also reports a $429M PowerSecure acquisition completed in May.
- Regulation and legal matters: The SEC was conducting a formal investigation concerning Kemper project costs, schedule, accounting and controls. Lawsuits concerning Kemper disclosures and a cancelled CO2 contract seek damages, including a $100M claim; outcomes are uncertain. Kemper rate recovery, environmental compliance costs and ash-pond closure obligations are additional exposures.
- Other operating pressures: Gulf Power disclosed that expiring Plant Scherer Unit 3 wholesale contracts would materially hurt its earnings in 2016 and could continue to do so until an alternative is secured. Fitch and Moody’s downgraded Southern Company’s senior unsecured debt ratings in May 2016; Fitch also downgraded Mississippi Power. The filing identifies possible collateral needs following further rating deterioration.
- Guidance: The filing provides no consolidated earnings or EPS guidance. Management describes earnings as dependent on regulatory cost recovery, weather and demand, construction execution, project completion, fuel markets and Southern Power’s ability to execute its growth strategy.
Important facts for investors to verify
- Progress, remaining costs, commissioning schedule and regulatory recovery for Kemper, including the effect of any delay past October 31, 2016.
- Vogtle schedule and cost forecasts, Georgia PSC review and whether construction costs will be found prudent and recoverable.
- Post-merger Southern Company Gas purchase accounting, integration costs, debt and liquidity needs, and the status and financing of the proposed Southern Natural Gas investment.
- How much Gulf Power can replace or redirect the expired Plant Scherer capacity contracts and the resulting earnings impact.
- Developments in the SEC investigation, Kemper-related litigation, credit ratings and associated collateral requirements.