SOUTHERN CO annual report, FY2017

Business context and reporting period

Southern Company’s combined Form 10-K covers the fiscal year ended December 31, 2017, with comparative results for 2016 and 2015. It reports the parent and subsidiaries, including four regulated electric utilities, Southern Power and Southern Company Gas. This is an annual filing, not a standalone fourth-quarter report. Southern Company Gas was included for all of 2017 but only from July 1 in 2016, limiting year-over-year comparability.

Key financial metrics

• Revenue growth mainly reflects the full-year inclusion of Southern Company Gas and a $500 million increase in wholesale electric revenues. Retail electric revenue rose $96 million, while retail electricity sales fell 2.6%; milder weather and lower customer usage contributed to the decline.
• Southern Company Gas reported $3.920 billion of revenue and $243 million of net income in 2017. The reported revenue increase versus 2016 is not directly comparable because of the Merger timing.
• Cash and cash equivalents were $2.130 billion at year-end. Current assets of $10.072 billion were below current liabilities of $13.594 billion. Long-term debt, excluding amounts due within one year, was $44.462 billion; securities due within one year were $3.892 billion and notes payable were $2.439 billion.
• Unused committed bank credit was approximately $8.094 billion. Management said operating cash flow, bank facilities and capital-market access would support liquidity needs, but projected dividends, capital expenditures and debt maturities were expected to exceed operating cash flow over 2018–2020.
• Property additions were $7.423 billion in 2017. The system’s estimated 2018 construction program was $9.4 billion. Southern Company’s 2017 common dividend was $2.30 per share; the payout ratio was 273%, reflecting the large reduction in earnings.
• Fourth-quarter 2017 revenue was $5.629 billion and net income attributable to Southern Company was $496 million, compared with $5.181 billion and $197 million, respectively, in fourth-quarter 2016.

Material changes versus prior period

• Net income attributable to Southern Company fell 65.6%, primarily because of $3.4 billion of 2017 pre-tax charges related to Mississippi Power’s Kemper IGCC project.
• The 2017 earnings comparison also included a $264 million net tax benefit from the Tax Cuts and Jobs Act. Southern Company recorded a $6.9 billion increase in regulatory liabilities and a $0.4 billion decrease in regulatory assets, primarily from remeasuring deferred taxes. These tax accounting amounts were provisional and subject to further guidance and regulatory decisions.
• Wholesale electric revenue increased 26.0%, principally from renewable generation sales and short-term sales at Southern Power. Southern Power’s operating fleet totaled 12,940 MW of nameplate capacity.
• Operating cash flow increased $1.5 billion, partly reflecting Southern Company Gas being consolidated for a full year and a $1.0 billion voluntary pension contribution made in 2016.

Outlook, commentary, risks and unusual items

• Kemper: The gasifier portion was suspended in June 2017 after substantial cost overruns and operating challenges. Total 2017 pre-tax charges were $3.4 billion; cumulative project charges through year-end were $6.2 billion pre-tax. In February 2018, the Mississippi PSC approved a settlement allowing natural-gas combined-cycle operation, with no future recovery for gasifier costs, an approximately $26.8 million annual customer rate reduction and an annual revenue requirement of approximately $99.3 million. The company estimated additional 2018 cancellation costs of $50–$100 million. The settlement remained subject to possible legal challenges.
• Vogtle Units 3 and 4: Construction continued after the EPC contractor’s bankruptcy, with Southern Nuclear as project manager and Bechtel as primary construction contractor under a cost-reimbursable arrangement. Georgia Power’s revised 45.7% share cost forecast was $7.3 billion net of Toshiba guarantee payments and customer refunds; the forecast was not a cost cap, and recovery of costs above specified thresholds remains subject to prudence review. The expected in-service dates were November 2021 and November 2022. Estimated financing costs were $3.1 billion, of which $1.6 billion had been incurred by year-end. Schedule, cost, licensing and recovery risks remain material.
• Tax and rates: The federal corporate tax rate fell to 21% effective January 1, 2018. State and federal implementation and regulatory treatment were unsettled at the filing date. Lower tax costs may flow to customers through rates, affecting utility revenues and credit measures.
• Other plans and exposures: Southern Company Gas had agreed to sell Elizabethtown Gas and Elkton Gas for $1.7 billion, subject to approvals, with completion expected by the end of third-quarter 2018. Southern Power was pursuing a sale of a 33% equity interest in substantially all its solar assets. A Southern Company Gas storage cavern could require early retirement; no impairment was recorded at year-end, but monitoring and regulatory requirements could change that assessment.
• Management identified regulatory cost recovery, environmental compliance, weather and demand, fuel and pipeline availability, construction execution, credit ratings, interest rates, counterparty performance, cyber and physical security, and litigation as significant risks. Moody’s and S&P had issued negative outlooks for parts of the group. The SEC staff concluded its Kemper investigation in November 2017 with no recommended enforcement action.
• The independent auditor gave an unqualified opinion on Southern Company’s consolidated financial statements and internal control over financial reporting. Management concluded disclosure controls were effective.

Important facts for investors to verify

1. Track Vogtle construction progress, updated cost-to-complete estimates, DOE loan-guarantee conditions, regulatory recovery and the effects of any further schedule slippage.
2. Confirm implementation of the Kemper settlement, final customer-rate treatment, remaining closure and cancellation costs, and the status of related appeals and litigation.
3. Review cash generation against capital spending, maturities, dividends and refinancing needs, especially the group’s near-term liquidity deficit and Mississippi Power’s $900 million term loan due March 31, 2018.
4. Assess how the 21% tax rate and resulting regulatory liabilities translate into customer rate reductions, earnings, cash flow and credit metrics.
5. Check regulatory approvals and closing proceeds for the proposed gas-utility asset sales and Southern Power solar-interest sale, and monitor the gas-storage cavern’s integrity findings.