Tennessee Valley Authority annual report, FY2017

Tennessee Valley Authority — FY2017 Form 10-K

Reporting period: Fiscal year ended September 30, 2017; the filing also reports fourth-quarter results. TVA is a U.S. government corporation operating a large public power system, serving more than nine million people through local power companies and direct customers. Electricity sales generate virtually all revenue. TVA cannot issue equity; its operations are funded primarily by power revenues and borrowings. TVA securities are not guaranteed by the U.S. government.

Financial performance and liquidity

Metric	FY2017	FY2016
Operating revenue	$10.739 billion	$10.616 billion
Operating income	$1.975 billion	$2.326 billion
Net income	$685 million	$1.233 billion
Operating margin	18.4%	21.9%
Net margin	6.4%	11.6%
Cash from operating activities	$2.736 billion	$3.042 billion
Construction expenditures	$2.153 billion	$2.710 billion
Total debt	$25.253 billion	$25.172 billion
Cash and cash equivalents, year-end	$300 million	$300 million

• Electricity sales were $10.586 billion, while total operating revenue included $153 million of other revenue. Electricity sales volume fell about 2% to 152.362 billion kWh. Fourth-quarter revenue was $3.075 billion and net income was $139 million.
• Operating expenses rose 5.7% to $8.764 billion. Operating and maintenance expense increased $520 million, primarily reflecting an additional $500 million pension contribution recognized as expense and higher nuclear outage costs. Net interest expense rose $210 million, largely because TVA stopped capitalizing construction interest after Watts Bar Unit 2 entered service.
• Operating cash flow declined $306 million, mainly because of higher pension contributions, fuel costs, and outage costs. Investing cash use was $2.536 billion. Cash from operations exceeded construction expenditures by approximately $583 million, before other investing and financing items.
• At year-end, current assets were $3.446 billion versus current liabilities of $6.401 billion. TVA relies on short-term borrowing as part of its liquidity management. It had $2.0 billion of short-term debt and $1.8 billion of current long-term debt maturities.
• TVA had $24.2 billion of power bonds outstanding against a statutory $30 billion debt ceiling. Four revolving facilities totaled $2.65 billion; approximately $1.15 billion was committed to letters of credit, leaving $1.50 billion available. The separate $150 million Treasury facility had no borrowings outstanding.

Material changes and business developments

• Revenue increased 1.2%, but net income fell 44%, as higher revenue was more than offset by increased operating costs and the end of construction-interest capitalization. Milder weather drove lower local power company sales; directly served industrial sales increased.
• The generation mix shifted: coal supplied 25% of power in 2017 versus 29% in 2016; nuclear supplied 38% versus 33%. Lower rainfall and runoff reduced conventional hydroelectric generation 11% year over year. Natural gas supplied 16% in both years.
• Watts Bar Unit 2 and the Paradise combined-cycle gas plant entered commercial operation. Allen combined-cycle construction was underway, with completion expected in 2018; TVA planned to retire the Allen coal units after completion. TVA also retired Paradise coal Units 1 and 2 and planned further coal retirements.
• TVA’s pension plan remained materially underfunded: assets were $7.989 billion against a $12.601 billion obligation, a $4.612 billion deficit. TVA contributed $800 million in 2017, including a discretionary $500 million contribution.

Outlook, risks, and unusual items

• A base-rate adjustment effective October 1, 2017 was expected to add approximately $195 million to 2018 revenue, equivalent to an approximately 2.4% wholesale rate increase excluding fuel. TVA projected capital expenditures of $1.974 billion in 2018, $1.885 billion in 2019, and $1.706 billion in 2020. Management said it expected no need for additional large baseload generation units for at least a decade and projected debt and other financing obligations below $22 billion by 2023.
• Gallatin coal-combustion residual litigation is a major contingency. A court ordered TVA to excavate and relocate the ash to a lined facility. TVA recorded estimated costs of approximately $900 million; offsite relocation could cost approximately $2.0 billion, plus inflation, and take substantially longer. Potential additional penalties or requirements were not estimable in the filing.
• TVA estimated further environmental expenditures of $1.1 billion for its CCR conversion program through 2022, excluding new Gallatin lawsuit requirements; $200 million for planned clean-air projects through 2022; and $500 million for Clean Water Act requirements through 2026. Estimates may change with litigation, regulatory developments, permitting, and project conditions.
• Other significant exposures include nuclear operations and decommissioning, dam safety remediation, changing environmental rules, fuel and power-price volatility, weather and water availability, cybersecurity and physical security, pension funding, and the $30 billion borrowing limit. TVA’s regulatory accounting included $9.145 billion in regulatory assets, whose recovery depends on future rate-setting and the continued probability of recovery.
• The financial statements received an unqualified audit opinion, and management and the auditor reported effective internal control over financial reporting as of September 30, 2017.

Most important facts for investors to verify

• Review the Gallatin litigation status, whether onsite permitting is achievable, and the potential cost and schedule of ash relocation, including costs excluded from TVA’s recorded estimate.
• Check actual 2018 rate recovery, electricity sales and weather effects, and progress against planned capital spending and debt reduction.
• Monitor pension-plan funded status, required contributions, investment returns, and benefit assumptions following the $800 million 2017 contribution.
• Assess remaining borrowing capacity under the statutory ceiling, short-term funding needs, credit-facility availability, and any rating or collateral developments.
• Track coal retirements and gas-plant completion alongside environmental compliance costs, dam remediation, and nuclear reliability and safety developments.