Business Context and Reporting Period
Company: Southern California Edison Company (SCE)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2007
Business Overview: SCE is an investor-owned utility regulated by the California Public Utilities Commission (CPUC) and the Federal Energy Regulatory Commission (FERC). It provides electricity to retail customers in central, coastal, and southern California. The company operates rate-regulated electric utility segments and consolidated variable interest entities (VIEs) consisting of gas-fired power plants.
Key Financial Metrics
| Financial Metric (in millions) | Q1 2007 | Q1 2006 |
|---|---|---|
| Operating Revenue | $2,222 | $2,217 |
| Operating Income | $374 | $332 |
| Net Income | $193 | $133 |
| Net Income Available for Common Stock | $180 | $121 |
| Operating Cash Flow | $664 | $320 |
| Capital Expenditures | ($560) | ($494) |
| Total Assets | $26,591 | $26,110 (Dec 31, 2006) |
| Total Debt (Short-term + Long-term) | $5,416 | $5,567 (Dec 31, 2006) |
| Cash and Equivalents | $85 | $83 (Dec 31, 2006) |
Margins: Operating margin for Q1 2007 was approximately 16.8% ($374M / $2,222M). The effective income tax rate was 22% for Q1 2007, compared to 38% in Q1 2006.
Material Changes vs. Prior Period
- Profitability Increase: Net income available for common stock increased 49% ($180M vs. $121M). This was primarily driven by a $31 million earnings benefit from progress in an administrative appeal with the IRS regarding environmental remediation tax costs and a lower effective tax rate.
- Purchased Power Expense: Total purchased power expense decreased significantly by $696 million ($317M vs. $1,013M). This reduction was largely due to net unrealized gains on economic hedging activities of $134 million in 2007, compared to net unrealized losses of $334 million in 2006, driven by higher forward natural gas prices.
- Operating Cash Flow: Cash provided by operating activities more than doubled to $664 million from $320 million, attributed to increased cash collections from customers due to rate changes and higher balancing account overcollections.
- Revenue Stability: Operating revenue remained relatively flat, increasing only $5 million, despite rate increases, due to balancing account over/under collections and lower sales for resale.
Guidance, Outlook, Risks, and Unusual Items
Management Commentary and Outlook
- Capital Plan: The Board approved a 2007-2011 capital investment plan totaling up to $17.3 billion. Q1 2007 capital spending was $495 million.
- Cost of Capital: SCE filed a 2008 cost of capital application seeking a return on common equity of 11.80% and a cost of long-term debt of 6.20%.
- Renewable Resources: SCE successfully challenged the CPUC's accounting determination of annual renewable targets in March 2007. While meeting targets for 2007 and 2008, a potential deficit is projected for 2009, though penalties are not guaranteed.
Risks and Contingencies
- Regulatory Investigations (PBR): The CPUC is investigating misconduct regarding customer satisfaction surveys and employee injury reporting. Potential refunds and penalties range from $52 million to $388 million. SCE has accrued the lower end of this range.
- FERC Refund Proceedings: SCE is pursuing refunds from sellers who manipulated markets during the 2000-2001 energy crisis. While a suit against governmental sellers was dismissed in federal court, it was refiled in state court. Recovery amounts remain uncertain.
- Environmental Remediation: Recorded minimum liability is $76 million, but costs could exceed this by up to $125 million. Most costs are expected to be recoverable through customer rates.
- ISO Disputed Charges: A FERC order in March 2007 favored SCE regarding $20-25 million in disputed transmission charges, but the opposing parties requested a rehearing.
Unusual Items
- Tax Benefit: A $39 million benefit was recognized in income tax expense due to reductions in the income tax reserve related to IRS settlement negotiations.
- Accounting Change: Adoption of FIN 48 (Accounting for Uncertainty in Income Taxes) on Jan 1, 2007, resulted in a $213 million cumulative-effect adjustment increasing retained earnings.
Investor Verification Checklist
- Regulatory Penalty Exposure: Verify the status of the CPUC investigation into Performance-Based Ratemaking (PBR) misconduct and the final determination of refunds/penalties (range: $52M - $388M).
- Tax Reserve Adjustments: Confirm the sustainability of the reduced effective tax rate (22%) and the outcome of ongoing IRS administrative appeals regarding environmental remediation costs.
- FERC Litigation: Monitor the outcome of the rehearing request regarding ISO disputed charges and the progress of civil claims against governmental power sellers for energy crisis refunds.
- Renewable Compliance: Track SCE's ability to meet the 2009 renewable portfolio standard target to avoid potential penalties of up to $25 million.
- Capital Expenditure Funding: Assess the company's ability to fund the $17.3 billion capital plan through operating cash flows and debt issuance given current liquidity and credit ratings (Moody's A2, S&P BBB+).