FirstEnergy Corp. (with FirstEnergy Solutions Corp. information) — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014; unaudited. Unless noted, financial amounts are in millions of dollars. The filing is a combined report for FirstEnergy Corp. (FE) and its wholly owned subsidiary FirstEnergy Solutions Corp. (FES).
Business context
FE operates regulated electric distribution and transmission businesses alongside competitive generation and retail energy operations. Its strategy is shifting toward regulated investment, particularly transmission, while FES and the Competitive Energy Services segment reduce exposure to less-profitable or weather-sensitive sales channels.
Financial performance and liquidity
| FE consolidated metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $3,888 | $4,032 | $11,566 | $11,259 |
| Operating income | $716 | $508 | $1,399 | $1,195 |
| Net income | $333 | $218 | $605 | $250 |
| Diluted EPS | $0.79 | $0.52 | $1.44 | $0.60 |
| Operating margin | 18.4% | 12.6% | 12.1% | 10.6% |
| Net margin | 8.6% | 5.4% | 5.2% | 2.2% |
Margins above are calculated from reported revenue and income. FE’s Q3 revenue fell about 4%, while operating income increased. For the nine months, revenue grew about 3% and net income more than doubled. Results benefited materially from lower regulatory-asset amortization versus 2013, which included a $254 million pre-tax impairment, and from the absence of the prior-year $473 million long-lived-asset impairment. Nine-month earnings also included an $86 million after-tax gain from discontinued operations, principally the hydro-asset sale.
- Segment results: Q3 net income was $227 million in Regulated Distribution, $55 million in Regulated Transmission and $66 million in Competitive Energy Services. For nine months, the segments reported $599 million, $169 million and a $91 million loss, respectively.
- Cash flow: Nine-month operating cash flow was $1,737 million, compared with $1,671 million. Property additions were $2,473 million, up from $1,960 million; cash used for investing was $2,290 million. Cash and equivalents were $109 million at September 30, versus $218 million at year-end 2013.
- Debt and liquidity: At September 30, FE reported $1,621 million of short-term borrowings, $1,386 million of currently payable long-term debt and $18,531 million of long-term debt and other long-term obligations. Current liabilities exceeded current assets by approximately $2,194 million, largely due to debt classification and short-term borrowings. As of October 31, total available liquidity was reported as $4,568 million, including $4,471 million of unused revolving facilities and $97 million of cash. FE said available liquidity was expected to be sufficient for anticipated needs.
- Capital returns: The quarterly common dividend was reduced in January 2014 from $0.55 to $0.36 per share, or an indicated annual rate of $1.44. Nine-month dividends declared were $1.44 per share, versus $1.65 in 2013.
- FES: Nine-month revenue was $4,802 million, operating loss $209 million and net loss $30 million, compared with net loss of $29 million in 2013. FES operating cash flow was $428 million; the parent contributed $500 million of equity. FES reported $535 million of currently payable long-term debt and $2,631 million of long-term debt and other long-term obligations.
Material changes and management commentary
- FE’s Q3 earnings improvement was driven substantially by the lower regulatory-asset expense compared with the prior-year impairment. Regulated Distribution also benefited from the Harrison/Pleasants generation asset transfer. Lower weather-related electricity use and lower Competitive Energy Services sales volumes weighed on revenue.
- For the first nine months, Competitive Energy Services’ net loss improved to $91 million from $300 million. The comparison reflects lower fuel and operating costs, the prior-year impairment and debt-redemption loss, but also higher purchased-power costs—including costs during the January 2014 polar vortex—and commodity-market volatility.
- Management described a $4.2 billion “Energizing the Future” transmission investment plan for 2014–2017, with 2014 Regulated Transmission capital expenditures forecast at approximately $1.35 billion. FE identified at least $7 billion of longer-term transmission investment opportunities. Funding is expected to include debt, equity issuances through a stock investment plan, employee plans where available, and cash.
- Competitive Energy Services is targeting annual sales of 65–75 million MWh and a revised mix of aggregation, POLR, commercial-industrial and wholesale sales. Management cited the prolonged weak demand and low energy and capacity prices, and said a power-price recovery’s timing cannot be predicted.
- FE completed the sale of hydroelectric assets in February for approximately $394 million, recording a $142 million pre-tax gain at FE. The proceeds contributed to investing cash flow.
Outlook, risks and contingencies
- Key exposures include power, fuel and capacity prices; weather and demand; plant outages and replacement-power costs; credit ratings and collateral requirements; and the ability to recover costs through regulated rates. A 10% adverse commodity-price move was estimated to reduce net income by about $4 million over the next 12 months, based on derivatives held at quarter-end.
- Environmental compliance could require substantial spending. Estimated MATS compliance costs were approximately $370 million. Potential water-discharge requirements at Fort Martin could require $150–$300 million of initial capital investment. The Little Blue Run closure plan was estimated at $234 million; FE increased the associated asset-retirement obligation by $163 million in 2013. Environmental remediation liabilities accrued were approximately $117 million.
- FE disclosed approximately $4.0 billion of guarantees and other assurances. A credit downgrade or material adverse event could trigger additional collateral or accelerated payments; disclosed credit-contingent obligations totaled up to $946 million. FES had posted $197 million of collateral for competitive power exposures.
- Regulatory proceedings remain material: Ohio ESP IV was pending, Pennsylvania utilities had filed distribution rate cases, JCP&L’s rate case was pending, and a West Virginia rate-case settlement was subject to commission approval. Recoverability of storm, transmission and other costs may depend on regulatory outcomes.
- Other material uncertainties include FTR underfunding (FES and AE Supply reported more than $94 million of lost revenues since June 2010), disputed ATSI/MISO transmission charges, coal transportation contract disputes, California claims for which loss could not be estimated, and litigation concerning the Little Blue Run impoundment and nuclear operations.
- FENOC reported that Davis-Besse shield-building cracking had propagated slightly in select areas; management’s analysis said structural integrity and safe functions remained intact. License-renewal contentions and Fukushima-related upgrades remain relevant matters.
- FE anticipated a fourth-quarter 2014 pension/OPEB mark-to-market loss of approximately $550–$750 million pre-tax, based on specified discount-rate and return assumptions; the eventual amount was uncertain.
- The filing provides no consolidated earnings-per-share guidance. It notes that the revenue-recognition standard issued in 2014 was under evaluation and would become effective for fiscal years beginning after December 15, 2016.
Important facts for investors to verify
- How much of the earnings increase reflects recurring operations versus prior-year impairments, regulatory-accounting changes and the hydro-sale gain.
- Whether FE can execute the transmission investment plan while maintaining investment-grade credit metrics, and how the plan will be funded.
- FES’s ability to improve competitive margins amid capacity costs, purchased-power exposure, outages and reduced customer counts.
- Outcomes and timing of major rate cases, cost-recovery proceedings and the proposed Ohio ESP IV.
- Potential cash demands from environmental compliance, pension funding, collateral triggers, guarantees and unresolved litigation.
- Whether the reported liquidity and revolving-credit availability remain adequate as debt maturities, capital spending and operating needs evolve.