SCE-PG

Business Context and Reporting Period

Company: Southern California Edison Company (SCE)
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Three and nine months ended September 30, 2003
Business Overview: SCE is a regulated public utility providing electricity to retail customers in central, coastal, and southern California. The period was marked by the full recovery of the $3.6 billion Procurement-Related Obligations Account (PROACT), the implementation of a customer rate-reduction plan effective August 1, 2003, and the resumption of power procurement responsibilities from the California Department of Water Resources (CDWR).

Key Financial Metrics

Note: Net income for the nine months ended Sept 30, 2003 includes a $44 million after-tax gain from discontinued operations (sale of oil storage/pipeline facilities).

Material Changes vs. Prior Period

• Revenue Growth: Operating revenue increased 3% for the nine months ended Sept 30, 2003, compared to 2002. This was driven by increased retail and wholesale revenue, warmer weather increasing usage, and the recognition of revenue from the amortization of a temporary surcharge collected in 2002. These gains were partially offset by the implementation of a rate-reduction plan in August 2003.
• Earnings Decline: Net income from continuing operations for the nine months ended Sept 30, 2003, decreased to $659 million from $1.09 billion in 2002. The 2002 figure included a $480 million non-recurring gain related to the Utility Retained Generation (URG) decision. Excluding this 2002 gain, earnings increased by $55 million year-over-year, primarily due to favorable regulatory resolutions in Q3 2003.
• Expense Increases: Purchased power expenses rose significantly due to the resumption of power procurement on Jan 1, 2003, and higher spot natural gas prices. Fuel expenses increased due to coal-related costs. Depreciation and amortization expenses increased due to changes in nuclear facility amortization periods and additions to transmission assets.
• Cash Flow Improvement: Net cash provided by operating activities surged to $2.287 billion in the first nine months of 2003, compared to $291 million in 2002. This dramatic improvement is largely attributed to the timing of cash receipts and the repayment of past-due obligations in March 2002, which had strained 2002 cash flows.
• Debt Reduction: Long-term debt due within one year decreased from $1.671 billion (Dec 31, 2002) to $406 million (Sept 30, 2003), reflecting significant debt repayments and an exchange offer of variable rate notes.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Rate Reductions: A CPUC-approved plan reduced annual rates by $1.2 billion effective August 1, 2003, with no impact on earnings. This followed the full recovery of the PROACT balance in July 2003.
• Capital Structure: Following the PROACT recovery, SCE's common equity to total capitalization ratio exceeded the CPUC-authorized level. On October 16, 2003, SCE transferred $945 million to its parent, Edison International, to rebalance the capital structure.
• Procurement: SCE resumed procurement of its residual net short on Jan 1, 2003. The company expects its residual net short to decline in 2004 as deliveries under CDWR contracts increase.
• Asset Retirement Obligations (ARO): Adoption of new accounting standards in 2003 resulted in a $354 million after-tax gain deferred as a regulatory liability. Future accretion and depreciation expenses related to AROs are expected to be approximately $143 million in 2003, with no impact on earnings.

Risks and Contingencies

• Regulatory Litigation: The CPUC Litigation Settlement Agreement (PROACT) remains subject to appeal by the Utility Reform Network (TURN) in the Ninth Circuit, though the California Supreme Court recently denied a petition for rehearing. SCE believes recovery is probable but cannot predict the ultimate outcome.
• FERC Investigations: SCE is subject to FERC enforcement orders regarding market manipulation allegations (2000-2001). While the FERC staff filed a motion to dismiss charges against SCE in November 2003, potential refunds or disgorgement of profits remain a risk. Under the CPUC settlement, 90% of any refunds realized would be passed to ratepayers.
• Environmental Remediation: SCE has recorded a minimum liability of $89 million for 30 identified sites. It is reasonably possible that cleanup costs could exceed this by up to $240 million.
• Navajo Nation Litigation: The Navajo Nation has sued SCE and Peabody Holding Company seeking damages of at least $600 million (plus treble damages and punitive damages) related to coal royalties. The outcome is uncertain and could impact the operation of the Mohave Generating Station beyond 2005.
• Infrastructure Costs: SCE faces potential significant costs for replacing steam generators at the San Onofre Nuclear Generating Station (estimated $581 million share) and Palo Verde (estimated $106 million share), subject to regulatory approval.

Investor Verification Checklist

• PROACT Litigation Status: Verify the final disposition of the Ninth Circuit appeal regarding the $3.6 billion procurement cost recovery settlement.
• FERC Market Manipulation Outcome: Monitor the final resolution of FERC enforcement orders to determine if any refunds or penalties will be imposed.
• Navajo Nation Lawsuit: Track the progress of the Navajo Nation's claims against SCE and Peabody, specifically regarding the impact on Mohave Generating Station operations and potential damages.
• San Onofre Steam Generators: Confirm the decision on replacing steam generators at San Onofre Units 2 and 3 and the associated regulatory approval for cost recovery.
• Environmental Liability Range: Assess the potential for environmental cleanup costs to exceed the recorded $89 million liability by the estimated $240 million upper limit.
• Capital Structure Compliance: Verify that the $945 million dividend to Edison International successfully rebalanced the capital structure to meet CPUC requirements.