Tennessee Valley Authority annual report, FY2012

Tennessee Valley Authority — FY2012 Form 10-K

Business context and reporting period. This is TVA’s annual report for the fiscal year ended September 30, 2012, not a standalone quarterly filing. TVA is a federally created, debt-financed public power system serving more than nine million people across seven southeastern states; electricity sales generated virtually all revenue. The filing also reports unaudited fourth-quarter results.

Financial and operating results

Metric	FY2012	FY2011
Operating revenue	$11.220 billion	$11.841 billion
Operating income	$1.300 billion	$1.437 billion
Net income	$60 million	$162 million
Operating cash flow	$2.574 billion	$2.437 billion
Cash used in investing	$2.513 billion	$3.142 billion
Cash and cash equivalents at year-end	$868 million	$507 million
Total assets	$47.334 billion	$46.393 billion
Total debt, net, including VIE debt	$25.078 billion	$24.431 billion

• Revenue declined 5.2%; electricity sales volume fell 1.5% to 165.255 billion kWh. Net income fell 63% year over year.
• Calculated operating margin was approximately 11.6% (12.1% in FY2011); net margin was approximately 0.5% (1.4% in FY2011).
• Operating cash flow increased $137 million. Construction expenditures were $2.119 billion. Cash provided by financing was $300 million, and cash increased $361 million.
• At September 30, TVA reported $24.1 billion of power bonds outstanding against its $30 billion statutory bond limit. It also consolidated $994 million of VIE debt. Three revolving facilities totaled $2.5 billion; $1.1 billion was committed to letters of credit, leaving $1.4 billion available. No revolver borrowings were outstanding.
• Current assets were $4.506 billion versus current liabilities of $6.988 billion. The filing notes that TVA uses short-term debt for liquidity and debt maturities.
• Fourth-quarter FY2012 revenue was $3.271 billion and net income was $350 million, compared with $3.388 billion and $197 million, respectively, in fourth-quarter FY2011.

Material changes and drivers

• Warm winter weather reduced residential and commercial demand: heating degree days were 23.2% below normal, and distributor-customer electricity sales fell 3.8%. Total electricity sales revenue declined $637 million; lower fuel recovery and base revenue drove the overall $621 million revenue decrease.
• Lower natural-gas prices and a shift in generation mix reduced fuel and purchased-power expense. Coal generation fell 21%, while natural-gas generation rose 145% and nuclear generation rose 11%.
• Operating expenses declined 4.7%, but depreciation and amortization increased 8.3%, including $308 million of accelerated depreciation related to coal units slated for idling or retirement. Net income also reflects substantial fixed interest expense.
• Generation shifted toward nuclear and gas: coal supplied 41% of TVA-operated generation, down from 52%; nuclear supplied 38%, up from 34%; and gas/oil supplied 12%, up from 5%.
• FY2012 cash flow improved partly through cost reductions and fewer nuclear refueling outages. TVA deferred discretionary and non-critical spending and reduced contractor, consultant, and management costs.

Outlook, risks, contingencies, and unusual items

• Management anticipated continued slow electricity-demand growth in 2013, citing a sluggish economic recovery and, to a lesser extent, energy-efficiency measures. The TVA Board had not approved a 2013 rate adjustment; the clean-air rate add-on was scheduled to end in September 2013 unless extended or replaced.
• TVA expected Watts Bar Unit 2 to enter commercial operation by December 2015. The revised estimated total completion cost was $4.0–$4.5 billion, with regulatory and licensing matters, including the NRC’s suspended final licensing decisions following the spent-fuel Waste Confidence ruling, presenting schedule risk. The cost and completion date for Bellefonte Unit 1 were under review and expected to increase or move later.
• Environmental commitments include retiring 18 coal units by 2017 and controlling, converting, or retiring additional units. Planned environmental expenditures included approximately $2.278 billion for clean-air projects through 2018, $1.224 billion for Clean Water Act requirements, and $1.4 billion for coal-combustion-residual work through 2022. TVA estimated dry conversion of wet ash facilities at $1.5–$2.0 billion; $428 million had been incurred by year-end.
• The 2008 Kingston ash spill remediation estimate was $1.1–$1.2 billion; $856 million had been spent and the remaining accrued liability was $269 million. The estimate excludes certain potential claims and costs, including some natural-resource damages and future litigation. TVA had accrued approximately $354 million for legal proceedings overall.
• Key operating risks included Browns Ferry’s heightened NRC oversight, the four Raccoon Mountain pumped-storage units being out of service following rotor cracking, high river temperatures and restricted water flows curtailing generation, dam-flooding analyses, and possible additional nuclear safety requirements. Associated costs were uncertain and could be significant.
• TVA’s pension plan remained materially underfunded: $7.029 billion in assets against an $11.995 billion benefit obligation. The filing cited discount-rate and investment-return sensitivity; TVA planned no qualified-plan contribution in 2013 due to prior prefunding, but further contributions may be needed in future years.
• TVA’s bonds are not guaranteed by the U.S. government. Debt-ceiling constraints, credit-rating changes, environmental obligations, weather, customer demand, construction overruns, and counterparties were identified as material risks. The 2011 rating downgrade had already required $100 million of additional collateral.
• Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting. Management also concluded disclosure controls and internal controls were effective at year-end.

Most important facts for investors to verify

• Progress, final cost, licensing, and in-service timing for Watts Bar Unit 2; updated Bellefonte Unit 1 plans.
• Coal-unit retirement/control decisions, actual environmental spending, and the effect of ash-conversion and water-regulation costs on rates and financing needs.
• Demand, weather, electricity sales, fuel-recovery timing, and whether savings can offset lower revenues without impairing reliability.
• Debt outstanding relative to the $30 billion statutory ceiling, short-term refinancing needs, facility availability, ratings, and collateral requirements.
• Kingston remediation developments and the status and potential exposure of related lawsuits, natural-resource claims, and the overall $354 million legal accrual.
• Pension funding, Browns Ferry NRC oversight, Raccoon Mountain restoration, and dam-safety findings and remediation costs.