Business context and reporting period
Exelon Corporation’s combined Form 10-Q covers the quarter and six months ended June 30, 2016. Its businesses include competitive power generation and regulated electric and gas utilities. Exelon completed its acquisition of Pepco Holdings (PHI) on March 23, 2016; results include PHI from March 24 onward. Accordingly, year-to-date comparisons include PHI only for part of 2016 and are not fully comparable with 2015. PHI’s pre- and post-acquisition financial statements also use different accounting bases.
Key financial metrics
Amounts below are in millions, except per-share data. Figures are Exelon consolidated unless stated otherwise.
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Operating revenue | $6,910 | $6,514 | $14,485 | $15,345 |
| Operating income | $647 | $1,134 | $1,130 | $2,501 |
| Net income attributable to common shareholders | $267 | $638 | $440 | $1,331 |
| Diluted EPS | $0.29 | $0.74 | $0.48 | $1.54 |
| Adjusted operating earnings, non-GAAP | $604 | $508 | $1,235 | $1,123 |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $4,553 | $3,969 |
| Capital expenditures | Not presented quarterly | Not presented quarterly | $4,489 | $3,460 |
Approximate consolidated operating margin was 9.4% in Q2 2016 versus 17.4% in Q2 2015, and 7.8% for the first half of 2016 versus 16.3% in the prior-year period. These comparisons are affected by PHI’s partial-period inclusion and significant items described below.
At June 30, 2016, Exelon reported cash of $1,647, down from $6,502 at December 31, 2015; current assets of $11,495 and current liabilities of $11,894; total assets of $112,778; and total equity of $27,298. Debt-related balance-sheet amounts included $951 of short-term borrowings, $2,693 of long-term debt due within one year, $31,541 of long-term debt and $641 of debt to financing trusts. Operating cash flow was more than offset by $10,877 of investing outflows, including $6,642 for acquisitions; financing provided $1,469. The filing reports $9.5 billion of aggregate credit commitments, with $7.8 billion available at quarter-end.
Material changes versus prior comparable periods
- Q2 revenue increased 6%, but operating income and common-shareholder net income fell substantially. Exelon attributed the deterioration mainly to Generation’s mark-to-market results, higher operating and maintenance expense, depreciation and interest expense. Q2 Generation hedge activity produced a $304 loss versus a $235 gain in Q2 2015; first-half results were a $201 loss versus a $397 gain.
- Adjusted operating earnings rose to $604 million in Q2 and $1,235 million for the first half, despite lower GAAP earnings. The adjustment excludes specified items and is a non-GAAP measure, not a substitute for GAAP results.
- The PHI merger added regulated utility operations and materially increased assets, goodwill and debt. The purchase price was approximately $7.1 billion; preliminary goodwill recorded was $4.0 billion. Acquisition accounting and partial-period inclusion limit direct year-over-year comparisons.
- Exelon recorded $508 million of PHI merger-related commitments in first-half operating and maintenance expense. Other notable items included $141 million of one-time charges tied to the planned Clinton and Quad Cities closures, $110 million of incremental second-quarter non-cash retirement-related expense, $155 million of Generation impairments for Upstream and wind assets, and a $52 million BGE charge related to smart-grid regulatory disallowances.
- Six-month operating cash flow increased to $4.6 billion, while cash fell sharply following the PHI acquisition, investment spending and related financing activity. Long-term debt rose from $23.6 billion at year-end 2015 to $31.5 billion at June 30, 2016.
Outlook, commentary, risks and unusual items
- Management described regulated utilities as a source of stable earnings and Generation as a source of cash flow, while noting challenging power-market economics for nuclear plants. Exelon projected approximately $8.975 billion of 2016 capital expenditures and about $25 billion of utility infrastructure investment over five years, with an estimated $11 billion increase in utility rate base by the end of 2020.
- Exelon’s cost-management program targets $350 million of operating and capital cost savings; management expected about 35% of run-rate savings by the end of 2016, full realization in 2018, and an EPS benefit of $0.13–$0.18 from 2018 onward. The board’s stated dividend policy calls for 2.5% annual increases for three years beginning with the June 2016 dividend; future dividends remain subject to board approval. The filing does not provide a clear full-year 2016 earnings or EPS guidance figure.
- Generation announced it plans to shut Clinton on June 1, 2017 and Quad Cities on June 1, 2018 after adverse capacity-auction results and limited progress on Illinois legislation and MISO market reform. TMI also failed to clear the 2019–2020 PJM capacity auction and remains economically challenged. Early retirements could bring accelerated depreciation, decommissioning costs, severance and potential funding needs; management estimated possible parental guarantees of up to $385 million for Clinton and $135 million for Quad Cities under certain scenarios.
- After quarter-end, New York approved a Clean Energy Standard that may support eligible nuclear plants through 2029, subject to contracts and other conditions. Generation also agreed to acquire FitzPatrick for $110 million, with expected additional refueling and operating costs of approximately $200–$250 million and a planned 2017 closing subject to approvals. A separate ConEdison Solutions retail-energy acquisition was announced for $53 million plus estimated purchase-price adjustments, including approximately $130 million of net working capital.
- Significant risks include wholesale power and fuel prices, nuclear-plant economics, regulatory decisions and rate recovery, merger integration and commitments, credit and collateral demands, environmental remediation, and litigation. The IRS like-kind-exchange dispute remains unresolved; the filing describes substantial potential tax and interest exposure if Exelon loses. Generation also disclosed potential additional collateral needs of $1.8 billion if downgraded below investment grade.
- Management concluded disclosure controls were effective. The filing disclosed non-material presentation errors: a $46 million PHI successor-period cash-flow classification error to be revised in a future filing, and a preliminary purchase-price-allocation disclosure correction that did not change net assets acquired or goodwill.
Important facts for investors to verify
- Reconcile GAAP earnings to adjusted operating earnings and examine the exclusions, particularly merger commitments, nuclear retirement charges, impairments and derivative mark-to-market effects.
- Review the final PHI purchase-price allocation, integration progress, remaining merger commitments and whether projected merger synergies and cost savings are achieved.
- Track the economics, closure costs, decommissioning funding and regulatory or legislative support for Clinton, Quad Cities, TMI, Ginna and other at-risk nuclear units.
- Assess liquidity and refinancing needs against the lower cash balance, higher debt, planned capital spending, available credit facilities and potential collateral calls.
- Follow utility rate-case outcomes, smart-grid cost recovery and any further BGE disallowances, as well as the timing and terms of the proposed acquisitions and the like-kind-exchange tax litigation.