FirstEnergy Corp. — 2010 Second-Quarter Form 10-Q
Business context and reporting period
FirstEnergy is an energy holding company with regulated electric utilities serving customers in Ohio, Pennsylvania, and New Jersey, and competitive generation and energy-sales businesses. This combined, unaudited Form 10-Q covers the quarter and six months ended June 30, 2010; it was filed August 3, 2010. Unless noted, figures below are FirstEnergy consolidated and in U.S. dollars.
Financial performance and condition
| Metric | Three months ended June 30, 2010 | Three months ended June 30, 2009 | Six months ended June 30, 2010 | Six months ended June 30, 2009 |
|---|---|---|---|---|
| Revenue | $3.128 billion | $3.271 billion | $6.427 billion | $6.605 billion |
| Operating income | $526 million | $802 million | $942 million | $1.148 billion |
| Net income | $256 million | $408 million | $405 million | $523 million |
| Earnings available to FirstEnergy; EPS | $265 million; $0.87 | $414 million; $1.36 | $420 million; $1.38 basic, $1.37 diluted | $533 million; $1.75 |
| Cash from operating activities | Not presented separately for the quarter | Not presented separately for the quarter | $858 million | $1.102 billion |
Operating margin was approximately 16.8% in Q2 2010 versus 24.5% in Q2 2009, and 14.7% for the first half versus 17.4%. Net margin was approximately 8.2% and 12.5% for the respective quarters, and 6.3% and 7.9% for the respective first halves.
- First-half property additions were $997 million, down from $1.143 billion. Operating cash less property additions was negative $139 million, compared with negative $41 million in the prior-year half; this simple measure excludes other investing activity.
- Cash and cash equivalents were $281 million at June 30, down from $874 million at December 31, 2009. Current liabilities exceeded current assets; management attributed the working-capital deficit mainly to short-term borrowings and debt classified as currently payable.
- At June 30, the balance sheet reported $1.463 billion of short-term borrowings, $1.571 billion of currently payable long-term debt, and $11.861 billion of long-term debt and other long-term obligations. FirstEnergy reported a 61.1% debt-to-capitalization ratio under its credit-facility definition, against a 65% covenant limit.
- Available liquidity as of July 31 was $1.801 billion, including $1.674 billion of available commitments and $127 million of cash. First-half common dividends paid were $335 million; dividends declared were $0.55 per share for the half.
Material changes versus the prior comparable period
- Q2 earnings available fell $149 million and first-half earnings fell $113 million. Management cited the absence of the 2009 $252 million pretax gain from selling a 9% OVEC participation interest; it accounted for approximately $0.52 per share of the year-over-year Q2 EPS change.
- Competitive Energy Services earnings declined $151 million in Q2 and $230 million for the first half, reflecting the absent OVEC gain and lower sales margins. Direct and government-aggregation revenue grew with customer additions, while POLR and wholesale revenues declined; purchased-power and fuel costs increased.
- Energy Delivery Services earnings decreased $11 million in Q2 but increased $121 million for the first half. First-half comparison benefited from the absence of CEI’s $216 million regulatory-asset impairment recorded in 2009 and from lower purchased-power costs. Retail generation revenue declined as Ohio customers increasingly chose alternative suppliers; distribution deliveries rose 8% in Q2 and 4% in the first half, partly reflecting warmer weather and improving industrial demand.
- First-half cash from operations fell $244 million year over year, mainly due to lower net income and less favorable working-capital and other cash movements. FirstEnergy issued no long-term debt in the first half, compared with $1.679 billion of new long-term debt in the first half of 2009; it repaid $407 million of long-term debt and increased net short-term borrowings by $281 million.
Outlook, management commentary, risks, and unusual items
- Management said existing liquidity sources were expected to remain sufficient. It expected to meet funding needs through operating cash flow, capital markets, and credit facilities. Capital requirements for property additions and capital leases in the remaining two quarters of 2010 were estimated at approximately $918 million, including $155 million for nuclear fuel.
- The proposed Allegheny Energy merger was expected to close in the first half of 2011, subject to shareholder, regulatory, and other approvals. The exchange ratio is 0.667 FirstEnergy share per Allegheny share; Allegheny shareholders would own approximately 27% of the combined company, and FirstEnergy would assume Allegheny debt. First-half merger costs were $21 million pretax; completion, approvals, integration, and anticipated benefits remained uncertain.
- The Ohio Companies’ proposed electric security plan for June 2011–May 2014 was awaiting PUCO action. It included a generation procurement process, a proposed distribution capital-recovery rider, and no base distribution-rate increase through May 2014. FirstEnergy recorded approximately $39.5 million of regulatory-asset impairments and expenses related to the filing. Energy-efficiency plan approval delays could jeopardize compliance with Ohio benchmarks.
- FirstEnergy expected ATSI and the Ohio Companies’ and Penn’s load to move into PJM effective June 1, 2011. Transmission cost allocation, integration costs, PJM/MISO disputes, and future capacity and congestion charges remain relevant uncertainties.
- Environmental compliance is a significant prospective cost and operational risk. Consent-decree work at coal plants was estimated at approximately $399 million for 2010–2012. Proposed air, mercury, greenhouse-gas, water, and coal-ash rules could require additional spending or changes to generation operations; management could idle or seasonally operate some smaller units. Accrued environmental remediation liabilities were approximately $105 million.
- Davis-Besse returned to service June 29 after a refueling outage and control-rod-drive-nozzle repairs. Approximately $40 million of modification costs were capitalized and $5 million affected Q2 operating and maintenance expense. A replacement reactor head was planned for fall 2011; the NRC had denied a request to delay restart, with further review of the petition unresolved.
- Tax settlements produced approximately $70 million of net tax benefits recognized in the first half, including $13 million that favorably affected Q2’s effective tax rate. A separate approximately $13 million first-quarter charge arose from healthcare legislation. FirstEnergy also reported $194 million of collateral posted against net liability positions and $451 million of potential collateral exposure under specified credit provisions; stress-case exposure was $609 million.
Most important facts for investors to verify
- Whether earnings and cash generation recover after the OVEC gain comparison, and whether competitive-sales growth produces sustainable margins after fuel, purchased-power, and transmission costs.
- Available liquidity, refinancing or remarketing of variable-rate pollution-control bonds, short-term borrowing levels, and headroom under the 65% debt covenant.
- Final PUCO decisions on the Ohio electric security plan and energy-efficiency programs, and the outcome of Met-Ed and Penelec’s appeal concerning approximately $199.7 million of marginal transmission-loss recovery.
- Allegheny merger approvals, final terms and timing, debt assumed, transaction costs, and the eventual realization of integration benefits.
- Environmental compliance spending and possible generation-unit restrictions, Davis-Besse replacement-head work, and changes in pension or decommissioning funding needs.