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, 2004
Business Overview: SCE is an investor-owned utility regulated by the California Public Utilities Commission (CPUC) and the Federal Energy Regulatory Commission (FERC), providing electricity to retail customers in central, coastal, and southern California.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Operating revenue decreased by $139 million (5%) for the quarter and $467 million (7%) for the nine months compared to 2003. This was driven by a CPUC-approved customer rate reduction effective August 2003, decreased sales volume due to increased energy provided by the California Department of Water Resources (CDWR), and the absence of 2003 surcharge revenue.
• Expense Fluctuations:
  • Fuel: Increased significantly due to the consolidation of four variable interest entities (VIEs) effective March 31, 2004, and higher coal generation at the Mohave facility.
  • Purchased Power: Decreased primarily due to the VIE consolidation, partially offset by higher ISO costs and gas bilateral contract expenses.
  • Regulatory Adjustments: Net provisions for regulatory adjustment clauses decreased substantially ($366 million for the quarter) due to the collection of the Procurement-Related Obligations Account (PROACT) balance and implementation of rate-reduction plans.
• Profitability: Net income available for common stock decreased by $115 million (31%) for the quarter and $100 million (14%) for the nine months. The decline reflects the expiration of the San Onofre nuclear incentive mechanism and lower regulatory gains compared to the prior year, partially offset by higher authorized revenue from the 2003 General Rate Case (GRC).
• Cash Flow: Operating cash flow decreased by $630 million for the nine months, largely due to overcollections in 2003 used to recover PROACT and timing differences in working capital.

Guidance, Outlook, Risks, and Unusual Items

Management Commentary and Outlook

• General Rate Case (GRC): The CPUC issued a final decision on the 2003 GRC in July 2004, authorizing a $73 million annual base rate increase retroactive to May 2003. SCE recorded $103 million in pre-tax gains in Q3 2004 related to this decision.
• Capital Expenditures: Projected 2004 capital expenditures are $1.9 billion, including the Mountainview project acquisition ($600 million).
• Liquidity: SCE maintains a $700 million credit facility (unused except for $9 million in letters of credit) and has the capacity to pay an additional $230 million in dividends to its parent, Edison International, based on weighted-average capital structure calculations.

Risks and Contingencies

• Performance Incentive Misconduct: SCE is investigating internal misconduct regarding customer satisfaction surveys and employee injury reporting.
  • Customer Satisfaction: Proposed refund of $14 million in rewards to ratepayers due to data alteration by employees.
  • Employee Safety: Proposed return of $20 million in previously received safety incentives due to recordkeeping failures.
• Mohave Generating Station: Uncertainty regarding post-2005 coal and water supply. A $1.1 billion investment (SCE share $605 million) for pollution controls is pending resolution. A temporary shutdown of at least three years is likely even if supply issues are resolved.
• San Onofre Nuclear: Replacement of steam generators is underway. Degradation was found in reactor vessel heads and pressurizer sleeves, requiring repairs that extended the Unit 3 outage. Costs are estimated at $9 million for the sleeve replacement.
• Legal Proceedings:
  • Navajo Nation Litigation: Claims for damages exceeding $1 billion related to coal supply agreements. Discovery is stayed until February 2005 for negotiations.
  • Market Manipulation Settlements: SCE received $76 million from El Paso and $37 million from Williams. Settlements with Dynegy ($40 million) and Duke ($45 million) are pending FERC approval. Most refunds will be passed to customers.
• Environmental Remediation: Recorded liability is $88 million, with a reasonable possibility of costs exceeding this by up to $131 million.

Unusual Items

• Variable Interest Entities (VIEs): Effective March 31, 2004, SCE consolidated four cogeneration projects owned partially by a related party (Edison Mission Energy). This changed the presentation of operating revenue and expenses but had no net impact on income from continuing operations before tax for the period.
• Discontinued Operations: In 2003, SCE sold oil storage and pipeline facilities, resulting in a $44 million after-tax gain. No discontinued operations were reported in 2004.

Investor Verification Checklist

• Regulatory Recovery: Verify the final CPUC decision on the 2003 General Rate Case and the timing of revenue recovery for the $103 million Q3 gain.
• Refund Obligations: Monitor the CPUC's final determination on the $34 million in proposed refunds related to customer satisfaction and employee safety incentive misconduct.
• Mohave Viability: Track the status of coal and water supply negotiations for the Mohave Generating Station, as the outcome determines the necessity of a $605 million capital investment.
• Market Settlements: Confirm FERC approval of pending settlements with Dynegy and Duke Energy and the specific mechanism for refunding proceeds to ratepayers.
• Capital Structure Compliance: Review SCE's ability to maintain the 48% common equity component required by the CPUC to ensure continued dividend capacity to Edison International.
• Environmental Liabilities: Assess the potential for environmental remediation costs to exceed the recorded $88 million liability, particularly given the $131 million potential upside risk.