Southern Company 2017 Third-Quarter Form 10-Q
Business context and reporting period. The combined filing covers The Southern Company and its electric utility, wholesale power, and natural gas subsidiaries. The quarter and nine months ended September 30, 2017 are compared with the corresponding 2016 periods. Southern Company Gas was included for nine months in 2017 but only from July 1 in 2016, so year-to-date comparisons are not fully like-for-like. The interim statements are unaudited; results are seasonal and not necessarily indicative of full-year performance.
Financial performance and position
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Operating revenue | $6.201 billion, versus $6.264 billion in 2016 | $17.403 billion, versus $14.715 billion |
| Operating income | $2.045 billion, versus $1.917 billion | $1.757 billion, versus $4.042 billion |
| Net income attributable to Southern Company | $1.069 billion, versus $1.139 billion | $347 million, versus $2.251 billion |
| Diluted earnings per share | $1.06, versus $1.17 | $0.35, versus $2.38 |
| Cash dividends per common share | $0.58, versus $0.56 | $1.72, versus $1.6625 |
Calculated operating margin was approximately 33.0% for the quarter and 10.1% year to date, compared with approximately 30.6% and 27.5% in 2016. The year-to-date decline largely reflects the Kemper charge. Revenue and operating margins are calculated from reported operating income and revenue.
- Cash flow: Nine-month operating cash flow was $5.253 billion, versus $4.296 billion. Investing cash flow was negative $6.687 billion, including $1.032 billion for acquisitions and $5.242 billion of property additions. Financing cash flow was positive $1.300 billion. Cash ended the period at $1.841 billion, down from $1.975 billion at year-end 2016.
- Debt and liquidity: At September 30, current liabilities were $12.603 billion and current assets were $9.202 billion, a $3.4 billion working-capital deficit. Long-term debt was $44.042 billion, with $3.505 billion due within one year and $2.579 billion of notes payable. The company reported $8.066 billion of unused committed bank credit arrangements and said it was in compliance with applicable credit covenants.
- Interest: Nine-month interest expense, net of amounts capitalized, was $1.248 billion, up from $913 million, primarily reflecting higher debt and Southern Company Gas’s inclusion for a longer period.
Material changes versus the prior period
- Southern Company recorded $3.2 billion of Kemper IGCC estimated-loss charges for the first nine months of 2017, versus $222 million in 2016; the 2017 charge was approximately $2.2 billion after tax. It drove the sharp year-to-date earnings decline. Since project inception, Mississippi Power had recorded approximately $6.0 billion of related pre-tax charges.
- Third-quarter earnings fell 6.1%, mainly from lower retail electric revenue associated with milder weather and lower usage, reduced Southern Power solar investment tax credits, and higher depreciation. Lower operations and maintenance expense partly offset those effects.
- Retail electric revenue declined 4.0% in the quarter and 1.2% year to date. Rate increases partly offset weather-related weakness and lower usage. Wholesale electric revenue rose, supported by renewable output and new capacity contracts.
- Southern Power’s year-to-date revenue increased 34%, reflecting new renewable and gas facilities, while attributable net income declined 12.4%, chiefly from lower solar tax credits and higher interest expense.
- Southern Company Gas year-to-date revenue and income comparisons reflect the Merger accounting and reporting-period difference; the filing states the predecessor and successor periods are not comparable.
Outlook, commentary, risks, and unusual items
- Kemper: Mississippi Power suspended gasifier operations and expects to continue operating the combined-cycle portion as a natural-gas plant. A filed settlement with certain parties proposes a $126 million annual revenue requirement, no customer rate increase, and no future recovery of gasifier costs. The Mississippi PSC ordered a full hearing after Mississippi Power and the Public Utilities Staff did not reach a joint stipulation; a decision was expected in January 2018. A final cancellation could entail another $100 million to $200 million pre-tax, and suspension beyond December 31, 2017 was estimated to cost about $5 million monthly.
- Vogtle: Following the EPC contractor’s bankruptcy, Georgia Power recommended continuing construction, with estimated completion in November 2021 for Unit 3 and November 2022 for Unit 4. Its estimated net additional capital cost was about $1.4 billion after the Toshiba guarantee settlement. The Georgia PSC decision was expected by February 6, 2018. Georgia Power estimated its share of cancellation costs at about $350 million; ultimate cost recovery, schedule, and guarantee collections remain uncertain.
- Toshiba acknowledged $3.68 billion of guarantee obligations across Vogtle owners, of which Georgia Power’s share is approximately $1.7 billion. Georgia Power received its first $137 million share on October 2, 2017, but Toshiba’s financial condition raised substantial doubt about full collection. Bechtel became the primary remaining-construction contractor under a cost-reimbursable-plus-fee agreement.
- Hurricane Irma restoration costs at Georgia Power were estimated at $150 million; approximately $145 million had been deferred as a regulatory asset. Management expected the regulatory treatment to prevent a material financial-statement impact.
- Southern Company Gas agreed to sell Elizabethtown Gas and Elkton Gas for $1.7 billion cash, subject to regulatory and other closing conditions; completion was expected by the end of third-quarter 2018. Southern Power was considering selling up to a one-third equity interest in its solar portfolio.
- Other risks include an SEC investigation and shareholder litigation concerning Kemper disclosures, a $500 million arbitration claim relating to the canceled Kemper CO2 contract, potential FERC restrictions on market-based rate authority, a possible impairment tied to a Southern Company Gas salt-dome storage cavern, environmental compliance costs, regulatory cost-recovery outcomes, weather, fuel prices, and financing conditions.
- No specific consolidated earnings guidance was provided. Management identified regulatory cost recovery, Vogtle and Kemper outcomes, customer demand, weather, construction execution, financing access, and potential tax reform as important factors affecting future results.
- Management concluded disclosure controls were effective and reported no material third-quarter change in internal control over financial reporting.
Most important facts for investors to verify
- The Mississippi PSC’s final Kemper order, including allowed recovery for combined-cycle costs and treatment of gasifier assets and suspension costs.
- The Georgia PSC’s Vogtle construction, cost, schedule, prudence, and rate-recovery decisions; realized project spending; and DOE loan-guarantee approvals.
- Toshiba’s ability to pay the remaining guarantee obligations and the status of contractor bankruptcy claims, liens, and Bechtel cost-and-schedule performance.
- Whether the proposed gas utility sales close on the announced terms and timing, and the effect of any Southern Power solar-interest sale.
- Liquidity and refinancing needs, particularly near-term maturities, the working-capital deficit, and Mississippi Power’s reliance on parent support.
- Developments in the Kemper SEC investigation, litigation and arbitration, the cavern integrity review, and FERC market-based rate proceedings.