SOUTHERN CO quarterly report, Q2 FY2015

Business context and reporting period

Southern Company’s unaudited combined Form 10-Q covers the quarter and six months ended June 30, 2015, compared with the same periods in 2014. The group is a regulated southeastern U.S. electric utility holding company, with wholesale generation and renewable-energy operations through Southern Power. Results are seasonal and are not necessarily indicative of full-year performance.

Key financial metrics

Retail revenue declined 1.5% in Q2 and 4.9% year to date; wholesale revenue declined 13.0% and 18.2%, respectively. Lower fuel and purchased-power prices reduced both revenues and related expenses, generally with little effect on earnings under cost-recovery mechanisms. Non-fuel operations and maintenance expense increased $81 million in Q2 and $217 million year to date.

For the first six months, operating cash flow was $2.107 billion, investing cash outflow was $2.766 billion, and financing cash inflow was $762 million. Cash at June 30 was $813 million. Property additions were $2.647 billion; common dividends paid were $972 million. At June 30, long-term debt was $22.674 billion, securities due within one year were $3.643 billion, and notes payable were $1.057 billion. Current liabilities exceeded current assets by $2.1 billion, primarily because of near-term debt maturities. Total assets were $74.181 billion.

Material changes and notable items

• Year-to-date earnings rose 18.3%, chiefly because Kemper-related estimated-loss charges fell to $32 million from $380 million in the prior-year period, and retail base rates increased. Q2 earnings rose 2.9%; warmer weather and rate increases were partly offset by higher operating costs and a Georgia Power billing correction.
• Georgia Power recorded a $75 million out-of-period reduction in Q2 retail revenue, reducing net income by about $47 million. Management concluded the error was not material to the affected prior periods and no amendment was required.
• Southern Company’s asset retirement obligation balance rose to $2.860 billion from $2.168 billion at year-end, largely reflecting new and revised obligations under the EPA coal-ash rule. The company recorded approximately $700 million of incremental AROs related to that rule.
• Southern Power’s attributable net income increased to $46 million in Q2 from $31 million and to $79 million year to date from $64 million, supported by affiliate sales and lower purchased-power costs. It acquired solar assets and continued solar construction; a planned 299-MW wind-facility acquisition was subject to milestones and closing conditions.

Outlook, risks and contingencies

• Kemper IGCC: The project’s current total cost estimate is $6.23 billion, including $4.96 billion subject to the Mississippi PSC cost cap; actual total costs through June 30 were $5.60 billion. Southern Company had recorded cumulative estimated-loss charges of $2.08 billion pretax. The gasifier and related facilities were expected to enter service in the first half of 2016. Further delays could add approximately $25–$30 million monthly in base costs, plus estimated monthly AFUDC of $13 million and other carrying, operating, consulting and legal costs of about $7 million. Mississippi Power said it would not seek recovery of costs above the applicable $2.88 billion cap, subject to specified exclusions.
• The Mississippi Supreme Court reversed the Mirror CWIP rate order and required refunds. Approximately $353 million, including carrying costs through June 30, was subject to refund; the rate ended July 20. Mississippi Power also returned about $301 million to SMEPA after SMEPA terminated its planned 15% project purchase. These events weakened Mississippi Power’s financing position. Rate proposals and interim relief remained subject to Mississippi PSC action; no final recovery outcome was assured.
• Vogtle Units 3 and 4: The contractor forecast an 18-month delay, to Q2 2019 for Unit 3 and Q2 2020 for Unit 4. Georgia Power’s requested certificate amendment estimated in-service capital cost of $5.0 billion versus the existing $4.4 billion certified amount; the PSC deemed the amendment unnecessary until Unit 3 completion and stated that the certified amount is not a recovery cap, subject to prudence review. Estimated owner costs associated with the proposed delay were about $10 million monthly, with construction financing costs about $30 million monthly. Contractor claims attributable to Georgia Power were updated to approximately $714 million; litigation and negotiations continued.
• Credit conditions bear watching: Fitch lowered Mississippi Power to BBB+ and maintained a negative outlook; Southern Company’s outlook was revised to negative. After quarter-end, S&P placed Southern Company and the traditional operating companies on CreditWatch with negative implications.
• Other uncertainties include environmental compliance costs and recovery, pending FERC review of market-power mitigation that could affect market-based rate authority, a roughly $390 million unrecognized tax benefit related to Kemper R&E deductions, and potential termination or modification of Kemper CO2 offtake agreements. Management provided no quantitative consolidated earnings guidance in the supplied filing text.

Important facts for investors to verify

• Progress, final cost and commissioning schedule for Kemper; the Mississippi PSC’s refund, interim-rate, prudence and long-term cost-recovery decisions.
• Vogtle construction progress, contractor claims, revised costs and schedule, and the extent of costs ultimately found prudent and recoverable.
• Near-term debt maturities, Mississippi Power’s funding arrangements, and the effect of credit-rating changes on financing access and collateral requirements.
• Updated CCR-related ARO estimates and the extent and timing of environmental-cost recovery through regulated rates.
• Whether the Georgia Power billing correction, tax positions, and other significant estimates or contingencies lead to further adjustments.