Tennessee Valley Authority annual report, FY2014

Tennessee Valley Authority — FY2014 Form 10-K

Business context and reporting period. TVA is a federally created, self-financing public power provider serving more than nine million people across seven southeastern states. This annual report covers the fiscal year ended September 30, 2014; the fourth quarter is included in the annual results. Electricity sales generated virtually all operating revenue. TVA cannot issue equity, and its bonds are not guaranteed by the U.S. government.

Financial performance and position

Metric	FY2014	FY2013
Operating revenue	$11.137 billion	$10.956 billion
Operating income	$1.589 billion	$1.453 billion
Net income	$469 million	$271 million
Operating margin	14.3%	13.3%
Net margin	4.2%	2.5%
Cash from operating activities	$2.980 billion	$2.597 billion
Construction expenditures	$2.384 billion	$2.051 billion
Net cash change	$(1.102) billion	$734 million

Fourth-quarter FY2014 revenue was $3.166 billion and net income was $322 million, versus $3.034 billion and $474 million, respectively, in Q4 FY2013.

Revenue increased 1.7% year over year. Higher LPC sales and the prior-year base-rate increase supported revenue, partly offset by sharply lower sales to directly served industries, especially USEC.
Operating expenses rose slightly to $9.548 billion. O&M declined $87 million to $3.341 billion, reflecting management cost reductions; depreciation and amortization rose $163 million, mainly from accelerated depreciation on coal units being idled.
Operating cash flow increased $383 million, including a $175 million Kingston-related insurance recovery. Investing cash outflow increased with construction and nuclear-fuel spending. Financing used $1.326 billion, principally reflecting net debt reductions; cash fell to $500 million from $1.602 billion.
Total debt was approximately $24.9 billion, including $23.6 billion of TVA bonds and $1.3 billion of VIE debt. Statutory bond capacity was $30 billion. Long-term power bonds averaged 5.575%; the blended borrowing rate was 5.146%.
Liquidity included $1.5 billion available under revolving facilities, after $1.0 billion of letters of credit, and a $150 million U.S. Treasury facility with no borrowings. Short-term debt was $596 million; current maturities of power bonds were $1.032 billion.
TVA had $45.596 billion in assets and $39.492 billion in liabilities. Current assets were $3.788 billion against current liabilities of $4.449 billion. Regulatory assets totaled approximately $9.5 billion and depend on continued expected recovery through rates.

Material changes and operating developments

Total electricity sales fell 2.4% to 158.1 billion kWh, primarily because industrial sales declined 33.1% following USEC’s shutdown; LPC sales rose 4.3%, helped by colder weather.
Net income improved by $198 million. Revenue gains and lower O&M costs were partly offset by higher accelerated depreciation and more expensive purchased power. Natural gas spot prices averaged 20% above FY2013, while reduced rainfall lowered hydro generation 27%.
TVA generated 44% of its power from coal, 38% from nuclear, 9% from hydro, and 9% from gas/oil. Purchased power supplied 11.6% of total power supply, compared with 11.4% in FY2013.
TVA repaid or redeemed more debt than it issued, reducing bonds outstanding; management said it used cash on hand to reduce debt by about $1.2 billion and fund near-term capital needs.
The qualified pension plan was underfunded by $4.758 billion at year-end: $7.507 billion in plan assets against a $12.265 billion obligation. TVA contributed $250 million in FY2014 and expected to contribute $275 million in FY2015.

Outlook, management commentary, and key risks

The Board approved a 2.61% non-fuel wholesale base-rate increase for FY2015, expected to add about $199 million in base revenue. TVA was also developing a longer-term pricing plan; a rate-change notice was scheduled for January 2015, with potential restructuring in October 2015.
Management targeted $500 million of O&M savings by 2015 versus the 2013 budget, reporting that it had exceeded its $300 million FY2014 savings target. Restructuring reduced approximately 2,000 positions; $45 million was accrued for severance.
Watts Bar Unit 2 was expected to enter commercial operation by December 2015, with estimated completion costs of $4.0–$4.5 billion. Fuel loading had shifted to May 2015; licensing, testing, emergent work, and transition to dual-unit operations remained execution risks.
TVA approved approximately 1,000 MW gas-fired facilities at Paradise (cost not to exceed $1.1 billion) and Allen (not to exceed $975 million); associated coal units are to retire after replacement facilities are completed. The Paradise project faced a legal challenge.
TVA planned $1.5–$2.0 billion to convert wet coal-ash and gypsum facilities to dry storage by December 2022; $618 million had been incurred. The filing’s environmental expenditure estimates also included $1.4 billion for coal-combustion-residual work, $900 million for planned air controls, and $400 million for Clean Water Act requirements, subject to regulatory and project uncertainty.
Environmental regulation, coal retirements, fuel and purchased-power price volatility, weather and water availability, nuclear licensing and safety, construction delays or overruns, dam and transmission reliability, and physical or cyber threats could affect costs and service. TVA also cited approaching its statutory debt ceiling and the risk of reduced market access or higher borrowing costs.
TVA accrued approximately $172 million for legal proceedings, but could not estimate reasonably possible additional losses. The Kingston ash-spill cleanup estimate was $1.1 billion; $1.1 billion had been spent and the remaining estimated liability was $21 million. Additional claims and costs were not fully estimable.
Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting; management reported disclosure controls and financial-reporting controls effective at September 30, 2014.

Most important facts for investors to verify

Whether FY2015 rate actions, demand, and industrial customer sales offset continued volume pressure and higher generation costs.
Watts Bar Unit 2’s final cost, fuel-loading and operating-license milestones, and commercial-operation date.
Actual costs and timing for coal-ash conversions, air and water compliance, and required transmission or dam upgrades.
Progress against the $500 million cost-reduction goal and the effect of coal retirements on replacement-power needs and reliability.
TVA’s remaining statutory borrowing capacity, available liquidity after letters of credit, and refinancing needs.
Pension funding requirements, legal-proceeding exposures, and the recoverability of the large regulatory-asset balance.