Why did Edison International's continuing-operations earnings fall so sharply in 2004 even though reported net income rose?

Reported net income of $916M includes $690M from discontinued operations, mainly gains on selling EME's international assets. Continuing operations earned only $226M ($0.69/share) versus $655M ($2.01/share) in 2003. The decline came from roughly $989M in asset impairment and Collins lease termination charges at MEHC/EME, a $56M asbestos indemnity charge, $29M in performance-incentive refunds and penalties at SCE, and the expiration of San Onofre incentive pricing. These were partly offset by SCE's regulatory gains and resolved tax issues.

How strong is the company's liquidity and balance sheet after the EME restructuring?

Parent-level debt was eliminated in 2004. EME had about $2.3B of cash and equivalents at year-end (about $1.8B corporate cash at February 28, 2005) and an undrawn $98M secured corporate credit facility. Edison International also obtained a $750M unsecured revolver in February 2005. Remaining leverage is concentrated at EME (about $3.7B consolidated debt, plus $5.0B of long-term lease obligations) and MEHC's $800M senior secured notes, which are non-recourse to Edison International. SCE's debt covenants were in compliance at year-end.

What are the biggest risks to earnings in 2005 and beyond?

Key risks include: (1) EME's exposure to merchant power prices as the Exelon contracts expired at the end of 2004, with capacity prices lower than under the old contracts and potential collateral needs up to about $400M if prices rise; (2) MEHC's interest coverage below 2.0x, which blocks dividends to the parent; (3) the unresolved future of Mohave, which requires about $605M (SCE's share) of pollution-control investment to operate past 2005; (4) regulatory decisions on the San Onofre steam generator replacement and the 2006 GRC; (5) federal environmental rules (mercury, NSR, carbon, cooling water intake), whose costs are uncertain; and (6) the IRS challenge to Edison Capital's leveraged leases, which could require significant cash payments even though it would not change earnings under current accounting rules.

What is SCE's growth outlook and how is it funded?

SCE expects to invest about $9.4B from 2005 through 2009, with capital expenditures of $1.6B in 2005, $1.8B in 2006, and $1.9B in 2007, and rate base growing from $9.4B at year-end 2004 to $14.2B by 2009. Ratemaking for 2005 capex is already in place under the 2003 GRC. The 2006 GRC requests $370M in additional revenue and is expected to be decided around December 2005. Funding is expected to come from operating cash flow and long-term debt and preferred stock issuance; SCE issued $650M of mortgage bonds in January 2005 and has authority to increase its preferred stock allocation to 9% of capitalization.

What is the status of the Navajo Nation litigation and Mohave plant?

The Navajo Nation's 1999 RICO and contract-related suit against SCE and Peabody (seeking not less than $600M, trebled, plus $1B in punitive damages) remains pending in the D.C. District Court, which has stayed the action while the parties negotiate facilitated settlements covering Mohave's coal and water supply. The CPUC's December 2004 Mohave decision directs continued negotiations, allows certain cost recovery, and requires alternatives studies. SCE says it cannot predict the outcome of the Navajo litigation or whether Mohave will operate after 2005. If the station shuts down, SCE expects no material impact, assuming its remaining book value (about $8M) and related regulatory asset (about $78M) remain recoverable in rates.

EIX 10-K FY2004 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 16, 2005. Cited figures are marked; the original filing is the authoritative source.

Edison International (EIX) reported 2004 consolidated net income of $916 million^a, or $2.81 per basic share, versus $821 million ($2.52) in 2003.

That headline figure is misleading as a measure of ongoing performance: earnings from continuing operations fell sharply to $226 million^b ($0.69 per share) from $655 million ($2.01), while discontinued operations contributed $690 million, driven largely by gains on the sale of EME's international portfolio (Contact Energy, MEC International B.V./IPM). The continuing-operations decline reflects a $956 million pre-tax loss from terminating the Collins Station lease, $304 million... more precisely, $989 million in total asset impairment and lease termination charges, a $56 million asbestos indemnity charge at the Illinois plants, and the expiration of San Onofre performance incentives, partly offset by a $180 million regulatory gain at SCE from the 2003 General Rate Case and other regulatory resolutions. The balance sheet and liquidity picture improved meaningfully.

EME used sale proceeds to retire much of its debt and held roughly $1.8 to $2.3 billion^c of corporate cash at year-end and in February 2005. Edison International eliminated its parent-level debt, closed a new $750 million unsecured revolver, and raised its 2005 dividend to $1.00 per share from $0.80. However, MEHC's interest coverage ratio fell to 1.18x, below the 2.0x threshold required for MEHC dividends, which constrains upstream cash flow.

EME's merchant exposure is rising in 2005 as Illinois plant contracts with Exelon expired, and Mohave's post-2005 operation remains unresolved. SCE, the largest contributor to earnings, faces heavy capital spending of about $9.4 billion^d over 2005 to 2009, with rate base projected to grow from $9.4 billion to $14.2 billion.

Key regulatory items include the 2006 GRC request of $370 million, the San Onofre steam generator replacement decision (with a possible ORA disallowance of up to about $260 million), and continuing federal and state environmental rulemakings (mercury, NSR, climate). The IRS is also challenging Edison Capital's SILO and LILO leases, with a potential cash-flow impact that could be significant even though it would not affect accounting earnings under current standards.

02—Key points

Key Highlights

Reported 2004 net income of $916M ($2.81/share), but continuing operations earned only $226M ($0.69/share) versus $655M ($2.01) in 2003; the gap is mainly discontinued operations ($690M, including $533M in gains).
$989M in asset impairment and lease termination charges in 2004, dominated by the ~$956M pre-tax loss on terminating EME's Collins Station lease (paid ~$960M in April 2004).
EME completed most of its international divestiture (about $2.7B in proceeds in 2004 plus CBK and Tri Energy sales in early 2005) and retired its parent-level debt; EME held roughly $1.8B of corporate cash in early 2005.
MEHC interest coverage ratio fell to 1.18x (from 1.56x), below the 2.0x minimum needed for MEHC dividends, restricting upstream cash flow to the parent.
SCE plans roughly $9.4B of capex for 2005 to 2009, with rate base rising from $9.4B to $14.2B, and a pending 2006 GRC request for a $370M base rate increase.
Dividend raised to $1.00/share for 2005 from $0.80 in 2004; the parent eliminated its debt and secured a new $750M unsecured revolver.
Pending risks include the San Onofre steam generator decision (ORA proposes a disallowance of up to ~$260M), uncertainty over Mohave operation after 2005, and an IRS challenge to Edison Capital's SILO/LILO leases ($558M+ of deferred taxes at issue).

03—Questions

Frequently Asked Questions

Why did Edison International's continuing-operations earnings fall so sharply in 2004 even though reported net income rose?
Reported net income of $916M includes $690M from discontinued operations, mainly gains on selling EME's international assets. Continuing operations earned only $226M ($0.69/share) versus $655M ($2.01/share) in 2003. The decline came from roughly $989M in asset impairment and Collins lease termination charges at MEHC/EME, a $56M asbestos indemnity charge, $29M in performance-incentive refunds and penalties at SCE, and the expiration of San Onofre incentive pricing. These were partly offset by SCE's regulatory gains and resolved tax issues.
How strong is the company's liquidity and balance sheet after the EME restructuring?
Parent-level debt was eliminated in 2004. EME had about $2.3B of cash and equivalents at year-end (about $1.8B corporate cash at February 28, 2005) and an undrawn $98M secured corporate credit facility. Edison International also obtained a $750M unsecured revolver in February 2005. Remaining leverage is concentrated at EME (about $3.7B consolidated debt, plus $5.0B of long-term lease obligations) and MEHC's $800M senior secured notes, which are non-recourse to Edison International. SCE's debt covenants were in compliance at year-end.
What are the biggest risks to earnings in 2005 and beyond?
Key risks include: (1) EME's exposure to merchant power prices as the Exelon contracts expired at the end of 2004, with capacity prices lower than under the old contracts and potential collateral needs up to about $400M if prices rise; (2) MEHC's interest coverage below 2.0x, which blocks dividends to the parent; (3) the unresolved future of Mohave, which requires about $605M (SCE's share) of pollution-control investment to operate past 2005; (4) regulatory decisions on the San Onofre steam generator replacement and the 2006 GRC; (5) federal environmental rules (mercury, NSR, carbon, cooling water intake), whose costs are uncertain; and (6) the IRS challenge to Edison Capital's leveraged leases, which could require significant cash payments even though it would not change earnings under current accounting rules.
What is SCE's growth outlook and how is it funded?
SCE expects to invest about $9.4B from 2005 through 2009, with capital expenditures of $1.6B in 2005, $1.8B in 2006, and $1.9B in 2007, and rate base growing from $9.4B at year-end 2004 to $14.2B by 2009. Ratemaking for 2005 capex is already in place under the 2003 GRC. The 2006 GRC requests $370M in additional revenue and is expected to be decided around December 2005. Funding is expected to come from operating cash flow and long-term debt and preferred stock issuance; SCE issued $650M of mortgage bonds in January 2005 and has authority to increase its preferred stock allocation to 9% of capitalization.
What is the status of the Navajo Nation litigation and Mohave plant?
The Navajo Nation's 1999 RICO and contract-related suit against SCE and Peabody (seeking not less than $600M, trebled, plus $1B in punitive damages) remains pending in the D.C. District Court, which has stayed the action while the parties negotiate facilitated settlements covering Mohave's coal and water supply. The CPUC's December 2004 Mohave decision directs continued negotiations, allows certain cost recovery, and requires alternatives studies. SCE says it cannot predict the outcome of the Navajo litigation or whether Mohave will operate after 2005. If the station shuts down, SCE expects no material impact, assuming its remaining book value (about $8M) and related regulatory asset (about $78M) remain recoverable in rates.

04—Continue

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