Why did Edison International's 2005 earnings improve so sharply compared with 2004?

Most of the improvement came from 2004 charges that did not recur. In 2004, MEHC recorded a $590 million charge for terminating the Collins Station lease and related impairments, and SCE had large one-time regulatory and tax items in 2004. In 2005, MEHC's results were driven by higher wholesale power prices in PJM, increased energy trading income, and lower interest expense. Continuing operations earnings were $1.108 billion ($3.38 per share) in 2005, compared with $226 million ($0.69 per share) in 2004.

What is the status of the Mohave plant, and what does it mean for SCE?

Mohave ceased operations on December 31, 2005, because agreements with the Navajo Nation and Hopi Tribe on post-2005 coal and water supply were not reached, and the 1999 consent decree's air-pollution requirements were not met. There is no definite return-to-service date, and a permanent shutdown remains possible. SCE expects to recover Mohave shutdown costs in customer rates. The 2006 ERRA forecast assumes Mohave is unavailable, and its replacement with higher-cost natural gas generation contributed to a $961 million increase in SCE's 2006 power procurement revenue requirement. SCE's remaining exposure includes its share of the roughly $605 million compliance cost and the Navajo Nation litigation seeking damages of at least $600 million, trebled, plus punitive damages of at least $1 billion.

How much debt does the nonutility business carry, and is it a credit risk for investors?

EME had $3.4 billion of consolidated debt at year-end 2005 and an additional $4.6 billion of long-term power plant lease obligations, with payments extending up to 29 years. MEHC's $800 million 13.5% senior secured notes depend on dividends from EME, and foreclosure on the pledged EME stock would change control of EME. Credit ratings were below investment grade: MEHC at B2/CCC+, EME at B1/B+, and Midwest Generation's first-priority secured debt at Ba3/BB-. Investors should therefore treat the nonutility segment as a highly leveraged, merchant-exposed credit, even though its 2005 earnings were strong.

What are the main tax and regulatory risks in the filing?

The largest tax risk involves Edison Capital's leveraged leases. The IRS challenges certain 1993–1999 transactions and expects to challenge a 1999 service contract, with deferred taxes at issue totaling about $1.48 billion. If the IRS prevails, Edison International would have to pay taxes and interest; the interest estimate is $323 million, and penalties of up to 20% of any sustained tax adjustment would materially affect earnings. On the regulatory side, the CPUC is examining SCE's performance-incentive reporting for customer satisfaction, employee injury reporting, and system reliability, which could lead to refunds or penalties. The CPUC also opened a rulemaking on holding-company relationships, and the 2006 General Rate Case outcome remains uncertain.

Does the 2005 filing show a stronger balance sheet, and how is the dividend positioned?

Management reports a stronger balance sheet. Edison International had no parent-level debt at year-end 2005, reduced MEHC's term loan, and recorded a rebalanced SCE capital structure with a 50% common equity ratio on a 13-month basis. The non-regulated subsidiaries held about $1.9 billion of combined cash and short-term investments at year-end. Consolidated long-term debt fell to $8.8 billion from $9.7 billion. The quarterly dividend was raised to $0.27 per share, and total 2005 dividends declared were $1.02 per share. Parent-level dividend capacity depends on SCE's dividend restrictions and MEHC's interest coverage requirement of 2.0 to 1, which was 2.79 to 1 at year-end 2005.

EIX 10-K FY2005 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 7, 2006. Cited figures are marked; the original filing is the authoritative source.

Edison International (EIX) reported a strong 2005 with net income of $1.137 billion^a, or $3.47 per basic share, up from $916 million ($2.81) in 2004.

Earnings from continuing operations rose to $1.108 billion^b ($3.38 per share) from $226 million, though 2004 was depressed by large charges, including a roughly $960 million loss on the Collins Station lease termination. Results were driven by three segments: Southern California Edison (SCE) earned $725 million, the nonutility power generation business (MEHC/EME) earned $322 million on higher wholesale power prices and trading income, and Edison Capital earned $91 million. Management highlighted a strengthened balance sheet, including debt reduction at MEHC and Edison Capital, a rebalanced SCE capital structure, and an 8% dividend increase to $1.02 per share.

The main risks are regulatory and environmental. SCE's Mohave coal plant ceased operations on December 31, 2005, with no definite return-to-service date, and SCE's share of required pollution-control and related costs is estimated at about $605 million^c. SCE's 2006 capital budget is roughly $2.2 billion, and the proposed 2006 General Rate Case decision may reduce the requested revenue increase.

The CPUC is also investigating performance-incentive reporting issues that could lead to refunds or penalties. At the parent level, Edison Capital's leveraged leases face IRS challenges; the company estimates about $1.48 billion^d of deferred taxes are at issue, with interest of about $323 million, which could hurt earnings if the IRS prevails. MEHC's position is more leveraged.

Its $800 million 13.5% senior secured notes depend on dividends from EME, and EME carries $3.4 billion of consolidated debt plus $4.6 billion of long-term lease obligations. Credit ratings for MEHC (B2/CCC+) and EME (B1/B+) remain below investment grade, and the Homer City insurance and rating-related consent issues add further uncertainty. Overall, the filing shows a financially stronger company whose earnings remain concentrated in merchant power prices and whose key exposures are the Mohave outage, tax disputes, and below-investment-grade subsidiary financing.

02—Key points

Key Highlights

Net income rose 24% to $1.137 billion ($3.47 per basic share) in 2005, versus $916 million ($2.81) in 2004, with continuing operations earnings of $1.108 billion ($3.38 per share).
SCE contributed $725 million in earnings from continuing operations, down from $915 million in 2004 when that year included $329 million of positive regulatory and tax items; excluding these items, SCE's earnings rose modestly.
MEHC/EME earnings swung to $322 million from a $666 million loss in 2004, driven by higher wholesale energy margins, $195 million in energy trading earnings, and the absence of 2004's $590 million Collins lease termination charge.
Mohave Generating Station (SCE's 56% share, 885 MW) ceased operations on December 31, 2005, with no definite return-to-service date; SCE's share of compliance costs is estimated at about $605 million.
The 2005 dividend rose 8% to $1.02 per share, and parent-level debt was eliminated, with MEHC's $385 million term loan repaid in 2005.
Edison Capital faces IRS challenges to its leveraged lease transactions, with about $1.48 billion of deferred taxes at issue and an estimated $323 million of interest, which could significantly affect earnings and cash flow if the IRS prevails.
SCE's 2006 capital expenditures are projected at $2.2 billion, and the proposed 2006 GRC decision would authorize $4.9 billion for 2006–2008; SCE's 2006 base rate revenue requirement is $3.70 billion under the proposed decision, versus $3.96 billion requested.

03—Questions

Frequently Asked Questions

Why did Edison International's 2005 earnings improve so sharply compared with 2004?
Most of the improvement came from 2004 charges that did not recur. In 2004, MEHC recorded a $590 million charge for terminating the Collins Station lease and related impairments, and SCE had large one-time regulatory and tax items in 2004. In 2005, MEHC's results were driven by higher wholesale power prices in PJM, increased energy trading income, and lower interest expense. Continuing operations earnings were $1.108 billion ($3.38 per share) in 2005, compared with $226 million ($0.69 per share) in 2004.
What is the status of the Mohave plant, and what does it mean for SCE?
Mohave ceased operations on December 31, 2005, because agreements with the Navajo Nation and Hopi Tribe on post-2005 coal and water supply were not reached, and the 1999 consent decree's air-pollution requirements were not met. There is no definite return-to-service date, and a permanent shutdown remains possible. SCE expects to recover Mohave shutdown costs in customer rates. The 2006 ERRA forecast assumes Mohave is unavailable, and its replacement with higher-cost natural gas generation contributed to a $961 million increase in SCE's 2006 power procurement revenue requirement. SCE's remaining exposure includes its share of the roughly $605 million compliance cost and the Navajo Nation litigation seeking damages of at least $600 million, trebled, plus punitive damages of at least $1 billion.
How much debt does the nonutility business carry, and is it a credit risk for investors?
EME had $3.4 billion of consolidated debt at year-end 2005 and an additional $4.6 billion of long-term power plant lease obligations, with payments extending up to 29 years. MEHC's $800 million 13.5% senior secured notes depend on dividends from EME, and foreclosure on the pledged EME stock would change control of EME. Credit ratings were below investment grade: MEHC at B2/CCC+, EME at B1/B+, and Midwest Generation's first-priority secured debt at Ba3/BB-. Investors should therefore treat the nonutility segment as a highly leveraged, merchant-exposed credit, even though its 2005 earnings were strong.
What are the main tax and regulatory risks in the filing?
The largest tax risk involves Edison Capital's leveraged leases. The IRS challenges certain 1993–1999 transactions and expects to challenge a 1999 service contract, with deferred taxes at issue totaling about $1.48 billion. If the IRS prevails, Edison International would have to pay taxes and interest; the interest estimate is $323 million, and penalties of up to 20% of any sustained tax adjustment would materially affect earnings. On the regulatory side, the CPUC is examining SCE's performance-incentive reporting for customer satisfaction, employee injury reporting, and system reliability, which could lead to refunds or penalties. The CPUC also opened a rulemaking on holding-company relationships, and the 2006 General Rate Case outcome remains uncertain.
Does the 2005 filing show a stronger balance sheet, and how is the dividend positioned?
Management reports a stronger balance sheet. Edison International had no parent-level debt at year-end 2005, reduced MEHC's term loan, and recorded a rebalanced SCE capital structure with a 50% common equity ratio on a 13-month basis. The non-regulated subsidiaries held about $1.9 billion of combined cash and short-term investments at year-end. Consolidated long-term debt fell to $8.8 billion from $9.7 billion. The quarterly dividend was raised to $0.27 per share, and total 2005 dividends declared were $1.02 per share. Parent-level dividend capacity depends on SCE's dividend restrictions and MEHC's interest coverage requirement of 2.0 to 1, which was 2.79 to 1 at year-end 2005.

04—Continue

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