Why did Exelon's 2006 earnings rise year over year when the company still took a large goodwill charge?

Net income rose to $1,592M from $923M mainly because 2005 included a $1.2B ComEd goodwill impairment (about $1.2B pre-tax) that did not recur at that size in 2006. The 2006 charge of $776M was smaller. Other drivers were higher realized wholesale prices and nuclear output at Generation, a one-time ~$290M benefit from ICC rate orders, and a $604M nuclear ARO reduction (pre-tax income of $149M). Note that much of the improvement reflects non-recurring items rather than underlying operating growth.

How much financial exposure does ComEd face if Illinois rolls back rates?

The filing estimates ComEd could incur operating losses of approximately $1.4B per year (about $850M after tax) or more if rates were rolled back and the transition-period rate freeze extended through 2009. ComEd projects a 2007 cash shortfall of roughly $1.4B or more under that scenario. Management says such shortfalls would severely limit ComEd's ability to refinance 2007 maturities and could lead it to seek bankruptcy protection. ComEd states it would challenge such legislation in court as violating federal law and the U.S. Constitution.

What is the status of Exelon's credit ratings and what are the consequences of a downgrade?

At December 31, 2006, Exelon was rated Baa2/BBB/BBB+ (senior unsecured, Moody's/S&P/Fitch), Generation Baa1/BBB+/BBB+, and PECO A3/BBB/A-. ComEd was downgraded: Moody's cut it to Baa3 (with a negative watch), S&P cut senior unsecured debt to BB+ (below investment grade), and Fitch placed it on negative watch. The filing states that none of the registrants' borrowings are subject to default or prepayment on a downgrade, although fees and interest on credit facilities could rise. For Generation, a loss of investment grade status could require roughly $880M of collateral under trading agreements.

What is the IRS issue around ComEd's 1999 fossil plant sale, and how big is it?

ComEd deferred the tax gain on its 1999 sale of fossil generating assets, relying partly on an involuntary-conversion position and a sale-leaseback structure. The IRS treats the leaseback as a listed 'SILO' transaction and in November 2006 issued a notice of proposed adjustment disallowing the deferral. Exelon estimates a potential after-tax cash outflow, including tax and interest, of up to $960M, and a potential after-tax interest expense hit of up to $166M if the IRS prevails. Exelon disagrees with the IRS and says it will defend its position; final IRS audit results are expected in late 2007.

How is Exelon's capital allocation changing?

Exelon raised its quarterly dividend to $0.44 per share from $0.40, payable March 10, 2007. The board also adopted a 'value return' policy that establishes a base dividend expected to grow modestly over time and contemplates periodic share repurchases to return excess cash and balance sheet capacity to shareholders after funding maintenance capex and other commitments. This replaces the prior policy of paying out 50-60% of ongoing operating earnings. The company repurchased 3.2 million shares for $186M in 2006 under an existing program. ComEd paid no dividend in 2006 and its board will reassess quarterly.

EXC 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed February 13, 2007. Cited figures are marked; the original filing is the authoritative source.

Exelon Corporation's FY2006 Form 10-K (filed February 13, 2007) covers a combined filing for Exelon, Generation, ComEd and PECO.

Exelon reported 2006 net income of $1,592 million^a ($2.35 diluted EPS), up from $923 million ($1.36) in 2005, though the improvement was largely due to lapping a $1.2 billion ComEd goodwill impairment in 2005; 2006 itself included a new $776 million ComEd goodwill impairment in Q3 after the ICC's July 2006 rate order. Generation was the profit engine, earning $1,407 million on higher realized wholesale prices, improved nuclear output (93.9% capacity factor) and a $604 million decrease in its nuclear ARO. ComEd posted a net loss of $112 million, and PECO's earnings declined to $441 million on higher CTC amortization.

The dominant investor risk is Illinois regulatory and political uncertainty. ComEd's transition period and rate freeze ended in January 2007, and the company warns that any legislative rate rollback and freeze could produce operating losses of roughly $1.4 billion^b per year, a projected 2007 cash shortfall of about $1.4 billion, and a possible Chapter 11 filing by ComEd. Moody's, Fitch and S&P have all downgraded ComEd, with S&P placing it at BB+ (below investment grade).

Exelon also faces a potential IRS challenge to ComEd's deferral of the 1999 fossil plant sale gain, with up to $960 million^c of potential cash outflow and $166 million of after-tax interest expense exposure. On the capital-return side, Exelon raised its quarterly dividend to $0.44 per share from $0.40 and adopted a 'value return' policy that contemplates share repurchases, replacing the prior 50-60% payout target.

The PSEG merger was terminated in September 2006 after New Jersey regulators failed to approve it, and Exelon recorded about $93 million^d of related expenses. Generation's long-term supply position is shifting toward market exposure as the ComEd PPA expired and PECO's PPA runs through 2010.

02—Key points

Key Highlights

2006 GAAP net income of $1,592M ($2.35 diluted EPS) versus $923M ($1.36) in 2005; the year-over-year gain is largely the absence of the prior year's $1.2B ComEd goodwill impairment, partly offset by a new $776M impairment in 2006.
Generation (1,407M net income) drove results on higher realized wholesale prices, a 93.9% nuclear capacity factor, and a $604M reduction in the nuclear decommissioning ARO; ComEd posted a $112M net loss and PECO earned $441M.
ComEd faces material Illinois regulatory risk: a pending rate-freeze rollback could cause ~$1.4B annual operating losses and a 2007 cash shortfall of ~$1.4B, and the company explicitly flags a possible Chapter 11 filing if such legislation is enacted.
Credit ratings pressure: Moody's and Fitch downgraded ComEd in 2006 and S&P cut ComEd's senior unsecured debt to BB+ (below investment grade) in October 2006; Exelon and Generation remain investment grade.
Potential IRS exposure: the IRS treats ComEd's 1999 fossil plant sale-leaseback as a SILO listed transaction; a successful challenge could require up to $960M of after-tax cash outflow and up to $166M of after-tax interest expense.
Capital return shift: quarterly dividend raised to $0.44 per share (from $0.40) with a new 'value return' policy that contemplates share repurchases, replacing the prior 50-60% payout target.
PSEG merger terminated September 14, 2006 after NJBPU approval was not received; Exelon wrote off ~$55M of capitalized costs (~$93M total Merger-related expense) and remains a standalone utility holding company.

03—Questions

Frequently Asked Questions

Why did Exelon's 2006 earnings rise year over year when the company still took a large goodwill charge?
Net income rose to $1,592M from $923M mainly because 2005 included a $1.2B ComEd goodwill impairment (about $1.2B pre-tax) that did not recur at that size in 2006. The 2006 charge of $776M was smaller. Other drivers were higher realized wholesale prices and nuclear output at Generation, a one-time ~$290M benefit from ICC rate orders, and a $604M nuclear ARO reduction (pre-tax income of $149M). Note that much of the improvement reflects non-recurring items rather than underlying operating growth.
How much financial exposure does ComEd face if Illinois rolls back rates?
The filing estimates ComEd could incur operating losses of approximately $1.4B per year (about $850M after tax) or more if rates were rolled back and the transition-period rate freeze extended through 2009. ComEd projects a 2007 cash shortfall of roughly $1.4B or more under that scenario. Management says such shortfalls would severely limit ComEd's ability to refinance 2007 maturities and could lead it to seek bankruptcy protection. ComEd states it would challenge such legislation in court as violating federal law and the U.S. Constitution.
What is the status of Exelon's credit ratings and what are the consequences of a downgrade?
At December 31, 2006, Exelon was rated Baa2/BBB/BBB+ (senior unsecured, Moody's/S&P/Fitch), Generation Baa1/BBB+/BBB+, and PECO A3/BBB/A-. ComEd was downgraded: Moody's cut it to Baa3 (with a negative watch), S&P cut senior unsecured debt to BB+ (below investment grade), and Fitch placed it on negative watch. The filing states that none of the registrants' borrowings are subject to default or prepayment on a downgrade, although fees and interest on credit facilities could rise. For Generation, a loss of investment grade status could require roughly $880M of collateral under trading agreements.
What is the IRS issue around ComEd's 1999 fossil plant sale, and how big is it?
ComEd deferred the tax gain on its 1999 sale of fossil generating assets, relying partly on an involuntary-conversion position and a sale-leaseback structure. The IRS treats the leaseback as a listed 'SILO' transaction and in November 2006 issued a notice of proposed adjustment disallowing the deferral. Exelon estimates a potential after-tax cash outflow, including tax and interest, of up to $960M, and a potential after-tax interest expense hit of up to $166M if the IRS prevails. Exelon disagrees with the IRS and says it will defend its position; final IRS audit results are expected in late 2007.
How is Exelon's capital allocation changing?
Exelon raised its quarterly dividend to $0.44 per share from $0.40, payable March 10, 2007. The board also adopted a 'value return' policy that establishes a base dividend expected to grow modestly over time and contemplates periodic share repurchases to return excess cash and balance sheet capacity to shareholders after funding maintenance capex and other commitments. This replaces the prior policy of paying out 50-60% of ongoing operating earnings. The company repurchased 3.2 million shares for $186M in 2006 under an existing program. ComEd paid no dividend in 2006 and its board will reassess quarterly.

04—Continue

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