Why did FirstEnergy's GAAP earnings decline in 2005 even though operating results improved?

GAAP net income fell to $861M from $878M, but the decline is largely from unusual items: a $28M DOJ/NRC penalty tied to Davis-Besse, a $30M FIN 47 charge, and Ohio tax adjustments. Management's non-GAAP measure, earnings before unusual items, was $984M versus $991M, so the underlying trend was modestly lower, not improved.

What are the main regulatory risks to FirstEnergy's earnings and cash flow?

The biggest risks are the Met-Ed/Penelec supply arrangement with FES, which FES can terminate on 60 days' notice and which could force purchased-power cost increases and rating pressure if not offset by PPUC relief; the FERC proceeding on the FES power sales agreements, with an initial decision expected in fall 2006; and the NJBPU's handling of JCP&L's securitization and NUG cost-recovery requests.

How large is the capital spending commitment and what drives it?

Management forecasts about $6.7 billion of capital expenditures for 2006-2010 excluding nuclear fuel. The largest components are FES generation (about $2.0B) and JCP&L and CEI distribution, with environmental compliance including roughly $1.5B for the Sammis NSR settlement, which was expected to be spent mainly from 2008 to 2011.

Does FirstEnergy have adequate liquidity and access to capital markets?

Yes, based on the filing. The company had about $731M of short-term debt at year-end against a $2B revolving facility and roughly $1.75B of unused credit and receivables capacity. Subsidiaries paid $1.3B in cash dividends to the holding company in 2005, and the company retained investment-grade ratings with positive outlooks at two of the three agencies.

What open legal or control issues should investors monitor?

Investors should watch the SEC formal order of investigation covering the 2003 restatement and Davis-Besse matters, the NRC's Perry plant oversight with a possible impact on operating authority, the August 2003 blackout complaints, and remediation of the Met-Ed and Penelec internal control weakness planned for the first quarter of 2006.

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

01—Abstract

Summary

Summary of the 10-K filed March 2, 2006. Cited figures are marked; the original filing is the authoritative source.

FirstEnergy Corp. (FE) filed its 10-K for fiscal 2005 on March 2, 2006, describing a holding company whose eight electric utility subsidiaries serve about 4.5 million customers across Ohio, Pennsylvania and New Jersey.

Consolidated 2005 revenues were $11.989 billion^a and GAAP net income was $861 million, or $2.62 basic EPS, down from $878 million ($2.68) in 2004. Non-GAAP earnings before unusual items were $984 million ($3.00 per share), versus $991 million ($3.03) in 2004. The earnings decline reflects one-time items including a $28 million Davis-Besse DOJ/NRC penalty, a $30 million after-tax FIN 47 cumulative-effect charge, and an Ohio tax-law adjustment, partly offset by higher distribution volumes from warm weather.

The company's near-term investment picture hinges on regulatory outcomes and capital needs. Key items include the Ohio Rate Certainty Plan approved in January 2006, the expiration of the New Jersey BGS arrangement, the pending Pennsylvania rate filing tied to the FES supply agreement, and a $1.5 billion^b NSR-settlement capital program at the W. H.

Sammis plant. Management projects 2006-2010 capital expenditures of about $6.7 billion^c, and the Met-Ed/Penelec supply arrangement with FES carries a stated risk that credit ratings could fall below investment grade if it is terminated without regulatory relief. Liquidity was adequate, with $1.75 billion of unused credit and receivables facilities at year end and $1.3 billion of cash dividends received from subsidiaries in 2005.

The filing also disclosed a material weakness in internal control over NUG-related regulatory accounting at Met-Ed and Penelec, which the company said it would remediate in early 2006. Several investor-relevant risks remain open: the SEC formal investigation, the Ohio transmission deferral appeal, the FERC review of the FES power sales agreements, and nuclear oversight at Perry. The 2005 share repurchases were limited to 614,766 shares for employee plan purposes, and no public buyback program was in place.

02—Key points

Key Highlights

2005 GAAP net income of $861M ($2.62 basic EPS) vs. $878M ($2.68) in 2004; earnings before unusual items of $984M ($3.00 per share) vs. $991M ($3.03).
Revenues of $11.99B in 2005, down slightly from $12.06B mainly because of a PJM transaction-netting change with no effect on earnings; ex-that change, revenues rose about $997M.
Unusual 2005 charges included a $28M Davis-Besse DOJ penalty, a $30M after-tax FIN 47 cumulative-effect charge, Ohio CAT tax adjustments of about $63M, and a $14M EPA settlement.
Capital plan of about $6.7B for 2006-2010 (excluding nuclear fuel), including roughly $1.5B for Sammis NSR environmental controls and $1.8B for broader environmental compliance.
Ohio RCP approved January 2006 maintains base distribution rates through 2008-2009 and defers fuel and distribution costs; Ohio's 2007 competitive bid auction drew insufficient interest and will not proceed in 2006.
Material weakness disclosed in NUG regulatory accounting at Met-Ed and Penelec; disclosure controls were deemed ineffective for those two registrants only.
Investment-grade senior unsecured ratings maintained (S&P BBB-, Moody's Baa3, Fitch BBB-), with outlooks positive at Moody's and Fitch and stable at S&P; $1.0B remaining on the 2003 shelf registration.

03—Questions

Frequently Asked Questions

Why did FirstEnergy's GAAP earnings decline in 2005 even though operating results improved?
GAAP net income fell to $861M from $878M, but the decline is largely from unusual items: a $28M DOJ/NRC penalty tied to Davis-Besse, a $30M FIN 47 charge, and Ohio tax adjustments. Management's non-GAAP measure, earnings before unusual items, was $984M versus $991M, so the underlying trend was modestly lower, not improved.
What are the main regulatory risks to FirstEnergy's earnings and cash flow?
The biggest risks are the Met-Ed/Penelec supply arrangement with FES, which FES can terminate on 60 days' notice and which could force purchased-power cost increases and rating pressure if not offset by PPUC relief; the FERC proceeding on the FES power sales agreements, with an initial decision expected in fall 2006; and the NJBPU's handling of JCP&L's securitization and NUG cost-recovery requests.
How large is the capital spending commitment and what drives it?
Management forecasts about $6.7 billion of capital expenditures for 2006-2010 excluding nuclear fuel. The largest components are FES generation (about $2.0B) and JCP&L and CEI distribution, with environmental compliance including roughly $1.5B for the Sammis NSR settlement, which was expected to be spent mainly from 2008 to 2011.
Does FirstEnergy have adequate liquidity and access to capital markets?
Yes, based on the filing. The company had about $731M of short-term debt at year-end against a $2B revolving facility and roughly $1.75B of unused credit and receivables capacity. Subsidiaries paid $1.3B in cash dividends to the holding company in 2005, and the company retained investment-grade ratings with positive outlooks at two of the three agencies.
What open legal or control issues should investors monitor?
Investors should watch the SEC formal order of investigation covering the 2003 restatement and Davis-Besse matters, the NRC's Perry plant oversight with a possible impact on operating authority, the August 2003 blackout complaints, and remediation of the Met-Ed and Penelec internal control weakness planned for the first quarter of 2006.

04—Continue

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