01—Abstract
Summary
Summary of the 10-K filed February 23, 2006. Cited figures are marked; the original filing is the authoritative source.
Sempra Energy (SRE) reported 2005 results that were solidly profitable at the bottom line but heavily affected by a large one-time charge tied to California energy crisis litigation.
Net income rose 2.8% to $920 milliona, while diluted EPS fell 4.7% to $3.65, largely because of roughly 19.7 million shares issued in 2005 to settle the 2002 Equity Units. Operating income fell to $1,111 million from $1,281 million, primarily due to a $551 million litigation expense, which included an after-tax $116 million charge recorded in Q4 2005 to fund settlements of the Continental Forge and Nevada antitrust cases. Operating revenues grew about 24% to $11.7 billion, driven by higher natural gas prices and strong trading results at Sempra Commodities, which earned $460 million of net income, up from $320 million.
The earnings mix is a key investor takeaway. The California Utilities (SoCalGas and SDG&E) produced about $473 millionb of net income, which provides relatively stable, regulated earnings. Sempra Commodities, a volatile trading business, now contributes about half of consolidated net income, which raises the importance of its credit rating, margin requirements and liquidity.
The filing notes that a ratings downgrade could trigger collateral calls and constrain trading. Other items to watch include the DWR power contract dispute, the Argentine investment arbitration, several unresolved energy-crisis lawsuits, and capital spending plans of roughly $2.3 billionc in 2006 focused on LNG terminals and California utility infrastructure. Shareholders' equity rose to $6.16 billion, and book value per share increased to $23.95.
The board also approved a quarterly dividend increase to $0.30d per share. Overall, the 2005 results reflect strong operating performance outside the litigation charge, but earnings quality depends on volatile trading income and on the outcome of several large legal and regulatory matters. Investors should weigh the expected settlement payments, the DWR arbitration, and the sustainability of trading margins when assessing the company's outlook.
02—Key points
Key Highlights
- Net income was $920 million in 2005, up 2.8% from $895 million, while diluted EPS declined 4.7% to $3.65 because of about 19.7 million new shares issued to settle Equity Units.
- Operating income fell 13% to $1,111 million, mainly because litigation expense rose to $551 million, including an after-tax $116 million Q4 charge for energy-crisis settlements totaling $585 million in reserves.
- Operating revenues increased 24% to $11.7 billion, reflecting higher natural gas prices and increased trading activity at Sempra Commodities.
- Sempra Commodities earned $460 million of net income (up from $320 million), now about half of consolidated earnings, which adds volatility and collateral and credit-rating sensitivity.
- The California Utilities earned $473 million combined, providing relatively stable, regulated earnings; SDG&E's ROE was approved at 10.7%.
- Key legal exposures remain, including the DWR 1,900 MW power contract dispute (trial set for September 2006), Argentine investment arbitration, and a California Attorney General lawsuit against Sempra Commodities seeking hundreds of millions of dollars.
- Planned 2006 capital expenditures and investments total $2.3 billion, including $600 million for LNG terminals; the Twin Oaks plant is being sold for $480 million, and the dividend was raised to $0.30 per quarter.
03—Questions
Frequently Asked Questions
Why did Sempra's diluted EPS decline in 2005 even though net income increased?
Net income rose 2.8% to $920 million, but diluted EPS fell 4.7% to $3.65. The main reason is dilution: about 19.7 million common shares were issued in 2005 to settle the 2002 Equity Units, which increased the weighted-average share count to about 252 million on a diluted basis from about 234 million the prior year.
How large is the California energy crisis litigation exposure, and how is it reserved?
In January 2006 Sempra agreed to settle several class action antitrust suits, subject to court approval. Total reserves were increased to $743 million at December 31, 2005, of which $585 million relates to the settled matters and $158 million covers continuing litigation. Settlement cash payments total $377 million in installments through about 2013, and the company also agreed to a price discount on DWR contract power. Costs could still differ materially from these estimates.
What risks does Sempra Commodities create for investors?
Sempra Commodities is a large trading business with significant earnings volatility and substantial margin requirements. Its trading assets were about $10.4 billion at year-end 2005. Because most of its obligations are guaranteed by Sempra Energy, a credit-rating downgrade could force collateral postings, make trading more costly, and divert liquidity away from other non-utility businesses. Trading counterparty credit exposure is also significant, with about $910 million owed by its 20 largest customers.
What is the status of the DWR power contract and why does it matter?
Sempra Generation has a 10-year contract to supply up to 1,900 MW to California's Department of Water Resources. The California Court of Appeal reversed a summary judgment in Sempra's favor in June 2005, and the case has been remanded for trial in September 2006. The DWR is also pursuing arbitration over operational performance and seeks to terminate the contract. Sempra voluntarily reduced the contract price by $4.15 per MWh as part of the settlement, which the filing values at up to about $300 million over the remaining term. An adverse outcome could materially affect Sempra Generation's revenues, which were $1.9 billion in 2005.
04—Continue