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| PPL > SEC Filings for PPL > Form 10-Q on 1-Aug-2008 | All Recent SEC Filings |
1-Aug-2008
Quarterly Report
PPL is an energy and utility holding company with headquarters in Allentown, Pennsylvania. In PPL's 2007 Form 10-K, descriptions of its domestic and international businesses are found in "Item 1. Business - Background." Through its subsidiaries, PPL is primarily engaged in the generation and marketing of electricity in two key markets - the northeastern and western U.S. - and in the delivery of electricity in Pennsylvania and the U.K. PPL's reportable segments are Supply, International Delivery and Pennsylvania Delivery. In 2007, PPL sold its regulated electricity delivery businesses in Latin America, which were included in the International Delivery segment. In July 2007, PPL announced its intention to sell its natural gas distribution and propane businesses, which are included in the Pennsylvania Delivery segment. See Note 8 to the Financial Statements for information on the sales and planned divestitures. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Overview" in PPL's 2007 Form 10-K for a discussion of PPL's strategy and the risks and the challenges that it faces in its business. See "Forward-Looking Information," Note 10 to the Financial Statements and the rest of Item 2 in this Form 10-Q and "Item 1A. Risk Factors" and the rest of Item 7 in PPL's 2007 Form 10-K for more information concerning the material risks and uncertainties that PPL faces in its businesses and with respect to its future earnings.
The following information should be read in conjunction with PPL's Condensed Consolidated Financial Statements and the accompanying Notes and with PPL's 2007 Form 10-K.
Terms and abbreviations are explained in the glossary. Dollars are in millions, except per share data, unless otherwise noted.
The following discussion begins with a summary of PPL's earnings. "Results of Operations" continues with a review of results by reportable segment and a description of key factors by segment that management expects may impact future earnings. This section ends with explanations of significant changes in principal items on PPL's Statements of Income, comparing the three and six months ended June 30, 2008, with the same periods in 2007.
Earnings
Net income and the related EPS were:
Three Months Ended June 30, Six Months Ended June 30,
2008 2007 2008 2007
Net income $ 190 $ 345 $ 450 $ 548
EPS - basic $ 0.51 $ 0.89 $ 1.21 $ 1.42
EPS - diluted $ 0.50 $ 0.88 $ 1.19 $ 1.41
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The changes in net income from period to period were, in part, attributable to several special items that management considers significant. Details of these special items are provided within the review of each segment's earnings.
The period-to-period changes in significant earnings components are explained in the "Statement of Income Analysis."
The results for interim periods can be disproportionately influenced by various factors and developments and by seasonal variations, and as such, the results of operations for interim periods do not necessarily indicate results or trends for the year or for future operating results.
Segment Results
Net income by segment was:
Three Months Ended June 30, Six Months Ended June 30,
2008 2007 2008 2007
Supply $ 97 $ 132 $ 199 $ 249
International
Delivery 62 183 160 211
Pennsylvania
Delivery 31 30 91 88
Total $ 190 $ 345 $ 450 $ 548
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Supply Segment
The Supply segment primarily consists of the domestic energy marketing, domestic
generation and domestic development operations of PPL Energy Supply. In August
2007, PPL completed the sale of its domestic telecommunication operations. See
Note 8 to the Financial Statements for additional information.
Supply segment net income was:
Three Months Ended June 30, Six Months Ended June 30,
2008 2007 2008 2007
Energy
revenues
External (a) $ (88 ) $ 410 $ 202 $ 690
Intersegment 428 422 917 903
Energy-related
businesses 122 176 229 351
Total
operating
revenues 462 1,008 1,348 1,944
Fuel and
energy
purchases
External (a) (150 ) 345 107 649
Intersegment 30 38 59 75
Other
operation and
maintenance 207 178 434 353
Depreciation 50 42 94 83
Taxes, other
than income 7 10 9 18
Energy-related
businesses 116 197 221 394
Total
operating
expenses 260 810 924 1,572
Other Income -
net 4 8 4 12
Interest
Expense 50 40 91 75
Income Taxes 58 34 137 59
Minority
Interest 1 1 1
Net Income $ 97 $ 132 $ 199 $ 249
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(a) Includes unrealized gains and losses from economic hedge activity. See Note 14 to the Financial Statements for additional information.
The after-tax change in net income between these periods was due to the following factors.
June 30, 2008 vs. June 30, 2007
Three Months Six Months
Ended Ended
Eastern U.S.
non-trading
margins $ (24 ) $ (36 )
Western U.S.
non-trading
margins 1 2
Net energy trading
margins 25 19
Taxes, other than
income 1 5
Depreciation (5 ) (7 )
Other operating
expenses (2 ) (12 )
Earnings from
synfuel projects (7 ) (34 )
Realized earnings
on nuclear plant
decommissioning
trust (3 )
Financing costs (5 ) (9 )
Other (6 ) (3 )
Special items (13 ) 28
$ (35 ) $ (50 )
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· See "Domestic Gross Energy Margins" for an explanation of non-trading margins by geographic region and for an explanation of net energy trading margins.
· Higher other operating expenses for the six months ended June 30, 2008, were attributable to higher operating costs at the fossil/hydro generating stations (including higher outage costs at the Eastern U.S. fossil/hydro stations) and higher operating costs in the energy marketing business. Partially offsetting these increases were lower outage costs at the Susquehanna nuclear station.
· Lower earnings contribution from synfuel projects for both periods was the result of the expiration of federal tax credits and closure of the synfuel facilities at the end of 2007.
The following after-tax amounts, which management considers special items, also had a significant impact on the Supply segment earnings. See the indicated Notes to the Financial Statements for additional information.
Three Months Ended June 30, Six Months Ended June 30,
2008 2007 2008 2007
Mark-to-market
adjustments from
certain economic
hedges (a) $ 4 $ 16 $ 54 $ 26
Impairment of
nuclear plant
decommissioning
trust investments
(Note 12) (4 ) (4 )
Sale of domestic
telecommunication
operations (Note
8) (2 ) (20 )
PJM billing
dispute (b) (1 )
Off-site
remediation of
ash basin leak
(Note 10) 1 1
Colstrip
groundwater
litigation (Note
10) (5 )
Synthetic fuel
tax adjustment
(Note 10) (13 )
Total $ 1 $ 14 $ 33 $ 5
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(a) These economic hedge transactions do not qualify for hedge accounting under
SFAS 133, or hedge accounting was not elected; however, they economically
hedge a specific risk and do not represent speculative trading
activity. These transactions are highly probable of going to physical
delivery; therefore, the mark-to-market gains or losses on these
transactions will reverse by the time the transactions settle in the
future. See "Domestic Gross Energy Margins by Region" and Note 14 to the
Financial Statements for additional information regarding economic
activity.
(b) Represents additional interest related to the settlement of this litigation
in 2007.
Outlook
Excluding special items, PPL projects lower earnings for its Supply segment in 2008 compared with 2007 as a result of the loss of synfuel-related benefits and higher depreciation and operating expenses for scrubbers that have been or will be installed during 2008 at its Montour and Brunner Island coal-fired power plants. PPL now expects its energy margins to be flat in 2008 compared with 2007. During the second half of 2008, increased margins as a result of higher-valued wholesale energy contracts and higher expected base-load generation are expected to be offset by higher coal commodity and transportation costs, and lower expected margins from PPL's marketing and trading activities as a result of reduced liquidity in certain energy markets.
The earnings projection for 2008 does not include the impact of a potential impairment of PPL's emission allowances. In July 2008, the United States Court of Appeals for the D.C. Circuit invalidated the EPA's Clean Air Interstate Rule (CAIR), stating that a regional cap-and-trade program cannot be used to facilitate attainment of the ozone and fine particulates standards.
As a result of this Court decision, PPL now anticipates that its annual nitrogen oxide allowances and its sulfur dioxide allowances may be impaired. The combined book value for these emission allowances was approximately $100 million at June 30, 2008, excluding the seasonal nitrogen oxide allowances unaffected by the Court's ruling. The amount of any third quarter 2008 impairment charge will be based on, among other factors, an assessment of the emission allowances PPL expects to consume in future periods, and prevailing market prices. As a result of the Court's decision, PPL also is reviewing aspects of its previously announced program to install certain pollution control equipment to meet the CAIR requirements. In addition, as a part of the analysis of the potential financial impacts of this decision, PPL is reviewing the relevant contracts for the purchase of these allowances. See Note 10 to the Financial Statements for additional information.
Although the annual planning cycle is not yet completed, PPL expects 2009 earnings for its Supply segment to be lower than projected 2008 earnings, excluding special items. Factors contributing to these lower earnings are rising delivered fuel prices and the completion of the scrubber construction program, coupled with lower sulfur dioxide allowance prices. PPL's ability to recover these fuel cost increases is constrained by the existence of the fixed-price PLR contract that expires at the end of 2009.
As discussed in "Item 1A. Risk Factors" in PPL's 2007 Form 10-K, activities by the FERC, other governmental authorities and other involved parties can have a significant effect on market prices for wholesale electricity, and thus on the margins that PPL EnergyPlus achieves on its future sales of energy. In April 2008, the FERC denied PJM's request to increase the Cost of New Entry element of the PJM capacity pricing formula. In a separate action, in connection with Duquesne Light Company's (Duquesne) decision to leave PJM, in April 2008 the FERC ruled that PJM may grant capacity resources in the Duquesne zone transmission rights that would facilitate inclusion of such capacity in PJM's Reliability Pricing Model (RPM) capacity markets, beginning with the 2011-2012 planning year auction, notwithstanding that such capacity would be treated as external generation to PJM at the time it had to be delivered. In response, PJM has indicated that it will grant generators in the Duquesne zone of PJM the necessary transmission rights. These FERC and PJM actions reduced capacity prices for the 2011-2012 RPM capacity auction that took place in May 2008 and could reduce capacity prices for future RPM capacity auctions. Because a large portion of PPL's generating capacity is located in PJM, the impact of any such reduced RPM capacity prices on PPL could be material. PPL cannot predict the ultimate outcome of these or related FERC proceedings and the impact on capacity prices in PJM or on PPL's financial results. See Note 10 to the Financial Statements for information on recent FERC litigation related to the RPM pricing model.
International Delivery Segment
The International Delivery segment includes operations of the international energy businesses of PPL Global that are primarily focused on the distribution of electricity. PPL Global's major remaining international business is located in the U.K. In 2007, PPL completed the sale of its Latin American operating businesses. In the first quarter of 2008, PPL Global recognized income tax adjustments and other expenses in Discontinued Operations as the dissolution of the remaining Latin American holding companies commenced. PPL Global may recognize additional adjustments and/or expenses in Discontinued Operations until this process is complete. See Note 8 to the Financial Statements for additional information.
The International Delivery segment results in 2008 and 2007 reflect the reclassification of Latin American revenues and expenses to Discontinued Operations.
International Delivery segment net income was:
Three Months Ended June 30, Six Months Ended June 30,
2008 2007 2008 2007
Utility
revenues $ 211 $ 218 $ 452 $ 434
Energy-related
businesses 9 9 18 19
Total
operating
revenues 220 227 470 453
Other
operation and
maintenance 50 69 96 125
Depreciation 35 35 71 78
Taxes, other
than income 17 16 34 32
Energy-related
businesses 3 4 6 9
Total
operating
expenses 105 124 207 244
Other Income -
net 1 6 4 17
Interest
Expense 34 45 72 94
Income Taxes 20 (18 ) 40 (3 )
Income from
Discontinued
Operations 101 5 76
Net Income $ 62 $ 183 $ 160 $ 211
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The after-tax change in net income between these periods was due to the following factors, including Discontinued Operations.
June 30, 2008 vs. June 30, 2007
Three Months Six Months
Ended Ended
U.K.:
Delivery margins $ 2 $ 18
Depreciation 5
Other operating
expenses 5 11
Interest expense 3 6
Income taxes (1 ) 12
Foreign currency
exchange rates 1 2
Hyder liquidation
distributions
(Note 8) (1 ) (3 )
Gain on transfer
of equity
investment (Note
8) (5 )
Other (1 ) (4 )
Discontinued
operations (Note
8) (18 ) (28 )
Change in tax
reserves (Note 5) (31 ) (31 )
Other 3 9
Special item (83 ) (43 )
$ (121 ) $ (51 )
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· The U.K.'s earnings for the six months ended June 30, 2008, were favorably impacted by higher delivery margins primarily due to higher prices, which include the annual regulatory adjustment for inflation.
· Lower U.K. other operating expenses for both periods were primarily due to lower pension expense resulting from an improvement in the fair value of pension assets and an increase in the discount rate, partially offset by lower mortality rates.
· Lower U.K. income taxes for the six months ended June 30, 2008, were primarily due to a favorable U.K. taxing authority determination in 2008 related to deductibility of imputed interest on a loan from Hyder.
The following after-tax amount, which management considers a special item, also had a significant impact on the International Delivery segment earnings.
Three Months Ended June 30, Six Months Ended June 30,
2008 2007 2008 2007
Sale of
Latin
American
businesses
(Note 8) $ 83 $ 43
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Outlook
Excluding special items, PPL projects the earnings of its International Delivery segment will decline in 2008 compared with 2007. This decline is a result of the 2007 sale of PPL's Latin American businesses and higher U.S. income taxes primarily driven by certain U.S. income tax benefits realized in 2007. Partially offsetting the impact of these negative earnings drivers are lower U.K. pension expense and lower financing costs.
Pennsylvania Delivery Segment
The Pennsylvania Delivery segment includes the regulated electric and gas delivery operations of PPL Electric and PPL Gas Utilities. In 2007, PPL announced its intention to sell its natural gas distribution and propane businesses. See Note 8 to the Financial Statements for additional information.
The Pennsylvania Delivery segment results in 2008 and 2007 reflect the reclassification of the natural gas distribution and propane businesses' revenues and expenses to Discontinued Operations.
Pennsylvania Delivery segment net income was:
Three Months Ended June 30, Six Months Ended June 30,
2008 2007 2008 2007
Operating
revenues
External $ 770 $ 760 $ 1,649 $ 1,625
Intersegment 30 38 59 75
Total
operating
revenues 800 798 1,708 1,700
Fuel and
energy
purchases
External 44 50 85 101
Intersegment 428 422 917 903
Other
operation
and
maintenance 103 100 207 194
Amortization
of
recoverable
transition
costs 68 70 144 151
Depreciation 33 33 65 65
Taxes, other
than income 48 46 104 100
Total
operating
expenses 724 721 1,522 1,514
Other Income
- net 3 7 8 19
Interest
Expense 26 35 55 71
Income Taxes 19 15 49 44
Dividends on
Preferred
Securities 4 4 9 9
Income from
Discontinued
Operations 1 10 7
Net Income $ 31 $ 30 $ 91 $ 88
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The after-tax change in net income between these periods was due to the following factors, including Discontinued Operations.
June 30, 2008 vs. June 30, 2007
Three Months Ended Six Months Ended
Delivery revenues
(net of CTC/ITC
amortization,
interest expense on
transition bonds
and ancillary
charges) $ 6 $ 16
Operating expenses (3 ) (10 )
Other (1 ) (2 )
Special item (1 ) (1 )
$ 1 $ 3
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· Higher delivery revenues were attributable to normal load growth and a PPL Electric base rate increase effective January 1, 2008.
· Higher operating expenses were primarily due to increased usage of contractors and other inflationary increases.
The following after-tax amount, which management considers a special item, also had an impact on the Pennsylvania Delivery segment earnings.
Three Months Ended June 30, Six Months Ended June 30, 2008 2007 2008 2007
Impairment
of gas and
propane
businesses
(Note 8) $ (1 ) $ (1 )
Outlook
Excluding special items, PPL projects higher earnings for its Pennsylvania Delivery segment, driven by higher revenues as a result of PPL Electric's new distribution rates that became effective January 1, 2008, partially offset by higher operating expenses.
In May 2007, the PUC approved final regulations regarding the obligation of Pennsylvania electric utilities to provide default electricity supply in 2011 and beyond. The new regulations provide that default service providers will acquire electricity supply at prevailing market prices pursuant to procurement and implementation plans approved by the PUC. The regulations also address the utilities' recovery of market supply costs. The final regulations became effective in September 2007.
In May 2007, the PUC approved PPL Electric's plan to procure default electricity supply in 2007-2009 for retail customers who do not choose an alternative competitive supplier in 2010 after PPL Electric's PLR contract with an affiliate expires. Under the plan, PPL Electric was approved to issue a series of competitive bids for such supply in 2007, 2008 and 2009. Each solicitation is for 850 MW of expected generation supply, or one-sixth of PPL Electric's expected PLR supply requirement in 2010. The average generation supply prices (per MWh), including Pennsylvania gross receipts tax and an adjustment for line losses, for the first three solicitations were as follows:
Residential Small Commercial and Small Industrial
July 2007 $ 101.77 $ 105.11
October 2007 105.08 105.75
March 2008 108.80 108.76
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As a result, PPL Electric has contracted for one-half of the electricity supply it expects to need for 2010. If the average prices paid for the supply purchased so far were to be the same for the remaining three purchases, the average residential customer's monthly bill in 2010 would increase about 34.4% over 2009 levels, while small commercial and small industrial bills would increase in the range of 23.8% to 42.8%. The estimated increases include Pennsylvania gross receipts tax, an adjustment for line losses, PPL Electric's January 1, 2008 rate increase and a court-ordered rate adjustment in 2007. Actual 2010 prices will not be known until all six supply purchases have been made. The fourth solicitation will be conducted in September 2008.
In addition, the Governor of Pennsylvania proposed an Energy Independence Strategy (Strategy) in early 2007 which, among other things, contains initiatives to address PLR issues. For example, under the Strategy as originally proposed, retail customers could elect to phase-in over three years any initial generation rate increase approved by the PUC. Also, PLR providers would be required to obtain a "least cost portfolio" of supply by purchasing power in the spot market and through contracts of varying lengths, and the provider would be required to procure energy conservation resources before acquiring additional power. In addition, PLR providers could enter into long-term contracts with large energy users and alternative energy developers. It is uncertain at this time whether the details of implementing the Strategy, including the issues of deferral of costs and recovery of interest for the customer rate phase-in program and the timing of PUC approval for PLR supply portfolios, will be delegated to the PUC.
Components of the Strategy are included in various bills. One such bill that passed in the Pennsylvania House of Representatives in February 2008 contains conservation and demand-side management targets and mandatory deployment of smart metering technology. The bill provides for full and current cost recovery through an energy efficiency and demand-side management recovery mechanism.
In September 2007, the Pennsylvania General Assembly (General Assembly) convened a special session to address the proposals in the Governor's Strategy. The Pennsylvania Senate has formed a special committee to manage legislation for the special legislative session. As an alternative to the $850 million Energy Independence Fund that the Governor initially proposed, the General Assembly passed, and the Governor signed, a bill that would create a $650 million fund for clean energy projects, conservation and energy efficiency initiatives and pollution control projects that would be funded through revenue bonds and gross receipts tax revenue, which will increase as rate caps expire.
Since September 2007, PPL and PPL Electric have been working with Pennsylvania legislators, regulators and other stakeholders to develop constructive measures to help customers transition to market rates after 2009, including a variety of rate mitigation, educational and energy conservation programs, consistent with . . .
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