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| EIX > SEC Filings for EIX > Form 10-Q on 8-Aug-2008 | All Recent SEC Filings |
8-Aug-2008
Quarterly Report
This MD&A for the three- and six-month periods ended June 30, 2008 discusses material changes in the consolidated financial condition, results of operations and other developments of Edison International since December 31, 2007, and as compared to the three- and six-month periods ended June 30, 2007. This discussion presumes that the reader has read or has access to Edison International's MD&A for the calendar year 2007 (the year-ended 2007 MD&A), which was included in Edison International's 2007 annual report to shareholders and incorporated by reference into Edison International's Annual Report on Form 10-K for the year ended December 31, 2007, filed with the Securities and Exchange Commission.
This MD&A contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements reflect Edison International's current expectations and projections about future events based on Edison International's knowledge of present facts and circumstances and assumptions about future events and include any statement that does not directly relate to a historical or current fact. Other information distributed by Edison International that is incorporated in this report, or that refers to or incorporates this report, may also contain forward-looking statements. In this report and elsewhere, the words "expects," "believes," "anticipates," "estimates," "projects," "intends," "plans," "probable," "may," "will," "could," "would," "should," and variations of such words and similar expressions, or discussions of strategy or of plans, are intended to identify forward-looking statements. Such statements necessarily involve risks and uncertainties that could cause actual results to differ materially from those anticipated. Some of the risks, uncertainties and other important factors that could cause results to differ, or that otherwise could impact Edison International or its subsidiaries, include, but are not limited to:
• the ability of Edison International to meet its financial obligations and to pay dividends on its common stock if its subsidiaries are unable to pay dividends;
• the ability of SCE to recover its costs in a timely manner from its customers through regulated rates;
• decisions and other actions by the CPUC, the FERC and other regulatory authorities and delays in regulatory actions;
• market risks affecting SCE's energy procurement activities;
• access to capital markets and the cost of capital;
• changes in interest rates, rates of inflation beyond those rates which may be adjusted from year to year by public utility regulators and foreign exchange rates;
• governmental, statutory, regulatory or administrative changes or initiatives affecting the electricity industry, including the market structure rules applicable to each market;
• environmental laws and regulations, both at the state and federal levels, that could require additional expenditures or otherwise affect the cost and manner of doing business;
• risks associated with operating nuclear and other power generating facilities, including operating risks, nuclear fuel storage, equipment failure, availability, heat rate, output, and availability and cost of spare parts and repairs;
• the cost and availability of labor, equipment and materials;
• the ability to obtain sufficient insurance, including insurance relating to SCE's nuclear facilities;
• effects of legal proceedings, changes in or interpretations of tax laws, rates or policies, and changes in accounting standards;
• the outcome of disputes with the IRS and other tax authorities regarding tax positions taken by Edison International;
• supply and demand for electric capacity and energy, and the resulting prices and dispatch volumes, in the wholesale markets to which EMG's generating units have access;
• the cost and availability of coal, natural gas, fuel oil, nuclear fuel, and associated transportation to the extent not recovered through regulated rate cost escalation provisions or balancing accounts;
• the cost and availability of emission credits or allowances for emission credits;
• transmission congestion in and to each market area and the resulting differences in prices between delivery points;
• the ability to provide sufficient collateral in support of hedging activities and purchased power and fuel;
• the risk of counterparty default in hedging transactions or power-purchase and fuel contracts;
• the extent of additional supplies of capacity, energy and ancillary services from current competitors or new market entrants, including the development of new generation facilities and technologies;
• the difficulty of predicting wholesale prices, transmission congestion, energy demand and other aspects of the complex and volatile markets in which EMG and its subsidiaries participate;
• general political, economic and business conditions;
• weather conditions, natural disasters and other unforeseen events;
• changes in the fair value of investments and other assets; and
• the risks inherent in the development of generation projects as well as transmission and distribution infrastructure replacement and expansion including those related to siting, financing, construction, permitting, and governmental approvals.
Additional information about risks and uncertainties, including more detail about the factors described above, are discussed throughout this MD&A and in the "Risk Factors" section included in Part I, Item 1A of Edison International's Annual Report on Form 10-K. Readers are urged to read this entire report, including the information incorporated by reference, and carefully consider the risks, uncertainties and other factors that affect Edison International's business. Forward-looking statements speak only as of the date they are made and Edison International is not obligated to publicly update or revise forward-looking statements. Readers should review future reports filed by Edison International with the Securities & Exchange Commission.
Edison International is engaged in the business of holding, for investment, the common stock of its subsidiaries. Edison International's principal operating subsidiaries are SCE, a rate-regulated electric utility, and EMG. EMG is the holding company for its principal wholly owned subsidiaries, EME, which is engaged in the business of developing, acquiring, owning or leasing, operating and selling energy and capacity from independent power production facilities, and Edison Capital, a provider of capital and financial services.
In this MD&A, except when stated to the contrary, references to each of Edison International, SCE, EMG, EME or Edison Capital mean each such company with its subsidiaries on a consolidated basis. References to Edison International (parent) or parent company mean Edison International on a stand-alone basis, not consolidated with its subsidiaries.
This MD&A is presented in 8 major sections. The company-by-company discussion of SCE, EMG, and Edison International (parent) includes discussions of liquidity, market risk exposures, and other matters (as relevant to each principal business segment). The remaining sections discuss Edison International on a consolidated basis. The consolidated sections should be read in conjunction with the discussion of each company's section.
The following section provides a summary of current developments related to Edison International's principal business segments. This section is intended to be a summary of those current developments that management believes are of most importance. This section is not intended to be an all-inclusive list of all current developments related to each principal business segment and should be read together with all sections of this MD&A.
EDISON INTERNATIONAL: CURRENT DEVELOPMENTS
Federal and State Income Taxes
Since the late 1990s, the IRS has been challenging tax return positions related to cross-border leveraged lease transactions. During the second quarter of 2008, several court developments addressing income taxation of cross-border leveraged leases occurred. As previously disclosed, Edison Capital had entered into several cross-border leveraged lease transactions: a foreign power plant and an electric locomotive sale/leaseback transaction entered into in 1993 and 1994 (which the IRS refers to as a sale-in/lease-out or "SILO" transaction), foreign power plants and an electric transmission system lease/leaseback transaction entered into in 1997 and 1998 (which the IRS refers to as a lease-in/lease-out or "LILO" transaction), and a lease/service contract transaction entered into in 2000 - 2002 involving a foreign telecommunications system (which the IRS also refers to as a "SILO" transaction).
The court developments represent increased uncertainty about the tax treatment of SILOs and LILOs generally. The IRS continues to challenge tax benefits taken by Edison Capital in its 1993 - 1994 and 1997 - 1998 transactions and is expected to challenge Edison Capital's 2000-2002 transactions. Despite these developments, Edison International believes it properly reported these transactions based on applicable statutes, regulations and case law and, in the absence of any settlement with the IRS, will continue to vigorously defend its tax treatment of these leases.
Recent developments, however, underscore the uncertain nature of tax conclusions in this area. Edison International believes that its maximum earnings exposure related to these leases, measured as of June 30, 2008, is approximately $1.25 billion after taxes. The exposure includes recomputing the cumulative earnings under the leases in accordance with lease accounting rules, and recording related interest. This exposure does not include IRS asserted penalties of 20%, as Edison International does not believe that even if the tax benefits taken by Edison Capital are successfully challenged by the IRS that these penalties would be sustained. The current and future income and cash positions of SCE and EME are virtually unaffected by these leases.
Edison International will continue to monitor and evaluate its lease transactions with respect to future events. Future adverse developments, including further adverse case law developments, could change Edison International's current conclusions.
As previously disclosed, Edison International has been engaged in settlement negotiations with the IRS. These negotiations seek to resolve the lease issues in their entirety and all other outstanding tax disputes for the years 1994 through 2002, including certain affirmative claims for unrecognized tax benefits. See "Edison International Notes to Consolidated Financial Statements-Note 3. Income Taxes." These negotiations have progressed to the point where Edison International and the IRS have reached nonbinding, preliminary understandings on the material principles for resolving such tax disputes on a "global" basis, including the lease issues. Final resolution of such disputes, however, is subject to reaching definitive agreements on final terms and calculations, mutually satisfactory documentation, and review of all or a portion of such settlements by the Staff of the Joint Committee on Taxation, a committee of the United States Congress (the "Joint Committee").
Were Edison International and the IRS to implement the preliminary understanding regarding the leases, Edison International anticipates that it will be required to terminate the leases as an interim step in the implementation of
the overall settlement before executing final agreements with the IRS and before review by the Joint Committee. Edison Capital and its subsidiaries have executed term sheets with the counterparties to its SILOs and LILOs which contemplate termination of the leases subject to the parties agreeing to and executing definitive agreements and to a final settlement agreement with the IRS. Upon termination of the leases, the lessees would be required to make termination payments from certain collateral deposits associated with the leases.
Termination of the leases, which may occur in 2008, would result in Edison International recording an after-tax charge to earnings currently estimated to be at least $650 million, and potentially up to the maximum earnings exposure indicated above. If all settlements included in the global settlement discussions were ultimately concluded consistent with the preliminary understandings, Edison International would expect that the settlement of the disputed lease issues and the resolution of the above-mentioned affirmative claims would result in a portion of the charge initially recorded upon termination of the leases being offset and/or reduced, and the net after-tax earnings charge that would remain is currently expected to be less than half of the maximum after-tax earnings exposure, calculated as of June 30, 2008, discussed above. Were all settlements completed in a manner consistent with the preliminary understandings, the net cash impact upon Edison International as a whole of the settlements and lease terminations would be positive over time, and it is not anticipated that borrowings would be required in connection with implementation of the settlements.
There can be no assurance, however, about the timing of final settlements with the IRS or that such final settlements will be ultimately consummated. Moreover, even if final settlements are reached with the IRS, review by the Joint Committee could result in adjustments. The IRS and Edison International may not reach final agreements that implement the preliminary understandings, or they may reach final agreements but conditions to consummating them may not be satisfied. If Edison International terminated the SILO and LILO leases without consummating the settlements, then it could not seek through litigation with the IRS future deferred tax benefits that may have been otherwise available in the absence of termination.
To the extent that an acceptable settlement is not reached with the IRS, Edison International will continue to vigorously defend its tax treatment of the leases and is prepared to take legal action. If Edison International were to commence litigation in certain forums, it would need to make payments of the disputed taxes, along with interest and any penalties asserted by the IRS, and thereafter pursue refunds. In the other litigation forum (the Tax Court), no upfront payment would be required. In 2006, Edison International paid $111 million of the taxes, interest and penalties for tax year 1999 followed by a refund claim for the same amount. The IRS did not act on this refund claim within the statutory six month period, which provides Edison International with the option of being able to take legal action to assert its refund claim. To the extent an acceptable settlement is not reached with the IRS, Edison International would expect to file a refund claim for any taxes and penalties paid for the 1994 - 1996 tax years related to the leases. Edison International has not decided whether and to what extent it would make additional payments related to later tax years to fund its right to litigate in certain forums should the global settlement discussed above not be consummated. See "Federal and State Income Taxes" for further information.
Enterprise-Wide Software System Project
Progress continued during 2008 for the installation of SAP's Enterprise Resource Planning system. On July 1, 2008, Edison International implemented SAP's financial, supply chain, and certain work management modules at SCE. In addition, Edison International also implemented the human resources module at SCE and EMG. Edison International expects to implement additional SAP modules in the future.
SCE: CURRENT DEVELOPMENTS
2009 General Rate Case Proceeding
On November 19, 2007, SCE filed its GRC application and subsequently revised its requested 2009 base rate revenue requirement to $5.162 billion. After considering the effects of sales growth and other offsets, SCE's request would be a $695 million increase over current authorized base rate revenue. On April 15, 2008, the DRA submitted testimony recommending that SCE's 2009 base rate revenue requirement be increased by approximately $19 million, $676 million less than SCE's revised request, mainly due to: reductions in capital-related costs, operating and maintenance expense, administrative and general expense, and other miscellaneous proposed reductions. Testimony submitted by TURN, another intervenor, seeks to reduce SCE's 2009 request by an additional $195 million over the DRA proposed adjustments, mainly due to reduced depreciation expense. See "SCE: Regulatory Matters-Current Regulatory Developments-2009 General Rate Case Proceeding" for further discussion.
2009 FERC Rate Case
On August 1, 2008, SCE filed a revision to its Transmission Owner Tariff with a
requested effective date of October 1, 2008 to reflect a proposed $129 million
increase in its retail transmission revenue requirements (or a 39% increase over
the current retail transmission revenue requirement). If the FERC approves this
requested increase, this would amount to a 1.2% system average rate increase due
to an increase in transmission capital-related costs as well as the increases in
transmission operating and maintenance expenses that SCE expects to incur in
2009 to maintain grid reliability. The proposed transmission revenue requirement
is based on an overall return on equity of 12.7%, which is composed of a 12.0%
base ROE and 0.7% in transmission incentives previously approved by the FERC
(see "SCE: Regulatory Matters-Current Regulatory Developments-FERC Construction
Work in Progress Mechanism" for further information). As discussed in "SCE:
Liquidity-Capital Expenditures," SCE is experiencing significant growth in
actual and planned expenditures to replace and expand its transmission
infrastructure.
Solar Photovoltaic Program
On March 27, 2008, SCE filed an application with the CPUC to implement its Solar Photovoltaic (PV) Program to develop up to 250 MW of utility-owned Solar PV generating facilities ranging in size from 1 to 2 MW each. Targeted at commercial and industrial rooftop space in SCE's service territory, SCE's program will use rooftop space from entities that would not otherwise be typical candidates for the net energy metering tariff, which allows customers to offset their usage with electricity generated at their own facilities. SCE proposes to develop these projects at a rate of approximately 50 MW per year at an average cost of $3.50/watt. The estimated base case capital cost for the Solar PV Program is $875 million over the period of the program (2008 - 2013). SCE proposes a reasonableness threshold of $963 million. Subject to CPUC approval, the capital expenditures will be eligible to be included in SCE's earning asset base if the actual costs of the program are equal to or lower than the reasonableness threshold amount. SCE also proposes to apply the CPUC-approved 100 basis point incentive adder for qualifying utility-owned renewable energy investments. SCE also requested to track costs spent on projects prior to the receipt of the CPUC's final decision in a memorandum account for potential future recovery. SCE expects a decision on the memorandum account in the fourth quarter of 2008. SCE expects to continue to move forward with projects in advance of the final CPUC decision. Several parties have filed protests to SCE's Solar PV program application. A scoping memorandum was issued on July 27, 2008 which identified issues to be addressed in the proceeding as well as set evidentiary hearings for November 2008 and a final decision for March 2009. SCE cannot predict the final outcome of this proceeding.
Impacts on Customer Rates
Natural gas prices have significantly increased during 2008 over forecasted prices used to set current generation rate levels and are subject to considerable volatility for the remainder of 2008 and in 2009. The increase in natural gas prices and the effect on power prices have, and are expected to continue to negatively impact SCE's
ERRA balancing account, which is expected to result in customer rate increases. For further discussion of the ERRA regulatory matters and the impact on customer rates, see "SCE: Regulatory Matters-Current Regulatory Developments-Impact of Regulatory Matters on Customer Rates" and "SCE: Regulatory Matters-Current Regulatory Developments-Energy Resource Recovery Account Proceedings."
EMG: CURRENT DEVELOPMENTS
Industry Developments
Commodity Prices
The 24-hour average market prices for energy at the Northern Illinois Hub and PJM West Hub increased 18% and 23%, respectively, during the six months ended June 30, 2008, compared to the corresponding period in 2007. In addition, the forward energy market prices for 2009 for these locations increased 21% and 41%, respectively, at June 30, 2008 from December 31, 2007. At June 30, 2008, EME had entered into hedge contracts that are recorded at fair value in its consolidated financial statements. Since forward energy prices have increased at June 30, 2008, the hedge contracts are reflected as a liability, with the effective portion of the contracts recorded as a reduction of shareholder's equity ($379 million after tax). Subsequent to June 30, 2008, forward energy market prices decreased (forward market prices for 2009 at July 29, 2008 decreased 18% and 22%, respectively, for the above locations from June 30, 2008) reflecting the volatile nature of commodity prices. See "EMG: Market Risk Exposures-Commodity Price Risk" for further discussion. During the three-month period ended June 30, 2008 of historically high forward energy market prices, EME increased its hedge position by approximately 11.2 million megawatt hours.
Regulatory Developments
In July 2008, the District of Columbia Circuit Court of Appeals vacated the US EPA's CAIR and remanded it to the US EPA. In addition, because Pennsylvania and Illinois promulgated their regulations in response to the CAIR, there is substantial uncertainty as to the impact of the Court's decision on these state regulations. Notwithstanding these developments, the Illinois plants and Homer City facilities continue to be governed by state rules as well as the existing "SIP Call" ozone season NOX cap-and-trade program (which was due to be replaced by the CAIR). For further discussion, see "Other Developments-Environmental Matters-Air Quality Regulation-Clean Air Interstate Rule."
Based on the CAIR requirements, Midwest Generation purchased $48 million of annual NOX allowances under the new CAIR annual NOXprogram which was vacated by the court ruling discussed above. As a result of this decision, the annual NOX allowances may no longer be required. Midwest Generation is currently evaluating the above decision including whether the purchased annual NOX allowances are impaired which could result in a charge against income during the third quarter ending September 30, 2008.
Extension of Production Tax Credits
New wind projects currently receive federal subsidies in the form of production tax credits. Production tax credits for a ten-year period are available for new projects placed in service prior to December 31, 2008. There have been proposals to extend the deadline for production tax credits beyond the end of 2008, but such proposals have not been enacted. Although EME believes there is significant support for extending production tax credits, congressional action may be delayed until next year, and there can be no guarantee that it will occur at all. EME supports extension of production tax credits, without an interruption, to encourage construction of renewable energy projects and plans to monitor legislative developments.
EME Growth Activities
Renewable Energy
At June 30, 2008, EME had 695 MW of wind projects in service and another 390 MW of wind projects under construction, with scheduled completion dates during 2008. As of the same date, EME had a development pipeline of potential wind projects with an estimated installed capacity of approximately 5,000 MW. The development pipeline represents potential projects with respect to which EME either owns the project rights or has exclusive acquisition rights. This development pipeline is supported by turbine purchase commitments totaling 1,061 MW for new wind projects. The majority of the turbines are scheduled to be delivered before the end of 2010.
Key activities during the second quarter of 2008 with respect to wind projects were:
• Completed the acquisition of a 240 MW planned wind project in Illinois, referred to as the Big Sky project with payments tied to various milestones. In addition, EME has commenced pre-construction activities for equipment purchases, site development and interconnection activities. Release of the project for full construction is pending a decision on selection of turbines. For further discussion refer to "Commitments, Guarantees and Indemnities-Turbine Commitments." The total commitments at June 30, 2008, excluding turbines, are approximately $97 million, including the project acquisition costs. Upon completion, the project plans to sell electricity into the PJM market as a merchant generator or to local utilities under power sales contracts.
• Acquired and/or completed development and commenced construction with completion scheduled for 2008 of the 19 MW Buffalo Bear wind project located in Oklahoma and the 80 MW Elkhorn Ridge project located in Nebraska. The estimated capital cost of these projects, excluding capitalized interest, is expected to be approximately $168 million. EME owns 66.67% of the Elkhorn Ridge wind project and 100% of the Buffalo Bear wind project. Each project will, after its completion, sell electricity pursuant to power sales agreements.
• Completed construction and commenced operations of the 29 MW Forward wind project located in Pennsylvania, the 20 MW Odin wind project located in Minnesota, and Phase I (80 MW) of the Goat wind project in Texas.
Subsequent to June 30, 2008, EME commenced construction of the 100 MW High . . .
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