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| EXC > SEC Filings for EXC > Form 10-Q on 27-Oct-2008 | All Recent SEC Filings |
27-Oct-2008
Quarterly Report
(Dollars in millions except per share data, unless otherwise noted)
General
Exelon is a utility services holding company. It operates through subsidiaries in the following operating segments:
• Generation, whose business consists of its owned and contracted electric generating facilities, its wholesale energy marketing operations and competitive retail sales operations.
• ComEd, whose business consists of the purchase and regulated retail sale of electricity and the provision of distribution and transmission services in northern Illinois, including the City of Chicago.
• PECO, whose business consists of the purchase and regulated retail sale of electricity and the provision of distribution and transmission services in southeastern Pennsylvania, including the City of Philadelphia, as well as the purchase and regulated retail sale of natural gas and the provision of distribution services in Pennsylvania in the counties surrounding the City of Philadelphia.
See Note 14 of the Combined Notes to Consolidated Financial Statements for segment information.
Exelon's corporate operations, some of which are performed through its business services subsidiary, Exelon Business Services Company, LLC (BSC), provide Exelon's business segments with a variety of support services at cost. The costs of these services are directly charged or allocated to the applicable business segments. Additionally, the results of Exelon's corporate operations include costs for corporate governance and interest costs and income from various investment and financing activities.
EXELON CORPORATION
Executive Overview
Financial Results. Exelon's net income was $700 million for the three months ended September 30, 2008, as compared to $780 million for the three months ended September 30, 2007, and diluted earnings per average common share were $1.06 for the three months ended September 30, 2008, as compared to $1.15 for the three months ended September 30, 2007.
Exelon's net income was $2,030 million for the nine months ended September 30, 2008, as compared to $2,173 million for the nine months ended September 30, 2007, and diluted earnings per average common share were $3.06 for the nine months ended September 30, 2008, as compared to $3.20 for the nine months ended September 30, 2007.
The decrease for the three months ended September 30, 2008 was primarily due to the following:
• unfavorable weather conditions in the ComEd and PECO service territories;
• increased allowance for uncollectible accounts expense at ComEd and PECO as well as the establishment of a reserve related to Generation's accounts receivable from Lehman Brothers Holdings Inc. (Lehman) due to its bankruptcy filing;
• discrete disallowances, net of allowed regulatory assets, mandated by the September 2008 Illinois Commerce Commission (ICC) order in ComEd's 2007 delivery service rate case;
• the impact of inflation on labor costs;
• net unrealized losses on Generation's nuclear decommissioning trust funds;
• increased scheduled competitive transition charge (CTC) amortization expense at PECO;
• the impact of the reduction of a reserve associated with PECO's property tax settlement under the Pennsylvania Public Utility Realty Tax Act (PURTA) in 2007; and
• income associated with Exelon's investments in synthetic fuel-producing facilities, including the impact of mark-to-market gains associated with the related derivatives in 2007.
Partially offsetting the factors above are the following changes in net income:
• higher average realized margins at Generation, reflecting higher realized prices on market sales partially offset by increased nuclear fuel costs;
• increased nuclear output at Generation.
• increased transmission and distribution revenue at ComEd resulting from the 2007 transmission and distribution rate cases;
• decreased stock-based compensation costs;
• net mark-to-market gains on economic hedging activities; and
• the impact of the Illinois settlement reached in 2007. See Note 4 of the Combined Notes to Consolidated Financial Statements for further information.
The decrease for the nine months ended September 30, 2008 was primarily due to the following:
• unfavorable weather conditions in the ComEd and PECO service territories;
• increased allowance for uncollectible accounts expense at ComEd and PECO as well as the establishment of a reserve related to Generation's accounts receivable from Lehman;
• decreased nuclear output at Generation reflecting a higher number of scheduled refueling outage days;
• increased planned nuclear refueling outage costs associated with a higher number of scheduled refueling outage days;
• nuclear site development costs for the evaluation and development of a new nuclear generating facility in Texas;
• discrete disallowances, net of allowed regulatory assets, mandated by the September 2008 ICC order in ComEd's 2007 delivery service rate case;
• higher storm costs at ComEd and PECO.
• the impact of inflation on labor costs;
• increased depreciation at Generation and ComEd due to increased capital expenditures;
• net unrealized and realized losses on Generation's nuclear decommissioning trust funds;
• increased scheduled CTC amortization expense at PECO;
• changes in Generation's decommissioning ARO determination;
• the impact of the reduction of a reserve associated with PECO's property tax settlement under the PURTA in 2007;
• the impact of a favorable PJM Interconnection, LLC (PJM) billing settlement with PPL Electric (PPL) in 2007;
• the impact of the Illinois settlement reached in 2007. See Note 4 of the Combined Notes to Consolidated Financial Statements for further information; and
• income associated with Exelon's investments in synthetic fuel-producing facilities, including the impact of mark-to-market gains (losses) associated with the related derivatives in 2007.
Partially offsetting the factors above are the following changes in net income:
• higher average realized margins at Generation, reflecting higher realized prices on market sales partially offset by increased nuclear fuel costs;
• gains related to the settlement of claims related to uranium supply agreements;
• net mark-to-market gains on economic hedging activities;
• increased revenue from certain long options in Generation's proprietary trading portfolio;
• increased transmission and distribution revenue at ComEd resulting from the 2007 transmission and distribution rate cases; and
• a favorable income tax benefit associated with Exelon's method of capitalizing overhead costs.
Capital and Credit Market Crisis
As the capital and credit market crisis has worsened, the Registrants have performed additional assessments to determine the impact, if any, of recent market developments, including the bankruptcy, restructuring or merging of certain financial and energy companies, on the Registrants' financial statements. The Registrants' additional assessments have included a review of access to liquidity in the capital and credit markets, counterparty creditworthiness, value of the Registrants' investments (particularly in the employee benefit plans and nuclear decommissioning trust funds), macroeconomic conditions and exposure to operational risk (particularly with respect to insurance). The recent unprecedented volatility in capital and credit markets may create additional risks in the upcoming months and possibly years.
• Liquidity in the capital and credit markets
The Registrants believe they have sufficient liquidity despite the disruption of the capital and credit markets. The Registrants fund liquidity needs for capital investment, working capital, energy hedging and other financial commitments through cash flow from continuing operations, public debt offerings, commercial paper markets and large, diversified credit facilities ($7.3 billion in aggregate total commitments as of September 30, 2008; of which no financial institution, assuming announced consolidations, has more than 10% of the aggregate commitments for Exelon, Generation and PECO and 12% for ComEd). While not significant to the Registrants to date, the disruptions in capital and credit markets may result in increased borrowing costs associated with short-term and long-term debt. The Registrants have accelerated a number of bond issuances in 2008 in order to limit the risk of volatility in the credit markets and to obtain liquidity for the remainder of the year. As more fully discussed in "Liquidity and Capital Resources", the Registrants have completed all their necessary long-term financings planned for 2008 with the completion of PECO's $300 million 5-year bond offering in October 2008. With the exception of debt to unconsolidated financing affiliates, the Registrants have no remaining debt maturities in 2008, no significant debt maturities in 2009 and $613 million of debt maturing in 2010 ($400 million and $213 million at Exelon Corporate and ComEd, respectively). The debt to unconsolidated financing affiliates at PECO is repaid through the collection of competitive transition charges from customers as allowed by restructuring legislation that was adopted in Pennsylvania in 1996. The Registrants routinely review liquidity sufficiency, including appropriate sizing of credit facility commitments, by performing various stress test scenarios, such as commodity price movements and the impacts of hypothetical credit downgrades. Management continues to monitor closely events and the financial institutions associated with its credit facilities, including monitoring credit ratings and outlooks, credit default swap levels, capital raising and merger activity. See PART II. ITEM 1A. Risk Factors for information regarding the effects of a longer-term disruption in the capital and credit markets or significant bank failures.
• Counterparty creditworthiness
The Registrants are subject to credit risk, which relates to the ability of counterparties to meet their contractual payment obligations or the potential non-performance of counterparties to deliver contracted commodities or services at the contracted price. Generation's power-marketing activities are governed by risk
management policies limiting transactions to a diversified group of high quality counterparties. Although Generation's credit exposure was predominately with investment grade companies at September 30, 2008, changes in forward market prices could have a disproportionate impact to the percentage of credit exposure with non investment grade companies. As of September 30, 2008, the net exposure after credit collateral for Generation's commodity contracts of $683 million included $582 million of exposure to investment grade companies and $101 million of exposure to non-investment grade companies, primarily in the coal supply industry. Within the past several weeks, the bankruptcy of Lehman Brothers Holdings Inc. and the weakening of companies within the energy industry have underscored the importance of these risk management practices. As a result of management's review of Generation's counterparties, the direct net exposure of $22 million to Lehman Brothers Commodity Services Inc., a counterparty in wholesale energy marketing transactions, has been fully reserved and charged to expense this quarter. As further discussed below, Generation also currently procures uranium concentrates through long-term contracts. Approximately 50% of the requirements from 2009 through 2013 are supplied by three producers. In the event of non-performance by these or other suppliers, Generation believes that replacement uranium concentrates can be obtained, although at prices that may be unfavorable when compared to the prices under the current supply agreements. Management continues to monitor closely the status of Generation's counterparties and will take action, as appropriate, to further manage its counterparty credit risk.
Under the Illinois Settlement Legislation, ComEd procures power through supplier forward contracts for the duration of their term, standard block energy purchases, and spot market purchases. Collateral postings are required only of suppliers for the supplier forward contracts that ComEd entered into with winning suppliers from the Illinois Auction, including Generation. The standard block energy purchases require collateral postings from both ComEd and the counterparty suppliers, including Generation, should exposures between forward market prices and benchmark price levels exceed established credit thresholds outlined in the agreements. In the event the counterparties fail to perform, ComEd might be forced to purchase power through an RFP process or in the spot markets at less favorable prices. As of September 30, 2008, there was no cash collateral or letters of credit posted between suppliers and ComEd. The potential failure of energy suppliers to perform is mitigated by ComEd's ability to recover its actual costs to procure power as stipulated in the Illinois legislation as well as the ICC-approved procurement tariff. PECO has counterparty credit risk related to its electricity and natural gas suppliers. Generation provides 100% of PECO's electric energy under a purchase power agreement (PPA). There are no collateral provisions included in the electric supply agreement with Generation. PECO procures natural gas from suppliers under both short-term and long-term contracts. The potential failure of natural gas suppliers to perform is mitigated by PECO's ability to seek recovery of its actual costs to procure natural gas through the PAPUC's purchased gas cost clause, subject to PAPUC review. A further discussion of counterparty risk is included in ITEM 3. Quantitative and Qualitative Disclosures about Market Risk.
• Value of investments (particularly in employee benefit plan trusts and nuclear decommissioning trust funds)
Exelon sponsors defined benefit pension plans and postretirement benefit plans for the employees of the Registrants. The Registrants believe that the oversight of the investments held under Exelon's employee benefit plans is rigorous and that the investment strategies are prudent. The market value of the investments within the employee benefit plan trusts declined by approximately 17% during the nine months ended September 30, 2008. The benefit plan assets and obligations of Exelon and AmerGen are remeasured annually using a December 31 measurement date. Reductions in plan assets from investment losses will result in an increase to the plans' unfunded status and a decrease in shareholders' equity upon actuarial revaluation of the plan on January 1, 2009. Changes in the value of plan assets will not have an impact on the income statement for 2008; however, reduced benefit plan assets will result in increased benefit costs in future years and may increase the amount and accelerate the timing of required future funding contributions. Such increases could be material to periods subsequent to 2009. See ITEM 3. Quantitative and Qualitative Disclosures about Market Risk for additional information regarding the potential impacts of declines in the return on benefit plan assets that is less than assumed.
Nuclear decommissioning trust funds have been established on a unit-by-unit basis to satisfy Generation's and Amergen's nuclear decommissioning obligations. Currently, Generation is making contributions only to the
trust funds of the former PECO units based on amounts being collected by PECO from its customers and remitted to Generation. While Generation has recourse to collect additional amounts from PECO customers (subject to certain limitations and thresholds), it has no recourse to collect additional amounts from ComEd customers or from the previous owners of AmerGen, if there is a shortfall of funds necessary for decommissioning. Generation believes that its oversight of these trust funds is rigorous and the investment strategy is prudent. At September 30, 2008, approximately 46% of the funds were invested in equity and 54% were invested in fixed income securities, with limitations related to concentration and investment grade ratings. See Note 10 - Asset Retirement Obligations for the amounts of unrealized gains (losses) on the trust funds during the three and nine months ended September 30, 2008. Nuclear Regulatory Commission (NRC) regulations require that licensees of nuclear generating facilities demonstrate reasonable assurance that funds will be available in certain minimum amounts at the end of the life of the facility to decommission the facility. Generation is required to provide to the NRC a biennial report by unit (annually for Generation's five units that have been retired or are within five years of the current approved license life) addressing Generation's ability to meet the NRC-estimated funding levels. Generation's next report is due to the NRC on March 31, 2009, based on trust fund values and estimated decommissioning obligations as of December 31, 2008. Should the trust funds continue to experience declines in market value, Generation may be required to take measures, such as providing financial guarantees through letters of credit or parent company guarantees or make additional contributions to the trusts, which could be significant, to ensure that the trusts are adequately funded and that NRC minimum funding requirements are met. As a result, Exelon's and Generation's cash flows and financial position may be significantly adversely affected. Management continues to monitor closely the performance of these investments and will take action, as appropriate. See PART II. ITEM 1A. Risk Factors for information regarding the effects of a longer-term disruption in the capital and credit markets or significant bank failures.
Based on a regulatory agreement with the ICC that applies to the former ComEd nuclear generating units on a unit-by-unit basis, as long as funds held in the nuclear decommissioning trust funds exceed the total estimated decommissioning obligation, decommissioning impacts recognized in the Consolidated Statement of Operations, including realized and unrealized income and losses of the trust funds and accretion of the decommissioning obligation, are generally offset within Exelon's and Generation's Consolidated Statements of Operations. Should the trust funds for the former ComEd units continue to experience declines in market value such that the value of the trust funds for any unit falls below the amount of the estimated decommissioning obligation for that unit, the accounting to offset decommissioning impacts in the Consolidated Statement of Operations for that unit would be discontinued, and the adverse impact to Exelon's and Generation's results of operations and financial position could be material. See Note 13 of the Combined Notes to Consolidated Financial Statements within Exelon's 2007 Annual Report on Form 10-K for additional information regarding the accounting for the former ComEd nuclear generating units as a result of the ICC order.
The Registrants engage in a securities lending program with respect to the investments within their employee benefit plan trusts and nuclear decommissioning trust funds. In connection with this program, the securities loaned are supported by collateral posted by the borrowers, which the Registrants invest in collateral pools of high quality debt instruments that have been exposed to the recent liquidity issues associated with the current capital and credit market crisis. The Registrants have taken steps to unwind their securities lending program; however, due to the absence of liquidity in the current market, they are currently restricted by the trustees from fully exiting the collateral pools for an extended period of time. Currently, the weighted average maturity of the securities within the collateral pools is approximately 6 months. If the market crisis continues and the Registrants do not have the desire or ability to wait for the maturity of the securities within the collateral pools, they may be exposed to investment losses. Such losses have not been material during the nine months ended September 30, 2008. Exelon has collateral of $1.1 billion that is subject to the liquidity risks of the collateral pools as of September 30, 2008. Management continues to monitor closely the performance of the collateral pools and to work closely with the trustees to limit any potential exposure to losses.
• Macroeconomic conditions
The recent capital and credit market crisis is adversely affecting the U.S. and global economies. This can have several adverse effects on Exelon's markets. Slower economic growth could lead to lower demand for
electricity and gas. As a result, Exelon's sales to industrial, commercial and residential customers within its service territories could be reduced. Lower demand for electricity could also lead to lower margins for Exelon's wholesale fleet, although this effect will be mitigated in the short term by Exelon's hedging policies. In addition, customers may not be able to pay, or may delay payment of, accounts receivable that are owed to the Registrants. Management has taken steps to mitigate this risk through heightened collection efforts.
The slowing global economies could lead to lower international demand for coal, oil and natural gas. While the bulk of Exelon's generation is produced by its nuclear fleet, wholesale prices are set by fossil-fuel fired plants in most markets. A drop in fossil fuel demand could lead to sharply lower fossil fuel prices, and put downward pressure on electricity prices. Exelon's hedging policies will at least partially mitigate these effects in the short term.
• Operational risk (particularly with respect to insurance)
The Registrants have reviewed their exposure to insurance risk and have concluded that there have been no material changes related to the availability and cost of liability, property, nuclear risk, and other forms of insurance. Management continues to monitor closely events and the ratings for insurance companies associated with its insurance programs.
Regulatory and Environmental Developments.
The following significant regulatory and environmental developments occurred during the three and nine months ended September 30, 2008. See Notes 4 and 12 of the Combined Notes to Consolidated Financial Statements for further information.
• Delivery Service Rate Case - On September 10, 2008, the ICC issued its final order in ComEd's rate case proceeding that was initiated in October 2007. The order approved an increase in the annual revenue requirement of $274 million, which became effective on September 16, 2008. The order also incorporated the joint recommendations of the ICC Staff and ComEd in the Original Cost Audit stipulation, including projected capital additions through the second quarter of 2008. Additionally, the ICC order required ComEd to record charges during the third quarter associated with fixed asset disallowances of approximately $37 million (pre-tax), partially offset by the establishment of regulatory assets of approximately of $13 million (pre-tax), for costs that have been previously expensed by ComEd that will be recovered through rates over the next several years, resulting in a net decrease in operating income of $24 million (pre-tax).
• Transmission Rate Case - ComEd received an annual transmission network service revenue requirement increase of approximately $93 million as a result of a settlement agreement relating to ComEd's March 2007 request to update its transmission rates and change the manner in which such rates are determined from fixed rates to a formula rate. FERC approved the settlement on January 16, 2008. On January 18, 2008, FERC issued an order on rehearing that allowed a 1.5% adder to return on equity for ComEd's largest transmission project and authorized the inclusion of 100% of construction work in progress in rate base for that project but rejected incentive treatment for any other project ComEd has pending. On February 19, 2008, several parties filed a petition for rehearing of FERC's January 18, 2008 order. On September 8, 2008, FERC issued an order on rehearing in which it reviewed, and then rejected intervenors' arguments on granting incentives and confirmed the result of the January 18, 2008 order.
On May 15, 2008, ComEd filed its first annual update filing, which updates ComEd's formula rate to include actual 2007 expenses and capital additions plus forecasted 2008 capital additions. The update resulted in a revenue requirement of $456 million, which includes $26 million related to the 2007 true-up for a total increase of approximately $66 million. The new rate will be used by PJM to determine charges for services in the ComEd zone for June 1, 2008 through May 31, 2009. The filing will be reviewed by FERC and intervenors, who have until December 2008 to challenge the calculation of the new rate. ComEd has been reflecting its best estimate of its anticipated approved true-up in the financial statements.
Gas Distribution Rate Case - On March 31, 2008, PECO filed a petition before the Pennsylvania Public Utility Commission (PAPUC) for a $98 million increase to its delivery service revenue to fund critical
infrastructure improvement projects that will ensure the safety and reliability of the natural gas delivery system. On July 1, 2008, PECO received testimony submitted by various state and special interest parties opposing the level of the proposed rate increase. On August 21, 2008, PECO filed a joint settlement petition with the PAPUC, signaling that it had reached an agreement with the opposing parties regarding the requested distribution rate increase. The settlement petition provides for a revenue increase of $77 million. As part of the settlement, PECO would enhance its low-income programs as well as provide funding for new energy efficiency programs to help customers manage their energy usage and gas bills. Additionally, PECO would agree not to file a new base rate case for natural gas distribution service before January 1, 2010. On September 18, 2008, the presiding administrative law judge (ALJ) issued a recommended decision approving all aspects of the joint settlement. On October 23, 2008, the PAPUC voted to approve the joint settlement. The approved rate adjustment will be effective beginning January 1, 2009.
• PECO AEPS Filing - On December 20, 2007, the PAPUC approved PECO's request to acquire and bank up to 450,000 non-solar Tier I Alternative Energy Credits (AECs) annually (corresponding to the annual output of approximately 240 MWs of wind power) for a five-year term in order to prepare for 2011, the first year of PECO's required compliance under the Alternative Energy Portfolio Standards Act (AEPS Act) following the completion of its transition period. PECO conducted its first request for proposal (RFP) for up to 250,000 AECs and received bids in March 2008. On June 24, 2008, the PAPUC authorized acceptance of one bid. Pursuant to the RFP process, PECO entered into a five-year agreement with the accepted bidder on August 28, 2008. PECO is planning to conduct a second RFP later in 2008.
Outlook for 2008 and Beyond.
Several significant events may occur during the rest of 2008 and beyond, including the following:
• On October 19, 2008, with authorization from Exelon's Board of Directors, . . .
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