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| PLS > SEC Filings for PLS > Form 10-Q on 4-Nov-2008 | All Recent SEC Filings |
4-Nov-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 October, 2008, PPL completed the sale of its natural gas distribution and propane businesses, which were included in the Pennsylvania Delivery segment. See Note 8 to the Financial Statements for information on the sales. 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 challenges 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.
Recent Market Events
The turmoil in the financial markets has increased the complexity of maintaining credit risk within acceptable tolerances, responding to liquidity needs, measuring derivative and other financial instruments at fair value, and managing market price risk.
Credit risk
Credit risk is the risk that PPL would incur a loss as a result of nonperformance by counterparties of their contractual obligations. PPL maintains credit policies and procedures with respect to counterparty credit (including requirements that counterparties maintain specified credit ratings) and requires other assurances in the form of credit support or collateral in certain circumstances in order to limit counterparty credit risk. However, PPL has concentrations of suppliers and customers among electric utilities, natural gas distribution companies, financial institutions and other energy marketing and trading companies. These concentrations may impact PPL's overall exposure to credit risk, either positively or negatively, as counterparties may be similarly affected by changes in economic, regulatory or other conditions. The volatility and downturn in financial and commodity markets in the third quarter of 2008 have generally increased PPL's exposure to credit risk. See Note 14 to the Financial Statements for additional information about credit concentration.
In September 2008, Lehman Brothers Holdings Inc. (Lehman), filed for protection under Chapter 11 of the Federal Bankruptcy Code. A subsidiary of Lehman was a counterparty of PPL. Lehman was a guarantor of the subsidiary, and because of the bankruptcy, PPL was allowed to declare an event of default under the contract with the subsidiary. At the time of Lehman's filing, PPL's direct exposure to the subsidiary of Lehman was a net liability of $3 million, pre-tax, which was liquidated prior to September 30, 2008. PPL believes that the Lehman bankruptcy has not had and will not have a material adverse effect on PPL or its subsidiaries.
Due to the recent market conditions, PPL has increased the amount of credit reserves related to certain counterparties other than Lehman, but the increase was not material to PPL's financial statements. At this time, PPL has not deemed it probable that any of these counterparties will default.
Liquidity Issues
The turmoil in financial markets has generally made obtaining new sources of credit more difficult and more costly for companies. Despite the tightening of the credit markets, PPL expects to continue to have adequate sources of liquidity through operating cash flows, cash and cash equivalents, short-term investments and its credit facilities. PPL currently does not expect to need to access commercial paper markets or debt and equity capital markets until the fourth quarter of 2009, except to remarket certain bonds at PPL Electric as discussed in "Financial Condition - Liquidity and Capital Resources - Financing Activities," but may decide to access capital markets, subject to market conditions, to enhance its liquidity.
Lehman Brothers Bank, FSB (Lehman Bank), another subsidiary of Lehman, is no longer honoring its commitments under PPL Energy Supply's $3.4 billion five-year credit facility and PPL Electric's $200 million five-year credit facility. Lehman Bank's commitments under these facilities total $185 million. See "Financial Condition - Liquidity and Capital Resources" for an expanded discussion of PPL's liquidity position and a discussion of financing transactions completed in October 2008 to prefund future debt maturities.
Valuations in Inactive Markets
The turmoil in the financial markets has generally made it more difficult for companies to determine the fair value of certain assets and liabilities in inactive markets. Management has reviewed the activity in the energy and financial markets in which PPL transacts, concluding that substantially all of these markets were active as of September 30, 2008. However, the market for auction rate securities remains inactive. See Note 13 to the Financial Statements and "Financial Condition - Liquidity and Capital Resources - Auction Rate Securities" for a discussion of these investments.
Commodity Price Risk
The volatility of wholesale energy prices significantly impacted PPL's earnings for the three and nine months ended September 30, 2008. See "Statement of Income Analysis - Domestic Gross Energy Margins - Domestic Gross Energy Margins By Region" for further discussion.
Securities Price Risk
Declines in the market price of debt and equity securities resulted in unrealized losses that have impacted the asset values of PPL's investments in its nuclear decommissioning trust funds and in its defined benefit plans. The nuclear decommissioning trust funds have experienced negative investment returns during 2008. The assets in these funds support the costs to decommission the Susquehanna nuclear station when its licenses expire in 2022 and 2024, subject to any license extensions. As a result, the obligation to decommission the nuclear station is long-term in nature, exposing the assets held in the funds to price risk. PPL actively monitors the performance of the investments held in the funds and periodically reviews the funds' investment allocations.
PPL's defined benefit plans have also experienced negative investment returns in 2008. However, significant increases in bond rates used to determine the discount rate for these plans may provide for reductions in the gross benefit obligations of these plans. This may offset some portion of the decline in asset values when determining the funded status of the plans as well as other measures at the end of 2008. Determination of the funded status of the defined benefit plans, contribution requirements and net periodic defined benefit costs for future years are subject to changes in assumptions, including the performance of the assets in the plans, through the annual measurement dates. See "Application of Critical Accounting Policies" for "Defined Benefits" in Part II, Item 7 of the 2007 Form 10-K for a discussion of the assumptions and sensitivities regarding those assumptions.
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 and 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 nine months ended September 30, 2008, with the same periods in 2007.
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.
Earnings
Net income and the related EPS were:
Three Months Ended Nine Months Ended
September 30, September 30,
2008 2007 2008 2007
Net income $ 203 $ 322 $ 653 $ 870
EPS - basic $ 0.54 $ 0.85 $ 1.75 $ 2.27
EPS - diluted $ 0.54 $ 0.84 $ 1.73 $ 2.25
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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."
Segment Results
Net income by segment was:
Three Months Ended September 30, Nine Months Ended September 30,
2008 2007 2008 2007
Supply $ 98 $ 205 $ 297 $ 454
International
Delivery 73 108 233 319
Pennsylvania
Delivery 32 9 123 97
Total $ 203 $ 322 $ 653 $ 870
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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 Nine Months Ended
September 30, September 30,
2008 2007 2008 2007
Energy
revenues
External (a) $ 1,825 $ 566 $ 2,027 $ 1,256
Intersegment 453 453 1,370 1,356
Energy-related
businesses 140 185 369 536
Total
operating
revenues 2,418 1,204 3,766 3,148
Fuel and
energy
purchases
External (a) 1,781 436 1,888 1,085
Intersegment 30 44 89 119
Other
operation and
maintenance 215 164 649 517
Depreciation 52 41 146 124
Taxes, other
than income 9 6 18 24
Energy-related
businesses 130 174 351 568
Total
operating
expenses 2,217 865 3,141 2,437
Other Income -
net (6 ) 15 (2 ) 27
Interest
Expense 53 38 144 113
Income Taxes 44 110 181 169
Minority
Interest 1 1 2
Net Income $ 98 $ 205 $ 297 $ 454
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(a) Includes unrealized gains and losses from economic 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.
Sept. 30, 2008 vs. Sept. 30,
2007
Three Months Nine Months
Ended Ended
Eastern U.S.
non-trading
margins $ (15 ) $ (48 )
Western U.S.
non-trading
margins 5
Net energy trading
margins (89 ) (70 )
Taxes, other than
income 1 4
Depreciation (5 ) (12 )
Other operating
expenses 2 (10 )
Earnings from
synfuel projects (9 ) (43 )
Realized earnings
on nuclear plant
decommissioning
trust (4 ) (7 )
Financing costs,
net of interest
income (13 ) (22 )
Income taxes (3 ) (6 )
Other 1 (3 )
Special items 27 55
$ (107 ) $ (157 )
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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 depreciation expense for both periods was due to additions to PP&E.
· Higher other operating expenses for the nine months ended September 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), higher costs of nuclear development and higher operating costs in the energy marketing business. Partially offsetting these increases were lower outage and non-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.
· Higher net financing costs for both periods were primarily due to lower interest income and higher interest expense on long-term debt primarily due to new issuances.
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 September 30, Nine Months Ended September 30,
2008 2007 2008 2007
Mark-to-market
adjustments from
certain economic
activity (a) $ 67 $ (6 ) $ 121 $ 20
Unrealized losses
on certain
nuclear plant
decommissioning
trust investments
(Note 12) (1 ) (5 )
Impairment of
certain emission
allowances
(Note 10) (27 ) (27 )
Impairment of
certain
transmission
rights (b) (12 ) (12 )
Settlement of
Wallingford
cost-based rates
(c) 33 33
Sale of domestic
telecommunication
operations (Note
8) (3 ) (23 )
Off-site
remediation of
ash basin leak
(Note 10) 1
Colstrip
groundwater
litigation (Note
10) (5 )
Synthetic fuel
tax adjustment
(Note 10) (13 )
PJM billing
dispute (d) (1 )
Total $ 39 $ 12 $ 72 $ 17
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(a) See Note 14 to the Financial Statements for additional information regarding
economic activity.
(b) See "Other Operation and Maintenance" for more information on the $21 million
pre-tax impairment.
(c) In 2003, PPL Wallingford and PPL EnergyPlus sought from the FERC cost-based
payments based upon the RMR status of four units at the Wallingford,
Connecticut generating facility. As a result of a settlement agreement,
during the third quarter of 2007, PPL recognized $55 million of revenue and
$4 million of interest income related to the settlement agreement, of which
$21 million had been previously collected.
(d) 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 tax benefits, higher coal commodity and transportation costs, lower expected baseload generation, higher financing costs and lower expected margins from PPL's marketing and trading activities. The decrease in wholesale energy prices and lack of liquidity in the power markets significantly impacted PPL's earnings for the three and nine months ended September 30, 2008. PPL has taken measures to reduce its exposure to the potential effect of any further decline in market prices on future trading margins.
PPL expects 2009 earnings for its Supply segment to be lower than projected 2008 earnings as a result of higher operation and maintenance expenses; higher depreciation and higher financing costs. PPL expects these increased costs to be partially offset by higher energy margins, despite higher expected coal expense, as a result of higher baseload generation, higher Western energy sales prices, and higher expected margins from its marketing and trading activities.
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 September 30, Nine Months Ended September 30,
2008 2007 2008 2007
Utility
revenues $ 195 $ 204 $ 647 $ 638
Energy-related
businesses 8 8 26 27
Total
operating
revenues 203 212 673 665
Other
operation and
maintenance 46 57 142 182
Depreciation 33 33 104 111
Taxes, other
than income 17 17 51 49
Energy-related
businesses 4 4 10 13
Total
operating
expenses 100 111 307 355
Other Income -
net 6 2 10 19
Interest
Expense 42 47 114 141
Income Tax
(Benefit)
Expense (6 ) (39 ) 34 (42 )
Income from
Discontinued
Operations 13 5 89
Net Income $ 73 $ 108 $ 233 $ 319
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The after-tax change in net income between these periods was due to the following factors, including Discontinued Operations.
Sept. 30, 2008 vs. Sept. 30,
2007
Three Months Nine Months
Ended Ended
U.K.:
Delivery margins $ 18
Depreciation $ (1 ) 4
Other operating
expenses 4 15
Interest expense (1 ) 5
Interest income (2 ) (5 )
Income taxes 9 21
Foreign currency
exchange rates (2 )
Hyder liquidation
distributions
(Note 8) (3 )
Gain on transfer
of equity
investment (Note
8) (5 )
Other (2 )
Discontinued
Operations, net of
special item (Note
8) (11 ) (39 )
Change in tax
reserves (Note 5) 1 (30 )
Other 8 20
U.S. income taxes 17 15
Special items (57 ) (100 )
$ (35 ) $ (86 )
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· The U.K.'s earnings for the nine months ended September 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 three and nine months ended September 30, 2008, were primarily due to the enactment of the U.K.'s Finance Act 2008, which included the phase-out of tax depreciation on certain buildings. As a result, a deferred tax benefit was recorded in the third quarter of 2008. Also contributing to the nine-month period variance was a favorable U.K. taxing authority determination in 2008 related to the deductibility of imputed interest on a loan from Hyder.
· Lower U.S. income taxes are primarily due to changes in the estimated taxable amount of planned cash repatriation.
· Changes in foreign currency exchange rates decreased the U.K.'s portion of revenue and expense line items by 4% and 1% for the three and nine months ended September 30, 2008, compared with the same periods in 2007.
The following after-tax amounts, which management considers special items, also had a significant impact on the International Delivery segment earnings. See the indicated Notes to the Financial Statements for additional information.
Nine Months Ended
Three Months Ended September 30, September 30,
2008 2007 2008 2007
Sale of
Latin
American
businesses
(Note 8) $ 3 $ 46
Change in
U.K. tax
rate (Note
5) 54 54
$ 57 $ 100
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Outlook
Excluding special items, PPL projects the 2008 earnings of its International Delivery segment to approximate the results of 2007.
PPL expects 2009 earnings for its International Delivery segment to be lower than projected 2008 earnings as a result of the loss of certain U.K. income tax benefits included in 2008 that are not expected to recur in 2009 and a less favorable foreign currency exchange rate in the U.K.
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. In October 2008, the sale was completed. 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:
Nine Months Ended
Three Months Ended September 30, September 30,
2008 2007 2008 2007
Operating
revenues
External $ 813 $ 811 $ 2,462 $ 2,436
Intersegment 30 44 89 119
Total
operating
revenues 843 855 2,551 2,555
Fuel and
energy
purchases
External 44 56 129 157
Intersegment 453 453 1,370 1,356
Other
operation
and
maintenance 103 103 310 297
Amortization
of
recoverable
transition
costs 73 78 217 229
Depreciation 32 34 97 99
Taxes, other
than income 51 50 155 150
Total
operating
expenses 756 774 2,278 2,288
Other Income
- net 1 6 9 25
Interest
Expense 25 32 80 103
Income Taxes 21 17 70 61
Dividends on
Preferred
Securities 5 5 14 14
(Loss)
Income from
. . .
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