07 August 2010

EIX: Income Statement Analysis for the June 2010 Quarter

Edison International (NYSE: EIX) earned $1.05 per diluted share on a GAAP basis in 2010's second quarter, which ended 30 June.  Of the $1.05 amount, $0.43 was due to non-recurring, tax-related gains.

In second quarter of 2009, special charges of $0.83 per share resulted in Edison losing $0.05 per share on a GAAP basis.

Stripping out the special items in both periods, "Core" earnings, a non-GAAP measure, fell from $0.78 to $0.62 per share.  Core earnings increased at the company's electric utility but declined by a greater amount at Edison's power-generation subsidiary.  The cost of performing an unusually high number of preventive maintenance activities at certain electricity-generating plants depressed the latter's results.

This post examines Edison's Income Statement for the quarter and compares the entries on each line to our "look-ahead" estimates.  Reported earnings per share were $0.31 more than the $0.74 per share we had forecast, and core EPS were $0.12 less.

The principal sources for this income statement analysis were the earnings announcement, the formal 10-Q, the conference call presentation [pdf], and the call transcript.  The latter is made available by Seeking Alpha.

In a second article, we will report Edison's scores as measured by the GCFR financial gauges.  The follow-up post will also provide the latest figures for the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Before getting into the details, we will take a step back to introduce the subject of today's analysis.

Edison International is the parent of Southern California Edison and Edison Mission Group.  SCE, which traces its roots back to 1886, operates a regulated electric utility serving commercial and residential consumers in central, coastal and southern California.  SCE owns facilities that generate, transmit, and distribute electricity.   Edison Mission Energy owns, or has interests in, various independent power-generation facilities

In 2009, Edison reached an agreement with the IRS settling all of the company's federal tax disputes, most notably those involving "cross-border, leveraged leases," for the tax years between 1986 and 2002.  The settlement resulted in numerous special charges, including some for lease terminations.  In the second quarter of 2010, the state tax impacts of the federal settlement became clearer when the California Franchise Tax Board accepted the company's tax positions.

Additional background information about Edison International and the business environment in which it is currently operating can be found in the look-ahead.

Please click here to see a normalized depiction of the actual and projected results for the just-concluded quarter, as well as the quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Revenue in the June quarter decreased 3.3 percent, from $2.83 billion last year to $2.74 billion in the most recent three months.  Our $3.02 billion estimate, which was based on typical seasonal patterns, was 10 percent too high.

The electric utility business (i.e., SCE) was responsible for 82 percent of total Revenue in the latest quarter.  Electric utility Revenue was essentially unchanged when compared to 2009's second quarter.  Revenue from the competitive power generation business (i.e, EMG) and other activities decreased 12 percent.

EMG's revenue was negatively affected by facility outages during maintenance and by tornado damage to a transmission line in Illinois.

We group Edison's reported Fuel, Purchased power, and Operations and maintenance costs and treat the combination as the Cost of Goods Sold.  CGS in the latest quarter was $2.01 billion, or 73.3 percent of Revenue.  This rate translates into a Gross Margin of 26.7 percent, a massive 330 basis points less profitable than last year's 30.0 percent.

The Gross Margin was a disappointing 230 basis points weaker than the 29.0 percent we had estimated.

The margin was pressured by higher costs for Purchased power and Operations & maintenance, offset by lower fuel costs. 

Depreciation, Decommissioning, and Amortization expenses increased 9.5 percent to $380 million, as a result of increased capital spending.  The reported amount was 2.7 percent more than our $370 million estimate.

The June 2010 quarter did not include additional operating charges.  The second quarter of 2009 included mammoth special charges of $866 million related to the federal tax settlement and associated lease terminations.  

Subtracting the various operating expenses mentioned above from Revenue yields Operating Income of $351 million.  Excluding last year's special charges, Operating Income declined 30 percent from $502 million.  The decrease was due to weakness in both Revenue and Gross Margin.

Our Operating Income target of $506 million proved to be 44 percent too high.  We failed to anticipate the magnitude of the declines in Revenue and the Gross Margin.

Edison's various non-operating items totaled a net expense of $131 million, almost exactly as expected, and down from $146 million in the June 2009 period.

Importantly, instead of a typical tax provision of roughly 30 percent of pretax income, Edison recorded a net tax benefit of $136 million.  The effective income tax rate was, therefore, negative in the quarter.  The tax benefit, as mentioned above, was related to the acceptance by state authorities of the 2009 settlement Edison reached with the IRS.  The tax benefit added $0.43 to the company's bottom line.

We  were anticipating 31.0 percent tax rate in the latest period. 

After adjusting for non-controlling interests and discontinued operations, the bottom-line Net Income  attributable to Edison's common shareholders was $344 million ($1.05 per diluted share), compared to a loss of $16 million ($0.05 per diluted share) in the year-earlier period. 

Although Operating Income was much weaker than we anticipated, the tax benefit caused reported Net Income to exceed our $244 million ($0.74 per diluted share) target by a wide margin.  Excluding the tax benefit, lower Revenue and higher maintenance costs at Edison's power-generating subsidiary resulted in Net Income $0.12 below our expectations.

Full disclosure: Long EIX at time of writing.

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