35 -------------------------------------------------------------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FIRSTENERGY'S BUSINESS
FE and its subsidiaries are principally involved in the transmission, distribution and generation of electricity through its reportable segments, Regulated Distribution and Regulated Transmission.
The Regulated Distribution segment distributes electricity through FirstEnergy's ten utility operating companies, serving approximately six million customers within 65,000 square miles ofOhio ,Pennsylvania ,West Virginia ,Maryland ,New Jersey andNew York , and purchases power for its POLR, SOS, SSO and default service requirements inOhio ,Pennsylvania ,New Jersey andMaryland . This segment also controls 3,580 MWs of regulated electric generation capacity located primarily inWest Virginia andVirginia . The segment's results reflect the costs of securing and delivering electric generation from transmission facilities to customers, including the deferral and amortization of certain related costs. The Regulated Transmission segment provides transmission infrastructure owned and operated by the Transmission Companies and certain of FirstEnergy's utilities (JCP&L, MP, PE and WP) to transmit electricity from generation sources to distribution facilities. The segment's revenues are primarily derived from forward-looking formula rates at the Transmission Companies and JCP&L as well as stated transmission rates at MP, PE and WP; although as explained in Note 8, "Regulatory Matters," effectiveJanuary 1, 2021 , subject to refund, MP's, PE's and WP's existing stated rates became forward-looking formula rates. JCP&L previously had stated transmission rates; however, effectiveJanuary 1, 2020 , JCP&L implemented forward-looking formula rates, which were approved byFERC onApril 15, 2021 . Both forward-looking formula and stated rates recover costs thatFERC determines are permitted to be recovered and provide a return on transmission capital investment. Under forward-looking formula rates, the revenue requirement is updated annually based on a projected rate base and projected costs, which is subject to an annual true-up based on actual costs. Revenue requirements under stated rates are calculated annually by multiplying the highest one-hour peak load in each respective transmission zone by the approved, stated rate in that zone. The segment's results also reflect the net transmission expenses related to the delivery of electricity on FirstEnergy's transmission facilities. Corporate/Other reflects corporate support and other costs not charged to FE's subsidiaries, including FE's retained Pension and OPEB assets and liabilities of theFES Debtors, interest expense on FE's holding company debt and other businesses that do not constitute an operating segment. Additionally, reconciling adjustments for the elimination of inter-segment transactions are included in Corporate/Other. As ofJune 30, 2021 , 67 MWs of electric generating capacity, representing AE Supply's OVEC capacity entitlement, was included in continuing operations of Corporate/Other. As ofJune 30, 2021 , Corporate/Other had approximately$7.9 billion of FE holding company debt. 36 --------------------------------------------------------------------------------
EXECUTIVE SUMMARY
FirstEnergy is a forward-thinking, electric utility centered on integrity, powered by a diverse team of employees, committed to making customers' lives brighter, the environment better and our communities stronger. As a fully regulated electric utility, FirstEnergy is focused on stable and predictable earnings and cash flow from its Regulated Distribution and Regulated Transmission business units that deliver enhanced customer service and reliability that supports FE's dividend. OnJuly 21, 2020 , a complaint and supporting affidavit containing federal criminal allegations were unsealed against the now former Ohio House SpeakerLarry Householder and other individuals and entities allegedly affiliated withMr. Householder . Also, onJuly 21, 2020 , and in connection with the investigation, FirstEnergy received subpoenas for records from theU.S. Attorney's Office for the S.D. Ohio . FirstEnergy was not aware of the criminal allegations, affidavit or subpoenas beforeJuly 21, 2020 . OnJuly 21, 2021 , FE entered into a three-year DPA with theU.S. Attorney's Office that, subject to court proceedings, resolves theU.S. Attorney's Office investigation into FirstEnergy relating to FirstEnergy's lobbying and governmental affairs activities concerning HB 6, which, among other things requires FE to pay a monetary penalty of$230 million within the next sixty days. Under the DPA, FE has agreed to the filing of a criminal information charging FE with one count of conspiracy to commit honest services wire fraud. The$230 million payment will neither be recovered in rates or charged to FirstEnergy customers nor will FirstEnergy seek any tax deduction related to such payment. Under the terms of the DPA, the criminal information will be dismissed after FirstEnergy fully complies with its obligations under the DPA. In addition to the subpoenas referenced above, the OAG, certain FE shareholders and FirstEnergy customers filed several lawsuits against FirstEnergy and certain current and former directors, officers and other employees, each relating to the allegations against the now former Ohio House SpeakerLarry Householder and other individuals and entities allegedly affiliated withMr. Householder . In addition, onAugust 10, 2020 , theSEC , through itsDivision of Enforcement , issued an order directing an investigation of possible securities laws violations by FE, and onSeptember 1, 2020 , issued subpoenas to FE and certain FE officers. Subsequently, onApril 28, 2021 , theSEC issued an additional subpoena to FE. Further, in a letter datedFebruary 22, 2021 , staff ofFERC's Division of Investigations notified FirstEnergy that the Division is conducting an investigation of FirstEnergy's lobbying and governmental affairs activities concerning HB 6. A committee of independent members of the FE Board of Directors was put in place to direct an internal investigation related to the ongoing government investigations. In addition, the Board formed a sub-committee of the Audit Committee to, together with the Board, assess FirstEnergy's compliance program and implement potential changes, as appropriate. FirstEnergy has taken the following steps to address current challenges and improve its compliance culture: •Certain members of senior management, including the former Chief Executive Officer, were terminated for violating certain FirstEnergy policies and code of conduct. •Immediately following these terminations, the independent members of its Board appointed Mr.Steven E. Strah to the position of Acting Chief Executive Officer and Mr.Christopher D. Pappas , a current member of the Board, to the temporary position of Executive Director. InMarch 2021 ,Mr. Strah was elected to the position of Chief Executive Officer and a Director of the Board. •FirstEnergy's Chief Legal Officer and Chief Ethics Officer were separated from FirstEnergy due to inaction and conduct that the Board determined was influenced by the improper tone at the top. •The Board appointed Mr.John W. Somerhalder II to the positions of Vice Chairperson of the Board and Executive Director, replacingMr. Pappas , who will continue to serve on the Board as an independent director. The Board also appointed Mr.Hyun Park to the position of Senior Vice President & Chief Legal Counsel and Mr.Antonio Fernández , to the position of Vice President and Chief Ethics and Compliance Officer. These executives help play a critical role in enhancing FirstEnergy's culture of compliance, ethics, integrity and accountability. •InMarch 2021 , in connection with an agreement withIcahn Capital , the Board appointedAndrew Teno andJesse Lynn as Directors to the Board, increasing the size from 12 directors to 14. However, until such time as all final regulatory approvals are obtained, neitherMr. Teno norMr. Lynn will have the right to vote at any meeting of the Board or any committee thereof. InMay 2021 ,Melvin D. Williams was elected to the Board, filling a vacant seat. InJune 2021 , the Board appointedLisa Winston Hicks andPaul Kaleta as directors to the Board, further increasing the size from 14 directors to 16. •FirstEnergy is making significant changes in its approach to political and legislative engagement and advocacy, through stopping all contributions to 501(c)(4) organizations, the pause of other political disbursements, including from the FirstEnergy Political Action Committee, limiting participation in the political process, suspending or terminating various political consulting relationships, and adding additional oversight and significantly more robust disclosure around political spending to provide increased transparency.
•The Board met with FirstEnergy's top 140 leaders to discuss expectations regarding compliance and ethics.
37 --------------------------------------------------------------------------------
•Performed training on up-the-ladder reporting for the Legal Department.
•Enhanced new employee and third-party on-boarding processes to include expectations of FirstEnergy's code of business conduct. •InMay 2021 , FirstEnergy separated its Vice President, Rates and Regulatory Affairs, and Acting Vice President, External Affairs due to this individual's inaction with respect to a previously disclosed purported consulting agreement. •OnJune 29, 2021 , the Board established a Special Litigation Committee of the Board, effectiveJuly 1, 2021 . The Special Litigation Committee has been delegated full authority by the Board to take all actions as the Special Litigation Committee deems advisable, appropriate, and in the best interests of FirstEnergy and its shareholders with respect to pending shareholder derivative litigation and demands. Each ofMs. Hicks and Messrs. Kaleta, Lynn and Williams were appointed to serve on the Special Litigation Committee. •OnJuly 20, 2021 , theBoard of FirstEnergy approved and adopted a new Code of Business Conduct and Ethics, which: •Promotes and emphasizes the Company's commitment to compliance and ethics, •establishes a "speak up" culture in which stakeholders are encouraged to report actual or suspected Code of Business Conduct violations without fear of retaliation, •Conforms to applicable compliance standards, and •Improves readability •OnJuly 20, 2021 , the Board approved FE entering into a DPA with theU.S. Attorney's Office that, subject to court proceedings, resolves theU.S. Attorney's Office investigation into FirstEnergy relating to FirstEnergy's lobbying and governmental affairs activities concerning HB 6, which, among other things requires FE to pay a monetary penalty of$230 million within the next sixty days. Also, in connection with the internal investigation, FirstEnergy identified certain transactions, which, in some instances, extended back ten years or more, including vendor service, that were either improperly classified, misallocated to certain of the Utilities and Transmission Companies, or lacked proper supporting documentation. These transactions resulted in amounts collected from customers that were immaterial to FirstEnergy. The Utilities and Transmission Companies are working with the appropriate regulatory agencies to address these amounts.
FirstEnergy has also taken proactive steps to reduce regulatory uncertainty affecting the Ohio Companies:
•OnJanuary 31, 2021 , FirstEnergy reached a partial settlement with the OAG and other parties regarding decoupling. While the partial settlement with the OAG focused specifically on decoupling, the Ohio Companies will of their own accord, not seek to recover lost distribution revenue from residential and commercial customers. •OnMarch 31, 2021 , FirstEnergy announced that the Ohio Companies will proactively refund to customers amounts previously collected under the decoupling mechanism authorized underOhio law, which totals approximately$27 million , with interest. OnJuly 7, 2021 , the PUCO approved the Ohio Companies' proposal to return the amount to customers inAugust 2021 . •Also onMarch 31, 2021 ,Governor DeWine signed HB 128, which, among other things, repealed parts of HB 6, the legislation that established support for nuclear energy supply inOhio , provided for a decoupling mechanism for electric utilities, and provided for the ending of current energy efficiency program mandates. •FirstEnergy is committed to pursuing an open dialogue in an appropriate manner with the several regulatory proceedings currently underway, including a state management audit, and multi-year SEET and ESP quadrennial review, among other matters. FirstEnergy believes a holistic, transparent discussion with the PUCO staff, and interested stakeholders in the regulatory process, is an important step towards removing uncertainties about regulatory concerns inOhio and critical to re-establishing trust in FirstEnergy and restoring its reputation. Despite the many disruptions FirstEnergy is currently facing, the leadership team remains committed and focused on executing its strategy and running the business. See "Outlook - Other Legal Proceedings" below for additional details on the government investigations, the DPA, and subsequent litigation surrounding the investigation of HB 6. See also "Outlook - State Regulation -Ohio " below for details on the PUCO proceeding reviewing political and charitable spending and legislative activity in response to the investigation of HB 6. The outcome of the government investigations, PUCO proceedings, legislative activity, and any of these lawsuits is uncertain and could have a material adverse effect on FE's or its subsidiaries' financial condition, results of operations and cash flows. As discussed below, FirstEnergy has made reductions to its Regulated Distribution and Regulated Transmission capital investment plans and is considering reductions to operating expenses, as well as changes to its planned equity issuances, to allow for flexibility to address the outcomes of the ongoing government investigations and related lawsuits and regulatory actions. 38 -------------------------------------------------------------------------------- FE and the Utilities and FET and certain of its subsidiaries participate in two separate five-year syndicated revolving credit facilities providing for aggregate commitments of$3.5 billion , which are available untilDecember 6, 2022 . Under the FE Revolving Facility, an aggregate amount of$2.5 billion is available to be borrowed, repaid and reborrowed, subject to separate borrowing sublimits for each borrower including FE and its regulated distribution subsidiaries. Under the FET Revolving Facility, an aggregate amount of$1.0 billion is available to be borrowed, repaid and reborrowed under a syndicated credit facility, subject to separate borrowing sublimits for each borrower including FE's transmission subsidiaries. OnJuly 21, 2021 , FE and the Utilities and FET and certain of its subsidiaries entered into amendments to the FE Revolving Facility and the FET Revolving Facility, respectively. The amendments provide for modifications and/or waivers of (i) certain representations and warranties, (ii) certain affirmative and negative covenants, contained therein, and (iii) any resulting event of default, which, in each case, resulted either from FE entering into the DPA or as a consequence of the facts and circumstances described in the DPA, thus allowing FirstEnergy to be in compliance with the revolving credit facilities and maintain access to the liquidity provided thereunder. FirstEnergy is also working to improve how it conducts business and serve its customers. InFebruary 2021 , FirstEnergy announced a new initiative to build upon FirstEnergy's strong operations and business fundamentals and deliver immediate value and resilience, with substantial operating and capital efficiencies ramping up through 2024. Called "FE Forward," the initiative will play a critical first step in FirstEnergy's transformation journey as it looks to optimize processes and procedures through range of opportunities, including:
•Optimizing operations by expanding capabilities in areas such as strategic sourcing, inventory optimization and commercial contract terms, and by standardizing best-in-class work management policies across FirstEnergy;
•accelerating FirstEnergy's digital transformation by revamping customers' online experience, automating sourcing data collection and management, and deploying advanced analytics in asset health decisions as well as vegetation management programs; and
•productivity improvements through system integration that puts advanced technology tools, such as mobile dashboards and remote access to asset management information, in the hands of frontline employees.
During the initial phase of FE Forward, FirstEnergy reviewed existing policies and practices, as well as the structure and processes around how decisions are made. In the second phase of FE Forward completed inMay 2021 , FirstEnergy reviewed further improvement opportunities and developed detailed, executable plans focusing on who, when, how and at what cost opportunities can be realized. InJune 2021 , phase three began and is focused on executing and implementing these findings and opportunities. By 2024, FE Forward is projected to generate approximately$300 million in annualized capital expenditure efficiencies while continuing to hold operating expenses flat by absorbing approximately$100 million in projected increases. In addition, FirstEnergy expects to generate approximately$250 million in working capital improvements by 2022. This program includes an estimated$150 million of costs to achieve through 2023, which are expected to be self-funded through these efficiencies. FE Forward is not a downsizing effort and there will not be any involuntary employee reductions in connection with this program. FirstEnergy expects that FE Forward will be a significant catalyst to augment its growth potential by taking a more strategic approach to operating expenditures and reinvesting in a more diverse capital program that over the long-term continues to support a smarter and cleaner electric grid. As part of these efforts, FirstEnergy will evaluate the appropriate cadence to initiate rates cases on a state-by-state basis to best support FirstEnergy's customer-focused strategic priorities. For the Years Ended December 31, FE Forward Expected Capital Efficiencies and Working Capital Improvements 2021 2022 2023 (In millions) Gross Capital Expenditure Efficiencies$ 180 $ 210 $ 300 Cost to Achieve (+/- 10%) (40) (60) (50) Net Capital Expenditure Efficiencies$ 140 $ 150 $ 250 Working Capital Improvements 100 150 - Total Free Cash Flow Improvements$ 240
With an operating territory of 65,000 square miles, the scale and diversity of the ten Utilities that comprise the Regulated Distribution business uniquely position this business for growth through opportunities for additional investment, with plans to invest up to$6.6 billion in capital from 2020 to 2023. Over the past several years, Regulated Distribution has experienced rate base growth through investments that have improved reliability and added operating flexibility to the distribution infrastructure, which provide benefits to the customers and communities those Utilities serve. Additionally, this business is exploring other opportunities for growth, including investments in electric system improvement and modernization projects to increase reliability and improve service to customers, as well as exploring opportunities in customer engagement that focus on the electrification of customers' homes and businesses by providing a full range of products and services.
With approximately 24,000 miles of transmission lines in operation, the Regulated Transmission business is the centerpiece of FirstEnergy's regulated investment strategy with 100% of its capital investments recovered under forward-looking formula rates
39 -------------------------------------------------------------------------------- at the Transmission Companies effectiveJanuary 1, 2021 . Regulated Transmission has also experienced significant growth as part of its Energizing the Future transmission plan with plans to invest up to$5.15 billion in capital from 2020 to 2023. FirstEnergy believes there are incremental investment opportunities for its existing transmission infrastructure of over$20 billion beyond those identified through 2023, which are expected to strengthen grid and cyber-security and make the transmission system more reliable, robust, secure and resistant to extreme weather events, with improved operational flexibility. While FirstEnergy continues to have customer-focused investment opportunities across its distribution and transmission businesses of up to$3 billion annually, it has discontinued providing a long-term earnings compound annual growth rate until there is further clarity regardingOhio regulatory matters and the ongoing government investigations. FE and the Utilities and FET and certain of its subsidiaries participate in two separate five-year syndicated revolving credit facilities providing for aggregate commitments of$3.5 billion , which are available untilDecember 6, 2022 . OnNovember 17, 2020 , FE and the Utilities and FET and certain of its subsidiaries entered into amendments to the FE Revolving Facility and the FET Revolving Facility, respectively. The amendment to the FE Revolving Facility, among other things, reduces the sublimit applicable to FE to$1.5 billion , and the amendments increased certain tiers of pricing applicable to borrowings under the credit facilities. OnNovember 23, 2020 , FE and JCP&L, ME, Penn, TE and WP, borrowed$950 million in the aggregate under the FE Revolving Facility, and FET and ATSI, borrowed$1 billion in the aggregate under the FET Revolving Facility. FE, FET and certain of their respective subsidiaries increased their borrowings under the Revolving Facilities as a proactive measure to increase their respective cash positions and preserve financial flexibility. OnMarch 19, 2021 , FET issued$500 million of 2.866% senior unsecured notes due 2028. Proceeds from the issuance were used to repay short-term borrowings under the FET Revolving Facility.
FE repaid
OnApril 9, 2021 , MP issued an additional$200 million of its 3.55% first mortgage bonds due 2027 at an effective interest rate of approximately 2.06%. Proceeds from the issuance were used to fund MP's ongoing capital expenditures, for working capital needs and for other general corporate purposes. OnMay 6, 2021 , TE issued$150 million of 2.65% senior secured notes due 2028. Proceeds from the issuance were used to repay short-term borrowings, fund TE's ongoing capital expenditures and for other general corporate purposes. OnMay 24, 2021 , MAIT issued an additional$150 million of its 4.10% senior notes due 2028 at an effective interest rate of approximately 2.55%. Proceeds from the issuance were used to repay borrowings outstanding under FirstEnergy's regulated company money pool, to fund MAIT's ongoing capital expenditures, to fund working capital and for other general corporate purposes.
On
On
Penn repaid
FirstEnergy does not currently anticipate the need to issue additional equity through 2021 and expects to issue, subject to, among other things, market conditions, pricing terms and business operations, up to$600 million of equity annually in 2022 and 2023, including up to$100 million in equity for its regular stock investment and employee benefit plans. FirstEnergy is also exploring various alternatives to raise equity capital in a manner that could be more value-enhancing to all stakeholders. FirstEnergy's expectations regarding the amount and timing of any potential equity issuances are subject to, among other matters, the ongoing government investigations and related lawsuits and regulatory actions. FirstEnergy has established new goals for key areas of its business that support the mission to be a forward-thinking, electric utility centered on integrity, powered by a diverse team of employees, committed to making customers' lives brighter, the environment better and our communities stronger. InNovember 2020 , FirstEnergy published its Climate Story which includes its climate position and strategy, as well as a new comprehensive and ambitious GHG emission goal. FirstEnergy pledged to achieve carbon neutrality by 2050 and set an interim goal for a 30% reduction in GHG within FirstEnergy's direct operational control by 2030, based on 2019 levels. In addition, FirstEnergy has also set a fleet electrification goal in which beginning in 2021, FirstEnergy plans for 100% of new purchases for 40 -------------------------------------------------------------------------------- its light duty and aerial truck fleet to be electric or hybrid vehicles, creating a path to 30% fleet electrification by 2030. Also, later in 2021, FirstEnergy will seek approval to construct a solar generation source of at least 50 MWs inWest Virginia . Future resource plans to achieve carbon reductions, including any determination of retirement dates of the regulated coal-fired generating facilities, will be developed by working collaboratively with regulators inWest Virginia . Determination of the useful life of the regulated coal-fired generating facilities could result in changes in depreciation, and/or continued collection of net plant in rates after retirement, securitization, sale, impairment or regulatory disallowances. If MP is unable to recover these costs, it could have a material adverse effect on FirstEnergy's and/or MP's financial condition, results of operations, and cash flow. InJanuary 2021 , the updated "Strategic Plan - Powered by our Core Values & Behaviors" was published. This comprehensive update provides a vision of FirstEnergy's path forward in an evolving electric industry. It also articulates significant new goals that will help achieve our long-term strategic commitments in a transparent, sustainable and responsible manner. The Strategic Plan includes specific targets related to:
•Enhancing a culture of compliance through transparency and accountability;
•Enabling a smarter, more resilient electric system;
•Embracing innovation across the organization;
•Meeting the challenges of climate change;
•Developing a diverse and inclusive workforce, including 2025 goals to increase the number of employees and leaders from underrepresented racial and ethnic groups by 30% each and targeting 20% of supply chain spend to be with diverse suppliers;
•Building collaborative relationships, marked by trust and respect, with all stakeholders;
•Strengthening FirstEnergy's safety-first culture; and
•Delivering strong and predictable financial results.
41 -------------------------------------------------------------------------------- FINANCIAL OVERVIEW AND RESULTS OF OPERATIONS (In millions) For the Three Months Ended June 30, For the Six Months Ended June 30, 2021 2020 Change 2021 2020 Change Revenues$ 2,622 $ 2,522 $ 100 4 %$ 5,348 $ 5,231 $ 117 2 % Operating expenses 2,310 2,007 303 15 % 4,477 4,184 293 7 % Operating income 312 515 (203) (39) % 871 1,047 (176) (17) % Other expenses, net (158) (142) (16) (11) % (295) (710) 415 58 % Income before income taxes 154 373 (219) (59) % 576 337 239 71 % Income taxes 96 66 30 45 % 183 6 177 NM Income from continuing operations 58 307 (249) (81) % 393 331 62 19 % Discontinued operations, net of tax - 2 (2) NM - 52 (52) NM Net income $ 58$ 309 $ (251) (81) %$ 393 $ 383 $ 10 3 % *NM= not meaningful The financial results discussed below include revenues and expenses from transactions among FirstEnergy's business segments. A reconciliation of segment financial results is provided in Note 10, "Segment Information," of the Notes to Consolidated Financial Statements. 42
--------------------------------------------------------------------------------
© Edgar Online, source