Item 1B - Unresolved Staff Comments
None.
Information relating to our properties is contained in Item 1 - Business - Electric Operations and Fuel Supply and Note 4 - Property, Plant and Equipment of Notes to DPL's Consolidated Financial Statements and Note 4 - Property, Plant and Equipment of Notes to DP&L's Financial Statements.
Our executive offices are located at 1065 Woodman Drive, Dayton, Ohio. This facility and the remainder of our material properties are owned directly by DP&L or AES Ohio Generation. We also own a distribution service center in Dayton, Ohio.
Substantially all property, plant & equipment of DP&L is subject to the lien of the mortgage securing DP&L’s First and Refunding Mortgage. All generation assets were released from the lien of DP&L's first and refunding mortgage in connection with the completion of Generation Separation on October 1, 2017.
Item 3
Item 3 - Legal Proceedings
DPL and DP&L are involved in certain claims, suits and legal proceedings in the normal course of business. DPL and DP&L have accrued for litigation and claims where it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. DPL and DP&L believe, based upon information they currently possess and considering established reserves for estimated liabilities and insurance coverage, that the ultimate outcome of these proceedings and actions is unlikely to have a material adverse effect on their financial statements. It is reasonably possible, however, that some matters could be decided unfavorably and could require DPL or DP&L to pay damages or make expenditures in amounts that could be material but cannot be estimated as of December 31, 2017.
The following additional information is incorporated by reference into this Item: information about the legal proceedings contained in Item 1 - Business - Competition and Regulation and Item 1 - Business - Environmental Matters.
Item 4
Item 4 - Mine Safety Disclosures
Not applicable.
PART II
Item 5
Item 5 - Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
All of the outstanding common stock of DPL is owned indirectly by AES and directly by a wholly-owned subsidiary of AES. As a result, our stock is not listed for trading on any stock exchange. DP&L’s common stock is held solely by DPL and, as a result, is not listed for trading on any stock exchange.
Dividends
During the years ended December 31, 2017, 2016 and 2015, DPL paid no dividends to AES. DP&L declares and pays dividends on its common shares to its parent DPL from time to time as declared by the DP&L board. Dividends on common shares in the amount of $39.0 million, $70.0 million and $50.0 million were declared and paid in the years ended December 31, 2017, 2016 and 2015, respectively. DP&L declared and paid dividends on preferred shares of $0.7 million in the year ended December 31, 2016 and $0.9 million in the year ended December 31, 2015.
DPL’s Amended Articles of Incorporation contain restrictions on DPL’s ability to make dividends, distributions and affiliate loans (other than to its subsidiaries), including restrictions of making such dividends, distributions and loans if certain financial ratios exceed specified levels and DPL’s senior long-term debt rating from a rating agency is below investment grade. As of December 31, 2017, DPL’s leverage ratio was at 1.50 to 1.00 and DPL’s senior long-term debt rating from all three major credit rating agencies was below investment grade. As a result, as of December 31, 2017, DPL was prohibited under its Articles of Incorporation from making a distribution to its shareholder or making a loan to any of its affiliates (other than its subsidiaries).
DP&L's 2017 ESP also contains restrictions on dividend or tax sharing payments from DPL to AES. See Note 11 - Equity for more information and Note 9 - Income Taxes for more information about the tax sharing payment restrictions.
On October 13, 2016 (the "Redemption Date"), DPL's subsidiary, DP&L redeemed all of its issued and outstanding preferred stock. See Note 11 - Equity of Notes to DPL's Consolidated Financial Statements for more information and Note 10 - Equity of Notes to DP&L's Financial Statements.
Item 6
Item 6 - Selected Financial Data
The following table presents our selected financial data which should be read in conjunction with DPL's audited Consolidated Financial Statements and the related Notes thereto, DP&L's audited Financial Statements and the related Notes thereto and Item 7
Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with DPL’s audited Consolidated Financial Statements and the related Notes thereto and DP&L’s audited Financial Statements and the related Notes thereto included in Item 8 - Financial Statements and Supplementary Data of this Form 10-K. The following discussion contains forward-looking statements. Our actual results may differ materially from the results suggested by these forward-looking statements. See “Forward-Looking Statements” at the beginning of this Form 10-K and Item 1A - Risk Factors. For a list of certain abbreviations or acronyms in this discussion, see Glossary of Terms at the beginning of this Form 10-K.
Key topics in Management's Discussion and Analysis
Our discussion covers the following:
•
Review of Results of Operations
◦
DPL
▪
DPL - T&D Segment
▪
DPL - Generation Segment
◦
DP&L
•
Key Trends and Uncertainties
•
Capital Resources and Liquidity
•
Critical Accounting Estimates
RESULTS OF OPERATIONS - DPL Inc.
DPL’s results of operations include the results of its subsidiaries, including the consolidated results of its principal subsidiary DP&L. All material intercompany accounts and transactions have been eliminated in consolidation. A separate specific discussion of the results of operations for DP&L is presented elsewhere in this report.
Statement of Operations Highlights - DPL
(a)
For purposes of discussing operating results, we present and discuss Loss from continuing operations before income tax. This format is useful to investors because it allows analysis and comparability of operating trends and includes the same information that is used by management to make decisions regarding our financial performance.
DPL - Revenues
Retail customers, especially residential and commercial customers, consume more electricity on warmer and colder days. Therefore, our retail sales volume is affected by the number of heating and cooling degree-days occurring during a year. Cooling degree-days typically have a more significant effect than heating degree-days since some residential customers do not use electricity to heat their homes.
Degree-days
(a)
Heating and cooling degree-days are a measure of the relative heating or cooling required for a home or business. The heating degrees in a day are calculated as the degrees that the average actual daily temperature is below 65 degrees Fahrenheit. For example, if the average temperature on March 20th was 40 degrees Fahrenheit, the heating degrees for that day would be the 25 degree difference between 65 degrees and 40 degrees. Similarly, cooling degrees in a day are calculated as the degrees that the average actual daily temperature is above 65 degrees Fahrenheit.
Since we have historically utilized our internal generating capacity to supply the needs of our retail customers within the DP&L service territory first, increases in on-system retail demand may have decreased the volume of internal generation available to be sold in the wholesale market and vice versa. Beginning in 2016, DP&L retail demand is entirely sourced through a competitive auction. We sell generation into the wholesale market, which covers a multi-state area and settles on an hourly basis throughout the year. Factors impacting our wholesale sales volume each hour of the year include: wholesale market prices; retail demand throughout the entire wholesale market area; availability of our generating plants and non-affiliated generating plants to sell into the wholesale market; contracted wholesale sales and our variable generation costs. Our goal is to make wholesale sales when it is profitable to do so.
The following table provides a summary of changes in revenues from prior periods:
During the year ended December 31, 2017, Revenues decreased $190.4 million to $1,236.9 million from $1,427.3 million in the same period of the prior year. This decrease was primarily the result of lower average retail and wholesale rates and volumes, slightly offset by higher RTO and RTO capacity revenues.
•
Retail revenues decreased $97.0 million primarily due to an unfavorable $69.2 million retail rate variance and an unfavorable $28.4 million retail volume variance. The decrease in average retail rates was primarily driven by reverting to ESP 1 rates in September of 2016. In addition, there were decreased collections on the USF, competitive bid, and energy efficiency revenue rate riders, as well as a decrease due to the collection of the remaining 2015 deferred fuel balance in the first quarter of 2016. These were partially offset by the implementation of the DMR in November 2017. The decrease in retail volume was primarily driven by more mild weather in 2017, as heating degree-days decreased by 229 degree-days and cooling degree-days decreased by 323 degree-days.
•
Wholesale revenues decreased $95.4 million primarily as a result of an unfavorable $67.8 million wholesale volume variance and an unfavorable $27.6 million wholesale rate variance. Despite increases in PJM market prices, the unfavorable price variance was due to lower realized gains on derivatives in 2017. The decrease in wholesale volumes of $67.8 million was primarily driven by a 13% decrease in internal generation at DPL's plants in 2017 and a decrease in the load served of other parties through their competitive bid process.
•
RTO capacity and other revenues, consisting primarily of compensation for use of DP&L’s transmission assets, regulation services, reactive supply and operating reserves, and PJM capacity payments, increased $2.1 million compared to the prior year. This increase was the result of a $6.5 million increase in revenue realized from the PJM capacity auction in 2017 primarily due to higher average prices in the CP auction. The capacity price that became effective in June of 2017 was $152/MW-day, compared to $59/MW-day under the base RPM auction and $134/MW-day for the transitional CP auction in June of 2016, and $136/MW-day in June of 2015. This increase was partially offset by a $4.4 million decrease in RTO revenues due to lower rates and availability related to compensation for DPL's reactive supply and operating reserves.
During the year ended December 31, 2016, Revenues decreased $185.5 million to $1,427.3 million from $1,612.8 million in the same period of the prior year. This decrease was primarily the result of lower average retail and wholesale rates and lower RTO and RTO capacity revenues, partially offset by higher retail and wholesale volumes.
•
Retail revenues decreased $46.5 million primarily due to an unfavorable $68.7 million retail rate variance and a favorable $21.0 million retail volume variance. The unfavorable rate variance was due to lower average DP&L retail rates, primarily driven by decreased retail revenue from SSO customers as the competitive auction rate, which represents 100% of DP&L SSO load in 2016 compared to 60% in 2015, was lower than the non-auction SSO rate. The decrease was also due to the recovery of deferred storm costs in 2015 and the reversion back to ESP 1 rates in September of 2016, partially offset by $20.1 million of revenue associated with energy efficiency programs recorded in 2016. This decrease in rate was partially offset by a volume increase due to warmer summer weather in 2016 as cooling degree-days increased by 153 along with increased sales to commercial and industrial customers, partially offset by milder winter weather in the first quarter of 2016 as heating degree-days-decreased by 129.
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Wholesale revenues decreased $120.5 million as a result of an unfavorable $124.4 million wholesale rate variance and a favorable $3.9 million wholesale volume variance. The unfavorable price variance of $124.4 million was primarily due to lower market prices in 2016 and higher average prices on sales to DPLER in 2015, as DP&L previously had full requirements sales to DPLER in 2015. This price decrease was partially offset by a favorable wholesale volume variance as DP&L had excess generation available to be sold in the wholesale market in 2016 resulting from 100% of its SSO load being served through the competitive bid process compared to 60% during 2015. In addition, there was a 4.5% increase in internal generation from DP&L's co-owned and operated plants in 2016 compared to the prior year, partially offset by a decrease in volume due to the contract termination with DPLER. As noted above, DP&L previously had full requirements sales to DPLER in 2015. These sales were previously eliminated in consolidation prior to DPLER being accounted for as a discontinued operation.
•
RTO capacity and other revenues, consisting primarily of compensation for use of DP&L’s transmission assets, regulation services, reactive supply and operating reserves, and PJM capacity payments, decreased $20.7 million compared to the prior year. This decrease was the result of a $7.7 million decrease in RTO transmission and congestion revenue, as 2015 congestion revenue charges were higher due to milder winter weather in 2016 than 2015. There was also a $13.0 million decrease in revenue realized from the PJM capacity auction in 2016 due to lower capacity cleared and lower prices in both the CP and RPM auctions. The capacity price that became effective in June of 2016 was $134/MW-day, compared to $136/MW-day in June 2015.
DPL - Cost of Revenues
During the year ended December 31, 2017, Total cost of revenues decreased $136.7 million compared to the prior year. This decrease was a result of:
•
Net fuel costs, which include coal, gas, oil and emission allowance costs, decreased $58.5 million compared to the same period in the prior year primarily due to a 11% decrease in average fuel cost per MWh and a 13% decrease in internal generation. There were fuel costs deferred in 2015 which were expensed in 2016 because they were collected in 2016, which contributed to the price decrease. The
decrease in internal generation was primarily due to plant outages, mostly resulting from the January 10, 2017 high pressure feedwater heater shell failure on Unit 1 at the J.M. Stuart station.
•
Net purchased power decreased $78.2 million compared to the prior year. This decrease was driven by the following factors:
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Purchased power decreased $66.5 million primarily due to a $32.4 million volume decrease and a $34.1 million price decrease compared to the same period in the prior year. The volume decrease was primarily driven by a lower load served through the competitive bid process of other parties compared to 2016, as well as the decrease in DP&L retail demand in 2017. The price decrease was primarily driven by lower rates in the competitive bid process in 2017 compared to 2016.
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RTO charges decreased $7.7 million compared to the prior year primarily due to lower transmission and congestion charges. RTO charges are incurred by DP&L as a member of PJM and primarily include transmission charges within our network, which are incurred and charged to customers in the transmission rider, transmission and congestion losses incurred on DP&L's wholesale revenues, and costs associated with load obligations for retail customers.
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RTO capacity charges decreased $6.6 million compared to the prior year primarily due to a lower retail load served in 2017, as well as a $1.7 million PJM penalty incurred in March 2016 associated with low plant availability. Retail load served relates to the load of other parties through their competitive bid process. As noted above, RTO capacity prices are set by an annual auction.
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Mark-to-market gains decreased $2.6 million due to changes in power prices in 2017 and 2016.
During the year ended December 31, 2016, Total cost of revenues decreased $136.2 million compared to the prior year. This decrease was a result of:
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Net fuel costs increased $9.0 million compared to the prior year primarily due to a 7.2% increase in internal generation, partially offset by a 2.4% decrease in average fuel cost per MWh.
•
Net purchased power decreased $145.2 million compared to the prior year. This decrease was driven by the following factors:
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Purchased power decreased $14.1 million primarily due to a $55.4 million volume decrease as DP&L no longer purchased power to source DPLER customers due to the sale of DPLER on January 1, 2016. This volume decrease was partially offset by increased purchases as DP&L sourced 100% of SSO load through the competitive bid process in 2016 as opposed to 60% in 2015. DPL purchases power for the SSO load sourced through the competitive bid process and to serve auction load requirements in service territories other than DP&L's. The decrease in volume was also offset by an unfavorable price variance of $41.3 million driven by higher prices in the competitive bid process.
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RTO charges decreased $19.5 million primarily as a result of no longer having a DP&L retail load obligation as a result of 100% SSO sales being sourced through the competitive auction. RTO charges are incurred by DP&L as a member of PJM and primarily include transmission charges within our network which are incurred and charged to customers in the TCRR-N rider, transmission and congestion losses incurred on DP&L's wholesale revenues, and costs associated with load obligations for retail customers.
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RTO capacity charges decreased $101.2 million primarily due to DP&L no longer having a retail load requirement in 2016, resulting from the SSO load being 100% sourced through competitive bid in 2016 as opposed to 60% in 2015 and, additionally, from the fact that DP&L did not provide power to DPLER in 2016. The remaining charges primarily relate to serving the load of other parties through their competitive bid process. As noted in the revenue section above, RTO capacity prices are set by an annual auction.
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Mark-to-market losses decreased $10.4 million due to less significant decreases in power prices in 2016, resulting in gains on derivative forward power purchase contracts.
DPL - Operation and Maintenance
During the year ended December 31, 2017, Operation and Maintenance expense decreased $20.5 million compared to the prior year. This decrease was a result of:
(a)
There is corresponding revenue associated with this program resulting in minimal impact to Net income.
During the year ended December 31, 2016, Operation and Maintenance expense decreased $13.2 million compared to the prior year. This decrease was a result of:
(a)
There is corresponding revenue associated with this program resulting in minimal impact to Net income.
DPL - Depreciation and Amortization
During the year ended December 31, 2017, Depreciation and amortization expense decreased $25.4 million compared to the prior year. The decrease was primarily a result of the fixed-asset impairments in the second and fourth quarters of 2016, and the first quarter of 2017, which reduced depreciation expense due to the lower asset values. In addition, the decrease was attributable to the discontinuation of Miami Fort and Zimmer depreciation expense due to the sale of these two plants.
During the year ended December 31, 2016, Depreciation and amortization expense decreased $2.3 million compared to the prior year. The decrease was primarily a result of the fixed asset impairment in Q2 of 2016, which reduced depreciation expense due to the lower asset values.
DPL - General Taxes
During the year ended December 31, 2017, General taxes increased $4.0 million compared to the prior year due to a $1.6 million favorable true-up of the 2015 Ohio property tax accrual recorded in 2016 to reflect actual payments made in 2016, combined with an unfavorable true-up of $1.2 million recorded in 2017 for the 2016 Ohio property tax accrual to reflect actual payments made in 2017 and a $0.7 million reserve recorded in 2017 for a potential property tax settlement.
During the year ended December 31, 2016, General taxes decreased $1.3 million compared to the prior year.
DPL - Goodwill Impairment
During the year ended December 31, 2015, DPL recorded an impairment of goodwill of $317.0 million, which was a full impairment of the remaining goodwill balance. The goodwill impairment test indicated that the fair value of the DP&L Reporting Unit was less than its carrying amount, primarily due to a decrease in dark spreads that were driven by decreases in forward power prices, and lower revenues from the new CP product. See Note 7 - Goodwill of Notes to DPL’s Consolidated Financial Statements.
DPL - Fixed-asset Impairments
During the year ended December 31, 2017, DPL recorded impairments of fixed assets totaling $175.8 million. In the first quarter of 2017, the Board of Directors of DP&L approved the retirement of the then DP&L operated and co-owned Stuart Station coal-fired and diesel-fired generating units and the Killen Station coal-fired generating unit and combustion turbine (collectively, the “Facilities”) on or before June 1, 2018. The co-owners of these facilities agreed with DP&L to proceed with this plan of retirement. DPL performed a long-lived asset impairment analysis and determined that the carrying amounts of the Facilities were not recoverable. As a result, DPL recognized asset impairment expense of $66.4 million in the first quarter of 2017. In the fourth quarter of 2017, DPL signed an agreement with Kimura Power, LLC for the sale of its Peaker assets. Because the Peaker assets met the criteria to be classified as held-for-sale and the carrying value of the Peaker assets exceeded the fair value less cost to sell as of December 31, 2017, DPL recognized asset impairment expense of $109.4 million in fourth quarter of 2017.
During the year ended December 31, 2016, DPL recorded impairments of fixed assets totaling $859.0 million. In the second quarter of 2016, DPL recorded a $235.5 million fixed-asset impairment as DP&L performed a long-lived asset impairment test and determined that the carrying amounts of the asset groups of Killen and certain DP&L peaking generating facilities were not recoverable. In the fourth quarter of 2016, DPL recorded an additional $623.5 million fixed asset impairment as DP&L performed a long-lived asset impairment analysis for the Killen, Stuart, Miami Fort, Zimmer and Conesville coal-fired facility asset groups, as well as the Hutchings gas-fired peaking plant asset group and determined that their carrying amounts were not recoverable.
During the year ended December 31, 2015, DPL did not record any impairments of fixed assets.
For more information on these impairments, see Note 15 - Fixed-asset Impairments of Notes to DPL's Consolidated Financial Statements.
DPL - Interest Expense
During the year ended December 31, 2017, Interest expense increased $2.4 million compared to the prior year primarily due to higher interest rates. On August 24, 2016, DP&L refinanced its 1.875% First Mortgage Bonds Due 2016, with a variable rate Term Loan B of $445.0 million maturing on August 24, 2022. The variable rate on the loan is calculated based on LIBOR plus a spread of 3.25%, with a LIBOR floor of 0.75%.
During the year ended December 31, 2016, Interest expense decreased $12.1 million compared to the prior year primarily due to debt repayments at DPL and DP&L, as well as a $3.8 million decrease in carrying costs primarily related to the recovery of deferred storm costs in 2015.
DPL - Charge for Early Redemption of Debt
During the year ended December 31, 2017, DPL recorded a charge for early redemption of debt of $3.3 million primarily due to the early redemption of the 4.8% Tax-exempt First Mortgage Bonds due 2036 and associated write-off of deferred financing costs.
During the year ended December 31, 2016, DPL recorded a charge for early redemption of debt
$3.1 million primarily due to the February 2016 make-whole premium of $2.4 million associated with the early retirement of $73.0 million of the 6.5% Senior Notes due in 2016.
During the year ended December 31, 2015, DPL recorded a charge for early redemption of debt of $2.1 million primarily due to the write off of deferred financing costs associated with the refinancing of its revolving credit facility and its term loan.
DPL - Other
During the year ended December 31, 2017, DPL recorded Other operating income of $6.6 million primarily consisting of the $14.0 million gain on sale of the Miami Fort and Zimmer plants and $8.7 million of insurance
recoveries, partially offset by the $16.2 million write-off of plant materials and supplies inventory at the Stuart and Killen plants.
During the year ended December 31, 2016, DPL recorded Other operating income of $0.1 million.
During the year ended December 31, 2015, DPL recorded Other operating expense of $0.4 million.
DPL - Income Tax Expense
During the year ended December 31, 2017, Income tax benefit decreased $253.5 million compared to the prior year primarily due to lower pre-tax loss in the current year compared to the prior year and the one-time re-measurement of deferred tax expense related to the recent enactment of the TCJA.
During the year ended December 31, 2016, Income tax benefit increased $298.8 million compared to the prior year primarily due to a pre-tax loss in the current year and the recording of a goodwill impairment, which is not deductible for income tax purposes, in 2015 that did not occur in 2016. This was partially offset by an increase to income tax expense due to non-taxable depreciation of AFUDC equity.
RESULTS OF OPERATIONS BY SEGMENT - DPL Inc.
DPL currently manages its business through two reportable operating segments, the T&D segment and the Generation segment. The primary segment performance measure is income / (loss) from continuing operations before income tax as management has concluded that this measure best reflects the underlying business performance of DPL and is the most relevant measure considered in DPL’s internal evaluation of the financial performance of its segments. The segments are discussed further below:
Transmission and Distribution Segment
The T&D segment is comprised primarily of DP&L’s electric transmission and distribution businesses, which distribute electricity to residential, commercial, industrial and governmental customers. DP&L distributes electricity to more than 521,000 retail customers who are located in a 6,000 square mile area of West Central Ohio. DP&L’s electric transmission and distribution businesses are subject to rate regulation by federal and state regulators. Accordingly, DP&L applies the accounting standards for regulated operations to its electric transmission and distribution businesses and records regulatory assets when incurred costs are expected to be recovered in future customer rates, and regulatory liabilities when current cost recoveries in customer rates relate to expected future costs. The T&D segment includes revenues and costs associated with DP&L's investment in OVEC and the historical results of DP&L’s Beckjord and Hutchings Coal generating facilities, which were either closed or sold in prior periods. As these assets were not transferred to AES Ohio Generation, they are grouped with the T&D assets for segment reporting purposes. In addition, regulatory deferrals and collections, which include fuel deferrals in historical periods, are included in the T&D segment.
Generation Segment
The Generation segment is comprised of AES Ohio Generation and the historical results of DP&L's electric generation business prior to Generation Separation. Beginning in 2001, Ohio law gave consumers the right to choose the electric generation supplier from whom they purchase retail generation services. AES Ohio Generation owns and operates coal-fired and peaking generating facilities and sells its generated energy and capacity into the PJM wholesale market. The 2015 Generation segment results also include sales to DPLER and to the T&D segment for SSO customers.
Included within the “Other” column are other businesses that do not meet the GAAP requirements for disclosure as reportable segments as well as certain corporate costs, which include interest expense on DPL’s debt and adjustments related to purchase accounting from the Merger. The accounting policies of the reportable segments are the same as those described in Note 1 - Overview and Summary of Significant Accounting Policies. Intersegment sales and profits are eliminated in consolidation. Certain shared and corporate costs are allocated among reporting segments.
See Note 14 - Business Segments of Notes to DPL’s Consolidated Financial Statements for additional information regarding DPL’s reportable segments.
The following table presents DPL’s Loss from continuing operations before income tax by business segment:
Statement of Operations Highlights - DPL - T&D Segment
The results of operations of the T&D segment for DPL are identical in all material respects and for all periods presented to those of DP&L results from continuing operations, which are included in Part II - Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations (Statement of Operations Highlights - DP&L) of this Form 10-K.
Statement of Operations Highlights - DPL - Generation Segment
(a)
For purposes of discussing operating results, we present and discuss Loss from continuing operations before income tax. This format is useful to investors because it allows analysis and comparability of operating trends and includes the same information that is used by management to make decisions regarding our financial performance.
DPL - Generation Segment - Revenues
During the year ended December 31, 2017, the segment’s revenues decreased $103.6 million to $507.9 million from $611.5 million in the prior year. This decrease was primarily the result of lower average wholesale rates, lower wholesale volumes, and lower RTO revenues, partially offset by increased RTO capacity revenues.
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Wholesale revenues decreased $104.1 million primarily as a result of an unfavorable wholesale volume variance of $81.3 million and an unfavorable wholesale price variance of $22.8 million. Despite increases in PJM market prices, the unfavorable price variance was due to lower realized gains on derivatives in
2017. The decrease in wholesale volumes was primarily driven by a 13% decrease in internal generation at DPL's plants in 2017 and a decrease in the load served of other parties through their competitive bid process.
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RTO capacity and other revenues, consisting primarily of PJM capacity revenues, regulation services, reactive supply and operating reserves, increased $0.4 million compared to the prior year primarily due to a $6.3 million increase in revenue realized from the PJM capacity auction in 2017 primarily due to higher average prices in the CP auction. The capacity price that became effective in June of 2017 was $152/MW-day, compared to $59/MW-day under the base RPM auction and $134/MW-day for the transitional CP auction in June of 2016, and $136/MW-day in June of 2015. This increase was partially offset by a $5.9 million decrease in RTO revenues due to lower rates and availability related to compensation for DPL's reactive supply and operating reserves.
During the year ended December 31, 2016, the segment’s revenues decreased $345.4 million to $611.5 million from $956.9 million in the prior year. This decrease was primarily the result of lower average wholesale rates, the sale of DPLER in 2016, and lower RTO capacity and other revenues, partially offset by increased wholesale volume.
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Wholesale revenues decreased $323.2 million primarily as a result of the 2016 sale of DPLER, which accounted for $304.8 million of wholesale sales in 2015. DP&L had full requirements sales to DPLER in 2015 until the competitive retail business was sold on January 1, 2016. The remaining decrease of $18.4 million was primarily due to lower market prices in 2016, partially offset by a 4.5% increase in internal generation from DP&L's co-owned and operated plants in 2016 compared to the prior year.
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RTO capacity and other revenues, consisting primarily of PJM capacity revenues, regulation services, reactive supply and operating reserves, decreased $21.9 million compared to the prior year. RTO transmission and congestion revenue decreased $8.1 million as 2015 congestion revenue charges were higher due to milder winter weather in 2016 than 2015. In addition, revenue realized from the PJM capacity auction decreased $13.8 million in 2016 due to lower capacity cleared and lower price in both the CP and RPM auctions. The capacity price that became effective in June 2016 was $134/MW-day compared to $136/MW-day in June 2015.
DPL - Generation Segment - Cost of Revenues
During the year ended December 31, 2017, Total cost of revenues decreased $105.7 million compared to the prior year. This decrease was a result of:
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Net fuel costs, which include coal, gas, oil and emission allowance costs, decreased $53.7 million compared to the prior year primarily due to a 11% decrease in average fuel cost per MWh and a 13% decrease in internal generation.
•
Net purchased power decreased $52.0 million compared to the prior year. This decrease was driven by the following factors:
◦
Purchased power decreased $39.6 million primarily due to a favorable volume variance of $28.7 million and a favorable price variance of $10.9 million. The decrease in volume was driven by a lower load served of other parties through their competitive bid process in 2017. Despite increases in PJM market prices, the favorable price variance was due to lower realized losses on derivatives in 2017. The generation segment purchases power to source retail load in other service territories and to meet contracted Wholesale requirements when generating facilities are not available due to planned and unplanned outages or when market prices are below the marginal costs associated with our generating facilities.
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RTO charges decreased $6.3 million compared to the prior year primarily due to lower transmission and congestion charges.
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RTO capacity charges decreased $8.8 million compared to the prior year primarily due to a lower retail load served in 2017, as well as a $1.7 million PJM penalty incurred in March 2016 associated with low plant availability. Retail load served relates to the load of other parties through their competitive bid process. As noted above, RTO capacity prices are set by an annual auction.
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Mark-to-market gains decreased $2.7 million due to changes in power prices in 2017 and 2016.
During the year ended December 31, 2016, Total cost of revenues decreased $358.2 million compared to the prior year. This decrease was a result of:
•
Net fuel costs, which include coal, gas, oil and emission allowance costs, decreased $5.3 million compared to the prior year primarily due to a 7.5% decrease in average fuel cost per MWh and a $3.3 million decrease in gains on the sale of coal, partially offset by a 7.2% increase in internal generation.
•
Net purchased power decreased $352.9 million compared to the prior year. This decrease was driven by the following factors:
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Purchased power decreased $240.1 million primarily due to decreased power purchased to source DPLER customers, as DP&L previously had full requirements sales to DPLER in 2015. We purchase power to source retail load in other service territories and to source DPLER customers in 2015. The generation segment also purchases power to meet contracted Wholesale requirements when generating facilities are not available due to planned and unplanned outages or when market prices are below the marginal costs associated with our generating facilities.
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RTO charges decreased $20.5 million primarily as a result of no longer having load obligations on sales to DPLER. RTO charges are incurred as a member of PJM and include costs associated with the segment's load obligations and transmission and congestion losses incurred on the segments wholesale revenues.
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RTO capacity charges decreased $81.8 million primarily due to the segment no longer providing power to DPLER in 2016. The remaining charges primarily relate to serving the load of other parties through their competitive bid process. As noted in the revenue section above, RTO capacity prices are set by an annual auction.
◦
Mark-to-market gains increased $10.5 million due to less significant decreases in power prices in 2016 causing gains on derivative forward power purchase contracts.
DPL - Generation Segment - Operation and Maintenance
During the year ended December 31, 2017, Operation and Maintenance expense decreased $2.2 million compared to the prior year. This decrease was a result of:
During the year ended December 31, 2016, Operation and Maintenance expense increased $3.4 million compared to the prior year. This increase was a result of:
DPL - Generation Segment - Depreciation and Amortization
During the year ended December 31, 2017, Depreciation and amortization expense decreased $34.5 million compared to the prior year. The decrease was primarily a result of the fixed-asset impairments in the second and fourth quarters of 2016, and the first quarter of 2017, which reduced depreciation expense due to the lower asset values. In addition, the decrease was attributable to the discontinuation of Miami Fort and Zimmer depreciation expense due to the sale of these two plants.
During the year ended December 31, 2016, Depreciation and amortization expense decreased $17.2 million compared to the prior year. The decrease was primarily a result of the fixed-asset impairment in the second quarter of 2016, which reduced depreciation expense due to the lower asset values.
DPL - Generation Segment - General Taxes
During the year ended December 31, 2017, General taxes decreased $4.4 million compared to the prior year. The decrease was primarily the result of a $3.0 million reduction in 2017 expense due to a true-up of the year to date 2017 Ohio property tax accrual to reflect final assessments for 2017 taxes and an unfavorable $0.9 million true-up of the 2015 Ohio property tax accrual to reflect actual payments made in 2016.
During the year ended December 31, 2016, General taxes increased $1.6 million compared to the prior year.
DPL - Generation Segment - Fixed-asset Impairments
During the year ended December 31, 2017, the Generation segment recorded fixed-asset impairments, without the effect of the purchase accounting adjustments included in the Other column of segments, of $66.3 million. In the first quarter of 2017, the Board of Directors of DP&L approved the retirement of the then DP&L-operated and co-owned Stuart Station coal-fired and diesel-fired generating units and the Killen Station coal-fired generating unit and combustion turbine (collectively, the “Facilities”) on or before June 1, 2018. The co-owners of these facilities agreed with DP&L to proceed with this plan of retirement. DPL performed a long-lived asset impairment analysis and determined that the carrying amounts of the Facilities were not recoverable. As a result, DPL's Generation segment recognized asset impairment expense of $66.3 million in the first quarter of 2017. Because the Peaker asset impairment expense was included with purchase accounting adjustments in the Other column of segments, DPL's Generation segment did not record a fixed-asset impairment related to the Peaker assets in 2017.
During the year ended December 31, 2016, DPL's Generation segment recorded fixed-asset impairments, without the effect of the purchase accounting adjustments included in the Other column of segments, of $1,353.5 million. In the second quarter of 2016, the Generation segment recorded an $857.1 million fixed-asset impairment, as DP&L performed a long-lived asset impairment test and determined that the carrying amounts of the asset groups of then DP&L-operated Killen and certain peaking generating facilities were not recoverable. In the fourth quarter of 2016, the Generation segment recorded an additional $496.4 million fixed-asset impairment as DP&L performed a long-lived asset impairment analysis for the then DP&L-operated Killen, Stuart, Miami Fort, Zimmer and Conesville coal-fired facility asset groups, as well as the Hutchings gas-fired peaking plant asset group and determined that their carrying amounts were not recoverable.
For more information on these impairments, see Note 15 - Fixed-asset Impairments of Notes to DPL's Consolidated Financial Statements.
DPL - Generation Segment - Interest Expense
During the year ended December 31, 2017, Interest expense decreased $0.3 million.
The PUCO authorized DP&L to maintain long-term debt of $750 million or 75% of its rate base, whichever is greater, until January 1, 2018, or to file an application to explain why it would not achieve those metrics. Prior to Generation Separation on October 1, 2017, for segment purposes, $750.0 million of debt and the pro rata interest expense associated with that debt were allocated to the T&D segment. All remaining debt and interest expense were included in the Generation segment.
During the year ended December 31, 2016, Interest expense decreased $2.5 million compared to the prior year due primarily to a reduction of debt.
RESULTS OF OPERATIONS - DP&L
Statement of Operations Highlights - DP&L
(a)
For purposes of discussing operating results, we present and discuss Income from continuing operations before income tax. This format is useful to investors because it allows analysis and comparability of operating trends and includes the same information that is used by management to make decisions regarding our financial performance.
DP&L - Revenues
The following table provides a summary of changes in DP&L’s Revenues from prior periods:
During the year ended December 31, 2017, Revenues decreased $88.0 million to $720.0 million from $808.0 million in the prior year. This decrease was primarily the result of lower average retail rates and lower retail volumes, partially offset by higher wholesale, RTO capacity and other revenues.
•
Retail revenues decreased $97.2 million primarily due to an unfavorable $69.3 million retail rate variance and an unfavorable $28.5 million retail volume variance. The decrease in average retail rates was primarily driven by reverting to ESP 1 rates in September of 2016. In addition, there were decreased collections on the USF, competitive bid, and energy efficiency revenue rate riders, as well as a decrease due to the collection of the remaining 2015 deferred fuel balance in the first quarter of 2016. These were partially offset by the implementation of the DMR in November 2017. The decrease in retail volume was primarily driven by more mild weather in 2017, as heating degree-days decreased by 229 degree-days and cooling degree-days decreased by 323 degree-days. In addition, there was a favorable other miscellaneous variance of $0.6 million.
•
Wholesale revenues increased $7.5 million. These revenues consist of DP&L's 4.9% share of the generation output of OVEC, which is sold into PJM at market prices.
•
RTO capacity and other revenues increased $1.7 million compared to the prior year.
During the year ended December 31, 2016, Revenues decreased $49.0 million to $808.0 million from $857.0 million in the prior year. This decrease was primarily the result of lower average retail rates, partially offset by higher retail volumes, higher wholesale revenues, and higher RTO revenues.
•
Retail revenues decreased $46.6 million primarily due to an unfavorable $68.7 million retail rate variance and a favorable $21.0 million retail volume variance. The unfavorable rate variance was due to lower average DP&L retail rates, primarily driven by decreased retail revenue from SSO customers as the competitive auction rate, which represents 100% of DP&L SSO load in 2016 compared to 60% in 2015, was lower than the non-auction SSO rate. The decrease was also due to the recovery of deferred storm costs in 2015 and the reversion back to ESP 1 rates in September of 2016, partially offset by $20.1 million of revenue associated with energy efficiency programs recorded in 2016. This decrease in rate was partially offset by a volume increase due to warmer summer weather in 2016 as cooling degree-days increased by 153 along with increased sales to commercial and industrial customers, partially offset by milder winter weather in the first quarter of 2016 as heating degree-days decreased by 129.
•
Wholesale revenues decreased $3.6 million. These revenues consisted of DP&L's 4.9% share of the generation output of OVEC, which is sold into PJM at market prices.
•
RTO capacity and other revenues increased $1.2 million compared to the prior year.
DP&L - Cost of Revenues
During the year ended December 31, 2017, total cost of revenues decreased $31.7 million compared to the prior year. This decrease was primarily due to:
•
Net fuel costs, which include expense recognition or deferral coinciding with the collection of fuel costs through the regulatory fuel deferral, decreased $4.8 million compared to the prior year primarily due to fuel costs deferred in 2015, being collected in 2016. There was only $0.5 million of previously deferred fuel costs collected in 2017.
•
Net purchased power decreased $26.9 million compared to the prior year. This decrease was driven by the following factors:
◦
Purchased power decreased $27.7 million compared to the prior year primarily due to a favorable price variance of $19.8 million driven by lower rates in the competitive bid process in 2017, and lower volumes of $7.9 million primarily due to the decrease in DP&L retail demand in 2017.
◦
RTO capacity and other charges increased $0.8 million compared to the prior year.
During the year ended December 31, 2016, total cost of revenues increased $13.6 million compared to the prior year. This increase was primarily due to:
•
Net fuel costs, which include expense recognition or deferral coinciding with the collection of fuel costs through the regulatory fuel deferral, increased $14.3 million compared to the prior year primarily due to fuel costs deferred in 2015, being collected in 2016.
•
Net purchased power decreased $0.7 million compared to the prior year. This decrease was driven by the following factors:
◦
Purchased power increased $20.2 million primarily due to an unfavorable price variance driven by prices in the competitive bid process. DP&L sourced 100% of SSO load through the competitive bid process in 2016 as opposed to 60% in 2015. DP&L purchases power for its SSO load.
◦
RTO capacity and other charges decreased $20.9 million driven by decreased load obligations for retail customers as DP&L's retail load fully transitioned to market and was fully sourced through the competitive bid process in 2016. RTO charges are incurred by DP&L as a member of PJM and primarily include transmission charges within DP&L's network, which are incurred and charged to customers in the TCRR-N rider, transmission and congestion losses incurred on revenues, and costs associated with load obligations for retail customers.
DP&L - Operation and Maintenance
During the year ended December 31, 2017, Operation and Maintenance expense decreased $21.3 million compared to the prior year. This decrease was a result of:
(a)
There is corresponding revenue associated with this program resulting in minimal impact to Net income.
During the year ended December 31, 2016, Operation and Maintenance expense decreased $4.7 million compared to the prior year. This decrease was a result of:
(a)
There is corresponding revenue associated with this program resulting in minimal impact to Net income.
DP&L - Depreciation and Amortization
During the year ended December 31, 2017, Depreciation and amortization expense increased $4.3 million compared to the prior year. The increase was primarily due to additional investments in transmission and distribution fixed assets.
During the year ended December 31, 2016, Depreciation and amortization expense decreased $0.5 million compared to the prior year.
DP&L - General Taxes
During the year ended December 31, 2017, General taxes increased $8.3 million compared to the prior year. The increase was primarily the result of an increase of $3.8 million in Ohio property tax expense driven by higher tax rates, higher property values, lower expense in 2016 due to a $2.4 million favorable true-up of the 2015 Ohio property tax accrual to reflect actual payments made in 2016, a 2017 unfavorable true-up of $1.1 million for the 2016 Ohio property tax accrual to reflect actual payments made in 2017 and a $1.0 million increase in other general taxes.
During the year ended December 31, 2016, General taxes decreased $2.8 million compared to the prior year primarily due to a $2.4 million favorable true-up of the 2015 property tax accrual to reflect actual payments made in 2016 and a $0.6 million unfavorable true-up of the 2014 property tax accrual to reflect actual payments made in 2015.
DP&L - Interest Expense
During the year ended December 31, 2017, interest expense increased $5.8 million compared to the prior year primarily due to higher interest rates. On August 24, 2016, DP&L refinanced its 1.875% First Mortgage Bonds Due 2016, with a variable rate Term Loan B of $445.0 million maturing on August 24, 2022. The variable rate on the loan is calculated based on LIBOR plus a spread of 3.25%, with a LIBOR floor of 0.75%.
During the year ended December 31, 2016, interest expense decreased $4.2 million compared to the prior year primarily due to a decrease in carrying costs related to the recovery of deferred storm costs in 2015. The PUCO authorized DP&L to maintain long-term debt of $750 million or 75% of its rate base, whichever is greater, until January 1, 2018, or to file an application to explain why it would not achieve those metrics. For DP&L purposes in 2016 and 2015, $750.0 million of debt and the pro rata interest expense associated with that debt has been allocated to DP&L continuing operations.
DP&L - Charge for Early Redemption of Debt
During the year ended December 31, 2017, DP&L recorded a charge for early redemption of debt of $1.1 million primarily due to the early redemption of the 4.8% Tax-exempt First Mortgage Bonds due 2036.
During the year ended December 31, 2016, DP&L recorded a charge for early redemption of debt
$0.5 million.
During the year ended December 31, 2015, DPL recorded a charge for early redemption of debt of $4.8 million primarily due to the write off of deferred financing costs associated with the refinancing of its revolving credit facility.
DP&L - Income Tax Expense
During the year ended December 31, 2017, Income tax expense decreased $14.9 million compared to the prior year primarily due to a decrease in pre-tax income in the current year, a decrease in the depreciation of AFUDC Equity, and a tax reserve that was recorded in the prior year. Partially offsetting the decrease was a prior year deferred tax adjustment that was not required in the current year.
During the year ended December 31, 2016, Income tax expense decreased $13.0 million compared to the prior year primarily due to a decrease in pre-tax income and a deferred tax adjustment that did not occur in 2015. Partially offsetting the decrease was an increase in the depreciation of AFUDC Equity and the addition of a tax reserve for the amended 2011 predecessor tax return refund claim.
DP&L - Discontinued Operations
During the years ended December 31, 2017, 2016, and 2015, DP&L recorded losses from discontinued operations (net of tax) of $40.4 million, $870.3 million and $23.6 million, respectively. These losses relate to the discontinued DP&L Generation segment, which was transferred to AES Ohio Generation through Generation Separation on October 1, 2017. See Note 13 - Generation Separation in Notes to DP&L's Consolidated Financial Statements.
KEY TRENDS AND UNCERTAINTIES
During 2018 and beyond, we expect that our financial results will be driven primarily by retail demand, weather, energy efficiency and wholesale prices on financial results. In addition, DPL financial results are likely to be driven by many factors including, but not limited to:
•
Outcome of DP&L's pending distribution rate case;
•
DPL's ability to reduce its cost structure;
•
Operation and performance of generation facilities;
•
Recovery in the power market, particularly as it relates to an expansion in dark spreads; and
•
PJM capacity prices.
Operational
During 2017, we began executing on our plans to exit generation by completing the sale of the Miami Fort and Zimmer EGUs and announcing the retirement of co-owned Stuart Station coal-fired and diesel-fired generating units and the co-owned Killen Station coal-fired generating unit and combustion turbine on or before June 1, 2018. Further, on October 1, 2017, Stuart Unit 1 was retired due to damage sustained when a high-pressure feedwater heater shell failed on January 10, 2017.
Additionally, on December 15, 2017 we entered into an agreement for the sale of the generation and related assets for our Peaker assets. For additional information on these events and DPL's coal fired facilities, see Note 4 - Property, Plant and Equipment and Note 17 - Assets and Liabilities Held-For-Sale and Dispositions of Notes to DPL's Consolidated Financial Statements.
Macroeconomic and Political
U.S. Tax Law Reform
On December 22, 2017, the United States enacted the TCJA. The legislation significantly revised the U.S. corporate income tax system by, among other things, lowering the corporate income tax rate and introducing new limitations on interest expense deductions. These changes will materially impact our effective tax rate in future periods. Specific provisions of the TCJA and their potential impacts on us are noted below. Our interpretation of the TCJA may change as the U.S. Treasury Department and the Internal Revenue Service issue additional guidance. Such changes may be material.
Lower Tax Rate - The corporate tax rate decreased from 35 percent to 21 percent beginning in 2018. In addition to deferred tax remeasurement impacts, the lower tax rate resulted in the recognition, at December 31, 2017, of a
regulatory liability at DP&L. The regulatory liability reflects deferred taxes that will flow back to ratepayers over time.
Limitation on Interest Expense Deductions - The TCJA introduced a new limitation on the deductibility of net interest expense beginning January 1, 2018. The deduction will be limited to interest income, plus 30 percent of tax basis EBITDA through 2021 (30 percent of EBIT beginning January 1, 2022). This determination is made at the consolidated group level. The limitation does not apply to interest expense attributable to regulated utility property. The U.S. Treasury and Internal Revenue Service are expected to provide guidance to clarify how the exception will apply to regulated utility holding companies. Depending on the guidance implementing the limitations, this could materially impact our effective tax rate.
Cost Recovery - The TCJA amended depreciation rules to provide full expensing (100% bonus depreciation) for assets that commence construction and are placed in service before January 1, 2023. This provision is phased down by 20 percent ratably through 2027. The immediate full expensing provision is elective, but it does not apply to regulated utility property. This change is not expected to impact our effective tax rate; however, if elected, it could impact taxable income and cash taxes in future periods.
State Taxes - The reactions of the individual states to federal tax reform is still evolving. These state and municipalities will assess whether and how the federal changes will be incorporated into their tax legislation.
SAB 118 - As further explained in Note 9 - Income Taxes of Notes to DPL's Consolidated Financial Statements and Note 8 - Income Taxes of Notes to DP&L's Financial Statements we have included certain reasonable estimates of the impact of U.S. tax law reform subject to potential adjustments in future periods.
On January 10, 2018 the PUCO initiated a proceeding to consider the impacts of the TCJA to determine the appropriate course of action to pass benefits resulting from the legislation on to ratepayers. The PUCO also directed Ohio utilities to record deferred liabilities for the estimated reduction in federal income tax resulting from the TCJA beginning January 1, 2018. Under the terms of the ESP, DPL will not make tax sharing payments and if our rates are reduced as a result of the TCJA, DPL's cash flows could be adversely affected. See Note 9 - Income Taxes of Notes to DPL's Consolidated Financial Statements and Note 8 - Income Taxes of Notes to DP&L's Financial Statements for more information.
Regulatory Environment
For a comprehensive discussion of the market structure and regulation of DPL and DP&L, see Part I, Item 1 - Business - Competition and Regulation.
DP&L filed a settlement in its 2017 ESP case in January 2017 and filed an amended stipulation on March 13, 2017. The PUCO issued a final decision on October 20, 2017, modifying and adopting the amended stipulation and recommendation. The 2017 ESP establishes DP&L's framework for providing retail service on a going forward basis including rate structures, non-bypassable charges and other specific rate recovery true-up rider mechanisms. The signatory parties agreed to a six-year settlement that provides a framework for energy rates and defines other components.
For more information regarding DP&L's ESP, see Note 3 - Regulatory Matters of Notes to DPL’s Consolidated Financial Statements and Note 3 - Regulatory Matters of Notes to DP&L’s Financial Statements.
CAPITAL RESOURCES AND LIQUIDITY
Cash and cash equivalents for DPL and DP&L was $24.5 million and $5.2 million, respectively, at December 31, 2017. At that date, neither DPL nor DP&L had short-term investments. DPL and DP&L had aggregate principal amounts of debt outstanding of $1,724.0 million and $658.4 million, respectively, at December 31, 2017.
Approximately $4.7 million of DPL's debt and $4.6 million of DP&L's debt matures within the next twelve months, which we expect to repay using a combination of cash on hand, net cash provided by operating activities and/or net proceeds from the issuance of new debt. From time to time, we may elect to repurchase our outstanding debt through cash purchases, privately negotiated transactions or otherwise when management believes such repurchases are favorable to make. The amounts involved in any such repurchases may be material.
We depend on timely and continued access to capital markets to manage our liquidity needs. The inability to raise capital on favorable terms, to refinance existing indebtedness or to fund operations and other commitments during times of political or economic uncertainty could have material adverse effects on our financial condition and results
of operations. In addition, changes in the timing of tariff increases or delays in the regulatory determinations could affect the cash flows and results of operations of our business.
CASH FLOWS
DPL’s financial condition, liquidity and capital requirements include the consolidated results of its principal subsidiary DP&L. All material intercompany accounts and transactions have been eliminated in consolidation. The following table summarizes the cash flows of DPL:
DPL - Net cash from operating activities
Fiscal year 2017 versus 2016:
The net change in operating assets and liabilities for the year ended December 31, 2017 compared to the year ended December 31, 2016 was driven by the following:
Fiscal year 2016 versus 2015:
The net change in operating assets and liabilities for the year ended December 31, 2016 compared to the year ended December 31, 2015 was driven by the following:
DPL - Net cash from investing activities
During the year ended December 31, 2017, net cash used for investing activities was primarily related to capital expenditures, partially offset by a decrease in restricted cash due to collateral requirements, insurance proceeds, and proceeds from the sale of the Miami Fort and Zimmer stations.
During the year ended December 31, 2016, net cash used for investing activities was primarily related to capital expenditures and an increase in restricted cash due to collateral requirements, partially offset by proceeds from the sale of DPLER.
During the year ended December 31, 2015, net cash used for investing activities was primarily related to capital expenditures.
DPL - Net cash from financing activities
During the year ended December 31, 2017, net cash used for financing activities primarily relates to the retirement of $159.5 million of long-term debt.
During the year ended December 31, 2016, net cash used for financing activities primarily relates to the retirement of $577.8 million of long-term debt and redemption of $23.5 million of preferred stock, partially offset by a $442.8 million issuance of new debt.
During the year ended December 31, 2015, net cash used for financing activities primarily relates to the retirement of $474.5 million of long-term debt, partially offset by a $325.0 million issuance of new debt.
The following table summarizes the cash flows of DP&L:
DP&L - Net cash from operating activities
Fiscal year 2017 versus 2016:
The net change in operating assets and liabilities for the year ended December 31, 2017 compared to the year ended December 31, 2016 was driven by the following:
Fiscal year 2016 versus 2015:
The net change in operating assets and liabilities for the year ended December 31, 2016 compared to the year ended December 31, 2015 was driven by the following:
DP&L - Net cash from investing activities
During the year ended December 31, 2017, net cash used for investing activities was primarily related to capital expenditures, partially offset by a decrease in restricted cash due to collateral requirements and insurance proceeds.
During the year ended December 31, 2016, net cash used for investing activities was primarily related to capital expenditures and an increase in restricted cash due to collateral requirements, partially offset by insurance proceeds.
During the year ended December 31, 2015, net cash used for investing activities was primarily related to capital expenditures, partially offset by insurance proceeds.
DP&L - Net cash from financing activities
During the year ended December 31, 2017, net cash used for financing activities primarily relates to retirement of $104.5 million of long-term debt and dividends and return of capital paid to parent of $39.0 million, partially offset by a $70.0 million capital contribution from DPL.
During the year ended December 31, 2016, net cash used for financing activities primarily relates to the retirement of $445.3 million of long-term debt, $70.0 million in dividends paid on common stock to parent, related party repayments, net of related party borrowings, of $30.0 million, and redemption of $23.5 million of preferred stock, partially offset by the issuance of $442.8 million of new debt.
During the year ended December 31, 2015, net cash used for financing activities primarily relates to the retirement of $314.4 million of long-term debt, $50.0 million in dividends paid on common stock to parent, partially offset by the issuance of $200.0 million of new debt, and $35.0 million of related party borrowings.
Liquidity
We expect our existing sources of liquidity to remain sufficient to meet our anticipated operating needs. Our business is capital intensive, requiring significant resources to fund operating expenses, construction expenditures, scheduled debt maturities and carrying costs, potential margin requirements related to energy hedges, taxes and
dividend payments. For 2018 and subsequent years, we expect to satisfy these requirements with a combination of cash from operations and funds from debt financing as our internal liquidity needs and market conditions warrant. We also expect that the borrowing capacity under bank credit facilities will continue to be available to manage working capital requirements during those periods. In addition, DP&L's 2017 ESP provides for a DMR, which will be used for debt obligations at DPL and DP&L. See Note 3 - Regulatory Matters for more information.
At December 31, 2017, DPL and DP&L have access to the following revolving credit facilities:
DP&L's revolving credit facility has a commitment of $175.0 million, with a $50.0 million letter of credit sublimit and a feature that provides DP&L the ability to increase the size of the facility by an additional $100.0 million, and extending the term of the facility from May 2018 to July 2020. At December 31, 2017, DP&L had $10.0 million drawn under this facility and had two letters of credit in the aggregate amount of $1.4 million outstanding, with the remaining $163.6 million available to DP&L.
DPL has a revolving credit facility of $205.0 million, with a $200.0 million letter of credit sublimit and a feature that provides DPL the ability to increase the size of the facility by an additional $95.0 million. This facility is secured by a pledge of common stock that DPL owns in DP&L, limited to the amount permitted to be pledged under certain Indentures dated October 3, 2011 and October 6, 2014 between DPL and Wells Fargo Bank, NA and U.S. Bank National Association, respectively, as Trustee and a limited recourse guarantee by AES Ohio Generation secured by assets of AES Ohio Generation. DPL further secured the credit facility through a leasehold mortgage on additional assets of AES Ohio Generation. The facility expires in July 2020; however, DPL's credit facility has a springing maturity feature providing that if, before July 1, 2019, DPL has not refinanced its senior unsecured bonds due October 2019 to have a maturity date that is at least six months later than July 31, 2020, then the maturity of this facility shall be July 1, 2019. At September 30, 2017, there were five letters of credit in the aggregate amount of $12.9 million outstanding under this facility, and $50.0 million borrowed on the facility, with the remaining $142.1 million available to DPL. Fees associated with this facility were not material during the years ended December 31, 2017, 2016 or 2015.
On December 15, 2017, shortly after DPL and AES Ohio Generation entered into an Asset Purchase Agreement agreeing to sell Peaker assets to Kimura Power, DPL and its lenders amended DPL's revolving credit loan and term loan credit agreement. This agreement was amended to, among other things, (a) explicitly carve out the sale of DPL's Peaker assets and coal generation facilities from its "limitation on asset disposition" covenant, (b) modify the definition of Consolidated EBITDA (which is used for measuring the Consolidated Debt to EBITDA ratio and the Interest Coverage Ratio in the agreement), to also exclude, out-of-pocket third party costs and expenses incurred directly in connection with the implementation, negotiation, documentation and closing of the Generation Separation and up to $25.0 million of non-recurring cash expenses related to the closure, or sale, of generation stations, (c) modify the definition of "maturity date" used in the agreement to mean July 31, 2020; provided, however, if DPL fails to retire, redeem, or refinance at least $100.0 million in aggregate of principal amount of its senior unsecured bonds due October 1, 2019, then the maturity date shall be July, 1 2019, and (d) modify the maximum Consolidated Debt to EBITDA ratio permitted not to exceed 7.25 to 1.00 September 20, 2015 through December 31, 2018, 7.00 to 1.00 January 1, 2019 through June 30, 2019, 6.75 to 1.00 July 1, 2019 through December 31, 2019, and 6.50 to 1.00 January 1, 2020 and beyond. As part of this agreement DPL has also agreed to repay the remaining balance on its secured term loan within 10 days after receiving proceeds from the sale of the Peaker assets. This agreement was effective December 15, 2017, however certain provisions, including the modification of the Consolidated Debt to EBITDA covenant and the carving out of the sale of Peaker assets from its "limitation on asset disposition" covenant, are conditioned on the repayment in full of the term loan.
Capital Requirements
Construction Additions
Capital projects are subject to continuing review and are revised in light of changes in financial and economic conditions, load forecasts, legislative and regulatory developments and changing environmental standards, among other factors.
DPL is projecting to spend an estimated $358.0 million in capital projects for the period 2018 through 2020. DP&L is subject to the mandatory reliability standards of NERC and Reliability First Corporation (RFC), one of the eight NERC regions, of which DP&L is a member. NERC has recently changed the definition of the Bulk Electric System to include 100 kV and above facilities, thus expanding the facilities to which the reliability standards apply. DP&L’s 138 kV facilities were previously not subject to these reliability standards. Accordingly, DP&L anticipates spending approximately $33.0 million within the next five years to reinforce its 138-kV system to comply with these new NERC standards. Our ability to complete capital projects and the reliability of future service will be affected by our financial condition, the availability of internal funds and the reasonable cost of external funds. We expect to finance our construction additions with a combination of cash on hand, short-term financing, long-term debt and cash flows from operations.
Debt Covenants
The DPL revolving credit facility and term loan agreement have a Total Debt to EBITDA ratio that will be calculated, at the end of each fiscal quarter, by dividing total debt at the end of the current quarter by consolidated EBITDA for the four prior fiscal quarters. The ratio in the agreements is not to exceed 7.25 to 1.00 for any fiscal quarter ending September 30, 2015 through December 31, 2018; it then steps down to not exceed 6.25 to 1.00 for any fiscal quarter ending March 31, 2019 through December 31, 2019; and it then steps down not to exceed 5.75 to 1.00 for any fiscal quarter ending March 31, 2020 through July 31, 2020. As of December 31, 2017, this financial covenant was met with a ratio of 6.34 to 1.00.
The DPL revolving credit facility and term loan agreement also have an EBITDA to Interest Expense ratio that is calculated at the end of each fiscal quarter by dividing consolidated EBITDA for the four prior fiscal quarters by the consolidated interest charges for the same period. The ratio, per the agreements, is to be not less than 2.10 to 1.00 for any fiscal quarter ending September 30, 2015 through December 31, 2018; it then steps up to be not less than 2.25 to 1.00 for any fiscal quarter ending March 31, 2019 through July 31, 2020. As of December 31, 2017, this financial covenant was met with a ratio of 2.50 to 1.00.
DP&L’s revolving credit facility and Bond Purchase and Covenants Agreement (financing document entered into in connection with the issuance of the $200.0 million of variable rate tax-exempt First Mortgage Bonds, dated as of August 1, 2015, containing representations, warranties and covenants consistent with those contained in DP&L's revolving credit facilities loan documents) have two financial covenants. First, prior to the date of completion of the separation of DP&L’s generation assets from its transmission and distribution assets, DP&L’s Total Debt to Total Capitalization may not be greater than 0.65 to 1.00 at any time; and, on and after the date of completion of the separation of DP&L’s generation assets from its transmission and distribution assets, which occurred October 1, 2017, DP&L’s Total Debt to Total Capitalization may not be greater than 0.75 to 1.00 at any time. Except that after separation required compliance with this financial covenant shall be suspended (a) any time after separation during which DP&L maintains a rating of BBB- (or in the case of Moody’s Investors Service, Inc. Baa3) or higher with a stable outlook from at least one of Fitch Investors Service Inc., Standard & Poor’s Ratings Services or Moody’s Investors Service, Inc., as determined in accordance with the terms of the revolving credit facility or (b) for the time period January 1, 2017 to December 31, 2017 (as modified by the amendment described below) if DP&L’s long-term indebtedness (as determined by the PUCO) is less than or equal to $750.0 million. The Total Debt to Capitalization covenant is calculated as the sum of DP&L’s current and long-term portion of debt, divided by the total of DP&L’s net worth and total debt.
On February 21, 2017, DP&L and its lenders amended DP&L’s revolving credit agreement and Bond Purchase and Covenant Agreement. These amendments modified the definition of Consolidated Net Worth in each agreement (which is used for measuring the Total Debt to Total Capitalization ratio under each of the agreements), to exclude, through March 31, 2018, non-cash charges related directly to impairments of coal generation assets in DP&L's fiscal quarter ending December 31, 2016 and thereafter. With this amendment, DP&L was able to ensure compliance with the Total Debt to Total Capitalization ratio through October 1, 2017, the date Generation Separation occurred. After Generation Separation, and per the terms of the original agreement (before any amendment), the required Total Debt to Total Capitalization ratio increased from 0.65 to 1.00 to 0.75 to 1.00. On September 30, 2017, DP&L's adjusted (excluding impairments) Total Debt to Total Capitalization was 0.61 to 1.00 and as of December 31, 2017 it was 0.67 to 1.00. After Generation Separation occurred, the calculation of this covenant is on an unadjusted basis. The amendment also changed, for each agreement, the dates after Generation Separation during which compliance with the Total Capitalization ratio detailed above will be suspended if long-term indebtedness, as determined by the PUCO, is less than or equal to $750.0 million. As noted above this time period previously was January 1, 2017 to December 31, 2017, and is now the twelve months immediately subsequent to the separation of the generation assets from DP&L (or from October 1, 2017 through September 30, 2018). Generation Separation occurred on October 1, 2017.
The second financial covenant measures DP&L’s EBITDA to Interest Expense ratio. Both prior to and after completion of the separation of DP&L's generation assets from its transmission and distribution assets, DP&L's EBITDA to Interest Expense ratio cannot be less than 2.50 to 1.00. The ratio is calculated at the end of each fiscal quarter, by dividing EBITDA for the four prior fiscal quarters by the interest charges for the same period. As of December 31, 2017, DP&L met this financial covenant with an EBITDA to Interest Expense ratio of 7.17 to 1.00.
Debt Ratings
The following table outlines the debt ratings and outlook for DPL and DP&L, along with the effective or affirmed date of each rating.
Credit Ratings
The following table outlines the credit ratings (issuer/corporate rating) and outlook for each company, along with the effective or affirmed dates of each rating and outlook for DPL and DP&L.
(a)
Rating relates to DPL’s Senior secured debt.
(b)
Rating relates to DPL's Senior unsecured debt.
(c)
Rating relates to DP&L’s Senior secured debt.
If the rating agencies were to reduce our debt or credit ratings, our borrowing costs may increase, our potential pool of investors and funding resources may be reduced, and we may be required to post additional collateral under certain contracts. These events may have an adverse effect on our results of operations, financial condition and cash flows. In addition, any such reduction in our debt or credit ratings may adversely affect the trading price of our outstanding debt securities. Non-investment grade companies, such as DPL, may experience higher costs to issue new securities. DP&L is still considered investment grade by one of the three rating agencies above.
Off-Balance Sheet Arrangements
DPL - Guarantees
In the normal course of business, DPL enters into various agreements with its wholly-owned subsidiary, AES Ohio Generation, providing financial or performance assurance to third parties. These agreements are entered into primarily to support or enhance the creditworthiness otherwise attributed to these subsidiaries on a stand-alone basis, thereby facilitating the extension of sufficient credit to accomplish this subsidiary's intended commercial
purposes. During the year ended December 31, 2017, DPL did not incur any losses related to the guarantees of these obligations and we believe it is unlikely that DPL would be required to perform or incur any losses in the future associated with any of the above guarantees.
At December 31, 2017, DPL had $38.1 million of guarantees to third parties for future financial or performance assurance under such agreements on behalf of AES Ohio Generation. The guarantee arrangements entered into by DPL with these third parties cover present and future obligations of AES Ohio Generation to such beneficiaries and are terminable at any time by DPL upon written notice to the beneficiaries. The carrying amount of obligations for commercial transactions covered by these guarantees and recorded in our Consolidated Balance Sheets was $0.9 million at December 31, 2017 and $2.3 million at December 31, 2016.
DP&L owns a 4.9% equity ownership interest in an electric generation company which is recorded using the cost method of accounting under GAAP. At December 31, 2017, DP&L could be responsible for the repayment of 4.9%, or $70.6 million, of a $1,440.8 million debt obligation comprised of both fixed and variable rate securities with maturities between 2019 and 2040. This would only happen if this electric generation company defaulted on its debt payments. At December 31, 2017, we have no knowledge of such a default.
Commercial Commitments and Contractual Obligations
We enter into various contractual obligations and other commercial commitments that may affect the liquidity of our operations. At December 31, 2017, these include:
(a)
Total at DP&L operated units.
Long-term debt:
DPL’s Long-term debt at December 31, 2017 consists of DPL’s unsecured notes, secured term loan and Capital Trust II securities, along with DP&L’s First Mortgage Bonds, tax-exempt First Mortgage Bonds and the Wright-Patterson Air Force Base (WPAFB) note. These long-term debt amounts include current maturities but exclude unamortized debt discounts, premiums and fair value adjustments.
DP&L’s Long-term debt at December 31, 2017 consists of its First Mortgage Bonds, tax-exempt First Mortgage Bonds and the WPAFB note. These long-term debt amounts include current maturities but exclude unamortized debt discounts.
See Note 8 - Debt of the Notes to DPL’s Consolidated Financial Statements and Note 7 - Debt of the Notes to DP&L’s Financial Statements.
Interest payments:
Interest payments are associated with the long-term debt described above. The interest payments relating to variable-rate debt are projected using the interest rate prevailing at December 31, 2017.
Pension and postretirement payments:
At December 31, 2017, DPL, through its principal subsidiary DP&L, had estimated future benefit payments as outlined in Note 10 - Benefit Plans of Notes to DPL’s Consolidated Financial Statements and Note 9 - Benefit Plans of Notes to DP&L’s Financial Statements. These estimated future benefit payments are projected through 2027. This amount also includes postretirement benefit costs.
Electricity purchase commitments:
DPL enters into long-term contracts for the purchase of electricity. In general, these contracts are subject to variable quantities or prices and are terminable only in limited circumstances.
Coal contracts:
DPL, through its subsidiary AES Ohio Generation, has entered into various long-term coal contracts to supply the coal requirements for the generating stations it operates. At December 31, 2017, a majority of our future committed coal obligations are with one supplier. Some contract prices are subject to periodic adjustment and have features that limit price escalation in any given year. As a result of our planned shutdown of our Stuart and Killen generating stations, our commitments for coal and limestone do not extend past 2018.
Purchase orders and other contractual obligations:
At December 31, 2017, DPL and DP&L had various other contractual obligations including non-cancelable contracts to purchase goods and services with various terms and expiration dates. Due to uncertainty regarding the timing and payment of future obligations to the Service Company, and DPL's and DP&L's ability to terminate such obligations upon 90 days' notice, we have excluded such amounts in the contractual obligations table above. See Note 13 - Related Party Transactions of Notes to DPL's Consolidated Financial Statements and Note 12 - Related Party Transactions of Notes to DP&L's Financial Statements for additional information on charges between related parties and amounts due to or from related parties.
Reserve for uncertain tax positions:
Due to the uncertainty regarding the timing of future cash outflows associated with our unrecognized tax benefits of $3.5 million at December 31, 2017, we are unable to make a reliable estimate of the periods of cash settlement with the respective tax authorities and have not included such amounts in the contractual obligations table above.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
DPL’s Consolidated Financial Statements and DP&L’s Financial Statements are prepared in accordance with GAAP. In connection with the preparation of these financial statements, our management is required to make assumptions, estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and the related disclosure of contingent liabilities. These assumptions, estimates and judgments are based on our historical experience and assumptions that we believe to be reasonable at the time. However, because future events and their effects cannot be determined with certainty, the determination of estimates requires the exercise of judgment. Our critical accounting estimates are those which require assumptions to be made about matters that are highly uncertain. Our significant accounting policies are described in Note 1 - Overview and Summary of Significant Accounting Policies of Notes to DPL's Consolidated Financial Statements and Note 1 - Overview and Summary of Significant Accounting Policies of Notes to DP&L's Financial Statements.
Different estimates could have a material effect on our financial results. Judgments and uncertainties affecting the application of these policies and estimates may result in materially different amounts being reported under different conditions or circumstances. Historically, however, recorded estimates have not differed materially from actual results. Significant items subject to such judgments include: the carrying value of property, plant and equipment; unbilled revenues; the valuation of allowances for deferred income taxes; regulatory assets and liabilities; reserves recorded for income tax exposures; litigation; contingencies; the valuation of AROs; and assets and liabilities related to employee benefits.
Revenue Recognition (including Unbilled Revenue)
We consider revenue realized, or realizable, and earned when persuasive evidence of an arrangement exists, the products or services have been provided to the customer, the sales price is fixed or determinable, and collection is reasonably assured. The determination of energy sales to customers is based on the reading of their meters, which occurs on a systematic basis throughout the month. We recognize revenues using an accrual method for retail and other energy sales that have not yet been billed, but where electricity has been consumed. This is termed “unbilled revenues” and is a widely recognized and accepted practice for utilities. At the end of each month, unbilled revenues are determined by the estimation of unbilled energy provided to customers since the date of the last meter reading, projected line losses, the assignment of unbilled energy provided to customer classes and the average rate per customer class. Given our estimation method and the fact that customers are billed monthly, we believe it is unlikely that materially different results will occur in future periods when these amounts are subsequently billed.
Income Taxes
We are subject to federal and state income taxes. Our income tax provision requires significant judgment and is based on calculations and assumptions that are subject to examination by the U.S. Internal Revenue Service and other tax authorities. We regularly assess the potential outcome of tax examinations when determining the adequacy of our income tax provisions by considering the technical merits of the filing position, case law, and results of previous tax examinations. Accounting guidance for uncertainty in income taxes prescribes a more-likely-than-not recognition threshold and measurement requirements for financial statement reporting of our income tax positions. Tax reserves have been established which we believe to be adequate in relation to the potential for additional assessments. Once established, reserves are adjusted only when there is more information available or when an event occurs necessitating a change to the reserves. While we believe that the amount of the tax reserves is reasonable, it is possible that the ultimate outcome of current or future examinations may be materially different than the reserve amounts.
Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of the existing assets and liabilities, and their respective income tax bases. We establish a valuation allowance when it is more likely than not that all or a portion of a deferred tax asset will not be realized.
Regulatory Assets and Liabilities
Application of the provisions of GAAP relating to regulatory accounting requires us to reflect the effect of rate regulation in DPL’s Consolidated Financial Statements and DP&L’s Financial Statements. For regulated businesses subject to federal or state cost-of-service rate regulation, regulatory practices that assign costs to accounting periods may differ from accounting methods generally applied by non-regulated companies. When it is probable that regulators will permit the recovery of current costs through future rates charged to customers, we defer these costs as Regulatory assets that otherwise would be expensed by non-regulated companies. Likewise, we recognize Regulatory liabilities when it is probable that regulators will require customer refunds through future rates and when revenue is collected from customers for expenses that are not yet incurred. Regulatory assets are amortized into expense and Regulatory liabilities are amortized into income over the recovery period authorized by the regulator.
We evaluate our Regulatory assets to determine whether or not they are probable of recovery through future rates and make various assumptions in our analyses. The expectations of future recovery are generally based on orders issued by regulatory commissions or historical experience, as well as discussions with applicable regulatory authorities. If recovery of a regulatory asset is determined to be less than probable, it will be expensed in the period the assessment is made. We currently believe the recovery of our Regulatory assets is probable. See Note 3 - Regulatory Matters of Notes to DPL’s Consolidated Financial Statements and Note 3 - Regulatory Matters of Notes to DP&L’s Financial Statements.
AROs
In accordance with the provisions of GAAP relating to the accounting for AROs, legal obligations associated with the retirement of long-lived assets are required to be recognized at their fair value at the time those obligations are incurred. Upon initial recognition of a legal liability, costs are capitalized as part of the related long-lived asset and allocated to expense over the useful life of the asset. These GAAP provisions also require that components of previously recorded depreciation related to the cost of removal of assets upon future retirement, whether legal AROs or not, must be removed from a company’s accumulated depreciation reserve and be reclassified as a regulatory liability. We make assumptions, estimates and judgments that affect the reported amounts of assets, liabilities and expenses as they relate to AROs. These assumptions and estimates are based on historical
experience and assumptions that we believe to be reasonable at the time. See Note 4 - Property, Plant and Equipment of Notes to DPL's Consolidated Financial Statements and Note 4 - Property, Plant and Equipment of Notes to DP&L’s Financial Statements for more information.
Impairments
In accordance with the provisions of GAAP relating to the accounting for impairments, long-lived assets are reviewed for impairment whenever events or circumstances indicate that the carrying amount may not be recoverable. When required, impairment losses on assets to be held and used are recognized based on the fair value of the asset group. Impairment losses on assets held-for-sale are recognized based on the fair value of the disposal group. We determine the fair value of these assets based upon estimates of future cash flows, market value of similar assets, if available, or independent appraisals, if required. In analyzing the fair value and recoverability using future cash flows, we make projections based on a number of assumptions and estimates of growth rates, future economic conditions, assignment of discount rates and estimates of terminal values. An impairment loss is recognized if the carrying amount of the long-lived asset is not recoverable from its undiscounted cash flows. The measurement of impairment loss is the difference between the carrying amount and fair value of the asset. See Note 15 - Fixed-asset Impairments of Notes to DPL’s Consolidated Financial Statements discussing the impairment of long-lived assets in 2017 and 2016.
Pension and Postretirement Benefits
We account for and disclose pension and postemployment benefits in accordance with the provisions of GAAP relating to the accounting for pension and other postemployment plans. These GAAP provisions require the use of assumptions, such as the discount rate for liabilities and long-term rate of return on assets, in determining the obligations, annual cost, and funding requirements of the plans. See Note 10 - Benefit Plans of Notes to DPL’s Consolidated Financial Statements and Note 9 - Benefit Plans of Notes to DP&L’s Financial Statements for more information.
Contingent and Other Obligations
During the conduct of our business, we are subject to a number of federal and state laws and regulations, as well as other factors and conditions that potentially subject us to environmental, litigation, insurance and other risks. We periodically evaluate our exposure to such risks and record estimated liabilities for those matters where a loss is considered probable and reasonably estimable in accordance with GAAP. In recording such estimated liabilities, we may make assumptions, estimates and judgments that affect the reported amounts of assets, liabilities and expenses as they relate to contingent and other obligations. These assumptions and estimates are based on historical experience and assumptions and may be subject to change. We believe such estimates and assumptions are reasonable.
Recently Issued Accounting Pronouncements
A discussion of recently issued accounting pronouncements is in Note 1 - Overview and Summary of Significant Accounting Policies of Notes to DPL’s Consolidated Financial Statements and Note 1 - Overview and Summary of Significant Accounting Policies of Notes to DP&L’s Financial Statements and such discussion is incorporated by reference in this Management's Discussion and Analysis of Financial Condition and Results of Operations and made a part hereof.
LEGAL AND OTHER MATTERS
Discussions of legal and other matters are provided in Item 1 - Business "Environmental Matters", Item 1 - Business "Competition and Regulation" and Item 3 - Legal Proceedings. Such discussions are incorporated by reference in this Management's Discussion and Analysis of Financial Condition and Results of Operations and made a part hereof.
Item 7A
Item 7A - Quantitative and Qualitative Disclosures about Market Risk
We are subject to certain market risks including, but not limited to, changes in commodity prices for electricity, coal, environmental emission allowances, and changes in capacity prices and fluctuations in interest rates. We use various market risk-sensitive instruments, including derivative contracts, primarily to limit our exposure to fluctuations in commodity pricing. Our Commodity Risk Management Committee (CRMC), comprised of members of senior management, is responsible for establishing risk management policies and the monitoring and reporting of
risk exposures related to our DPL operated generation units. The CRMC meets on a regular basis with the objective of identifying, assessing and quantifying material risk issues and developing strategies to manage these risks.
Commodity pricing risk
Commodity pricing risk exposure includes the impacts of weather, market demand, increased competition and other economic conditions. To manage the volatility relating to these exposures at our DPL-operated generation units, we use a variety of non-derivative and derivative instruments including forward contracts and futures contracts. These instruments are used principally for economic hedging purposes and none are held for trading purposes. Derivatives that fall within the scope of derivative accounting under GAAP must be recorded at their fair value and marked to market. MTM gains and losses on derivative instruments that qualify for cash flow hedge accounting are deferred in AOCI until the forecasted transactions occur. We adjust the derivative instruments that do not qualify for cash flow hedging to fair value monthly through the Statement of Operations.
The coal market has increasingly been influenced by both international and domestic supply and consumption, making the price of coal more volatile than in the past, and while we have substantially all of the total expected coal volume needed to meet our sales requirements for 2018 under contract, power sales obligations may change. Fuel costs are affected by changes in volume and price and are driven by a number of variables including weather, the wholesale market price of power, certain provisions in coal contracts related to government-imposed costs, counterparty performance and credit, scheduled outages and electric generation station mix.
In addition, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), signed into law in July 2010, contains significant requirements relating to derivatives, including, among others, a requirement that certain transactions be cleared on exchanges that would necessitate the posting of cash collateral for these transactions. We are considered an end-user under the Dodd-Frank Act and therefore are exempt from most of the collateral and margining requirements. We are required to report our bilateral derivative contracts, unless our counterparty is a major swap participant or has elected to report on our behalf. Even though we qualify for an exception from these requirements, our counterparties that do not qualify for the exception may pass along any increased costs incurred by them through higher prices and reductions in unsecured credit limits or be unable to enter into certain transactions with us.
For purposes of potential risk analysis, we use a sensitivity analysis to quantify potential impacts of market rate changes on the statements of operations. The sensitivity analysis represents hypothetical changes in market values that may or may not occur in the future.
Commodity derivatives
To minimize the risk of fluctuations in the market price of commodities, such as coal, power, and natural gas, we may enter into commodity forward and futures contracts to effectively hedge the cost/revenues of the commodity. Maturity dates of the contracts are scheduled to coincide with market purchases/sales of the commodity. Cash proceeds or payments between us and the counterparty at maturity of the contracts are recognized as an adjustment to the cost of the commodity purchased or sold. We generally do not enter into forward contracts beyond thirty-six months. At December 31, 2017, there are no coal derivatives.
A 10% increase or decrease in the market price of our FTRs and natural gas futures at December 31, 2017 would not have a significant effect on Net income.
A 10% increase or decrease in the market price of our forward power contracts at December 31, 2017 would not have a significant effect on Net income.
Wholesale revenues
DPL sells its generation into the wholesale market when we can identify opportunities with positive margins.
Approximately 43% of DPL’s electric revenues during the year ended December 31, 2017 were from sales of excess energy and capacity in the wholesale market.
For DPL, a hypothetical increase or decrease of 10% in the price per megawatt hour of wholesale power, including the impact of a corresponding 10% change in the portion of purchased power used as part of the sale, would result in an approximate $20.9 million change to net income.
Fuel and purchased power costs
We have a significant portion of projected 2018 fuel needs under contract. Most of our contracted coal is purchased at fixed prices although some contracts provide for periodic pricing adjustments. We may purchase SO2 allowances for 2018; however, the exact consumption of SO2 allowances will depend on market prices for power, availability of our generation units and the actual sulfur content of the coal burned. We may purchase some NOX allowances for 2018 depending on NOX emissions. Fuel costs are affected by changes in volume and price and are driven by a number of variables including weather, reliability of coal deliveries, scheduled outages and electric generation station mix.
DP&L conducts competitive bid auctions to purchase power for SSO service, as DP&L's SSO is 100% sourced through the competitive bid. AES Ohio Generation purchases power to source retail load in other service territories and to meet contracted wholesale requirements when generating facilities are not available due to planned and unplanned outages or when market prices are below the marginal costs associated with our generating facilities.
The table below provides the effect on annual Net income (net of estimated income tax at 35%) as of December 31, 2017, of a hypothetical increase or decrease of 10% in the prices of fuel and purchased power:
Interest rate risk
Because of our normal investing and borrowing activities, our financial results are exposed to fluctuations in interest rates, which we manage through our regular financing activities. We maintain both cash on deposit and investments in cash equivalents that may be affected by adverse interest rate fluctuations. DPL and DP&L have both fixed-rate and variable rate long-term debt. DPL’s variable-rate debt consists of a $70.0 million secured term loan with a syndicated bank group. DP&L’s variable-rate debt is comprised of $200 million of bank held tax-exempt First Mortgage Bonds and $440.6 million Term Loan B debt secured by First Mortgage Bonds. Each variable-rate bond bears interest based on an underlying interest rate index, typically LIBOR. On November 21, 2016, the DP&L $200.0 million variable-rate First Mortgage Bonds were hedged with floating for fixed interest rate swaps, reducing interest rate risk exposure for the term of the bonds. On January 1, 2018 the interest rate on these First Mortgage Bonds was adjusted and as a result the bonds are no longer fully hedged and are treated as variable. Market indexes can be affected by market demand, supply, market interest rates and other economic conditions. See Note 8 - Debt of Notes to DPL’s Consolidated Financial Statements and Note 7 - Debt of Notes to DP&L’s Financial Statements.
Principal payments and interest rate detail by contractual maturity date
The principal amount of DPL’s long-term debt was $1,724.0 million at December 31, 2017, consisting of DPL’s unsecured notes, secured term loan, Capital Trust II securities along with DP&L’s First Mortgage Bonds, tax-exempt First Mortgage Bonds and the WPAFB note. All of DPL’s existing debt was adjusted to fair value at the Merger date according to FASB Accounting Standards Codification No. 805, “Business Combinations”. The fair value of this debt at December 31, 2017 was $1,819.3 million, based on current market prices or discounted cash flows using current rates for similar issues with similar terms and remaining maturities. The following table provides information about DPL’s debt obligations that are sensitive to interest rate changes:
(a)
Amounts exclude immaterial capital lease obligations
The principal amount of DP&L’s long-term debt was $658.4 million at December 31, 2017, consisting of its First Mortgage Bonds, tax-exempt First Mortgage Bonds and the WPAFB note. The fair value of this debt at December 31, 2017 was $658.4 million, based on current market prices or discounted cash flows using current rates for similar issues with similar terms and remaining maturities. The following table provides information about DP&L’s debt obligations that are sensitive to interest rate changes. The DP&L debt was not revalued using push-down accounting as a result of the Merger.
(a)
Amounts exclude immaterial capital lease obligations
Long-term debt interest rate risk sensitivity analysis
Our estimate of market risk exposure is presented for our fixed-rate and variable-rate debt at December 31, 2017 and 2016 for which an immediate adverse market movement causes a potential material effect on our financial condition, results of operations, or the fair value of the debt. We believe that the adverse market movement represents the hypothetical loss to future earnings and does not represent the maximum possible loss nor any expected actual loss, even under adverse conditions, because actual adverse fluctuations would likely differ. At December 31, 2017 and 2016, we did not hold any market risk sensitive instruments which were entered into for trading purposes.
Principal value and fair value of debt with one percent interest rate risk
(a)
Amounts exclude immaterial capital lease obligations
(b)
In 2016, fixed-rate debt includes $200.0 million DP&L Tax-exempt First Mortgage Bonds that have been hedged, per discussion above. See Note 6 - Derivative Instruments and Hedging Activities of Notes to DPL's Consolidated Financial Statements.
(a)
Amounts exclude immaterial capital lease obligations
(b)
In 2016, fixed-rate debt includes $200.0 million DP&L Tax-exempt First Mortgage Bonds that have been hedged, per discussion above. See Note 6 - Derivative Instruments and Hedging Activities of Notes to DP&L's Consolidated Financial Statements.
DPL’s debt is comprised of both fixed-rate debt and variable-rate debt. In regard to fixed rate debt, the interest rate risk with respect to DPL’s long-term debt primarily relates to the potential impact a decrease of one percentage point in interest rates has on the fair value of DPL’s $1,108.7 million of fixed-rate debt and not on DPL’s financial condition or results of operations. On the variable-rate debt, the interest rate risk with respect to DPL’s long-term debt represents the potential impact an increase of one percentage point in the interest rate has on DPL’s results of operations related to DPL’s $710.6 million variable-rate long-term debt outstanding at December 31, 2017.
DP&L’s interest rate risk with respect to DP&L’s long-term debt primarily relates to the potential impact a decrease in interest rates of one percentage point has on the fair value of DP&L’s $17.8 million of fixed-rate debt and not on DP&L’s financial condition or DP&L’s results of operations. On the variable-rate debt, the interest rate risk with respect to DP&L’s long-term debt represents the potential impact an increase of one percentage point in the interest rate has on DP&L’s results of operations related to DP&L’s $640.6 million variable-rate long-term debt outstanding at December 31, 2017.
Equity price risk
At December 31, 2017, approximately 35% of the defined benefit pension plan assets were comprised of investments in equity securities and 65% related to investments in fixed income securities, cash and cash equivalents, and alternative investments. The equity securities are carried at their market value of approximately $124.5 million at December 31, 2017. A hypothetical 10% decrease in prices quoted by stock exchanges would result in a $12.5 million reduction in fair value at December 31, 2017 and approximately a $1.8 million increase to the 2018 pension expense.
Credit risk
Credit risk is the risk of an obligor's failure to meet the terms of any investment contract, loan agreement or otherwise perform as agreed. Credit risk arises from all activities in which success depends on issuer, borrower or
counterparty performance, whether reflected on or off the balance sheet. We limit our credit risk by assessing the creditworthiness of potential counterparties before entering into transactions with them and continue to evaluate their creditworthiness after transactions have been originated. We use the three leading corporate credit rating agencies and other current market-based qualitative and quantitative data to assess the financial strength of counterparties on an ongoing basis. We may require various forms of credit assurance from counterparties to mitigate credit risk.
Item 8
Item 8 - Financial Statements and Supplementary Data
This report includes the combined filing of DPL and DP&L. Throughout this report, the terms “we,” “us,” “our” and “ours” are used to refer to both DPL and DP&L, respectively and altogether, unless the context indicates otherwise. Discussions or areas of this report that apply only to DPL or DP&L will clearly be noted in the section.
FINANCIAL STATEMENTS
DPL INC.
Report of Independent Registered Public Accounting Firm
To the Board of Directors of DPL Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of DPL Inc. (the Company) as of December 31, 2017 and 2016, the related consolidated statements of operations, comprehensive loss, cash flows and shareholder’s equity for each of the three years in the period ended December 31, 2017, and the related notes and schedules (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017 in conformity with U.S. generally accepted accounting principles.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our December 31, 2017 and 2016 audits in accordance with the standards of the PCAOB and in accordance with auditing standards generally accepted in the United States of America and our December 31, 2015 audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Ernst & Young LLP
We have served as the Company’s auditor since 2011.
Indianapolis, Indiana
February 26, 2018
See Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.
(a)
1,500 shares authorized.
(b)
Includes $5.1 million charged to Other paid-in capital for the redemption of the DP&L preferred shares. See Note 11 - Equity.
(c)
Includes a $97.1 million tax sharing payable to AES conversion to contributed capital, as DP&L's 2017 ESP restricts tax sharing payments to AES during the term of the ESP. See Note 9 - Income Taxes.
See Notes to Consolidated Financial Statements.
DPL Inc.
Notes to Consolidated Financial Statements
For the years ended December 31, 2017, 2016 and 2015
Note 1 - Overview and Summary of Significant Accounting Policies
Description of Business
DPL is a diversified regional energy company organized in 1985 under the laws of Ohio. DPL has two reportable segments, the Transmission and Distribution ("T&D") segment and the Generation segment. See Note 14 - Business Segments for more information relating to reportable segments. The terms “we”, “us”, “our” and “ours” are used to refer to DPL and its subsidiaries.
On November 28, 2011, DPL was acquired by AES in the Merger and DPL became a wholly-owned subsidiary of AES. Following the merger of DPL and Dolphin Subsidiary II, Inc., DPL became an indirectly wholly-owned subsidiary of AES.
DP&L is a public utility incorporated in 1911 under the laws of Ohio. Beginning in 2001, Ohio law gave consumers the right to choose the electric generation supplier from whom they purchase retail generation service, however transmission and distribution services are still regulated. DP&L has the exclusive right to provide such service to its approximately 521,000 customers located in West Central Ohio. DP&L is required to procure and provide retail SSO electric service to residential, commercial, industrial and governmental customers in a 6,000 square mile area of West Central Ohio. Since January 2016, DP&L has been sourcing 100% of the generation for its SSO customers through a competitive bid process. Through September 30, 2017, DP&L owned undivided interests in five coal-fired power stations and multiple peaking electric generating facilities as well as numerous transmission facilities. On October 1, 2017, the DP&L-owned generating facilities were transferred to AES Ohio Generation, an affiliate of DP&L and wholly-owned subsidiary of DPL, through an asset contribution agreement to a subsidiary that was merged into AES Ohio Generation. Also, Stuart Station Unit 1 was retired on October 1, 2017. Principal industries located in DP&L’s service territory include automotive, food processing, paper, plastic, manufacturing and defense. DP&L's sales reflect the general economic conditions, seasonal weather patterns of the area and the market price of electricity. Through the date of Generation Separation, DP&L sold energy and capacity into the wholesale market.
DPLER was sold by DPL on January 1, 2016. DPLER sold competitive retail electric service, under contract, to residential, commercial and industrial customers. DPLER did not own any transmission or generation assets, and it purchased all of its electric energy from DP&L to meet its sales obligations. See Note 16 - Discontinued Operations for more information.
DPL’s other significant subsidiaries include AES Ohio Generation, which owns and operates coal-fired and peaking generating facilities from which it makes wholesale sales of electricity, and MVIC, our captive insurance company that provides insurance services to us and our other subsidiaries. DPL wholly owns each of its subsidiaries.
On December 8, 2017, AES Ohio Generation completed the sale of the Miami Fort and Zimmer stations to subsidiaries of Dynegy in accordance with an asset purchase agreement dated April 21, 2017. In addition, on December 15, 2017, AES Ohio Generation entered into an asset purchase agreement for the sale of its Peaker assets to Kimura Power, LLC.
DPL also has a wholly-owned business trust, DPL Capital Trust II, formed for the purpose of issuing trust capital securities to investors.
DP&L’s electric transmission and distribution businesses are subject to rate regulation by federal and state regulators. Accordingly, DP&L applies the accounting standards for regulated operations to its electric transmission and distribution businesses and records regulatory assets when incurred costs are expected to be recovered in future customer rates, and regulatory liabilities when current cost recoveries in customer rates relate to expected future costs.
DPL and its subsidiaries employed 1,060 people at January 31, 2018, of which 660 were employed by DP&L. Approximately 60% of all DPL employees are under a collective bargaining agreement. The current agreement, after initially being extended, expired on January 31, 2018. Under national labor law, all the terms and conditions of the expired agreement continue indefinitely, with a few exceptions. Notably, the union has the right to strike and
DP&L and AES Ohio Generation each have the right to lock out employees. We are continuing to negotiate with the union to enter into a new collective bargaining agreement. Currently, we are unable to predict the eventual outcome of these negotiations and have contingency plans to continue our operations. If we are not able to reach an agreement on terms favorable to us or to effectively implement our plans in the event that agreement is not reached, our results of operations, financial position and cash flows could be adversely impacted.
Financial Statement Presentation
We prepare Consolidated Financial Statements for DPL. DPL’s Consolidated Financial Statements include the accounts of DPL and its wholly-owned subsidiaries except for DPL Capital Trust II which is not consolidated, consistent with the provisions of GAAP.
AES Ohio Generation's undivided ownership interests in certain coal-fired generating stations are included in the financial statements at amortized cost, net of subsequent impairments. Operating revenues and expenses are included on a pro rata basis in the corresponding lines in the Consolidated Statement of Operations.
DP&L has undivided ownership interests in numerous transmission facilities. These undivided interests in jointly-owned facilities are accounted for on a pro rata basis in the Consolidated Financial Statements.
See Note 4 - Property, Plant and Equipment for more information.
All material intercompany accounts and transactions are eliminated in consolidation. We have evaluated subsequent events through the date this report is issued.
Certain amounts from prior periods have been reclassified to conform to the current period presentation.
The preparation of financial statements in conformity with GAAP requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the revenues and expenses of the periods reported. Actual results could differ from these estimates. Significant items subject to such estimates and judgments include: the carrying value of Property, plant and equipment; unbilled revenues; the valuation of derivative instruments; the valuation of insurance and claims liabilities; the valuation of allowances for receivables and deferred income taxes; regulatory assets and liabilities; reserves recorded for income tax exposures; litigation; contingencies; the valuation of AROs; assets and liabilities related to employee benefits; and intangibles.
Revenue Recognition
Revenues are recognized from retail and wholesale electricity sales and electricity transmission and distribution delivery services. We consider revenue realized, or realizable, and earned when persuasive evidence of an arrangement exists, the products or services have been provided to the customer, the sales price is fixed or determinable, and collection is reasonably assured. Energy sales to customers are based on the reading of their meters that occurs on a systematic basis throughout the month. We recognize the revenues on our Consolidated Statements of Operations using an accrual method for retail and other energy sales that have not yet been billed, but where electricity has been consumed. This is termed “unbilled revenues” and is a widely recognized and accepted practice for utilities. At the end of each month, unbilled revenues are determined by the estimation of unbilled energy provided to customers since the date of the last meter reading, estimated line losses, the assignment of unbilled energy provided to customer classes and the average rate per customer class.
All of the power produced at the generation stations is sold to an RTO. We record expenses when purchased electricity is received and when expenses are incurred, with the exception of the ineffective portion of certain power purchase contracts that are derivatives and qualify for hedge accounting. We also have certain derivative contracts that do not qualify for hedge accounting, and their unrealized gains or losses are recorded prior to the receipt of electricity.
Allowance for Uncollectible Accounts
We establish provisions for uncollectible accounts by using both historical average loss percentages to project future losses and by establishing specific provisions for known credit issues. Amounts are written off when reasonable collections efforts have been exhausted.
Property, Plant and Equipment
We record our ownership share of our undivided interest in jointly-held stations as an asset in property, plant and equipment. New property, plant and equipment additions are stated at cost. For regulated transmission and distribution property, cost includes direct labor and material, allocable overhead expenses and an allowance for funds used during construction (AFUDC). AFUDC represents the cost of borrowed funds and equity used to finance regulated construction projects. For non-regulated property, cost also includes capitalized interest. Capitalization of AFUDC and interest ceases at either project completion or at the date specified by regulators. AFUDC and capitalized interest was $2.3 million, $2.8 million and $2.0 million in the years ended December 31, 2017, 2016 and 2015, respectively.
For unregulated generation property, cost includes direct labor and material, allocable overhead expenses and interest capitalized during construction per the provisions of GAAP related to the accounting for capitalized interest.
For substantially all depreciable property, when a unit of property is retired, the original cost of that property less any salvage value is charged to Accumulated depreciation and amortization, consistent with composite depreciation practices.
Property is evaluated for impairment when events or changes in circumstances indicate that its carrying amount may not be recoverable. See Note 15 - Fixed-asset Impairments for more information.
Repairs and Maintenance
Costs associated with maintenance activities, primarily power station outages, are recognized at the time the work is performed. These costs, which include labor, materials and supplies, and outside services required to maintain equipment and facilities, are capitalized or expensed based on defined units of property.
Depreciation
Depreciation expense is calculated using the straight-line method, which allocates the cost of property over its estimated useful life. For DPL’s generation, transmission and distribution assets, straight-line depreciation is applied monthly on an average composite basis using group rates that approximated 5.0% in 2017, 6.1% in 2016 and 4.4% in 2015. Depreciation expense was $100.1 million, $124.6 million and $125.6 million for the years ended December 31, 2017, 2016 and 2015, respectively.
Regulatory Accounting
As a regulated utility, DP&L applies the provisions of FASC 980 “Regulated Operations”, which gives recognition to the ratemaking and accounting practices of the PUCO and the FERC. Regulatory assets generally represent incurred costs that have been deferred because such costs are probable of future recovery in customer rates. Regulatory assets can also represent performance incentives permitted by the regulator. Regulatory assets have been included as allowable costs for ratemaking purposes, as authorized by the PUCO or established regulatory practices. Regulatory liabilities generally represent obligations to make refunds or future rate reductions to customers for previous over collections or the deferral of revenues collected for costs that DP&L expects to incur in the future.
The deferral of costs (as regulatory assets) is appropriate only when the future recovery of such costs is probable. In assessing probability, we consider such factors as specific orders from the PUCO or FERC, regulatory precedent and the current regulatory environment. To the extent recovery of costs is no longer deemed probable, related regulatory assets would be required to be expensed in current period earnings. Our regulatory assets and liabilities have been created pursuant to a specific order of the PUCO or FERC or established regulatory practices, such as other utilities under the jurisdiction of the PUCO or FERC being granted recovery of similar costs. It is probable, but not certain, that these regulatory assets will be recoverable, subject to PUCO or FERC approval. Regulatory assets and liabilities are classified as current or non-current based on the term in which recovery is expected. See Note 3 - Regulatory Matters for more information.
Inventories
Inventories are carried at average cost, net of reserves, and include coal, limestone, oil and gas used for electric generation, and materials and supplies used for utility operations.
Intangibles
Intangibles include software, emission allowances and renewable energy credits. Emission allowances are carried on a first-in, first-out (FIFO) basis for purchased emission allowances. Net gains or losses on the sale of excess
emission allowances, representing the difference between the sales proceeds and the cost of emission allowances, are recorded as a component of our fuel costs and are reflected in Operating income when realized. Emission allowances are amortized as they are used in our operations on a FIFO basis. Renewable energy credits are carried on a weighted average cost basis and amortized as they are used or retired.
Software is amortized over seven years. Amortization expense was $6.8 million, $7.7 million and $9.0 million for the years ended December 31, 2017, 2016 and 2015, respectively. The estimated amortization expense of this internal-use software over the next five years is $17.2 million ($7.2 million in 2018, $4.2 million in 2019, $2.7 million in 2020, $1.7 million in 2021 and $1.4 million in 2022).
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of the existing assets and liabilities, and their respective income tax bases. We establish an allowance when it is more likely than not that all or a portion of a deferred tax asset will not be realized. Our tax positions are evaluated under a more likely than not recognition threshold and measurement analysis before they are recognized for financial statement reporting. Uncertain tax positions have been classified as noncurrent income tax liabilities unless expected to be paid within one year. Our policy for interest and penalties is to recognize interest and penalties as a component of the provision for income taxes in the Consolidated Statement of Operations.
Income taxes payable, which are includable in allowable costs for ratemaking purposes in future years, are recorded as regulatory assets with a corresponding deferred tax liability. Investment tax credits that reduced federal income taxes in the years they arose have been deferred and are being amortized to income over the useful lives of the properties in accordance with regulatory treatment. See Note 3 - Regulatory Matters for additional information.
DPL and its subsidiaries file U.S. federal income tax returns as part of the consolidated U.S. income tax return filed by AES. The consolidated tax liability is allocated to each subsidiary based on the separate return method which is specified in our tax allocation agreement and which provides a consistent, systematic and rational approach. See Note 9 - Income Taxes for additional information.
Financial Instruments
We classify our investments in debt and equity financial instruments of publicly traded entities into different categories: held-to-maturity and available-for-sale. Available-for-sale securities are carried at fair value and unrealized gains and losses on those securities, net of deferred income taxes, are presented as a separate component of shareholder's equity. Other-than-temporary declines in value are recognized currently in earnings. Financial instruments classified as held-to-maturity are carried at amortized cost. The cost bases for public equity security and fixed maturity investments are average cost and amortized cost, respectively.
Held-for-sale Businesses
A business classified as held-for-sale is reflected on the balance sheet at the lower of its carrying amount or estimated fair value less cost to sell. A loss is recognized if the carrying amount of the business exceeds its estimated fair value less cost to sell. This loss is limited to the carrying value of long lived assets until the completion of the sale, at which point, any additional loss is recognized. If the fair value of the business subsequently exceeds the carrying amount while the business is still held-for-sale, any impairment expense previously recognized will be reversed up to the lower of the previously recognized expense or the subsequent excess.
Assets and liabilities related to a business classified as held-for-sale are segregated in the current balance sheet in the period in which the business is classified as held-for-sale. Assets and liabilities of held-for-sale businesses are classified as current when they are expected to be disposed of within twelve months. Transactions between the business held-for-sale and businesses that are expected to continue to exist after the disposal are not eliminated to appropriately reflect the continuing operations and balances held-for-sale. See Note 17 - Assets and Liabilities Held-For-Sale and Dispositions for further information.
Discontinued Operations
Discontinued operations reporting occurs only when the disposal of a business or a group of businesses represents a strategic shift that has (or will have) a major effect on our operations and financial results. We report financial results for discontinued operations separately from continuing operations to distinguish the financial impact of
disposal transactions from ongoing operations. Prior period amounts in the statement of operations and balance sheet are retrospectively revised to reflect the businesses determined to be discontinued operations. The cash flows of businesses that are determined to be discontinued operations are included within the relevant categories within operating, investing and financing activities on the face of the Statements of Cash Flows.
Transactions between the businesses determined to be discontinued operations and businesses that are expected to continue to exist after the disposal are not eliminated to appropriately reflect the continuing operations and balances held-for-sale. The results of discontinued operations include any gain or loss recognized on closing or adjustment of the carrying amount to fair value. See Note 16 - Discontinued Operations for further information.
Accounting for Taxes Collected from Customers and Remitted to Governmental Authorities
DP&L collects certain excise taxes levied by state or local governments from its customers. DP&L’s excise taxes and certain other taxes are accounted for on a net basis and recorded as a reduction in revenues in the accompanying Statements of Operations. The amounts for the years ended December 31, 2017, 2016 and 2015, were $49.4 million, $50.9 million and $49.9 million, respectively.
Cash and Cash Equivalents
Cash and cash equivalents are stated at cost, which approximates fair value. All highly liquid short-term investments with original maturities of three months or less are considered cash equivalents.
Restricted Cash
Restricted cash includes cash which is restricted as to withdrawal or usage. The nature of the restrictions includes restrictions imposed by agreements related to deposits held as collateral and cash collected under the DMR which is restricted to pay debt obligations at DPL and DP&L and position DP&L to modernize and/or maintain its transmission and distribution infrastructure.
Financial Derivatives
All derivatives are recognized as either assets or liabilities in the balance sheets and are measured at fair value. Changes in the fair value are recorded in earnings unless the derivative is designated as a cash flow hedge of a forecasted transaction or it qualifies for the normal purchases and sales exception.
We use forward contracts to reduce our exposure to changes in energy and commodity prices and as a hedge against the risk of changes in cash flows associated with expected electricity purchases. We hold forward sales contracts that hedge against the risk of changes in cash flows associated with power sales during periods of projected generation facility availability. We use cash flow hedge accounting when the hedge or a portion of the hedge is deemed to be highly effective, which results in changes in fair value being recorded within accumulated other comprehensive income, a component of shareholder’s equity. We have elected not to offset net derivative positions in the financial statements. Accordingly, we do not offset such derivative positions against the fair value of amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral under master netting agreements. See Note 6 - Derivative Instruments and Hedging Activities for additional information.
Insurance and Claims Costs
In addition to insurance obtained from third-party providers, MVIC, a wholly-owned captive subsidiary of DPL, provides insurance coverage solely to us, our subsidiaries and, in some cases, our partners in commonly-owned facilities we operate, for workers’ compensation, general liability, and property damage on an ongoing basis. Insurance and Claims Costs on DPL’s Consolidated Balance Sheets associated with MVIC include estimated liabilities of approximately $3.0 million and $5.4 million at December 31, 2017 and 2016, respectively. DPL has estimated liabilities for medical, life, disability, and other reserves for claims costs below certain coverage thresholds of third-party providers of approximately $11.9 million and $10.9 million at December 31, 2017 and 2016, respectively, within Other current liabilities and Other deferred credits on the balance sheets. The estimated liabilities for workers’ compensation, medical, life and disability costs at DPL are actuarially determined using certain assumptions. There is uncertainty associated with these loss estimates and actual results may differ from the estimates. Modification of these loss estimates based on experience and changed circumstances is reflected in the period in which the estimate is re-evaluated.
Pension and Postretirement Benefits
We recognize in our Consolidated Balance Sheets an asset or liability reflecting the funded status of pension and other postretirement plans with current-year changes in the funded status, that would otherwise be recognized in AOCI, recorded as a regulatory asset as this can be recovered through future rates. All plan assets are recorded at
fair value. We follow the measurement date provisions of the accounting guidance, which require a year-end measurement date of plan assets and obligations for all defined benefit plans.
We account for and disclose pension and postretirement benefits in accordance with the provisions of GAAP relating to the accounting for pension and other postretirement plans. These GAAP provisions require the use of assumptions, such as the discount rate for liabilities and long-term rate of return on assets, in determining the obligations, annual cost and funding requirements of the plans. Consistent with the requirements of FASC 715, we apply a disaggregated discount rate approach for determining service cost and interest cost for our defined benefit pension plans and postretirement plans.
Effective January 1, 2016, we applied a disaggregated discount rate approach for determining service cost and interest cost for our defined benefit pension plans and post-retirement plans. This approach is consistent with the requirements of FASC 715 and is considered to be preferential to the aggregated single rate discount approach, which has historically been used in the U.S., because it is more consistent with the philosophy of a full yield curve valuation.
See Note 10 - Benefit Plans for more information.
Related Party Transactions
In the normal course of business, DPL enters into transactions with related parties. All material intercompany accounts and transactions are eliminated in DPL’s Consolidated Financial Statements.
See Note 13 - Related Party Transactions for more information on Related Party Transactions.
DPL Capital Trust II
DPL has a wholly-owned business trust, DPL Capital Trust II (the Trust), formed for the purpose of issuing trust capital securities to third-party investors. Effective in 2003, DPL deconsolidated the Trust upon adoption of the accounting standards related to variable interest entities and currently treats the Trust as a nonconsolidated subsidiary. The Trust holds mandatorily redeemable trust capital securities. The investment in the Trust, which amounts to $0.3 million and $0.3 million at December 31, 2017 and 2016, respectively, is included in Other deferred assets within Other noncurrent assets. DPL also has a note payable to the Trust amounting to $15.6 million and $15.6 million at December 31, 2017 and December 31, 2016, respectively, that was established upon the Trust’s deconsolidation in 2003. See Note 8 - Debt for additional information.
In addition to the obligations under the note payable mentioned above, DPL also agreed to a security obligation which represents a full and unconditional guarantee of payments to the capital security holders of the Trust.
New accounting pronouncements
The following table provides a brief description of recent accounting pronouncements that could have a material impact on our consolidated financial statements:
Accounting Standard
Description
Date of Adoption
Effect on the financial statements upon adoption
New Accounting Standards Adopted
2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
The standard simplifies the following aspects of accounting for share-based payment awards: accounting for income taxes, classification of excess tax benefits on the statement of cash flows, forfeitures, statutory tax withholding requirements, classification of awards as either equity or liabilities and classification of employee taxes paid on statement of cash flows when an employer withholds shares for tax-withholding purposes.
Transition method: The recording of excess tax benefits and tax deficiencies arising from vesting or settlement will be applied prospectively. The elimination of the requirement that excess tax benefits be realized before they are recognized will be adopted on a modified retrospective basis with a cumulative adjustment to the opening balance sheet.
January 1, 2017.
The recognition of excess tax benefits in our provision for income taxes in the period when the awards vest or are settled, rather than in paid-in-capital in the period when the excess tax benefits are realized.
New Accounting Standards Issued But Not Yet Effective
2018-02, Income Statement - Reporting Comprehensive Income (Topic 220), Reclassification of Certain Tax Effects from AOCI
This amendment allows a reclassification of the stranded tax effects resulting from the implementation of the Tax Cuts and Jobs Act from AOCI to retained earnings. Because this amendment only relates to the reclassification of the income tax effects of the Tax Cuts and Jobs Act, the underlying guidance that requires that the effect of a change in tax laws or rates be included in income from continuing operations is not affected.
January 1, 2019. Early adoption is permitted.
We are currently evaluating the impact of adopting the standard on our consolidated financial statements.
2017-12, Derivatives and Hedging (Topic 815): Targeted improvements to Accounting for Hedging Activities
The standard updates the hedge accounting model to expand the ability to hedge nonfinancial and financial risk components, reduce complexity, and ease certain documentation and assessment requirements. When facts and circumstances are the same as at the previous quantitative test, a subsequent quantitative effectiveness test is not required. The standard also eliminates the requirement to separately measure and report hedge ineffectiveness. For cash flow hedges, this means that the entire change in the fair value of a hedging instrument will be recorded in other comprehensive income and amounts deferred will be reclassified to earnings in the same income statement line as the hedged item.
Transition method: modified retrospective with the cumulative effect adjustment recorded to the opening balance of retained earnings as of the initial application date. Prospective for presentation and disclosures.
January 1, 2019. Early adoption is permitted.
We are currently evaluating the impact of adopting the standard on our consolidated financial statements.
2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities
This standard shortens the period of amortization for the premium on certain callable debt securities to the earliest call date.
Transition method: modified retrospective.
January 1, 2019. Early adoption is permitted.
We are currently evaluating the impact of adopting the standard on our consolidated financial statements.
2017-07, Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost
This standard changes the presentation of non-service cost associated with defined benefit plans and updates the guidance so that only the service cost component will be eligible for capitalization.
January 1, 2018.
We expect the adoption of this standard to result in a reclassification of non-service pension costs from Operating expenses to Other expense of $1.9 million and $1.8 million in 2017 and 2016, respectively.
ASU 2014-09 and its subsequent corresponding updates provide the principles an entity must apply to measure and recognize revenue. The core principle is that an entity shall recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Amendments to the standard were issued that provide further clarification of the principle and to provide certain transition expedients. The standard replaces most existing revenue recognition guidance in GAAP.
The standard requires retrospective application and allows either a full retrospective adoption in which all of the periods are presented under the new standard or a modified retrospective approach in which the cumulative effect of initially applying the guidance is recognized at the date of initial application.
In 2016, we established a cross-functional implementation team and are in the process of evaluating changes to our business processes, systems and controls to support recognition and disclosure under the new standard. At this time, we do not expect any significant impact on our financial systems or a material change to controls as a result of the implementation of the new revenue recognition standard.
We are assessing the standard on a contract-by-contract basis applying the interpretations reached during 2017 on key issues. This includes the application of the practical expedient for measuring progress towards satisfaction of a performance obligation, when variable quantities would be considered variable consideration versus an option to acquire additional goods and services and how to allocate variable consideration to one or more, but not all, distinct goods or services promised in a series of distinct goods or services that forms part of a single performance obligation. Additionally, we have been working on the application of the standard to contracts that are under the scope of Service Concession Arrangements (Topic 853) and assessing the gross versus net presentation for spot energy sale and purchases. Through this assessment to date, we have not identified any situations where revenue recognized under FASC 606 could differ from that recognized under FASC 605 or where the presentation of sales to and purchases from the spot markets will change. Given the limited impact, we expect to use the modified retrospective approach.
We are continuing to work with various non-authoritative industry groups and continue to monitor the FASB and Transition Resource Group activity as we finalize our accounting policy on these and other industry-specific interpretive issues.
ASU 2016-02 and its subsequent corresponding updates require lessees to recognize assets and liabilities for most leases but recognize expenses in a manner similar to today’s accounting. For Lessors, the guidance modifies the lease classification criteria and the accounting for sales-type and direct financing leases. The guidance also eliminates today’s real estate-specific provisions.
The standard requires modified retrospective adoption at the beginning of the earliest comparative period presented in the financial statements (January 1, 2017). The FASB proposed amending the standard to give another option for transition. The proposed transition method would allow entities to not apply the new lease standard in the comparative periods presented in their financial statements in the year of adoption. Under the proposed transition method, the entity would apply the transition provisions on January 1, 2019 (i.e., the effective date). At transition, lessees and lessors are permitted to make an election to apply a package of practical expedients that allow them not to reassess: (1) whether any expired or existing contracts are or contain leases, (2) lease classification for any expired or existing leases, and (3) whether initial direct costs for any expired or existing leases qualify for capitalization under FASC 842. These three practical expedients must be elected as a package and must be consistently applied to all leases. Furthermore, entities are also permitted to make an election to use hindsight when determining lease term and entities can elect to use hindsight when assessing the impairment of right-of-use assets.
We have established a task force focused on the identification of contracts that would be under the scope of the new standard and on the assessment and measurement of the right-of-use asset and related liability. Additionally, the implementation team has been working on the identification and selection of a lease accounting system that would support the implementation and the subsequent accounting. The implementation team is in the process of evaluating changes to our business processes, systems and controls to support recognition and disclosure under the new standard.
As we have preliminarily concluded that at transition we would be using the package of practical expedients, the main impact expected as of the effective date is the recognition of the right to use asset and the related liability in the financial statements for all those contracts that contain a lease and for which we are the lessee. However, income statement presentation and the expense recognition pattern is not expected to change.
Under FASC 842, it is expected that fewer contracts will contain a lease. However, due to the elimination of today's real estate-specific guidance and changes to certain lessor classification criteria, more leases will qualify as sales-type leases and direct financing leases. Under these two models, a lessor will derecognize the asset and will recognize a lease receivable. According to FASC 842, the lease receivable does not include variable payments that depend on the use of the asset (e.g. Mwh produced by a facility). Therefore, the lease receivable could be lower than the carrying amount of the underlying asset at lease commencement. In such circumstances, the difference between the initially recognized lease receivable and the carrying amount of the underlying is recognized as a selling loss at lease commencement. We are assessing situations for which this guidance would apply.
Note 2 - Supplemental Financial Information
Accumulated Other Comprehensive Income / (Loss)
The amounts reclassified out of Accumulated Other Comprehensive Income / (Loss) by component during the years ended December 31, 2017, 2016 and 2015 are as follows:
The changes in the components of Accumulated Other Comprehensive Income / (Loss) during the years ended December 31, 2017 and 2016 are as follows:
Operating expenses - other
Operating expenses - other generally includes gains or losses on asset sales or dispositions, insurance recoveries, gains or losses on the sale of businesses and other expense or income from miscellaneous transactions. The components are summarized as follows:
Note 3 - Regulatory Matters
In January 2017, DP&L filed a settlement in its 2017 ESP case and filed an amended stipulation on March 13, 2017, which was subject to approval by the PUCO. A final decision was issued by the PUCO on October 20, 2017, modifying and adopting the amended stipulation and recommendation. The 2017 ESP establishes DP&L's framework for providing retail service on a going forward basis including rate structures, non-bypassable charges and other specific rate recovery true-up mechanisms. The signatory parties agreed to a six-year settlement that provides a framework for energy rates and defines components which include, but are not limited to, the following:
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Bypassable standard offer energy rates for DP&L’s customers based on competitive bid auctions;
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The establishment of a three-year non-bypassable Distribution Modernization Rider (DMR) designed to collect $105.0 million in revenue per year to pay debt obligations at DPL and DP&L and position DP&L to modernize and/or maintain its transmission and distribution infrastructure with an option for DP&L to file for an extension of the rider for an additional two years in an amount subject to approval by the PUCO;
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The establishment of a non-bypassable Distribution Investment Rider to recover incremental distribution capital investments, the amount of which is to be established in a separate DP&L distribution rate case;
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A non-bypassable Reconciliation Rider permitting DP&L to defer, recover or credit the net proceeds from selling energy and capacity received as part of DP&L’s investment in OVEC and DP&L's OVEC related costs;
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Implementation by DP&L of a Smart Grid Rider, Economic Development Rider, Economic Development Fund, Regulatory Compliance Rider and certain other new, or changes to existing, rates, riders and competitive retail market enhancements, with tariffs consistent with the order. These riders became effective November 1, 2017;
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A commitment to commence a sale process to sell our ownership interests in the Miami Fort, Zimmer and Conesville coal-fired generation plants, with all sales proceeds used to pay debt of DPL and DP&L;
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Restrictions on DPL making dividend or tax sharing payments and an obligation to convert then existing tax payments owed by DPL to AES into equity investments in DPL. See Note 9 - Income Taxes and Note 11 - Equity for more information on the tax sharing payment restrictions; and
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Various other riders and competitive retail market enhancements.
In connection with any sale or closure of our generation plants, DPL expects to incur certain cash and non-cash charges, some or all of which could be material to the business and financial condition of DPL.
As part of the normal review and approval process, the PUCO‘s order approving the 2017 ESP settlement is subject to rehearing requests. Several parties, including DP&L, applied for a rehearing. Those rehearing applications are still pending.
DP&L is subject to a SEET threshold and is required to apply general rules for calculating earnings and comparing them to a comparable group to determine whether there were significantly excessive earnings during a given calendar year. The 2017 ESP maintains DP&L’s return on equity SEET threshold at 12% and provides that DMR amounts are excluded from the SEET calculation. A stipulation was reached with the PUCO staff agreeing that DP&L did not exceed the SEET threshold for 2015, which was approved by the PUCO on September 6, 2017. On May 15, 2017, DP&L filed its application to demonstrate that it did not have significantly excessive earnings for calendar year 2016. That case is still pending. In future years, the SEET could have a material effect on results of operations, financial condition and cash flows.
The DOE issued a Notice of Proposed Rule Making on September 29, 2017, which directed the FERC to exercise its authority to set just and reasonable rates that recognize the “resiliency” value provided by generation plants with certain characteristics, including having 90-days or more of on-site fuel and operating in markets where they do not receive rate base treatment through state ratemaking. Nuclear and coal-fired generation plants would have been most likely to be able to meet the requirements. As proposed, the DOE would value resiliency through rates that recover “compensable costs” that were defined to include the recovery of operating and fuel expenses, debt service and a fair return on equity. On January 8, 2018, the FERC issued an order terminating this docket stating that it failed to satisfy the legal requirements of Section 206 of the Federal Power Act of 1935. The FERC initiated a new docket to take additional steps to explore resilience issues in RTOs/ISOs. The goal of this new proceeding is to: (1) develop a common understanding among the FERC, State Commissions, RTOs, transmission owners, and others as to what resilience of the bulk power system means and requires; (2) understand how each RTO and ISO assesses resilience in its geographic footprint; and (3) use this information to evaluate whether additional action regarding resilience is appropriate at this time. We are not able at this time to predict the impact of this proceeding on our business, financial condition or results of operations.
Impact of tax reform
On January 10, 2018 the PUCO initiated a proceeding to consider the impacts of the TCJA to determine the appropriate course of action to pass benefits resulting from the legislation on to ratepayers. The PUCO also directed Ohio utilities to record deferred liabilities for the estimated reduction in federal income tax resulting from the TCJA beginning January 1, 2018. Under the terms of the ESP, DPL will not make tax sharing payments and if DP&L's rates are reduced as a result of the TCJA, our cash flows could be adversely affected. It is too early to determine whether this proceeding may have a material impact on DP&L's business, financial condition or results of operations.
Regulatory assets and liabilities
In accordance with FASC 980, we have recognized total regulatory assets of $187.1 million and $204.0 million at December 31, 2017 and 2016, respectively, and total regulatory liabilities of $236.0 million and $164.1 million at December 31, 2017 and 2016, respectively. Regulatory assets and liabilities are classified as current or non-
current based on the term in which recovery is expected. See Note 1 - Overview and Summary of Significant Accounting Policies for accounting policies regarding Regulatory Assets and Liabilities.
The following table presents DPL’s Regulatory assets and liabilities:
A - Recovery of incurred costs plus rate of return.
B - Recovery of incurred costs without a rate of return.
C - Balance has an offsetting liability resulting in no effect on rate base.
D - Recovery not yet determined, but recovery is probable of occurring in future rate proceedings.
Current regulatory assets and liabilities primarily represent costs that are being recovered per specific rate order; recovery for the remaining costs is probable, but not certain. DP&L is earning a return on $12.5 million of this deferral. These items include undercollection of: (i) Distribution Modernization Rider revenues, (ii) certain transmission related costs, and (iii) declines in net revenues resulting from implementation of energy efficiency programs. It also includes the current portion of the following deferred costs which are described in greater detail below: unbilled fuel, Regulatory Compliance Rider costs and deferred storm costs. As current liabilities, this includes overcollection of: (i) competitive bidding energy and auction costs, (ii) energy efficiency program costs, (iii) alternative energy rider, (iv) economic development rider and (v) uncollectible rider.
Pension benefits represent the qualifying FASC 715 “Compensation - Retirement Benefits” costs of our regulated operations that for ratemaking purposes are deferred for future recovery. We recognize an asset for a plan’s overfunded status or a liability for a plan’s underfunded status, and recognize, as a component of OCI, the changes in the funded status of the plan that arise during the year that are not recognized as a component of net periodic benefit cost. This regulatory asset represents the regulated portion that would otherwise be charged as a loss to OCI. As per PUCO and FERC precedents, these costs are probable of future rate recovery.
Unrecovered OVEC charges includes the portion of charges from OVEC that were not recoverable through DP&L’s fuel rider from October 2014 through October 2017. DP&L expects to recover these costs through a future rate proceeding. Beginning on November 1, 2017, such costs are being recovered through DP&L’s Reconciliation Rider which was authorized as part of the 2017 ESP.
Fuel costs represent unrecovered fuel costs related to DP&L’s fuel rider from 2010 through 2015 resulting from a declining SSO customer base. DP&L was granted recovery of these costs without a return through the SSO as approved in the 2017 ESP. These costs are being recovered over the three-year period that began November 1, 2017.
Regulatory compliance costs represent the long-term portion of the regulatory compliance rider which was established by the 2017 ESP to recover the following costs: (i) Consumer Education Campaign, (ii) Retail Settlement System, (iii) Generation Separation, (iv) Bill Format Redesign, (v) Green Pricing Tariff and (vi) Supplier Consolidated Billing. All of these costs except for Generation Separation earn a return. The majority of these costs are being recovered over the three-years beginning November 1, 2017. Recovery of a small portion of the Generation Separation costs, including ongoing costs, will be sought in a future proceeding.
Rate case costs represents costs associated with preparing a distribution rate case and ESP. DP&L has requested recovery of these costs which do not earn a return, as part of its pending distribution rate case filing.
Smart Grid and AMI costs represent costs incurred as a result of studying and developing distribution system upgrades and implementation of AMI. On October 19, 2010, DP&L elected to withdraw its case pertaining to the Smart Grid and AMI programs. The PUCO accepted the withdrawal in an order issued on January 5, 2011. The PUCO also indicated that it expects DP&L to continue to monitor other utilities’ Smart Grid and AMI programs and to explore the potential benefits of investing in Smart Grid and AMI programs and that DP&L will, when appropriate, file new Smart Grid and/or AMI business cases in the future. This plan is currently under development and we plan to seek recovery of these deferred costs, which currently do not earn a return, in a regulatory rate proceeding in the near future. Based on PUCO precedent, we believe these costs are probable of future recovery in rates.
Unamortized loss on reacquired debt represents losses on long-term debt reacquired or redeemed in prior periods that have been deferred. These deferred losses are being amortized over the lives of the original issues in accordance with the rules of the FERC and the PUCO.
Deferred storm costs represent the long-term portion of deferred costs for major storms which occurred during 2016 and 2017. The 2017 ESP granted DP&L approval to establish a rider by which to seek recovery of these types of costs with a return. DP&L filed to recover 2016 storm costs on February 2, 2018 and expects to file to recover 2017 costs later in 2018. Recovery of these costs is probable by 2019, but not certain.
Estimated costs of removal - regulated property reflect an estimate of amounts collected in customer rates for costs that are expected to be incurred in the future to remove existing transmission and distribution property from service when the property is retired.
Deferred income taxes payable to customers represent deferred income tax assets recognized from the normalization of flow-through items as the result of taxes previously charged to customers. A deferred income tax asset or liability is created from a difference in income recognition between tax laws and accounting methods. As a regulated utility, DP&L includes in ratemaking the impacts of current income taxes and changes in deferred income tax liabilities or assets. The 2016 regulatory asset of $35.9 million represents the portion of DP&L’s deferred income tax asset that we believed would be recovered through future rates, without interest, based upon established regulatory practices. That 2016 asset was based upon an expected future federal income tax rate of 35%. On December 22, 2017, the TCJA was signed, which includes a provision to, among other things, reduce the federal corporate income tax rate to 21%, beginning January 1, 2018. As required by GAAP, on December 31, 2017, DP&L remeasured their deferred income tax assets and liabilities using the new expected tax rate. DP&L believes that the portion of the reduction in the net deferred tax liability which is related to deferred taxes considered in ratemaking will be used in future ratemaking to reduce jurisdictional retail rates. Accordingly, the related regulatory asset became a $83.4 million regulatory liability.
Postretirement benefits represent the qualifying FASC 715 “Compensation - Retirement Benefits” gains related to our regulated operations that, for ratemaking purposes, are probable of being reflected in future rates. We
recognize an asset for a plan’s overfunded status or a liability for a plan’s underfunded status, and recognize, as a component of OCI, the changes in the funded status of the plan that arise during the year that are not recognized as a component of net periodic benefit cost. This regulatory liability represents the regulated portion that would otherwise be reflected as a gain to OCI.
Note 4 - Property, Plant and Equipment
The following is a summary of DPL’s Property, plant and equipment with corresponding composite depreciation rates at December 31, 2017 and 2016:
Coal-fired facilities
DPL and certain other Ohio utilities have undivided ownership interests in three coal-fired electric generating facilities and numerous transmission facilities. Certain expenses, primarily fuel costs for the generating units, are allocated to the owners based on their energy usage. The remaining expenses, investments in fuel inventory, plant materials and operating supplies, and capital additions are allocated to the owners in accordance with their respective ownership interests. DPL’s share of the operations of such facilities is included within the corresponding line in the Consolidated Statements of Operations, and DPL’s share of the investment in the facilities is included within Total net property, plant and equipment in the Consolidated Balance Sheets. Each joint owner provides their own financing for their share of the operations and capital expenditures of the jointly-owned station.
DPL’s undivided ownership interest in such facilities at December 31, 2017, is as follows:
Each of the above generating units has SCR and FGD equipment installed.
On January 10, 2017, a high-pressure feedwater heater shell failed on Unit 1 at the J.M. Stuart station. The unit was retired on October 1, 2017. Accordingly, DPL's 202 MWs of capacity associated with Stuart Unit 1 have been removed from the table above.
DPL announced during 2017 that it plans on retiring the co-owned Stuart Station coal-fired and diesel-fired generating units and the co-owned Killen Station coal-fired generating unit and combustion turbine on or before June 1, 2018, and the co-owners of these facilities agreed with this plan of retirement.
On December 8, 2017, AES Ohio Generation completed the sale of the Miami Fort and Zimmer EGUs.
In the fourth quarter of 2017, DPL entered into an agreement to sell its Peaker assets. See Note 17 - Assets and Liabilities Held-For-Sale and Dispositions for more information.
AROs
We recognize AROs in accordance with GAAP which requires legal obligations associated with the retirement of long-lived assets to be recognized at their fair value at the time those obligations are incurred. Upon initial recognition of a legal liability, costs are capitalized as part of the related long-lived asset and depreciated over the useful life of the related asset. Our legal obligations are associated with the retirement of our long-lived assets, consisting primarily of river intake and discharge structures, coal unloading facilities, loading docks, ice breakers and ash disposal facilities. Our generation AROs are recorded within Other deferred credits on the consolidated balance sheets.
Estimating the amount and timing of future expenditures of this type requires significant judgment. Management routinely updates these estimates as additional information becomes available.
Changes in the Liability for Generation AROs
See Note 5 - Fair Value for further discussion on ARO additions.
Asset Removal Costs
We continue to record costs of removal for our regulated transmission and distribution assets through our depreciation rates and recover those amounts in rates charged to our customers. There are no known legal AROs associated with these assets. We have recorded $132.8 million and $126.5 million in estimated costs of removal at December 31, 2017 and 2016, respectively, as regulatory liabilities for our transmission and distribution property. These amounts represent the excess of the cumulative removal costs recorded through depreciation rates versus the cumulative removal costs actually incurred. See Note 3 - Regulatory Matters for additional information.
Changes in the Liability for Transmission and Distribution Asset Removal Costs
Note 5 - Fair Value
The fair values of our financial instruments are based on published sources for pricing when possible. We rely on valuation models only when no other method is available to us. The fair value of our financial instruments represents estimates of possible value that may or may not be realized in the future.
The table below presents the fair value and cost of our non-derivative instruments at December 31, 2017 and 2016. See Note 6 - Derivative Instruments and Hedging Activities for the fair values of our derivative instruments.
(a)
Amounts exclude immaterial capital lease obligations
Fair value hierarchy
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. These inputs are then categorized as:
•
Level 1 (quoted prices in active markets for identical assets or liabilities);
•
Level 2 (observable inputs such as quoted prices for similar assets or liabilities or quoted prices in markets that are not active); or
•
Level 3 (unobservable inputs reflecting management’s own assumptions about the inputs used in pricing the asset or liability).
Valuations of assets and liabilities reflect the value of the instrument including the values associated with counterparty risk. We include our own credit risk and our counterparty’s credit risk in our calculation of fair value using global average default rates based on an annual study conducted by a large rating agency.
We did not have any transfers of the fair values of our financial instruments between Level 1 and Level 2 of the fair value hierarchy during the years ended December 31, 2017 and 2016.
Debt
The fair value of debt is based on current public market prices for disclosure purposes only. Unrealized gains or losses are not recognized in the financial statements as debt is presented at the carrying value, net of unamortized premium or discount, in the financial statements. The debt amounts include the current portion payable in the next twelve months and have maturities that range from 2019 to 2061.
Master trust assets
DP&L established a Master Trust to hold assets that could be used for the benefit of employees participating in employee benefit plans. These assets are primarily comprised of open-ended mutual funds, which are valued using the net asset value per unit. These investments are recorded at fair value within Other deferred assets on the balance sheets and classified as available for sale. Any unrealized gains or losses are recorded in AOCI until the securities are sold.
DPL had $1.6 million ($1.0 million after tax) in unrealized gains and immaterial unrealized losses on the Master Trust assets in AOCI at December 31, 2017, and $1.0 million ($0.6 million after tax) in unrealized gains and immaterial unrealized losses in AOCI at December 31, 2016.
During the year ended December 31, 2017, $0.9 million ($0.6 million after tax) of various investments were sold to facilitate the distribution of benefits. Over the next twelve months, an immaterial amount of unrealized gains is expected to be reversed to earnings.
The fair value of assets and liabilities at December 31, 2017 and the respective category within the fair value hierarchy for DPL was determined as follows:
(a)
Includes credit valuation adjustment
(b)
Amounts exclude immaterial capital lease obligations
The fair value of assets and liabilities at December 31, 2016 and the respective category within the fair value hierarchy for DPL was determined as follows:
(a)
Includes credit valuation adjustment
(b)
Amounts exclude immaterial capital lease obligations
Our financial instruments are valued using the market approach in the following categories:
•
Level 1 inputs are used for derivative contracts, such as heating oil futures, and for money market accounts that are considered cash equivalents. The fair value is determined by reference to quoted market prices and other relevant information generated by market transactions.
•
Level 2 inputs are used to value derivatives such as forward power contracts (which are traded on the OTC market, but which are valued using prices on the NYMEX for similar contracts on the OTC market). Other Level 2 assets include open-ended mutual funds in the Master Trust, which are valued using the end of day NAV per unit.
•
Level 3 inputs, such as financial transmission rights, are considered a Level 3 input because the monthly auctions are considered inactive. Our Level 3 inputs are immaterial to our derivative balances as a whole and as such no further disclosures are presented.
Approximately 98.7% of the inputs to the fair value of our derivative instruments are from quoted market prices.
Our long-term debt is fair valued for disclosure purposes only and most of the fair values are determined using quoted market prices in inactive markets. These fair value inputs are considered Level 2 in the fair value hierarchy. As the Wright-Patterson Air Force Base note is not publicly traded, fair value is assumed to equal carrying value.
These fair value inputs are considered Level 3 in the fair value hierarchy as there are no observable inputs. Additional Level 3 disclosures are not presented since our long-term debt is not recorded at fair value.
Non-recurring Fair Value Measurements
We use the cost approach to determine the fair value of our AROs, which are estimated by discounting expected cash outflows to their present value at the initial recording of the liability. Cash outflows are based on the approximate future disposal cost as determined by market information, historical information or other management estimates. These inputs to the fair value of the AROs would be considered Level 3 inputs under the fair value hierarchy. AROs for asbestos, ash ponds, underground storage tanks, and river structures decreased due to changes in our estimates of costs to be incurred by a net amount of $2.6 million ($1.7 million after tax) in 2017 and increased by a net amount of $72.9 million ($47.4 million after tax) in 2016 largely driven by the increases to the AROs for the Stuart and Killen plants discussed below. Increases to the AROs for the Stuart and Killen plants totaling $67.9 million ($44.1 million after tax) were recorded in 2016 to reflect revised estimated closure expenditures as well as plant closure dates that are earlier than previously forecast. Smaller changes were also recorded to the AROs for certain other plants to reflect changes in estimated closure costs. See Note 4 - Property, Plant and Equipment for more information about AROs.
When evaluating impairment of goodwill and long-lived assets, we measure fair value using the applicable fair value measurement guidance. Impairment expense is measured by comparing the fair value at the evaluation date to the carrying amount.
The following table summarizes major categories of assets and liabilities measured at fair value on a nonrecurring basis during the period and their level within the fair value hierarchy:
(a)
See Note 15 - Fixed-asset Impairments for further information
(b)
See Note 7 - Goodwill for further information
(c)
Carrying amount at date of valuation
The following summarizes the significant unobservable inputs used in the Level 3 measurement on a non-recurring basis during the year ended December 31, 2017:
The following summarizes the significant unobservable inputs used in the Level 3 measurement on a non-recurring basis during the year ended December 31, 2016:
Note 6 - Derivative Instruments and Hedging Activities
In the normal course of business, DPL enters into various financial instruments, including derivative financial instruments. We use derivatives principally to manage the risk of changes in market prices for commodities and interest rate risk associated with our long-term debt. The derivatives that we use to economically hedge these risks are governed by our risk management policies for forward and futures contracts. Our net positions are continually
assessed within our structured hedging programs to determine whether new or offsetting transactions are required. The objective of the hedging program is to mitigate financial risks while ensuring that we have adequate resources to meet our requirements. We monitor and value derivative positions monthly as part of our risk management processes. We use published sources for pricing, when possible, to mark positions to market. All of our derivative instruments are used for risk management purposes and are designated as cash flow hedges if they qualify under FASC 815 for accounting purposes.
At December 31, 2017, DPL's outstanding derivative instruments were as follows:
(a)
Refers to whether the derivative instruments have been designated as a cash flow hedge.
At December 31, 2016, DPL's outstanding derivative instruments were as follows:
(a)
Refers to whether the derivative instruments have been designated as a cash flow hedge.
Cash flow hedges
As part of our risk management processes, we identify the relationships between hedging instruments and hedged items, as well as the risk management objective and strategy for undertaking various hedge transactions. The fair values of cash flow hedges determined by current public market prices will continue to fluctuate with changes in market prices up to contract expiration. The effective portion of the hedging transaction is recognized in AOCI and transferred to earnings using specific identification of each contract when the forecasted hedged transaction takes place or when the forecasted hedged transaction is probable of not occurring. The ineffective portion of the cash flow hedge is recognized in earnings in the current period. All risk components were considered to determine the hedge effectiveness of the cash flow hedges.
We enter into forward power contracts and forward natural gas contracts to manage commodity price risk exposure related to our generation of electricity. We do not hedge all commodity price risk. We reclassify gains and losses on forward power contracts from AOCI into earnings in those periods in which the contracts settle.
We have two interest rate swaps to hedge the variable interest on our $200.0 million variable interest rate tax-exempt First Mortgage Bonds. The interest rate swaps have a combined notional amount of $200.0 million and will settle monthly based on a one-month LIBOR. We use the income approach to value the swaps, which consists of forecasting future cash flows based on contractual notional amounts and applicable and available market data as of the valuation date. The most common market data inputs used in the income approach include volatilities, spot and forward benchmark interest rates (LIBOR). Forward rates with the same tenor as the derivative instrument being valued are generally obtained from published sources, with these forward rates being assessed quarterly at a portfolio-level for reasonableness versus comparable published rates. We reclassify gains and losses on the swaps out of AOCI and into earnings in those periods in which hedged interest payments occur.
The following tables provide information on gains or losses recognized in AOCI for the cash flow hedges for the periods indicated:
(a)
The actual amounts that we reclassify from AOCI to earnings related to power can differ from the estimate above due to market price changes.
Net gains or losses associated with the ineffective portion of the hedging transactions were immaterial in the periods presented.
Derivatives not designated as hedges
Certain derivative contracts are entered into on a regular basis as part of our risk management program but do not qualify for hedge accounting or the normal purchases and sales exceptions under FASC 815. Accordingly, such contracts are recorded at fair value with changes in the fair value charged or credited to the consolidated statements of operations in the period in which the change occurred. This is commonly referred to as “MTM accounting”. Contracts we enter into as part of our risk management program may be settled financially, by physical delivery or net settled with the counterparty. We mark to market FTRs, natural gas futures and certain forward power contracts.
Certain qualifying derivative instruments have been designated as normal purchases or normal sales contracts, as provided under GAAP. Derivative contracts that have been designated as normal purchases or normal sales under GAAP are not subject to MTM accounting treatment and are recognized in the consolidated statements of operations on an accrual basis.
The following tables show the amount and classification within the Consolidated Statements of Operations or Balance Sheets of the gains and losses on DPL’s derivatives not designated as hedging instruments for the years ended December 31, 2017, 2016 and 2015:
DPL has elected not to offset derivative assets and liabilities and not to offset net derivative positions against the right to reclaim cash collateral pledged (an asset) or the obligation to return cash collateral received (a liability) under derivative agreements.
The following tables summarize the derivative positions presented in the balance sheet where a right of offset exists under these arrangements and related cash collateral received or pledged; as well as the fair value, balance sheet classification and hedging designation of DPL’s derivative instruments.
(a)
Includes credit valuation adjustment.
(a)
Includes credit valuation adjustment.
Credit risk-related contingent features
Certain of our OTC commodity derivative contracts are under master netting agreements that contain provisions that require us to post collateral if our credit ratings drop below certain thresholds. We have crossed this threshold and our counterparties could request that we post collateral for our net liability position with them. As of the date of the filing of this report, we have not had to post collateral with any of these counterparties.
The aggregate fair value of DPL’s derivative instruments that were in a MTM loss position at December 31, 2017 is $15.3 million. This amount is offset by $8.7 million of collateral posted directly with third parties and in a broker margin account which offsets our loss positions on the forward contracts. This liability position is further offset by the asset position of counterparties with master netting agreements of $1.4 million. Since our debt is below investment grade, we could have to post collateral for the remaining $4.9 million.
Note 7 - Goodwill
DP&L Reporting Unit
During the fourth quarter of 2015, DPL performed its annual goodwill impairment test and recognized a goodwill impairment at its DP&L reporting unit of $317.0 million. The reporting unit failed Step 1 as its fair value was less than its carrying amount, which was primarily due to a decrease forecasted in dark spreads that were driven by decreases in projected forward power prices, and lower than expected revenues from the CP product. The fair value of the reporting unit was determined under the income approach using a discounted cash flow valuation model. The significant assumptions included within the discounted cash flow valuation model were forward
commodity price curves, expected revenues from the new CP product, and planned environmental expenditures. In Step 2, goodwill was determined to have no implied fair value after the hypothetical purchase price allocation under the accounting guidance for business combinations; therefore, a full impairment of the remaining goodwill balance of $317.0 million was recognized.
The goodwill associated with the Merger is not deductible for tax purposes. Accordingly, there is no cash or financial statement tax benefit related to the impairment.
Note 8 - Debt
(a)
Range of interest rates for the year ended December 31, 2017.
(b)
Range of interest rates for the year ended December 31, 2016.
(c)
Note payable to related party. See Note 13 - Related Party Transactions for additional information.
At December 31, 2017, maturities of long-term debt are summarized as follows:
Premiums or discounts recognized at the Merger date are amortized over the life of the debt using the effective interest method.
Significant transactions
On January 3, 2018, DP&L and its lenders amended DP&L's Term Loan B credit agreement. The amendment (a) modified the definition of "applicable rate", from 2.25% per annum to 1.00% per annum - in the case of the Base Rate, and from 3.25% per annum to 2.00% per annum - in the case of the Eurodollar Rate, and (b) included a "call protection" provision which stated that in the event the loan was repriced or any portion of the loans were prepaid, repaid, refinanced, substituted, or replaced on or prior July 3, 2018, such prepayment, acceleration, repayment, refinancing, substitution or replacement would be made at 101% of the principal amount so prepaid, repaid, refinanced, substituted or replaced. After July 3, 2018 any such transaction would occur at 100% of the principal amount of the then outstanding loans.
On December 15, 2017, shortly after DPL and AES Ohio Generation entered into an Asset Purchase Agreement agreeing to sell Peaker assets to Kimura Power, DPL and its lenders amended DPL's revolving credit loan and term loan credit agreement. This agreement was amended to, among other things, (a) explicitly carve out the sale of DPL's Peaker assets and coal generation facilities from its "limitation on asset disposition" covenant, (b) modify the definition of Consolidated EBITDA (which is used for measuring the Consolidated Debt to EBITDA ratio and the Interest Coverage Ratio in the agreement), to also exclude, out-of-pocket third party costs and expenses incurred directly in connection with the implementation, negotiation, documentation and closing of the Generation Separation and up to $25.0 million of non-recurring cash expenses related to the closure, or sale, of generation stations, (c) modify the definition of "maturity date" used in the agreement to mean July 31, 2020; provided, however, if DPL fails to retire, redeem, or refinance at least $100.0 million in aggregate of principal amount of its senior unsecured bonds due October 1, 2019, then the maturity date shall be July, 1 2019, and (d) modify the maximum Consolidated Debt to EBITDA ratio permitted not to exceed 7.25 to 1.00 September 20, 2015 through December 31, 2018, 7.00 to 1.00 January 1, 2019 through June 30, 2019, 6.75 to 1.00 July 1, 2019 through December 31, 2019, and 6.50 to 1.00 January 1, 2020 and beyond. As part of this agreement DPL has also agreed to repay the remaining balance on its secured term loan within 10 days after receiving proceeds from the sale of the Peaker assets. This agreement was effective December 15, 2017, however certain provisions, including the modification of the Consolidated Debt to EBITDA covenant and the carving out of the sale of Peaker assets from its "limitation on asset disposition" covenant, are conditioned on the repayment in full of the term loan.
On December 8, 2017, DPL made a $30.0 million prepayment on its term loan. As of December 31, 2017, the outstanding balance was $70.0 million.
On May 26, 2017, DP&L commenced a tender offer to purchase any and all of the outstanding 4.8% tax-exempt First Mortgage Bonds at par value (plus accrued and unpaid interest). By June 23, 2017, or the expiration date of the tender, $8.1 million of the outstanding bonds were tendered. On June 26, 2017, DP&L accepted all of the tendered bonds, redeemed and retired them. On July 7, 2017, DP&L notified the Ohio Air Quality Development Authority and the Trustee of the same First Mortgage Bonds that DP&L was going to call at par value (plus accrued and unpaid interest) $21.9 million of these bonds. This call was completed on August 7, 2017. On September 28, 2017, DP&L issued an irrevocable call notice to purchase all of the remaining outstanding 4.8% tax-exempt First Mortgage Bonds at par value (plus accrued and unpaid interest). As of September 30, 2017, all of the bonds were either redeemed or defeased. This was done to facilitate Generation Separation and the release of the DP&L generation assets from the lien of DP&L's First and Refunding Mortgage. The redemption of the $70.0 million principal amount of bonds was completed on October 30, 2017.
On January 6, 2016, DPL issued a Notice of Partial Redemption to the Trustee (Wells Fargo Bank N.A.) on the DPL 6.5% Senior Notes due 2016 (a component of the Dolphin Subsidiary II, Inc. debt). DPL notified the trustee that it was calling $73.0 million of the $130.0 million outstanding principal amount of these notes. The record date of this redemption was January 21, 2016, and the redemption date was February 5, 2016. These bonds were redeemed at par plus accrued interest and a make-whole premium of $2.4 million. On October 17, 2016, the remaining $57.0 million of outstanding principal was redeemed at par on their maturity date with cash on hand.
On August 24, 2016, DP&L refinanced its 1.875% First Mortgage Bonds due 2016, with a variable rate Term Loan B of $445.0 million maturing on August 24, 2022 and secured by a pledge of DP&L First Mortgage Bonds. The variable rate on the loan is calculated based on LIBOR plus a spread of 3.25%, with a LIBOR floor of 0.75%. Up to the maturity date but not starting until March 31, 2017, the loan amortizes 0.25% of the initial principal balance quarterly and contains covenants and restrictions that are generally consistent with existing DP&L credit agreements.
Debt covenants and restrictions
DP&L’s unsecured revolving credit agreement and Bond Purchase and Covenants Agreement (financing document entered into in connection with the sale of $200.0 million of variable rate tax-exempt First Mortgage Bonds, dated as of August 1, 2015, containing representations, warranties, covenants and defaults consistent with those contained in the revolving credit facilities loan documents of DP&L) have two financial covenants. The first measures Total Debt to Total Capitalization and is calculated, at the end of each fiscal quarter, by dividing total debt at the end of the quarter by total capitalization at the end of the quarter. The second financial covenant measures EBITDA to Interest Expense. The EBITDA to Interest Expense ratio is calculated, at the end of each fiscal quarter, by dividing consolidated EBITDA for the four prior fiscal quarters by the consolidated interest charges for the same period.
DPL’s revolving credit agreement and term loan have two financial covenants. The first financial covenant, a Total Debt to EBITDA ratio, is calculated at the end of each fiscal quarter by dividing total debt at the end of the current quarter by consolidated EBITDA for the four prior fiscal quarters. The second financial covenant is an EBITDA to Interest Expense ratio that is calculated, at the end of each fiscal quarter, by dividing EBITDA for the four prior fiscal quarters by the consolidated interest charges for the same period.
DP&L does not have any meaningful restrictions in its debt financing documents prohibiting dividends to its parent, DPL. DPL’s secured revolving credit agreement, secured term loan, and senior unsecured notes due 2019 restrict dividend payments from DPL to AES, such that DPL cannot make dividend payments unless at the time of, and/or as a result of, the distribution, DPL’s leverage ratio does not exceed 0.67 to 1.00 and DPL’s interest coverage ratio is not less than 2.50 to 1.00 or, if such ratios are not within the parameters, DPL’s senior long-term debt rating from one of the three major credit rating agencies is at least investment grade. As of December 31, 2017, DPL’s leverage ratio was at 1.50 to 1.00 and DPL’s senior long-term debt rating from all three major credit rating agencies was below investment grade. As a result, as of December 31, 2017, DPL was prohibited under each of these agreements from making a distribution to its shareholder or making a loan to any of its affiliates (other than its subsidiaries). DPL is also restricted from making dividend and tax sharing payments from DPL to AES per its 2017 ESP. This order restricts dividend payments from DPL to AES during the term of the 2017 ESP and restricts tax sharing payments from DPL to AES during the term of the DMR. See Note 9 - Income Taxes for more information.
DP&L’s revolving credit facility and Bond Purchase and Covenants Agreement (financing document entered into in connection with the issuance of the $200.0 million of variable rate tax-exempt First Mortgage Bonds, dated as of August 1, 2015, containing representations, warranties and covenants consistent with those contained in DP&L's revolving credit facilities loan documents) have two financial covenants. First, prior to the date of completion of the separation of DP&L’s generation assets from its transmission and distribution assets, DP&L’s Total Debt to Total Capitalization may not be greater than 0.65 to 1.00 at any time; and, on and after the date of completion of the separation of DP&L’s generation assets from its transmission and distribution assets, which occurred October 1, 2017, DP&L’s Total Debt to Total Capitalization may not be greater than 0.75 to 1.00 at any time. Except that after separation required compliance with this financial covenant shall be suspended (a) any time after separation during which DP&L maintains a rating of BBB- (or in the case of Moody’s Investors Service, Inc. Baa3) or higher with a stable outlook from at least one of Fitch Investors Service Inc., Standard & Poor’s Ratings Services or Moody’s Investors Service, Inc., as determined in accordance with the terms of the revolving credit facility or (b) for the time period January 1, 2017 to December 31, 2017 (as modified by the amendment described below) if DP&L’s long-term indebtedness (as determined by the PUCO) is less than or equal to $750.0 million. The Total Debt to Capitalization covenant is calculated as the sum of DP&L’s current and long-term portion of debt, divided by the total of DP&L’s net worth and total debt.
On February 21, 2017, DP&L and its lenders amended DP&L’s revolving credit agreement and Bond Purchase and Covenant Agreement. These amendments modified the definition of Consolidated Net Worth in each agreement (which is used for measuring the Total Debt to Total Capitalization ratio under each of the agreements), to exclude, through March 31, 2018, non-cash charges related directly to impairments of coal generation assets in DP&L's fiscal quarter ending December 31, 2016 and thereafter. With this amendment, DP&L was able to ensure compliance with the Total Debt to Total Capitalization ratio through October 1, 2017, the date Generation Separation occurred. After Generation Separation, and per the terms of the original agreement (before any amendment), the required Total Debt to Total Capitalization ratio increased from 0.65 to 1.00 to 0.75 to 1.00. On September 30, 2017, DP&L's adjusted (excluding impairments) Total Debt to Total Capitalization was 0.61 to 1.00 and as of December 31, 2017 it was 0.67 to 1.00. After Generation Separation occurred, the calculation of this covenant is on an unadjusted basis. The amendment also changed, for each agreement, the dates after Generation Separation during which compliance with the Total Capitalization ratio detailed above will be suspended if long-term indebtedness, as determined by the PUCO, is less than or equal to $750.0 million. As noted above this
time period previously was January 1, 2017 to December 31, 2017, and is now the twelve months immediately subsequent to the separation of the generation assets from DP&L (or from October 1, 2017 through September 30, 2018). Generation Separation occurred on October 1, 2017.
As of December 31, 2017, DP&L and DPL were in compliance with all debt covenants, including the financial covenants described above.
Substantially all property, plant & equipment of DP&L is subject to the lien of the mortgage securing DP&L’s First and Refunding Mortgage. All generation assets were released from the lien of DP&L's first and refunding mortgage in connection with the completion of Generation Separation on October 1, 2017.
Note 9 - Income Taxes
DPL’s components of income tax expense on continuing operations were as follows:
(a)
The statutory tax rate of 35% was applied to pre-tax earnings.
(b)
Includes expense / (benefit) of $3.5 million, $(0.3) million and $0.2 million in the years ended December 31, 2017, 2016, and 2015, respectively, of income tax related to adjustments from prior years. The 2017 tax year also includes a one-time remeasurement of deferred tax expense related to the recent enactment of the TCJA of $13.7 million.
Effective and Statutory Rate Reconciliation
The following table summarizes a reconciliation of the U.S. statutory federal income tax rate to DPL's effective tax rate, as a percentage of income from continuing operations before taxes for the years ended December 31, 2017, 2016 and 2015:
(a)
In 2017, this is primarily a result of the application of the TCJA.
Deferred Income Taxes
Deferred income taxes reflect the net tax effects of (a) temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes and (b) operating loss carryforwards. These items are stated at the enacted tax rates that are expected to be in effect when taxes are actually paid or recovered. Investment tax credits related to utility property have been deferred and are being amortized over the estimated useful lives of the related property.
(a)
The Other caption includes deferred tax assets of $36.3 million in 2017 and $38.3 million in 2016 related to state and local tax net operating loss carryforwards, net of related valuation allowances of $36.3 million in 2017 and $38.3 million in 2016. These net operating loss carryforwards expire from 2018 to 2037.
U. S Tax Reform
On December 22, 2017, the U.S. enacted the TCJA. The TCJA significantly changes U.S. corporate income tax law.
We recognized the income tax effects of the TCJA in accordance with Staff Accounting Bulletin No. 118 (“SAB 118”) which provides SEC guidance on the application of FASC 740, Income Taxes, in the reporting period in which the TCJA was signed into law. Accordingly, our financial statements reflect the income tax effects of U.S. tax reform for which the accounting is complete and provisional amounts for those impacts for which the accounting under FASC 740 is incomplete, but a reasonable estimate could be determined.
We have calculated our best estimate of the impact of the TCJA in our income tax provision for the year ended December 31, 2017 in accordance with our understanding of the TCJA and guidance available as of the date of this filing, and as a result recognized $13.7 million of discrete tax expense in the fourth quarter of 2017 related to non-operating and non-regulated property.
This amount results from the remeasurement of certain deferred tax assets and liabilities from 35% to 21%. The most material deferred taxes to be remeasured related to property, plant and equipment. The remeasurement of deferred tax assets and liabilities related to regulated utility property of $135.2 million was recorded as a regulatory liability, which was a non-cash adjustment. Additional time is required to finalize remeasurement effects in accordance with GAAP.
Per the terms of the order issued by the PUCO on DP&L's 2017 ESP, DPL will not make any tax-sharing payments to AES and AES will forgo collection of the payments during the term of the DMR. The agreed upon term of the DMR is three years. With commission approval, the DMR can be extended two additional years allowing for the term to potentially be five years. Both the current and non-current existing tax sharing liabilities with AES were converted into additional equity investment in DPL, per the requirements of the order. Throughout the term, further accrued tax sharing liabilities will also be converted to additional equity. All parties agreed that the initial conversion and any future conversions will not be reversed. In 2017 we converted $97.1 million to equity in accordance with this requirement.
The following table presents the tax expense / (benefit) related to pensions, postemployment benefits, cash flow hedges and financial instruments that were credited to Accumulated other comprehensive loss.
Uncertain Tax Positions
We apply the provisions of GAAP relating to the accounting for uncertainty in income taxes. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
Of the December 31, 2017 balance of unrecognized tax benefits, $0.9 million is due to uncertainty in the timing of deductibility.
We recognize interest and penalties related to unrecognized tax benefits in Income tax expense. The amounts accrued and the expense / (benefit) recorded were not material for each period presented.
Following is a summary of the tax years open to examination by major tax jurisdiction:
U.S. Federal - 2011 and forward
State and Local - 2011 and forward
None of the unrecognized tax benefits are expected to significantly increase or decrease within the next twelve months other than those subject to expiring statute of limitations.
Note 10 - Benefit Plans
Defined contribution plans
DP&L sponsors two defined contribution plans. One is for non-union employees (the management plan) and one is for collective bargaining employees (the union plan). Both plans are qualified under Section 401 of the Internal Revenue Code.
Certain non-union and union employees become eligible to participate in their respective plan upon date of hire.
Participants may elect to contribute up to 85% of eligible compensation to their plan. Non-union participant contributions are matched 100% on the first 1% of eligible compensation and 50% on the next 5% of eligible compensation and they are fully vested in their employer contributions after 2 years of service. Union participant contributions are matched 150% but are capped at $2,300 for 2017 and they are fully vested in their employer contributions after 3 years of service. All participants are fully vested in their own contributions.
We contributed $3.1 million, $5.1 million and $4.9 million in the years ended December 31, 2017, 2016 and 2015, respectively. DP&L matching contributions are paid quarterly, in arrears. Therefore, the contributions by year include the fourth quarter matching contribution that is paid in the following year. DP&L also contributes an annual bonus to the accounts of its union participants. This payment is typically made in January of the following year. For 2017, the annual bonus amount is yet to be determined and paid; pending the results of negotiations with the bargaining unit.
Defined benefit plans
DP&L sponsors a traditional defined benefit pension plan for most of the employees of DPL and its subsidiaries. For collective bargaining employees, the defined benefits are based on a specific dollar amount per year of service. For all other employees (management employees), the traditional defined benefit pension plan is based primarily on compensation and years of service. As of December 31, 2010, this traditional pension plan formula was closed to new management employees. A participant is 100% vested in all amounts credited to his or her account upon the completion of five vesting years, as defined in The Dayton Power and Light Company Retirement Income Plan, or the participant’s death or disability. If a participant’s employment is terminated, other than by death or disability, prior to such participant becoming 100% vested in his or her account, the account shall be forfeited as of the date of termination. Effective January 1, 2014, the Service Company began providing services including accounting, legal, human resources, information technology and other corporate services on behalf of companies that are part of the U.S. SBU, including among other companies, DPL and DP&L. Employees that transferred from DP&L to the Service Company maintain their previous eligibility to participate in the DP&L pension plan.
Almost all management employees beginning employment on or after January 1, 2011 participate in a cash balance pension plan formula. Similar to the traditional pension plan for management employees, the cash balance benefits are based on compensation and years of service. A participant shall become 100% vested in all amounts credited to his or her account upon the completion of three vesting years, as defined in The Dayton Power and Light Company Retirement Income Plan, or the participant’s death or disability. If a participant’s employment is terminated, other than by death or disability, prior to such participant becoming 100% vested in his or her account, the account shall be forfeited as of the date of termination. Vested benefits in the cash balance plan are fully portable upon termination of employment.
In addition, we have a Supplemental Executive Retirement Plan (SERP) for certain retired key executives. The SERP has an immaterial unfunded liability related to agreements for retirement benefits of certain terminated and retired key executives. We also include our net liability to our partners in our co-owned generating plants related to our share of their pension liabilities within Pension, retiree and other benefits on our Consolidated Balance Sheets.
We recognize an asset for a plan’s overfunded status and a liability for a plan’s underfunded status and recognize, as a component of OCI, the changes in the funded status of the plan that arise during the year that are not recognized as a component of net periodic benefit cost. For the transmission and distribution areas of our electric business, these amounts are recorded as regulatory assets and liabilities which represent the regulated portion that would otherwise be charged or credited to AOCI. We have historically recorded these costs on the accrual basis and this is how these costs have been historically recovered through customer rates. This factor, combined with the historical precedents from the PUCO and FERC, make these costs probable of future rate recovery.
Postretirement benefits
Qualified employees who retired prior to 1987 and their dependents are eligible for health care and life insurance benefits until their death, while qualified employees who retired after 1987 are eligible for life insurance benefits and partially subsidized health care. The partially subsidized health care is at the election of the employee, who pays the majority of the cost, and is available only from their retirement until they are covered by Medicare. We have funded a portion of the union-eligible benefits using a Voluntary Employee Beneficiary Association Trust. These postretirement health care benefits and the related unfunded obligation of $12.7 million and $15.8 million at
December 31, 2017 and 2016, respectively, were not material to the consolidated financial statements in the periods covered by this report.
The following tables set forth the changes in our pension plan's obligations and assets recorded on the Consolidated Balance Sheets at December 31, 2017 and 2016. The amounts presented in the following tables for pension obligations include the collective bargaining plan formula, traditional management plan formula and cash balance plan formula and the SERP in the aggregate and have not been adjusted for $1.1 million and $1.3 million of costs billed to the service company for the years ended December 31, 2017 and 2016.
The accumulated benefit obligation for our defined benefit pension plans was $428.3 million and $409.2 million at December 31, 2017 and 2016, respectively.
The net periodic benefit cost of the pension plans was:
Other Changes in Plan Assets and Benefit Obligation Recognized in Accumulated Other Comprehensive Income, Regulatory Assets and Regulatory Liabilities
Estimated amounts that will be amortized from AOCI, Regulatory assets and Regulatory liabilities into net periodic benefit costs during 2018 are:
Assumptions
Our expected return on plan asset assumptions, used to determine benefit obligations, are based on historical long-term rates of return on investments, which use the widely accepted capital market principle that assets with higher volatility generate a greater return over the long run. Current market factors, such as inflation and interest rates, as well as asset diversification and portfolio rebalancing, are evaluated when long-term capital market assumptions are determined. Peer data and historical returns are reviewed to verify reasonableness and appropriateness.
At December 31, 2017, we are decreasing our long-term rate of return assumption to 6.25% for pension plan assets. The rate of return represents our long-term assumptions based on our long-term portfolio mix. Also, at December 31, 2017, we have decreased our assumed discount rate to 3.66% from 4.28% for pension expense to reflect current duration-based yield curve discount rates. A one percent increase in the rate of return assumption for pension would result in a decrease in 2018 pension expense of approximately $3.4 million. A one percent decrease in the rate of return assumption for pension would result in an increase in 2018 pension expense of approximately $3.4 million. A 25-basis point increase in the discount rate for pension would result in a decrease of approximately
$0.6 million to 2018 pension expense. A 25-basis point decrease in the discount rate for pension would result in an increase of approximately $0.6 million to 2018 pension expense.
In determining the discount rate to use for valuing liabilities, we used a market yield curve on high-quality fixed income investments as of December 31, 2017. We project the expected benefit payments under the plan based on participant data and based on certain assumptions concerning mortality, retirement rates, termination rates, etc. The expected benefit payments for each year are then discounted back to the measurement date using the appropriate spot rate for each half-year from the yield curve, thereby obtaining a present value of all expected future benefit payments using the yield curve. Finally, an equivalent single discount rate is determined which produces a present value equal to the present value determined using the full yield curve.
Effective January 1, 2016, we applied a disaggregated discount rate approach for determining service cost and interest cost for our defined benefit pension plans and postretirement plans. See Note 1 - Overview and Summary of Significant Accounting Policies for more information.
In future periods, differences in the actual return on pension plan assets and assumed return, or changes in the discount rate, will affect the timing of contributions, if any, to the plans.
The weighted average assumptions used to determine benefit obligations at December 31, 2017, 2016 and 2015 were:
Pension plan assets
Plan assets are invested using a total return investment approach whereby a mix of equity securities, debt securities and other investments are used to preserve asset values, diversify risk and achieve our target investment return benchmark. Investment strategies and asset allocations are based on careful consideration of plan liabilities, the plan's funded status and our financial condition. Investment performance and asset allocation are measured and monitored on an ongoing basis.
Plan assets are managed in a balanced portfolio comprised of two major components: an equity portion and a fixed income portion. The expected role of plan equity investments is to maximize the long-term real growth of plan assets, while the role of fixed income investments is to generate current income, provide for more stable periodic returns and provide some protection against a prolonged decline in the market value of plan equity investments.
Long-term strategic asset allocation guidelines, as well as short-term tactical asset allocation guidelines, are determined by a Risk/Advisory Committee and approved by a Fiduciary Committee. These allocations consider the plan’s long-term objectives. The long-term target allocations for plan assets are 24% - 52% for equity securities and 47% - 65% for fixed income securities. Equity securities include U.S. and international equity, while fixed income securities include long-duration and high-yield bond funds and emerging market debt funds.
Tactically, the committees, on a short-term basis, will make asset allocations that are outside the long-term allocation guidelines. The short-term allocation positions are likely to not exceed one-year in duration. In addition to the equity and fixed income investments, the short-term allocation may also include a relatively small allocation to alternative investments. The plan currently has a small target allocation in a core property fund.
Most of our plan assets are measured using quoted, observable prices which are considered Level One inputs in the Fair Value Hierarchy. The Core Property Collective Fund is measured using Level Two inputs that are quoted prices for identical assets in markets that are less active.
The following table summarizes our target pension plan allocation for 2017:
The fair values of our pension plan assets at December 31, 2017 by asset category are as follows:
(a)
This category includes investments in equity securities of large, small and medium sized U.S. companies and equity securities of foreign companies including those in developing countries. The funds are valued using the net asset value method in which an average of the market prices for the underlying investments is used to value the fund.
(b)
This category includes investments in investment-grade fixed-income instruments, U.S. dollar-denominated debt securities of emerging market issuers and high yield fixed-income securities that are rated below investment grade. The funds are valued using the net asset value method in which an average of the market prices for the underlying investments is used to value the fund.
(c)
This category represents a property fund that invests in commercial real estate. The fair value of the fund is valued using the net asset value method in which an average of the market prices for the underlying investments is used to value the fund.
The fair values of our pension plan assets at December 31, 2016 by asset category are as follows:
(a)
This category includes investments in equity securities of large, small and medium sized U.S. companies and equity securities of foreign companies including those in developing countries. The funds are valued using the net asset value method in which an average of the market prices for the underlying investments is used to value the fund.
(b)
This category includes investments in investment-grade fixed-income instruments, U.S. dollar-denominated debt securities of emerging market issuers and high yield fixed-income securities that are rated below investment grade. The funds are valued using the net asset value method in which an average of the market prices for the underlying investments is used to value the fund.
(c)
This category represents a property fund that invests in commercial real estate. The fair value of the fund is valued using the net asset value method in which an average of the market prices for the underlying investments is used to value the fund.
Pension funding
We generally fund pension plan benefits as accrued in accordance with the minimum funding requirements of the Employee Retirement Income Security Act of 1974 (ERISA) and, in addition, make voluntary contributions from time to time. We contributed $5.0 million to the pension plan in each of the years ended December 31, 2017, 2016 and 2015.
We expect to make contributions of $0.4 million to our SERP in 2018 to cover benefit payments. We made contributions of $7.5 million to our pension plan during January 2018.
Funding for the qualified Defined Benefit Pension Plan is based upon actuarially determined contributions that consider the amount deductible for income tax purposes and the minimum contribution required under ERISA, as amended by the Pension Protection Act of 2006, as well as targeted funding levels necessary to meet certain thresholds.
From an ERISA funding perspective, DP&L’s funded target liability percentage was estimated to be 99%. In addition, DP&L must also contribute the normal service cost earned by active participants during the plan year. The funding of normal cost is expected to be approximately $7.5 million in 2018, which includes $2.2 million for plan expenses. Each year thereafter, if the plan’s underfunding increases to more than the present value of the remaining annual installments, the excess is separately amortized over a seven-year period. DP&L’s funding policy for the pension plans is to contribute annually no less than the minimum required by applicable law, and no more than the maximum amount that can be deducted for federal income tax purposes.
Benefit payments, which reflect future service, are expected to be paid as follows:
Note 11 - Equity
Redeemable Preferred Stock of Subsidiary
On October 13, 2016 (the "Redemption Date"), DPL's subsidiary, DP&L redeemed all of its issued and outstanding preferred stock, consisting of the following series: Preferred Stock, 3.75% Series A, Cumulative (the “Series A Stock”); Preferred Stock, 3.75% Series B, Cumulative (the “Series B Stock”); and Preferred Stock, 3.90% Series C, Cumulative (the “Series C Stock” and, together with the Series A Stock and the Series B Stock, the “Preferred Stock”). On the Redemption Date, the Preferred Stock of each series was redeemed at the following prices as specified in DP&L’s Amended and Restated Articles of Incorporation, plus, in each case an amount equal to all accrued dividends payable with respect to such Preferred Stock to the Redemption Date: a price of $102.50 per share for the Series A Stock, a price of $103.00 per share for the Series B Stock, and a price of $101.00 per share for the Series C Stock. Dividends on the Preferred Stock ceased to accrue on the Redemption Date. Upon redemption, the Preferred Stock was no longer outstanding, and all rights of the holders thereof as shareholders of DP&L, except the right to payment of the redemption price, ceased to exist. The difference between the carrying value of the Redeemable Preferred Stock of Subsidiary and the redemption amount was charged to Other paid-in capital.
Dividend Restrictions
DPL’s Amended Articles of Incorporation (the Articles) contain provisions which state that DPL may not make a distribution to its shareholder or make a loan to any of its affiliates (other than its subsidiaries), unless: (a) there exists no Event of Default (as defined in the Articles) and no such Event of Default would result from the making of the distribution or loan; and either (b)(i) at the time of, and/or as a result of, the distribution or loan, DPL’s leverage ratio does not exceed 0.67 to 1.00 and DPL’s interest coverage ratio is not less than 2.50 to 1.00 or, (b)(ii) if such ratios are not within the parameters, DPL’s senior long-term debt rating from one of the three major credit rating agencies is at least investment grade. Further, the restrictions on the payment of distributions to a shareholder and the making of loans to its affiliates (other than subsidiaries) cease to be in effect if the three major credit rating agencies confirm that a lowering of DPL’s senior long-term debt rating below investment grade by the credit rating agencies would not occur without these restrictions. DPL is also restricted from making dividend and tax sharing payments from DPL to AES per its 2017 ESP. This order restricts dividend payments from DPL to AES during the term of the ESP and restricts tax sharing payments from DPL to AES during the term of the DMR.
Common Stock
Effective on the Merger date, DPL's Amended Articles of Incorporation provided for 1,500 authorized common shares, of which one share is outstanding at December 31, 2017.
As described above, DPL’s Amended Articles of Incorporation contain restrictions on DPL’s ability to make dividends, distributions and affiliate loans (other than to its subsidiaries), including restrictions of making such dividends, distributions and loans if certain financial ratios exceed specified levels and DPL’s senior long-term debt rating from a rating agency is below investment grade. As of December 31, 2017, DPL’s leverage ratio was at 1.50 to 1.00 and DPL’s senior long-term debt rating from all three major credit rating agencies was below investment grade. As a result, as of December 31, 2017, DPL was prohibited under its Articles of Incorporation from making a distribution to its shareholder or making a loan to any of its affiliates (other than its subsidiaries).
DP&L has 250,000,000 authorized common shares, of which 41,172,173 are outstanding at December 31, 2017. All common shares are held by DP&L’s parent, DPL.
As part of the PUCO’s approval of the Merger, DP&L agreed to maintain a capital structure that includes an equity ratio of at least 50 percent and not to have a negative retained earnings balance. After the fixed-asset impairments recorded during 2016 and 2017, DP&L's equity ratio was 33% and its retained earnings balance was negative as of December 31, 2017. It is unknown what impact, if any, this will have on DP&L.
Capital Contributions from AES
In DP&L's approved six-year 2017 ESP, the PUCO imposed restrictions on DPL making dividend payments to its parent company, AES, during the term of the ESP, as well as on making tax-sharing payments to AES during the term of the DMR. The PUCO also required that existing tax payments owed by DPL to AES, and similar tax payments that accrue during the term of the DMR, be converted into equity investments in DPL.
As such, AES agreed to make non-cash capital contributions of $97.1 million and waive the amount owed to it by DPL related to tax-sharing payments for current tax liabilities through December 31, 2017. See Note 9 - Income Taxes for additional information.
Note 12 - Contractual Obligations, Commercial Commitments and Contingencies
DPL - Guarantees
In the normal course of business, DPL enters into various agreements with its wholly-owned subsidiary, AES Ohio Generation, providing financial or performance assurance to third parties. These agreements are entered into primarily to support or enhance the creditworthiness otherwise attributed to this subsidiary on a stand-alone basis, thereby facilitating the extension of sufficient credit to accomplish this subsidiary's intended commercial purposes.
At December 31, 2017, DPL had $38.1 million of guarantees on behalf of AES Ohio Generation to third parties for future financial or performance assurance under such agreements. The guarantee arrangements entered into by DPL with these third parties cover present and future obligations of AES Ohio Generation to such beneficiaries and are terminable at any time by DPL upon written notice to the beneficiaries. The carrying amount of obligations for commercial transactions covered by these guarantees and recorded in our Consolidated Balance Sheets was $0.9 million and $2.3 million at December 31, 2017 and 2016, respectively.
To date, DPL has not incurred any losses related to these guarantees and we believe it is remote that DPL would be required to perform or incur any losses in the future associated with any of the above guarantees.
Equity Ownership Interest
DP&L has a 4.9% equity ownership interest in OVEC which is recorded using the cost method of accounting under GAAP. At December 31, 2017, DP&L could be responsible for the repayment of 4.9%, or $70.6 million, of a $1,440.8 million debt obligation comprised of both fixed and variable rate securities with maturities between 2019 and 2040. OVEC could also seek additional contributions from us to avoid a default in the event that other OVEC members defaulted on their respective OVEC obligations. At December 31, 2017, we have no knowledge of such a default.
Contractual Obligations and Commercial Commitments
We enter into various contractual obligations and other commercial commitments that may affect the liquidity of our operations. At December 31, 2017, these include:
(a)
Total at DPL operated units.
Electricity purchase commitments:
DPL enters into long-term contracts for the purchase of electricity. In general, these contracts are subject to variable quantities or prices and are terminable only in limited circumstances.
Coal contracts:
DPL, through its subsidiary AES Ohio Generation, has entered into various long-term coal contracts to supply the coal requirements for the generating stations it operates. At December 31, 2017, a majority of our future committed coal obligations are with one supplier. Some contract prices are subject to periodic adjustment and have features that limit price escalation in any given year. As a result of our planned shutdown of our Stuart and Killen generating stations, our commitments for coal and limestone do not extend past 2018.
Purchase orders and other contractual obligations:
At December 31, 2017, DPL had various other contractual obligations including non-cancelable contracts to purchase goods and services with various terms and expiration dates. Due to uncertainty regarding the timing and payment of future obligations to the Service Company, and DPL's ability to terminate such obligations upon 90 days' notice, we have excluded such amounts in the contractual obligations table above..
Contingencies
In the normal course of business, we are subject to various lawsuits, actions, proceedings, claims and other matters asserted under laws and regulations. We believe the amounts provided in our Consolidated Financial Statements, as prescribed by GAAP, are adequate in light of the probable and estimable contingencies. However, there can be no assurances that the actual amounts required to satisfy alleged liabilities from various legal proceedings, claims, tax examinations, and other matters, including the matters discussed below, and to comply with applicable laws and regulations, will not exceed the amounts reflected in our Consolidated Financial Statements. As such, costs, if any, that may be incurred in excess of those amounts provided as of December 31, 2017, cannot be reasonably determined.
Environmental Matters
DPL’s facilities and operations are subject to a wide range of federal, state and local environmental regulations and laws. The environmental issues that may affect us include:
•
The federal CAA and state laws and regulations (including SIPs) which require compliance, obtaining permits and reporting as to air emissions;
•
Litigation with federal and certain state governments and certain special interest groups regarding whether modifications to or maintenance of certain coal-fired generating stations require additional permitting or
pollution control technology, or whether emissions from coal-fired generating stations cause or contribute to global climate changes;
•
Rules and future rules issued by the USEPA, the Ohio EPA or other authorities that require or will require substantial reductions in SO2, particulates, mercury, acid gases, NOx, and other air emissions. DPL installed emission control technology and is taking other measures to comply with required and anticipated reductions. As AES Ohio Generation is now operating these facilities, it is continuing to comply with these requirements;
•
Rules and future rules issued by the USEPA, the Ohio EPA or other authorities that require or will require reporting and reductions of GHGs;
•
Rules and future rules issued by the USEPA, the Ohio EPA or other authorities associated with the federal Clean Water Act, which prohibits the discharge of pollutants into waters of the United States except pursuant to appropriate permits; and
•
Solid and hazardous waste laws and regulations, which govern the management and disposal of certain waste. The majority of solid waste created from the combustion of coal and fossil fuels is fly ash and other coal combustion by-products.
In addition to imposing continuing compliance obligations, these laws and regulations authorize the imposition of substantial penalties for noncompliance, including fines, injunctive relief and other sanctions. In the normal course of business, we have investigatory and remedial activities underway at our facilities to comply, or to determine compliance, with such regulations. We record liabilities for loss contingencies related to environmental matters when a loss is probable of occurring and can be reasonably estimated in accordance with the provisions of GAAP. Accordingly, we have immaterial accruals for loss contingencies for environmental matters. We also have a number of environmental matters for which we have not accrued loss contingencies because the risk of loss is not probable, or a loss cannot be reasonably estimated. We evaluate the potential liability related to environmental matters quarterly and may revise our estimates. Such revisions in the estimates of the potential liabilities could have a material adverse effect on our results of operations, financial condition or cash flows.
We have several pending environmental matters associated with our coal-fired generation units. Some of these matters could have material adverse impacts on the operation of the power stations.
Note 13 - Related Party Transactions
Service Company
Effective January 1, 2014, the Service Company began providing services including operations, accounting, legal, human resources, information technology and other corporate services on behalf of companies that are part of the U.S. SBU, including, among other companies, DPL and DP&L. The Service Company allocates the costs for these services based on cost drivers designed to result in fair and equitable allocations. This includes ensuring that the regulated utilities served, including DP&L, are not subsidizing costs incurred for the benefit of other businesses.
Benefit plans
DPL participates in an agreement with Health and Welfare Benefit Plans LLC, an affiliate of AES, to participate in a group benefits program, including but not limited to, health, dental, vision and life benefits. Health and Welfare Benefit Plans LLC administers the financial aspects of the group insurance program, receives all premium payments from the participating affiliates, and makes all vendor payments.
Long-term Compensation Plan
During 2017, 2016 and 2015, many of DPL’s non-union employees received benefits under the AES Long-term Compensation Plan, a deferred compensation program. This type of plan is a common employee retention tool used in our industry. Benefits under this plan are granted in the form of performance units payable in cash and AES restricted stock units and options to purchase shares of AES common stock, however no stock options were granted in 2016. All such components vest over a three-year period and the terms of the AES restricted stock units issued prior to 2011 also include a two-year minimum holding period after the awards vest. Awards made in 2011 and for subsequent years are not subject to a two-year holding period. In addition, the performance units payable in cash are subject to certain AES performance criteria. Total deferred compensation expense recorded during 2017, 2016 and 2015 was $0.4 million, $0.5 million and $0.5 million, respectively, and was included in “Other Operating Expenses” on DPL’s Consolidated Statements of Operations. The value of these benefits is being recognized over the 36-month vesting period and a portion is recorded as miscellaneous deferred credits with the
remainder recorded as “Paid in capital” on DPL’s Consolidated Balance Sheets in accordance with FASC 718 “Compensation - Stock Compensation.”
The following table provides a summary of these transactions:
DPL Capital Trust II
DPL has a wholly-owned business trust, DPL Capital Trust II (the Trust), formed for the purpose of issuing trust capital securities to third-party investors. Effective in 2003, DPL deconsolidated the Trust upon adoption of the accounting standards related to variable interest entities and currently treats the Trust as a nonconsolidated subsidiary. The Trust holds mandatorily redeemable trust capital securities. The investment in the Trust, which amounted to $0.3 million and $0.3 million at December 31, 2017 and 2016, respectively, is included in Other deferred assets within Other noncurrent assets. DPL also has a note payable to the Trust amounting to $15.6 million and $15.6 million at December 31, 2017 and 2016, respectively, that was established upon the Trust’s deconsolidation in 2003. See Note 8 - Debt for additional information.
In addition to the obligations under the note payable mentioned above, DPL also agreed to a security obligation which represents a full and unconditional guarantee of payments to the capital security holders of the Trust.
Income taxes
AES files federal and state income tax returns which consolidate DPL and its subsidiaries. Under a tax sharing agreement with AES, DPL is responsible for the income taxes associated with its own taxable income and records the provision for income taxes using a separate return method. Under this agreement, DPL had a net payable balance of $0.0 million at December 31, 2016, respectively, which is recorded in Accrued taxes on the accompanying Consolidated Balance Sheets. Effective with the approval of DP&L's 2017 ESP, DPL is restricted from making tax sharing payments to AES throughout the term of the DMR and amounts that would otherwise have been tax sharing liabilities are considered deemed capital contributions. See Note 9 - Income Taxes for more information.
Note 14 - Business Segments
DPL currently manages its business through two reportable operating segments, the T&D segment and the Generation segment. The primary segment performance measure is income / (loss) from continuing operations before income tax as management has concluded that this measure best reflects the underlying business performance of DPL and is the most relevant measure considered in DPL’s internal evaluation of the financial performance of its segments. The segments are discussed further below:
Transmission and Distribution Segment
The T&D segment is comprised primarily of DP&L’s electric transmission and distribution businesses, which distribute electricity to residential, commercial, industrial and governmental customers. DP&L distributes electricity to more than 521,000 retail customers who are located in a 6,000 square mile area of West Central Ohio. DP&L’s electric transmission and distribution businesses are subject to rate regulation by federal and state regulators. Accordingly, DP&L applies the accounting standards for regulated operations to its electric transmission and distribution businesses and records regulatory assets when incurred costs are expected to be recovered in future customer rates, and regulatory liabilities when current cost recoveries in customer rates relate to expected future costs. The T&D segment includes revenues and costs associated with DP&L's investment in OVEC and the
historical results of DP&L’s Beckjord and Hutchings Coal generating facilities, which were either closed or sold in prior periods. As these assets were not transferred to AES Ohio Generation, they are grouped with the T&D assets for segment reporting purposes. In addition, regulatory deferrals and collections, which include fuel deferrals in historical periods, are included in the T&D segment.
Generation Segment
The Generation segment is comprised of AES Ohio Generation and the historical results of DP&L's electric generation business prior to Generation Separation. Beginning in 2001, Ohio law gave consumers the right to choose the electric generation supplier from whom they purchase retail generation services. AES Ohio Generation owns and operates coal-fired and peaking generating facilities and sells its generated energy and capacity into the PJM wholesale market. The 2015 Generation segment results also include sales to DPLER and to the T&D segment for SSO customers.
Included within the “Other” column are other businesses that do not meet the GAAP requirements for disclosure as reportable segments as well as certain corporate costs, which include interest expense on DPL’s debt and adjustments related to purchase accounting from the Merger. The accounting policies of the reportable segments are the same as those described in Note 1 - Overview and Summary of Significant Accounting Policies. Intersegment sales and profits are eliminated in consolidation. Certain shared and corporate costs are allocated among reporting segments.
The following tables present financial information for each of DPL’s reportable business segments:
(a)
Includes assets held-for-sale related to the sale of DPLER.
(b)
Wholesale revenue for the T&D segment in 2015 includes OVEC revenue of $19.7 million that was previously netted in purchased power. The impact of this netting adjustment is included in the Adjustments and Eliminations column in the table above but has no impact on consolidated revenues or Income / (loss) from continuing operations before income tax.
Note 15 - Fixed-asset Impairments
During the years ended December 31, 2017, 2016 and 2015, DPL had the following fixed-asset impairments:
AES Ohio Generation peakers - In December 2017, AES Ohio Generation signed an agreement for the sale of its peaking and diesel generation assets. As a result of this transaction, DPL recognized an impairment of fixed assets in the amount of $109.4 million.
Stuart and Killen, March 17, 2017 - On March 17, 2017, the Board of Directors of DP&L approved the retirement of the Stuart Station coal-fired and diesel-fired generating units and the Killen Station coal-fired generating unit and combustion turbine (collectively, the “Facilities”) on or before June 1, 2018. The co-owners of these facilities agreed with DP&L to proceed with this plan of retirement. We performed a long-lived asset impairment analysis and determined that the carrying amounts of the Facilities were not recoverable. The asset groups of Stuart Station and Killen Station were determined to have fair values of $3.3 million and $7.9 million, respectively, using the discounted cash flows under the income approach. As a result, we recognized asset impairment expense of $39.1 million and $27.3 million for Stuart Station and Killen Station, respectively.
Additionally, as a result of the decision to retire the Facilities by June 1, 2018, we concluded that inventory at these Facilities is considered obsolete. As a result, we recognized a loss on disposal of $9.8 million and $6.4 million for Stuart Station and Killen Station inventories, respectively, during the first quarter of 2017, which is recorded in Loss on asset disposal in the Consolidated Statements of Operations.
Killen, Stuart, Miami Fort, Zimmer, Conesville and Hutchings, December 31, 2016 - During the fourth quarter of 2016, we tested the recoverability of our long-lived coal-fired generation assets and one gas-fired peaking plant. Additional uncertainty around the useful life of Stuart and Killen related to the DP&L ESP proceedings along with lower expectations of forward dark spreads and capacity prices beyond the cleared period were collectively determined to be an impairment indicator for these assets. Market information indicating that there was a significant decrease in the fair value of the Miami Fort and Zimmer stations was determined to be an indicator of impairment for these assets. The lower forward dark spreads and capacity prices, along with the indicators at the other coal-fired facilities, collectively, resulted in an indicator of impairment for the Conesville asset group. For the gas-fired peaking plant, significant incremental capital expenditures relative to its fair value along with the fact that an impairment charge was previously taken at this facility in Q2 2016, were collectively determined to be an impairment indicator for this asset. We performed a long-lived asset impairment analysis for each of these asset groups and determined that their carrying amounts were not recoverable. The Killen, Stuart, Miami Fort, Zimmer and Conesville coal-fired facility asset groups and the Hutchings gas-fired peaking plant asset group were determined to have a fair value of $42.8 million, $57.4 million, $36.5 million, $23.7 million, $1.1 million and $1.6 million, respectively, using the market approach for Miami Fort and Zimmer and the income approach for the remaining asset groups. As a result, DPL recognized a total pre-tax asset impairment expense of $623.5 million.
Killen and DP&L peaking facilities, June 30, 2016 - During the second quarter of 2016, we tested the recoverability of our long-lived assets at certain of our generation facilities at DP&L. A ruling by the Supreme Court of Ohio on June 20, 2016, lower expectation of future capacity revenue resulting from the most recent PJM capacity auction and a higher anticipated level of environmental compliance costs resulting from third party studies were collectively determined to be an impairment indicator for these assets. We performed a long-lived asset impairment analysis and determined that the carrying amounts of Killen and certain DP&L peaking generating facilities were not recoverable. The asset groups of Killen and these DP&L peaking generating facilities were determined to have fair values of $84.3 million and $5.2 million, respectively, using the discounted cash flows under the income approach. As a result, DPL recognized an asset impairment expense of $230.8 million and $4.7 million for Killen and these DP&L peaking generating facilities, respectively.
Note 16 - Discontinued Operations
On January 1, 2016, DPL closed on the sale of DPLER, its competitive retail business. The sale agreement was signed on December 28, 2015, and DPL recorded a gain on this transaction of $49.2 million in the first quarter of 2016. The gain included the impact of DPLER’s liability to DP&L that transferred with the sale on January 1, 2016.
Operating activities related to DPLER have been reclassified to "Discontinued operations" in the Consolidated Statements of Operations for the years ended December 31, 2016 and 2015.
The following table summarizes the revenues, cost of revenues, operating expenses and income tax of discontinued operations for the periods indicated:
Cash flows related to discontinued operations are included in our Consolidated Statements of Cash Flows. Cash flows from operating activities for discontinued operations were $(0.7) million and $35.8 million for the years ended December 31, 2016 and 2015, respectively. Cash flows from investing activities for discontinued operations were $75.5 million and $0.5 million for the years ended December 31, 2016 and 2015, respectively. All cash generated from discontinued operations was paid to DPL through dividends for all years presented.
Note 17 - Assets and Liabilities Held-For-Sale and Dispositions
Assets and liabilities held-for-sale
On December 15, 2017, DPL and AES Ohio Generation entered into an asset purchase agreement with Kimura Power, LLC, as Buyer (“Kimura Power”), and, for certain limited purposes provided therein, Rockland Power Partners III, LP, as Guarantor, pursuant to which AES Ohio Generation will, subject to the terms and conditions in the asset purchase agreement, sell to Kimura Power the Peaker assets. The Peaker assets are being sold for $241.0 million in cash. The cash purchase price is subject to adjustments at closing based on working capital, capacity commitments and timing of the closing of the transaction. The sale transaction is subject to regulatory approvals and other closing conditions. The FERC approved this transaction on February 9, 2018.
As a result of entering into the asset purchase agreement, DPL recognized aggregate impairment charges with respect to the Peaker assets of $109.4 million. For more information on these impairment charges, see Note 15 - Fixed-asset Impairments of Notes to DPL's Consolidated Financial Statements.
The assets and liabilities related to the Peaker assets were classified as held-for-sale as of December 31, 2017, but the Peaker assets did not meet the criteria to be reported as discontinued operations. The following table summarizes the major classes of assets and liabilities classified as held-for-sale as of December 31, 2017:
The Peaker assets' results of operations are reflected within continuing operations in the Consolidated Statements of Operations. The income from continuing operations before income tax for the Peaker assets was $16.9 million, $20.0 million and $23.9 million (excluding impairment charges of $109.4 million, $1.3 million and $0.0 million, respectively) for the years ended December 31, 2017, 2016, and 2015, respectively. The Peaker assets are included in the Generation segment.
Dispositions
On December 8, 2017, DPL and AES Ohio Generation completed the sale transaction of their entire undivided interest in the Miami Fort station and the Zimmer station to Dynegy Zimmer and Dynegy Miami Fort, indirect wholly-owned subsidiaries of Dynegy. On that date, AES Ohio Generation received $50.0 million in cash, plus an amount in cash equal to $20.1 million as an estimated purchase price adjustment based on estimated amounts of certain pre-closing inventories, pre-paid and other amounts, employment benefits, insurance premiums, property taxes and other payables, which will be subject to a customary post-closing reconciliation. This transaction resulted in a gain on sale of $14.0 million for the year ended December 31, 2017. Prior to the sale, the Miami Fort and Zimmer stations were included in the Generation segment.
The results of operations of the Miami Fort and Zimmer stations are presented within continuing operations in the Consolidated Statements of Operations. The combined income / (loss) from continuing operations before income tax for the Miami Fort and Zimmer stations was $25.7 million (excluding gain on sale of $14.0 million), $(13.5) million (excluding impairment charges of $294.1 million) and $5.6 million for the years ended December 31, 2017, 2016, and 2015, respectively.
Note 18 - Subsequent Event
On February 26, 2018, DP&L and its co-owners of the retired Beckjord Facility agreed to transfer their interests in the retired Facility to a third party, including their obligations to remediate the Facility and its site, and the transfer occurred on that same date. As a result, DPL estimates that it will recognize aggregate pre-tax loss on disposal charges of approximately $11.7 million and that cash expenditures of $15.0 million in the aggregate will be made, inclusive of cash expenditures for the disposal charges.
FINANCIAL STATEMENTS
The Dayton Power and Light Company
Report of Independent Registered Public Accounting Firm
To the Board of Directors of The Dayton Power & Light Company
Opinion on the Financial Statements
We have audited the accompanying balance sheets of The Dayton Power & Light Company (the Company) as of December 31, 2017 and 2016, the related statements of operations, comprehensive income/(loss), cash flows and shareholder’s equity for each of the three years in the period ended December 31, 2017, and the related notes and schedules (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017 in conformity with U.S. generally accepted accounting principles.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our December 31, 2017 and 2016 audits in accordance with the standards of the PCAOB and in accordance with auditing standards generally accepted in the United States of America and our December 31, 2015 audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Ernst & Young LLP
We have served as the Company’s auditor since 2012.
Indianapolis, Indiana
February 26, 2018
See Notes to Financial Statements.
See Notes to Financial Statements.
See Notes to Financial Statements.
See Notes to Financial Statements.
(a)
$0.01 par value, 250,000,000 shares authorized.
(b)
In the current period, we have reclassified the presentation of the December 2016 dividend payment of $70.0 million which was originally recorded as a charge to Accumulated deficit and is now presented as a charge to Other paid-in capital.
See Notes to Financial Statements.
The Dayton Power and Light Company
Notes to Financial Statements
For the years ended December 31, 2017, 2016 and 2015
Note 1 - Overview and Summary of Significant Accounting Policies
Description of Business
DP&L is a public utility incorporated in 1911 under the laws of Ohio. Beginning in 2001, Ohio law gave consumers the right to choose the electric generation supplier from whom they purchase retail generation service, however transmission and distribution services are still regulated. DP&L has the exclusive right to provide such service to its approximately 521,000 customers located in West Central Ohio. DP&L is required to procure and provide retail SSO electric service to residential, commercial, industrial and governmental customers in a 6,000 square mile area of West Central Ohio. Since January 2016, DP&L has been sourcing 100% of the generation for its SSO customers through a competitive bid process. Through September 30, 2017, DP&L owned undivided interests in five coal-fired power stations and multiple peaking electric generating facilities as well as numerous transmission facilities. On October 1, 2017, the DP&L-owned generating facilities were transferred to AES Ohio Generation, an affiliate of DP&L, through an asset contribution agreement to a subsidiary that was merged into AES Ohio Generation. As a result of Generation Separation, DP&L now only has one reportable segment, Transmission and Distribution. In addition to DP&L's electric transmission and distribution businesses, the Transmission and Distribution segment includes revenues and costs associated with DP&L's investment in OVEC and the historical results of DP&L’s Beckjord and Hutchings Coal generating facilities, which were either closed or sold in prior periods. Principal industries located in DP&L’s service territory include automotive, food processing, paper, plastic, manufacturing and defense. DP&L's sales reflect the general economic conditions, seasonal weather patterns of the area and the market price of electricity. Through the date of Generation Separation, DP&L sold energy and capacity into the wholesale market.
DP&L’s electric transmission and distribution businesses are subject to rate regulation by federal and state regulators. Accordingly, DP&L applies the accounting standards for regulated operations to its electric transmission and distribution businesses and records regulatory assets when incurred costs are expected to be recovered in future customer rates, and regulatory liabilities when current cost recoveries in customer rates relate to expected future costs.
DP&L employed 660 people at January 31, 2018. Approximately 53% of all employees are under a collective bargaining agreement. The current agreement, after initially being extended, expired on January 31, 2018. Under national labor law, all the terms and conditions of the expired agreement continue indefinitely, with a few exceptions. Notably, the union has the right to strike and DP&L has the right to lock out employees. We are continuing to negotiate with the union to enter into a new collective bargaining agreement. Currently, we are unable to predict the eventual outcome of these negotiations and have contingency plans to continue our operations. If we are not able to reach an agreement on terms favorable to us or to effectively implement our plans in the event that agreement is not reached, our results of operations, financial position and cash flows could be adversely impacted.
Financial Statement Presentation
DP&L does not have any subsidiaries.
DP&L has undivided ownership interests in numerous transmission facilities. These undivided interests in jointly-owned facilities are accounted for on a pro rata basis in the Financial Statements. In the fourth quarter of 2017, DP&L entered into an agreement with two other Ohio utilities to eliminate the co-ownership relationship they have had with respect to certain transmission facilities (transmission lines and substations) located in Ohio. See Note 4 - Property, Plant and Equipment for more information.
We have evaluated subsequent events through the date this report is issued.
Certain amounts from prior periods have been reclassified to conform to the current period presentation. In 2017, we have reclassified the presentation of the December 2016 dividend payment of $70.0 million which was originally recorded as a charge to Accumulated deficit and is now presented as a charge to Other paid-in capital. This reclassification was to prospectively correct an immaterial error.
The preparation of financial statements in conformity with GAAP requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the
revenues and expenses of the periods reported. Actual results could differ from these estimates. Significant items subject to such estimates and judgments include: the carrying value of Property, plant and equipment; unbilled revenues; the valuation of derivative instruments; the valuation of insurance and claims liabilities; the valuation of allowances for receivables and deferred income taxes; regulatory assets and liabilities; reserves recorded for income tax exposures; litigation; contingencies; the valuation of AROs; and assets and liabilities related to employee benefits.
Revenue Recognition
Revenues are recognized from retail and wholesale electricity sales and electricity transmission and distribution delivery services. We consider revenue realized, or realizable, and earned when persuasive evidence of an arrangement exists, the products or services have been provided to the customer, the sales price is fixed or determinable, and collection is reasonably assured. Energy sales to customers are based on the reading of their meters that occurs on a systematic basis throughout the month. We recognize the revenues on our Statements of Operations using an accrual method for retail and other energy sales that have not yet been billed, but where electricity has been consumed. This is termed “unbilled revenues” and is a widely recognized and accepted practice for utilities. At the end of each month, unbilled revenues are determined by the estimation of unbilled energy provided to customers since the date of the last meter reading, estimated line losses, the assignment of unbilled energy provided to customer classes and the average rate per customer class.
The power sales and purchases within DP&L’s service territory are reported on a net hourly basis as revenues or purchased power on our Statements of Operations. We record expenses when purchased electricity is received and when expenses are incurred.
Allowance for Uncollectible Accounts
We establish provisions for uncollectible accounts by using both historical average loss percentages to project future losses and by establishing specific provisions for known credit issues. Amounts are written off when reasonable collections efforts have been exhausted.
Property, Plant and Equipment
We record our ownership share of our undivided interest in jointly-owned transmission and distribution property as an asset in property, plant and equipment. New property, plant and equipment additions are stated at cost. For regulated transmission and distribution property, cost includes direct labor and material, allocable overhead expenses and an allowance for funds used during construction (AFUDC). AFUDC represents the cost of borrowed funds and equity used to finance regulated construction projects. For non-regulated property, cost also includes capitalized interest. Capitalization of AFUDC and interest ceases at either project completion or at the date specified by regulators. AFUDC and capitalized interest was $2.0 million, $2.7 million and $2.0 million for the years ended December 31, 2017, 2016 and 2015, respectively.
For substantially all depreciable property, when a unit of property is retired, the original cost of that property less any salvage value is charged to Accumulated depreciation and amortization, consistent with composite depreciation practices.
Property is evaluated for impairment when events or changes in circumstances indicate that its carrying amount may not be recoverable.
Repairs and Maintenance
Costs associated with maintenance activities, primarily power station outages, are recognized at the time the work is performed. These costs, which include labor, materials and supplies, and outside services required to maintain equipment and facilities, are capitalized or expensed based on defined units of property.
Depreciation
Depreciation expense is calculated using the straight-line method, which allocates the cost of property over its estimated useful life. For DP&L’s transmission and distribution assets, straight-line depreciation is applied monthly on an average composite basis using group rates. For DP&L’s transmission and distribution assets, straight-line depreciation is applied on an average annual composite basis using group rates that approximated 3.4% in 2017, 4.6% in 2016 and 2.5% in 2015. Depreciation expense was $69.6 million, $64.3 million and $64.3 million for the years ended December 31, 2017, 2016 and 2015, respectively.
Regulatory Accounting
As a regulated utility, DP&L applies the provisions of FASC 980 “Regulated Operations”, which gives recognition to the ratemaking and accounting practices of the PUCO and the FERC. Regulatory assets generally represent incurred costs that have been deferred because such costs are probable of future recovery in customer rates. Regulatory assets can also represent performance incentives permitted by the regulator. Regulatory assets have been included as allowable costs for ratemaking purposes, as authorized by the PUCO or established regulatory practices. Regulatory liabilities generally represent obligations to make refunds or future rate reductions to customers for previous over collections or the deferral of revenues collected for costs that DP&L expects to incur in the future.
The deferral of costs (as regulatory assets) is appropriate only when the future recovery of such costs is probable. In assessing probability, we consider such factors as specific orders from the PUCO or FERC, regulatory precedent and the current regulatory environment. To the extent recovery of costs is no longer deemed probable, related regulatory assets would be required to be expensed in current period earnings. Our regulatory assets and liabilities have been created pursuant to a specific order of the PUCO or FERC or established regulatory practices, such as other utilities under the jurisdiction of the PUCO or FERC being granted recovery of similar costs. It is probable, but not certain, that these regulatory assets will be recoverable, subject to PUCO or FERC approval. Regulatory assets and liabilities are classified as current or non-current based on the term in which recovery is expected. See Note 3 - Regulatory Matters for more information.
Inventories
Inventories are carried at average cost and include materials and supplies used for utility operations.
Intangibles
Intangibles include software, emission allowances and renewable energy credits. Emission allowances are carried on a first-in, first-out (FIFO) basis for purchased emission allowances. Net gains or losses on the sale of excess emission allowances, representing the difference between the sales proceeds and the cost of emission allowances, are recorded as a component of our fuel costs and are reflected in Operating income when realized. Emission allowances are amortized as they are used in our operations on a FIFO basis. Renewable energy credits are carried on a weighted average cost basis and amortized as they are used or retired.
Software is amortized over seven years. Amortization expense was $5.7 million, $6.7 million and $7.2 million for the years ended December 31, 2017, 2016 and 2015, respectively. The estimated amortization expense of this internal-use software over the next five years is $10.7 million ($5.1 million in 2018, $3.1 million in 2019, $1.6 million in 2020, $0.6 million in 2021 and $0.3 million in 2022).
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of the existing assets and liabilities, and their respective income tax bases. We establish an allowance when it is more likely than not that all or a portion of a deferred tax asset will not be realized. Our tax positions are evaluated under a more likely than not recognition threshold and measurement analysis before they are recognized for financial statement reporting. Uncertain tax positions have been classified as noncurrent income tax liabilities unless expected to be paid within one year. Our policy for interest and penalties is to recognize interest and penalties as a component of the provision for income taxes in the Statement of Operations.
Income taxes payable, which are includable in allowable costs for ratemaking purposes in future years, are recorded as regulatory assets with a corresponding deferred tax liability. Investment tax credits that reduced federal income taxes in the years they arose have been deferred and are being amortized to income over the useful lives of the properties in accordance with regulatory treatment. See Note 3 - Regulatory Matters for additional information.
DP&L files U.S. federal income tax returns as part of the consolidated U.S. income tax return filed by AES. The consolidated tax liability is allocated to each subsidiary based on the separate return method which is specified in our tax allocation agreement and which provides a consistent, systematic and rational approach. See Note 8 - Income Taxes for additional information.
Financial Instruments
We classify our investments in debt and equity financial instruments of publicly traded entities into different categories: held-to-maturity and available-for-sale. Available-for-sale securities are carried at fair value and unrealized gains and losses on those securities, net of deferred income taxes, are presented as a separate component of shareholder's equity. Other-than-temporary declines in value are recognized currently in earnings. Financial instruments classified as held-to-maturity are carried at amortized cost. The cost bases for public equity security and fixed maturity investments are average cost and amortized cost, respectively.
Held-for-sale Businesses
A business classified as held-for-sale is reflected on the balance sheet at the lower of its carrying amount or estimated fair value less cost to sell. A loss is recognized if the carrying amount of the business exceeds its estimated fair value less cost to sell. This loss is limited to the carrying value of long lived assets until the completion of the sale, at which point, any additional loss is recognized. If the fair value of the business subsequently exceeds the carrying amount while the business is still held-for-sale, any impairment expense previously recognized will be reversed up to the lower of the previously recognized expense or the subsequent excess.
Assets and liabilities related to a business classified as held-for-sale are segregated in the current balance sheet in the period in which the business is classified as held-for-sale. Assets and liabilities of held-for-sale businesses are classified as current when they are expected to be disposed of within twelve months. Transactions between the business held-for-sale and businesses that are expected to continue to exist after the disposal are not eliminated to appropriately reflect the continuing operations and balances held-for-sale. See Note 13 - Generation Separation for further information.
Discontinued Operations
Discontinued operations reporting occurs only when the disposal of a business or a group of businesses represents a strategic shift that has (or will have) a major effect on our operations and financial results. We report financial results for discontinued operations separately from continuing operations to distinguish the financial impact of disposal transactions from ongoing operations. Prior period amounts in the statement of operations and balance sheet are retrospectively revised to reflect the businesses determined to be discontinued operations. The cash flows of businesses that are determined to be discontinued operations are included within the relevant categories within operating, investing and financing activities on the face of the Statements of Cash Flows.
Transactions between the businesses determined to be discontinued operations and businesses that are expected to continue to exist after the disposal are not eliminated to appropriately reflect the continuing operations and balances held-for-sale. The results of discontinued operations include any gain or loss recognized on closing or adjustment of the carrying amount to fair value. See Note 13 - Generation Separation for further information.
Generation Separation
With the transfer of DP&L's generation assets to an affiliate (see Note 13 - Generation Separation), DP&L's generation business is presented as a discontinued operation and the operating activities have been reclassified to "Discontinued operations" in the Statements of Operations for the years ended December 31, 2017, 2016 and 2015 and in the footnotes to the financial statements. The assets and liabilities related to the discontinued operations have been reclassified to held-for-sale in the balance sheet as of December 31, 2016.
Accounting for Taxes Collected from Customers and Remitted to Governmental Authorities
DP&L collects certain excise taxes levied by state or local governments from its customers. DP&L’s excise taxes and certain other taxes are accounted for on a net basis and recorded as a reduction in revenues in the accompanying Statements of Operations. The amounts for the years ended December 31, 2017, 2016 and 2015 were $49.4 million, $50.9 million and $49.9 million, respectively.
Cash and Cash Equivalents
Cash and cash equivalents are stated at cost, which approximates fair value. All highly liquid short-term investments with original maturities of three months or less are considered cash equivalents.
Restricted Cash
Restricted cash includes cash which is restricted as to withdrawal or usage. The nature of the restrictions relates to cash collected under the DMR which is restricted to pay debt obligations at DPL and DP&L and position DP&L to modernize and/or maintain its transmission and distribution infrastructure.
Financial Derivatives
All derivatives are recognized as either assets or liabilities in the balance sheets and are measured at fair value. Changes in the fair value are recorded in earnings unless the derivative is designated as a cash flow hedge of a forecasted transaction.
We use forward contracts to reduce our exposure to changes in interest rates. We use cash flow hedge accounting when the hedge or a portion of the hedge is deemed to be highly effective, which results in changes in fair value being recorded within accumulated other comprehensive income, a component of shareholder’s equity. We have elected not to offset net derivative positions in the financial statements. Accordingly, we do not offset such derivative positions against the fair value of amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral under master netting agreements. See Note 6 - Derivative Instruments and Hedging Activities for additional information.
Insurance and Claims Costs
In addition to insurance obtained from third-party providers, MVIC, a wholly-owned captive subsidiary of DPL, provides insurance coverage solely to us, other DPL subsidiaries and, in some cases, our partners in commonly-owned facilities we operate, for workers’ compensation, general liability, and property damage on an ongoing basis. MVIC maintains an active run-off policy for directors’ and officers’ liability and fiduciary through their expiration in 2017, which may or may not be renewed at that time. DP&L is responsible for claim costs below certain coverage thresholds of MVIC and third-party insurers for the insurance coverage noted above. DP&L has estimated liabilities for medical, life, disability, and other reserves for claims costs below certain coverage thresholds of MVIC and third-party providers. We recorded these additional insurance and claims costs of approximately $4.4 million and $3.9 million at December 31, 2017 and 2016, respectively, within Other current liabilities and Other deferred credits on the balance sheets. The estimated liabilities for workers’ compensation, medical, life and disability costs at DP&L are actuarially determined using certain assumptions. There is uncertainty associated with these loss estimates and actual results may differ from the estimates. Modification of these loss estimates based on experience and changed circumstances is reflected in the period in which the estimate is re-evaluated.
Pension and Postretirement Benefits
We recognize in our Balance Sheets an asset or liability reflecting the funded status of pension and other postretirement plans with current-year changes in the funded status, that would otherwise be recognized in AOCI, recorded as a regulatory asset as this can be recovered through future rates. All plan assets are recorded at fair value. We follow the measurement date provisions of the accounting guidance, which require a year-end measurement date of plan assets and obligations for all defined benefit plans.
We account for and disclose pension and postretirement benefits in accordance with the provisions of GAAP relating to the accounting for pension and other postretirement plans. These GAAP provisions require the use of assumptions, such as the discount rate for liabilities and long-term rate of return on assets, in determining the obligations, annual cost and funding requirements of the plans. Consistent with the requirements of FASC 715, we apply a disaggregated discount rate approach for determining service cost and interest cost for our defined benefit pension plans and postretirement plans.
Effective January 1, 2016, we applied a disaggregated discount rate approach for determining service cost and interest cost for our defined benefit pension plans and post-retirement plans. This approach is consistent with the requirements of FASC 715 and is considered to be preferential to the aggregated single rate discount approach, which has historically been used in the U.S., because it is more consistent with the philosophy of a full yield curve valuation.
See Note 9 - Benefit Plans for more information.
Related Party Transactions
In the normal course of business, DP&L enters into transactions with other subsidiaries of DPL or AES. See Note 12 - Related Party Transactions for additional information on Related Party Transactions.
New accounting pronouncements
The following table provides a brief description of recent accounting pronouncements that could have a material impact on our financial statements:
Accounting Standard
Description
Date of Adoption
Effect on the financial statements upon adoption
New Accounting Standards Adopted
2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
The standard simplifies the following aspects of accounting for share-based payment awards: accounting for income taxes, classification of excess tax benefits on the statement of cash flows, forfeitures, statutory tax withholding requirements, classification of awards as either equity or liabilities and classification of employee taxes paid on statement of cash flows when an employer withholds shares for tax-withholding purposes.
Transition method: The recording of excess tax benefits and tax deficiencies arising from vesting or settlement will be applied prospectively. The elimination of the requirement that excess tax benefits be realized before they are recognized will be adopted on a modified retrospective basis with a cumulative adjustment to the opening balance sheet.
January 1, 2017.
The recognition of excess tax benefits in our provision for income taxes in the period when the awards vest or are settled, rather than in paid-in-capital in the period when the excess tax benefits are realized.
New Accounting Standards Issued But Not Yet Effective
2018-02, Income Statement - Reporting Comprehensive Income (Topic 220), Reclassification of Certain Tax Effects from AOCI
This amendment allows a reclassification of the stranded tax effects resulting from the implementation of the Tax Cuts and Jobs Act from AOCI to retained earnings. Because this amendment only relates to the reclassification of the income tax effects of the Tax Cuts and Jobs Act, the underlying guidance that requires that the effect of a change in tax laws or rates be included in income from continuing operations is not affected.
January 1, 2019. Early adoption is permitted.
We are currently evaluating the impact of adopting the standard on our financial statements.
2017-12, Derivatives and Hedging (Topic 815): Targeted improvements to Accounting for Hedging Activities
The standard updates the hedge accounting model to expand the ability to hedge nonfinancial and financial risk components, reduce complexity, and ease certain documentation and assessment requirements. When facts and circumstances are the same as at the previous quantitative test, a subsequent quantitative effectiveness test is not required. The standard also eliminates the requirement to separately measure and report hedge ineffectiveness. For cash flow hedges, this means that the entire change in the fair value of a hedging instrument will be recorded in other comprehensive income and amounts deferred will be reclassified to earnings in the same income statement line as the hedged item.
Transition method: modified retrospective with the cumulative effect adjustment recorded to the opening balance of retained earnings as of the initial application date. Prospective for presentation and disclosures.
January 1, 2019. Early adoption is permitted.
We are currently evaluating the impact of adopting the standard on our financial statements.
2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities
This standard shortens the period of amortization for the premium on certain callable debt securities to the earliest call date.
Transition method: modified retrospective.
January 1, 2019. Early adoption is permitted.
We are currently evaluating the impact of adopting the standard on our financial statements.
2017-07, Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost
This standard changes the presentation of non-service cost associated with defined benefit plans and updates the guidance so that only the service cost component will be eligible for capitalization.
January 1, 2018.
We expect the adoption of this standard to result in a reclassification of non-service pension costs from Operating expenses to Other expense of $7.2 million and $7.8 million in 2017 and 2016, respectively.
2016-18, Statement of Cash Flows (Topic 320): Restricted Cash (a consensus of the FASB Emerging Issues Task Force)
This standard requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows.
Transition method: retrospective.
January 1, 2018
We expect the adoption of this standard to result in a reclassification from "Net cash used in investing activities" to "Net increase / (decrease) in cash" of $26.6 million and ($11.9) million in 2017 and 2016, respectively.
ASU 2014-09 and its subsequent corresponding updates provide the principles an entity must apply to measure and recognize revenue. The core principle is that an entity shall recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Amendments to the standard were issued that provide further clarification of the principle and to provide certain transition expedients. The standard replaces most existing revenue recognition guidance in GAAP.
The standard requires retrospective application and allows either a full retrospective adoption in which all of the periods are presented under the new standard or a modified retrospective approach in which the cumulative effect of initially applying the guidance is recognized at the date of initial application.
In 2016, we established a cross-functional implementation team and are in the process of evaluating changes to our business processes, systems and controls to support recognition and disclosure under the new standard. At this time, we do not expect any significant impact on our financial systems or a material change to controls as a result of the implementation of the new revenue recognition standard.
We are assessing the standard on a contract-by-contract basis applying the interpretations reached during 2017 on key issues. This includes the application of the practical expedient for measuring progress towards satisfaction of a performance obligation, when variable quantities would be considered variable consideration versus an option to acquire additional goods and services and how to allocate variable consideration to one or more, but not all, distinct goods or services promised in a series of distinct goods or services that forms part of a single performance obligation. Additionally, we have been working on the application of the standard to contracts that are under the scope of Service Concession Arrangements (Topic 853) and assessing the gross versus net presentation for spot energy sale and purchases. Through this assessment to date, we have not identified any situations where revenue recognized under FASC 606 could differ from that recognized under FASC 605 or where the presentation of sales to and purchases from the spot markets will change. Given the limited impact, we expect to use the modified retrospective approach.
We are continuing to work with various non-authoritative industry groups and continue to monitor the FASB and Transition Resource Group activity as we finalize our accounting policy on these and other industry-specific interpretive issues.
ASU 2016-02 and its subsequent corresponding updates require lessees to recognize assets and liabilities for most leases but recognize expenses in a manner similar to today’s accounting. For Lessors, the guidance modifies the
lease classification criteria and the accounting for sales-type and direct financing leases. The guidance also eliminates today’s real estate-specific provisions.
The standard requires modified retrospective adoption at the beginning of the earliest comparative period presented in the financial statements (January 1, 2017). The FASB proposed amending the standard to give another option for transition. The proposed transition method would allow entities to not apply the new lease standard in the comparative periods presented in their financial statements in the year of adoption. Under the proposed transition method, the entity would apply the transition provisions on January 1, 2019 (i.e., the effective date). At transition, lessees and lessors are permitted to make an election to apply a package of practical expedients that allow them not to reassess: (1) whether any expired or existing contracts are or contain leases, (2) lease classification for any expired or existing leases, and (3) whether initial direct costs for any expired or existing leases qualify for capitalization under FASC 842. These three practical expedients must be elected as a package and must be consistently applied to all leases. Furthermore, entities are also permitted to make an election to use hindsight when determining lease term and entities can elect to use hindsight when assessing the impairment of right-of-use assets.
We have established a task force focused on the identification of contracts that would be under the scope of the new standard and on the assessment and measurement of the right-of-use asset and related liability. Additionally, the implementation team has been working on the identification and selection of a lease accounting system that would support the implementation and the subsequent accounting. The implementation team is in the process of evaluating changes to our business processes, systems and controls to support recognition and disclosure under the new standard.
As we have preliminarily concluded that at transition we would be using the package of practical expedients, the main impact expected as of the effective date is the recognition of the right to use asset and the related liability in the financial statements for all those contracts that contain a lease and for which we are the lessee. However, income statement presentation and the expense recognition pattern is not expected to change.
Under FASC 842, it is expected that fewer contracts will contain a lease. However, due to the elimination of today's real estate-specific guidance and changes to certain lessor classification criteria, more leases will qualify as sales-type leases and direct financing leases. Under these two models, a lessor will derecognize the asset and will recognize a lease receivable. According to FASC 842, the lease receivable does not include variable payments that depend on the use of the asset (e.g. Mwh produced by a facility). Therefore, the lease receivable could be lower than the carrying amount of the underlying asset at lease commencement. In such circumstances, the difference between the initially recognized lease receivable and the carrying amount of the underlying is recognized as a selling loss at lease commencement. We are assessing situations for which this guidance would apply.
Note 2 - Supplemental Financial Information
Accumulated Other Comprehensive Income (Loss)
The amounts reclassified out of Accumulated Other Comprehensive Income / (Loss) by component during the years ended December 31, 2017, 2016 and 2015 are as follows:
The changes in the components of Accumulated Other Comprehensive Income / (Loss) during the years ended December 31, 2017 and 2016 are as follows:
Note 3 - Regulatory Matters
In January 2017, DP&L filed a settlement in its 2017 ESP case and filed an amended stipulation on March 13, 2017, which was subject to approval by the PUCO. A final decision was issued by the PUCO on October 20, 2017, modifying and adopting the amended stipulation and recommendation. The 2017 ESP establishes DP&L's framework for providing retail service on a going forward basis including rate structures, non-bypassable charges and other specific rate recovery true-up mechanisms. The signatory parties agreed to a six-year settlement that provides a framework for energy rates and defines components which include, but are not limited to, the following:
•
Bypassable standard offer energy rates for DP&L’s customers based on competitive bid auctions;
•
The establishment of a three-year non-bypassable Distribution Modernization Rider (DMR) designed to collect $105.0 million in revenue per year to pay debt obligations at DPL and DP&L and position DP&L to modernize and/or maintain its transmission and distribution infrastructure with an option for DP&L to file for an extension of the rider for an additional two years in an amount subject to approval by the PUCO;
•
The establishment of a non-bypassable Distribution Investment Rider to recover incremental distribution capital investments, the amount of which is to be established in a separate DP&L distribution rate case;
•
A non-bypassable Reconciliation Rider permitting DP&L to defer, recover or credit the net proceeds from selling energy and capacity received as part of DP&L’s investment in OVEC and DP&L's OVEC related costs;
•
Implementation by DP&L of a Smart Grid Rider, Economic Development Rider, Economic Development Fund, Regulatory Compliance Rider and certain other new, or changes to existing, rates, riders and competitive retail market enhancements, with tariffs consistent with the order. These riders became effective November 1, 2017;
•
A commitment to commence a sale process to sell our ownership interests in the Miami Fort, Zimmer and Conesville coal-fired generation plants, with all sales proceeds used to pay debt of DPL and DP&L;
•
Restrictions on DPL making dividend or tax sharing payments and an obligation to convert then existing tax payments owed by DPL to AES into equity investments in DPL;
•
Various other riders and competitive retail market enhancements.
As part of the normal review and approval process, the PUCO‘s order approving the 2017 ESP settlement is subject to rehearing requests. Several parties, including DP&L, applied for a rehearing. Those rehearing applications are still pending.
DP&L is subject to a SEET threshold and is required to apply general rules for calculating earnings and comparing them to a comparable group to determine whether there were significantly excessive earnings during a given calendar year. The 2017 ESP maintains DP&L’s return on equity SEET threshold at 12% and provides that DMR amounts are excluded from the SEET calculation. A stipulation was reached with the PUCO staff agreeing that DP&L did not exceed the SEET threshold for 2015, which was approved by the PUCO on September 6, 2017. On May 15, 2017, DP&L filed its application to demonstrate that it did not have significantly excessive earnings for calendar year 2016. That case is still pending. In future years, the SEET could have a material effect on results of operations, financial condition and cash flows.
The DOE issued a Notice of Proposed Rule Making on September 29, 2017, which directed the FERC to exercise its authority to set just and reasonable rates that recognize the “resiliency” value provided by generation plants with certain characteristics, including having 90-days or more of on-site fuel and operating in markets where they do not receive rate base treatment through state ratemaking. Nuclear and coal-fired generation plants would have been most likely to be able to meet the requirements. As proposed, the DOE would value resiliency through rates that recover “compensable costs” that were defined to include the recovery of operating and fuel expenses, debt service and a fair return on equity. On January 8, 2018, the FERC issued an order terminating this docket stating that it failed to satisfy the legal requirements of Section 206 of the Federal Power Act of 1935. The FERC initiated a new docket to take additional steps to explore resilience issues in RTOs/ISOs. The goal of this new proceeding is to: (1) develop a common understanding among the FERC, State Commissions, RTOs, transmission owners, and others as to what resilience of the bulk power system means and requires; (2) understand how each RTO and ISO assesses resilience in its geographic footprint; and (3) use this information to evaluate whether additional action regarding resilience is appropriate at this time. We are not able at this time to predict the impact of this proceeding on our business, financial condition or results of operations.
Impact of tax reform
On January 10, 2018 the PUCO initiated a proceeding to consider the impacts of the TCJA to determine the appropriate course of action to pass benefits resulting from the legislation on to ratepayers. The PUCO also directed Ohio utilities to record deferred liabilities for the estimated reduction in federal income tax resulting from the TCJA beginning January 1, 2018. Under the terms of the ESP, DPL will not make tax sharing payments and if DP&L's rates are reduced as a result of the TCJA, our cash flows could be adversely affected. It is too early to determine whether this proceeding may have a material impact on DP&L's business, financial condition or results of operations.
Regulatory assets and liabilities
In accordance with FASC 980, we have recognized total regulatory assets of $187.1 million and $204.0 million at December 31, 2017 and 2016, respectively, and total regulatory liabilities of $236.0 million and $164.1 million at December 31, 2017 and 2016, respectively. Regulatory assets and liabilities are classified as current or non-current based on the term in which recovery is expected. See Note 1 - Overview and Summary of Significant Accounting Policies for accounting policies regarding Regulatory Assets and Liabilities.
The following table presents DP&L’s Regulatory assets and liabilities:
A - Recovery of incurred costs plus rate of return.
B - Recovery of incurred costs without a rate of return.
C - Balance has an offsetting liability resulting in no effect on rate base.
D - Recovery not yet determined, but recovery is probable of occurring in future rate proceedings.
Current regulatory assets and liabilities primarily represent costs that are being recovered per specific rate order; recovery for the remaining costs is probable, but not certain. DP&L is earning a return on $12.5 million of this deferral. These items include undercollection of: (i) Distribution Modernization Rider revenues, (ii) certain transmission related costs, and (iii) declines in net revenues resulting from implementation of energy efficiency programs. It also includes the current portion of the following deferred costs which are described in greater detail below: unbilled fuel, Regulatory Compliance Rider costs and deferred storm costs. As current liabilities, this includes overcollection of: (i) competitive bidding energy and auction costs, (ii) energy efficiency program costs, (iii) alternative energy rider, (iv) economic development rider and (v) uncollectible rider.
Pension benefits represent the qualifying FASC 715 “Compensation - Retirement Benefits” costs of our regulated operations that for ratemaking purposes are deferred for future recovery. We recognize an asset for a plan’s overfunded status or a liability for a plan’s underfunded status, and recognize, as a component of OCI, the changes in the funded status of the plan that arise during the year that are not recognized as a component of net periodic benefit cost. This regulatory asset represents the regulated portion that would otherwise be charged as a loss to OCI. As per PUCO and FERC precedents, these costs are probable of future rate recovery.
Unrecovered OVEC charges includes the portion of charges from OVEC that were not recoverable through DP&L’s fuel rider from October 2014 through October 2017. DP&L expects to recover these costs through a future rate
proceeding. Beginning on November 1, 2017, such costs are being recovered through DP&L’s Reconciliation Rider which was authorized as part of the 2017 ESP.
Fuel costs represent unrecovered fuel costs related to DP&L’s fuel rider from 2010 through 2015 resulting from a declining SSO customer base. DP&L was granted recovery of these costs without a return through the SSO as approved in the 2017 ESP. These costs are being recovered over the three-year period that began November 1, 2017.
Regulatory compliance costs represent the long-term portion of the regulatory compliance rider which was established by the 2017 ESP to recover the following costs: (i) Consumer Education Campaign, (ii) Retail Settlement System, (iii) Generation Separation, (iv) Bill Format Redesign, (v) Green Pricing Tariff and (vi) Supplier Consolidated Billing. All of these costs except for Generation Separation earn a return. The majority of these costs are being recovered over the three-years beginning November 1, 2017. Recovery of a small portion of the Generation Separation costs, including ongoing costs, will be sought in a future proceeding.
Rate case costs represents costs associated with preparing a distribution rate case and ESP. DP&L has requested recovery of these costs which do not earn a return, as part of its pending distribution rate case filing.
Smart Grid and AMI costs represent costs incurred as a result of studying and developing distribution system upgrades and implementation of AMI. On October 19, 2010, DP&L elected to withdraw its case pertaining to the Smart Grid and AMI programs. The PUCO accepted the withdrawal in an order issued on January 5, 2011. The PUCO also indicated that it expects DP&L to continue to monitor other utilities’ Smart Grid and AMI programs and to explore the potential benefits of investing in Smart Grid and AMI programs and that DP&L will, when appropriate, file new Smart Grid and/or AMI business cases in the future. This plan is currently under development and we plan to seek recovery of these deferred costs, which currently do not earn a return, in a regulatory rate proceeding in the near future. Based on PUCO precedent, we believe these costs are probable of future recovery in rates.
Unamortized loss on reacquired debt represents losses on long-term debt reacquired or redeemed in prior periods that have been deferred. These deferred losses are being amortized over the lives of the original issues in accordance with the rules of the FERC and the PUCO.
Deferred storm costs represent the long-term portion of deferred costs for major storms which occurred during 2016 and 2017. The 2017 ESP granted DP&L approval to establish a rider by which to seek recovery of these types of costs with a return. DP&L filed to recover 2016 storm costs on February 2, 2018 and expects to file to recover 2017 costs later in 2018. Recovery of these costs is probable by 2019, but not certain.
Estimated costs of removal - regulated property reflect an estimate of amounts collected in customer rates for costs that are expected to be incurred in the future to remove existing transmission and distribution property from service when the property is retired.
Deferred income taxes payable to customers represent deferred income tax assets recognized from the normalization of flow-through items as the result of taxes previously charged to customers. A deferred income tax asset or liability is created from a difference in income recognition between tax laws and accounting methods. As a regulated utility, DP&L includes in ratemaking the impacts of current income taxes and changes in deferred income tax liabilities or assets. The 2016 regulatory asset of $35.9 million represents the portion of DP&L’s deferred income tax asset that we believed would be recovered through future rates, without interest, based upon established regulatory practices. That 2016 asset was based upon an expected future federal income tax rate of 35%. On December 22, 2017, the TCJA was signed, which includes a provision to, among other things, reduce the federal corporate income tax rate to 21%, beginning January 1, 2018. As required by GAAP, on December 31, 2017, DP&L remeasured their deferred income tax assets and liabilities using the new expected tax rate. DP&L believes that the portion of the reduction in the net deferred tax liability which is related to deferred taxes considered in ratemaking will be used in future ratemaking to reduce jurisdictional retail rates. Accordingly, the related regulatory asset became a 83.4 million regulatory liability.
Postretirement benefits represent the qualifying FASC 715 “Compensation - Retirement Benefits” gains related to our regulated operations that, for ratemaking purposes, are probable of being reflected in future rates. We recognize an asset for a plan’s overfunded status or a liability for a plan’s underfunded status, and recognize, as a component of OCI, the changes in the funded status of the plan that arise during the year that are not recognized
as a component of net periodic benefit cost. This regulatory liability represents the regulated portion that would otherwise be reflected as a gain to OCI.
Note 4 - Property, Plant and Equipment
The following is a summary of DP&L’s Property, plant and equipment with corresponding composite depreciation rates at December 31, 2017 and 2016:
AROs
We recognize AROs in accordance with GAAP which requires legal obligations associated with the retirement of long-lived assets to be recognized at their fair value at the time those obligations are incurred. Upon initial recognition of a legal liability, costs are capitalized as part of the related long-lived asset and depreciated over the useful life of the related asset. Our legal obligations are associated with the retirement of our long-lived assets, consisting primarily of river intake and discharge structures, coal unloading facilities, loading docks, ice breakers and ash disposal facilities.
Estimating the amount and timing of future expenditures of this type requires significant judgment. Management routinely updates these estimates as additional information becomes available.
Changes in the Liability for Generation AROs
See Note 5 - Fair Value for further discussion on current year ARO additions.
Asset Removal Costs
We continue to record costs of removal for our regulated transmission and distribution assets through our depreciation rates and recover those amounts in rates charged to our customers. There are no known legal AROs associated with these assets. We have recorded $132.8 million and $126.5 million in estimated costs of removal at December 31, 2017 and 2016, respectively, as regulatory liabilities for our transmission and distribution property.
These amounts represent the excess of the cumulative removal costs recorded through depreciation rates versus the cumulative removal costs actually incurred. See Note 3 - Regulatory Matters for additional information.
Changes in the Liability for Transmission and Distribution Asset Removal Costs
Note 5 - Fair Value
The fair values of our financial instruments are based on published sources for pricing when possible. We rely on valuation models only when no other method is available to us. The fair value of our financial instruments represents estimates of possible value that may or may not be realized in the future.
The table below presents the fair value and cost of our non-derivative instruments at December 31, 2017 and 2016. See also Note 6 - Derivative Instruments and Hedging Activities for the fair values of our derivative instruments.
(a)
Amounts exclude immaterial capital lease obligations in 2016
Fair value hierarchy
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. These inputs are then categorized as:
•
Level 1 (quoted prices in active markets for identical assets or liabilities);
•
Level 2 (observable inputs such as quoted prices for similar assets or liabilities or quoted prices in markets that are not active); or
•
Level 3 (unobservable inputs reflecting management’s own assumptions about the inputs used in pricing the asset or liability).
Valuations of assets and liabilities reflect the value of the instrument including the values associated with counterparty risk. We include our own credit risk and our counterparty’s credit risk in our calculation of fair value using global average default rates based on an annual study conducted by a large rating agency.
We did not have any transfers of the fair values of our financial instruments between Level 1 and Level 2 of the fair value hierarchy during the years ended December 31, 2017 and 2016.
Debt
The fair value of debt is based on current public market prices for disclosure purposes only. Unrealized gains or losses are not recognized in the financial statements as debt is presented at the carrying value, net of unamortized premium or discount, in the financial statements. The debt amounts include the current portion payable in the next twelve months and have maturities that range from 2020 to 2061.
Master trust assets
DP&L established a Master Trust to hold assets that could be used for the benefit of employees participating in employee benefit plans. These assets are primarily comprised of open-ended mutual funds, which are valued using the net asset value per unit. These investments are recorded at fair value within Other deferred assets on the balance sheets and classified as available for sale. Any unrealized gains or losses are recorded in AOCI until the securities are sold.
DP&L had $1.7 million ($1.1 million after tax) in unrealized gains and immaterial unrealized losses on the Master Trust assets in AOCI at December 31, 2017 and $1.1 million ($0.7 million after tax) in unrealized gains and immaterial unrealized losses in AOCI at December 31, 2016.
During the year ended December 31, 2017, $0.9 million ($0.6 million after tax) of various investments were sold to facilitate the distribution of benefits. Over the next twelve months, an immaterial amount of unrealized gains is expected to be reversed to earnings.
The fair value of assets and liabilities at December 31, 2017 and the respective category within the fair value hierarchy for DP&L was determined as follows:
(a)
Includes credit valuation adjustment
(b)
Amounts exclude immaterial capital lease obligations
The fair value of assets and liabilities at December 31, 2016 and the respective category within the fair value hierarchy for DP&L was determined as follows:
(a)
Includes credit valuation adjustment
(b)
Amounts exclude immaterial capital lease obligations
Our financial instruments are valued using the market approach in the following categories:
•
Level 1 inputs are used for financial contracts, such as money market accounts that are considered cash equivalents. The fair value is determined by reference to quoted market prices and other relevant information generated by market transactions.
•
Level 2 inputs are used to value derivatives such as interest rate hedges. Other Level 2 assets include open-ended mutual funds in the Master Trust, which are valued using the end of day NAV per unit.
•
Level 3 inputs are used to value some debt which is not publicly traded. Our Level 3 inputs are immaterial to our derivative balances as a whole and as such no further disclosures are presented.
Approximately 100% of the inputs to the fair value of our derivative instruments are from quoted market prices.
Our long-term debt is fair valued for disclosure purposes only and most of the fair values are determined using quoted market prices in inactive markets. These fair value inputs are considered Level 2 in the fair value hierarchy. As the Wright-Patterson Air Force Base note is not publicly traded, fair value is assumed to equal carrying value. These fair value inputs are considered Level 3 in the fair value hierarchy as there are no observable inputs. Additional Level 3 disclosures are not presented since our long-term debt is not recorded at fair value.
Non-recurring Fair Value Measurements
We use the cost approach to determine the fair value of our AROs, which are estimated by discounting expected cash outflows to their present value at the initial recording of the liability. Cash outflows are based on the approximate future disposal cost as determined by market information, historical information or other management estimates. These inputs to the fair value of the AROs would be considered Level 3 inputs under the fair value hierarchy. AROs for asbestos, ash landfill, underground storage tanks, and river structures decreased by a net amount of $0.2 million ($0.1 million after tax) and increased by a net amount of $3.2 million ($2.1 million after tax) December 31, 2017 and 2016, respectively. See Note 4 - Property, Plant and Equipment for more information about AROs.
Note 6 - Derivative Instruments and Hedging Activities
In the normal course of business, DP&L enters into various financial instruments, including derivative financial instruments. We use derivatives principally to manage the risk of changes in market prices for commodities and interest rate risk associated with our long-term debt. The derivatives that we use to economically hedge these risks are governed by our risk management policies for forward and futures contracts. Our net positions are continually assessed within our structured hedging programs to determine whether new or offsetting transactions are required. The objective of the hedging program is to mitigate financial risks while ensuring that we have adequate resources to meet our requirements. We monitor and value derivative positions monthly as part of our risk management processes. We use published sources for pricing, when possible, to mark positions to market. All of our derivative instruments are used for risk management purposes and are designated as cash flow hedges if they qualify under FASC 815 for accounting purposes.
DP&L's interest rate swaps are designated as a cash flow hedge. At December 31, 2017 and 2016, the principal balance of the interest rate hedges was $200.0 million.
Cash flow hedges
As part of our risk management processes, we identify the relationships between hedging instruments and hedged items, as well as the risk management objective and strategy for undertaking various hedge transactions. The fair values of cash flow hedges determined by current public market prices will continue to fluctuate with changes in market prices up to contract expiration. The effective portion of the hedging transaction is recognized in AOCI and transferred to earnings using specific identification of each contract when the forecasted hedged transaction takes place or when the forecasted hedged transaction is probable of not occurring. The ineffective portion of the cash flow hedge is recognized in earnings in the current period. All risk components were considered to determine the hedge effectiveness of the cash flow hedges.
We have two interest rate swaps to hedge the variable interest on our $200.0 million variable interest rate tax-exempt First Mortgage Bonds. The interest rate swaps have a combined notional amount of $200.0 million and will settle monthly based on a one-month LIBOR. We use the income approach to value the swaps, which consists of forecasting future cash flows based on contractual notional amounts and applicable and available market data as of the valuation date. The most common market data inputs used in the income approach include volatilities, spot and forward benchmark interest rates (LIBOR). Forward rates with the same tenor as the derivative instrument being valued are generally obtained from published sources, with these forward rates being assessed quarterly at a portfolio-level for reasonableness versus comparable published rates. We reclassify gains and losses on the swaps out of AOCI and into earnings in those periods in which hedged interest payments occur.
The following tables provide information on gains or losses recognized in AOCI for the cash flow hedges for the periods indicated:
Net gains or losses associated with the ineffective portion of the hedging transactions were immaterial in the periods presented.
DP&L has elected not to offset derivative assets and liabilities and not to offset net derivative positions against the right to reclaim cash collateral pledged (an asset) or the obligation to return cash collateral received (a liability) under derivative agreements. The fair value derivative position of DP&L's interest rate swaps are as follows:
Note 7 - Debt
Long-term debt is as follows:
(a)
Range of interest rates for the year ended December 31, 2017.
(b)
Range of interest rates for the year ended December 31, 2016.
At December 31, 2017, maturities of long-term debt are summarized as follows:
Significant transactions
On January 3, 2018, DP&L and its lenders amended DP&L's Term Loan B credit agreement. The amendment (a) modified the definition of "applicable rate", from 2.25% per annum to 1.00% per annum - in the case of the Base Rate, and from 3.25% per annum to 2.00% per annum - in the case of the Eurodollar Rate, and (b) included a "call protection" provision which stated that in the event the loan was repriced or any portion of the loans were prepaid, repaid, refinanced, substituted, or replaced on or prior July 3, 2018, such prepayment, acceleration, repayment, refinancing, substitution or replacement would be made at 101% of the principal amount so prepaid, repaid, refinanced, substituted or replaced. After July 3, 2018 any such transaction would occur at 100% of the principal amount of the then outstanding loans.
On May 26, 2017, DP&L commenced a tender offer to purchase any and all of the outstanding 4.8% tax-exempt First Mortgage Bonds at par value (plus accrued and unpaid interest). By June 23, 2017, or the expiration date of the tender, $8.1 million of the outstanding bonds were tendered. On June 26, 2017, DP&L accepted all of the tendered bonds, redeemed and retired them. On July 7, 2017, DP&L notified the Ohio Air Quality Development Authority and the Trustee of the same First Mortgage Bonds that DP&L was going to call at par value (plus accrued and unpaid interest) $21.9 million of these bonds. This call was completed on August 7, 2017. On September 28, 2017, DP&L issued an irrevocable call notice to purchase all of the remaining outstanding 4.8% tax-exempt First Mortgage Bonds at par value (plus accrued and unpaid interest). As of September 30, 2017, all of the bonds were either redeemed or defeased. This was done to facilitate Generation Separation and the release of the DP&L
generation assets from the lien of DP&L's First and Refunding Mortgage. The redemption of the $70.0 million principal amount of bonds was completed on October 30, 2017.
On February 21, 2017, DP&L and its lenders amended DP&L’s revolving credit agreement and Bond Purchase and Covenant Agreement. These amendments modified the definition of Consolidated Net Worth in each agreement (which is used for measuring the Total Debt to Total Capitalization ratio under each of the agreements), to exclude, through March 31, 2018, non-cash charges related directly to impairments of coal generation assets in DP&L's fiscal quarter ending December 31, 2016 and thereafter. With this amendment, DP&L was able to ensure compliance with the Total Debt to Total Capitalization ratio through October 1, 2017, the date Generation Separation occurred. After Generation Separation, and per the terms of the original agreement (before any amendment), the required Total Debt to Total Capitalization ratio increased from 0.65 to 1.00 to 0.75 to 1.00. On September 30, 2017, DP&L's adjusted (excluding impairments) Total Debt to Total Capitalization was 0.61 to 1.00 and as of December 31, 2017 it was 0.67 to 1.00. After Generation Separation occurred, the calculation of this covenant is on an unadjusted basis. The amendment also changed, for each agreement, the dates after Generation Separation during which compliance with the Total Capitalization ratio detailed above will be suspended if long-term indebtedness, as determined by the PUCO, is less than or equal to $750.0 million. As noted above this time period previously was January 1, 2017 to December 31, 2017, and is now the twelve months immediately subsequent to the separation of the generation assets from DP&L (or from October 1, 2017 through September 30, 2018). Generation Separation occurred on October 1, 2017.
On December 31, 2016, DP&L borrowed $5.0 million from DPL at an interest rate of 3.02%. The notes were due on or before January 30, 2017 and were repaid on the maturity date.
On August 24, 2016, DP&L refinanced its 1.875% First Mortgage Bonds due 2016, with a variable rate Term Loan B of $445.0 million maturing on August 24, 2022 and secured by a pledge of DP&L First Mortgage Bonds. The variable rate on the loan is calculated based on LIBOR plus a spread of 3.25%, with a LIBOR floor of 0.75%. Up to the maturity date but not starting until March 31, 2017, the loan amortizes 0.25% of the initial principal balance quarterly and contains covenants and restrictions that are generally consistent with existing DP&L credit agreements.
Debt covenants and restrictions
DP&L’s unsecured revolving credit agreement and Bond Purchase and Covenants Agreement (financing document entered into in connection with the sale of $200.0 million of variable rate tax-exempt First Mortgage Bonds, dated as of August 1, 2015, containing representations, warranties, covenants and defaults consistent with those contained in the revolving credit facilities loan documents of DP&L) have two financial covenants. The first measures Total Debt to Total Capitalization and is calculated, at the end of each fiscal quarter, by dividing total debt at the end of the quarter by total capitalization at the end of the quarter. The second financial covenant measures EBITDA to Interest Expense. The EBITDA to Interest Expense ratio is calculated, at the end of each fiscal quarter, by dividing consolidated EBITDA for the four prior fiscal quarters by the consolidated interest charges for the same period.
DP&L’s revolving credit facility and Bond Purchase and Covenants Agreement (financing document entered into in connection with the issuance of the $200.0 million of variable rate tax-exempt First Mortgage Bonds, dated as of August 1, 2015, containing representations, warranties and covenants consistent with those contained in DP&L's revolving credit facilities loan documents) have two financial covenants. First, prior to the date of completion of the separation of DP&L’s generation assets from its transmission and distribution assets, DP&L’s Total Debt to Total Capitalization may not be greater than 0.65 to 1.00 at any time; and, on and after the date of completion of the separation of DP&L’s generation assets from its transmission and distribution assets, which occurred October 1, 2017, DP&L’s Total Debt to Total Capitalization may not be greater than 0.75 to 1.00 at any time. Except that after separation required compliance with this financial covenant shall be suspended (a) any time after separation during which DP&L maintains a rating of BBB- (or in the case of Moody’s Investors Service, Inc. Baa3) or higher with a stable outlook from at least one of Fitch Investors Service Inc., Standard & Poor’s Ratings Services or Moody’s Investors Service, Inc., as determined in accordance with the terms of the revolving credit facility or (b) for the time period January 1, 2017 to December 31, 2017 (as modified by the amendment described below) if DP&L’s long-term indebtedness (as determined by the PUCO) is less than or equal to $750.0 million. The Total Debt to Capitalization covenant is calculated as the sum of DP&L’s current and long-term portion of debt, divided by the total of DP&L’s net worth and total debt.
On February 21, 2017, DP&L and its lenders amended DP&L’s revolving credit agreement and Bond Purchase and Covenant Agreement. These amendments modified the definition of Consolidated Net Worth in each agreement
(which is used for measuring the Total Debt to Total Capitalization ratio under each of the agreements), to exclude, through March 31, 2018, non-cash charges related directly to impairments of coal generation assets in DP&L's fiscal quarter ending December 31, 2016 and thereafter. With this amendment, DP&L was able to ensure compliance with the Total Debt to Total Capitalization ratio through October 1, 2017, the date Generation Separation occurred. After Generation Separation, and per the terms of the original agreement (before any amendment), the required Total Debt to Total Capitalization ratio increased from 0.65 to 1.00 to 0.75 to 1.00. On September 30, 2017, DP&L's adjusted (excluding impairments) Total Debt to Total Capitalization was 0.61 to 1.00 and as of December 31, 2017 it was 0.67 to 1.00. After Generation Separation occurred, the calculation of this covenant is on an unadjusted basis. The amendment also changed, for each agreement, the dates after Generation Separation during which compliance with the Total Capitalization ratio detailed above will be suspended if long-term indebtedness, as determined by the PUCO, is less than or equal to $750.0 million. As noted above this time period previously was January 1, 2017 to December 31, 2017, and is now the twelve months immediately subsequent to the separation of the generation assets from DP&L (or from October 1, 2017 through September 30, 2018). Generation Separation occurred on October 1, 2017.
As of December 31, 2017, DP&L was in compliance with all debt covenants, including the financial covenants described above and did not have any meaningful restrictions in its debt financing documents prohibiting dividends to its parent, DPL.
Substantially all property, plant & equipment of DP&L is subject to the lien of the mortgage securing DP&L’s First and Refunding Mortgage. All generation assets were released from the lien of DP&L's first and refunding mortgage in connection with the completion of Generation Separation on October 1, 2017.
Note 8 - Income Taxes
DP&L’s components of income tax expense on continuing operations were as follows:
(a)
The statutory tax rate of 35% was applied to pre-tax earnings.
(b)
Includes expense / (benefit) of $0.0 million, $(0.4) million and $0.1 million in the years ended December 31, 2017, 2016 and 2015, respectively, of income tax related to adjustments from prior years.
Effective and Statutory Rate Reconciliation
The following table summarizes a reconciliation of the U.S. statutory federal income tax rate to DP&L's effective tax rate, as a percentage of income from continuing operations before taxes for the years ended December 31, 2017, 2016 and 2015:
Deferred Income Taxes
Deferred income taxes reflect the net tax effects of (a) temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes and (b) operating loss carryforwards. These items are stated at the enacted tax rates that are expected to be in effect when taxes are actually paid or recovered. Investment tax credits related to utility property have been deferred and are being amortized over the estimated useful lives of the related property.
U. S Tax Reform
On December 22, 2017, the U.S. enacted the TCJA. The TCJA significantly changes U.S. corporate income tax law.
We recognized the income tax effects of the TCJA in accordance with Staff Accounting Bulletin No. 118 (“SAB 118”) which provides SEC guidance on the application of FASC 740, Income Taxes, in the reporting period in which the TCJA was signed into law. Accordingly, our financial statements reflect the income tax effects of U.S. tax reform for which the accounting is complete and provisional amounts for those impacts for which the accounting under FASC 740 is incomplete, but a reasonable estimate could be determined.
We have calculated our best estimate of the impact of the TCJA in our income tax provision for the year ended December 31, 2017 in accordance with our understanding of the TCJA and guidance available as of the date of this filing.
Certain deferred tax assets and liabilities were remeasured as the rates changed from 35% to 21%. The most material deferred taxes to be remeasured related to property, plant and equipment. The remeasurement of deferred tax assets and liabilities related to regulated utility property of $135.2 million was recorded as a regulatory liability, which was a non-cash adjustment. Additional time is required to finalize remeasurement effects in accordance with GAAP.
The following table presents the tax expense / (benefit) related to pensions, postemployment benefits, cash flow hedges and financial instruments that were credited to Accumulated other comprehensive loss.
Uncertain Tax Positions
We apply the provisions of GAAP relating to the accounting for uncertainty in income taxes. A reconciliation of the beginning and ending amount of unrecognized tax benefits for DP&L is as follows:
Of the December 31, 2017 balance of unrecognized tax benefits, $0.9 million is due to uncertainty in the timing of deductibility.
We recognize interest and penalties related to unrecognized tax benefits in Income tax expense. The amounts accrued and tax expense / (benefit) recorded were not material for each period presented.
Following is a summary of the tax years open to examination by major tax jurisdiction:
U.S. Federal - 2011 and forward
State and Local - 2011 and forward
None of the unrecognized tax benefits are expected to significantly increase or decrease within the next twelve months other than those subject to expiring statute of limitations.
Note 9 - Benefit Plans
Defined contribution plans
DP&L sponsors two defined contribution plans. One is for non-union employees (the management plan) and one is for collective bargaining employees (the union plan). Both plans are qualified under Section 401 of the Internal Revenue Code.
Certain non-union and union employees become eligible to participate in their respective plan upon date of hire.
Participants may elect to contribute up to 85% of eligible compensation to their plan. Non-union participant contributions are matched 100% on the first 1% of eligible compensation and 50% on the next 5% of eligible compensation and they are fully vested in their employer contributions after 2 years of service. Union participant contributions are matched 150% but are capped at $2,300 for 2017 and they are fully vested in their employer contributions after 3 years of service. All participants are fully vested in their own contributions.
We contributed $3.1 million, $5.1 million and $4.9 million in the years ended December 31, 2017, 2016 and 2015, respectively. DP&L matching contributions are paid quarterly, in arrears. Therefore, the contributions by year include the fourth quarter matching contribution that is paid in the following year. DP&L also contributes an annual bonus to the accounts of its union participants. This payment is typically made in January of the following year. For 2017, the annual bonus amount is yet to be determined and paid; pending the results of negotiations with the bargaining unit.
Defined benefit plans
DP&L sponsors a traditional defined benefit pension plan for most of the employees of DPL and its subsidiaries. For collective bargaining employees, the defined benefits are based on a specific dollar amount per year of service. For all other employees (management employees), the traditional defined benefit pension plan is based primarily on compensation and years of service. As of December 31, 2010, this traditional pension plan formula was closed to new management employees. A participant is 100% vested in all amounts credited to his or her account upon the completion of five vesting years, as defined in The Dayton Power and Light Company Retirement Income Plan, or the participant’s death or disability. If a participant’s employment is terminated, other than by death or disability, prior to such participant becoming 100% vested in his or her account, the account shall be forfeited as of the date of termination. Effective January 1, 2014, the Service Company began providing services including accounting, legal, human resources, information technology and other corporate services on behalf of companies that are part of the U.S. SBU, including among other companies, DPL and DP&L. Employees that transferred from DP&L to the Service Company maintain their previous eligibility to participate in the DP&L pension plan. In addition, employees that transferred from DP&L to AES Ohio Generation due to Generation Separation maintain their previous eligibility to participate in the DP&L pension plan.
Almost all management employees beginning employment on or after January 1, 2011 participate in a cash balance pension plan formula. Similar to the traditional pension plan for management employees, the cash balance benefits are based on compensation and years of service. A participant shall become 100% vested in all amounts credited to his or her account upon the completion of three vesting years, as defined in The Dayton Power and Light Company Retirement Income Plan, or the participant’s death or disability. If a participant’s employment is terminated, other than by death or disability, prior to such participant becoming 100% vested in his or her account, the account shall be forfeited as of the date of termination. Vested benefits in the cash balance plan are fully portable upon termination of employment.
In addition, we have a Supplemental Executive Retirement Plan (SERP) for certain retired key executives. The SERP has an immaterial unfunded liability related to agreements for retirement benefits of certain terminated and retired key executives. We also include our net liability to our partners in our co-owned generating plants related to our share of their pension liabilities within Pension, retiree and other benefits on our Balance Sheets.
We recognize an asset for a plan’s overfunded status and a liability for a plan’s underfunded status and recognize, as a component of OCI, the changes in the funded status of the plan that arise during the year that are not recognized as a component of net periodic benefit cost. For the transmission and distribution areas of our electric business, these amounts are recorded as regulatory assets and liabilities which represent the regulated portion that would otherwise be charged or credited to AOCI. We have historically recorded these costs on the accrual basis and this is how these costs have been historically recovered through customer rates. This factor, combined with the historical precedents from the PUCO and FERC, make these costs probable of future rate recovery.
Postretirement benefits
Qualified employees who retired prior to 1987 and their dependents are eligible for health care and life insurance benefits until their death, while qualified employees who retired after 1987 are eligible for life insurance benefits and partially subsidized health care. The partially subsidized health care is at the election of the employee, who pays the majority of the cost, and is available only from their retirement until they are covered by Medicare. We have funded a portion of the union-eligible benefits using a Voluntary Employee Beneficiary Association Trust. These postretirement health care benefits and the related unfunded obligation of $12.7 million and $15.8 million at December 31, 2017 and 2016, respectively, were not material to the financial statements in the periods covered by this report.
The following tables set forth the changes in our pension plan's obligations and assets recorded on the Balance Sheets at December 31, 2017 and 2016. The amounts presented in the following tables for pension obligations include the collective bargaining plan formula, traditional management plan formula and cash balance plan formula and the SERP in the aggregate and have not been adjusted for $1.1 million and $1.3 million of costs billed to the service company for the years ended December 31, 2017 and 2016 or $0.7 million of costs billed to AES Ohio Generation for the year ended December 31, 2017.
The accumulated benefit obligation for our defined benefit pension plans was $428.3 million and $409.2 million at December 31, 2017 and 2016, respectively.
The net periodic benefit cost of the pension plans was:
Other Changes in Plan Assets and Benefit Obligation Recognized in Accumulated Other Comprehensive Income, Regulatory Assets and Regulatory Liabilities
Estimated amounts that will be amortized from AOCI, Regulatory assets and Regulatory liabilities into net periodic benefit costs during 2018 are:
Assumptions
Our expected return on plan asset assumptions, used to determine benefit obligations, are based on historical long-term rates of return on investments, which use the widely accepted capital market principle that assets with higher volatility generate a greater return over the long run. Current market factors, such as inflation and interest rates, as well as asset diversification and portfolio rebalancing, are evaluated when long-term capital market assumptions are determined. Peer data and historical returns are reviewed to verify reasonableness and appropriateness.
At December 31, 2017, we are decreasing our long-term rate of return assumption to 6.25% for pension plan assets. The rate of return represents our long-term assumptions based on our long-term portfolio mix. Also, at December 31, 2017, we have decreased our assumed discount rate to 3.66% from 4.28% for pension expense to reflect current duration-based yield curve discount rates. A one percent increase in the rate of return assumption for pension would result in a decrease in 2018 pension expense of approximately $3.4 million. A one percent decrease in the rate of return assumption for pension would result in an increase in 2018 pension expense of approximately $3.4 million. A 25-basis point increase in the discount rate for pension would result in a decrease of approximately
$0.6 million to 2018 pension expense. A 25-basis point decrease in the discount rate for pension would result in an increase of approximately $0.6 million to 2018 pension expense.
In determining the discount rate to use for valuing liabilities, we used a market yield curve on high-quality fixed income investments as of December 31, 2017. We project the expected benefit payments under the plan based on participant data and based on certain assumptions concerning mortality, retirement rates, termination rates, etc. The expected benefit payments for each year are then discounted back to the measurement date using the appropriate spot rate for each half-year from the yield curve, thereby obtaining a present value of all expected future benefit payments using the yield curve. Finally, an equivalent single discount rate is determined which produces a present value equal to the present value determined using the full yield curve.
Effective January 1, 2016, we applied a disaggregated discount rate approach for determining service cost and interest cost for our defined benefit pension plans and postretirement plans. See Note 1 - Overview and Summary of Significant Accounting Policies for more information.
In future periods, differences in the actual return on pension plan assets and assumed return, or changes in the discount rate, will affect the timing of contributions, if any, to the plans.
The weighted average assumptions used to determine benefit obligations at December 31, 2017, 2016 and 2015 were:
Pension plan assets
Plan assets are invested using a total return investment approach whereby a mix of equity securities, debt securities and other investments are used to preserve asset values, diversify risk and achieve our target investment return benchmark. Investment strategies and asset allocations are based on careful consideration of plan liabilities, the plan's funded status and our financial condition. Investment performance and asset allocation are measured and monitored on an ongoing basis.
Plan assets are managed in a balanced portfolio comprised of two major components: an equity portion and a fixed income portion. The expected role of plan equity investments is to maximize the long-term real growth of plan assets, while the role of fixed income investments is to generate current income, provide for more stable periodic returns and provide some protection against a prolonged decline in the market value of plan equity investments.
Long-term strategic asset allocation guidelines, as well as short-term tactical asset allocation guidelines, are determined by a Risk/Advisory Committee and approved by a Fiduciary Committee. These allocations consider the plan’s long-term objectives. The long-term target allocations for plan assets are 24% - 52% for equity securities and 47% - 65% for fixed income securities. Equity securities include U.S. and international equity, while fixed income securities include long-duration and high-yield bond funds and emerging market debt funds.
Tactically, the committees, on a short-term basis, will make asset allocations that are outside the long-term allocation guidelines. The short-term allocation positions are likely to not exceed one-year in duration. In addition to the equity and fixed income investments, the short-term allocation may also include a relatively small allocation to alternative investments. The plan currently has a small target allocation in a core property fund.
Most of our plan assets are measured using quoted, observable prices which are considered Level One inputs in the Fair Value Hierarchy. The Core Property Collective Fund is measured using Level Two inputs that are quoted prices for identical assets in markets that are less active.
The following table summarizes our target pension plan allocation for 2017:
The fair values of our pension plan assets at December 31, 2017 by asset category are as follows:
(a)
This category includes investments in equity securities of large, small and medium sized U.S. companies and equity securities of foreign companies including those in developing countries. The funds are valued using the net asset value method in which an average of the market prices for the underlying investments is used to value the fund.
(b)
This category includes investments in investment-grade fixed-income instruments, U.S. dollar-denominated debt securities of emerging market issuers and high yield fixed-income securities that are rated below investment grade. The funds are valued using the net asset value method in which an average of the market prices for the underlying investments is used to value the fund.
(c)
This category represents a property fund that invests in commercial real estate. The fair value of the fund is valued using the net asset value method in which an average of the market prices for the underlying investments is used to value the fund.
The fair values of our pension plan assets at December 31, 2016 by asset category are as follows:
(a)
This category includes investments in equity securities of large, small and medium sized U.S. companies and equity securities of foreign companies including those in developing countries. The funds are valued using the net asset value method in which an average of the market prices for the underlying investments is used to value the fund.
(b)
This category includes investments in investment-grade fixed-income instruments, U.S. dollar-denominated debt securities of emerging market issuers and high yield fixed-income securities that are rated below investment grade. The funds are valued using the net asset value method in which an average of the market prices for the underlying investments is used to value the fund.
(c)
This category represents a property fund that invests in commercial real estate. The fair value of the fund is valued using the net asset value method in which an average of the market prices for the underlying investments is used to value the fund.
Pension funding
We generally fund pension plan benefits as accrued in accordance with the minimum funding requirements of the Employee Retirement Income Security Act of 1974 (ERISA) and, in addition, make voluntary contributions from time to time. We contributed $5.0 million to the pension plan in each of the years ended December 31, 2017, 2016 and 2015.
We expect to make contributions of $0.4 million to our SERP in 2018 to cover benefit payments. We made contributions of $7.5 million to our pension plan during January 2018.
Funding for the qualified Defined Benefit Pension Plan is based upon actuarially determined contributions that consider the amount deductible for income tax purposes and the minimum contribution required under ERISA, as amended by the Pension Protection Act of 2006, as well as targeted funding levels necessary to meet certain thresholds.
From an ERISA funding perspective, DP&L’s funded target liability percentage was estimated to be 99%. In addition, DP&L must also contribute the normal service cost earned by active participants during the plan year. The funding of normal cost is expected to be approximately $7.5 million in 2018, which includes $2.2 million for plan expenses. Each year thereafter, if the plan’s underfunding increases to more than the present value of the remaining annual installments, the excess is separately amortized over a seven-year period. DP&L’s funding policy for the pension plans is to contribute annually no less than the minimum required by applicable law, and no more than the maximum amount that can be deducted for federal income tax purposes.
Benefit payments, which reflect future service, are expected to be paid as follows:
Note 10 - Equity
Redeemable Preferred Stock
On October 13, 2016 (the "Redemption Date"), DP&L redeemed all of its issued and outstanding preferred stock, consisting of the following series: Preferred Stock, 3.75% Series A, Cumulative (the “Series A Stock”); Preferred Stock, 3.75% Series B, Cumulative (the “Series B Stock”); and Preferred Stock, 3.90% Series C, Cumulative (the “Series C Stock” and, together with the Series A Stock and the Series B Stock, the “Preferred Stock”). On the Redemption Date, the Preferred Stock of each series was redeemed at the following prices as specified in DP&L’s Amended and Restated Articles of Incorporation, plus, in each case an amount equal to all accrued dividends payable with respect to such Preferred Stock to the Redemption Date: a price of $102.50 per share for the Series A Stock, a price of $103.00 per share for the Series B Stock, and a price of $101.00 per share for the Series C Stock. Dividends on the Preferred Stock ceased to accrue on the Redemption Date. Upon redemption, the Preferred Stock was no longer outstanding, and all rights of the holders thereof as shareholders of DP&L, except the right to payment of the redemption price, ceased to exist. The difference between the carrying value of the Redeemable Preferred Stock and the redemption amount was charged to Other paid-in capital.
Common Stock
DP&L has 250,000,000 authorized common shares, of which 41,172,173 are outstanding at December 31, 2017. All common shares are held by DP&L’s parent, DPL.
As part of the PUCO’s approval of the Merger, DP&L agreed to maintain a capital structure that includes an equity ratio of at least 50 percent and not to have a negative retained earnings balance. After the fixed-asset impairments
recorded during the first quarter of 2017 and the second and fourth quarters of 2016 and as of December 31, 2017, DP&L's equity ratio was 33% and its retained earnings balance was negative. It is unknown what impact, if any, this will have on DP&L.
Equity settlement of related party payable
In 2016, DP&L settled a $7.5 million payable to DPL relating to income taxes. This payable balance was settled through equity and DPL's investment in DP&L was increased by $7.5 million as consideration for extinguishing the payable.
Capital Contribution and Returns of Capital
In 2017, DP&L received a $70.0 million capital contribution from its parent, DPL. In addition, DP&L made returns of capital payments of $39.0 million to DPL. In connection with Generation Separation, DP&L recorded $86.2 million as a return of capital. See Note 13 - Generation Separation for more information.
In 2016, DP&L made a dividend payment of $70.0 million to DPL.
Note 11 - Contractual Obligations, Commercial Commitments and Contingencies
DP&L - Equity Ownership Interest
DP&L has a 4.9% equity ownership interest in OVEC which is recorded using the cost method of accounting under GAAP. At December 31, 2017, DP&L could be responsible for the repayment of 4.9%, or $70.6 million, of a $1,440.8 million debt obligation comprised of both fixed and variable rate securities with maturities between 2019 and 2040. OVEC could also seek additional contributions from us to avoid a default in the event that other OVEC members defaulted on their respective OVEC obligations. At December 31, 2017, we have no knowledge of such a default.
Contractual Obligations and Commercial Commitments
We enter into various contractual obligations and other commercial commitments that may affect the liquidity of our operations. At December 31, 2017, these include:
Electricity purchase commitments:
DP&L enters into long-term contracts for the purchase of electricity. In general, these contracts are subject to variable quantities or prices and are terminable only in limited circumstances.
Purchase orders and other contractual obligations:
At December 31, 2017, DP&L had various other contractual obligations including non-cancelable contracts to purchase goods and services with various terms and expiration dates. Due to uncertainty regarding the timing and payment of future obligations to the Service Company, and DP&L's ability to terminate such obligations upon 90 days' notice, we have excluded such amounts in the contractual obligations table above.
Contingencies
In the normal course of business, we are subject to various lawsuits, actions, proceedings, claims and other matters asserted under laws and regulations. We believe the amounts provided in our Financial Statements, as prescribed by GAAP, are adequate in light of the probable and estimable contingencies. However, there can be no assurances that the actual amounts required to satisfy alleged liabilities from various legal proceedings, claims, tax examinations, and other matters, including the matters discussed below, and to comply with applicable laws and regulations, will not exceed the amounts reflected in our Financial Statements. As such, costs, if any, that may be incurred in excess of those amounts provided as of December 31, 2017, cannot be reasonably determined.
Environmental Matters
DP&L's facilities and operations are subject to a wide range of federal, state and local environmental regulations and laws. The environmental issues that may affect us include:
•
The federal CAA and state laws and regulations (including SIPs) which require compliance, obtaining permits and reporting as to air emissions;
•
Rules and future rules issued by the USEPA, the Ohio EPA or other authorities that require or will require reporting and reductions of GHGs;
•
Rules and future rules issued by the USEPA, the Ohio EPA or other authorities associated with the federal Clean Water Act, which prohibits the discharge of pollutants into waters of the United States except pursuant to appropriate permits; and
•
Solid and hazardous waste laws and regulations, which govern the management and disposal of certain waste.
In addition to imposing continuing compliance obligations, these laws and regulations authorize the imposition of substantial penalties for noncompliance, including fines, injunctive relief and other sanctions. In the normal course of business, we have investigatory and remedial activities underway at our facilities to comply, or to determine compliance, with such regulations. We record liabilities for loss contingencies related to environmental matters when a loss is probable of occurring and can be reasonably estimated in accordance with the provisions of GAAP. Accordingly, we have immaterial accruals for loss contingencies for environmental matters. We also have a number of environmental matters for which we have not accrued loss contingencies because the risk of loss is not probable, or a loss cannot be reasonably estimated. We evaluate the potential liability related to environmental matters quarterly and may revise our estimates. Such revisions in the estimates of the potential liabilities could have a material adverse effect on our results of operations, financial condition or cash flows.
We have several pending environmental matters associated with our coal-fired generation units. Some of these matters could have material adverse impacts on the operation of the power stations.
Note 12 - Related Party Transactions
Service Company
Effective January 1, 2014, the Service Company began providing services including operations, accounting, legal, human resources, information technology and other corporate services on behalf of companies that are part of the U.S. SBU, including, among other companies, DPL and DP&L. The Service Company allocates the costs for these services based on cost drivers designed to result in fair and equitable allocations. This includes ensuring that the regulated utilities served, including DP&L, are not subsidizing costs incurred for the benefit of other businesses.
Benefit plans
DPL participates in an agreement with Health and Welfare Benefit Plans LLC, an affiliate of AES, to participate in a group benefits program, including but not limited to, health, dental, vision and life benefits. Health and Welfare Benefit Plans LLC administers the financial aspects of the group insurance program, receives all premium payments from the participating affiliates, and makes all vendor payments.
Long-term Compensation Plan
During 2017, 2016 and 2015, many of DP&L’s non-union employees received benefits under the AES Long-term Compensation Plan, a deferred compensation program. This type of plan is a common employee retention tool used in our industry. Benefits under this plan are granted in the form of performance units payable in cash and AES restricted stock units and options to purchase shares of AES common stock, however no stock options were granted in 2016. All such components vest over a three-year period and the terms of the AES restricted stock units issued prior to 2011 also include a two-year minimum holding period after the awards vest. Awards made in 2011 and for subsequent years are not subject to a two-year holding period. In addition, the performance units payable in cash are subject to certain AES performance criteria. Total deferred compensation expense recorded during 2017, 2016 and 2015 was $0.4 million, $0.5 million and $0.5 million, respectively, and was included in “Other Operating Expenses” on DP&L’s Statements of Operations. The value of these benefits is being recognized over the 36-month vesting period and a portion is recorded as miscellaneous deferred credits with the remainder recorded as “Paid in capital” on DP&L’s Balance Sheets in accordance with FASC 718 “Compensation - Stock Compensation.”
The following table provides a summary of these transactions:
(a)
DP&L sold power to DPLER and MC Squared to satisfy the electric requirements of their retail customers. The revenue dollars associated with sales to DPLER and MC Squared are recorded as wholesale revenues in DP&L’s Financial Statements. These agreements were terminated on the sale of DPLER on January 1, 2016.
(b)
MVIC, a wholly-owned captive insurance subsidiary of DPL, provides insurance coverage to DP&L and other DPL subsidiaries for workers’ compensation, general liability, property damages and directors’ and officers’ liability. These amounts represent insurance premiums charged by MVIC to DP&L.
(c)
In the normal course of business DP&L incurred and recorded expenses on behalf of DPL affiliates, which included DPLER. Such expenses included but were not limited to employee-related expenses, accounting, information technology, payroll, legal and other administration expenses. DP&L subsequently charged these expenses to the affiliates at DP&L’s cost and credited the expense in which they were initially recorded.
Income taxes
AES files federal and state income tax returns which consolidate DPL and its subsidiaries, including DP&L. Under a tax sharing agreement with DPL, DP&L is responsible for the income taxes associated with its own taxable income and records the provision for income taxes using a separate return method. Under this agreement, DP&L had a net receivable balance of $8.6 million and $9.5 million at December 31, 2017 and 2016, respectively, which is recorded in Other current assets on the accompanying Balance Sheets.
Note 13 - Generation Separation
On October 1, 2017, DP&L completed the transfer of its generating plants, the real property on which the generation plants and generation-related assets are sited, step-up transformers and other transmission plant assets used to interconnect with the electric transmission grid, fuel inventory, equipment inventory and spare parts, working capital, and other miscellaneous generation-related assets and liabilities ("Generation assets") to AES Ohio Generation. The transfer was completed as a contribution through an asset contribution agreement to a wholly-owned subsidiary of DP&L after which DP&L then distributed all of the outstanding equity in the subsidiary to DPL and then the subsidiary was merged into AES Ohio Generation.
The following table summarizes the carrying amounts of DP&L's Generation assets that were transferred to AES Ohio Generation on October 1, 2017:
(a)
Long-term debt that transferred to AES Ohio Generation relates to capital leases.
(b)
Accrued taxes and deferred taxes transferred to AES Ohio Generation represent the tax asset position netted with liabilities on DP&L prior to Generation Separation.
DP&L's generation business met the criteria to be classified as a discontinued operation, and, accordingly, the historical activity has been reclassified to "Discontinued operations" in the Statements of Operations for the years ended December 31, 2017, 2016 and 2015. Similarly, the assets and liabilities related to the generation business were classified as held-for-sale as of December 31, 2016.
The following table summarizes the major categories of assets and liabilities at December 31, 2016, and the revenues, cost of revenues, operating and other expenses and income tax of discontinued operations for the periods indicated:
(a)
Deferred taxes represent the tax asset position netted with liabilities on DP&L prior to Generation Separation.
Cash flows related to discontinued operations are included in the Statements of Cash Flows. Cash flows from operating activities for discontinued operations were $(10.4) million, $50.9 million and $138.7 million for the years ended December 31, 2017, 2016 and 2015, respectively. Cash flows from investing activities for discontinued operations were $23.4 million, $(50.9) million and $(24.3) million for the years ended December 31, 2017, 2016 and 2015, respectively. Cash flows from financing activities for discontinued operations were $(13.0) million, $0.0 million and $(114.4) million for the years ended December 31, 2017, 2016 and 2015, respectively.
The PUCO authorized DP&L to maintain long-term debt of $750 million or 75% of its rate base, whichever is greater, until January 1, 2018, or to file an application to explain why it would not achieve those metrics. Accordingly, $750.0 million of debt and the pro rata interest expense associated with that debt were allocated to continuing operations. All remaining debt and interest expense were included in discontinued operations above. The interest expense included in discontinued operations was $0.2 million, $0.5 million and $2.9 million for the years ended December 31, 2017, 2016 and 2015, respectively.
Note 14 - Subsequent Event
On February 26, 2018, DP&L and its co-owners of the retired Beckjord Facility agreed to transfer their interests in the retired Facility to a third party, including their obligations to remediate the Facility and its site, and the transfer occurred on that same date. As a result, DP&L estimates that it will recognize aggregate pre-tax loss on disposal charges of approximately $12.4 million and that cash expenditures of $15.0 million in the aggregate will be made, inclusive of cash expenditures for the disposal charges.
Item 9
Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A
Item 9A - Controls and Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the CEO and CFO, as appropriate, to allow timely decisions regarding required disclosures.
We carried out the evaluation required by Rules 13a-15(b) and 15d-15(b), under the supervision and with the participation of our management, including the CEO and CFO, of the effectiveness of our “disclosure controls and procedures” (as defined in the Exchange Act Rules 13a-15(e) and 15d-15(e)). Based upon this evaluation, our CEO and CFO concluded that as of December 31, 2017, our disclosure controls and procedures were effective.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Exchange Act. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP and includes those policies and procedures that:
•
pertain to the maintenance of records that in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
•
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and
•
provide reasonable assurance that unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements are prevented or detected timely.
Management, including our CEO and CFO, does not expect that our internal controls will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. In addition, any evaluation of the effectiveness of controls is subject to risks that those internal controls may become inadequate in future periods because of changes in business conditions, or that the degree of compliance with the policies or procedures deteriorates.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2017. In making this assessment, management used the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in 2013. Based on this assessment, management believes that we maintained effective internal control over financial reporting as of December 31, 2017.
Changes in Internal Control Over Financial Reporting:
There were no changes that occurred during the quarter ended December 31, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B
Item 9B - Other Information
On February 26, 2018, DP&L and its co-owners of the retired Beckjord Facility agreed to transfer their interests in the retired Facility to a third party, including their obligations to remediate the Facility and its site, and the transfer occurred on that same date. As a result, DPL and DP&L estimate that they will recognize aggregate pre-tax loss on disposal charges of approximately $11.7 million and $12.4 million, respectively, and that cash expenditures of $15.0 million in the aggregate will be made, inclusive of cash expenditures for the disposal charges.
PART III
Item 10
Item 10 - Directors, Executive Officers and Corporate Governance
Not applicable pursuant to General Instruction I of the Form 10-K.
Item 11
Item 11 - Executive Compensation
Not applicable pursuant to General Instruction I of the Form 10-K.
Item 12
Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
Not applicable pursuant to General Instruction I of the Form 10-K.
Item 13
Item 13 - Certain Relationships and Related Transactions, and Director Independence
Not applicable pursuant to General Instruction I of the Form 10-K.
Item 14
Item 14 - Principal Accountant Fees and Services
Accountant Fees and Services
The following table presents the aggregate fees billed for professional services rendered to DPL and DP&L by Ernst & Young LLP during the years ended December 31, 2017 and 2016. Other than as set forth below, no professional services were rendered or fees billed by Ernst & Young LLP during the years ended December 31, 2017 and 2016.
(a)
Audit fees relate to professional services rendered for the audit of our annual financial statements and the reviews of our quarterly financial statements and other services that are normally provided in connection with regulatory filing or engagements and services rendered under an agreed upon procedure engagement related to environmental studies.
(b)
Audit-related fees relate to services rendered to us for assurance and related services.
The Boards of Directors of DPL Inc. and The Dayton Power and Light Company (collectively, the Board) pre-approve all audit and permitted non-audit services, including engagement fees and terms for such services in accordance with Section 10A of the Securities Exchange Act of 1934, as amended. The Board will generally pre-approve a listing of specific services and categories of services, including audit, audit-related and other services, for the upcoming or current fiscal year, subject to a specified cost level. Any material service not included in the pre-approved list of services must be separately pre-approved by the Board. In addition, all audit and permissible non-audit services in excess of the pre-approved cost level, whether or not such services are included on the pre-approved list of services, must be separately pre-approved by the Board.
PART IV
Item 15
Item 15 - Exhibits, Financial Statements and Financial Statement Schedules
Exhibits
DPL and DP&L exhibits are incorporated by reference as described unless otherwise filed as set forth herein.
The exhibits filed as part of DPL’s and DP&L’s Annual Report on Form 10-K, respectively, are:
Exhibits referencing File No. 1-9052 have been filed by DPL Inc. and those referencing File No. 1-2385 have been filed by The Dayton Power and Light Company.
Pursuant to paragraph (b)(4)(iii)(A) of Item 601 of Regulation S-K, we may not file as an exhibit to this Form 10-K certain instruments with respect to long-term debt if the total amount of securities authorized thereunder does not exceed 10% of the total assets of us and our subsidiaries on a consolidated basis, but we hereby agree to furnish to the SEC on request any such instruments.
Item 16 - Form 10-K Summary
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, DPL Inc. and The Dayton Power and Light Company have duly caused this report to be signed on their behalf by the undersigned, thereunto duly authorized.
DPL Inc.
February 26, 2018
/s/ Kenneth J. Zagzebski
Kenneth J. Zagzebski
President and Chief Executive Officer
(principal executive officer)
The Dayton Power and Light Company
February 26, 2018
/s/ Thomas A. Raga
Thomas A. Raga
President and Chief Executive Officer
(principal executive officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of DPL Inc. and in the capacities and on the dates indicated.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of The Dayton Power and Light Company and in the capacities and on the dates indicated.
Schedule II
(a) Amounts written off, net of recoveries of accounts previously written off