MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FIRSTENERGY'S BUSINESS
FE and its subsidiaries are principally involved in the transmission, distribution and generation of electricity through its reportable segments, Regulated Distribution and Regulated Transmission.
The Regulated Distribution segment distributes electricity through FirstEnergy's ten utility operating companies, serving approximately six million customers within 65,000 square miles ofOhio ,Pennsylvania ,West Virginia ,Maryland ,New Jersey andNew York , and purchases power for its POLR, SOS, SSO and default service requirements inOhio ,Pennsylvania ,New Jersey andMaryland . This segment also controls 3,580 MWs of regulated electric generation capacity located primarily inWest Virginia andVirginia . The segment's results reflect the costs of securing and delivering electric generation from transmission facilities to customers, including the deferral and amortization of certain related costs. The Regulated Transmission segment provides transmission infrastructure owned and operated by the Transmission Companies and certain of FirstEnergy's utilities (JCP&L, MP, PE and WP) to transmit electricity from generation sources to distribution facilities. The segment's revenues are derived from forward-looking formula rates. Forward-looking rates recover costs thatFERC determines are permitted to be recovered and provide a return on transmission capital investment. Under forward-looking formula rates, the revenue requirement is updated annually based on a projected rate base and projected costs, which is subject to an annual true-up based on actual costs. The segment's results also reflect the net transmission expenses related to the delivery of electricity on FirstEnergy's transmission facilities. Corporate/Other reflects corporate support and other costs not charged or attributable to the Utilities or Transmission Companies, including FE's retained Pension and OPEB assets and liabilities of theFES Debtors, interest expense on FE's holding company debt and other businesses that do not constitute an operating segment. Additionally, reconciling adjustments for the elimination of inter-segment transactions are included in Corporate/Other. As ofSeptember 30, 2021 , 67 MWs of electric generating capacity, representing AE Supply's OVEC capacity entitlement, was included in continuing operations of Corporate/Other. As ofSeptember 30, 2021 , Corporate/Other had approximately$7.4 billion of FE holding company debt. 38
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EXECUTIVE SUMMARY
FirstEnergy is a forward-thinking, electric utility centered on integrity, powered by a diverse team of employees, committed to making customers' lives brighter, the environment better and our communities stronger. As a fully regulated electric utility, FirstEnergy is focused on stable and predictable earnings and cash flow from its Regulated Distribution and Regulated Transmission business units that deliver enhanced customer service and reliability that supports FE's dividend. OnJuly 21, 2020 , a complaint and supporting affidavit containing federal criminal allegations were unsealed against the now former Ohio House SpeakerLarry Householder and other individuals and entities allegedly affiliated withMr. Householder . Also, onJuly 21, 2020 , and in connection with the investigation, FirstEnergy received subpoenas for records from theU.S. Attorney's Office for the S.D. Ohio . FirstEnergy was not aware of the criminal allegations, affidavit or subpoenas beforeJuly 21, 2020 . OnJuly 21, 2021 , FE entered into a three-year DPA with theU.S. Attorney's Office that, subject to court proceedings, resolves theU.S. Attorney's Office investigation into FirstEnergy relating to FirstEnergy's lobbying and governmental affairs activities concerning HB 6, which, among other things required FE to pay a monetary penalty of$230 million , which FE paid in the third quarter of 2021. Under the DPA, FE agreed to the filing of a criminal information charging FE with one count of conspiracy to commit honest services wire fraud. The$230 million payment was made during the third quarter of 2021 and will neither be recovered in rates or charged to FirstEnergy customers nor will FirstEnergy seek any tax deduction related to such payment. Under the terms of the DPA, the criminal information will be dismissed after FirstEnergy fully complies with its obligations under the DPA. In addition to the subpoenas referenced above, the OAG, certain FE shareholders and FirstEnergy customers filed several lawsuits against FirstEnergy and certain current and former directors, officers and other employees, each relating to the allegations against the now former Ohio House SpeakerLarry Householder and other individuals and entities allegedly affiliated withMr. Householder . In addition, onAugust 10, 2020 , theSEC , through itsDivision of Enforcement , issued an order directing an investigation of possible securities laws violations by FE, and onSeptember 1, 2020 , issued subpoenas to FE and certain FE officers. Subsequently, onApril 28, 2021 , theSEC issued an additional subpoena to FE. Further, in a letter datedFebruary 22, 2021 , staff ofFERC's Division of Investigations notified FirstEnergy that the Division is investigating FirstEnergy's lobbying and governmental affairs activities concerning HB 6. A committee of independent members of the FE Board was put in place to direct an internal investigation related to the ongoing government investigations. In addition, the FE Board formed a sub-committee of the Audit Committee to, together with the FE Board, assess FirstEnergy's compliance program and implement potential changes, as appropriate. FirstEnergy has taken the following steps to address current challenges and improve its compliance culture: •Certain members of senior management, including the former Chief Executive Officer, were terminated for violating certain FirstEnergy policies and code of conduct. •Immediately following these terminations, the independent members of its FE Board appointed Mr.Steven E. Strah to the position of Acting Chief Executive Officer and Mr.Christopher D. Pappas , a current member of the FE Board, to the temporary position of Executive Director. InMarch 2021 ,Mr. Strah was elected to the position of Chief Executive Officer and a Director of the FE Board.
•FirstEnergy's Chief Legal Officer and Chief Ethics Officer were separated from
FirstEnergy in
•InFebruary 2021 , the FE Board appointed Mr.John W. Somerhalder II to the positions of Vice Chairperson of the FE Board and Executive Director, replacingMr. Pappas , who continues to serve on the FE Board as an independent director. The FE Board also appointed Mr.Hyun Park to the position of Senior Vice President & Chief Legal Officer and Mr.Antonio Fernández , to the position of Vice President and Chief Ethics and Compliance Officer, inJanuary 2021 andMarch 2021 , respectively. These executives help play a critical role in enhancing FirstEnergy's culture of compliance, ethics, integrity and accountability. •InMarch 2021 , in connection with an agreement withIcahn Capital , the FE Board appointedAndrew Teno andJesse Lynn as Directors to the FE Board, increasing the size from 12 directors to 14. However, until such time as all final regulatory approvals are obtained, neitherMr. Teno norMr. Lynn will have the right to vote at any meeting of the FE Board or any committee thereof. InMay 2021 ,Melvin D. Williams was elected to the FE Board, filling a vacant seat. InJune 2021 , the FE Board appointedLisa Winston Hicks andPaul Kaleta as directors to the FE Board, further increasing the size from 14 directors to 16. •FirstEnergy is making significant changes in its approach to political and legislative engagement and advocacy, through stopping all contributions to 501(c)(4) organizations, the pause of other political disbursements, including from the FirstEnergy Political Action Committee, limiting participation in the political process, suspending or terminating various political consulting relationships, and adding additional oversight and significantly more robust disclosure around political spending to provide increased transparency. 39 --------------------------------------------------------------------------------
•In
•Performed training on up-the-ladder reporting for the Legal Department in
•In
•InMay 2021 , FirstEnergy separated its Vice President, Rates and Regulatory Affairs, and Acting Vice President, External Affairs due to this individual's inaction with respect to a previously disclosed purported consulting agreement. •OnJune 29, 2021 , the FE Board established a SLC of the FE Board, effectiveJuly 1, 2021 . The SLC has been delegated full authority by the FE Board to take all actions as the SLC deems advisable, appropriate, and in the best interests of FirstEnergy and its shareholders with respect to pending shareholder derivative litigation and demands. Each ofMs. Hicks and Messrs. Kaleta, Lynn and Williams were appointed to serve on the SLC. •OnJuly 20, 2021 , the FE Board approved and adopted a new Code of Business Conduct, which: •Promotes and emphasizes FirstEnergy's commitment to compliance and ethics, •Establishes a "speak up" culture in which stakeholders are encouraged to report actual or suspected Code of Business Conduct violations without fear of retaliation, •Conforms to applicable compliance standards, and •Improves readability
•On
•During the third quarter of 2021, FirstEnergy appointed new senior leaders committed to supporting integrity, including: •Vice President of Internal Audit, •Vice President andChief Risk Officer , and •Director of Ethics & Compliance. •FirstEnergy completed additional steps toward enhancing the overall compliance program, including: •Completion of theOffice of Ethics & Compliance charter, •Delivered a Chief Ethics & Compliance Officer-led Code Awareness training to senior leader and individuals with significant roles in FirstEnergy's control environment, •Conducted leader-led training on the Code of Business Conduct for all leaders, •Published an Ethics & Compliance Communication Plan, and •Selected and began implementation planning for a Governance, Risk and Compliance tool Also, in connection with the internal investigation, FirstEnergy identified certain transactions, which, in some instances, extended back ten years or more, including vendor service, that were either improperly classified, misallocated to certain of the Utilities and Transmission Companies, or lacked proper supporting documentation. These transactions resulted in amounts collected from customers that were immaterial to FirstEnergy. The Utilities and Transmission Companies are working with the appropriate regulatory agencies to address these amounts.
FirstEnergy has also taken proactive steps to reduce regulatory uncertainty affecting the Ohio Companies:
•OnJanuary 31, 2021 , FirstEnergy reached a partial settlement with the OAG and other parties regarding decoupling. While the partial settlement with the OAG focused specifically on decoupling, the Ohio Companies will of their own accord, not seek to recover lost distribution revenue from residential and commercial customers. •OnMarch 31, 2021 , FirstEnergy announced that the Ohio Companies will proactively refund to customers amounts previously collected under the decoupling mechanism authorized underOhio law, which totals approximately$27 million , with interest. OnJuly 7, 2021 , the PUCO approved the Ohio Companies' proposal to return the amount to customers inAugust 2021 . •Also onMarch 31, 2021 ,Governor DeWine signed HB 128, which, among other things, repealed parts of HB 6, the legislation that established support for nuclear energy supply inOhio , provided for a decoupling mechanism for electric utilities, and provided for the ending of current energy efficiency program mandates. •FirstEnergy is committed to pursuing an open dialogue in an appropriate manner with the several regulatory proceedings currently underway, including a state management audit, and multi-year SEET and ESP quadrennial review, among other matters. FirstEnergy believes a holistic transparent discussion with the PUCO staff, and interested 40 -------------------------------------------------------------------------------- stakeholders in the regulatory process, is an important step towards removing uncertainties about regulatory concerns inOhio and critical to re-establishing trust in FirstEnergy and restoring its reputation. Despite the many disruptions FirstEnergy is currently facing, the leadership team remains committed and focused on executing its strategy and running the business. See "Outlook - Other Legal Proceedings" below for additional details on the government investigations, the DPA, and subsequent litigation surrounding the investigation of HB 6. See also "Outlook - State Regulation -Ohio " below for details on the PUCO proceeding reviewing political and charitable spending and legislative activity in response to the investigation of HB 6. The outcome of the government investigations, PUCO proceedings, legislative activity, and any of these lawsuits is uncertain and could have a material adverse effect on FirstEnergy's financial condition, results of operations and cash flows. As discussed below, FirstEnergy has made reductions to its Regulated Distribution and Regulated Transmission capital investment plans and is considering reductions to operating expenses, as well as changes to its planned equity issuances, to allow for flexibility, for among other things, to address the outcomes of the ongoing government investigations and related lawsuits and regulatory actions. OnOctober 18, 2021 , FE, FET, the Utilities, and the Transmission Companies entered into six separate senior unsecured five-year syndicated revolving credit facilities withJPMorgan Chase Bank, N.A .,Mizuho Bank, Ltd. andPNC Bank, National Association (collectively, the "2021 Credit Facilities"), which replace the FE Revolving Facility and the FET Revolving Facility, and provide for aggregate commitments of$4.5 billion . The 2021 Credit Facilities are available untilOctober 18, 2026 , as follows:
•FE and FET,
Under the 2021 Credit Facilities, an aggregate amount of$4.5 billion is available to be borrowed, repaid and reborrowed, subject to each borrower's respective sublimit for each borrower under the respective facilities. These new credit facilities provide substantial liquidity to support the Regulated Distribution and Regulated Transmission businesses, and each of the operating companies within the businesses. FirstEnergy is also working to improve how it conducts business and serve its customers. InFebruary 2021 , FirstEnergy announced a new initiative to build upon FirstEnergy's strong operations and business fundamentals and deliver immediate value and resilience, with substantial operating and capital efficiencies ramping up through 2024. Called "FE Forward," the initiative will play a critical first step in FirstEnergy's transformation journey as it looks to optimize processes and procedures through range of opportunities, including:
•Optimizing operations by expanding capabilities in areas such as strategic sourcing, inventory optimization and commercial contract terms, and by standardizing best-in-class work management policies across FirstEnergy;
•accelerating FirstEnergy's digital transformation by revamping customers' online experience, automating sourcing data collection and management, and deploying advanced analytics in asset health decisions as well as vegetation management programs; and
•productivity improvements through system integration that puts advanced technology tools, such as mobile dashboards and remote access to asset management information, in the hands of frontline employees.
During the initial phase of FE Forward, FirstEnergy reviewed existing policies and practices, as well as the structure and processes around how decisions are made. In the second phase of FE Forward completed inMay 2021 , FirstEnergy reviewed further improvement opportunities and developed detailed, executable plans focusing on who, when, how and at what cost opportunities can be realized. InJune 2021 , phase three began and is focused on executing and implementing these findings and opportunities. By 2024, FE Forward is projected to generate approximately$300 million in annualized capital expenditure efficiencies while continuing to hold operating expenses flat by absorbing approximately$100 million in projected increases. In addition, FirstEnergy expects to generate approximately$250 million in working capital improvements by 2022. This program includes an estimated$150 million of costs to achieve through 2023, which are expected to be self-funded through these efficiencies. FE Forward is not a downsizing effort and there will not be any involuntary employee reductions in connection with this program. FirstEnergy expects that FE Forward will be a significant catalyst to augment its growth potential by taking a more strategic approach to operating expenditures and reinvesting in a more diverse capital program that over the long-term continues to support a smarter and cleaner electric grid. As part of these efforts, FirstEnergy will evaluate the appropriate cadence to initiate rates cases on a state-by-state basis to best support FirstEnergy's customer-focused strategic priorities. 41 -------------------------------------------------------------------------------- For the Years Ended December 31, FE Forward Expected Capital Efficiencies and Working Capital Improvements 2021 2022 2023 (In millions) Gross Capital Expenditure Efficiencies$ 180 $ 210 $ 300 Cost to Achieve (+/- 10%) (40) (60) (50) Net Capital Expenditure Efficiencies$ 140 $ 150 $ 250 Working Capital Improvements 100 150 - Total Cash Flow Improvements$ 240
With an operating territory of 65,000 square miles, the scale and diversity of the ten Utilities that comprise the Regulated Distribution business uniquely position this business for growth through opportunities for additional investment, with plans to invest up to$6.6 billion in capital from 2020 to 2023. Over the past several years, Regulated Distribution has experienced rate base growth through investments that have improved reliability and added operating flexibility to the distribution infrastructure, which provide benefits to the customers and communities those Utilities serve. Additionally, this business is exploring other opportunities for growth, including investments in electric system improvement and modernization projects to increase reliability and improve service to customers, as well as exploring opportunities in customer engagement that focus on the electrification of customers' homes and businesses by providing a full range of products and services. With approximately 24,000 miles of transmission lines in operation, the Regulated Transmission business is the centerpiece of FirstEnergy's regulated investment strategy with 100% of its capital investments recovered under forward-looking formula rates at the Transmission Companies effectiveJanuary 1, 2021 . Regulated Transmission has also experienced significant growth as part of its Energizing the Future transmission plan with plans to invest up to$5.15 billion in capital from 2020 to 2023. FirstEnergy believes there are incremental investment opportunities for its existing transmission infrastructure of over$20 billion beyond those identified through 2023, which are expected to strengthen grid and cyber-security and make the transmission system more reliable, robust, secure and resistant to extreme weather events, with improved operational flexibility. While FirstEnergy continues to have customer-focused investment opportunities across its distribution and transmission businesses of up to$3 billion annually, it has discontinued providing a long-term earnings compound annual growth rate until there is further clarity regardingOhio regulatory matters and the ongoing government investigations. FirstEnergy anticipates the need to raise equity and continues to consider all options to raise equity capital. Currently, FirstEnergy is engaging in a process to sell a minority interest in its transmission holding company, FET. FirstEnergy is committed to improving the balance sheet, targeting metrics that support investment grade credit ratings, and to ensure financial flexibility to fund capital expenditures that support a smarter and cleaner electric grid. Beyond FirstEnergy's expectation to issue up to$100 million per year in equity for its regular stock investment and employee benefit plans, FirstEnergy continues to consider all options to raise equity and expects to provide additional clarity on those financing plans later during the fourth quarter of 2021. The amount and timing of any potential equity issuances or alternatives to raise equity capital, are subject to, among other matters, the ongoing government investigations, related lawsuits and regulatory actions, market conditions and business operations. FirstEnergy has established new goals for key areas of its business that support the mission to be a forward-thinking, electric utility centered on integrity, powered by a diverse team of employees, committed to making customers' lives brighter, the environment better and our communities stronger. InNovember 2020 , FirstEnergy published its Climate Story which includes its climate position and strategy, as well as a new comprehensive and ambitious GHG emission goal. FirstEnergy pledged to achieve carbon neutrality by 2050 and set an interim goal for a 30% reduction in GHG within FirstEnergy's direct operational control by 2030, based on 2019 levels. In addition, FirstEnergy has also set a fleet electrification goal in which beginning in 2021, FirstEnergy plans for 100% of new purchases for its light duty and aerial truck fleet to be electric or hybrid vehicles, creating a path to 30% fleet electrification by 2030. Also, later in 2021, FirstEnergy will seek approval to construct a solar generation source of at least 50 MWs inWest Virginia . Future resource plans to achieve carbon reductions, including any determination of retirement dates of the regulated coal-fired generating facilities, will be developed by working collaboratively with regulators inWest Virginia . Determination of the useful life of the regulated coal-fired generating facilities could result in changes in depreciation, and/or continued collection of net plant in rates after retirement, securitization, sale, impairment or regulatory disallowances. If MP is unable to recover these costs, it could have a material adverse effect on FirstEnergy's and/or MP's financial condition, results of operations, and cash flow. 42
-------------------------------------------------------------------------------- InJanuary 2021 , the updated "Strategic Plan - Powered by our Core Values & Behaviors" was published. This comprehensive update provides a vision of FirstEnergy's path forward in an evolving electric industry. It also articulates significant new goals that will help achieve our long-term strategic commitments in a transparent, sustainable and responsible manner. The Strategic Plan includes specific targets related to:
•Enhancing a culture of compliance through transparency and accountability;
•Enabling a smarter, more resilient electric system;
•Embracing innovation across the organization;
•Meeting the challenges of climate change;
•Developing a diverse and inclusive workforce, including 2025 goals to increase the number of employees and leaders from underrepresented racial and ethnic groups by 30% each and targeting 20% of supply chain spend to be with diverse suppliers;
•Building collaborative relationships, marked by trust and respect, with all stakeholders;
•Strengthening FirstEnergy's safety-first culture; and
•Delivering strong and predictable financial results.
43 -------------------------------------------------------------------------------- FINANCIAL OVERVIEW AND RESULTS OF OPERATIONS (In millions) For the Three Months Ended September 30, For the Nine Months Ended September 30, 2021 2020 Change 2021 2020 Change Revenues$ 3,124 $ 3,022 $ 102 3 %$ 8,472 $ 8,253 $ 219 3 % Operating expenses 2,493 2,301 192 8 % 6,970 6,485 485 7 % Operating income 631 721 (90) (12) % 1,502 1,768 (266) (15) % Other expenses, net (127) (145) 18 12 % (422) (855) 433 51 % Income before income taxes 504 576 (72) (13) % 1,080 913 167 18 % Income taxes 88 116 (28) (24) % 271 122 149 NM Income from continuing operations 416 460 (44) (10) % 809 791 18 2 % Discontinued operations, net of tax 47 (6) 53 NM 47 46 1 NM Net income$ 463 $ 454 $ 9 2 %$ 856 $ 837 $ 19 2 % *NM= not meaningful The financial results discussed below include revenues and expenses from transactions among FirstEnergy's business segments. A reconciliation of segment financial results is provided in Note 10, "Segment Information," of the Notes to Consolidated Financial Statements. 44
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