For the three months ended and year to date September 30, 2007, the computation of diluted EPS excludes anti-dilutive shares of 182,807 and 134,788 performance shares and 421,685 and 381,451 restricted stock shares, respectively. There were no anti-dilutive shares applicable to FELINE PRIDES, stock options or a forward sale agreement. FELINE PRIDES settled in the first quarter of 2007 and the forward sale agreement settled in the second quarter of 2007. For the three months ended and year to date September 30, 2006, the computation of diluted EPS excludes anti-dilutive shares of 105,198 and 106,706 performance shares and 99,838 and 116,468 restricted stock shares, respectively. Additionally, for the three months ended and year to date September 30, 2006, 6.5 million of anti-dilutive FELINE PRIDES were excluded from the computation of diluted EPS and there were no anti-dilutive shares applicable to stock options or a forward sale agreement.
Consolidated KCP&L’s other receivables at September 30, 2007, and December 31, 2006, consisted primarily of receivables from partners in jointly owned electric utility plants and wholesale sales receivables. Great Plains Energy’s other receivables at September 30, 2007, and December 31, 2006, consisted primarily of accounts receivable held by Strategic Energy, including unbilled receivables of $155.7 million and $95.0 million, respectively.
| | | | | | | |
| | September 30 | December 31 |
| | 2007 | 2006 |
Regulatory Assets | | (millions) | |
| Taxes recoverable through future rates | | $ | 70.8 | | | $ | 81.7 | |
| Loss on reacquired debt | | | 6.0 | | | | 6.4 | |
| Change in depreciable life of Wolf Creek | | | 45.4 | | | | 45.4 | |
| Cost of removal | | | 8.0 | | | | 8.2 | |
| Asset retirement obligations | | | 18.1 | | | | 16.9 | |
| SFAS 158 pension and post-retirement costs | | | 177.2 | | | | 190.0 | |
| Other pension and post-retirement costs | | | 74.7 | | | | 66.9 | |
| Surface Transportation Board litigation expenses | | | 1.8 | | | | 1.7 | |
| Deferred customer programs | | | 10.5 | | | | 5.9 | |
| 2006 rate case expenses | | | 1.9 | | | | 2.6 | |
| 2007 rate case expenses | | | 0.9 | | | | - | |
| Other | | | 6.4 | | | | 8.7 | |
| Total | | $ | 421.7 | | | $ | 434.4 | |
Regulatory Liabilities | | | | | | | | |
| Emission allowances | | $ | 64.5 | | | $ | 64.5 | |
| Asset retirement obligations | | | 40.7 | | | | 35.6 | |
| Additional Wolf Creek amortization (Missouri) | | | 14.7 | | | | 14.6 | |
| Total | | $ | 119.9 | | | $ | 114.7 | |
| | | | | | | | | |
Except as noted below, regulatory assets for which costs have been incurred have been included (or are expected to be included, for costs incurred subsequent to the most recently approved rate case) in KCP&L’s rate base, thereby providing a return on invested costs. Certain regulatory assets do not result from cash expenditures and therefore do not represent investments included in rate base or have offsetting liabilities that reduce rate base. The regulatory asset for Statement of Financial Accounting Standards (SFAS) 158 pension and post-retirement costs at September 30, 2007, includes $2.5 million, net of related liabilities, not included in rate base, representing the difference between funding and expenses recognized for the pension and post-retirement plans, which will be amortized in accordance with SFAS No. 87, “Employers’ Accounting for Pensions.” The regulatory asset for other pension and post-retirement costs at September 30, 2007, includes $36.1 million representing pension settlements and financial and regulatory accounting method differences. The pension settlements will be amortized over a five-year period beginning with the effective date of rates approved in KCP&L’s next rate case. The accounting method difference will be eliminated over the life of the pension plans. Certain insignificant items in Regulatory Assets – Other are also not included in rate base.
Revenue Sufficiency Guarantee
Since the April 2005 implementation of Midwest Independent Transmission System Operator Inc. (MISO) market operations, MISO’s business practice manuals and other instructions to market participants have stated that Revenue Sufficiency Guarantee (RSG) charges will not be imposed on day-ahead virtual offers to supply power not supported by actual generation. RSG charges are collected by MISO in order to compensate generators that are standing by to supply electricity when called upon by MISO. In April 2006, FERC issued an order regarding MISO RSG charges. In its order, FERC interpreted MISO's tariff to require that virtual supply offers be included in the calculation of RSG charges and that to the extent that MISO did not charge market participants RSG charges on virtual supply offers, MISO violated its tariff. The FERC order required MISO to recalculate RSG rates back to April 1, 2005, and make refunds to customers who paid RSG charges on imbalances, with interest, reflecting the recalculated charges. In order to make such refunds, RSG charges could have been retroactively imposed on market participants who submitted virtual supply offers during the recalculation period. Strategic Energy was among the MISO participants that could have been subject to a retroactive assessment from MISO for RSG charges on virtual supply offers it submitted during the recalculation period. In October 2006, FERC issued an order on rehearing of the April 2006 order stating it would not assess RSG charges on virtual supply offers going back to April 1, 2005, but ordered prospective allocation of RSG to virtual transactions and directed MISO to propose a tariff change that would assess RSG costs to virtual supply offers based on principles of cost causation within 60 days of the October 2006 order.
In March 2007, FERC issued an order denying requests for rehearing of its October 2006 order, which refused to allow MISO to retroactively assess RSG charges on virtual supply offers. Also in March 2007, FERC rejected MISO’s tariff filing that would have established a new RSG charge prospectively and instructed MISO to recalculate RSG charges from April 2006 forward. Parties, including Strategic Energy, have appealed and filed requests for rehearing. Management believes the ultimate outcome of this matter will not have a significant impact on the Company’s financial position or results of operations; however, the actual exposure, if any, could ultimately be greater than management’s estimate depending on the outcome of appeals and the requests pending before FERC. Management is unable to predict the outcome of any appeals or further requests for rehearing.
Seams Elimination Charge Adjustment
Seams Elimination Charge Adjustment (SECA) is a transitional pricing mechanism authorized by FERC and intended to compensate transmission owners for the revenue lost as a result of FERC’s elimination of regional through and out rates between PJM Interconnection, LLC (PJM) and MISO during a 16-month transition period from December 1, 2004, through March 31, 2006. Each relevant PJM and MISO zone and the load-serving entities within that zone were allocated a portion of SECA based on
transmission services provided to that zone during 2002 and 2003. For the three months ended September 30, 2007, Strategic Energy recorded no reduction of purchased power expenses and recorded $1.9 million year to date to reflect recoveries obtained through settlements primarily with Transmission Owners. Strategic Energy did not record any significant SECA activity for the three months ended September 30, 2006. Year to date September 30, 2006, Strategic Energy recorded a reduction of purchased power expense of $2.4 million for SECA, which partially offset $2.7 million of expense recorded in the first quarter. Strategic Energy billed $1.3 million year to date September 30, 2006 of its SECA costs to its retail customers. No further retail customer billings are anticipated pending the outcome of proceedings discussed below.
There are several unresolved matters and legal challenges related to SECA that are pending before FERC on rehearing. In 2006, FERC held hearings on the justness and reasonableness of the SECA rate and on attempts by suppliers to shift SECA to wholesale counterparties and subsequently, a favorable initial decision was extended by an administrative law judge, which could potentially result in a refund of prior SECA payments, including payments made by Strategic Energy. Management is awaiting FERC action and is unable to predict the outcome of legal and regulatory challenges to the SECA mechanism.
Investigation of Strategic Energy Non-Compliance
During the first quarter of 2007, Strategic Energy identified and self-reported an event of non-compliance to one of the primary market regulators where Strategic Energy conducts scheduling and settlement operations. The regulator subsequently notified Strategic Energy in April 2007 of its intent to conduct an investigation, which concluded in October 2007. There will not be any adverse actions or events as an outcome of this investigation significantly beyond the amount of penalty recorded at September 30, 2007.
7. | SHORT-TERM BORROWINGS AND SHORT-TERM BANK LINES OF CREDIT |
In July 2007, pursuant to the terms of their credit agreements, Great Plains Energy and KCP&L transferred $200 million of unused lender commitments from the Great Plains Energy credit agreement to the KCP&L credit agreement. The maximum aggregate amount available under the Great Plains Energy credit agreement was reduced to $400 million from $600 million, and the maximum aggregate amount available under the KCP&L credit agreement was increased to $600 million from $400 million.
Great Plains Energy’s $400 million revolving credit facility with a group of banks expires in May 2011. A default by Great Plains Energy or any of its significant subsidiaries on other indebtedness totaling more than $25.0 million is a default under the facility. Under the terms of this agreement, Great Plains Energy is required to maintain a consolidated indebtedness to consolidated capitalization ratio, as defined in the agreement, not greater than 0.65 to 1.00 at all times. At September 30, 2007, Great Plains Energy was in compliance with this covenant. At September 30, 2007, Great Plains Energy had $36.0 million of outstanding borrowings with a weighted average interest rate of 5.95% and had issued letters of credit totaling $151.3 million under the credit facility as credit support for Strategic Energy. At December 31, 2006, Great Plains Energy had no cash borrowings and had issued letters of credit totaling $103.7 million under the credit facility as credit support for Strategic Energy.
KCP&L’s $600 million revolving credit facility with a group of banks to provide support for its issuance of commercial paper and other general corporate purposes expires in May 2011. A default by KCP&L on other indebtedness totaling more than $25.0 million is a default under the facility. Under the terms of the agreement, KCP&L is required to maintain a consolidated indebtedness to consolidated capitalization ratio, as defined in the agreement, not greater than 0.65 to 1.00 at all times. At September 30, 2007, KCP&L was in compliance with this covenant. At September 30, 2007, KCP&L had $208.6 million of commercial paper outstanding, at a weighted-average interest rate of 5.79%, $6.8 million of letters of credit and $50.0 million of outstanding cash borrowings with a weighted average interest rate of 5.47%
under the facility. At December 31, 2006, KCP&L had $156.4 million of commercial paper outstanding, at a weighted-average interest rate of 5.38%, $8.7 million of letters of credit and no cash borrowings under the facility.
At September 30, 2007, Strategic Energy had a $135 million revolving credit facility with a group of banks, expiring in June 2009. Under the agreement, $50.0 million in letters of credit had been issued and there were no cash borrowings at September 30, 2007. At December 31, 2006, $59.8 million in letters of credit had been issued and there were no cash borrowings under the agreement. In October 2007, Strategic Energy terminated the facility and entered into a new revolving credit facility with a group of banks, expiring in October 2010. The new facility provides for loans and letters of credit not exceeding an aggregate of the lesser of $50 million or the borrowing base, which is generally 85% of Strategic Energy’s retail accounts receivables plus the amount of a Great Plains Energy guarantee. Great Plains Energy issued an initial guarantee in the amount of $12.5 million and may increase the guarantee up to a maximum of $27.5 million to increase the borrowing base or to cure a default of the minimum fixed charge coverage ratio, provided that Great Plains Energy maintains certain favorable ratings on its senior unsecured debt. Under the terms of the agreement, Strategic Energy is required to maintain, as of the end of each quarter, a minimum fixed charge coverage ratio of at least 1.05 to 1.0 and a minimum EBITDA, as defined in the agreement, for the four quarters then ended of $15 million through March 31, 2008 and thereafter increasing to $17.5 million (through September 30, 2008), $20 million (through March 31, 2009) and $22.5 million through maturity.
At the same time, Strategic Energy entered into an agreement to sell its current and future retail accounts receivable to its wholly owned subsidiary, Strategic Receivables, which in turn sells undivided percentage ownership interests in the accounts receivable to Market Street and Fifth Third Bank ratably based on each purchaser’s commitments. Strategic Receivables may also issue letters of credit to Strategic Energy, with the amount of such letters of credit being credited against the purchase price. Market Street’s and Fifth Third Bank’s obligation to purchase accounts receivable is limited to $112.5 million and $62.5 million, respectively, less the proportionate aggregate amount of letters of credit issued pursuant to the agreement. Strategic Energy transferred its outstanding letters of credit under the terminated revolving credit facility totaling $49.8 million to the receivables facility upon termination.
8. | LONG-TERM DEBT AND EIRR BONDS CLASSIFIED AS CURRENT LIABILITIES |
Great Plains Energy and consolidated KCP&L’s long-term debt is detailed in the following table.
| | | | | | | |
| | | | | September 30 | | December 31 |
| | | Year Due | | 2007 | | 2006 |
Consolidated KCP&L | | | | (millions) |
| General Mortgage Bonds | | | | | | |
| 7.95% Medium-Term Notes | | 2007 | | $ - | | $ 0.5 |
| 4.00%* EIRR bonds | | 2012-2035 | | 158.8 | | 158.8 |
| Senior Notes | | | | | | |
| 6.00% | | 2007 | | - | | 225.0 |
| 6.50% | | 2011 | | 150.0 | | 150.0 |
| 5.85% | | 2017 | | 250.0 | | - |
| 6.05% | | 2035 | | 250.0 | | 250.0 |
| Unamortized discount | | | | (1.9) | | (1.6) |
| EIRR bonds | | | | | | |
| 4.75% Series 1998 A & B | | 2015 | | 106.5 | | 105.2 |
| 4.75% Series 1998 D | | 2017 | | 40.0 | | 39.5 |
| 4.65% Series 2005 | | 2035 | | 50.0 | | 50.0 |
| 4.05% Series 2007 A & B | | 2035 | | 146.5 | | - |
| Current liabilities | | | | | | |
| Current maturities | | | | - | | (225.5) |
| EIRR bonds classified as current | | | | (146.5) | | (144.7) |
| Total consolidated KCP&L excluding current maturities | | | 1,003.4 | | 607.2 |
| | | | | | | |
Other Great Plains Energy | | | | | | |
| 6.875% Senior Notes | | 2017 | | 100.0 | | - |
| Unamortized discount | | | | (0.5) | | - |
| 7.74% Affordable Housing Notes | | 2007-2008 | | 0.9 | | 0.9 |
| 4.25% FELINE PRIDES Senior Notes | | | | - | | 163.6 |
| Current maturities | | | | (0.6) | | (164.2) |
| Total consolidated Great Plains Energy excluding current maturities | | $ 1,103.2 | | $ 607.5 |
| * Weighted-average interest rates at September 30, 2007. | | | | | | |
| | | | | | | |
Effective Interest Rates on Unsecured Notes at September 30, 2007
Interest rate swaps on KCP&L’s Series A, B and D EIRR bonds resulted in an effective interest rate of 6.67%. As a result of amortizing the gain recognized in other comprehensive income (OCI) on KCP&L’s 2005 Treasury Locks (T-Locks), the effective interest rate on KCP&L’s 6.05% Senior Notes is 5.78%. During June 2007, KCP&L issued $250.0 million of 5.85% unsecured Senior Notes, maturing in 2017. As a result of amortizing the gain recognized in OCI on KCP&L’s 2006 Forward Starting Swaps (FSS), the effective interest rate on KCP&L’s 5.85% Senior Notes is 5.72%.
During September 2007, Great Plains Energy issued $100.0 million of 6.875% unsecured Senior Notes, maturing in 2017. As a result of amortizing the loss recognized in OCI on Great Plains Energy’s 2007 T-Locks, the effective interest rate on Great Plains Energy’s 6.875% Senior Notes is 7.33%.
EIRR Bonds Classified as Current Liabilities
KCP&L classified its 4.75% Series 1998 A, B and D EIRR bonds with maturity dates of 2015 and 2017 as current liabilities at September 30, 2007 and December 31, 2006. The cash proceeds of $146.5 million from KCP&L’s unsecured EIRR Bonds Series 2007A and 2007B issued during the third quarter of 2007 were used to repay the 4.75% Series 1998 A, B and D EIRR bonds on October 1, 2007.
The EIRR Bonds Series 2007A and 2007B are covered by a municipal bond insurance policy issued by Financial Guaranty Insurance Company (FGIC). The insurance agreement between KCP&L and FGIC provides for reimbursement by KCP&L for any amounts that FGIC pays under the municipal bond insurance policy. The insurance policy is in effect for the term of the bonds. The policy also restricts the amount of secured debt KCP&L may issue. In the event that KCP&L issues debt secured by liens not permitted by the agreement, KCP&L is required to issue and deliver to FGIC first mortgage bonds or similar securities equal in principal amount to the principal amount of the EIRR Bonds Series 2007A and 2007B then outstanding.
Amortization of Debt Expense
Great Plains Energy’s and consolidated KCP&L’s amortization of debt expense is detailed in the following table.
| | | | | | | | | | | | | | | |
| | Three Months Ended | | Year to Date | |
| | September 30 | | September 30 | |
| | | 2007 | | | | 2006 | | | 2007 | | | | 2006 | |
| | | (millions) | |
| Consolidated KCP&L | | $ | 0.5 | | | | $ | 0.5 | | | $ | 1.3 | | | | $ | 1.5 | |
| Other Great Plains Energy | | | 0.1 | | | | | 0.2 | | | | 0.8 | | | | | 0.5 | |
| Total Great Plains Energy | | $ | 0.6 | | | | $ | 0.7 | | | $ | 2.1 | | | | $ | 2.0 | |
| | | | | | | | | | | | | | | | | | | |
9. | COMMON SHAREHOLDERS’ EQUITY |
In 2006, Great Plains Energy entered into a forward sale agreement with Merrill Lynch Financial Markets, Inc. (forward purchaser) for 1.8 million shares of Great Plains Energy common stock. In April 2007, Great Plains Energy elected to terminate the forward sale agreement and settle it in cash. Based on the difference between Great Plains Energy’s average stock price of $32.60 over the period used to determine the settlement and the then-applicable forward price of $25.58, Great Plains Energy paid $12.3 million to Merrill Lynch Financial Markets, Inc.
Great Plains Energy made a capital contribution to KCP&L of $94.0 million in the third quarter of 2007. This contribution was used by KCP&L to repay a portion of its outstanding commercial paper.
10. | PENSION PLANS AND OTHER EMPLOYEE BENEFITS |
The Company maintains defined benefit pension plans for substantially all employees, including officers, of KCP&L, Services and WCNOC. Pension benefits under these plans reflect the employees’ compensation, years of service and age at retirement. The market value of plan assets is determined using a five-year average of assets.
Pension expense for KCP&L is recorded in accordance with rate orders from the MPSC and KCC that allow KCP&L to record the difference between pension costs under SFAS No. 87, “Employers Accounting for Pensions,” and pension costs for ratemaking to be recognized as a regulatory asset or liability.
Effective January 1, 2008, the Company is amending the defined benefit pension plan for management employees (other than WCNOC employees) to allow current employees the option to remain in the existing program or to choose a new retirement program which will provide, among other things, an enhanced benefit under the employee savings plan and a lower benefit accrual rate under the defined pension benefit plan. Employees hired after September 1, 2007, will be placed in the new retirement program.
In addition to providing pension benefits, the Company provides certain post-retirement health care and life insurance benefits for substantially all retired employees of KCP&L, Services and WCNOC. The cost of post-retirement benefits charged to KCP&L is accrued during an employee's years of service and recovered through rates.
The following table provides the components of net periodic benefit costs prior to the effect of capitalization and sharing with joint-owners of power plants.
| | | | | | | | | | | | | |
| | | Pension Benefits | | | Other Benefits | |
Three Months Ended September 30 | | 2007 | | | 2006 | | | 2007 | | | 2006 | |
Components of net periodic benefit cost | | (millions) | |
| Service cost | | $ | 4.6 | | | $ | 4.7 | | | $ | 0.3 | | | $ | 0.3 | |
| Interest cost | | | 7.5 | | | | 7.8 | | | | 1.0 | | | | 0.7 | |
| Expected return on plan assets | | | (7.4 | ) | | | (8.1 | ) | | | (0.1 | ) | | | (0.1 | ) |
| Prior service cost | | | 1.1 | | | | 1.0 | | | | 0.7 | | | | - | |
| Recognized net actuarial loss | | | 8.8 | | | | 7.9 | | | | 0.1 | | | | 0.2 | |
| Transition obligation | | | - | | | | - | | | | 0.3 | | | | 0.3 | |
| Settlement charge | | | - | | | | 2.0 | | | | - | | | | - | |
| Net periodic benefit cost before | | | | | | | | | | | | | | | | |
| regulatory adjustment | | | 14.6 | | | | 15.3 | | | | 2.3 | | | | 1.4 | |
| Regulatory adjustment | | | (2.1 | ) | | | (7.6 | ) | | | - | | | | - | |
| Net periodic benefit cost | | $ | 12.5 | | | $ | 7.7 | | | $ | 2.3 | | | $ | 1.4 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | Pension Benefits | | | Other Benefits | |
Year to Date September 30 | | 2007 | | | 2006 | | | 2007 | | | 2006 | |
Components of net periodic benefit cost | | (millions) | |
| Service cost | | $ | 13.8 | | | $ | 14.1 | | | $ | 0.8 | | | $ | 0.7 | |
| Interest cost | | | 22.4 | | | | 23.2 | | | | 2.8 | | | | 2.2 | |
| Expected return on plan assets | | | (22.2 | ) | | | (24.5 | ) | | | (0.5 | ) | | | (0.4 | ) |
| Prior service cost | | | 3.3 | | | | 3.2 | | | | 1.4 | | | | 0.1 | |
| Recognized net actuarial loss | | | 26.5 | | | | 23.9 | | | | 0.4 | | | | 0.6 | |
| Transition obligation | | | - | | | | - | | | | 0.9 | | | | 0.9 | |
| Settlement and termination charge | | | - | | | | 9.5 | | | | 0.3 | | | | - | |
| Net periodic benefit cost before | | | | | | | | | | | | | | | | |
| regulatory adjustment | | | 43.8 | | | | 49.4 | | | | 6.1 | | | | 4.1 | |
| Regulatory adjustment | | | (6.3 | ) | | | (22.9 | ) | | | - | | | | - | |
| Net periodic benefit cost | | $ | 37.5 | | | $ | 26.5 | | | $ | 6.1 | | | $ | 4.1 | |
| | | | | | | | | | | | | | | | | |
Great Plains Energy’s Long-Term Incentive Plan is an equity compensation plan approved by Great Plains Energy’s shareholders. KCP&L does not have an equity compensation plan; however, KCP&L officers participate in Great Plains Energy’s Long-Term Incentive Plan. The Long-Term Incentive Plan permits the grant of restricted stock, stock options, limited stock appreciation rights and performance shares to officers and other employees of the Company and its subsidiaries. Forfeiture rates are based on historical forfeitures and future expectations and are reevaluated annually.
The following table summarizes Great Plains Energy’s and KCP&L’s equity compensation expense and associated income tax benefits.
| | | | | | | | | |
| | Three Months Ended | Year to Date |
| | | September 30 | | September 30 |
| | | 2007 | | 2006 | | 2007 | | 2006 |
Compensation expense | | (millions) |
| Great Plains Energy | | $ 2.1 | | $ 1.2 | | $ 4.7 | | $ 2.9 |
| KCP&L | | 1.4 | | 0.7 | | 3.1 | | 1.8 |
Income tax benefits | | | | | | | | |
| Great Plains Energy | | 0.8 | | 0.4 | | 1.8 | | 0.8 |
| KCP&L | | 0.6 | | 0.2 | | 1.2 | | 0.5 |
| | | | | | | | | |
Performance Shares
Performance share activity year to date September 30, 2007, is summarized in the following table. Performance adjustment represents the number of performance shares ultimately paid that can vary from the number of shares initially granted depending on Company performance, based on internal and external measures, over stated performance periods.
| | | | | | | |
| | | | | | Grant Date |
Performance | | Shares | | Fair Value* |
| Beginning balance | | | 254,771 | | | $ | 29.56 | |
| Performance adjustment | | | (22,070 | ) | | | | |
| Granted | | | 123,542 | | | | 32.00 | |
| Issued | | | (42,169 | ) | | | 30.27 | |
| Forfeited | | | (4,385 | ) | | | 32.35 | |
| Ending balance | | | 309,689 | | | | 30.34 | |
| * weighted-average | | | | | | | | |
| | | | | | | | | |
At September 30, 2007, the remaining weighted-average contractual term was 1.4 years. No performance shares were granted during the three months ended September 30, 2007 and 2006. The weighted-average grant-date fair value of shares granted was $32.00 and $28.20 year to date September 30, 2007 and 2006, respectively. At September 30, 2007, there was $4.1 million of total unrecognized compensation expense, net of forfeiture rates, related to performance shares granted under the Long-Term Incentive Plan, which will be recognized over the remaining weighted-average contractual term. No shares of common stock related to performance shares were issued during the three months ended September 30, 2007 and 2006. The total fair value of shares of common stock related to performance shares issued year to date September 30, 2007 and 2006 was $1.3 million and $0.3 million, respectively.
Restricted Stock
Restricted stock activity year to date September 30, 2007, is summarized in the following table.
| | | | | | | |
Nonvested | | | | | Grant Date | |
Restricted stock | | Shares | | | Fair Value* | |
| Beginning balance | | | 140,603 | | | $ | 29.75 | |
| Granted and issued | | | 348,527 | | | | 31.93 | |
| Vested | | | (11,000 | ) | | | 30.01 | |
| Forfeited | | | (5,842 | ) | | | 31.40 | |
| Ending balance | | | 472,288 | | | | 31.33 | |
| * weighted-average | | | | | | | | |
| | | | | | | | | |
At September 30, 2007, the remaining weighted-average contractual term was 1.6 years. The weighted-average grant-date fair value of shares granted for the three months ended and year to date September 30, 2007, was $27.76 and $31.93, respectively. No restricted shares were granted during the three months ended September 30, 2006, and the weighted-average grant-date fair value of shares granted year to date September 30, 2006, was $28.22. As of September 30, 2007, there was $8.4 million of total unrecognized compensation expense, net of forfeiture rates, related to nonvested restricted stock granted under the Long-Term Incentive Plan, which will be recognized over the remaining weighted-average contractual term. The total fair value of shares vested for the three months ended was insignificant and $0.3 million year to date September 30, 2007. No shares vested during the same periods in 2006.
Components of income tax expense (benefit) are detailed in the following tables.
| | | | | | | | | | | | | |
| | | Three Months Ended | | | Year to Date | |
| | | September 30 | | | September 30 | |
| | | | | As Adjusted | | | | As Adjusted |
Great Plains Energy | | 2007 | | | 2006 | | | 2007 | | | 2006 | |
| Current income taxes | | (millions) | |
| Federal | | $ | 15.9 | | | $ | 38.3 | | | $ | 22.0 | | | $ | 67.6 | |
| State | | | 4.4 | | | | 2.9 | | | | 4.4 | | | | 4.3 | |
| Total | | | 20.3 | | | | 41.2 | | | | 26.4 | | | | 71.9 | |
| Deferred income taxes | | | | | | | | | | | | | | | | |
| Federal | | | 5.8 | | | | (11.6 | ) | | | 19.1 | | | | (25.3 | ) |
| State | | | (2.2 | ) | | | (1.8 | ) | | | 1.7 | | | | (6.0 | ) |
| Total | | | 3.6 | | | | (13.4 | ) | | | 20.8 | | | | (31.3 | ) |
| Investment tax credit amortization | | | (0.4 | ) | | | (0.8 | ) | | | (1.1 | ) | | | (2.3 | ) |
| Total | | $ | 23.5 | | | $ | 27.0 | | | $ | 46.1 | | | $ | 38.3 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | Three Months Ended | | | Year to Date | |
| | | September 30 | | | September 30 | |
| | | | | As Adjusted | | | | As Adjusted |
Consolidated KCP&L | | 2007 | | | 2006 | | | 2007 | | | 2006 | |
| Current income taxes | | (millions) | |
| Federal | | $ | 13.8 | | | $ | 36.5 | | | $ | 25.2 | | | $ | 60.0 | |
| State | | | 2.4 | | | | 4.6 | | | | 4.7 | | | | 7.3 | |
| Total | | | 16.2 | | | | 41.1 | | | | 29.9 | | | | 67.3 | |
| Deferred income taxes | | | | | | | | | | | | | | | | |
| Federal | | | 15.9 | | | | (0.5 | ) | | | 15.1 | | | | (1.4 | ) |
| State | | | 1.8 | | | | - | | | | 1.8 | | | | (0.1 | ) |
| Total | | | 17.7 | | | | (0.5 | ) | | | 16.9 | | | | (1.5 | ) |
| Investment tax credit amortization | | | (0.4 | ) | | | (0.8 | ) | | | (1.1 | ) | | | (2.3 | ) |
| Total | | $ | 33.5 | | | $ | 39.8 | | | $ | 45.7 | | | $ | 63.5 | |
| | | | | | | | | | | | | | | | | |
Income Tax Expense (Benefit) and Effective Income Tax Rates
Income tax expense and the effective income tax rates reflected in the financial statements and the reasons for their differences from the statutory federal rates are detailed in the following tables.
| | | | | | | | | | | | | |
| | | Income Tax Expense | | | Income Tax Rate | |
Great Plains Energy | | | | As Adjusted | | | | As Adjusted |
Three Months Ended September 30 | | 2007 | | 2006 | | 2007 | | 2006 |
| | | (millions) | | | | | | | |
| Federal statutory income tax | | $ | 29.9 | | | $ | 29.0 | | | | 35.0 | % | | | 35.0 | % |
| Differences between book and tax | | | | | | | | | | | | | | | | |
| depreciation not normalized | | | 0.8 | | | | 0.2 | | | | 0.9 | | | | 0.2 | |
| Amortization of investment tax credits | | | (0.4 | ) | | | (0.8 | ) | | | (0.4 | ) | | | (0.9 | ) |
| Federal income tax credits | | | (3.1 | ) | | | (2.1 | ) | | | (3.7 | ) | | | (2.5 | ) |
| State income taxes | | | 1.7 | | | | 0.9 | | | | 2.0 | | | | 1.0 | |
| Changes in uncertain tax positions, net | | | - | | | | 0.1 | | | | 0.1 | | | | 0.2 | |
| Aquila transaction costs | | | (2.9 | ) | | | - | | | | (3.4 | ) | | | - | |
| Other | | | (2.5 | ) | | | (0.3 | ) | | | (3.2 | ) | | | (0.5 | ) |
| Total | | $ | 23.5 | | | $ | 27.0 | | | | 27.3 | % | | | 32.5 | % |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | Income Tax Expense | | | Income Tax Rate | |
Great Plains Energy | | | | As Adjusted | | | | As Adjusted |
Year to Date September 30 | | 2007 | | | 2006 | | | 2007 | | | 2006 | |
| | | (millions) | | | | | | | |
| Federal statutory income tax | | $ | 55.0 | | | $ | 46.0 | | | | 35.0 | % | | | 35.0 | % |
| Differences between book and tax | | | | | | | | | | | | | | | | |
| depreciation not normalized | | | 2.5 | | | | 0.9 | | | | 1.6 | | | | 0.7 | |
| Amortization of investment tax credits | | | (1.1 | ) | | | (2.3 | ) | | | (0.7 | ) | | | (1.7 | ) |
| Federal income tax credits | | | (6.9 | ) | | | (4.5 | ) | | | (4.4 | ) | | | (3.4 | ) |
| State income taxes | | | 3.9 | | | | - | | | | 2.5 | | | | (0.1 | ) |
| Changes in uncertain tax positions, net | | | 0.2 | | | | 0.2 | | | | 0.1 | | | | 0.1 | |
| Aquila transaction costs | | | (2.9 | ) | | | - | | | | (1.8 | ) | | | - | |
| Other | | | (4.6 | ) | | | (2.0 | ) | | | (3.0 | ) | | | (1.5 | ) |
| Total | | $ | 46.1 | | | $ | 38.3 | | | | 29.3 | % | | | 29.1 | % |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | Income Tax Expense | | | Income Tax Rate | |
Consolidated KCP&L | | | | As Adjusted | | | | As Adjusted |
Three Months Ended September 30 | | 2007 | | | 2006 | | | 2007 | | | 2006 | |
| | | (millions) | | | | | | | |
| Federal statutory income tax | | $ | 38.6 | | | $ | 38.3 | | | | 35.0 | % | | | 35.0 | % |
| Differences between book and tax | | | | | | | | | | | | | | | | |
| depreciation not normalized | | | 0.8 | | | | 0.2 | | | | 0.7 | | | | 0.2 | |
| Federal income tax credits | | | (2.6 | ) | | | (0.9 | ) | | | (2.3 | ) | | | (0.8 | ) |
| Amortization of investment tax credits | | | (0.4 | ) | | | (0.8 | ) | | | (0.3 | ) | | | (0.7 | ) |
| State income taxes | | | 3.3 | | | | 3.0 | | | | 3.0 | | | | 2.7 | |
| Changes in uncertain tax positions, net | | | (0.3 | ) | | | 0.1 | | | | (0.2 | ) | | | 0.1 | |
| Parent company tax benefits | | | (4.4 | ) | | | (1.1 | ) | | | (4.0 | ) | | | (1.0 | ) |
| Other | | | (1.5 | ) | | | 1.0 | | | | (1.5 | ) | | | 0.9 | |
| Total | | $ | 33.5 | | | $ | 39.8 | | | | 30.4 | % | | | 36.4 | % |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | Income Tax Expense | | | Income Tax Rate | |
Consolidated KCP&L | | | | As Adjusted | | | | As Adjusted |
Year to Date September 30 | | 2007 | | | 2006 | | | 2007 | | | 2006 | |
| | | (millions) | | | | | | | |
| Federal statutory income tax | | $ | 56.3 | | | $ | 63.9 | | | | 35.0 | % | | | 35.0 | % |
| Differences between book and tax | | | | | | | | | | | | | | | | |
| depreciation not normalized | | | 2.5 | | | | 0.9 | | | | 1.6 | | | | 0.5 | |
| Federal income tax credits | | | (5.7 | ) | | | (0.9 | ) | | | (3.5 | ) | | | (0.5 | ) |
| Amortization of investment tax credits | | | (1.1 | ) | | | (2.3 | ) | | | (0.7 | ) | | | (1.3 | ) |
| State income taxes | | | 4.6 | | | | 4.7 | | | | 2.9 | | | | 2.6 | |
| Changes in uncertain tax positions, net | | | (0.1 | ) | | | 0.6 | | | | (0.1 | ) | | | 0.3 | |
| Parent company tax benefits | | | (7.6 | ) | | | (3.3 | ) | | | (4.7 | ) | | | (1.8 | ) |
| Other | | | (3.2 | ) | | | (0.1 | ) | | | (2.1 | ) | | | - | |
| Total | | $ | 45.7 | | | $ | 63.5 | | | | 28.4 | % | | | 34.8 | % |
| | | | | | | | | | | | | | | | | |
Uncertain Tax Positions
In 2006, the FASB issued FASB Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes,” an interpretation of SFAS No. 109, “Accounting for Income Taxes.” FIN No. 48 establishes a “more-likely-than-not” recognition threshold that must be met before a tax benefit can be recognized in the financial statements with various additional disclosures required and is effective for fiscal years beginning after December 15, 2006. Upon adoption of FIN No. 48 on January 1, 2007, Great Plains Energy recognized an $18.8 million increase in the liability for unrecognized tax benefits. This increase was offset by a $0.9 million decrease to the January 1, 2007, balance of retained earnings, a $17.9 million decrease in deferred taxes, a $4.0 million decrease in accrued taxes and a $4.0 million increase in accrued interest. The total amount of unrecognized tax benefits at January 1, 2007, was $23.5 million of which $3.5 million would impact the effective tax rate, if recognized. Consolidated KCP&L recognized a $19.8 million increase in the liability for unrecognized tax benefits. This increase was offset by a $0.2 million decrease to the January 1, 2007, balance of retained earnings, a $15.7 million decrease in deferred taxes and a $3.9 million decrease in accrued taxes. The total amount of unrecognized tax benefits at January 1, 2007, was $21.6 million of which $1.6 million would impact the effective tax rate, if recognized.
In addition with the adoption of FIN No. 48, Great Plains Energy and consolidated KCP&L elected to make an accounting policy change to recognize interest accrued related to unrecognized tax benefits in interest expense and penalties in non-operating expenses. As of the date of adoption, Great Plains Energy and consolidated KCP&L had $6.4 million and $2.4 million, respectively, accrued for the
payment of interest. No amounts were accrued for penalties with respect to unrecognized tax benefits. At September 30, 2007, Great Plains Energy and consolidated KCP&L had $7.8 million and $3.0 million, respectively, accrued for the payment of interest.
Subsequent to adoption, Great Plains Energy filed amended returns based on research and development tax credit studies completed for the 2000 through 2004 tax years. This resulted in a release of unrecognized tax benefits of $2.2 million for both Great Plains Energy and consolidated KCP&L. At September 30, 2007, the total amount of uncertain tax benefits for Great Plains Energy and consolidated KCP&L was $21.6 million and $19.5 million, respectively.
Great Plains Energy files a consolidated federal income tax return as well as unitary and combined income tax returns in several state jurisdictions with Kansas and Missouri being the most significant. Great Plains Energy and its subsidiaries have completed examinations by federal and state taxing authorities for taxable years prior to 2000; however several tax issues remain unresolved for tax years 2000 through 2003. During 2006, the IRS commenced an audit of Great Plains Energy and its subsidiaries for taxable years 2004 through 2005 and is expected to complete the audit by the end of 2008.
It is reasonably possible that, as a result of a settlement agreement for the federal audit of the 2000 through 2003 tax years expected to be reached by September 2008, federal and state unrecognized tax benefits related primarily to the timing of tax deductions would be recognized by Great Plains Energy and consolidated KCP&L, as well as reversal of accrued interest for the relevant tax years. As of the date of adoption, an estimate of the range of the reasonably possible recognition of unrecognized tax benefits, net of reversal of accrued interest, was $5 million to $7 million for Great Plains Energy and $7 million to $9 million for consolidated KCP&L. At September 30, 2007, an estimate of the range of the reasonably possible recognition of unrecognized tax benefits, net of reversal of accrued interest, is $3 million to $5 million for Great Plains Energy and $6 million to $8 million for consolidated KCP&L.
13. | RELATED PARTY TRANSACTIONS AND RELATIONSHIPS |
Consolidated KCP&L receives various support and administrative services from Services. These services are billed to consolidated KCP&L at cost, based on payroll and other expenses, incurred by Services for the benefit of consolidated KCP&L. These costs totaled $3.6 million and $11.4 million for the three months ended and year to date September 30, 2007, respectively, and $4.6 million and $14.1 million for the same periods in 2006. These costs consisted primarily of employee compensation, benefits and fees associated with various professional services. At September 30, 2007, and December 31, 2006, consolidated KCP&L had a short-term intercompany payable to Services of $1.2 million and $2.5 million, respectively. Also at September 30, 2007, and December 31, 2006, consolidated KCP&L had a long-term intercompany payable to Services of $5.9 million and $5.7 million, respectively, related to unrecognized pension expense. At September 30, 2007, and December 31, 2006, consolidated KCP&L’s balance sheets reflect a note payable from HSS to Great Plains Energy of $0.6 million.
14. | COMMITMENTS AND CONTINGENCIES |
Environmental Matters
The Company is subject to regulation by federal, state and local authorities with regard to air quality and other environmental matters primarily through KCP&L’s operations. The generation, transmission and distribution of electricity produces and requires disposal of certain hazardous products that are subject to these laws and regulations. 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. Failure to comply with these laws and regulations could have a material adverse effect on consolidated KCP&L and Great Plains Energy.
KCP&L seeks to use current environmental technology. KCP&L conducts environmental audits designed to ensure compliance with governmental regulations. At September 30, 2007, and December 31, 2006, KCP&L had $0.3 million accrued for environmental remediation expenses. The accrual covers water monitoring at one site. The amounts accrued were established on an undiscounted basis and KCP&L does not currently have an estimated time frame over which the accrued amounts may be paid.
Environmental-related legislation is continually introduced in Congress. Such legislation typically includes various compliance dates and compliance limits. It is possible that legislation could be enacted at the federal or state level to address global climate change, including efforts to reduce and control the emission of greenhouse gases, such as CO2, which is created in the combustion of fossil fuels. In addition, there could be national and state mandates to produce a set percentage of electricity from renewable forms of energy, such as wind. The probability and impact of such legislation cannot be reasonably estimated at this time, including the cost to install new pollution control equipment to achieve compliance, but such legislation could have the potential for a significant financial impact on KCP&L. KCP&L would seek recovery of capital costs and expenses for such compliance through rate increases; however, there can be no assurance that such rate increases would be granted. KCP&L will continue to monitor proposed legislation.
The Clean Air Act requires companies to obtain permits and, if necessary, install control equipment to reduce emissions when making a major modification or a change in operation if either is expected to cause a significant net increase in regulated emissions. The Sierra Club and Concerned Citizens of Platte County have claimed that modifications were made to Iatan No. 1 in violation of Clean Air Act regulations. Although KCP&L has entered into a Collaboration Agreement with those parties that provides, among other things, for the release of such claims, the Collaboration Agreement does not bind any other entity. KCP&L is aware of subpoenas issued by a Federal grand jury to certain third parties seeking documents relating to capital projects at Iatan No. 1. KCP&L has not received a subpoena, and has not been informed of the scope of the grand jury inquiry. KCP&L believes that it is in compliance with all relevant laws and regulations; however, the ultimate outcome of these grand jury activities cannot presently be determined, nor can the costs and other liabilities that could potentially result from a negative outcome presently be reasonably estimated. There is no assurance these costs, if any, could be recovered in rates.
The following table contains current estimates of KCP&L’s capital expenditures (exclusive of allowance for funds used during construction and property taxes) to comply with environmental laws and regulations described below, including accelerated environmental upgrade expenditures outlined in KCP&L’s Comprehensive Energy Plan. The ultimate cost could be significantly different from the amounts estimated. The demand for environmental projects among utilities in the United States continues to present upward pressure on pricing and lead times for environmental control equipment. KCP&L has obtained contracts to date for approximately 84% of the estimated direct costs of its Iatan No. 1 environmental project, which has enabled KCP&L to refine the cost estimate of this project. Additionally, the impact of the current pricing pressure is relatively less on this project than on other
environmental projects where contracts have not been awarded yet. KCP&L has also developed more detailed project definition and cost estimates for the LaCygne Station environmental projects, reflecting increases in both project scope and prices. The developments regarding these two projects are the primary drivers of the increases in the estimated environmental expenditure ranges from what was disclosed in Great Plains Energy’s and consolidated KCP&L’s 2006 Form 10-K and Form 10-Q for the second quarter of 2007. KCP&L continues to refine its cost estimates detailed in the table below and explore alternatives. The allocation between states is based on location of the facilities and has no bearing as to recovery in jurisdictional rates.
The table does not reflect potential costs relating to additional wind generation, energy efficiency and other CO2 emission offsets contemplated by the Collaboration Agreement among KCP&L, Sierra Club and Concerned Citizens of Platte County. Potential costs relating to the additional wind generation and energy efficiency investments that are subject to regulatory approval cannot be reasonably estimated at this time. As well, the potential costs relating to the additional offset of approximately 711,000 tons of CO2 emissions under the Collaboration Agreement cannot be reasonably estimated at this time. KCP&L will evaluate the available operational and capital resource alternatives, and will select the most cost-effective mix of actions to achieve this additional offset. The potential capital costs of the Collaboration Agreement provisions relating to emission limits at Iatan and LaCygne generating stations are within the overall estimated capital cost ranges disclosed below. KCP&L expects to seek recovery of the costs associated with the Collaboration Agreement through rate increases; however, there can be no assurance that such rate increases would be granted.
| | | | | | | | | | | | | |
Clean Air Estimated Required | | | | | | | | | | | |
Environmental Expenditures (a) | | Missouri | Kansas | Total |
| | | | (millions) |
| CAIR | | $426 | - | 1,020 | $ | - | | $426 | - | 1,020 | (b) |
| Incremental BART | | | - | | 538 | - | 657 | 538 | - | 657 | (c) |
| Incremental CAMR | | 11 | - | 15 | 5 | - | 6 | 16 | - | 21 | |
| Estimated required environmental expenditures | | $437 | - | 1,035 | $543 | - | 663 | $980 | - | 1,698 | |
(a) | The amounts reflect KCP&L's portion of the cost of projects at jointly-owned units. | | | | |
(b) | Reflects an estimated $275 million to $287 million associated with the Iatan No. 1 environmental project included in the Comprehensive Energy Plan. |
(c) | Reflects an estimated $261 million to $318 million associated with the LaCygne No. 1 baghouse and scrubber project included in the Comprehensive Energy Plan. |
| | | | | | | | | | | | | |
The table above has been adjusted from what was disclosed in Great Plains Energy’s and consolidated KCP&L’s 2006 Form 10-K to remove approximately $41 million for the first phase of environmental upgrades at LaCygne No. 1, installation of selective catalytic reduction equipment, which was completed and placed into service during the second quarter of 2007. The table has not been adjusted for other environmental expenditures since 2006 of approximately $75 million related to the projects contemplated in the table above.
Clean Air Interstate Rule
The Environmental Protection Agency (EPA) Clean Air Interstate Rule (CAIR) requires reductions in SO2 and NOx emissions in 28 states, including Missouri. The reduction in both SO2 and NOx emissions will be accomplished through establishment of permanent statewide caps for NOx effective January 1, 2009, and SO2 effective January 1, 2010. More restrictive caps will be effective January 1, 2015. KCP&L’s fossil fuel-fired plants located in Missouri are subject to CAIR, while its fossil fuel-fired plants in Kansas are not.
KCP&L expects to meet the emissions reductions required by CAIR at its Missouri plants through a combination of pollution control capital projects and the purchase of emission allowances in the open market as needed. The final CAIR rule establishes a market-based cap-and-trade program. Missouri has approved a State Implementation Plan (SIP), which includes an emission allowance allocation mechanism, and in September 2007, EPA published its approval of the SIP in the Federal Register. Facilities will demonstrate compliance with CAIR by holding sufficient allowances for each ton of SO2 and NOx emitted in any given year, with SO2 emission allowances transferable among all regulated facilities nationwide and NOx emission allowances transferable among all regulated facilities within the 28 CAIR states. KCP&L will also be allowed to utilize unused SO2 emission allowances that it has accumulated during previous years of the Acid Rain Program to meet the more stringent CAIR requirements. At September 30, 2007, KCP&L had accumulated unused SO2 emission allowances sufficient to support just over 122,000 tons of SO2 emissions under the provisions of the Acid Rain program, which are recorded in inventory at zero cost. KCP&L is permitted to sell excess SO2 emission allowances in accordance with KCP&L’s Comprehensive Energy Plan as approved by the MPSC and KCC and in October 2007, KCP&L sold 25,000 SO2 emission allowances.
Analysis of the final CAIR rule indicates that NOx and SO2 control may be required for KCP&L’s Montrose Station in Missouri, in addition to the environmental upgrades at Iatan No. 1 included in the Comprehensive Energy Plan. The timing and necessity of the installation of such control equipment is currently being developed, and as required by the Collaboration Agreement with Sierra Club and Concerned Citizens of Platte County, a study will be completed in 2008 to assess potential future use of Montrose Station, including without limitation, retiring, re-powering and upgrading the units. As discussed below, some of the control technology for SO2 and NOx will also aid in the control of mercury.
Best Available Retrofit Technology Rule
The EPA best available retrofit technology rule (BART) directs state air quality agencies to identify whether visibility-reducing emissions from sources subject to BART are below limits set by the state or whether retrofit measures are needed to reduce emissions. BART applies to specific eligible facilities including LaCygne Nos. 1 and 2 in Kansas and Iatan No. 1 and Montrose No. 3 in Missouri. The CAIR suggests that states that meet the CAIR requirements through installation of environmental control equipment may also meet BART requirements for individual sources. Missouri has included this understanding as part of its CAIR SIP. Depending on the timing of installation of environmental control equipment and the availability of SO2 emission allowances, the estimated required environmental expenditures presented in the table above could shift from CAIR to incremental BART for Missouri. Kansas is not a CAIR state and therefore BART will impact LaCygne Nos. 1 and 2. KCP&L is in discussions with the Kansas Department of Health and Environment (KDHE) regarding a Regional Haze (also referred to as BART) Agreement that will become part of the Kansas Regional Haze State Implementation Plan. States must submit a BART implementation plan in 2007. In the Collaboration Agreement with Sierra Club and Concerned Citizens of Platte County, KCP&L agreed to seek, through the BART regulation process, a consent agreement with the KDHE incorporating limits for stack particulate matter emissions, as well as limits for NOx and SO2 emissions at its LaCygne Station that will be below the presumptive limits under BART. KCP&L further agreed to use its best efforts to install emission control technologies to reduce those emissions from the LaCygne Station prior to the required compliance date under BART, but in no event later than June 1, 2015. KCP&L further agreed to issue requests for proposal for the equipment required to comply with BART by December 31, 2008, requesting that construction commence by December 31, 2010.
Mercury Emissions
The EPA Clean Air Mercury Rule (CAMR) regulates mercury emissions from coal-fired power plants located in 48 states, including Kansas and Missouri, under the New Source Performance Standards of the Clean Air Act. The rule established a market-based cap-and-trade program that will reduce nationwide utility emissions of mercury in two phases. The first phase cap is effective January 1, 2010,
and will establish a permanent nationwide cap of 38 tons of mercury for coal-fired power plants. Management anticipates meeting the first phase cap by taking advantage of KCP&L’s mercury reductions achieved through capital expenditures to comply with CAIR and BART. The second phase is effective January 1, 2018, and will establish a permanent nationwide cap of 15 tons of mercury for coal-fired power plants. When fully implemented, the rule will reduce utility emissions of mercury by nearly 70% from current emissions of 48 tons per year. Both Missouri and Kansas have approved the SIPs implementing the CAMR cap-and-trade program. In September 2007, EPA published its approval of the Missouri SIP in the Federal Register. The Kansas SIP is currently being reviewed by EPA.
Facilities will be required to hold allowances for each ounce of mercury emitted in any given year and allowances will be readily transferable among facilities nationwide. Under the cap-and-trade program, KCP&L will be able to purchase mercury allowances or elect to install pollution control equipment to achieve compliance. While it is expected that mercury allowances will be available in sufficient quantities for purchase in the 2010-2018 timeframe, the significant reduction in the nationwide cap in 2018 may hamper KCP&L’s ability to obtain reasonably priced allowances beyond 2018. Management expects capital expenditures will be required to install additional pollution control equipment to meet the second phase cap. During the ensuing years, management will closely monitor advances in technology for removal of mercury from Powder River Basin (PRB) coal and expects to make decisions regarding second phase removal based on then available technology to meet the 2018 compliance date.
Carbon Dioxide
Many bills concerning CO2 are being debated in the U.S. Congress. There are various compliance dates and nationwide caps stipulated in the bills. The U.S. Supreme Court has determined that the EPA has statutory authority to regulate CO2 from new motor vehicles if EPA forms a judgment that such emissions contribute to climate change. If EPA forms such a judgment, it may ultimately regulate other sources of CO2, which may include KCP&L facilities. In addition, the Secretary of the KDHE stated in October 2007, that the KDHE intends to work with various industries and stakeholders to establish goals for reducing CO2 emissions and strategies to achieve those goals. CO2 regulation has the potential for a significant financial impact on KCP&L in connection with achieving compliance with limits that may be established. However, the financial consequences to KCP&L cannot be determined until final legislation is passed or regulations enacted. Management will continue to monitor the progress of these bills. As previously discussed, KCP&L has entered into a Collaboration Agreement that includes various provisions regarding wind generation, energy efficiency and other CO2 emission offsets.
Ozone
In June 2007, the Missouri Department of Natural Resources (MDNR) and KDHE submitted to EPA for approval their respective maintenance plans for the control of ozone for the Kansas City area. These plans were approved by EPA in July 2007. As part of the SIP requirements, contingency control measures were included. These measures would go into effect only if associated triggers (such as a violation of the eight-hour ozone standard) occur. It is anticipated the proposed controls for CAIR and BART will provide the required contingency control measures at KCP&L’s generation facilities.
In June 2007, monitor data indicated that the Kansas City area violated the eight-hour ozone national ambient air quality standard. The monitor data must be quality-assured and provided to EPA before the violation will be confirmed and for EPA to respond to the violation. Upon quality assurance of the monitoring data, Missouri and Kansas will implement the responses established in the maintenance plans for control of ozone, upon approval by EPA. The responses in both states do not require additional controls at KCP&L’s generation facilities beyond the currently proposed controls for CAIR and BART. EPA has various options over and above the implementation of the maintenance plans for control of ozone to address a confirmed violation. These options include, but are not limited to, designating the area “non-attainment” and requiring a new regulatory plan to reduce emissions or leaving the designation unchanged, but still requiring a new regulatory plan. At this time, management
is unable to predict how the EPA will respond or how that response will impact KCP&L’s operations, but the EPA’s response could have a significant impact on Great Plains Energy's and consolidated KCP&L's results of operations and financial position. Management will continue to monitor the response and be involved in any regulatory developments to the extent possible.
Also in June 2007, EPA issued a proposal for comment to reduce the existing eight-hour ozone national ambient air quality standard. The proposal recommends an ozone standard within a range of 0.07 to 0.075 parts per million (ppm). EPA also is taking comments on alternative standards within a range from 0.06 ppm up to the level of the current eight-hour ozone standard, which is 0.08 ppm. The Kansas City area may have difficulty attaining a revised standard in the future. EPA has taken public comments and will issue final standards by March 12, 2008. Although it is difficult to determine the ultimate impact of the proposal at this time, it could have a significant impact on Great Plains Energy's and consolidated KCP&L's results of operations and financial position. Management will continue to monitor proposed revisions to the standard.
Sulfuric Acid Mist BACT Analysis – Iatan Station
As a requirement of the Iatan Station air permit and the Collaboration Agreement, KCP&L submitted a best available control technology (BACT) analysis for sulfuric acid mist to MDNR in June 2007. MDNR will conduct its own BACT analysis and determine the final emission limit. Although KCP&L believes the emission limit submitted is a BACT limit and can be achieved by the currently proposed emission control equipment, MDNR may ultimately determine a BACT limit for sulfuric acid mist that could require additional control equipment. The above Clean Air Estimated Required Environmental Expenditures table does not reflect the potential costs for additional controls that may be required to meet such a determination. If MDNR does make such a determination, KCP&L will evaluate the available operational and capital resource alternatives, and will select the most cost-effective mix of actions to achieve compliance.
Water Use Regulations
The Clean Water Act (Act) establishes standards for cooling water intake structures. Section 316(b) of the Act applies to certain existing power producing facilities that employ cooling water intake structures that withdraw 50 million gallons or more per day from lakes and rivers and use 25% or more of that water for cooling purposes. EPA had previously issued regulations that required KCP&L to conduct demonstration studies regarding the impact of its generating facilities’ intake structures on aquatic life that were expected to cost a total of $1.2 million to $2.0 million. In July 2007, EPA suspended many of those regulations and indicated it will consider further rulemaking on this matter. At this time, management is unable to predict how the EPA will respond or how that response will impact KCP&L’s operations. Management will monitor any subsequent rulemaking.
KCP&L holds a permit from the MDNR covering water discharge from its Hawthorn Station. The permit authorizes KCP&L, among other things, to withdraw water from the Missouri river for cooling purposes and return the heated water to the Missouri river. KCP&L has applied for a renewal of this permit and the EPA has submitted an interim objection letter regarding the allowable amount of heat that can be contained in the returned water. Until this matter is resolved, KCP&L continues to operate under its current permit. KCP&L cannot predict the outcome of this matter; however, while less significant outcomes are possible, this matter may require KCP&L to reduce its generation at Hawthorn Station, install cooling towers or both, any of which could have a material adverse effect on KCP&L. The outcome could also affect the terms of water permit renewals at KCP&L’s Iatan and Montrose Stations.
Contractual Obligations
Great Plains Energy’s and consolidated KCP&L’s contractual obligations for KCP&L’s Comprehensive Energy Plan were $140.5 million for the remainder of 2007 and $472.4 million, $135.9 million and $14.0 million for the years 2008 through 2010, respectively. Great Plains Energy’s and consolidated KCP&L’s
other contractual obligations have not significantly changed at September 30, 2007, compared to December 31, 2006.
Union Pacific
In 2005, KCP&L filed a rate complaint case with the Surface Transportation Board (STB) charging that Union Pacific Railroad Company’s (Union Pacific) rates for transporting coal from the PRB in Wyoming to KCP&L’s Montrose Station are unreasonably high. Prior to the end of 2005, the rates were established under a contract with Union Pacific. Efforts to extend the term of the contract were unsuccessful and Union Pacific is the only service for coal transportation from the PRB to Montrose Station. A procedural schedule was issued by the STB in May 2007, and KCP&L and Union Pacific submitted reply evidence on August 20, 2007. Given this expedited schedule, the STB has indicated it may issue a final decision on this rate complaint in the fourth quarter of 2007. Until the case is decided, KCP&L is paying the higher tariff rates subject to refund.
Hawthorn No. 5 Insurance Litigation
KCP&L received reimbursement for the 1999 Hawthorn No. 5 boiler explosion under a property damage insurance policy with Travelers Property Casualty Company of America (Travelers). Travelers filed suit in the U.S. District Court for the Eastern District of Missouri in November 2005, against National Union, and KCP&L was added as a defendant in June 2006. The case was subsequently transferred to, and is pending in, the U.S. District Court for the Western District of Missouri. Travelers seeks recovery of $10 million that KCP&L recovered through subrogation litigation. Management is unable to predict the outcome of this case.
Emergis Technologies, Inc.
In March 2006, Emergis Technologies, Inc. f/k/a BCE Emergis Technologies, Inc. (Emergis) filed suit against KCP&L in Federal District Court for the Western District of Missouri, alleging infringement of a patent, entitled “Electronic Invoicing and Payment System” and seeking unspecified monetary damages and injunctive relief. This patent relates to automated electronic bill presentment and payment systems, particularly those involving Internet billing and collection. In March 2006, KCP&L filed a response and denied infringing the patent. KCP&L counterclaimed for a declaration that the patent is invalid and not infringed. Emergis responded to KCP&L’s counterclaims in April 2006. Court ordered mediation occurred in July 2006, but the case was not resolved. Management does not expect the outcome of this case to have a significant impact on Great Plains Energy's or consolidated KCP&L's results of operations and financial position.
Spent Nuclear Fuel and Radioactive Waste
In 2004, KCP&L and the other two Wolf Creek owners filed suit against the United States in the U.S. Court of Federal Claims seeking an unspecified amount of monetary damages resulting from the government’s failure to begin accepting spent fuel for disposal in January 1998, as the government was required to do by the Nuclear Waste Policy Act of 1982. Approximately sixty other similar cases are pending before that court. A handful of the cases have received damages awards, most of which are on appeal now. The Wolf Creek case is on a court-ordered stay until further order of the court to allow for some of the earlier cases to be decided first by an appellate court. Another Federal court has already determined that the government breached its obligation to begin accepting spent fuel for disposal. The questions now before the court in the pending cases are whether and to what extent the utilities are entitled to monetary damages for that breach. KCP&L management cannot predict the outcome of this case.
Class Action Complaint
In 2005, a class action complaint for breach of contract was filed against Strategic Energy in the Court of Common Pleas of Allegheny County, Pennsylvania. The plaintiffs purportedly represent the interests of certain customers in Pennsylvania who entered into Power Supply Coordination Service Agreements (Agreements) for a certain product in Pennsylvania. The complaint seeks monetary damages alleged to be in excess of $25,000, attorney fees and costs and a declaration that the customers may terminate their Agreements with Strategic Energy. In response to Strategic Energy’s preliminary objections, plaintiffs filed an amended complaint in July 2006, and Strategic Energy filed its preliminary objections in July 2007. Plaintiff’s counsel agreed to file an additional amended complaint in response to Strategic Energy’s preliminary objections. Management is awaiting the amended complaint and is unable to predict the outcome of this case.
Texas Customer Dispute
In February 2006, a customer in Texas that procures electricity for schools notified Strategic Energy that it had selected another provider for its school members during the time it was under contract with Strategic Energy. Strategic Energy exercised it rights under the agreement for breach. In June 2006, Strategic Energy received a notice of demand for arbitration from the customer pursuant to the agreement. In July 2007, the parties settled this matter and there was no material impact on the Company’s financial position or results of operations.
Weinstein v. KLT Telecom
Richard D. Weinstein (Weinstein) filed suit against KLT Telecom Inc. (KLT Telecom) in September 2003 in the St. Louis County, Missouri Circuit Court. KLT Telecom acquired a controlling interest in DTI Holdings, Inc. (Holdings) in February 2001 through the purchase of approximately two-thirds of the Holdings stock held by Weinstein. In connection with that purchase, KLT Telecom entered into a put option in favor of Weinstein, which granted Weinstein an option to sell to KLT Telecom his remaining shares of Holdings stock. The put option provided for an aggregate exercise price for the remaining shares equal to their fair market value with an aggregate floor amount of $15 million and was exercisable between September 1, 2003, and August 31, 2005. In June 2003, the stock of Holdings was cancelled and extinguished pursuant to the joint Chapter 11 plan confirmed by the Bankruptcy Court. In September 2003, Weinstein delivered a notice of exercise of his claimed rights under the put option. KLT Telecom rejected the notice of exercise, and Weinstein filed suit, alleging breach of contract. Weinstein sought damages of at least $15 million, plus statutory interest. In April 2005, summary judgment was granted in favor of KLT Telecom, and Weinstein appealed this judgment to the Missouri Court of Appeals for the Eastern District. In May 2006, the Court of Appeals affirmed the judgment. In July 2006, Weinstein filed an application for transfer of this case to the Missouri Supreme Court, which was granted. Oral arguments were presented to the Missouri Supreme Court in December 2006. In May 2007, the Missouri Supreme Court reversed the summary judgment and remanded the case to the trial court. In July 2007, Weinstein filed a renewed Motion for Summary Judgment and KLT Telecom responded in opposition in August 2007. A hearing on the motion is anticipated to occur in the fourth quarter of 2007. A $15 million reserve was recorded in 2001 for this matter.
16. | SEGMENTS AND RELATED INFORMATION |
Great Plains Energy
Great Plains Energy has two reportable segments based on its method of internal reporting, which generally segregates the reportable segments based on products and services, management responsibility and regulation. The two reportable business segments are KCP&L, an integrated, regulated electric utility, and Strategic Energy, a competitive retail electricity supplier. Other includes HSS, Services, all KLT Inc. activity other than Strategic Energy, unallocated corporate charges, consolidating entries and intercompany eliminations. Intercompany eliminations include insignificant amounts of intercompany financing-related activities. The summary of significant accounting policies applies to all of the reportable segments. For segment reporting, each segment’s income taxes include
the effects of allocating holding company tax benefits. Segment performance is evaluated based on net income.
The following tables reflect summarized financial information concerning Great Plains Energy’s reportable segments.
| | | | | | | | | | | | | |
Three Months Ended | | | | | Strategic | | | | | Great Plains |
September 30, 2007 | | KCP&L | | Energy | | Other | | Energy |
| | | (millions) | |
| Operating revenues | | $ | 416.0 | | | $ | 576.0 | | | $ | - | | | $ | 992.0 | |
| Depreciation and amortization | | | (44.1 | ) | | | (2.1 | ) | | | - | | | | (46.2 | ) |
| Interest charges | | | (17.1 | ) | | | (0.9 | ) | | | (10.2 | ) | | | (28.2 | ) |
| Income taxes | | | (33.5 | ) | | | 4.7 | | | | 5.3 | | | | (23.5 | ) |
| Loss from equity investments | | | - | | | | - | | | | (0.4 | ) | | | (0.4 | ) |
| Net income (loss) | | | 76.5 | | | | (4.1 | ) | | | (10.3 | ) | | | 62.1 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | |
As Adjusted | | | | | | | | | | | | |
Three Months Ended | | | | | Strategic | | | | | Great Plains |
September 30, 2006 | | KCP&L | | Energy | | Other | | Energy |
| | | (millions) | |
| Operating revenues | | $ | 359.3 | | | $ | 459.2 | | | $ | - | | | $ | 818.5 | |
| Depreciation and amortization | | | (38.5 | ) | | | (1.9 | ) | | | - | | | | (40.4 | ) |
| Interest charges | | | (15.5 | ) | | | (0.6 | ) | | | (1.9 | ) | | | (18.0 | ) |
| Income taxes | | | (40.0 | ) | | | 10.2 | | | | 2.8 | | | | (27.0 | ) |
| Loss from equity investments | | | - | | | | - | | | | (0.4 | ) | | | (0.4 | ) |
| Net income (loss) | | | 70.7 | | | | (10.9 | ) | | | (3.9 | ) | | | 55.9 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Year to Date | | | | | Strategic | | | | | Great Plains |
September 30, 2007 | | KCP&L | | Energy | | Other | | Energy |
| | | (millions) | |
| Operating revenues | | $ | 990.8 | | | $ | 1,470.1 | | | $ | - | | | $ | 2,460.9 | |
| Depreciation and amortization | | | (130.9 | ) | | | (6.2 | ) | | | - | | | | (137.1 | ) |
| Interest charges | | | (52.0 | ) | | | (2.4 | ) | | | (13.4 | ) | | | (67.8 | ) |
| Income taxes | | | (45.7 | ) | | | (9.1 | ) | | | 8.7 | | | | (46.1 | ) |
| Loss from equity investments | | | - | | | | - | | | | (1.1 | ) | | | (1.1 | ) |
| Net income (loss) | | | 115.1 | | | | 16.5 | | | | (20.5 | ) | | | 111.1 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | |
As Adjusted | | | | | | | | | | | | |
Year to Date | | | | | Strategic | | | | | Great Plains |
September 30, 2006 | | KCP&L | | Energy | | Other | | Energy |
| | | (millions) | |
| Operating revenues | | $ | 890.6 | | | $ | 1,129.2 | | | $ | - | | | $ | 2,019.8 | |
| Depreciation and amortization | | | (112.8 | ) | | | (5.8 | ) | | | - | | | | (118.6 | ) |
| Interest charges | | | (45.4 | ) | | | (1.5 | ) | | | (6.2 | ) | | | (53.1 | ) |
| Income taxes | | | (63.7 | ) | | | 17.4 | | | | 8.0 | | | | (38.3 | ) |
| Loss from equity investments | | | - | | | | - | | | | (1.0 | ) | | | (1.0 | ) |
| Net income (loss) | | | 120.3 | | | | (17.6 | ) | | | (9.5 | ) | | | 93.2 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | Strategic | | | | | Great Plains |
| | | KCP&L | | | Energy | | | Other | | Energy |
September 30, 2007 | | (millions) | |
| Assets | | $ | 4,313.6 | | | $ | 476.9 | | | $ | 44.9 | | | $ | 4,835.4 | |
Capital expenditures (a) | | | 359.7 | | | | 3.0 | | | | 0.7 | | | | 363.4 | |
December 31, 2006 | | | | | | | | | | | | | | | | |
| Assets | | $ | 3,858.0 | | | $ | 459.6 | | | $ | 18.1 | | | $ | 4,335.7 | |
Capital expenditures (a) | | | 476.0 | | | | 3.9 | | | | 0.2 | | | | 480.1 | |
(a) Capital expenditures reflect year to date amounts for the periods presented. | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
Consolidated KCP&L
The following tables reflect summarized financial information concerning consolidated KCP&L’s reportable segment. Other includes HSS and intercompany eliminations. Intercompany eliminations include insignificant amounts of intercompany financing-related activities.
| | | | | | | | | | |
Three Months Ended | | | | | | | | Consolidated | |
September 30, 2007 | | KCP&L | | | Other | | | KCP&L | |
| | | (millions) | |
| Operating revenues | | $ | 416.0 | | | $ | - | | | $ | 416.0 | |
| Depreciation and amortization | | | (44.1 | ) | | | - | | | | (44.1 | ) |
| Interest charges | | | (17.1 | ) | | | - | | | | (17.1 | ) |
| Income taxes | | | (33.5 | ) | | | - | | | | (33.5 | ) |
| Net income | | | 76.5 | | | | 0.1 | | | | 76.6 | |
| | | | | | | | | | | | | |
| | | | | | | | | | |
As Adjusted | | | | | | | | | |
Three Months Ended | | | | | | | | Consolidated | |
September 30, 2006 | | KCP&L | | | Other | | | KCP&L | |
| | | (millions) | |
| Operating revenues | | $ | 359.3 | | | $ | - | | | $ | 359.3 | |
| Depreciation and amortization | | | (38.5 | ) | | | - | | | | (38.5 | ) |
| Interest charges | | | (15.5 | ) | | | (0.1 | ) | | | (15.6 | ) |
| Income taxes | | | (40.0 | ) | | | 0.2 | | | | (39.8 | ) |
| Net income (loss) | | | 70.7 | | | | (1.2 | ) | | | 69.5 | |
| | | | | | | | | | | | | |
| | | | | | | | | | |
Year to Date | | | | | | | | Consolidated | |
September 30, 2007 | | KCP&L | | | Other | | | KCP&L | |
| | | (millions) | |
| Operating revenues | | $ | 990.8 | | | $ | - | | | $ | 990.8 | |
| Depreciation and amortization | | | (130.9 | ) | | | - | | | | (130.9 | ) |
| Interest charges | | | (52.0 | ) | | | - | | | | (52.0 | ) |
| Income taxes | | | (45.7 | ) | | | - | | | | (45.7 | ) |
| Net income (loss) | | | 115.1 | | | | - | | | | 115.1 | |
| | | | | | | | | | | | | |
| | | | | | | | | | |
As Adjusted | | | | | | | | | |
Year to Date | | | | | | | | Consolidated | |
September 30, 2006 | | KCP&L | | | Other | | | KCP&L | |
| | | (millions) | |
| Operating revenues | | $ | 890.6 | | | $ | - | | | $ | 890.6 | |
| Depreciation and amortization | | | (112.8 | ) | | | - | | | | (112.8 | ) |
| Interest charges | | | (45.4 | ) | | | (0.1 | ) | | | (45.5 | ) |
| Income taxes | | | (63.7 | ) | | | 0.2 | | | | (63.5 | ) |
| Net income (loss) | | | 120.3 | | | | (1.2 | ) | | | 119.1 | |
| | | | | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | Consolidated | |
| | | KCP&L | | | Other | | | KCP&L | |
September 30, 2007 | | (millions) | |
| Assets | | $ | 4,313.6 | | | $ | 2.1 | | | $ | 4,315.7 | |
Capital expenditures (a) | | | 359.7 | | | | - | | | | 359.7 | |
December 31, 2006 | | | | | | | | | | | | |
| Assets | | $ | 3,858.0 | | | $ | 1.5 | | | $ | 3,859.5 | |
Capital expenditures (a) | | | 476.0 | | | | - | | | | 476.0 | |
(a) Capital expenditures reflect year to date amounts for the periods presented. | | | | | | | | | |
| | | | | | | | | | | | | |
17. | DERIVATIVE INSTRUMENTS |
The Company is exposed to a variety of market risks including interest rates and commodity prices. Management has established risk management policies and strategies to reduce the potentially adverse effects that the volatility of the markets may have on the Company’s operating results. The risk management activities, including the use of derivative instruments, are subject to the management, direction and control of internal risk management committees. Management’s interest rate risk management strategy uses derivative instruments to adjust the Company’s liability portfolio to optimize the mix of fixed and floating rate debt within an established range. In addition, the Company uses derivative instruments to hedge against future interest rate fluctuations on anticipated debt issuances. Management maintains commodity-price risk management strategies that use derivative instruments to reduce the effects of fluctuations in fuel and purchased power expense caused by commodity price volatility. Counterparties to commodity derivatives and interest rate swap agreements expose the Company to credit loss in the event of nonperformance. This credit loss is limited to the cost of replacing these contracts at current market rates less the application of counterparty collateral held. Derivative instruments, excluding those instruments that qualify for the NPNS election, which are accounted for by accrual accounting, are recorded on the balance sheet at fair value as an asset or liability. Changes in the fair value are recognized currently in net income unless specific hedge accounting criteria are met.
Interest Rate Risk Management
Fair Value Hedges
In 2002, KCP&L remarketed its Series 1998 A, B and D EIRR bonds totaling $146.5 million to a five-year fixed interest rate of 4.75% ending October 1, 2007. Simultaneously with the remarketing, KCP&L entered into an interest rate swap for the $146.5 million based on the London Interbank Offered Rate (LIBOR) to effectively create a floating interest rate obligation, which expired on October 1, 2007. The transaction was a fair value hedge with no ineffectiveness. Changes in the fair market value of the swap were recorded on the balance sheet as an asset or liability with an offsetting entry to the respective debt balances with no net impact on net income.
Forward Starting Swaps
In July 2007, Great Plains Energy entered into three Forward Starting Swaps (FSS), with a total notional amount of $250.0 million, to hedge against interest rate fluctuations on future issuances of long-term debt. The long-term debt issuance is contingent on the consummation of the acquisition of Aquila. If the merger is terminated due to regulatory actions, neither Great Plains Energy or the counterparty to these transactions are obligated to settle the FSS since the fair value of the FSS is set to zero. The FSS was designed to effectively remove most of the interest rate and credit spread uncertainty with respect to the debt to be issued, thereby enabling Great Plains Energy to predict with greater assurance what its future interest costs on that debt will be. The transaction is an economic hedge (non-hedging derivative) that does not qualify for cash flow hedge accounting. The change in the fair value of this derivative instrument increased interest expense by $9.0 million for the three months ended and year to date September 30, 2007.
In 2006, KCP&L entered into two FSS to hedge against interest rate fluctuations on the $250.0 million 10-year long-term debt that KCP&L issued in the second quarter of 2007. The FSS settled simultaneously with the issuance of the long-term fixed rate debt. The FSS removed most of the interest rate and credit spread uncertainty with respect to debt to be issued, thereby enabling KCP&L to predict with greater assurance what its future interest costs on that debt would be. The FSS were accounted for as a cash flow hedge and no ineffectiveness was recorded on the FSS. A pre-tax gain of $3.3 million on the FSS was recorded to OCI and is being reclassified to interest expense over the life of the 10-year debt. An insignificant amount was reclassified from OCI to interest expense subsequent to the debt issuance. At September 30, 2007, KCP&L had $3.2 million recorded in OCI for the FSS.
Treasury Locks
In 2007, Great Plains Energy entered into three T-Locks, with a notional amount of $350.0 million, to hedge against interest rate fluctuations on the U.S. Treasury rate component on future issuances of long-term debt. The T-Locks will settle simultaneously with the issuance of the long-term fixed rate debt. The T-Locks remove the uncertainty with respect to the U.S. Treasury rate component of the debt to be issued, thereby enabling Great Plains Energy to predict with greater assurance what its future interest costs on that debt will be. The T-Locks are accounted for as cash flow hedges and the fair value is recorded as a current asset or liability with an offsetting entry to OCI, to the extent the hedges are effective, until the forecasted transaction occurs. No ineffectiveness has been recorded on the T-Locks. The pre-tax gain or loss on the T-Locks recorded to OCI will be reclassified to interest expense over the life of the future debt issuance.
In 2007, Great Plains Energy entered into a T-Lock to hedge against interest rate fluctuations on the U.S. Treasury rate component of the $100.0 million 10-year long-term debt that Great Plains Energy issued in the third quarter of 2007. The T-Lock settled simultaneously with the issuance of the long-term fixed rate debt. The T-Lock removed the uncertainty with respect to the U.S. Treasury rate component of the debt to be issued, thereby enabling Great Plains Energy to predict with greater assurance what its future interest costs on that debt would be. The T-Lock was accounted for as cash flow hedge and no ineffectiveness was recorded on the T-Lock. A pre-tax loss of $4.5 million on the T-Lock was recorded to OCI and is being reclassified to interest expense over the life of the issued 10-year debt. An insignificant amount was reclassified from OCI to interest expense subsequent to the debt issuance. At September 30, 2007, Great Plains Energy had $4.5 million recorded in OCI for this T-Lock. Great Plains Energy had originally hedged this debt in 2006 using a T-Lock. In the first quarter of 2007, Great Plains Energy allowed the T-Lock to expire while the terms of the debt offering were re-evaluated. The $0.2 million gain recorded in OCI at December 31, 2006, and the first quarter fair value loss of $0.1 million was reclassified to interest expense as cash flow ineffectiveness.
In 2005, KCP&L entered into two T-Locks to hedge against interest rate fluctuations on the U.S. Treasury rate component of the $250.0 million 30-year long-term debt that KCP&L issued in 2005. The T-Locks settled simultaneously with the issuance of the long-term fixed rate debt. The T-Locks removed the uncertainty with respect to the U.S. Treasury rate component of the debt to be issued, thereby enabling KCP&L to predict with greater assurance what its future interest costs on that debt would be. The T-Locks were accounted for as cash flow hedges and no ineffectiveness was recorded on the T-Locks. A pre-tax gain of $12.0 million on the T-Locks was recorded to OCI and is being reclassified to interest expense over the life of the issued 30-year debt. An insignificant amount was reclassified from OCI to interest expense subsequent to the debt issuance. At September 30, 2007, KCP&L had $11.2 million recorded in OCI for the 2005 T-Locks.
Commodity Risk Management
KCP&L’s risk management policy is to use derivative instruments to mitigate its exposure to market price fluctuations on a portion of its projected natural gas purchases to meet generation requirements for retail and firm wholesale sales. As of September 30, 2007, KCP&L had hedged 17% and 4% of its 2008 and 2009 projected natural gas usage for retail load and firm MWh sales, respectively, primarily by utilizing fixed forward physical contracts and financial calls. The fair values of these instruments are recorded as assets or liabilities with an offsetting entry to OCI for the effective portion of the hedge. To the extent the hedges are not effective, the ineffective portion of the change in fair market value is recorded currently in fuel expense. KCP&L did not record any gains or losses due to ineffectiveness during the three months ended and year to date September 30, 2007 and 2006.
KCP&L has entered into an economic hedge (non-hedging derivative) that does not qualify for cash flow hedge accounting. The change in the fair value of this derivative instrument recorded as a component of electric revenues was a gain of $0.2 million and $0.6 million for the three months ended and year to date September 30, 2007, respectively.
Strategic Energy maintains a commodity-price risk management strategy that uses forward physical energy purchases and other derivative instruments to reduce the effects of fluctuations in purchased power expense caused by commodity-price volatility. Derivative instruments are used to limit the unfavorable effect that price increases will have on electricity purchases, effectively fixing the future purchase price of electricity for the applicable forecasted usage and protecting Strategic Energy from significant price volatility. The maximum term over which Strategic Energy hedged its exposure and variability of future cash flows was 5.25 years at September 30, 2007, and 5.5 years at December 31, 2006.
Certain forward fixed price purchases and swap agreements are designated as cash flow hedges. The fair values of these instruments are recorded as assets or liabilities with an offsetting entry to OCI for the effective portion of the hedge. To the extent the hedges are not effective, the ineffective portion of the change in fair market value is recorded currently in purchased power. When the forecasted purchase is completed, the amounts in OCI are reclassified to purchased power expense. Purchased power expense for the three months ended and year to date September 30, 2007, includes a loss of $16.1 million and a gain of $5.5 million, respectively, due to ineffectiveness of the cash flow hedges, and a $13.1 million and $27.1 million loss for the same periods of 2006.
As part of its commodity-price risk management strategy, Strategic Energy also enters into economic hedges (non-hedging derivatives) that do not qualify for cash flow hedge accounting. The changes in the fair value of these derivative instruments recorded as a component of purchased power expense were a loss of $3.2 million and $13.5 million for the three months ended September 30, 2007 and 2006, respectively, and a $15.0 million gain and $37.4 million loss year to date September 30, 2007 and 2006, respectively.
The fair value of non-hedging derivatives at September 30, 2007, also includes certain forward contracts at Strategic Energy that were amended during 2005. Prior to being amended, the contracts were accounted for under the NPNS election in accordance with SFAS No. 133. As a result of being amended, the contracts no longer qualify for NPNS exceptions or cash flow hedge accounting and are now accounted for as non-hedging derivatives with the fair value at amendment being recorded as a deferred liability that will be reclassified to net income as the contracts settle. For the three months ended September 30, 2007 and 2006, Strategic Energy amortized $0.2 million and $0.4 million, respectively, of the deferred liability to purchased power expense related to the delivery of power under the contracts. Year to date September 30, 2007 and 2006, Strategic Energy amortized $0.6 million and $5.0 million, respectively, of the deferred liability to purchased power expense related to the delivery of power under the contracts. Strategic Energy will amortize the remaining deferred liability over the remaining original contract lengths, which end in the first quarter of 2008. After the amendment, Strategic Energy is recording the change in fair value of these contracts to purchased power expense.
The notional and recorded fair values of the companies’ open positions for derivative instruments are summarized in the following table. The fair values of these derivatives are recorded on the consolidated balance sheets.
| | | | | | | | | | | | | |
| | | September 30 | | | December 31 | |
| | | 2007 | | | 2006 | |
| | | Notional | | | | | | Notional | | | | |
| | | Contract | | | Fair | | | Contract | | | Fair | |
| | | Amount | | | Value | | | Amount | | | Value | |
Great Plains Energy | | (millions) | |
| Swap contracts | | | | | | | | | | | | |
| Cash flow hedges | | $ | 302.2 | | | $ | (23.5 | ) | | $ | 477.5 | | | $ | (38.9 | ) |
| Non-hedging derivatives | | | 89.4 | | | | (7.6 | ) | | | 37.1 | | | | (6.8 | ) |
| Forward contracts | | | | | | | | | | | | | | | | |
| Cash flow hedges | | | 1,022.9 | | | | (28.4 | ) | | | 871.5 | | | | (69.7 | ) |
| Non-hedging derivatives | | | 318.5 | | | | (9.0 | ) | | | 250.7 | | | | (24.8 | ) |
| Anticipated debt issuance | | | | | | | | | | | | | | | | |
| Forward starting swap | | | - | | | | - | | | | 225.0 | | | | (0.4 | ) |
| Treasury lock | | | 350.0 | | | | (9.9 | ) | | | 77.6 | | | | 0.2 | |
| Non-hedging derivatives | | | 250.0 | | | | (9.0 | ) | | | - | | | | - | |
| Interest rate swaps | | | | | | | | | | | | | | | | |
| Fair value hedges | | | 146.5 | | | | - | | | | 146.5 | | | | (1.8 | ) |
Consolidated KCP&L | | | | | | | | | | | | | | | | |
| Swap contracts | | | | | | | | | | | | | | | | |
| Cash flow hedges | | | 1.9 | | | | - | | | | - | | | | - | |
| Forward contracts | | | | | | | | | | | | | | | | |
| Cash flow hedges | | | 1.4 | | | | (0.1 | ) | | | 6.1 | | | | (0.5 | ) |
| Non-hedging derivatives | | | 3.4 | | | | 0.6 | | | | - | | | | - | |
| Anticipated debt issuance | | | | | | | | | | | | | | | | |
| Forward starting swap | | | - | | | | - | | | | 225.0 | | | | (0.4 | ) |
| Interest rate swaps | | | | | | | | | | | | | | | | |
| Fair value hedges | | | 146.5 | | | | - | | | | 146.5 | | | | (1.8 | ) |
| | | | | | | | | | | | | | | | | |
The amounts recorded in accumulated OCI related to the cash flow hedges are summarized in the following table.
| | | | | | | | | | | | | |
| | | Great Plains Energy | | | Consolidated KCP&L | |
| | September 30 | December 31 | September 30 | December 31 |
| | 2007 | 2006 | 2007 | 2006 |
| | | (millions) | |
| Current assets | | $ | 12.1 | | | $ | 12.7 | | | $ | 14.4 | | | $ | 12.0 | |
| Other deferred charges | | | 3.9 | | | | 1.7 | | | | - | | | | - | |
| Other current liabilities | | | (50.4 | ) | | | (56.3 | ) | | | (0.1 | ) | | | (1.3 | ) |
| Deferred income taxes | | | 15.1 | | | | 32.1 | | | | (5.4 | ) | | | (4.0 | ) |
| Other deferred credits | | | (2.5 | ) | | | (35.3 | ) | | | - | | | | - | |
| Total | | $ | (21.8 | ) | | $ | (45.1 | ) | | $ | 8.9 | | | $ | 6.7 | |
| | | | | | | | | | | | | | | | | |
Great Plains Energy’s accumulated OCI in the table above at September 30, 2007, includes a loss of $38.2 million that is expected to be reclassified to expenses over the next twelve months. Consolidated KCP&L’s accumulated OCI includes a gain of $0.7 million that is expected to be reclassified to expense over the next twelve months.
The amounts reclassified to expenses are summarized in the following table.
| | | | | | | | | | | | | |
| | | Three Months Ended | | | Year to Date | |
| | | September 30 | | | September 30 | |
| | | 2007 | | | 2006 | | | 2007 | | | 2006 | |
Great Plains Energy | | (millions) | |
| Purchased power expense | | $ | 26.1 | | | $ | 13.0 | | | $ | 64.4 | | | $ | 29.6 | |
| Interest expense | | | (0.2 | ) | | | (0.1 | ) | | | (0.4 | ) | | | (0.3 | ) |
| Income taxes | | | (10.6 | ) | | | (5.3 | ) | | | (26.1 | ) | | | (12.2 | ) |
| OCI | | $ | 15.3 | | | $ | 7.6 | | | $ | 37.9 | | | $ | 17.1 | |
Consolidated KCP&L | | | | | | | | | | | | | | | | |
| Interest expense | | $ | (0.3 | ) | | $ | (0.1 | ) | | $ | (0.5 | ) | | $ | (0.3 | ) |
| Income taxes | | | 0.1 | | | | - | | | | 0.2 | | | | 0.1 | |
| OCI | | $ | (0.2 | ) | | $ | (0.1 | ) | | $ | (0.3 | ) | | $ | (0.2 | ) |
| | | | | | | | | | | | | | | | | |
18. | JOINTLY OWNED ELECTRIC UTILITY PLANTS |
KCP&L’s share of jointly owned electric utility plants at September 30, 2007, is detailed in the following table.
| |
| | | Wolf Creek | | LaCygne | | Iatan No. 1 | | Iatan No. 2 |
| | | Unit | | Units | | Unit | | Unit |
| | | (millions, except MW amounts) | |
| KCP&L's share | | | 47 % | | | 50 % | | | 70 % | | | | 55 % |
| | | | | | | | | | | | | | | |
| Utility plant in service | | $ | 1,379.9 | | $ | 392.6 | | $ | 275.6 | | | $ | - | |
| Accumulated depreciation | | | 741.3 | | | 260.1 | | | 198.3 | | | | - | |
| Nuclear fuel, net | | | 64.4 | | | - | | | - | | | | - | |
| Construction work in progress | | | 21.5 | | | 0.7 | | | 87.7 | | | | 217.0 | |
| KCP&L's 2007 accredited capacity-MWs | | | 548 | | | 709 | | | 460 | (a) | | | - | |
(a) The Iatan No. 2 air permit limits KCP&L's accredited capacity of Iatan No. 1 to 460 MWs from 469 MWs until the |
| air quality control equipment included in the Comprehensive Energy Plan is operational. |
| |
Each owner must fund its own portion of the plant's operating expenses and capital expenditures. KCP&L’s share of direct expenses is included in the appropriate operating expense classifications in Great Plains Energy’s and consolidated KCP&L’s financial statements.
19. | NEW ACCOUNTING STANDARDS |
SFAS No. 159
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115.” This statement provides companies with an option to report selected financial assets and liabilities at fair value, with changes in fair value recorded in earnings. The statement is effective for Great Plains Energy and consolidated KCP&L January 1, 2008, with earlier application permitted in certain circumstances. Management is currently evaluating the impact of SFAS No. 159 and has not yet determined the impact on Great Plains Energy’s and consolidated KCP&L’s consolidated financial statements.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The MD&A that follows is a combined presentation for Great Plains Energy and consolidated KCP&L, both registrants under this filing. The discussion and analysis by management focuses on those factors that had a material effect on the financial condition and results of operations of the registrants during the periods presented.
Great Plains Energy is a public utility holding company and does not own or operate any significant assets other than the stock of its subsidiaries. Great Plains Energy’s direct subsidiaries with operations or active subsidiaries are KCP&L, KLT Inc., IEC and Services. As a diversified energy company, Great Plains Energy’s reportable business segments include KCP&L and Strategic Energy.
Executive Summary
At KCP&L, both retail and wholesale revenues were higher for the three months ended September 30, 2007, compared to the same period last year. Favorable weather, new retail rates and customer growth more than offset higher purchased power expense and higher operating expenses. Retail and wholesale revenues were higher year to date September 30, 2007, compared to the same period last year; however, outages at base load generating units during the first half of 2007 led to increased use of natural gas, increased purchased power expense and increased maintenance expense. For both the three months ended and year to date September 30, 2007, KCP&L experienced higher pension costs due to the increased level of pension costs in KCP&L’s rates effective January 1, 2007, and higher depreciation and amortization expense.
On May 9, 2007, KCP&L experienced a steam pipe rupture at Iatan No. 1, which resulted in two fatalities. The repair and precautionary work on Iatan No. 1 resulted in an 18-day outage. An Occupational Safety and Health Administration (OSHA) investigation is on-going and expected to be completed before the end of the year. Management is unable to predict the outcome of this investigation.
At Strategic Energy, average retail gross margin per MWh for the three months ended September 30, 2007, increased compared to the same period last year primarily due to the changes in fair value related to non-hedging energy contracts and from hedge ineffectiveness. Average retail gross margins per MWh without the impact of unrealized fair value gains and losses on energy contracts increased slightly due to increased retail MWh deliveries to the small business segment, which has a higher margin, and lower customer acquisition costs.
Average retail gross margin per MWh year to date September 30, 2007, increased compared to the same period last year primarily due to the changes in fair value related to non-hedging energy contracts and from hedge ineffectiveness. Average retail gross margins per MWh without the impact of unrealized fair value gains and losses on energy contracts decreased primarily due to increased purchased power expense associated with a resettlement attributable to under-reported deliveries to one of the primary market regulators where Strategic Energy conducts scheduling and settlement operations, the disposition of previously-acquired power at lower than contracted prices and the absence of supplier contract settlements. Strategic Energy also experienced an increase in bad debt expense in the small business segment and recognized potential penalty expense related to the purchased power adjustment for under-reported deliveries.
Anticipated Acquisition of Aquila, Inc.
In February 2007, Great Plains Energy entered into an agreement to acquire all outstanding shares of Aquila for $1.80 in cash plus 0.0856 of a share of Great Plains Energy common stock for each share of Aquila common stock. Immediately prior to Great Plains Energy’s acquisition of Aquila, Black Hills will acquire Aquila’s electric utility in Colorado and its gas utilities in Colorado, Kansas, Nebraska and Iowa plus associated liabilities for a total of $940 million in cash, subject to closing adjustments. Each of the two transactions is conditioned on the completion of the other transaction and is expected to close in the first quarter of 2008. Activity related to the anticipated acquisition of Aquila is as follows:
| · | In April 2007, Great Plains Energy, KCP&L and Aquila filed joint applications with the MPSC and KCC for approval of the acquisition of Aquila by Great Plains Energy. These filings were updated in August 2007. The MPSC Staff has filed testimony asserting that the transaction is detrimental to the public interest and should not be approved. Other parties in the MPSC case have asserted that the transaction should not be approved, or approved with conditions. Evidentiary hearings are scheduled for December 2007 in Missouri and January 2008 in Kansas, with decisions expected in the first quarter of 2008. |
| · | In April 2007, Aquila and Black Hills filed applications with the Colorado Public Utilities Commission (CPUC), KCC, the Nebraska Public Service Commission (NPSC) and the Iowa Utilities Board (IUB) seeking approval of the sale of assets to Black Hills. The IUB and NPSC have approved the sale of assets. |
| · | In May 2007, Great Plains Energy, KCP&L, Aquila and Black Hills filed a joint application (which was amended in June 2007) with FERC for approval of the transactions. On October 18, 2007, FERC granted the joint application. |
| · | In July 2007, Great Plains Energy and Aquila submitted their respective Hart-Scott-Rodino pre-merger notifications relating to the acquisition of Aquila by Great Plains Energy, and received early termination of the waiting period on August 27, 2007. |
| · | In October 2007, Great Plains Energy received approval from its shareholders to issue common stock in connection with the anticipated acquisition of Aquila and Aquila’s shareholders approved the acquisition of Aquila by Great Plains Energy. |
| · | Integration planning is underway. |
See Note 2 to the consolidated financial statements for additional information.
Strategic Energy Alternatives Review
Great Plains Energy has retained Merrill Lynch & Co. as financial advisor to assist in a review of strategic and structural alternatives for its Strategic Energy subsidiary. The alternatives may include, among others, continuation of Strategic Energy’s current subsidiary status and business plans, joint ventures with strategic partners, acquisitions of similar businesses, or sales of part or all of Strategic Energy. There is no assurance regarding which of the foregoing alternatives, if any, will be selected, or the terms of any possible joint venture, acquisition or sale.
EXECUTING ON STRATEGIC INTENT
KCP&L’s Comprehensive Energy Plan
KCP&L continues to execute on its Comprehensive Energy Plan. The first phase of environmental upgrades at LaCygne No. 1, installation of selective catalytic reduction equipment, was completed and placed into service during the second quarter of 2007. Environmental upgrades at Iatan No. 1 are currently underway and completion is scheduled for late 2008. An outage at Iatan No. 1 is planned to complete and place in service these environmental upgrades during the fourth quarter of 2008. Construction of Iatan No. 2 is on-going and on schedule for completion in 2010. The erection of the stack liner continues, underground utilities and foundations are proceeding on schedule, boiler foundations have been released to the boiler erection contractor, steel erection has commenced and the turbine generator pedestal is complete.
In March 2007, KCP&L, the Sierra Club and the Concerned Citizens of Platte County entered into a Collaboration Agreement that resolved disputes among the parties and KCP&L agreed to pursue a set of initiatives including energy efficiency, additional wind generation, lower emission permit levels at its Iatan and LaCygne generating stations and other initiatives designed to offset carbon dioxide emissions. Under the Collaboration Agreement, KCP&L will, among other things, pursue increasing its wind generation capacity by 100 MW by year-end 2010 and another 300 MW by year-end 2012, subject to regulatory approval. In April 2007, KCP&L issued a request for proposals to develop 100 MW of wind generation in Missouri and/or Kansas. The request is an outgrowth of commitments under the Comprehensive Energy Plan. KCP&L has received proposals, which are being evaluated. KCP&L will address the other items contemplated in the Collaboration Agreement in its integrated resource planning and comprehensive energy planning processes expected to be completed in the third and fourth quarters of 2008. See Notes 6 and 14 to the consolidated financial statements for additional information.
KCP&L Regulatory Proceedings
On February 1, 2007, KCP&L filed a request with the MPSC for an annual rate increase of $45 million or 8.3%, which, if approved, would take effect January 1, 2008. In July 2007, the MPSC Staff filed its case regarding KCP&L’s rate request. In its filing, the Staff asserted that KCP&L’s annual revenues should be increased by $0.7 million, before adjustments resulting from the September 30, 2007, true-up of test year information. The Staff’s filing assumed adjustments resulting from this true-up would increase revenue requirements by $14 million, resulting in a required increase in annual revenues of $14.7 million. This amount reflects approximately $15 million to $17 million in accelerated depreciation, which the Staff asserts will maintain certain KCP&L credit ratios at investment-grade levels as provided for in the stipulation and agreement approved by the MPSC in 2005. Evidentiary hearings were held in October 2007, true-up hearings are anticipated in November 2007 and a decision is expected in December 2007.
On March 1, 2007, KCP&L filed a request with KCC for an annual rate increase of $47 million or 10.8%, along with a proposed energy cost adjustment clause, which, if approved, would take effect January 1, 2008. KCP&L reached a negotiated settlement of its request with certain parties to the rate proceedings and in September 2007 filed a Joint Stipulation and Agreement (Agreement) containing the settlement with KCC. The Agreement stipulates a $28 million increase in annual revenues effective January 1,
2008, with $11 million of that amount treated for accounting purposes as an increase to the depreciation reserve. The Agreement also recommends an Energy Cost Adjustment Clause (ECA) tariff. The ECA tariff will reflect the projected annual amount of fuel, purchased power, emission allowances, transmission costs and asset-based off-system sales margin. The Agreement is subject to KCC approval, and is voidable if not approved in its entirety. It is possible that KCC may approve the Agreement with changes, or may not approve the Agreement. A decision is expected in December 2007. See Note 6 to the consolidated financial statement for additional information.
The rate increases were filed in order to help recover costs of air quality improvement investments included in KCP&L’s Comprehensive Energy Plan as well as higher fuel and other operational costs.
KCP&L BUSINESS OVERVIEW
KCP&L is an integrated, regulated electric utility that engages in the generation, transmission, distribution and sale of electricity. KCP&L has over 4,000 MWs of generating capacity and has transmission and distribution facilities that provide electricity to approximately 507,000 customers in the states of Missouri and Kansas. KCP&L has continued to experience modest load growth. Load growth consists of higher usage per customer and the addition of new customers. Retail electricity rates are below the national average.
KCP&L’s residential customers’ usage is significantly affected by weather. Bulk power sales, the major component of wholesale sales, vary with system requirements, generating unit and purchased power availability, fuel costs and requirements of other electric systems. Less than 1% of revenues currently include a fuel cost adjustment clause; however, an energy cost adjustment clause is expected to be implemented in Kansas retail rates in 2008.
KCP&L’s nuclear unit, Wolf Creek, accounts for approximately 20% of KCP&L’s base load capacity. KCP&L defers operations and maintenance expenses incurred for scheduled refueling outages and amortizes these expenses evenly (monthly) over the unit’s 18 month operating cycle until the next scheduled outage. Replacement power costs during refueling outages are expensed as incurred. The next refueling outage is scheduled to begin in March 2008.
The fuel cost per MWh generated and the purchased power cost per MWh have a significant impact on the results of operations for KCP&L. Generation fuel mix can substantially change the fuel cost per MWh generated. Nuclear fuel cost per MWh generated is substantially less than the cost of coal per MWh generated, which is significantly lower than the cost of natural gas and oil per MWh generated. The cost per MWh for purchased power is generally significantly higher than the cost per MWh of coal and nuclear generation. KCP&L continually evaluates its system requirements, the availability of generating units, availability and cost of fuel supply and purchased power, and the requirements of other electric systems to provide reliable power economically.
STRATEGIC ENERGY BUSINESS OVERVIEW
Great Plains Energy indirectly owns 100% of Strategic Energy. Strategic Energy does not own any generation, transmission or distribution facilities. Strategic Energy provides competitive retail electricity supply services by entering into power supply contracts to supply electricity to its end-use customers. Of the states that offer retail choice, Strategic Energy operates in California, Connecticut, Illinois, Maryland, Massachusetts, Michigan, New Jersey, New York, Ohio, Pennsylvania and Texas. In addition to competitive retail electricity supply services, Strategic Energy also provides strategic planning, consulting and billing and scheduling services in the natural gas and electricity markets.
The cost of supplying electric service to retail customers can vary widely by geographic market. This variability can be affected by many factors, including, but not limited to, geographic differences in the cost per MWh of purchased power, renewable energy requirements and capacity charges due to regional purchased power availability and requirements of other electricity providers and differences in transmission charges.
Strategic Energy provides services to approximately 110,200 commercial, institutional and small manufacturing accounts (for approximately 26,000 customers) including numerous Fortune 500 companies, smaller companies and governmental entities. Strategic Energy offers an array of products designed to meet the various requirements of a diverse customer base including fixed price, index-based and month-to-month renewal products. Strategic Energy’s volume-based customer retention rate, excluding month-to-month customers on market-based rates was 57% for the three months ended and 48% year to date September 30, 2007. The corresponding volume-based customer retention rates including month-to-month customers on market-based rates was 74% and 60%, respectively. The year to date retention rates are lower than the typical rates experienced by Strategic Energy, reflecting Strategic Energy's decision not to renew two large customer accounts during the second quarter.
Management has focused sales and marketing efforts on states that currently provide a more competitive pricing environment in relation to host utility default rates. In these states, Strategic Energy continues to experience improvement in certain key metrics, including forecasted future MWh commitments (backlog) growth. Total backlog grew to 37.4 million MWh at September 30, 2007, compared to 28.4 million MWh at September 30, 2006. Based solely on expected MWh usage under current signed contracts, Strategic Energy has backlog of 5.3 million MWh for the remainder of 2007, 15.9 million MWh and 7.6 million MWh for the years 2008 and 2009, respectively, and 8.6 million MWh over the years 2010 through 2012. Strategic Energy expects to deliver additional MWhs above amounts currently in backlog through new and renewed term contracts and MWh deliveries to month-to-month customers. Strategic Energy’s projected MWh deliveries for 2007 are in the range of 19 million to 21 million MWhs.
Strategic Energy currently expects the average retail gross margin per MWh (retail revenues less retail purchased power divided by retail MWhs delivered) delivered in 2007 to average $4.00 to $5.00. This range excludes unrealized changes in fair value of non-hedging energy contracts and from hedge ineffectiveness because management does not predict the future impact of these unrealized changes. Actual retail gross margin per MWh may differ from these estimates.
RELATED PARTY TRANSACTIONS
See Note 13 to the consolidated financial statements for information regarding related party transactions.
GREAT PLAINS ENERGY RESULTS OF OPERATIONS
The following table summarizes Great Plains Energy’s comparative results of operations.
| | | | | | | | | | | | |
| | | Three Months Ended | | | Year to Date | |
| | | September 30 | | | September 30 | |
| | | | | | As Adjusted | | | | | | As Adjusted | |
| | | 2007 | | 2006 | | | 2007 | | 2006 | |
| | | (millions) | |
| Operating revenues | | $ | 992.0 | | | $ | 818.5 | | | $ | 2,460.9 | | | $ | 2,019.8 | |
| Fuel | | | (75.6 | ) | | | (76.3 | ) | | | (186.2 | ) | | | (178.1 | ) |
| Purchased power | | | (606.8 | ) | | | (467.4 | ) | | | (1,467.2 | ) | | | (1,136.2 | ) |
| Other operating expenses | | | (150.4 | ) | | | (139.4 | ) | | | (448.7 | ) | | | (397.1 | ) |
| Skill set realignment costs | | | - | | | | (1.4 | ) | | | - | | | | (15.9 | ) |
| Depreciation and amortization | | | (46.2 | ) | | | (40.4 | ) | | | (137.1 | ) | | | (118.6 | ) |
| Gain on property | | | - | | | | - | | | | - | | | | 0.6 | |
| Operating income | | | 113.0 | | | | 93.6 | | | | 221.7 | | | | 174.5 | |
| Non-operating income and expenses | | | 1.2 | | | | 7.7 | | | | 4.4 | | | | 11.1 | |
| Interest charges | | | (28.2 | ) | | | (18.0 | ) | | | (67.8 | ) | | | (53.1 | ) |
| Income taxes | | | (23.5 | ) | | | (27.0 | ) | | | (46.1 | ) | | | (38.3 | ) |
| Loss from equity investments | | | (0.4 | ) | | | (0.4 | ) | | | (1.1 | ) | | | (1.0 | ) |
| Net income | | | 62.1 | | | | 55.9 | | | | 111.1 | | | | 93.2 | |
| Preferred dividends | | | (0.3 | ) | | | (0.5 | ) | | | (1.2 | ) | | | (1.3 | ) |
| Earnings available for common shareholders | $ | 61.8 | | | $ | 55.4 | | | $ | 109.9 | | | $ | 91.9 | |
| | | | | | | | | | | | | | | | | | |
In December 2006, Great Plains Energy and consolidated KCP&L adopted Financial Accounting Standards Board (FASB) Staff Position (FSP) No. AUG AIR-1, “Accounting for Planned Major Maintenance Activities,” and retrospectively adjusted prior periods. FSP No. AUG AIR-1 prohibits the use of the accrue-in-advance method of accounting for planned major maintenance activities. Prior to adoption, KCP&L utilized the accrue-in-advance method for incremental costs to be incurred during scheduled Wolf Creek refueling outages. KCP&L adopted the deferral method to account for operations and maintenance expenses incurred for scheduled refueling outages to be amortized evenly (monthly) over the unit’s 18 month operating cycle until the next scheduled outage. Replacement power costs during the outage are expensed as incurred. See Note 5 to the consolidated financial statements for additional information.
Three Months Ended September 30, 2007, Compared to September 30, 2006
Great Plains Energy’s earnings for the three months ended September 30, 2007, increased to $61.8 million, or $0.72 per share, from earnings of $55.4 million, or $0.69 per share, in the same period in 2006. A higher average number of common shares, primarily due to the issuance of 5.2 million shares to the holders of FELINE PRIDES in February 2007, diluted 2007 earnings per share by $0.05.
Consolidated KCP&L’s net income increased to $76.6 million for the three months ended September 30, 2007, compared to $69.5 million for the same period in 2006. Increased retail and wholesale revenues were partially offset by increased purchased power expense as lower natural gas prices allowed KCP&L to purchase power more economically than running natural gas-fired generation, increased pension expense, increased amortization per 2006 rate orders and increased depreciation related to the Spearville Wind Energy Facility.
Strategic Energy had a net loss of $4.1 million for the three months ended September 30, 2007, compared to a net loss of $10.9 million for the same period in 2006. The after-tax loss from the changes in fair value related to non-hedging energy contracts and from hedge ineffectiveness decreased $4.3 million in 2007 compared to 2006.
The $6.2 million decrease in other non-regulated activities for the three months ended September 30, 2007, compared to the same period in 2006, is primarily due to a $5.6 million after-tax loss for the fair value of FSS entered into by Great Plains Energy in July 2007, related to a future debt issuance that is contingent on the consummation of the acquisition of Aquila. If the merger is terminated due to regulatory actions, neither Great Plains Energy or the counterparty to these transactions are obligated to settle the FSS since the fair value of the FSS is set to zero.
Year to Date September 30, 2007, Compared to September 30, 2006
Great Plains Energy’s earnings year to date September 30, 2007, increased to $109.9 million, or $1.29 per diluted share, from $91.9 million, or $1.19 per share, in the same period in 2006. A higher average number of common shares, primarily due to the issuance of 5.2 million shares to the holders of FELINE PRIDES in February 2007 and 5.2 million shares in May 2006, diluted 2007 earnings per share by $0.13.
Consolidated KCP&L’s net income decreased to $115.1 million year to date September 30, 2007, compared to $119.1 million for the same period in 2006. A scheduled maintenance outage which was extended by several days at Iatan No. 1 during the first quarter of 2007 and outages at KCP&L’s base load generating units during the first and second quarter of 2007, including the unplanned outage at Iatan No. 1, led to increased fuel, purchased power and maintenance expense. Additionally, pension expense, depreciation and amortization and interest expense increased. These decreases to net income were partially offset by an increase in retail revenue, wholesale revenue and the absence of skill set realignment costs.
Strategic Energy had net income of $16.5 million year to date September 30, 2007, compared to a $17.6 million net loss in the same period in 2006. This change is primarily due to the impact of a $50.2 million after-tax increase in changes in fair value related to non-hedging energy contracts and from hedge ineffectiveness. This increase was partially offset by increased purchased power expense due to a resettlement attributable to under-reported deliveries and the disposition of previously-acquired power at lower than contracted prices caused by early terminations in the small business segment and the absence of supplier contract settlements. Strategic Energy also experienced an increase in bad debt expense in the small business segment and recognized penalty expense related to the purchased power adjustment for under-reported deliveries.
The $10.9 million decrease in other non-regulated activities year to date September 30, 2007, compared to the same period in 2006, is primarily attributable to a decline in available tax credits from affordable housing investment and overall higher expenses at the holding company including $5.9 million of transition costs related to the anticipated acquisition of Aquila and a $5.6 million after-tax loss for the fair value of FSS entered into by Great Plains Energy in July 2007.
CONSOLIDATED KCP&L RESULTS OF OPERATIONS
The following discussion of consolidated KCP&L results of operations includes KCP&L, an integrated, regulated electric utility and HSS, an unregulated inactive subsidiary of KCP&L. In the discussion that follows, references to KCP&L reflect only the operations of the utility. The following table summarizes consolidated KCP&L's comparative results of operations.
| | | | | | | | | | | | | |
| | | Three Months Ended | | | Year to Date | |
| | | September 30 | | | September 30 | |
| | | | | | As Adjusted | | | | | | As Adjusted | |
| | | 2007 | | | 2006 | | | 2007 | | | 2006 | |
| | | (millions) | |
| Operating revenues | | $ | 416.0 | | | $ | 359.3 | | | $ | 990.8 | | | $ | 890.6 | |
| Fuel | | | (75.6 | ) | | | (76.3 | ) | | | (186.2 | ) | | | (178.1 | ) |
| Purchased power | | | (41.3 | ) | | | (5.1 | ) | | | (80.4 | ) | | | (18.8 | ) |
| Other operating expenses | | | (128.0 | ) | | | (119.6 | ) | | | (383.1 | ) | | | (346.6 | ) |
| Skill set realignment costs | | | - | | | | (1.4 | ) | | | - | | | | (15.6 | ) |
| Depreciation and amortization | | | (44.1 | ) | | | (38.5 | ) | | | (130.9 | ) | | | (112.8 | ) |
| Gain on property | | | - | | | | - | | | | - | | | | 0.6 | |
| Operating income | | | 127.0 | | | | 118.4 | | | | 210.2 | | | | 219.3 | |
| Non-operating income and expenses | | | 0.2 | | | | 6.5 | | | | 2.6 | | | | 8.8 | |
| Interest charges | | | (17.1 | ) | | | (15.6 | ) | | | (52.0 | ) | | | (45.5 | ) |
| Income taxes | | | (33.5 | ) | | | (39.8 | ) | | | (45.7 | ) | | | (63.5 | ) |
| Net income | | $ | 76.6 | | | $ | 69.5 | | | $ | 115.1 | | | $ | 119.1 | |
| | | | | | | | | | | | | | | | | |
Consolidated KCP&L Sales Revenues and MWh Sales
| |
| | | Three Months Ended | | | | | | Year to Date | | | | |
| | | September 30 | | | % | | | September 30 | | | % | |
| | | 2007 | | | 2006 | | | Change | | | 2007 | | | 2006 | | | Change | |
| Retail revenues | | (millions) | | | | | | (millions) | | | | |
| Residential | | $ | 160.0 | | | $ | 140.2 | | | | 14 | | | $ | 348.8 | | | $ | 310.4 | | | | 12 | |
| Commercial | | | 157.8 | | | | 140.2 | | | | 13 | | | | 386.1 | | | | 347.7 | | | | 11 | |
| Industrial | | | 31.7 | | | | 28.7 | | | | 10 | | | | 83.4 | | | | 77.6 | | | | 7 | |
| Other retail revenues | | | 2.4 | | | | 2.3 | | | | 14 | | | | 7.3 | | | | 6.7 | | | | 11 | |
| Total retail | | | 351.9 | | | | 311.4 | | | | 13 | | | | 825.6 | | | | 742.4 | | | | 11 | |
| Wholesale revenues | | | 59.3 | | | | 43.7 | | | | 36 | | | | 152.0 | | | | 137.4 | | | | 11 | |
| Other revenues | | | 4.8 | | | | 4.2 | | | | 11 | | | | 13.2 | | | | 10.8 | | | | 22 | |
| Consolidated KCP&L revenues | | $ | 416.0 | | | $ | 359.3 | | | | 16 | | | $ | 990.8 | | | $ | 890.6 | | | | 11 | |
| |
| | | | | | | | | | | | | |
| | | Three Months Ended | | | | Year to Date | |
| | | September 30 | | % | | September 30 | % |
| | | 2007 | | 2006 | | Change | | 2007 | | 2006 | | Change |
| Retail MWh sales | | (thousands) | | | | (thousands) | |
| Residential | | 1,840 | | 1,769 | | 4 | | | | 4,232 | | 3 |
| Commercial | | 2,242 | | 2,117 | | 6 | | 5,905 | | 5,654 | | 4 |
| Industrial | | 602 | | 579 | | 4 | | 1,657 | | 1,643 | | 1 |
| Other retail MWh sales | | 19 | | 21 | | (3) | | 67 | | 63 | | 6 |
| Total retail | | 4,703 | | 4,486 | | 5 | | 11,996 | | 11,592 | | 3 |
| Wholesale MWh sales | | 1,438 | | 1,058 | | 36 | | 3,686 | | 3,240 | | 14 |
| KCP&L electric MWh sales | | 6,141 | | 5,544 | | 11 | | 15,682 | | 14,832 | | 6 |
| | | | | | | | | | | | | |
Retail revenues increased $40.5 million for the three months ended September 30, 2007, compared to the same period in 2006 due to favorable weather, with an 8% increase in cooling degree days, new retail rates effective January 1, 2007, growth in the number of customers and higher usage per customer. Retail revenues increased $83.2 million year to date September 30, 2007, compared to the same period in 2006 due to new retail rates effective January 1, 2007, growth in the number of customers and higher usage per customer. Favorable winter and third quarter weather partially offset by a 29% decrease in cooling degree days in the second quarter of 2007 also contributed to the year to date increase in retail revenue.
Wholesale revenues increased $15.6 million for the three months ended September 30, 2007, compared to the same period in 2006 due to an 11% increase in the average market price per MWh to $41.99 and a 36% increase in wholesale MWh sales resulting from increased generation due to greater plant availability. Wholesale revenues increased $14.6 million year to date September 30, 2007, compared to the same period in 2006 due to a 14% increase in wholesale MWh sales. Wholesale MWh sales increased for both the second and third quarter of 2007 partially offset by a 20% decrease in wholesale MWh sales in the first quarter of 2007. This first quarter decrease was the result of a 3% decrease in MWhs generated due to planned and unplanned plant outages as well as an increase in retail load. These increases were slightly offset by $2.5 million in litigation recoveries received in 2006 for the loss of use of Hawthorn No. 5 from a 1999 boiler explosion.
Consolidated KCP&L Fuel and Purchased Power
| |
| | | Three Months Ended | | | | Year to Date | |
| | | September 30 | | % | | September 30 | % |
| | | 2007 | | 2006 | | Change | | 2007 | | 2006 | | Change |
| Net MWhs Generated by Fuel Type | | (thousands) | | | | (thousands) | | |
| Coal | | 4,232 | | 4,067 | | 4 | | 10,829 | | 10,945 | | (1) |
| Nuclear | | 1,215 | | 1,216 | | - | | 3,638 | | 3,641 | | - |
| Natural gas and oil | | 280 | | 346 | | (19) | | 524 | | 522 | | - |
| Wind | | 74 | | 24 | | NM | | 211 | | 24 | | NM |
| Total Generation | | 5,801 | | 5,653 | | 3 | | 15,202 | | 15,132 | | - |
| ; |
For the three months ended September 30, 2007, KCP&L’s coal base load equivalent availability factor increased slightly to 89% from 88% compared to the same period in 2006. The capacity factor, which reflects how much coal generation that is available is actually utilized by retail or sold wholesale, increased to 86% from 82% resulting in greater coal generation as there were fewer outages in the third quarter of 2007 compared to 2006.
Year to date September 30, 2007, KCP&L’s coal base load equivalent availability factor decreased to 78% from 82% compared to the same period in 2006, and the capacity factor also decreased to 74% from 75% reflecting the impact of planned and unplanned plant outages during the first half of 2007.
Fuel expense decreased $0.7 million for the three months ended September 30, 2007, compared to the same period in 2006 due to less natural gas, which has higher cost compared to other fuel types, and more coal in the fuel mix partially offset by higher coal and coal transportation costs. Fuel expense increased $8.1 million year to date September 30, 2007, compared to the same period in 2006 primarily due to higher coal and coal transportation costs. Fuel expense for the three months ended and year to date September 30, 2006, was reduced by $3.7 million in Hawthorn No. 5 litigation recoveries.
Purchased power expense increased $36.2 million for the three months ended September 30, 2007, compared to the same period in 2006 primarily due to a 284% increase in MWh purchases resulting from increased peak power purchases as lower natural gas prices allowed KCP&L to purchase power more economically than running natural gas-fired generation, slightly offset by a 29% decrease in the average price per MWh due to lower natural gas prices. Purchased power expense increased $61.6 million year to date September 30, 2007, compared to the same period in 2006 primarily due to a 240% increase in MWh purchases to support increased retail load and the impact of planned and unplanned outages in the first half of 2007, slightly offset by a 12% decrease in the average price per MWh. Purchased power expense for the three months ended and year to date September 30, 2006, was reduced by $10.8 million in Hawthorn No. 5 litigation recoveries.
Consolidated KCP&L Other Operating Expenses (including operating expenses – KCP&L, maintenance, general taxes and other)
Consolidated KCP&L's other operating expenses increased $8.4 million for the three months ended September 30, 2007, compared to the same period in 2006 primarily due to the following:
| · | increased pension expense of $4.6 million primarily due to the increased level of pension costs in KCP&L’s rates effective January 1, 2007, |
| · | increased transmission expenses of $1.6 million due to increased transmission usage charges as a result of the increased wholesale MWh sales and higher Southwest Power Pool, Inc. (SPP) fees, |
| · | increased property tax expense of $1.1 million due to increases in assessed property valuations and mill levies and |
| · | increased gross receipts tax expense of $1.3 million due to the increase in revenues. |
Consolidated KCP&L’s other operating expenses increased $36.5 million year to date September 30, 2007, compared to the same period in 2006 primarily due to the following:
| · | increased pension expenses of $14.3 million due to the increased level of pension costs in KCP&L’s rates effective January 1, 2007, |
| · | increased plant operations and maintenance expenses of $8.8 million primarily due to planned and unplanned outages and the addition of the Spearville Wind Energy Facility in the third quarter of 2006, |
| · | increased labor expense of $2.1 million primarily due to filling open positions subsequent to the skill set realignment process, |
| · | increased transmission expenses of $5.1 million primarily due to increased transmission usage charges as a result of the increased wholesale MWh sales and higher SPP fees, |
| · | increased gross receipts tax expense of $3.2 million due to the increase in revenues and |
| · | increased equity compensation of $1.7 million. |
Partially offsetting the year to date increase in other operating expenses was decreased incentive compensation expense of $5.5 million.
Consolidated KCP&L Depreciation and Amortization
Consolidated KCP&L’s depreciation and amortization costs increased $5.6 million for the three months ended and $18.1 million year to date September 30, 2007, compared to the same periods in 2006 primarily due to additional amortization pursuant to 2006 rate case orders of $3.0 million for the three months ended and $8.9 million year to date September 30, 2007. Additionally, depreciation increased $1.0 million and $4.6 million for the three months ended and year to date September 30, 2007, respectively, due to wind generation assets placed in service in the third quarter of 2006.
Consolidated KCP&L Interest Charges
Consolidated KCP&L’s interest charges increased $6.5 million year to date September 30, 2007, compared to the same period in 2006 due to an increase in commercial paper borrowings.
Consolidated KCP&L Income Taxes
Consolidated KCP&L’s income taxes decreased $6.3 million for the three months ended September 30, 2007, compared to the same period in 2006, due to recognition of wind credits in the amount of $1.1 million, $2.3 million of income tax true ups and a $3.3 million increase in the allocation of tax benefits from holding company losses pursuant to Great Plains Energy’s intercompany tax allocation agreement.
Consolidated KCP&L’s income taxes decreased $17.8 million year to date September 30, 2007, compared to the same period in 2006 due to a decrease in pre-tax income, $3.8 million of wind credits, $2.3 million of income tax true ups and a $4.3 million increase in the allocation of tax benefits from holding company losses pursuant to Great Plains Energy’s intercompany tax allocation agreement.
STRATEGIC ENERGY RESULTS OF OPERATIONS
The following table summarizes Strategic Energy's comparative results of operations.
| | | | | | | | | | | | | |
| | | Three Months Ended | | | Year to Date | |
| | | September 30 | | | September 30 | |
| | | 2007 | | | 2006 | | | 2007 | | | 2006 | |
| | | (millions) | |
| Operating revenues | | $ | 576.0 | | | $ | 459.2 | | | $ | 1,470.1 | | | $ | 1,129.2 | |
| Purchased power | | | (565.5 | ) | | | (462.3 | ) | | | (1,386.8 | ) | | | (1,117.4 | ) |
| Other operating expenses | | | (17.1 | ) | | | (16.6 | ) | | | (52.1 | ) | | | (42.5 | ) |
| Depreciation and amortization | | | (2.1 | ) | | | (1.9 | ) | | | (6.2 | ) | | | (5.8 | ) |
| Operating income (loss) | | | (8.7 | ) | | | (21.6 | ) | | | 25.0 | | | | (36.5 | ) |
| Non-operating income and expenses | | | 0.8 | | | | 1.1 | | | | 3.0 | | | | 3.0 | |
| Interest charges | | | (0.9 | ) | | | (0.6 | ) | | | (2.4 | ) | | | (1.5 | ) |
| Income taxes | | | 4.7 | | | | 10.2 | | | | (9.1 | ) | | | 17.4 | |
| Net income (loss) | | $ | (4.1 | ) | | $ | (10.9 | ) | | $ | 16.5 | | | $ | (17.6 | ) |
| | | | | | | | | | | | | | | | | |
Strategic Energy’s retail MWh deliveries increased 23% to 5.8 million for the three months ended and 22% to 15.1 million year to date September 30, 2007, compared to the same periods in 2006.
Strategic Energy had a net loss of $4.1 million for the three months ended September 30, 2007, compared to a net loss of $10.9 million for the same period in 2006. The after-tax loss from the changes in fair value related to non-hedging energy contracts and from hedge ineffectiveness decreased $4.3 million in 2007 compared to 2006. Strategic Energy also experienced higher bad debt expense mostly offset by lower employee-related expenses.
Strategic Energy had net income of $16.5 million year to date September 30, 2007, compared to a net loss of $17.6 million for the same period in 2006 due to the impact of a $50.2 million after-tax increase in changes in fair value related to non-hedging energy contracts and from hedge ineffectiveness. Partially offsetting this increase to net income was increased purchased power associated with a resettlement attributable to under-reported deliveries and the disposition of previously-acquired power at lower than contract prices caused by early terminations in the small business segment and the absence of supplier contract settlements. Strategic Energy also experienced increased bad debt expense in the small business segment and recognized penalty expense related to the purchased power adjustment for under-reported deliveries.
Average Retail Gross Margin per MWh Without Fair Value Impacts
| | | | | | | | | | | | | |
| | | Three Months Ended | | | Year to Date | |
| | | September 30 | | | September 30 | |
| | | 2007 | | | 2006 | | | 2007 | | | 2006 | |
| Average retail gross margin per MWh | | $ | 1.75 | | | $ | (0.79 | ) | | $ | 5.42 | | | $ | 0.78 | |
| Change in fair value related to non-hedging energy | | | | | | | | | | | | | | | | |
| contracts and from cash flow hedge ineffectiveness | | | 3.30 | | | | 5.60 | | | | (1.36 | ) | | | 5.21 | |
| Average retail gross margin per MWh without | | | | | | | | | | | | | | | | |
| fair value impacts | | $ | 5.05 | | | $ | 4.81 | | | $ | 4.06 | | | $ | 5.99 | |
| | | | | | | | | | | | | | | | | |
Average retail gross margin per MWh without fair value impacts is a non-GAAP financial measure that differs from GAAP because it excludes the impact of unrealized fair value gains or losses. Fair value impacts result from changes in fair value of non-hedging energy contracts and from hedge ineffectiveness associated with MWhs under contract but not yet delivered. By not reflecting the impact of unrealized fair value gains or losses, this non-GAAP financial measure does not reflect the volatility recognized in the Company’s consolidated statement of income as a result of the unrealized fair value gains or losses in the periods presented related to energy under contract for future delivery to customers. The fair value of energy under contract but not yet delivered fluctuates from the time the contract is entered into until the energy is delivered to customers. However, the ultimate value realized by Strategic Energy under the customer sales contracts is determined when the electricity supply contract settles at the originally contracted price at the time of delivery to customers. Management and the Board of Directors use this as a measurement of Strategic Energy’s realized retail gross margin per delivered MWh, which are settled at contracted prices upon delivery. Because certain of Strategic Energy’s derivative supply contracts do not meet the requirements for cash flow hedge designation and certain other derivative supply contracts designated as cash flow hedges have a level of ineffectiveness, Strategic Energy recognizes unrealized gains or losses during the term of these derivative supply contracts prior to delivery while the associated customer sales contracts are not subject to fair value accounting treatment and therefore do not result in unrecognized gains or losses being recorded during the term prior to delivery. By removing these non-cash timing differences that occur during the term of the contracts prior to delivery and impact only one side of the overall buy-sell transaction, management believes this non-GAAP financial measure provides investors with a measure of average retail gross margin per MWh that more accurately reflects Strategic Energy’s realized margin on delivered MWhs.
As detailed in the table above, average retail gross margin per MWh without the impact of unrealized fair value gains and losses increased to $5.05 for the three months ended September 30, 2007, compared to $4.81 for the same period in 2006 due to increased retail MWh deliveries to the small business segment, which has a higher margin, and lower customer acquisition costs.
The average retail gross margin per MWh without the impact of unrealized fair value gains and losses decreased to $4.06 year to date September 30, 2007, compared to $5.99 for the same period in 2006. This decrease is attributable to the disposition of previously-acquired power at lower than contracted prices caused by early terminations in the small business segment, increased purchased power expense associated with a resettlement attributable to under-reported deliveries and the absence of settlements of supplier contracts. Partially offsetting these decreases was an increase in net SECA recoveries.
Strategic Energy Purchased Power
Purchased power is the cost component of Strategic Energy’s average retail gross margin. Strategic Energy purchases electricity from power suppliers based on forecasted peak demand for its retail customers. Actual customer demand does not always equate to the volume purchased based on forecasted peak demand. Consequently, Strategic Energy makes short-term power purchases in the wholesale market when necessary to meet actual customer requirements. Strategic Energy also sells any excess retail electricity supply over actual customer requirements back into the wholesale market. These sales occur on many contracts, are usually short-term power sales (day ahead) and typically settle within the reporting period. Excess retail electricity supply sales also include long-term and short-term forward physical sales to wholesale counterparties, which are accounted for on a mark-to-market basis. Strategic Energy typically executes these transactions to manage basis and credit risks. The proceeds from excess retail supply sales are recorded as a reduction of purchased power, as they do not represent the quantity of electricity consumed by Strategic Energy’s customers. The amount of excess retail supply sales that reduced purchased power was $16.6 million for the three months ended and $47.9 million year to date September 30, 2007, compared to $1.6 million and $67.0 million for the same periods in 2006, respectively. Additionally, in certain markets, Strategic Energy is required to sell to and purchase power from a RTO/ISO rather than directly transact with suppliers and end use customers. The sale and purchase activity related to these certain RTO/ISO markets is reflected on a net basis in Strategic Energy’s purchased power.
Strategic Energy utilizes derivative instruments, including forward physical delivery contracts, in the procurement of electricity. Purchased power is also impacted by the net change in fair value related to non-hedging energy contracts and from cash flow hedge ineffectiveness. Net changes in fair value increased purchased power expenses by $19.3 million for the three months ended September 30, 2007, compared to an increase of $26.6 million for the same period in 2006. Net changes in fair value decreased purchased power expense by $20.5 million year to date September 30, 2007, compared to an increase of $64.5 million for the same period in 2006. These changes are a result of volatility in the forward market prices for power combined with Strategic Energy designating more derivative instruments as cash flow hedges that no longer qualify for the NPNS election. See Note 17 to the consolidated financial statements for more information.
Strategic Energy Other Operating Expenses (including selling, general and administrative – non-regulated and general taxes)
Strategic Energy’s other operating expenses increased $0.5 million for the three months ended September 30, 2007, compared to the same period in 2006 primarily due to a $3.2 million increase in bad debt expense attributable to the small business segment, which has a higher default rate than Strategic Energy’s larger customers, mostly offset by lower employee-related expenses.
Strategic Energy’s other operating expenses increased $9.6 million year to date September 30, 2007, compared to the same period in 2006 due to a $9.4 million increase in bad debt expense combined with penalty expense related to the purchased power adjustment for under-reported deliveries recorded in the first quarter of 2007 partially offset by lower employee-related expenses.
Strategic Energy Income Taxes
Strategic Energy had a tax benefit of $4.7 million for the three months ended September 30, 2007, compared to a tax benefit of $10.2 million for the same period in 2006 due to a decrease in pre-tax losses. The deferred tax benefit related to the net changes in fair value related to non-hedging energy contracts and hedge ineffectiveness decreased $3.0 million for the three months ended September 30, 2007, compared to the same period in 2006.
Strategic Energy had tax expense of $9.1 million year to date September 30, 2007, compared to a tax benefit of $17.4 million for the same period in 2006 due to pre-tax income year to date September 30, 2007, compared to a pre-tax loss for the same period in 2006. The deferred tax expense related to the net changes in fair value related to non-hedging energy contracts and from hedge ineffectiveness was $8.3 million year to date September 30, 2007, compared to a tax benefit of $26.5 million for the same period in 2006.
GREAT PLAINS ENERGY AND CONSOLIDATED KCP&L SIGNIFICANT BALANCE SHEET CHANGES (September 30, 2007 compared to December 31, 2006)
| · | Great Plains Energy’s and consolidated KCP&L’s restricted cash increased $147.0 million and $146.5 million, respectively, due to proceeds from KCP&L’s $146.5 million EIRR Bonds Series 2007A and 2007B issued in the third quarter of 2007 being restricted for the repayment of $146.5 million of Series 1998 A, B and D EIRR bonds on October 1, 2007. |
| · | Great Plains Energy’s and consolidated KCP&L’s receivables increased $136.3 million and $63.2 million, respectively. KCP&L’s receivables increased $46.3 million due to new retail rates effective January 1, 2007, seasonal increases from higher summer tariff rates and usage and $12.1 million due to additional receivables from joint owners related to Comprehensive Energy Plan projects. Strategic Energy’s receivables increased $78.7 million due to seasonal increases in MWh deliveries at higher prices slightly offset by a higher allowance for doubtful accounts primarily due to an increase in the aging of the small business customer segment. |
| · | Great Plains Energy’s and consolidated KCP&L’s fuel inventories increased $7.6 million primarily due to increased coal inventory due to plant outages as well as increased coal and coal transportation costs. |
| · | Great Plains Energy’s combined refundable income taxes and accrued taxes of a net current liability of $58.9 million at September 30, 2007, increased $44.6 million from December 31, 2006 due to an increase at consolidated KCP&L. Consolidated KCP&L’s refundable income taxes and accrued taxes of a net current liability of $60.4 million at September 30, 2007, increased $49.5 million from December 31, 2006. This increase was due to higher property and income tax accruals partially offset by a $6.0 million reclassification of an income tax receivable from other deferred charges. |
| · | Great Plains Energy’s derivative instruments, including current and deferred liabilities, decreased $56.2 million primarily due to a $70.7 million decrease in the fair value of Strategic Energy’s energy-related derivative instruments as a result of increases in the forward market prices for power partially offset by an $18.9 million increase related to the fair value of FSS entered into in 2007 by Great Plains Energy. |
| · | Great Plains Energy’s and consolidated KCP&L’s construction work in progress increased $173.5 million due to $196.8 million related to KCP&L’s Comprehensive Energy Plan, including $49.4 million for environmental upgrades and $147.4 million related to the construction of Iatan No. 2 partially offset by normal construction activity as assets are completed and placed into service. |
| · | Great Plains Energy’s other deferred charges and other assets increased $16.1 million primarily due to deferred costs associated with Great Plains Energy’s anticipated acquisition of Aquila. |
| · | Great Plains Energy’s notes payable increased $86.0 million due to an increase in consolidated KCP&L’s notes payable and borrowings on its short-term credit facility used to settle a forward sale agreement for $12.3 million, with the remainder due to the timing of cash payments. Consolidated KCP&L’s notes payable increased $50.0 million due to a decrease in operating cash flows resulting from higher operating expense due to the impact of outages at KCP&L’s base load generating units during the first half of 2007. KCP&L elected to make a cash borrowing on its short-term credit facility as this was a more economical option than issuing commercial paper. |
| · | Great Plains Energy’s and consolidated KCP&L’s commercial paper increased $52.2 million primarily due to a decrease in operating cash flows resulting from higher operating expense due to the impact of outages at KCP&L’s base load generating units during the first half of 2007. |
| · | Great Plains Energy’s and consolidated KCP&L’s current maturities of long-term debt decreased $389.1 million and $225.5 million, respectively, due to Great Plains Energy’s settlement of the FELINE PRIDES Senior Notes by issuing $163.6 million of common stock and KCP&L’s repayment of $225.0 million 6.00% Senior Notes at maturity. |
| · | Great Plains Energy’s and consolidated KCP&L’s accrued interest increased $10.4 million and $6.6 million due to the timing of interest payments and an increase in interest accrued related to unrecognized tax benefits. |
| · | Great Plains Energy’s and consolidated KCP&L’s accrued compensation and benefits decreased $10.2 million and $2.7 million, respectively, primarily due to the 2007 payments of employee incentive compensation accrued at December 31, 2006, and lower incentive compensation expense during 2007. |
| · | Great Plains Energy’s and consolidated KCP&L’s other – deferred credits and other liabilities increased $23.7 million and $20.6 million, respectively, primarily due to a $19.5 million impact of the adoption of FIN 48, which was mostly a reclassification from deferred income taxes. |
| · | Consolidated KCP&L’s common stock increased $94.0 million due to an equity contribution from Great Plains Energy. |
| · | Great Plains Energy’s accumulated other comprehensive loss decreased $23.3 million primarily due to changes in the fair value of Strategic Energy’s energy-related derivative instruments. |
| · | Great Plains Energy’s long-term debt increased $495.7 million due to Great Plains Energy’s issuance of $100.0 million of 6.875% Senior Notes and an increase at consolidated KCP&L. Consolidated KCP&L’s long-term debt increased $396.2 million reflecting the issuance of $250.0 million of 5.85% Senior Notes and the issuance of $146.5 million of EIRR Bonds Series 2007A and 2007B. The proceeds from the issuance of $146.5 million EIRR Bonds Series 2007A and 2007B were used for the repayment of $146.5 million of Series 1998 A, B and D EIRR bonds on October 1, 2007. |
CAPITAL REQUIREMENTS AND LIQUIDITY
Great Plains Energy operates through its subsidiaries and has no material assets other than the stock of its subsidiaries. Great Plains Energy’s ability to make payments on its debt securities and its ability to pay dividends is dependent on its receipt of dividends or other distributions from its subsidiaries and proceeds from the issuance of its securities.
Great Plains Energy’s capital requirements are principally comprised of KCP&L’s utility construction and other capital expenditures, debt maturities and credit support provided to Strategic Energy. These items as well as additional cash and capital requirements for the companies are discussed below.
Great Plains Energy's liquid resources at September 30, 2007, consisted of $35.0 million of cash and cash equivalents on hand, including $0.7 million at consolidated KCP&L, and $632.3 million of unused bank lines of credit. The unused lines at September 30, 2007, consisted of $334.6 million from KCP&L's revolving credit facility, $85.0 million from Strategic Energy’s revolving credit facility and $212.7 million from Great Plains Energy's revolving credit facility. See the Debt Agreements section below for more information on these agreements.
KCP&L currently expects to fund its Comprehensive Energy Plan expenditures from a combination of internal and external sources including, but not limited to, contributions from rate increases, capital contributions to KCP&L from Great Plains Energy's security issuances and new short and long-term debt financing.
KCP&L expects to meet day-to-day cash flow requirements including interest payments, construction requirements (excluding its comprehensive energy plan), dividends to Great Plains Energy and pension benefit plan funding requirements, discussed below, with internally generated funds. KCP&L may not be able to meet these requirements with internally generated funds because of the effect of inflation on operating expenses, the level of MWh sales, regulatory actions, compliance with environmental regulations and the availability of generating units. The funds Great Plains Energy and consolidated KCP&L need to retire maturing debt will be provided from operations, the issuance of long and short-term debt and/or the issuance of equity or equity-linked instruments. In addition, the Company may issue debt, equity and/or equity-linked instruments to finance growth or take advantage of new opportunities.
Strategic Energy expects to meet day-to-day cash flow requirements including interest payments, credit support fees and capital expenditures with internally generated funds. Strategic Energy may not be able to meet these requirements with internally generated funds because of the effect of inflation on operating expenses, the level of MWh sales, seasonal working capital requirements, commodity-price volatility and the effects of counterparty non-performance.
In February 2007, Great Plains Energy entered into an agreement to acquire Aquila. See Note 2 to the consolidated financial statements for additional information.
Cash Flows from Operating Activities
Great Plains Energy and consolidated KCP&L generated positive cash flows from operating activities for the periods presented. Great Plains Energy’s cash flows from operating activities year to date September 30, 2007, decreased primarily due to lower net income at Strategic Energy after considering non-cash after-tax fair value impacts from energy contracts, an increase in receivables at Strategic Energy due to seasonal increases in MWh deliveries at higher prices and $12.1 million of costs associated with the anticipated acquisition of Aquila. Other changes in working capital detailed in Note 3 to the consolidated financial statements also impacted operating cash flows. Consolidated KCP&L’s cash flows from operating activities year to date September 30, 2007, increased primarily due to the changes in working capital detailed in Note 3 to the consolidated financial statements. The timing of the
Wolf Creek outage affects the deferred refueling outage costs, deferred income taxes and amortization of nuclear fuel. The individual components of working capital vary with normal business cycles and operations.
Cash Flows from Investing Activities
Great Plains Energy’s and consolidated KCP&L’s cash used for investing activities varies with the timing of utility capital expenditures and purchases of investments and nonutility property. Investing activities are offset by the proceeds from the sale of properties and insurance recoveries. Great Plains Energy’s and consolidated KCP&L’s cash flows from investing activities decreased $167.9 million and $161.6 million, respectively, year to date September 30, 2007, compared to the same period in 2006 primarily due to the $146.5 million of proceeds from KCP&L’s EIRR Bonds Series 2007A and 2007B issued in the third quarter of 2007 being restricted for the repayment of $146.5 million of Series 1998 A, B and D EIRR bonds on October 1, 2007. Additionally in 2006, KCP&L received $15.8 million of litigation recoveries related to Hawthorn No. 5.
Cash Flows from Financing Activities
Great Plains Energy’s cash flows from financing activities year to date September 30, 2007, reflect consolidated KCP&L’s repayment and issuance of Senior Notes; an issuance, at a discount, of $100.0 million of 6.875% Senior Notes that mature in 2017, an increase in short-term borrowings and the $12.3 million settlement of an equity forward contract at Great Plains Energy. Consolidated KCP&L’s financing activities year to date September 30, 2007, reflect KCP&L’s repayment of its $225.0 million 6.00% Senior Notes at maturity; issuance, at a discount, of $250.0 million 5.85% Senior Notes that mature in 2017, issuance of $146.5 million of EIRR Bonds Series 2007A and 2007B and an increase in short-term borrowings. Consolidated KCP&L’s short-term borrowings have increased primarily due to a decrease in operating cash flows year to date September 30, 2007, resulting from higher operating expense due to the impact of outages at KCP&L’s base load generating units in the first half of 2007.
Financing Authorization
Under stipulations with the MPSC and KCC, Great Plains Energy and KCP&L must maintain common equity at not less than 30% and 35%, respectively, of total capitalization. KCP&L’s long-term financing activities are subject to the authorization of the MPSC. In 2005, the MPSC authorized KCP&L to issue up to $635.0 million of long-term debt and to enter into interest rate hedging instruments in connection with such debt through December 31, 2009. KCP&L has $135.0 million of authorization remaining.
During 2006, FERC authorized KCP&L to issue up to a total of $600.0 million in outstanding short-term debt instruments through February 2008. The authorizations are subject to four restrictions: (i) proceeds of debt backed by utility assets must be used for utility purposes; (ii) if any utility assets that secure authorized debt are divested or spun off, the debt must follow the assets and also be divested or spun off; (iii) if any proceeds of the authorized debt are used for non-utility purposes, the debt must follow the non-utility assets (specifically, if the non-utility assets are divested or spun off, then a proportionate share of the debt must follow the divested or spun off non-utility assets); and (iv) if utility assets financed by the authorized short-term debt are divested or spun off to another entity, a proportionate share of the debt must also be divested or spun off. In October 2007, KCP&L filed an application with FERC to increase the authorization to $800.0 million for a two-year period following the effective date of a FERC order granting such authorization.
Significant Financing Activities
Great Plains Energy
In the third quarter of 2007, Great Plains Energy issued $100.0 million of 6.875% unsecured Senior Notes. Great Plains Energy used the proceeds to make a $94.0 million equity contribution to KCP&L.
In 2006, Great Plains Energy entered into a forward sale agreement with Merrill Lynch Financial Markets, Inc. (forward purchaser) for 1.8 million shares of Great Plains Energy common stock. In April 2007, Great Plains Energy elected to terminate the forward sale agreement and settle it in cash. Based on the difference between Great Plains Energy’s average stock price of $32.60 over the period used to determine the settlement and the then-applicable forward price of $25.58, Great Plains Energy paid $12.3 million to Merrill Lynch Financial Markets, Inc.
KCP&L
In the third quarter of 2007, KCP&L’s $146.5 million of unsecured EIRR Bonds Series 2007A and 2007B were issued. The bonds mature on September 1, 2035, and will bear interest as determined through 35-day auction periods. The initial interest rate was 4.05%. The EIRR Bonds Series 2007A and 2007B are covered by a municipal bond insurance policy issued by FGIC. The insurance agreement between KCP&L and FGIC provides for reimbursement by KCP&L for any amounts that FGIC pays under the municipal bond insurance policy. The insurance policy is in effect for the term of the bonds. The policy also restricts the amount of secured debt KCP&L may issue. In the event that KCP&L issues debt secured by liens not permitted by the agreement, KCP&L is required to issue and deliver to FGIC first mortgage bonds or similar securities equal in principal amount to the principal amount of the EIRR Bonds Series 2007A and 2007B then outstanding. The proceeds from the issuance of $146.5 million EIRR Bonds Series 2007A and 2007B were used for the repayment of $146.5 million of Series 1998 A, B and D EIRR bonds on October 1, 2007.
In the second quarter of 2007, KCP&L issued $250.0 million of 5.85% unsecured Senior Notes. The proceeds from this issuance were used to repay a short-term intercompany loan from Great Plains Energy. KCP&L used the proceeds from the intercompany loan to repay its $225.0 million unsecured 6.00% Senior Notes at maturity.
In January 2007, KCP&L received authorization from FERC, as part of its aggregate $600.0 million short-term debt authorization, to issue an aggregate of $150 million of short-term debt in connection with participation in the Great Plains Energy money pool for a period of three years. The money pool was an internal financing arrangement in which up to $150 million of funds deposited into the money pool by Great Plains Energy and Strategic Energy could be lent on a short-term basis to KCP&L. The money pool was terminated in July 2007.
Debt Agreements
See Note 7 to the consolidated financial statements for discussion of Great Plains Energy’s, KCP&L’s and Strategic Energy’s revolving credit facilities. Strategic Energy’s facility contains a Material Adverse Change (MAC) clause that requires Strategic Energy to represent prior to receiving funding, that no MAC has occurred.
In October 2007, Strategic Energy terminated its $135 million revolving credit facility with a group of banks, expiring in June 2009, and entered into a new revolving credit facility with a group of banks, expiring in October 2010. The new facility provides for loans and letters of credit not exceeding an aggregate of the lesser of $50 million or the borrowing base, which is generally 85% of Strategic Energy’s retail accounts receivables plus the amount of a Great Plains Energy guarantee. Great Plains Energy issued an initial guarantee in the amount of $12.5 million and may increase the guarantee up to a maximum of $27.5 million to increase the borrowing base or to cure a default of the minimum fixed charge coverage ratio, provided that Great Plains Energy maintains certain favorable ratings on its
senior unsecured debt. Under the terms of the agreement, Strategic Energy is required to maintain, as of the end of each quarter, a minimum fixed charge coverage ratio of at least 1.05 to 1.0 and a minimum EBITDA, as defined in the agreement, for the four quarters then ended of $15 million through March 31, 2008, and thereafter increasing to $17.5 million (through September 30, 2008), $20 million (through March 31, 2009) and $22.5 million through maturity.
At the same time, Strategic Energy entered into an agreement to sell its current and future retail accounts receivable to its wholly owned subsidiary, Strategic Receivables, LLC (Strategic Receivables), which in turn sells undivided percentage ownership interests in the accounts receivable to Market Street Funding LLC (Market Street) and Fifth Third Bank ratably based on each purchaser’s commitments. Strategic Energy sells its receivables at a price equal to the amount of the accounts receivable less a discount based on the prime rate and days sales outstanding (as defined in the agreement). Strategic Receivables may also issue letters of credit to Strategic Energy, with the amount of such letters of credit being credited against the purchase price. Market Street’s and Fifth Third Bank’s obligation to purchase accounts receivable is limited to $112.5 million and $62.5 million, respectively, less the proportionate aggregate amount of letters of credit issued pursuant to the agreement. Strategic Energy services the receivables and receives an annual servicing fee of 1.0% times the daily average aggregate outstanding balance of receivables. Strategic Energy transferred its outstanding letters of credit under the terminated revolving credit facility totaling $49.8 million to the receivables facility upon termination.
Credit Ratings
None of the companies’ outstanding debt, except for the notes associated with affordable housing investments, requires the acceleration of interest and/or principal payments in the event of a ratings downgrade, unless the downgrade occurs in the context of Great Plains Energy or KCP&L entering into a merger, consolidation or sale. In the event of a downgrade, the companies and/or their subsidiaries may be subject to increased interest costs on their credit facilities. The anticipated acquisition of Aquila will not be a merger, consolidation or sale that would trigger acceleration of interest and/or principal payments.
Pensions
The Company maintains defined benefit plans for substantially all employees of KCP&L, Services and WCNOC and incurs significant costs in providing the plans, with the majority incurred by KCP&L. All plans meet the funding requirements of the Employee Retirement Income Security Act of 1974 (ERISA) with additional contributions made when deemed financially advantageous.
Year to date September 30, 2007, the Company contributed $25.9 million to the plans and an additional $6.8 million is expected to be contributed during the remainder of 2007, all paid by KCP&L. Management believes KCP&L has adequate access to capital resources through cash flows from operations or through existing lines of credit to support the funding requirements.
Under the terms of the pension plans, the Company reserves the right to amend or terminate the plans. See Note 10 to the consolidated financial statements for additional information regarding plan amendments.
Strategic Energy Supplier Concentration and Credit
Strategic Energy enters into forward physical contracts with multiple suppliers. At September 30, 2007, Strategic Energy’s five largest suppliers under forward supply contracts represented 70% of the total future dollar committed purchases. The five largest suppliers, or their guarantors, are rated investment grade. In the event of supplier non-delivery or default, Strategic Energy’s results of operations could be affected to the extent the cost of replacement power exceeded the combination of the contracted price with the supplier and the amount of collateral held by Strategic Energy to mitigate its credit risk with the supplier. In addition to the collateral, if any, that the supplier provides, Strategic Energy’s risk may be
further mitigated by the obligation of the supplier to make a default payment equal to the shortfall and to pay liquidated damages in the event of a failure to deliver power. There is no assurance that the supplier in such an instance would make the default payment and/or pay liquidated damages. Strategic Energy’s results of operations and financial position could also be affected, in a given period, if it were required to make a payment upon termination of a supplier contract to the extent the contracted price with the supplier exceeded the market value of the contract at the time of termination.
The following tables provide information on Strategic Energy’s credit exposure to suppliers, net of collateral, at September 30, 2007.
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | Number Of | | Net Exposure Of |
| | | | | | | | | | | | Counterparties | | Counterparties |
| | Exposure | | | | | | | | Greater Than | | Greater Than |
| | Before Credit | | Credit | | | Net | | | 10% Of Net | | 10% of Net |
Rating | Collateral | | Collateral | | | Exposure | | | Exposure | | Exposure |
| External rating | | (millions) | | | | | | (millions) | |
| Investment Grade | | $ | 1.8 | | | $ | - | | | $ | 1.8 | | | | 2 | | | $ | 1.8 | |
| Non-Investment Grade | | | 7.2 | | | | 6.2 | | | | 1.0 | | | | 1 | | | | 1.0 | |
| Internal rating | | | | | | | | | | | | | | | | | | | | |
| Non-Investment Grade | | | - | | | | - | | | | - | | | | - | | | | - | |
| Total | | $ | 9.0 | | | $ | 6.2 | | | $ | 2.8 | | | | 3 | | | $ | 2.8 | |
| | | | | | | | | | | | | | | | | | | | | |
| |
Maturity Of Credit Risk Exposure Before Credit Collateral |
| | Less Than | | | | Total |
Rating | 2 Years | 2 - 5 Years | Exposure |
| External rating | | (millions) | |
| Investment Grade | | $ | 0.9 | | | $ | 0.9 | | | $ | 1.8 | |
| Non-Investment Grade | | | 4.3 | | | | 2.9 | | | | 7.2 | |
| Internal rating | | | | | | | | | | | | |
| Non-Investment Grade | | | - | | | | - | | | | - | |
| Total | | $ | 5.2 | | | $ | 3.8 | | | $ | 9.0 | |
| | | | | | | | | | | | | |
External ratings are determined by using publicly available credit ratings of the counterparty. If a counterparty has provided a guarantee by a higher rated entity, the determination has been based on the rating of its guarantor. Internal ratings are determined by, among other things, an analysis of the counterparty’s financial statements and consideration of publicly available credit ratings of the counterparty’s parent. Investment grade counterparties are those with a minimum senior unsecured debt rating of BBB- from Standard & Poor’s or Baa3 from Moody’s Investors Service. Exposure before credit collateral has been calculated considering all netting agreements in place, netting accounts payable and receivable exposure with net mark-to-market exposure. Exposure before credit collateral, after consideration of all netting agreements, is impacted significantly by the power supply volume under contract with a given counterparty and the relationship between current market prices and contracted power supply prices. Credit collateral includes the amount of cash deposits and letters of credit received from counterparties. Net exposure has only been calculated for those counterparties to which Strategic Energy is exposed and excludes counterparties exposed to Strategic Energy.
At September 30, 2007, Strategic Energy had exposure before collateral to non-investment grade counterparties totaling $7.2 million, of which $4.3 million is scheduled to mature in less than two years. In addition, Strategic Energy held collateral totaling $6.2 million limiting its exposure to these non-investment grade counterparties to $1.0 million.
Strategic Energy contracts with national and regional counterparties that have direct supplies and assets in the region of demand. Strategic Energy also manages its counterparty portfolio through disciplined margining, collateral requirements and contract-based netting of credit exposures against payable balances.
Supplemental Capital Requirements and Liquidity Information
Great Plains Energy’s and consolidated KCP&L’s contractual obligations for KCP&L’s Comprehensive Energy Plan were $140.5 million for the remainder of 2007 and $472.4 million, $135.9 million and $14.0 million for the years 2008 through 2010, respectively. Great Plains Energy’s and consolidated KCP&L’s other contractual obligations have not significantly changed outside of the ordinary course of business at September 30, 2007, compared to December 31, 2006.
Great Plains Energy and consolidated KCP&L adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” an interpretation of SFAS No. 109, ”Accounting for Income Taxes” on January 1, 2007. At September 30, 2007, the total liability for unrecognized tax benefits for Great Plains Energy and consolidated KCP&L was $21.6 million and $19.5 million, respectively. Great Plains Energy and consolidated KCP&L are unable to determine reasonably reliable estimates of the period of cash settlement with the respective taxing authorities.
Off-Balance Sheet Arrangements
In the normal course of business, Great Plains Energy and certain of its subsidiaries enter into various agreements providing financial or performance assurance to third parties on behalf of certain subsidiaries. Such agreements include, for example, guarantees, stand-by letters of credit and surety bonds. These agreements are entered into primarily to support or enhance the creditworthiness otherwise attributed to a subsidiary on a stand-alone basis, thereby facilitating the extension of sufficient credit to accomplish the subsidiaries’ intended business purposes. Great Plains Energy’s guarantees provided on behalf of Strategic Energy for its power purchases and regulatory requirements increased $79.0 million to $337.7 million at September 30, 2007, compared to $258.7 million at December 31, 2006. This increase is comprised of $31.4 million in direct guarantees and $47.6 million in letters of credit and is due to a combination of higher collateral requirements at Strategic Energy and more emphasis on using Great Plains Energy’s facilities for credit support due to its lower cost than Strategic Energy’s credit facility. Consolidated KCP&L’s guarantees were unchanged at September 30, 2007, compared to December 31, 2006.
New Accounting Standards
See Note 19 of the consolidated financial statements for information regarding new accounting standards.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Great Plains Energy and consolidated KCP&L are exposed to market risks associated with commodity price and supply, interest rates and equity prices. Market risks are handled in accordance with established policies, which may include entering into various derivative transactions. In the normal course of business, Great Plains Energy and consolidated KCP&L also face risks that are either non-financial or non-quantifiable. Such risks principally include business, legal, regulatory, operational and credit risks and are discussed elsewhere in this document as well as in the 2006 Form 10-K and therefore are not represented here.
Great Plains Energy and consolidated KCP&L interim period disclosures about market risk included in quarterly reports on Form 10-Q address material changes, if any, from the most recently filed annual report on Form 10-K. Therefore, these interim period disclosures should be read in connection with Item 7A. Quantitative and Qualitative Disclosures About Market Risk, included in the 2006 Form 10-K of each of Great Plains Energy and KCP&L, incorporated herein by reference.
Strategic Energy maintains a commodity-price risk management strategy that uses derivative instruments including forward physical energy purchases, to minimize significant, unanticipated net income fluctuations caused by commodity-price volatility. In certain markets where Strategic Energy operates, entering into forward fixed price contracts is cost prohibitive. Financial derivative instruments, including swaps, are used to limit the unfavorable effect that price increases will have on electricity purchases, effectively fixing the future purchase price of electricity for the applicable forecasted usage and protecting Strategic Energy from significant price volatility. At September 30, 2007, a hypothetical 10% increase in the market price of purchased power could result in a $3.6 million increase in purchased power expense for the remainder of 2007.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Great Plains Energy carried out evaluations of its disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the fiscal quarter ended September 30, 2007. These evaluations were conducted under the supervision, and with the participation, of the company’s management, including the chief executive officer, chief financial officer and the disclosure committee.
Based upon these evaluations, the chief executive officer and chief financial officer of Great Plains Energy have concluded as of the end of the period covered by this report that the disclosure controls and procedures of Great Plains Energy are functioning effectively to provide reasonable assurance that: (i) the information required to be disclosed by the company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) the information required to be disclosed by the company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to management, including the principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There has been no change in Great Plains Energy’s internal control over financial reporting that occurred during the quarterly period ended September 30, 2007, that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting.
ITEM 4T. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
KCP&L carried out evaluations of its disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the fiscal quarter ended September 30, 2007. These evaluations were conducted under the supervision, and with the participation, of the company’s management, including the chief executive officer, chief financial officer and the disclosure committee.
Based upon these evaluations, the chief executive officer and chief financial officer of KCP&L have concluded as of the end of the period covered by this report that the disclosure controls and procedures of KCP&L are functioning effectively to provide reasonable assurance that: (i) the information required to be disclosed by the company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) the information required to be disclosed by the company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to management, including the principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There has been no change in KCP&L’s internal control over financial reporting that occurred during the quarterly period ended September 30, 2007, that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting.
PART II – OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
KCP&L Missouri 2007 Rate Case
On February 1, 2007, KCP&L filed a retail rate case with the MPSC, requesting an annual rate increase effective January 1, 2008, of approximately $45 million over current levels. In July 2007, the MPSC Staff filed its case regarding KCP&L’s rate request. In its filing, the Staff asserted that KCP&L’s annual revenues should be increased by $0.7 million, before adjustments resulting from the September 30, 2007, true-up of test year information. The Staff’s filing assumed adjustments resulting from this true-up would increase revenue requirements by $14 million, resulting in a required increase in annual revenues of $14.7 million. This amount reflects approximately $15 million to $17 million in accelerated depreciation, which the Staff asserts will maintain certain KCP&L credit ratios at investment-grade levels as provided for in the stipulation and agreement approved by the MPSC in 2005. Evidentiary hearings were held in October 2007, and true-up hearings are anticipated in November 2007. A decision is expected in December 2007.
KCP&L Kansas 2007 Rate Case
On March 1, 2007, KCP&L filed a rate increase request with KCC, requesting an additional approximate $47 million in annual revenues, with approximately $13 million of that amount treated for accounting purposes as an increase to KCP&L’s depreciation reserve. KCP&L reached a negotiated settlement of its request with certain parties to the rate proceedings, and on September 12, 2007, filed a Joint Stipulation and Agreement (Agreement) containing the settlement with KCC.
The parties to the Agreement are KCP&L, the Staff of the KCC, and the Citizens’ Utility Ratepayers Board (CURB). The Agreement stipulates a $28 million increase in annual revenues effective January 1, 2008, with $11 million of that amount treated for accounting purposes as an increase to KCP&L’s depreciation reserve. The Agreement also recommends an ECA tariff. The ECA tariff will reflect the projected annual amount of fuel, purchased power, emission allowances and transmission costs and asset-based off-system sales margin. The ECA tariff provides that these projected amounts are subject
to quarterly re-forecasts. Any difference between the ECA revenue collected and the actual ECA amounts for a given year (which may be positive or negative) will be recovered over twelve months beginning April 1 of the succeeding year.
The Agreement recommends various other provisions, including but not limited to: (i) establishing an energy efficiency rider as an interim mechanism to recover deferred costs incurred for affordability, energy efficiency and demand side management programs; (ii) establishing for regulatory purposes annual pension cost for the period beginning January 1, 2008, of approximately $40 million ($18 million on a Kansas jurisdictional basis), before amounts capitalized and amounts billed to the other joint owners of KCP&L’s power plants, through the creation of a regulatory asset or liability, as appropriate; (iii) amortizing over ten years the costs incurred in 2006 of approximately $9 million ($4 million on a Kansas jurisdictional basis) associated with skill set realignment; and (iv) setting at 8.3% the equity rate used to calculate the equity component of the allowance for funds used during construction rate calculation for Iatan 2 as of January 1, 2008. The treatment of pension costs in the Agreement is consistent with KCP&L’s last Kansas rate order.
The Agreement is subject to KCC approval, and is voidable if not approved in its entirety. It is possible that the KCC may approve the Agreement with changes, or may not approve the Agreement. A decision is expected in December 2007.
Aquila Transaction Proceedings
On April 4, 2007, Great Plains Energy, KCP&L and Aquila submitted joint applications to the MPSC and KCC seeking approval of the proposed acquisition by Great Plains Energy of Aquila. In the MPSC filing, the companies requested that Aquila be authorized to use an additional amortization mechanism to maintain credit ratios once Aquila achieves financial metrics necessary to support an investment-grade credit rating. Aquila and KCP&L also requested authorization to amortize transaction and incremental transition-related costs over five years, and to collectively retain for a five year period 50 percent of estimated synergy savings resulting from the transaction. Aquila further requested approval to transfer to Great Plains Energy approximately $677 million of the proceeds from the sale of its non-Missouri utility operations to Black Hills to fund substantially all of the cash portion of the merger consideration payable to its shareholders by Great Plains Energy. In the KCC filing, KCP&L requested similar regulatory treatment of costs and synergies. In updates filed with the MPSC and KCC on August 8, 2007, Great Plains Energy and KCP&L currently propose to retain for a five year period 50 percent of the estimated utility operational synergies, net of estimated transition costs. The MPSC Staff has filed testimony asserting that the transaction is detrimental to the public interest and should not be approved. Other parties in the MPSC case have asserted that the transaction should not be approved, or approved with conditions. Evidentiary hearings are scheduled for December in Missouri and January 2008 in Kansas, with decisions expected in the first quarter of 2008.
On May 25, 2007, Great Plains Energy, KCP&L, Aquila and Black Hills filed a joint application (which was amended in June 2007) with FERC seeking approval of the proposed acquisition by Great Plains Energy of Aquila and certain Aquila Colorado electric assets by Black Hills, and for a declaratory order that the transfer of proceeds from Aquila to Great Plains Energy will not constitute a payment of funds properly included in a capital account in a manner contrary to the Federal Power Act. On October 18, 2007, the FERC granted the joint application. Great Plains Energy and Aquila submitted their respective Hart-Scott-Rodino pre-merger notifications in July 2007 relating to the acquisition of Aquila by Great Plains Energy, and received early termination of the waiting period on August 27, 2007.
Two purported shareholder class action lawsuits were filed against Aquila and certain of its individual directors and officers on February 8, 2007, in Jackson County, Missouri, Circuit Court seeking, among other things, an injunction against the consummation of the proposed transaction. The lawsuits allege, among other things, breaches of fiduciary duties and self-dealing by Aquila directors and officers. In July 2007, the plaintiff in one of the suits amended his petition to include Great Plains Energy and Black Hills as defendants, alleging that they aided and abetted alleged breaches of fiduciary duties by the named Aquila directors and officers. On July 26, 2007, the Court consolidated the two cases and directed plaintiffs to file a Consolidated Petition, which was done on August 31, 2007. Aquila, Great Plains Energy and Black Hills filed motions to dismiss this case, which were granted on October 29, 2007. Plaintiffs have 30 days to appeal the dismissal.
Weinstein v. KLT Telecom
Richard D. Weinstein (Weinstein) filed suit against KLT Telecom Inc. (KLT Telecom) in September 2003 in the St. Louis County, Missouri Circuit Court. KLT Telecom acquired a controlling interest in DTI Holdings, Inc. (Holdings) in February 2001 through the purchase of approximately two-thirds of the Holdings stock held by Weinstein. In connection with that purchase, KLT Telecom entered into a put option in favor of Weinstein, which granted Weinstein an option to sell to KLT Telecom his remaining shares of Holdings stock. The put option provided for an aggregate exercise price for the remaining shares equal to their fair market value with an aggregate floor amount of $15 million and was exercisable between September 1, 2003, and August 31, 2005. In June 2003, the stock of Holdings was cancelled and extinguished pursuant to the joint Chapter 11 plan confirmed by the Bankruptcy Court. In September 2003, Weinstein delivered a notice of exercise of his claimed rights under the put option. KLT Telecom rejected the notice of exercise, and Weinstein filed suit alleging breach of contract. Weinstein sought damages of at least $15 million, plus statutory interest. In April 2005, summary judgment was granted in favor of KLT Telecom, and Weinstein appealed this judgment to the Missouri Court of Appeals for the Eastern District. On May 16, 2006, the Court of Appeals affirmed the judgment. Weinstein filed a motion for transfer of this case to the Missouri Supreme Court, which was granted. On May 29, 2007, the Supreme Court reversed the summary judgment and remanded the case to the trial court. On July 26, 2007, Weinstein filed a renewed Motion for Summary Judgment and KLT Telecom responded in opposition on August 28, 2007. A hearing on the motion is anticipated to occur in the fourth quarter of 2007. A $15 million reserve was recorded in 2001 for this matter.
Other Proceedings
The companies are parties to various other lawsuits and regulatory proceedings in the ordinary course of their respective businesses. For information regarding other lawsuits and proceedings, see Notes 6, 14 and 15 to the consolidated financial statements. Such descriptions are incorporated herein by reference.
ITEM 1A. RISK FACTORS
Actual results in future periods for Great Plains Energy and consolidated KCP&L could differ materially from historical results and the forward-looking statements contained in this report. Factors that might cause or contribute to such differences include, but are not limited to, those discussed below and in Item 1A. Risk Factors included in the 2006 Form 10-K of each of Great Plains Energy and KCP&L. The companies’ businesses are influenced by many factors that are difficult to predict, involve uncertainties that may materially affect actual results, and are often beyond the companies’ control. Additional risks and uncertainties not presently known or that the companies’ management currently believes to be immaterial may also adversely affect the companies. The information presented below updates certain of the risk factors described in the 2006 Form 10-K of each of Great Plains Energy and KCP&L. This information, as well as the other information included in this report and in the other documents filed with the SEC, should be carefully considered before making an investment in the securities of Great Plains Energy and KCP&L. Risk factors of consolidated KCP&L are also risk factors for Great Plains Energy.
The Company has Regulatory Risks
The Company is subject to extensive federal and state regulation. Failure to obtain adequate rates or regulatory approvals, in a timely manner, adoption of new regulations by federal or state agencies, or changes to current regulations and interpretations of such regulations may materially affect the Company’s business and its results of operations and financial position.
In October 2007, the MPSC adopted rules requiring vegetation management programs and periodic inspections of transmission and distribution facilities. The vegetation management rules require periodic inspections and completion of tree trimming cycles every four years in urban areas and every six years in rural areas. The transmission and distribution facilities inspection rules require periodic inspections of, and any necessary repairs to, these facilities. Electric utilities may request to defer the costs incurred in implementing these rules, above the levels reflected in rates, for possible recovery in future rate cases. KCP&L currently expects that the costs of implementing these rules will not be material to its results of operation or financial condition.
The outcome of KCP&L’s pending and future retail rate proceedings could have a material impact on its business and are largely outside its control.
The rates that KCP&L is allowed to charge its customers are the single most important item influencing its results of operations, financial position and liquidity. These rates are subject to the determination, in large part, of governmental entities outside of KCP&L’s control, including the MPSC, KCC and FERC. Decisions made by these entities could have a material impact on KCP&L’s business including its results of operations and financial position.
In February 2007, KCP&L filed a request with the MPSC to increase the annual rates charged to its retail customers in Missouri by approximately $45 million. KCP&L and certain parties filed a negotiated stipulation and agreement with the KCC in September 2007 to increase the annual rates it is permitted to charge its Kansas retail customers by approximately $28 million. The requested rate increases are subject to the approvals of the MPSC and KCC, respectively, which are expected to rule on the requests in December 2007, with any rate changes taking effect on January 1, 2008. It is possible that the MPSC and/or KCC will authorize a lower rate increase than what KCP&L has requested, or no increase or a rate reduction. Additionally, the December 2006 order of the MPSC authorizing an increase in annual rates of approximately $51 million has been appealed in the Missouri courts. It is possible that the MPSC order could be vacated and the proceedings remanded to the MPSC. Management cannot predict or provide any assurances regarding the outcome of these proceedings.
As a part of the Missouri and Kansas stipulations approved by the MPSC and KCC in 2005, KCP&L began implementation of its Comprehensive Energy Plan. Under the Comprehensive Energy Plan, KCP&L agreed to undertake certain projects, including building and owning a portion of Iatan No. 2, installing a new wind-powered generating facility, installing environmental upgrades to certain existing plants, infrastructure improvements and demand management, distributed generation, and customer efficiency and affordability programs. In March 2007, KCP&L entered into a Collaboration Agreement with the Sierra Club and Concerned Citizens of Platte County that provides for increases in KCP&L’s wind generation capacity and energy efficiency initiatives, reductions in certain emission permit levels at its Iatan and LaCygne generating stations, and projects to offset certain carbon dioxide emissions. Most, but not all, of these commitments are conditioned on regulatory approval. A reduction or rejection by the MPSC or KCC of rate increase requests reflecting the costs of projects under the comprehensive energy plan or Collaboration Agreement may result in increased financing requirements or a significant adverse effect on KCP&L’s results of operations and financial position, or both.
In response to competitive, economic, political, legislative and regulatory pressures, KCP&L may be subject to rate moratoriums, rate refunds, limits on rate increases or rate reductions, including phase-in plans designed to spread the impact of rate increases over an extended period of time for the benefit of customers. Any or all of these could have a significant adverse effect on KCP&L’s results of operations and financial position.
The Company is Subject to Environmental Laws and the Incurrence of Environmental Liabilities
The Company is subject to regulation by federal, state and local authorities with regard to air quality and other environmental matters primarily through KCP&L’s operations. The generation, transmission and distribution of electricity produces and requires disposal of certain hazardous products, which are subject to these laws and regulations. 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. Failure to comply with these laws and regulations could have a material adverse effect on Great Plains Energy’s and consolidated KCP&L’s results of operations and financial position.
The Clean Air Act requires companies to obtain permits and, if necessary, install control equipment to reduce emissions when making a major modification or a change in operation if either is expected to cause a significant net increase in regulated emissions. The Sierra Club and Concerned Citizens of Platte County have claimed that modifications were made to Iatan No. 1 in violation of Clean Air Act regulations. Although KCP&L has entered into a Collaboration Agreement with those parties that provides, among other things, for the release of such claims, the Collaboration Agreement does not bind any other entity. KCP&L is aware of subpoenas issued by a Federal grand jury to certain third parties seeking documents relating to capital projects at Iatan No. 1. KCP&L has not received a subpoena, and has not been informed of the scope of the grand jury inquiry. KCP&L believes that it is in compliance with all relevant laws and regulations; however, the ultimate outcome of these grand jury activities cannot presently be determined, nor can the costs and other liabilities that could potentially result from a negative outcome presently be reasonably estimated. There is no assurance these costs, if any, could be recovered in rates and failure to recover such costs could have a material adverse effect on Great Plains Energy’s and consolidated KCP&L’s results of operations and financial position.
New environmental laws and regulations affecting KCP&L’s operations may be adopted, including but not limited to, regulation of carbon dioxide and other greenhouse gases or requirements that a portion of electric generation come from renewable resources, and new interpretations of existing laws and regulations could be adopted or become applicable to KCP&L or its facilities, any of which may substantially increase its environmental expenditures in the future. New facilities, or modifications of existing facilities, may require new environmental permits or amendments to existing permits. Delays in the environmental permitting process, denials of permit applications, and conditions imposed in permits
may materially affect the cost and timing of the generation and environmental retrofit projects included in the comprehensive energy plan, among other projects, and thus materially affect KCP&L’s results of operations and financial position. Under current law, KCP&L is also generally responsible for any on-site liabilities associated with the environmental condition of its facilities, including those that it has previously owned or operated, regardless of whether the liabilities arose before, during or after the time it owned or operated the facilities. KCP&L may not be able to recover all of its costs for environmental expenditures through rates in the future. The incurrence of material environmental costs or liabilities, without related rate recovery, could have a material adverse effect on KCP&L’s results of operations and financial position. See Note 14 to the consolidated financial statements for additional information regarding environmental matters.
Fossil Fuel and Transportation Prices Impact KCP&L’s Costs
KCP&L's electric tariffs in Missouri and Kansas do not currently contain fuel or purchased power cost adjustment clauses. This exposes KCP&L to risk from changes in the market prices of coal, natural gas and purchased power. Changes in KCP&L’s fuel mix due to electricity demand, plant availability, transportation issues, fuel prices and other factors can also adversely affect KCP&L’s fuel and purchased power costs.
KCP&L does not hedge its entire exposure from fossil fuel and transportation price volatility. Consequently, its results of operations and financial position may be materially impacted by changes in these prices until increased costs are recovered in rates. KCP&L and other parties filed a stipulation and agreement with the KCC in September 2007 to implement a mechanism to fully recover its fuel and purchased power costs allocated to its Kansas operations. If approved, it is slated to become effective in Kansas in January 2008. KCP&L does not have, and has not requested, an energy cost adjustment mechanism for its Missouri operations.
Wholesale Electricity Prices Affect Costs and Revenue, Creating Earnings Volatility
KCP&L's ability to maintain or increase its level of wholesale sales depends on the wholesale market price, transmission availability and the availability of KCP&L’s generation for wholesale sales, among other factors. A substantial portion of KCP&L’s wholesale sales are made in the spot market, and thus KCP&L has immediate exposure to wholesale price changes. Declines in wholesale market price or availability of generation or transmission constraints in the wholesale markets could reduce KCP&L's wholesale sales and adversely affect KCP&L’s results of operations and financial position. If the aggregate margin on KCP&L’s wholesale sales exceeds a certain level, KCP&L is required to treat the Missouri jurisdictional portion of this excess as a regulatory liability.
KCP&L is also exposed to price risk because at times it purchases power to meet its customers’ needs. The cost of these purchases may be affected by the timing of customer demand and/or unavailability of KCP&L’s lower-priced generating units. Wholesale power prices can be volatile and generally increase in times of high regional demand and high natural gas prices. KCP&L and other parties filed a stipulation and agreement with the KCC in September 2007 to implement a mechanism to fully recover its fuel and purchased power costs allocated to its Kansas operations. If approved, it is slated to become effective in Kansas in January 2008. KCP&L does not have, and has not requested, an energy cost adjustment mechanism for its Missouri operations.
Strategic Energy operates in competitive retail electricity markets, competing against the host utilities and other retail suppliers. Wholesale electricity costs, which account for a significant portion of its operating expenses, can materially affect Strategic Energy’s ability to attract and retain retail electricity customers. There is also a regulatory lag that slows the adjustment of host public utility rates in response to changes in wholesale prices. This lag can negatively affect Strategic Energy’s ability to compete in a rising wholesale price environment. Strategic Energy manages wholesale electricity risk by establishing risk limits and entering into contracts to offset some of its positions to balance energy
supply and demand; however, Strategic Energy is not always able to exactly match hedges to its aggregate exposure. This imbalance position leaves Strategic Energy subject to the effects of electricity price volatility. Consequently, its results of operations and financial position may be materially impacted by changes in the wholesale price of electricity.
Great Plains Energy is subject to business and regulatory uncertainties as a result of the anticipated acquisition of Aquila, Inc., which could adversely affect its business.
On February 6, 2007, Great Plains Energy entered into definitive agreements under which it would acquire all the outstanding shares of Aquila. Immediately prior to this acquisition, Black Hills will acquire from Aquila its electric utility in Colorado and its gas utilities in Colorado, Kansas, Nebraska and Iowa. These transactions are complex, and are subject to numerous regulatory approvals and other conditions. The timing of, and the conditions imposed by, regulatory approvals may delay, or give rise to the ability to terminate the transactions. In addition, the shareholder lawsuits filed against Aquila, Black Hills Corporation and Great Plains Energy seek to enjoin the transactions and recover alleged damages. In the event of termination, Great Plains Energy would be required to write-off its deferred transaction costs, which could be material. The conditions imposed by regulatory approvals could increase the costs, or decrease the benefits, anticipated by Great Plains Energy from the transaction.
While it is anticipated that Great Plains Energy, KCP&L and Aquila will be rated investment grade after the transactions close, Great Plains Energy and KCP&L credit ratings have been negatively affected after the announcement of the proposed acquisition, and may be further negatively affected. Credit rating downgrades could result in higher financing costs and potentially limit the companies’ access to the capital and credit markets, impact the regulatory rate treatment provided KCP&L, or both.
Great Plains Energy entered into the transaction agreements with the expectation that the acquisition would result in various benefits to it and KCP&L including, among other things, synergies, cost savings and operating efficiencies. Although Great Plains Energy expects to achieve the anticipated benefits of the acquisition, achieving them cannot be assured. Great Plains Energy, KCP&L and Aquila proposed to regulators that the benefits resulting from the transaction be shared between retail electric customers and Great Plains Energy shareholders, and requested certain other regulatory assurances. There is no assurance regarding the amount of benefit-sharing, or other regulatory treatment, in rate cases occurring after the closing of the transactions.
Most of the Aquila employees remaining after the sale to Black Hills are expected to become employees of KCP&L. KCP&L employees will operate and manage both KCP&L properties and Aquila’s properties, and KCP&L will charge Aquila for the cost of these services. Procurement of goods and services for both KCP&L and Aquila is expected to be done by KCP&L, with the cost of goods and services used by Aquila being billed to Aquila. These expected arrangements may pose risks to KCP&L, including possible claims by Aquila or third parties arising from actions of KCP&L employees in operating Aquila’s properties and providing other services to Aquila. KCP&L’s claims for reimbursement for goods and services provided to Aquila will be unsecured and rank equally with other unsecured obligations of Aquila. KCP&L’s ability to be reimbursed for the costs incurred for the benefit of Aquila depends on the financial ability of Aquila to make such payments.
Additionally, Aquila’s utility operations are subject to regulation by numerous government entities, including the MPSC and FERC. As such, a successful acquisition of Aquila will subject Great Plains Energy to additional regulatory risk.
The outcome of legal proceedings cannot be predicted. An adverse finding could have a material adverse effect on Great Plains Energy’s and KCP&L’s financial condition.
Great Plains Energy and KCP&L are party to various material litigation and regulatory matters arising out of their business operations. The ultimate outcome of these matters cannot presently be determined, nor can the liability that could potentially result from a negative outcome in each case
presently be reasonably estimated. The liability Great Plains Energy and KCP&L may ultimately incur with respect to any of these cases in the event of a negative outcome may be in excess of amounts currently reserved and insured against with respect to such matters and, as a result, these matters may have a material adverse effect on the consolidated financial position of Great Plains Energy, KCP&L or both.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table provides information regarding purchases by Great Plains Energy of its equity securities during the third quarter of 2007.
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Issuer Purchases of Equity Securities |
| | | | | | | | | | | | | Maximum Number |
| | | | | | | | | Total Number of | | (or Approximate |
| | | | | | | | | Shares (or Units) | | Dollar Value) of |
| | | Total | | | | Purchased as | | Shares (or Units) |
| | | Number of | Average | Part of Publicly | | that May Yet Be |
| | | Shares | Price Paid | Announced | | Purchased Under |
| | | (or Units) | per Share | Plans or | | the Plans or |
Month | Purchased | (or Unit) | Programs | | Programs |
| July 1-31 | | 167 | (1) | | $ 29.47 | | | - | | | | N/A |
| August 1-31 | | - | | | - | | | - | | | | N/A |
| September 1-30 | | - | | | - | | | - | | | | N/A |
| Total | | 167 | | | $ 29.47 | | | - | | | | N/A |
(1)Represents shares of common stock surrendered to Great Plains Energy by certain officers to |
pay taxes related to the issuance of restricted stock and performance shares. |
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
Pursuant to the guidance provided by the SEC Division of Corporation Finance in the Current Report on Form 8-K Frequently Asked Questions dated November 23, 2004, the following information is provided pursuant to the requirements of Item 5.02(e) of Form 8-K.
On October 30, 2007, the Board of Directors of Great Plains Energy took the following executive compensation actions affecting one or more of its principal executive officer, principal financial officer, and other named executive officers.
Section 409A Remediation
2003 Stock Options
In 2003, Great Plains Energy entered into stock option grant agreements with certain of its officers, including William H. Downey, President and Chief Operating Officer, that included the right to receive dividend equivalent payments in connection with the officer’s exercise of such stock options. Under the terms established in 2003, these dividend equivalents accrue quarterly in a notional account, and are proportionately paid when the option holder exercises his stock options. No interest is accrued on the notional account. Mr. Downey’s stock option grant is for 5,249 shares, no portion of which has been exercised. These stock option grants were made prior to the enactment of Internal Revenue Code Section 409A (Section 409A). Section 409A would impose adverse tax consequences on the option holders due to the present structuring of the dividend equivalent payments, unless these options are either brought into compliance with Section 409A or amended so as to fall within an available exemption from Section 409A. To avoid these consequences, which were not foreseeable when the stock options were granted, and cause these stock option grants to be exempt from Section 409A, Great Plains Energy will offer each affected option holder the opportunity to amend these stock option grants to provide that the accrued dividend equivalents will be paid if there is a change in control of Great Plains Energy, or upon the earlier of (i) the first anniversary of the option holder’s separation from service with Great Plains Energy, or (ii) July 1, 2014. Assuming (i) Mr. Downey does not exercise any of his 2003 stock options, (ii) no change in control occurs and he remains employed by Great Plains Energy through July 1, 2014, and (iii) Great Plains Energy continues to pay a quarterly common stock dividend of $0.415 per share, he would be entitled to receive a cash payment of approximately $95,847 on July 1, 2014.
Supplemental Executive Retirement Plan
Great Plains Energy’s Supplemental Executive Retirement Plan (SERP) provides certain supplemental retirement benefits to Michael J. Chesser, Chairman of the Board and Chief Executive Officer, Mr. Downey, Terry Bassham, Executive Vice President – Finance and Strategic Development and Chief Financial Officer, John R. Marshall, Senior Vice President – Deliver of KCP&L, and other officers. The SERP is unfunded and provides out of general assets an amount substantially equal to the difference between the amount that would have been payable under Great Plain Energy's qualified pension plan in the absence of legislation limiting pension benefits and earnings that may be considered in calculating pension benefits, and the amount actually payable under such pension plan. In order to bring the SERP into compliance with Section 409A, and to accommodate certain design changes to Great Plains Energy’s defined benefit pension plan covering KCP&L and Services employees (Pension Plan), the Great Plains Energy Board of Directors froze the existing SERP (Frozen SERP) with respect to all benefits accrued and vested through December 31, 2004, and adopted an amended and restated SERP (409A SERP) with respect to all benefits accruing or vesting after December 31, 2004. The principal changes include:
| · | The 409A SERP limits payment of benefits to the events permitted under Section 409A; |
| · | The 409A SERP delays by six months any payments due upon the separation from service of “specified employees”, as defined in Section 409A (which includes the four officers named above); |
| · | Participants in the 409A SERP have an opportunity until December 31, 2008, to change their election as to when and in what form benefits under the 409A SERP will be paid (however, no election change made during 2007 can result in amounts being paid in 2007 or defer amounts that otherwise would have been paid in 2007 and no election change made during 2008 can result in amounts being paid in 2008 or defer amounts that otherwise would have been paid in 2008); and |
| · | The Pension Plan benefit accrual rates have been reduced for employees hired on and after September 1, 2007, among other changes. Those who were employees prior to that date had the option to either continue under the terms of the Pension Plan prior to that date, or to elect to be covered under the new terms of the Pension Plan. The 409A SERP benefit accrual rate is reduced from 2% to 1.58%, effective January 1, 2008, for those participants with reduced Pension Plan benefit accrual rates. Of the officers named in the first paragraph of this section, Messrs. Bassham and Marshall have elected to be covered under the new terms of the Pension Plan. |
Nonqualified Deferred Compensation Plan
Great Plains Energy’s Nonqualified Deferred Compensation Plan (DCP) is available to the Board of Directors, Messrs. Chesser, Downey, Bassham, Marshall, Shahid Malik, President and Chief Executive Officer of Strategic Energy and other officers. The DCP provides the opportunity for participants to defer the receipt of compensation and to earn interest on the deferred amounts. In order to bring the DCP into compliance with Section 409A, and to accommodate certain design changes to Great Plains Energy’s 401(k) plan covering KCP&L and Services employees (401(k) Plan), the Great Plains Energy Board of Directors (1) froze the existing DCP (Frozen DCP) with respect to all contributions accrued and vested through December 31, 2004 (and all earnings on such contributions) and (2) adopted an amended and restated DCP (409A DCP) with respect to all contributions accruing or vesting after December 31, 2004 (and all earnings on such contributions). The principal changes include:
| · | The 409A DCP limits payment of contributions and earnings to the events permitted under Section 409A; |
| · | The 409A DCP delays by six months any payments due upon the separation from service of “specified employees”, as defined in Section 409A (which includes the five officers named above); |
| · | The 409A DCP limits the form of payments to a lump-sum payment, or annual installments over 5, 10 or 15 years; |
| · | Participants in the 409A DCP have an opportunity until December 31, 2008, to change their election as to when and in what form their contributions and earnings under the 409A DCP will be paid (however, no election change made during 2007 can result in amounts being paid in 2007 or defer amounts that otherwise would have been paid in 2007 and no election change made during 2008 can result in amounts being paid in 2008 or defer amounts that otherwise would have been paid in 2008); |
| · | Participants do not have to contribute to the 401(k) Plan to be eligible to contribute under the 409A DCP; however, participants who do not contribute the maximum amount to the 401(k) Plan (excluding “catch up” contributions) are not eligible to receive the matching contributions described below; |
| · | The 409A DCP permits Great Plains Energy to make additional discretionary contributions to participants if the Board of Directors determines such contributions are appropriate; and |
| · | In connection with the Pension Plan changes discussed above, the 401(k) Plan benefits have been enhanced for employees hired on and after September 1, 2007, among other changes. Those who were employees prior to that date had the option to either continue under the terms of the 401(k) Plan and Pension Plan prior to that date, or to elect to be covered under the new terms of the 401(k) Plan and Pension Plan. For those participants who are covered under the new terms of the 401(k) Plan, (i) Great Plains Energy’s matching contribution under the 409A DCP will be 100% on each dollar contributed up to 6% of compensation (including base salary, bonus and incentive pay), offset by the matching contribution for 401(k) Plan contributions, and (ii) such matching contributions and earnings thereon will be fully and immediately vested. For other participants, matching contributions and earnings thereon will continue to remain subject to a 6-year graded vesting schedule. Of the officers named in the first paragraph of this section, Messrs. Bassham and Marshall have elected to be covered under the new terms of the 401(k) Plan. |
The foregoing descriptions of the stock option amendment, Frozen SERP, 409A SERP, Frozen DCP and 409A DCP do not purport to be complete and are qualified in their entirety by the text of such plans themselves, which are filed as exhibits to this report.
ITEM 6. EXHIBITS
Great Plains Energy Documents
Exhibit Number | | Description of Document |
| 4.1 | * | Second Supplemental Indenture dated as of September 25, 2007, between Great Plains Energy Incorporated and The Bank of New York Trust Company, N.A., as trustee (Exhibit 4.1 to Form 8-K dated September 25, 2007). |
| 10.1.1 | | $50,000,000 Revolving Credit Facility Credit Agreement by and among Strategic Energy, L.L.C., the lenders party thereto and PNC Bank, National Association, as Administrative Agent, dated as of October 3, 2007. |
| 10.1.2 | | Receivables Purchase Agreement dated as of October 3, 2007, by and among Strategic Receivables, LLC, as Seller, Strategic Energy, L.L.C., as initial Servicer, the Conduit Purchasers party thereto, the Purchaser Agents party thereto, the Financial Institutions from time to time party thereto as LC Participants, and PNC Bank, National Association, as Administrator and as LC Bank. |
| 10.1.3 | | Purchase and Sale Agreement dated as of October 3, 2007, by and among the various entities from time to time party thereto as Originators, Strategic Energy, L.L.C., as Servicer, and Strategic Receivables, LLC, as Buyer. |
| 10.1.4 | | Letter Agreement dated as of August 31, 2007, to Asset Purchase Agreement and Partnership Interests Purchase Agreement by and among Aquila, Inc., Black Hills Corporation, Great Plains Energy Incorporated and Gregory Acquisition Corp. |
| 10.1.5 | | Letter Agreement dated as of September 28, 2007, to Asset Purchase Agreement and Partnership Interests Purchase Agreement by and among Aquila, Inc., Black Hills Corporation, Great Plains Energy Incorporated and Gregory Acquisition Corp. |
| 10.1.6 | | Letter Agreement dated as of October 3, 2007, to Agreement and Plan of Merger, Asset Purchase Agreement and Partnership Interests Purchase Agreement by and among Aquila, Inc., Black Hills Corporation, Great Plains Energy Incorporated and Gregory Acquisition Corp. |
| 10.1.7 | | Joint Stipulation and Agreement dated as of September 12, 2007, among Kansas City Power & Light Company, the Staff of the Kansas Corporation Commission and the Citizens’ Utility Ratepayer Board (filed as Exhibit 10.2.1 hereto). |
| 10.1.8 | | Insurance Agreement dated as of September 19, 2007, by and between Financial Guaranty Insurance Company and Kansas City Power & Light Company (filed as Exhibit 10.2.2 hereto). |
| 10.1.9 | + | Form of Amendment to 2003 Stock Option Grants |
| 10.1.10 | + | Great Plains Energy Incorporated Supplemental Executive Retirement Plan (As Amended and Restated for I.R.C. §409A) |
| 10.1.11 | + | Great Plains Energy Incorporated Nonqualified Deferred Compensation Plan (As Amended and Restated for I.R.C. §409A) |
| 10.1.12 | * | Notice of Election to Transfer Unused Commitment between the Great Plains Energy Incorporated and Kansas City Power & Light Company Credit Agreements dated as of May 11, 2006, with Bank of America, N.A., as Administrative Agent, JPMorgan Chase Bank, N.A., as Syndication Agent, BNP Paribas, The Bank of Tokyo-Mitsubishi UFJ, Limited, Chicago Branch and Wachovia Bank N.A., as Co-Documentation Agents, The Bank of New York, KeyBank National Association, The Bank of Nova Scotia, UMB Bank, N.A., and Commerce Bank, N.A. (Exhibit 10.1.2 to Quarterly Report on Form 10-Q for the period ended June 30, 2007). |
| 12.1 | | Computation of Ratio of Earnings to Fixed Charges. |
| 31.1.a | | Rule 13a-14(a)/15d-14(a) Certifications of Michael J. Chesser. |
| 31.1.b | | Rule 13a-14(a)/15d-14(a) Certifications of Terry Bassham. |
| 32.1 | | Section 1350 Certifications. |
*Filed with the SEC as exhibits to prior SEC filings and are incorporated herein by reference and made a part hereof. The SEC filing and the exhibit number of the documents so filed, and incorporated herein by reference, are stated in parenthesis in the description of such exhibit.
+Indicates management contract or compensatory plan or arrangement.
Copies of any of the exhibits filed with the SEC in connection with this document may be obtained from Great Plains Energy upon written request.
KCP&L Documents
Exhibit Number | | Description of Document |
| 10.2.1 | | Joint Stipulation and Agreement dated as of September 12, 2007, among Kansas City Power & Light Company, the Staff of the Kansas Corporation Commission and the Citizens’ Utility Ratepayer Board. |
| 10.2.2 | | Insurance Agreement dated as of September 19, 2007, by and between Financial Guaranty Insurance Company and Kansas City Power & Light Company (Exhibit 10.2.2 hereto). |
| 10.2.3 | * | Notice of Election to Transfer Unused Commitment between the Great Plains Energy Incorporated and Kansas City Power & Light Company Credit Agreements dated as of May 11, 2006, with Bank of America, N.A., as Administrative Agent, JPMorgan Chase Bank, N.A., as Syndication Agent, BNP Paribas, The Bank of Tokyo-Mitsubishi UFJ, Limited, Chicago Branch and Wachovia Bank N.A., as Co-Documentation Agents, The Bank of New York, KeyBank National Association, The Bank of Nova Scotia, UMB Bank, N.A., and Commerce Bank, N.A. (Exhibit 10.1.2 to Quarterly Report on Form 10-Q for the period ended June 30, 2007). |
| 12.2 | | Computation of Ratio of Earnings to Fixed Charges. |
| 31.2.a | | Rule 13a-14(a)/15d-14(a) Certifications of William H. Downey. |
| 31.2.b | | Rule 13a-14(a)/15d-14(a) Certifications of Terry Bassham. |
| 32.2 | | Section 1350 Certifications. |
* Filed with the SEC as exhibits to prior SEC filings and are incorporated herein by reference and made a part hereof. The SEC filings and the exhibit number of the documents so filed, and incorporated herein by reference, are stated in parenthesis in the description of such exhibit.
Copies of any of the exhibits filed with the SEC in connection with this document may be obtained from KCP&L upon written request.
KCP&L agrees to furnish to the SEC upon request any instrument with respect to long-term debt as to which the total amount of securities authorized does not exceed 10% of total assets of KCP&L and its subsidiaries on a consolidated basis.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, Great Plains Energy Incorporated and Kansas City Power & Light Company have duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | GREAT PLAINS ENERGY INCORPORATED |
| | |
| Dated: November 5, 2007 | By: /s/Michael J. Chesser |
| | (Michael J. Chesser) |
| | (Chief Executive Officer) |
| | |
| Dated: November 5, 2007 | By: /s/Lori A. Wright |
| | (Lori A. Wright) |
| | (Principal Accounting Officer) |
| | KANSAS CITY POWER & LIGHT COMPANY |
| | |
| Dated: November 5, 2007 | By: /s/William H. Downey |
| | (William H. Downey) |
| | (Chief Executive Officer) |
| | |
| Dated: November 5, 2007 | By: /s/Lori A. Wright |
| | (Lori A. Wright) |
| | (Principal Accounting Officer) |
