UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . ------- ------- Commission Exact name of registrants as specified in their charters, state of I.R.S. Employer File Number incorporation, address of principal executive offices, and telephone number Identification Number 1-8349 Florida Progress Corporation 59-2147112 410 South Wilmington Street Raleigh, North Carolina 27601 Telephone (919) 546-6111 State of Incorporation: Florida 1-3274 Florida Power Corporation 59-0247770 d/b/a Progress Energy Florida, Inc. 100 Central Avenue St. Petersburg, Florida 33701 Telephone (727) 820-5151 State of Incorporation: Florida NONE (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark whether the registrants are accelerated filers (as defined in Rule 12b-2 of the Exchange Act). Yes __ No X - This combined Form 10-Q is filed separately by two registrants: Florida Progress Corporation and Florida Power Corporation d/b/a Progress Energy Florida (PEF). Information contained herein relating to either individual registrant is filed by such registrant solely on its own behalf. Each registrant makes no representation as to information relating exclusively to the other registrant. Indicate the number of shares outstanding of each of the issuers' classes of common stock, as of the latest practicable date. As of October 31, 2003, each registrant had the following shares of common stock outstanding: Registrant Description Shares ---------- ----------- ------ Florida Progress Corporation Common Stock, without par value 98,616,658 (all of which were held by Progress Energy, Inc.) PEF Common Stock, without par value 100 (all of which were held by Florida Progress Corporation) Florida Progress Corporation and Florida Power Corporation meet the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and are therefore filing this form with the reduced disclosure format. 1 FLORIDA PROGRESS CORPORATION AND PROGRESS ENERGY FLORIDA, INC. FORM 10-Q - For the Quarter Ended September 30, 2003 Glossary of Terms Safe Harbor For Forward-Looking Statements PART I. FINANCIAL INFORMATION Item 1. Financial Statements Florida Progress Corporation Consolidated Statements of Income Consolidated Balance Sheets Consolidated Statements of Cash Flows Florida Power Corporation d/b/a Progress Energy Florida, Inc. Statements of Income Balance Sheets Statements of Cash Flows Notes to Financial Statements Florida Progress Corporation and Progress Energy Florida, Inc. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk Item 4. Controls and Procedures PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K Signatures 2 GLOSSARY OF TERMS The following abbreviations or acronyms used in the text of this combined Form 10-Q are defined below: TERM DEFINITION AFUDC Allowance for funds used during construction the Agreement Stipulation and Settlement Agreement APB No. 28 Accounting Principles Board Opinion No. 28, "Interim Financial Reporting" ARO Asset retirement obligation Bcf Billion cubic feet the Code Internal Revenue Code Colona Colona Synfuel Limited Partnership, L.L.L.P. the Company or Florida Progress Florida Progress Corporation CPI Consumer Price Index CR3 Progress Energy Florida Inc.'s nuclear generating plant, Crystal River Unit No. 3 DIG Derivatives Implementation Group DOE United States Department of Energy Dt Dekatherm EITF Emerging Issues Task Force EPA United States Environmental Protection Agency FASB Financial Accounting Standards Board FDEP Florida Department of Environmental Protection Federal Circuit United States Circuit Court of Appeals FERC Federal Energy Regulatory Commission FIN No. 46 FASB Interpretation No. 46, "Consolidation of Variable Interest Entities - An Interpretation of ARB No. 51" Florida Progress or FPC Florida Progress Corporation FPSC Florida Public Service Commission Funding Corp. Florida Progress Funding Corporation GAAP Accounting principles generally accepted in the United States of America IRS Internal Revenue Service ISO Independent System Operator MACT Maximum Available Control Technology MGP Manufactured Gas Plant MW Megawatts NRC United States Nuclear Regulatory Commission NSP Northern States Power PEF or the utility Progress Energy Florida, Inc., formerly referred to as Florida Power Corporation PFA IRS Prefiling Agreement the Plan Revenue Sharing Incentive Plan PLRs Private Letter Rulings Preferred Securities 7.10% Cumulative Quarterly Income Preferred Securities, Series A, of FPC Capital I, fully and unconditionally guaranteed by Florida Progress Progress Capital Progress Capital Holdings, Inc. Progress Energy or the Parent Progress Energy, Inc. Progress Fuels Progress Fuels Corporation Progress Rail Progress Rail Services Corporation Progress Telecom Progress Telecommunications Corporation PVI Progress Ventures, Inc., formerly referred to as Energy Ventures PUHCA Public Utility Holding Company Act of 1935, as amended PWR Pressurized water reactor RAFT Railcar Asset Financing Trust Rail Rail Services RTO Regional Transmission Organization SEC United States Securities and Exchange Commission Section 29 Section 29 of the Internal Revenue Code Service Company Progress Energy Service Company, LLC 3 SFAS No. 5 Statement of Financial Accounting Standards No. 5, "Accounting for Contingencies" SFAS No. 71 Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation" SFAS No. 133 Statement of Financial Accounting Standards No. 133, "Accounting for Derivative and Hedging Activities" SFAS No. 142 Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" SFAS No. 143 Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" SFAS No. 148 Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - An Amendment of FASB Statement No. 123" SFAS No. 149 Statement of Financial Accounting Standards No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" SFAS No. 150 Statement of Financial Accounting Standards No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity" SMD NOPR Notice of Proposed Rulemaking in Docket No. RM01-12-000, Remedying Undue Discrimination through Open Access Transmission and Standard Market Design The Staff The Staff of the Florida Public Service Commission the Trust FPC Capital I Trust 4 SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS This combined report contains forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The matters discussed throughout this combined Form 10-Q that are not historical facts are forward-looking and, accordingly, involve estimates, projections, goals, forecasts, assumptions, risks and uncertainties that could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements. In addition, forward-looking statements are discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" including, but not limited to, statements under the sub-heading "Liquidity and Capital Resources" concerning operating cash flows and estimated capital requirements. Any forward-looking statement speaks only as of the date on which such statement is made, and Florida Progress and Florida Power Corporation doing business as Progress Energy Florida, Inc. (PEF) undertake no obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made. Examples of factors that you should consider with respect to any forward-looking statements made throughout this document include, but are not limited to, the following: the impact of fluid and complex government laws and regulations, including those relating to the environment; the impact of recent events in the energy markets that have increased the level of public and regulatory scrutiny in the energy industry and in the capital markets; the impact of the settlement of PEF's rate case; deregulation or restructuring in the electric industry that may result in increased competition and unrecovered (stranded) costs; the uncertainty regarding the timing, creation and structure of regional transmission organizations; weather conditions that directly influence the demand for electricity; recurring seasonal fluctuations in demand for electricity; fluctuations in the price of energy commodities and purchased power; successful maintenance and operation of PEF's energy commodities and purchased power; economic fluctuations and the corresponding impact on PEF's commercial and industrial customers; the inherent risks associated with operating nuclear facilities, including environmental, health, regulatory and financial risks; the impact of any terrorist acts generally and on our generating facilities and other properties; the ability to access capital markets on favorable terms; the impact that increases in leverage may have on the Company and PEF; the ability of the Company and PEF to maintain their current credit ratings; the impact of derivative contracts used in the normal course of business; the outcome of the IRS's audit and inquiry into the availability and use of Section 29 tax credits by synthetic fuel producers and the Company's continued ability to use Section 29 tax credits related to its coal and synthetic fuels businesses; the continued depressed state of the telecommunications industry and the Company's ability to realize future returns from Progress Telecommunications Corporation; the Company's ability to successfully integrate newly acquired assets or properties into its operations as quickly or as profitably as expected; and unanticipated changes in operating expenses and capital expenditures. Most of these risks similarly impact the Company's subsidiaries, including PEF. These and other risks are detailed from time to time in the SEC reports of the Company and PEF. All such factors are difficult to predict, contain uncertainties that may materially affect actual results, and may be beyond the control of the Company and PEF. Many, but not all of the factors that may impact actual results of the Company and PEF are discussed in the Risk Factors section of PEF's annual report on Form 10-K for the year ended December 31, 2002 which were filed with the SEC on March 21, 2003. You should carefully read these SEC reports. New factors emerge from time to time, and it is not possible for management to predict all such factors, nor can it assess the effect of each such factor on Florida Progress and PEF. 5 PART I. FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS Florida Progress Corporation CONSOLIDATED INTERIM FINANCIAL STATEMENTS September 30, 2003 CONSOLIDATED STATEMENTS of INCOME (Unaudited) Three Months Ended Nine Months Ended September 30, September 30, - ------------------------------------------------------------------------------------------------------------------ (In thousands) 2003 2002 2003 2002 - ------------------------------------------------------------------------------------------------------------------ Operating Revenues Utility $ 904,115 $ 863,637 $ 2,399,079 $ 2,316,001 Diversified business 470,872 358,823 1,289,911 1,047,953 - ------------------------------------------------------------------------------------------------------------------ Total Operating Revenues 1,374,987 1,222,460 3,688,990 3,363,954 - ------------------------------------------------------------------------------------------------------------------ Operating Expenses Utility Fuel used in electric generation 255,071 229,366 657,463 623,472 Purchased power 156,414 145,743 426,824 387,473 Operation and maintenance 163,528 146,814 458,261 433,441 Depreciation and amortization 82,160 73,427 240,956 218,004 Taxes other than on income 62,567 61,186 179,986 175,119 Diversified business Cost of sales 405,198 336,025 1,126,210 991,448 Depreciation and amortization 25,243 15,152 65,376 47,741 Impairment of long-lived assets - 214,617 - 214,617 Other 29,987 43,379 89,709 84,402 - ------------------------------------------------------------------------------------------------------------------ Total Operating Expenses 1,180,168 1,265,709 3,244,785 3,175,717 - ------------------------------------------------------------------------------------------------------------------ Operating Income (Loss) 194,819 (43,249) 444,205 188,237 - ------------------------------------------------------------------------------------------------------------------ Other Income (Expense) Interest income 819 1,744 2,505 5,619 Other, net 5,747 (3,171) (250) (12,645) - ------------------------------------------------------------------------------------------------------------------ Total Other Income (Expense) 6,566 (1,427) 2,255 (7,026) - ------------------------------------------------------------------------------------------------------------------ Interest Charges Interest charges 28,921 45,773 123,613 141,083 Allowance for borrowed funds used during (2,251) (899) (5,777) (1,932) construction - ------------------------------------------------------------------------------------------------------------------ Total Interest Charges, Net 26,670 44,874 117,836 139,151 - ------------------------------------------------------------------------------------------------------------------ Income (Loss) from Continuing Operations before Income Taxes 174,715 (89,550) 328,624 42,060 Income Tax Benefit (299) (32,529) (37,049) (67,049) - ------------------------------------------------------------------------------------------------------------------ Income (Loss) from Continuing Operations $ 175,014 $ (57,021) $ 365,673 $ 109,109 Discontinued Operations, Net of Tax: Income from discontinued operations - 5,120 - 5,120 - ------------------------------------------------------------------------------------------------------------------ Net Income (Loss) $ 175,014 $ (51,901) $ 365,673 $ 114,229 - ------------------------------------------------------------------------------------------------------------------ See Notes to Interim Financial Statements. 6 Florida Progress Corporation CONSOLIDATED BALANCE SHEETS (Unaudited) (In thousands) September 30, December 31, Assets 2003 2002 - --------------------------------------------------------------------------------------------------------------- Utility Plant Utility plant in service $ 7,793,068 $ 7,477,025 Accumulated depreciation (3,983,759) (4,123,947) - --------------------------------------------------------------------------------------------------------------- Utility plant in service, net 3,809,309 3,353,078 Held for future use 7,921 7,921 Construction work in progress 561,666 426,641 Nuclear fuel, net of amortization 72,231 40,260 - --------------------------------------------------------------------------------------------------------------- Total Utility Plant, Net 4,451,127 3,827,900 - --------------------------------------------------------------------------------------------------------------- Current Assets Cash and cash equivalents 16,305 33,601 Accounts receivable 472,456 385,431 Unbilled accounts receivable 63,167 60,481 Receivables from affiliated companies 33,191 42,418 Deferred income taxes 41,561 26,209 Inventory 445,405 492,273 Deferred fuel cost 192,150 37,503 Prepayments and other current assets 183,647 93,802 - --------------------------------------------------------------------------------------------------------------- Total Current Assets 1,447,882 1,171,718 - --------------------------------------------------------------------------------------------------------------- Deferred Debits and Other Assets Regulatory assets 118,201 130,114 Unamortized debt expense 30,985 23,363 Nuclear decommissioning trust funds 403,703 373,551 Diversified business property, net 817,823 699,493 Miscellaneous other property and investments 81,173 83,222 Prepaid pension cost 225,325 226,413 Other assets and deferred debits 174,799 90,716 - --------------------------------------------------------------------------------------------------------------- Total Deferred Debits and Other Assets 1,852,009 1,626,872 - --------------------------------------------------------------------------------------------------------------- Total Assets $ 7,751,018 $ 6,626,490 - --------------------------------------------------------------------------------------------------------------- Capitalization and Liabilities - --------------------------------------------------------------------------------------------------------------- Capitalization - --------------------------------------------------------------------------------------------------------------- Common stock $ 1,784,026 $ 1,628,951 Retained earnings 760,614 598,191 Accumulated other comprehensive loss (11,140) (15,737) - --------------------------------------------------------------------------------------------------------------- Total Common Stock Equity 2,533,500 2,211,405 - --------------------------------------------------------------------------------------------------------------- Preferred stock of subsidiaries - not subject to mandatory redemption 33,497 33,497 Unsecured note with parent 500,000 500,000 Long-term debt, net 2,146,515 1,710,363 - --------------------------------------------------------------------------------------------------------------- Total Capitalization 5,213,512 4,455,265 - --------------------------------------------------------------------------------------------------------------- Current Liabilities Current portion of long-term debt 68,008 275,397 Accounts payable 356,127 348,842 Payables to affiliated companies 82,614 102,619 Notes payable to affiliated companies 703,397 379,677 Taxes accrued 76,516 28,486 Interest accrued 28,933 68,120 Short-term obligations - 257,100 Customer deposits 129,228 121,998 Other current liabilities 224,093 138,678 - --------------------------------------------------------------------------------------------------------------- Total Current Liabilities 1,668,916 1,720,917 - --------------------------------------------------------------------------------------------------------------- Deferred Credits and Other Liabilities Accumulated deferred investment tax credits 43,381 47,914 Regulatory liabilities 159,357 61,004 Asset retirement obligations 322,992 - Other liabilities and deferred credits 342,860 341,390 - --------------------------------------------------------------------------------------------------------------- Total Deferred Credits and Other Liabilities 868,590 450,308 - --------------------------------------------------------------------------------------------------------------- Commitments and Contingencies (Note 14) - --------------------------------------------------------------------------------------------------------------- Total Capitalization and Liabilities $ 7,751,018 $ 6,626,490 - --------------------------------------------------------------------------------------------------------------- See Notes to Interim Financial Statements. 7 Florida Progress Corporation CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Nine Months Ended September 30, (In thousands) 2003 2002 - --------------------------------------------------------------------------------------------------------------- Operating Activities Net income $ 365,673 $ 114,229 Adjustments to reconcile net income to net cash provided by operating activities: Income from discontinued operations - (5,120) Impairment of long-lived assets - 214,617 Depreciation and amortization 311,274 283,993 Deferred income taxes and investment tax credits, net (134,020) (171,769) Deferred fuel credit (154,647) (14,693) Net increase in accounts receivable (84,410) (60,646) Net (increase) decrease in affiliate accounts receivable 13,543 (46,334) Net (increase) decrease in inventories 43,585 (28,368) Net (increase) decrease in prepayments and other current assets 1,698 (11,062) Net increase in accounts payable 24,314 22,407 Net decrease in affiliate accounts payable (18,306) (14,066) Net increase in income taxes, net 88,352 112,456 Net increase in other current liabilities 53,165 18,542 Other 24,664 52,989 - --------------------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 534,885 467,175 - --------------------------------------------------------------------------------------------------------------- Investing Activities Gross utility property additions (412,181) (316,479) Diversified business property additions (306,145) (101,499) Nuclear fuel additions (50,374) - Net contributions to nuclear decommissioning fund - 12,206 Acquisition, net of cash acquired - (17,355) Other (10,627) 4,292 - --------------------------------------------------------------------------------------------------------------- Net Cash Used in Investing Activities (779,327) (418,835) - --------------------------------------------------------------------------------------------------------------- Financing Activities Proceeds from issuance of long-term debt 638,756 236,242 Net increase (decrease) in short-term obligations (258,149) 90,350 Retirement of long-term debt (429,940) (338,632) Net increase in intercompany notes 323,719 177,815 Equity contributions from parent 155,088 73,916 Dividends paid to parent (203,273) (253,186) Other 945 (487) - --------------------------------------------------------------------------------------------------------------- Net Cash Provided by (Used in) Financing Activities 227,146 (13,982) - --------------------------------------------------------------------------------------------------------------- Net Increase (Decrease) in Cash and Cash Equivalents (17,296) 34,358 - --------------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents at Beginning of the Period 33,601 5,201 - --------------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents at End of the Period $ 16,305 $ 39,559 - --------------------------------------------------------------------------------------------------------------- Supplemental Disclosures of Cash Flow Information Cash paid during the year - interest (net of amount capitalized) $ 137,704 $ 132,219 income taxes (net of refunds) $ 10,358 $ 51,582 See Notes to Interim Financial Statements. 8 Florida Power Corporation d/b/a Progress Energy Florida, Inc. INTERIM FINANCIAL STATEMENTS September 30, 2003 STATEMENTS of INCOME (Unaudited) Three Months Ended Nine Months Ended September 30, September 30, - ------------------------------------------------------------------------------------------------------------------------- (In thousands) 2003 2002 2003 2002 - ------------------------------------------------------------------------------------------------------------------------- Operating Revenues - Utility $ 904,115 $ 863,637 $ 2,399,079 $ 2,316,001 Operating Expenses Fuel used in electric generation 255,071 229,366 657,463 623,472 Purchased power 156,414 145,743 426,824 387,473 Operation and maintenance 163,528 146,814 458,261 433,441 Depreciation and amortization 82,160 73,427 240,956 218,004 Taxes other than on income 62,567 61,186 179,986 175,119 - ------------------------------------------------------------------------------------------------------------------------- Total Operating Expenses 719,740 656,536 1,963,490 1,837,509 - ------------------------------------------------------------------------------------------------------------------------- Operating Income 184,375 207,101 435,589 478,492 - ------------------------------------------------------------------------------------------------------------------------- Other Income (Expense) Interest income 85 297 219 1,574 Other, net 501 (1,454) 1,397 (3,529) - ------------------------------------------------------------------------------------------------------------------------- Total Other Income (Expense) 586 (1,157) 1,616 (1,955) - ------------------------------------------------------------------------------------------------------------------------- Interest Charges Interest charges 10,291 26,663 68,245 84,026 Allowance for borrowed funds used during (2,251) (899) (5,777) (1,932) construction - ------------------------------------------------------------------------------------------------------------------------- Total Interest Charges, Net 8,040 25,764 62,468 82,094 - ------------------------------------------------------------------------------------------------------------------------- Income before Income Taxes 176,921 180,180 374,737 394,443 Income Tax Expense 62,202 56,028 127,146 135,038 - ------------------------------------------------------------------------------------------------------------------------- Net Income $ 114,719 $ 124,152 $ 247,591 $ 259,405 Dividends on Preferred Stock 378 378 1,134 1,134 - ------------------------------------------------------------------------------------------------------------------------- Earnings for Common Stock $ 114,341 $ 123,774 $ 246,457 $ 258,271 - ------------------------------------------------------------------------------------------------------------------------- See Notes to Interim Financial Statements. 9 Florida Power Corporation d/b/a Progress Energy Florida, Inc. BALANCE SHEETS (Unaudited) (In thousands) September 30, December 31, Assets 2003 2002 - --------------------------------------------------------------------------------------------------- Utility Plant Utility plant in service $ 7,793,068 $ 7,477,025 Accumulated depreciation (3,983,759) (4,123,947) - --------------------------------------------------------------------------------------------------- Utility plant in service, net 3,809,309 3,353,078 Held for future use 7,921 7,921 Construction work in progress 561,666 426,641 Nuclear fuel, net of amortization 72,231 40,260 - --------------------------------------------------------------------------------------------------- Total Utility Plant, Net 4,451,127 3,827,900 - --------------------------------------------------------------------------------------------------- Current Assets Cash and cash equivalents 14,813 15,636 Accounts receivable 233,322 186,630 Unbilled accounts receivable 63,167 60,481 Receivables from affiliated companies 10,045 44,976 Deferred income taxes 41,561 26,209 Inventory 229,002 235,043 Deferred fuel cost 192,150 37,503 Prepayments and other current assets 3,674 5,339 - --------------------------------------------------------------------------------------------------- Total Current Assets 787,734 611,817 - --------------------------------------------------------------------------------------------------- Deferred Debits and Other Assets Regulatory assets 118,201 130,114 Unamortized debt expense 22,359 14,503 Nuclear decommissioning trust funds 403,703 373,551 Miscellaneous other property and investments 38,987 39,298 Prepaid pension cost 221,884 222,543 Other assets and deferred debits 4,243 6,517 - --------------------------------------------------------------------------------------------------- Total Deferred Debits and Other Assets 809,377 786,526 - --------------------------------------------------------------------------------------------------- Total Assets $ 6,048,238 $ 5,226,243 - --------------------------------------------------------------------------------------------------- Capitalization and Liabilities - --------------------------------------------------------------------------------------------------- Capitalization - --------------------------------------------------------------------------------------------------- Common stock $ 1,081,256 $ 1,081,257 Retained earnings 1,012,979 969,795 Accumulated other comprehensive loss (2,446) (2,684) - --------------------------------------------------------------------------------------------------- Total Common Stock Equity 2,091,789 2,048,368 - --------------------------------------------------------------------------------------------------- Preferred stock - not subject to mandatory redemption 33,497 33,497 Long-term debt, net 1,705,659 1,244,411 - --------------------------------------------------------------------------------------------------- Total Capitalization 3,830,945 3,326,276 - --------------------------------------------------------------------------------------------------- Current Liabilities Current portion of long-term debt 42,550 216,921 Accounts payable 169,567 147,978 Payables to affiliated companies 63,327 88,661 Notes payable to affiliated companies 476,669 237,425 Taxes accrued 76,236 24,472 Interest accrued 20,607 55,675 Short-term obligations - 257,100 Customer deposits 129,228 121,998 Accrued taxes other than income 74,770 9,046 Other current liabilities 44,081 46,277 - --------------------------------------------------------------------------------------------------- Total Current Liabilities 1,097,035 1,205,553 - --------------------------------------------------------------------------------------------------- Deferred Credits and Other Liabilities Accumulated deferred income taxes 358,338 361,133 Accumulated deferred investment tax credits 42,905 47,423 Regulatory liabilities 159,357 61,004 Asset retirement obligations 315,077 - Other liabilities and deferred credits 244,581 224,854 - --------------------------------------------------------------------------------------------------- Total Deferred Credits and Other Liabilities 1,120,258 694,414 - --------------------------------------------------------------------------------------------------- Commitments and Contingencies (Note 14) - --------------------------------------------------------------------------------------------------- Total Capitalization and Liabilities $ 6,048,238 $ 5,226,243 - --------------------------------------------------------------------------------------------------- See Notes to Interim Financial Statements. Florida Power Corporation d/b/a Progress Energy Florida, Inc. STATEMENTS OF CASH FLOWS (Unaudited) Nine Months Ended September 30, (In thousands) 2003 2002 - -------------------------------------------------------------------------------------------------------------- Operating Activities Net income $ 247,591 $ 259,405 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 246,102 236,520 Deferred income taxes and investment tax credits, net (29,846) (13,555) Deferred fuel credit (154,647) (14,693) Net increase in accounts receivable (49,378) (42,036) Net (increase) decrease in affiliate accounts receivable 34,931 (20,180) Net (increase) decrease in inventories 6,041 (15,971) Net (increase) decrease in prepayments and other current assets 1,665 (4,627) Net increase in accounts payable 21,589 8,261 Net decrease in affiliate accounts payable (25,334) (122,291) Net increase in income taxes, net 51,764 26,361 Net increase in other current liabilities 53,574 35,380 Other 12,890 12,711 - -------------------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 416,942 345,285 - -------------------------------------------------------------------------------------------------------------- Investing Activities Gross utility property additions (412,181) (316,479) Nuclear fuel additions (50,374) - Net contributions to nuclear decommissioning fund - 12,206 Other (638) (280) - -------------------------------------------------------------------------------------------------------------- Net Cash Used in Investing Activities (463,193) (304,553) - -------------------------------------------------------------------------------------------------------------- Financing Activities Proceeds from issuance of long-term debt 638,756 236,242 Net increase (decrease) in short-term obligations (258,149) 90,350 Retirement of long-term debt (371,825) (276,459) Net increase in intercompany notes 239,244 192,180 Dividends paid to parent (203,273) (253,186) Dividends paid on preferred stock (1,134) (1,134) Other 1,809 - - -------------------------------------------------------------------------------------------------------------- Net Cash Provided by (Used in) Financing Activities 45,428 (12,007) - -------------------------------------------------------------------------------------------------------------- Net Increase (Decrease) in Cash and Cash Equivalents (823) 28,725 - -------------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents at Beginning of the Period 15,636 - - -------------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents at End of the Period $ 14,813 $ 28,725 - -------------------------------------------------------------------------------------------------------------- Supplemental Disclosures of Cash Flow Information Cash paid during the year - interest (net of amount capitalized) $ 78,219 $ 99,729 income taxes (net of refunds) $ 105,228 $ 116,991 See Notes to Interim Financial Statements. 11 Florida Progress Corporation and Florida Power Corporation d/b/a Progress Energy Florida, Inc. NOTES TO INTERIM FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A. Organization Florida Progress Corporation (the Company or Florida Progress) is a holding company under the Public Utility Holding Company Act of 1935 (PUHCA), as amended. The Company became subject to the regulations of PUHCA when CP&L Energy, Inc. acquired it on November 30, 2000. CP&L Energy, Inc. subsequently changed its name to Progress Energy, Inc. (Progress Energy or the Parent). Effective January 1, 2003, Florida Power Corporation began doing business under the assumed name Progress Energy Florida, Inc. The legal name of the entity has not changed and there was no restructuring of any kind related to the name change. The current corporate and business unit structure remains unchanged. Florida Progress' two primary subsidiaries are Progress Energy Florida, Inc. (PEF) and Progress Fuels Corporation (Progress Fuels). PEF is a regulated public utility engaged in the generation, purchase, transmission, distribution and sale of electricity primarily in portions of Florida. PEF is regulated by the Florida Public Service Commission (FPSC) and the Federal Energy Regulatory Commission (FERC). Progress Fuels is a diversified non-utility energy company, whose principal business segments are Fuels and Rail. Progress Fuels' Rail Services and a portion of its Fuels operations report their results one month in arrears. B. Basis of Presentation These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. Because the accompanying consolidated interim financial statements do not include all of the information and footnotes required by GAAP, they should be read in conjunction with the audited financial statements and notes thereto included in Florida Progress' and PEF's Form 10-K for the year ended December 31, 2002. In accordance with the provisions of Accounting Principles Board Opinion (APB) No. 28, "Interim Financial Reporting," GAAP requires companies to apply a levelized effective tax rate to interim periods that is consistent with the estimated annual effective tax rate. The intra-period tax allocation, which will have no impact on total year net income, resulted in a tax benefit of $2.7 million and a tax expense of $60.2 million for the three months ended September 30, 2003 and 2002, respectively in order to maintain an effective tax rate consistent with the estimated annual effective tax rate. The levelization resulted in a tax benefit of $17.6 million and a tax expense of $82.0 million in the nine months ended September 30, 2003 and 2002, respectively. The amounts included in the consolidated interim financial statements are unaudited but, in the opinion of management, reflect all normal recurring adjustments necessary to fairly present Florida Progress' and PEF's financial position and results of operations for the interim periods. Due to seasonal weather variations and the timing of outages of electric generating units, especially the nuclear-fueled unit, the results of operations for interim periods are not necessarily indicative of amounts expected for the entire year or future periods. In preparing financial statements that conform with GAAP, management must make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and amounts of revenues and expenses reflected during the reporting period. Actual results could differ from those estimates. Certain reclassifications for 2002 have been made to conform to the 2003 presentation. 2. ACQUISITION OF NATURAL GAS RESERVES During the first quarter of 2003, Progress Fuels entered into three independent transactions to acquire approximately 162 natural gas-producing wells with proven reserves of approximately 180 billion cubic feet (Bcf) from Republic Energy, Inc. and two other privately-owned companies, all headquartered in Texas. The primary assets in the acquisition have been contributed to Progress Fuels North Texas Gas, L.P., a wholly-owned subsidiary of Progress Fuels. The cash purchase price for the transactions totaled $148 million. 12 3. DIVESTITURES A. Mesa Hydrocarbons, Inc. Divestiture In September 2003, the Finance Committee as authorized by the Company's Board of Directors adopted a resolution approving the sale of certain gas producing properties owned by Mesa Hydrocarbons, LLC, a wholly-owned subsidiary of Progress Fuels Corporation, which is included in the Fuels segment. The $79.7 million book value of the assets to be sold has been grouped as assets held for sale and are included in other current assets on the accompanying Consolidated Balance Sheets as of September 30, 2003. The primary components of assets held for sale are oil and gas leases and wells. On October 1, 2003, the Company completed the sale of these assets. Net proceeds of approximately $97 million was used to reduce debt. The Company will record this transaction in the fourth quarter of 2003. B. Railcar Ltd. Divestiture In December 2002, the Progress Energy Board of Directors adopted a resolution authorizing the sale of the majority of the assets of Railcar Ltd., a leasing subsidiary included in the Rail Services segment. An estimated impairment on assets held for sale was recognized in December 2002 for the write-down of the assets to be sold to fair value less the costs to sell. The assets of Railcar Ltd. have been grouped as assets held for sale and are included in other current assets on the Consolidated Balance Sheets as of September 30, 2003. The assets are recorded at $33.1 million and $23.6 million as of September 30, 2003 and December 31, 2002, respectively. On March 12, 2003, the Company signed a letter of intent with The Andersons, Inc. to sell the majority of Railcar Ltd. assets. A definitive purchase agreement was signed on November 6, 2003 with the buyers, including Cap Acquire LLC. A significant portion of the proceeds from the sale will be used by Progress Energy to pay off certain Railcar Ltd. off balance sheet lease obligations for railcars that will be transferred to the buyers as part of the sales transaction. The transaction is targeted to close in 2003, but is subject to various closing conditions including financing and due diligence. 4. FINANCIAL INFORMATION BY BUSINESS SEGMENT The Company currently has the following business segments: PEF, Fuels, Rail and Other Businesses (Other). PEF is engaged in the generation, transmission, distribution and sale of electric energy primarily in portions of Florida. These electric operations are subject to the rules and regulations of the FERC, the FPSC and the U.S. Nuclear Regulatory Commission (NRC). Fuels' operations, which are located in the United States, include natural gas drilling and production, coal mining and terminals, and the production of synthetic fuels. Fuels sells coal to Progress Ventures, Inc. (PVI), a subsidiary of Progress Energy. These related party sales are included in the revenues that follow and are $48.7 million and $41.8 million for the three months ended September 30, 2003 and 2002, respectively, and $124.4 million and $153.7 million for the nine months ended September 30, 2003 and 2002, respectively. Rail operations include railcar repair, rail parts reconditioning and sales, railcar leasing (primarily through Railcar Ltd.) and sales, and scrap metal recycling. These activities include maintenance and reconditioning of salvageable scrap components of railcars, locomotive repair and right-of-way maintenance. Rail's primary operations are located in the United States, with limited operations in Mexico and Canada. Other primarily includes the operations of Progress Telecommunications Corporation (Progress Telecom), the Company's telecommunications subsidiary; the Company's investment in FPC Capital Trust, which holds the Preferred Securities; and the holding company, Florida Progress. Progress Telecom markets wholesale fiber-optic based capacity service in the Eastern United States and also markets wireless structure attachments to wireless communication companies and governmental entities. Intersegment sales and transfers consist primarily of coal sales from the Fuels segment to PEF. The price that Fuels charges PEF is based on market rates for coal procurement and for water-borne transportation under a methodology approved by the FPSC. 13 The following summarizes the revenues, segment profits or losses and assets for the reportable business segments. The combined segment profits and losses represents Florida Progress' total income (loss) from continuing operations. (In thousands) PEF Fuels Rail Other Consolidated --------------------------------------------------------------------------------------------------------------- Three Months Ended September 30, 2003: Revenues 904,115 254,901 208,795 7,176 1,374,987 Intersegment revenues - 87,054 951 (88,005) - Total revenues 904,115 341,955 209,746 (80,829) 1,374,987 Segment profit 114,341 59,674 706 293 175,014 =============================================================================================================== PEF Fuels Rail Other Consolidated --------------------------------------------------------------------------------------------------------------- Three Months Ended September 30, 2002: Revenues 863,637 171,959 179,712 7,152 1,222,460 Intersegment revenues - 91,078 1,282 (92,360) - Total revenues 863,637 263,037 180,994 (85,208) 1,222,460 Segment profit (loss) 123,774 30,178 (579) (210,394) (57,021) =============================================================================================================== (In thousands) PEF Fuels Rail Other Consolidated --------------------------------------------------------------------------------------------------------------- Nine Months Ended September 30, 2003: Revenues 2,399,079 669,253 600,013 20,645 3,688,990 Intersegment revenues - 256,114 1,282 (257,396) - Total revenues 2,399,079 925,367 601,295 (236,751) 3,688,990 Segment profit (loss) 246,457 111,468 (498) 8,246 365,673 Total segment assets 6,048,238 915,419 595,104 192,257 7,751,018 =============================================================================================================== PEF Fuels Rail Other Consolidated --------------------------------------------------------------------------------------------------------------- Nine Months Ended September 30, 2002: Revenues 2,316,001 492,597 529,818 25,538 3,363,954 Intersegment revenues - 235,704 2,632 (238,336) - Total revenues 2,316,001 728,301 532,450 (212,798) 3,363,954 Segment profit (loss) 258,271 93,215 1,667 (244,044) 109,109 Total segment assets 5,079,718 843,422 579,947 79,944 6,583,031 =============================================================================================================== 5. IMPACT OF NEW ACCOUNTING STANDARDS SFAS No. 148, "Accounting for Stock-Based Compensation" The Company measures compensation expense for stock options as the difference between the market price of its common stock and the exercise price of the option at the grant date. The exercise price at which options are granted by the Company equals the market price at the grant date and accordingly, no compensation expense has been recognized for stock option grants. For purposes of the pro forma disclosures required by SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an Amendment of FASB Statement No. 123," the estimated fair value of Progress Energy's stock options is amortized to expense over the options' vesting period. The Company's information related to the pro forma impact on earnings assuming stock options were expensed for the three and nine months ended September 30, 2003 and 2002 is as follows: 14 (in thousands) Three Months Ended Nine Months Ended September 30, September 30, -------------------------------------------------------------- FLORIDA PROGRESS CORPORATION 2003 2002 2003 2002 -------------- ----------------------------- ---------------- Net income (loss), as reported $ 175,014 $ (51,901) $ 365,673 $ 114,229 Deduct: Total stock option expense determined under fair value method for all awards, net of related tax effects 997 865 1,690 1,369 -------------- ----------------------------- ---------------- Pro forma net income (loss) $ 174,017 $ (52,766) $ 363,983 $ 112,860 ============== ============================= ================ Three Months Ended Nine Months Ended September 30, September 30, -------------------------------------------------------------- PROGRESS ENERGY FLORIDA, INC. 2003 2002 2003 2002 -------------- ----------------------------- ---------------- Earnings for common stock, as reported $ 114,341 $ 123,774 $ 246,457 $ 258,271 Deduct: Total stock option expense determined under fair value method for all awards, net of related tax effects 525 596 1,160 1,058 -------------- ----------------------------- ---------------- Pro forma earnings for common stock $ 113,816 $ 123,178 $ 245,297 $ 257,213 ============== ============================= ================ During 2003, the Financial Accounting Standards Board (FASB) has approved certain decisions in conjunction with its stock-based compensation project. Some of the key decisions reached by the FASB were that stock-based compensation should be recognized in the income statement as an expense and that the expense should be measured as of the grant date at fair value. The FASB continues to deliberate additional issues in this project and plans to issue an exposure draft early 2004. Derivative Instruments and Hedging Activities In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." The statement amends and clarifies SFAS No. 133 on accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The new guidance incorporates decisions made as part of the Derivatives Implementation Group (DIG) process, as well as decisions regarding implementation issues raised in relation to the application of the definition of a derivative. SFAS No. 149 is generally effective for contracts entered into or modified after June 30, 2003. Interpretations and implementation issues with regard to SFAS No. 149 continue to evolve. Based on its analysis and understanding to date, and considering the types of contracts historically entered into, the Company does not anticipate that this statement will have a significant impact on its results of operations or financial position. In connection with the January 2003 FASB Emerging Issues Task Force (EITF) meeting, the FASB was requested to reconsider an interpretation of SFAS No. 133. The interpretation, which is contained in the Derivative Implementation Group's C11 guidance, relates to the pricing of contracts that include broad market indices (e.g., CPI). In particular, that guidance discusses whether the pricing in a contract that contains broad market indices could qualify as a normal purchase or sale (the normal purchase or sale term is a defined accounting term, and may not, in all cases, indicate whether the contract would be "normal" from an operating entity viewpoint). In late June 2003, the FASB issued final superseding guidance (DIG Issue C20) on this issue, which is significantly different from the tentative superseding guidance that was issued in April 2003. The new guidance is effective October 1, 2003 for the Company. DIG Issue C20 specifies new pricing-related criteria for qualifying as a normal purchase or sale, and it requires a special transition adjustment as of October 1, 2003. The Company has no current contracts affected by this revised guidance. SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity" In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The financial instruments within the scope of SFAS No. 150 include mandatorily redeemable stock, obligations to repurchase the issuer's equity shares by transferring assets, and certain obligations to issue a variable number of shares. SFAS No. 150 is effective immediately for such instruments entered into or modified after May 31, 2003, and was effective for previously issued financial instruments within its scope on July 1, 2003. The FPC Capital I Preferred Securities, as discussed in Note 8, were reported as debt prior to July 1, 2003. Therefore, the adoption of SFAS No. 150 did not have a material impact on the Company's results of operations or financial position as of and for the periods ended September 30, 2003. 15 FIN No. 46, "Consolidation of Variable Interest Entities" In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities - an Interpretation of ARB No. 51" (FIN No. 46). This interpretation provides guidance related to identifying variable interest entities and determining whether such entities should be consolidated. FIN No. 46 requires an enterprise to consolidate a variable interest entity when the enterprise (a) absorbs a majority of the variable interest entity's expected losses, (b) receives a majority of the entity's expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. Prior to the effective date of FIN No. 46, entities were generally consolidated by an enterprise that had control through ownership of a majority voting interest in the entity. FIN No. 46 applies immediately to variable interest entities created or obtained after January 31, 2003. During the first nine months of 2003, the Company did not participate in the creation of, or obtain a new variable interest in, any variable interest entity. On October 9, 2003, the FASB issued Staff Position No. FIN 46-6, which allowed for the optional deferral of the effective date of FIN No. 46 from July 1, 2003 until December 31, 2003, for interests held by a public company in variable interest entities created prior to February 1, 2003. Because the Company expects additional transitional guidance to be issued, it has deferred its implementation of FIN No. 46 until December 31, 2003. The Company has entered into arrangements with several variable interest entities through its Railcar, Ltd. subsidiary. These arrangements include six synthetic leases with a master trust, a servicing contract with the Railcar Asset Financing Trust (RAFT), and a receivables securitization transaction with a commercial paper conduit. Because the Company expects to divest of its interests in all these arrangements in 2003, the adoption of FIN No. 46 related to these variable interests is not expected to have a significant effect on the Company's financial position or results of operations. If the Company does not divest of its interests in 2003 as expected, under the current guidance the Company would consolidate the master trust and record an increase in both total assets and total liabilities of approximately $25.8 million. As of September 30, 2003, the maximum cash obligations under all three of these arrangements total approximately $39.2 million. Management believes this maximum loss exposure is significantly reduced based on the current fair values of the underlying assets of the entities. Upon adoption of FIN No. 46 as currently issued, the Company expects to deconsolidate the FPC Capital I Trust (the Trust), which holds FPC-obligated mandatorily redeemable preferred securities (see Note 8). The Trust is a variable interest entity, but the Company does not absorb a majority of the Trust's expected losses and therefore is not its primary beneficiary. In connection with the planned deconsolidation as of December 31, 2003, the Company expects to record an additional equity investment in the Trust of approximately $9.3 million and an increase in outstanding debt of approximately $9.3 million. See Note 8 for a discussion of the Company's guarantees with the Trust. The Company also has interests in several other variable interest entities created before January 31, 2003, for which the Company would not be the primary beneficiary based on the current guidance. These arrangements include equity investments in approximately six limited partnerships, limited liability corporations and venture capital funds. The aggregate maximum loss exposure as of September 30, 2003 under these arrangements totals approximately $11.6 million. The creditors of these variable interest entities do not have recourse to the general credit of the Company in excess of the aggregate maximum loss exposure. EITF Issue No. 03-04, "Accounting for `Cash Balance' Pension Plans" In May 2003, the EITF reached consensus in EITF Issue No. 03-04 to specifically address the accounting for certain cash balance pension plans. The consensus reached in EITF Issue No. 03-04 requires certain cash balance pension plans to be accounted for as defined benefit plans. For cash balance plans described in the consensus, the consensus also requires the use of the traditional unit credit method for purposes of measuring the benefit obligation and annual cost of benefits earned as opposed to the projected unit credit method. The Company has historically accounted for its cash balance plans as defined benefit plans; however, the Company is required to adopt the measurement provisions of EITF 03-04 at its cash balance plans' next measurement date of December 31, 2003. Any differences in the measurement of the obligations as a result of applying the consensus will be reported as a component of actuarial gain or loss. The effect of this standard on the Company is dependent on other factors that also affect the determination of actuarial gains and losses and the subsequent amortization of such gains and losses. However, the Company does not expect the adoption of EITF 03-04 to have a material effect on its results of operations or financial position. 16 6. ASSET RETIREMENT OBLIGATIONS SFAS No. 143, "Accounting for Asset Retirement Obligations," provides accounting and disclosure requirements for retirement obligations associated with long-lived assets and was adopted by the Company effective January 1, 2003. This statement requires that the present value of retirement costs for which the Company has a legal obligation be recorded as a liability with an equivalent amount added to the asset cost and depreciated over an appropriate period. The liability is then accreted over time by applying an interest method of allocation to the liability. Cumulative accretion and accumulated depreciation were recognized for the time period from the date the liability would have been recognized had the provisions of this statement been in effect, to the date of adoption of this statement. Upon adoption of SFAS No. 143, PEF recorded asset retirement obligations (AROs) totaling $302.8 million for nuclear decommissioning of irradiated plant. PEF used an expected cash flow approach to measure these obligations. This amount includes accruals recorded prior to adoption totaling $283.9 million, which were previously recorded in accumulated depreciation. The related asset retirement costs, net of accumulated depreciation, recorded upon adoption totaled $38.5 million for regulated operations. The adoption of this statement had no impact on the income of PEF, as the effects were offset by the establishment of a regulatory liability in the amount of $19.6 million, pursuant to SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation." The regulatory liability represents the amount by which previously recorded accruals exceeded the cumulative accretion and accumulated depreciation for the time period from the date the liability would have been recognized had the provisions of this statement been in effect to the date of adoption. Funds set aside in PEF's nuclear decommissioning trust fund for the nuclear decommissioning liability totaled $403.7 million at September 30, 2003 and $373.6 million at December 31, 2002. In accordance with SFAS No. 143, unrealized gains and losses on the nuclear decommissioning trust fund are now included in regulatory liabilities rather than accumulated depreciation. The balance of this regulatory liability as of September 30, 2003 was $78.1 million for PEF. The Company also recorded AROs totaling $9.6 million for coal mine operations, synthetic fuel operations and gas production of Progress Fuels Corporation. The Company used an expected cash flow approach to measure these obligations. This amount includes accruals recorded prior to adoption totaling $4.6 million, which were previously recorded in other liabilities and deferred credits. The related asset retirement costs, net of accumulated depreciation, recorded upon adoption totaled $3.4 million for nonregulated operations. The cumulative effect of initial adoption of this statement related to nonregulated operations was $1.6 million of pre-tax expense, which is included in other, net on the Consolidated Statements of Income for the nine months ended September 30, 2003. The ongoing impact on earnings related to accretion and depreciation was not significant for the three or nine months ended September 30, 2003. Pro forma net income has not been presented for prior years because the pro forma application of SFAS No. 143 to prior years would result in pro forma net income not materially different from the actual amounts reported. The Company has identified but not recognized ARO liabilities related to electric transmission and distribution, gas distribution and telecommunications assets as the result of easements over property not owned by the Company. These easements are generally perpetual and only require retirement action upon abandonment or cessation of use of the property for the specified purpose. The ARO liability is not estimable for such easements, as the Company intends to utilize these properties indefinitely. In the event the Company decides to abandon or cease the use of a particular easement, an ARO liability would be recorded at that time. PEF has previously recognized removal costs as a component of depreciation in accordance with regulatory treatment. As of September 30, 2003, the portion of such costs not representing AROs under SFAS No. 143 was $955.8 million. This amount is included in accumulated depreciation on the accompanying Balance Sheets. PEF has collected amounts for non-irradiated areas at nuclear facilities, which do not represent AROs. These amounts as of September 30, 2003 totaled $61.5 million, which is included in accumulated depreciation on the accompanying Balance Sheets. PEF previously collected amounts for dismantlement of its fossil generation plants. As of September 30, 2003, this amounted to $142.4 million, which is included in accumulated depreciation on the accompanying Balance Sheets. This collection was suspended pursuant to the rate case settlement discussed in Note 9. 17 On January 23, 2003, the Staff of the FPSC issued a notice of proposed rule development to adopt provisions relating to accounting for AROs under SFAS No. 143. Accompanying the notice was a draft rule presented by the Staff which adopts the provisions of SFAS No. 143 along with the requirement to record the difference between amounts prescribed by the FPSC and those used in the application of SFAS No. 143 as regulatory assets or regulatory liabilities, which was accepted by all parties. Therefore, the adoption of the statements had no impact on the income of PEF due to the establishment of a regulatory liability pursuant to SFAS No. 71. The Commission approved this draft rule and a final order was issued in the third quarter of 2003. 7. GOODWILL AND OTHER INTANGIBLE ASSETS Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets." This statement clarifies the criteria for recording of other intangible assets separately from goodwill. Effective January 1, 2002, goodwill was no longer subject to amortization over its estimated useful life. Instead, goodwill is subject to at least an annual assessment for impairment by applying a two-step fair-value based test. This assessment could result in periodic impairment charges. The Company completed the first step of the initial transitional goodwill impairment test, which indicated that the Company's goodwill was not impaired as of January 1, 2002. The Company's carrying amount of goodwill at September 30, 2003 and December 31, 2002, was $9.9 million and $11.1 million, respectively, in the Fuels segment. The Company has $9.0 million of net intangible assets as of September 30, 2003 and no significant intangible assets as of December 31, 2002. The $9.0 million relates to a $9.2 million contract acquired as part of the Westchester Gas Company acquisition (for which the purchase price allocation was finalized during the first quarter of 2003) net of amortization to date. PEF has no significant intangible assets and no goodwill as of September 30, 2003 and December 31, 2002. 8. COMPANY-OBLIGATED MANDATORILY REDEEMABLE CUMULATIVE QUARTERLY INCOME PREFERRED SECURITIES OF A SUBSIDIARY TRUST HOLDING SOLELY FLORIDA PROGRESS GUARANTEED SUBORDINATED DEFERRABLE INTEREST NOTES In April 1999, FPC Capital I (the Trust), an indirect wholly-owned subsidiary of the Company, issued 12 million shares of $25 par cumulative Company-obligated mandatorily redeemable preferred securities (Preferred Securities) due 2039, with an aggregate liquidation value of $300 million with an annual distribution rate of 7.10%, payable quarterly. Currently, all 12 million shares of the Preferred Securities that were issued are outstanding. Concurrent with the issuance of the Preferred Securities, the Trust issued to Florida Progress Funding Corporation (Funding Corp.) all of the common securities of the Trust (371,135 shares) for $9.3 million. Funding Corp. is a direct wholly-owned subsidiary of the Company. The existence of the Trust is for the sole purpose of issuing the Preferred Securities and the common securities and using the proceeds thereof to purchase from Funding Corp. its 7.10% Junior Subordinated Deferrable Interest Notes (subordinated notes) due 2039, for a principal amount of $309.3 million. The subordinated notes and the Notes Guarantee (as discussed below) are the sole assets of the Trust. Funding Corp.'s proceeds from the sale of the subordinated notes were advanced to Progress Capital and used for general corporate purposes including the repayment of a portion of certain outstanding short-term bank loans and commercial paper. The Company has fully and unconditionally guaranteed the obligations of Funding Corp. under the subordinated notes (the Notes Guarantee). In addition, the Company has guaranteed the payment of all distributions required to be made by the Trust, but only to the extent that the Trust has funds available for such distributions (Preferred Securities Guarantee). The Preferred Securities Guarantee, considered together with the Notes Guarantee, constitutes a full and unconditional guarantee by the Company of the Trust's obligations under the Preferred Securities. The subordinated notes may be redeemed at the option of Funding Corp. beginning in 2004 at par value plus accrued interest through the redemption date. The proceeds of any redemption of the subordinated notes will be used by the Trust to redeem proportional amounts of the Preferred Securities and common securities in accordance with their terms. Upon liquidation or dissolution of Funding Corp., holders of the Preferred Securities would be entitled to the liquidation preference of $25 per share plus all accrued and unpaid dividends thereon to the date of payment. These Preferred Securities are classified as long-term debt on Florida Progress' Consolidated Balance Sheets. Upon adoption of the current FIN No. 46 standard, the Company anticipates deconsolidating the Trust which is not expected to have a material effect on the consolidated financial position, results of operations or liquidity (see Note 5). 18 9. REGULATORY MATTERS A. Retail Rate Matters On March 27, 2002, the parties in PEF's rate case entered into a Stipulation and Settlement Agreement (the Agreement) related to retail rate matters. The Agreement was approved by the FPSC on April 23, 2002. The Agreement provides that PEF will operate under a Revenue Sharing Incentive Plan (the Plan) through 2005 and thereafter until terminated by the FPSC. The Plan establishes annual revenue caps and sharing thresholds. The Plan provides that all retail base revenues between an established threshold and cap will be shared - a 2/3 share to be refunded to PEF's retail customers, and a 1/3 share to be received by PEF's shareholders. All retail base rate revenues above the retail base rate revenue caps established for each year will be refunded 100% to retail customers on an annual basis. The retail base rate revenue sharing threshold amounts for 2003 are $1.333 billion and will increase $37 million each year thereafter. The retail base revenue cap for 2003 is $1.393 billion and will increase $37 million each year thereafter. As of December 31, 2002, $4.7 million was accrued and was refunded to customers in March 2003. On February 24, 2003, the parties to the Agreement filed a motion seeking an order from the FPSC to enforce the Agreement. In this motion, the parties disputed PEF's calculation of retail revenue subject to refund and contended that the refund should be approximately $23 million. On July 9, 2003, the FPSC ruled that PEF must provide an additional refund of $18.4 million to its retail customers related to the 2002 revenue sharing calculation. PEF recorded this refund in the second quarter of 2003 as a charge against electric operating revenue and refunded this amount by October 31, 2003. For the nine months ended September 30, 2003, PEF recorded an additional accrual of $5.4 million related to estimated 2003 revenue sharing. On March 4, 2003, the FPSC approved PEF's petition to increase its fuel factors due to continuing increases in oil and natural gas commodity prices. New rates became effective on March 28, 2003. On September 12, 2003, PEF announced that it had asked the FPSC to approve a cost adjustment in its annual fuel filing, primarily related to rising costs of fuel that will increase retail customer bills beginning January 1, 2004. The total amount of the fuel adjustment requested above current levels was $322 million. A decision from the FPSC is expected on November 12, 2003. B. Regional Transmission Organizations In early 2000, the FERC issued Order 2000 regarding regional transmission organizations (RTOs). This Order set minimum characteristics and functions that RTOs must meet, including independent transmission service. As a result of Order 2000, PEF, along with Florida Power & Light Company and Tampa Electric Company, filed with the FERC, in October 2000, an application for approval of a GridFlorida RTO. In March 2001, the FERC issued an order provisionally approving GridFlorida. In July 2001, the FERC issued orders recommending that companies in the Southeast engage in a mediation to develop a plan for a single RTO for the Southeast. PEF participated in the mediation. The FERC has not issued an order specifically on this mediation. In July 2002, the FERC issued its Notice of Proposed Rulemaking in Docket No. RM01-12-000, Remedying Undue Discrimination through Open Access Transmission Service and Standard Electricity Market Design (SMD NOPR). If adopted as proposed, the rules set forth in the SMD NOPR would materially alter the manner in which transmission and generation services are provided and paid for. PEF, as a subsidiary of Progress Energy, filed comments on November 15, 2002 and supplemental comments on January 10, 2003. On April 28, 2003, the FERC released a White Paper on the Wholesale Market Platform. The White Paper provides an overview of what the FERC currently intends to include in a final rule in the SMD NOPR docket. The White Paper retains the fundamental and most protested aspects of SMD NOPR, including mandatory RTOs and the FERC's assertion of jurisdiction over certain aspects of retail service. PEF, as a subsidiary of Progress Energy, plans to file comments on the White Paper. The FERC has also indicated that it expects to issue a final rule after Congress votes this fall on the proposed House and Senate Energy Bills. The Company cannot predict the outcome of these matters or the effect that they may have on the GridFlorida proceedings currently ongoing before the FERC. It is unknown what impact future proceedings will have on the Company's earnings, revenues or prices. The Company has actively participated in the RTO formation in Florida. The three peninsular Florida investor-owned utilities, PEF, Florida Power and Light Company and Tampa Electric Company (the Applicants) have proposed the formation of GridFlorida, a single ISO (Independent System Operator) for peninsular Florida. Participation is expected from many of the other transmission owners in the state of Florida. The GridFlorida proposal is pending before both the FERC and the FPSC. In December 2001, the FPSC found the Applicants were prudent in proactively forming GridFlorida but ordered the Applicants to modify the proposal in several material respects, 19 including a change to status as a not-for-profit ISO. The Commission's most recent order in September 2002 ordered further state proceedings. The issues to be addressed as modifications include but are not limited to 1) pricing/rate structure; 2) elimination of pancaking revenues; 3) cost recovery of incremental costs; 4) demarcation dates for new facilities and long-term transmission contracts; 5) market design. The Florida Office of Public Counsel appealed the September order to the Florida Supreme Court and in October 2002 the FPSC abated its proceedings pending the outcome of the appeal. On June 2, 2003 the Florida Supreme Court dismissed the appeal without prejudice on the ground that certain portions of the Commission's order constituted non-final action. The dismissal is without prejudice to any party to challenge the Commission's order after all portions are final. A technical conference for the state of Florida was conducted by the FERC on September 15, 2003. At September 30, 2003, the Company had an immaterial amount invested in GridFlorida. It is unknown when the FERC or the FPSC will take final action with regard to the status of GridFlorida or what the impact of further proceedings will have on the Company's or PEF's earnings, revenues or prices. 10. COMPREHENSIVE INCOME Comprehensive income for Florida Progress for the three and nine months ended September 30, 2003 was $181.7 million and $370.3 million, respectively. Florida Progress comprehensive loss for the three months September 30, 2002 was $58.4 and comprehensive income for the nine months ended September 30, 2002 was $108.0 million. Comprehensive income for PEF for the three and nine months ended September 30, 2003 was $114.7 million and $247.8 million, respectively. PEF did not have any items of other comprehensive income for the three or nine months ended September 30, 2002. Items of other comprehensive income consisted primarily of changes in fair value of derivatives used to hedge cash flows related to interest on long-term debt and gas sales, and to foreign currency translation adjustments. 11. FINANCING ACTIVITIES On February 21, 2003, PEF issued $425 million of First Mortgage Bonds, 4.80% Series Due March 1, 2013 and $225 million of First Mortgage Bonds, 5.90% Series, Due March 1, 2033. Proceeds from this issuance were used to repay the balance of its outstanding commercial paper, to refinance its secured and unsecured indebtedness, including $70 million of First Mortgage Bonds 6.125% Series Due March 1, 2003, and to redeem on March 24, 2003, the $150 million aggregate outstanding balance of its 8% First Mortgage Bonds Due 2022 at 103.75% of the principal amount of such bonds. On April 1, 2003, PEF entered into a new $200 million 364-day credit agreement and a new $200 million three-year credit agreement replacing its prior credit facilities (which had been a $90 million 364-day facility and a $200 million five-year facility). The new PEF credit facilities contain a defined maximum total debt to total capital ratio of 65%; as of September 30, 2003 the calculated ratio, as defined, was 51.3%. The new credit facilities also contain a requirement that the ratio of EBITDA, as defined in the facilities, to interest expense to be at least 3 to 1; as of September 30, 2003 the calculated ratio, as defined, was 8.1 to 1. On July 1, 2003, $110 million of PEF's First Mortgage Bonds, 6.0% Series, Due July 1, 2003 and $35 million of PEF's medium-term notes, 6.62% Series, matured. The Company received proceeds of approximately $97 million in October 2003 for the sale of its Mesa gas properties located in Colorado. Proceeds will primarily be used to reduce short-term debt. On October 31, 2003, PEF announced the redemption of $100 million of its First Mortgage Bonds, 7% Series, Due 2023 at 103.19% of the principal amount of such bonds. PEF intends to redeem the bonds on December 1, 2003 with commercial paper proceeds. 12. RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS Progress Energy and its subsidiaries, including the Company and PEF, are exposed to various risks related to changes in market conditions. The Company has a risk management committee that is chaired by the Chief Financial Officer and includes senior executives from various business groups. The risk management committee is responsible for administering risk management policies and monitoring compliance with those policies by all subsidiaries. The Company manages its market risk in accordance with its established risk management policies, which may include entering into various derivative transactions. 20 The Company uses interest rate derivative instruments to adjust the fixed and variable rate debt components of its debt portfolio and to hedge interest rates with regard to future fixed rate debt issuances. Treasury rate lock agreements were terminated in conjunction with the pricing of the PEF First Mortgage Bonds in February 2003. The loss on the agreements was deferred and is being amortized over the life of the bonds as these agreements had been designated as cash flow hedges for accounting purposes. The amount of this loss was not material. Progress Fuels Corporation periodically enters into derivative instruments to hedge its exposure to price fluctuations on natural gas sales. As of September 30, 2003, Progress Fuels Corporation has executed cash flow hedges on approximately 12.6 Bcf of natural gas sales through December 2004. These instruments did not have a material impact on the Company's consolidated financial position or results of operations. 13. OTHER INCOME AND OTHER EXPENSE Other income and expense includes interest income and other income and expense items as discussed below. The components of other, net as shown on the accompanying Consolidated Statements of Income for three and nine months ended September 30, 2003 and 2002 are as follows: (in thousands) Three Months Ended Nine Months Ended September 30, September 30, ----------------------------- ---------------------------- 2003 2002 2003 2002 ------------ ------------ ----------- ------------- Other income Net energy brokered for resale gain (loss) $ (435) $ 1,470 $ (548) $ 1,775 Nonregulated energy and delivery services 3,553 3,060 10,456 9,953 income AFUDC equity 2,714 362 6,764 777 Other - 49 - (33) ------------ ------------ ----------- ------------- Total other income - PEF and Florida $ 5,832 $ 4,941 $ 16,672 $ 12,472 Progress ------------ ------------ ----------- ------------- Other expense Nonregulated energy and delivery services expenses $ 2,617 $ 2,022 $ 8,318 $ 6,138 Donations 2,396 2,033 6,449 6,481 Other 318 2,340 508 3,382 ------------ ------------ ----------- ------------- Total other expense - PEF $ 5,331 $ 6,395 $ 15,275 $ 16,001 Other expense - Florida Progress(a) (5,246) 1,717 1,647 9,116 ------------ ------------ ----------- ------------- Total other expense - PEF and Florida $ 85 $ 8,112 $ 16,922 $ 25,117 Progress ------------ ------------ ----------- ------------- Other, net $ 5,747 $ (3,171) $ (250) $ (12,645) ============ ============ =========== ============= (a) 2003 includes reduction of approximately $6 million in the FPC contractual environmental liability as discussed in Note 14. Net energy brokered for resale gain (loss) represents electricity purchased for simultaneous sale to a third party. Nonregulated energy and delivery services include power protection services and mass market programs (surge protection, appliance services and area light sales) and delivery, transmission and substation work for other utilities. 14. COMMITMENTS AND CONTINGENCIES Contingencies and significant changes to the commitments discussed in Note 22 of the financial statements included in the Company's 2002 Annual Report on Form 10-K are described below. A. Guarantees As a part of normal business, Florida Progress and certain subsidiaries including PEF enter into various agreements providing financial or performance assessments to third parties. Such agreements include guarantees, standby 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 commercial purposes. 21 Guarantees as of September 30, 2003, are summarized in the table below and discussed more fully in the subsequent paragraphs: (in millions) Guarantees issued on behalf of the Company and affiliates Standby letters of credit $ 35.3 Surety bonds 47.3 Other guarantees 30.6 Guarantees issued on behalf of third parties Other guarantees 16.4 ---------------- Total $ 129.6 ================ Standby Letters of Credit The Company has issued standby letters of credit to financial institutions for the benefit of third parties that have extended credit to the Company and certain subsidiaries. Of the total standby letters of credit issued, PEF has issued commitments totaling $11.1 million. Letters of credit have decreased approximately $7.2 million over the first nine months of the year. These letters of credit have been issued primarily for the purpose of supporting payments of trade payables, securing performance under contracts and lease obligations and self insurance for workers compensation. If a subsidiary does not pay amounts when due under a covered contract, the counterparty may present its claim for payment to the financial institution, which will in turn request payment from the Company. Any amounts owed by the Company's subsidiaries are reflected in the accompanying Consolidated Balance Sheets. Surety Bonds At September 30, 2003, the Company had $47.3 million in surety bonds, of which PEF accounted for $4.2 million, purchased primarily for purposes such as providing workers compensation coverage and obtaining licenses, permits and rights-of-way. To the extent liabilities are incurred as a result of the activities covered by the surety bonds, such liabilities are included in the accompanying Consolidated Balance Sheets. Other Guarantees The Company has total other guarantees outstanding of approximately $47.0 million related primarily to prompt performance payments, lease obligations and other payments subject to contingencies. Approximately $25.5 million in additional guarantees were issued during 2003. Guarantees Issued by Progress Energy Progress Energy has issued approximately $7.5 million of financial guarantees on behalf of Progress Rail Services Corporation for obligations related to the purchase and sale of railcar parts, equipment and services which are not included in the table above. In addition, Progress Energy has issued approximately $26.5 million of guarantees on behalf of Progress Fuels and its subsidiaries for obligations under coal trading operations. All of these guarantees were issued during 2003. As of September 30, 2003, management does not believe conditions are likely for performance under these agreements. B. Insurance PEF is insured against public liability for a nuclear incident. Under the current provisions of the Price Anderson Act, which limits liability for accidents at nuclear power plants, PEF, as owner of a nuclear unit, can be assessed a portion of any third-party liability claims arising from an accident at any commercial nuclear power plant in the United States. In the event that public liability claims from an insured nuclear incident exceed $300 million (currently available through commercial insurers), each company would be subject to pro rata assessments for each reactor owned per occurrence. Effective August 20, 2003, the retroactive premium assessments increased to $100.6 million per reactor from the previous amount of $88.1 million. The total limit available to cover nuclear liability losses increased as well from $9.6 billion to $10.8 billion. The annual retroactive premium limit of $10 million per reactor owned did not change. C. Claims and Uncertainties The Company is subject to federal, state and local regulations addressing hazardous and solid waste management, air and water quality and other environmental matters. 22 Hazardous and Solid Waste Management Various organic materials associated with the production of manufactured gas, generally referred to as coal tar, are regulated under federal and state laws. The principal regulatory agency that is responsible for a specific former manufactured gas plant (MGP) site depends largely upon the state in which the site is located. There are several MGP sites to which the Company has some connection. In this regard, PEF and other potentially responsible parties, are participating in investigating and, if necessary, remediating former MGP sites with several regulatory agencies, including, but not limited to, the U.S. Environmental Protection Agency (EPA) and the Florida Department of Environmental Protection (FDEP). In addition, PEF is periodically notified by regulators such as the EPA and various state agencies of their involvement or potential involvement in sites, other than MGP sites, that may require investigation and/or remediation. PEF As of September 30, 2003, PEF has accrued $23.6 million for probable and estimable costs related to various environmental sites. Of this accrual, $16.6 million is for costs associated with the investigation and remediation of transmission and distribution substations and transformers which are more fully discussed below. The remaining $7.0 million is related to two former MGP sites and 10 other active sites associated with PEF that have required or are anticipated to require investigation and/or remediation costs. PEF does not believe that it can provide an estimate of the reasonably possible total remediation costs beyond what is currently accrued. In 2002, PEF accrued approximately $3.4 million for investigation and remediation costs associated with transmission and distribution substations and transformers and received approval from the FPSC for annual recovery of these environmental costs through the Environmental Cost Recovery Clause (ECRC). In September 2003, PEF also accrued an additional $15.1 million for similar environmental costs as a result of increased sites and estimated costs per site. PEF plans to seek approval from the FPSC to recover these costs through the ECRC. As more activity occurs at these sites, PEF will assess the need to adjust the accruals. These accruals have been recorded on an undiscounted basis. PEF measures its liability for these sites based on available evidence including its experience in investigating and remediating environmentally impaired sites. This process often includes assessing and developing cost-sharing arrangements with other potentially responsible parties. Presently, PEF cannot determine the total costs that may be incurred in connection with the remediation of all sites. Florida Progress In 2001, Progress Fuels sold its Inland Marine Transportation business to AEP Resources, Inc. Progress Fuels established an accrual to address indemnities and retained environmental liability associated with the transaction. Progress Fuels estimates that its contractual liability to AEP Resources, Inc. associated with Inland Marine Transportation is $3.5 million at September 30, 2003 and has accrued such amount. The previous accrual of $9.9 million was reduced based on a change in estimate. This accrual has been determined on an undiscounted basis. Progress Fuels measures its liability for this site based on estimable and probable remediation scenarios. The Company believes that it is not reasonably probable that additional costs will be incurred related to the environmental indemnification provision beyond the amount accrued. The Company cannot predict the outcome of this matter. PEF has filed claims with the Company's general liability insurance carriers to recover costs arising out of actual or potential environmental liabilities. Some claims have been settled and others are still pending. The Company cannot predict the outcome of this matter. Certain historical waste sites exist that are being addressed voluntarily by the Fuels segment. The Company cannot determine the total costs that may be incurred in connection with these sites. The Company cannot predict the outcome of this matter. Rail Services is voluntarily addressing certain historical waste sites. The Company cannot determine the total costs that may be incurred in connection with these sites. The Company cannot predict the outcome of this matter. The Company is also currently in the process of assessing potential costs and exposures at other environmentally impaired sites. As the assessments are developed and analyzed, the Company will accrue costs for the sites to the extent the costs are probable and can be reasonably estimated. 23 Air Quality There has been and may be further proposed federal legislation requiring reductions in air emissions for nitrogen oxides, sulfur dioxide, carbon dioxide and mercury. Some of these proposals establish nationwide caps and emission rates over an extended period of time. This national multi-pollutant approach to air pollution control could involve significant capital costs which could be material to the Company's consolidated financial position or results of operations. Some companies may seek recovery of the related cost through rate adjustments or similar mechanisms. However, the Company cannot predict the outcome of this matter. The EPA is conducting an enforcement initiative related to a number of coal-fired utility power plants in an effort to determine whether modifications at those facilities were subject to New Source Review requirements or New Source Performance Standards under the Clean Air Act. PEF was asked to provide information to the EPA as part of this initiative and cooperated in providing the requested information. During the first quarter of 2003, PEF received a supplemental information request from the EPA and responded to it in the second quarter. The EPA initiated civil enforcement actions against other unaffiliated utilities as part of this initiative. Some of these actions resulted in settlement agreements calling for expenditures ranging from $1.0 billion to $1.4 billion. A utility that was not subject to a civil enforcement action settled its New Source Review issues with the EPA for $300 million. These settlement agreements have generally called for expenditures to be made over extended time periods, and some of the companies may seek recovery of the related cost through rate adjustments or similar mechanisms. The Company cannot predict the outcome of the EPA's initiative or its impact, if any, on the Company. Other Environmental Matters The Kyoto Protocol was adopted in 1997 by the United Nations to address global climate change by reducing emissions of carbon dioxide and other greenhouse gases. The United States has not adopted the Kyoto Protocol; however, a number of carbon dioxide emissions control proposals have been advanced in Congress and by the Bush Administration. The Bush Administration favors voluntary programs. Reductions in carbon dioxide emissions to the levels specified by the Kyoto Protocol and some legislative proposals could be materially adverse to the Company's financials and operations if associated costs cannot be recovered from customers. The Company favors the voluntary program approach recommended by the administration, and is evaluating options for the reduction, avoidance and sequestration of greenhouse gases. However, the Company cannot predict the outcome of this matter. In 1997, the EPA's Mercury Study Report and Utility Report to Congress conveyed that mercury is not a risk to the average American and expressed uncertainty about whether reductions in mercury emissions from coal-fired power plants would reduce human exposure. Nevertheless, the EPA determined in 2000 that regulation of mercury emissions from coal-fired power plants was appropriate. Pursuant to a Court Order, the EPA is developing a Maximum Available Control Technology (MACT) standard, which is expected to become final in December 2004, with compliance in 2008. Achieving compliance with the MACT standard could be materially adverse to the Company's financial condition and results of operations. However, the Company cannot predict the outcome of this matter. Other Contingencies 1) Franchise Litigation Four cities, with a total of approximately 31,000 customers, have litigation pending against PEF in various circuit courts in Florida. As discussed below, three other cities, with a total of approximately 30,000 customers, have subsequently settled their lawsuits with PEF and signed new, 30-year franchise agreements. The lawsuits principally seek (1) a declaratory judgment that the cities have the right to purchase PEF's electric distribution system located within the municipal boundaries of the cities, (2) a declaratory judgment that the value of the distribution system must be determined through arbitration, and (3) injunctive relief requiring PEF to continue to collect from PEF's customers and remit to the cities, franchise fees during the pending litigation, and as long as PEF continues to occupy the cities' rights-of-way to provide electric service, notwithstanding the expiration of the franchise ordinances under which PEF had agreed to collect such fees. Five circuit courts have entered orders requiring arbitration to establish the purchase price of PEF's electric distribution system within five cities. Two appellate courts have upheld those circuit court decisions and authorized cities to determine the value of PEF's electric distribution system within the cities through arbitration. Arbitration in one of the cases (the City of Casselberry) was held in August 2002. Following arbitration, the parties entered settlement discussions, and on July 28, 2003 the City approved a settlement agreement and a new, 30-year franchise agreement with PEF. The settlement resolves all pending litigation with that City. A second arbitration (with the 24 13,000-customer City of Winter Park) was completed in February 2003. That arbitration panel issued an award on May 29, 2003 setting the value of PEF's distribution system within the City of Winter Park at approximately $31.5 million, not including separation and reintegration and construction work in progress, which could add several million dollars to the award. The panel also awarded PEF approximately $10.7 million in stranded costs. On September 9, 2003, Winter Park voters passed a referendum that would authorize the City to issue bonds of up to approximately $50 million to acquire PEF's electric distribution system. The City has not yet definitively decided whether it will acquire the system, but has indicated that it will seek wholesale power supply bids and bids to operate and maintain the distribution system. At this time, whether and when there will be further proceedings regarding the City of Winter Park cannot be determined. A third arbitration (with the 2,500-customer Town of Belleair) was completed on June 16, 2003. On September 2, 2003, the arbitration panel issued an award in that case setting the value of the electric distribution system within the Town at approximately $6.3 million. The panel further required the Town to pay to PEF its requested $690,000 in separation and reintegration costs and $1.528 million in stranded costs. The Town has not yet decided whether it will attempt to acquire the system. At this time, whether and when there will be further proceedings regarding the Town of Belleair cannot be determined. A fourth arbitration (with the 13,000-customer City of Apopka) has been scheduled for January 2004. Arbitration in the remaining city's litigation (the 1,500-customer City of Edgewood) has not yet been scheduled. As part of the above litigation, two appellate courts have also reached opposite conclusions regarding whether PEF must continue to collect from its customers and remit to the cities "franchise fees" under the expired franchise ordinances. PEF has filed an appeal with the Florida Supreme Court to resolve the conflict between the two appellate courts. The Florida Supreme Court held oral argument in one of the appeals on August 27, 2003. Subsequently, the Court requested briefing from the parties in the other appeal. Briefing likely will be completed in the second appeal in early November. PEF cannot predict the outcome of these matters at this time. 2) DOE Litigation As required under the Nuclear Waste Policy Act of 1982, PEF entered into a contract with the U.S. Department of Energy (DOE) under which the DOE agreed to begin taking spent nuclear fuel by no later than January 31, 1998. All similarly situated utilities were required to sign the same standard contract. In April 1995, the DOE issued a final interpretation that it did not have an unconditional obligation to take spent nuclear fuel by January 31, 1998. In Indiana & Michigan Power v. DOE, the Court of Appeals vacated the DOE's final interpretation and ruled that the DOE had an unconditional obligation to begin taking spent nuclear fuel. The Court did not specify a remedy because the DOE was not yet in default. After the DOE failed to comply with the decision in Indiana & Michigan Power v. DOE, a group of utilities petitioned the Court of Appeals in Northern States Power (NSP) v. DOE, seeking an order requiring the DOE to begin taking spent nuclear fuel by January 31, 1998. The DOE took the position that its delay was unavoidable, and the DOE was excused from performance under the terms and conditions of the contract. The Court of Appeals did not order the DOE to begin taking spent nuclear fuel, stating that the utilities had a potentially adequate remedy by filing a claim for damages under the contract. After the DOE failed to begin taking spent nuclear fuel by January 31, 1998, a group of utilities filed a motion with the Court of Appeals to enforce the mandate in NSP v. DOE. Specifically, this group of utilities asked the Court to permit the utilities to escrow their waste fee payments, to order the DOE not to use the waste fund to pay damages to the utilities, and to order the DOE to establish a schedule for disposal of spent nuclear fuel. The Court denied this motion based primarily on the grounds that a review of the matter was premature, and that some of the requested remedies fell outside of the mandate in NSP v. DOE. Subsequently, a number of utilities each filed an action for damages in the Federal Court of Claims. The U.S. Circuit Court of Appeals (Federal Circuit) has ruled that utilities may sue the DOE for damages in the Federal Court of Claims instead of having to file an administrative claim with DOE. PEF is in the process of evaluating whether it should file a similar action for damages. On July 9, 2002, Congress passed an override resolution to Nevada's veto of DOE's proposal to locate a permanent underground nuclear waste storage facility at Yucca Mountain, Nevada. DOE plans to submit a license application for the Yucca Mountain facility by the end of 2004. PEF cannot predict the outcome of this matter. PEF is currently storing spent nuclear fuel onsite in spent fuel pools. If PEF does not seek renewal of the Crystal River Nuclear Plant (CR3) operating license, CR3 will have sufficient storage capacity in place for fuel consumed through the end of the expiration of the license in 2016. If PEF extends the CR3 operating license, dry storage may be necessary. 25 3) Easement Litigation In December 1998, PEF was served with a class action lawsuit seeking damages, declaratory and injunctive relief for the alleged improper use of electric transmission easements. The plaintiffs contend that the licensing of fiber-optic telecommunications lines to third parties or telecommunications companies for other than PEF's internal use along the electric transmission line right-of-way exceeds the authority granted in the easements. In 1999, plaintiffs amended their complaint to add Progress Telecom as a defendant and adding counts for unjust enrichment and constructive trust. In January 2000, the trial court conditionally certified the class statewide. In mediation held in March 2000, the parties reached a tentative settlement of this claim. In January 2001, the trial court preliminarily approved the amended settlement agreement, certified the settlement class and approved the class notice. In November 2001, the trial court issued a final order approving the settlement. Several objectors to the settlement appealed the order to the First District Court of Appeal. On February 12, 2003, the appellate court issued an opinion upholding the trial court's subject matter jurisdiction over the case, but reversing the trial court's order approving the mandatory settlement class for purposes of declaratory and injunctive relief. The appellate court remanded the case to the trial court for further proceedings. The Company filed a motion to seek discretionary review before the Florida Supreme Court. Other parties filed similar motions as well as motions for rehearing before the First District Court of Appeal. Subsequent to filing these motions, the Company and the appellants reached a settlement resolving the appellants' dispute. The settlement was contingent upon the trial court approving a mandatory class settlement consistent with the First District Court of Appeal's February 12, 2003 opinion. On May 29, 2003 the trial court entered an Amended Final Judgment again approving the mandatory class settlement, consistent with the First District Court of Appeals' February 12, 2003 opinion. No appeals have been taken from that judgment, and the time to appeal has expired. On July 1, 2003, PEF, the class representatives and the appellants filed a joint withdrawal of all pending motions with the First District Court of Appeal. The First District Court of Appeal acknowledged the withdrawal of all pending motions and issued a mandate on July 14, 2003. Under the terms of the mandatory class settlement, PEF made settlement payments to class members in August 2003. The settlement payments did not have a material adverse effect upon PEF's financial condition or results of operations. 4) Synthetic Fuel Tax Credits The Company, through its subsidiaries, produces a coal-based solid synthetic fuel. The production and sale of the synthetic fuel from these facilities qualifies for tax credits under Section 29 of the Internal Revenue Code (Section 29) if certain requirements are satisfied, including a requirement that the synthetic fuel differs significantly in chemical composition from the coal used to produce such synthetic fuel. Any synthetic fuel tax credit amounts not utilized are carried forward indefinitely. All of Progress Energy's synthetic fuel facilities have received private letter rulings (PLRs) from the Internal Revenue Service (IRS) with respect to their synthetic fuel operations. These tax credits are subject to review by the IRS, and if Progress Energy fails to prevail through the administrative or legal process, there could be a significant tax liability owed for previously taken Section 29 credits, with a significant impact on earnings and cash flows. Additionally, the ability to use tax credits currently being carried forward could be denied. Total Section 29 credits generated to date at FPC are approximately $699.8 million, of which $296.9 million have been used and $402.9 million are being carried forward as of September 30, 2003. The current Section 29 tax credit program expires at the end of 2007. One synthetic fuel entity, Colona Synfuel Limited Partnership, L.L.L.P. (Colona), from which the Company has been allocated approximately $280.4 million in tax credits to date, is being audited by the IRS. The audit of Colona was expected. The Company is audited regularly in the normal course of business, as are most similarly situated companies. In September 2002, all of the Company's majority-owned synthetic fuel entities, including Colona, were accepted into the IRS Prefiling Agreement (PFA) program. The PFA program allows taxpayers to voluntarily accelerate the IRS exam process in order to seek resolution of specific issues. Either the Company or the IRS can withdraw from the program at any time, and issues not resolved through the program may proceed to the next level of the IRS exam process. 26 In June 2003, the Company was informed that IRS field auditors had raised questions regarding the chemical change associated with coal-based synthetic fuel manufactured at its Colona facility and the testing process by which the chemical change is verified. (The questions arose in connection with the Company's participation in the PFA program.) The chemical change and the associated testing process were described as part of the PLR request for Colona. Based on that application, the IRS ruled in Colona's PLR that the synthetic fuel produced at Colona undergoes a significant chemical change and thus qualifies for tax credits under Section 29. In October 2003, the National Office of the IRS informed the Company that it had rejected the IRS field auditors' challenges regarding whether the synthetic fuel produced at the Company's Colona facility was the result of a significant chemical change. The National office had concluded that the experts, engaged by Colona who test the synthetic fuel for chemical change, use reasonable scientific methods to reach their conclusions. Accordingly, the National Office will not take any adverse action on the PLR that has been issued for the Colona facility. A written decision memorializing the National Office's conclusions should be available within the next two months. At that time, the IRS field auditors will have the right to ask for reconsideration of the National Office's decision. Although this ruling applies only to the Colona facility, the Company believes that the National Office's reasoning should be equally applicable to the other Progress Energy facilities, given that the Company applies essentially the same chemical process and uses the same independent laboratories to confirm chemical change in the synthetic fuel manufactured at each of its other facilities. However, the IRS has not yet formally informed the Company as to its position on the Company's other facilities. Although this is a significant event, the audits of the Colona facility and the Company's other facilities are not yet completed. Progress Energy continues to believe that it operates its facilities in conformity with its PLRs and Section 29. Accordingly, the Company has no current plans to alter its synthetic fuel production schedule as a result of these matters. In addition, the Company has retained an advisor to assist in selling an interest in one or more synthetic fuel entities. The Company is pursuing the sale of a portion of its synthetic fuel production capacity that is underutilized due to limits on the amount of credits that can be generated and utilized by the Company. The Company would expect to retain an ownership interest and to operate any sold facility for a management fee. The final outcome and timing of the Company's efforts to sell interests in synthetic fuel facilities is uncertain and while the Company cannot predict the outcome of this matter, the outcome is not expected to have a material effect on the consolidated financial position, cash flows or results of operations. 5) Other Legal Matters Florida Progress and PEF are involved in various other claims and legal actions arising in the ordinary course of business, some of which involve claims for substantial amounts. Where appropriate, accruals have been made in accordance with SFAS No. 5, "Accounting for Contingencies," to provide for such matters. Florida Progress and PEF believe the ultimate disposition of these matters will not have a material adverse effect upon either company's consolidated financial position, results of operation or liquidity. 16. SUBSEQUENT EVENT On November 3, 2003, Progress Telecom Corporation (PTC), Progress Telecommunications Corporation (PTC Communications), and Caronet, Inc. (Caronet), all of which are indirectly wholly-owned subsidiaries of Progress Energy, agreed to enter into a Contribution Agreement (Agreement) with EPIK Communications, Inc. (EPIK). EPIK is a wholly-owned subsidiary of Odyssey Telecorp, Inc. (Odyssey). The Company plans to account for this transaction as a business combination. Under terms of the Agreement, on November 4, 2003, PTC was converted into a limited liability company and renamed Progress Telecom, LLC (PTC LLC). The Agreement provides that PTC Communications, Caronet and EPIK will contribute substantially all of their assets and transfer certain liabilities to PTC LLC in exchange for membership interests in PTC LLC. Following the contribution of their respective net assets, PTC Communications will hold a 55 percent membership interest in PTC LLC; Caronet will hold a 5 percent membership interest; and EPIK will hold a 40 percent membership interest. After the contribution of net assets to PTC LLC, the stock of Caronet will be sold to an affiliate of Odyssey for cash and Caronet will then become an indirect wholly-owned subsidiary of Odyssey. Following consummation of the transactions described above, PTC Communications will hold a 55 percent ownership interest in PTC LLC, and Odyssey will hold a 45 percent ownership interest in PTC LLC through EPIK and Caronet. The Company anticipates closing the transaction by the end of the year; however, the closing of all of these transactions is subject to certain conditions precedent, including receipt of applicable governmental and regulatory permits and approvals. 27 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following Management's Discussion and Analysis contains forward-looking statements that involve estimates, projections, goals, forecasts, assumptions, risks and uncertainties that could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements. Please review "SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS" for a discussion of the factors that may impact any such forward-looking statements made herein. Amounts reported in the interim Consolidated Statements of Income for Florida Progress Corporation (Florida Progress) and the interim Statements of Income for Progress Energy Florida, Inc. (PEF) are not necessarily indicative of amounts expected for the respective annual or future periods due to the effects of seasonal temperature variations on energy consumption and the timing of maintenance on electric generating units, among other factors. This discussion should be read in conjunction with the accompanying financial statements found elsewhere in this report and in conjunction with the 2002 Form 10-K. OPERATING RESULTS Florida Progress' segment profit, which is equivalent to income from continuing operations, for the three months ended September 30, 2003 and 2002 was $175.0 million and a loss of $57.0 million, respectively. Segment profits for the nine months ended September 30, 2003 and 2002 was $365.7 million and $109.1 million, respectively. The Company's segments contributed segment profits or losses for the three and nine months ended September 30, 2003 and 2002 as follows: - -------------------------------------------------------------------------------------------------------- (in millions) Three Months Ended September 30, Nine Months Ended September 30, - -------------------------------------------------------------------------------------------------------- Business Segment 2003 2002 2003 2002 - -------------------------------------------------------------------------------------------------------- PEF $ 114.3 $ 123.8 $ 246.5 $ 258.3 Fuels 59.7 30.2 111.5 93.2 Rail 0.7 (0.6) (.5) 1.7 Other 0.3 (210.4) 8.2 (244.1) ------- ------- ------- ------- Segment profit/(loss) $ 175.0 $ (57.0) $ 365.7 $ 109.1 - -------------------------------------------------------------------------------------------------------- PROGRESS ENERGY FLORIDA PEF contributed segment profits of $114.3 million and $123.8 million in the three months ended September 30, 2003 and 2002, respectively, and $246.5 million and $258.3 million in the nine months ended September 30, 2003 and 2002, respectively. The decrease in profits for the three months ended September 30, 2003 when compared to 2002 is primarily due to increased pension expense and an unfavorable impact of the tax benefit reallocation from Corporate, partially offset by favorable interest charges. Weather had a slight negative impact, but was offset by customer growth and usage. The decrease in profits when comparing the nine month periods results primarily from the net impact of the 2002 rate settlement and higher pension expense, partially offset by a slightly favorable weather impact, improved customer growth and usage and favorable interest charges. In March 2002, PEF settled a rate case which provided for a one-time retroactive rate refund, decreased future retail rates by 9.25% (effective May 1, 2002), provided for lower depreciation and amortization, provided for increases in certain service revenue rates and provided for revenue sharing with the retail customers if certain revenue thresholds were met. The impacts of the settlement agreement are included below. 29 PEF's electric revenues for the three and nine months ended September 30, 2003 and 2002 and the amount and percentage change by customer class are as follows: - --------------------------------------------------------------------------------------------------------------------- Three Months Ended September 30, Nine Months Ended September 30, (in millions of $) - ------------------------------------------------------------------------------------------------------------------ 2003 Change % Change 2002 2003 Change % Change 2002 Customer Class - ------------------------------------------------------------------------------------------------------------------ Residential $ 501.8 $32.0 6.8% $469.8 $ 1,300.3 $55.6 4.5% $ 1,244.7 Commercial 214.3 14.8 7.4% 199.5 556.7 7.0 1.3% 549.7 Industrial 56.9 4.3 8.2% 52.6 160.4 2.7 1.7% 157.7 Governmental 49.3 4.2 9.3% 45.1 133.1 4.6 3.6% 128.5 Retroactive rate refund - - - - - 35.0 - (35.0) Revenue sharing/rate refund 4.1 4.1 - - (23.9) (23.9) - - ---------------------- ------------------------------- ---------- Total retail revenues 826.4 59.4 7.7% 767.0 2,126.6 81.0 4.0% 2,045.6 Wholesale 51.8 (6.1) (10.5%) 57.9 172.9 6.8 4.1% 166.1 Unbilled (3.9) (12.3) - 8.4 2.7 (17.5) - 20.2 Miscellaneous 29.8 (0.5) (1.7%) 30.3 96.9 12.8 15.2% 84.1 ---------------------- ------------------------------- ---------- Total electric revenues $904.1 $40.5 4.7% $863.6 $ 2,399.1 $83.1 3.6% $ 2,316.0 - ------------------------------------------------------------------------------------------------------------------ PEF's electric energy sales for the three and nine ended September 30, 2003 and 2002 and the amount and percentage change by customer class are as follows: - ------------------------------------------------------------------------------------------------------------------ Three Months Ended September 30, Nine Months Ended September 30, (in thousands of mWh) - ------------------------------------------------------------------------------------------------------------------ 2003 Change % Change 2002 2003 Change % Change 2002 Customer Class - ------------------------------------------------------------------------------------------------------------------ Residential 5,739 236 4.3% 5,503 14,996 918 6.5% 14,078 Commercial 3,334 127 4.0% 3,207 8,727 208 2.4% 8,519 Industrial 1,028 45 4.6% 983 2,951 92 3.2% 2,859 Governmental 805 46 6.1% 759 2,204 109 5.2% 2,095 ---------------------- ------------------------------- ---------- Total retail energy 10,906 454 4.3% 10,452 28,878 1,327 4.8% 27,551 sales Wholesale 1,006 (14) (1.4%) 1,020 3,172 196 6.6% 2,976 Unbilled (112) (326) - 214 441 (248) - 689 ---------------------- ------------------------------- ---------- Total mWh sales 11,800 114 1.0% 11,686 32,491 1,275 4.1% 31,216 - ------------------------------------------------------------------------------------------------------------------ Three months ended September 30, 2003 compared to three months ended September 30, 2002 Retail revenues, excluding fuel revenues of $370.0 million and $332.1 million for the three months ended September 30, 2003 and 2002, respectively, increased $21.5 million as a result of favorable customer growth, partially offset by lower customer usage. Fuel revenues, which are offset by fuel expenses and thus have no earnings impact, increased compared to the prior year primarily due to increased generation and higher fuel prices. Operations and maintenance (O&M) costs increased $16.7 million, when compared to the $146.8 million incurred during the three months ended September 30, 2002. This increase is primarily related to increased pension expense and other benefit costs. Depreciation and amortization increased $8.7 million when compared to the $73.4 million incurred during the three months ended September 30, 2002 primarily due to additional depreciable assets placed in service. Interest charges decreased $17.7 million when compared to $25.8 million incurred in the three months ended September 2002 primarily due to the reversal of a regulatory liability for accrued interest related to previously resolved tax matters. Income tax expense increased $6.2 million when compared to $56.0 million incurred during three months ended September 30, 2002 primarily from the $10.1 million lower tax benefit reallocation, in accordance with an SEC order, partially offset by lower pretax income. 29 Nine months ended September 30, 2003 compared to nine months ended September 30, 2002 Retail revenues, excluding fuel revenues of $1,123.7 million and $1,046.0 million for the nine months ending September 30, 2003 and 2002, respectively, increased primarily due to the impact of the $35.0 million retroactive rate refund that was recognized in 2002 as part of the settlement agreement, continued customer growth and usage and favorable weather. Partially offsetting these gains were the impact of the 9.25% rate reduction, the 2002 revenue sharing refund which was resolved in 2003, and the 2003 revenue sharing accrual, all of which are discussed previously. The average number of customers for the nine months ended September 30, 2003 increased by approximately 35,200 or 2.4% in 2003 as compared to the same period in 2002. O&M costs increased $24.8 million when compared to the $433.4 million incurred during the nine months ended September 30, 2002 primarily due to increased pension expenses and other benefit costs. Depreciation and amortization increased $23.0 million when compared to the $218.0 million incurred during the nine months ended September 30, 2002 primarily due to increased assets placed into service, which accounted for $12.1 million of the increase, and the amortization of a purchased power contract. This purchased power was completely amortized as of September 30, 2003. The amortization of the purchased power contract is recovered through a cost recovery clause and therefore has no impact on earnings. Interest charges decreased $19.6 million when compared to the $82.1 million incurred during the nine months ended September 30, 2002 primarily due to the reversal of a regulatory liability for accrued interest related to previously resolved tax matters. Income tax expense decreased $7.9 million when compared to the $135.0 million incurred during the nine months ended September 30, 2002. Fluctuations in income tax expense result from the tax benefit reallocation and lower pretax income. FUELS The Fuels segment, which includes coal and synthetic fuel operations, natural gas operations and other fuel related operations, earned segment profits of $59.7 million and $30.2 million in the three months ended September 30, 2003 and 2002, respectively, and $111.5 million and $93.2 million for the nine months ended September 30, 2003 and 2002, respectively. The increase in earnings was due primarily to increased gas production and a favorable synthetic fuels tax credit true up from 2002. The Fuels segment produced 1.8 million and 1.7 million tons of synthetic fuel in the three months ended September 30, 2003 and 2002, respectively, that resulted in tax credits of $57.5 million and $44.8 million, respectively. Synthetic fuel production in the nine months ended September 30, 2003 and 2002 was 4.4 million tons and 5.3 million tons, respectively, which generated tax credits of $126.6 million and $144.5 million, respectively. These tax credits more than offset the pre-tax credit operating losses of the synthetic fuels operations. In late June 2003, the IRS announced that field auditors hae raised questions associated with synthetic fuel manufactured at the Colona facility regarding the scientific validity of test procedures and results used to verify a significant chemical change, which is a requirement of the synthetic fuel program. The impact of this review on the Company's synthetic fuel tax credits previously taken or expected to be taken in the future cannot be predicted at this time (See Synthetic Fuel Tax Credits section of Note 14). Gas operations generated profits of $11.1 million and $2.5 million in the three and nine months ended September 30, 2003, respectively, and of $25.8 million and $3.7 million in the three and nine months ended September 30, 2003, respectively. The increase in production resulting from the acquisitions of Westchester Gas in 2002 and North Texas Gas in the first quarter of 2003 drove increased revenue and earnings. The Mesa operations were sold effective October 1, 2003. The following summarizes the gas production and revenues for the three and nine months ended September 30, 2003 and 2002 by production facility. - ---------------------------------------------------------------------------------------------------- Gas Production Three Months Ended September 30, Nine Months Ended September 30, - ---------------------------------------------------------------------------------------------------- (in millions of cubic feet) 2003 2002 2003 2002 - ---------------------------------------------------------------------------------------------------- Mesa 1.3 1.6 4.4 4.2 Westchester Gas 3.3 1.9 9.1 2.4 North Texas Gas 3.0 - 4.6 - ------------------------------------------------------------------ Total gas production 7.6 3.5 18.1 6.6 - ---------------------------------------------------------------------------------------------------- 30 - ----------------------------------------------------------------------------------------------------- Gas Sales Three Months Ended September 30, Nine Months Ended September 30, - ----------------------------------------------------------------------------------------------------- (in millions) 2003 2002 2003 2002 - ----------------------------------------------------------------------------------------------------- Mesa $ 4.0 $ 3.7 $ 12.8 $ 10.3 Westchester Gas 16.4 5.8 45.0 7.4 North Texas Gas 14.0 - 24.4 - Other 1.8 1.6 4.4 2.4 -------------------------------------------------------------------- Total gas sales $ 36.2 $ 11.1 $ 86.6 $ 20.1 - ----------------------------------------------------------------------------------------------------- Coal fuel operations and other operations within the Fuels segment have immaterial impacts on comparative earnings. RAIL Rail's operations include railcar and locomotive repair, trackwork, rail parts reconditioning and sales, scrap metal recycling, railcar leasing and other rail related services. The Company intends to sell the assets of Railcar Ltd., a leasing subsidiary, in 2003 and has classified these assets as assets held for sale at September 30, 2003. See Note 3B. Progress Rail contributed segment profit of $0.7 million for both the three months ended September 30, 2003 and 2002, respectively, and a segment loss of $0.5 million and segment profit of $3.0 million for the for the nine months ended September 30, 2003 and 2002, respectively. As a result of an SEC order, Rail incurred additional Service Company allocations the three and nine months ended September 30, 2003, respectively, when compared to the same periods in 2002. These increased costs were partially offset by improvements in the recycling business and reduced operating costs. An SEC order approving the merger of FPC required the Company to divest Rail by November 30, 2003. The Company is pursuing alternatives, but does not expect to find the right divestiture opportunity by that date. Therefore, the Company sought, and in October 2003, was granted approval of, a three year extension from the SEC. OTHER The Other group, which includes telecommunications, holding company and financing expenses, generated a profit of $0.3 million and a loss of $210.4 million for the three months ended September 30, 2003 and 2002, respectively, and a profit of $8.2 million and a loss of $244.0 million for the nine months ended September 30, 2003 and 2002, respectively. The improvement in the quarter is due primarily to the recognition of a $144.0 asset impairment and other charges in the telecommunications business in September 2002 and an intra-period income tax allocation adjustment which GAAP requires in order to apply a levelized effective tax rate to interim periods that is consistent with the estimated annual rate. The intra-period tax allocation, which will have no impact on total year net income, resulted in a tax benefit of $2.7 million and a tax expense of $60.2 million for the three months ended September 30, 2003 and 2002, respectively. The levelization resulted in a tax benefit of $17.6 million and tax expense of $82.0 million in the nine months ended September 30, 2003 and 2002, respectively. LIQUIDITY AND CAPITAL RESOURCES Statements of Cash Flows and Financing Activities Cash provided by operating activities increased $67.7 million for the nine months ended September 30, 2003, when compared to the nine months ended September 30, 2002. The increase in operating cash flow was due primarily to changes in working capital. Net cash used in investing activities increased $360.5 million for the nine months ended September 30, 2003, when compared to the nine months ended September 30, 2002. The increase is primarily due to construction expenditures associated with PEF's Hines II generating unit, nuclear fuel purchases and the acquisition of gas reserves by Progress Fuels (See Note 2). On February 21, 2003, PEF issued $425 million of First Mortgage Bonds, 4.80% Series Due March 1, 2013 and $225 million of First Mortgage Bonds, 5.90% Series, Due March 1, 2033. Proceeds from this issuance were used to repay the balance of its outstanding commercial paper, to refinance its secured and unsecured indebtedness, including $70 million of First Mortgage Bonds, 6.125% Series and to redeem on March 24, 2003, the $150 million aggregate outstanding balance of its 8% First Mortgage Bonds due 2022 at 103.75% of the principal amount of such bonds. 31 On April 1, 2003, PEF entered into a new $200 million 364-day credit agreement and a new $200 million three-year credit agreement, replacing its prior credit facilities (which had been a $90 million 364-day facility and a $200 million five-year facility). The new PEF credit facilities contain a defined maximum total debt to total capital ratio of 65%; as of September 30, 2003 the calculated ratio, as defined, was 51.3%. The new credit facilities also contain a requirement that the ratio of EBITDA, as defined in the facilities, to interest expense to be at least 3 to 1; as of September 30, 2003 the calculated ratio, as defined, was 8.1 to 1. On July 1, 2003, $110 million of PEF's First Mortgage Bonds, 6.0% Series and $35 million of medium-term notes, 6.62% Series, matured. On August 29, 2003, Standard & Poor's Ratings Services (S&P) announced that it was lowering its corporate credit rating on Progress Energy, PEF and Florida Progress to BBB from BBB+. The outlook of the Companies' ratings was changed from negative to stable. The Companies do not expect these changes to have a material impact on their respective access to capital or financial results. On October 31, 2003, PEF announced the redemption of $100 million of its First Mortgage Bonds, 7% Series, Due 2023 at 103.19% of the principal amount of such bonds. PEF intends to redeem the bonds on December 1, 2003, with commercial paper proceeds. The amount and timing of future sales of company securities will depend on market conditions, operating cash flow, asset sales and the specific needs of the Company. The Company may from time to time sell securities beyond the amount needed to meet capital requirements in order to allow for the early redemption of long-term debt, the redemption of preferred stock, the reduction of short-term debt or for other generation corporate purposes. Future Commitments As of September 30, 2003, both Florida Progress' and PEF's contractual cash obligations and other commercial commitments have not changed materially from what was reported in the 2002 Annual Report on Form 10-K. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information called for by ITEM 3 is omitted pursuant to Instruction H(2)(c) to Form 10-Q (Omission of Information by Certain Wholly Owned Subsidiaries). Item 4. CONTROLS AND PROCEDURES Florida Progress Corporation Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, Florida Progress carried out an evaluation, with the participation of Florida Progress' management, including Florida Progress' Chairman and Chief Executive Officer, and Chief Financial Officer, of the effectiveness of Florida Progress' disclosure controls and procedures (as defined under Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, Florida Progress' Chairman and Chief Executive Officer, and Chief Financial Officer concluded that Florida Progress' disclosure controls and procedures are effective in timely alerting them to material information relating to Florida Progress (including its consolidated subsidiaries) required to be included in Florida Progress' periodic SEC filings. There has been no change in Florida Progress' internal control over financial reporting during the quarter ended September 30, 2003 that has materially affected, or is reasonably likely to materially affect, Florida Progress' internal control over financial reporting. Progress Energy Florida, Inc. Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, PEF carried out an evaluation, with the participation of PEF's management, including PEF's Chairman and Chief Executive Officer, and Chief Financial Officer, of the effectiveness of PEF's disclosure controls and procedures (as defined under Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, PEF's Chairman and Chief Executive Officer, and Chief Financial Officer concluded that PEF's disclosure controls and procedures are effective in timely alerting them to material information relating to PEF (including its consolidated subsidiaries) required to be included in PEF's periodic SEC filings. There has been no change in PEF's internal control over financial reporting during the quarter ended September 30, 2003 that has materially affected, or is reasonably likely to materially affect, PEF's internal control over financial reporting. 32 PART II. OTHER INFORMATION Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: Exhibit Florida Progress Energy Number Description Progress Corporation Florida, Inc. ------ ----------- -------------------- ------------- 3(ii) Bylaws of Florida Progress Corporation, amended as of X September 19, 2003 31(a) Certifications pursuant to Section 302 of the X X Sarbanes-Oxley Action of 2002 - Chairman and Chief Executive Officer 31(b) Certifications pursuant to Section 302 of the X X Sarbanes-Oxley Action of 2002 - Executive Vice President and Chief Financial Officer 32(a) Certifications pursuant to Section 906 of the X X Sarbanes-Oxley Action of 2002 - Chairman and Chief Executive Officer 32(b) Certifications pursuant to Section 906 of the X X Sarbanes-Oxley Action of 2002 - Chief Financial Officer (b) Reports filed or furnished on Form 8-K since the beginning of the quarter: Florida Progress Corporation Financial Item Statements Reported Included Date of Event Date Filed or Furnished 9, 12 Yes July 23, 2003 July 23, 2003 5 No August 29, 2003 September 2, 2003 9, 12 Yes October 22, 2003 October 22, 2003 Florida Power Corporation d/b/a Progress Energy Florida, Inc. Financial Item Statements Reported Included Date of Event Date Filed or Furnished 9, 12 Yes July 23, 2003 July 23, 2003 5 No August 29, 2003 September 2, 2003 9, 12 Yes October 22, 2003 October 22, 2003 33 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FLORIDA PROGRESS CORPORATION FLORIDA POWER CORPORATION (Registrants) Date: November 12, 2003 By: /s/Peter M. Scott III --------------------- Peter M. Scott III Executive Vice President and Chief Financial Officer By: /s/Robert H. Bazemore, Jr. -------------------------- Robert H. Bazemore, Jr. Vice President and Controller Chief Accounting Officer