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 June 30, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
-------- --------
Exact name of registrants as specified in their charters, state
Commission of incorporation, address of principal executive offices, and I.R.S. Employer
File Number 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 -
Indicate the number of shares outstanding of each of the issuers' classes of
common stock, as of the latest practicable date. As of July 31, 2005, 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)
This combined Form 10-Q is filed separately by two registrants: Florida Progress
Corporation and Florida Power Corporation d/b/a Progress Energy Florida, Inc.
(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.
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 June 30, 2005
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 Florida Power Corporation d/b/a Progress
Energy Florida, Inc.
Item 1. Legal Proceedings
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 1. Legal Proceedings
Item 6. Exhibits
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 related to retail rate matters
APB Accounting Principles Board
ARO Asset retirement obligation
AST Advanced Separation Technology
Bcf Billion cubic feet
CAIR Clean Air Interstate Rule
CAMR Clean Air Mercury Rule
Calgon Calgon Carbon Corporation
CAMR Clean air mercury rule
the City The City of Winter Park, Florida
the Code Internal Revenue Code
Colona Colona Synfuel Limited Partnership, L.L.L.P.
the Company, Florida Progress or FPC Florida Progress Corporation
CR3 PEF's nuclear generating plant, Crystal River Unit No. 3
DOE United States Department of Energy
ECRC Environmental Cost Recovery Clause
EIA Energy Information Agency
EPA United States Environmental Protection Agency
FASB Financial Accounting Standards Board
FDEP Florida Department of Environmental Protection
FERC Federal Energy Regulatory Commission
FIN No. 45 Financial Accounting Standards Board (FASB) Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others"
FIN No. 46R FASB Interpretation No. 46, "Consolidation of Variable Interest
Entities - an Interpretation of ARB No. 51"
Financial Statements Florida Progress' Financial Statements and Progress Energy Florida's
Financial Statements
Florida Power or the Utility Florida Power Corporation d/b/a Progress Energy Florida, Inc.
FPSC Florida Public Service Commission
GAAP Accounting principles generally accepted in the United States of America
HLW High Level Waste
IRS Internal Revenue Service
MACT Maximum Achievable Control Technology
MGP Manufactured Gas Plant
MW Megawatts
NOx Nitrogen Oxide
NRC United States Nuclear Regulatory Commission
NYMEX New York Mercantile Exchange
NEIL Nuclear Electric Insurance Limited
OCI Other comprehensive income
OPEB Other postretirement benefits
PEF or the Utility Progress Energy Florida, Inc., formerly referred to as Florida Power Corporation
PESC Progress Energy Service Company
PFA IRS Prefiling Agreement
PLRs Private Letter Rulings
PRPs Potentially Responsible Parties
Progress Energy or the Parent Progress Energy, Inc.
Progress Fuels Progress Fuels Corporation, formerly Electric Fuels Corporation
Progress Rail Progress Rail Services Corporation
PTC Progress Telecommunications Corporation
PT LLC Progress Telecom LLC
3
PVI Progress Ventures, Inc., formerly referred to as Energy Ventures, a
business unit of Progress Energy
PUHCA Public Utility Holding Company Act of 1935, as amended
RBCA or Global RBCA Risk-based corrective action
Rail Rail Services
RCA Revolving credit agreement
SEC United States Securities and Exchange Commission
Section 29 Section 29 of the Internal Revenue Service Code
Service Company Progress Energy Service Company, LLC
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. 109 Statement of Financial Accounting Standards No. 109, "Accounting for
Income Taxes"
SFAS No. 123 Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation"
SFAS No. 133 Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative and Hedging Activities"
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"
SNF Spent Nuclear Fuel
SO2 Sulfur dioxide
the Trust FPC Capital I
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 "Results of
Operations" about trends and uncertainties and "Liquidity and Capital Resources"
concerning operating cash flows and future liquidity requirements.
Any forward-looking statement is based on information current as of the date of
this report and speaks only as of the date on which such statement is made, and
neither Florida Progress (the Company) nor Florida Power Corporation doing
business as Progress Energy Florida, Inc. (PEF) undertakes any 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; 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 GridFlorida or other regional transmission organizations; weather conditions
that directly influence the demand for electricity; the Company's timing of
recovery of the costs associated with the four hurricanes that impacted our
service territory in 2004 or the ability to recover through the regulatory
process other future significant weather events; recurring seasonal fluctuations
in demand for electricity; fluctuations in the price of energy commodities and
purchased power; economic fluctuations and the corresponding impact on the
Company and its subsidiaries' commercial and industrial customers; the ability
of the Company's subsidiaries to pay upstream dividends or distributions to it;
the impact on the facilities and the businesses of the Company from a terrorist
attack; the inherent risks associated with the operation of nuclear facilities,
including environmental, health, regulatory and financial risks; the ability to
successfully access capital markets on favorable terms; the ability of the
Company to maintain its current credit ratings and the impact of the Company's
financial condition and ability to meet its cash and other financial obligations
in the event its credit ratings are downgraded below investment grade; the
impact that increases in leverage and the affect it may have on the Company; the
impact of derivative contracts used in the normal course of business by the
Company; investment performance of pension and benefit plans; the Company's
ability to control costs, including pension and benefit expense, and achieve its
cost management targets for 2007; the availability and use of Internal Revenue
Code Section 29 (Section 29) tax credits by synthetic fuel producers and the
Company's continued ability to use Section 29 tax credits related to its
coal-based solid synthetic fuel businesses; the impact to the Company's
financial condition and performance in the event it is determined the Company is
not entitled to previously taken Section 29 tax credits; the impact of the
proposed accounting pronouncement regarding uncertain tax positions; the impact
that future crude oil prices may have on the value of the Company's Section 29
tax credits; the outcome of PEF's rate proceeding in 2005 regarding its future
base rates; the Company's ability to manage the risks involved with the
operation of its nonregulated plants, including dependence on third parties and
related counter-party risks, and a lack of operating history; the Company's
ability to manage the risks associated with its energy marketing operations; the
outcome of any ongoing or future litigation or similar disputes and the impact
of any such outcome or related settlements; and unanticipated changes in
operating expenses and capital expenditures. Many of these risks similarly
impact the Company's subsidiaries.
These and other risks are detailed from time to time in Florida Progress' and
PEF's filings with the United States Securities and Exchange Commission (SEC).
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, 2004 which was filed with the SEC
on March 16, 2005. You should carefully read this SEC report. 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
June 30, 2005
UNAUDITED CONSOLIDATED STATEMENTS of INCOME
Three Months Ended Six Months Ended
June 30 June 30
------------------------------------------------
(in millions) 2005 2004 2005 2004
- -----------------------------------------------------------------------------------------------------------
Operating revenues
Utility $ 908 $ 860 $ 1,756 $ 1,644
Diversified business 425 350 792 635
- -----------------------------------------------------------------------------------------------------------
Total operating revenues 1,333 1,210 2,548 2,279
- -----------------------------------------------------------------------------------------------------------
Operating expenses
Utility
Fuel used in electric generation 313 276 615 545
Purchased power 144 139 275 260
Operation and maintenance 288 152 477 312
Depreciation and amortization 71 72 141 141
Taxes other than on income 66 64 133 126
Diversified business
Cost of sales 394 301 727 564
Depreciation and amortization 24 21 47 41
Gain on the sale of assets - - (5) (1)
Other 20 21 48 41
- -----------------------------------------------------------------------------------------------------------
Total operating expenses 1,320 1,046 2,458 2,029
- -----------------------------------------------------------------------------------------------------------
Operating income 13 164 90 250
- -----------------------------------------------------------------------------------------------------------
Other income (expense)
Interest income 1 1 2 2
Other, net 18 (3) 17 (7)
- -----------------------------------------------------------------------------------------------------------
Total other income (expense) 19 (2) 19 (5)
- -----------------------------------------------------------------------------------------------------------
Interest charges
Interest charges 48 43 95 84
Allowance for borrowed funds used during construction (2) (1) (4) (2)
- -----------------------------------------------------------------------------------------------------------
Total interest charges, net 46 42 91 82
- -----------------------------------------------------------------------------------------------------------
(Loss) income from continuing operations before income
taxes and minority interest (14) 120 18 163
Income tax benefit 6 8 11 13
- -----------------------------------------------------------------------------------------------------------
(Loss) income from continuing operations before minority
interest, net of tax (8) 128 29 176
Minority interest in subsidiaries' loss, net of tax 9 1 17 -
- -----------------------------------------------------------------------------------------------------------
Income from continuing operations 1 129 46 176
Discontinued operations, net of tax (9) 6 (36) 14
- -----------------------------------------------------------------------------------------------------------
Net (loss) income $ (8) $ 135 $ 10 $ 190
- -----------------------------------------------------------------------------------------------------------
See Notes to Interim Financial Statements.
6
FLORIDA PROGRESS CORPORATION
UNAUDITED CONSOLIDATED BALANCE SHEETS
(in millions) June 30 December 31
ASSETS 2005 2004
- -------------------------------------------------------------------------------------------------------------
Utility plant
Utility plant in service $ 8,399 $ 8,387
Accumulated depreciation (3,357) (2,978)
- -------------------------------------------------------------------------------------------------------------
Utility plant in service, net 5,042 5,409
Held for future use 1 8
Construction work in progress 561 420
Nuclear fuel, net of amortization 67 45
- -------------------------------------------------------------------------------------------------------------
Total utility plant, net 5,671 5,882
- -------------------------------------------------------------------------------------------------------------
Current assets
Cash and cash equivalents 23 24
Receivables, net 537 476
Receivables from affiliated companies 72 40
Deferred income taxes 65 60
Inventory 367 341
Deferred fuel cost 93 89
Assets of discontinued operations - 590
Prepayments and other current assets 122 33
- -------------------------------------------------------------------------------------------------------------
Total current assets 1,279 1,653
- -------------------------------------------------------------------------------------------------------------
Deferred debits and other assets
Regulatory assets 439 524
Nuclear decommissioning trust funds 473 463
Diversified business property, net 653 576
Miscellaneous other property and investments 103 95
Other assets and deferred debits 514 492
- -------------------------------------------------------------------------------------------------------------
Total deferred debits and other assets 2,182 2,150
- -------------------------------------------------------------------------------------------------------------
Total assets $ 9,132 $ 9,685
- -------------------------------------------------------------------------------------------------------------
CAPITALIZATION AND LIABILITIES
- -------------------------------------------------------------------------------------------------------------
Common stock equity
Common stock without par value $ 1,726 $ 1,712
Retained earnings 986 976
Accumulated other comprehensive loss (19) (7)
- -------------------------------------------------------------------------------------------------------------
Total common stock equity 2,693 2,681
- -------------------------------------------------------------------------------------------------------------
Preferred stock of subsidiaries - not subject to mandatory redemption 34 34
Minority interest 36 32
Long-term debt, affiliate 440 809
Long-term debt, net 2,294 2,052
- -------------------------------------------------------------------------------------------------------------
Total capitalization 5,497 5,608
- -------------------------------------------------------------------------------------------------------------
Current liabilities
Current portion of long-term debt 48 49
Accounts payable 327 333
Payables to affiliated companies 73 71
Notes payable to affiliated companies 391 431
Short-term obligations 261 293
Customer deposits 141 135
Liabilities of discontinued operations - 152
Other current liabilities 394 406
- -------------------------------------------------------------------------------------------------------------
Total current liabilities 1,635 1,870
- -------------------------------------------------------------------------------------------------------------
Deferred credits and other liabilities
Noncurrent income tax liabilities 59 64
Accumulated deferred investment tax credits 33 36
Regulatory liabilities 1,128 1,362
Asset retirement obligations 278 358
Other liabilities and deferred credits 502 387
- -------------------------------------------------------------------------------------------------------------
Total deferred credits and other liabilities 2,000 2,207
- -------------------------------------------------------------------------------------------------------------
Commitments and contingencies (Note 14)
- -------------------------------------------------------------------------------------------------------------
Total capitalization and liabilities $ 9,132 $ 9,685
- -------------------------------------------------------------------------------------------------------------
See Notes to Interim Financial Statements.
7
FLORIDA PROGRESS CORPORATION
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
- -------------------------------------------------------------------------------------------------------------
(in millions)
- -------------------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2005 2004
- -------------------------------------------------------------------------------------------------------------
Operating activities
Net income $ 10 $ 190
Adjustments to reconcile net income to net cash provided by operating
activities:
Discontinued operations, net of tax 36 (14)
Charges for voluntary enhanced retirement program 93 -
Depreciation and amortization 205 196
Deferred income taxes and investment tax credits, net (99) (151)
Tax levelization 45 23
Deferred fuel cost 36 26
Other adjustments to net income 51 6
Cash provided/(used) by changes in operating assets and liabilities:
Receivables (43) (113)
Receivables from affiliated companies (16) (2)
Inventory (43) (27)
Prepayments and other current assets (26) (2)
Accounts payable 79 49
Payables to affiliated companies 2 51
Other current liabilities (60) 193
Regulatory assets and liabilities (54) 6
Other (13) 11
- -------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 203 442
- -------------------------------------------------------------------------------------------------------------
Investing activities
Utility property additions (253) (230)
Diversified business property additions (112) (85)
Nuclear fuel additions (34) -
Proceeds from sales of subsidiaries and other investments, net of cash
divested 435 84
Other (11) (13)
- -------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 25 (244)
- -------------------------------------------------------------------------------------------------------------
Financing activities
Issuance of long-term debt, net 297 1
Net (decrease) increase in short-term obligations (32) 231
Retirement of long-term debt (426) (26)
Net change in intercompany notes (57) (309)
Dividends paid to parent - (78)
Other 19 7
- -------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (199) (174)
- -------------------------------------------------------------------------------------------------------------
Cash used by discontinued operations:
Operating activities (26) (4)
Investing activities (4) (8)
Financing activities - -
Net (decrease) increase in cash and cash equivalents (1) 12
Cash and cash equivalents at beginning of period 24 15
- -------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 23 $ 27
- -------------------------------------------------------------------------------------------------------------
See Notes to Interim Financial Statements.
8
FLORIDA POWER CORPORATION
d/b/a PROGRESS ENERGY FLORIDA, INC.
INTERIM FINANCIAL STATEMENTS
June 30, 2005
UNAUDITED STATEMENTS of INCOME
Three Months Ended Six Months Ended
June 30 June 30
------------------------------------------------------
(in millions) 2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------------------------
Operating revenues $ 908 $ 860 $ 1,756 $ 1,644
Operating expenses
Fuel used in electric generation 313 276 615 545
Purchased power 144 139 275 260
Operation and maintenance 288 152 477 312
Depreciation and amortization 71 72 141 141
Taxes other than on income 66 64 133 126
- ---------------------------------------------------------------------------------------------------------------
Total operating expenses 882 703 1,641 1,384
- ---------------------------------------------------------------------------------------------------------------
Operating income 26 157 115 260
- ---------------------------------------------------------------------------------------------------------------
Other income (expense)
Other, net 24 - 27 (1)
- ---------------------------------------------------------------------------------------------------------------
Total other income (expense) 24 - 27 (1)
- ---------------------------------------------------------------------------------------------------------------
Interest charges
Interest charges 34 29 68 60
Allowance for borrowed funds used during construction (2) (1) (4) (2)
- ---------------------------------------------------------------------------------------------------------------
Total interest charges, net 32 28 64 58
- ---------------------------------------------------------------------------------------------------------------
Income before income taxes 18 129 78 201
Income tax expense 8 45 24 67
- ---------------------------------------------------------------------------------------------------------------
Net income $ 10 $ 84 $ 54 $ 134
Preferred stock dividend requirement - - 1 1
- ---------------------------------------------------------------------------------------------------------------
Earnings for common stock $ 10 $ 84 $ 53 $ 133
- ---------------------------------------------------------------------------------------------------------------
See Notes to Interim Financial Statements.
9
FLORIDA POWER CORPORATION
d/b/a PROGRESS ENERGY FLORIDA, INC.
UNAUDITED BALANCE SHEETS
- --------------------------------------------------------------------------------------------------
(in millions) June 30 December 31
ASSETS 2005 2004
- --------------------------------------------------------------------------------------------------
Utility plant
Utility plant in service $ 8,399 $ 8,387
Accumulated depreciation (3,357) (2,978)
- --------------------------------------------------------------------------------------------------
Utility plant in service, net 5,042 5,409
Held for future use 1 8
Construction work in progress 561 420
Nuclear fuel, net of amortization 67 45
- --------------------------------------------------------------------------------------------------
Total utility plant, net 5,671 5,882
- --------------------------------------------------------------------------------------------------
Current Assets
Cash and cash equivalents 10 12
Receivables, net 306 266
Receivables from affiliated companies 37 16
Deferred income taxes 48 42
Inventory 281 279
Deferred fuel cost 93 89
Prepayments and other current assets 96 12
- --------------------------------------------------------------------------------------------------
Total current assets 871 716
- --------------------------------------------------------------------------------------------------
Deferred debits and other assets
Regulatory assets 439 524
Nuclear decommissioning trust funds 473 463
Miscellaneous other property and investments 46 46
Prepaid pension costs 194 234
Other assets and deferred debits 48 59
- --------------------------------------------------------------------------------------------------
Total deferred debits and other assets 1,200 1,326
- --------------------------------------------------------------------------------------------------
Total assets $ 7,742 $ 7,924
- --------------------------------------------------------------------------------------------------
CAPITALIZATION AND LIABILITIES
- --------------------------------------------------------------------------------------------------
Common stock equity
Common stock without par value $ 1,096 $ 1,081
Retained earnings 1,293 1,240
- --------------------------------------------------------------------------------------------------
Total common stock equity 2,389 2,321
- --------------------------------------------------------------------------------------------------
Preferred stock - not subject to mandatory redemption 34 34
Long-term debt, net 2,152 1,912
- --------------------------------------------------------------------------------------------------
Total capitalization 4,575 4,267
- --------------------------------------------------------------------------------------------------
Current liabilities
Current portion of long-term debt 48 48
Accounts payable 212 262
Payables to affiliated companies 90 80
Notes payable to affiliated companies - 178
Short-term obligations 261 293
Customer deposits 141 135
Other current liabilities 193 161
- --------------------------------------------------------------------------------------------------
Total current liabilities 945 1,157
- --------------------------------------------------------------------------------------------------
Deferred credits and other liabilities
Noncurrent income tax liabilities 458 489
Accumulated deferred investment tax credits 33 35
Regulatory liabilities 1,128 1,362
Asset retirement obligations 256 337
Other liabilities and deferred credits 347 277
- --------------------------------------------------------------------------------------------------
Total deferred credits and other liabilities 2,222 2,500
- --------------------------------------------------------------------------------------------------
Commitments and contingencies (Note 14)
- --------------------------------------------------------------------------------------------------
Total capitalization and liabilities $ 7,742 $ 7,924
- --------------------------------------------------------------------------------------------------
See Notes to Interim Financial Statements.
10
FLORIDA POWER CORPORATION
d/b/a PROGRESS ENERGY FLORIDA, INC.
UNAUDITED STATEMENTS of CASH FLOWS
- -----------------------------------------------------------------------------------------------------------------
(in millions)
Six Months Ended June 30, 2005 2004
- ----------------------------------------------------------------------------------------------------------------
Operating activities
Net income $ 54 $ 134
Adjustments to reconcile net income to net cash provided by operating activities:
Charges for voluntary enhanced retirement program 90 -
Depreciation and amortization 158 155
Deferred income taxes and investment tax credits, net (55) 1
Deferred fuel cost 36 26
Other adjustments to net income 39 -
Cash provided/(used) by changes in operating assets and liabilities:
Receivables (42) (48)
Receivables from affiliated companies 5 1
Inventory (15) (11)
Prepayments and other current assets (24) 2
Accounts payable 32 33
Payables to affiliated companies 10 54
Other current liabilities 5 82
Regulatory assets and liabilities (54) 6
Other 5 7
- ----------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 244 442
- ----------------------------------------------------------------------------------------------------------------
Investing activities
Property additions (253) (230)
Nuclear fuel additions (34) -
Proceeds from sales of assets 42 -
Other (4) -
- ----------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (249) (230)
- ----------------------------------------------------------------------------------------------------------------
Financing activities
Issuance of long-term debt, net 297 1
Net (decrease) increase in short-term obligations (32) 231
Retirement of long-term debt (57) (1)
Net change in intercompany notes (204) (363)
Dividends paid to parent - (78)
Dividends paid on preferred stock (1) (1)
- ----------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 3 (211)
- ----------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (2) 1
- ----------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at beginning of period 12 10
- ----------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 10 $ 11
- --------------------------------------------------------------------------------------------------------------
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. BASIS OF PRESENTATION
A. 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 for annual statements,
they should be read in conjunction with the audited financial statements
and notes thereto included in Florida Progress' (the Company) and Progress
Energy Florida's (PEF) Form 10-K for the year ended December 31, 2004.
In accordance with the provisions of Accounting Principles Board (APB)
Opinion 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, maintains
an effective tax rate consistent with the estimated annual effective tax
rate. For the three months ended June 30, 2005 and 2004, the Company's
income tax expense was increased by $39 million and decreased by $11
million, respectively. For the six months ended June 30, 2005 and 2004, the
Company's income tax expense increased by $45 million and $23 million,
respectively. The income tax provisions for the Company differ from amounts
computed by applying the federal statutory tax rate to income before income
taxes, primarily due to the recognition of synthetic fuel tax credits.
PEF's income tax expense was increased by $8 million for the three and six
months ended June 30, 2005 in order to maintain an effective tax rate
consistent with the estimated annual rate.
PEF collects from customers certain excise taxes levied by the state or
local government upon the customer. PEF accounts for excise taxes on a
gross basis. For the three months ended June 30, 2005 and 2004, gross
receipts tax and franchise taxes of approximately $38 million and $37
million, respectively, are included in electric operating revenues and
taxes other than on income on the Statements of Income. For the six months
ended June 30, 2005 and 2004, gross receipts tax and franchise taxes of
approximately $73 million and $69 million, respectively, are included in
electric operating revenues and taxes other than as income on the
Statements of Income.
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 is 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 2004 have been made to
conform to the 2005 presentation.
B. Stock-Based Compensation
The Company and PEF measure compensation expense for stock options as the
difference between the market price of Progress Energy's common stock and
the exercise price of the option at the grant date. The exercise price at
which options are granted by Progress Energy 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" (SFAS No. 148), the
estimated fair value of the Company's and PEF's stock options is amortized
to expense over the options' vesting period. The following table
illustrates the effect on net income and earnings per share if the fair
value method had been applied to all outstanding and unvested awards in
each period:
12
Three Months Ended Six Months Ended
(in millions) June 30 June 30
--------------------------- -------------------------
FLORIDA PROGRESS CORPORATION 2005 2004 2005 2004
-------------- ----------- ------------- -----------
Net (loss) income, as reported $ (8) $ 135 $ 10 $ 190
Deduct: Total stock option expense determined under fair
value method for all awards, net of related tax effects - 1 1 2
-------------- ----------- ------------- -----------
Pro forma net (loss) income $ (8) $ 134 $ 9 $ 188
============== =========== ============= ===========
Three Months Ended Six Months Ended
(in millions) June 30 June 30
--------------------------- -------------------------
PROGRESS ENERGY FLORIDA, INC. 2005 2004 2005 2004
-------------- ----------- ------------- -----------
Net income, as reported $ 10 $ 84 $ 54 $ 134
Deduct: Total stock option expense determined under fair
value method for all awards, net of related tax effects - 1 1 2
-------------- ----------- ------------- -----------
Pro forma net income $ 10 $ 83 $ 53 $ 132
============== =========== ============= ===========
The Company and PEF expect to begin expensing stock options during the
third quarter of 2005 (See Note 2).
C. Consolidation of Variable Interest Entities
Florida Progress and PEF consolidate all voting interest entities in which
they own a majority voting interest and all variable interest entities for
which they are the primary beneficiary in accordance with FASB
Interpretation No. 46R, "Consolidation of Variable Interest Entities - an
Interpretation of ARB No. 51" (FIN No. 46R). A subsidiary of Florida
Progress is the primary beneficiary of and consolidates Colona Synfuel
Limited Partnership LLLP (Colona), a synthetic fuel production facility
that qualifies for federal tax credits under Section 29 of the Internal
Revenue Code. As of June 30, 2005, Colona's total assets were $30 million.
None of Florida Progress' consolidated assets are collateral for Colona's
obligations.
Florida Progress and PEF have interests in several variable interest
entities for which they are not the primary beneficiary. These arrangements
include investments in approximately five limited partnerships, limited
liability corporations and venture capital funds. The aggregate maximum
loss exposure at June 30, 2005, that Florida Progress could be required to
record in its consolidated income statement as a result of these
arrangements totals approximately $13 million. The aggregate maximum loss
exposure at June 30, 2005, that PEF could be required to record in its
income statement as a result of these arrangements totals approximately $6
million. The creditors of these variable interest entities do not have
recourse to the general credit of Florida Progress or PEF in excess of the
aggregate maximum loss exposure.
2. IMPACT OF NEW ACCOUNTING STANDARDS
FASB EXPOSURE DRAFT ON ACCOUNTING FOR UNCERTAIN TAX POSITIONS, AN
INTERPRETATION OF SFAS NO. 109, "ACCOUNTING FOR INCOME TAXES"
On July 14, 2005, the Financial Accounting Standards Board (FASB) issued an
exposure draft of a proposed interpretation of SFAS No. 109, "Accounting
for Income Taxes" (SFAS No. 109), that would address the accounting for
uncertain tax positions. The proposed interpretation would require that
uncertain tax benefits be probable of being sustained in order to record
such benefits in the consolidated financial statements. The Company
currently accounts for uncertain tax benefits in accordance with SFAS No.
5, "Accounting for Contingencies" (SFAS No. 5). Under SFAS No. 5,
contingent losses are recorded when it is probable that the tax position
will not be sustained and the amount of the disallowance can be reasonably
estimated. The exposure draft has a 60-day public comment period ending
September 12, 2005. As currently drafted, the proposed interpretation would
apply to all uncertain tax positions and be effective for the Company on
December 31, 2005.
As discussed in Note 14, the Internal Revenue Service (IRS) field auditors
have recommended that the Section 29 tax credits generated by the Company's
Earthco facilities, totaling $595 million through June 30, 2005, be
disallowed. The Company disagrees with the field audit team's findings and
has requested that the National Office of the IRS review this issue. The
Company has not yet determined how the proposed interpretation would impact
its various income tax positions, including the status of the Earthco tax
credits. Depending on the provisions of the FASB's final interpretation and
the Company's facts and circumstances that exist at the date of
13
implementation, including the Company's assessment of the probability of
sustaining any currently recorded and future tax benefits, the proposed
interpretation could have a material adverse impact on the Company's
financial position and results of operations.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123 (REVISED 2004),
"SHARE-BASED PAYMENT" (SFAS NO. 123R)
In December 2004, the FASB Issued SFAS No. 123R, which revises SFAS No.
123, "Accounting for Stock-Based Compensation" (SFAS No. 123) and
supersedes Accounting Principles Board (APB) Opinion No. 25, "Accounting
for Stock Issued to Employees." The key requirement of SFAS No. 123R is
that the cost of share-based awards to employees will be measured based on
an award's fair value at the grant date, with such cost to be amortized
over the appropriate service period. Previously, entities could elect to
continue accounting for such awards at their grant date intrinsic value
under APB Opinion No. 25, and the Company made that election. The intrinsic
value method resulted in the Company and PEF recording no compensation
expense for stock options granted to employees (See Note 1B).
As written, SFAS No. 123R had an original effective date of July 1, 2005
for the Company. In April 2005, the SEC delayed the effective date for
public companies, which resulted in a required effective date of January 1,
2006 for the Company. The SEC delayed the effective date due to concerns
that implementation in mid-year could make compliance more difficult and
make comparisons of quarterly reports more difficult. The Company is
planning to implement SFAS No. 123R during the third quarter of 2005,
effective as of July 1, 2005. The Company will implement the standard using
the required modified prospective method. Under that method, the Company
will record compensation expense under SFAS No. 123R for all awards it
grants after the effective date, and it will record compensation expense
(as previous awards continue to vest) for the unvested portion of
previously granted awards that remain outstanding at the effective date. In
2004, Progress Energy made the decision to cease granting stock options and
replaced that compensation with alternative forms of compensation.
Therefore, the amount of stock option expense expected to be recorded in
2005 is below the amount that would have been recorded if the stock option
program had continued. Assuming a July 1, 2005 effective date, the Company
and PEF expect to record less than $1 million of pre-tax expense for stock
options in 2005.
FASB INTERPRETATION NO. 47, "ACCOUNTING FOR CONDITIONAL ASSET RETIREMENT
OBLIGATIONS"
On March 30, 2005, the FASB issued Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations," an interpretation of SFAS No.
143, "Accounting for Asset Retirement Obligations." The interpretation
clarifies that a legal obligation to perform an asset retirement activity
that is conditional on a future event is within the scope of SFAS No. 143.
Accordingly, an entity is required to recognize a liability for the fair
value of an asset retirement obligation that is conditional on a future
event if the liability's fair value can be reasonably estimated. The
interpretation also provides additional guidance for evaluating whether
sufficient information is available to make a reasonable estimate of the
fair value. The interpretation is effective for Florida Progress and PEF no
later than December 31, 2005. Neither Florida Progress nor PEF has yet
determined the impact of the interpretation on its financial position,
results of operations or liquidity.
3. DIVESTITURE
Progress Rail Divestiture
On March 24, 2005, the Company completed the sale of Progress Rail to One
Equity Partners LLC, a private equity unit of J.P. Morgan Chase & Co. Gross
cash proceeds from the sale are estimated to be approximately $430 million,
consisting of $405 million base proceeds plus an estimated working capital
adjustment. Proceeds from the sale were used to reduce debt.
Based on the estimated gross proceeds associated with the sale of $430
million, the Company recorded an estimated after-tax loss on disposal of
$41 million during the six months ended June 30, 2005. The Company
anticipates adjustments to the loss on the divestiture during the third
quarter of 2005 related to employee benefit settlements and the
finalization of the working capital adjustment and other operating
estimates.
The accompanying consolidated interim financial statements of Florida
Progress have been restated for all periods presented to reflect the
operations of Progress Rail as discontinued operations. Interest expense
has been allocated to discontinued operations based on the net assets of
Progress Rail, assuming a uniform debt-to-equity ratio across the Company's
operations. Interest expense allocated for the three months ended June 30,
2004 was $4 million. Interest expense allocated for the six months ended
14
June 30, 2005 and 2004 was $4 million and $8 million, respectively. The
Company ceased recording depreciation upon classification of the assets as
discontinued operations in February 2005. After-tax depreciation expense
recorded by Progress Rail during the three months ended June 30, 2004 was
$3 million. After-tax depreciation during the six months ended June 30,
2005 and 2004 was $3 million and $6 million, respectively. Results of
discontinued operations were as follows:
----------------------------------------------------------------------------------------------------
(in millions) Three Months Ended Six Months Ended
June 30 June 30
2005 2004 2005 2004
----------------------------------------------------------------------------------------------------
Revenues $ - $ 285 $ 358 $ 525
----------------------------------------------------------------------------------------------------
Earnings before income taxes $ - $ 13 $ 7 24
Income tax expense - 7 2 10
----------------------------------------------------------------------------------------------------
Net earnings from discontinued operations - 6 5 14
----------------------------------------------------------------------------------------------------
Estimated loss on disposal of discontinued operations,
including income tax benefit of $0 and $21 for the
three and six month ended June 30, 2005, respectively (9) - (41) -
----------------------------------------------------------------------------------------------------
(Loss) earnings from discontinued operations $ (9) $ 6 $ (36) $ 14
----------------------------------------------------------------------------------------------------
In connection with the sale, Progress Fuels and Progress Energy provided
guarantees and indemnifications of certain legal, tax and environmental
matters to One Equity Partners LLC. See discussion of the Company's
guarantees at Note 14A. The ultimate resolution of these matters could
result in adjustments to the loss on sale in future periods.
The major balance sheet classes included in assets and liabilities of
discontinued operations in the Consolidated Balance Sheet as of December
31, 2004 are as follows:
----------------------------------------------------------
(in millions)
----------------------------------------------------------
Accounts receivable $ 172
Inventory 177
Other current assets 15
Total property, plant and equipment, net 199
Total other assets 27
----------------------------------------------------------
Assets of discontinued operations $ 590
----------------------------------------------------------
Accounts payable $ 113
Accrued expenses 37
Total long-term liabilities 2
----------------------------------------------------------
Liabilities of discontinued operations $ 152
----------------------------------------------------------
In February 2004, the Company sold the majority of the assets of Railcar
Ltd., a subsidiary of Progress Rail, to The Andersons, Inc. for proceeds of
approximately $82 million.
Winter Park Divestiture
As discussed in Note 5, PEF sold certain electric distribution assets to
the City of Winter Park, Florida on June 1, 2005.
4. ACQUISITIONS
In May 2005, Winchester Production Company, Ltd., an indirectly wholly
owned subsidiary of Progress Fuels Corporation, acquired an interest in
approximately 11 natural gas producing wells and proven reserves of
approximately 25 billion cubic feet equivalent from a privately-owned
company headquartered in Texas. In addition to the natural gas reserves,
the transaction also included a 50% interest in the gas gathering systems
related to these reserves. The total cash purchase price for the
transaction was $46 million.
5. REGULATORY MATTERS
PEF Retail Rate Matters
On July 14, 2005, the Florida Public Service Commission (FPSC) issued an
order authorizing PEF to recover $232 million, including interest, of the
costs it incurred and previously deferred related to PEF's restoration of
power to customers associated with the four hurricanes in 2004. The ruling
will allow PEF to include a charge of approximately $3.27 on the average
15
residential monthly customer bill beginning August 1, 2005. The ruling by
the FPSC approved the majority of the Company's request with two
exceptions: the reclassification of $8 million from operation and
maintenance expense (O&M) to utility plant and reclassification of $17
million as normal O&M expense. As a result of these adjustments,
approximately $17 million was charged to O&M expense in June 2005,
representing the retail portion of these adjustments.
The amount included in the original petition requesting recovery of $252
million in November 2004 was an estimate, as actual total costs were not
known at that time. The Company currently estimates that it has incurred an
additional $18 million in costs in excess of the amount requested in the
petition. The difference between the actual costs and the amount requested
will be trued-up in September 2005, subject to FPSC approval, and the
impact will be included in customer bills beginning January 1, 2006.
On June 1, 2005, Florida Governor Jeb Bush signed into law a bill that
would allow utilities to petition the FPSC to use securitized bonds to
recover storm related costs. PEF intends to ask the FPSC for approval to
issue securitized debt. This arrangement would benefit the Company by
providing immediate cash recovery of the hurricane costs and would benefit
the customer by providing a longer recovery period, which will reduce the
price impact on monthly bills. Assuming FPSC approval, PEF expects the
process to take six to nine months to complete.
On June 1, 2005, the City of Winter Park, Florida (the City) acquired PEF's
electric distribution system that serves the City for approximately $42
million. PEF transferred the distribution system to the City on June 1,
2005, and recognized a pre-tax gain of approximately $25 million on the
transaction, which is included in other, net on the Consolidated Statements
of Income. This amount is subject to adjustment pending accumulation of the
final capital expenditures incurred since arbitration. The Company also
recorded a regulatory liability of $8 million for stranded cost revenues
which will be amortized to revenues over the next six years in accordance
with the provisions of the transfer agreement with the City.
On April 29, 2005, PEF submitted minimum filing requirements, based on a
2006 projected test year, to initiate a base rate proceeding regarding its
future base rates. In its filing, PEF has requested a $206 million annual
increase in base rates effective January 1, 2006. PEF's request for an
increase in base rates reflects an increase in operational costs with (i)
the addition of Hines 2 generation facility into base rates rather than the
Fuel Clause as was permitted under the terms of existing Stipulation and
Settlement Agreement (the Agreement) (ii) completion of the Hines 3
generation facility, (iii) the need, in light of recent history, to
replenish PEF's depleted storm reserve on a going-forward basis by
adjusting the annual accrual, (iv) the expected infrastructure investment
necessary to meet high customer expectations, coupled with the demands
placed on PEF's system due to strong customer growth, (v) significant
additional costs including increased depreciation and fossil dismantlement
expenses and (vi) general inflationary pressures.
Hearings on the base rate proceeding are scheduled from September 7 through
September 16, 2005, and a final decision is expected by the end of 2005.
Although the Company cannot predict the outcome of this matter, an adverse
outcome could negatively impact the Company's and PEF's financial condition
and results of operations.
The FPSC requires that PEF perform a depreciation study no less than every
four years. PEF filed a depreciation study with the FPSC on April 29, 2005,
as part of the Company's base rate filing, which will increase depreciation
expense by $14 million beginning in 2006 if approved by the FPSC. The
Company cannot predict the outcome or impact of this matter. PEF reduced
its estimated removal costs to take into account the estimates used in the
depreciation study. This resulted in a downward revision in the PEF
estimated removal costs, a component of regulatory liabilities, and equal
increase in accumulated depreciation of approximately $401 million.
The FPSC requires that PEF update its cost estimate for fossil plant
dismantlement every four years. PEF filed an updated fossil plant
dismantlement study with the FPSC on April 29, 2005, as part of the
Company's base rate filing. The new study calls for an increase in the
annual accrual of $10 million beginning in 2006. PEF's retail reserve for
fossil plant dismantlement was approximately $133 million at June 30, 2005.
Retail accruals on PEF's reserves for fossil plant dismantlement were
previously suspended through December 2005 under the terms of PEF's
existing Agreement. The Company cannot predict the outcome or impact of
this matter.
16
The FPSC requires that PEF update its cost estimate for nuclear
decommissioning every five years. PEF filed a new site-specific estimate of
decommissioning costs for the Crystal River Nuclear Plant Unit No. 3 (CR3)
with the FPSC on April 29, 2005 as part of the Company's base rate filing.
PEF's estimate was based on prompt decommissioning. The estimate, in 2005
dollars, is $614 million and is subject to change based on a variety of
factors including, but not limited to, cost escalation, changes in
technology applicable to nuclear decommissioning and changes in federal,
state or local regulations. The cost estimate excludes the portion
attributable to other co-owners of CR3. The NRC operating license held by
PEF for CR3 currently expires in December 2016. An application to extend
this license 20 years is expected to be submitted in the first quarter of
2009. As part of this new estimate and assumed license extension, PEF
reduced its ARO liability by approximately $88 million. Retail accruals on
PEF's reserves for nuclear decommissioning were previously suspended
through December 2005 under the terms of the Agreement and the new study
supports a continuation of that suspension. The Company cannot predict the
outcome or impact of this matter.
6. COMPREHENSIVE INCOME
-----------------------------------------------------------------------------------
Three Months Ended
Florida Progress Corporation June 30,
----------------------
(in millions) 2005 2004
-----------------------------------------------------------------------------------
Net (loss) income $ (8) $ 135
Other comprehensive loss:
Reclassification adjustments included in net income:
Change in cash flow hedges (net of tax expense of $2
and $1, respectively) 2 2
Changes in net unrealized losses on cash flow hedges
(net of tax benefit of $0 and $3, respectively) - (6)
Foreign currency translation adjustment and other 1 -
-----------------------------------------------------------------------------------
Other comprehensive loss $ 3 $ (4)
-----------------------------------------------------------------------------------
Comprehensive (loss) income $ (5) $ 131
-----------------------------------------------------------------------------------
-----------------------------------------------------------------------------------
Six Months Ended
Florida Progress Corporation June 30,
----------------------
(in millions) 2005 2004
-----------------------------------------------------------------------------------
Net income $ 10 $ 190
Other comprehensive loss:
Reclassification adjustments included in net income:
Change in cash flow hedges (net of tax expense of $2
and $2, respectively) 3 4
Foreign currency translation adjustment included in
discontinued operations (5) -
Minimum pension liability adjustment included in
discontinued operations (net of tax expense of $1) 1 -
Changes in net unrealized losses on cash flow hedges
(net of tax benefit of $7 and $10, respectively) (12) (18)
Foreign currency translation adjustment and other 1 1
-----------------------------------------------------------------------------------
Other comprehensive loss $ (12) $ (13)
-----------------------------------------------------------------------------------
Comprehensive (loss) income $ (2) $ 177
-----------------------------------------------------------------------------------
Comprehensive income and net income for PEF for the three months ended June
30, 2005 and 2004 were $10 million and $84 million, respectively.
Comprehensive income and net income for PEF for the six months ended June
30, 2005 and 2004 were $54 million and $134 million, respectively.
7. DEBT AND CREDIT FACILITIES AND FINANCING ACTIVITIES
Changes to the Company's and PEF's debt and credit facilities since
December 31, 2004, discussed in Note 12 to the Financial Statements in Item
8 of the Company's and PEF's 2004 Form 10-K, are described below.
In January 2005, PEF used proceeds from the issuance of commercial paper to
pay off $170 million of revolving credit agreement (RCA) loans. PEF
subsequently used money pool borrowings to reduce commercial paper. In
February 2005, PEF used proceeds from money pool borrowings to pay off $55
million of RCA loans.
17
On March 28, 2005, PEF entered into a new $450 million five-year RCA with a
syndication of financial institutions. The RCA will be used to provide
liquidity support for PEF's issuances of commercial paper and other
short-term obligations. The RCA will expire on March 28, 2010. The new $450
million RCA replaced PEF's $200 million three-year RCA and $200 million
364-day RCA, which were each terminated effective March 28, 2005. Fees and
interest rates under the $450 million RCA are to be determined based upon
the credit rating of PEF's long-term unsecured senior non-credit enhanced
debt, currently rated as A3 by Moody's Investor Services (Moody's) and BBB
by Standard and Poor's (S&P). The RCA includes a defined maximum total debt
to capital ratio of 65%. The RCA also contains various cross-default and
other acceleration provisions, including a cross-default provision for
defaults of indebtedness in excess of $35 million. The RCA does not include
a material adverse change representation for borrowings or a financial
covenant for interest coverage, which had been provisions in the terminated
agreements.
On May 16, 2005, PEF issued $300 million of First Mortgage Bonds, 4.50%
Series due 2010. The net proceeds from the sale of the bonds were used to
reduce the outstanding balance of commercial paper.
On July 1, 2005, PEF paid at maturity $45 million of its 6.72% Medium-Term
Notes, Series B with short-term debt proceeds.
On July 28, 2005, PEF filed a shelf registration statement with the SEC to
provide an additional $1.0 billion of capacity in addition to the $450
million remaining on PEF's current shelf registration statement. The shelf
registration statement will allow PEF to issue various securities,
including First Mortgage Bonds, Debt Securities and Preferred Stock.
8. BENEFIT PLANS
The Company and some of its subsidiaries (including PEF) have a
noncontributory defined benefit retirement (pension) plan for substantially
all full-time employees. The Company also has supplementary defined benefit
pension plans that provide benefits to higher-level employees. In addition
to pension benefits, the Company and some of its subsidiaries (including
PEF) provide contributory other postretirement benefits (OPEB), including
certain health care and life insurance benefits, for retired employees who
meet specified criteria. The components of the net periodic benefit cost
for the three and six months ended June 30 are:
Three Months Ended June 30, Other Postretirement
Pension Benefits Benefits
--------------------- ------------------------
(in millions) 2005 2004 2005 2004
--------------------- ------------------------
Service cost $ 6 $ 5 $ 1 $ 1
Interest cost 13 12 4 4
Expected return on plan assets (19) (18) - -
Net amortization - 1 1 1
--------------------- ------------------------
Net cost recognized by Florida Progress $ - $ - $ 6 $ 6
--------------------- ------------------------
Net cost/(benefit) recognized by PEF $ (1) $ (1) $ 5 $ 6
===================== ========================
Six Months Ended June 30, Other Postretirement
Pension Benefits Benefits
--------------------- -----------------------
(in millions) 2005 2004 2005 2004
--------------------- -----------------------
Service cost $ 12 $ 11 $ 2 $ 3
Interest cost 25 23 7 8
Expected return on plan assets (38) (36) - -
Net amortization - 1 2 2
--------------------- -----------------------
Net cost/(benefit) recognized by Florida
Progress $ (1) $ (1) $ 11 $ 13
--------------------- -----------------------
Net cost/(benefit) recognized by PEF $ (2) $ (2) $ 11 $ 12
===================== =======================
In addition, in the second quarter of 2005 the Company and PEF recorded
costs for special termination benefits related to the voluntary enhanced
retirement program (see Note 10) of approximately $86 million and $83
million, respectively, for pension benefits and $7 million for other
postretirement benefits. For the Company, these charges resulted in a $49
million decrease in prepaid pension cost, which is included in other assets
and deferred debits, and a $44 million increase in pension and OPEB
liabilities, which are included in other liabilities and deferred credits
18
on the Consolidated Balance Sheets. For PEF, these charges resulted in a
$47 million decrease in prepaid pension cost and a $43 million increase in
pension and OPEB liabilities, which are included in other liabilities and
deferred credits on the Balance Sheets.
9. RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS
The Company and PEF are exposed to various risks related to changes in
market conditions. The Company's and PEF's parent, Progress Energy, has a
risk management committee that 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. Under its risk management policy, the Company
and PEF may use a variety of instruments, including swaps, options and
forward contracts, to manage exposure to fluctuations in commodity prices
and interest rates. Such instruments contain credit risk if the
counterparty fails to perform under the contract. The Company and PEF
minimize such risk by performing credit reviews using, among other things,
publicly available credit ratings of such counterparties. Potential
non-performance by counterparties is not expected to have a material effect
on the consolidated financial position or consolidated results of
operations of the Company or PEF.
A. Commodity Derivatives
GENERAL
Most of the Company's and PEF's commodity contracts either are not
derivatives or qualify as normal purchases or sales pursuant to SFAS No.
133, "Accounting for Derivative and Hedging Activities" (SFAS No. 133).
Therefore, such contracts are not recorded at fair value.
ECONOMIC DERIVATIVES
Derivative products, primarily electricity and natural gas contracts, may
be entered into from time to time for economic hedging purposes. While
management believes the economic hedges mitigate exposures to fluctuations
in commodity prices, these instruments are not designated as hedges for
accounting purposes and are monitored consistent with trading positions.
The Company and PEF manage open positions with strict policies that limit
exposure to market risk and require daily reporting to management of
potential financial exposures. Gains and losses from such contracts were
not material to results of operations during the three and six months ended
June 30, 2005 and 2004. The Company and PEF did not have material
outstanding positions in such contracts as of June 30, 2005 or December 31,
2004, other than those receiving regulatory accounting treatment, as
discussed below.
PEF has derivative instruments related to its exposure to price
fluctuations on fuel oil purchases. These instruments receive regulatory
accounting treatment. Unrealized gains and losses are recorded in
regulatory liabilities and regulatory assets, respectively. As of June 30,
2005, the fair values of these instruments were a $60 million short-term
derivative asset position included in other current assets and a $22
million long-term derivative asset position included in other assets and
deferred debits. At December 31, 2004, the fair values of these instruments
were a $2 million long-term derivative asset position included in other
assets and deferred debits and a $5 million short-term derivative liability
position included in other current liabilities.
CASH FLOW HEDGES
The Company's nonregulated subsidiaries designate a portion of commodity
derivative instruments as cash flow hedges under SFAS No. 133. The
objective for holding these instruments is to hedge exposure to market risk
associated with fluctuations in the price of natural gas for the Company's
forecasted sales. In the normal course of business, Progress Fuels through
an affiliate, Progress Ventures, Inc. (PVI), enters natural gas cash flow
hedging instruments, which PVI offsets with third party transactions.
Progress Fuels accounts for such contracts as if it were transacted with a
third party and records the contract using mark-to-market accounting. As of
June 30, 2005, Progress Fuels is hedging exposures to the price variability
of natural gas through December 2006.
The total fair value of these instruments as of June 30, 2005, was a $2
million asset position and a $24 million liability position. The total fair
value of these instruments as of December 31, 2004, was a $9 million
liability position. The ineffective portion of commodity cash flow hedges
was not material for the three and six months ending June 30, 2005 and
2004. As of June 30, 2005, there were $14 million of after-tax deferred
losses in accumulated other comprehensive income (OCI) of which $9 million
is expected to be reclassified to earnings during the next 12 months as the
hedged transactions occur. Due to the volatility of the commodities
markets, the value in OCI is subject to change prior to its
reclassification into earnings.
19
B. Interest Rate Derivatives - Fair Value or Cash Flow Hedges
The Company and PEF manage their interest rate exposures in part by
maintaining variable-rate and fixed rate-exposures within defined limits.
In addition, the Company and PEF also enter into financial derivative
instruments, including, but not limited to, interest rate swaps and lock
agreements to manage and mitigate interest rate risk exposure.
The Company and PEF use cash flow hedging strategies to reduce exposure to
changes in cash flow due to fluctuating interest rates. The Company and PEF
held no interest rate cash flow hedges as of June 30, 2005 and December 31,
2004.
The Company and PEF use fair value hedging strategies to reduce exposure to
changes in fair value due to interest rate changes. As of June 30, 2005 and
December 31, 2004, the Company and PEF had no open interest rate fair value
hedges.
10. SEVERANCE COSTS
On February 28, 2005, as part of a previously announced cost management
initiative, Progress Energy approved a workforce restructuring which is
expected to be completed in September 2005. In addition to the workforce
restructuring, the cost management initiative included a voluntary enhanced
retirement program. In connection with this initiative, the Company
incurred approximately $113 million of pre-tax charges for severance and
postretirement benefits during the six months ended June 30, 2005, as
described below. Of this amount, $107 million was recorded by PEF.
The Company recorded $15 million of severance expense during the first
quarter of 2005 for the workforce restructuring and implementation of an
automated meter reading initiative at PEF. The workforce restructuring
expense was computed based on the approximate number of positions to be
eliminated. This amount included approximately $4 million of severance
costs allocated from Progress Energy Service Company (PESC). During the
second quarter of 2005, 692 of the Company's employees eligible for
participation in the voluntary enhanced retirement program elected to
participate, including 680 PEF employees. Consequently, in the second
quarter of 2005, the Company decreased its estimated severance costs by $6
million due to the impact of the employees electing participation in the
voluntary enhanced retirement program. This amount included approximately
$2 million of decreased severance costs allocated from PESC. The severance
expenses are primarily included in O&M expense on the Consolidated
Statements of Income.
The accrued severance expense will be paid over time. The activity in the
severance liability is as follows:
-------------------------------------------------------
(in millions) FPC PEF
-------------------------------------------------------
Balance as of January 1, 2005 $ 1 $ -
Severance costs accrued 11 10
Adjustments (4) (4)
Payments (1) -
-------------------------------------------------------
Balance as of June 30, 2005 $ 7 $ 6
-------------------------------------------------------
The Company recorded a $93 million charge in the second quarter of 2005
related to postretirement benefits that will be paid over time to eligible
employees who elected to participate in the voluntary enhanced retirement
program (see Note 8). In addition, the Company recorded approximately $10
million of charges for postretirement benefits and early retirement
incentives allocated from PESC.
The cost management initiative charges are subject to revision in future
quarters based on completion of the workforce restructuring and the
potential additional impacts that the early retirements and outplacements
may have on the postretirement plans. Such revisions may be significant and
may adversely impact the Company's and PEF's results of operations in
future periods. In addition, the Company expects to incur certain
incremental costs for recruiting and staff augmentation activities that
cannot be quantified at this time.
20
11. FINANCIAL INFORMATION BY BUSINESS SEGMENT
The Company's principal business segment is PEF, a utility engaged in the
generation, transmission, distribution and sale of electricity primarily in
Florida. The other reportable business segments are Progress Fuels' Energy
& Related Services and Synthetic Fuels. The Energy & Related Services
segment includes coal operations, natural gas production and sales, river
terminal services and off-shore marine transportation. Synthetic Fuels'
operations include the production and sale of coal-based solid synthetic
fuel as defined under the Internal Revenue Code and the operation of
synthetic fuel facilities for outside parties. See Note 14 for more
information. The Other category consists primarily of Progress
Telecommunications Corp (PTC), the Company's telecommunications subsidiary,
and the holding company, Florida Progress Corporation. PTC 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. The Company allocates a portion of its
operating expenses to business segments.
Prior to 2005, Rail Services was reported as a separate segment. In
connection with the divestiture of Progress Rail (see Note 3), the
operations of Rail Services were reclassified to discontinued operations in
the first quarter of 2005 and therefore are not included in the results
from continuing operations during the periods reported. In addition,
Synthetic Fuel activities were reported in the Energy & Related Services
segment prior to 2005 and now are considered a separate reportable segment.
These reportable segment changes reflect the current reporting structure.
For comparative purposes, the prior year results have been restated to
conform to the current presentation.
The Company's segments are based on differences in products and services,
and therefore no additional disclosures are presented. All intersegment
transactions are at cost except for coal sales from the Energy and Related
Services segment to PEF. The price Progress Fuels charges PEF is based on
market rates for coal procurement. Rail transportation is also based on
market rates plus a return allowed by the FPSC on equity in transportation
equipment utilized in transporting coal to PEF. The allowed rate of return
is currently 12%. In accordance with SFAS No. 71, profits on intercompany
sales between Energy and Related Services and PEF are not eliminated if the
sales price is reasonable and the future recovery of sales price through
the ratemaking process is probable. The profits for the periods presented
were not significant. No single customer accounted for 10% or more of
unaffiliated revenues.
The following summarizes the revenues and segment profits or losses for the
reportable business segments. The combined segment profits and losses
represents Florida Progress' total income from continuing operations.
-----------------------------------------------------------------------------------------------------------
(in millions) Energy and
PEF Related Synthetic Other Consolidated
Services Fuels
-----------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2005:
Revenues $ 908 $ 226 $ 182 $ 17 $ 1,333
Intersegment revenues - 287 - (287) -
Total revenues 908 513 182 (270) 1,333
Postretirement and Severance Charges 93 4 - - 97
Segment profit (loss) $ 10 $ 12 $ 13 $ (34) $ 1
-----------------------------------------------------------------------------------------------------------
Energy and
(in millions) PEF Related Synthetic Other Consolidated
Services Fuels
-----------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2004:
Revenues $ 860 $ 212 $ 121 $ 17 $ 1,210
Intersegment revenues - 207 2 (209) -
Total revenues 860 419 123 (192) 1,210
Postretirement and Severance Charges - - - - -
Segment profit (loss) $ 84 $ 17 $ 21 $ 7 $ 129
-----------------------------------------------------------------------------------------------------------
21
-----------------------------------------------------------------------------------------------------------
(in millions) Energy and
PEF Related Synthetic Other Consolidated
Services Fuels
-----------------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2005:
Revenues $ 1,756 $ 409 $ 348 $ 35 $ 2,548
Intersegment revenues - 547 - (547) -
Total revenues 1,756 956 348 (512) 2,548
Postretirement and Severance Charges 107 6 - - 113
Segment profit (loss) $ 53 $ 23 $ 13 $ (43) $ 46
-----------------------------------------------------------------------------------------------------------
Energy and
(in millions) PEF Related Synthetic Other Consolidated
Services Fuels
-----------------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2004:
Revenues $ 1,644 $ 347 $ 257 $ 31 $ 2,279
Intersegment revenues - 444 6 (450) -
Total revenues 1,644 791 263 (419) 2,279
Postretirement and Severance Charges 1 - - - 1
Segment profit (loss) $ 133 $ 27 $ 47 $ (31) $ 176
-----------------------------------------------------------------------------------------------------------
12. 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 ended June 30,
2005 and 2004, are as follows:
Three Months Ended Six Months Ended
(in millions) June 30 June 30
-------------------- -------------------
2005 2004 2005 2004
-------- -------- ------- -------
Other income
Nonregulated energy and delivery services income 4 4 8 7
Gain on sale of distribution assets (see Note 5) 25 - 25 -
AFUDC equity 4 1 7 2
Other - - 2 2
-------- -------- ------- -------
Total other income - PEF $ 33 $ 5 $ 42 $ 11
Other income - Florida Progress - 1 3 2
-------- -------- ------- -------
Total other income - PEF and Florida Progress $ 33 $ 6 $ 45 $ 13
-------- -------- ------- -------
Other expense
Nonregulated energy and delivery services expenses $ 3 $ 3 $ 6 $ 5
Donations 3 1 6 5
FERC Audit Settlement 3 - 3 -
Other - 1 - 2
-------- -------- ------- -------
Total other expense - PEF $ 9 $ 5 $ 15 $ 12
Loss from equity investments 4 4 10 7
Other expense - Florida Progress 2 - 3 1
-------- -------- ------- -------
Total other expense - PEF and Florida Progress $ 15 $ 9 $ 28 $ 20
-------- -------- ------- -------
Other, net $ 18 $ (3) $ 17 $ (7)
======== ======== ======= =======
Nonregulated energy and delivery services include power protection services
and mass market programs such as surge protection, appliance services and
area light sales, and delivery, transmission and substation work for other
utilities.
FERC audit settlement includes amounts approved by the FERC on May 25,
2005, to settle the FERC Staff's Audit of PEF's compliance with the FERC's
Standards of Conduct and Code of Conduct. In the settlement, PEF agreed to
make certain operational and organizational changes and to provide its
retail and wholesale customers a one-time credit of approximately $3
million which was recorded as other expense in the second quarter of 2005.
22
13. ENVIRONMENTAL MATTERS
The Company and PEF are subject to federal, state and local regulations
addressing hazardous and solid waste management, air and water quality and
other environmental matters. See Note 20 of the Company's and PEF's 2004
Annual Report on Form 10-K for a more detailed, historical discussion of
these federal, state, and local regulations.
HAZARDOUS AND SOLID WASTE MANAGEMENT
The provisions of the Comprehensive Environmental Response, Compensation
and Liability Act of 1980, as amended, authorize the EPA to require the
cleanup of hazardous waste sites. This statute imposes retroactive joint
and several liabilities. Some states, including Florida, have similar types
of legislation. The Company and PEF are periodically notified by regulators
such as the EPA and various state agencies of their involvement or
potential involvement in sites that may require investigation and/or
remediation. The Company and PEF are also currently in the process of
assessing potential costs and exposures at other environmentally impaired
sites. For all sites, as the assessments are developed and analyzed, the
Company and PEF will accrue costs for the sites to the extent the costs are
probable and can be reasonably estimated.
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, through PEF, has some connection. In this regard, PEF and
other potentially responsible parties (PRPs), 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 Florida, a risk-based corrective action (RBCA, known as Global RBCA)
rule was developed by the FDEP and adopted at the February 2, 2005,
Environmental Review Commission hearing. Risk-based corrective action
generally means that the corrective action prescribed for contaminated
sites can correlate to the level of human health risk imposed by the
contamination at the property. The Global RBCA rule expands the use of the
risk-based corrective action to all contaminated sites in the state that
are not currently in one of the state's waste cleanup programs and has the
potential for making future cleanups in Florida more costly to complete.
The effective date of the Global RBCA rule was April 17, 2005. The Company
and PEF are in the process of assessing the impact of this rule.
The Company and PEF have filed claims with the Company's general liability
insurance carriers to recover costs arising out of actual or potential
environmental liabilities. Almost all claims have been settled and a few
are still pending. While the Company and PEF cannot predict the outcome of
these matters, the outcome is not expected to have a material effect on the
Company's consolidated or PEF's financial condition or results of
operations.
PEF
As of June 30, 2005 and December 31, 2004, PEF's accruals for probable and
estimable costs related to various environmental sites, which are included
in other liabilities and deferred credits and are expected to be paid out
over one to fifteen years, were:
-----------------------------------------------------------------------------------------------
(in millions) June 30, 2005 December 31, 2004
-----------------------------------------------------------------------------------------------
Remediation of distribution and substation transformers $ 22 $ 27
MGP and other sites 18 18
-----------------------------------------------------------------------------------------------
Total accrual for environmental sites $ 40 $ 45
-----------------------------------------------------------------------------------------------
PEF has received approval from the FPSC for recovery of costs associated
with the remediation of distribution and substation transformers through
the Environmental Cost Recovery Clause (ECRC). Under agreements with the
FDEP, PEF is in the process of examining distribution transformer sites and
substation sites for potential equipment integrity issues that could result
in the need for mineral oil impacted soil remediation. PEF has reviewed a
number of distribution transformer sites and all substation sites. PEF
expects to have completed its review of distribution transformer sites by
the end of 2007. Should further sites be identified, PEF believes that any
estimated costs would also be recovered through the ECRC. For the three and
six months ended June 30, 2005, PEF made no additional accruals and spent
approximately $3 million and $5 million, respectively, related to the
remediation of transformers. PEF has recorded a regulatory asset for the
probable recovery of these costs through the ECRC.
23
The amounts for MGP and other sites, in the table above, relate to two
former MGP sites and other sites associated with PEF that have required or
are anticipated to require investigation and/or remediation. In 2004, PEF
received approximately $12 million in insurance claim settlement proceeds
and recorded a related accrual for associated environmental expenses, as
these insurance proceeds are restricted for use in addressing costs
associated with environmental liabilities. For the three and six months
ended June 30, 2005, PEF made no additional accruals or material
expenditures and received no insurance proceeds.
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 PRPs. Because the extent of environmental impact,
allocation among PRPs for all sites, remediation alternatives (which could
involve either minimal or significant efforts), and concurrence of the
regulatory authorities have not yet advanced to the stage where a
reasonable estimate of the remediation costs can be made, at this time PEF
is unable to provide an estimate of its obligation to remediate these sites
beyond what is currently accrued. As more activity occurs at these sites,
PEF will assess the need to adjust the accruals. It is anticipated that
sufficient information will become available in 2005 to make a reasonable
estimate of PEF's obligation for one of the MGP sites.
Florida Progress Corporation
In 2001, FPC established an accrual to address indemnities and retained an
environmental liability associated with the sale of its Inland Marine
Transportation business. In 2003, the accrual was reduced to $4 million
based on a change in estimate. As of June 30, 2005 and December 31, 2004,
the remaining accrual balance was approximately $3 million. Expenditures
related to this liability were not material to the Company's financial
condition for the three and six months ended June 30, 2005. FPC measures
its liability for these exposures based on estimable and probable
remediation scenarios.
Certain historical sites are being addressed voluntarily by FPC. An
immaterial accrual has been established to address investigation expenses
related to these sites. At this time, the Company cannot determine the
total costs that may be incurred in connection with these sites.
Progress Rail
On March 24, 2005, the Company closed on the sale of its Progress Rail
subsidiary. In connection with the sale, the Company incurred indemnity
obligations related to certain pre-closing liabilities, including certain
environmental matters (see discussion under Guarantees in Note 14A).
AIR QUALITY
The Company and PEF are subject to various current and proposed federal,
state, and local environmental compliance laws and regulations, which may
result in increased planned capital expenditures and operating and
maintenance costs. Significant updates to these laws and regulations and
related impacts to the Company and PEF since December 31, 2004, are
discussed below. Additionally, Congress is considering legislation that
would require reductions in air emissions of NOx, SO2, 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
that could be material to the Company's and PEF's consolidated financial
position or results of operations. However, the Company and PEF cannot
predict the outcome of the matter.
The EPA is conducting an enforcement initiative related to a number of
coal-fired utility power plants in an effort to determine whether changes
at those facilities were subject to New Source Review (NSR) requirements or
New Source Performance Standards under the Clean Air Act. The Company was
asked to provide information to the EPA as part of this initiative and
cooperated in supplying the requested information. 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 by these unaffiliated utilities in excess of $1.0 billion.
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 and PEF cannot predict the outcome of this matter.
24
On March 10, 2005, the EPA issued the final Clean Air Interstate Rule
(CAIR). The EPA's rule requires 28 states, including Florida, and the
District of Columbia, to reduce NOx and SO2 emissions in order to attain
state NOx and SO2 emissions levels. Installation of additional air quality
controls is likely to be needed to meet the CAIR requirements. The Company
and PEF preliminarily estimate compliance costs for PEF could be
approximately $1.0 billion over ten years. PEF has joined a coalition of
Florida utilities that has filed a challenge to CAIR as it applies to
Florida. A petition for reconsideration and stay and a petition for
judicial review of CAIR were filed on July 11, 2005. The Company and PEF
cannot predict the outcome of this matter.
On March 15, 2005, the EPA finalized two separate but related rules: the
Clean Air Mercury Rule (CAMR) that sets emissions limits to be met in two
phases and encourages a cap and trade approach to achieving those caps, and
a de-listing rule that eliminated any requirement to pursue a maximum
achievable control technology (MACT) approach for limiting mercury
emissions from coal-fired power plants. NOx and SO2 controls also are
effective in reducing mercury emissions. However, according to the EPA the
second phase cap reflects a level of mercury emissions reduction that
exceeds the level that would be achieved solely as a co-benefit of
controlling NOx and SO2 under CAIR. The Company is in the process of
determining compliance plans and the cost to comply with the CAMR.
Installation of additional air quality controls is likely to be needed to
meet the CAMR's requirements. The de-listing rule has been challenged by a
number of parties; the resolution of the challenges could impact the
Company's final compliance plans and costs.
On June 24, 2005, the Court of Appeals for the District of Columbia Circuit
rendered a decision in a suit regarding EPA's NSR rules. As part of the
decision, the court struck down a provision excluding pollution control
projects from NSR requirements. As a result of this decision, additional
regulatory review of PEF's pollution control equipment proposals will be
required adding time and cost to the overall project.
In conjunction with the proposed mercury rule, the EPA proposed a MACT
standard to regulate nickel emissions from residual oil-fired units. The
EPA withdrew the proposed nickel rule in March 2005.
On May 6, 2005, PEF filed a petition with the FPSC through the ECRC program
for recovery of costs associated with the development and implementation of
an integrated strategy to comply with the CAIR and CAMR. PEF is developing
an integrated compliance strategy for the CAIR and CAMR rules because NOx
and SO2 controls also are effective in reducing mercury emissions. PEF
estimates the program costs for 2005 to be approximately $2 million for
preliminary engineering activities and strategy development work necessary
to determine PEF's integrated compliance strategy. PEF projects
approximately $62 million in program costs for 2006. These costs may
increase or decrease depending upon the results of the engineering and
strategy development work. Among other things; subsequent rule
interpretations, equipment availability, or the unexpected acceleration of
the initial NOx or other compliance dates could require acceleration of
some projects and therefore result in additional costs in 2005 and 2006.
PEF expects to incur significant additional capital and O&M costs to
achieve compliance with the CAIR and CAMR through 2015 and beyond. The
timing and extent of the costs for future projects will depend upon the
final compliance strategy.
In a decision issued July 15, 2005, the U.S. Court of Appeals for the
District of Columbia Circuit denied petitions for review filed by several
states, cities and organizations seeking the regulation by the EPA of
carbon dioxide emissions under the Clean Air Act. The court, in a 2-1
decision, held that the EPA Administrator properly exercised his discretion
in denying the request for regulation.
WATER QUALITY
As a result of the operation of certain control equipment needed to address
the air quality issues outlined above, new wastewater streams may be
generated at the affected facilities. Integration of these new wastewater
streams into the existing wastewater treatment processes may result in
permitting, construction and treatment requirements imposed on PEF in the
immediate and extended future.
Based on changes to the estimated time frame of expenditures since December
31, 2004, the Company has revised the estimated time period for
expenditures to meet Section 316(b) requirements of the Clean Water Act.
PEF currently estimates that from 2005 through 2010 the range of
expenditures will be approximately $65 million to $85 million.
25
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 treaty went into effect on February 16, 2005. The
United States has not adopted the Kyoto Protocol, and the Bush
administration has stated it favors voluntary programs. A number of carbon
dioxide emissions control proposals have been advanced in Congress.
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 consolidated financial position or results of operations if
associated costs of control or limitation cannot be recovered from
customers. The Company favors the voluntary program approach recommended by
the Bush administration and continually evaluates options for the
reduction, avoidance and sequestration of greenhouse gases. However, the
Company and PEF cannot predict the outcome of this matter.
Progress Energy has announced its plan to issue a report on the Progress
Energy's activities associated with current and future environmental
requirements. The report will include a discussion of the environmental
requirements that the Company and PEF currently face and expect to face in
the future with respect to its air emissions. The report is expected to be
issued by March 31, 2006.
14. COMMITMENTS AND CONTINGENCIES
Contingencies and significant changes to the commitments discussed in Note
21 of the Company's 2004 Annual Report on Form 10-K are described below.
A. Guarantees
As a part of normal business, Florida Progress and certain subsidiaries,
including PEF and Progress Fuels, enter into various agreements providing
financial or performance assurances to third parties, which are outside the
scope of FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness
of Others" (FIN No. 45). 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. As of June 30, 2005, management does not believe conditions are
likely for significant performance under these agreements. To the extent
liabilities are incurred as a result of the activities covered by the
guarantees, such liabilities are included in the accompanying Consolidated
Balance Sheets.
As of June 30, 2005, the Company has issued guarantees and indemnifications
of certain legal, tax and environmental matters to third parties in
connection with sales of businesses and for timely payment of obligations
in support of its non-wholly owned synthetic fuel operations. Related to
the sales of businesses, the notice period extends until 2012 for the
majority of matters provided for in the indemnification provisions. For
matters for which the Company has received timely notice, the Company's
indemnity obligations may extend beyond the notice period. Certain
environmental indemnifications related to the sale of synthetic fuel
operations have no limitations as to time or maximum potential future
payments. Other guarantees and indemnifications have an estimated maximum
exposure of approximately $152 million. As of June 30, 2005, the Company
has recorded liabilities related to guarantees and indemnifications to
third-parties of $27 million. Management does not believe conditions are
likely for significant performance under these agreements in excess of the
recorded liabilities.
Securities of Affiliated Trust
The Company has guaranteed certain payments of an affiliated company, FPC
Capital I (the Trust). Due to the nature of the relationship between the
Trust and Florida Progress Funding Corporation, the Company has guaranteed
the payment of all distributions related to the Trust's outstanding
mandatorily redeemable preferred securities. As of June 30, 2005, the Trust
had outstanding 12 million shares of the securities with a liquidation
value of $300 million.
26
B. Insurance
PEF is a member of Nuclear Electric Insurance Limited (NEIL), which
provides primary and excess insurance coverage against property damage to
members' nuclear generating facilities. Under the primary program, PEF is
insured for $500 million at its nuclear plant, CR3. In addition to primary
coverage, NEIL also provides decontamination, premature decommissioning and
excess property insurance with a limit of $1.75 billion.
C. Other Commitments
As discussed in Note 21B of the Company's annual report on Form 10-K for
the year ended December 31, 2004, the Company has certain future
commitments related to four synthetic fuel facilities purchased that
provide for contingent payments (royalties). The Company has exercised its
right in the related agreements to escrow those payments if certain
conditions in the agreements were met. The Company previously accrued and
retained 2004 and 2003 royalty payments of approximately $20 million and
$22 million, respectively. In May 2005, these funds were placed into escrow
upon establishment of the necessary escrow accounts.
On May 15, 2005, the original owners of the Earthco synthetic fuel
facilities filed suit in New York state court alleging breach of contract
against the Progress Fuels Corporation subsidiaries that purchased the
Earthco facilities (Progress Fuels subsidiaries). The plaintiffs also named
Progress Energy, Inc. as a defendant. The plaintiffs' complaint is that
periodic payments otherwise due to them under the sales arrangement with
the Progress Fuels subsidiaries are, contrary to the sales agreement, being
escrowed pending the outcome of the ongoing IRS audit of the Earthco
facilities. The Progress Fuels subsidiaries believe that the parties'
agreements allow for the payments to be escrowed in such event and also
allow for the use of such escrowed amounts to satisfy any potential
disallowance of tax credits that arises out of such an event. Currently,
the escrowed amount in question attributable to the Earthco facilities
currently owned by Florida Progress subsidiaries is $40 million, which
reflects periodic payments that would have been paid to the plaintiffs
beginning April 30, 2003 through July 31, 2005. This amount will increase
as future periodic payments are made to the escrow which would otherwise
have been payable to the plaintiffs. The Company and the Progress Fuels
subsidiaries intend to vigorously defend their actions, but cannot predict
the outcome of this matter.
D. Other Contingencies
1. Franchise Litigation
Two cities, Edgewood and Belleair, with a total of approximately 4,000
customers, have litigation pending against PEF in two circuit courts in
Florida. As discussed below, proceedings against PEF by a third city, the
City of Winter Park, were concluded during the second quarter of 2005. As
previously reported, 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, 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. The circuit courts in those cases 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 the cities to
determine the value of PEF's electric distribution system within those
cities, which orders have been upheld by the appellate courts.
Arbitration in the case by the City of Winter Park was completed in
February 2003. That arbitration panel issued an award in May 2003 setting
the value of PEF's distribution system within the City (13,000 customers)
at approximately $32 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 $11 million in
stranded costs, which, according to the award, decrease over time. In
September 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. On April 26, 2004, the City Commission voted
to proceed with the acquisition. The City sought and received wholesale
power supply bids and on June 24, 2004, executed a wholesale power supply
contract with PEF with a five-year term from the date service begins and a
renewal option. On May 12, 2004, the City solicited bids to operate and
maintain the distribution system and awarded a contract in January 2005. On
February 10, 2005, PEF filed a petition with the Florida Public Service
Commission (FPSC) to relieve the Company of its statutory obligation to
27
serve customers in Winter Park on June 1, 2005, or at such time when the
City is able to provide retail service. On April 19, 2005, the FPSC voted
to approve PEF's petition. On June 1, 2005, the City acquired PEF's
electric distribution system that serves the City for approximately $42
million. PEF transferred the distribution system to the City on June 1,
2005 and recognized a pre-tax gain of $25 million on the transaction, which
is included in other, net on the Consolidated Statements of Income. This
amount is subject to true-up pending accumulation of the final capital
expenditures since arbitration. PEF also recorded a regulatory liability of
$8 million for stranded cost revenues which will be amortized to revenues
over the next six years in accordance with the provisions of the transfer
agreement with the City.
Arbitration with the 2,500-customer Town of Belleair (the Town) was
completed in June 2003. In September 2003, the arbitration panel issued an
award in that case setting the value of the electric distribution system
within the Town at approximately $6 million. The panel further required the
Town to pay to PEF its requested $1 million in separation and reintegration
costs and $2 million in stranded costs. The Town has not yet decided
whether it will attempt to acquire the system; however, on January 18,
2005, it issued a request for proposals for wholesale power supply and to
operate and maintain the distribution system. In March 2005, PEF submitted
a bid to supply wholesale power to the Town. The Town received several
other proposals for wholesale power and distribution services. In February
2005, the Town Commission also voted to put the issue of whether to acquire
the distribution system to a voter referendum. A referendum is scheduled to
occur on November 8, 2005. At this time, whether and when there will be
further proceedings regarding the Town of Belleair cannot be determined.
Arbitration in the remaining city's litigation (the 1,500-customer City of
Edgewood) has not yet been scheduled. On February 17, 2005, the parties
filed a joint motion to stay the litigation for a 90-day period during
which the parties will discuss potential settlement. In April, the City
Council voted to proceed with arbitration and on July 6, 2005, the circuit
court referred the matter to arbitration, but did not set an arbitration
date. The parties are engaged in settlement discussions and have reached a
tentative agreement to resolve the case under which the City of Edgewood
would sign a 30-year franchise agreement. At this time, whether and when
there will be further proceedings regarding the City of Edgewood cannot be
determined.
A fourth city (the 7,000-customer City of Maitland) is contemplating
municipalization but has indicated its intent to enter into a new franchise
agreement with PEF. Maitland's franchise expires in August 2005. At this
time, whether and when there will be further proceedings regarding the City
of Maitland cannot be determined.
As part of the above litigation, two appellate courts 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 filed an appeal with the Florida Supreme Court to
resolve the conflict between the two appellate courts. On October 28, 2004,
the Court issued a decision holding that PEF must collect from its
customers and remit to the cities franchise fees during the interim period
when the city exercises its purchase option or executes a new franchise
agreement. The Court's decision should not have a material impact on the
Company.
2. DOE Litigation
Pursuant to the Nuclear Waste Policy Act of 1982, the predecessors to PEF
entered into contracts with the U.S. Department of Energy (DOE) under which
the DOE agreed to begin taking spent nuclear fuel (SNF) by no later than
January 31, 1998. All similarly situated utilities were required to sign
the same standard contract.
The DOE failed to begin taking spent nuclear fuel by January 31, 1998. In
January 2004, PEF filed a complaint with the United States Court of Federal
Claims against the DOE, claiming that the DOE breached the Standard
Contract for Disposal of Spent Nuclear Fuel by failing to accept SNF from
PEF facilities on or before January 31, 1998. Damages due to the DOE's
breach will likely be significant, but have yet to be determined.
Approximately 60 cases involving the Government's actions in connection
with SNF are currently pending in the Court of Federal Claims.
The DOE and the PEF parties have agreed to a stay of the lawsuit, including
discovery. The parties agreed to, and the trial court entered, a stay of
proceedings, in order to allow for possible efficiencies due to the
resolution of legal and factual issues in previously-filed cases in which
similar claims are being pursued by other plaintiffs. These issues may
include, among others, so-called "rate issues," or the minimum mandatory
schedule for the acceptance of SNF and high level waste (HLW) by which the
Government was contractually obligated to accept contract holders' SNF
and/or HLW, and issues regarding recovery of damages under a partial breach
of contract theory that will be alleged to occur in the future. These
issues are expected to be presented in the trials or appeals that are
28
scheduled to occur during 2005. Resolution of these issues in other cases
could facilitate agreements by the parties in the PEF lawsuit, or at a
minimum, inform the Court of decisions reached by other courts if they
remain contested and require resolution in this case. In July 2005, the
parties jointly requested a continuance of the stay through December 15,
2005, which the trial court generated.
With certain modifications and additional approval by the NRC, including
the installation of onsite dry storage facilities at PEF's nuclear unit,
Crystal River Unit No. 3 (CR3), PEF's spent nuclear fuel storage facilities
will be sufficient to provide storage space for spent fuel generated on
PEF's system through the expiration of the operating license for CR3.
In July 2002, Congress passed an override resolution to Nevada's veto of
the DOE's proposal to locate a permanent underground nuclear waste storage
facility at Yucca Mountain, Nevada. In January 2003, the State of Nevada,
Clark County, Nevada and the City of Las Vegas petitioned the U.S. Court of
Appeals for the District of Columbia Circuit for review of the
Congressional override resolution. These same parties also challenged the
EPA's radiation standards for Yucca Mountain. On July 9, 2004, the Court
rejected the challenge to the constitutionality of the resolution approving
Yucca Mountain, but ruled that the EPA was wrong to set a 10,000-year
compliance period in the radiation protection standard. The EPA is
currently reworking the standard but has not stated when the work will be
complete. The DOE originally planned to submit a license application to the
NRC to construct the Yucca Mountain facility by the end of 2004. However,
in November 2004, the DOE announced it would not submit the license
application until mid-2005 or later. Also in November 2004, Congressional
negotiators approved $577 million for fiscal year 2005 for the Yucca
Mountain project, approximately $300 million less than requested by the DOE
but approximately the same as approved in 2004. The DOE has acknowledged
that a working repository will not be operational until sometime after
2010, but the DOE has not identified a new target date. PEF cannot predict
the outcome of this matter.
3. Advanced Separation Technologies (AST)
In 1996, Florida Progress sold its 80% interest in AST to Calgon Carbon
Corporation (Calgon) for net proceeds of $56 million in cash. In 1998,
Calgon filed a lawsuit against Florida Progress and the other selling
shareholder and amended it in April 1998, alleging misstatement of AST's
1996 revenues, assets and liabilities, seeking damages and granting Calgon
the right to rescind the sale. The lawsuit also accused the sellers of
failing to disclose flaws in AST's manufacturing process and a lack of
quality control.
All parties filed motions for summary judgment in July 2001. The summary
judgment motions of Calgon and the other selling shareholder were denied in
April 2002. The summary judgment motion of Florida Progress was withdrawn
pending a legal challenge to portions of the report of Calgon's expert,
Arthur Andersen, which had been used to oppose summary judgment. In
September 2003, the United States District Court for the Western District
of Pennsylvania issued final orders excluding from evidence in the case
that portion of Arthur Andersen's damage analysis based on the discounted
cash flow methodology of valuation. The Court did not exclude Arthur
Andersen's use of the guideline publicly traded company methodology in its
damage analysis. Florida Progress filed a renewed motion for summary
judgment in October 2003, which is pending. A magistrate judge has
recommended that the summary judgment motion be denied. Florida Progress
has objected to this recommendation. A final ruling on the motion is
expected at any time.
Florida Progress believes that the aggregate total of all legitimate
warranty claims by customers of AST for which it is probable that Florida
Progress will be responsible for under the Stock Purchase Agreement with
Calgon is approximately $3 million, and accordingly, accrued $3 million in
the third quarter of 1999 as an estimate of probable loss.
The Company cannot predict the outcome of this matter.
4. Synthetic Fuel Tax Credits
At December 31, 2003, Florida Progress, through its subsidiaries, was a
majority-owner in three entities and a minority owner in three entities
that own facilities that produce coal-based solid synthetic fuel as defined
under the Internal Revenue Code (Code). In June 2004, Progress Fuels sold,
in two transactions, a combined 49.8 percent partnership interest in Colona
Synfuel Limited Partnership, LLLP (Colona), one of its majority owned
synthetic fuel operations. The Company is now a minority owner in Colona,
but continues to consolidate Colona in accordance with FASB Interpretation
No. 46R. Florida Progress, through its subsidiaries, is currently a
majority owner in two synthetic fuel entities and a minority owner in four
synthetic fuel entities, including Colona. The production and sale of the
synthetic fuel from these facilities qualifies for tax credits under
Section 29 of the Code (Section 29) if certain requirements are satisfied,
29
including a requirement that the synthetic fuel differs significantly in
chemical composition from the coal used to produce such synthetic fuel and
that the fuel was produced from a facility that was placed-in-service
before July 1, 1998. The amount of Section 29 tax credits that the Company
is allowed to claim in any calendar year is limited by the amount of the
Company's regular federal income tax liability. Synthetic fuel tax credit
amounts allowed but not utilized are carried forward indefinitely as
deferred alternative minimum tax credits. All majority-owned and
minority-owned entities received private letter rulings (PLRs) from the IRS
with respect to their synthetic fuel operations. However, these PLR's do
not address the placed-in-service date determinations. The PLRs do not
limit the production on which synthetic fuel credits may be claimed. Total
Section 29 credits generated to date are approximately $983 million, of
which $436 million have been used to offset regular federal income tax
liability and $529 million are being carried forward as deferred
alternative minimum tax credits. Also $18 million has not been recognized
due to the decrease in tax liability from the 2004 hurricane damage and
loss on sale of Progress Rail. The current Section 29 tax credit program
expires at the end of 2007.
The sale of Progress Rail in 2005 resulted in a capital loss for tax
purposes. Capital losses that are not offset with capital gains generated
in 2005 will be carried back to reduce the regular federal income tax
liability in 2004. The estimated impact of the sale resulted in
approximately $11 million in tax credits no longer being realized and
reflected as a deferred tax asset.
IRS PROCEEDINGS
In September 2002, all of Florida Progress' majority-owned synthetic fuel
entities at that time, including Colona, and two of the Company's minority
owned synthetic fuel entities were accepted into the IRS's Pre-Filing
Agreement (PFA) program in lieu of the ordinary IRS audit process. The PFA
program allows taxpayers to voluntarily accelerate the IRS exam process in
order to seek resolution of specific issues.
In February 2004, subsidiaries of the Company finalized execution of the
Colona Closing Agreement with the IRS concerning their Colona synthetic
fuel facilities. The Closing Agreement provided that the Colona facilities
were placed in service before July 1, 1998, which is one of the
qualification requirements for tax credits under Section 29 of the Code.
The Closing Agreement further provides that the fuel produced by the Colona
facilities in 2001 is a "qualified fuel" for purposes of the Section 29 tax
credits. This action concluded the PFA program with respect to Colona.
In July 2004, Progress Energy was notified that the IRS field auditors
anticipate taking an adverse position regarding the placed-in-service date
of the Company's four Earthco synthetic fuel facilities. Due to the IRS
auditors' position, the IRS has decided to exercise its right to withdraw
from the PFA program with Progress Energy. With the IRS's withdrawal from
the PFA program, the review of the Company's Earthco facilities is back on
the normal procedural audit path of the Company's tax returns.
On October 29, 2004, Progress Energy received the IRS field auditors'
preliminary report concluding that the Earthco facilities had not been
placed in service before July 1, 1998, and that the tax credits generated
by those facilities should be disallowed. The Company disagrees with the
field audit team's factual findings and believes that the Earthco
facilities were placed in service before July 1, 1998. The Company also
believes that the report applies an inappropriate legal standard concerning
what constitutes "placed in service." The Company intends to contest the
field auditors' findings and their proposed disallowance of the tax
credits.
Because of the disagreement between the Company and the field auditors as
to the proper legal standard to apply, the Company believes that it is
appropriate and helpful to have this issue reviewed by the National Office
of the IRS, just as the National Office reviewed the issues involving
chemical change. Therefore, the Company is asking the National office to
review the issue and clarify the legal standard and has initiated this
process with the National Office. The Company believes that the appeals
process, including proceedings before the National Office, could take up to
two years to complete, however, it cannot control the actual timing of
resolution and cannot predict the outcome of this matter.
Through June 30, 2005, based on its ownership percentage, the Company has
used or carried forward $595 million of tax credits generated by its
Earthco facilities. If these credits were disallowed, Florida Progress' one
time exposure for cash tax payments would be $67 million (excluding
interest), and earnings and equity would be reduced by $595 million,
excluding interest. These amounts have not been reduced for the use of any
escrowed amounts to satisfy a potential disallowance of these tax credits
(see Note 14C).
30
The Company believes that it is complying with all the necessary
requirements to be allowed such credits under Section 29, and, although it
cannot provide certainty, it believes that it will prevail in these
matters. The Company has no current plans to alter its synthetic fuel
production schedule for 2005 or future years as a result of the IRS field
auditors' report. However, should the Company fail to prevail in these
matters, there could be a material liability for previously used or carried
forward Section 29 tax credits, with a material adverse impact on earnings
and cash flows.
As discussed in Note 8D of the Company's annual report on Form 10-K for the
year ended December 31, 2004, PEF implemented changes in its capitalization
policies for its Energy Delivery business unit effective January 1, 2005.
As a result of the changes in accounting estimates for the outage and
emergency work and indirect costs, a lesser proportion of PEF's costs will
be capitalized on a prospective basis. The Company has requested a method
change from the IRS. If the IRS does not grant the Company's request, the
Company cannot predict how the IRS would suggest that the method change be
applied. However, the application of the method change to past periods
could be reflected in a cumulative adjustment to taxable income in 2005,
which likely would have a material impact on income from synthetic fuel tax
credits.
PROPOSED ACCOUNTING RULES FOR UNCERTAIN TAX POSITIONS
On July 14, 2005, the Financial Accounting Standards Board (FASB) issued an
exposure draft of a proposed interpretation of SFAS No. 109, "Accounting
for Income Taxes" (SFAS No. 109), that would address the accounting for
uncertain tax positions. The proposed interpretation would require that
uncertain tax benefits be probable of being sustained in order to record
such benefits in the consolidated financial statements. The Company
currently accounts for uncertain tax benefits in accordance with SFAS No.
5, "Accounting for Contingencies" (SFAS No. 5). Under SFAS No. 5,
contingent losses are recorded when it is probable that the tax position
will not be sustained and the amount of the disallowance can be reasonably
estimated. The exposure draft has a 60-day public comment period ending
September 12, 2005. As currently drafted, the proposed interpretation would
apply to all uncertain tax positions and be effective for the Company on
December 31, 2005.
As discussed above, the IRS field auditors have recommended that the
Section 29 tax credits generated by the Company's Earthco facilities,
totaling $595 million through June 30, 2005, be disallowed. The Company has
not yet determined how the proposed interpretation would impact its various
income tax positions, including the status of the Earthco tax credits.
Depending on the provisions of the FASB's final interpretation and the
Company's facts and circumstances that exist at the date of implementation,
including the Company's assessment of the probability of sustaining any
currently recorded and future tax benefits, the proposed interpretation
could have a material adverse impact on the Company's financial position
and results of operations.
PERMANENT SUBCOMMITTEE
In October 2003, the United States Senate Permanent Subcommittee on
Investigations began a general investigation concerning synthetic fuel tax
credits claimed under Section 29 of the Code. The investigation is
examining the utilization of the credits, the nature of the technologies
and fuels created, the use of the synthetic fuel, and other aspects of
Section 29 and is not specific to the Company's synthetic fuel operations.
Progress Energy provided information in connection with this investigation.
The Company cannot predict the outcome of this matter.
IMPACT OF CRUDE OIL PRICES
Although the Internal Revenue Code Section 29 tax credit program is
expected to continue through 2007, recent unprecedented increases in the
price of oil could limit the amount of those credits or eliminate them
entirely for one or more of the years following 2004. This possibility is
due to a provision of Section 29 that provides that if the average wellhead
price per barrel for unregulated domestic crude oil for the year (the
Annual Average Price) exceeds a certain threshold value (the Threshold
Price), the amount of Section 29 tax credits are reduced for that year.
Also, if the Annual Average Price increases high enough (the Phase Out
Price), the Section 29 tax credits are eliminated for that year. For 2004,
the Threshold Price was $51.35 per barrel and the Phase Out Price was
$64.47 per barrel. The Threshold Price and the Phase Out Price are adjusted
annually for inflation.
31
If the Annual Average Price falls between the Threshold Price and the Phase
Out Price for a year, the amount by which Section 29 tax credits are
reduced will depend on where the Average Annual Price falls in that
continuum. For example, for 2004, if the Annual Average Price had been
$57.91 per barrel, there would have been a 50% reduction in the amount of
Section 29 tax credits for that year.
The Secretary of the Treasury calculates the Annual Average Price based on
the Domestic Crude Oil First Purchases Prices published by the Energy
Information Agency (EIA). Because the EIA publishes its information on a
three month lag, the Secretary of the Treasury finalizes its calculations
three months after the year in question ends. Thus, the Annual Average
Price for calendar year 2004 was published on April 6, 2005, and the Annual
Average Price for 2004 did not reach the Threshold Price for 2004.
Consequently, the amount of the Company's 2004 Section 29 tax credits was
not adversely affected by oil prices.
The Company estimates that the 2005 Threshold Price will be approximately
$52 per barrel and the Phase Out price will be approximately $65 per
barrel, based on an estimated 2005 inflation adjustment. The monthly
Domestic Crude Oil First Purchases price published by the EIA has recently
averaged $5 to $6 lower than the corresponding monthly New York Mercantile
Exchange (NYMEX) settlement price for light sweet crude oil. Through July
31, 2005, the average NYMEX contract settlement price for light sweet crude
oil was $51.90 per barrel and the average futures price for the remainder
of 2005 was $61.86 per barrel. The Company estimates that NYMEX settlement
price would have to average approximately $69 per barrel for the remainder
of 2005 for the Threshold Price to be reached.
The Company estimates that the 2006 Threshold Price will be approximately
$52 per barrel and the Phase Out price will be approximately $66 per
barrel, based on estimated inflation adjustments for 2005 and 2006. The
monthly Domestic Crude Oil First Purchases price published by the EIA has
recently averaged $5 to $6 lower than the corresponding monthly NYMEX
settlement price for light sweet crude oil. As of July 31, 2005, the
average NYMEX futures price for light sweet crude oil for calendar year
2006 was $63.17 per barrel. Based upon the estimated 2006 Threshold Price
and Phase Out prices, if oil prices for 2006 remained at the July 31, 2005
average futures price level of $63.17 per barrel for the entire year in
2006, the Company currently estimates that the Section 29 tax credit amount
for 2006 would be reduced by approximately 35% to 40%.
The Company cannot predict with any certainty the Annual Average Price for
2005 or beyond. Therefore, it cannot predict whether the price of oil will
have a material effect on it synthetic fuel business after 2004. However,
if during 2005 through 2007, oil prices remain at historically high levels
or increase, the Company's synthetic fuel business may be adversely
affected for those years and, depending on the magnitude of such increases
in oil prices, the adverse affect for those years could be material and
could have an impact on the Company's results of operations and synthetic
fuel production plans.
In response to the historically high oil prices to date in 2005, the
Company adjusted its planned production schedule for its synthetic fuel
facilities by shifting some of its production planned for April and May
2005 to the second half of 2005. If oil prices rise and stay at levels high
enough to cause a phase out of tax credits, the Company may reduce planned
production or suspend production at some or all of its synthetic fuel
facilities.
SALE OF PARTNERSHIP INTEREST
In June 2004, the Company, through its subsidiary Progress Fuels, sold in
two transactions a combined 49.8% partnership interest in Colona Synfuel
Limited Partnership, LLLP, one of its synthetic fuel facilities.
Substantially all proceeds from the sales will be received over time, which
is typical of such sales in the industry. Gain from the sales will be
recognized on a cost recovery basis as the facility produces and sells
synthetic fuel and when there is persuasive evidence that the sales
proceeds have become fixed or determinable and collectability is reasonably
assured. Based on projected production and tax credit levels, the Company
anticipates receiving total gross proceeds of approximately $22 million in
2005, approximately $32 million in 2006, approximately $34 million in 2007
and approximately $10 million through the second quarter of 2008. Gain
recognition is dependent on the synthetic fuel production qualifying for
Section 29 tax credits and the value of such tax credits as discussed
above. Until the gain recognition criteria are met, gains from selling
interests in Colona will be deferred. It is possible that gains will be
deferred in the first, second and/or third quarters of each year until
there is persuasive evidence that no tax credit phase out will occur for
the applicable calendar year. This could result in shifting earnings from
earlier quarters to later quarters in a calendar year. In the event that
the synthetic fuel tax credits from the Colona facility are reduced,
including an increase in the price of oil that could limit or eliminate
synthetic fuel tax credits, the amount of proceeds realized from the sale
could be significantly impacted. As of June 30, 2005, a pre-tax gain on
monetization of $6 million has been deferred. Assuming oil prices stay at
current levels, the Company anticipates that this gain will be recognized
later this year.
32
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 and disclosures
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 or
results of operation.
33
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 and the Risk
Factors section of the Florida Progress and Progress Energy Florida annual
report on Form 10-K for the year-ended December 31, 2004.
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 2004 Form
10-K. See Note 13 for a discussion of environmental matters.
OPERATING RESULTS
The Company's segments contributed segment profits or losses from continuing
operations for the three and six months ended June 30, 2005 and 2004 as follows:
- --------------------------------------------------------------------------------------------
(in millions) Three Months Ended June 30 Six Months Ended June 30
- --------------------------------------------------------------------------------------------
Business Segment 2005 2004 2005 2004
- --------------------------------------------------------------------------------------------
PEF $ 10 $ 84 $ 53 $ 133
Energy and Related Services 12 17 23 27
Synthetic Fuels 13 21 13 47
Other (34) 7 (43) (31)
----------------------------------------------------------
Segment profit/(loss) $ 1 $ 129 $ 46 $ 176
- --------------------------------------------------------------------------------------------
Prior to 2005, Rail Services was reported as a separate segment. In connection
with the divestiture of Progress Rail (see Note 3), the operations of Rail
Services were reclassified to discontinued operations in the first quarter of
2005 and therefore are no longer a reportable segment. In addition, Synthetic
Fuel activities were reported in the Energy and Related Services segment prior
to 2005 and now are considered a separate reportable segment. These reportable
segment changes reflect the current reporting structure. For comparative
purposes, the prior year results have been restated to conform to the current
presentation.
COST MANAGEMENT INITIATIVE
On February 28, 2005, as part of a previously announced cost management
initiative, Progress Energy approved a workforce restructuring which is expected
to be completed in September 2005. In addition to the workforce restructuring,
the cost management initiative included a voluntary enhanced retirement program.
In connection with this initiative, the Company incurred approximately $113
million of pre-tax charges for severance and postretirement benefits during the
six months ended June 30, 2005, as described below. Of this amount, $107 million
was recorded by PEF.
The Company recorded $15 million of severance expense during the first quarter
of 2005 for the workforce restructuring and implementation of an automated meter
reading initiative at PEF. The workforce restructuring expense was computed
based on the approximate number of positions to be eliminated. This amount
included approximately $4 million of severance costs allocated from Progress
Energy Service Company (PESC). During the second quarter of 2005, 692 of the
Company's employees eligible for participation in the voluntary enhanced
retirement plan elected to participate, including 680 PEF employees.
Consequently, in the second quarter of 2005, the Company decreased its estimated
severance costs by $6 million due to the impact of the employees electing
participation in the voluntary enhanced retirement plan. This amount included
approximately $2 million of decreased severance costs allocated from PESC. The
severance expenses are primarily included in O&M expense on the Consolidated
Statements of Income and will be paid over time.
The Company recorded a $93 million charge in the second quarter of 2005 related
to postretirement benefits that will be paid over time to eligible employees who
elected to participate in the voluntary enhanced retirement program (see Note
8). In addition, the Company recorded approximately $10 million of
postretirement benefits and early retirement incentives allocated from PESC.
34
The cost management initiative charges are subject to revision in future
quarters based on completion of the workforce restructuring and the potential
additional impacts that the early retirements and outplacements may have on the
postretirement plans. Such revisions may be significant and may adversely impact
the Company's and PEF's results of operations in future periods. In addition,
the Company expects to incur certain incremental costs for recruiting and staff
augmentation activities that cannot be quantified at this time.
PROGRESS ENERGY FLORIDA
PEF contributed segment profits of $10 million and $84 million for the three
months ended June 30, 2005 and 2004, respectively. The decrease in profits for
the three months ended June 30, 2005 when compared to 2004 is primarily due to
higher O&M expenses (as a result of postretirement and severance costs, the
write-off of unrecovered storm costs and the change in accounting estimates for
certain Energy Delivery capital costs), the impact of milder weather and lower
average retail usage per customer, partially offset by higher wholesale sales,
favorable provision for rate refund, favorable retail customer growth and the
gain on the sale of the Winter Park distribution system.
PEF contributed segment profits of $53 million and $133 million for the six
months ended June 30, 2005 and 2004, respectively. The decrease in profits for
the six months ended June 30, 2005 when compared to 2004 is primarily due to
higher O&M expenses (as a result of postretirement and severance costs and the
write-off of unrecovered storm costs and the change in accounting estimates for
certain Energy Delivery capital costs), lower average usage per retail customer
and the impact of milder weather partially offset by higher wholesale sales,
favorable provision for rate refund, favorable retail customer growth and the
gain on the sale of the Winter Park distribution system.
Three months ended June 30, 2005 as compared to the three months ended June 30,
2004
Revenues
PEF's electric revenues for the three months ended June 30, 2005 and 2004, and
the amount and percentage change by customer class are as follows:
- --------------------------------------------------------------------
Three Months Ended June 30,
(in millions of $)
2005 Change % Change 2004
Customer Class
- --------------------------------------------------------------------
Residential $ 431 $ 9 2.1 $ 422
Commercial 227 13 6.1 214
Industrial 71 5 7.6 66
Governmental 57 5 9.6 52
Retail revenue sharing 2 5 - (3)
- ------------------------------------------------- -------
Total retail revenues 788 37 4.9 751
Wholesale 68 15 28.3 53
Unbilled 18 (6) - 24
Miscellaneous 34 2 6.3 32
- ------------------------------------------------- -------
Total electric revenues $ 908 $ 48 5.6 $ 860
- ------------------------------------------------- -------
Less:
- ------------------------------------------------- -------
Pass-through revenues (527) (49) (10.3) (478)
- ------------------------------------------------- -------
Revenues excluding pass-
through revenues $ 381 $ (1) (0.3) $382
- --------------------------------------------------------------------
35
PEF's electric energy sales for the three months ended June 30, 2005 and 2004,
and the amount and percentage change by customer class are as follows:
- ----------------------------------------------------------------------
Three Months Ended June 30,
(in millions of kWh)
2005 Change % Change 2004
Customer Class
- ----------------------------------------------------------------------
Residential 4,341 (164) (3.6) 4,505
Commercial 2,888 (53) (1.8) 2,941
Industrial 1,040 (11) (1.0) 1,051
Governmental 762 11 1.5 751
- -------------------------------------------------- --------
Total retail energy sales 9,031 (217) (2.3) 9,248
Wholesale 1,318 225 20.6 1,093
Unbilled 428 (362) - 790
- -------------------------------------------------- --------
Total kWh sales 10,777 (354) (3.2) 11,131
- ----------------------------------------------------------------------
PEF's revenues, excluding recoverable fuel and other pass-through revenues of
$527 million and $478 million for the three months ended June 30, 2005 and 2004,
respectively, decreased $1 million. The decrease in revenues is due to
unfavorable average usage per retail customer of $13 million and the impact of
milder weather of $5 million with heating degree days and cooling degree days
43% and 7% below prior year, respectively. These decreases were partially offset
by favorable provision for rate refund of $5 million (due to lower base revenues
as discussed above and higher revenue sharing threshold in 2005), favorable
retail customer growth of $6 million and favorable wholesale revenues of $4
million. Wholesale revenue favorability is attributable primarily to new
contracts entered into subsequent to June 2004.
Expenses
Fuel and Purchased Power
Fuel and purchased power costs represent the costs of generation, which include
fuel purchases for generation, as well as energy purchased in the market to meet
customer load. Fuel and purchased power expenses are recovered primarily through
cost recovery clauses, and, as such changes in these expenses do not have a
material impact on earnings. The difference between fuel and purchased power
costs incurred and associated fuel revenues that are subject to recovery is
deferred for future collection from or refund to customers.
Fuel and purchased power expenses were $457 million for the three months ended
June 30, 2005, which represents a $42 million increase compared to prior year.
This increase is due to increases in fuel used in electric generation and
purchased power expenses of $37 million and $5 million, respectively. Increased
fuel costs in the current year account for $12 million of the increase in fuel
used in electric generation. The remaining increase was due to an increase in
deferred fuel expense as recovery of fuel expenses in the current year was
greater than in the prior year. In December 2004, the FPSC approved PEF's
request for a cost recovery adjustment in its annual filing due to the rising
cost of fuel. Fuel recovery rates increased effective January 1, 2005. The
increase in purchased power expense was primarily due to higher prices of
purchases in the current year as a result of increased fuel costs.
Operations and Maintenance (O&M)
O&M expenses were $288 million for the three months ended June 30, 2005, which
represents an increase of $136 million, when compared to the $152 million
incurred during the three months ended June 30, 2004. Postretirement and
severance expense related to the cost management initiative increased O&M costs
by $93 million during 2005. In addition, PEF wrote-off $17 million of
unrecoverable storm costs associated with the 2004 hurricanes (see Note 5 to the
Consolidated Interim Financial Statements). O&M expense also increased $9
million related to the change in accounting estimates for certain Energy
Delivery capital costs. See discussion of change in Energy Delivery
capitalization practice in Note 8D of the Florida Progress annual report on Form
10-K for the year ended December 31, 2004. The remaining increase in O&M expense
is attributable to higher environmental cost recovery expenses (primarily
emission allowances) of $6 million and a $3 million bad debt reserve recorded
during the period. The environmental cost recovery expenses are pass-through
expenses and have no impact on earnings.
36
Other income, net
Other income, net has increased $24 million for the three months ended June 30,
2005 as compared to the prior year. This increase was due primarily to the
pre-tax gain recognized on the sale of the Winter Park distribution system of
$25 million (see Note 5 to the Consolidated Interim Financial Statements). In
addition, the equity component of the allowance for funds used during
construction increased $3 million as a result of the Hines Unit 3 & Unit 4
construction projects. These favorable items were offset partially by the FERC
Code of Conduct audit settlement that required $3 million to be refunded to
customers (see discussion in Note 12 to the Consolidated Interim Financial
Statements).
Interest charges, net
Total interest charges, net increased $4 million to $32 million for the three
months ended June 30, 2005 as compared to $28 million for the three months ended
June 30, 2004. This increase is due primarily to additional commercial paper and
internal money pool borrowings related to unrecovered storm costs.
Income tax expense
GAAP requires companies to apply a levelized effective tax rate to interim
periods that is consistent with the estimated annual effective tax rate. Income
tax expense was increased by $8 million for the three months ended June 30,
2005, in order to maintain an effective tax rate consistent with the estimated
annual rate. Fluctuations in estimated annual earnings and the timing of various
permanent and temporary deductions can also cause swings in the effective tax
rate for interim periods. Therefore, this adjustment will vary each quarter, but
will have no effect on net income for the year. The remaining fluctuation in
income tax expense is attributable to reduced earnings compared to prior period.
Six months ended June 30, 2005 as compared to six months ended June 30, 2004
Revenues
PEF's electric revenues for the six months ended June 30, 2005 and 2004, and the
amount and percentage change by customer class are as follows:
- ----------------------------------------------------------------------
Six Months Ended June 30,
(in millions of $)
2005 Change % Change 2004
Customer Class
- ----------------------------------------------------------------------
Residential $ 861 $ 37 4.5 $ 824
Commercial 428 33 8.4 395
Industrial 134 6 4.7 128
Governmental 110 11 11.1 99
Retail revenue sharing - 7 - (7)
- -------------------------------------------------- --------
Total retail revenues $ 1,533 $ 94 6.5 $ 1,439
Wholesale 142 22 18.3 120
Unbilled 13 (5) - 18
Miscellaneous 68 1 1.5 67
- -------------------------------------------------- --------
Total electric revenues $ 1,756 $ 112 6.8 $ 1,644
- -------------------------------------------------- --------
Less:
- -------------------------------------------------- --------
Pass-through revenues (1,028) (103) (11.1) (925)
- -------------------------------------------------- --------
Revenues excluding pass-
through revenues $ 728 $ 9 1.3 $ 719
- -----------------------------------------------------------------------
37
PEF's electric energy sales for the six months ended June 30, 2005 and 2004, and
the amount and percentage change by customer class are as follows:
- ------------------------------------------------------------------------
Six Months Ended June 30,
(in millions of kWh)
2005 Change % Change 2004
Customer Class
- ------------------------------------------------------------------------
Residential 8,688 (109) (1.2) 8,797
Commercial 5,459 28 0.5 5,431
Industrial 1,981 (93) (4.5) 2,074
Governmental 1,471 48 3.4 1,423
- -------------------------------------------------- ----------
Total retail energy sales 17,599 (126) (0.7) 17,725
Wholesale 2,655 240 9.9 2,415
Unbilled 325 (330) - 655
- -------------------------------------------------- ----------
Total kWh sales 20,579 (216) (1.0) 20,795
- ------------------------------------------------------------------------
PEF's revenues, excluding recoverable fuel and other pass-through revenues of
$1.028 billion and $925 million for the six months ended June 30, 2005 and 2004,
respectively, increased $9 million. The increase in revenues is due to favorable
retail customer growth, increased wholesale revenues and the favorable provision
for rate refund of $12 million, $11 million and $7 million, respectively.
Wholesale revenue improvement is attributable primarily to new contracts entered
into subsequent to May 2004. These increases were partially offset by lower
average usage per retail customer of $12 million, and the impact of milder
weather in the current year of $7 million with heating degree days 18% below the
prior year. In addition, weaker industrial sales reduced revenues $2 million.
Expenses
Fuel and Purchased Power
Fuel and purchased power costs represent the costs of generation, which include
fuel purchases for generation, as well as energy purchased in the market to meet
customer load. Fuel and purchased power expenses are recovered primarily through
cost recovery clauses, and, as such changes in these expenses do not have a
material impact on earnings. The difference between fuel and purchased power
costs incurred and associated fuel revenues that are subject to recovery is
deferred for future collection from or refund to customers.
Fuel and purchased power expenses were $890 million for the six months ended
June 30, 2005, which represents an $85 million increase compared to prior year.
This increase is due to increases in fuel used in electric generation and
purchased power expenses of $70 million and $15 million, respectively. Higher
system requirements and increased fuel costs in the current year account for $52
million of the increase in fuel used in electric generation. The remaining
increase was due to an increase in deferred fuel expense as recovery of fuel
expenses in the current year was greater than in the prior year. In December
2004, the FPSC approved PEF's request for a cost recovery adjustment in its
annual filing due to the rising cost of fuel. Fuel recovery rates increased
effective January 1, 2005. The increase in purchased power expense was primarily
due to higher prices of purchases in the current year as a result of increased
fuel costs.
Operations and Maintenance (O&M)
O&M expenses were $477 million for the six months ended June 30, 2005, which
represents an increase of $165 million, when compared to the $312 million
incurred during the six months ended June 30, 2004. Postretirement and severance
costs associated with the cost management initiative increased O&M costs by $107
million during 2005. In addition, PEF wrote-off $17 million of unrecoverable
storm costs associated with the 2004 hurricanes (see Note 5 to the Consolidated
Interim Financial Statements). O&M expense also increased $17 million related to
the change in accounting estimates for certain Energy Delivery capital costs.
See discussion of change in Energy Delivery capitalization practice in Note 8D
of the Florida Progress annual report on Form 10-K for the year ended December
31, 2004. O&M expense increased $11 million due to higher environmental cost
recovery expenses (primarily emission allowances). The environmental cost
recovery expenses are pass-through expense and have no impact on earnings. The
remaining increase in O&M expense is attributable to an $8 million workers
compensation benefit adjustment recorded in 2005 as a result of an actuarial
study.
38
Other income, net
Other income, net has increased $28 million for the six months ended June 30,
2005 as compared to the prior year. This increase was due primarily to the
pre-tax gain recognized on the sale of the Winter Park distribution system of
$25 million (see Note 5 to the Consolidated Interim Financial Statements). In
addition, the equity component of the allowance for funds used during
construction increased $5 million as a result of the Hines Unit 3 & Unit 4
construction projects. These favorable items were offset partially by the FERC
Code of Conduct audit settlement that required $3 million to be refunded to
customers (see discussion in Note 12 of the Consolidated Interim Financial
Statements).
Interest charges, net
Total interest charges, net increased $6 million to $64 million for the six
months ended June 30, 2005 as compared to $58 million for the six months ended
June 30, 2004. This increase is due primarily to additional commercial paper and
internal money pool borrowings related to unrecovered storm costs.
Income tax expense
GAAP requires companies to apply a levelized effective tax rate to interim
periods that is consistent with the estimated annual effective tax rate. Income
tax expense was increased by $8 million for the six months ended June 30, 2005,
in order to maintain an effective tax rate consistent with the estimated annual
rate. Fluctuations in estimated annual earnings and the timing of various
permanent and temporary deductions can also cause swings in the effective tax
rate for interim periods. Therefore, this adjustment will vary each quarter, but
will have no effect on net income for the year. The remaining fluctuation in
income tax expense is attributable to reduced earnings compared to prior year.
DIVERSIFIED BUSINESSES
The Company's diversified businesses consist of the Energy and Related Services
segment and the Synthetic Fuels segment. These businesses are explained in more
detail below.
ENERGY AND RELATED SERVICES
The Energy and Related Services' segment operations include natural gas
production, coal extraction and terminal operations. The following summarizes
Energy and Related Services' segment profits for the three and six months ended
June 30, 2005 and 2004:
- ----------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
- ----------------------------------------------------------------------------------------------
(in millions) 2005 2004 2005 2004
- ----------------------------------------------------------------------------------------------
Gas production $ 12 $ 12 $ 24 $ 25
Coal fuel and other operations - 5 (1) 2
- ----------------------------------------------------------------------------------------------
Segment Profits $ 12 $ 17 $ 23 $ 27
- ----------------------------------------------------------------------------------------------
Natural Gas Operations
Natural gas operations generated profits of $12 million for both of the three
months ended June 30, 2005 and 2004, and $24 million and $25 million for the six
months ended June 30, 2005 and 2004, respectively. The decrease in gas earnings
compared to prior year is attributable to reduced production as a result of the
sale of gas assets in 2004 offset partially by higher natural gas prices. In
addition, results for the six months ended June 30, 2005 were negatively
impacted by a reduction in capitalized interest of $3 million pre-tax. In
December 2004, the Company sold certain gas-producing properties and related
assets owned by Winchester Production Company, Ltd., a subsidiary of Progress
Fuels (North Texas gas operations). The following summarizes the gas production,
revenues and gross margins for the three and six months ended June 30, 2005 and
2004 by production facility:
39
- ------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
- ------------------------------------------------------------------------------------------------
2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------
Production in Bcf equivalent
East Texas/LA gas operations 6.0 4.9 11.4 9.0
North Texas gas operations - 2.7 - 5.3
- ------------------------------------------------------------------------------------------------
Total Production 6.0 7.6 11.4 14.3
- ------------------------------------------------------------------------------------------------
Revenues in millions
East Texas/LA gas operations $ 39 $ 27 $ 72 $ 48
North Texas gas operations - 13 - 27
- ------------------------------------------------------------------------------------------------
Total Revenues $ 39 $ 40 $ 72 $ 75
- ------------------------------------------------------------------------------------------------
Gross Margin
in millions of $ $ 30 $ 33 $ 58 $ 60
As a % of revenues 77% 83% 81% 80%
- ------------------------------------------------------------------------------------------------
Coal Fuel and Other Operations
Coal fuel and other operations earnings were essentially break even for the
three months ended June 30, 2005 compared to segment profits of $5 million for
the three months ended June 30, 2004. The decrease in earnings compared to the
prior period is due to higher coal mining costs (due to rising prices of fuel
and steel) and reduced sales volumes due to the expiration of several contracts
in the current year. In addition, results were unfavorably impacted by
postretirement and severance costs of $4 million pre-tax recorded during 2005
related to the cost management initiative.
Coal fuel and other operations generated segment losses of $1 million for the
six months ended June 30, 2005 compared to segment profit of $2 million for the
six months ended June 30, 2004. The decrease in earnings of $3 million is due
primarily to higher coal mining costs of $11 million pre-tax (due to rising
prices of fuel and steel) , a workers compensation accrual adjustment booked
during the first quarter of 2005 of $5 million pre-tax and postretirement and
severance costs of $6 million pre-tax as a part of the cost management
initiative. This unfavorability was partially offset by increased revenues as a
result of higher coal prices.
The Company is exploring strategic alternatives regarding the Energy and Related
Services' coal mining business, which could include divesting these assets. As
of June 30, 2005, the carrying value of long-lived assets of the coal mining
business was $65 million. The Company cannot currently predict the outcome of
this matter.
SYNTHETIC FUEL
The synthetic fuel operations generated segment profits of $13 million and $21
million for the three months ended June 30, 2005 and 2004, and $13 million and
$47 million for the six months ended June 30, 2005 and 2004, respectively. The
production and sale of coal-based solid synthetic fuel generate operating
losses, but qualify for tax credits under Section 29 of the Code, which
typically more than offset the effect of such losses. See Note 14 to the
Consolidated Interim Financial Statements.
The operations resulted in the following for the three and six months ended June
30, 2005 and 2004:
- ---------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
- ---------------------------------------------------------------------------------------------------
(in millions) 2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------------
Tons sold 1.4 1.5 2.5 3.4
- ---------------------------------------------------------------------------------------------------
Operating losses, excluding tax credits $ (23) $ (16) $ (43) $ (40)
Tax credits generated, net 36 37 56 87
- ---------------------------------------------------------------------------------------------------
Segment profits $ 13 $ 21 $ 13 $ 47
- ---------------------------------------------------------------------------------------------------
Synthetic fuels' earnings for the three months ended June 30, 2005, as compared
to the prior period were negatively impacted by lower sales and higher
production costs. The decrease in sales is due primarily to an internal change
in the quarterly production schedule in 2005 compared to 2004.
40
Synthetic fuels' earnings for the six months ended June 30, 2005, as compared to
the prior period were negatively impacted by lower sales and the forfeiture of
tax credits as a result of the sale of Progress Rail. The decrease in sales year
over year is primarily attributable to an internal change in the quarterly
production schedule in 2005 compared to 2004. The sale of Progress Rail resulted
in a capital loss for tax purposes, therefore $11 million of previously recorded
tax credits were forfeited during the current year. See Note 14 to the
Consolidated Interim Financial Statements for further discussion.
In response to the historically high oil prices to date in 2005, the Company
adjusted its planned production schedule for its synthetic fuel plant by
shifting some of its production planned for April and May 2005 to the second
half of 2005. If oil prices rise and stay at levels high enough to cause a phase
out of tax credits, the Company may reduce planned production or suspend
production at some or all of its synthetic fuel facilities.
OTHER
The Other segment includes telecommunications, holding company and financing
expenses.
Other segment profits decreased $41 million and $12 million, respectively, for
the three and six months ended June 30, 2005 compared to the same periods in the
prior year. This decrease was due primarily to the impact of tax levelization
adjustments booked during the periods. GAAP requires companies to apply a
levelized effective tax rate to interim periods that is consistent with the
estimated annual effective tax rate. Income tax expense was increased by $31
million for the three months ended June 30, 2005 compared to a reduction in tax
expense of $11 million for the three months ended June 30, 2004, in order to
maintain an effective tax rate consistent with the estimated annual rate. For
the six months ended June 30, 2005 income tax expense was increased $36 million
compared to an increase of $23 million for the six months ended June 30, 2004.
The tax credits associated with the Company's synthetic fuel operations
primarily drive the required levelization amount. Fluctuations in estimated
annual earnings and tax credits can also cause large swings in the effective tax
rate for interim periods. Therefore, this adjustment will vary each quarter, but
will have no effect on net income for the year.
DISCONTINUED OPERATIONS
On March 24, 2005, the Company completed the sale of Progress Rail to One Equity
Partners LLC, a private equity firm unit of J.P. Morgan Chase & Co. Gross cash
proceeds from the sale are estimated to be approximately $430 million,
consisting of $405 million base proceeds plus an estimated working capital
adjustment. Proceeds from the sale were used to reduce debt. The accompanying
consolidated interim financial statements have been restated for all periods
presented for the discontinued operations of Progress Rail. See Note 3 for
additional discussion.
Rail discontinued operations resulted in losses of $9 million for the three
months ended June 30, 2005 compared to profits of $6 million for the three
months ended June, 2004. Earnings for 2005 include an adjustment of $9 million
to the estimated after-tax loss on the sale related to working capital
adjustments and revisions of other operating estimates. Results for 2004 include
three months of operations. Results for the three months ended June 30,2 005 do
not include any income or loss from operations as the sale closed in the first
quarter. See discontinued earnings summary included at Note 3 to the
Consolidated Interim Financial Statements.
Rail discontinued operations resulted in losses of $36 million for the six
months ended June 30, 2005 compared to profits of $14 million for the six months
ended June 30, 2004. Earnings for 2005 include an estimated after-tax loss on
the sale of $41 million. Results for 2004 included six months of earnings
activity compared to only three months in 2005.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows from Operations
The Company's net cash provided by operating activities was $203 million for the
six months ended June 30, 2005, compared to $442 million for the six months
ended June 30, 2004. The decrease in operating cash flow was due primarily to a
$256 million increase in working capital requirements at Progress Fuels and PEF
and storm restoration expenditures at PEF, as explained below. The increase in
working capital requirements at Progress Fuels is primarily due to a $32 million
reduction in tax liabilities related to the loss on disposal of Rail (see Note 3
of the Notes to Interim Financial Statements) and $42 million in synthetic fuel
royalty payments (see Note 14C of the Notes to Interim Financial Statements).
41
PEF's net cash provided by operating activities was $244 million for the six
months ended June 30, 2005, compared to $442 million for the six months ended
June 30, 2004. The decrease in operating cash flow was due primarily to payment
of approximately $63 million in storm restoration expenditures and a $142
million increase in working capital requirements, largely driven by timing of
settlement of payables to affiliates and differences in estimated tax payments.
Investing Activities
The Company's net cash provided by investing activities was $25 million for the
six months ended June 30, 2005, compared to cash used in investing activities of
$244 million for the six months ended June 30, 2004. The increase is primarily
due to proceeds of approximately $405 million from the sale of Progress Rail
(See Note 3), partially offset by the purchase of natural gas assets at Progress
Fuels in May 2005 (see Note 4 of the Notes to Interim Financial Statements) and
nuclear fuel and property additions at PEF, as explained below.
PEF's net cash used in investing activities was $249 million for the six months
ended June 30, 2005, compared to $230 million for the six months ended June 30,
2004. The increase in cash used in investing activities is primarily due to $23
million in additional capital expenditures in 2005, primarily related to the
Hines 4 plant, and $34 million in nuclear fuel additions related to a planned
outage later in 2005. These increases were partially offset by $42 million in
proceeds from the sale of Winter Park assets (see Note 14D of the Notes to
Interim Financial Statements).
Financing Activities
In January 2005, PEF used proceeds from the issuance of commercial paper to pay
off $170 million of revolving credit agreement (RCA) loans. PEF subsequently
used money pool borrowings to reduce commercial paper. In February 2005, PEF
used proceeds from money pool borrowings to pay off $55 million of RCA loans.
On March 28, 2005, PEF entered into a new $450 million five-year RCA with a
syndication of financial institutions. The RCA will be used to provide liquidity
support for PEF's issuances of commercial paper and other short-term
obligations. The RCA will expire on March 28, 2010. The new $450 million RCA
replaced PEF's $200 million three-year RCA and $200 million 364-day RCA, which
were each terminated effective March 28, 2005. Fees and interest rates under the
$450 million RCA are to be determined based upon the credit rating of PEF's
long-term unsecured senior non-credit enhanced debt, currently rated as A3 by
Moody's Investor Services (Moody's) and BBB by Standard and Poor's (S&P). The
RCA includes a defined maximum total debt to capital ratio of 65%. The RCA also
contains various cross-default and other acceleration provisions, including a
cross-default provision for defaults of indebtedness in excess of $35 million.
The RCA does not include a material adverse change representation for borrowings
or a financial covenant for interest coverage, which had been provisions in the
terminated agreements.
On May 16, 2005, PEF issued $300 million of First Mortgage Bonds, 4.50% Series
due 2010. The net proceeds from the sale of the bonds were used to reduce the
outstanding balance of commercial paper.
On July 1, 2005, PEF paid at maturity $45 million of its 6.72% Medium-Term
Notes, Series B with short-term debt proceeds.
On July 28, 2005, PEF filed a shelf registration statement with the SEC to
provide an additional $1.0 billion of capacity in addition to the $450 million
remaining on PEF's current shelf registration statement. The shelf registration
statement will allow PEF to issue various securities, including First Mortgage
Bonds, Debt Securities and Preferred Stock.
Future Liquidity and Capital Resources
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.
On April 29, 2005, PEF made its initial filing with the FPSC seeking annual base
revenue increase of $206 million (See Note 5). Hearings for this proceeding are
expected to occur during the third quarter of 2005. A final ruling from the FPSC
is expected in December 2005 with new rates in effect January 2006.
On June 21, 2005, the FPSC ruled that PEF will recover $232 million of storm
costs over a two-year period. PEF's initial petition was for $252 million. The
final order was received on July 14, 2005.
42
On June 1, 2005, Florida Governor Jeb Bush signed into law a bill that would
allow utilities to petition the FPSC to use securitized bonds to recover storm
related costs. PEF intends to ask the FPSC for approval to issue securitized
debt. This arrangement would benefit the Company by providing immediate cash
recovery of the hurricane costs and would benefit the customer by providing a
longer recovery period, which will reduce the price impact on monthly bills.
Assuming FPSC approval, PEF expects the process to take six to nine months to
complete.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
The Company and PEF's off-balance sheet arrangements and contractual obligations
are described below.
Guarantees
As of June 30, 2005, the Company has issued guarantees and indemnifications of
certain legal, tax and environmental matters to third parties in connection with
sales of businesses and for timely payment of obligations in support of its
non-wholly owned synthetic fuel operations. Related to the sales of businesses,
the notice period extends until 2012 for the majority of matters provided for in
the indemnification provisions. For matters for which the Company has received
timely notice, the Company's indemnity obligations may extend beyond the notice
period. Certain environmental indemnifications related to the sale of synthetic
fuel operations have no limitations as to time or maximum potential future
payments. Other guarantees and indemnifications have an estimated maximum
exposure of approximately $152 million. As of June 30, 2005, the Company has
recorded liabilities related to guarantees and indemnifications to third-parties
of $27 million. Management does not believe conditions are likely for
significant performance under these agreements in excess of the recorded
liabilities.
Market Risk and Derivatives
The Company and PEF, are exposed to various risks related to changes in market
conditions. The Company's and PEF's parent, Progress Energy, has a risk
management committee that 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 and PEF manage market risk in accordance with its established risk
management policies, which may include entering into various derivative
transactions. The Company and PEF may use a variety of instruments, including
swaps, options and forward contracts, to manage exposure to fluctuations in
commodity prices and interest rates. See Note 9 for a discussion of market risk
and derivatives.
Contractual Obligations
As of June 30, 2005, the Company's and PEF's contractual cash obligations and
other commercial commitments have not changed materially from what was reported
in the 2004 Annual Report on Form 10-K.
NEW ACCOUNTING STANDARDS
See Note 2 to the Financial Statements for a discussion of the anticipated
impact of new accounting standards.
43
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 the Securities Exchange Act of 1934, Florida Progress carried out an
evaluation, and with the participation of its management, including Florida
Progress' Chief Executive Officer and Chief Financial Officer, of the
effectiveness of Florida Progress' disclosure controls and procedures (as
defined under the Securities Exchange Act of 1934) as of the end of the period
covered by this report. Based upon that evaluation, Florida Progress' Chief
Executive Officer and Chief Financial Officer concluded that its disclosure
controls and procedures are effective to ensure that information required to be
disclosed by Florida Progress (including its consolidated subsidiaries) in the
reports that it files or submits under the Exchange Act, is recorded, processed,
summarized and reported, within the time periods specified in the SEC's rules
and forms, and that such information is accumulated and communicated to Florida
Progress' management, including the Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding required
disclosure.
On May 24, 2005, Progress Energy announced that Jeffrey M. Stone was appointed
to the position of Controller (Chief Accounting Officer) of Progress Energy,
Inc. and its subsidiary, Florida Progress Corporation, effective June 1, 2005.
Mr. Stone will also serve as Controller of Florida Power Corporation d/b/a
Progress Energy Florida, Inc. These positions were previously held by Robert H.
Bazemore, Jr. since 2000. Mr. Bazemore has been reassigned to the position of
Vice President, Capital Planning and Control for Progress Energy.
Other than the above-referenced item, there has been no change in Florida
Progress' internal control over financial reporting during the quarter ended
June 30, 2005, that has materially affected, or is reasonably likely to
materially affect, Florida Progress' internal control over financial reporting.
Progress Energy Florida, Inc.
Pursuant to the Securities Exchange Act of 1934, PEF carried out an evaluation,
and with the participation of its management, including PEF's Chief Executive
Officer and Chief Financial Officer, of the effectiveness of PEF's disclosure
controls and procedures (as defined under the Securities Exchange Act of 1934)
as of the end of the period covered by this report. Based upon that evaluation,
PEF's Chief Executive Officer and Chief Financial Officer concluded that its
disclosure controls and procedures are effective to ensure that information
required to be disclosed by PEF in the reports that it files or submits under
the Exchange Act, is recorded, processed, summarized and reported, within the
time periods specified in the SEC's rules and forms, and that such information
is accumulated and communicated to PEF's management, including the Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure.
On May 24, 2005, Progress Energy announced that Jeffrey M. Stone was appointed
to the position of Controller (Chief Accounting Officer) of the Company and its
subsidiary, Florida Progress Corporation (FPC), effective June 1, 2005. Mr.
Stone will also serve as Controller of Florida Power Corporation d/b/a Progress
Energy Florida, Inc. (PEF). These positions were previously held by Robert H.
Bazemore, Jr. since 2000. Mr. Bazemore has been reassigned to the position of
Vice President, Capital Planning and Control for Progress Energy.
Other than the above-referenced item, there has been no change in PEF's internal
control over financial reporting during the quarter ended June 30, 2005, that
has materially affected, or is reasonably likely to materially affect, PEF's
internal control over financial reporting.
44
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
Legal aspects of certain matters are set forth in Part I, Item 1. See Note 14 to
the Company's Consolidated Interim Financial Statements.
Item 6. EXHIBITS
(a) Exhibits:
Exhibit Florida Progress Progress Energy
Number Description Corporation Florida, Inc.
------ ----------- ----------- -------------
10 Amendment to Employment Agreement Between Progress X
Energy Service Company, LLC and Peter M. Scott III,
dated August 5, 2005
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
45
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: August 5, 2005 By: /s/ Geoffrey Chatas
-------------------
Geoffrey Chatas
Executive Vice President and
Chief Financial Officer
By: /s/ Jeffrey M. Stone
---------------------
Jeffrey M. Stone
Controller and Chief Accounting Officer
Florida Progress Corporation
Controller - Florida Power Corporation
46