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 of I.R.S. Employer
Commission incorporation, address of principal executive offices, and telephone Identification
File Number number Number
1-15929 Progress Energy, Inc. 56-2155481
410 South Wilmington Street
Raleigh, North Carolina 27601-1748
Telephone: (919) 546-6111
State of Incorporation: North Carolina
1-3382 Carolina Power & Light Company 56-0165465
d/b/a Progress Energy Carolinas, Inc.
410 South Wilmington Street
Raleigh, North Carolina 27601-1748
Telephone: (919) 546-6111
State of Incorporation: North Carolina
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
registrants were 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 Progress Energy, Inc. (Progress Energy) is an
accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No __ -
Indicate by check mark whether Carolina Power & Light Company is an accelerated
filer (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
---------- ----------- ------
Progress Energy Common Stock (Without Par Value) 251,227,350
PEC Common Stock (Without Par Value) 159,608,055 (all of which
were held by Progress Energy, Inc.)
This combined Form 10-Q is filed separately by two registrants: Progress Energy
and Carolina Power & Light Company d/b/a Progress Energy Carolinas, Inc. (PEC).
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.
PROGRESS ENERGY, INC. AND PROGRESS ENERGY CAROLINAS, 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
Consolidated Interim Financial Statements:
Progress Energy, Inc.
--------------------------------------------------------------
Consolidated Statements of Income
Consolidated Balance Sheets
Consolidated Statements of Cash Flows
Notes to Consolidated Interim Financial Statements
Carolina Power & Light Company
d/b/a Progress Energy Carolinas, Inc.
---------------------------------------------------------------
Consolidated Statements of Income
Consolidated Balance Sheets
Consolidated Statements of Cash Flows
Notes to Consolidated Interim Financial Statements
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 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 4. Submission of Matters to a Vote of Security Holders
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
401(k) Progress Energy 401(k) Savings and Stock Ownership Plan
AFUDC Allowance for funds used during construction
the Agreement Stipulation and Settlement Agreement related to retail rate matters
ARO Asset retirement obligation
Bcf Billion cubic feet
Btu British thermal unit
CAIR Clean Air Interstate Rule
CAMR Clean Air Mercury Rule
CCO Competitive Commercial Operations business segment
CERCLA or Superfund Comprehensive Environmental Response, Compensation and Liability Act of
1980, as amended
The City The City of Winter Park, Florida
Code Internal Revenue Code
Colona Colona Synfuel Limited Partnership, LLLP
the Company Progress Energy, Inc. and subsidiaries
CP&L Carolina Power & Light Company d/b/a Progress Energy Carolinas, Inc.
CR3 Crystal River Unit No. 3
CVO Contingent value obligation
DOE United States Department of Energy
DWM North Carolina Department of Environment and Natural Resources, Division of
Waste Management
ECRC Environmental Cost Recovery Clause
EITF Emerging Issues Task Force
EMCs Electric Membership Cooperatives
EPA of 1992 Energy Policy Act of 1992
FASB Financial Accounting Standards Board
FDEP Florida Department of Environment and 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. 46R, "Consolidation of Variable Interest Entities -
an Interpretation of ARB No. 51"
Florida Progress or FPC Florida Progress Corporation
FPSC Florida Public Service Commission
Fuels Fuels business segment
GAAP Accounting Principles Generally Accepted in the United States of America
Global U.S. Global LLC
the holding company Progress Energy Corporate
IRS Internal Revenue Service
Jackson Jackson Electric Membership Corporation
LIBOR London Inter Bank Offering Rate
MACT Maximum Achievable Control Technology
Medicare Act Medicare Prescription Drug, Improvement and Modernization Act of 2003
MGP Manufactured Gas Plant
MW Megawatt
MWh Megawatt-hour
NCNG North Carolina Natural Gas Corporation
NCUC North Carolina Utilities Commission
NEIL Nuclear Electric Insurance Limited
Norfolk Southern Norfolk Southern Railway Company
NOx Nitrogen Oxide
3
NOx SIP Call EPA rule which requires 22
states including North Carolina and
South Carolina (but excluding Florida)
to further reduce nitrogen oxide
emissions.
NRC United States Nuclear Regulatory Commission
Nuclear Waste Act Nuclear Waste Policy Act of 1982
NYMEX New York Mercantile Exchange
O&M Operation and Maintenance Expense
OPEB Postretirement benefits other than pensions
PEC Progress Energy Carolinas, Inc., formerly referred to as Carolina Power &
Light Company
PEC Electric PEC Electric business segment made up of the utility operations and
excludes operations of nonregulated subsidiaries
PEF Progress Energy Florida, formerly referred to as Florida Power Corporation
PESC Progress Energy Service Company
PFA IRS Prefiling Agreement
PLR Private Letter Ruling
Progress Energy Progress Energy, Inc.
Progress Fuels Progress Fuels Corporation, formerly Electric Fuels Corporation
Progress Rail Progress Rail Services Corporation
Progress Ventures Business unit of Progress Energy primarily made up of nonregulated energy
generation and marketing activities, as well as gas, coal and synthetic
fuel operations
PRP Potentially responsible party, as defined in CERCLA
PTC Progress Telecommunications Corporation
PT LLC Progress Telecom, LLC
PUHCA Public Utility Holding Company Act of 1935, as amended
PVI Progress Energy Ventures, Inc. (formerly referred to as CPL Energy
Ventures, Inc.)
Rail Services Rail Services business segment
RCA Revolving credit agreement
ROE Return on Equity
SCPSC Public Service Commission of South Carolina
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 Statement of Financial Accounting Standards
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. 123R Statement of Financial Accounting Standards No. 123R, "Accounting for
Stock-Based Compensation"
SFAS No. 133 Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative and Hedging Activities"
SFAS No. 138 Statement of Financial Accounting Standards No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities - An
Amendment of FASB Statement No. 133"
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"
Smokestacks Act North Carolina Clean Smokestacks Act enacted in June 2002
SO2 Sulfur dioxide
SRS Strategic Resource Solutions Corp.
STB Surface Transportation Board
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, "Liquidity and Capital Resources"
about future liquidity requirements and "Other Matters" about the Company's
synthetic fuel facilities.
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 Progress Energy, Inc. (Progress Energy or the Company) nor Progress
Energy Carolinas, Inc. (PEC) 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 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 on 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 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 Progress Energy Florida's (PEF) 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 risk factors are detailed from time to time in the Company's and
PEC's filings with the United States Securities and Exchange Commission (SEC).
Many, but not all, of the factors that may impact actual results are discussed
in the Risk Factors sections of Progress Energy's and PEC's annual reports on
Form 10-K for the year ended December 31, 2004, which were filed with the SEC on
March 16, 2005. All such factors are difficult to predict, contain uncertainties
that may materially affect actual results and may be beyond the control of
Progress Energy and PEC. 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 Progress Energy and PEC.
5
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
PROGRESS ENERGY, INC.
CONSOLIDATED INTERIM FINANCIAL STATEMENTS
June 30, 2005
UNAUDITED CONSOLIDATED STATEMENTS of INCOME
Three Months Ended Six Months Ended
June 30 June 30
- ----------------------------------------------------------------------------------------------------------
(in millions except per share data) 2005 2004 2005 2004
- ----------------------------------------------------------------------------------------------------------
Operating revenues
Utility $1,768 $ 1,721 $ 3,551 $ 3,406
Diversified business 565 402 980 723
- ----------------------------------------------------------------------------------------------------------
Total operating revenues 2,333 2,123 4,531 4,129
- ----------------------------------------------------------------------------------------------------------
Operating expenses
Utility
Fuel used in electric generation 529 468 1,079 961
Purchased power 217 219 415 402
Operation and maintenance 543 372 949 735
Depreciation and amortization 207 207 415 409
Taxes other than on income 108 109 225 214
Diversified business
Cost of sales 539 388 934 699
Depreciation and amortization 43 42 82 83
Other 31 31 63 61
- ----------------------------------------------------------------------------------------------------------
Total operating expenses 2,217 1,836 4,162 3,564
- ----------------------------------------------------------------------------------------------------------
Operating income 116 287 369 565
- ----------------------------------------------------------------------------------------------------------
Other income (expense)
Interest income 4 4 8 6
Other, net 19 (3) 21 (25)
- ----------------------------------------------------------------------------------------------------------
Total other income (expense) 23 1 29 (19)
- ----------------------------------------------------------------------------------------------------------
Interest charges
Net interest charges 168 157 334 318
Allowance for borrowed funds used during construction (4) (2) (7) (3)
- ----------------------------------------------------------------------------------------------------------
Total interest charges, net 164 155 327 315
- ----------------------------------------------------------------------------------------------------------
(Loss) income from continuing operations before income tax
and minority interest (25) 133 71 231
Income tax benefit 22 12 23 14
- ----------------------------------------------------------------------------------------------------------
(Loss) income from continuing operations before minority
interest (3) 145 94 245
Minority interest in subsidiaries' loss, net of tax 9 1 17 -
- ----------------------------------------------------------------------------------------------------------
Income from continuing operations 6 146 111 245
Discontinued operations, net of tax (7) 8 (19) 17
- ----------------------------------------------------------------------------------------------------------
Net (loss) income $ (1) $ 154 $ 92 $ 262
- ----------------------------------------------------------------------------------------------------------
Average common shares outstanding 246 242 245 242
- ----------------------------------------------------------------------------------------------------------
Basic earnings per common share
Income from continuing operations $ 0.02 $ 0.60 $ 0.45 $ 1.01
Discontinued operations, net of tax (0.03) 0.03 (0.08) 0.07
Net (loss) income $(0.01) $ 0.63 $ 0.37 $ 1.08
- ----------------------------------------------------------------------------------------------------------
Diluted earnings per common share
Income from continuing operations $ 0.02 $ 0.60 $ 0.45 $ 1.01
Discontinued operations, net of tax (0.03) 0.03 (0.08) 0.07
Net (loss) income $(0.01) 0.63 $ 0.37 $ 1.08
- ----------------------------------------------------------------------------------------------------------
Dividends declared per common share $0.590 $ 0.575 $ 1.180 $ 1.150
- ----------------------------------------------------------------------------------------------------------
See Notes to Progress Energy, Inc. Consolidated Interim Financial Statements.
6
PROGRESS ENERGY, INC.
UNAUDITED CONSOLIDATED BALANCE SHEETS
(in millions) June 30 December 31
ASSETS 2005 2004
- ------------------------------------------------------------------------------------------------------------
Utility Plant
Utility plant in service $22,320 $ 22,103
Accumulated depreciation (9,341) (8,783)
- ------------------------------------------------------------------------------------------------------------
Utility plant in service, net 12,979 13,320
Held for future use 6 13
Construction work in progress 1,001 799
Nuclear fuel, net of amortization 230 231
- ------------------------------------------------------------------------------------------------------------
Total utility plant, net 14,216 14,363
- ------------------------------------------------------------------------------------------------------------
Current assets
Cash and cash equivalents 141 56
Short-term investments 40 82
Receivables, net 995 911
Inventory 801 805
Deferred fuel cost 231 229
Deferred income taxes 100 114
Assets of discontinued operations - 577
Prepayments and other current assets 235 174
- ------------------------------------------------------------------------------------------------------------
Total current assets 2,543 2,948
- ------------------------------------------------------------------------------------------------------------
Deferred debits and other assets
Regulatory assets 1,001 1,064
Nuclear decommissioning trust funds 1,081 1,044
Diversified business property, net 1,917 1,838
Miscellaneous other property and investments 502 444
Goodwill 3,719 3,719
Intangibles, net 321 337
Other assets and deferred debits 346 262
- ------------------------------------------------------------------------------------------------------------
Total deferred debits and other assets 8,887 8,708
- ------------------------------------------------------------------------------------------------------------
Total assets $25,646 $ 26,019
- ------------------------------------------------------------------------------------------------------------
CAPITALIZATION AND LIABILITIES
- ------------------------------------------------------------------------------------------------------------
Common stock equity
Common stock without par value, 500 million shares authorized,
251 and 247 million shares issued and outstanding, respectively $ 5,540 $ 5,360
Unearned restricted shares (16) (13)
Unearned ESOP shares (63) (76)
Accumulated other comprehensive loss (113) (164)
Retained earnings 2,327 2,526
- ------------------------------------------------------------------------------------------------------------
Total common stock equity 7,675 7,633
- ------------------------------------------------------------------------------------------------------------
Preferred stock of subsidiaries-not subject to mandatory redemption 93 93
Minority interest 41 36
Long-term debt, affiliate 270 270
Long-term debt, net 9,041 9,251
- ------------------------------------------------------------------------------------------------------------
Total capitalization 17,120 17,283
- ------------------------------------------------------------------------------------------------------------
Current liabilities
Current portion of long-term debt 848 349
Accounts payable 576 630
Interest accrued 221 219
Dividends declared 147 145
Short-term obligations 403 684
Customer deposits 189 180
Liabilities of discontinued operations - 152
Other current liabilities 666 703
- ------------------------------------------------------------------------------------------------------------
Total current liabilities 3,050 3,062
- ------------------------------------------------------------------------------------------------------------
Deferred credits and other liabilities
Noncurrent income tax liabilities 532 625
Accumulated deferred investment tax credits 170 176
Regulatory liabilities 2,451 2,654
Asset retirement obligations 1,229 1,282
Other liabilities and deferred credits 1,094 937
- ------------------------------------------------------------------------------------------------------------
Total deferred credits and other liabilities 5,476 5,674
- ------------------------------------------------------------------------------------------------------------
Commitments and contingencies (Note 14)
- ------------------------------------------------------------------------------------------------------------
Total capitalization and liabilities $25,646 $ 26,019
- ------------------------------------------------------------------------------------------------------------
See Notes to Progress Energy, Inc. Consolidated Interim Financial Statements
7
PROGRESS ENERGY, INC.
UNAUDITED CONSOLIDATED STATEMENTS of CASH FLOWS
- ----------------------------------------------------------------------------------------------------------
(in millions)
Six Months Ended June 30, 2005 2004
- ----------------------------------------------------------------------------------------------------------
Operating activities
Net income $ 92 $ 262
Adjustments to reconcile net income to net cash provided by operating
activities:
Discontinued operations, net of tax 19 (17)
Charges for voluntary enhanced retirement program 158 -
Depreciation and amortization 556 549
Deferred income taxes (132) (203)
Investment tax credit (6) (6)
Tax levelization 63 43
Deferred fuel cost - 13
Other adjustments to net income 61 27
Cash provided (used) by changes in operating assets and liabilities:
Receivables (60) (138)
Inventory (90) (2)
Prepayments and other current assets (27) (18)
Accounts payable 76 72
Other current liabilities (68) 230
Regulatory assets and liabilities (59) 10
Other (3) 80
- ----------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 580 902
- ----------------------------------------------------------------------------------------------------------
Investing activities
Gross utility property additions (539) (473)
Diversified business property additions (130) (93)
Nuclear fuel additions (67) (47)
Proceeds from sales of subsidiaries and other investments, net of cash
divested 436 94
Purchases of short-term investments (2,804) (651)
Proceeds from sales of short-term investments 2,846 853
Other (41) (37)
- ----------------------------------------------------------------------------------------------------------
Net cash used in investing activities (299) (354)
- ----------------------------------------------------------------------------------------------------------
Financing activities
Issuance of common stock 171 59
Issuance of long-term debt 792 1
Net (decrease) increase in short-term indebtedness (281) 624
Retirement of long-term debt (517) (865)
Dividends paid on common stock (289) (278)
Other (42) (61)
- --------------------------------------------------------------------------------------------------------
Net cash used in financing activities (166) (520)
- ----------------------------------------------------------------------------------------------------------
Cash used by discontinued operations:
Operating activities (26) (4)
Investing activities (4) (8)
Financing activities - -
Net increase in cash and cash equivalents 85 16
Cash and cash equivalents at beginning of period 56 35
- ----------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 141 $ 51
- ----------------------------------------------------------------------------------------------------------
See Notes to Progress Energy, Inc. Consolidated Interim Financial Statements.
8
PROGRESS ENERGY, INC.
NOTES TO CONSOLIDATED 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 annual 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 for the
period ended December 31, 2004, and notes thereto included in Progress
Energy's Form 10-K for the year ended December 31, 2004.
In accordance with the provisions of Accounting Principles Board Opinion
(APB) No. 28, "Interim Financial Reporting," GAAP requires companies to
apply a levelized effective tax rate to interim periods that is consistent
with the estimated annual effective tax rate. The intra-period tax
allocation, which will have no impact on total year net income, maintains
an effective tax rate consistent with the estimated annual effective tax
rate. Income tax expense was increased by $60 million and $5 million for
the three months ended June 30, 2005 and 2004, respectively. Income tax
expense was increased by $63 million and $43 million for the six months
ended June 30, 2005 and 2004, 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.
PEC and PEF collect from customers certain excise taxes levied by the state
or local government upon the customers. PEC and PEF account for excise
taxes on a gross basis. For the three months ended June 30, 2005 and 2004,
gross receipts tax, franchise taxes and other excise taxes of approximately
$58 million and $61 million, respectively, are included in utility revenues
and taxes other than on income in the Consolidated Statements of Income.
For the six months ended June 30, 2005 and 2004, excise taxes of
approximately $114 million for both periods are included in utility
revenues and taxes other than on income in the Consolidated 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 the Company'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 nuclear-fueled units, the results of operations for interim
periods are not necessarily indicative of amounts expected for the entire
year or future periods.
In preparing financial statements that conform with GAAP, management must
make estimates and assumptions that affect the reported amounts of assets
and liabilities, disclosure of contingent assets and liabilities at the
date of the financial statements and amounts of revenues and expenses
reflected during the reporting period. Actual results could differ from
those estimates. Certain amounts for 2004 have been reclassified to conform
to the 2005 presentation.
B. Stock-Based Compensation
The Company measures compensation expense for stock options as the
difference between the market price of its common stock and the exercise
price of the option at the grant date. The exercise price at which options
are granted by the Company equals the market price at the grant date, and
accordingly, no compensation expense has been recognized for stock option
grants. For purposes of the pro forma disclosures required by SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure - an
Amendment of FASB Statement No. 123" (SFAS No. 148), the estimated fair
value of the Company'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:
9
------------------------------------------------------------------------------ ----------------------
(in millions except per share data) Three Months Ended Six Months Ended
June 30 June 30
---------------------- ----------------------
2005 2004 2005 2004
------------------------------------------------------------------------------------------------------
Net (loss) income, as reported $ (1) $ 154 $ 92 $ 262
Deduct: Total stock option expense determined under
fair value method for all awards, net of related tax
effects 1 3 2 6
------------------------------------------------------------------------------------------------------
Pro forma net (loss) income $ (2) $ 151 $ 90 $ 256
------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------
Basic earnings per share
As reported $ (0.01) $ 0.63 $ 0.37 $ 1.08
Pro forma $ (0.01) $ 0.62 $ 0.36 $ 1.06
Fully diluted earnings per share
As reported $ (0.01) $ 0.63 $ 0.37 $ 1.08
Pro forma $ (0.01) $ 0.62 $ 0.36 $ 1.05
------------------------------------------------------------------------------------------------------
The Company is planning to begin expensing stock options in the third
quarter of 2005 (See Note 2).
C. Consolidation of Variable Interest Entities
The Company consolidates all voting interest entities in which it owns a
majority voting interest and all variable interest entities for which it is
the primary beneficiary in accordance with FASB Interpretation No. 46R,
"Consolidation of Variable Interest Entities - An Interpretation of ARB No.
51" (FIN No. 46R). The Company is the primary beneficiary of and
consolidates two limited partnerships that qualify for federal affordable
housing and historic tax credits under Section 42 of the Internal Revenue
Code (Code). As of June 30, 2005, the total assets of the two entities were
$38 million, the majority of which are collateral for the entities'
obligations and are included in miscellaneous other property and
investments in the Consolidated Balance Sheets.
The Company has an interest in a limited partnership that invests in 17
low-income housing partnerships that qualify for federal and state tax
credits. The Company also has interests in two power plants resulting from
long-term power purchase contracts. The Company has requested the necessary
information to determine if the 17 partnerships and the two power plant
owners are variable interest entities or to identify the primary
beneficiaries; all three entities declined to provide the Company with the
necessary financial information. Therefore, the Company has applied the
information scope exception in FIN No. 46R, paragraph 4(g) to the 17
partnerships and the two power plants. The Company believes that if it is
determined to be the primary beneficiary of any of these entities, the
effect of consolidating the entities would result in increases to total
assets, long-term debt and other liabilities, but would have an
insignificant or no impact on the Company's common stock equity, net
earnings or cash flows.
The Company also has interests in several other variable interest entities
for which the Company is not the primary beneficiary. These arrangements
include investments in approximately 28 limited partnerships, limited
liability corporations and venture capital funds and two building leases
with special-purpose entities. The aggregate maximum loss exposure at June
30, 2005, that the Company could be required to record in its income
statement as a result of these arrangements totals approximately $38
million. The creditors of these variable interest entities do not have
recourse to the general credit of the Company in excess of the aggregate
maximum loss exposure.
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
10
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 $1.1 billion 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
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.
SFAS 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," 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 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, the Company 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
expects to record approximately $3 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" (SFAS No. 143). 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
the Company no later than December 31, 2005. The Company has not yet
determined the impact of the interpretation on its financial position,
results of operations or liquidity.
11
3. DIVESTITURES
Progress Rail Divestiture
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.
Based on the estimated gross proceeds associated with the sale of $430
million, the Company recorded an estimated after-tax loss on disposal of
$19 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 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 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 expense during the six months ended June 30, 2005 and 2004 was
$3 million and $5 million, respectively. Results of discontinued operations
were as follows:
------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
-------------------- ---------------------
(in millions) 2005 2004 2005 2004
------------------------------------------------------------------------------------------------------
Revenues $ - $285 $ 358 $ 524
------------------------------------------------------------------------------------------------------
Earnings before income taxes $ - $ 14 $ 8 $ 27
Income tax expense - 7 3 11
------------------------------------------------------------------------------------------------------
Net earnings from discontinued operations - 7 5 16
------------------------------------------------------------------------------------------------------
Estimated loss on disposal of discontinued operations,
including income tax benefit of $0 and $14 for the
three and six months ended June 30, 2005, respectively (7) - (24) -
------------------------------------------------------------------------------------------------------
(Loss) earnings from discontinued operations $ (7) $ 7 $ (19) $ 16
------------------------------------------------------------------------------------------------------
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 14B. 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 174
Total other assets 39
--------------------------------------------------------------
Assets of discontinued operations $577
--------------------------------------------------------------
Accounts payable $113
Accrued expenses 39
--------------------------------------------------------------
Liabilities of discontinued operations $152
--------------------------------------------------------------
12
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.
NCNG Divestiture
In October 2002, the Company announced the Board of Directors' approval to
sell North Carolina Natural Gas Corporation (NCNG) and the Company's equity
investment in Eastern North Carolina Natural Gas Company to Piedmont
Natural Gas Company, Inc. On September 30, 2003, the Company completed the
sale. During the three months ended June 30, 2004, the Company recorded an
additional gain after taxes of approximately $1 million related to deferred
taxes on the loss from the NCNG sale.
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
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 would reduce the
price impact on monthly bills. Assuming FPSC approval, PEF expects the
process to take six to nine months.
13
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 for 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 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.
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 is 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.
14
PEC Retail Rate Matters
On April 27, 2005, PEC filed for an increase in the fuel rate charged to
its South Carolina retail customers with the Public Service Commission of
South Carolina (SCPSC). PEC requested the increase for underrecovered fuel
costs for the previous 15 months and to meet future expected fuel costs. On
June 23, 2005, the SCPSC approved a settlement agreement filed jointly by
PEC and all other parties to the proceeding. The settlement agreement
levelizes the collection of underrecovered fuel costs over a three-year
period ending June 30, 2008, and allows PEC to charge and recover carrying
costs on the monthly unpaid balance, beginning July 1, 2006, at an interest
rate of 6% compounded annually. An annual increase of $55 million, or 12
percent, in PEC's rates was effective July 1, 2005.
On June 3, 2005, PEC filed for an increase in the fuel rate charged to its
North Carolina retail customers with the North Carolina Utilities
Commission (NCUC). PEC asked the NCUC to approve a $276 million, or 11
percent, increase in rates. PEC requested the increase for underrecovered
fuel costs for the previous 12 months and to meet future expected fuel
costs. If approved, the increase would take effect October 1, 2005.
On July 25, 2005, PEC, the NCUC Public Staff and the Carolina Industrial
Group for Fair Utility Rates jointly filed a proposed settlement agreement
with the NCUC to resolve issues concerning PEC's 2005 North Carolina fuel
adjustment proceeding. Other intervening parties to the fuel proceeding
have not agreed to the proposed settlement. The settlement proposes that
PEC collect all of its fuel cost undercollections that occurred during the
test year ended March 31, 2005 over a one-year period beginning October 1,
2005. Under the proposed settlement, PEC agreed to reduce its proposed
billing increment designed to collect future fuel costs in order to address
customer concerns regarding the magnitude of the proposed increase. In
recognition of the likely undercollection that will result during the year
ending September 30, 2006, PEC would be allowed to calculate and collect
interest at 6% on the difference between its collection factor in the
original request to the NCUC and the factor included in the proposed
settlement agreement until such amounts have been collected. Hearings on
this matter are scheduled for August 2005 with an order due in September
2005. If approved, the increase would take effect October 1, 2005. The
Company cannot predict the outcome of this matter.
6. EQUITY AND COMPREHENSIVE INCOME
A. Earnings Per Common Share
A reconciliation of the weighted-average number of common shares
outstanding for basic and dilutive earnings per share purposes is as
follows:
---------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
(in millions) June 30 June 30
------------------------- --------------------------
2005 2004 2005 2004
---------------------------------------------------------------------------------------------------
Weighted-average common shares - basic 246 242 245 242
Restricted stock awards 1 1 1 1
---------------------------------------------------------------------------------------------------
Weighted-average shares - fully dilutive 247 243 246 243
---------------------------------------------------------------------------------------------------
B. Comprehensive Income
---------------------------------------------------------------------------------------
Three Months Ended
June 30
-----------------------
(in millions) 2005 2004
---------------------------------------------------------------------------------------
Net (loss) income $ (1) $ 154
Other comprehensive income (loss):
Reclassification adjustments included in net income:
Change in cash flow hedges (net of tax expense of
$2 and $3, respectively) 3 4
Changes in net unrealized gains on cash flow hedges
(net of tax expense of $26 and $0, respectively) 44 2
Foreign currency translation adjustment and other (1) (1)
---------------------------------------------------------------------------------------
Other comprehensive income $ 46 $ 5
---------------------------------------------------------------------------------------
Comprehensive income $ 45 $ 159
---------------------------------------------------------------------------------------
15
---------------------------------------------------------------------------------------
Six Months Ended
June 30
-----------------------
(in millions) 2005 2004
---------------------------------------------------------------------------------------
Net income $ 92 $ 262
Other comprehensive income (loss):
Reclassification adjustments included in net income:
Change in cash flow hedges (net of tax expense of
$3 and $5, respectively) 5 8
Foreign currency translation adjustments included in
discontinued operations (6) -
Minimum pension liability adjustment included in
discontinued operations (net of tax expense of $1) 1 -
Changes in net unrealized gains (losses) on cash flow hedges
(net of tax expense (benefit) of $31 and ($8),respectively) 50 (15)
Foreign currency translation adjustment and other 1 1
---------------------------------------------------------------------------------------
Other comprehensive income (loss) $ 51 $ (6)
---------------------------------------------------------------------------------------
Comprehensive income $ 143 $ 256
---------------------------------------------------------------------------------------
C. Common Stock
At December 31, 2004, the Company had approximately 63 million shares of
common stock authorized by the Board of Directors that remained unissued
and reserved. In 2002, the Board of Directors authorized meeting the
requirements of the Progress Energy 401(k) Savings and Stock Ownership Plan
and the Investor Plus Stock Purchase Plan with original issue shares. For
the three and six months ended June 30, 2005, the Company issued
approximately 2.6 million shares and 3.9 million shares, respectively,
under these plans for net proceeds of approximately $111 million and $169
million, respectively.
7. DEBT AND CREDIT FACILITIES AND FINANCING ACTIVITIES
Changes to the Company's debt and credit facilities since December 31,
2004, discussed in Note 13 of the Company's 2004 Annual Report on Form
10-K, are described below.
In January 2005, the Company used proceeds from the issuance of commercial
paper to pay off $260 million of revolving credit agreement (RCA) loans,
which included $90 million at PEC and $170 million at PEF.
On January 31, 2005, Progress Energy, Inc. entered into a new $600 million
RCA, which was to expire on December 30, 2005. This facility was added to
provide additional liquidity, to the extent necessary, during 2005 due in
part to the uncertainty of the timing of storm restoration cost recovery
from the hurricanes in Florida during 2004. On February 4, 2005, $300
million was drawn under the new facility to reduce commercial paper and pay
off the remaining amount of loans outstanding under other RCA facilities,
which consisted of $160 million at Progress Energy and $55 million at PEF.
As discussed below, the maximum size of this RCA was reduced to $300
million on March 22, 2005 and subsequently terminated on May 16, 2005.
On March 22, 2005, PEC issued $300 million of First Mortgage Bonds, 5.15%
Series due 2015, and $200 million of First Mortgage Bonds, 5.70% Series due
2035. The net proceeds from the sale of the bonds were used to pay at
maturity $300 million of PEC's 7.50% Senior Notes on April 1, 2005 and
reduce the outstanding balance of PEC's commercial paper. Pursuant to the
terms of the Progress Energy $600 million RCA, commitments were reduced to
$300 million, effective March 22, 2005.
In March 2005, Progress Energy, Inc.'s $1.1 billion five-year credit
facility was amended to increase the maximum total debt to total capital
ratio from 65% to 68% due to the potential impacts of a proposed
interpretation of SFAS No. 109 regarding accounting rules for uncertain tax
positions (See Note 2).
16
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 March 28, 2005, PEC 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 PEC's issuances of commercial paper and other
short-term obligations. The RCA will expire on June 28, 2010. The new $450
million RCA replaced PEC's $285 million three-year RCA and $165 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 PEC's long-term unsecured senior non-credit enhanced
debt, currently rated as Baa1 by Moody's and BBB by 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, which had been a provision in the terminated agreements.
In May 2005, Progress Energy, Inc. used proceeds from the issuance of
commercial paper to pay off $300 million of its $600 million RCA.
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. Pursuant to the terms
of the Progress Energy $600 million RCA, commitments were completely
reduced and the RCA was terminated, effective May 16, 2005.
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, PEC filed a shelf registration statement with the SEC to
provide an additional $1.0 billion of capacity in addition to the $400
million remaining on PEC's current shelf registration statement. The shelf
registration statement will allow PEC to issue various securities,
including First Mortgage Bonds, Senior Notes, Debt Securities and Preferred
Stock.
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 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 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:
17
Other Postretirement
Pension Benefits Benefits
Three Months Ended June 30 ----------------------- -----------------------
(in millions) 2005 2004 2005 2004
----------------------- -----------------------
Service cost $ 15 $ 13 $ 3 $ 4
Interest cost 29 28 8 8
Expected return on plan assets (37) (37) (1) (1)
Amortization of actuarial loss 6 5 1 1
Other amortization, net 1 - - 1
---------------------- -----------------------
Net periodic cost $ 14 $ 9 $ 11 $ 13
Additional cost / (benefit) recognition (a) (4) (4) 1 1
---------------------- -----------------------
Net periodic cost recognized $ 10 $ 5 $ 12 $ 14
====================== ======================
Other Postretirement
Pension Benefits Benefits
Six Months Ended June 30 ----------------------- -----------------------
(in millions) 2005 2004 2005 2004
----------------------- -----------------------
Service cost $ 30 $ 27 $ 6 $ 8
Interest cost 57 55 16 17
Expected return on plan assets (73) (75) (3) (2)
Amortization of actuarial loss 12 11 2 2
Other amortization, net 1 - 1 1
----------------------- ------------------------
Net periodic cost $ 27 $ 18 $ 22 $ 26
Additional cost / (benefit) recognition (a) (8) (8) 1 1
----------------------- ------------------------
Net periodic cost recognized $ 19 $ 10 $ 23 $ 27
======================= ========================
(a) Relates to the acquisition of FPC. See Note 17B of Progress Energy's
Form 10-K for year ended December 31, 2004.
In addition, in the second quarter of 2005 the Company recorded costs for
special termination benefits related to its voluntary enhanced retirement
program (see Note 10) of approximately $122 million for pension benefits
and $19 million for other postretirement benefits. These charges resulted
in a $37 million decrease in prepaid pension assets, which is included in
other assets and deferred debits, and a $104 million increase in pension
and OPEB liabilities, which are included in other liabilities and deferred
credits on the Consolidated Balance Sheets.
9. RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS
Progress Energy and its subsidiaries are exposed to various risks related
to changes in market conditions. The Company 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 policy, the Company 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 minimizes such risk by performing credit reviews
using, among other things, publicly available credit ratings of such
counterparties. Potential nonperformance by counterparties is not expected
to have a material effect on the consolidated financial position or
consolidated results of operations of the Company. See Note 18 to the
Company's Annual Report on Form 10-K for the year ended December 31, 2004.
A. Commodity Derivatives
General
Most of the Company's commodity contracts are not derivatives pursuant to
SFAS No. 133, "Accounting for Derivative and Hedging Activities" (SFAS No.
133) or qualify as normal purchases or sales pursuant to SFAS No. 133.
Therefore, such contracts are not recorded at fair value.
18
In 2003, PEC recorded a $38 million pre-tax ($23 million after-tax) fair
value loss transition adjustment pursuant to the provisions of DIG Issue
C20, "Scope Exceptions: Interpretation of the Meaning of Not Clearly and
Closely Related in Paragraph 10(b) regarding Contracts with a Price
Adjustment Feature." The related liability is being amortized to earnings
over the term of the related contract (See Note 12). As of June 30, 2005
and December 31, 2004, the remaining liability was $23 million and $26
million, respectively.
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 manages open positions with strict policies that limit its
exposure to market risk and require daily reporting to management of
potential financial exposures. The Company recorded pre-tax losses of less
than $1 million and $2 million on such contracts for the three months ended
June 30, 2005 and 2004, respectively. The Company recorded a $2 million
pre-tax gain and a $14 million pre-tax loss on such contracts for the six
months ended June 30, 2005 and 2004, respectively. The Company did not have
material outstanding positions in such contracts as of June 30, 2005 and
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. As of 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
Progress Energy'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 purchases and sales. Realized gains and losses are
recorded net in operating revenues or operating expenses, as appropriate.
The ineffective portion of commodity cash flow hedges for the three and six
months ending June 30, 2005 and 2004, was not material to the Company's
results of operations.
The fair values of commodity cash flow hedges as of June 30, 2005 and
December 31, 2004, were as follows:
--------------------------------------------------------------
(in millions) June 30, December 31,
2005 2004
--------------------------------------------------------------
Fair value of assets $ 96 $ -
Fair value of liabilities (24) (15)
--------------------------------------------------------------
Fair value, net $ 72 $ (15)
--------------------------------------------------------------
The following table presents selected information related to the Company's
commodity cash flow hedges as of June 30, 2005:
19
---------------------------------------------------------------------------
Accumulated Other Portion Expected to
Comprehensive be Reclassified to
(term in years/ Maximum Income/(Loss), net of Earnings during the
millions of dollars) Term(a) tax Next 12 Months(b)
---------------------------------------------------------------------------
Commodity cash flow
hedges 10 $ 44 $ (9)
---------------------------------------------------------------------------
(a) Hedges in fair value liability positions have a maximum term of less
than two years and hedges in fair value asset positions have a maximum
term of 10 years.
(b) Due to the volatility of the commodities markets, the value in
accumulated other comprehensive income/(loss) (OCI) is subject to
change prior to its reclassification into earnings.
B. Interest Rate Derivatives - Fair Value or Cash Flow Hedges
The Company uses cash flow hedging strategies to reduce exposure to changes
in cash flow due to fluctuating interest rates. The Company uses fair value
hedging strategies to reduce exposure to changes in fair value due to
interest rate changes. The notional amounts of interest rate derivatives
are not exchanged and do not represent exposure to credit loss. In the
event of default by the counterparty, the risk in these transactions is the
cost of replacing the agreements at current market rates.
The fair values of interest rate hedges as of June 30, 2005 and December
31, 2004, were as follows:
--------------------------------------------------------------------
June 30, December 31,
(in millions) 2005 2004
--------------------------------------------------------------------
Interest rate cash flow hedges $ (3) $(2)
Interest rate fair value hedges $ 2 $ 3
--------------------------------------------------------------------
Cash Flow Hedges
Gains and losses from cash flow hedges are recorded in OCI and amounts
reclassified to earnings are included in net interest charges as the hedged
transactions occur. Amounts in OCI related to terminated hedges are
reclassified to earnings as the interest expense is recorded. The
ineffective portion of interest rate cash flow hedges for the three and six
months ending June 30, 2005 and 2004, was not material to the Company's
results of operations.
The following table presents selected information related to the Company's
interest rate cash flow hedges included in OCI as of June 30, 2005:
-----------------------------------------------------------------------------
Accumulated Other Portion Expected to
Comprehensive be Reclassified to
(term in years/ Maximum Income/(Loss), net of Earnings during the
millions of dollars) Term tax(a) Next 12 Months(b)
-----------------------------------------------------------------------------
-----------------------------------------------------------------------------
Interest rate cash Less than
flow hedges one $ (17) $ (3)
-----------------------------------------------------------------------------
(a) Includes amounts related to terminated hedges.
(b) Actual amounts that will be reclassified to earnings may vary from the
expected amounts presented above as a result of changes in interest
rates.
As of June 30, 2005 and December 31, 2004, the Company had $300 million
notional and $331 million notional, respectively, of interest rate cash
flow hedges.
20
Fair Value Hedges
For interest rate fair value hedges, the change in the fair value of the
hedging derivative is recorded in net interest charges and is offset by the
change in the fair value of the hedged item. As of June 30, 2005 and
December 31, 2004, the Company had $150 million notional of interest rate
fair value hedges.
10. SEVERANCE COSTS
On February 28, 2005, as part of a previously announced cost management
initiative, the Company approved a workforce restructuring which is
expected to be completed in September 2005 and result in a reduction of
approximately 450 positions. The cost management initiative is designed to
permanently reduce by $75 million to $100 million the projected growth in
the Company's annual O&M expenses by the end of 2007. 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 $176 million of pre-tax charges for
severance and postretirement benefits during the six months ended June 30,
2005, as described below.
The Company recorded $31 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. During the second quarter of 2005, 1,447 employees eligible for
participation in the voluntary enhanced retirement program elected to
participate. Consequently, in the second quarter of 2005, the Company
decreased its estimated severance costs by $13 million due to the impact of
the employees electing participation in the voluntary enhanced retirement
program. 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)
------------------------------------------------------------
Balance as of January 1, 2005 $ 5
Severance costs accrued 31
Adjustments (13)
Payments (2)
------------------------------------------------------------
Balance as of June 30, 2005 $21
------------------------------------------------------------
The Company recorded a $141 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 a $17 million
charge for early retirement incentives to be paid over time to certain
employees.
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 Company's postretirement plans. Such revisions may be
significant and may adversely impact the Company'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.
11. FINANCIAL INFORMATION BY BUSINESS SEGMENT
The Company's reportable segments include: Progress Energy Carolinas
Electric (PEC Electric), Progress Energy Florida (PEF), Competitive
Commercial Operations (CCO), Fuels and Synthetic Fuels.
PEC Electric and PEF are primarily engaged in the generation, transmission,
distribution and sale of electric energy in portions of (i) North Carolina
and South Carolina and (ii) Florida, respectively. These electric
operations are subject to the rules and regulations of the FERC, the NCUC,
the SCPSC, the FPSC and the United States Nuclear Regulatory Commission
(NRC). These electric operations also distribute and sell electricity to
other utilities, primarily on the east coast of the United States.
21
Fuels is engaged in natural gas production in Texas and Louisiana, coal
mining, coal terminal services and fuel transportation and delivery in
Kentucky, West Virginia and Virginia.
CCO is primarily engaged in nonregulated electric generation operations and
marketing activities in Georgia, North Carolina and Florida.
Synthetic Fuel 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 in West
Virginia, Virginia and Kentucky. See Note 14 for more information.
In addition to these reportable operating segments, the Company has
Corporate and other activities that include holding company and service
company operations as well as other nonregulated business areas. These
nonregulated business areas include telecommunications and energy service
operations and other nonregulated subsidiaries that do not separately meet
the disclosure requirements of SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." The profit or loss of the
identified segments plus the loss of Corporate and Other represents the
Company's total income from continuing operations.
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 Fuels 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.
-------------------------------------------------------------------------- --------------------------
Revenues
-----------------------------------
Postretirement Income
and from
Severance Continuing
(in millions) Unaffiliated Intersegment Total Charges Operations Assets
-----------------------------------------------------------------------------------------------------
FOR THE THREE MONTHS
ENDED JUNE 30, 2005
--------------------------
PEC Electric $ 860 $ - $ 860 $ 46 $ 68 $ 10,830
PEF 908 - 908 93 10 7,742
Fuels 178 335 513 4 12 813
CCO 158 - 158 1 (3) 1,755
Synthetic Fuels 213 - 213 - 23 290
Corporate and Other 16 126 142 1 (104) 17,456
Eliminations - (461) (461) - - (13,240)
------------------------------------------------------------------------------------------------------
Consolidated totals $ 2,333 $ - $2,333 $ 145 $ 6 $ 25,646
------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------
FOR THE THREE MONTHS
ENDED JUNE 30, 2004
--------------------------
PEC Electric $ 861 $ - $ 861 $ 5 $ 97
PEF 860 - 860 - 84
Fuels 146 273 419 - 17
CCO 72 - 72 - 5
Synthetic Fuels 161 2 163 - 36
Corporate and Other 23 104 127 - (93)
Eliminations - (379) (379) - -
-----------------------------------------------------------------------------------------
Consolidated totals $ 2,123 $ - $2,123 $ 5 $ 146
-----------------------------------------------------------------------------------------
22
-------------------------------------------------------------------------- --------------------------
Revenues
-----------------------------------
Postretirement Income
and from
Severance Continuing
(in millions) Unaffiliated Intersegment Total Charges Operations Assets
-----------------------------------------------------------------------------------------------------
FOR THE SIX
MONTHS ENDED
JUNE 30, 2005
--------------------------
PEC Electric $ 1,795 $ - $1,795 $ 60 $ 184 $ 10,830
PEF 1,756 - 1,756 107 53 7,742
Fuels 314 642 956 6 23 813
CCO 222 - 222 2 (9) 1,755
Synthetic Fuels 411 - 411 - 22 290
Corporate and Other 33 227 260 1 (162) 17,456
Eliminations - (869) (869) - - (13,240)
------------------------------------------------------------------------------------------------------
Consolidated totals $ 4,531 $ - $4,531 $ 176 $ 111 $ 25,646
------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
FOR THE SIX
MONTHS ENDED
JUNE 30, 2004
--------------------------
PEC Electric $ 1,762 $ - $1,762 $ 5 $ 213
PEF 1,644 - 1,644 1 133
Fuels 252 539 791 - 27
CCO 105 - 105 - (3)
Synthetic Fuels 326 6 332 - 72
Corporate and Other 40 201 241 - (197)
Eliminations - (746) (746) - -
----------------------------------------------------------------------------------------------
Consolidated totals $ 4,129 $ - $4,129 $ 6 $ 245
----------------------------------------------------------------------------------------------
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 are as follows:
---------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
------------------- ----------------
(in millions) 2005 2004 2005 2004
---------------------------------------------------------------------------------------
Other income
Nonregulated energy and delivery services income $ 11 $ 7 $ 17 $ 12
DIG Issue C20 Amortization (see Note 9) 2 2 3 4
Investment gains - 2 3 4
Income from equity investments 3 - 5 -
Gain on sale of distribution assets (see Note 5) 25 - 25 -
AFUDC equity 5 2 9 4
Other 3 8 8 14
---------------------------------------------------------------------------------------
Total other income $ 49 $ 21 $ 70 $ 38
---------------------------------------------------------------------------------------
Other expense
Nonregulated energy and delivery services
expenses $ 5 $ 5 $ 10 $ 9
Donations 5 2 11 10
Investment losses - 3 - 3
Contingent value obligations unrealized loss - 5 - 13
Loss from equity investments 4 4 10 7
Write-off of non-trade receivables - - - 7
FERC audit settlement 7 - 7 -
Other 9 5 11 14
---------------------------------------------------------------------------------------
Total other expense $ 30 $ 24 $ 49 $ 63
---------------------------------------------------------------------------------------
Other, net $ 19 $ (3) $ 21 $(25)
---------------------------------------------------------------------------------------
23
Nonregulated energy and delivery services include power protection services
and mass-market programs (surge protection, appliance services and area
light sales) and delivery, transmission and substation work for other
utilities.
FERC audit settlement includes amounts approved by the FERC on May 25,
2005, to settle the FERC Staff's Audit of PEC's and PEF's compliance with
the FERC's Standards of Conduct and Code of Conduct. In the settlement, PEC
and PEF agreed to make certain operational and organizational changes and
to provide their retail and wholesale customers a one-time credit of
approximately $7 million which was recorded as other expense in the second
quarter of 2005. PEC recorded $4 million of the settlement and PEF recorded
the remaining $3 million.
13. ENVIRONMENTAL MATTERS
The Company is subject to federal, state and local regulations addressing
hazardous and solid waste management, air and water quality and other
environmental matters. See Note 22 of the Company'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 (CERCLA), authorize the EPA to
require the cleanup of hazardous waste sites. This statute imposes
retroactive joint and several liabilities. Some states, including North
Carolina and South Carolina and Florida, have similar types of legislation.
The Company and its subsidiaries are periodically notified by regulators,
including the EPA and various state agencies, of their involvement or
potential involvement in sites that may require investigation and/or
remediation. There are presently several sites with respect to which the
Company has been notified by the EPA, the State of North Carolina or the
State of Florida of its potential liability, as described below in greater
detail. The Company also is currently in the process of assessing potential
costs and exposures at other sites. For all sites, as the assessments are
developed and analyzed, the Company will accrue costs for the sites to the
extent the costs are probable and can be reasonably estimated. A discussion
of sites by legal entity follows.
Various organic materials associated with the production of manufactured
gas, generally referred to as coal tar, are regulated under federal and
state laws. PEC and PEF are each potentially responsible parties (PRPs) at
several manufactured gas plant (MGP) sites.
The Company has filed claims with its general liability insurance carriers
to recover costs arising from actual or potential environmental
liabilities. Almost all claims have been settled and a few are still
pending. While the Company cannot predict the outcome of these matters, the
outcome is not expected to have a material effect on the consolidated
financial position or results of operations.
PEC
There are nine former MGP sites and a number of other sites associated with
PEC that have required or are anticipated to require investigation and/or
remediation.
During the fourth quarter of 2004, the EPA advised PEC that it had been
identified as a PRP at the Ward Transformer site located in Raleigh, North
Carolina. The EPA offered PEC and a number of other PRPs the opportunity to
negotiate cleanup of the site and reimbursement of less than $2 million to
the EPA for EPA's past expenditures in addressing conditions at the site.
PEC and other PRP's are in discussions with the EPA to reach an agreement.
However, as an agreement among PRPs has not yet been reached, it is not
possible at this time to reasonably estimate the total amount of PEC's
obligation for remediation of the Ward Transformer site. If an agreement
cannot be reached, the EPA could issue a unilateral order requiring cleanup
of the site. The Company cannot predict the outcome of this matter.
24
As of June 30, 2005 and December 31, 2004, PEC'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 five years, were:
--------------------------------------------------------------------------------
(in millions) June 30, 2005 December 31, 2004
--------------------------------------------------------------------------------
Insurance fund $ 4 $ 7
Transferred from North Carolina Natural Gas
Corporation at time of sale 2 2
--------------------------------------------------------------------------------
Total accrual for environmental sites $ 6 $ 9
--------------------------------------------------------------------------------
The insurance fund in the table above was established when PEC received
insurance proceeds to address costs associated with environmental
liabilities related to its involvement with some sites. All eligible
expenses related to these sites are charged against a specific fund
containing these proceeds. For the three and six months ended June 30,
2005, PEC made no additional accruals, received no insurance proceeds, and
spent approximately $1 million and $3 million, respectively, related to
environmental remediation.
This accrual has been recorded on an undiscounted basis. PEC measures its
liability for these sites based on available evidence including its
experience in investigating and remediating environmentally impaired sites.
The process often involves assessing and developing cost-sharing
arrangements with other PRPs. PEC will accrue costs for the sites to the
extent its liability is probable and the costs can be reasonably estimated.
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 reached the stage where a reasonable estimate of the remediation
costs can be made, PEC cannot determine the total costs that may be
incurred in connection with the remediation of all sites at this time. It
is anticipated that sufficient information will become available for
several sites during 2005 to allow a reasonable estimate of PEC's
obligation for those sites to be made.
On March 30, 2005, the North Carolina Division of Water Quality renewed a
PEC permit for the continued use of coal combustion products generated at
any of the Company's coal-fired plants located in the state. The Company
has reviewed the permit conditions, which could significantly restrict the
reuse of coal ash and result in higher ash management costs and plans to
adjudicate the permit conditions. The Company cannot predict the outcome of
this matter.
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
Florida Department of Environmental Protection (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.
25
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.
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
is in the process of assessing the impact of this rule.
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 14B).
AIR QUALITY
The Company is 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 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
consolidated financial position or results of operations. Control equipment
that will be installed on North Carolina fossil generating facilities as
part of the North Carolina Clean Smokestacks Act (Smokestacks Act), enacted
in 2002 and discussed below, may address some of the issues outlined above.
However, the Company cannot predict the outcome of the matter.
26
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.
Total capital expenditures to meet the requirements of the final rule under
Section 110 of the Clean Air Act (NOx SIP Call) in North and South Carolina
could reach approximately $370 million. This amount also includes the cost
to install NOx controls under North Carolina's and South Carolina's
programs to comply with the federal 8-hour ozone standard. However, further
technical analysis and rulemaking may result in requirements for additional
controls at some units. To date, the Company has spent approximately $324
million related to these projected amounts. Increased operation and
maintenance costs relating to the NOx SIP Call are not expected to be
material to the Company's results of operations. Further controls are
anticipated as electricity demand increases. Parties unrelated to the
Company have undertaken efforts to have Georgia excluded from the rule and
its requirements. Georgia has not yet submitted a state implementation plan
to comply with the Section 110 NOx SIP Call. The Company cannot predict the
outcome of this matter for the impact to its nonregulated operations in
Georgia.
The Company projects that its capital costs to meet emission targets for
NOx and SO2 from coal-fired power plants under the Smokestacks Act, will
total approximately $895 million by the end of 2013. PEC has expended
approximately $190 million of these capital costs through June 30, 2005.
The Smokestacks Act requires PEC to amortize 70% of the original cost
estimate of $813 million, during a five-year rate freeze period. PEC
recognized amortization of $27 million and $54 million, respectively, for
the three and six months ended June 30, 2005, and has recognized $302
million in cumulative amortization through June 30, 2005. The remaining
amortization requirement will be recorded over the future period ending
December 31, 2007. The law permits PEC the flexibility to vary the
amortization schedule for recording the compliance costs from zero up to
$174 million of amortization expense per year. The NCUC will hold a hearing
prior to December 31, 2007, to determine cost recovery amounts for 2008 and
future periods. O&M expense will significantly increase due to the
additional materials, personnel and general maintenance associated with the
equipment. O&M expenses are recoverable through base rates, rather than as
part of this program. The Company cannot predict the future regulatory
interpretation, implementation or impact of this law.
On March 10, 2005, the EPA issued the final Clean Air Interstate Rule
(CAIR). The EPA's rule requires 28 states, including North Carolina, South
Carolina, Georgia and 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 is in the process of determining
compliance plans and the cost to comply with the rule. The air quality
controls already installed for compliance with the NOx SIP Call and
currently planned by the Company to comply with the Smokestacks Act will
reduce the costs required to meet the CAIR requirements for the Company's
North Carolina units. The Company preliminarily estimates compliance costs
for PEF could be approximately $1.0 billion over the next 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 cannot predict the outcome of this matter.
27
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 the Company'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 the Company'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 March 2004, the North Carolina Attorney General filed a petition with
the EPA under Section 126 of the Clean Air Act, asking the federal
government to force coal-fired power plants in 13 other states, including
South Carolina, to reduce their NOx and SO2 emissions. The state of North
Carolina contends these out-of-state emissions interfere with North
Carolina's ability to meet national air quality standards for ozone and
particulate matter. On August 1, 2005, the EPA issued a proposed response
denying the petition. The EPA's rationale for denial is that compliance
with CAIR will reduce the emissions from surrounding states sufficiently to
address North Carolina's concerns. The EPA will hold a 60-day public
comment period from the date that the proposal is published in the Federal
Register and must take final action by March 15, 2006. The Company cannot
predict the outcome of this matter.
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 PEC and PEF
in the immediate and extended future.
28
Based on new cost information and changes to the estimated time frame of
expenditures since December 31, 2004, the Company has revised the estimated
amounts and time period for expenditures to meet Section 316(b)
requirements of the Clean Water Act. The Company currently estimates that
from 2005 through 2010 the range of expenditures will be approximately $80
million to $110 million. The range includes $15 million to $25 million at
PEC and $65 million to $85 million at PEF.
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 cannot predict the outcome of this matter.
Progress Energy has announced its plan to issue a report on the Company's
activities associated with current and future environmental requirements.
The report will include a discussion of the environmental requirements that
the Company currently faces and expects 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
23 of the Company's 2004 Annual Report on Form 10-K are described below.
A. Purchase Obligations
As part of Progress Energy's ordinary course of business, it enters into
various long and short term contracts for fuel requirements at its
generating plants. Through June 30, 2005, contracts procured through PEC
have increased the Company's aggregate purchase obligations for fuel and
purchased power by approximately $709 million as compared to the amount
stated in the Company's Form 10-K for the year ended December 31, 2004. The
increase primarily covers the period ranging from 2005 through 2009. A
majority of the contracts related to the increase in purchase obligations
for fuel and purchased power are for future coal purchases primarily with
fixed prices.
B. Guarantees
As a part of normal business, Progress Energy and certain wholly-owned
subsidiaries enter into various agreements providing future 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. As of June 30, 2005, the Company does
not believe conditions are likely for significant performance under these
guarantees. 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.
29
C. Insurance
PEC and PEF are members 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, each
company is insured for $500 million at each of its respective nuclear
plants. In addition to primary coverage, NEIL also provides
decontamination, premature decommissioning and excess property insurance
with limits of $1.75 billion on each plant.
D. Other Commitments
As discussed in Note 23B of the Progress Energy 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 $41 million and
$49 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 is $87 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.
E. Other Contingencies
1. Pursuant to the Nuclear Waste Policy Act of 1982, the predecessors to
PEF and PEC 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, PEC and PEF filed a complaint in 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
various Progress Energy facilities on or before January 31, 1998. Damages
due to the DOE's breach will 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 PEC/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 have been or are expected to be presented in the trials or appeals
that are currently scheduled to occur during 2005. Resolution of these
issues in other cases could facilitate agreements by the parties in the
PEC/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 granted.
30
On February 27, 2004, PEC requested to have its license for the Independent
Spent Fuel Storage Installation at the Robinson Plant extended by 20 years
with an exemption request for an additional 20-year extension. Its current
license is due to expire in August 2006. On March 30, 2005, the NRC issued
the 40-year license renewal.
With certain modifications and additional approval by the NRC, including
the installation of onsite dry storage facilities at Robinson and
Brunswick, PEC's spent nuclear fuel storage facilities will be sufficient
to provide storage space for spent fuel generated on PEC's system through
the expiration of the operating licenses for all of PEC's nuclear
generating units.
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. The Company cannot
predict the outcome of this matter.
2. In 2001, PEC entered into a contract to purchase coal from Dynegy
Marketing and Trade (DMT). After DMT experienced financial difficulties,
including credit ratings downgrades by certain credit reporting agencies,
PEC requested credit enhancements in accordance with the terms of the coal
purchase agreement in July 2002. When DMT did not offer credit
enhancements, as required by a provision in the contract, PEC terminated
the contract in July 2002.
PEC initiated a lawsuit seeking a declaratory judgment that the termination
was lawful. DMT counterclaimed, stating the termination was a breach of
contract and an unfair and deceptive trade practice. On March 23, 2004, the
United States District Court for the Eastern District of North Carolina
ruled that PEC was liable for breach of contract, but ruled against DMT on
its unfair and deceptive trade practices claim. On April 6, 2004, the Court
entered a judgment against PEC in the amount of approximately $10 million.
The Court did not rule on DMT's request under the contract for pending
legal costs.
On May 4, 2004, PEC authorized its outside counsel to file a notice of
appeal of the April 6, 2004 judgment, and on May 7, 2004, the notice of
appeal was filed with the United States Court of Appeals for the Fourth
Circuit. On June 8, 2004, DMT filed a motion to dismiss PEC's appeal on the
ground that it was untimely. On July 20, 2005, the appellate court denied
DMT's motion to dismiss and ruled that the time for PEC to appeal had not
yet expired. The appellate court remanded the case to the trial court for
further proceedings.
In the first quarter of 2004, PEC recorded a liability for the judgment of
approximately $10 million and a regulatory asset for the probable recovery
through its fuel adjustment clause. The Company cannot predict the outcome
of this matter.
3. On February 1, 2002, PEC filed a complaint with the Surface
Transportation Board (STB) challenging the rates charged by Norfolk
Southern Railway Company (Norfolk Southern) for coal transportation to
certain generating plants. In a decision served in December, 2003, the STB
found that the challenged rates exceeded maximum reasonable rate levels and
prescribed lower rates. In a subsequent decision on reconsideration the STB
31
concluded that the rates had not been shown to be unreasonable, following
which PEC requested the STB to consider requiring that the rates be phased
in over a period of time. During the course of the complaint process, PEC
accrued a liability of $42 million. The liability was comprised of $23
million of reparations remitted to PEC by Norfolk Southern that were
subject to refund and an additional $19 million, of which $17 million was
recorded as deferred fuel cost on the Consolidated Balance Sheet. This
matter has now been settled by mutual agreement, and the STB has issued an
order dismissing the case. As a result of the settlement, PEC reversed the
previously recorded deferred fuel cost and settled the remaining
obligations for the approximate amount previously accrued. The settlement
had an immaterial impact on the Company's results of operations.
4. The Company, through its subsidiaries, is a majority owner in five
entities and a minority owner in one entity that owns facilities that
produce coal-based solid synthetic fuel as defined under the Internal
Revenue Code (Code). The production and sale of the synthetic fuel from
these facilities qualify for tax credits under Section 29 if certain
requirements are satisfied, including a requirement that the synthetic fuel
differs significantly in chemical composition from the coal used to produce
such synthetic fuel 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 entities have
received PLRs from the IRS with respect to their synthetic fuel operations.
However, these PLRs do not address the placed-in-service date
determination. The PLRs do not limit the production on which synthetic fuel
credits may be claimed. Total Section 29 credits generated to date
(including those generated by FPC prior to its acquisition by the Company)
are approximately $1.6 billion, of which $719 million have been used to
offset regular federal income tax liability and $839 million are being
carried forward as deferred alternative minimum tax credits. Also, $27
million has not been recognized due to the decrease in tax liability
resulting from expenses incurred for 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 (see Note 3) 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 $17 million in tax credits no longer being realized and
reflected as a deferred tax asset.
IRS PROCEEDINGS
In September 2002, all of Progress Energy's majority-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 Colona 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. The Colona
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
anticipated 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 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 Progress Energy'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.
32
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, the Company, on a consolidated basis, has used or
carried forward approximately $1.1 billion of tax credits generated by
Earthco facilities. If these credits were disallowed, the Company's
one-time exposure for cash tax payments would be $300 million (excluding
interest), and earnings and equity would be reduced by approximately $1.1
billion, 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 14D). Progress Energy's amended $1.13 billion credit
facility includes a covenant that limits the maximum debt-to-total capital
ratio to 68%. This ratio includes other forms of indebtedness such as
guarantees issued by PGN, letters of credit and capital leases. As of June
30, 2005, the Company's debt-to-total capital ratio was 59.1% based on the
credit agreement definition for this ratio. The impact on this ratio of
reversing approximately $1.1 billion of tax credits and paying $300 million
for taxes would be an increase of the ratio to 63.2%.
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 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 8F of the Progress Energy annual report on Form 10-K
for the year ended December 31, 2004, the Company implemented changes in
its capitalization policies for its Energy Delivery business units in PEC
and PEF 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 PEC's and 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 $1.1 billion 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.
33
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. 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 price (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.
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 its 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 synthetic fuel results of operations
and production plans.
34
In response to the historically high oil prices to date in 2005, the
Company adjusted its planned production schedule for its synthetic fuel
plants 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.
5. The Company and its subsidiaries are involved in various litigation
matters in the ordinary course of business, some of which involve
substantial amounts. Where appropriate, accruals and disclosures have been
made in accordance with SFAS No. 5, "Accounting for Contingencies," to
provide for such matters. In the opinion of management, the final
disposition of pending litigation would not have a material adverse effect
on the Company's consolidated results of operations or financial position.
35
CAROLINA POWER & LIGHT COMPANY
d/b/a PROGRESS ENERGY CAROLINAS, INC.
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
Electric $860 $861 $1,795 $1,762
Diversified business 1 1 1 1
- ----------------------------------------------------------------------------------------------
Total operating revenues 861 862 1,796 1,763
- ----------------------------------------------------------------------------------------------
Operating expenses
Fuel used in electric generation 216 193 464 417
Purchased power 73 80 140 142
Operation and maintenance 260 226 484 435
Depreciation and amortization 130 127 259 254
Taxes other than on income 42 45 88 88
- ----------------------------------------------------------------------------------------------
Total operating expenses 721 671 1,435 1,336
- ----------------------------------------------------------------------------------------------
Operating income 140 191 361 427
- ----------------------------------------------------------------------------------------------
Other income (expense)
Interest income 1 1 3 2
Other, net (2) 4 (1) (8)
- ----------------------------------------------------------------------------------------------
Total other (expense) income (1) 5 2 (6)
- ----------------------------------------------------------------------------------------------
Interest charges
Interest charges 50 47 102 96
Allowance for borrowed funds used during construction (2) - (3) (1)
- ----------------------------------------------------------------------------------------------
Total interest charges, net 48 47 99 95
- ----------------------------------------------------------------------------------------------
Income before income tax 91 149 264 326
Income tax expense 24 53 81 115
- ----------------------------------------------------------------------------------------------
Net income $ 67 $ 96 $ 183 $ 211
Preferred stock dividend requirement - - 1 1
- ----------------------------------------------------------------------------------------------
Earnings for common stock $ 67 $ 96 $ 182 $ 210
- ----------------------------------------------------------------------------------------------
See Notes to Consolidated Interim Financial Statements.
36
CAROLINA POWER & LIGHT COMPANY
d/b/a PROGRESS ENERGY CAROLINAS, INC.
UNAUDITED CONSOLIDATED BALANCE SHEETS
(in millions) June 30 December 31
ASSETS 2005 2004
- ------------------------------------------------------------------------------------------------------------
Utility plant
Utility plant in service $13,738 $ 13,521
Accumulated depreciation (5,940) (5,806)
- ------------------------------------------------------------------------------------------------------------
Utility plant in service, net 7,798 7,715
Held for future use 5 5
Construction work in progress 440 379
Nuclear fuel, net of amortization 163 186
- ------------------------------------------------------------------------------------------------------------
Total utility plant, net 8,406 8,285
- ------------------------------------------------------------------------------------------------------------
Current assets
Cash and cash equivalents 14 18
Short-term investments 18 82
Receivables, net 397 397
Receivables from affiliated companies 12 20
Inventory 399 390
Deferred fuel cost 138 140
Prepayments and other current assets 107 135
- ------------------------------------------------------------------------------------------------------------
Total current assets 1,085 1,182
- ------------------------------------------------------------------------------------------------------------
Deferred debits and other assets
Regulatory assets 496 473
Nuclear decommissioning trust funds 608 581
Miscellaneous other property and investments 212 158
Other assets and deferred debits 157 108
- ------------------------------------------------------------------------------------------------------------
Total deferred debits and other assets 1,473 1,320
- ------------------------------------------------------------------------------------------------------------
Total assets $10,964 $ 10,787
- ------------------------------------------------------------------------------------------------------------
CAPITALIZATION AND LIABILITIES
- ------------------------------------------------------------------------------------------------------------
Common stock equity
Common stock without par value, authorized 200 million shares,
160 million shares issued and outstanding $1,991 $ 1,975
Unearned ESOP common stock (63) (76)
Accumulated other comprehensive loss (111) (114)
Retained earnings 1,240 1,287
- ------------------------------------------------------------------------------------------------------------
Total common stock equity 3,057 3,072
- ------------------------------------------------------------------------------------------------------------
Preferred stock - not subject to mandatory redemption 59 59
Long-term debt, net 3,263 2,750
- ------------------------------------------------------------------------------------------------------------
Total capitalization 6,379 5,881
- ------------------------------------------------------------------------------------------------------------
Current liabilities
Current portion of long-term debt - 300
Accounts payable 202 254
Payables to affiliated companies 67 83
Notes payable to affiliated companies 67 116
Short-term obligations 142 221
Customer deposits 48 45
Other current liabilities 271 256
- ------------------------------------------------------------------------------------------------------------
Total current liabilities 797 1,275
- ------------------------------------------------------------------------------------------------------------
Deferred credits and other liabilities
Noncurrent income tax liabilities 993 991
Accumulated deferred investment tax credits 137 140
Regulatory liabilities 1,147 1,052
Asset retirement obligations 950 924
Other liabilities and deferred credits 561 524
- ------------------------------------------------------------------------------------------------------------
Total deferred credits and other liabilities 3,788 3,631
- ------------------------------------------------------------------------------------------------------------
Commitments and contingencies (Note 12)
- ------------------------------------------------------------------------------------------------------------
Total capitalization and liabilities $10,964 $ 10,787
- ------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Interim Financial Statements.
37
CAROLINA POWER & LIGHT COMPANY
d/b/a PROGRESS ENERGY CAROLINAS, INC.
UNAUDITED CONSOLIDATED STATEMENTS of CASH FLOWS
- ----------------------------------------------------------------------------------------------------------------
(in millions)
Six Months Ended June 30, 2005 2004
- ----------------------------------------------------------------------------------------------------------------
Operating activities
Net income $ 183 $ 211
Adjustments to reconcile net income to net cash provided by operating activities:
Charges for voluntary enhanced retirement program 42 -
Depreciation and amortization 301 297
Deferred income taxes 7 4
Investment tax credit (3) (4)
Deferred fuel credit (36) (13)
Other adjustments to net income 11 12
Cash provided (used) by changes in operating assets and liabilities:
Receivables 3 -
Receivables from affiliated companies 8 16
Inventory (46) 26
Prepayments and other current assets (17) 7
Accounts payable (3) 7
Payables to affiliated companies (16) (59)
Other current liabilities 27 61
Other (6) 47
- ----------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 455 612
---------------------------------------------------------------------------------------------------------------
Investing activities
Gross property additions (303) (243)
Nuclear fuel additions (33) (47)
Net contributions to nuclear decommissioning trust (18) (18)
Purchases of short-term investments (1,136) (651)
Proceeds from sales of short-term investments 1,200 853
Other investing activities (6) 4
- ----------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (296) (102)
- ----------------------------------------------------------------------------------------------------------------
Financing activities
Issuance of long-term debt, net 495 -
Net (decrease) increase in short-term obligations (79) 64
Net change in intercompany notes (49) 1
Retirement of long-term debt (300) (339)
Dividends paid to parent (229) (228)
Dividends paid on preferred stock (1) (1)
- ----------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (163) (503)
- ----------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (4) 7
Cash and cash equivalents at beginning of period 18 12
- ----------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 14 $ 19
- ----------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Interim Financial Statements.
38
CAROLINA POWER & LIGHT COMPANY
d/b/a PROGRESS ENERGY CAROLINAS, INC.
NOTES TO CONSOLIDATED 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 annual 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 for the
period ended December 31, 2004 and notes thereto included in Progress
Energy Carolinas, Inc.'s (PEC) Form 10-K for the year ended December 31,
2004.
In accordance with the provisions of Accounting Principles Board Opinion
(APB) No. 28, "Interim Financial Reporting," GAAP requires companies to
apply a levelized effective tax rate to interim periods that is consistent
with the estimated annual effective tax rate. The intra-period tax
allocation, which will have no impact on total year net income, maintains
an effective tax rate consistent with the estimated annual effective tax
rate. Income tax expense was increased by $3 million for the three and six
months ended June 30, 2005.
PEC collects from customers certain excise taxes levied by the state or
local government upon the customer. PEC accounts for excise taxes on a
gross basis. For the three months ended June 30, 2005 and 2004, gross
receipts tax and other excise taxes of approximately $20 million and $23
million, respectively, are included in electric revenue and taxes other
than on income on the Consolidated Statements of Income. For the six months
ended June 30, 2005 and 2004, gross receipts tax and other excise taxes of
approximately $41 million and $45 million, respectively, are included in
electric revenue and taxes other than income on the Consolidated 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 PEC'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 nuclear-fueled units, the results of operations for interim
periods are not necessarily indicative of amounts expected for the entire
year or future periods.
In preparing financial statements that conform with GAAP, management must
make estimates and assumptions that affect the reported amounts of assets
and liabilities, disclosure of contingent assets and liabilities at the
date of the financial statements and amounts of revenues and expenses
reflected during the reporting period. Actual results could differ from
those estimates. Certain amounts for 2004 have been reclassified to conform
to the 2005 presentation.
B. Stock-Based Compensation
PEC measures 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 PEC'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:
39
--------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
-------------------- ---------------------
(in millions) 2005 2004 2005 2004
--------------------------------------------------------------------------------------------------------------
Net Income, as reported $ 67 $ 96 $ 183 $ 211
Deduct: Total stock option expense determined under
fair value method for all awards, net of related tax effects 1 2 2 4
--------------------------------------------------------------------------------------------------------------
Pro forma net income $ 66 $ 94 $ 181 $ 207
--------------------------------------------------------------------------------------------------------------
PEC is planning to begin expensing stock options in the third quarter of
2005 (See Note 2).
C. Consolidation of Variable Interest Entities
PEC consolidates all voting interest entities in which it owns a majority
voting interest and all variable interest entities for which it is the
primary beneficiary in accordance with FASB Interpretation No. 46R,
"Consolidation of Variable Interest Entities - An Interpretation of ARB No.
51" (FIN No. 46R). PEC is the primary beneficiary of and consolidates two
limited partnerships that qualify for federal affordable housing and
historic tax credits under Section 42 of the Internal Revenue Code (Code).
As of June 30, 2005, the total assets of the two entities were $38 million,
the majority of which are collateral for the entities' obligations and are
included in miscellaneous other property and investments in the
Consolidated Balance Sheets.
PEC has an interest in a limited partnership that invests in 17 low-income
housing partnerships that qualify for federal and state tax credits. PEC
also has interests in two power plants resulting from long-term power
purchase contracts. PEC has requested the necessary information to
determine if the 17 partnerships and the two power plant owners are
variable interest entities or to identify the primary beneficiaries; all
three entities declined to provide PEC with the necessary financial
information. Therefore, PEC has applied the information scope exception in
FIN No. 46R, paragraph 4(g) to the 17 partnerships and the two power
plants. PEC believes that if it is determined to be the primary beneficiary
of any of these entities, the effect of consolidating the entities would
result in increases to total assets, long-term debt and other liabilities,
but would have an insignificant or no impact on PEC's common stock equity,
net earnings or cash flows.
PEC also has interests in several other variable interest entities for
which PEC is not the primary beneficiary. These arrangements include
investments in approximately 22 limited partnerships, limited liability
corporations and venture capital funds and two building leases with
special-purpose entities. The aggregate maximum loss exposure at June 30,
2005, that PEC could be required to record in its income statement as a
result of these arrangements totals approximately $24 million. The
creditors of these variable interest entities do not have recourse to the
general credit of PEC in excess of the aggregate maximum loss exposure.
2. NEW ACCOUNTING STANDARDS
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123 (REVISED 2004),
"SHARE-BASED PAYMENT" (SFAS NO. 123R)
In December 2004, the Financial Accounting Standards Board (FASB) issued
SFAS No. 123R, which revises SFAS No. 123, "Accounting for Stock-Based
Compensation" 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 PEC made that election. The
intrinsic value method resulted in PEC recording no compensation expense
for stock options granted to employees (See Note 1B).
40
As written, SFAS No. 123R had an original effective date of July 1, 2005
for PEC. In April 2005, the SEC delayed the effective date for public
companies, which resulted in a required effective date of January 1, 2006
for PEC. 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. PEC is planning to
implement SFAS No. 123R during the third quarter of 2005, effective as of
July 1, 2005. PEC will implement the standard using the required modified
prospective method. Under that method, PEC 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, PEC expects to record approximately
$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 PEC no later than December
31, 2005. PEC has not yet determined the impact of the interpretation on
its financial position, results of operations or liquidity.
3. REGULATORY MATTERS
On April 27, 2005, PEC filed for an increase in the fuel rate charged to
its South Carolina retail customers with the Public Service Commission of
South Carolina (SCPSC). PEC requested the increase for underrecovered fuel
costs for the previous 15 months and to meet future expected fuel costs. On
June 23, 2005, the SCPSC approved a settlement agreement filed jointly by
PEC and all other parties to the proceeding. The settlement agreement
levelizes the collection of underrecovered fuel costs over a three-year
period ending June 30, 2008, and allows PEC to charge and recover carrying
costs on the monthly unpaid balance, beginning July 1, 2006, at an interest
rate of 6% compounded annually. An annual increase of $55 million, or 12
percent, in PEC's rates was effective July 1, 2005.
On June 3, 2005, PEC filed for an increase in the fuel rate charged to its
North Carolina retail customers with the North Carolina Utilities
Commission (NCUC). PEC asked the NCUC to approve a $276 million, or 11
percent, increase in rates. PEC requested the increase for underrecovered
fuel costs for the previous 12 months and to meet future expected fuel
costs.
On July 25, 2005, PEC, the NCUC Public Staff and the Carolina Industrial
Group for Fair Utility Rates jointly filed a proposed settlement agreement
with the NCUC to resolve issues concerning PEC's 2005 North Carolina fuel
adjustment proceeding. Other intervening parties to the fuel proceeding
have not agreed to the proposed settlement. The settlement proposes that
PEC collect all of its fuel cost undercollections that occurred during the
test year ended March 31, 2005 over a one-year period beginning October 1,
2005. Under the proposed settlement, PEC agreed to reduce its proposed
billing increment designed to collect future fuel costs in order to address
customer concerns regarding the magnitude of the proposed increase. In
recognition of the likely undercollection that will result during the year
ending September 30, 2006, PEC would be allowed to calculate and collect
interest at 6% on the difference between its collection factor in the
original request to the NCUC and the factor included in the proposed
settlement agreement until such amounts have been collected. Hearings on
this matter are scheduled for August 2005 with an order due in September
2005. If approved, the increase would take effect October 1, 2005. PEC
cannot predict the outcome of this matter.
41
4. COMPREHENSIVE INCOME
------------------------------------------------------------------------------
Three Months Ended
(in millions) June 30
----------------------
2005 2004
-------------------------------------------------------------------------------
Net income $ 67 $ 96
Other comprehensive income:
Changes in net unrealized gains on cash flow hedges
(net of tax expense of $2) - 3
Other 1 (1)
-------------------------------------------------------------------------------
Other comprehensive income $ 1 $ 2
-------------------------------------------------------------------------------
Comprehensive income $ 68 $ 98
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Six Months Ended
(in millions) June 30
----------------------
2005 2004
-------------------------------------------------------------------------------
Net income $183 $211
Other comprehensive income:
Changes in net unrealized gains on cash flow hedges
(net of tax expense of $1 and $2, respectively) 2 3
Other 1 -
-------------------------------------------------------------------------------
Other comprehensive income $ 3 $ 3
-------------------------------------------------------------------------------
Comprehensive income $186 $214
-------------------------------------------------------------------------------
5. DEBT AND CREDIT FACILITIES AND FINANCING ACTIVITIES
Changes to PEC's debt and credit facilities since December 31, 2004,
discussed in Note 9 of PEC's 2004 Annual Report on Form 10-K, are described
below.
In January 2005, PEC used proceeds from the issuance of commercial paper to
pay off $90 million of revolving credit agreement (RCA) loans.
On March 22, 2005, PEC issued $300 million of First Mortgage Bonds, 5.15%
Series due 2015, and $200 million of First Mortgage Bonds, 5.70% Series due
2035. The net proceeds from the sale of the bonds were used to pay at
maturity $300 million of PEC's 7.50% Senior Notes on April 1, 2005 and
reduce the outstanding balance of commercial paper.
On March 28, 2005, PEC 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 PEC's issuances of commercial paper and other
short-term obligations. The RCA will expire on June 28, 2010. The new $450
million RCA replaced PEC's $285 million three-year RCA and $165 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 PEC's long-term unsecured senior non-credit enhanced
debt, currently rated as Baa1 by Moody's and BBB by 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, which had been a provision in the terminated agreements.
On July 28, 2005, PEC filed a shelf registration statement with the SEC to
provide an additional $1.0 billion of capacity in addition to the $400
million remaining on PEC's current shelf registration statement. The shelf
registration statement will allow PEC to issue various securities,
including First Mortgage Bonds, Senior Notes, Debt Securities and Preferred
Stock.
42
6. BENEFIT PLANS
PEC has a noncontributory defined benefit retirement (pension) plan for
substantially all full-time employees. PEC also has supplementary defined
benefit pension plans that provide benefits to higher-level employees. In
addition to pension benefits, PEC provides 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:
Other Postretirement
Three Months Ended June 30 Pension Benefits Benefits
----------------------- ----------------------
(in millions) 2005 2004 2005 2004
----------------------- ----------------------
Service cost $ 7 $ 6 $ 2 $ 2
Interest cost 13 13 4 4
Expected return on plan assets (16) (17) (1) (1)
Amortization, net 2 - - 1
----------------------- ----------------------
Net periodic cost $ 6 $ 2 $ 5 $ 6
======================= ======================
Other Postretirement
Six Months Ended June 30 Pension Benefits Benefits
----------------------- ----------------------
(in millions) 2005 2004 2005 2004
----------------------- ----------------------
Service cost $ 13 $ 12 $ 3 $ 4
Interest cost 27 26 8 8
Expected return on plan assets (31) (34) (2) (2)
Amortization, net 4 1 1 2
----------------------- ----------------------
Net periodic cost $ 13 $ 5 $ 10 $ 12
======================= ======================
In addition, in the second quarter of 2005, PEC recorded special
termination benefits related to the voluntary enhanced retirement program
(see Note 8) of approximately $21 million for pension benefits and $8
million for other postretirement benefits. These charges resulted in a $29
million increase in pension and OPEB liabilities, which are included in
other liabilities and deferred credits on the Consolidated Balance Sheets.
7. RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS
PEC is exposed to various risks related to changes in market conditions.
PEC'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, PEC 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. PEC minimizes such risk by performing credit reviews using, among
other things, publicly available credit ratings of such counterparties.
Potential nonperformance by counterparties is not expected to have a
material effect on the consolidated financial position or consolidated
results of operations of PEC. See Note 13 to PEC's Annual Report on Form
10-K for the year ended December 31, 2004.
A. Commodity Derivatives
General
Most of PEC's commodity contracts are not derivatives pursuant to SFAS No.
133, "Accounting for Derivative and Hedging Activities" (SFAS No. 133) or
qualify as normal purchases or sales pursuant to SFAS No. 133. Therefore,
such contracts are not recorded at fair value.
43
In 2003, PEC recorded a $38 million pre-tax ($23 million after-tax) fair
value loss transition adjustment pursuant to the provisions of DIG Issue
C20, "Scope Exceptions: Interpretation of the Meaning of Not Clearly and
Closely Related in Paragraph 10(b) regarding Contracts with a Price
Adjustment Feature." The related liability is being amortized to earnings
over the term of the related contract (See Note 10). As of June 30, 2005
and December 31, 2004, the remaining liability was $23 million and $26
million, respectively.
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.
PEC manages open positions with strict policies that limit its 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 ending June 30,
2005 and 2004, and PEC did not have material outstanding positions in such
contracts at June 30, 2005 and December 31, 2004.
B. Interest Rate Derivatives - Fair Value or Cash Flow Hedges
PEC uses cash flow hedging strategies to reduce exposure to changes in cash
flow due to fluctuating interest rates. PEC uses fair value hedging
strategies to reduce exposure to changes in fair value due to interest rate
changes. The notional amounts of interest rate derivatives are not
exchanged and do not represent exposure to credit loss. In the event of
default by the counterparty, the risk in these transactions is the cost of
replacing the agreements at current market rates.
Cash Flow Hedges
Gains and losses from cash flow hedges are recorded in accumulated other
comprehensive income (OCI) and amounts reclassified to earnings are
included in net interest charges as the hedged transactions occur. Amounts
in OCI related to terminated hedges are reclassified to earnings as the
interest expense is recorded. The ineffective portion of interest rate cash
flow hedges for the three and six months ending June 30, 2005 and 2004, was
not material to PEC's results of operations. As of June 30, 2005, PEC had
$5 million of after-tax deferred losses in OCI related to terminated
hedges, of which an immaterial amount is expected to be reclassified to
earnings within the next 12 months.
During the first quarter of 2005, PEC terminated all of its cash flow
hedges which were open at December 31, 2004, and had no open interest rate
cash flow hedges as of June 30, 2005. As of December 31, 2004, PEC had $131
million notional of open interest rate cash flow hedges.
Fair Value Hedges
As of June 30, 2005 and December 31, 2004, PEC had no open interest rate
fair value hedges.
8. 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, PEC incurred
approximately $60 million of pre-tax charges for severance and
postretirement benefits during the six months ended June 30, 2005, as
described below.
PEC recorded $14 million of severance expense during the first quarter of
2005 for the workforce restructuring. 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, 553 PEC employees eligible for participation in the voluntary
enhanced retirement program elected to participate. Consequently, in the
second quarter of 2005, PEC decreased its estimated severance costs by $7
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.
44
The accrued severance expense will be paid over time. The activity in the
severance liability is as follows:
-------------------------------------------------
(in millions)
-------------------------------------------------
Balance as of January 1, 2005 $ 2
Severance costs accrued 10
Adjustments (5)
Payments -
-------------------------------------------------
Balance as of June 30, 2005 $ 7
-------------------------------------------------
PEC recorded a $29 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 6). PEC also recorded a $13 million charge for early retirement
incentives which will be paid over time to certain employees. In addition,
PEC recorded approximately $10 million of 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 PEC's results of operations in future periods. In
addition, PEC expects to incur certain incremental costs for recruiting and
staff augmentation activities that cannot be quantified at this time.
9. FINANCIAL INFORMATION BY BUSINESS SEGMENT
PEC's operations consist primarily of the PEC Electric segment which is
engaged in the generation, transmission, distribution and sale of electric
energy primarily in portions of North Carolina and South Carolina. These
electric operations are subject to the rules and regulations of the FERC,
the NCUC, the SCPSC and the NRC. PEC Electric also distributes and sells
electricity to other utilities, primarily on the east coast of the United
States.
The Other segment, the operations of which are primarily in the eastern
United States, is made up of other nonregulated business areas that do not
separately meet the disclosure requirements of SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information" and consolidation
entities and eliminations.
The financial information for PEC segments for the three months ended June
30, 2005 and 2004, is as follows:
-------------------------------------------------------------------------------------------------
(in millions) 2005 2004
-------------------------------------------------------------------------------------------------
PEC PEC
Electric Other Total Electric Other Total
-------------------------------------------------------------------------------------------------
Total revenues $ 860 $ 1 $ 861 $ 861 $ 1 $ 862
Postretirement and
severance charges 46 - 46 5 - 5
Segment profit (loss) 68 (1) 67 97 (1) 96
-------------------------------------------------------------------------------------------------
45
The financial information for PEC segments for the six months ended June
30, 2005 and 2004 is as follows:
-----------------------------------------------------------------------------------------------
(in millions) 2005 2004
-----------------------------------------------------------------------------------------------
PEC PEC
Electric Other Total Electric Other Total
-----------------------------------------------------------------------------------------------
Total revenues $ 1,795 $ 1 $ 1,796 $ 1,762 $ 1 $ 1,763
Postretirement and
severance charges 60 - 60 5 - 5
Segment profit (loss) 184 (2) 182 213 (3) 210
-----------------------------------------------------------------------------------------------
10. 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 the three and six
months ended June 30, 2005 and 2004, are as follows:
---------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
------------------------- ----------------------
(in millions) 2005 2004 2005 2004
---------------------------------------------------------------------------------------------------
Other income
Nonregulated energy and delivery services income $ 7 $ 3 $ 9 $ 5
DIG Issue C20 Amortization (See Note 7) 2 2 3 4
AFUDC equity 1 1 2 2
Other 2 6 5 5
---------------------------------------------------------------------------------------------------
Total other income $ 12 $ 12 $ 19 $ 16
---------------------------------------------------------------------------------------------------
Other expense
Nonregulated energy and delivery services expenses $ 2 $ 2 $ 4 $ 4
Donations 2 1 5 5
Write-off of non-trade receivables - - - 7
FERC Audit Settlement 4 - 4 -
Other 6 5 7 8
---------------------------------------------------------------------------------------------------
Total other expense $ 14 $ 8 $ 20 $ 24
---------------------------------------------------------------------------------------------------
Other, net $ (2) $ 4 $ (1) $ (8)
---------------------------------------------------------------------------------------------------
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 PEC's compliance with the FERC's
Standards of Conduct and Code of Conduct. In the settlement, PEC agreed to
make certain operational and organizational changes and to provide its
retail and wholesale customers a one-time credit of approximately $4
million which was recorded as other expense in the second quarter of 2005.
11. ENVIRONMENTAL MATTERS
PEC is subject to federal, state and local regulations addressing hazardous
and solid waste management, air and water quality and other environmental
matters. See Note 17 of PEC'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 (CERCLA), authorize the EPA to
require the cleanup of hazardous waste sites. This statute imposes
retroactive joint and several liabilities. Some states, including North
Carolina and South Carolina, have similar types of legislation. PEC is
46
periodically notified by regulators, including the EPA and various state
agencies, of their involvement or potential involvement in sites that may
require investigation and/or remediation. There are presently several sites
with respect to which PEC has been notified by the EPA and the State of
North Carolina of its potential liability, as described below in greater
detail. PEC is also currently in the process of assessing potential costs
and exposures at other sites. For all sites, as assessments are developed
and analyzed, PEC 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
PEC has some connection. In this regard, PEC 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 North Carolina Department of Environment and Natural
Resources, Division of Waste Management (DWM).
PEC filed claims with its general liability insurance carriers to recover
costs arising from actual or potential environmental liabilities. All
claims have been settled other than with insolvent carriers. These
settlements have not had a material effect on the consolidated financial
position or results of operations.
There are nine former MGP sites and a number of other sites associated with
PEC that have required or are anticipated to require investigation and/or
remediation.
During the fourth quarter of 2004, the EPA advised PEC that it had been
identified as a PRP at the Ward Transformer site located in Raleigh, North
Carolina. The EPA offered PEC and a number of other PRPs the opportunity to
negotiate cleanup of the site and reimbursement of less than $2 million to
the EPA for EPA's past expenditures in addressing conditions at the site.
PEC and other PRP's are in discussions with the EPA to reach an agreement.
However, as an agreement among PRPs has not yet been reached, it is not
possible at this time to reasonably estimate the total amount of PEC's
obligation for remediation of the Ward Transformer site. If an agreement
cannot be reached, the EPA could issue a unilateral order requiring cleanup
of the site. PEC cannot predict the outcome of this matter.
As of June 30, 2005 and December 31, 2004, PEC'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 five years, were:
-----------------------------------------------------------------------------------
(in millions) June 30, 2005 December 31, 2004
-----------------------------------------------------------------------------------
Insurance fund $ 4 $ 7
Transferred from North Carolina Natural Gas
Corporation at time of sale 2 2
-----------------------------------------------------------------------------------
Total accrual for environmental sites $ 6 $ 9
-----------------------------------------------------------------------------------
The insurance fund in the table above was established when PEC received
insurance proceeds to address costs associated with environmental
liabilities related to its involvement with some sites. All eligible
expenses related to these are charged against a specific fund containing
these proceeds. For the three and six months ended June 30, 2005, PEC made
no additional accruals, received no insurance proceeds, and spent
approximately $1 million and $3 million, respectively, related to
environmental remediation.
This accrual has been recorded on an undiscounted basis. PEC measures its
liability for these sites based on available evidence including its
experience in investigating and remediating environmentally impaired sites.
The process often involves assessing and developing cost-sharing
arrangements with other PRPs. PEC will accrue costs for the sites to the
extent its liability is probable and the costs can be reasonably estimated.
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 reached the stage where a reasonable estimate of the remediation
costs can be made, PEC cannot determine the total costs that may be
incurred in connection with the remediation of all sites at this time. It
is anticipated that sufficient information will become available for
several sites during 2005 to allow a reasonable estimate of PEC's
obligation for those sites to be made.
47
On March 30, 2005, the North Carolina Division of Water Quality renewed a
PEC permit for the continued use of coal combustion products generated at
any of the Company's coal-fired plants located in the state. The Company
has reviewed the permit conditions, which could significantly restrict the
reuse of coal ash and result in higher ash management costs and plans to
adjudicate the permit conditions. The Company cannot predict the outcome of
this matter.
AIR QUALITY
PEC is 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
PEC 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 PEC's consolidated
financial position or results of operations. Control equipment that will be
installed on North Carolina fossil generating facilities as part of the
North Carolina Clean Smokestacks Act (Smokestacks Act), enacted in 2002 and
discussed below, may address some of the issues outlined above. However,
PEC 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.
Total capital expenditures to meet the requirements of the final rule under
Section 110 of the Clean Air Act (NOx SIP Call) in North Carolina and South
Carolina could reach approximately $370 million. This amount also includes
the cost to install NOx controls under North Carolina's and South
Carolina's programs to comply with the federal 8-hour ozone standard.
However, further technical analysis and rulemaking may result in
requirements for additional controls at some units. PEC has spent
approximately $324 million to date related to these projected amounts.
Increased operation and maintenance costs relating to the NOx SIP Call are
not expected to be material to PEC's results of operations. Further
controls are anticipated as electricity demand increases.
PEC projects that its capital costs to meet emission targets for NOx and
SO2 from coal-fired power plants under the Smokestacks Act, will total
approximately $895 million by the end of 2013. PEC has expended
approximately $190 million of these capital costs through June 30, 2005.
The Smokestacks Act requires PEC to amortize 70% of the original cost
estimate of $813 million, during a five-year rate freeze period. PEC
recognized amortization of $27 million and $54 million, respectively, for
the three and six months ended June 30, 2005, and has recognized $302
million in cumulative amortization through June 30, 2005. The remaining
amortization requirement will be recorded over the future period ending
December 31, 2007. The law permits PEC the flexibility to vary the
amortization schedule for recording the compliance costs from zero up to
$174 million of amortization expense per year. The NCUC will hold a hearing
prior to December 31, 2007, to determine cost recovery amounts for 2008 and
future periods. O&M expense will increase due to the additional materials,
personnel and general maintenance associated with the equipment. O&M
expenses are recoverable through base rates, rather than as part of this
program. PEC cannot predict the future regulatory interpretation,
implementation or impact of this law.
48
On March 10, 2005, the EPA issued the final Clean Air Interstate Rule
(CAIR). The EPA's rule requires 28 states, including North Carolina and
South Carolina, 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. PEC is in the process of determining compliance
plans and the cost to comply with the rule. The air quality controls
already installed for compliance with the NOx SIP Call and currently
planned by PEC to comply with the Smokestacks Act will reduce the costs
required to meet the CAIR requirements for PEC's North Carolina units.
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. PEC 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 PEC'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 the Company'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.
In March 2004, the North Carolina Attorney General filed a petition with
the EPA under Section 126 of the Clean Air Act, asking the federal
government to force coal-fired power plants in 13 other states, including
South Carolina, to reduce their NOx and SO2 emissions. The state of North
Carolina contends these out-of-state emissions interfere with North
Carolina's ability to meet national air quality standards for ozone and
particulate matter. On August 1, 2005, the EPA issued a proposed response
denying the petition. The EPA's rationale for denial is that compliance
with CAIR will reduce the emissions from surrounding states sufficiently to
address North Carolina's concerns. The EPA will hold a 60-day public
comment period from the date that the proposal is published in the Federal
Register and must take final action by March 15, 2006. PEC cannot predict
the outcome of this matter.
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 PEC in the
immediate and extended future.
Based on new cost information and changes to the estimated time frame of
expenditures since December 31, 2004, PEC has revised the estimated amounts
and time period for expenditures to meet Section 316(b) requirements of the
Clean Water Act. PEC currently estimates that from 2005 through 2010 the
range of expenditures will be approximately $15 million to $25 million.
49
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
PEC's consolidated financial position or results of operations if
associated costs of control or limitation cannot be recovered from
customers. PEC favors the voluntary program approach recommended by the
Bush administration and continually evaluates options for the reduction,
avoidance and sequestration of greenhouse gases. However, PEC cannot
predict the outcome of this matter.
Progress Energy has announced its plan to issue a report on the Company's
activities associated with current and future environmental requirements.
The report will include a discussion of the environmental requirements that
PEC currently faces and expects to face in the future with respect to its
air emissions. The report is expected to be issued by March 31, 2006.
12. COMMITMENTS AND CONTINGENCIES
Contingencies and significant changes to the commitments discussed in Note
18 of PEC's 2004 Annual Report on Form 10-K are described below.
A. Purchase Obligations
As part of PEC's ordinary course of business, it enters into various long
and short term contracts for fuel requirements at its generating plants.
Through June 30, 2005, these contracts have increased the Company's
aggregate purchase obligations for fuel and purchased power by
approximately $709 million as compared to the amount stated in the
Company's Form 10-K for the year ended December 31, 2004. The increase
primarily covers the period ranging from 2005 through 2009. A majority of
the contracts related to the increase in purchase obligations for fuel and
purchased power are for future coal purchases primarily with fixed prices.
B. Guarantees
As a part of normal business, PEC enters into various agreements providing
future financial or performance assurances to third parties, which are
outside the scope of 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. 45). Such agreements include guarantees, standby letters of credit
and surety bonds. As of June 30, 2005, PEC does not believe conditions are
likely for significant performance under these guarantees. 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, PEC had no guarantees issued on behalf
of unconsolidated subsidiaries or other third parties.
C. Insurance
PEC 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, PEC is
insured for $500 million at each of its nuclear plants. In addition to
primary coverage, NEIL also provides decontamination, premature
decommissioning and excess property insurance with limits of $1.75 billion
on each plant.
D. Other Contingencies
1. Pursuant to the Nuclear Waste Policy Act of 1982, the predecessors to
PEC 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.
50
DOE failed to begin taking spent nuclear fuel by January 31, 1998. In
January 2004, PEC filed a complaint in 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
various PEC facilities on or before January 31, 1998. Damages due to the
DOE's breach will be significant, but have yet to be determined.
Approximately 60 cases involving the Government's actions in connection
with spent nuclear fuel are currently pending in the Court of Federal
Claims.
The DOE and the PEC 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 have been or are expected to be presented in the trials or appeals
that are currently scheduled to occur during 2005. Resolution of these
issues in other cases could facilitate agreements by the parties in the PEC
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 granted.
On February 27, 2004, PEC requested to have its license for the Independent
Spent Fuel Storage Installation at the Robinson Plant extended by 20 years
with an exemption request for an additional 20-year extension. Its current
license is due to expire in August 2006. On March 30, 2005, the NRC issued
the 40-year license renewal.
With certain modifications and additional approval by the NRC, including
the installation of onsite dry storage facilities at Robinson and
Brunswick, PEC's spent nuclear fuel storage facilities will be sufficient
to provide storage space for spent fuel generated on PEC's system through
the expiration of the operating licenses for all of PEC's nuclear
generating units.
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. PEC cannot predict
the outcome of this matter.
2. In 2001, PEC entered into a contract to purchase coal from Dynegy
Marketing and Trade (DMT). After DMT experienced financial difficulties,
including credit ratings downgrades by certain credit reporting agencies,
PEC requested credit enhancements in accordance with the terms of the coal
purchase agreement in July 2002. When DMT did not offer credit
enhancements, as required by a provision in the contract, PEC terminated
the contract in July 2002.
PEC initiated a lawsuit seeking a declaratory judgment that the termination
was lawful. DMT counterclaimed, stating the termination was a breach of
contract and an unfair and deceptive trade practice. On March 23, 2004, the
United States District Court for the Eastern District of North Carolina
ruled that PEC was liable for breach of contract, but ruled against DMT on
its unfair and deceptive trade practices claim. On April 6, 2004, the Court
entered a judgment against PEC in the amount of approximately $10 million.
The Court did not rule on DMT's request under the contract for pending
legal costs.
51
On May 4, 2004, PEC authorized its outside counsel to file a notice of
appeal of the April 6, 2004 judgment, and on May 7, 2004, the notice of
appeal was filed with the United States Court of Appeals for the Fourth
Circuit. On June 8, 2004, DMT filed a motion to dismiss PEC's appeal on the
ground that it was untimely. On July 20, 2005, the appellate court denied
DMT's motion to dismiss and ruled that the time for PEC to appeal had not
yet expired. The appellate court remanded the case to the trial court for
further proceedings.
PEC recorded a liability for the judgment of approximately $10 million and
a regulatory asset for the probable recovery through its fuel adjustment
clause in the first quarter of 2004. PEC cannot predict the outcome of this
matter.
3. On February 1, 2002, PEC filed a complaint with the Surface
Transportation Board (STB) challenging the rates charged by Norfolk
Southern Railway Company (Norfolk Southern) for coal transportation to
certain generating plants. In a decision served in December, 2003, the STB
found that the challenged rates exceeded maximum reasonable rate levels and
prescribed lower rates. In a subsequent decision on reconsideration the STB
concluded that the rates had not been shown to be unreasonable, following
which PEC requested the STB to consider requiring that the rates be phased
in over a period of time. During the course of the complaint process, PEC
accrued a liability of $42 million. The liability was comprised of $23
million of reparations remitted to PEC by Norfolk Southern that were
subject to refund and an additional $19 million, of which $17 million was
recorded as deferred fuel cost on the Consolidated Balance Sheet. This
matter has now been settled by mutual agreement, and the STB has issued an
order dismissing the case. As a result of the settlement, PEC reversed the
previously recorded deferred fuel cost and settled the remaining
obligations for the approximate amount previously accrued. The settlement
had an immaterial impact on PEC's results of operations.
4. PEC is involved in various litigation matters in the ordinary course of
business, some of which involve substantial amounts. Where appropriate,
accruals and disclosures have been made in accordance with SFAS No. 5,
"Accounting for Contingencies," to provide for such matters. In the opinion
of management, the final disposition of pending litigation would not have a
material adverse effect on PEC's consolidated results of operations or
financial position.
52
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 sections of Progress Energy's and Progress Energy Carolina's (PEC)
annual report on Form 10-K for the year ended December 31, 2004.
Amounts reported in the interim Consolidated Statements of Income 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.
RESULTS OF OPERATIONS
The Company's reportable business segments and their primary operations include:
o Progress Energy Carolinas Electric (PEC Electric) - primarily engaged in
the generation, transmission, distribution and sale of electricity in
portions of North Carolina and South Carolina;
o Progress Energy Florida (PEF) - primarily engaged in the generation,
transmission, distribution and sale of electricity in portions of Florida;
o Competitive Commercial Operations (CCO) - engaged in nonregulated electric
generation operations and marketing activities primarily in Georgia, North
Carolina and Florida;
o Fuels - primarily engaged in natural gas production in Texas and Louisiana,
coal mining, coal terminal services and fuel transportation and delivery in
Kentucky, West Virginia and Virginia; and
o Synthetic Fuels - engaged in the production and sale of coal-based solid
synthetic fuels and the operation of synthetic fuel facilities for outside
parties in Kentucky, West Virginia and Virginia.
The Corporate and Other category includes other businesses engaged in other
nonregulated business areas, including telecommunications, primarily in the
eastern United States, energy services operations and holding company results,
which do not meet the requirements for separate segment reporting disclosure.
Prior to 2005, Rail Services was reported as a separate segment. In connection
with the divestiture of Progress Rail (see Note 3 of the Progress Energy
Consolidated Interim Financial Statements), 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 Fuels 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.
In this section, earnings and the factors affecting earnings for the three and
six months ended June 30, 2005 as compared to the same periods in 2004 are
discussed. The discussion begins with a summarized overview of the Company's
consolidated earnings, which is followed by a more detailed discussion and
analysis by business segment.
OVERVIEW
For the quarter ended June 30, 2005, Progress Energy's net loss was $1 million,
or $(0.01) per share, compared to net income of $154 million, or $0.63 per
share, for the same period in 2004. The decrease in net income as compared to
prior year was due primarily to:
o Postretirement and severance charges recorded throughout the Company
related to the cost management initiative.
o Unfavorable weather at both utilities.
o Unfavorable retail usage in Florida.
o The write-off of unrecoverable storm costs in Florida.
53
o The change in accounting estimates for certain Energy Delivery capital
costs.
o Decreased nonregulated generation earnings.
o Decreased synthetic fuel earnings.
o The impact of tax levelization.
Partially offsetting these items were:
o Utility customer growth in the Carolinas and Florida.
o Favorable wholesale sales in both the Carolinas and Florida.
o Gain recorded on the sale of distribution system in Florida.
o Reduced losses recorded on contingent value obligations.
For the six months ended June 30, 2005, Progress Energy's net income was $92
million, or $0.37 per share, compared to $262 million, or $1.08 per share for
the same period in 2004. The decrease in net income as compared to prior year
was due primarily to:
o Postretirement and severance charges recorded throughout the Company
related to the cost management initiative.
o Unfavorable weather at both utilities.
o Unfavorable retail usage in Florida.
o The write-off of unrecoverable storm costs in Florida.
o The change in accounting estimates for certain Energy Delivery capital
costs.
o Decreased nonregulated generation earnings.
o Decreased synthetic fuel earnings.
o The impact of tax levelization.
Partially offsetting these items were:
o Utility customer growth in the Carolinas and Florida.
o Favorable wholesale sales in both the Carolinas and Florida.
o Gain recorded on the sale of distribution assets in Florida.
o Reduced losses recorded on contingent value obligations.
Basic earnings per share decreased in 2005 due in part to the factors outlined
above. Dilution related to the issuances of an aggregate of approximately 4
million and 1 million shares of common stock under the Company's Investor Plus
Stock Purchase Plan and employee benefit programs for the year to date in 2005
and the year ended December 31, 2004, respectively, also reduced basic earnings
per share by $0.01 and $0.02 for the three and six months ended June 30, 2005,
respectively.
The Company's segments contributed the following profits or losses for the three
and six months ended June 30, 2005 and 2004:
- -------------------------------------------------------------------------------------------------
(in millions) Three Months Ended June 30, Six Months Ended June 30,
Business Segment 2005 2004 2005 2004
- -------------------------------------------------------------------------------------------------
PEC Electric $ 68 $ 97 $184 $213
PEF 10 84 53 133
Fuels 12 17 23 27
CCO (3) 5 (9) (3)
Synthetic Fuel 23 36 22 72
- -------------------------------------------------------------------------------------------------
Total Segment Profit 110 239 273 442
- -------------------------------------------------------------------------------------------------
Corporate & Other (104) (93) (162) (197)
- -------------------------------------------------------------------------------------------------
Income from continuing operations 6 146 111 245
Discontinued operations, net of tax (7) 8 (19) 17
- -------------------------------------------------------------------------------------------------
Net income $ (1) $154 $ 92 $262
- -------------------------------------------------------------------------------------------------
COST MANAGEMENT INITIATIVE
On February 28, 2005, as part of a previously announced cost management
initiative, the Company approved a workforce restructuring which is expected to
be completed in September 2005 and result in a reduction of approximately 450
positions. The cost management initiative is designed to permanently reduce by
$75 million to $100 million the projected growth in the Company's annual
operation and maintenance (O&M) expenses by the end of 2007. 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 $176 million of pre-tax charges for severance and
postretirement benefits during the six months ended June 30, 2005, as described
below.
54
The Company recorded $31 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. During the second
quarter of 2005, 1,447 employees eligible for participation in the voluntary
enhanced retirement program elected to participate. Consequently, in the second
quarter of 2005, the Company decreased its estimated severance costs by $13
million due to the impact of the employees electing participation in the
voluntary enhanced retirement program. 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 $141 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
to the Progress Energy Consolidated Interim Financial Statements for additional
information on postretirement benefits. In addition, the Company recorded a $17
million charge for early retirement incentives to be paid over time to certain
employees.
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
Company's postretirement plans. Such revisions may be significant and may
adversely impact the Company'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 CAROLINAS ELECTRIC
PEC Electric contributed segment profits of $68 million and $97 million for the
three months ended June 30, 2005 and 2004, respectively. Results for 2005 were
unfavorably impacted by higher O&M costs primarily due to postretirement and
severance costs associated with the cost management initiative and unfavorable
weather. These unfavorable items were partially offset by favorable customer
growth and usage and increased wholesale revenues.
PEC Electric contributed segment profits of $184 million and $213 million for
the six months ended June 30, 2005 and 2004, respectively. Results for 2005 were
unfavorably impacted by higher O&M costs primarily due to postretirement and
severance costs associated with the cost management initiative and the change in
accounting estimates for certain Energy Delivery capital costs and unfavorable
weather. These unfavorable items were partially offset by favorable customer
growth and usage and increased wholesale revenues.
Three months ended June 30, 2005 compared to the three months ended June 30,
2004
Revenues
PEC Electric's revenues for the three months ended June 30, 2005 and 2004, and
the percentage change by customer class are as follows:
- -----------------------------------------------------------------------
(in millions of $) Three Months Ended June 30,
Customer Class 2005 Change % Change 2004
- -----------------------------------------------------------------------
Residential $272 $ (12) (4.2) $ 284
Commercial 214 1 0.5 213
Industrial 164 3 1.9 161
Governmental 18 (1) (5.3) 19
- ------------------------------------------------ --------
Total retail revenues 668 (9) (1.3) 677
Wholesale 154 15 10.8 139
Unbilled 15 (9) - 24
Miscellaneous 23 2 9.5 21
- ------------------------------------------------ ---------
Total electric revenues $860 $ (1) (0.1) $ 861
- ------------------------------------------------ ---------
Less:
Pass-through fuel revenues (238) (16) (7.2) (222)
- ------------------------------------------------ ---------
Revenues excluding fuel $622 $ (17) (2.7) $ 639
- -----------------------------------------------------------------------
55
PEC Electric's energy sales for the three months ended June 30, 2005 and 2004,
and the amount and percentage change by customer class are as follows:
- -----------------------------------------------------------------------
(in millions of kWh) Three Months Ended June 30,
Customer Class 2005 Change % Change 2004
----------------------------------------------------------------------
Residential 3,285 (240) (6.8) 3,525
Commercial 3,087 (85) (2.7) 3,172
Industrial 3,230 (50) (1.5) 3,280
Governmental 314 (23) (6.8) 337
----------------------------------------------- ---------
Total retail energy sales 9,916 (398) (3.9) 10,314
Wholesale 3,341 227 7.3 3,114
Unbilled 235 (169) - 404
- ------------------------------------------------ ---------
Total kWh sales 13,492 (340) (2.5) 13,832
- -----------------------------------------------------------------------
PEC Electric's revenues, excluding recoverable fuel revenues of $238 million and
$222 million for the three months ended June 30, 2005 and 2004, respectively,
decreased $17 million. The decrease in revenues is attributable primarily to
unfavorable weather offset partially by favorable retail growth and usage and
increased wholesale revenues. The impact of weather is $28 million unfavorable
with cooling degree days 36% below prior year. Favorable growth and usage of $6
million was driven by an increase in the number of customers as of June 30, 2005
compared to June 30, 2004 of 28,000. The increase in wholesale revenues less
fuel of $3 million was driven primarily by the impact of increased capacity
under contract.
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 $289 million for the three months ended
June 30, 2005, which represents a $16 million increase compared to the same
period in the prior year. Fuel used in electric generation increased $23 million
to $216 million compared to the prior year. This increase is due to an increase
in fuel used in generation of $17 million due primarily to higher fuel costs
which are being driven primarily by rising coal, oil and natural gas prices. In
addition, deferred fuel expense increased $6 million due to the write-off of $5
million in deferred fuel costs as a result of the South Carolina annual fuel
hearing. Purchased power expense decreased $7 million to $73 million compared to
the prior year. Prior year purchased power costs were higher due to plant
outages during periods of favorable weather during the second quarter of 2004.
Operations and Maintenance (O&M)
O&M expenses were $260 million for the three months ended June 30, 2005, which
represents a $34 million increase compared to the same period in 2004.
Postretirement and severance expenses related to the cost management initiative
increased O&M expenses by $46 million during 2005. This is an increase of $41
million compared to the same period in 2004 as prior year expenses include $5
million related to a separate initiative. In addition, O&M expenses increased $6
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 8F of the Progress Energy annual report on Form
10-K for the year ended December 31, 2004. These unfavorable items were
partially offset by decreased plant outage costs of $12 million compared to the
same period of 2004, which included a nuclear plant outage.
56
Depreciation and Amortization
Depreciation and amortization expense was $130 million for the three months
ended June 30, 2005, which represents a $3 million increase compared to the same
period in 2004. The increase is attributable to higher NC Clean Air amortization
of $12 million and higher depreciation for assets placed in service of $1
million. These increases were partially offset by a reduction in depreciation
expense of $10 million related to the depreciation studies filed in 2004.
Depreciation rates are the same for 2005 and 2004; however, the 2004 year to
date retroactive adjustment for the new rates adopted related to the expanded
lives of the nuclear units was made in November 2004.
Other income, net
Other income, net has decreased $4 million for the three months ending June 30,
2005, as compared to the same period in the prior year. This fluctuation is due
primarily to the FERC Code of Conduct audit settlement reached in 2005 that
required $4 million to be refunded to customers (see discussion in Note 12 to
the Progress Energy Consolidated Interim Financial Statements).
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 $3 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 year.
Six months ended June 30, 2005 compared to the six months ended June 30, 2004
Revenues
PEC Electric's revenues for the six months ended June 30, 2005 and 2004, and the
percentage change by customer class are as follows:
- -----------------------------------------------------------------------
(in millions of $) Six Months Ended June 30,
Customer Class 2005 Change % Change 2004
- -----------------------------------------------------------------------
Residential $ 646 $ (9) (1.4) $ 655
Commercial 428 8 1.9 420
Industrial 313 5 1.6 308
Governmental 38 - - 38
- ------------------------------------------------- ---------
Total retail revenues 1,425 4 0.3 1,421
Wholesale 328 33 11.2 295
Unbilled (3) (4) - 1
Miscellaneous 45 - - 45
- ------------------------------------------------- ---------
Total electric revenues $1,795 $ 33 1.9 $1,762
- ------------------------------------------------- ---------
Less:
Pass-through fuel revenues (509) (49) (10.7) (460)
- ------------------------------------------------- ---------
Revenues excluding fuel $1,286 $(16) (1.2) $1,302
- ------------------------------------------------------------------------
57
PEC Electric's energy sales for the six months ended June 30, 2005 and 2004, and
the amount and percentage change by customer class are as follows:
- -------------------------------------------------------------------------
(in millions of kWh) Six Months Ended June 30,
Customer Class 2005 Change % Change 2004
- -------------------------------------------------------------------------
Residential 7,957 (309) (3.7) 8,266
Commercial 6,167 (63) (1.0) 6,230
Industrial 6,161 (112) (1.8) 6,273
Governmental 642 (40) (5.9) 682
- ------------------------------------------------- --------
Total retail energy sales 20,927 (524) (2.4) 21,451
Wholesale 7,278 374 5.4 6,904
Unbilled (67) (87) - 20
- ------------------------------------------------- ---------
Total kWh sales 28,138 (237) (0.8) 28,375
- -------------------------------------------------------------------------
PEC Electric's revenues, excluding recoverable fuel revenues of $509 million and
$460 million for the six months ended June 30, 2005 and 2004, respectively,
decreased $16 million. The decrease in revenues is attributable primarily to
unfavorable weather offset partially by favorable retail growth and usage and
increased wholesale revenues. The impact of weather is $47 million unfavorable
with cooling degree days 37% below prior year. Favorable growth and usage of $26
million was driven by an increase in the number of customers as of June 30, 2005
compared to June 30, 2004 of 28,000. The increase in wholesale revenues less
fuel of $5 million was driven primarily by the impact of increased capacity
under contract.
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 $604 million for the six months ended
June 30, 2005, which represents a $45 million increase compared to same period
in the prior year. Fuel used in electric generation increased $47 million to
$464 million compared to June 30, 2004. This increase is due to an increase in
fuel used in generation of $70 million due primarily to higher coal, oil and
natural gas costs. The increase in fuel used in generation was offset by a
reduction in deferred fuel expense of $24 million as a result of the
under-recovery of current period fuel costs offset partially by the write-off of
$5 million in deferred fuel costs as a result of the South Carolina annual fuel
hearing. Purchased power expense decreased $2 million to $140 million compared
to prior year.
Operations and Maintenance (O&M)
O&M expenses were $484 million for the six months ended June 30, 2005, which
represents a $49 million increase compared to the same period in 2004.
Postretirement and severance expenses related to the cost management initiative
increased O&M expenses by $60 million during 2005. This is an increase of $55
million compared to the same period in 2004 as prior year expenses included $5
million related to a separate initiative. In addition, O&M expenses increased
$12 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 8F of the Progress Energy annual report on Form
10-K for the year ended December 31, 2004. These unfavorable items were
partially offset by decreased plant outage costs of $8 million compared to 2004,
which included an additional planned nuclear plant outage. In addition, results
for 2004 included $6 million of costs associated with an ice storm that hit the
Carolinas service territory in the first quarter of 2004.
58
Depreciation and Amortization
Depreciation and amortization expense was $259 million for the six months ended
June 30, 2005, which represents a $5 million increase compared to the same
period in 2004. The increase is attributable to higher NC Clean Air amortization
of $23 million and higher depreciation for assets placed in services of $3
million. These increases were partially offset by a reduction in depreciation
expense of $21 million related to the depreciation studies filed in 2004.
Depreciation rates are the same for 2005 and 2004; however, the 2004 year to
date retroactive adjustment for the new rates adopted related to the expanded
lives of the nuclear units was made in November 2004.
Other income, net
Other income, net has increased $8 million for the six months ending June 30,
2005 as compared to the same period in the prior year. This increase is due
primarily to a write-off of $7 million of non-trade receivables in the prior
year.
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 $3 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 primarily to reduced earnings compared to
prior year.
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, 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:
59
- -----------------------------------------------------------------------
(in millions of $) Three Months Ended June 30,
Customer Class 2005 Change % Change 2004
- -----------------------------------------------------------------------
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
- -----------------------------------------------------------------------
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:
- ----------------------------------------------------------------------------
(in millions of kWh) Three Months Ended June 30,
Customer Class 2005 Change Change 2004
- ----------------------------------------------------------------------------
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 a 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.
60
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
Progress Energy 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 8F of the Progress Energy 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.
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 Progress Energy 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 Progress Energy 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:
61
- ----------------------------------------------------------------------------
(in millions of $) Six Months Ended June 30,
Customer Class 2005 Change % Change 2004
- ----------------------------------------------------------------------------
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
- ----------------------------------------------------------------------------
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:
- ----------------------------------------------------------------------------
(in millions of kWh) Six Months Ended June 30,
Customer Class 2005 Change % Change 2004
- ----------------------------------------------------------------------------
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.
62
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 Progress
Energy 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 8F of the Progress Energy 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.
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 Progress Energy 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 to the Progress Energy 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 Fuels segment, the CCO
segment and the Synthetic Fuels segment. These businesses are explained in more
detail below.
FUELS
The Fuels' segment operations include natural gas production, coal extraction
and terminal operations. The following summarizes Fuels' 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
- -----------------------------------------------------------------------------------------------
63
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:
- ------------------------------------------------------------------------------------------
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 Fuels' 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 $69 million.
The Company cannot currently predict the outcome of this matter.
COMPETITIVE COMMERCIAL OPERATIONS
CCO's operations generated segment losses of $3 million for the three months
ended June 30, 2005 compared to segment profit of $5 million in the prior year.
The decrease in earnings compared to prior year is due primarily to a reduction
in gross margin of $13 million pre-tax ($8 million after-tax) offset partially
by favorable interest expense. Contract margins are unfavorable compared to
prior year due to the expiration of certain tolling agreements and lower
at-market sales. This margin unfavorability was partially offset by increased
earnings from new full-requirements contracts and increased load on an existing
contract. In addition, interest expense decreased $3 million pre-tax ($2 million
after-tax) compared to the prior period due to the termination of CCO's Genco
financing arrangement in December 2004.
64
CCO's operations generated segment losses of $9 million for the six months ended
June 30, 2005 compared to segment losses of $3 million in the prior period. The
increase in losses compared to prior year is due primarily to a reduction in
gross margin of $15 million pre-tax ($9 million after-tax) offset partially by
favorable depreciation and amortization expense and interest expense. Contract
margins are unfavorable compared to prior year due to the expiration of certain
tolling agreements and lower at-market sales. This unfavorability was partially
offset by increased earnings from new full-requirements contracts and increased
load on an existing contract. In addition, results in the current year included
$2 million pre-tax ($1 million after-tax) in postretirement and severance costs
associated with the cost management initiative. Depreciation and amortization
expenses decreased $4 million pre-tax ($2 million after-tax) as a result of the
expiration of certain acquired contracts that were subject to amortization.
Interest expense decreased $5 million pre-tax ($2 million after-tax) due to the
termination of the Genco financing arrangement in December 2004.
- -----------------------------------------------------------------------------------------
Three months ended June 30, Six months ended June 30,
- -----------------------------------------------------------------------------------------
(in millions) 2005 2004 2005 2004
- -----------------------------------------------------------------------------------------
Total revenues $ 158 $ 72 $222 $ 105
Gross margin
In millions of $ $ 29 $ 42 $ 50 $ 65
As a % of revenues 18% 58% 23% 62%
Segment losses $ (3) $ 5 $ (9) $ (3)
- -----------------------------------------------------------------------------------------
The Company has contracts for its planned production capacity, which includes
callable resources from the cooperatives, of approximately 77% for 2005,
approximately 81% for 2006 and approximately 75% for 2007. The Company continues
to seek opportunities to optimize its nonregulated generation portfolio.
SYNTHETIC FUEL
The synthetic fuel operations generated segment profits of $23 million and $36
million for the three months ended June 30, 2005 and 2004, and $22 million and
$72 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
Progress Energy 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 2.3 2.7 4.3 5.7
- -----------------------------------------------------------------------------------------------
Operating losses, excluding tax credits $ (39) $(35) $ (77) $(77)
Tax credits generated, net 62 71 99 149
- -----------------------------------------------------------------------------------------------
Segment profits $ 23 $ 36 $ 22 $ 72
- -----------------------------------------------------------------------------------------------
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.
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 $17 million of previously recorded
tax credits were forfeited during the current year. See Note 14 to the Progress
Energy 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.
65
CORPORATE & OTHER
Corporate & Other consists of the operations of Progress Energy Holding Company
(the holding company), Progress Energy Service Company and other consolidating
and non-operating entities. Corporate & Other also includes other nonregulated
business areas including the telecommunications operations of Progress Telecom,
LLC (PT LLC) and the operations of Strategic Resource Solutions (SRS). PT LLC
operations provide broadband capacity services, dark fiber and wireless services
in Florida and the eastern United States. SRS was engaged in providing energy
services to industrial, commercial and institutional customers to help manage
energy costs primarily in the southeastern United States. During 2004, SRS sold
its subsidiary, Progress Energy Solutions (PES). With the disposition of PES,
the Company exited this business area.
Other nonregulated business areas
Other nonregulated businesses contributed segment losses of $2 million for the
three months ended June 30, 2005 compared to segment losses of $31 million for
the three months ended June 30, 2004. This favorability is due primarily to a
reduction in losses at SRS. During the second quarter of 2004 SRS recorded the
litigation settlement reached with the San Francisco United School District
related to civil proceedings. In June 2004, SRS reached a settlement with the
District which settled all outstanding claims for approximately $43 million
pre-tax ($29 million after-tax).
Other nonregulated businesses contributed segment losses of $2 million for the
six months ended June 30, 2005 compared to segment losses of $35 million for the
six months ended June 30, 2004. This favorability is due primarily to the
reduction of losses at SRS as discussed above.
Corporate Services
Corporate Services (Corporate) includes the operations of the Holding Company,
the Service Company and consolidation entities, as summarized below:
- ---------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
- ---------------------------------------------------------------------------------------------
Income (expense) in millions 2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------
Other interest expense $ (72) $ (67) $ (143) $ (140)
Contingent value obligations - (5) - (13)
Tax levelization (49) (5) (52) (43)
Tax reallocation (9) (9) (19) (18)
Other income taxes 32 28 62 59
Other (4) (4) (8) (7)
- ---------------------------------------------------------------------------------------------
Segment profit (loss) $ (102) $ (62) $ (160) $ (162)
- ---------------------------------------------------------------------------------------------
Other interest expense increased $5 million compared to $67 million for the
three months ended June 30, 2004 and increased $3 million compared to $140
million for the six months ended June 30, 2004. Interest expense increased
during the current periods due to increased rates on commercial paper
borrowings, interest rate swaps and additional expenses incurred related to draw
downs on revolving credit agreements.
Progress Energy issued 98.6 million contingent value obligations (CVOs) in
connection with the 2000 FPC acquisition. Each CVO represents the right to
receive contingent payments based on the performance of four synthetic fuel
facilities owned by Progress Energy. The payments, if any, are based on the net
after-tax cash flows the facilities generate. At June 30, 2005 and 2004, the
CVOs had fair market values of approximately $13 million and $36 million,
respectively. Progress Energy recorded unrealized losses of $0.5 million and $5
million for the three months ended June 30, 2005 and 2004, respectively, to
record the changes in fair value of the CVOs, which had average unit prices of
$0.14 and $0.36 at June 30, 2005 and 2004, respectively. Progress Energy
recorded an unrealized loss of $13 million for the six months ended June 30,
2004. The CVO values at June 30, 2005 were unchanged from the December 31, 2004
values, thus requiring no recognition of unrealized gain or loss for the six
months ended June 30, 2005.
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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 $49 million and $5 million for the three months
ended June 30, 2005 and 2004, and $52 million and $43 million for the six months
ended June 30, 2005 and 2004, respectively, in order to maintain an effective
tax rate consistent with the estimated annual rate. 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 Notes 3 and 14B
to the Progress Energy Consolidated Interim Financial Statements for additional
discussion.
Rail discontinued operations resulted in losses of $7 million for the three
months ended June 30, 2005 compared to profits of $7 million for the three
months ended June, 2004. Earnings for 2005 include an adjustment of $7 million
to the estimated after-tax loss on the sale related to working capital
adjustments and other revisions of operating estimates. Results for 2004 include
three months of operations. Results for the three months ended June 30, 2005 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 Progress
Energy Consolidated Interim Financial Statements.
Rail discontinued operations resulted in losses of $19 million for the six
months ended June 30, 2005 compared to profits of $16 million for the six months
ended June 30, 2004. Earnings for 2005 include an estimated after-tax loss on
the sale of $24 million. Results for 2004 included six months of earnings
activity compared to only three months in 2005.
NCNG discontinued operations contributed $1 million of net income for the three
and six months ended June 30, 2004. The sale of NCNG to Piedmont Natural Gas
Company closed in 2003; however, during the three and six months ended June 30,
2004, the Company recorded an additional gain of $1 million after tax related to
deferred taxes on the loss from the sale.
LIQUIDITY AND CAPITAL RESOURCES
Progress Energy, Inc.
Progress Energy is a registered holding company and, as such, has no operations
of its own. The Company's primary cash needs at the holding company level are
its common stock dividend and interest expense and principal payments on its
$4.3 billion of senior unsecured debt. The ability to meet these needs is
dependent on its access to the capital markets, the earnings and cash flows of
its two electric utilities and nonregulated subsidiaries, and the ability of
those subsidiaries to pay dividends or repay funds to Progress Energy.
Cash Flows from Operations
Net cash provided by operating activities decreased $322 million for the six
months ended June 30, 2005, when compared to the corresponding period in the
prior year. The decrease in operating cash flow was due primarily to a $313
million increase in working capital requirements. The increase in working
capital requirements was primarily driven by $90 million in synthetic fuel
royalty payments (see Note 14D), a $71 million difference in PEC's coal
inventory fluctuations, $73 million due to timing of tax payments at PEF, and a
$32 million reduction in tax liabilities related to the loss on disposal of
Rail. See Note 3 to the Progress Energy Consolidated Interim Financial
Statements.
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Investing Activities
Net cash used in investing activities decreased by $55 million for the six
months ended June 30, 2005, when compared to the corresponding period in the
prior year. The decrease is due primarily to $405 million in proceeds from the
sale of Progress Rail in March 2005, compared to $94 million in proceeds from
the sale of assets during the six months ended June 30, 2004. See Note 3 to the
Progress Energy Consolidated Interim Financial Statements. This was partially
offset by $160 million of lower net proceeds from short-term investments, $86
million in additional capital expenditures for utility property and nuclear fuel
additions, and the purchase of natural gas assets for $46 million at Progress
Fuels in May 2005. See Note 4 to the Progress Energy Consolidated Interim
Financial Statements.
Financing Activities
Net cash used in financing activities was $166 million for the six months ended
June 30, 2005, compared to $520 million for the six months ended June 30, 2004,
or a net decrease of $354 million. The change in cash used in financing
activities was due primarily to the March 1, 2004 maturity of $500 million 6.55%
senior unsecured notes. These notes were paid with cash and commercial paper
capacity which was created from the sale of assets during 2003.
In January 2005, the Company used proceeds from the issuance of commercial paper
to pay off $260 million of revolving credit agreement (RCA) loans, which
included $90 million at PEC and $170 million at PEF.
On January 31, 2005, Progress Energy, Inc. entered into a new $600 million RCA,
which was to expire on December 30, 2005. This facility was added to provide
additional liquidity, to the extent necessary, during 2005 due in part to the
uncertainty of the timing of storm restoration cost recovery from the hurricanes
in Florida during 2004. On February 4, 2005, $300 million was drawn under the
new facility to reduce commercial paper and pay off the remaining amount of
loans outstanding under other RCA facilities, which consisted of $160 million at
Progress Energy and $55 million at PEF. As discussed below, the maximum size of
this RCA was reduced to $300 million on March 22, 2005 and subsequently
terminated on May 16, 2005.
On March 22, 2005, PEC issued $300 million of First Mortgage Bonds, 5.15% Series
due 2015, and $200 million of First Mortgage Bonds, 5.70% Series due 2035. The
net proceeds from the sale of the bonds were used to pay at maturity $300
million of PEC's 7.50% Senior Notes on April 1, 2005 and reduce the outstanding
balance of PEC's commercial paper. Pursuant to the terms of the Progress Energy
$600 million RCA, commitments were reduced to $300 million, effective March 22,
2005.
In March 2005, Progress Energy, Inc.'s $1.1 billion five-year credit facility
was amended to increase the maximum total debt to total capital ratio from 65%
to 68% due to the potential impacts of a proposed interpretation of SFAS No. 109
regarding accounting rules for uncertain tax positions (See Note 2).
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 March 28, 2005, PEC 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 PEC's issuances of commercial paper and other short-term
obligations. The RCA will expire on June 28, 2010. The new $450 million RCA
replaced PEC's $285 million three-year RCA and $165 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 PEC's
long-term unsecured senior non-credit enhanced debt, currently rated as Baa1 by
Moody's and BBB by 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, which had been a provision in the terminated
agreements.
68
In May 2005, Progress Energy, Inc. used proceeds from the issuance of commercial
paper to pay off $300 million of its $600 million RCA.
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. Pursuant to the terms of the Progress
Energy $600 million RCA, commitments were completely reduced and the RCA was
terminated, effective May 16, 2005.
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, PEC filed a shelf registration statement with the SEC to
provide an additional $1.0 billion of capacity in addition to the $400 million
remaining on PEC's current shelf registration statement. The shelf registration
statement will allow PEC to issue various securities, including First Mortgage
Bonds, Senior Notes, Debt Securities and Preferred Stock.
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.
For the six months ended June 30, 2005, the Company issued approximately 4.0
million shares representing approximately $171 million in proceeds from its
Investor Plus Stock Purchase Plan and its employee benefit and stock option
plans, net of purchases of restricted shares. For the year 2005, the Company
expects to realize approximately $200 million aggregate amount from the sale of
stock through these plans.
Future Liquidity and Capital Resources
As of June 30, 2005, there were no material changes in the Company's "Capital
Expenditures," "Other Cash Needs," "Credit Facilities," or "Credit Rating
Matters" as compared to those discussed under in Item 7 of the Form 10-K, other
than "Environmental Matters" and as described below and under "Financing
Activities."
As of June 30, 2005, the current portion of long-term debt was $848 million,
which the Company expects to fund from proceeds from the sale of Progress Rail,
issuances of new long-term debt, commercial paper borrowings and/or issuance of
new equity securities.
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 general corporate purposes.
On April 29, 2005, PEF made its initial filing with the FPSC seeking annual base
revenue increase of $206 million. See Note 4 to the Progress Energy Consolidated
Interim Financial Statements. 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.
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's off-balance sheet arrangements and contractual obligations are
described below.
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Guarantees
As a part of normal business, Progress Energy and certain wholly owned
subsidiaries enter into various agreements providing future financial or
performance assurances to third parties that are outside the scope of 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. 45). These agreements are entered into
primarily to support or enhance the creditworthiness otherwise attributed to
Progress Energy and subsidiaries on a stand-alone basis, thereby facilitating
the extension of sufficient credit to accomplish the subsidiaries' intended
commercial purposes. The Company's guarantees include performance obligations
under power supply agreements, tolling agreements, transmission agreements, gas
agreements, fuel procurement agreements and trading operations. The Company's
guarantees also include standby letters of credit, surety bonds and guarantees
in support of nuclear decommissioning. As of June 30, 2005, the Company had
issued $1.3 billion of guarantees for future financial or performance assurance.
The Company does not believe conditions are likely for significant performance
under the guarantees of performance issued by or on behalf of affiliates.
The majority of contracts supported by the guarantees contain provisions that
trigger guarantee obligations based on downgrade events to below investment
grade (below BBB- or Baa3), ratings triggers, monthly netting of exposure and/or
payments and offset provisions in the event of a default. As of June 30, 2005,
no guarantee obligations had been triggered. If the guarantee obligations were
triggered, the maximum amount of liquidity requirements to support ongoing
operations within a 90-day period, associated with guarantees for the Company's
nonregulated portfolio and power supply agreements was $437 million. The Company
believes that it would be able to meet this obligation with cash or letters of
credit.
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
Under its risk management policy, the Company 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 to the Progress
Energy Consolidated Interim Financial Statements and Item 3, "Quantitative and
Qualitative Disclosures about Market Risk," for a discussion of market risk and
derivatives.
Contractual Obligations
As part of Progress Energy's ordinary course of business, it enters into various
long and short term contracts for fuel requirements at its generating plants.
Through June 30, 2005, contracts procured through PEC have increased the
Company's aggregate purchase obligations for fuel and purchased power by
approximately $709 million as compared to the amount stated in the Company's
Form 10-K for the year ended December 31, 2004. The increase primarily covers
the period ranging from 2005 through 2009. A majority of the contracts related
to the increase in purchase obligations for fuel and purchased power are for
future coal purchases primarily with fixed prices.
OTHER MATTERS
Synthetic Fuels Tax Credits
The Company has substantial operations associated with the production of
coal-based solid synthetic fuels. The production and sale of these products
qualifies for federal income tax credits so long as certain requirements are
satisfied. These operations are subject to numerous risks.
70
Although the Company believes that it operates its synthetic fuel facilities in
compliance with applicable legal requirements for claiming the credits, its four
Earthco facilities are under audit by the IRS. IRS field auditors have taken an
adverse position with respect to the Company's compliance with one of these
legal requirements, and if the Company fails to prevail with respect to this
position, it could incur significant liability and/or lose the ability to claim
the benefit of tax credits carried forward or generated in the future.
Similarly, in July 2005 the Financial Accounting Standards Board issued proposed
new accounting rules that would require that uncertain tax benefits (such as
those associated with the Earthco plants) be probable of being sustained in
order to be recorded on the financial statements; if adopted as currently
drafted, this provision could have an adverse financial impact on the Company.
See Note 2 to the Progress Energy Consolidated Interim Financial Statements.
The Company's ability to utilize tax credits is dependent on having sufficient
tax liability. Any conditions that reduce the Company's tax liability, such as
weather, could also diminish the Company's ability to utilize credits, including
those previously generated, and the synthetic fuel is generally not economical
to produce absent the credits. Finally, the tax credits associated with
synthetic fuels may be phased out if market prices for crude oil exceed certain
prices.
The Company's synthetic fuel operations and related risks are described in more
detail in Note 14 to the Progress Energy Consolidated Interim Financial
Statements and in the Risk Factors section of Progress Energy's Annual Report on
Form 10-K for the year ended December 31, 2004, which was filed with the SEC on
March 16, 2005.
PEF Rate Case Filing
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.
PEF Storm Cost Filing
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
associated with the four hurricanes in 2004. The ruling will allow PEF to
include a charge of approximately $3.27 on the average 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 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 over and above 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.
71
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.
Energy Bill
On July 29, 2005, the U.S. Senate gave the final approval for comprehensive
energy policy legislation. This bill provides tax changes for the utility
industry, incentives for emissions reductions, and federal insurance and
incentives to build new nuclear power plants. The U.S. House passed the measure
on July 28, 2005, and President Bush is expected to sign the legislation into
law on or about August 8, 2005.
The bill contains key provisions affecting the electric power industry,
including provisions on nuclear security and nuclear regulatory risk insurance,
repeal of the Public Utility Holding Company Act (PUHCA), and protection for
native retail load customers of utilities that are not in regional transmission
organizations. It gives the Federal Energy Regulatory Commission (FERC)
"backstop" transmission siting authority as well as increased utility merger
oversight. The bill also provides incentives and funding for clean coal
technologies and initiatives to voluntarily reduce greenhouse gases and
redesignates the Section 29 tax credit as a general business credit.
The Company is reviewing the new energy bill legislation and cannot currently
predict what impact the proposed law would have on its financial condition and
results of operations.
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, Florida, were concluded in 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 (the City) 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 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 assets that serve the City for approximately $42 million.
PEF transferred the distribution assets 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.
72
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. The Court's decision should not
have a material impact on the Company.
Environmental Matters
The Company is subject to federal, state and local regulations addressing air
and water quality, hazardous and solid waste management and other environmental
matters. The Company currently estimates total compliance costs, for PEC and PEF
combined, related to environmental laws and regulations addressing air and water
quality, which will primarily be for capital expenditures, may be in excess of
$2.0 billion over ten years. These environmental matters are discussed in detail
in Note 13. This discussion identifies specific environmental issues, the status
of the issues, accruals associated with issue resolutions and the associated
exposures to the Company. The Company accrues costs to the extent they are
probable and can be reasonably estimated. It is reasonably possible that
additional losses, which could be material, may be incurred in the future.
Progress Energy Carolinas, Inc.
The information required by this item is incorporated herein by reference to the
following portions of Progress Energy's Management's Discussion and Analysis of
Financial Condition and Results of Operations, insofar as they relate to PEC:
RESULTS OF OPERATIONS; LIQUIDITY AND CAPITAL RESOURCES and OTHER MATTERS.
RESULTS OF OPERATIONS
The results of operations for the PEC Electric segment are identical between PEC
and Progress Energy. The results of operations for PEC's nonutility subsidiaries
for the three and six months ended June 30, 2005 and 2004 are not material to
PEC's consolidated financial statements.
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LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities decreased $157 million for the six months
ended June 30, 2005, when compared to the corresponding period in the prior
year. The decrease was caused primarily by a change in emission allowance
inventory fluctuations of $46 million and a $102 million increase in working
capital requirements, primarily driven by a $71 million difference in coal
inventory fluctuations.
Cash used in investing activities increased $194 million for the six months
ended June 30, 2005, when compared to the corresponding period in the prior year
primarily due to lower net proceeds from short-term investments in 2005 compared
to 2004.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
PEC's off-balance sheet arrangements and contractual obligations are described
below.
Market Risk and Derivatives
Under its risk management policy, PEC 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 7 to PEC's
Consolidated Interim Financial Statements and Item 3, "Quantitative and
Qualitative Disclosures About Market Risk," for a discussion of market risk and
derivatives.
Contractual Obligations
As part of PEC's ordinary course of business, it enters into various long and
short term contracts for fuel requirements at its generating plants. Through
June 30, 2005, these contracts have increased the Company's aggregate purchase
obligations for fuel and purchased power by approximately $709 million as
compared to the amount stated in the Company's Form 10-K for the year ended
December 31, 2004. The increase primarily covers the period ranging from 2005
through 2009. A majority of the contracts related to the increase in purchase
obligations for fuel and purchased power are for future coal purchases primarily
with fixed prices.
74
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Progress Energy, Inc.
Other than described below, the various risks that the Company is exposed to has
not materially changed since December 31, 2004.
Progress Energy and its subsidiaries are exposed to various risks related to
changes in market conditions. Market risk represents the potential loss arising
from adverse changes in market rates and prices. The Company 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 policy, the Company 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 to the extent that the counterparty fails to perform under the
contract. The Company mitigates such risk by performing credit reviews using,
among other things, publicly available credit ratings of such counterparties.
Certain market risks are inherent in the Company's financial instruments, which
arise from transactions entered into in the normal course of business. The
Company's primary exposures are changes in interest rates with respect to its
long-term debt and commercial paper, fluctuations in the return on marketable
securities with respect to its nuclear decommissioning trust funds, changes in
the market value of CVOs, and changes in energy related commodity prices.
Interest Rate Risk
The Company's exposure to changes in interest rates from fixed rate and variable
rate long-term debt at June 30, 2005 has changed from December 31, 2004. The
total fixed rate long-term debt as of June 30, 2005, was $9.35 billion, with an
average interest rate of 6.40% and fair market value of $10.16 billion. The
total variable rate long-term debt as of June 30, 2005, was $0.86 billion, with
an average interest rate of 2.41% and fair market value of $0.86 billion.
In addition to the Company's variable rate long-term debt, the Company typically
has commercial paper and/or loans outstanding under its RCA facilities, which
are also exposed to floating interest rates. As of June 30, 2005, approximately
11.4% of consolidated debt, including interest rate swaps, was in floating rate
mode compared to 16.1% at the end of 2004.
From time to time, Progress Energy uses interest rate derivative instruments to
adjust the mix between fixed and floating rate debt in its debt portfolio, to
mitigate its exposure to interest rate fluctuations associated with certain debt
instruments, and to hedge interest rates with regard to future fixed rate debt
issuances.
The notional amounts of interest rate derivatives are not exchanged and do not
represent exposure to credit loss. In the event of default by a counterparty,
the risk in the transaction is the cost of replacing the agreements at current
market rates. Progress Energy only enters into interest rate derivative
agreements with banks with credit ratings of single A or better.
The Company uses a number of models and methods to determine interest rate risk
exposure and fair value of derivative positions. For reporting purposes, fair
values and exposures of derivative positions are determined as of the end of the
reporting period using the Bloomberg Financial Markets system.
In accordance with SFAS No. 133, interest rate derivatives that qualify as
hedges are broken into one of two categories, cash flow hedges or fair value
hedges. Cash flow hedges are used to reduce exposure to changes in cash flow due
to fluctuating interest rates. Fair value hedges are used to reduce exposure to
changes in fair value due to interest rate changes.
75
The following tables summarize the terms, fair market values and exposures of
the Company's interest rate derivative instruments:
Cash Flow Hedges:
As of June 30, 2005, Progress Energy had $200 million of pay-fixed swaps to
hedge cash flow for commercial paper interest and $100 million of pay-fixed
forward starting swaps to hedge cash flow risk with regard to future financing
transactions. Under terms of these swap agreements, Progress Energy will pay a
fixed rate and receive a floating rate based on either 1-month or 3-month LIBOR,
respectively.
- -------------------------------------------------------------------------------------------------------------
Cash Flow Hedges (dollars in millions)
Notional Fair
Progress Energy, Inc. Amount Pay Receive(b) Value Exposure(c)
- -------------------------------------------------------------------------------------------------------------
Risk hedged as of June 30, 2005:
Commercial Paper interest rate risk through
2005 $ 200 3.07% 1-month LIBOR $ 1 $ -
Anticipated 10-year debt issue(d) $ 100 4.87% 3-month LIBOR $ (4) $ (2)
- -------------------------------------------------------------------------------------------------------------
Total $ 300 3.67%(a) $ (3) $ (2)
- -------------------------------------------------------------------------------------------------------------
Risk hedged as of December 31, 2004:
Commercial Paper interest risk from 2005
through 2008 $ 200 3.07% 1-month LIBOR $ - $ -
Progress Energy Carolinas
- -------------------------------------------------------------------------------------------------------------
Risk hedged as of June 30, 2005: None
Risk hedged as of December 31, 2004:
- -------------------------------------------------------------------------------------------------------------
Anticipated 10-year debt issue $ 110 4.85% 3-month LIBOR $ (1) $ (2)
Rail car lease payment $ 21 5.17% 3-month LIBOR $ (1) $ -
- -------------------------------------------------------------------------------------------------------------
Total $ 131 4.90%(a) $ (2) $ (2)
- -------------------------------------------------------------------------------------------------------------
(a) Weighted average interest rate.
(b) 1-month LIBOR rate was 3.34% as of June 30, 2005, and 2.40% as of December
31, 2004.
3-month LIBOR rate was 3.52% as of June 30, 2005, and 2.56% as of December
31, 2004.
(c) Exposure indicates change in value due to 25 basis point unfavorable shift
in interest rates.
(d) Anticipated 10-year debt issue hedges mature on March 1, 2016, and require
mandatory cash settlement on March 1, 2006.
Fair Value Hedges:
As of June 30, 2005, Progress Energy had $150 million of fixed rate debt swapped
to floating rate debt. Under terms of these swap agreements, Progress Energy
will receive a fixed rate and pay a floating rate based on 3-month LIBOR.
76
- -------------------------------------------------------------------------------------------------------------
Fair Value Hedges (dollars in millions)
Notional
Progress Energy, Inc. Amount Receive Pay(b) Fair Value Exposure (c)
- -------------------------------------------------------------------------------------------------------------
Risk hedged as of June 30, 2005:
- -------------------------------------------------------------------------------------------------------------
5.85% Notes due 10/30/2008 $ 100 4.10% 3-month LIBOR $ - $ (1)
7.10% Notes due 3/1/2011 $ 50 4.65% 3-month LIBOR $ 2 $ (1)
- -------------------------------------------------------------------------------------------------------------
Total $ 150 4.28%(a) $ 2 $ (2)
- -------------------------------------------------------------------------------------------------------------
Risk hedged as of December 31, 2004:
- -------------------------------------------------------------------------------------------------------------
5.85% Notes due 10/30/2008 $ 100 4.10% 3-month LIBOR $ 1 $ (1)
7.10% Notes due 3/1/2011 $ 50 4.65% 3-month LIBOR $ 2 $ (1)
- -------------------------------------------------------------------------------------------------------------
Total $ 150 4.28%(a) $ 3 $ (2)
- -------------------------------------------------------------------------------------------------------------
(a) Weighted average interest rate.
(b) 3-month LIBOR rate was 3.52% as of June 30, 2005, and 2.56% as of December
31, 2004.
(c) Exposure indicates change in value due to 25 basis point unfavorable shift
in interest rates.
Marketable Securities Price Risk
The Company's exposure to return on marketable securities for the nuclear
decommissioning trust funds has not changed materially since December 31, 2004.
CVO Market Value Risk
The Company's exposure to market value risk with respect to the CVOs has not
changed materially since December 31, 2004.
Commodity Price Risk
The Company is exposed to the effects of market fluctuations in the price of
natural gas, coal, fuel oil, electricity and other energy-related products
marketed and purchased as a result of its ownership of energy-related assets.
The Company's exposure to these fluctuations is significantly limited by the
cost-based regulation of PEC and PEF. Each state commission allows electric
utilities to recover certain of these costs through various cost recovery
clauses to the extent the respective commission determines that such costs are
prudent. Therefore, while there may be a delay in the timing between when these
costs are incurred and when these costs are recovered from the ratepayers,
changes from year to year have no material impact on operating results. In
addition, many of the Company's long-term power sales contracts shift
substantially all fuel responsibility to the purchaser. The Company also has oil
price risk exposure related to synfuel tax credits. See discussion in Note 14E
to the Progress Energy Consolidated Interim Financial Statements.
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 manages open
positions with strict policies that limit its exposure to market risk and
require daily reporting to management of potential financial exposures. The
Company recorded pre-tax losses of less than $1 million and $2 million on such
contracts for the three months ended June 30, 2005 and 2004, respectively. The
Company recorded a $2 million pre-tax gain and a $14 million pre-tax loss on
such contracts for the six months ended June 30, 2005 and 2004, respectively.
The Company did not have material outstanding positions in such contracts as of
June 30, 2005 and 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. As of 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.
77
The Company uses natural gas hedging instruments to manage a portion of the
market risk associated with fluctuations in the future purchase and sales prices
of the Company's natural gas. Progress Energy's nonregulated subsidiaries
designate a portion of commodity derivative instruments as cash flow hedges
under SFAS No. 133. The fair values of commodity cash flow hedges as of June 30,
2005 and December 31, 2004 were as follows:
- ---------------------------------------------------------
(in millions) June 30, December 31,
2005 2004
- ---------------------------------------------------------
Fair value of assets $ 96 $ -
Fair value of liabilities (24) (15)
- ---------------------------------------------------------
Fair value, net $ 72 $ (15)
- ---------------------------------------------------------
The Company performs sensitivity analyses to estimate its exposure to the market
risk of its commodity positions. The Company's exposure to commodity price risk
has not changed materially since December 31, 2004. A hypothetical 10% increase
or decrease in quoted market prices in the near term on the Company's derivative
commodity instruments would not have had a material effect on the Company's
consolidated financial position, results of operations or cash flows as of June
30, 2005.
Refer to Note 9 for additional information with regard to the Company's
commodity contracts and use of derivative financial instruments.
Progress Energy Carolinas, Inc.
PEC has certain market risks inherent in its financial instruments, which arise
from transactions entered into in the normal course of business. PEC's primary
exposures are changes in interest rates with respect to long-term debt and
commercial paper, fluctuations in the return on marketable securities with
respect to its nuclear decommissioning trust funds, and changes in energy
related commodity prices. PEC's exposure to these risks has not materially
changed since December 31, 2004.
The information required by this item is incorporated herein by reference to the
"Quantitative and Qualitative Disclosures about Market Risk" discussed above
insofar as it relates to PEC.
Item 4: Controls and Procedures
Progress Energy, Inc.
Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, Progress
Energy carried out an evaluation, with the participation of its management,
including Progress Energy's Chairman and Chief Executive Officer and Chief
Financial Officer, of the effectiveness of Progress Energy's disclosure controls
and procedures (as defined under Rule 13a-15(e) under the Securities Exchange
Act of 1934) as of the end of the period covered by this report. Based upon that
evaluation, Progress Energy'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 Progress Energy 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 Progress
Energy'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
subsidiaries, Carolina Power & Light Company d/b/a Progress Energy Carolinas,
Inc. and 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. and Progress Energy Service Company, LLC. 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.
Other than the above-referenced item, there has been no change in Progress
Energy's internal control over financial reporting during the quarter ended June
30, 2005, that has materially affected, or is reasonably likely to materially
affect, Progress Energy's internal control over financial reporting.
78
Progress Energy Carolinas, Inc.
Pursuant to the Securities Exchange Act of 1934, PEC carried out an evaluation,
with the participation of its management, including PEC's Chairman and Chief
Executive Officer and Chief Financial Officer, of the effectiveness of PEC'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, PEC'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 PEC 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 PEC'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, Carolina Power & Light Company d/b/a Progress Energy Carolinas, 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 PEC's internal
control over financial reporting during the quarter ended June 30, 2005, that
has materially affected, or is reasonably likely to materially affect, its
internal control over financial reporting.
79
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Legal aspects of certain matters are set forth in Part I, Item 1. For a
discussion of certain other legal matters, see Note 14 to the Progress Energy,
Inc. Consolidated Interim Financial Statements and Note 12 to the PEC
Consolidated Interim Financial Statements.
In re Progress Energy, Inc. Securities Litigation, Master File No. 04-CV-636
(JES)
On February 3, 2004, Progress Energy, Inc. was served with a class action
complaint alleging violations of federal security laws in connection with the
Company's issuance of Contingent Value Obligations (CVOs). The action was filed
by Gerber Asset Management LLC in the United States District Court for the
Southern District of New York and names Progress Energy, Inc.'s former Chairman
William Cavanaugh III and Progress Energy, Inc. as defendants. The Complaint
alleges that Progress Energy failed to timely disclose the impact of the
Alternative Minimum Tax required under Sections 55-59 of the Internal Revenue
Code (Code) on the value of certain CVOs issued in connection with the Florida
Progress Corporation merger. The suit seeks unspecified compensatory damages, as
well as attorneys' fees and litigation costs.
On March 31, 2004, a second class action complaint was filed by Stanley Fried,
Raymond X. Talamantes and Jacquelin Talamantes against William Cavanaugh III and
Progress Energy, Inc. in the United States District Court for the Southern
District of New York alleging violations of federal securities laws arising out
of the Company's issuance of CVOs nearly identical to those alleged in the
February 3, 2004, Gerber Asset Management complaint. On April 29, 2004, the
Honorable John E. Sprizzo ordered among other things that (1) the two class
action cases be consolidated, (2) Peak6 Capital Management LLC shall serve as
the lead plaintiff in the consolidated action, and (3) the lead plaintiff shall
file a consolidated amended complaint on or before June 15, 2004.
The lead plaintiff filed a consolidated amended complaint on June 15, 2004. In
addition to the allegations asserted in the Gerber Asset Management and Fried
complaints, the consolidated amended complaint alleges that the Company failed
to disclose that excess fuel credits could not be carried over from one tax year
into later years. On July 30, 2004, the Company filed a motion to dismiss the
complaint; plaintiff submitted its opposition brief on September 14, 2004. The
Court heard oral argument on the Company's motion to dismiss on November 15,
2004. On May 24, 2005, the Court dismissed the litigation with prejudice.
Item 2. Unregistered Sale of Equity Securities and Use of Proceeds
a. RESTRICTED STOCK AWARDS:
(a) Securities Delivered. On April 1, 2005, 72,600 restricted shares of the
Company's Common Shares were granted to certain key employees pursuant to
the terms of the Company's 2002 Equity Incentive Plan (Plan), which was
approved by the Company's shareholders on May 8, 2002. Section 9 of the
Plan provides for the granting of Restricted Stock by the Organization and
Compensation Committee of the Company's Board of Directors, (the Committee)
to key employees of the Company, including its Affiliates or any successor,
and to outside directors of the Company. The Common Shares delivered
pursuant to the Plan were acquired in market transactions directly for the
accounts of the recipients and do not represent newly issued shares of the
Company.
(b) Underwriters and Other Purchasers. No underwriters were used in connection
with the delivery of Common Shares described above. The Common Shares were
delivered to certain key employees of the Company. The Plan defines "key
employee" as an officer or other employee of the Company who is selected
for participation in the Plan.
(c) Consideration. The Common Shares were delivered to provide an incentive to
the employee recipients to exert their utmost efforts on the Company's
behalf and thus enhance the Company's performance while aligning the
employee's interest with those of the Company's shareholders.
(d) Exemption from Registration Claimed. The Common Shares described in this
Item were delivered on the basis of an exemption from registration under
Section 4(2) of the Securities Act of 1933. Receipt of the Common Shares
required no investment decision on the part of the recipients.
80
c. ISSUER PURCHASES OF EQUITY SECURITIES FOR SECOND QUARTER OF 2005
- --------------------------------------------------------------------------------------------------------------------------
Period (a) (b) (c) (d)
Total Number of Shares Maximum Number (or
Total Number of Average (or Units) Purchased as Approximate Dollar Value) of
Shares Price Paid Part of Publicly Shares (or Units) that May
(or Units) Per Share Announced Plans or Yet Be Purchased Under the
Purchased(1)(2) (or Unit) Programs(1) Plans or Programs(1)
- --------------------------------------------------------------------------------------------------------------------------
April 1 - April 30 72,600 $42.53 N/A N/A
- --------------------------------------------------------------------------------------------------------------------------
May 1- May 31 N/A N/A N/A N/A
- --------------------------------------------------------------------------------------------------------------------------
June 1 - June 30 N/A N/A N/A N/A
- --------------------------------------------------------------------------------------------------------------------------
Total: 72,600 $42.53 N/A N/A
- --------------------------------------------------------------------------------------------------------------------------
(1) As of June 30, 2005, Progress Energy does not have any publicly announced
plans or programs to purchase shares of its common stock.
(2) 72,600 shares of our common stock were purchased in open-market
transactions in connection with restricted stock awards that were granted
to certain key employees pursuant to the terms of the Progress Energy 2002
Equity Incentive Plan, which was approved by Progress Energy's Shareholders
on May 8, 2002.
81
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Annual Meeting of the Shareholders of Progress Energy, Inc. was held on
May 11, 2005.
(b) The meeting involved the election of three Class I directors to serve for
three-year terms. Proxies for the meeting were solicited pursuant to
Regulation 14, there was no solicitation in opposition to management's
nominees as listed below, and all nominees were elected.
(c) The total votes for the election of directors were as follows:
Class I (Term Expiring in 2008) Votes For Votes Withheld
- ----------------------------------------------------------------------------
William O. McCoy 205,913,326 4,398,058
John H. Mullin, III 206,101,396 4,209,988
Carlos A. Saladrigas 206,112,664 4,198,720
The Board of Director proposal to ratify the selection of Deloitte & Touche LLP
as the Company's independent registered public accounting firm was approved by
the shareholders.
The number of shares voted for the proposal was 205,625,939
The number of shares voted against the proposal was 2,651,127
The number of abstaining votes was 2,034,318
Carolina Power & Light Company, doing business as Progress Energy Carolinas,
Inc.
(a) The Annual Meeting of the Shareholders of Carolina Power & Light Company
was held on May 11, 2005.
(b) The meeting involved the election of three Class I directors to serve for
three-year terms. Proxies for the meeting were solicited pursuant to
Regulation 14, there was no solicitation in opposition to management's
nominees as listed below, and all nominees were elected.
(c) The total votes for the election of directors were as follows:
Class I (Term Expiring in 2008) Votes For Votes Withheld
- --------------------------------------------------------------------------
William O. McCoy 160,129,938 4,171
John H. Mullin, III 160,129,664 4,445
Carlos A. Saladrigas 160,129,764 4,345
The Board of Director proposal to ratify the selection of Deloitte & Touche LLP
as the Company's independent registered public accounting firm was approved by
the shareholders.
The number of shares voted for the proposal was 160,129,689
The number of shares voted against the proposal was 2,288
The number of abstaining votes was 2,132
82
Item 6. Exhibits
(a) Exhibits
Exhibit Progress Progress Energy
Number Description Energy, Inc. Carolinas, Inc.
- ------ ----------- ------------ ---------------
10 Amendment to Employment Agreement Between Progress X 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 Act of 2002 - Chairman and Chief
Executive Officer
31(b) Certifications pursuant to Section 302 of the X X
Sarbanes-Oxley Act of 2002 - Executive Vice
President and Chief Financial Officer
32(a) Certifications pursuant to Section 906 of the X X
Sarbanes-Oxley Act of 2002 - Chairman and Chief
Executive Officer
32(b) Certifications pursuant to Section 906 of the X X
Sarbanes-Oxley Act of 2002 - Executive Vice
President and Chief Financial Officer
83
SIGNATURES
Pursuant to 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.
PROGRESS ENERGY, INC.
CAROLINA POWER & LIGHT COMPANY
Date: August 5, 2005 (Registrants)
By: /s/Geoffrey S. Chatas
-------------------------
Geoffrey S. Chatas
Executive Vice President and
Chief Financial Officer
By:/s/Jeffrey M.Stone
-------------------------
Jeffrey M. Stone
Controller and Chief Accounting Officer
84