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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 QUARTER ENDED SEPTEMBER 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____TO_____
MIRANT MID-ATLANTIC, LLC
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 58-2574140
- ------------------------------------------- ---------------------------------------- ----------------------------------------
(State or other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
1155 Perimeter Center West, Suite 100, Atlanta, Georgia 30338
- ------------------------------------------------------------------------------------ ----------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(678) 579-5000
- --------------------------------------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
----------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Registrant meets the conditions set forth in General Instruction H of Form
10-Q and is therefore filing this Form with the permitted reduced disclosure
format.
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MIRANT MID-ATLANTIC, LLC AND SUBSIDIARIES
INDEX
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
PAGE
NUMBER
------
DEFINITIONS 1
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION 2
PART I - FINANCIAL INFORMATION
Item 1. Interim Financial Statements (Unaudited):
Condensed Consolidated Statements of Income 3
Condensed Consolidated Balance Sheets 4
Condensed Consolidated Statement of Members' Equity 6
Condensed Consolidated Statements of Cash Flows 7
Notes to the Condensed Consolidated Financial Statements 8
Independent Accountants' Review Report 21
Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 22
Item 3. Quantitative and Qualitative Disclosures about Market Risk 35
Item 4. Controls and Procedures 37
PART II - OTHER INFORMATION
Item 1. Legal Proceedings Inapplicable
Item 2. Changes in Securities and Use of Proceeds Inapplicable
Item 3. Defaults Upon Senior Securities Inapplicable
Item 4. Submission of Matters to a Vote of Security Holders Inapplicable
Item 5. Other Information Inapplicable
Item 6. Exhibits and Reports on Form 8-K 37
Signatures
Certifications
i
DEFINITIONS
TERM MEANING
- ---- -------
Clean Air Act Clean Air Act Amendments of 1990
ECSA Energy and Capacity Sales Agreement between
Mirant Americas Energy Marketing and
Mirant Mid-Atlantic
EITF Emerging Issues Task Force
EPA U. S. Environmental Protection Agency
FASB Financial Accounting Standards Board
LIBOR London Interbank Offering Rate
Mirant Mirant Corporation and its subsidiaries
Mirant Americas Mirant Americas, Inc.
Mirant Americas Energy Marketing Mirant Americas Energy Marketing, L. P.
Mirant Americas Generation Mirant Americas Generation, LLC
Mirant Chalk Point Mirant Chalk Point, LLC
Mirant D.C. O&M Mirant D.C. O&M, LLC
Mirant MD Ash Management Mirant MD Ash Management, LLC
Mirant Mid-Atlantic or the Company Mirant Mid-Atlantic, LLC and its
subsidiaries
Mirant Peaker Mirant Peaker, LLC
Mirant Piney Point Mirant Piney Point, LLC
Mirant Potomac River Mirant Potomac River, LLC
Mirant Services Mirant Services, LLC
OCI Other comprehensive income
PEPCO Potomac Electric Power Company
PJM PJM Interconnection Market
SEC Securities and Exchange Commission
SFAS Statement of Financial Accounting Standards
1
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
The information presented in this quarterly report on Form 10-Q includes
forward-looking statements, in addition to historical information. These
statements involve known and unknown risks and relate to future events, Mirant
Mid-Atlantic's future financial performance or projected business results. In
some cases, forward-looking statements may be identified by terminology such as
"may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "targets," "potential" or "continue" or the negative of
these terms or other comparable terminology.
Forward-looking statements are only predictions. Actual events or results
may differ materially from any forward-looking statement as a result of various
factors, which include:
o legislative and regulatory initiatives regarding deregulation, regulation
or restructuring of the electric utility industry;
o the extent and timing of the entry of additional competition in the
markets of the Company and its affiliates;
o our pursuit of potential business strategies, including acquisitions or
dispositions of assets or internal restructuring;
o political, legal and economic conditions and developments and state,
federal and other rate regulations in the United States;
o changes in or application of environmental and other laws and regulations
to which we and subsidiaries and affiliates are subject;
o financial market conditions and the results of our or our affiliates
financing efforts;
o changes in market conditions, including developments in energy and
commodity supply, volume and pricing and interest rates;
o weather and other natural phenomena;
o the direct or indirect effects on our business, including the availability
of insurance, resulting from the terrorist actions on September 11, 2001
or any other terrorist actions or responses to such actions, including,
but not limited to, acts of war;
o the direct or indirect effects on our business of a further lowering of
the credit rating of the pass through certificates or the credit ratings
of Mirant Americas Generation, Mirant Americas Energy Marketing and Mirant
Corporation (or actions we may take in response to changing credit ratings
criteria), including, refusal by current or potential counterparties to
enter into transactions with us, Mirant Americas Generation, Mirant
Americas Energy Marketing and Mirant and our respective inability to
obtain credit or capital in desired amounts or on terms favorable to us;
o the direct or indirect effects of the accounting issues discussed in Note
A in the notes to the unaudited condensed consolidated financial
statements included in this Form 10-Q and any additional issues arising
from the weakness identified by the internal control and procedures review
of Mirant Corporation discussed in Item 4 of this Form 10-Q;
o the direct or indirect ramifications of the results of the reaudits of the
2000 and 2001 financial statements of Mirant Corporation, Mirant Americas
Generation and the Company and any restatements that may be required as a
result of these reaudits including potential effects on our or our
affiliates financing arrangements and possible future refinancing efforts;
o the direct or indirect effects on our business of our failure to timely
file our Form 10-Q for the quarters ended June 30, 2002 and September 30,
2002;
o the direct or indirect effects of the change in the way the Company
calculates its fixed charge coverage ratios as discussed in Item 2 of this
Form 10-Q; and
o other factors discussed in this Form 10-Q and in our reports filed from
time to time with the SEC (including our Form 10-K filed March 28, 2002,
our Form 10-Q filed on May 13, 2002, as amended by our Form 10-Q/A for the
quarter ended March 31, 2002 filed on December 20, 2002 and our Form 10-Q
for the quarter ended June 30, 2002 filed on December 20, 2002).
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, events, levels of
activity, performance or achievements. We expressly disclaim a duty to update
any of the forward-looking statements contained herein.
2
MIRANT MID-ATLANTIC, LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(Wholly-Owned Indirect Subsidiary of Mirant Corporation)
(In Millions)
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- --------------------
2002 2001 2002 2001
----- ----- ----- -----
OPERATING REVENUES:
Affiliates (Notes A and E) $ 202 $ 285 $ 592 $ 830
Other 16 9 25 17
----- ----- ----- -----
Total operating revenues 218 294 617 847
----- ----- ----- -----
COST OF FUEL, ELECTRICITY AND OTHER PRODUCTS:
Affiliates (Note E) 108 172 262 486
Other 26 1 27 2
----- ----- ----- -----
Total cost of fuel, electricity and other products 134 173 289 488
----- ----- ----- -----
GROSS MARGIN 84 121 328 359
----- ----- ----- -----
OTHER OPERATING EXPENSES:
Maintenance - affiliates 5 6 16 17
Maintenance - other 6 6 18 18
Generation facilities lease (Note F) 24 24 72 72
Depreciation and amortization 12 18 36 55
Selling, general and administrative - affiliates (Note E) 9 5 21 14
Selling, general and administrative - other -- 3 7 13
Taxes other than income taxes 8 9 26 23
Restructuring charges (Note E) 2 -- 5 --
Other - affiliates 8 7 22 23
Other 5 5 12 12
----- ----- ----- -----
Total other operating expenses 79 83 235 247
----- ----- ----- -----
OPERATING INCOME 5 38 93 112
----- ----- ----- -----
OTHER INCOME (EXPENSE), NET:
Interest income - affiliates 7 6 21 19
Interest income - other -- -- -- 1
Interest expense - affiliates (1) (3) (1) (6)
Interest expense - other -- -- -- (2)
----- ----- ----- -----
Total other income, net 6 3 20 12
----- ----- ----- -----
Net Income $ 11 $ 41 $ 113 $ 124
===== ===== ===== =====
The accompanying notes are an integral part of
these condensed consolidated statements.
3
MIRANT MID-ATLANTIC, LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(Wholly-Owned Indirect Subsidiary of Mirant Corporation)
(In Millions)
AT SEPTEMBER 30, AT DECEMBER 31,
2002 2001
---------------- ---------------
ASSETS:
CURRENT ASSETS:
Receivables:
Customer accounts $ 9 $ 10
Affiliates 49 59
Interest from affiliates 6 --
Notes receivable from affiliate (Note E) 97 29
Assets from risk management activities (Note D) 1 2
Derivative hedging instruments (Notes C and D) 6 1
Fuel stock 30 71
Materials and supplies 31 33
Prepaid rent 96 96
Other prepaids 14 21
------- -------
Total current assets 339 322
------- -------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment 1,079 1,046
Less accumulated provision for depreciation (68) (39)
------- -------
1,011 1,007
Construction work in progress 21 20
------- -------
Total property, plant and equipment, net 1,032 1,027
------- -------
NONCURRENT ASSETS:
Notes receivable from affiliates (Note E) 223 223
Assets from risk management activities (Note D) 7 3
Derivative hedging instruments (Notes C and D) 6 --
Goodwill, net of accumulated amortization of $35 and $34 for
2002 and 2001, respectively (Notes A and B) 1,229 1,169
Other intangible assets, net of accumulated amortization of $10 and
$4 for 2002 and 2001, respectively (Notes A and B) 180 280
Prepaid rent and other 83 35
------- -------
Total noncurrent assets 1,728 1,710
------- -------
Total assets $ 3,099 $ 3,059
======= =======
The accompanying notes are an integral part of
these condensed consolidated balance sheets.
4
MIRANT MID-ATLANTIC, LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(Wholly-Owned Indirect Subsidiary of Mirant Corporation)
(In Millions)
AT SEPTEMBER 30, AT DECEMBER 31,
2002 2001
---------------- ---------------
LIABILITIES AND MEMBERS' EQUITY:
CURRENT LIABILITIES:
Accounts payable and accrued liabilities $ 40 $ 41
Payables to affiliates 41 24
Liabilities from risk management activities (Note D) 5 5
Derivative hedging instruments (Notes C and D) 1 1
Note payable to affiliate (Note E) 18 130
------- -------
Total current liabilities 105 201
------- -------
NONCURRENT LIABILITIES:
Liabilities from risk management activities (Note D) -- 2
Derivative hedging instruments (Notes C and D) -- 2
Other long term liabilities 5 5
------- -------
Total noncurrent liabilities 5 9
------- -------
COMMITMENTS AND CONTINGENT MATTERS (NOTE F)
MEMBERS' EQUITY:
Members' interest 3,074 2,902
Capital contribution receivable from affiliate pursuant to ECSA (Note E) (47) (91)
Accumulated other comprehensive income (loss) (Note C) 11 (2)
(Accumulated deficit) retained earnings (49) 40
------- -------
Total members' equity 2,989 2,849
------- -------
TOTAL LIABILITIES AND MEMBERS' EQUITY $ 3,099 $ 3,059
======= =======
The accompanying notes are an integral part of
these condensed consolidated balance sheets.
5
MIRANT MID-ATLANTIC, LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF MEMBERS' EQUITY (UNAUDITED)
(Wholly-Owned Indirect Subsidiary of Mirant Corporation)
(In Millions)
CAPITAL RETAINED ACCUMULATED
CONTRIBUTION EARNINGS OTHER
MEMBERS' RECEIVABLE (ACCUMULATED COMPREHENSIVE COMPREHENSIVE
INTEREST FROM AFFILIATE DEFICIT) INCOME (LOSS) INCOME
----------- --------------- ------------- --------------- ------------
BALANCE, DECEMBER 31, 2001 $ 2,902 $ (91) $ 40 $ (2)
Net income -- -- 113 -- $ 113
Other comprehensive income (Note C) -- -- -- 13 13
-----
Comprehensive income $ 126
=====
Dividends -- -- (202) --
Push down of tax effects of the
implementation of SFAS No. 142 (37) -- -- --
Capital contributions - cash 26 -- -- --
Capital contributions - noncash 183 (53) -- --
Capital contribution received pursuant
to ECSA (Note E) -- 97 -- --
------- ------- ------- -------
BALANCE, SEPTEMBER 30, 2002 $ 3,074 $ (47) $ (49) $ 11
======= ======= ======= =======
The accompanying notes are an integral part of
these condensed consolidated statements.
6
MIRANT MID-ATLANTIC, LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(Wholly-Owned Indirect Subsidiary of Mirant Corporation)
(In Millions)
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
--------------------
2002 2001
----- -----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 113 $ 124
----- -----
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 36 55
Risk management activities, net (5) 3
Changes in certain assets and liabilities:
Customer accounts receivables -- (5)
Affiliate receivables 4 (57)
Prepaid rent (47) (69)
Fuel stock 42 (40)
Other current assets 7 10
Accounts payable and accrued liabilities (3) 23
Payables to affiliate 16 29
Other current liabilities -- (1)
----- -----
Total adjustments 50 (52)
----- -----
Net cash provided by operating activities 163 72
----- -----
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (34) (40)
Asset acquisition costs -- (2)
Notes receivable from affiliates, net (68) --
----- -----
Net cash used in investing activities (102) (42)
----- -----
CASH FLOWS FROM FINANCING ACTIVITIES:
Capital contributions 26 15
Payment of dividends (202) (46)
Capital contribution received from affiliate pursuant to ECSA (Note E) 97 10
Notes payable to affiliates, net 18 55
----- -----
Net cash (used in) provided by financing activities (61) 34
----- -----
NET INCREASE IN CASH AND CASH EQUIVALENTS -- 64
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD -- 22
----- -----
CASH AND CASH EQUIVALENTS, END OF PERIOD $ -- $ 86
===== =====
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Cash paid for interest, net of amounts capitalized $ -- $ 4
===== =====
NONCASH INVESTING AND FINANCING ACTIVITIES:
Capital contribution from forgiveness of note payable
to affiliate $ 130 $ --
===== =====
Capital contribution receivable from affiliate pursuant to ECSA $ 53 $ 120
===== =====
The accompanying notes are an integral part of
these condensed consolidated statements.
7
MIRANT MID-ATLANTIC, LLC AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Wholly-Owned Indirect Subsidiary of Mirant Corporation)
A. ACCOUNTING AND REPORTING POLICIES
GENERAL. Mirant Mid-Atlantic, a Delaware limited liability company, was
formed on July 12, 2000 in conjunction with Mirant's planned acquisition of
generating assets and other related assets from Potomac Electric Power Company.
At September 30, 2002, Mirant Mid-Atlantic was an indirect wholly owned
subsidiary of Mirant Americas Generation, an indirect wholly owned subsidiary of
Mirant Corporation ("Mirant"). Effective October 1, 2002, Mirant Mid-Atlantic is
a direct wholly owned subsidiary of Mirant Americas Generation. Substantially
all of the Company's revenues are earned from Mirant Americas Energy Marketing.
The Company is primarily engaged in the operation of merchant power
generation facilities in Maryland and the District of Columbia. The Company's
accompanying unaudited condensed consolidated financial statements include its
wholly owned subsidiaries as follows:
o Mirant Chalk Point;
o Mirant D.C.O&M;
o Mirant Piney Point; and
o Mirant MD Ash Management.
ADJUSTMENTS TO PREVIOUSLY ISSUED FINANCIAL STATEMENTS. The Company has
restated its previously reported finanical statements for the first quarter of
2002. The restatement adjustments reduced net income to $60 million from the
originally reported net income of $71 million. At March 31, 2002, revenue
related to the Company's ECSA with Mirant Americas Energy Marketing (an
affiliate), was reduced by $11 million, accounts receivable from Mirant Americas
Energy Marketing was reduced by $5 million, and capital contribution receivable
pursuant to the ECSA (a members' equity account) was reduced by $6 million. The
previously issued financial statements did not take into account Mirant Americas
Energy Marketing's election under the ECSA in January 2002 to increase the
energy purchased from the Company for 2002 to 100% of the capacity of its
facilities from the contractual minimum of 75%, as described in Note E. In
addition, the Company recorded an addition to members' equity, with a
corresponding capital contribution receivable pursuant to the ECSA, of $53
million, to reflect the excess of the fixed price of the capacity and energy in
the ECSA over the projected market prices when the Company became committed to
provide the additional energy to Mirant Americas Energy Marketing.
The statement of cash flows has also been restated to reflect amounts
received under the ECSA attributable to the capital contribution received as a
financing activity, rather than an operating activity.
A summary comparison of the previously reported and restated first quarter
2002 unaudited condensed consolidated statement of income follows (in millions):
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 2002, AS MARCH 31, 2002,
PREVIOUSLY REPORTED AS RESTATED
------------------------- ------------------------
Operating revenues............................. $210 $199
Cost of fuel, electricity and other products... 65 65
---- ----
Gross margin................................... 145 134
Other.......................................... (74) (74)
---- ----
Net income..................................... $ 71 $ 60
==== ====
8
A summary comparison of the previously reported and restated first quarter
2002 unaudited condensed consolidated statement of cash flows follows (in
millions):
THREE MONTHS ENDED MARCH THREE MONTHS ENDED
31, 2002 AS PREVIOUSLY MARCH 31, 2002 AS
REPORTED RESTATED
-------------------------- ------------------------
Cash flows from operating activities........... $116 $96
Cash flows from investing activities........... (99) (99)
Cash flows from financing activities........... (17) 3
----- -----
Net change in cash and cash equivalents........ $ 0 $ 0
===== ====
The Company has engaged KPMG to reaudit the Company's 2000 and 2001
financial statements in conjunction with the reaudit of Mirant's 2000 and 2001
financial statements. The effects, if any, of such reaudit on the Company's
financial statements cannot be determined. In addition, we are not currently
able to assess the impact on the Company of the reaudit of Mirant and the
accounting issues at Mirant Americas Energy Marketing in light of the business
relationships between the Company, Mirant Americas Energy Marketing and Mirant
Corporation.
BASIS OF ACCOUNTING. These unaudited condensed consolidated financial
statements should be read in conjunction with the Company's audited 2000 and
2001 consolidated financial statements and the accompanying footnotes which are
contained in the Company's annual report on Form 10-K for the year ended
December 31, 2001. As previously discussed, Mirant has engaged its independent
auditors to reaudit its 2000 and 2001 financial statements.
The results for interim periods are not necessarily indicative of the
results for the entire year. Certain prior-year amounts have been reclassified
to conform with the current year financial statement presentation.
The Company has changed its classification, on the accompanying unaudited
condensed consolidated statements of income, of realized and unrealized gains
and losses related to commodity derivative financial instruments and risk
management financial instruments. Under the new classification, gains and
losses, both realized and unrealized, for electricity related financial
instruments are included in operating revenues. Gains and losses, both realized
and unrealized, for fuel related financial instruments are included in cost of
fuel, electricity and other products. Prior year amounts have been reclassified
to conform to the current year presentation.
Management believes that the accompanying unaudited condensed consolidated
financial statements as of September 30, 2002 and for the three and nine months
then ended reflect adjustments, consisting of normal recurring items, necessary
for a fair presentation of results for those interim periods presented.
ACCOUNTING CHANGES. In July 2001, the FASB issued SFAS No. 141, "Business
Combinations" ("SFAS No. 141"), and SFAS No. 142, "Goodwill and Other Intangible
Assets" ("SFAS No. 142"). These pronouncements significantly change the
accounting for business combinations, goodwill and intangible assets. SFAS No.
141 establishes that all business combinations will be accounted for using the
purchase method; use of the pooling-of-interests method is no longer allowed.
The statement further clarifies the criteria to recognize intangible assets
separately from goodwill. The provisions of SFAS No. 141 are effective for all
business combinations initiated after June 30, 2001 and for business
combinations accounted for using the purchase method for which the acquisition
date was before July 1, 2001. SFAS No. 142 addresses financial accounting and
reporting for acquired goodwill and other intangible assets and, generally,
adopts a non-amortization and periodic impairment-analysis approach to goodwill
and indefinite-lived intangibles. SFAS No. 142 is effective for the Company's
2002 fiscal year or for business combinations initiated after June 30, 2001.
Mirant Mid-Atlantic adopted these statements on January 1, 2002.
9
Upon initial application of SFAS No. 141, Mirant Mid-Atlantic reassessed
the classification of its intangible assets and determined that trading rights
resulting from business combinations did not meet the new criteria for
recognition apart from goodwill. Effective January 1, 2002, trading rights
related to business combinations were reclassified to goodwill as required by
the Statement. The reclassification increased goodwill by $55 million, net of
accumulated amortization of $3 million, and net of the effect on deferred taxes
of the adjustment recorded by our parent of $37 million. Since Mirant
Mid-Atlantic is not a taxable entity, all deferred income taxes related to
book/tax differences of the assets and liabilities of Mirant Mid-Atlantic are
recorded by Mirant Americas, Mirant Americas Generation's parent company. A
deferred tax liability was not recognized by Mirant Americas in the purchase
accounting for the non-deductible goodwill attributed to the Company. A deferred
tax liability was recognized for the book/tax basis difference related to the
trading rights attributed to the Company. The reclassification of trading rights
to goodwill in connection with the adoption of SFAS No. 142 resulted in the
reversal of the deferred tax liability recorded by Mirant Americas. The
reduction in the deferred tax liability at Mirant Americas resulted in a
reduction in the amount of goodwill attributed to Mirant Mid-Atlantic.
As a result of the adoption of SFAS No. 142, Mirant Mid-Atlantic
discontinued amortization of goodwill effective January 1, 2002. During the
three months ended March 31, 2002, Mirant Mid-Atlantic completed the
transitional impairment test required by SFAS No. 142 and did not record any
impairments of goodwill. Net income for the three and nine months ended
September 30, 2001 has been adjusted below to exclude amortization related to
goodwill and trading rights recognized in business combinations for the period
(in millions).
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2001
---------------- --- -----------------
Net income as reported................................ $ 41 $ 124
Effect of goodwill and trading rights amortization.... 7 24
------- -------
Net income as adjusted................................ $ 48 $ 148
====== =====
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations" ("SFAS No. 143"). SFAS No. 143 addresses financial
accounting and reporting obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. The provisions of
SFAS No. 143 are effective for the Company's 2003 fiscal year. Mirant
Mid-Atlantic has not yet determined the financial statement impact of this
statement.
In October 2001, the FASB issued SFAS No. 144, which supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of" and Accounting Principles Board Opinion No. 30,
"Reporting the Results of Operations - Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions." SFAS No. 144 amends accounting and reporting standards
for the disposal of segments of a business and addresses various issues related
to the accounting for impairments or disposals of long-lived assets. Mirant
Mid-Atlantic's adoption of SFAS No. 144, effective January 1, 2002, did not have
a material impact on its unaudited condensed consolidated financial statements.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities " ("SFAS No. 146"). SFAS No. 146
requires companies to recognize certain costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. Examples of costs covered by the standard include lease
termination costs and certain employee severance costs that are associated with
a restructuring, discontinued operation, plant closing, or other exit or
disposal activity. The provisions of SFAS No. 146 are effective for exit or
disposal activities that are initiated after December 31, 2002. Mirant
Mid-Atlantic will adopt SFAS No. 146 on January 1, 2003 and does not believe
that it will have a material impact on its financial statements.
10
In June 2002, the EITF reached consensus on certain issues related to EITF
Issue 02-3, "Accounting for Contracts Involved in Energy Trading and Risk
Management Activities," with the main consensus being that gains and losses on
energy trading contracts should be reported net in the statement of income. In
October 2002, the Task Force rescinded EITF Issue 98-10, "Accounting for
Contracts Involved in Energy Trading and Risk Management Activities" resulting
in energy-related contracts that are not accounted for pursuant to SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities, as amended"
("SFAS No. 133") such as transportation contracts, storage contracts and tolling
agreements, being accounted for as executory contracts using the accrual method
of accounting and not at fair value. The consensus reached on EITF Issue 02-3
and the rescission of EITF Issue 98-10 do not impact the Company's financial
statements.
CONCENTRATION OF REVENUES AND CREDIT RISK. Revenues earned from Mirant
Americas Energy Marketing approximated 93% and 96% of the Company's total
operating revenues for the three and nine months ended September 30, 2002,
respectively, as compared to 97% and 98% for the same periods in 2001. As of
September 30, 2002, Mirant Mid-Atlantic's exposure to Mirant Americas Energy
Marketing, Mirant, Mirant Potomac River and Mirant Peaker was $95 million
(including $47 million shown as a capital contribution receivable from affiliate
pursuant to ECSA in the members' equity section of the accompanying unaudited
condensed consolidated balance sheet), $98 million, $156 million and $73
million, respectively, each representing more than 10% of the Company's total
credit exposure. The Mirant exposure is related to participation in Mirant's
cash management program in which available cash was loaned to Mirant on a daily
basis (Note E). Mirant Mid-Atlantic's total credit exposure is computed as total
accounts and notes receivable, adjusted for risk management and derivative
hedging activities, netted where appropriate.
B. GOODWILL AND OTHER INTANGIBLE ASSETS
During the nine months ended September 30, 2002, no goodwill was acquired,
impaired or written off. Subsequent to September 30, 2002, there may be an
impairment of goodwill at Mirant Mid-Atlantic as a result of the overall
conditions impacting the energy sector. The Company cannot currently estimate
the potential goodwill impairment charge, if any, until completion of its
assessment of the book values of long-lived assets, estimated future cash flows
associated with such assets as well as the completion of the 2003 planning
process. The Company expects to complete its analysis prior to reporting its
2002 results. As of September 30, 2002, Mirant Mid-Atlantic's goodwill was
$1.23 billion.
All of Mirant Mid-Atlantic's other intangible assets are subject to
amortization. Other intangible assets are being amortized on a straight-line
basis over the related useful lives, up to 40 years. Effective January 1, 2002,
trading rights related to business combinations were reclassified to goodwill.
The reclassification decreased other intangible assets by $92 million, net of
accumulated amortization of $3 million. The trading rights represent the
Company's ability to create additional cash flows by incorporating Mirant's
trading organization activities with generation assets. In a deregulated
marketing structure, trading rights are the ability to create value beyond that
of the tangible assets through developing markets. Development rights represent
the ability to expand capacity at certain acquired generation facilities. The
existing infrastructure, including storage facilities, transmission
interconnections, and fuel delivery systems, and contractual rights acquired by
Mirant provide the opportunity to expand or repower generation facilities. This
ability to repower or expand is at significant cost savings compared to
greenfield construction. Other intangible asset amortization expense for the
three and nine months ended September 30, 2002 was $2 million and $9 million,
respectively. The components of other intangible assets as of September 30, 2002
and December 31, 2001 were as follows (in millions):
11
SEPTEMBER 30, 2002 DECEMBER 31, 2001
-------------------------------- -------------------------------------
GROSS CARRYING ACCUMULATED GROSS CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
----------------- -------------- ----------------- -------------------
Trading rights................... $ -- $ -- $ 95 $ (3)
Development rights............... 47 (2) 46 (1)
Emissions allowances............. 131 (7) 131 --
Other intangibles................ 12 (1) 12 --
------ ------ ------ ----
Total other intangible assets. $ 190 $ (10) $ 284 $ (4)
===== ====== ===== =====
Assuming no future acquisitions, dispositions or impairments of the
intangible assets, amortization expense is estimated to be $10 million for the
year ended December 31, 2002 and $6 million for each of the following four
years.
C. COMPREHENSIVE INCOME
Comprehensive income includes unrealized gains and losses on certain
derivatives that qualify as cash flow hedges. The following table sets forth the
comprehensive income for the three and nine months ended September 30, 2002 and
2001 (in millions):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- ----------------------
2002 2001 2002 2001
------------- ----------- ------------- --------
Net income........................ $ 11 $ 41 $ 113 $ 124
Other comprehensive income (loss). 2 (14) 13 --
----- ----- ----- -------
Comprehensive income.............. $ 13 $ 27 $ 126 $ 124
==== ==== ===== =====
Components of accumulated other comprehensive income (loss) consisted of
the following (in millions):
BALANCE, DECEMBER 31, 2001.................................... $ (2)
Other comprehensive income for the period:
Change in fair value of derivative hedging instruments...... (5)
Reclassification to earnings................................ 18
----
Other comprehensive income.................................... 13
----
BALANCE, SEPTEMBER 30, 2002................................... $ 11
====
Mirant Mid-Atlantic estimates that approximately $5 million of net
derivative gains included in accumulated other comprehensive income as of
September 30, 2002 will be reclassified into earnings or otherwise settled
within the next twelve months as certain transactions relating to commodity
contracts are realized.
D. FINANCIAL INSTRUMENTS
DERIVATIVE HEDGING INSTRUMENTS
Mirant Mid-Atlantic uses derivative instruments to manage exposures
arising from changes in commodity prices. Mirant Mid-Atlantic's objective for
holding derivative instruments is to minimize risks using the most effective
methods to eliminate or reduce the impacts of these exposures and to provide a
measure of stability to the Company's cash flows in a time of volatile changes
in commodity prices.
Derivative gains and losses arising from cash flow hedges that are
included in OCI are reclassified into earnings in the same period as the
settlement of the underlying transaction. During the three and nine months ended
September 30, 2002, $9 million and $18 million of derivative losses were
reclassified to operating income. The derivative gains and losses reclassified
to earnings were partly offset by realized gains and losses arising from the
settlement of the underlying physical transactions being hedged. Under SFAS No.
133, transactions may meet the requirements for hedge treatment, but may be less
than 100% effective. For example, a derivative instrument specifying one
commodity delivery location may be used to hedge a risk at a different commodity
12
delivery location. The price differential between the two locations is
considered the ineffective portion of the hedge. Any changes in the fair value
of the ineffective portion must be recorded currently in earnings. During the
three and nine months ended September 30, 2002, gains or losses arising from
hedge ineffectiveness were immaterial. At September 30, 2002, the maximum term
over which the Company is hedging exposures to the variability of cash flows is
through 2007.
COMMODITY PRICE HEDGING
Mirant Mid-Atlantic enters into commodity financial instruments in order
to hedge market risk and exposure to market prices for natural gas, oil and
other fuels utilized by its generation assets. These financial instruments
primarily include forwards, futures and swaps. Where these contracts are
derivatives and are designated as cash flow hedges, the gains and losses are
deferred in OCI and are then recognized in earnings in the same period as the
settlement of the underlying physical transaction.
At September 30, 2002, Mirant Mid-Atlantic had a net commodity derivative
hedging asset of approximately $11 million. The fair value of the Company's
commodity derivative hedging instruments is determined using various factors,
including closing exchange or over-the-counter market price quotations, time
value and volatility factors underlying options and contractual commitments.
At September 30, 2002, these contracts related to periods through 2007.
The net notional amount, or net long position, of the commodity derivative
hedging instruments for natural gas and residual fuel at September 30, 2002 was
approximately 2.2 million equivalent megawatt-hours. Following is a summary of
the units, equivalent megawatt-hours and duration by commodity. These notional
amounts are indicative only of the volume of activity and not of the amount
exchanged by the parties to the financial instruments. Consequently, these
amounts are not a measure of market risk.
EQUIVALENT AVERAGE
NOMINAL UNITS MEGAWATT-HOURS DURATION
LONG (SHORT) LONG (SHORT) (YEARS)
-------------- ------------ -------
Natural gas.................... 13 million mmbtu 1.3 million 1.64
Residual fuel.................. 1.4 million barrels 0.9 million 1.10
RISK MANAGEMENT ACTIVITIES
Certain financial instruments used by the Company to manage risk exposure
to energy and fuel prices do not meet the hedge criteria under SFAS No. 133. The
fair values of these financial instruments are included in assets and
liabilities from risk management activities in the accompanying unaudited
condensed consolidated balance sheets. These financial instruments include
contracts such as forward contracts, futures contracts, option contracts and
financial swap agreements.
At September 30, 2002, these contracts related to periods through 2004. The
net notional amount, or net long position, of the risk management assets and
liabilities at September 30, 2002 was approximately 0.2 million equivalent
megawatt-hours. Following is a summary of the units, equivalent megawatt-hours
and duration by commodity. These notional amounts are indicative only of the
volume of activity and not of the amount exchanged by the parties to the
financial instruments. Consequently, these amounts are not a measure of market
risk.
EQUIVALENT AVERAGE
NOMINAL UNITS MEGAWATT-HOURS DURATION
LONG (SHORT) LONG (SHORT) (YEARS)
------------- -------------- --------
Natural gas.................... (1.1) million mmbtu (.1) million 0.28
Crude oil...................... 0.4 million barrels 0.2 million 0.86
Residual fuel.................. 0.2 million barrels 0.1 million 1.75
The fair values of the assets and liabilities from risk management
activities recorded on the unaudited condensed consolidated balance sheet as of
September 30, 2002 are included in the following table (in millions).
RISK MANAGEMENT
-----------------------
ASSETS LIABILITIES
----------- -----------
Energy commodity instruments:
Crude oil........................ $ 2 $ --
Residual fuel.................... 3 4
Natural gas...................... 3 1
----- -----
Total......................... $ 8 $ 5
==== ====
13
E. BUSINESS DEVELOPMENTS AND RELATED PARTY TRANSACTIONS
SALES AGREEMENT WITH MIRANT AMERICAS ENERGY MARKETING
The Company has entered into an Energy and Capacity Sales Agreement
("ECSA"), which is a fixed rate power purchase agreement with Mirant Americas
Energy Marketing. Under the terms of the ECSA, Mirant Mid-Atlantic supplies all
of its facilities' capacity and energy to Mirant Americas Energy Marketing for
the period from August 1, 2001 through June 30, 2004, extendable through
December 31, 2004 at Mirant Americas Energy Marketing's option. For 2002 and
2003, Mirant Americas Energy Marketing has elected to keep its committed
capacity and energy purchases at 100% of the total output of the Company's
facilities. For 2004, Mirant Americas Energy Marketing has the option to
purchase up to 100 % (in blocks of 25%) of the total output of the Company's
facilities, with no minimum commitment. Mirant Americas Energy Marketing is a
party to transitional power agreements with PEPCO under which PEPCO has a
similar option to purchase energy with respect to PEPCO's load requirements.
Prior to August 1, 2001, the Company sold its power to Mirant Americas
Energy Marketing pursuant to a master sales agreement. Under this agreement the
price the Company received was based on the market price for energy in the PJM
market at the time the energy was delivered. The Company also sold power to
Mirant Americas Energy Marketing under fixed price contracts.
The Company's affiliated companies, Mirant Potomac River and Mirant
Peaker, have also entered into fixed rate power purchase agreements with Mirant
Americas Energy Marketing on the same terms and effective over the same period
as the agreement outlined above. Through a capital contribution agreement
between Mirant Mid-Atlantic and Mirant, the cash available from these affiliated
companies is paid as a dividend to Mirant, which in turn makes an indirect
capital contribution to Mirant Mid-Atlantic for the same amount.
At the inception date of the ECSA, the pricing of Mirant Americas Energy
Marketing's minimum committed capacity and energy purchases was favorable to
Mirant Mid-Atlantic and its affiliates when compared to estimated market rates
in the PJM for power to be delivered over the initial term of the agreement. The
estimated market rates were based on quoted market prices in the PJM, as
adjusted upwards by approximately 12% for what the Company believed, at the
time, to be temporary anomalies in such market prices based on forecasted demand
growth and other factors.
At inception, the aggregate value to the Company and its affiliates
relating to the favorable pricing variance was approximately $167 million. The
amount related specifically to Mirant Mid-Atlantic's owned or leased facilities
amounted to $120 million and was reflected as both an addition to members'
interest and an offsetting capital contribution receivable pursuant to the ECSA
on the Company's consolidated balance sheet and statement of members' equity at
the inception of the agreements. At inception, the Company had assumed that in
2002 Mirant Americas Energy Marketing would elect to take the contracted minimum
75% of the capacity and output of the Company's facilities. In January 2002,
Mirant Americas Energy Marketing elected to keep its committed capacity at 100%
of the total output of the Company's facilities. Therefore, the Company has
recorded an additional equity contribution of $53 million in the first quarter
of 2002 to reflect the favorable pricing variance
14
related to the additional 25% capacity and energy that Mirant Americas Energy
Marketing committed to take in 2002. This adjustment is reflected in the
accompanying unaudited condensed consolidated balance sheet and statement of
members' equity as both an addition to members' interest and an offsetting
capital contribution receivable pursuant to the ECSA.
The contractual amounts payable under the ECSA in excess of the amount of
revenue recognized due to the favorable pricing variances were $43 million and
$104 million for the three and nine months ended September 30, 2002,
respectively. These amounts are generally received in the month following the
month the related revenue is recognized and are recorded as a reduction in the
capital contribution receivable pursuant to the ECSA when received. During the
nine months ended September 30, 2002, the Company received $97 million under the
ECSA that was applied as a reduction to the capital contribution receivable
pursuant to the ECSA. The capital contribution receivable pursuant to the ECSA
was $47 million at September 30, 2002, of which $12 million represents amounts
received subsequent to September 30, 2002 related to the revenue recognized
prior to that date and $35 million relates to the favorable pricing variance
over the remaining three months of 2002.
The favorable pricing variance accounted for as a capital contribution
receivable is not adjusted for subsequent changes in energy prices. As a result,
amounts recognized as revenue under the ECSA do not necessarily reflect market
prices at the time the energy is delivered. Amounts recognized as revenue for
capacity and energy delivered under the ECSA were less than the amounts based on
current market prices by approximately $31 million for the three months ended
September 30, 2002 and exceeded the amounts based on current market prices by
approximately $126 million for the nine months ended September 30, 2002.
On November 15, 2002, Mirant Americas Energy Marketing elected to keep
its committed capacity at 100% of the output of the Company's facilities for
2003. The aggregate value to the Company and its affiliates relating to the
favorable price variance from this election was approximately $170 million. The
amount allocated specifically to Mirant Mid-Atlantic's owned or leased
facilities was approximately $120 million. Accordingly, an adjustment of
approximately $120 million to members' equity and an offsetting capital
contribution receivable pursuant to the ECSA will be recorded in the fourth
quarter of 2002.
SERVICES AND ADMINISTRATION ARRANGEMENTS
The Company and its subsidiaries utilize the services of Mirant, Mirant
Services and Mirant Americas Energy Marketing. The significant arrangements with
these affiliated companies are described below. Management believes that the
amounts allocated or charged to the Company are reasonable and are substantially
similar to costs it would have incurred on a stand-alone basis. The following
table summarizes the amounts incurred under the arrangements that are recorded
in the accompanying unaudited condensed consolidated statements of income as
selling, general and administrative expenses - affiliates:
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- -----------------------
2002 2001 2002 2001
---- ---- ---- ----
Management, personnel and services agreement............. $ 3 $ 4 $ 9 $ 10
Services agreements...................................... 2 1 5 4
Administration arrangement............................... 4 -- 7 --
---- ----- ------ -------
Total selling, general and administrative expenses -
affiliates............................................ $ 9 $ 5 $ 21 $ 14
=== === ==== ====
Management, Personnel and Services Agreement with Mirant Services
Mirant Services provides the Company with various management, personnel
and other services. The Company reimburses Mirant Services for amounts equal to
Mirant Services' direct costs of providing such services.
15
The total costs incurred under the agreement for the three and nine months
ended September 30, 2002 and 2001 have been included in the accompanying
unaudited condensed consolidated statements of income as follows (in millions):
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- -----------------------
2002 2001 2002 2001
---- ---- ---- ----
Cost of fuel, electricity and other products $ 1 $ 1 $ 4 $ 4
Maintenance 5 6 16 17
Selling, general and administrative expense......... 3 4 9 10
Other operating expense............................. 8 7 22 23
------ ---- ----- ----
Total costs under the Management, Personnel and
Services Agreement............................. $ 17 $ 18 $ 51 $ 54
==== ==== ==== ====
Services Agreements with Mirant Americas Energy Marketing
The Company, through its subsidiaries, is a party to separate power sales,
fuel supply and services agreements with Mirant Americas Energy Marketing.
Mirant Americas Energy Marketing is responsible for marketing and scheduling the
majority of the capacity from the Company's facilities. Mirant Americas Energy
Marketing has no minimum purchase requirements under these agreements, except
for a commitment under its ECSA which runs through the end of 2003 with an
option by Mirant Americas Energy Marketing to extend it through 2004.
During the three and nine months ended September 30, 2002, the Company
incurred approximately $2 million and $5 million, respectively, in costs under
the power sales, fuel supply and services agreements it has with Mirant Americas
Energy Marketing as compared to $1 million and $4 million, respectively, for the
same periods in 2001. These costs are included in selling, general and
administrative expenses - affiliates in the accompanying unaudited condensed
consolidated statements of income.
Effective July 1, 2002, the Company and Mirant Americas Energy Marketing
amended the services and risk management agreement with regard to the provision
of the residual fuel oil requirements at Mirant Mid-Atlantic's Chalk Point
facility. The revised agreement is an all-requirements contract with pricing
based on the daily Platts New York Harbor mean index for residual fuel oil plus
a delivery charge. Pursuant to the revised agreement, Mirant Americas Energy
Marketing will also manage the fuel oil storage associated with Chalk Point. The
Company believes that its fuel price risk can be more effectively managed
because the forward fuel oil hedge instruments frequently purchased by the
Company typically settle against the New York Harbor index. The new arrangement
is expected to lower the working capital requirements for the Company, as Mirant
Americas Energy Marketing will now own the majority of fuel oil inventory at the
Chalk Point facility. Under the new arrangement, Mirant Mid-Atlantic will be
obligated to purchase residual fuel oil at the index price on the day it is
utilized at Chalk Point. Previously, Mirant Mid-Atlantic ordered residual fuel
oil at market prices in advance of its use. In July 2002, the Company sold fuel
oil inventory at its book value of approximately $15 million to Mirant Americas
Energy Marketing.
Administration Arrangement with Mirant Services
Beginning in May 2002, Mirant Services implemented a fixed administration
charge to various subsidiaries of Mirant, including Mirant Mid-Atlantic, which
serves to reimburse Mirant Services for various indirect administrative services
performed on the subsidiaries' behalf, including, but not limited to,
information technology services, regulatory support, consulting, legal and
accounting and financial services. The fixed charge is approximately $1.4
million per month and the initial term of the agreement expires on December 31,
2002. For the three and nine months ended September 30, 2002, the Company
incurred approximately $4 million and $7 million, respectively, in costs under
this arrangement which are included in selling, general and administrative
expense in the accompanying unaudited condensed consolidated statements of
income. Prior to May 2002, similar administrative services were charged by
Mirant Services to the Company based on incremental costs directly attributable
to the Company.
16
NOTES PAYABLE TO AND NOTES RECEIVABLE FROM AFFILIATES
In January 2002, through the forgiveness of debt, Mirant Americas
Generation made a capital contribution of $130 million to Mirant Mid-Atlantic.
The related credit facility was concurrently terminated and is no longer
available to Mirant Mid-Atlantic.
Mirant Peaker and Mirant Potomac River borrowed funds from the Company in
order to finance their respective acquisitions of generation assets. At both
September 30, 2002 and December 31, 2001, notes receivable from these two
affiliates consisted of the following (in millions):
BORROWER PRINCIPAL INTEREST RATE MATURITY
-------- --------- ------------- --------
Mirant Potomac River................ $ 152 10% 12/30/2028
Mirant Peaker ..................... $ 71 10% 12/30/2028
Mirant Potomac River and Mirant Peaker have a capital contribution
agreement with Mirant in which they make quarterly distributions to Mirant of
all cash available after taking into consideration projected cash requirements,
including mandatory debt service, prepayments permitted under the terms of the
notes payable and maintenance reserves.
Under the capital contribution agreement, the owner lessors, the holders
of the lessor notes, and the indenture trustee of Mirant Mid-Atlantic's lease
arrangements (Note F) have the ability to enforce the payment terms of the notes
receivable.
Principal is due on maturity with interest due semiannually, in arrears,
on June 30 and December 30. Any amount not paid when due bears interest
thereafter at 12%. Mirant Potomac River and Mirant Peaker may prepay up to $5
million and $3 million per year, respectively. Interest earned from Mirant
Potomac and Mirant Peaker was $6 million for both the three months ended
September 30, 2002 and 2001 and $17 million for both the nine months ended
September 30, 2002 and 2001.
As of September 30, 2002, Mirant Mid-Atlantic had a cash management
agreement with Mirant, whereby any excess cash, including capital contributions,
was transferred to Mirant pursuant to a note agreement which was payable upon
demand. Similarly, Mirant advanced funds to Mirant Mid-Atlantic for working
capital purposes. At September 30, 2002, the Company and its subsidiaries had
made net advances to Mirant under the cash management agreement totaling $79
million (consisting of $97 million in advances to Mirant recorded as a notes
receivable from affiliates on the unaudited condensed consolidated balance sheet
and $18 million in advances from Mirant recorded as a notes payable to
affiliates on the unaudited condensed consolidated balance sheet). These
advances were due on demand. Effective February 1, 2002, the interest rate
payable on the advances was changed to LIBOR plus 180 basis points from an
interest rate based on the actual return obtained by Mirant on its short-term
investments. The repayment by Mirant of any advances was subordinate to the
repayment of the senior obligations of Mirant.
Effective October 21, 2002, the Company discontinued its involvement in
Mirant's cash management program and commenced the operation of bank deposit and
money market accounts in the Company's own name. As of October 21, 2002, the net
principal balance outstanding under the cash management program of $83 million
was received by the Company from Mirant.
CAPITAL CONTRIBUTION AGREEMENT
Under a capital contribution agreement, Mirant Potomac River and Mirant
Peaker, both of which are direct wholly owned subsidiaries of Mirant, make
distributions to Mirant at least once per quarter, if funds are available.
Distributions are equal to all cash available after taking into account
projected cash requirements, including mandatory debt service, prepayments
permitted under the Mirant Potomac River and Mirant Peaker notes, and
maintenance reserves, as reasonably determined by Mirant. Mirant will contribute
or cause these amounts to be contributed to the Company. Total capital
contributions received by the Company under this agreement totaled $26 million
for the nine months ended September 30, 2002, as compared to $15 million for the
same period in 2001.
17
MIRANT RESTRUCTURING
As a result of changing market conditions including constrained access to
capital markets attributable primarily to the Enron bankruptcy and Moody's
December 2001 downgrade of Mirant's credit rating, Mirant adopted a plan to
restructure its operations by exiting certain business operations, canceling and
suspending planned power plant developments, closing business development
offices and severing employees. As of September 30, 2002, Mirant Services had
terminated 23 employees at Mirant Mid-Atlantic locations and an additional 64
employees have been terminated as of November 1, 2002. Severance costs of $2
million and $5 million were expensed during the three and nine months ended
September 30, 2002, respectively, and are reflected in "Restructuring charges"
in the accompanying unaudited condensed consolidated statements of income. The
severance costs and other employee termination-related charges associated with
the restructuring at Mirant Mid-Atlantic locations were paid by Mirant Services
and billed to Mirant Mid-Atlantic.
F. COMMITMENTS AND CONTINGENT MATTERS
OPERATING LEASES
On December 19, 2000, in conjunction with the purchase of the PEPCO
assets, the Company entered into multiple sale-leaseback transactions totaling
$1.5 billion relating to the Dickerson and the Morgantown baseload units and
associated property. The terms of each lease vary between 28.5 and 33.75 years.
The Company is accounting for these leases as operating leases. The Company's
expenses associated with the commitments under the Dickerson and Morgantown
operating leases totaled approximately $24 million for both the three months
ended September 30, 2002 and 2001 and $72 million for both the nine months ended
September 30, 2002 and 2001 and are recorded as generation facilities lease
expense in the accompanying unaudited condensed consolidated statements of
income. As of September 30, 2002, the total notional minimum lease payments for
the remaining life of the leases was approximately $2.8 billion. The lease
agreements contain covenants that restrict the Company's ability to, among other
things, make dividend distributions, incur indebtedness, or sublease the
facilities.
Mirant Mid-Atlantic is not permitted to make any dividend distributions
unless, at the time of such distribution, each of the following conditions is
satisfied:
o Mirant Mid-Atlantic's fixed charge coverage ratio for the most
recently ended four full fiscal quarters equals at least:
(1) 1.7 to 1.0; or
(2) 1.6 to 1.0, 1.45 to 1.0, 1.3 to 1.0 or 1.2 to 1.0 if, as of the
last day of the most recently completed fiscal quarter, Mirant
Mid-Atlantic and its designated subsidiaries have entered into power sales
agreements (meeting certain criteria, including investment grade ratings
criteria) covering, in the aggregate, at least 25%, 50%, 75% or 100%,
respectively of the projected total consolidated operating revenue for the
consecutive period of eight full fiscal quarters following that date; and
o the projected fixed charge coverage ratio (determined on a pro forma
basis after giving effect to any such dividend) for each of the two
following periods of four fiscal quarters commencing with the fiscal
quarter in which the restricted payment is proposed to be made
equals at least:
18
(1) 1.7 to 1.0; or
(2) 1.6 to 1.0, 1.45 to 1.0, 1.3 to 1.0 or 1.2 to 1.0, if, as of the
last day of the most recently completed fiscal quarter, Mirant
Mid-Atlantic and its designated subsidiaries have entered into power sales
agreements (meeting certain criteria, including investment grade ratings
criteria) covering, in the aggregate, at least 25%, 50%, 75% or 100%,
respectively, of the projected total consolidated operating revenue for
the consecutive period of eight full fiscal quarters following that date;
and
o no significant lease default or event of default has occurred and is
continuing.
In accordance with the terms of the lease documentation, Mirant
Mid-Atlantic calculates the projected fixed charge coverage ratio based on
projections prepared in good faith based upon assumptions consistent in all
material respects with the relevant contracts and agreements, historical
operations, and Mirant Mid-Atlantic's good faith projections of future revenues
and projections of operating and maintenance expenses in light of then existing
or reasonably expected regulatory and market environments in the markets in
which the leased facilities or other assets owned by it will be operated. Mirant
Mid-Atlantic also assumes that there will be no early redemption or prepayment
of Indebtedness, and that any Indebtedness which matures within such projected
periods will be refinanced on reasonable terms. The reclassification of the
capital contribution received pursuant to the ECSA will reduce the Company's
fixed charge coverage ratios calculated for purposes of determining its ability
to make dividend payments.
These leases are part of a leveraged lease transaction. Three series of
certificates were issued and sold pursuant to a Rule 144A offering. These
certificates are interests in pass through trusts that hold the lessor notes
issued by the owner lessors. The Company pays rent to an indenture trustee, who
in turn makes payments of principal and interest to the pass through trusts and
any remaining balance to the owner lessors for the benefit of the owner
participants. According to the registration rights agreement dated December 18,
2000, the Company must maintain its status as a reporting company under the
Exchange Act. The Company was also obliged to consummate an exchange offer
pursuant to an effective registration statement under the Securities Act. On
July 6, 2001, the Company's registration statement became effective and the
exchange offer was completed in August 2001.
The Company has an option to renew the lease for a period that would cover
up to 75% of the economic useful life of the facility, as measured near the end
of the lease term. However, the extended term of the lease will always be less
than 75% of the revised economic useful life of the facility.
Upon an event of default by the Company, the lessors are entitled to a
termination value payment as defined in the agreements, which, in general,
decreases over time . At September 30, 2002, the termination value was
approximately $1.4 billion. Upon expiration of the original lease term, the
termination value will be $300 million.
FUEL PURCHASE AGREEMENTS
In April 2002, Mirant Mid-Atlantic entered into a long-term fuel purchase
agreement. The fuel supplier will convert coal feedstock received at the
Company's Morgantown facility into a synthetic fuel. Under the terms of the
agreement, Mirant Mid-Atlantic is required to purchase a minimum of 2.4 million
tons of fuel per annum through December 2007. The purchase price of the fuel
will vary with the delivered cost of the coal feedstock. Based on current coal
prices, it is expected that the annual purchase commitment will be approximately
$100 million. In July 2002, synthetic fuel plant operations commenced at the
Morgantown facility at which time the minimum purchase commitment became
effective. At September 30, 2002, total estimated minimum commitments under the
agreement were $525 million. In July 2002, the Company sold its coal inventory
at the Morgantown facility to the synthetic fuel supplier for approximately $10
million.
19
ENVIRONMENTAL INFORMATION REQUESTS
In January 2001, the EPA, Region 3 issued a request for information to
Mirant Mid-Atlantic concerning the air permitting implications of past repair
and maintenance activities at its Chalk Point, Dickerson and Morgantown plants
in Maryland. The requested information concerns the period of operations that
predates Mirant Mid-Atlantic's ownership of the plants. Mirant Mid-Atlantic has
responded fully to this request. If a violation is determined to have occurred
at any of the plants, Mirant Mid-Atlantic may be responsible for the cost of
purchasing and installing emission control equipment, the cost of which may be
material. Under the sales agreement with PEPCO for those plants, PEPCO is
responsible for fines and penalties arising from any violation associated with
historical operations prior to the Company's acquisition of the plants. The
state or federal government could, however, seek fines and penalties directly
from Mirant Mid-Atlantic, the cost of which may be material.
The Company cannot provide assurance that lawsuits or other administrative
actions against its power plants will not be filed or taken in the future. If an
action is filed against the Company or its power plants and it is judged to not
be in compliance, this could require substantial expenditures to bring the
Company's power plants into compliance and have a material adverse effect on its
financial condition, cash flows and results of operations.
ASBESTOS CASES
On December 19, 2000, Mirant, through its subsidiaries and together with
lessors in a lease transaction, purchased from PEPCO four electric generation
facilities in the Washington D.C. area. As a part of the purchase, and with
certain qualifications, Mirant agreed to indemnify PEPCO for certain liabilities
arising in lawsuits filed after December 19, 2000, even if they relate to
incidents occurring prior to that date. Since the acquisition, PEPCO has
notified Mirant of approximately 50 asbestos cases, distributed among three
Maryland jurisdictions (Prince George's County, Baltimore City and Baltimore
County), as to which it claims a right of indemnity. In each of these claims,
the plaintiff's allegation of liability on the part of PEPCO is primarily
grounded on the theory of premises liability. Each plaintiff seeks a
multi-million dollar award. It is expected that additional such lawsuits will be
filed in the future; however, the number of such additional lawsuits cannot now
be determined. Five suits have been set for trial in 2003, while the remainder
have not yet been scheduled for trial. Mirant Mid-Atlantic believes that
substantial defenses to liability exist and that, even if found liable,
plaintiffs' damages claims are greatly exaggerated. Based on information and
relevant circumstances known at this time, Mirant Mid-Atlantic does not believe
these suits will have a material adverse effect on its financial position. An
unfavorable decision, however, could have a material adverse effect on results
of operations in the particular year in which a decision is rendered.
20
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
The Board of Directors and Members
Mirant Mid-Atlantic, LLC:
We have reviewed the accompanying condensed consolidated balance sheet of Mirant
Mid-Atlantic, LLC (a wholly-owned indirect subsidiary of Mirant Corporation) and
subsidiaries as of September 30, 2002, and the related condensed consolidated
statements of income for the three-month and nine-month periods ended September
30, 2002, and the related statements of members' equity and cash flows for the
nine-month period ended September 30, 2002. These condensed consolidated
financial statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquires of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modification that should
be made to the condensed consolidated financial statements referred to above for
them to be in conformity with accounting principles generally accepted in the
United States of America.
The consolidated financial statements of the Company as of and for the year
ended December 31, 2001, were not audited by us and, accordingly, we do not
express an opinion or any form of assurance on the information set forth in the
accompanying condensed consolidated balance sheet as of December 31, 2001.
Additionally, the condensed consolidated statements of income for the
three-month and nine-month periods ended September 30, 2001, and the related
statement of cash flows for the nine-month period ended September 30, 2001, were
not reviewed or audited by us and, accordingly, we do not express an opinion or
any form of assurance on them.
/s/ KPMG LLP
Atlanta, Georgia
December 19, 2002
21
ITEM 2.
MIRANT MID-ATLANTIC, LLC AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
OVERVIEW
We are an indirect wholly owned subsidiary of Mirant. We were formed,
along with our subsidiaries, in conjunction with the acquisition of our
facilities from PEPCO on December 19, 2000.
We or our subsidiaries, along with our affiliates Mirant Potomac River and
Mirant Peaker, own, lease or control approximately 5,256 MW of electricity
generating capacity in the Washington D.C. area and have a fixed rate power
purchase agreement (the ECSA) with Mirant Americas Energy Marketing that
currently provides us with payments for our committed capacity and energy at
prices that are not directly linked to spot market prices. Furthermore, under
the ECSA essentially all of our credit exposure is with Mirant Americas Energy
Marketing.
In November 2002, Mirant Americas Energy Marketing exercised its option
under the ECSA to purchase 100% of the Company's energy and capacity in 2003. At
the time the option was exercised, the market price for energy to be delivered
in 2003 was less than the price received for revenue recorded under the ECSA in
2002, after the reduction for the favorable pricing variance. Accordingly,
revenues recorded in 2003, after the reduction for the favorable pricing
variance, will be less than the revenue recorded in 2002. In the event that
Mirant Americas Energy Marketing exercises its option for 2004 and similar
market conditions exist at that time, revenue recorded in 2004, after the
reduction for the favorable pricing variance, will also be less than in 2002.
The cash flows received under the ECSA are unaffected by changes in market
price. However, the reclassification of the capital contribution received
pursuant to the ECSA (Note A) will reduce the Company's fixed charge coverage
ratios calculated for purposes of determining its ability to make dividend
payments. Because the Company's ability to pay dividends could be restricted by
this change, Mirant Americas Energy Marketing may not exercise its option to
renew the ECSA for future periods. To the extent that the option to renew the
ECSA is not exercised, the Company would likely sell its energy at market prices
in the PJM. Over the term of the ECSA, PJM market prices have tended to be lower
than the prices received from Mirant Americas Energy Marketing under the ECSA.
If current market conditions persist, the inability to enter into contracts with
margins similar to those realized in 2002 when the ECSA expires would also be
expected to adversely impact our future operating results.
We expect the majority of our other revenues to be derived from sales of
capacity, energy and ancillary services from the generating facilities owned or
leased by us into the PJM spot and forward markets, with the balance of our
revenues derived from sales to other competitive power markets or fixed price
agreements. The market for wholesale electric energy and energy services in the
PJM is largely deregulated. To the extent that we have not sold our energy and
capacity under fixed price agreements, our revenues and results of operations
will depend, in part, upon prevailing market prices for energy, capacity and
ancillary services in the PJM and other competitive markets. Mirant Americas
Energy Marketing acts as our agent and procures fuel and emissions credits
necessary for the operation of the generating facilities owned or leased by us.
Our costs primarily consist of the ongoing maintenance and operation of
the generating facilities owned or leased by us, capital expenditures needed to
ensure their continued reliable, safe and environmentally compliant operation
and our obligation to make rental payments on leased facilities.
Our Mid-Atlantic facilities are subject to the northeast ozone transport
region NOx allowance cap and trade regulatory program. As part of that
regulatory program, the various state regulations allocate NOx emission
allowances to covered facilities, and if the allocated allowances are not
sufficient to cover actual NOx emissions, facilities must purchase NOx
allowances from other facilities. We presently have to purchase additional NOx
allowances beyond our allocation to cover our emissions. We expect that the
number of allowances allocated to our plants will decrease in 2003 and that the
market price may increase significantly in 2003 and in subsequent years for NOx
allowances we need to purchase under the regulatory program.
As a result of the PEPCO acquisition, several owner lessors each own
undivided interests in the Dickerson and Morgantown generating assets. We have
entered into long-term leases for each of these undivided interests. The leases
were part of the leveraged lease transactions that raised approximately $1.5
22
billion, which was used by the owner lessors to acquire the undivided interests
in the lease facilities and to pay the lease transaction expenses.
The subsidiaries of the institutional investors who hold the membership
interests in the owner lessors are called owner participants. Equity funding by
the owner participants plus transaction expenses paid by the owner participants
totals $299 million. The issuance and sale of pass through certificates raised
the remaining $1.224 billion.
Pass through certificates in the aggregate principal amount of $1.224
billion were issued on December 18, 2000. The pass through certificates are not
our direct obligations. Each pass through certificate represents a fractional
undivided interest in one of three pass through trusts formed pursuant to three
separate pass through trust agreements between us and State Street Bank and
Trust Company of Connecticut, National Association, as pass through trustee
under each pass through trust agreement.
The property of the pass through trusts consists of lessor notes. The
lessor notes were issued in connection with eleven separate leveraged lease
transactions with respect to each lessor's undivided interest in either (i) the
Dickerson electric generating baseload units 1, 2, and 3 and related assets or
(ii) the Morgantown electric generating baseload units 1 and 2 and related
assets. The lessor notes issued by an owner lessor are secured by that owner
lessor's undivided interest in the lease facilities and its rights under the
related lease and other financing documents.
The lessor notes issued by each owner lessor were issued in three series.
Each pass through trust purchased one series of the lessor notes issued by each
owner lessor so that all of the lessor notes held in each pass through trust
have an interest rate corresponding to the interest rate of the pass through
certificates, and a final maturity on or before the final expected distribution
date applicable to the certificates issued by that pass through trust. Principal
and interest paid on the lessor notes held in each pass through trust is
distributed by each pass through trust to its certificate holders on June 30 and
December 30 of each year.
Although neither the certificates nor the lessor notes are obligations of,
or guaranteed by, us, the amount unconditionally payable by us under our leases
of the leased facilities will be at least sufficient to pay in full when due all
payments of principal, premium, if any, and interest on the lessor notes. Our
lease obligations are not obligations of, or guaranteed by, our indirect parent,
Mirant, or any of its other affiliates. However, Mirant is currently providing
the credit support to fund the rent payment reserve required in connection with
this lease transaction.
Our lease payment obligations are senior unsecured obligations and rank
equally in right of payment with all of our other existing and future senior
unsecured obligations. Under the terms of the lease, we are responsible for the
payment of rent to the indenture trustee, which in turn makes payments of
principal and interest to the pass through trust and any remaining balance to
the owner lessors for the benefit of the owner participants.
RESTRUCTURING AND CHANGES IN SENIOR MANAGEMENT
As a result of changing market conditions including constrained access to
capital markets attributable primarily to the Enron bankruptcy and Moody's
downgrade of Mirant's credit rating, Mirant adopted a plan to restructure its
operations by exiting certain business operations, canceling and suspending
planned power plant developments, closing business development offices and
severing employees. As of November 1, 2002, Mirant Services has terminated 87
employees at our locations. The severance costs and other employee
termination-related charges associated with the restructuring were paid by
Mirant Services and billed to Mirant Mid-Atlantic. Severance costs of $2 million
and $5 million were expensed by us during the three and nine months ended
September 30, 2002, respectively.
In October 2002, the Company announced that at the end of October 2002,
Randy Harrison, Chief Executive Officer and Director of the Company, would be
retiring. Rick Pershing, President and Chief
23
Executive Officer of Mirant Americas Generation has assumed the responsibilities
of Chief Executive Officer of the Company.
On December 4, 2002, Mirant announced that Harvey Wagner would be joining
Mirant as its Executive Vice President and Chief Financial Officer beginning
January 1, 2003. Mr. Wagner will be replacing Mirant's current Chief Financial
Officer, Raymond Hill. Mr. Hill is a Manager of Mirant Americas Generation, the
Company's sole member and will be leaving Mirant Americas Generation effective
December 31, 2002.
ACCOUNTING ERRORS AND REAUDIT OF HISTORICAL FINANCIAL STATEMENTS
As disclosed in a press release dated July 30, 2002, Mirant Corporation,
Mirant Mid-Atlantic's ultimate parent company, identified several accounting
issues related to its risk management and marketing operations. These issues
related to Mirant Americas Energy Marketing, which is an affiliate of the
Company and a separate subsidiary of Mirant. Corrections have been reflected in
Mirant's amended first quarter Form 10-Q/A and Mirant's second quarter Form 10-Q
both filed on November 7, 2002. The resolution of these items did not impact the
Company's financial statements.
As a result of the identification of the initial accounting issues
described in the July 30, 2002 press release, Mirant retained the law firm of
King & Spalding , with the support of a nationally recognized accounting firm,
to conduct an independent review and to report to Mirant's Audit Committee. King
& Spalding has concluded that there was no fraudulent conduct on the part of any
Mirant employee or officer related to the identified accounting issues.
In the course of resolving Mirant's previously announced accounting issues
discussed above, and the concurrent review of Mirant's interim financial
statements, errors affecting the Company's historical financial statements were
identified. At March 31, 2002, revenue related to the Company's ECSA with Mirant
Americas Energy Marketing (an affiliate), was reduced by $11 million, accounts
receivable from Mirant Americas Energy Marketing was reduced by $5 million, and
capital contribution receivable pursuant to the ECSA (a members' equity account)
was reduced by $6 million. The previously issued financial statements did not
take into account Mirant Americas Energy Marketing's election under the ECSA in
January 2002 to increase the energy purchased from the Company to 100% of the
capacity of its facilities from the contractual minimum of 75%, as described in
Note E. In addition, the Company recorded an addition to members' equity, with a
corresponding capital contribution receivable pursuant to the ECSA, of $53
million, to reflect the excess of the fixed price of the capacity and energy in
the ECSA over the projected market prices when the Company became committed to
provide the additional energy to Mirant Americas Energy Marketing.
The statement of cash flows for the three months ended March 31, 2002 has
also been restated to reflect amounts received under the ECSA attributable to
the capital contribution receivable as a financing activity, rather than an
operating activity.
A summary comparison of the previously filed and restated first quarter
2002 unaudited condensed consolidated statement of income follows (in millions):
THREE MONTHS ENDED
MARCH 31, 2002
-----------------------------------
AS PREVIOUSLY
FILED AS RESTATED
----------------- -----------------
Operating revenues................................... $210 $199
Cost of fuel, electricity and other products......... 65 65
Gross margin......................................... 145 134
Other................................................ (74) (74)
---- ----
Net income........................................... $ 71 $ 60
==== ====
24
A summary comparison of the previously reported and restated first quarter
2002 unaudited condensed consolidated statement of cash flows follows (in
millions):
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 2002 AS MARCH 31, 2002 AS
PREVIOUSLY REPORTED RESTATED
------------------- ------------------
Cash flows from operating activities........... $116 $96
Cash flows from investing activities........... (99) (99)
Cash flows from financing activities........... (17) 3
----- ----
Net change in cash and cash equivalents........ $ 0 $ 0
===== ====
Mirant's independent auditors assessed Mirant's internal controls of its
North American energy marketing and risk management operations as part of the
interim review of Mirant for the second quarter. The independent auditors
provided Mirant with detailed process improvement recommendations to address
internal control deficiencies in existence at June 30, 2002. The independent
auditors have advised Mirant's Audit Committee that these internal control
deficiencies constitute reportable conditions and, collectively, a material
weakness as defined in Statement on Auditing Standards No. 60. Mirant has
assigned the highest priority to the short-term and long-term correction of
these internal control deficiencies. Mirant has discussed its proposed actions
with its Audit Committee and its independent auditors. Mirant Americas Energy
Marketing personnel prepare certain entries to the Company's accounts, however,
there has been no indication that control deficiencies present in Mirant's North
American energy marketing and risk management operations directly impact the
Company or its financial statements. Mirant has implemented corrective actions
to mitigate the risk that these deficiencies could lead to material
misstatements in Mirant's or the Company's current financial statements. In
addition, the Company has performed additional procedures to enable the
completion of the independent auditors' review of the Company's interim
financial statements despite the presence of the control weaknesses at Mirant
noted above.
The Company has engaged KPMG to reaudit the Company's 2000 and 2001
financial statements in conjunction with the reaudit of Mirant's 2000 and 2001
financial statements. The effects, if any, of such reaudit on the Company's
financial statements cannot be determined. In addition, we are not currently
able to assess the impact on the Company of the reaudit of Mirant and the
accounting issues at Mirant Americas Energy Marketing in light of the business
relationships between the Company, Mirant Americas Energy Marketing and Mirant
Corporation.
RESULTS OF OPERATIONS
THIRD QUARTER 2002 vs. THIRD QUARTER 2001
AND
YEAR-TO-DATE 2002 vs. YEAR-TO-DATE 2001
Results of operations for the three and nine months ended September 30,
2002 include revenue under the ECSA agreement with Mirant Americas Energy
Marketing which was based on forward price curves at the inception of the ECSA
and at the time of Mirant Americas Energy Marketing's election to keep its
committed capacity at 100% of the total output of the Company's facilities for
2002, which resulted in higher revenues and margins than are currently available
based on current market prices. The revenue recognized under the ECSA is not
adjusted for subsequent changes in market prices. As a result, amounts
recognized as revenue under the ECSA do not necessarily reflect market prices at
the time the energy is delivered. Amounts recognized as revenue for energy
delivered under the ECSA were less than the amounts based on current market
prices by approximately $31 million for the three months ended September 30,
2002 and exceeded the amounts based on current market prices by approximately
$126 million for the nine months ended September 30, 2002.
25
Significant income statement items appropriate for discussion include the
following:
INCREASE (DECREASE)
-------------------------------------------------------
THIRD QUARTER YEAR-TO-DATE
------------------------------ ------------------------
(IN MILLIONS)
Operating revenues ......................... (76) (26%) (230) (27%)
Cost of fuel, electricity and other products (39) (23%) (199) (41%)
Gross margin ............................... (37) (31%) (31) (9%)
Other operating expenses:
Depreciation and amortization ........... (6) (33%) (19) (35%)
Selling, general and administrative ..... 1 13% 1 4%
Taxes other than income taxes ........... (1) (11%) 3 13%
Total other income, net .................... 3 100% 8 67%
Operating Revenues. Operating revenues for the three and nine months ended
September 30, 2002, were $218 million and $617 million, compared to $294 million
and $847 million for the same periods in 2001. These decreases of $76 million
and $230 million resulted primarily from decreased prices for our energy and the
termination in August 2001 of fixed price contracts with Mirant Americas Energy
Marketing. Under each of these fixed price contracts, the Company received a
fixed price from Mirant Americas Energy Marketing for a defined volume of
generation. Such revenues were offset in the cost of fuel, electricity and other
products by the cost of purchasing matching megawatt-hours, either from the PJM
pool or under a fixed price purchase contract. As the Company continued to
receive payments at market prices for all of its generation, such contracts
enabled the Company to reduce its exposure to energy price risk. The fixed price
contracts with Mirant Americas Energy Marketing terminated in August 2001, with
the inception of the ECSA.
Cost of Fuel, Electricity and Other Products. Cost of fuel, electricity
and other products for the three and nine months ended September 30, 2002, was
$134 million and $289 million, compared to $173 million and $488 million for the
same periods in 2001. These decreases of $39 million and $199 million were
primarily attributable the termination in August 2001 of fixed price contracts
with Mirant Americas Energy Marketing, as described above. The Company made
purchases at PJM pool prices or under fixed price contracts to offset the
megawatt-hour sales made at fixed prices. With the inception of the ECSA in
August 2001, such contracts were terminated. In addition, a reduction in the
proportion of generation by cycling units reduced fuel costs per megawatt hour
in the three and nine months ended September 30, 2002, as compared to the same
periods in 2001. This was offset by higher generation volumes in the three and
nine months ended September 30, 2002, as compared to the same periods in 2001.
Gross Margin. Gross margin for the three and nine months ended September
30, 2002, was $84 million and $328 million, compared to $121 million and $359
million for the same periods in 2001. The decreases of $37 million and $31
million were primarily attributable to lower energy prices.
Other Operating Expenses. Other operating expenses for the three and nine
months ended September 30, 2002, were $79 million and $235 million, compared to
$83 million and $247 million for the same periods in 2001. The following factors
were responsible for the decreases in other operating expenses of $4 million and
$12 million:
o Depreciation and amortization expense for the three and nine months
ended September 30, 2002, was $12 million and $36 million, compared
to $18 million and $55 million for the same periods in 2001. These
decreases of $6 million and $19 million are due to the
non-amortization of goodwill offset by additional depreciation on
the increased property, plant and equipment balance, and the
additional amortization of other intangible assets recognized as
part of the purchase accounting adjustments made in December 2001.
o Selling, general and administrative expenses for the three and nine
months ended September 30, 2002, were $9 million and $28 million,
compared to $8 million and $27 million for the same periods in 2001.
The increases of $1 million for the three and nine months ended
September 30, 2002 were primarily due to the fixed administration
charge from Mirant Services as a result of the administration
arrangement with Mirant and higher insurance costs in 2002,
partially offset by lower labor costs and legal expenses.
26
o Taxes other than income taxes for the three and nine months ended
September 30, 2002, were $8 million and $26 million, as compared to
$9 million and $23 million for the same periods in 2001. The
increase of $3 million for the nine months ended September 30, 2002
is due to an increase in assessed property values.
Total Other Income, Net. Other income, net for the three and nine months
ended September 30, 2002, was $6 million and $20 million, compared to $3 million
and $12 million for the same periods in 2001. The increases of $3 million and $8
million resulted primarily from the conversion of the note payable to Mirant
Americas Generation into equity in January 2002 which eliminated the interest
expense associated with this note payable for 2002.
SEASONALITY
Our revenues are expected to be seasonal and affected by changes in
weather conditions, although the current ECSA reduces the impact of such
seasonality during its term. Short-term prices for capacity, energy and
ancillary services in the PJM are particularly impacted by weather conditions.
Peak demand for electricity typically occurs during the summer months, caused by
the increased use of air-conditioning. Cooler than normal temperatures during
months that are normally warm may lead to reduced use of air-conditioners, which
would reduce short-term demand for capacity, energy and ancillary services and
result in a reduction in wholesale prices.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
Historically, we have obtained cash from our operations, issuances of debt
and capital contributions from Mirant. These funds have been used to finance
operations, service debt obligations, fund acquisitions, finance capital
expenditures and meet other cash and liquidity needs.
Operating Activities. Net cash provided by operating activities totaled
$163 million for the nine months ended September 30, 2002, as compared to $72
million for the same period in 2001. This increase is primarily due to the
decrease in net income offset by non-cash charges and the timing of payments for
affiliate receivables, accounts payable and accrued liabilities, and fuel stock,
as well as a reduction in the amount of lease rent paid.
Investing Activities. Net cash used in investing activities totaled $102
million for the nine months ended September 30, 2002, as compared to $42 million
for the same period in 2001. During the nine months ended September 30, 2002,
our investment activities were primarily attributable to capital expenditures of
$34 million and issuance of notes receivables from affiliates totalling $68
million. During the nine months ended September 30, 2001, our investment
activities were attributed primarily to $40 million in capital expenditures.
Financing Activities. Net cash used in financing activities totaled $61
million for the nine months ended September 30, 2002, as compared to net cash
provided by financing activities of $34 million for the same period in 2001.
During the nine months ended September 30, 2002, our financing activities were
attributable to the payment of dividends of $202 million partially offset by
proceeds from issuance of notes payable to affiliate of $18 million, the receipt
of a $26 million capital contribution related to Mirant Peaker and Mirant
Potomac River and the receipt of $97 million related to the capital contribution
receivable pursuant to the ECSA. During the nine months ended September 30,
2001, our financing activities were attributable to the payment of dividends of
$46 million, which was offset by proceeds from issuance of notes payable to
affiliate
27
of $55 million, the receipt of a $15 million capital contribution related to
Mirant Peaker and Mirant Potomac River and the receipt of $10 million related to
the capital contribution receivable pursuant to the ECSA.
We expect our cash needs over the next several years to be met primarily
by cash flows from operations, capital contributions related to Mirant Peaker,
Mirant Potomac River and the ECSA. Such cash flows are expected to provide
sufficient liquidity for working capital and capital expenditure needs for the
next 12 months. However, reclassification of the capital contribution received
pursuant to the ECSA (Note A) will reduce the Company's fixed charge coverage
ratios calculated for purposes of determining its ability to make dividend
payments. Because the Company's ability to pay dividends could be restricted by
this change, Mirant Americas Energy Marketing may not exercise its option to
renew the ECSA for future periods. To the extent that the option to renew the
ECSA is not exercised, the Company would likely sell its energy at market prices
in the PJM. Over the term of the ECSA, PJM market prices have tended to be lower
than the prices received from Mirant Americas Energy Marketing under the ECSA.
Credit Ratings
Three pass through trusts were formed in 2000, pursuant to the lease
agreements. These pass through trusts issued pass through certificates in
December 2000. As of December 20, 2002, the pass through certificates have a
credit rating of Ba3 (non-investment grade) with a negative watch by Moody's, BB
(non-investment grade) with a negative outlook by S&P and BB+ (non-investment
grade) with a negative outlook by Fitch. While the foregoing indicates the
ratings from the various agencies, we note that these ratings are not a
recommendation to buy, sell or hold the pass through certificates, that the
ratings may be subject to revision or withdrawal at any time by the assigning
rating organization and that each rating should be evaluated independently of
any other rating. There can be no assurance that a rating will remain in effect
for any given period of time or that a rating will not be lowered or withdrawn
entirely by a rating agency if, in its judgement, circumstances in the future so
warrant. Further, the Company notes that each of the rating agencies continues
to monitor the Company's credit profile with increased scrutiny arising from the
reported financial difficulties of other market participants, the uncertainty
and turmoil in the financial markets generally and in the energy sector
specifically and our pending reaudit. In addition, we note the risk factors
related to a downgrade in our credit ratings as disclosed in our Form 10-K filed
in March 2002.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
Operating Leases
On December 19, 2000, in conjunction with the purchase of the PEPCO
assets, the Company entered into multiple sale-leaseback transactions totaling
$1.5 billion relating to the Dickerson and the Morgantown baseload units and
associated property. The terms of each lease vary between 28.5 and 33.75 years.
The Company is accounting for these leases as operating leases. The Company's
expenses associated with the commitments under the Dickerson and Morgantown
operating leases totaled approximately $24 million for both the three months
ended September 30, 2002 and 2001 and $72 million for both the nine months ended
September 30, 2002 and 2001. As of September 30, 2002, the total notional
minimum lease payments for the remaining life of the leases was approximately
$2.8 billion. The lease agreements contain covenants that restrict the Company's
ability to, among other things, make dividend distributions, incur indebtedness,
or sublease the facilities.
Mirant Mid-Atlantic is not permitted to make any dividend distributions
unless, at the time of such distribution, each of the following conditions is
satisfied:
28
o Mirant Mid-Atlantic's fixed charge coverage ratio for the most
recently ended four full fiscal quarters equals at least:
(1) 1.7 to 1.0; or
(2) 1.6 to 1.0, 1.45 to 1.0, 1.3 to 1.0 or 1.2 to 1.0 if, as of the
last day of the most recently completed fiscal quarter, Mirant
Mid-Atlantic and its designated subsidiaries have entered into power sales
agreements (meeting certain criteria, including investment grade ratings
criteria) covering, in the aggregate, at least 25%, 50%, 75% or 100%,
respectively of the projected total consolidated operating revenue for the
consecutive period of eight full fiscal quarters following that date; and
o the projected fixed charge coverage ratio (determined on a pro forma
basis after giving effect to any such dividend) for each of the two
following periods of four fiscal quarters commencing with the fiscal
quarter in which the restricted payment is proposed to be made
equals at least:
(1) 1.7 to 1.0; or
(2) 1.6 to 1.0, 1.45 to 1.0, 1.3 to 1.0 or 1.2 to 1.0, if, as of the
last day of the most recently completed fiscal quarter, Mirant
Mid-Atlantic and its designated subsidiaries have entered into power sales
agreements (meeting certain criteria, including investment grade ratings
criteria) covering, in the aggregate, at least 25%, 50%, 75% or 100%,
respectively, of the projected total consolidated operating revenue for
the consecutive period of eight full fiscal quarters following that date;
and
o no significant lease default or event of default has occurred and is
continuing.
In accordance with the terms of the lease documentation, Mirant
Mid-Atlantic calculates the projected fixed charge coverage ratio based on
projections prepared in good faith based upon assumptions consistent in all
material respects with the relevant contracts and agreements, historical
operations, and Mirant Mid-Atlantic's good faith projections of future revenues
and projections of operating and maintenance expenses in light of then existing
or reasonably expected regulatory and market environments in the markets in
which the leased facilities or other assets owned by it will be operated. Mirant
Mid-Atlantic also assumes that there will be no early redemption or prepayment
of Indebtedness, and that any Indebtedness which matures within such projected
periods will be refinanced on reasonable terms. The reclassification of the
capital contribution received pursuant to the ECSA (Note A) will reduce the
Company's fixed charge coverage ratios calculated for purposes of determining
its ability to make dividend payments.
These leases are part of a leveraged lease transaction. Three series of
certificates were issued and sold pursuant to a Rule 144A offering. These
certificates are interests in pass through trusts that hold the lessor notes
issued by the owner lessors. The Company pays rent to an indenture trustee, who
in turn makes payments of principal and interest to the pass through trusts and
any remaining balance to the owner lessors for the benefit of the owner
participants. According to the registration rights agreement dated December 18,
2000, the Company must maintain its status as a reporting company under the
Exchange Act. The Company was also obliged to consummate an exchange offer
pursuant to an effective registration statement under the Securities Act. On
July 6, 2001, the Company's registration statement became effective and the
exchange offer was completed in August 2001.
The Company has an option to renew the lease for a period that would cover
up to 75% of the economic useful life of the facility, as measured near the end
of the lease term. However, the extended term of the lease will always be less
than 75% of the revised economic useful life of the facility.
Upon an event of default by the Company, the lessors are entitled to a
termination value payment as defined in the agreements, which, in general,
decreases over time. At September 30, 2002, the termination value was
approximately $1.4 billion. Upon expiration of the original lease term, the
termination value will be $300 million.
29
Fuel Purchase Agreement
In April 2002, we entered into a long-term fuel purchase agreement. The
fuel supplier will convert coal feedstock received at our Morgantown facility
into a synthetic fuel. Under the terms of the agreement, we are required to
purchase a minimum of 2.4 million tons of fuel per annum through December 2007.
The purchase price of the fuel will vary with the delivered cost of the coal
feedstock. Based on current coal prices, it is expected that the annual purchase
commitment will be approximately $100 million. In July 2002, the synthetic fuel
plant operations commenced at the Morgantown facility at which time the minimum
purchase commitment became effective. At September 30, 2002, total estimated
minimum commitments under the agreement were $525 million. In July 2002, we sold
our coal inventory at the Morgantown facility to the synthetic fuel supplier for
approximately $10 million.
RELATED PARTY ARRANGEMENTS AND TRANSACTIONS
Our Relationship with Mirant
At September 30, 2002, ninety-nine percent of our membership interests
were owned by Mirant Mid-Atlantic Investments, LLC and one percent of our
interests were owned by Mirant Mid-Atlantic Management, Inc., which were both
direct wholly owned subsidiaries of Mirant Americas Generation. Effective
October 1, 2002, Mirant Mid-Atlantic is a direct wholly owned subsidiary of
Mirant Americas Generation. Mirant Americas Generation is a direct wholly owned
subsidiary of Mirant Americas, which is a direct wholly owned subsidiary of
Mirant.
We are organized and operate as a legal entity separate and apart from
Mirant and any other affiliates of Mirant. Therefore, our facilities are not
generally available to satisfy the obligations of Mirant or any other affiliates
of Mirant. However, our unrestricted cash or other assets which are available
for distribution may, subject to applicable law and the terms of financing
arrangements, be advanced, loaned, paid as dividends or otherwise distributed or
contributed to Mirant or any of its affiliates. Mirant is not obligated to make
any payments under the certificates or lessor notes and is not obligated to
guarantee our lease obligations.
Services Agreements with Mirant Americas Energy Marketing
Effective July 1, 2002, the Company and Mirant Americas Energy Marketing
amended the services and risk management agreement with regard to the provision
of the residual fuel oil requirements at Mirant Mid-Atlantic's Chalk Point
facility. The revised agreement is an all-requirements contract with pricing
based on the daily Platts New York Harbor mean index for residual fuel oil plus
a delivery charge. Pursuant to the revised agreement, Mirant Americas Energy
Marketing will also manage the fuel oil storage associated with Chalk Point. The
Company believes that its fuel price risk can be more effectively managed
because the forward fuel oil hedge instruments frequently purchased by the
Company typically settle against the New York Harbor index. The new arrangement
is expected to lower the working capital requirements for the Company, as Mirant
Americas Energy Marketing will now own the majority of fuel oil inventory at the
Chalk Point facility. Under the new arrangement, Mirant Mid-Atlantic will be
obligated to purchase residual fuel oil at the index price on the day it is
utilized at Chalk Point. Previously, Mirant Mid-Atlantic ordered residual fuel
oil at market prices in advance of its use. In July 2002, the Company sold fuel
oil inventory at its book value of approximately $15 million to Mirant Americas
Energy Marketing.
Management, Personnel and Services Agreements with Mirant Services
Mirant Services provides us with various management, personnel and
administrative services. We reimburse Mirant Services for amounts equal to
Mirant Services' direct costs of providing such services.
30
The total costs incurred under the agreement with Mirant Services for the
three and nine months ended September 30, 2002 were approximately $17 million
and $51 million, as compared to $18 million and $54 million for the same periods
in 2001.
Administration Arrangement With Mirant Services
Beginning in May 2002, Mirant Services implemented a fixed administration
charge to various subsidiaries of Mirant, including Mirant Mid-Atlantic, which
serves to reimburse Mirant Services for various indirect administrative services
performed on the subsidiaries' behalf, including, but not limited to,
information technology services, regulatory support, consulting, legal and
accounting and financial services. The fixed charge is approximately $1.4
million per month and the initial term of the agreement expires on December 31,
2002. For the three and nine months ended September 30, 2002, we incurred
approximately $4 million and $7 million, respectively in costs under this
arrangement which are included in selling, general and administrative expense on
the accompanying unaudited condensed consolidated statements of income.
Management believes that the amounts allocated to the Company are reasonable and
are substantially similar to costs it would have incurred on a stand-alone basis
for the periods covered by the fixed administration charge. Prior to May 2002,
similar administrative services were charged by Mirant Services to the Company
based on incremental costs directly attributable to the Company.
Capital Contribution Agreement
Under a capital contribution agreement, Mirant Potomac River and Mirant
Peaker, both of which are direct wholly owned subsidiaries of Mirant, will make
distributions to Mirant at least once per quarter, if funds are available.
Distributions will equal all cash available after taking into account projected
cash requirements, including mandatory debt service, prepayments permitted under
the Mirant Potomac River and Mirant Peaker notes, and maintenance reserves, as
reasonably determined by Mirant. Mirant will contribute or cause these amounts
to be contributed to us. For the nine months ended September 30, 2002, total
capital contributions received by us under this agreement totaled $26 million,
as compared to $15 million for the same period in 2001.
Power Sales Agreement With Mirant Americas Energy Marketing
The Company has entered into an Energy and Capacity Sales Agreement
("ECSA"), which is a fixed rate power purchase agreement with Mirant Americas
Energy Marketing. Under the terms of the ECSA, we supply all of our facilities'
capacity and energy to Mirant Americas Energy Marketing for the period from
August 1, 2001 through June 30, 2004, extendable through December 31, 2004. For
2002 and 2003, Mirant Americas Energy Marketing has elected to keep its
committed capacity and energy purchases at 100% of the total output of our
facilities. For 2004, Mirant Americas Energy Marketing has the option to
purchase up to 100 % (in blocks of 25%) of the total output of our facilities,
with no minimum commitment. Mirant Americas Energy Marketing is a party to
transitional power agreements with PEPCO under which PEPCO has a similar option
for the purchase of energy with respect to PEPCO's load requirements.
Prior to August 1, 2001, the Company sold its power to Mirant Americas
Energy Marketing pursuant to a master sales agreement. Under this agreement the
price the Company received was based on the market price for energy in the PJM
market at the time the energy was delivered. The Company also sold power to
Mirant Americas Energy Marketing under fixed price contracts.
Our affiliated companies, Mirant Potomac River and Mirant Peaker, have
also entered into fixed rate power purchase agreements with Mirant Americas
Energy Marketing on the same terms and effective over the same period as the
agreement outlined above. Through a capital contribution agreement between us
and Mirant, the cash available from these affiliated companies is paid as a
dividend to Mirant, which in turn makes an indirect capital contribution to us
for the same amount.
31
At the inception date of the ECSA, the pricing of Mirant Americas Energy
Marketing's minimum committed capacity and energy purchases was favorable to us
and our affiliates when compared to estimated market rates in the PJM for power
to be delivered over the initial term of the agreement. The estimated market
rates were based on quoted market prices in the PJM, as adjusted upwards by
approximately 12% for what the Company believed, at the time, to be temporary
anomalies in such market prices based on forecasted demand growth and other
factors expected to affect demand and supply in the PJM market through 2002. At
inception, the aggregate value to us and our affiliates relating to the
favorable pricing variance was approximately $167 million. The amount related
specifically to our owned or leased facilities amounted to $120 million and was
reflected as both an addition to members' interest and an offsetting capital
contribution receivable pursuant to the ECSA on our consolidated balance sheet
and statement of members' equity at the inception of the agreements. At
inception, the Company had assumed that in 2002 Mirant Americas Energy Marketing
would elect to take the contracted minimum 75% of the capacity and output of the
Company's facilities. In January 2002, Mirant Americas Energy Marketing elected
to keep its committed capacity at 100% of the total output of the Company's
facilities. Therefore, the Company has recorded an additional equity
contribution of $53 million in the first quarter of 2002 to reflect the
favorable pricing terms related to the additional 25% capacity and energy that
Mirant Americas Energy Marketing committed to take in 2002. This adjustment is
reflected in the accompanying unaudited condensed consolidated balance sheet and
statement of members' equity as both an addition to members' interest and an
offsetting capital contribution receivable pursuant to the ECSA.
The contractual amounts payable under the ECSA in excess of the amount of
revenue recognized due to the favorable pricing variances were $43 million and
$104 million for the three and nine months ended September 30, 2002,
respectively. These amounts are generally received in the month following the
month the related revenue is recognized and are recorded as a reduction in the
capital contribution receivable pursuant to the ECSA when received. During the
nine months ended September 30, 2002, the Company received $97 million under the
ECSA that was applied as a reduction to the capital contribution receivable
pursuant to the ECSA. The capital contribution receivable pursuant to the ECSA
was $47 million at September 30, 2002, of which $12 million represents amounts
received subsequent to September 30, 2002 related to the revenue recognized
prior to that date and $35 million relates to the favorable pricing variance
over the remaining three months of 2002.
The favorable pricing variance accounted for as a capital contribution
receivable is not adjusted for subsequent changes in energy prices. As a result,
amounts recognized as revenue under the ECSA do not necessarily reflect market
prices at the time the energy is delivered. Amounts recognized as revenue for
capacity and energy delivered under the ECSA were less than the amounts based on
current market prices by approximately $31 million for the three months ended
September 30, 2002 and exceeded the amounts based on current market prices by
approximately $126 million for the nine months ended September 30, 2002.
On November 15, 2002, Mirant Americas Energy Marketing elected to keep its
committed capacity at 100% of the output of the Company's facilities for 2003.
This election will result in an adjustment of approximately $120 million to
members' equity and an offsetting capital contribution receivable pursuant to
the ECSA in the fourth quarter of 2002. However, the reclassification of the
capital contribution received pursuant to the ECSA (Note A) will reduce the
Company's fixed charged coverage ratios calculated for the purpose of
determining its ability to make dividend payments. Because the Company's ability
to pay dividends could be restricted by this change, Mirant Americas Energy
Marketing may not exercise its option to renew the ECSA for future periods. To
the extent that the option to renew the ECSA is not exercised, the Company would
likely sell its energy at market prices in the PJM. Over the term of the ECSA,
PJM market prices have tended to be lower than the prices received from Mirant
Americas Energy Marketing under the ECSA.
32
Notes Payable to and Notes Receivable From Affiliates
Mirant Peaker and Mirant Potomac River borrowed funds from the Company in
order to finance their respective acquisitions of generation assets. At both
September 30, 2002 and December 31, 2001, notes receivable from these two
affiliates consisted of the following (in millions):
BORROWER PRINCIPAL INTEREST RATE MATURITY
-------- ---------- -------------- --------
Mirant Potomac River.................... $ 152 10% 12/30/2028
Mirant Peaker........................... $ 71 10% 12/30/2028
Mirant Potomac River and Mirant Peaker have a capital contribution
agreement with Mirant in which they make quarterly distributions to Mirant of
all cash available after taking into consideration projected cash requirements,
including mandatory debt service, prepayments permitted under the terms of the
notes payable and maintenance reserves.
Under the capital contribution agreement, the owner lessors, the holders
of the lessor notes, and the indenture trustee of Mirant Mid-Atlantic's lease
arrangements (Note F) have the ability to enforce the payment terms of the notes
receivable.
Principal is due on maturity with interest due semiannually, in arrears,
on June 30 and December 30. Any amount not paid when due bears interest
thereafter at 12%. Mirant Potomac River and Mirant Peaker may prepay up to $5
million and $3 million per year, respectively. Interest earned from Mirant
Potomac and Mirant Peaker was $6 million for both the three months ended
September 30, 2002 and 2001 and $17 million for both the nine months ended
September 30, 2002 and 2001.
We had a cash management agreement with Mirant, whereby any excess cash,
including capital contributions, was transferred to Mirant pursuant to a note
agreement which was payable upon demand. Similarly, Mirant advanced funds to us
for working capital purposes. Effective October 21, 2002, the Company
discontinued its involvement in Mirant's cash management program and commenced
the operation of bank deposit and money market accounts in the Company's own
name. As of October 21, 2002, the net principal balance outstanding under the
cash management program of $83 million was received by the Company from Mirant.
LITIGATION AND OTHER CONTINGENCIES
Reference is made to Note F to the financial statements filed as part of
this quarterly report on Form 10-Q relating to the following litigation matters
and other contingencies:
Litigation:
o Asbestos Cases
o Environmental Information Requests
Other Contingencies:
NONE
Additionally, for recent events occurring after September 30, 2002
reference is made to Note F to the financial statements filed as part of this
quarterly report on Form 10-Q.
In addition to the proceedings described above, we experience routine
litigation from time to time in the normal course of our business, which is not
expected to have a material adverse effect on our consolidated financial
condition, cash flows or results of operations.
33
CRITICAL ACCOUNTING ESTIMATES
The accounting policies described in the Company's Form 10-K and below are
viewed by management as "critical" because their correct application requires
the use of material estimates and because they have a material impact on its
financial results and position. To aid in the Company's application of these
critical accounting policies, management invests substantial human and financial
capital in the development and maintenance of models and other forecasting tools
and operates a robust environment of internal controls surrounding these areas
in particular. These tools, in part, facilitate the measurement of less liquid
financial instruments accounted for at fair value and ensure that such
measurements are applied consistently across periods.
Additionally, in 2002, the Company adopted SFAS Nos. 141, 142 and 144.
These new pronouncements, among other things, change the accounting model for
impairing the balance sheet value of assets held for use and held for sale, as
well as the book value of goodwill and other intangible assets. The overall
conditions affecting the Company and its sector, may materially impact the
carrying values of its property plant and equipment, its construction work in
progress, its goodwill and its other intangible assets.
As discussed above, the Company adopted SFAS No. 142 effective January 1,
2002. SFAS No. 142 requires a two-step impairment analysis process. The first
step of the test compares the estimated fair value of a reporting unit to its
net book value to determine if there is potential goodwill impairment. If no
impairment is indicated in step one the test is complete. If the net book value
of the reporting unit exceeds the fair value in step one, the second step of the
impairment test is required. Step two measures the amount of the impairment
charge by comparing the estimated fair value of the reporting unit goodwill to
its book value. The excess of the book value of goodwill to its estimated fair
value is recognized as an impairment charge. Subsequent to September 30, 2002,
there may be an impairment of goodwill at Mirant Mid-Atlantic as a result of the
overall conditions impacting the energy sector. The Company cannot currently
estimate the potential goodwill impairment charge, if any, until completion of
its assessment of the book values of long-lived assets, estimated future cash
flows associated with such assets as well as the completion of the 2003 planning
process. The Company expects to complete its analysis prior to reporting its
2002 results. As of September 30, 2002, Mirant Mid Atlantic's goodwill was $1.23
billion.
AUDIT COMMITTEE PRE-APPROVAL OF AUDIT AND NON-AUDIT SERVICES
The Board of Managers of Mirant Mid-Atlantic's sole member, Mirant
Americas Generation, is responsible for approving all audit and audit related
services performed by its independent auditor, KPMG, for Mirant Mid-Atlantic and
its subsidiaries. In addition, theBoard has delegated to its Chair the ability
to pre-approve other non-audit services by KPMG.
34
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
Market risk is the potential loss that we may incur as a result of changes
in the fair value of a particular instrument or commodity. All financial and
commodities-related instruments, including derivatives, are subject to market
risk. Through various hedging mechanisms, primarily contractual arrangements
with Mirant Americas Energy Marketing, we attempt to mitigate some of the impact
of changes in energy prices and fuel costs on our results of operations.
We engage in commodity-related marketing and price risk management
activities, through Mirant Americas Energy Marketing, in order to hedge market
risk and exposure to electricity generated and to oil, natural gas, and coal
utilized by our generation assets. These financial instruments primarily include
fixed rate power purchase agreements, fixed price coal contracts, forwards,
futures and swaps. With the adoption of SFAS No. 133 on January 1, 2001,
derivative instruments that do not meet the normal sales and purchases
exemption, are recorded in the unaudited condensed consolidated balance sheet as
either assets or liabilities measured at fair value, and changes in the fair
value are recognized currently in earnings, unless specific hedge accounting
criteria are met. If the criteria for hedge accounting are met, changes in the
fair value are recognized in OCI until such time as the underlying physical
transaction is settled and the gains and losses related to these derivatives are
recognized in earnings. Contractual commitments expose us to both market risk
and credit risk.
We maintain clear policies for undertaking risk-mitigating actions that
may become necessary when measured risks temporarily exceed limits as a result
of market conditions. To the extent an open position exists, fluctuating
commodity prices can impact financial results and financial position, either
favorably or unfavorably. As a result, we cannot predict with precision the
impact that our risk management decisions may have on our business, operating
results or financial position. Mirant Americas Energy Marketing manages price
market risk for us through formal oversight groups, which include senior
management, mechanisms that independently verify transactions and measure risk
and the use of a value-at-risk methodology ("VaR") on a daily basis. We bear all
gains and losses of the market risk management activities conducted by Mirant
Americas Energy Marketing on our behalf.
For commodity contracts in which hedge accounting criteria are met, any
changes in the fair value essentially reflect offset changes in the value of the
underlying physical transactions. Therefore, we have minimal exposure to market
risk on the portion of our portfolio of commodity contracts in which we are
effectively hedging the exposure of our physical assets to changes in market
prices.
For those derivative instruments in which hedge criteria are not met, we
employ a systematic approach to the evaluation and management of risk associated
with these commodity contracts, including VaR. VaR is defined as the maximum
loss that is not expected to be exceeded with a given degree of confidence and
over a specified holding period. We use a 95% confidence interval and holding
periods that vary by commodity and tenor to evaluate our VaR exposure. Based on
a 95% confidence interval and employing a one-day holding period for all
positions, our portfolio of positions had a VaR of $0.2 million at September 30,
2002. During the nine months ended September 30, 2002, the actual daily change
in fair value exceeded the corresponding daily VaR calculation eleven times,
which falls near our 95% confidence interval. We also utilize additional risk
control mechanisms such as commodity position limits and stress testing of the
total portfolio and its components.
35
CREDIT RISK
For all derivative financial instruments, we are exposed to losses in the
event of nonperformance by counterparties to these derivative financial
instruments. Through Mirant Americas Energy Marketing, we have established
controls to determine and monitor the creditworthiness of counterparties to
mitigate our exposure to counterparty credit risk. Concentrations of credit risk
from financial instruments, including contractual commitments, exist when groups
of counterparties have similar business characteristics or are engaged in like
activities that would cause their ability to meet their contractual commitments
to be adversely affected, in a similar manner, by changes in the economy or
other market conditions. Mirant Americas Energy Marketing monitors credit risk
for us on both an individual basis and a group counterparty basis. Our overall
exposure to credit risk may be impacted, either positively or negatively,
because our counterparties may be similarly affected by changes in economic,
regulatory or other conditions.
We currently make substantially all of our sales to Mirant Americas Energy
Marketing. As such, we are also subject to the risk of collection from Mirant
Americas Energy Marketing of substantially all of our outstanding accounts
receivables at any point in time.
36
ITEM 4. CONTROLS AND PROCEDURES
Mirant's independent auditors assessed Mirant's internal controls of its
North American energy marketing and risk management operations as part of the
interim review for the second quarter. Mirant has received detailed process
improvement recommendations during October 2002 from its independent auditors
which address internal control deficiencies in existence at June 30, 2002, the
most significant of which relate to Mirant's North American energy marketing and
risk management operation systems and processes.
Mirant's independent auditors have advised Mirant's Audit Committee that
these internal control deficiencies constitute reportable conditions and,
collectively, a material weakness as defined in Statement on Auditing Standards
No. 60 ("SAS No. 60"). Mirant has assigned the highest priority to the
short-term and long-term correction of these internal control deficiencies.
Mirant has discussed its proposed actions with its Audit Committee and its
independent auditors. There has been no indication that control deficiencies
present in Mirant's North American energy marketing and risk management
operations directly impact the Company or its financial statements; however,
Mirant Americas Energy Marketing personnel prepare certain entries to the
Company's accounts. Mirant has implemented corrective actions to mitigate the
risk that these deficiencies could lead to material misstatements in Mirant's or
the Company's current financial statements. In addition, the Company has
performed additional procedures to enable the completion of the independent
auditors' review of the Company's interim financial statements, despite the
presence of control weaknesses at Mirant noted above.
The Company has evaluated the effectiveness of its disclosure controls and
procedures within 90 days prior to the filing date of this quarterly report. The
evaluation did not identify any significant deficiencies or material weaknesses
in the Company's disclosure controls and procedures. The Company does note,
however, that it is in the process of being reaudited. The results of the
reaudit (including conclusions regarding the Company's disclosure controls and
procedures) cannot be determined. No significant changes have been made in the
Company's internal controls or in other factors that could significantly affect
these controls subsequent to the date of their evaluation. The Company continues
to evaluate the effectiveness of its overall controls and procedures and will
take such further actions as dictated by such continuing reviews.
PART II OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS.
None.
(b) REPORTS ON FORM 8-K.
During the quarter ended September 30, 2002, we filed a Current Report on
Form 8-K dated August 14, 2002. Item 5 was reported and no financial
statements were filed.
37
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. The signature of the undersigned company
shall be deemed to relate only to matters having reference to such company and
any subsidiaries thereof.
MIRANT MID-ATLANTIC, LLC
By /s/ PAUL LANSDELL
----------------------------------------
Paul Lansdell
VICE PRESIDENT AND CONTROLLER
(PRINCIPAL ACCOUNTING OFFICER)
Date: December 20, 2002
38
================================================================================
CERTIFICATIONS
I, Richard J. Pershing, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Mirant
Mid-Atlantic, LLC;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: December 20, 2002 /s/ RICHARD J. PERSHING
-----------------------------
Richard J. Pershing
Chief Executive Officer
(Principal Executive Officer)
I, William Holden, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Mirant
Mid-Atlantic, LLC;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: December 20, 2002 /s/ J. WILLIAM HOLDEN, III
----------------------------
J. William Holden, III
Vice President, Finance
(Principal Financial Officer)