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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 quarterly period ended March 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Exact name of registrants as specified in their charters, state of
Commission incorporation, address of principal executive offices, and telephone I.R.S. Employer
File Number number Identification Number
1-15929 Progress Energy, Inc. 56-2155481
410 South Wilmington Street
Raleigh, North Carolina 27601-1748
Telephone: (919) 546-6111
State of Incorporation: North Carolina
1-3382 Carolina Power & Light Company 56-0165465
d/b/a Progress Energy Carolinas, Inc.
410 South Wilmington Street
Raleigh, North Carolina 27601-1748
Telephone: (919) 546-6111
State of Incorporation: North Carolina
NONE
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrants (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days. Yes X No
Indicate by check mark whether Progress Energy, Inc. (Progress Energy) is an
accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No __
Indicate by check mark whether Carolina Power & Light Company is an accelerated
filer (as defined in Rule 12b-2 of the Exchange Act). Yes __ No X
This combined Form 10-Q is filed separately by two registrants: Progress Energy
and Carolina Power & Light Company d/b/a Progress Energy Carolinas, Inc. (PEC).
Information contained herein relating to either individual registrant is filed
by such registrant solely on its own behalf. Each registrant makes no
representation as to information relating exclusively to the other registrant.
Indicate the number of shares outstanding of each of the issuers' classes of
common stock, as of the latest practicable date. As of April 30, 2004, each
registrant had the following shares of common stock outstanding:
Registrant Description Shares
---------- ----------- ------
Progress Energy Common Stock (Without Par Value) 246,577,745
PEC Common Stock (Without Par Value) 159,608,055 (all of which
were held by Progress Energy, Inc.)
1
PROGRESS ENERGY, INC. AND PROGRESS ENERGY CAROLINAS, INC.
FORM 10-Q - For the Quarter Ended March 31, 2004
Glossary of Terms
Safe Harbor For Forward-Looking Statements
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Interim Financial Statements:
Progress Energy, Inc.
--------------------------------------------------------------
Consolidated Statements of Income
Consolidated Balance Sheets
Consolidated Statements of Cash Flows
Notes to Consolidated Interim Financial Statements
Carolina Power & Light Company
d/b/a Progress Energy Carolinas, Inc.
---------------------------------------------------------------
Consolidated Statements of Income
Consolidated Balance Sheets
Consolidated Statements of Cash Flows
Notes to Consolidated Interim Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities
Item 6. Exhibits and Reports on Form 8-K
Signatures
2
GLOSSARY OF TERMS
The following abbreviations or acronyms used in the text of this combined Form
10-Q are defined below:
TERM DEFINITION
the Act Medicare Prescription Drug, Improvement and Modernization Act of 2003
AFUDC Allowance for funds used during construction
the Agreement Stipulation and Settlement Agreement
Bcf Billion cubic feet
CCO Competitive Commercial Operations business segment
Colona Colona Synfuel Limited Partnership, L.L.L.P.
the Company or Progress Progress Energy, Inc. and subsidiaries
Energy
CR3 Progress Energy Florida Inc.'s nuclear generating plant, Crystal River Unit No. 3
CVO Contingent value obligation
DIG Derivatives Implementation Group
DOE United States Department of Energy
DWM North Carolina Department of Environment and Natural Resources, Division of Waste
Management
EITF Emerging Issues Task Force
ENCNG Eastern North Carolina Natural Gas Company, formerly referred to as Eastern NC
EPA United States Environmental Protection Agency
FDEP Florida Department of Environment and Protection
Federal Circuit United States Circuit Court of Appeals
FERC Federal Energy Regulatory Commission
FIN No. 46 FASB Interpretation No. 46, "Consolidation of Variable Interest Entities - An
Interpretation of ARB No. 51"
Florida Progress or FPC Florida Progress Corporation
FPSC Florida Public Service Commission
Fuels Fuels business segment
Genco Progress Genco Ventures, LLC
Jackson Jackson County EMC
MACT Maximum Available Control Technology
Mesa Mesa Hydrocarbons, LLC
MGP Manufactured gas plant
NCNG North Carolina Natural Gas Corporation
NCUC North Carolina Utilities Commission
NOx Nitrogen oxide
NOx SIP Call EPA rule which requires 23 jurisdictions including North and South
Carolina and Georgia to further reduce nitrogen oxide emissions
NRC United States Nuclear Regulatory Commission
NSP Northern States Power
PCH Progress Capital Holdings, Inc.
PEC Progress Energy Carolinas, Inc., formerly referred to as Carolina Power & Light
Company
PEF Progress Energy Florida, Inc., formerly referred to as Florida Power Corporation
PFA IRS Prefiling Agreement
the Plan Revenue Sharing Incentive Plan
PLRs Private Letter Rulings
Progress Rail Progress Rail Services Corporation
PTC LLC Progress Telecom LLC
Progress Ventures Business unit of Progress
Energy primarily made up of nonregulated
energy generation, gas, coal and
synthetic fuel operations and energy
marketing
PUHCA Public Utility Holding Company Act of 1935, as amended
PVI Legal entity of Progress Ventures, Inc.
PWR Pressurized water reactor
Rail Services or Rail Rail Services business segment
RTO Regional Transmission Organization
3
SCPSC Public Service Commission of South Carolina
Section 29 Section 29 of the Internal Revenue Code
Service Company Progress Energy Service Company, LLC
SFAS No. 71 Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of
Certain Types of Regulation"
SFAS No. 131 Statement of Financial Accounting Standards No. 131, "Disclosures about Segments
of an Enterprise and Related Information"
SFAS No. 133 Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
and Hedging Activities"
SFAS No. 142 Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets"
SFAS No. 143 Statement of Financial Accounting Standards No. 143, "Accounting for Asset
Retirement Obligations"
SFAS No. 148 Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - An Amendment of FASB Statement No.
123"
SFAS No. 149 Statement of Financial Accounting Standards No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities"
SMD NOPR Notice of Proposed Rulemaking in Docket No. RM01-12-000, Remedying Undue
Discrimination through Open Access Transmission and Standard Market Design
SO2 Sulfur dioxide
SRS Strategic Resource Solutions Corp.
the Trust FPC Capital I trust
Westchester Westchester Gas Company
4
SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS
This combined report contains forward-looking statements within the meaning of
the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. The matters discussed throughout this combined Form 10-Q that are not
historical facts are forward-looking and, accordingly, involve estimates,
projections, goals, forecasts, assumptions, risks and uncertainties that could
cause actual results or outcomes to differ materially from those expressed in
the forward-looking statements.
In addition, forward-looking statements are discussed in "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
including, but not limited to, statements under the sub-heading "Other Matters"
about the effects of new environmental regulations, nuclear decommissioning
costs and the effect of electric utility industry restructuring.
Any forward-looking statement speaks only as of the date on which such statement
is made, and neither Progress Energy, Inc. (Progress Energy or the Company) nor
Progress Energy Carolinas, Inc. (PEC) undertakes any obligation to update any
forward-looking statement or statements to reflect events or circumstances after
the date on which such statement is made.
Examples of factors that you should consider with respect to any forward-looking
statements made throughout this document include, but are not limited to, the
following: the impact of fluid and complex government laws and regulations,
including those relating to the environment; the impact of recent events in the
energy markets that have increased the level of public and regulatory scrutiny
in the energy industry and in the capital markets; deregulation or restructuring
in the electric industry that may result in increased competition and
unrecovered (stranded) costs; the uncertainty regarding the timing, creation and
structure of regional transmission organizations; weather conditions that
directly influence the demand for electricity; recurring seasonal fluctuations
in demand for electricity; fluctuations in the price of energy commodities and
purchased power; economic fluctuations and the corresponding impact on Progress
Energy, Inc. and subsidiaries' (the Company) commercial and industrial
customers; the ability of the Company's subsidiaries to pay upstream dividends
or distributions to it; the impact on the facilities and the businesses of the
Company from a terrorist attack; the inherent risks associated with the
operation of nuclear facilities, including environmental, health, regulatory and
financial risks; the ability to successfully access capital markets on favorable
terms; the impact that increases in leverage may have on the Company; the
ability of the Company to maintain its current credit ratings; the impact of
derivative contracts used in the normal course of business by the Company;
investment performance of pension and benefit plans and the ability to control
costs; the availability and use of Internal Revenue Code Section 29 (Section 29)
tax credits by synthetic fuel producers and the Company's continued ability to
use Section 29 tax credits related to its coal and synthetic fuels businesses;
the Company's ability to successfully integrate newly acquired assets,
properties or businesses into its operations as quickly or as profitably as
expected; the Company's ability to manage the risks involved with the operation
of its nonregulated plants, including dependence on third parties and related
counter-party risks, and a lack of operating history; the Company's ability to
manage the risks associated with its energy marketing operations; and
unanticipated changes in operating expenses and capital expenditures. Many of
these risks similarly impact the Company's subsidiaries.
These and other risk factors are detailed from time to time in the Progress
Energy and PEC United States Securities and Exchange Commission (SEC) reports.
Many, but not all of the factors that may impact actual results are discussed in
the Risk Factors sections of Progress Energy's and PEC's annual report on Form
10-K for the year ended December 31, 2003, which were filed with the SEC on
March 12, 2004. All such factors are difficult to predict, contain uncertainties
that may materially affect actual results and may be beyond the control of
Progress Energy and PEC. New factors emerge from time to time, and it is not
possible for management to predict all such factors, nor can it assess the
effect of each such factor on Progress Energy and PEC.
5
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Progress Energy, Inc.
CONSOLIDATED INTERIM FINANCIAL STATEMENTS
March 31, 2004
UNAUDITED CONSOLIDATED STATEMENTS of INCOME
Three Months Ended March 31,
(in millions except per share data) 2004 2003
- ---------------------------------------------------------------------------------------------
Operating Revenues
Utility $ 1,685 $ 1,654
Diversified business 549 533
- ---------------------------------------------------------------------------------------------
Total Operating Revenues 2,234 2,187
- ---------------------------------------------------------------------------------------------
Operating Expenses
Utility
Fuel used in electric generation 493 411
Purchased power 183 203
Operation and maintenance 363 335
Depreciation and amortization 202 220
Taxes other than on income 105 103
Diversified business
Cost of sales 504 475
Depreciation and amortization 45 33
Other 43 50
- ---------------------------------------------------------------------------------------------
Total Operating Expenses 1,938 1,830
- ---------------------------------------------------------------------------------------------
Operating Income 296 357
- ---------------------------------------------------------------------------------------------
Other Income (Expense)
Interest income 3 3
Other, net (25) (6)
- ---------------------------------------------------------------------------------------------
Total Other Expense (22) (3)
- ---------------------------------------------------------------------------------------------
Interest Charges
Net interest charges 166 156
Allowance for borrowed funds used during construction (1) (3)
- ---------------------------------------------------------------------------------------------
Total Interest Charges, Net 165 153
- ---------------------------------------------------------------------------------------------
Income from Continuing Operations before Income Tax and
Cumulative Effect of Change in Accounting Principle 109 201
Income Tax Expense (Benefit) 1 (6)
- ---------------------------------------------------------------------------------------------
Income from Continuing Operations before Cumulative Effect of
Change in Accounting Principle 108 207
Discontinued Operations, Net of Tax - 11
- ---------------------------------------------------------------------------------------------
Income before Cumulative Effect of Change in Accounting Principle 108 218
Cumulative Effect of Change in Accounting Principle, Net of Tax - 1
- ---------------------------------------------------------------------------------------------
Net Income $ 108 $ 219
- ---------------------------------------------------------------------------------------------
Average Common Shares Outstanding 241 233
- ---------------------------------------------------------------------------------------------
Basic Earnings per Common Share
Income from Continuing Operations before Cumulative Effect of
Change in Accounting Principle $ 0.45 $ 0.89
Discontinued Operations, Net of Tax - 0.05
Cumulative Effect of Change in Accounting Principle, Net of Tax - -
Net Income $ 0.45 $ 0.94
- ---------------------------------------------------------------------------------------------
Diluted Earnings per Common Share
Income from Continuing Operations before Cumulative Effect of $ 0.45 $ 0.89
Change in Accounting Principle
Discontinued Operations, Net of Tax - 0.05
Cumulative Effect of Change in Accounting Principle, Net of Tax - -
Net Income $ 0.45 $ 0.94
- ---------------------------------------------------------------------------------------------
Dividends Declared per Common Share $ 0.575 $ 0.560
- ---------------------------------------------------------------------------------------------
See Notes to Progress Energy, Inc. Consolidated Interim Financial Statements.
6
PROGRESS ENERGY, INC.
UNAUDITED CONSOLIDATED BALANCE SHEETS
(in millions) March 31, December 31,
ASSETS 2004 2003
- -----------------------------------------------------------------------------------------------------
Utility Plant
Utility plant in service $ 21,761 $ 21,675
Accumulated depreciation (8,204) (8,116)
- -----------------------------------------------------------------------------------------------------
Utility plant in service, net 13,557 13,559
Held for future use 13 13
Construction work in progress 722 634
Nuclear fuel, net of amortization 233 228
- -----------------------------------------------------------------------------------------------------
Total Utility Plant, Net 14,525 14,434
- -----------------------------------------------------------------------------------------------------
Current Assets
Cash and cash equivalents 41 273
Accounts receivable 794 841
Unbilled accounts receivable 193 217
Inventory 782 808
Deferred fuel cost 254 317
Prepayments and other current assets 297 375
- -----------------------------------------------------------------------------------------------------
Total Current Assets 2,361 2,831
- -----------------------------------------------------------------------------------------------------
Deferred Debits and Other Assets
Regulatory assets 626 612
Nuclear decommissioning trust funds 988 938
Diversified business property, net 2,181 2,158
Miscellaneous other property and investments 464 464
Goodwill 3,729 3,726
Prepaid pension costs 453 462
Intangibles, net 319 327
Other assets and deferred debits 237 253
- -----------------------------------------------------------------------------------------------------
Total Deferred Debits and Other Assets 8,997 8,940
- -----------------------------------------------------------------------------------------------------
Total Assets $ 25,883 $ 26,205
- -----------------------------------------------------------------------------------------------------
Capitalization and Liabilities
- -----------------------------------------------------------------------------------------------------
Common Stock Equity
Common stock without par value, 500 million shares authorized,
246 million shares issued and outstanding $ 5,310 $ 5,270
Unearned restricted shares (20) (17)
Unearned ESOP shares (79) (89)
Accumulated other comprehensive loss (61) (50)
Retained earnings 2,299 2,330
- -----------------------------------------------------------------------------------------------------
Total Common Stock Equity 7,449 7,444
- -----------------------------------------------------------------------------------------------------
Preferred Stock of Subsidiaries-Not Subject to Mandatory Redemption 93 93
Long-Term Debt, Affiliate 309 309
Long-Term Debt , Net 9,603 9,625
- -----------------------------------------------------------------------------------------------------
Total Capitalization 17,454 17,471
- -----------------------------------------------------------------------------------------------------
Current Liabilities
Current portion of long-term debt 232 868
Accounts payable 618 699
Interest accrued 140 209
Dividends declared 141 140
Short-term obligations 507 4
Customer deposits 169 167
Other current liabilities 524 580
- -----------------------------------------------------------------------------------------------------
Total Current Liabilities 2,331 2,667
- -----------------------------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Accumulated deferred income taxes 682 737
Accumulated deferred investment tax credits 186 190
Regulatory liabilities 2,995 2,938
Asset retirement obligations 1,289 1,271
Other liabilities and deferred credits 946 931
- -----------------------------------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 6,098 6,067
- -----------------------------------------------------------------------------------------------------
Commitments and Contingencies (Note 12)
- -----------------------------------------------------------------------------------------------------
Total Capitalization and Liabilities $ 25,883 $ 26,205
- -----------------------------------------------------------------------------------------------------
See Notes to Progress Energy, Inc. Consolidated Interim Financial Statements.
7
PROGRESS ENERGY, INC.
UNAUDITED CONSOLIDATED STATEMENTS of CASH FLOWS
Three Months Ended March 31,
(in millions) 2004 2003
- --------------------------------------------------------------------------------------------------------
Operating Activities
Net income $ 108 $ 219
Adjustments to reconcile net income to net cash provided by operating
activities:
Income from discontinued operations - (11)
Cumulative effect of change in accounting principle - (1)
Depreciation and amortization 275 280
Deferred income taxes (22) (3)
Investment tax credit (4) (4)
Deferred fuel cost (credit) 63 (46)
Cash provided (used) by changes in operating assets and
liabilities:
Accounts receivable 65 16
Inventories 26 32
Prepayments and other current assets (37) (3)
Accounts payable (64) 49
Other current liabilities (85) (91)
Other 57 2
- --------------------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 382 439
- --------------------------------------------------------------------------------------------------------
Investing Activities
Gross utility property additions (248) (291)
Diversified business property additions (58) (229)
Nuclear fuel additions (39) (68)
Proceeds from sales of investments and assets 85 -
Other (8) (12)
- --------------------------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (268) (600)
- --------------------------------------------------------------------------------------------------------
Financing Activities
Issuance of common stock 29 74
Issuance of long-term debt - 655
Net increase (decrease) in short-term indebtedness 503 (205)
Retirement of long-term debt (675) (226)
Dividends paid on common stock (141) (133)
Other (62) (30)
- --------------------------------------------------------------------------------------------------------
Net Cash (Used in) Provided by Financing Activities (346) 135
- --------------------------------------------------------------------------------------------------------
Net Decrease in Cash and Cash Equivalents (232) (26)
Cash and Cash Equivalents at Beginning of Period 273 61
- --------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 41 $ 35
- --------------------------------------------------------------------------------------------------------
Supplemental Disclosures of Cash Flow Information
Cash paid during the year - interest (net of amount capitalized) $ 232 $ 209
income taxes (net of refunds) $ 32 $ 3
- --------------------------------------------------------------------------------------------------------
See Notes to Progress Energy, Inc. Consolidated Interim Financial Statements.
8
Progress Energy, Inc.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
1. ORGANIZATION AND BASIS OF PRESENTATION
A. Organization
Progress Energy, Inc. (Progress Energy or the Company) is a holding company
headquartered in Raleigh, North Carolina. The Company is registered under
the Public Utility Holding Company Act of 1935 (PUHCA), as amended and as
such, the Company and its subsidiaries are subject to the regulatory
provisions of PUHCA.
Through its wholly-owned subsidiaries, Carolina Power & Light Company d/b/a
Progress Energy Carolinas, Inc. (PEC) and Florida Power Corporation d/b/a
Progress Energy Florida, Inc. (PEF), the Company's PEC Electric and PEF
segments are primarily engaged in the generation, transmission,
distribution and sale of electricity in portions of North Carolina, South
Carolina and Florida. The Progress Ventures business unit consists of the
Fuels (Fuels) and the Competitive Commercial Operations (CCO) business
segments. The Fuels segment is involved in natural gas drilling and
production, coal terminal services, coal mining, synthetic fuel production,
fuel transportation and delivery. The CCO segment includes nonregulated
electric generation and energy marketing activities. Through the Rail
Services (Rail) segment, the Company is involved in nonregulated railcar
repair, rail parts reconditioning and sales, and scrap metal recycling.
Through its other business units, the Company engages in other nonregulated
business areas, including telecommunications and energy management and
related services. Progress Energy's legal structure is not currently
aligned with the functional management and financial reporting of the
Progress Ventures business unit. Whether, and when, the legal and
functional structures will converge depends upon regulatory action, which
cannot currently be anticipated.
B. Basis of Presentation
These financial statements have been prepared in accordance with accounting
principles generally accepted in the United States of America (GAAP) for
interim financial information and with the instructions to Form 10-Q and
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by GAAP for annual statements. Because the accompanying
consolidated interim financial statements do not include all of the
information and footnotes required by GAAP, they should be read in
conjunction with the audited financial statements for the period ended
December 31, 2003, and notes thereto included in Progress Energy's Form
10-K for the year ended December 31, 2003.
In accordance with the provisions of Accounting Principles Board Opinion
(APB) No. 28, "Interim Financial Reporting," GAAP requires companies to
apply a levelized effective tax rate to interim periods that is consistent
with the estimated annual effective tax rate. Income tax expense was
increased by $39 million and decreased by $10 million for the three months
ended March 31, 2004 and 2003, respectively, in order to maintain an
effective tax rate consistent with the estimated annual rate. The income
tax provisions for the Company differ from amounts computed by applying the
Federal statutory tax rate to income before income taxes, primarily due to
the recognition of synthetic fuel tax credits.
The amounts included in the consolidated interim financial statements are
unaudited but, in the opinion of management, reflect all normal recurring
adjustments necessary to fairly present the Company's financial position
and results of operations for the interim periods. Due to seasonal weather
variations and the timing of outages of electric generating units,
especially nuclear-fueled units, the results of operations for interim
periods are not necessarily indicative of amounts expected for the entire
year or future periods.
In preparing financial statements that conform with GAAP, management must
make estimates and assumptions that affect the reported amounts of assets
and liabilities, disclosure of contingent assets and liabilities at the
date of the financial statements and amounts of revenues and expenses
reflected during the reporting period. Actual results could differ from
those estimates. Certain amounts for 2003 have been reclassified to conform
to the 2004 presentation.
9
C. Subsidiary Reporting Period Change
In the fourth quarter of 2003, the Company ceased recording portions of
Fuels' segment operations, primarily synthetic fuel operations, one month
in arrears. As a result, earnings for the year ended December 31, 2003 as
reported in the Company's Form 10-K, included 13 months of results for
these operations. The 2003 quarterly results for periods ended March 31,
June 30 and September 30 have been restated for the above-mentioned
reporting period change. This resulted in four months of earnings in the
first quarter. The impact of the reclassification of earnings between
quarters is outlined for the first quarter of 2003 in the table below:
(in millions, except per share data) As Previously Quarter As
Reported Reclassification Restated
---------------------------------------------------------------------------------------------------------
Income from Continuing Operations before Cumulative Effect $ 196 $ 11 $ 207
of Change in Accounting Principle
Net Income $ 208 $ 11 $ 219
Basic and Diluted earnings per common share
Income from Continuing Operations before Cumulative
Effect of Change in Accounting Principle $ 0.84 $ 0.05 $ 0.89
Net Income $ 0.89 $ 0.05 $ 0.94
D. Stock-Based Compensation
The Company measures compensation expense for stock options as the
difference between the market price of its common stock and the exercise
price of the option at the grant date. The exercise price at which options
are granted by the Company equals the market price at the grant date, and
accordingly, no compensation expense has been recognized for stock option
grants. For purposes of the pro forma disclosures required by SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure - an
Amendment of FASB Statement No. 123" (SFAS No. 148), the estimated fair
value of the Company's stock options is amortized to expense over the
options' vesting period. The following table illustrates the effect on net
income and earnings per share if the fair value method had been applied to
all outstanding and unvested awards in each period:
Three Months Ended March 31,
------------------------------
(in millions except per share data) 2004 2003
-------------- --------------
Net Income, as reported $ 108 $ 219
Deduct: Total stock option expense determined under fair
value method for all awards, net of related tax effects 3 3
-------------- --------------
Pro forma net income $ 105 $ 216
============== ==============
Basic earnings per share
As reported $0.45 $0.94
Pro forma $0.44 $0.93
Fully diluted earnings per share
As reported $0.45 $0.94
Pro forma $0.43 $0.92
2. IMPACT OF NEW ACCOUNTING STANDARDS
FIN No. 46, "Consolidation of Variable Interest Entities"
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities - an Interpretation of ARB No. 51" (FIN No. 46).
This interpretation provides guidance related to identifying variable
interest entities and determining whether such entities should be
consolidated or deconsolidated. FIN No. 46 requires an enterprise to
consolidate a variable interest entity when the enterprise (a) absorbs a
majority of the variable interest entity's expected losses, (b) receives a
majority of the entity's expected residual returns, or both, as a result of
ownership, contractual or other financial interests in the entity. Prior to
the effective date of FIN No. 46, entities were generally consolidated by
an enterprise that had control through ownership of a majority voting
interest in the entity. FIN No. 46 originally applied immediately to
variable interest entities created or obtained after January 31, 2003.
10
During 2003 and the first quarter of 2004, the Company did not participate
in the creation of, or obtain a significant new variable interest in, any
variable interest entity. In December 2003, the FASB issued a revision to
FIN No. 46 (FIN No. 46R), which modified certain requirements of FIN No. 46
and was effective for all variable interest entities as of March 31, 2004.
The Company adopted FIN No. 46 for special-purpose entities as of December
31, 2003, and deconsolidated the FPC Capital I trust (the Trust) as of that
date. Upon the adoption of FIN No. 46R as of March 31, 2004, no other
variable interest entities were required to be deconsolidated.
Upon adoption of FIN No. 46R as of March 31, 2004, the Company determined
that it is the primary beneficiary of a limited partnership which invests
in 17 low-income housing partnerships that qualify for federal and state
tax credits. The Company consolidated the limited partnership as of March
31, 2004, the effect of which was insignificant. The Company has requested
but has not received all the necessary information to determine the primary
beneficiary of the limited partnership's underlying 17 partnership
investments, and has applied the information scope exception in FIN No.
46R, paragraph 4(g) to the 17 partnerships. The Company has no direct
exposure to loss from the 17 partnerships; the Company's only exposure to
loss is from its investment of approximately $1 million in the newly-
consolidated limited partnership. The Company will continue its efforts to
obtain the necessary information to fully apply FIN No. 46R to the 17
partnerships. The Company believes that if the newly-consolidated limited
partnership is determined to be the primary beneficiary of the 17
partnerships, the effect of consolidating the 17 partnerships would not be
significant to the Company's Consolidated Balance Sheets.
The Company has variable interests in two power plants resulting from
long-term power purchase contracts. The Company has requested but has not
received all the necessary information to determine if the counterparties
are variable interest entities or to identify the primary beneficiaries,
and has applied the information scope exception in FIN No. 46R, paragraph
4(g). Certain payments for fuel costs under these contracts are linked to
inflation indices. The Company's only significant exposure to loss from
these contracts results from fluctuations in the market price of fuel used
by the two plants to produce the power purchased by the Company. Total
purchases from these counterparties were approximately $9 million in each
of the first quarters of 2003 and 2004. The Company will continue its
efforts to obtain the necessary information to fully apply FIN No. 46R to
these contracts. Although the Company has not received any financial
information from these two counterparties, the Company believes that if it
is determined to be the primary beneficiary of these two entities the
effect of consolidating the entities could be significant to its
Consolidated Balance Sheets. However, the approximate impact cannot be
determined at this time.
The Company also has interests in several other variable interest entities
created before January 31, 2003, for which the Company is not the primary
beneficiary. These arrangements include investments in approximately 33
limited partnerships, limited liability corporations and venture capital
funds and two building leases with special-purpose entities. The aggregate
maximum loss exposure at March 31, 2004, that the Company could be required
to record in its income statement as a result of these arrangements totals
approximately $39 million. The creditors of these variable interest
entities do not have recourse to the general credit of the Company in
excess of the aggregate maximum loss exposure.
3. DIVESTITURES
A. Railcar Ltd. Divestiture
In December 2002, the Progress Energy Board of Directors adopted a
resolution approving the sale of Railcar Ltd., a subsidiary included in the
Rail Services segment. In March 2003, the Company signed a letter of intent
to sell the majority of Railcar Ltd. assets to The Andersons, Inc. and the
transaction closed in February 2004. Proceeds from the sale were
approximately $82 million before transaction costs and taxes of
approximately $13 million. The assets of Railcar Ltd. were grouped as
assets held for sale and are included in other current assets on the
Consolidated Balance Sheets at December 31, 2003 and March 31, 2004. The
assets were recorded at approximately $6 million and $75 million at March
31, 2004 and December 31, 2003, respectively, which reflects the Company's
estimates of the fair value expected to be realized from the sale of these
assets less costs to sell. The primary component of assets held for sale at
December 31, 2003 was property and equipment of $74 million.
11
B. NCNG Divestiture
In October 2002, the Company announced the Board of Directors' approval to
sell North Carolina Natural Gas Corporation (NCNG) and the Company's equity
investment in Eastern North Carolina Natural Gas Company (ENCNG) to
Piedmont Natural Gas Company, Inc. On September 30, 2003, the Company
completed the sale. The 2003 net income of these operations is reported as
discontinued operations in the Consolidated Statements of Income. Interest
expense of $4 million for the three months ended March 31, 2003 has been
allocated to discontinued operations based on the net assets of NCNG,
assuming a uniform debt-to-equity ratio across the Company's operations.
Results of discontinued operations were as follows:
(in millions) First Quarter
2003
----------------
Revenues $ 154
================
Earnings before income taxes $ 18
Income tax expense 7
----------------
Net earnings from discontinued operations $ 11
================
4. REGULATORY MATTERS
A. Retail Rate Matters
PEC has exclusively utilized external funding for its decommissioning
liability since 1994. Prior to 1994, PEC retained its funds internally to
meet its decommissioning liability. The North Carolina Utilities Commission
(NCUC) order issued in February 2004 found that by January 1, 2008 PEC must
begin transitioning these amounts to external funds. The transition of $131
million must be completed by December 31, 2017, and at least 10% must be
transitioned each year.
PEC filed with the Public Service Commission of South Carolina (SCPSC)
seeking permission to defer expenses incurred from the first quarter 2004
winter storm. The SCPSC approved PEC's request to defer the costs and
amortize them over five years beginning in January 2005. Approximately $10
million related to storm costs incurred during the quarter was deferred.
During the first quarter of 2004, PEC filed with the NCUC and obtained
approval from the SCPSC for a depreciation study which allowed the utility
to reduce the rates used to calculate depreciation expense. As a result,
depreciation expense decreased $7 million compared to the prior year
quarter.
On April 29, 2004, PEF, the Office of Public Counsel and the Florida
Industrial Power Users Group executed a Stipulation and Settlement that,
upon approval by the Florida Public Service Commission (FPSC), will resolve
the issue currently pending before the FPSC regarding the costs PEF will be
allowed to recover through its Fuel and Purchased Power Cost Recovery
clause in 2004 and beyond for waterborne coal deliveries by the Company's
affiliated coal supplier, Progress Fuels Corporation. The settlement sets
fixed per ton prices based on point of origin for all waterborne coal
deliveries in 2004, and establishes a market-based pricing methodology for
determining recoverable waterborne coal transportation costs through a
competitive solicitation process or market price proxies beginning in 2005
and thereafter. The settlement will reduce the amount that PEF will charge
to the Fuel and Purchased Power Cost Recovery clause for waterborne
transportation by approximately $13 million beginning in 2004. Also on
April 29, 2004, the parties filed a joint request with the FPSC for
approval of the Stipulation and Settlement, which the FPSC is expected to
act upon prior to the commencement of a hearing on the waterborne
transportation issues scheduled for June 10, 2004.
B. Regional Transmission Organizations
In 2000, the Federal Energy Regulatory Commission (FERC) issued Order 2000
regarding regional transmission organizations (RTOs). This Order set
minimum characteristics and functions that RTOs must meet, including
independent transmission service. In July 2002, the FERC issued its Notice
of Proposed Rulemaking in Docket No. RM01-12-000, Remedying Undue
Discrimination through Open Access Transmission Service and Standard
Electricity Market Design (SMD NOPR). If adopted as proposed, the rules set
12
forth in the SMD NOPR would materially alter the manner in which
transmission and generation services are provided and paid for. In April
2003, the FERC released a White Paper on the Wholesale Market Platform. The
White Paper provides an overview of what the FERC currently intends to
include in a final rule in the SMD NOPR docket. The White Paper retains the
fundamental and most protested aspects of SMD NOPR, including mandatory
RTOs and the FERC's assertion of jurisdiction over certain aspects of
retail service. The FERC has not yet issued a final rule on SMD NOPR. The
Company cannot predict the outcome of these matters or the effect that they
may have on the GridSouth and GridFlorida proceedings currently ongoing
before the FERC. It is unknown what impact the future proceedings will have
on the Company's earnings, revenues or prices.
The Company has recorded $33 million and $4 million related to startup
costs for GridSouth and GridFlorida, respectively, at March 31, 2004. The
Company expects to recover these startup costs in conjunction with the
GridSouth and GridFlorida original structures or in conjunction with any
alternate combined transmission structures that emerge.
5. GOODWILL AND OTHER INTANGIBLE ASSETS
The Company performed the annual goodwill impairment test in accordance
with SFAS No. 142, "Goodwill and Other Intangible Assets," for the CCO
segment in the first quarter of 2004, and the annual goodwill impairment
test for the PEC Electric and PEF segments in the second quarter of 2003,
which indicated no impairment. The first annual impairment test for the
Other segment will be performed in the fourth quarter 2004.
The changes in the carrying amount of goodwill for the periods ended March
31, 2004 and December 31, 2003, by reportable segment, are as follows:
(in millions) PEC Electric PEF CCO Other Total
---------------------------------------------------------------
Balance as of January 1, 2003 $ 1,922 $ 1,733 $ 64 $ - $ 3,719
Acquisitions - - - 7 7
---------------------------------------------------------------
Balance as of December 31, 2003 $ 1,922 $ 1,733 $ 64 $ 7 $ 3,726
Purchase price adjustment - - - 3 3
---------------------------------------------------------------
Balance as of March 31, 2004 $ 1,922 $ 1,733 $ 64 $10 $ 3,729
===============================================================
The gross carrying amount and accumulated amortization of the Company's
intangible assets at March 31, 2004 and December 31, 2003, are as follows:
March 31, 2004 December 31, 2003
------------------------------------ ---------------------------------
(in millions) Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
--------------------------------- ---------------------------------
Synthetic fuel intangibles $ 140 $ (69) $ 140 $ (64)
Power agreements acquired 221 (24) 221 (20)
Other 63 (12) 62 (12)
--------------------------------- ---------------------------------
Total $ 424 $(105) $ 423 $ (96)
================================= =================================
13
All of the Company's intangibles are subject to amortization. Synthetic
fuel intangibles represent intangibles for synthetic fuel technology. These
intangibles are being amortized on a straight-line basis until the
expiration of tax credits under Section 29 of the Internal Revenue Code
(Section 29) in December 2007. The intangibles related to power agreements
acquired are being amortized based on the economic benefits of the
contracts. Other intangibles are primarily acquired customer contracts and
permits that are amortized over their respective lives.
Amortization expense recorded on intangible assets for the three months
ended March 31, 2004 and 2003, was $9 million and $7 million, respectively.
The estimated annual amortization expense for intangible assets for 2004
through 2008, in millions, is approximately $42, $35, $36, $36 and $17,
respectively.
6. EQUITY
A. Earnings Per Common Share
A reconciliation of the weighted-average number of common shares
outstanding for basic and dilutive earnings per share purposes is as
follows:
(in millions) Three Months Ended March 31,
----------------------------
2004 2003
----------- ---------
Weighted-average common shares - basic 241 233
Restricted stock awards 1 1
----------- ---------
Weighted-average shares - fully dilutive 242 234
----------- ---------
B. Comprehensive Income
Comprehensive income for the three months ended March 31, 2004 and 2003 was
$97 million and $219 million, respectively. Changes in other comprehensive
income for the periods consisted primarily of changes in the fair value of
derivatives used to hedge cash flows related to interest on long-term debt
and gas sales.
7. FINANCING ACTIVITIES
On March 1, 2004, Progress Energy used available cash and proceeds from the
issuance of commercial paper to retire $500 million 6.55% senior unsecured
notes. Cash and commercial paper capacity was created primarily from the
sale of assets in 2003.
On January 15, 2004, PEC paid at maturity $150 million 5.875% First
Mortgage Bonds with commercial paper proceeds. On April 15, 2004, PEC also
paid at maturity $150 million 7.875% First Mortgage Bonds with commercial
paper proceeds and internally-generated funds.
On March 31, 2004, PEC announced the redemption of $35 million of
Darlington County 6.6% Series Pollution Control Bonds at 102.5% of par, $2
million of New Hanover County 6.30% Series Pollution Control Bonds at
101.5% of par, and $3 million of Chatham County 6.30% Series Pollution
Control Bonds at 101.5% of par. All three series were fully redeemed on
April 30, 2004.
On February 9, 2004, Progress Capital Holdings, Inc. paid at maturity $25
million 6.48% medium term notes with excess cash.
For the three months ended March 31, 2004, the Company issued approximately
0.7 million shares of its common stock for approximately $29 million in
proceeds from its Investor Plus Stock Purchase Plan and its employee
benefit plans.
8. BENEFIT PLANS
The Company and some of its subsidiaries have a non-contributory defined
benefit retirement (pension) plan for substantially all full-time
employees. The Company also has supplementary defined benefit pension plans
that provide benefits to higher-level employees. In addition to pension
14
benefits, the Company and some of its subsidiaries provide contributory
other postretirement benefits (OPEB), including certain health care and
life insurance benefits, for retired employees who meet specified criteria.
The components of the net periodic benefit cost for the three months ended
March 31 are:
Other Postretirement
Pension Benefits Benefits
-------------------- ---------------------
(in millions) 2004 2003 2004 2003
-------------------- ---------------------
Service cost $ 13 $ 13 $ 4 $ 3
Interest cost 28 27 8 8
Expected return on plan assets (37) (36) (1) (1)
Amortization of actuarial (gain) loss 5 5 1 1
Other amortization, net - - 1 1
-------------------- ---------------------
Net periodic cost $ 9 $ 9 $ 13 $ 12
Additional cost / (benefit) recognition (a) (4) (4) 1 1
-------------------- ---------------------
Net periodic cost / (benefit) recognized $ 5 $ 5 $ 14 $ 13
==================== =====================
(a) Relates to the acquisition of FPC. See Note 16B of Progress Energy's
Form 10-K for year ended December 31, 2003.
In December 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the Act) was signed into law. In accordance with
guidance issued by the FASB in FASB Staff Position FAS 106-1, the Company
has elected to defer accounting for the effects of the Act due to
uncertainties regarding the effects of the implementation of the Act and
the accounting for certain provisions of the Act. Therefore, OPEB
information presented in the financial statements does not reflect the
effects of the Act. When specific authoritative accounting guidance is
issued, it could require plan sponsors to change previously reported
information. The Company is in the early stages of reviewing the Act and
determining its potential effects on the Company.
9. RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS
Progress Energy and its subsidiaries are exposed to various risks related
to changes in market conditions. The Company has a risk management
committee that includes senior executives from various business groups. The
risk management committee is responsible for administering risk management
policies and monitoring compliance with those policies by all subsidiaries.
Under its risk management policy, the Company may use a variety of
instruments, including swaps, options and forward contracts, to manage
exposure to fluctuations in commodity prices and interest rates. Such
instruments contain credit risk if the counterparty fails to perform under
the contract. The Company minimizes such risk by performing credit reviews
using, among other things, publicly available credit ratings of such
counterparties. Potential nonperformance by counterparties is not expected
to have a material effect on the consolidated financial position or
consolidated results of operations of the Company.
Progress Energy uses interest rate derivative instruments to adjust the
fixed and variable rate debt components of its debt portfolio and to hedge
interest rates with regard to future fixed rate debt issuances. In March
2004, two interest rate swap agreements totaling $200 million were
terminated. These swaps were associated with Progress Energy 5.85% Notes
due in 2008. The loss on the agreements was deferred and is being amortized
over the life of the bonds as these agreements had been designated as fair
value hedges for accounting purposes.
As of March 31, 2004, Progress Energy had $650 million of fixed rate debt
swapped to floating rate debt by executing interest rate derivative
agreements. Under terms of these swap rate agreements, Progress Energy will
receive a fixed rate and pay a floating rate based on 3-month LIBOR. These
agreements expire in March 2006 and April 2007.
In March 2004, PEC entered into a forward swap to hedge its exposure to
interest rates with regard to a future issuance of approximately $300
million of debt. This agreement has a computational period of ten years.
In April 2004, PEC entered into a cash flow hedge to hedge the payment
stream associated with an upcoming lease.
15
The Company holds interest rate collars with a varying notional amount and
maximum of $195 million to hedge floating rate exposure associated with
variable rate long-term debt. The Company is required to hedge 50% of the
amount outstanding under its bank facility through March 2007.
The Company also holds interest rate cash flow hedges, with a total
notional amount of $400 million, related to projected outstanding balances
of commercial paper.
The notional amounts of interest rate derivatives are not exchanged and do
not represent exposure to credit loss. In the event of default by a
counterparty, the risk in the transaction is the cost of replacing the
agreements at current market rates. Progress Energy only enters into
interest rate derivative agreements with banks with credit ratings of
single A or better.
Progress Fuels Corporation, through Progress Ventures, Inc. (PVI),
periodically enters into derivative instruments to hedge its exposure to
price fluctuations on natural gas sales. As of March 31, 2004, Progress
Fuels Corporation is hedging exposures to the price variability of its
natural gas production through December 2005. These instruments did not
have a material impact on the Company's consolidated financial position or
results of operations.
Nonhedging derivatives, primarily electricity and natural gas contracts,
are entered into for trading purposes and for economic hedging purposes.
While management believes the economic hedges mitigate exposures to
fluctuations in commodity prices, these instruments are not designated as
hedges for accounting purposes and are monitored consistent with trading
positions.
The Company recorded mark-to-market losses of $9 million in the first
quarter of 2004 related to an agreement to provide energy needed to fulfill
a contract obligation.
10. FINANCIAL INFORMATION BY BUSINESS SEGMENT
The Company currently provides services through the following business
segments: PEC Electric, PEF, Fuels, CCO, Rail Services and Other.
PEC Electric and PEF are primarily engaged in the generation, transmission,
distribution and sale of electric energy in portions of North Carolina,
South Carolina and Florida. These electric operations are subject to the
rules and regulations of the FERC, the NCUC, the SCPSC, the FPSC and the
United States Nuclear Regulatory Commission (NRC). These electric
operations also distribute and sell electricity to other utilities,
primarily on the east coast of the United States.
Fuels' operations, which are located throughout the United States, are
involved in natural gas drilling and production, coal terminal services,
coal mining, synthetic fuel production, fuel transportation and delivery.
CCO's operations, which are located in the southeastern United States,
include nonregulated electric generation operations and marketing
activities.
Rail Services' operations include railcar repair, rail parts reconditioning
and sales, and scrap metal recycling. These activities include maintenance
and reconditioning of salvageable scrap components of railcars, locomotive
repair and right-of-way maintenance. Rail Services' operations are located
in the United States, Canada and Mexico.
The Other segment, whose operations are in the United States, is composed
of other nonregulated business areas including telecommunications and
energy service operations and other nonregulated subsidiaries that do not
separately meet the disclosure requirements of SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information."
In addition to these reportable operating segments, the Company has other
corporate activities that include holding company operations, service
company operations and eliminations. The profit or loss of the identified
segments plus the loss of Corporate represents the Company's total income
from continuing operations before cumulative effect of change in accounting
principle.
16
Revenues
-----------------------------------------------
Income from
Continuing
(in millions) Unaffiliated Intersegment Total Operations Assets
------------- ------------- ------------ --------------- -------------
FOR THE THREE MONTHS
ENDED MARCH 31, 2004
PEC Electric $ 901 $ - $ 901 $ 116 $ 10,669
PEF 784 - 784 49 7,284
Fuels 255 82 337 48 1,164
CCO 33 - 33 (8) 1,764
Rail Services 240 - 240 6 543
Other 21 1 22 (2) 320
Corporate - (83) (83) (101) 4,139
------------- ------------- ------------ --------------- -------------
Consolidated totals $ 2,234 $ - $ 2,234 $ 108 $ 25,883
------------- ------------- ------------ --------------- -------------
FOR THE THREE MONTHS
ENDED MARCH 31, 2003
PEC Electric $ 926 $ - $ 926 $ 135
PEF 728 - 728 71
Fuels 304 82 386 38
CCO 37 - 37 9
Rail Services 178 - 178 (3)
Other 14 4 18 -
Corporate - (86) (86) (43)
------------- ------------- ------------ ---------------
Consolidated totals $ 2,187 $ - $ 2,187 $ 207
------------- ------------- ------------ ---------------
11. OTHER INCOME AND OTHER EXPENSE
Other income and expense includes interest income and other income and
expense items as discussed below. The components of other, net as shown on
the accompanying Consolidated Statements of Income are as follows:
Three Months Ended
March 31,
-----------------------------
(in millions) 2004 2003
-------------- -----------
Other income
Net financial trading gain $ 1 $ -
Net energy brokered for resale - (2)
Nonregulated energy and delivery services income 6 5
Contingent value obligation unrealized gain - 2
Income from equity investments 2 -
AFUDC equity 2 2
Other 2 3
-------------- -----------
Total other income $ 13 $ 10
-------------- -----------
Other expense
Nonregulated energy and delivery services expenses $ 4 $ 4
Donations 8 3
Investment losses 4 4
Contingent value obligations unrealized loss 7 -
Write-off of non-trade receivable 7 -
Other 8 5
-------------- -----------
Total other expense $ 38 $ 16
-------------- -----------
Other, net $ (25) $ (6)
============== ===========
Net financial trading gains and losses represent non-asset-backed trades of
electricity and gas. Net energy brokered for resale represents electricity
purchased for simultaneous sale to a third party. Nonregulated energy and
delivery services include power protection services and mass-market
programs such as surge protection, appliance services and area light sales,
and delivery, transmission and substation work for other utilities.
17
12. COMMITMENTS AND CONTINGENCIES
Contingencies and significant changes to the commitments discussed in Note
21 of the Company's 2003 Annual Report on Form 10-K are described below.
A. Guarantees
As a part of normal business, Progress Energy and certain subsidiaries
enter into various agreements providing financial or performance assurances
to third parties. Such agreements include guarantees, standby letters of
credit and surety bonds. These agreements are entered into primarily to
support or enhance the creditworthiness otherwise attributed to
subsidiaries on a stand-alone basis, thereby facilitating the extension of
sufficient credit to accomplish the subsidiaries' intended commercial
purposes. At March 31, 2004, management does not believe conditions are
likely for significant performance under the guarantees of performance
issued by or on behalf of affiliates discussed herein.
Guarantees at March 31, 2004, are summarized in the table below and
discussed more fully in the subsequent paragraphs.
(in millions)
Guarantees issued on behalf of affiliates
Guarantees supporting nonregulated portfolio and energy marketing
activities issued by Progress Energy $ 383
Guarantees supporting nuclear decommissioning 276
Guarantee supporting power supply agreements 307
Standby letters of credit 11
Surety bonds 115
Other guarantees 1
Guarantees issued on behalf of third parties
Other guarantees 10
-----------
Total $ 1,103
===========
Guarantees Supporting Nonregulated Portfolio and Energy Marketing
Activities
Progress Energy has issued approximately $383 million of guarantees on
behalf of Progress Ventures (the business unit) and its subsidiaries for
obligations under tolling agreements, transmission agreements, gas
agreements, construction agreements, fuel procurement agreements and
trading operations. Approximately $38 million of these guarantees were
issued during the first quarter of 2004 to support Fuels and
energy-marketing activities. The majority of the marketing contracts
supported by the guarantees contain language regarding downgrade events,
ratings triggers, monthly netting of exposure and/or payments and offset
provisions in the event of a default. Based upon current business levels at
March 31, 2004, if the Company's ratings were to decline below investment
grade, the Company estimates that it may have to deposit cash or provide
letters of credit or other cash collateral of approximately $115 million
for the benefit of the Company's counterparties to support ongoing
operations within a 90-day period.
Guarantees Supporting Nuclear Decommissioning
In 2003, PEC determined that its external funding levels did not fully meet
the nuclear decommissioning financial assurance levels required by the NRC.
Therefore, PEC met the financial assurance requirements by obtaining
guarantees from Progress Energy in the amount of $276 million.
Guarantees Supporting Power Supply Agreements
In March 2003, PVI entered into a definitive agreement with Williams Energy
Marketing and Trading, a subsidiary of The Williams Companies, Inc., to
acquire a long-term full-requirements power supply agreement at fixed
prices with Jackson County EMC (Jackson). The power supply agreement
included a performance guarantee by Progress Energy. The transaction closed
during the second quarter of 2003. The Company issued a payment and
performance guarantee to Jackson related to the power supply agreement of
18
$280 million. In the event that Progress Energy's credit ratings fall below
investment grade, Progress Energy may be required to provide additional
security for this guarantee in form and amount (not to exceed $280 million)
acceptable to Jackson. During the third quarter of 2003, PVI entered into
an agreement with Morgan Stanley Capital Group Inc. (Morgan Stanley) to
fulfill Morgan Stanley's obligations to schedule resources and supply
energy to Oglethorpe Power Corporation of Georgia through March 31, 2005.
The Company issued a payment and performance guarantee to Morgan Stanley
related to the power supply agreement. In the event that Progress Energy's
credit ratings fall below investment grade, Progress Energy estimates that
it may have to deposit cash or provide letters of credit or other cash
collateral of approximately $27 million for the benefit of Morgan Stanley
at March 31, 2004.
Standby Letters of Credit
The Company has issued $11 million of standby letters of credit to
financial institutions for the benefit of third parties that have extended
credit to the Company and certain subsidiaries. These letters of credit
have been issued primarily for the purpose of supporting payments of trade
payables, securing performance under contracts and lease obligations and
self-insurance for workers' compensation. If a subsidiary does not pay
amounts when due under a covered contract, the counterparty may present its
claim for payment to the financial institution, which will in turn request
payment from the Company. Any amounts owed by the Company's subsidiaries
are reflected in the accompanying Consolidated Balance Sheets.
Surety Bonds
At March 31, 2004, the Company had $115 million in surety bonds purchased
primarily for purposes such as providing workers' compensation coverage,
obtaining licenses, permits, rights-of-way and project performance. To the
extent liabilities are incurred as a result of the activities covered by
the surety bonds, such liabilities are included in the accompanying
Consolidated Balance Sheets.
Other Guarantees
The Company has other guarantees outstanding of approximately $11 million.
Included in the $11 million are $10 million of guarantees issued on behalf
of third parties which is in support of synthetic fuel operations at a
third-party plant. The remaining $1 million in affiliate guarantees is
related primarily to prompt performance payments and other payments subject
to contingencies.
B. Insurance
Both PEC and PEF are insured against public liability for a nuclear
incident up to $10,760 million per occurrence. Under the current provisions
of the Price Anderson Act, which limits liability for accidents at nuclear
power plants, each company, as an owner of nuclear units, can be assessed a
portion of any third-party liability claims arising from an accident at any
commercial nuclear power plant in the United States. In the event that
public liability claims from an insured nuclear incident exceed $300
million (currently available through commercial insurers), each company
would be subject to assessments of up to $101 million for each reactor
owned per occurrence. Payment of such assessments would be made over time
as necessary to limit the payment in any one year to no more than $10
million per reactor owned. Congress is expected to approve revisions to the
Price Anderson Act during 2004 that could include increased limits and
assessments per reactor owned. The final outcome of this matter cannot be
predicted at this time.
C. Claims and Uncertainties
The Company is subject to federal, state and local regulations addressing
hazardous and solid waste management, air and water quality and other
environmental matters.
19
Hazardous and Solid Waste Management
Various organic materials associated with the production of manufactured
gas, generally referred to as coal tar, are regulated under federal and
state laws. The principal regulatory agency that is responsible for a
specific former manufactured gas plant (MGP) site depends largely upon the
state in which the site is located. Both electric utilities and other
potentially responsible parties (PRPs) are participating in, investigating
and, if necessary, remediating former MGP sites with several regulatory
agencies, including, but not limited to, the U.S. Environmental Protection
Agency (EPA), the Florida Department of Environmental Protection (FDEP) and
the North Carolina Department of Environment and Natural Resources,
Division of Waste Management (DWM). In addition, the Company and its
subsidiaries are periodically notified by regulators such as the EPA and
various state agencies of their involvement or potential involvement in
sites, other than MGP sites, that may require investigation and/or
remediation. A discussion of these sites by legal entity follows.
PEC, PEF and Progress Fuels Corporation have filed claims with the
Company's general liability insurance carriers to recover costs arising out
of actual or potential environmental liabilities. Some claims have been
settled and others are still pending. While the Company cannot predict the
outcome of these matters, the outcome is not expected to have a material
effect on the consolidated financial position or results of operations.
The Company is also currently in the process of assessing potential costs
and exposures at other environmentally impaired sites. As the assessments
are developed and analyzed, the Company will accrue costs for the sites to
the extent the costs are probable and can be reasonably estimated.
PEC There are nine former MGP sites and other sites associated with PEC
that have required or are anticipated to require investigation and/or
remediation costs. PEC received insurance proceeds to address costs
associated with environmental liabilities related to its involvement with
some sites. All eligible expenses related to these are charged against a
specific fund containing these proceeds. At March 31, 2004, approximately
$8 million remains in this centralized fund with a related accrual of $8
million recorded for the associated expenses of environmental issues. PEC
does not believe that it can provide an estimate of the reasonably possible
total remediation costs beyond what is currently accrued due to the fact
that investigations have not been completed at all sites. This accrual has
been recorded on an undiscounted basis. PEC measures its liability for
these sites based on available evidence including its experience in
investigating and remediating environmentally impaired sites. The process
often involves assessing and developing cost-sharing arrangements with
other PRPs. PEC will accrue costs for the sites to the extent its liability
is probable and the costs can be reasonably estimated. Presently, PEC
cannot determine the total costs that may be incurred in connection with
the remediation of all sites.
In September 2003, the Company sold NCNG to Piedmont Natural Gas Company,
Inc. As part of the sales agreement, the Company retained responsibility to
remediate five former NCNG MGP sites, all of which also are associated with
PEC, to state standards pursuant to an Administrative Order on Consent.
These sites are anticipated to have investigation or remediation costs
associated with them. NCNG had previously accrued approximately $2 million
for probable and reasonably estimable remediation costs at these sites.
These accruals have been recorded on an undiscounted basis. At the time of
the sale, the liability for these costs and the related accrual was
transferred to PEC. PEC does not believe it can provide an estimate of the
reasonably possible total remediation costs beyond the accrual because
investigations have not been completed at all sites. Therefore, PEC cannot
currently determine the total costs that may be incurred in connection with
the investigation and/or remediation of all sites.
PEF At March 31, 2004, PEF has accrued $20 million for probable and
estimable costs related to various environmental sites. Of this accrual,
$10 million is for costs associated with the remediation of distribution
transformers which are more fully discussed below. The remaining $10
million is related to two former MGP sites and other sites associated with
PEF that have required or are anticipated to require investigation and/or
remediation costs. PEF does not believe that it can provide an estimate of
the reasonably possible total remediation costs beyond what is currently
accrued.
In 2002, PEF accrued approximately $3 million for investigation and
remediation associated with distribution transformers and received approval
from the FPSC for annual recovery of these environmental costs through the
Environmental Cost Recovery Clause (ECRC). By December 2003, PEF accrued an
additional $9 million for similar environmental costs as a result of
increased sites and estimated costs per site. PEF has received approval
from the FPSC to recover these costs through the ECRC. As more activity
occurs at these sites, PEF will assess the need to adjust the accruals.
20
In addition, PEF received insurance proceeds of approximately $3 million to
address costs associated with environmental liabilities related to its
involvement with some MGP and other sites. All eligible expenses related to
these sites are included in the amount accrued above and charged against a
fund containing these proceeds.
These accruals have been recorded on an undiscounted basis. PEF measures
its liability for these sites based on available evidence including its
experience in investigating and remediating environmentally impaired sites.
This process often includes assessing and developing cost-sharing
arrangements with other PRPs. Presently, PEF cannot determine the total
costs that may be incurred in connection with the remediation of all sites.
Florida Progress Corporation In 2001, FPC sold its Inland Marine
Transportation business operated by MEMCO Barge Line, Inc. to AEP
Resources, Inc. FPC established an accrual to address indemnities and
retained an environmental liability associated with the transaction. FPC
estimates that its contractual liability to AEP Resources, Inc., associated
with Inland Marine Transportation, is $4 million at March 31, 2004 and has
accrued such amount. The previous accrual of $10 million was reduced in
2003 based on a change in estimate. This accrual has been determined on an
undiscounted basis. FPC measures its liability for this site based on
estimable and probable remediation scenarios. The Company believes that it
is not reasonably probable that additional costs, which cannot be currently
estimated, will be incurred related to the environmental indemnification
provision beyond the amount accrued. The Company cannot predict the outcome
of this matter.
Certain historical sites exist that are being addressed voluntarily by FPC.
An immaterial accrual has been established to address investigation
expenses related to these sites. The Company cannot determine the total
costs that may be incurred in connection with these sites.
Rail Services is voluntarily addressing certain historical waste sites. The
Company cannot determine the total costs that may be incurred in connection
with these sites.
Air Quality
There has been and may be further proposed legislation requiring reductions
in air emissions for NOx, SO2, carbon dioxide and mercury. Some of these
proposals establish nationwide caps and emission rates over an extended
period of time. This national multi-pollutant approach to air pollution
control could involve significant capital costs which could be material to
the Company's consolidated financial position or results of operations.
Control equipment that will be installed on North Carolina fossil
generating facilities as part of the North Carolina legislation discussed
below may address some of the issues outlined above. However, the Company
cannot predict the outcome of this matter.
The EPA is conducting an enforcement initiative related to a number of
coal-fired utility power plants in an effort to determine whether
modifications at those facilities were subject to New Source Review
requirements or New Source Performance Standards under the Clean Air Act.
Both PEC and PEF were asked to provide information to the EPA as part of
this initiative and cooperated in providing the requested information. The
EPA initiated civil enforcement actions against other unaffiliated
utilities as part of this initiative. Some of these actions resulted in
settlement agreements calling for expenditures by these unaffiliated
utilities, ranging from $1.0 billion to $1.4 billion. A utility that was
not subject to a civil enforcement action settled its New Source Review
issues with the EPA for $300 million. These settlement agreements have
generally called for expenditures to be made over extended time periods,
and some of the companies may seek recovery of the related cost through
rate adjustments or similar mechanisms. The Company cannot predict the
outcome of this matter.
In 2003, the EPA published a final rule addressing routine equipment
replacement under the New Source Review program. The rule defines routine
equipment replacement and the types of activities that are not subject to
New Source Review requirements or New Source Performance Standards under
the Clean Air Act. The rule was challenged in the Federal Appeals Court and
its implementation stayed. The Company cannot predict the outcome of this
matter.
In 1998, the EPA published a final rule at Section 110 of the Clean Air Act
addressing the regional transport of ozone (NOx SIP Call). The EPA's rule
requires 23 jurisdictions, including North Carolina, South Carolina and
Georgia, but not Florida, to further reduce NOx emissions in order to
attain a preset emission level during each year's "ozone season," beginning
May 31, 2004. PEC is currently installing controls necessary to comply with
the rule and expects to be in compliance as required by the final rule.
Total capital expenditures to meet these measures in North and South
21
Carolina could reach approximately $370 million, which has not been
adjusted for inflation. The Company has spent approximately $265 million to
date related to these expenditures. Increased operation and maintenance
costs relating to the NOx SIP Call are not expected to be material to the
Company's results of operations. Further controls are anticipated as
electricity demand increases.
In 1997, the EPA issued final regulations establishing a new 8-hour ozone
standard. In 1999, the District of Columbia Circuit Court of Appeals ruled
against the EPA with regard to the federal 8-hour ozone standard. The U.S.
Supreme Court has upheld, in part, the District of Columbia Circuit Court
of Appeals' decision. In April 2004, the EPA identified areas that do not
meet the standard. The states with identified areas, including North and
South Carolina are proceeding with the implementation of the federal 8-hour
ozone standard. Both states promulgated final regulations, which will
require PEC to install NOx controls under the states' 8-hour standard. The
costs of those controls are included in the $370 million cost estimate
above. However, further technical analysis and rulemaking may result in a
requirement for additional controls at some units. The Company cannot
predict the outcome of this matter.
The EPA published a final rule approving petitions under Section 126 of the
Clean Air Act. This rule, as originally promulgated, required certain
sources to make reductions in NOx emissions by May 1, 2003. The final rule
also includes a set of regulations that affect NOx emissions from sources
included in the petitions. The North Carolina coal-fired electric
generating plants are included in these petitions. Acceptable state plans
under the NOx SIP Call can be approved in lieu of the final rules the EPA
approved as part of the Section 126 petitions. In April 2002, the EPA
published a final rule harmonizing the dates for the Section 126 rule and
the NOx SIP Call. The new compliance date for all affected sources is now
May 31, 2004, rather than May 1, 2003. The EPA has approved North
Carolina's NOx SIP Call rule and has indicated it will rescind the Section
126 rule in a future rulemaking. The Company expects a favorable outcome of
this matter.
In June 2002, legislation was enacted in North Carolina requiring the
state's electric utilities to reduce the emissions of NOx and SO2 from
coal-fired power plants. Progress Energy expects its capital costs to meet
these emission targets will be approximately $813 million by 2013. PEC has
expended approximately $32 million of these capital costs through March 31,
2004. PEC currently has approximately 5,100 MW of coal-fired generation
capacity in North Carolina that is affected by this legislation. The
legislation requires the emissions reductions to be completed in phases by
2013, and applies to each utility's total system rather than setting
requirements for individual power plants. The legislation also freezes the
utilities' base rates for five years unless there are extraordinary events
beyond the control of the utilities or unless the utilities persistently
earn a return substantially in excess of the rate of return established and
found reasonable by the NCUC in the utilities' last general rate case.
Further, the legislation allows the utilities to recover from their retail
customers the projected capital costs during the first seven years of the
ten-year compliance period beginning on January 1, 2003. The utilities must
recover at least 70% of their projected capital costs during the five-year
rate freeze period. PEC recognized amortization of $15 million and $20
million in the quarters ended March 31, 2004 and 2003, respectively.
Pursuant to the law, PEC entered into an agreement with the state of North
Carolina to transfer to the state certain NOx and SO2 emissions allowances
that result from compliance with the collective NOx and SO2 emissions
limitations set out in the law. The law also requires the state to
undertake a study of mercury and carbon dioxide emissions in North
Carolina. Operation and maintenance costs will increase due to the
additional personnel, materials and general maintenance associated with the
equipment. Operation and maintenance expenses are recoverable through base
rates, rather than as part of this program. Progress Energy cannot predict
the future regulatory interpretation, implementation or impact of this law.
In 2004, a bill was introduced in the Florida legislature that would
require significant reductions in NOx, SO2 and particulate emissions from
certain coal, natural gas and oil-fired generating units owned or operated
by investor-owned electric utilities, including PEF. The NOx and SO2
reductions would be effective beginning with calendar year 2010 and the
particulate reductions would be effective beginning with calendar year
2012. Under the proposed legislation, the FPSC would be authorized to allow
the utilities to recover the costs of compliance with the emission
reductions over a period not greater than seven years beginning in 2005,
but the utilities' rates would be frozen at 2004 levels for at least five
years of the maximum recovery period. The 2004 legislature took no action
on this matter.
22
In 1997, the EPA's Mercury Study Report and Utility Report to Congress
conveyed that mercury is not a risk to the average American and expressed
uncertainty about whether reductions in mercury emissions from coal-fired
power plants would reduce human exposure. Nevertheless, the EPA determined
in 2000 that regulation of mercury emissions from coal-fired power plants
was appropriate. In 2003, the EPA proposed alternative control plans that
would limit mercury emissions from coal-fired power plants. The first, a
Maximum Achievable Control Technology (MACT) standard applicable to every
coal-fired plant, would require compliance in 2008. The second, a mercury
cap and trade program, would require limits to be met in two phases, 2010
and 2018. The mercury rule is expected to become final in March 2005.
Achieving compliance with the proposal could involve significant capital
costs which could be material to the Company's consolidated financial
position or results of operations. The Company cannot predict the outcome
of this matter.
In conjunction with the proposed mercury rule, the EPA proposed a MACT
standard to regulate nickel emissions from residual oil-fired units. The
agency estimates the proposal will reduce national nickel emissions to
approximately 103 tons. The rule is expected to become final in March 2005.
The Company cannot predict the outcome of this matter.
In December 2003, the EPA released its proposed Interstate Air Quality Rule
(commonly known as the Fine Particulate Transport Rule and/or the Regional
Transport Rule). The EPA's proposal requires 28 jurisdictions, including
North Carolina, South Carolina, Georgia and Florida, to further reduce NOx
and SO2 emissions in order to attain preset state NOx and SO2 emissions
levels (which have not yet been determined). The rule is expected to become
final in 2004. The air quality controls already installed for compliance
with the NOx SIP Call and currently planned by the Company for compliance
with the North Carolina legislation will reduce the costs required to meet
the requirements of the Interstate Air Quality Rule for the Company's North
Carolina units. Additional compliance costs will be determined later this
year once the rule is better defined.
In March 2004, the North Carolina Attorney General filed a petition with
the EPA under Section 126 of the Clean Air Act, asking the federal
government to force coal-fired power plants in thirteen other states,
including South Carolina to reduce their NOx and SO2 emissions. The state
of North Carolina contends these out-of-state polluters are interfering
with North Carolina's ability to meet national air quality standards for
ozone and particulate matter. The EPA has not made a determination on the
Section 126 petition, and the Company cannot predict the outcome of this
matter.
Water Quality
As a result of the operation of certain control equipment needed to address
the air quality issues outlined above, new wastewater streams may be
generated at the applicable facilities. Integration of these new wastewater
streams into the existing wastewater treatment processes may result in
permitting, construction and treatment challenges to PEC in the immediate
and extended future.
After many years of litigation and settlement negotiations the EPA
published regulations in February 2004 for the implementation of Section
316(b) of the Clean Water Act. The purpose of these regulations is to
minimize adverse environmental impacts caused by cooling water intake
structures and intake systems. Over the next several years these
regulations will impact the larger base load generation facilities and may
require the facilities to mitigate the effects to aquatic organisms by
constructing intake modifications or undertaking other restorative
activities. Substantial costs could be incurred by the facilities in order
to comply with the new regulation. The Company cannot predict the outcome
and impacts to the facilities at this time.
The EPA has published for comment a draft Environmental Impact Statement
(EIS) for surface coal mining (sometimes referred to as "mountaintop
mining") and valley fills in the Appalachian coal region, where Progress
Fuels currently operates a surface mine and may operate others in the
future. The final EIS, when published, may affect regulations for the
permitting of mines and the cost of compliance with environmental
regulations. Regulatory changes for mining may also affect the cost of fuel
for the coal-fueled electric generating plants. The Company cannot predict
the outcome of this matter.
23
Other Environmental Matters
The Kyoto Protocol was adopted in 1997 by the United Nations to address
global climate change by reducing emissions of carbon dioxide and other
greenhouse gases. The United States has not adopted the Kyoto Protocol;
however, a number of carbon dioxide emissions control proposals have been
advanced in Congress and by the Bush administration. The Bush
administration favors voluntary programs. Reductions in carbon dioxide
emissions to the levels specified by the Kyoto Protocol and some
legislative proposals could be materially adverse to the Company's
consolidated financial position or results of operations if associated
costs cannot be recovered from customers. The Company favors the voluntary
program approach recommended by the administration and is evaluating
options for the reduction, avoidance and sequestration of greenhouse gases.
However, the Company cannot predict the outcome of this matter.
Other Contingencies
1. As required under the Nuclear Waste Policy Act of 1982, PEC and PEF each
entered into a contract with the United States Department of Energy (DOE)
under which the DOE agreed to begin taking spent nuclear fuel by no later
than January 31, 1998. All similarly situated utilities were required to
sign the same standard contract.
In 1995, the DOE issued a final interpretation that it did not have an
unconditional obligation to take spent nuclear fuel by January 31, 1998. In
Indiana Michigan Power v. DOE, the Court of Appeals vacated the DOE's final
interpretation and ruled that the DOE had an unconditional obligation to
begin taking spent nuclear fuel. The Court did not specify a remedy because
the DOE was not yet in default.
After the DOE failed to comply with the decision in Indiana Michigan Power
v. DOE, a group of utilities petitioned the Court of Appeals in Northern
States Power (NSP) v. DOE, seeking an order requiring the DOE to begin
taking spent nuclear fuel by January 31, 1998. The DOE took the position
that their delay was unavoidable, and the DOE was excused from performance
under the terms and conditions of the contract. The Court of Appeals found
that the delay was not unavoidable, but did not order the DOE to begin
taking spent nuclear fuel, stating that the utilities had a potentially
adequate remedy by filing a claim for damages under the contract.
After the DOE failed to begin taking spent nuclear fuel by January 31,
1998, a group of utilities filed a motion with the Court of Appeals to
enforce the mandate in NSP v. DOE. Specifically, this group of utilities
asked the Court to permit the utilities to escrow their waste fee payments,
to order the DOE not to use the waste fund to pay damages to the utilities,
and to order the DOE to establish a schedule for disposal of spent nuclear
fuel. The Court denied this motion based primarily on the grounds that a
review of the matter was premature, and that some of the requested remedies
fell outside of the mandate in NSP v. DOE.
Subsequently, a number of utilities each filed an action for damages in the
Federal Court of Claims. The U.S. Circuit Court of Appeals (Federal
Circuit) ruled that utilities may sue the DOE for damages in the Federal
Court of Claims instead of having to file an administrative claim with the
DOE.
In January 2004, PEC and PEF filed a complaint with the DOE claiming that
the DOE breached the Standard Contract for Disposal of Spent Nuclear Fuel
by failing to accept spent nuclear fuel from various Progress Energy
facilities on or before January 31, 1998. Damages due to DOE's breach will
likely exceed $100 million. Similar suits have been initiated by over two
dozen other utilities.
In July 2002, Congress passed an override resolution to Nevada's veto of
DOE's proposal to locate a permanent underground nuclear waste storage
facility at Yucca Mountain, Nevada. DOE plans to submit a license
application for the Yucca Mountain facility by the end of 2004. In November
2003, Congressional negotiators approved $580 million for fiscal year 2004
for the Yucca Mountain project, $123 million more than the previous year.
PEC and PEF cannot predict the outcome of this matter.
24
With certain modifications and additional approval by the NRC including the
installation of onsite dry storage facilities at Robinson (2005) and
Brunswick (2008), PEC's spent nuclear fuel storage facilities will be
sufficient to provide storage space for spent fuel generated on PEC's
system through the expiration of the operating licenses for all of PEC's
nuclear generating units.
PEF is currently storing spent nuclear fuel onsite in spent fuel pools.
PEF's nuclear unit, Crystal River Unit No. 3 (CR3), has sufficient storage
capacity in place for fuel consumed through the end of the expiration of
the current license in 2016. PEF will seek renewal of the CR3 operating
license and if approved, additional dry storage may be necessary.
2. In November 2001, Strategic Resource Solutions Corp. (SRS) filed a claim
against the San Francisco Unified School District (the District) and other
defendants claiming that SRS is entitled to approximately $10 million in
unpaid contract payments and delay and impact damages related to the
District's $30 million contract with SRS. In March 2002, the District filed
a counterclaim, seeking compensatory damages and liquidated damages in
excess of $120 million, for various claims, including breach of contract
and demand on a performance bond. SRS has asserted defenses to the
District's claims. SRS has amended its claims and asserted new claims
against the District and other parties, including a former SRS employee and
a former District employee.
In March 2003, the City Attorney and the District filed new claims in the
form of a cross-complaint against SRS, Progress Energy, Inc., Progress
Energy Solutions, Inc., and certain individuals, alleging fraud, false
claims, violations of California statutes, and seeking compensatory
damages, punitive damages, liquidated damages, treble damages, penalties,
attorneys' fees and injunctive relief. The filing states that the City and
the District seek "more than $300 million in damages and penalties." PEC
was added as a cross-defendant later in 2003.
The Company, SRS, Progress Energy Solutions, Inc. and PEC all have denied
the District's allegations and cross-claims. Discovery is in progress in
the matter. The case has been assigned to a judge under the Sacramento
County superior court's case management rules, and the judge and the
parties have been conferring on scheduling and processes to narrow or
resolve issues, if possible, and to get the case ready for trial. No trial
date has been set. SRS and the Company are vigorously defending and
litigating all of these claims. In November 2003, PEC filed a motion to
dismiss the plaintiffs' first amended complaint. The Company cannot predict
the outcome of this matter, but will vigorously defend against the
allegations.
3. In August 2003, PEC was served as a co-defendant in a purported class
action lawsuit styled as Collins v. Duke Energy Corporation et al, in South
Carolina's Circuit Court of Common Pleas for the Fifth Judicial Circuit.
PEC is one of three electric utilities operating in South Carolina named in
the suit. The plaintiffs are seeking damages for the alleged improper use
of electric easements but have not asserted a dollar amount for their
damage claims. The complaint alleges that the licensing of attachments on
electric utility poles, towers and other structures to nonutility third
parties or telecommunication companies for other than the electric
utilities' internal use along the electric right-of-way constitutes a
trespass.
In September 2003, PEC filed a motion to dismiss all counts of the
complaint on substantive and procedural grounds. In October 2003, the
plaintiffs filed a motion to amend their complaint. PEC believes the
amended complaint asserts the same factual allegations as are in the
original complaint and also seeks money damages and injunctive relief. In
March 2004, the plaintiffs in this case filed a notice of dismissal without
prejudice of their claims against PEC and Duke Energy Corporation.
4. In 2001, PEC entered into a contract to purchase coal from Dynegy
Marketing and Trade (DMT). After DMT experienced financial difficulties,
including credit ratings downgrades by certain credit reporting agencies,
PEC requested credit enhancements in accordance with the terms of the coal
purchase agreement in July 2002. When DMT did not offer credit
enhancements, as required by a provision in the contract, PEC terminated
the contract in July 2002.
PEC initiated a lawsuit seeking a declaratory judgment that the termination
was lawful. DMT counterclaimed, stating the termination was a breach of
contract. On March 23, 2004, the United States District Court for the
Eastern District of North Carolina ruled that PEC was liable for breach of
contract, but ruled against DMT on its unfair and deceptive trade practices
claim. The Court subsequently entered a judgment against PEC in the amount
of approximately $10 million. PEC intends to appeal the Court's ruling, but
cannot predict the outcome of this matter. PEC recorded an accrual for the
judgment and a regulatory asset for the probable recovery through its fuel
adjustment clause.
25
5. The Company, through its subsidiaries, is a majority owner in five
entities and a minority owner in one entity that owns facilities that
produce synthetic fuel as defined under the Internal Revenue Code (Code).
The production and sale of the synthetic fuel from these facilities
qualifies for tax credits under Section 29 if certain requirements are
satisfied, including a requirement that the synthetic fuel differs
significantly in chemical composition from the coal used to produce such
synthetic fuel and that the fuel was produced from a facility that was
placed in service before July 1, 1998. All entities have received private
letter rulings (PLRs) from the Internal Revenue Service (IRS) with respect
to their synthetic fuel operations. The PLRs do not limit the production on
which synthetic fuel credits may be claimed. Should the tax credits be
denied on audit, and the Company fails to prevail through the IRS or legal
process, there could be a significant tax liability owed for previously
taken Section 29 credits, with a significant impact on earnings and cash
flows.
In September 2002, all of Progress Energy's majority-owned synthetic fuel
entities were accepted into the IRS's Pre-Filing Agreement (PFA) program.
The PFA program allows taxpayers to voluntarily accelerate the IRS exam
process in order to seek resolution of specific issues. Either the Company
or the IRS can withdraw from the program at any time, and issues not
resolved through the program may proceed to the next level of the IRS exam
process.
In February 2004, subsidiaries of the Company finalized execution of the
Colona Closing Agreement with the IRS concerning their Colona synthetic
fuel facilities. The Colona Closing Agreement provided that the Colona
facilities were placed in service before July 1, 1998, which is one of the
qualification requirements for tax credits under Section 29. The Colona
Closing Agreement further provides that the fuel produced by the Colona
facilities in 2001 is a "qualified fuel" for purposes of the Section 29 tax
credits. This action concludes the IRS PFA program with respect to Colona.
Although the execution of the Colona Closing Agreement is a significant
event, the PFA process continues with respect to the four synthetic fuel
facilities owned by other affiliates of Progress Energy and Florida
Progress Corporation. Currently, the focus of that process is to determine
that the facilities were placed in service before July 1, 1998. In
management's opinion, Progress Energy is complying with all the necessary
requirements to be allowed such credits under Section 29, although it
cannot provide certainty, that it will prevail if challenged by the IRS on
credits taken. Accordingly, the Company has no current plans to alter its
synthetic fuel production schedule as a result of these matters.
In October 2003, the United States Senate Permanent Subcommittee on
Investigations began a general investigation concerning synthetic fuel tax
credits claimed under Section 29. The investigation is examining the
utilization of the credits, the nature of the technologies and fuels
created, the use of the synthetic fuel and other aspects of Section 29 and
is not specific to the Company's synthetic fuel operations. Progress Energy
is providing information in connection with this investigation. The Company
cannot predict the outcome of this matter.
6. The Company and its subsidiaries are involved in various litigation
matters in the ordinary course of business, some of which involve
substantial amounts. Where appropriate, accruals have been made in
accordance with SFAS No. 5, "Accounting for Contingencies," to provide for
such matters. In the opinion of management, the final disposition of
pending litigation would not have a material adverse effect on the
Company's consolidated results of operations or financial position.
26
CAROLINA POWER & LIGHT COMPANY
d/b/a PROGRESS ENERGY CAROLINAS, INC.
CONSOLIDATED INTERIM FINANCIAL STATEMENTS
March 31, 2004
UNAUDITED CONSOLIDATED STATEMENTS of INCOME
Three Months Ended March 31,
(in millions) 2004 2003
- ----------------------------------------------------------------------------------------
Operating Revenues
Electric $ 901 $ 926
Diversified business - 3
- ----------------------------------------------------------------------------------------
Total Operating Revenues 901 929
- ----------------------------------------------------------------------------------------
Operating Expenses
Fuel used in electric generation 224 226
Purchased power 62 73
Operation and maintenance 209 190
Depreciation and amortization 127 139
Taxes other than on income 43 44
Diversified business - 1
- ----------------------------------------------------------------------------------------
Total Operating Expenses 665 673
- ----------------------------------------------------------------------------------------
Operating Income 236 256
- ----------------------------------------------------------------------------------------
Other Income (Expense)
Interest income 1 1
Other, net (12) (2)
- ----------------------------------------------------------------------------------------
Total Other Expense (11) (1)
- ----------------------------------------------------------------------------------------
Interest Charges
Interest charges 49 49
Allowance for borrowed funds used during construction (1) (1)
- ----------------------------------------------------------------------------------------
Total Interest Charges, Net 48 48
- ----------------------------------------------------------------------------------------
Income before Income Tax 177 207
Income Tax Expense 62 72
- ----------------------------------------------------------------------------------------
Net Income 115 135
Preferred Stock Dividend Requirement 1 1
- ----------------------------------------------------------------------------------------
Earnings for Common Stock $ 114 $ 134
- ----------------------------------------------------------------------------------------
See Notes to Consolidated Interim Financial Statements.
27
Carolina Power & Light Company
d/b/a Progress Energy Carolinas, Inc.
UNAUDITED CONSOLIDATED BALANCE SHEETS
(in millions) March 31, December 31,
ASSETS 2004 2003
- ----------------------------------------------------------------------------------------------------
Utility Plant
Utility plant in service $ 13,384 $ 13,331
Accumulated depreciation (5,344) (5,280)
- ----------------------------------------------------------------------------------------------------
Utility plant in service, net 8,040 8,051
Held for future use 5 5
Construction work in progress 342 306
Nuclear fuel, net of amortization 170 159
- ----------------------------------------------------------------------------------------------------
Total Utility Plant, Net 8,557 8,521
- ----------------------------------------------------------------------------------------------------
Current Assets
Cash and cash equivalents 13 238
Accounts receivable 246 265
Unbilled accounts receivable 122 145
Receivables from affiliated companies 22 27
Advances from affiliated companies 84 -
Inventory 314 348
Deferred fuel cost 99 113
Prepayments and other current assets 53 82
- ----------------------------------------------------------------------------------------------------
Total Current Assets 953 1,218
- ----------------------------------------------------------------------------------------------------
Deferred Debits and Other Assets
Regulatory assets 494 477
Nuclear decommissioning trust funds 544 505
Miscellaneous other property and investments 168 169
Other assets and deferred debits 109 118
- ----------------------------------------------------------------------------------------------------
Total Deferred Debits and Other Assets 1,315 1,269
- ----------------------------------------------------------------------------------------------------
Total Assets $ 10,825 $ 11,008
- ----------------------------------------------------------------------------------------------------
Capitalization and Liabilities
- ----------------------------------------------------------------------------------------------------
Common Stock Equity
Common stock without par value, authorized 200 million shares,
160 million shares issued and outstanding $ 1,966 $ 1,953
Unearned ESOP common stock (79) (89)
Accumulated other comprehensive loss (6) (7)
Retained earnings 1,368 1,380
- ----------------------------------------------------------------------------------------------------
Total Common Stock Equity 3,249 3,237
- ----------------------------------------------------------------------------------------------------
Preferred Stock - Not Subject to Mandatory Redemption 59 59
Long-Term Debt, Net 3,048 3,086
- ----------------------------------------------------------------------------------------------------
Total Capitalization 6,356 6,382
- ----------------------------------------------------------------------------------------------------
Current Liabilities
Current portion of long-term debt 189 300
Accounts payable 173 188
Payables to affiliated companies 52 136
Notes payable to affiliated companies - 25
Interest accrued 46 64
Short-term obligations - 4
Other current liabilities 191 166
- ----------------------------------------------------------------------------------------------------
Total Current Liabilities 651 883
- ----------------------------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Accumulated deferred income taxes 1,138 1,125
Accumulated deferred investment tax credits 146 148
Regulatory liabilities 1,222 1,175
Asset retirement obligations 945 932
Other liabilities and deferred credits 367 363
- ----------------------------------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 3,818 3,743
- ----------------------------------------------------------------------------------------------------
Commitments and Contingencies (Note 10)
- ----------------------------------------------------------------------------------------------------
Total Capitalization and Liabilities $ 10,825 $ 11,008
- ----------------------------------------------------------------------------------------------------
See Notes to Consolidated Interim Financial Statements.
28
CAROLINA POWER & LIGHT COMPANY
d/b/a PROGRESS ENERGY CAROLINAS, INC.
UNAUDITED CONSOLIDATED STATEMENTS of CASH FLOWS
Three Months Ended March 31,
(in millions) 2004 2003
- ---------------------------------------------------------------------------------------------------------------
Operating Activities
Net income $ 115 $ 135
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 149 160
Deferred income taxes 22 (10)
Investment tax credit (3) (3)
Deferred fuel cost 13 8
Cash provided (used) by changes in operating assets and liabilities:
Accounts receivable 40 20
Inventories 36 19
Prepayments and other current assets 4 7
Accounts payable (88) 14
Other current liabilities 13 62
Other 32 28
- ---------------------------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 333 440
- ---------------------------------------------------------------------------------------------------------------
Investing Activities
Gross property additions (123) (150)
Nuclear fuel additions (39) (30)
Net contributions to nuclear decommissioning trust (10) (10)
Other investing activities 3 (4)
- ---------------------------------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (169) (194)
- ---------------------------------------------------------------------------------------------------------------
Financing Activities
Net decrease in short-term obligations (4) (216)
Net change in intercompany notes (109) 89
Retirement of long-term debt (150) -
Dividends paid to parent (125) (123)
Dividends paid on preferred stock (1) (1)
- ---------------------------------------------------------------------------------------------------------------
Net Cash Used in Financing Activities (389) (251)
- ---------------------------------------------------------------------------------------------------------------
Net Decrease in Cash and Cash Equivalents (225) (5)
Cash and Cash Equivalents at Beginning of Period 238 18
- ----------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 13 $ 13
- ---------------------------------------------------------------------------------------------------------------
Supplemental Disclosures of Cash Flow Information
Cash paid during the year - interest (net of amount capitalized) $ 66 $ 58
income taxes (net of refunds) $ 1 $ 3
- ----------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Interim Financial Statements.
29
CAROLINA POWER & LIGHT COMPANY
d/b/a PROGRESS ENERGY CAROLINAS, INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
1. ORGANIZATION AND BASIS OF PRESENTATION
A. Organization
Carolina Power & Light Company is a public service corporation primarily
engaged in the generation, transmission, distribution and sale of
electricity in portions of North Carolina and South Carolina. Through its
wholly-owned subsidiaries, Carolina Power & Light Company d/b/a Progress
Energy Carolinas, Inc. (PEC) is involved in several nonregulated business
activities. PEC is a wholly-owned subsidiary of Progress Energy, Inc. (the
Company or Progress Energy). The Company is a registered holding company
under the Public Utility Holding Company Act of 1935 (PUHCA). Both the
Company and its subsidiaries are subject to the regulatory provisions of
PUHCA. PEC is regulated by the North Carolina Utilities Commission (NCUC),
the Public Service Commission of South Carolina (SCPSC), the Federal Energy
Regulatory Commission (FERC) and the United States Nuclear Regulatory
Commission (NRC).
B. Basis of Presentation
These financial statements have been prepared in accordance with accounting
principles generally accepted in the United States of America (GAAP) for
interim financial information and with the instructions to Form 10-Q and
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by GAAP for annual statements. Because the accompanying
consolidated interim financial statements do not include all of the
information and footnotes required by GAAP, they should be read in
conjunction with the audited financial statements for the period ended
December 31, 2003 and notes thereto included in PEC's Form 10-K for the
year ended December 31, 2003.
The amounts included in the consolidated interim financial statements are
unaudited but, in the opinion of management, reflect all normal recurring
adjustments necessary to fairly present PEC's financial position and
results of operations for the interim periods. Due to seasonal weather
variations and the timing of outages of electric generating units,
especially nuclear-fueled units, the results of operations for interim
periods are not necessarily indicative of amounts expected for the entire
year or future periods.
In preparing financial statements that conform with GAAP, management must
make estimates and assumptions that affect the reported amounts of assets
and liabilities, disclosure of contingent assets and liabilities at the
date of the financial statements and amounts of revenues and expenses
reflected during the reporting period. Actual results could differ from
those estimates. Certain amounts for 2003 have been reclassified to conform
to the 2004 presentation.
C. Stock-Based Compensation
The Company measures compensation expense for stock options as the
difference between the market price of its common stock and the exercise
price of the option at the grant date. The exercise price at which options
are granted by the Company equals the market price at the grant date, and
accordingly, no compensation expense has been recognized for stock option
grants. For purposes of the pro forma disclosures required by SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure - an
Amendment of FASB Statement No. 123" (SFAS No. 148), the estimated fair
value of the Company's stock options is amortized to expense over the
options' vesting period. The following table illustrates the effect on net
income and earnings per share if the fair value method had been applied to
all outstanding and unvested awards in each period:
30
(in millions) 2004 2003
------------ ----------
Net Income, as reported $ 115 $ 135
Deduct: Total stock option expense determined under fair
value method for all awards, net of related tax effects 2 1
------------ ----------
Pro forma net income $ 113 $ 134
============ ==========
2. NEW ACCOUNTING STANDARDS
FIN No. 46, "Consolidation of Variable Interest Entities"
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities - an Interpretation of ARB No. 51" (FIN No. 46).
This interpretation provides guidance related to identifying variable
interest entities and determining whether such entities should be
consolidated or deconsolidated. FIN No. 46 requires an enterprise to
consolidate a variable interest entity when the enterprise (a) absorbs a
majority of the variable interest entity's expected losses, (b) receives a
majority of the entity's expected residual returns, or both, as a result of
ownership, contractual or other financial interests in the entity. Prior to
the effective date of FIN No. 46, entities were generally consolidated by
an enterprise that had control through ownership of a majority voting
interest in the entity. FIN No. 46 originally applied immediately to
variable interest entities created or obtained after January 31, 2003.
During 2003 and the first quarter of 2004, PEC did not participate in the
creation of, or obtain a significant new variable interest in, any variable
interest entity. In December 2003, the FASB issued a revision to FIN No. 46
(FIN No. 46R), which modified certain requirements of FIN No. 46 and was
effective for all variable interest entities as of March 31, 2004. Upon the
adoption of FIN No. 46R, no variable interest entities were required to be
deconsolidated by PEC.
Upon adoption of FIN No. 46R as of March 31 2004, PEC determined that it is
the primary beneficiary of a limited partnership which invests in 17
low-income housing partnerships that qualify for federal and state tax
credits. PEC consolidated the limited partnership as of March 31, 2004, the
effect of which was insignificant. PEC has requested but has not received
all the necessary information to determine the primary beneficiary of the
limited partnership's underlying 17 partnership investments, and has
applied the information scope exception in FIN No. 46R, paragraph 4(g) to
the 17 partnerships. PEC has no direct exposure to loss from the 17
partnerships; PEC's only exposure to loss is from its investment of
approximately $1 million in the newly-consolidated limited partnership. PEC
will continue its efforts to obtain the necessary information to fully
apply FIN No. 46R to the 17 partnerships. PEC believes that if the
newly-consolidated limited partnership is determined to be the primary
beneficiary of the 17 partnerships, the effect of consolidating the 17
partnerships would not be significant to its Consolidated Balance Sheets.
PEC has variable interests in two power plants resulting from long-term
power purchase contracts. PEC has requested but has not received all the
necessary information to determine if the counterparties are variable
interest entities or to identify the primary beneficiaries, and has applied
the information scope exception in FIN No. 46R, paragraph 4(g). Certain
payments for fuel costs under these contracts are linked to inflation
indices. PEC's only significant exposure to loss from these contracts
results from fluctuations in the market price of fuel used by the two
plants to produce the power purchased by PEC. Total purchases from these
counterparties were approximately $9 million in each of the first quarters
of 2003 and 2004. PEC will continue its efforts to obtain the necessary
information to fully apply FIN No. 46R to these contracts. Although PEC has
not received any financial information from these two counterparties, PEC
believes that if it is determined to be the primary beneficiary of these
two entities the effect of consolidating the entities could be significant
to its Consolidated Balance Sheets. However, the approximate impact cannot
be determined at this time.
PEC also has interests in several other variable interest entities created
before January 31, 2003, for which it is not the primary beneficiary. These
arrangements include investments in approximately 27 limited partnerships,
limited liability corporations and venture capital funds and two building
leases with special-purpose entities. The aggregate maximum loss exposure
at March 31, 2004, that PEC could be required to record in its income
statement as a result of these arrangements totals approximately $27
million. The creditors of these variable interest entities do not have
recourse to the general credit of PEC in excess of the aggregate maximum
loss exposure.
31
3. REGULATORY MATTERS
A. Retail Rate Matters
PEC has exclusively utilized external funding for its decommissioning
liability since 1994. Prior to 1994, PEC retained funds internally to meet
its decommissioning liability. An NCUC order issued in February 2004 found
that by January 1, 2008 PEC must begin transitioning these amounts to
external funds. The transition of $131 million must be completed by
December 31, 2017, and at least 10% must be transitioned each year.
PEC filed with the SCPSC seeking permission to defer expenses incurred from
the first quarter 2004 winter storm. The SCPSC approved PEC's request to
defer the costs and amortize them over five years beginning in January
2005. Approximately $10 million related to storm costs incurred during the
quarter was deferred.
During the first quarter of 2004, PEC filed with the NCUC and obtained
approval from the SCPSC for a depreciation study which allowed the utility
to reduce the rates used to calculate depreciation expense. As a result,
depreciation expense decreased $7 million compared to the prior year
quarter.
B. Regional Transmission Organizations
In 2000, the FERC issued Order No. 2000 on RTOs, which set minimum
characteristics and functions that RTOs must meet, including independent
transmission service. In July 2002, the FERC issued its Notice of Proposed
Rulemaking in Docket No. RM01-12-000, Remedying Undue Discrimination
through Open Access Transmission Service and Standard Electricity Market
Design (SMD NOPR). If adopted as proposed, the rules set forth in the SMD
NOPR would materially alter the manner in which transmission and generation
services are provided and paid for. In April 2003, the FERC released a
White Paper on the Wholesale Market Platform. The White Paper provides an
overview of what the FERC currently intends to include in a final rule in
the SMD NOPR docket. The White Paper retains the fundamental and most
protested aspects of SMD NOPR, including mandatory RTOs and the FERC's
assertion of jurisdiction over certain aspects of retail service. The FERC
has not yet issued a final rule on SMD NOPR. PEC cannot predict the outcome
of these matters or the effect that they may have on the GridSouth
proceedings currently ongoing before the FERC. It is unknown what impact
the future proceedings will have on PEC's earnings, revenues or prices.
PEC has recorded $33 million related to startup costs for GridSouth at
March 31, 2004. PEC expects to recover these startup costs in conjunction
with the GridSouth original structure or in conjunction with any alternate
combined transmission structures that emerge.
4. COMPREHENSIVE INCOME
Comprehensive income for the three months ended March 31, 2004 and 2003 was
$116 million and $135 million, respectively. Changes in other comprehensive
income for the periods consisted primarily of changes in fair value of
derivatives used to hedge cash flows related to interest on long-term debt.
5. FINANCING ACTIVITIES
On January 15, 2004, PEC paid at maturity $150 million 5.875% First
Mortgage Bonds with commercial paper proceeds. On April 15, 2004, PEC also
paid at maturity $150 million 7.875% First Mortgage Bonds with commercial
paper proceeds and internally-generated funds.
On March 31, 2004, PEC announced the redemption of $35 million of
Darlington County 6.6% Series Pollution Control Bonds at 102.5% of par, $2
million of New Hanover County 6.30% Series Pollution Control Bonds at
101.5% of par, and $3 million of Chatham County 6.30% Series Pollution
Control Bonds at 101.5% of par. All three series were fully redeemed
effective April 30, 2004.
32
6. BENEFIT PLANS
PEC has a non-contributory defined benefit retirement (pension) plan for
substantially all full-time employees. PEC also has supplementary defined
benefit pension plans that provide benefits to higher-level employees. In
addition to pension benefits, PEC provides contributory other
postretirement benefits (OPEB), including certain health care and life
insurance benefits, for retired employees who meet specified criteria. The
components of the net periodic benefit cost for the three months ended
March 31 are:
Other Postretirement
Pension Benefits Benefits
--------------------- --------------------
(in millions) 2004 2003 2004 2003
--------------------- --------------------
Service cost $ 6 $ 5 $ 2 $ 2
Interest cost 13 12 4 3
Expected return on plan assets (17) (16) (1) (1)
Amortization, net - - 1 1
--------------------- --------------------
Net periodic cost / (benefit) $ 2 $ 1 $ 6 $ 5
===================== ===-================
In December 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the Act) was signed into law. In accordance with
guidance issued by the FASB in FASB Staff Position FAS 106-1, PEC has
elected to defer accounting for the effects of the Act due to uncertainties
regarding the effects of the implementation of the Act and the accounting
for certain provisions of the Act. Therefore, OPEB information presented in
the financial statements does not reflect the effects of the Act. When
specific authoritative accounting guidance is issued, it could require plan
sponsors to change previously reported information. PEC is in the early
stages of reviewing the Act and determining its potential effects on PEC.
7. RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS
PEC uses interest rate derivative instruments to adjust the fixed and
variable rate debt components of its debt portfolio and to hedge interest
rates with regard to future fixed rate debt issuances. In March 2004, PEC
entered into a forward swap to hedge its exposure to interest rates with
regard to a future issuance of approximately $300 million of debt.
In April 2004, PEC entered into a cash flow hedge to hedge the payment
stream associated with an upcoming lease.
The notional amounts of the above contracts are not exchanged and do not
represent exposure to credit loss. In the event of default by a
counterparty, the risk in the transaction is the cost of replacing the
agreements at current market rates. PEC only enters into interest rate
derivative agreements with banks with credit ratings of single A or better.
8. FINANCIAL INFORMATION BY BUSINESS SEGMENT
PEC's operations consist primarily of the PEC Electric segment which is
engaged in the generation, transmission, distribution and sale of electric
energy primarily in portions of North Carolina and South Carolina. These
electric operations are subject to the rules and regulations of the FERC,
the NCUC, the SCPSC and the NRC. PEC Electric also distributes and sells
electricity to other utilities, primarily on the east coast of the United
States.
The Other segment, whose operations are primarily in the United States, is
made up of other nonregulated business areas that do not separately meet
the disclosure requirements of SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information" and consolidation entities and
eliminations.
33
The financial information for PEC segments for the three months ended March
31, 2004 and 2003 is as follows:
2004 2003
-------------------------------- -------------------------------
PEC PEC
(in millions) Electric Other Total Electric Other Total
-------------------------------- -------------------------------
Total revenues $ 901 $ - $ 901 $ 926 $ 3 $ 929
Segment profit (loss) 116 (2) 114 135 (1) 134
-------------------------------- -------------------------------
9. OTHER INCOME AND OTHER EXPENSE
Other income and expense includes interest income and other income and
expense items as discussed below. The components of other, net as shown on
the accompanying Consolidated Statements of Income for the three months
ended March 31, 2004 and 2003, are as follows:
(in millions) 2004 2003
------------- --------------
Other income
Net financial trading gain (loss) $ 1 $ (1)
Net energy brokered for resale - (2)
Nonregulated energy and delivery services income 2 2
AFUDC equity 1 1
Other 2
1
------------- --------------
Total other income $ 5 $ 2
------------- --------------
Other expense
Nonregulated energy and delivery services expenses $ 2 $ 2
Donations 4 1
Write-off of non-trade receivable 7 -
Other 4 1
------------- --------------
Total other expense $ 17 $ 4
------------- --------------
Other, net $ (12) $ (2)
============= ==============
Net financial trading gains and losses represent non-asset-backed trades of
electricity and gas. Net energy brokered for resale represents electricity
purchased for simultaneous sale to a third party. Nonregulated energy and
delivery services include power protection services and mass market
programs such as surge protection, appliance services and area light sales,
and delivery, transmission and substation work for other utilities.
10. COMMITMENTS AND CONTINGENCIES
Contingencies existing as of the date of these statements are described
below. No significant changes have occurred since December 31, 2003, with
respect to the commitments discussed in Note 16 of PEC's 2003 Annual Report
on Form 10-K.
A. Guarantees
As a part of normal business, PEC enters into various agreements providing
financial or performance assessments to third parties. Such agreements
include, for example, guarantees, standby letters of credit and surety
bonds. These agreements are entered into primarily to support or enhance
the creditworthiness otherwise attributed to subsidiaries on a stand-alone
basis, thereby facilitating the extension of sufficient credit to
accomplish the subsidiaries' intended commercial purposes. At March 31,
2004, management does not believe conditions are likely for performance
under these agreements.
34
At March 31, 2004, outstanding guarantees consisted of the following:
(in millions)
Standby letters of credit $ 3
Surety bonds 9
---------------
Total $ 12
===============
Standby Letters of Credit
PEC has issued standby letters of credit to financial institutions for the
benefit of third parties that have extended credit to PEC and certain
subsidiaries. These letters of credit have been issued primarily for the
purpose of supporting payments of trade payables, securing performance
under contracts and on interest payments on outstanding debt obligations.
If a subsidiary does not pay amounts when due under a covered contract, the
counterparty may present its claim for payment to the financial
institution, which will in turn request payment from PEC. Any amounts owed
by its subsidiaries are reflected in the Consolidated Balance Sheets.
Surety Bonds
At March 31, 2004, PEC had $9 million in surety bonds purchased primarily
for purposes such as providing workers' compensation coverage and obtaining
licenses, permits and rights-of-way. To the extent liabilities are incurred
as a result of the activities covered by the surety bonds, such liabilities
are included in the Consolidated Balance Sheets.
Guarantees Issued by the Parent
In 2003, PEC determined that its external funding levels did not fully meet
the nuclear decommissioning financial assurance levels required by the NRC.
Therefore, PEC obtained parent company guarantees of $276 million to meet
the required levels.
B. Insurance
PEC is insured against public liability for a nuclear incident up to
$10,760 million per occurrence. Under the current provisions of the Price
Anderson Act, which limits liability for accidents at nuclear plants, PEC,
as an owner of nuclear units, can be assessed a portion of any third-party
liability claims arising from an accident at any commercial nuclear power
plant in the United States. In the event that public liability claims from
an insured nuclear incident exceed $300 million (currently available
through commercial insurers), PEC would be subject to assessments of up to
$101 million for each reactor owned per occurrence. Payment of such
assessments would be made over time as necessary to limit the payment in
any one year to no more than $10 million per reactor owned. Congress is
expected to approve revisions to the Price Anderson Act during 2004 that
could include increased limits and assessments per reactor owned. The final
outcome of this matter cannot be predicted at this time.
C. Claims and Uncertainties
PEC is subject to federal, state and local regulations addressing hazardous
and solid waste management, air and water quality and other environmental
matters.
Hazardous and Solid Waste Management
Various organic materials associated with the production of manufactured
gas, generally referred to as coal tar, are regulated under federal and
state laws. The principal regulatory agency that is responsible for a
specific former manufactured gas plant (MGP) site depends largely upon the
state in which the site is located. There are several MGP sites to which
PEC has some connection. In this regard, PEC and other potentially
responsible parties (PRPs) are participating in, investigating and, if
necessary, remediating former MGP sites with several regulatory agencies,
including, but not limited to, the U.S. Environmental Protection Agency
(EPA) and the North Carolina Department of Environment and Natural
Resources, Division of Waste Management (DWM). In addition, PEC is
periodically notified by regulators such as the EPA and various state
agencies of its involvement or potential involvement in sites, other than
MGP sites, that may require investigation and/or remediation.
35
PEC has filed claims with its general liability insurance carriers to
recover costs arising out of actual or potential environmental liabilities.
All claims have settled other than with insolvent carriers. These
settlements have not had a material effect on the consolidated financial
position or results of operations.
PEC is also currently in the process of assessing potential costs and
exposures at other environmentally impaired sites. As the assessments are
developed and analyzed, PEC will accrue costs for the sites to the extent
the costs are probable and can be reasonably estimated.
There are nine former MGP sites and other sites associated with PEC that
have required or are anticipated to require investigation and/or
remediation costs. PEC received insurance proceeds to address costs
associated with PEC environmental liabilities related to its involvement
with some sites. All eligible expenses related to these are charged against
a specific fund containing these proceeds. At March 31, 2004, approximately
$8 million remains in this centralized fund with a related accrual of $8
million recorded for the associated expenses of environmental issues. PEC
does not believe that it can provide an estimate of the reasonably possible
total remediation costs beyond what is currently accrued due to the fact
that investigations have not been completed at all sites. This accrual has
been recorded on an undiscounted basis. PEC measures its liability for
these sites based on available evidence including its experience in
investigating and remediating environmentally impaired sites. The process
often involves assessing and developing cost-sharing arrangements with
other PRPs. PEC will accrue costs for the sites to the extent its liability
is probable and the costs can be reasonably estimated. Presently, PEC
cannot determine the total costs that may be incurred in connection with
the remediation of all sites.
In September 2003, the Company sold NCNG to Piedmont Natural Gas Company,
Inc. As part of the sales agreement, the Company retained responsibility to
remediate five former NCNG MGP sites, all of which also are associated with
PEC, to state standards pursuant to an Administrative Order on Consent.
These sites are anticipated to have investigation or remediation costs
associated with them. NCNG had previously accrued approximately $2 million
for probable and reasonably estimable remediation costs at these sites.
These accruals have been recorded on an undiscounted basis. At the time of
the sale, the liability for these costs and the related accrual was
transferred to PEC. PEC does not believe it can provide an estimate of the
reasonably possible total remediation costs beyond the accrual because
investigations have not been completed at all sites. Therefore, PEC cannot
currently determine the total costs that may be incurred in connection with
the investigation and/or remediation of all sites.
Air Quality
There has been and may be further proposed legislation requiring reductions
in air emissions for NOx, SO2, carbon dioxide and mercury. Some of these
proposals establish nationwide caps and emission rates over an extended
period of time. This national multi-pollutant approach to air pollution
control could involve significant capital costs which could be material to
PEC's consolidated financial position or results of operations. Control
equipment that will be installed on North Carolina fossil generating
facilities as part of the North Carolina legislation discussed below may
address some of the issues outlined above. However, PEC cannot predict the
outcome of this matter.
The EPA is conducting an enforcement initiative related to a number of
coal-fired utility power plants in an effort to determine whether
modifications at those facilities were subject to New Source Review
requirements or New Source Performance Standards under the Clean Air Act.
PEC was asked to provide information to the EPA as part of this initiative
and cooperated in providing the requested information. The EPA initiated
civil enforcement actions against other unaffiliated utilities as part of
this initiative. Some of these actions resulted in settlement agreements
calling for expenditures by these unaffiliated utilities, ranging from $1.0
billion to $1.4 billion. A utility that was not subject to a civil
enforcement action settled its New Source Review issues with the EPA for
$300 million. These settlement agreements have generally called for
expenditures to be made over extended time periods, and some of the
companies may seek recovery of the related cost through rate adjustments or
similar mechanisms. PEC cannot predict the outcome of this matter.
36
In 2003, the EPA published a final rule addressing routine equipment
replacement under the New Source Review program. The rule defines routine
equipment replacement and the types of activities that are not subject to
New Source Review requirements or New Source Performance Standards under
the Clean Air Act. The rule was challenged in the Federal Appeals Court and
its implementation stayed. The Company cannot predict the outcome of this
matter.
In 1998, the EPA published a final rule at Section 110 of the Clean Air Act
addressing the regional transport of ozone (NOx SIP Call). The EPA's rule
requires 23 jurisdictions, including North Carolina, South Carolina and
Georgia, to further reduce NOx emissions in order to attain a preset
emission level during each year's "ozone season," beginning May 31, 2004.
PEC is currently installing controls necessary to comply with the rule and
expects to be in compliance as required by the final rule. Total capital
expenditures to meet these measures in North and South Carolina could reach
approximately $370 million, which has not been adjusted for inflation. PEC
has spent approximately $265 million to date related to these expenditures.
Increased operation and maintenance costs relating to the NOx SIP Call are
not expected to be material to PEC's results of operations. Further
controls are anticipated as electricity demand increases.
In 1997, the EPA issued final regulations establishing a new 8-hour ozone
standard. In 1999, the District of Columbia Circuit Court of Appeals ruled
against the EPA with regard to the federal 8-hour ozone standard. The U.S.
Supreme Court has upheld, in part, the District of Columbia Circuit Court
of Appeals decision. In April 2004, the EPA identified areas that do not
meet the standard. The states with identified areas, including North and
South Carolina are proceeding with the implementation of the federal 8-hour
ozone standard . Both states promulgated final regulations, which will
require PEC to install NOx controls under the states' 8-hour standard. The
costs of those controls are included in the $370 million cost estimate
above. However, further technical analysis and rulemaking may result in a
requirement for additional controls at some units. PEC cannot predict the
outcome of this matter.
The EPA published a final rule approving petitions under Section 126 of the
Clean Air Act. This rule as originally promulgated required certain sources
to make reductions in NOx emissions by May 1, 2003. The final rule also
includes a set of regulations that affect NOx emissions from sources
included in the petitions. The North Carolina coal-fired electric
generating plants are included in these petitions. Acceptable state plans
under the NOx SIP Call can be approved in lieu of the final rules the EPA
approved as part of the 126 petitions. In April 2002, the EPA published a
final rule harmonizing the dates for the Section 126 Rule and the NOx SIP
Call. In addition, the EPA determined in this rule that the future growth
factor estimation methodology was appropriate. The new compliance date for
all affected sources is now May 31, 2004, rather than May 1, 2003. The EPA
has approved North Carolina's NOx SIP Call rule and has indicated it will
rescind the Section 126 rule in a future rulemaking. PEC expects a
favorable outcome of this matter.
In June 2002, legislation was enacted in North Carolina requiring the
state's electric utilities to reduce the emissions of NOx and SO2 from
coal-fired power plants. PEC expects its capital costs to meet these
emission targets will be approximately $813 million by 2013. PEC has
expended approximately $32 million of these capital costs through March 31,
2004. PEC currently has approximately 5,100 MW of coal-fired generation in
North Carolina that is affected by this legislation. The legislation
requires the emissions reductions to be completed in phases by 2013, and
applies to each utility's total system rather than setting requirements for
individual power plants. The legislation also freezes the utilities' base
rates for five years unless there are extraordinary events beyond the
control of the utilities or unless the utilities persistently earn a return
substantially in excess of the rate of return established and found
reasonable by the NCUC in the utilities' last general rate case. Further,
the legislation allows the utilities to recover from their retail customers
the projected capital costs during the first seven years of the 10-year
compliance period beginning on January 1, 2003. The utilities must recover
at least 70% of their projected capital costs during the five-year rate
freeze period. PEC recognized amortization of $15 million and $20 million
in the quarters ended March 31, 2004 and 2003, respectively. Pursuant to
the law, PEC entered into an agreement with the state of North Carolina to
transfer to the state certain NOx and SO2 emissions allowances that result
from compliance with the collective NOx and SO2 emission limitations set
out in the law. The law also requires the state to undertake a study of
mercury and carbon dioxide emissions in North Carolina. Operation and
maintenance costs will increase due to the additional personnel, materials
and general maintenance associated with the equipment. Operation and
maintenance expenses are recoverable through base rates, rather than as
part of this program. PEC cannot predict the future regulatory
interpretation, implementation or impact of this law.
37
In 1997, the EPA's Mercury Study Report and Utility Report to Congress
conveyed that mercury is not a risk to the average American and expressed
uncertainty about whether reductions in mercury emissions from coal-fired
power plants would reduce human exposure. Nevertheless, the EPA determined
in 2000 that regulation of mercury emissions from coal-fired power plants
was appropriate. In 2003, the EPA proposed alternative control plans that
would limit mercury emissions from coal-fired power plants. The first, a
Maximum Available Control Technology (MACT) standard applicable to every
coal-fired plant, would require compliance in 2008. The second, a mercury
cap and trade program, would require limits to be met in two phases, 2010
and 2018. The mercury rule is expected to become final in March 2005.
Achieving compliance with either proposal could involve significant capital
costs which could be material to PEC's consolidated financial position or
results of operations. PEC cannot predict the outcome of this matter.
In conjunction with the proposed mercury rule, the EPA proposed a MACT
standard to regulate nickel emissions from residual oil-fired units. The
agency estimates the proposal will reduce national nickel emissions to
approximately 103 tons. The rule is expected to become final in March 2005.
In December 2003, the EPA released its proposed Interstate Air Quality Rule
(commonly known as the Fine Particulate Transport Rule and/or the Regional
Transport Rule). The EPA's proposal requires 28 jurisdictions, including
North Carolina, South Carolina, Georgia and Florida, to further reduce NOx
and SO2 emissions in order to attain pre-set NOx and SO2 emissions levels
(which have not yet been determined). The rule is expected to become final
in 2004. The air quality controls already installed for compliance with the
NOx SIP Call and currently planned by PEC for compliance with the North
Carolina legislation will reduce the costs required to meet the
requirements of the Interstate Air Quality Rule for the Company's North
Carolina units. Additional compliance costs will be determined later this
year once the rule is better defined.
In March 2004, the North Carolina Attorney General filed a petition with
the EPA under Section 126 of the Clean Air Act, asking the federal
government to force coal-fired power plants in thirteen other states,
including South Carolina, to reduce their NOx and SO2 emissions. The state
of North Carolina contends these out-of-state polluters are interfering
with North Carolina's ability to meet national air quality standards for
ozone and particulate matter. The EPA has not made a determination on the
Section 126 petition, and PEC cannot predict the outcome of this matter.
Water Quality
As a result of the operation of certain control equipment needed to address
the air quality issues outlined above, new wastewater streams may be
generated at the applicable facilities. Integration of these new wastewater
streams into the existing wastewater treatment processes may result in
permitting, construction and treatment challenges to PEC in the immediate
and extended future.
After many years of litigation and settlement negotiations the EPA
published regulations in February 2004 for the implementation of Section
316(b) of the Clean Water Act. The purpose of these regulations is to
minimize adverse environmental impacts caused by cooling water intake
structures and intake systems. Over the next several years these
regulations will impact the larger base load generation facilities and may
require the facilities to mitigate the effects to aquatic organisms by
constructing intake modifications or undertaking other restorative
activities. Substantial costs could be incurred by the facilities in order
to comply with the new regulation. PEC cannot predict the outcome and
impacts to the facilities at this time.
Other Environmental Matters
The Kyoto Protocol was adopted in 1997 by the United Nations to address
global climate change by reducing emissions of carbon dioxide and other
greenhouse gases. The United States has not adopted the Kyoto Protocol,
however, a number of carbon dioxide emissions control proposals have been
advanced in Congress and by the Bush administration. The Bush
administration favors voluntary programs. Reductions in carbon dioxide
emissions to the levels specified by the Kyoto Protocol and some
legislative proposals could be materially adverse to PEC's consolidated
financial position or results of operations if associated costs cannot be
recovered from customers. PEC favors the voluntary program approach
recommended by the administration and is evaluating options for the
reduction, avoidance, and sequestration of greenhouse gases. However, PEC
cannot predict the outcome of this matter.
38
Other Contingencies
1. As required under the Nuclear Waste Policy Act of 1982, PEC entered into
a contract with the DOE under which the DOE agreed to begin taking spent
nuclear fuel by no later than January 31, 1998. All similarly situated
utilities were required to sign the same standard contract.
In 1995, the DOE issued a final interpretation that it did not have an
unconditional obligation to take spent nuclear fuel by January 31, 1998. In
Indiana Michigan Power v. DOE, the Court of Appeals vacated the DOE's final
interpretation and ruled that the DOE had an unconditional obligation to
begin taking spent nuclear fuel. The Court did not specify a remedy because
the DOE was not yet in default.
After the DOE failed to comply with the decision in Indiana Michigan Power
v. DOE, a group of utilities petitioned the Court of Appeals in Northern
States Power (NSP) v. DOE, seeking an order requiring the DOE to begin
taking spent nuclear fuel by January 31, 1998. The DOE took the position
that its delay was unavoidable, and the DOE was excused from performance
under the terms and conditions of the contract. The Court of Appeals found
that the delay was not unavoidable, but did not order the DOE to begin
taking spent nuclear fuel, stating that the utilities had a potentially
adequate remedy by filing a claim for damages under the contract.
After the DOE failed to begin taking spent nuclear fuel by January 31,
1998, a group of utilities filed a motion with the Court of Appeals to
enforce the mandate in NSP v. DOE. Specifically, this group of utilities
asked the Court to permit the utilities to escrow their waste fee payments,
to order the DOE not to use the waste fund to pay damages to the utilities,
and to order the DOE to establish a schedule for disposal of spent nuclear
fuel. The Court denied this motion based primarily on the grounds that a
review of the matter was premature, and that some of the requested remedies
fell outside of the mandate in NSP v. DOE.
Subsequently, a number of utilities each filed an action for damages in the
Federal Court of Claims. The U.S. Circuit Court of Appeals (Federal
Circuit) ruled that utilities may sue the DOE for damages in the Federal
Court of Claims instead of having to file an administrative claim with DOE.
In January 2004, PEC filed a complaint with the DOE claiming that the DOE
breached the Standard Contract for Disposal of Spent Nuclear Fuel by
failing to accept spent nuclear fuel from various Progress Energy
facilities on or before January 31, 1998. Damages due to DOE's breach will
likely exceed $100 million. Similar suits have been initiated by over two
dozen other utilities.
In July 2002, Congress passed an override resolution to Nevada's veto of
DOE's proposal to locate a permanent underground nuclear waste storage
facility at Yucca Mountain, Nevada. DOE plans to submit a license
application for the Yucca Mountain facility by the end of 2004. In November
2003, Congressional negotiators approved $580 million for fiscal year 2004
for the Yucca Mountain project, $123 million more than the previous year.
PEC cannot predict the outcome of this matter.
With certain modifications and additional approval by the NRC including the
installation of onsite dry storage facilities at Robinson (2005) and
Brunswick (2008), PEC's spent nuclear fuel storage facilities will be
sufficient to provide storage space for spent fuel generated on its system
through the expiration of the operating licenses for all of its nuclear
generating units.
2. In August 2003, PEC was served as a co-defendant in a purported class
action lawsuit styled as Collins v. Duke Energy Corporation et al, in South
Carolina's Circuit Court of Common Pleas for the Fifth Judicial Circuit.
PEC is one of three electric utilities operating in South Carolina named in
the suit. The plaintiffs are seeking damages for the alleged improper use
of electric easements but have not asserted a dollar amount for their
damage claims. The complaint alleges that the licensing of attachments on
electric utility poles, towers and other structures to non-utility third
parties or telecommunication companies for other than the electric
utilities' internal use along the electric right-of-way constitutes a
trespass.
39
In September 2003, PEC filed a motion to dismiss all counts of the
complaint on substantive and procedural grounds. In October 2003, the
plaintiffs filed a motion to amend their complaint. PEC believes the
amended complaint asserts the same factual allegations as are in the
original complaint and also seeks money damages and injunctive relief. In
November 2003, PEC filed a motion to dismiss the plaintiffs' first amended
complaint. In March 2004, the plaintiffs in this case filed a notice of
dismissal without prejudice of their claims against PEC and Duke Energy
Corporation.
3. In 2001, PEC entered into a contract to purchase coal from Dynegy
Marketing and Trade (DMT). After DMT experienced financial difficulties,
including credit ratings downgrades by certain credit reporting agencies,
PEC requested credit enhancements in accordance with the terms of the coal
purchase agreement in July 2002. When DMT did not offer credit
enhancements, as required by a provision in the contract, PEC terminated
the contract in July 2002.
PEC initiated a lawsuit seeking a declaratory judgment that the termination
was lawful. DMT counterclaimed, stating the termination was a breach of
contract. On March 23, 2004, the United States District Court for the
Eastern District of North Carolina ruled that PEC was liable for breach of
contract, but ruled against DMT on its unfair and deceptive trade practices
claim. The Court subsequently entered a judgment against PEC in the amount
of approximately $10 million. PEC intends to appeal the Court's ruling, but
cannot predict the outcome of this matter. PEC recorded an accrual for the
judgment and a regulatory asset for the probable recovery through its fuel
adjustment clause.
4. PEC is involved in various litigation matters in the ordinary course of
business, some of which involve substantial amounts. Where appropriate,
accruals have been made in accordance with SFAS No. 5, "Accounting for
Contingencies," to provide for such matters. In the opinion of management,
the final disposition of pending litigation would not have a material
adverse effect on PEC's consolidated results of operations or financial
position.
40
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following Management's Discussion and Analysis contains forward-looking
statements that involve estimates, projections, goals, forecasts, assumptions,
risks and uncertainties that could cause actual results or outcomes to differ
materially from those expressed in the forward-looking statements. Please review
"SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS" for a discussion of the factors
that may impact any such forward-looking statements made herein.
Amounts reported in the interim Consolidated Statements of Income are not
necessarily indicative of amounts expected for the respective annual or future
periods due to the effects of seasonal temperature variations on energy
consumption and the timing of maintenance on electric generating units, among
other factors.
This discussion should be read in conjunction with the accompanying financial
statements found elsewhere in this report and in conjunction with the 2003 Form
10-K.
RESULTS OF OPERATIONS
Progress Energy is an integrated energy company, with its primary focus on the
end-use and wholesale electricity markets. The Company's reportable business
segments and their primary operations include:
o Progress Energy Carolinas Electric (PEC Electric) - primarily engaged
in the generation, transmission, distribution and sale of electricity
in portions of North Carolina and South Carolina;
o Progress Energy Florida (PEF) - primarily engaged in the generation,
transmission, distribution and sale of electricity in portions of
Florida;
o Competitive Commercial Operations (CCO) - engaged in nonregulated
electric generation operations and marketing activities primarily in
the southeastern United States;
o Fuels - primarily engaged in natural gas production in Texas and
Louisiana, coal mining and related services, and the production of
synthetic fuels and related services, both of which are located in
Kentucky, West Virginia, and Virginia;
o Rail Services (Rail) - engaged in various rail and railcar related
services in 23 states, Mexico and Canada; and
o Other Businesses (Other) - engaged in other nonregulated business
areas, including telecommunications primarily in the eastern United
States and energy services operations, which do not meet the
requirements for separate segment reporting disclosure.
In this section, earnings and the factors affecting earnings for the three
months ended March 31, 2004 as compared to the same period in 2003 are
discussed. The discussion begins with a summarized overview of the Company's
consolidated earnings, which is followed by a more detailed discussion and
analysis by business segment.
OVERVIEW
For the quarter ended March 31 2004, Progress Energy's net income was $108
million or $0.45 per share compared to $219 million or $0.94 per share for the
same period in 2003. The decrease in net income as compared to prior year was
due primarily to:
o Lower off-system sales, primarily by PEC Electric.
o Higher O&M costs at the utilities due to increased spending for
scheduled plant outages in both the Carolinas and Florida and planned
reliability improvements in Florida.
o Decreased nonregulated generation earnings due to receipt of a
contract termination payment on a tolling agreement in 2003 and higher
fixed costs and interest charges in 2004.
o Unrealized losses recorded on contingent value obligations.
o The impact of tax levelization.
Partially offsetting these items were:
o Increased natural gas revenues.
o Utility customer growth in the Carolinas.
41
Basic earnings per share decreased in 2004 due in part to the factors outlined
above. Dilution related to the issuances under the Company's Investor Plus Stock
Purchase Plan and employee benefit programs in 2003 and 2004 also reduced basic
earnings per share by $0.02 in the first quarter of 2004.
Beginning in the fourth quarter of 2003, the Company ceased recording portions
of Fuels segment's operations, primarily synthetic fuel facilities, one month in
arrears. As a result, earnings for the year ended December 31, 2003 included 13
months of operations, resulting in a net income increase of $2 million for the
year. The Company restated previously reported consolidated quarterly earnings
to reflect the new reporting periods, resulting in four months of earnings in
the restated first quarter 2003 net income which increased $11 million from the
amount previously reported.
The Company's segments contributed the following profits or losses for the three
months ended March 31, 2004 and 2003:
- ------------------------------------------------------------------------------
(in millions) Three Months Ended March 31,
- ------------------------------------------------------------------------------
Business Segment 2004 2003
- ------------------------------------------------------------------------------
PEC Electric $ 116 $ 135
PEF 49 71
Fuels 48 38
CCO (8) 9
Rail 6 (3)
Other (2) -
----------------------------------
Total Segment Profit 209 250
Corporate (101) (43)
----------------------------------
Income from continuing operations 108 207
NCNG discontinued operations - 11
Cumulative effect of change in accounting
principle, net of tax - 1
----------------------------------
Net income $ 108 $ 219
- ------------------------------------------------------------------------------
In March 2003, the SEC completed an audit of Progress Energy Service Company,
LLC (Service Company) and recommended that the Company change its cost
allocation methodology for allocating Service Company costs. As part of the
audit process, the Company was required to change the cost allocation
methodology for 2003 and record retroactive reallocations between its affiliates
in the first quarter of 2003 for allocations originally made in 2001 and 2002.
This change in allocation methodology and the related retroactive adjustments
have no impact on consolidated expense or earnings. The new allocation
methodology, as compared to the previous allocation methodology, generally
decreases expenses in the regulated utilities and increases expenses in the
nonregulated businesses. The regulated utilities' reallocations are within
operation and maintenance (O&M) expense, while the diversified businesses'
reallocations are generally within diversified business expenses. The impact on
the individual lines of business is included in the following discussions.
PROGRESS ENERGY CAROLINAS ELECTRIC
PEC Electric contributed segment profits of $116 million and $135 million for
the three months ended March 31, 2004 and 2003, respectively. The decrease in
profits for the three months ended March 31, 2004 as compared to the same period
in 2003 is primarily due to lower off-system sales and higher O&M charges,
partially offset by the favorable impact of colder weather, increased revenues
from customer growth and lower depreciation and amortization charges.
Revenues
PEC Electric's revenues for the three months ended March 31, 2004 and 2003, and
the percentage change by customer class are as follows:
42
- ------------------------------------------------------------------------
(in millions of $) Three Months Ended March 31,
- ------------------------------------------------------------------------
Customer Class 2004 Change % Change 2003
- ------------------------------------------------------------------------
Residential $ 371 $ 14 3.9% $ 357
Commercial 208 7 3.5% 201
Industrial 147 - - 147
Governmental 19 - - 19
---------------------- ----------
Total retail revenues 745 21 2.9% 724
Wholesale 156 (53) (25.4%) 209
Unbilled (23) 8 - (31)
Miscellaneous 23 (1) (4.2%) 24
---------------------- ----------
Total electric revenues $ 901 $ (25) (2.7%) $ 926
- ------------------------------------------------------------------------
PEC Electric's energy sales for the three months ended March 31, 2004 and 2003,
and the amount and percentage change by customer class are as follows:
- ------------------------------------------------------------------------
(in millions of kWh) Three Months Ended March 31,
- ------------------------------------------------------------------------
Customer Class 2004 Change % Change 2003
- ------------------------------------------------------------------------
Residential 4,741 154 3.4% 4,587
Commercial 3,058 75 2.5% 2,983
Industrial 2,993 (12) (0.4%) 3,005
Governmental 345 2 0.6% 343
---------------------- ----------
Total retail energy 11,137 219 2.0% 10,918
sales
Wholesale 3,791 (828) (17.9%) 4,619
Unbilled (385) 95 - (480)
---------------------- ----------
Total kWh sales 14,543 (514) (3.4%) 15,057
- ------------------------------------------------------------------------
PEC Electric's revenues, excluding recoverable fuel revenues of $239 million and
$251 million for the three months ended March 31, 2004 and 2003, respectively,
decreased $13 million. The decrease in revenues was due primarily to lower
wholesale sales. Revenues for the quarter ended March 31, 2003 included strong
sales to the Northeastern United States as a result of favorable market
conditions. The decline in wholesale revenues was partially offset by increased
retail revenues as a result of favorable weather, with heating degree days 3.8%
above prior year. In addition, favorable customer growth partially offset the
decrease in wholesale sales. PEC Electric has approximately 24,000 additional
customers as of March 31, 2004 compared to March 31, 2003.
Expenses
Fuel and purchased power expenses are recovered primarily through cost recovery
clauses and, as such, changes in expense have no material impact on operating
results.
O&M costs were $209 million for the three months ended March 31, 2004, which
represents a $19 million increase compared to the same period in 2003. O&M
expenses increased in the current year due primarily to the Service Company
reallocation in 2003. O&M charges were favorably impacted by $16 million related
to the retroactive reallocation of Service Company costs in the prior year. In
addition, O&M costs increased $5 million related to a planned outage at the
Brunswick Nuclear Plant and another $5 million related to right-of-way
maintenance costs. These increases were partially offset by lower storm costs of
$4 million compared to the prior year. PEC Electric incurred severe storm costs
of $16 million during the quarter, of which approximately $10 million related to
costs in the South Carolina service territory was deferred. Storm costs for the
quarter ended March 31, 2003 were approximately $10 million and while these
costs were also deferred, the deferral was not received until the fourth quarter
of 2003; therefore, the effects of the reversal were recorded in the fourth
quarter.
Depreciation and amortization expense decreased $12 million from $139 million
for the quarter ended March 31, 2003 to $127 million for the quarter ended March
31, 2004. During the first quarter of 2004, PEC Electric filed with the North
Carolina Utilities Commission (NCUC) and obtained approval from the South
Carolina Public Service Commission (SCPSC) for a depreciation study which
allowed the utility to reduce the rates used to calculate depreciation expense.
As a result depreciation expense decreased $7 million compared to the prior year
quarter. The new depreciation study provides support for reducing depreciation
expense on an annual basis by approximately $45 million. The reduction in
depreciation expense is primarily attributable to assumption changes for nuclear
generation, offset by increases for distribution assets. In addition, clean air
amortization decreased $5 million compared to the prior year.
43
Other expenses have increased $10 million for the period ending March 31, 2004
as compared to the same period in the prior year. This increase is due primarily
to the write-off of $7 million of non-trade receivables.
PROGRESS ENERGY FLORIDA
PEF contributed segment profits of $49 million and $71 million in the three
months ended March 31, 2004 and 2003, respectively. The decrease in profits for
the three months ended March 31, 2004 when compared to 2003 is primarily due to
the impact of milder weather and higher O&M costs, partially offset by the
additional return on investment on the Hines 2 plant.
PEF's electric revenues for the three months ended March 31, 2004 and 2003, and
the amount and percentage change by customer class are as follows:
- ------------------------------------------------------------------------
(in millions of $) Three Months Ended March 31,
- ------------------------------------------------------------------------
Customer Class 2004 Change % Change 2003
- ------------------------------------------------------------------------
Residential $ 402 $ 17 4.4% $ 385
Commercial 181 31 20.7% 150
Industrial 63 15 31.3% 48
Governmental 46 8 21.1% 38
Retroactive rate refund - - - -
Retail revenue sharing (4) (4) - -
---------------------- ----------
Total retail revenues 688 67 10.8% 621
Wholesale 67 (4) (5.6%) 71
Unbilled (6) (5) - (1)
Miscellaneous 35 (2) (5.4%) 37
---------------------- ----------
Total electric revenues $ 784 $ 56 7.7% $ 728
- ------------------------------------------------------------------------
PEF's electric energy sales for the three months ended March 31, 2004
and 2003, and the amount and percentage change by customer class are as
follows:
- ------------------------------------------------------------------------
(in millions of kWh) Three Months Ended March 31,
- ------------------------------------------------------------------------
Customer Class 2004 Change % Change 2003
- ------------------------------------------------------------------------
Residential 4,291 (262) (5.8%) 4,553
Commercial 2,491 49 2.0% 2,442
Industrial 1,023 107 11.7% 916
Governmental 672 16 2.4% 656
---------------------- ----------
Total retail energy 8,477 (90) (1.1%) 8,567
sales
Wholesale 1,323 46 3.6% 1,277
Unbilled (135) (190) - 55
---------------------- ----------
Total kWh sales 9,665 (234) (2.4%) 9,899
- ------------------------------------------------------------------------
Revenues
PEF's revenues, excluding recoverable fuel and other pass-through revenues of
$448 million and $372 million for the three months ended March 31, 2004 and
2003, respectively, decreased $20 million. This decrease was due primarily to
the impact of milder weather which was offset partially by the $7 million return
on Hines 2 which was placed in service in December 2003.
Expenses
Fuel and purchased power expenses are recovered primarily through cost recovery
clauses and, as such, changes in expense have no material impact on operating
results.
O&M costs increased $19 million, when compared to the $141 million incurred
during the three months ended March 31, 2003. This increase is primarily related
to higher costs associated with scheduled plant outages and planned reliability
improvements of approximately $6 million each.
Depreciation and amortization decreased $10 million when compared to the $79
million incurred during the three months ended March 31, 2003, primarily due to
the amortization of the Tiger Bay regulatory asset in the prior year. During the
first quarter of 2003, Tiger Bay amortization was $15 million. The Tiger Bay
asset was fully amortized in September 2003. The decrease in Tiger Bay
amortization was partially offset by additional depreciation for assets placed
in service.
44
DIVERSIFIED BUSINESSES
The Company's diversified businesses consist of the Fuels segment, the CCO
segment, the Rail segment and the Other segment. These businesses are explained
in more detail below.
Fuels
The Fuels' segment operations include synthetic fuels production, natural gas
production, coal extraction and terminal operations. Fuels' results for the
three months ended March 31, 2003 were restated to reflect four months of
earnings for certain operations, primarily synthetic fuel facilities. Fuels'
segment profits increased $10 million as compared to $38 million for the same
period prior year due primarily to increased earnings from gas operations with a
full quarter of North Texas Gas volumes in the current year (acquired late
February 2003) and higher gas prices in 2004.
The following summarizes Fuels' segment profits for the three months ended March
31, 2004 and 2003:
- -----------------------------------------------------------------
(in millions) 2004 2003
- -----------------------------------------------------------------
Synthetic fuel operations $ 36 $ 34
Gas production 13 7
Coal fuel and other operations (1) (3)
------------------------------
Segment Profits $ 48 $ 38
- -----------------------------------------------------------------
Synthetic Fuel Operations
The synthetic fuel operations generated net profits of $36 million and $34
million for the three months ended March 31, 2004 and 2003, respectively. The
production and sale of synthetic fuel generate operating losses, but qualify for
tax credits under Section 29 of the Code, which more than offset the effect of
such losses. See Note 12 to the Progress Energy Notes to the Consolidated
Interim Financial Statements.
The operations resulted in the following for the three months ended March 31,
2004 and 2003:
- ---------------------------------------------------------------------
(in millions) 2004 2003
- ---------------------------------------------------------------------
Tons sold 2.9 2.5
- ---------------------------------------------------------------------
Operating losses, excluding tax credits $ (42) $ (32)
Tax credits generated 78 66
---------------------------
Net profits $ 36 $ 34
- ---------------------------------------------------------------------
Synthetic fuels' tons sold and net profits increased as compared to the same
period in 2003 due primarily to a change in internal production schedule in 2004
compared to 2003. The Company anticipates total synthetic fuel production of
approximately 11 to 12 million tons for 2004 which is comparable to 2003
production levels.
Natural Gas Operations
Natural gas operations generated profits of $13 million and $7 million for the
three months ended March 31, 2004 and 2003, respectively. The increase in
production resulted from the acquisition of North Texas Gas in late February
2003 and higher gas prices in 2004 contributed to increased earnings in 2004 as
compared to 2003. In October 2003, the Company completed the sale of certain gas
producing properties owned by Mesa Hydrocarbons, LLC. The following summarizes
the gas production, revenues and gross margins for the three months ended March
31, 2004 and 2003 by production facility:
45
- -----------------------------------------------------------------------------
2004 2003
- -----------------------------------------------------------------------------
Production in Bcf equivalent
Mesa - 1.7
Westchester 4.0 3.2
North Texas Gas 2.7 0.5
------------------------------------
Total Production 6.7 5.4
------------------------------------
Revenues in millions
Mesa $ - $ 5
Westchester 22 15
North Texas Gas 13 4
------------------------------------
Total Revenues $35 $ 24
------------------------------------
Gross Margin
in millions of $ $ 27 $ 19
As a % of revenues 77% 79%
- -----------------------------------------------------------------------------
Coal Fuel and Other Operations
Coal fuel and other operations generated segment losses of $1 million for the
three months ended March 31, 2004 compared to losses of $3 million for the three
months ended March 31, 2003. The decrease in losses of $2 million is due
primarily to the impact of the retroactive Service Company allocation in the
prior year. Results in the same period for the prior year were negatively
impacted by the retroactive reallocation of Service Company costs of $4 million
after-tax.
COMPETiTIVE COMMERCIAL OPERATIONS
CCO's operations generated segment losses of $8 million for the three months
ended March 31, 2004 compared to $9 million of net income for the comparable
period in the prior year. Segment results for the three months ended March 31,
2003 include a contract termination payment received on a tolling agreement.
Results for the quarter ended March 31, 2004 were also unfavorably impacted by
mark-to-market losses of $9 million and higher fixed costs. Fixed costs
increased $9 million from additional depreciation and amortization on plants
placed into service in 2003 and from an increase in interest expense of $5
million due primarily to interest no longer being capitalized due to the
completion of construction in the prior year. These items were partially offset
by favorable margins on tolling and new marketing contracts of $16 million and
the fact that results in the prior year quarter were negatively impacted by the
retroactive reallocation of Service Company costs of $3 million ($2 million
after-tax).
- ------------------------------------------------------------
(in millions) 2004 2003
- ------------------------------------------------------------
Total revenues $ 33 $ 37
Gross margin
In millions of $ $ 23 $ 34
As a % of revenues 70% 92%
Segment profits $ (8) $ 9
- ------------------------------------------------------------
The Company has contracts for 90% of planned production capacity for 2004 and
55% in both 2005 and 2006. The 2005 decline results from the expiration of four
tolling contracts. The Company continues to pursue opportunities with both
current customers and other potential customers.
Rail
Rail's operations include railcar and locomotive repair, trackwork, rail parts
reconditioning and sales, scrap metal recycling and other rail related services.
The Company sold the majority of the assets of Railcar Ltd., a leasing
subsidiary, in 2004. See Note 3A of the Progress Energy Notes to the
Consolidated Interim Financial Statements.
Rail contributed segment profit of $6 million for the quarter ended March 31,
2004 compared with a net loss of $3 million for the same period in the prior
year. Rail's earnings were positively impacted by higher prices and margins on
recycling operations. In addition, results for the same period in the prior year
were negatively impacted by the retroactive reallocation of Service Company
costs of $3 million after-tax.
46
Other Businesses Segment
Progress Energy's Other segment primarily includes the operations of SRS and the
telecommunications operations of PTC LLC. SRS is engaged in providing energy
services to industrial, commercial and institutional customers to help manage
energy costs and currently focuses its activities in the southeastern United
States. PTC LLC operations provide broadband capacity services, dark fiber and
wireless services in Florida and the eastern United States.
PTC LLC recorded a segment net loss of $1 million net of minority interest for
the quarter ended March 31, 2004 compared with segment net income of less than
$1 million for the same period last year. PTC LLC's results were negatively
impacted by integration costs associated with its combination with EPIK in
December 2003. In addition, results in the prior quarter were favorably impacted
by the retroactive reallocation of Service Company costs of $1 million
after-tax.
CORPORATE SERVICES
Corporate Services includes the operations of the Holding Company, the Service
Company and consolidation entities, as summarized below:
- -----------------------------------------------------------------
Three Months Ended
March 31,
- -----------------------------------------------------------------
Income (expense) in millions 2004 2003
- -----------------------------------------------------------------
Other interest expense $ (76) $ (71)
Contingent value obligations (7) 2
Tax levelization (39) 10
Tax reallocation (9) (9)
Other income taxes 30 31
Other - (6)
-------------------------
Segment profit (loss) $ (101) $ (43)
- -----------------------------------------------------------------
Other interest expense has increased $5 million compared to $71 million for the
quarter ended March 31, 2003. Interest expense increased during the current
quarter from interest no longer being capitalized due to the completion of
construction in the prior year. Approximately $5 million ($3 million after-tax)
was capitalized in the first quarter of 2003.
Progress Energy issued 98.6 million contingent value obligations (CVOs) in
connection with the 2000 FPC acquisition. Each CVO represents the right to
receive contingent payments based on the performance of four synthetic fuel
facilities owned by Progress Energy. The payments, if any, are based on the net
after-tax cash flows the facilities generate. At March 31, 2004 and 2003, the
CVOs had fair market values of approximately $30 million and $12 million,
respectively. Progress Energy recorded an unrealized loss of $7 million and
unrealized gain of $2 million for the three months ended March 31, 2004 and
2003, respectively, to record the changes in fair value of the CVOs, which had
average unit prices of $0.31 and $0.12 at March 31, 2004 and 2003, respectively.
GAAP requires companies to apply a levelized effective tax rate to interim
periods that is consistent with the estimated annual effective tax rate. Income
tax expense was increased by $39 million and decreased by $10 million for the
three months ended March 31, 2004 and 2003, respectively, in order to maintain
an effective tax rate consistent with the estimated annual rate. The tax credits
associated with the Company's synthetic fuel operations primarily drive the
required levelization amount. Fluctuations in estimated annual earnings and tax
credits can also cause large swings in the effective tax rate for interim
periods. Therefore, this adjustment will vary each quarter, but will have no
effect on net income for the year.
Other expenses decreased $6 million compared to prior year. This decrease is due
primarily to the impact of retroactive reallocation of Service Company costs in
the prior year. Other expenses for the quarter ended March 31, 2003 included $5
million in expenses ($3 million after-tax) based on the reallocation.
47
DISCONTINUED OPERATIONS
In 2002, the Company approved the sale of NCNG and the Company's equity
investment in ENCNG to Piedmont Natural Gas Company, Inc. The sale closed on
September 30, 2003. Net proceeds of approximately $450 million from the sale of
NCNG and ENCNG were used to reduce outstanding short-term debt. NCNG contributed
$11 million of net income to the Company in the first quarter of 2003.
LIQUIDITY AND CAPITAL RESOURCES
Progress Energy, Inc.
Progress Energy is a registered holding company and, as such, has no operations
of its own. As a holding company, Progress Energy's primary cash obligations are
its common dividend and interest expense. The ability to meet its obligations is
primarily dependent on the earnings and cash flows of its two electric utilities
and nonregulated subsidiaries, and the ability of those subsidiaries to pay
dividends or repay funds to Progress Energy.
Net cash provided by operating activities decreased $57 million for the three
months ended March 31, 2004, when compared to the corresponding period in the
prior year. The decrease in cash from operating activities for the 2004 period
is primarily due to lower operating results at the Company's two electric
utilities and changes in working capital.
Net cash used in investing activities decreased $332 million for the three
months ended March 31, 2004, when compared to the corresponding period in the
prior year. The decrease in cash used in investing activities is primarily due
to reduced nonregulated capital expenditures, primarily the purchase of North
Texas Gas assets in the first quarter of 2003 and proceeds from the sale of
Railcar Ltd. assets during the first quarter of 2004.
Net cash used in financing activities was $346 million for the three months
ended March 31, 2004. On March 1, 2004, Progress Energy used available cash and
proceeds from the issuance of commercial paper to retire $500 million 6.55%
senior unsecured notes. Cash and commercial paper capacity were created
primarily from the sale of assets in 2003.
For the three months ended March 31, 2004, the Company issued approximately 0.7
million shares representing approximately $29 million in proceeds from its
Investor Plus Stock Purchase Plan and its employee benefit plans. The Company
expects to realize between $50 and $75 million of cash from the sale of stock
through these plans during 2004.
The amount and timing of future sales of company securities will depend on
market conditions, operating cash flow, asset sales and the specific needs of
the Company. The Company may from time to time sell securities beyond the amount
needed to meet capital requirements in order to allow for the early redemption
of long-term debt, the redemption of preferred stock, the reduction of
short-term debt or for other general corporate purposes.
Future Commitments
As of March 31, 2004, the current portion of long-term debt of $232 million
includes $150 million of secured debt issued by PEC which matured. This note was
paid off through the issuance of commercial paper and with internally-generated
funds.
As of March 31, 2004, Progress Energy's guarantees issued on behalf of third
parties were approximately $10 million.
OTHER MATTERS
PEF Rate Case Settlement
In March 2002, the parties in PEF's rate case entered into a Stipulation and
Settlement Agreement (the Agreement) related to retail rate matters. The
Agreement was approved by the FPSC and is generally effective from May 1, 2002
through December 31, 2005; provided, however, that if PEF's base rate earnings
fall below a 10% return on equity, PEF may petition the FPSC to amend its base
rates.
48
Synthetic Fuels Tax Credits
Progress Energy, through its subsidiaries, produces a coal-based solid synthetic
fuel. The production and sale of the synthetic fuel from these facilities
qualifies for tax credits under Section 29 of the Code (Section 29) if certain
requirements are satisfied, including a requirement that the synthetic fuel
differs significantly in chemical composition from the coal used to produce such
synthetic fuel and that the fuel was produced from a facility that was placed in
service before July 1, 1998. Any synthetic fuel tax credit amounts not utilized
are carried forward indefinitely. All of Progress Energy's synthetic fuel
facilities have received private letter rulings (PLRs) from the Internal Revenue
Service (IRS) with respect to their synthetic fuel operations. These tax credits
are subject to review by the IRS, and if Progress Energy fails to prevail
through the administrative or legal process, there could be a significant tax
liability owed for previously taken Section 29 credits, with a significant
impact on earnings and cash flows. Additionally, the ability to use tax credits
currently being carried forward could be denied. Total Section 29 credits
generated to date (including those generated by FPC prior to its acquisition by
the Company) are approximately $1.3 billion, of which $585 million have been
used and $736 million are being carried forward as deferred tax credits. The
current Section 29 tax credit program expires at the end of 2007.
In September 2002, all of the Company's majority-owned synthetic fuel entities
were accepted into the IRS's Pre-filing Agreement (PFA) program. The PFA program
allows taxpayers to voluntarily accelerate the IRS exam process in order to seek
resolution of specific issues. Either the Company or the IRS can withdraw from
the program, and issues not resolved through the program may proceed to the next
level of the IRS exam process.
In February 2004, subsidiaries of the Company finalized execution of the Colona
Closing Agreement with the IRS concerning their Colona synthetic fuel
facilities. The Colona Closing Agreement provided that the Colona facilities
were placed in service before July 1, 1998, which is one of the qualification
requirements for tax credits under Section 29. The Colona Closing Agreement
further provides that the fuel produced by the Colona facilities in 2001 is a
"qualified fuel" for purposes of the Section 29 tax credits. This action
concludes the IRS PFA program with respect to Colona. Although the execution of
the Colona Closing Agreement is a significant event, the PFA process continues
with respect to the four synthetic fuel facilities owned by other affiliates of
Progress Energy and FPC. Currently, the focus of that process is to determine
that the facilities were placed in service before July 1, 1998. In management's
opinion, Progress Energy is complying with all the necessary requirements to be
allowed such credits under Section 29, although it cannot provide certainty,
that it will prevail if challenged by the IRS on credits taken. Accordingly, the
Company has no current plans to alter its synthetic fuel production schedule as
a result of these matters.
In October 2003, the United States Senate Permanent Subcommittee on
Investigations began a general investigation concerning synthetic fuel tax
credits claimed under Section 29. The investigation is examining the utilization
of the credits, the nature of the technologies and fuels created, the use of the
synthetic fuel and other aspects of Section 29 and is not specific to the
Company's synthetic fuel operations. Progress Energy is providing information in
connection with this investigation. The Company cannot predict the outcome of
this matter.
In addition, the Company has retained an advisor to assist in selling an
interest in one or more synthetic fuel entities. The Company is pursuing the
sale of a portion of its synthetic fuel production capacity that is
underutilized due to limits on the amount of credits that can be generated and
utilized by the Company. The Company would expect to retain an ownership
interest and to operate any sold facility for a management fee. The final
outcome and timing of the Company's efforts to sell interests in synthetic fuel
facilities is uncertain and while the Company cannot predict the outcome of this
matter, the outcome is not expected to have a material effect on the
consolidated financial position, cash flows or results of operations.
Nuclear Matters
The United States Nuclear Regulatory Commission (NRC) on April 19, 2004,
announced that it has renewed the operating license for PEC's Robinson Nuclear
Plant for an additional 20 years through July 2030. The original operating
license of 40 years was set to expire in 2010. During the first quarter of 2004,
PEC filed with the NCUC and obtained approval from the SCPSC for a depreciation
study which allowed the utility to reduce the rates used to calculate
depreciation expense. The reduction in depreciation expense is primarily
attributable to assumption changes for nuclear generation.
49
In February 2004, the NRC issued a revised Order for inspection requirements for
reactor pressure vessel heads at PWRs. The Company is in the process of
complying with the Order. No adverse impact is anticipated.
The NRC has issued various orders since September 2001 with regard to security
at nuclear plants. These orders include additional restrictions on access,
increased security measures at nuclear facilities and closer coordination with
the Company's partners in intelligence, military, law enforcement and emergency
response at the federal, state and local levels. The Company is completing the
requirements as outlined in the orders by the established deadlines. As the NRC,
other governmental entities and the industry continue to consider security
issues, it is possible that more extensive security plans could be required.
Franchise Litigation
Three cities, with a total of approximately 18,000 customers, have litigation
pending against PEF in various circuit courts in Florida. As discussed below,
three other cities, with a total of approximately 30,000 customers, have
subsequently settled their lawsuits with PEF and signed new, 30-year franchise
agreements. The lawsuits principally seek 1) a declaratory judgment that the
cities have the right to purchase PEF's electric distribution system located
within the municipal boundaries of the cities, 2) a declaratory judgment that
the value of the distribution system must be determined through arbitration, and
3) injunctive relief requiring PEF to continue to collect from PEF's customers
and remit to the cities, franchise fees during the pending litigation, and as
long as PEF continues to occupy the cities' rights-of-way to provide electric
service, notwithstanding the expiration of the franchise ordinances under which
PEF had agreed to collect such fees. Five circuit courts have entered orders
requiring arbitration to establish the purchase price of PEF's electric
distribution system within five cities. Two appellate courts have upheld these
circuit court decisions and authorized cities to determine the value of PEF's
electric distribution system within the cities through arbitration.
Arbitration in one of the cases (the City of Casselberry) was held in August
2002. Following arbitration, the parties entered settlement discussions, and in
July 2003 the City approved a settlement agreement and a new, 30-year franchise
agreement with PEF. The settlement resolves all pending litigation with that
city. A second arbitration (with the 13,000-customer City of Winter Park) was
completed in February 2003. That arbitration panel issued an award in May 2003
setting the value of PEF's distribution system within the City of Winter Park at
approximately $32 million, not including separation and reintegration costs and
construction work in progress, which could add several million dollars to the
award. The panel also awarded PEF approximately $11 million in stranded costs,
which according to the award decreases over time. In September 2003, Winter Park
voters passed a referendum that would authorize the City to issue bonds of up to
approximately $50 million to acquire PEF's electric distribution system. While
the City has not yet definitively decided whether it will acquire the system, on
April 26, 2004, the City Commission voted to enter into a hedge agreement to
lock into interest rates for the acquisition of the system. The City has sought
and received wholesale power supply bids and has indicated that it will seek
bids to operate and maintain the distribution system. At this time, whether and
when there will be further proceedings regarding the City of Winter Park cannot
be determined. A third arbitration (with the 2,500-customer Town of Belleair)
was completed in June 2003. In September 2003, the arbitration panel issued an
award in that case setting the value of the electric distribution system within
the Town at approximately $6 million. The panel further required the Town to pay
to PEF its requested $1 million in separation and reintegration costs and
approximately $2 million in stranded costs. The Town has not yet decided whether
it will attempt to acquire the system. At this time, whether and when there will
be further proceedings regarding the Town of Belleair cannot be determined. A
fourth arbitration (with the 13,000-customer City of Apopka) had been scheduled
for January 2004. In December 2003, the Apopka City Commission voted on first
reading to approve a settlement agreement and a 30-year franchise with PEF. The
settlement and franchise became effective upon approval by the Commission at a
second reading of the franchise in January 2004. The settlement resolves all
outstanding litigation between the parties.
Arbitration in the remaining city's litigation (the 1,500-customer City of
Edgewood) has not yet been scheduled.
As part of the above litigation, two appellate courts have also reached opposite
conclusions regarding whether PEF must continue to collect from its customers
and remit to the cities "franchise fees" under the expired franchise ordinances.
PEF has filed an appeal with the Florida Supreme Court to resolve the conflict
between the two appellate courts. The Florida Supreme Court held oral argument
in one of the appeals in August 2003. Subsequently, the Court requested briefing
from the parties in the other appeal, which was completed in November 2003. The
Company cannot predict the outcome of these matters at this time.
50
Progress Energy Carolinas, Inc.
The information required by this item is incorporated herein by reference to the
following portions of Progress Energy's Management's Discussion and Analysis of
Financial Condition and Results of Operations, insofar as they relate to PEC:
RESULTS OF OPERATIONS; LIQUIDITY AND CAPITAL RESOURCES and OTHER MATTERS.
RESULTS OF OPERATIONS
The results of operations for the PEC Electric segment are identical between PEC
and Progress Energy. The results of operations for PEC's non-utility
subsidiaries for the three months ended March 31, 2004 and 2003 are not material
to PEC's consolidated financial statements.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities decreased $107 million for the three
months ended March 31, 2004, when compared to the corresponding period in the
prior year. The decrease was caused primarily by a $112 million increase in
working capital requirements.
Cash used in investing activities decreased $25 million for the three months
ended March 31, 2004, when compared to the corresponding period in the prior
year primarily due to lower construction spending.
The current portion of long-term debt includes $150 million of 7.875% First
Mortgage Bonds which matured on April 15, 2004. In addition, $150 million of
First Mortgage Bonds matured on January 15, 2004. The remaining current portion
of long-term debt will be refinanced or retired through commercial paper,
capital market transactions and internally generated funds.
51
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Progress Energy, Inc.
Market risk represents the potential loss arising from adverse changes in market
rates and prices. Certain market risks are inherent in the Company's financial
instruments, which arise from transactions entered into in the normal course of
business. The Company's primary exposures are changes in interest rates with
respect to its long-term debt and commercial paper, and fluctuations in the
return on marketable securities with respect to its nuclear decommissioning
trust funds. The Company manages its market risk in accordance with its
established risk management policies, which may include entering into various
derivative transactions.
The Company's exposure to return on marketable securities for the
decommissioning trust funds has not changed materially since December 31, 2003.
The Company's exposure to market value risk with respect to the CVOs has also
not changed materially since December 31, 2003.
On March 1, 2004, Progress Energy used available cash and proceeds from the
issuance of commercial paper to retire $500 million 6.55% senior unsecured
notes.
The exposure to changes in interest rates from the Company's fixed rate and
variable rate long-term debt at March 31, 2004 has changed from December 31,
2003. The total fixed rate long-term debt at March 31, 2004 was $9.1 billion,
with an average interest rate of 6.58% and fair market value of $10.0 billion.
The total variable rate long-term debt at March 31, 2004, was $1.1 billion, with
an average interest rate of 1.35% and fair market value of $1.1 billion.
In March 2004, two interest rate swap agreements totaling $200 million were
terminated. These swaps were associated with Progress Energy 5.85% Notes due in
2008. These loss on the agreements was deferred and is being amortized over the
life of the bonds as these agreements had been designated as fair value hedges
for accounting purposes.
The exposure to changes in interest rates from the Company's commercial paper
was not materially different than at December 31, 2003.
Progress Energy Carolinas, Inc.
PEC has certain market risks inherent in its financial instruments, which arise
from transactions entered into in the normal course of business. PEC's primary
exposures are changes in interest rates with respect to long-term debt and
commercial paper, and fluctuations in the return on marketable securities with
respect to its nuclear decommissioning trust funds. PEC's exposure to return on
marketable securities for the decommission trust funds has not changed
materially since December 31, 2003.
The exposure to changes in interest rates from the PEC's fixed rate long-term
debt, variable rate long-term debt and commercial paper at March 31, 2004 was
not materially different than at December 31, 2003.
52
Item 4: Controls and Procedures
Progress Energy, Inc.
Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, Progress
Energy carried out an evaluation, with the participation of Progress Energy's
management, including Progress Energy's President and Chief Executive Officer,
and Chief Financial Officer, of the effectiveness of Progress Energy's
disclosure controls and procedures (as defined under Rule 13a-15(e) under the
Securities Exchange Act of 1934) as of the end of the period covered by this
report. Based upon that evaluation, Progress Energy's President and Chief
Executive Officer, and Chief Financial Officer concluded that Progress Energy's
disclosure controls and procedures are effective in timely alerting them to
material information relating to Progress Energy (including its consolidated
subsidiaries) required to be included in Progress Energy's periodic SEC filings.
These officers noted that after the end of the period covered by the report,
Progress Energy was late in filing a Form 8-K pursuant to Item 11 of that Form
(Temporary Suspension of Trading Under Registrant's Employee Benefit Plans). The
filing relates to notice to Section 16 insiders informing them of the
prohibition of trading in the Company's securities during an upcoming 401(k)
blackout period. Notice was given to all Section 16 insiders regarding these
trading restrictions well before the blackout period commenced. The President
and Chief Executive Officer, and Chief Financial Officer have confirmed that
procedures were in place identifying this filing requirement and allocating
responsibility for notification to the appropriate personnel, and that this late
filing was the result of a human performance error, not a process deficiency.
There has been no change in Progress Energy's internal control over financial
reporting during the quarter ended March 31, 2004 that has materially affected,
or is reasonably likely to materially affect, Progress Energy's internal control
over financial reporting.
Progress Energy Carolinas, Inc.
Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, PEC
carried out an evaluation, with the participation of PEC's management, including
PEC's President and Chief Executive Officer, and Chief Financial Officer, of the
effectiveness of PEC's disclosure controls and procedures (as defined under Rule
13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period
covered by this report. Based upon that evaluation, PEC's President and Chief
Executive Officer, and Chief Financial Officer concluded that PEC's disclosure
controls and procedures are effective in timely alerting them to material
information relating to PEC (including its consolidated subsidiaries) required
to be included in PEC's periodic SEC filings.
There has been no change in PEC's internal control over financial reporting
during the quarter ended March 31, 2004 that has materially affected, or is
reasonably likely to materially affect, PEC's internal control over financial
reporting.
53
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Legal aspects of certain matters are set forth in Part I, Item 1. See Note 12 to
the Progress Energy, Inc. Consolidated Interim Financial Statements and Note 10
to the PEC's Consolidated Interim Financial Statements.
1. Strategic Resource Solutions Corp. ("SRS") v. San Francisco Unified School
District, et al., Sacramento Superior Court, Case No. 02AS033114
In November 2001, SRS filed a claim against the San Francisco Unified School
District (the District) and other defendants claiming that SRS is entitled to
approximately $10 million in unpaid contract payments and delay and impact
damages related to the District's $30 million contract with SRS. In March 2002,
the District filed a counterclaim, seeking compensatory damages and liquidated
damages in excess of $120 million, for various claims, including breach of
contract and demand on a performance bond. SRS has asserted defenses to the
District's claims. SRS has amended its claims and asserted new claims against
the District and other parties, including a former SRS employee and a former
District employee.
On March 13, 2003, the City Attorney's office announced the filing of new claims
by the City Attorney and the District in the form of a cross-complaint against
SRS, Progress Energy, Inc., Progress Energy Solutions, Inc., and certain
individuals, alleging fraud, false claims, violations of California statutes,
and seeking compensatory damages, punitive damages, liquidated damages, treble
damages, penalties, attorneys' fees and injunctive relief. The City Attorney's
announcement states that the City and the District seek "more than $300 million
in damages and penalties." PEC was added as a cross-defendant.
The Company, SRS, Progress Energy Solutions, Inc. and PEC all have denied the
District's allegations and cross-claims. Discovery is in progress in the matter.
The case has been assigned to a judge under the Sacramento County superior
court's case management rules, and the judge and the parties have been
conferring on scheduling and process to narrow or resolve issues, if possible,
and to prepare the case for trial. No trial date has been set. SRS and the
Company cannot predict the outcome of this matter, but will vigorously defend
against the allegations.
2. Collins v. Duke Energy Corporation, Civil Action No. 03CP404050
On August 21, 2003, PEC was served as a co-defendant in a purported class action
lawsuit styled as Collins v. Duke Energy Corporation, Civil Action No.
03CP404050, in South Carolina's Circuit Court of Common Pleas for the Fifth
Judicial Circuit. PEC is one of three electric utilities operating in South
Carolina named in the suit. The plaintiffs are seeking damages for the alleged
improper use of electric easements but have not asserted a dollar amount for
their damage claims. The complaint alleges that the licensing of attachments on
electric utility poles, towers and other structures to non-utility third parties
or telecommunication companies for other than the electric utilities' internal
use along the electric right-of-way constitutes a trespass.
On September 19, 2003, PEC filed a motion to dismiss all counts of the complaint
on substantive and procedural grounds. On October 6, 2003, the plaintiffs filed
a motion to amend their complaint. PEC believes the amended complaint asserts
the same factual allegations as are in the original complaint and also seeks
money damages and injunctive relief.
On March 16, 2004, the plaintiffs in this case filed a notice of dismissal
without prejudice of their claims against PEC and Duke Energy Corporation.
3. U.S. Global, LLC v. Progress Energy, Inc. et al, Case No. 03004028-03 and
Progress Synfuel Holdings, Inc. et al, v. U.S. Global, LLC, Case No.
03004028-03
A number of Progress Energy, Inc. subsidiaries and affiliates are parties to two
lawsuits arising out of an Asset Purchase Agreement dated as of October 19,
1999, by and among U.S. Global LLC (Global), EARTHCO, certain affiliates of
EARTHCO (collectively the EARTHCO Sellers), EFC Synfuel LLC (which is owned
indirectly be Progress Energy, Inc.) and certain of its affiliates, including
Solid Energy LLC, Solid Fuel LLC, Ceredo Synfuel LLC, Gulf Coast Synfuel LLC
(currently named Sandy River Synfuel LLC) (Collectively the Progress
Affiliates), as amended by an amendment to Purchase Agreement as of August 23,
2000 (the Asset Purchase Agreement). Global has asserted that pursuant to the
Asset Purchase Agreement it is entitled to (1) interest in two synthetic fuel
facilities currently owned by the Progress Affiliates, and (2) an option to
purchase additional interests in the two synthetic fuel facilities.
54
The first suit, U.S. Global, LLC v. Progress Energy, Inc. et al, was filed in
the Circuit Court for Broward County, Florida in March 2003 (the Florida Global
Case). The Florida Global Case asserts claims for breach of the Asset Purchase
Agreement and other contract and tort claims related to the Progress Affiliates'
alleged interference with Global's rights under the Asset Purchase Agreement.
The Florida Global Case requests an unspecified amount of compensatory damages,
as well as declaratory relief. On December 15, 2003, the Progress Affiliates
filed a motion to dismiss the Third Amended Complaint in the Florida Global
Case. The motion to dismiss filed on behalf of the Progress Energy, Inc.
subsidiaries and affiliates that are parties to the case will be heard by the
Circuit Court of Broward County, Florida on June 7, 2004.
The second suit, Progress Synfuel Holdings, Inc. et al. v. U.S. Global, LLC, was
filed by the Progress Affiliates in the Superior Court for Wake County, North
Carolina seeking declaratory relief consistent with the Company's interpretation
of the asset Purchase Agreement (the North Carolina Global Case). Global was
served with the North Carolina Global Case on April 17, 2003.
On May 15, 2003, Global moved to dismiss the North Carolina Global Case for lack
of personal jurisdiction over Global. In the alternative, Global requested that
the court decline to exercise its discretion to hear the Progress Affiliates'
declaratory judgment action. On August 7, 2003, the Wake County Superior court
denied Global's motion to dismiss and entered an order staying the North
Carolina Global Case, pending the outcome of the Florida Global Case. The
Progress Affiliates have appealed the Superior court's order staying the case;
Global has cross appealed the denial of its motion to dismiss for lack of
personal jurisdiction. The North Carolina Court of Appeals has not set a hearing
date for the Progress Affiliates' Appeal or Global's cross appeal. The Company
cannot predict the outcome of these matters, but will vigorously defend against
the allegations.
4. Gerber Asset Management LLC v. William Cavanaugh III and Progress Energy,
Inc. et al, Case No. 04 CV 636
Stanley Fried, Raymond X. Talamantes and Jacquelin Talamantes v. William
Cavanaugh III and Progress Energy, Inc. Case No. 04 CV 2494
On February 3, 2004, Progress Energy, Inc. was served with a class action
complaint alleging violations of federal security laws in connection with the
Company's issuance of Contingent Value Obligations (CVOs). The action was filed
by Gerber Asset Management LLC in the United States District Court for the
Southern District of New York and names Progress Energy, Inc. Chairman William
Cavanaugh III and Progress Energy, Inc. as defendants. The Complaint alleges
that Progress Energy failed to timely disclose the impact of the Alternative
Minimum Tax required under Sections 55-59 of the Internal Revenue Code (Code) on
the value of certain CVOs issued in connection with the Florida Progress
Corporation merger. The suit seeks unspecified compensatory damages, as well as
attorneys' fees and litigation costs.
On March 31, 2004, a second class action complaint was filed by Stanley Fried,
Raymond X. Talamantes and Jacquelin Talamantes against William Cavanaugh III and
Progress Energy, Inc. in the United States District Court for the Southern
District of New York alleging violations of federal security laws arising out of
the Company's issuance of CVOs nearly identical to those alleged in the February
3, 2004 complaint. On April 29, 2004, the Honorable John E. Sprizzo ordered that
(1) the two class action cases be consolidated, (2) Peak6 Capital Management LLC
shall serve as the lead plaintiff in the consolidated action, (3) the law firm
of Goodkind, Labaton Rudoff & Sucharow LLP shall serve as class counsel, and (4)
the lead plaintiff shall file a consolidated amended complaint on or before June
14, 2004.
The Company cannot predict the outcome of this matter, but will vigorously
defend against the allegations.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities
RESTRICTED STOCK AWARDS:
(a) Securities Delivered. On March 16, 2004, 131,200 restricted shares of the
Company's Common Shares were granted to certain key employees pursuant to
the terms of the Company's 2002 Equity Incentive Plan (Plan), which was
approved by the Company's shareholders on May 8, 2002. Section 9 of the
Plan provides for the granting of Restricted Stock by the Organization and
Compensation Committee of the Company's Board of Directors, (the Committee)
to key employees of the Company, including its Affiliates or any successor,
and to outside directors of the Company. The Common Shares delivered
pursuant to the Plan were acquired in market transactions directly for the
accounts of the recipients and do not represent newly issued shares of the
Company.
(b) Underwriters and Other Purchasers. No underwriters were used in connection
with the delivery of Common Shares described above. The Common Shares were
delivered to certain key employees of the Company. The Plan defines "key
employee" as an officer or other employee of the Company who is selected
for participation in the Plan.
(c) Consideration. The Common Shares were delivered to provide an incentive to
the employee recipients to exert their utmost efforts on the Company's
behalf and thus enhance the Company's performance while aligning the
employee's interest with those of the Company's shareholders.
(d) Exemption from Registration Claimed. The Common Shares described in this
Item were delivered on the basis of an exemption from registration under
Section 4(2) of the Securities Act of 1933. Receipt of the Common Shares
required no investment decision on the part of the recipients. All award
decisions were made by the Committee, which consists entirely of
non-employee directors.
56
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit Progress Progress Energy
Number Description Energy, Inc. Carolinas, Inc.
------ ----------- ------------ ---------------
3(ii)(a) By-Laws of Progress Energy, Inc., as amended on X X
March 17, 2004
3(ii)(b) By-Laws of Carolina Power & Light Company, as X
amended on March 17, 2004
31(a) Certifications pursuant to Section 302 of the X X
Sarbanes-Oxley Act of 2002 - Chairman and Chief
Executive Officer
31(b) Certifications pursuant to Section 302 of the X X
Sarbanes-Oxley Act of 2002 - Executive Vice
President and Chief Financial Officer
32(a) Certifications pursuant to Section 906 of the X X
Sarbanes-Oxley Act of 2002 - Chairman and Chief
Executive Officer
32(b) Certifications pursuant to Section 906 of the X X
Sarbanes-Oxley Act of 2002 - Executive Vice
President and Chief Financial Officer
(b) Reports filed or furnished on Form 8-K since the beginning of the quarter:
Progress Energy, Inc.
Financial
Item Statements
Reported Included Date of Event Date Filed or Furnished
-------- -------- ------------- -----------------------
7, 9 No April 28, 2004 April 28, 2004
7, 11 No April 5, 2004 April 23, 2004
9, 12 Yes April 21, 2004 April 21, 2004
12 Yes February 26, 2004 February 26, 2004
5 No February 24, 2004 February 24, 2004
5 No January 23, 2004 January 23, 2004
9, 12 Yes January 21, 2004 January 21, 2004
Carolina Power & Light Company
d/b/a Progress Energy Carolinas, Inc.
Financial
Item Statements
Reported Included Date of Event Date Filed or Furnished
-------- -------- ------------- -----------------------
9, 12 Yes April 21, 2004 April 21, 2004
12 Yes February 26, 2004 February 26, 2004
5 No January 23, 2004 January 23, 2004
9, 12 Yes January 21, 2004 January 21, 2004
57
SIGNATURES
Pursuant to requirements of the Securities Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
PROGRESS ENERGY, INC.
CAROLINA POWER & LIGHT COMPANY
Date: May 6, 2004 (Registrants)
By: /s/Geoffrey S. Chatas
Geoffrey S. Chatas
Executive Vice President and
Chief Financial Officer
By: /s/Robert H. Bazemore, Jr.
Robert H. Bazemore, Jr.
Vice President and Controller
Chief Accounting Officer
58