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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, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
-------- --------
Exact name of registrants as specified in their charters, state of I.R.S. Employer
Commission incorporation, address of principal executive offices, and telephone Identification
File Number number Number
1-15929 Progress Energy, Inc. 56-2155481
410 South Wilmington Street
Raleigh, North Carolina 27601-1748
Telephone: (919) 546-6111
State of Incorporation: North Carolina
1-3382 Carolina Power & Light Company 56-0165465
d/b/a Progress Energy Carolinas, Inc.
410 South Wilmington Street
Raleigh, North Carolina 27601-1748
Telephone: (919) 546-6111
State of Incorporation: North Carolina
NONE
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrants (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days. Yes X No
Indicate by check mark whether Progress Energy, Inc. (Progress Energy) is an
accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No
Indicate by check mark whether Carolina Power & Light Company is an accelerated
filer (as defined in Rule 12b-2 of the Exchange Act). Yes No X
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, 2005, each
registrant had the following shares of common stock outstanding:
Registrant Description Shares
Progress Energy Common Stock (Without Par Value) 248,680,504
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, 2005
Glossary of Terms
Safe Harbor For Forward-Looking Statements
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Interim Financial Statements:
Progress Energy, Inc.
--------------------------------------------------------------
Consolidated Statements of Income
Consolidated Balance Sheets
Consolidated Statements of Cash Flows
Notes to Consolidated Interim Financial Statements
Carolina Power & Light Company
d/b/a Progress Energy Carolinas, Inc.
---------------------------------------------------------------
Consolidated Statements of Income
Consolidated Balance Sheets
Consolidated Statements of Cash Flows
Notes to Consolidated Interim Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 6. Exhibits
Signatures
2
GLOSSARY OF TERMS
The following abbreviations or acronyms used in the text of this combined Form
10-Q are defined below:
TERM DEFINITION
401(k) Progress Energy 401(k) Savings and Stock Ownership Plan
AFUDC Allowance for funds used during construction
the Agreement Stipulation and Settlement Agreement related to retail rate matters
ARO Asset retirement obligation
Bcf Billion cubic feet
Btu British thermal unit
CAIR Clean Air Interstate Rule
CAMR Clean Air Mercury Rule
CCO Competitive Commercial Operations business segment
CERCLA or Superfund Comprehensive Environmental Response, Compensation and Liability Act of
1980, as amended
Code Internal Revenue Code
Colona Colona Synfuel Limited Partnership, LLLP
the Company Progress Energy, Inc. and subsidiaries
CP&L Carolina Power & Light Company, d/b/a Progress Energy Carolinas, Inc.
CR3 Crystal River Unit No. 3
CVO Contingent value obligation
DOE United States Department of Energy
DWM North Carolina Department of Environment and Natural Resources, Division of
Waste Management
ECRC Environmental Cost Recovery Clause
EITF Emerging Issues Task Force
EMCs Electric Membership Cooperatives
EPA of 1992 Energy Policy Act of 1992
FASB Financial Accounting Standards Board
FDEP Florida Department of Environment and Protection
FERC Federal Energy Regulatory Commission
FIN No. 45 Financial Accounting Standards Board (FASB) Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others"
FIN No. 46R FASB Interpretation No. 46R, "Consolidation of Variable Interest Entities -
an Interpretation of ARB No. 51"
Florida Progress or FPC Florida Progress Corporation
FPSC Florida Public Service Commission
Fuels Fuels business segment
GAAP Accounting Principles Generally Accepted in the United States of America
Global U.S. Global LLC
the holding company Progress Energy Corporate
IRS Internal Revenue Service
Jackson Jackson Electric Membership Corporation
LIBOR London Inter Bank Offering Rate
MACT Maximum Achievable Control Technology
Medicare Act Medicare Prescription Drug, Improvement and Modernization Act of 2003
MGP Manufactured Gas Plant
MW Megawatt
MWh Megawatt-hour
NCUC North Carolina Utilities Commission
NOx Nitrogen Oxide
NOx SIP Call EPA rule which requires 22 states including North and South Carolina to
further reduce nitrogen oxide emissions.
NRC United States Nuclear Regulatory Commission
Nuclear Waste Act Nuclear Waste Policy Act of 1982
3
O&M Operations & Maintenance Expense
OPEB Postretirement benefits other than pensions
PEC Progress Energy Carolinas, Inc., formerly referred to as Carolina Power &
Light Company
PEC Electric PEC Electric business segment made up of the utility operations and
excludes operations of nonregulated subsidiaries
PEF Progress Energy Florida, formerly referred to as Florida Power Corporation
PFA IRS Prefiling Agreement
PLR Private Letter Ruling
Progress Energy Progress Energy, Inc.
Progress Fuels Progress Fuels Corporation, formerly Electric Fuels Corporation
Progress Rail Progress Rail Services Corporation
Progress Ventures Business unit of Progress Energy primarily made up of nonregulated energy
generation and marketing activities, as well as gas, coal and synthetic
fuel operations
PRP Potentially responsible party, as defined in CERCLA
PTC Progress Telecommunications Corporation
PT LLC Progress Telecom, LLC
PUHCA Public Utility Holding Company Act of 1935, as amended
PVI Progress Energy Ventures, Inc. (formerly referred to as CPL Energy
Ventures, Inc.)
Rail Services Rail Services business segment
RCA Revolving credit agreement
ROE Return on Equity
SCPSC Public Service Commission of South Carolina
SEC United States Securities and Exchange Commission
Section 29 Section 29 of the Internal Revenue Service Code
Service Company Progress Energy Service Company, LLC
SFAS Statement of Financial Accounting Standards
SFAS No. 5 Statement of Financial Accounting Standards No. 5, "Accounting for
Contingencies"
SFAS No. 71 Statement of Financial Accounting Standards No. 71, "Accounting for the
Effects of Certain Types of Regulation"
SFAS No. 123R Statement of Financial Accounting Standards No. 123R, "Accounting for
Stock-Based Compensation"
SFAS No. 133 Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative and Hedging Activities"
SFAS No. 138 Statement of Financial Accounting Standards No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities - An
Amendment of FASB Statement No. 133"
SFAS No. 143 Statement of Financial Accounting Standards No. 143, "Accounting for Asset
Retirement Obligations"
SFAS No. 148 Statement of Financial Accounting Standards No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure - An Amendment of FASB
Statement No. 123"
Smokestacks Act North Carolina Clean Smokestacks Act enacted in June 2002
SO2 Sulfur dioxide
SRS Strategic Resource Solutions Corp.
the Trust FPC Capital I
4
SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS
This combined report contains forward-looking statements within the meaning of
the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. The matters discussed throughout this combined Form 10-Q that are not
historical facts are forward-looking and, accordingly, involve estimates,
projections, goals, forecasts, assumptions, risks and uncertainties that could
cause actual results or outcomes to differ materially from those expressed in
the forward-looking statements.
In addition, forward-looking statements are discussed in "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
including, but not limited to, statements under the sub-heading "Results of
Operations" about trends and uncertainties, "Liquidity and Capital Resources"
about future liquidity requirements and "Other Matters" about the Company's
synthetic fuel facilities.
Any forward-looking statement is based on information current as of the date of
this report and speaks only as of the date on which such statement is made, and
neither Progress Energy, Inc. (Progress Energy or the Company) nor Progress
Energy Carolinas, Inc. (PEC) undertakes any obligation to update any
forward-looking statement or statements to reflect events or circumstances after
the date on which such statement is made.
Examples of factors that you should consider with respect to any forward-looking
statements made throughout this document include, but are not limited to, the
following: the impact of fluid and complex government laws and regulations,
including those relating to the environment; deregulation or restructuring in
the electric industry that may result in increased competition and unrecovered
(stranded) costs; the uncertainty regarding the timing, creation and structure
of regional transmission organizations; weather conditions that directly
influence the demand for electricity; the Company's ability to recover through
the regulatory process, and the timing of such recovery of, the costs associated
with the four hurricanes that impacted our service territory in 2004 or other
future significant weather events; recurring seasonal fluctuations in demand for
electricity; fluctuations in the price of energy commodities and purchased
power; economic fluctuations and the corresponding impact on the Company and its
subsidiaries' commercial and industrial customers; the ability of the Company's
subsidiaries to pay upstream dividends or distributions to it; the impact on the
facilities and the businesses of the Company from a terrorist attack; the
inherent risks associated with the operation of nuclear facilities, including
environmental, health, regulatory and financial risks; the ability to
successfully access capital markets on favorable terms; the ability of the
Company to maintain its current credit ratings and the impact on the Company's
financial condition and ability to meet its cash and other financial obligations
in the event its credit ratings are downgraded below investment grade; the
impact that increases in leverage may have on the Company; the impact of
derivative contracts used in the normal course of business by the Company;
investment performance of pension and benefit plans; the Company's ability to
control costs, including pension and benefit expense, and achieve its cost
management targets for 2007; the availability and use of Internal Revenue Code
Section 29 (Section 29) tax credits by synthetic fuel producers and the
Company's continued ability to use Section 29 tax credits related to its coal
and synthetic fuel businesses; the impact to the Company's financial condition
and performance in the event it is determined the Company is not entitled to
previously taken Section 29 tax credits; the impact of future accounting
pronouncements regarding uncertain tax positions; the outcome of Progress Energy
Florida's (PEF) rate proceeding in 2005 regarding its future base rates; the
Company's ability to manage the risks involved with the operation of its
nonregulated plants, including dependence on third parties and related
counter-party risks, and a lack of operating history; the Company's ability to
manage the risks associated with its energy marketing operations; the outcome of
any ongoing or future litigation or similar disputes and the impact of any such
outcome or related settlements; and unanticipated changes in operating expenses
and capital expenditures. Many of these risks similarly impact the Company's
subsidiaries.
These and other risk factors are detailed from time to time in the Company's and
PEC's filings with the United States Securities and Exchange Commission (SEC).
Many, but not all, of the factors that may impact actual results are discussed
in the Risk Factors sections of Progress Energy's and PEC's annual reports on
Form 10-K for the year ended December 31, 2004, which were filed with the SEC on
March 16, 2005. All such factors are difficult to predict, contain uncertainties
that may materially affect actual results and may be beyond the control of
Progress Energy and PEC. New factors emerge from time to time, and it is not
possible for management to predict all such factors, nor can it assess the
effect of each such factor on Progress Energy and PEC.
5
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
PROGRESS ENERGY, INC.
CONSOLIDATED INTERIM FINANCIAL STATEMENTS
March 31, 2005
UNAUDITED CONSOLIDATED STATEMENTS of INCOME
- ----------------------------------------------------------------------------------------
(in millions except per share data)
Three months ended March 31, 2005 2004
- ----------------------------------------------------------------------------------------
Operating revenues
Utility $ 1,783 $ 1,685
Diversified business 415 321
- ----------------------------------------------------------------------------------------
Total operating revenues 2,198 2,006
- ----------------------------------------------------------------------------------------
Operating expenses
Utility
Fuel used in electric generation 550 493
Purchased power 198 183
Operation and maintenance 406 363
Depreciation and amortization 208 202
Taxes other than on income 117 105
Diversified business
Cost of sales 395 311
Depreciation and amortization 39 41
Other 32 30
- ----------------------------------------------------------------------------------------
Total operating expenses 1,945 1,728
- ----------------------------------------------------------------------------------------
Operating income 253 278
- ----------------------------------------------------------------------------------------
Other income (expense)
Interest income 4 2
Other, net 2 (22)
- ----------------------------------------------------------------------------------------
Total other income (expense) 6 (20)
- ----------------------------------------------------------------------------------------
Interest charges
Net interest charges 166 161
Allowance for borrowed funds used during construction (3) (1)
- ----------------------------------------------------------------------------------------
Total interest charges, net 163 160
- ----------------------------------------------------------------------------------------
Income from continuing operations before income tax and 96 98
minority interest
Income tax benefit 1 2
- ----------------------------------------------------------------------------------------
Income from continuing operations before minority interest 97 100
Minority interest in subsidiaries' loss (income), net of tax 8 (1)
- ----------------------------------------------------------------------------------------
Income from continuing operations 105 99
Discontinued operations, net of tax (12) 9
- ----------------------------------------------------------------------------------------
Net income $ 93 $ 108
- ----------------------------------------------------------------------------------------
Average common shares outstanding 244 241
- ----------------------------------------------------------------------------------------
Basic earnings per common share
Income from continuing operations $ 0.43 $ 0.41
Discontinued operations, net of tax (0.05) 0.04
Net income $ 0.38 $ 0.45
- ----------------------------------------------------------------------------------------
Diluted earnings per common share
Income from continuing operations $ 0.43 $ 0.41
Discontinued operations, net of tax (0.05) 0.04
Net income $ 0.38 $ 0.45
- ----------------------------------------------------------------------------------------
Dividends declared per common share $ 0.590 $ 0.575
- ----------------------------------------------------------------------------------------
See Notes to Progress Energy, Inc. Consolidated Interim Financial Statements.
6
PROGRESS ENERGY, INC.
UNAUDITED CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------------------------------
(in millions) March 31, December 31,
2005 2004
- --------------------------------------------------------------------------------------------------------
ASSETS
Utility plant
Utility plant in service $ 22,117 $ 22,103
Accumulated depreciation (9,231) (8,783)
- --------------------------------------------------------------------------------------------------------
Utility plant in service, net 12,886 13,320
Held for future use 13 13
Construction work in progress 972 799
Nuclear fuel, net of amortization 251 231
- --------------------------------------------------------------------------------------------------------
Total utility plant, net 14,122 14,363
- --------------------------------------------------------------------------------------------------------
Current assets
Cash and cash equivalents 280 56
Short-term investments 229 82
Receivables 931 911
Inventory 772 805
Deferred fuel cost 235 229
Deferred income taxes 65 111
Assets of discontinued operations - 574
Prepayments and other current assets 291 174
- --------------------------------------------------------------------------------------------------------
Total current assets 2,803 2,942
- --------------------------------------------------------------------------------------------------------
Deferred debits and other assets
Regulatory assets 1,021 1,064
Nuclear decommissioning trust funds 1,078 1,044
Diversified business property, net 1,861 1,838
Miscellaneous other property and investments 480 444
Goodwill 3,719 3,719
Intangibles, net 330 337
Other assets and deferred debits 282 265
- --------------------------------------------------------------------------------------------------------
Total deferred debits and other assets 8,771 8,711
- --------------------------------------------------------------------------------------------------------
Total assets $ 25,696 $ 26,016
- --------------------------------------------------------------------------------------------------------
CAPITALIZATION AND LIABILITIES
- --------------------------------------------------------------------------------------------------------
Common stock equity
Common stock without par value, 500 million shares authorized,
249 and 247 million shares issued and outstanding, respectively $ 5,428 $ 5,360
Unearned restricted shares (1 and 1 million shares, respectively) (16) (13)
Unearned ESOP shares (3 and 3 million shares, respectively (65) (76)
Accumulated other comprehensive loss (159) (164)
Retained earnings 2,475 2,526
- --------------------------------------------------------------------------------------------------------
Total common stock equity 7,663 7,633
- --------------------------------------------------------------------------------------------------------
Preferred stock of subsidiaries-not subject to mandatory redemption 93 93
Minority interest 38 36
Long-term debt, affiliate 270 270
Long-term debt, net 8,728 9,251
- --------------------------------------------------------------------------------------------------------
Total capitalization 16,792 17,283
- --------------------------------------------------------------------------------------------------------
Current liabilities
Current portion of long-term debt 1,148 349
Accounts payable 582 630
Interest accrued 165 219
Dividends declared 146 145
Short-term obligations 691 684
Customer deposits 186 180
Liabilities of discontinued operations - 149
Other current liabilities 620 703
- --------------------------------------------------------------------------------------------------------
Total current liabilities 3,538 3,059
- --------------------------------------------------------------------------------------------------------
Deferred credits and other liabilities
Noncurrent income tax liabilities 603 625
Accumulated deferred investment tax credits 173 176
Regulatory liabilities 2,402 2,654
Asset retirement obligations 1,211 1,282
Other liabilities and deferred credits 977 937
- --------------------------------------------------------------------------------------------------------
Total deferred credits and other liabilities 5,366 5,674
- --------------------------------------------------------------------------------------------------------
Commitments and contingencies (Note 14)
- --------------------------------------------------------------------------------------------------------
Total capitalization and liabilities $ 25,696 $ 26,016
- --------------------------------------------------------------------------------------------------------
See Notes to Progress Energy, Inc. Consolidated Interim Financial Statements.
7
PROGRESS ENERGY, INC.
UNAUDITED CONSOLIDATED STATEMENTS of CASH FLOWS
- -----------------------------------------------------------------------------------------------------
(in millions)
Three Months Ended March 31, 2005 2004
- -----------------------------------------------------------------------------------------------------
Operating activities
Net income $ 93 $ 108
Adjustments to reconcile net income to net cash provided by operating
activities:
Discontinued operations, net of tax 12 (9)
Depreciation and amortization 276 271
Deferred income taxes 13 (7)
Investment tax credit (3) (4)
Deferred fuel cost 19 63
Other adjustments to net income 42 16
Cash provided (used) by changes in operating assets and
liabilities:
Receivables 4 50
Inventory (23) 6
Prepayments and other current assets (10) (20)
Accounts payable 38 (35)
Other current liabilities (156) (131)
Regulatory assets and liabilities (55) (7)
Other 29 66
- -----------------------------------------------------------------------------------------------------
Net cash provided by operating activities 279 367
- -----------------------------------------------------------------------------------------------------
Investing activities
Gross utility property additions (263) (242)
Diversified business property additions (49) (45)
Nuclear fuel additions (64) (39)
Proceeds from sales of subsidiaries and other investments 406 84
Purchases of short-term investments (1,840) (601)
Proceeds from sales of short-term investments 1,693 828
Other (49) (9)
- -----------------------------------------------------------------------------------------------------
Net cash used in investing activities (166) (24)
- -----------------------------------------------------------------------------------------------------
Financing activities
Issuance of common stock 60 29
Issuance of long-term debt 495 -
Net increase in short-term indebtedness 7 503
Retirement of long-term debt (216) (675)
Dividends paid on common stock (145) (141)
Other (48) (62)
- ---------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 153 (346)
- -----------------------------------------------------------------------------------------------------
Cash (used) provided by discontinued operations (42) 6
Net increase in cash and cash equivalents 224 3
Cash and cash equivalents at beginning of period 56 34
- -----------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 280 $ 37
- -----------------------------------------------------------------------------------------------------
See Notes to Progress Energy, Inc. Consolidated Interim Financial Statements.
8
PROGRESS ENERGY, INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
A. Basis of Presentation
These financial statements have been prepared in accordance with accounting
principles generally accepted in the United States of America (GAAP) for
interim financial information and with the instructions to Form 10-Q and
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by GAAP for annual statements. Because the accompanying
consolidated interim financial statements do not include all of the
information and footnotes required by GAAP, they should be read in
conjunction with the audited financial statements for the period ended
December 31, 2004, and notes thereto included in Progress Energy's Form
10-K for the year ended December 31, 2004.
In accordance with the provisions of Accounting Principles Board Opinion
(APB) No. 28, "Interim Financial Reporting," GAAP requires companies to
apply a levelized effective tax rate to interim periods that is consistent
with the estimated annual effective tax rate. Income tax expense was
increased by $3 million and $39 million for the three months ended March
31, 2005 and 2004, 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.
PEC and PEF collect from customers certain excise taxes levied by the state
or local government upon the customers. PEC and PEF account for excise
taxes on a gross basis. For the three months ended March 31, 2005 and 2004,
gross receipts tax, franchise taxes and other excise taxes of approximately
$57 million and $53 million, respectively, are included in utility revenues
and taxes other than on income in the Consolidated Statements of Income.
The amounts included in the consolidated interim financial statements are
unaudited but, in the opinion of management, reflect all normal recurring
adjustments necessary to fairly present the Company's financial position
and results of operations for the interim periods. Due to seasonal weather
variations and the timing of outages of electric generating units,
especially nuclear-fueled units, the results of operations for interim
periods are not necessarily indicative of amounts expected for the entire
year or future periods.
In preparing financial statements that conform with GAAP, management must
make estimates and assumptions that affect the reported amounts of assets
and liabilities, disclosure of contingent assets and liabilities at the
date of the financial statements and amounts of revenues and expenses
reflected during the reporting period. Actual results could differ from
those estimates. Certain amounts for 2004 have been reclassified to conform
to the 2005 presentation.
B. Stock-Based Compensation
The Company measures compensation expense for stock options as the
difference between the market price of its common stock and the exercise
price of the option at the grant date. The exercise price at which options
are granted by the Company equals the market price at the grant date, and
accordingly, no compensation expense has been recognized for stock option
grants. For purposes of the pro forma disclosures required by SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure - an
Amendment of FASB Statement No. 123" (SFAS No. 148), the estimated fair
value of the Company's stock options is amortized to expense over the
options' vesting period. The following table illustrates the effect on net
income and earnings per share if the fair value method had been applied to
all outstanding and unvested awards in each period:
9
-----------------------------------------------------------------------------------------------
(in millions except per share data) Three Months Ended March 31,
2005 2004
-----------------------------------------------------------------------------------------------
Net income, as reported $ 93 $ 108
Deduct: Total stock option expense determined under fair
value method for all awards, net of related tax effects 1 3
-----------------------------------------------------------------------------------------------
Pro forma net income $ 92 $ 105
-----------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------
Basic earnings per share
As reported $ 0.38 $ 0.45
Pro forma $ 0.38 $ 0.44
Fully diluted earnings per share
As reported $ 0.38 $ 0.45
Pro forma $ 0.38 $ 0.43
-----------------------------------------------------------------------------------------------
The Company expects to begin expensing stock options on July 1, 2005 (See
Note 2).
C. Consolidation of Variable Interest Entities
The Company consolidates all voting interest entities in which it owns a
majority voting interest and all variable interest entities for which it is
the primary beneficiary in accordance with FASB Interpretation No. 46R,
"Consolidation of Variable Interest Entities - An Interpretation of ARB No.
51" (FIN No. 46R). The Company is the primary beneficiary of and
consolidates two limited partnerships that qualify for federal affordable
housing and historic tax credits under Section 42 of the Internal Revenue
Code (Code). As of March 31, 2005, the total assets of the two entities
were $37 million, the majority of which are collateral for the entities'
obligations and are included in other current assets and miscellaneous
other property and investments in the Consolidated Balance Sheets.
The Company has an interest in a limited partnership that invests in 17
low-income housing partnerships that qualify for federal and state tax
credits. The Company also has interests in two power plants resulting from
long-term power purchase contracts. The Company has requested the necessary
information to determine if the 17 partnerships and the two power plant
owners are variable interest entities or to identify the primary
beneficiaries; all three entities declined to provide the Company with the
necessary financial information. Therefore, the Company has applied the
information scope exception in FIN No. 46R, paragraph 4(g) to the 17
partnerships and the two power plants. The Company believes that if it is
determined to be the primary beneficiary of any of these entities, the
effect of consolidating the entities would result in increases to total
assets, long-term debt and other liabilities, but would have an
insignificant or no impact on the Company's common stock equity, net
earnings or cash flows.
The Company also has interests in several other variable interest entities
for which the Company is not the primary beneficiary. These arrangements
include investments in approximately 28 limited partnerships, limited
liability corporations and venture capital funds and two building leases
with special-purpose entities. The aggregate maximum loss exposure at March
31, 2005, that the Company could be required to record in its income
statement as a result of these arrangements totals approximately $38
million. The creditors of these variable interest entities do not have
recourse to the general credit of the Company in excess of the aggregate
maximum loss exposure.
2. IMPACT OF NEW ACCOUNTING STANDARDS
PROPOSED FASB INTERPRETATION OF SFAS NO. 109, "ACCOUNTING FOR INCOME TAXES"
In July 2004, the Financial Accounting Standards Board (FASB) stated that
it plans to issue an exposure draft of a proposed interpretation of SFAS
No. 109, "Accounting for Income Taxes" (SFAS No. 109), that would address
the accounting for uncertain tax positions. The FASB has indicated that the
interpretation would require that uncertain tax benefits be probable of
being sustained in order to record such benefits in the consolidated
financial statements. The exposure draft is expected to be issued in the
second quarter of 2005. The Company cannot predict what actions the FASB
10
will take or how any such actions might ultimately affect the Company's
financial position or results of operations, but such changes could have a
material impact on the Company's evaluation and recognition of Section 29
tax credits (See Note 14).
SFAS NO. 123 (REVISED 2004), "SHARE-BASED PAYMENT" (SFAS NO. 123R)
In December 2004, the FASB issued SFAS No. 123R, which revises SFAS No.
123, "Accounting for Stock-Based Compensation," and supersedes Accounting
Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to
Employees." The key requirement of SFAS No. 123R is that the cost of
share-based awards to employees will be measured based on an award's fair
value at the grant date, with such cost to be amortized over the
appropriate service period. Previously, entities could elect to continue
accounting for such awards at their grant date intrinsic value under APB
Opinion No. 25, and the Company made that election. The intrinsic value
method resulted in the Company recording no compensation expense for stock
options granted to employees (See Note 1B).
As written, SFAS No. 123R had an original effective date of July 1, 2005
for the Company. In April 2005, the SEC delayed the effective date for
public companies, which resulted in a required effective date of January 1,
2006 for the Company. The SEC delayed the effective date due to concerns
that implementation in mid-year could make compliance more difficult and
make comparisons of quarterly reports more difficult. The Company currently
intends to implement SFAS No. 123R on the original effective date of July
1, 2005. The Company intends to implement the standard using the required
modified prospective method. Under that method and with a July 1, 2005
implementation, the Company will record compensation expense under SFAS No.
123R for all awards it grants after July 1, 2005, and it will record
compensation expense (as previous awards continue to vest) for the unvested
portion of previously granted awards that remain outstanding at July 1,
2005. In 2004, the Company made the decision to cease granting stock
options and replaced that compensation with alternative forms of
compensation. Therefore, the amount of stock option expense expected to be
recorded in 2005 is below the amount that would have been recorded if the
stock option program had continued. The Company expects to record
approximately $3 million of pre-tax expense for stock options in 2005.
FASB INTERPRETATION NO. 47, "ACCOUNTING FOR CONDITIONAL ASSET RETIREMENT
OBLIGATIONS"
On March 30, 2005, the FASB issued Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations," an interpretation of SFAS No.
143, "Accounting for Asset Retirement Obligations" (SFAS No. 143). The
interpretation clarifies that a legal obligation to perform an asset
retirement activity that is conditional on a future event is within the
scope of SFAS No. 143. Accordingly, an entity is required to recognize a
liability for the fair value of an asset retirement obligation that is
conditional on a future event if the liability's fair value can be
reasonably estimated. The interpretation also provides additional guidance
for evaluating whether sufficient information is available to make a
reasonable estimate of the fair value. The interpretation is effective for
the Company no later than December 31, 2005. The Company has not yet
determined the impact of the interpretation on its financial position,
results of operations or liquidity.
3. DIVESTITURES
Progress Rail Divestiture
On March 24, 2005, the Company completed the sale of Progress Rail to One
Equity Partners LLC, a private equity firm unit of J.P. Morgan Chase & Co.
Gross cash proceeds from the sale are estimated to be $433 million,
consisting of $405 million base proceeds plus an estimated working capital
adjustment. Proceeds from the sale were used to reduce debt.
Based on the estimated gross proceeds associated with the sale of $433
million, the Company recorded an estimated after-tax loss on disposal of
$17 million during the first quarter of 2005. The Company anticipates
adjustments to the loss on the divestiture during the second quarter of
2005 related to employee benefit settlements and the finalization of the
working capital adjustment and other operating estimates.
11
The accompanying consolidated interim financial statements have been
restated for all periods presented to reflect the operations of Progress
Rail as discontinued operations in the Consolidated Statements of Income.
Interest expense has been allocated to discontinued operations based on the
net assets of Progress Rail, assuming a uniform debt-to-equity ratio across
the Company's operations. Interest expense allocated for the three months
ended March 31, 2005 and 2004 was $4 million each period. The Company
ceased recording depreciation upon classification of the assets as
discontinued operations in February 2005. After-tax depreciation expense
recorded by Progress Rail during the three months ended March 31, 2005 and
2004 was $3 million and $2 million, respectively. Results of discontinued
operations were as follows:
------------------------------------------------------------------------------
Three Months Ended
March 31,
(in millions) 2005 2004
------------------------------------------------------------------------------
Revenues $ 358 $ 239
------------------------------------------------------------------------------
Earnings before income taxes $ 8 $ 12
Income tax expense 3 3
------------------------------------------------------------------------------
Net earnings from discontinued operations 5 9
Estimated loss on disposal of discontinued operations,
including income tax benefit of $14 (17) -
------------------------------------------------------------------------------
Earnings (loss) from discontinued operations $ (12) $ 9
------------------------------------------------------------------------------
Prior to the sale of Progress Rail, the results of operations of Progress
Rail were reported one month in arrears. Accordingly, the net loss from
discontinued operations for the first quarter of 2005 includes four months
of Progress Rail's operations.
In connection with the sale, Progress Fuels and Progress Energy provided
guarantees and indemnifications of certain legal, tax and environmental
matters to One Equity Partners, LLC. See discussion of the Company's
guarantees at Note 14A.
The major balance sheet classes included in assets and liabilities of
discontinued operations in the Consolidated Balance Sheets as of December
31, 2004 are as follows:
----------------------------------------------------------
(in millions)
----------------------------------------------------------
Accounts receivable $ 172
----------------------------------------------------------
Inventory 177
----------------------------------------------------------
Other current assets 18
Total property, plant and equipment, net 174
Total other assets 33
----------------------------------------------------------
Assets of discontinued operations $ 574
----------------------------------------------------------
Accounts payable $ 112
Accrued expenses 37
----------------------------------------------------------
Liabilities of discontinued operations $ 149
----------------------------------------------------------
In February 2004, the Company sold the majority of the assets of Railcar
Ltd., a subsidiary of Progress Rail, to The Andersons, Inc. for proceeds of
approximately $82 million.
4. REGULATORY MATTERS
PEF Retail Rate Matters
Hearings on PEF's petition for recovery of $252 million of storm costs
filed with the Florida Public Service Commission (FPSC) were held from
March 30, 2005 to April 1, 2005. The FPSC is scheduled to vote on the
Company's petition on June 14, 2005, with an order expected on July 5,
2005. The Company cannot predict the outcome of this matter.
12
On May 4, 2005, a bill was approved by the Florida Legislature that would
authorize the FPSC to consider allowing the state's investor-owned
utilities to issue bonds that are secured by surcharges on utility customer
bills. These bonds would be issued for recovery of storm damage costs and
potentially to restore depleted storm reserves. The amount of funds
established for recovery is subject to the review and approval of the FPSC.
The bill will now be sent to Governor Bush for his consideration. The
Governor has indicated that he supports the bill. The Company cannot
predict the outcome of this matter.
On April 29, 2005, PEF submitted minimum filing requirements, based on a
2006 projected test year, to initiate a base rate proceeding regarding its
future base rates. In its filing, PEF has requested a $206 million annual
increase in base rates effective January 1, 2006. PEF's request for an
increase in base rates reflects an increase in operational costs with (i)
the addition of Hines 2 generation facility into base rates rather than the
Fuel Clause as was permitted under the terms of existing Stipulation and
Settlement Agreement (the Agreement), (ii) completion of the Hines 3
generation facility, (iii) the need to replenish PEF's depleted storm
reserve by adjusting the annual accrual in light of recent history on a
going-forward basis, (iv) the expected infrastructure investment necessary
to meet high customer expectations, coupled with the demands placed on
PEF's strong customer growth, (v) significant additional costs including
increased depreciation and fossil dismantlement expenses and (vi) general
inflationary pressures.
Hearings on the base rate proceeding are expected during the third quarter
of 2005 and a final decision is expected by the end of 2005. The Company
cannot predict the outcome of this matter.
The FPSC requires that PEF perform a depreciation study no less than every
four years. PEF filed a depreciation study with the FPSC on April 29, 2005,
as part of the Company's base rate filing, which will increase depreciation
expense in 2006 by $14 million and forward if approved by the FPSC. The
Company cannot predict the outcome or impact of this matter. PEF reduced
its estimated removal costs to take into account the estimates used in the
depreciation study. This resulted in a downward revision in the PEF
estimated removal costs and equal increase in accumulated depreciation of
approximately $379 million.
The FPSC requires that PEF update its cost estimate for fossil
dismantlement every four years. PEF filed an updated fossil dismantlement
study with the FPSC on April 29, 2005, as part of the Company's base rate
filing, which will increase the accrual by $10 million and what PEF
collects in base rates for fossil dismantlement in 2006 and forward if
approved by the FPSC. PEF's retail reserve for fossil plant dismantlement
was approximately $133 million at March 31, 2005. Retail accruals on PEF's
reserves for fossil dismantlement were previously suspended through
December 2005 under the terms of PEF's existing Agreement. The Company
cannot predict the outcome or impact of this matter.
The FPSC requires that PEF update its cost estimate for nuclear
decommissioning every five years. PEF filed a new site-specific estimate of
decommissioning costs for the Crystal River Nuclear Plant (CR3) with the
FPSC on April 29, 2005 as part of the Company's base rate filing. PEF's
estimate was based on prompt decommissioning. The estimate, in 2005
dollars, is $614 million and is subject to change based on a variety of
factors including, but not limited to, cost escalation, changes in
technology applicable to nuclear decommissioning and changes in federal,
state or local regulations. The cost estimate excludes the portion
attributable to other co-owners of CR3. The NRC operating license held by
PEF for Crystal River Unit No. 3 (CR3) currently expires in December 2016.
An application to extend this license 20 years is expected to be submitted
in the first quarter of 2009. As part of this new estimate and assumed
license extension, PEF reduced its ARO liability by approximately $88
million at March 31, 2005. Retail accruals on PEF's reserves for nuclear
decommissioning were previously suspended through December 2005 under the
terms of the Agreement and the new study supports a continuation of that
suspension. The Company cannot predict the outcome or impact of this
matter.
13
PEC Retail Rate Matters
On April 27, 2005, PEC filed for an increase in the fuel rate charged to
its South Carolina customers with the Public Service Commission of South
Carolina (SCPSC). PEC is asking the SCPSC to approve a $97 million, or 21
percent, increase in rates. PEC requested the increase for underrecovered
fuel costs for the previous 15 months and to meet future expected fuel
costs. This request reflects increases in the prices of coal and natural
gas. If approved, the increase would take effect July 1, 2005. The Company
cannot predict the outcome of this matter.
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 2005, which indicated no impairment was
necessary. The annual impairment tests for the PEC Electric and PEF
segments will be performed in the second quarter of 2005.
The changes in the carrying amount of goodwill for the periods ended March
31, 2005 and December 31, 2004, by reportable segment, are as follows:
---------------------------------------------------------------------------------------------
(in millions) PEC Electric PEF CCO Other Total
---------------------------------------------------------------------------------------------
Balance as of January 1, 2004 $ 1,922 $ 1,733 $ 64 $ 7 $ 3,726
Purchase accounting adjustment - - - (7) (7)
---------------------------------------------------------------------------------------------
Balance as of December 31, 2004 $ 1,922 $ 1,733 $ 64 $ - $ 3,719
---------------------------------------------------------------------------------------------
Balance as of March 31, 2005 $ 1,922 $ 1,733 $ 64 $ - $ 3,719
---------------------------------------------------------------------------------------------
The gross carrying amount and accumulated amortization of the Company's
intangible assets at March 31, 2005 and December 31, 2004, are as follows:
------------------------------------------------------------------------------------------------
March 31, 2005 December 31, 2004
------------------------------------------------------------------------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
(in millions) Amount Amortization Amount Amortization
------------------------------------------------------------------------------------------------
Synthetic fuel intangibles $ 134 $ (84) $ 134 $ (80)
Power agreements acquired 188 (8) 188 (6)
Other 119 (19) 119 (18)
------------------------------------------------------------------------------------------------
Total $ 441 $ (111) $ 441 $ (104)
------------------------------------------------------------------------------------------------
Amortization expense recorded on intangible assets for the three months
ended March 31, 2005 and 2004, was $7 million and $10 million,
respectively. The estimated annual amortization expense for intangible
assets for 2005 through 2009, in millions, is approximately $35, $36, $36,
$18 and $18, respectively.
6. EQUITY AND COMPREHENSIVE INCOME
A. Earnings Per Common Share
A reconciliation of the weighted-average number of common shares
outstanding for basic and dilutive earnings per share purposes is as
follows:
---------------------------------------------------------------------------
Three Months Ended March 31,
(in millions) 2005 2004
---------------------------------------------------------------------------
Weighted-average common shares - basic 244 241
Restricted stock awards 1 1
--------------------------------------------------------------------------
Weighted-average shares - fully dilutive 245 242
---------------------------------------------------------------------------
14
B. Comprehensive Income
-------------------------------------------------------------------------------------------
Three Months Ended
March 31,
(in millions) 2005 2004
------------------------------------------------------------------------------------------
Net income $ 93 $ 108
Other comprehensive income (loss):
Reclassification adjustments included in net income:
Change in cash flow hedges (net of tax expense of
$1 and $2, respectively) 2 4
Foreign currency translation adjustments included in
discontinued operations (6) -
Minimum pension liability adjustment included in
discontinued operations (net of tax expense of $1) 1 -
Changes in net unrealized gains (losses) on cash flow hedges
(net of tax expense (benefit) of $5 and ($8), respectively) 6 (17)
Foreign currency translation adjustment and other 2 2
------------------------------------------------------------------------------------------
Other comprehensive income (loss) $ 5 $ (11)
------------------------------------------------------------------------------------------
Comprehensive income $ 98 $ 97
------------------------------------------------------------------------------------------
C. Common Stock
At December 31, 2004, the Company had approximately 63 million shares of
common stock authorized by the Board of Directors that remained unissued
and reserved. In 2002, the Board of Directors authorized meeting the
requirements of the Progress Energy 401(k) Savings and Stock Ownership Plan
and the Investor Plus Stock Purchase Plan with original issue shares. For
the three months ended March 31, 2005, the Company issued approximately 1.3
million shares under these plans for net proceeds of approximately $58
million.
7. DEBT AND CREDIT FACILITIES AND FINANCING ACTIVITIES
Changes to the Company's debt and credit facilities since December 31,
2004, discussed in Note 13 of the Company's 2004 Annual Report on Form
10-K, are described below.
In January 2005, the Company used proceeds from the issuance of commercial
paper to pay off $260 million of revolving credit agreement (RCA) loans,
which included $90 million at PEC and $170 million at PEF.
On January 31, 2005, Progress Energy, Inc. entered into a new $600 million
RCA, which expires December 30, 2005. This facility was added to provide
additional liquidity during 2005 due in part to the uncertainty of the
timing of storm restoration cost recovery from the hurricanes in Florida
during 2004. The RCA includes a defined maximum total debt to total capital
ratio of 68% and a minimum interest coverage ratio of 2.5 to 1. The RCA
also contains various cross-default and other acceleration provisions. On
February 4, 2005, $300 million was drawn under the new facility to reduce
commercial paper and pay off the remaining amount of loans outstanding
under other RCA facilities, which consisted of $160 million at Progress
Energy and $55 million at PEF. As discussed below, the maximum size of this
RCA was reduced to $300 million on March 22, 2005.
On March 22, 2005, PEC issued $300 million of First Mortgage Bonds, 5.15%
Series due 2015, and $200 million of First Mortgage Bonds, 5.70% Series due
2035. The net proceeds from the sale of the bonds were used to pay off $300
million of its 7.50% Senior Notes on April 1, 2005, and reduce the
outstanding balance of commercial paper. Pursuant to the terms of the
Progress Energy $600 million RCA, commitments were reduced to $300 million,
effective March 22, 2005.
In March 2005, Progress Energy, Inc.'s five-year credit facility was
amended to increase the maximum total debt to total capital ratio from 65%
to 68% due to the potential impacts of proposed accounting rules for
uncertain tax positions (See Note 2).
15
On March 28, 2005, PEF entered into a new $450 million RCA with a
syndication of financial institutions. The RCA will be used to provide
liquidity support for PEF's issuances of commercial paper and other
short-term obligations. The RCA will expire on March 28, 2010. The new $450
million RCA replaced PEF's $200 million three-year RCA and $200 million
364-day RCA, which were each terminated effective March 28, 2005. Fees and
interest rates under the $450 million RCA are to be determined based upon
the credit rating of PEF's long-term unsecured senior non-credit enhanced
debt, currently rated as A3 by Moody's Investor Services (Moody's) and BBB
by Standard and Poor's (S&P). The RCA includes a defined maximum total debt
to capital ratio of 65%. The RCA also contains various cross-default and
other acceleration provisions, including a cross-default provision for
defaults of indebtedness in excess of $35 million. The RCA does not include
a material adverse change representation for borrowings or a financial
covenant for interest coverage, which had been provisions in the terminated
agreements.
On March 28, 2005, PEC entered into a new $450 million RCA with a
syndication of financial institutions. The RCA will be used to provide
liquidity support for PEC's issuances of commercial paper and other
short-term obligations. The RCA will expire on June 28, 2010. The new $450
million RCA replaced PEC's $285 million three-year RCA and $165 million
364-day RCA, which were each terminated effective March 28, 2005. Fees and
interest rates under the $450 million RCA are to be determined based upon
the credit rating of PEC's long-term unsecured senior non-credit enhanced
debt, currently rated as Baa1 by Moody's and BBB by S&P. The RCA includes a
defined maximum total debt to capital ratio of 65%. The RCA also contains
various cross-default and other acceleration provisions, including a
cross-default provision for defaults of indebtedness in excess of $35
million. The RCA does not include a material adverse change representation
for borrowings, which had been a provision in the terminated agreements.
8. BENEFIT PLANS
The Company and some of its subsidiaries have a noncontributory defined
benefit retirement (pension) plan for substantially all full-time
employees. The Company also has supplementary defined benefit pension plans
that provide benefits to higher-level employees. In addition to pension
benefits, the Company and some of its subsidiaries provide contributory
other postretirement benefits (OPEB), including certain health care and
life insurance benefits, for retired employees who meet specified criteria.
The components of the net periodic benefit cost for the three months ended
March 31 are:
----------------------------------------------------------------------------------------------
Other Postretirement
Pension Benefits Benefits
----------------------- ----------------------
(in millions) 2005 2004 2005 2004
----------------------------------------------------------------------------------------------
Service cost $ 15 $ 13 $ 3 $ 4
Interest cost 29 28 8 8
Expected return on plan assets (37) (37) (1) (1)
Amortization of actuarial loss 6 5 1 1
Other amortization, net 1 - - 1
----------------------------------------------------------------------------------------------
Net periodic cost $ 14 $ 9 $ 11 $ 13
Additional cost / (benefit) recognition (a) (4) (4) 1 1
----------------------------------------------------------------------------------------------
Net periodic cost recognized $ 10 $ 5 $ 12 $ 14
----------------------------------------------------------------------------------------------
(a) Relates to the acquisition of FPC. See Note 17B of Progress Energy's
Form 10-K for year ended December 31, 2004.
9. RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS
Progress Energy and its subsidiaries are exposed to various risks related
to changes in market conditions. The Company has a risk management
committee that includes senior executives from various business groups. The
risk management committee is responsible for administering risk management
policies and monitoring compliance with those policies by all subsidiaries.
Under its risk policy, the Company may use a variety of instruments,
including swaps, options and forward contracts, to manage exposure to
fluctuations in commodity prices and interest rates. Such instruments
contain credit risk if the counterparty fails to perform under the
16
contract. The Company minimizes such risk by performing credit reviews
using, among other things, publicly available credit ratings of such
counterparties. See Note 18 to the Company's Annual Report on Form 10-K for
the year ended December 31, 2004.
A. Commodity Derivatives
General
Most of the Company's commodity contracts are not derivatives pursuant to
SFAS No. 133 or qualify as normal purchases or sales pursuant to SFAS No.
133. Therefore, such contracts are not recorded at fair value.
In 2003, PEC recorded a $38 million pre-tax ($23 million after-tax) fair
value loss transition adjustment pursuant to the provisions of DIG Issue
C20, "Scope Exceptions: Interpretation of the Meaning of Not Clearly and
Closely Related in Paragraph 10(b) regarding Contracts with a Price
Adjustment Feature." The related liability is being amortized to earnings
over the term of the related contract (See Note 12). At March 31, 2005 and
December 31, 2004, the remaining liability was $25 million and $26 million,
respectively.
Economic Derivatives
Derivative products, primarily electricity and natural gas contracts, may
be entered into from time to time for economic hedging purposes. While
management believes the economic hedges mitigate exposures to fluctuations
in commodity prices, these instruments are not designated as hedges for
accounting purposes and are monitored consistent with trading positions.
The Company manages open positions with strict policies that limit its
exposure to market risk and require daily reporting to management of
potential financial exposures. The Company recorded a $2 million pre-tax
gain and a $12 million pre-tax loss on such contracts for the three months
ended March 31, 2005 and 2004, respectively. The Company did not have
material outstanding positions in such contracts at March 31, 2005 and
December 31, 2004.
PEF has derivative instruments related to its exposure to price
fluctuations on fuel oil purchases. At March 31, 2005, the fair values of
these instruments were a $34 million short-term derivative asset position
included in other current assets and a $23 million long-term derivative
asset position included in other assets and deferred debits. At December
31, 2004, the fair values of these instruments were a $2 million long-term
derivative asset position included in other assets and deferred debits and
a $5 million short-term derivative liability position included in other
current liabilities. These instruments receive regulatory accounting
treatment. Unrealized gains and losses are recorded in regulatory
liabilities and regulatory assets, respectively.
Cash Flow Hedges
Progress Energy's subsidiaries designate a portion of commodity derivative
instruments as cash flow hedges under SFAS No. 133. The objective for
holding these instruments is to hedge exposure to market risk associated
with fluctuations in the price of natural gas for the Company's forecasted
purchases and sales. Realized gains and losses are recorded net in
operating revenues or operating expenses, as appropriate. The ineffective
portion of commodity cash flow hedges for the three months ending March 31,
2005 and 2004 was not material to the Company's results of operations.
The fair values of commodity cash flow hedges at March 31, 2005 and
December 31, 2004 were as follows:
--------------------------------------------------------
(in millions) March 31, December 31,
2005 2004
--------------------------------------------------------
Fair value of assets $ 19 $ -
Fair value of liabilities (26) (15)
--------------------------------------------------------
Fair value, net $ (7) $ (15)
--------------------------------------------------------
17
The following table presents selected information related to the Company's
commodity cash flow hedges at March 31, 2005:
------------------------------------------------------------------------------------
Accumulated Other Portion Expected to
Comprehensive be Reclassified to
(term in years/ Maximum Income/(Loss), net of Earnings during the
millions of dollars) Term(a) tax Next 12 Months(b)
------------------------------------------------------------------------------------
Commodity cash flow
hedges 10 $ (5) $ (16)
------------------------------------------------------------------------------------
(a) Hedges in fair value liability positions have a maximum term of less
than two years and hedges in fair value asset positions have a maximum term
of 10 years.
(b) Due to the volatility of the commodities markets, the value in
accumulated other comprehensive income/(loss) (OCI) is subject to change
prior to its reclassification into earnings.
B. Interest Rate Derivatives - Fair Value or Cash Flow Hedges
The Company uses cash flow hedging strategies to hedge variable interest
rates on long-term and short-term debt and to hedge interest rates with
regard to future fixed-rate debt issuances. The Company uses fair value
hedging strategies to manage its exposure to fixed interest rates on
long-term debt. The notional amounts of interest rate derivatives are not
exchanged and do not represent exposure to credit loss. In the event of
default by the counterparty, the risk in these transactions is the cost of
replacing the agreements at current market rates.
The fair values of interest rate hedges at March 31, 2005 and December 31,
2004 were as follows:
------------------------------------------------------------------
March 31, December 31,
(in millions) 2005 2004
------------------------------------------------------------------
Interest rate cash flow hedges $ 2 $ (2)
Interest rate fair value hedges $ - $ 3
------------------------------------------------------------------
Cash Flow Hedges
Gains and losses from cash flow hedges are recorded in OCI and amounts
reclassified to earnings are included in net interest charges as the hedged
transactions occur. Amounts in OCI related to terminated hedges are
reclassified to earnings as the hedged interest payments occur. The
ineffective portion of interest rate cash flow hedges for the three months
ending March 31, 2005 and 2004 was not material to the Company's results of
operations
The following table presents selected information related to the Company's
interest rate cash flow hedges included in OCI at March 31, 2005:
-------------------------------------------------------------------------------------
Accumulated Other Portion Expected to
Comprehensive be Reclassified to
(term in years/ Maximum Income/(Loss), net of Earnings during the
millions of dollars) Term tax(a) Next 12 Months(b)
-------------------------------------------------------------------------------------
Interest rate cash
flow hedges 1 $ (15) $ (3)
-------------------------------------------------------------------------------------
(a) Includes amounts related to terminated hedges.
(b) Actual amounts that will be reclassified to earnings may vary from the
expected amounts presented above as a result of changes in interest rates.
As of March 31, 2005 and December 31, 2004, the Company had $275 million
notional and $331 million notional, respectively, of interest rate cash
flow hedges.
18
Fair Value Hedges
For interest rate fair value hedges, the change in the fair value of the
hedging derivative is recorded in net interest charges and is offset by the
change in the fair value of the hedged item. As of March 31, 2005 and
December 31, 2004, the Company had $150 million notional of interest rate
fair value hedges.
10. SEVERANCE COSTS
On February 28, 2005, as part of a previously announced cost management
initiative, the Company approved a workforce restructuring which is
expected to be completed in September 2005 and result in a reduction of
approximately 450 positions. The cost management initiative is designed to
permanently reduce by $75 million to $100 million the projected growth in
the Company's annual operation and maintenance (O&M) expenses by the end of
2007. In addition to the workforce restructuring, the cost management
initiative includes a voluntary enhanced retirement program. In connection
with this initiative, the Company currently expects to incur estimated
pre-tax charges of approximately $210 million for severance and
postretirement benefits as described below. In addition, the Company
expects to incur certain incremental costs other than severance and
postretirement benefits for recruiting, training and staff augmentation
activities that cannot be quantified at this time.
The Company recorded $31 million of expense during the first quarter of
2005 for the estimated severance benefits to be paid as a result of the
approximate number of positions to be eliminated under the restructuring
and due to the implementation of an automated meter reading initiative at
PEF. These amounts will be paid over time and are subject to revision in
future quarters based on the impact of the voluntary enhanced retirement
program. The severance expenses are primarily included in O&M expense on
the Consolidated Statements of Income.
The activity in the severance liability is as follows:
--------------------------------------------------------
(in millions)
--------------------------------------------------------
Balance as of January 1, 2005 $ 5
Severance Costs Accrued 31
Payments (1)
--------------------------------------------------------
Balance as of March 31, 2005 $ 35
--------------------------------------------------------
The Company has estimated that an additional $180 million charge will be
recognized in the second quarter of 2005 that relates primarily to
postretirement benefits that will be paid over time to those eligible
employees who elected to participate in the voluntary enhanced retirement
program. Approximately 3,500 of the Company's 12,300 employees were
eligible to participate in the voluntary enhanced retirement program. The
results from the employee elections indicate that 1,447 of the Company's
employees have elected to participate in the voluntary enhanced retirement
program. The cost management initiative charges could change significantly
primarily due to the demographics of the specific employees who elected
enhanced retirement and its impact on the postretirement benefit actuarial
studies.
11. FINANCIAL INFORMATION BY BUSINESS SEGMENT
The Company currently provides services through the following business
segments: PEC Electric, PEF, Fuels, CCO and Synthetic Fuels. Prior to 2005,
Rail Services was reported as a separate segment. In connection with the
divestiture of Progress Rail (see Note 3), the operations of Rail Services
were reclassified to discontinued operations in the first quarter of 2005
and therefore are not included in the results from continuing operations
during the periods reported. In addition, Synthetic Fuel activities were
reported in the Fuels segment prior to 2005 and now are considered a
reportable segment. These reportable segment changes reflect the current
reporting structure. For comparative purposes, the prior year results have
been restated to align with the current presentation.
19
PEC Electric and PEF are primarily engaged in the generation, transmission,
distribution and sale of electric energy in portions of (i) North Carolina
and South Carolina and (ii) Florida, respectively. These electric
operations are subject to the rules and regulations of the FERC, the NCUC,
the SCPSC, the FPSC and the United States Nuclear Regulatory Commission
(NRC). These electric operations also distribute and sell electricity to
other utilities, primarily on the east coast of the United States.
Fuels' operations, which are located throughout the United States, are
involved in natural gas drilling and production, coal terminal services,
coal mining and fuel transportation and delivery.
CCO's operations, which are located primarily in Georgia, North Carolina
and Florida, include nonregulated electric generation operations and
marketing activities.
Synthetic Fuel operations include the production and sale of synthetic fuel
as defined under the Internal Revenue Code and the operation of synthetic
fuel facilities for outside parties. These facilities are located in West
Virginia, Virginia and Kentucky. See Note 14 for more information.
In addition to these reportable operating segments, the Company has
Corporate and other activities that include holding company and service
company operations as well as other nonregulated business areas. These
nonregulated business areas include telecommunications and energy service
operations and other nonregulated subsidiaries that do not separately meet
the disclosure requirements of SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." The profit or loss of the
identified segments plus the loss of Corporate and Other represents the
Company's total income from continuing operations.
------------------------------------------------------------------------------------------------------------
Revenues
-----------------------------------------------
(in millions) Unaffiliated Intersegment Total Income from Assets
Continuing
Operations
------------------------------------------------------------------------------------------------------------
FOR THE THREE MONTHS
ENDED MARCH 31, 2005
--------------------------
PEC Electric $ 935 $ - $ 935 $ 116 $ 10,953
PEF 848 - 848 43 7,663
Fuels 136 307 443 10 721
CCO 65 - 65 (5) 1,699
Synthetic Fuels 198 - 198 (1) 302
Corporate and Other 16 102 118 (58) 17,778
Eliminations - (409) (409) - (13,420)
------------------------------------------------------------------------------------------------------------
Consolidated totals $ 2,198 $ - $ 2,198 $ 105 $ 25,696
------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
FOR THE THREE MONTHS
ENDED MARCH 31, 2004
-
--------------------------
PEC Electric $ 901 $ - $ 901 $ 116
PEF 784 - 784 49
Fuels 98 269 367 10
CCO 33 - 33 (8)
Synthetic Fuels 172 4 176 36
Corporate and Other 18 97 115 (104)
Eliminations - (370) (370) -
----------------------------------------------------------------------------------------------
Consolidated totals $ 2,006 $ - $ 2,006 $ 99
----------------------------------------------------------------------------------------------
20
12. OTHER INCOME AND OTHER EXPENSE
Other income and expense includes interest income and other income and
expense items as discussed below. The components of other, net as shown on
the accompanying Consolidated Statements of Income are as follows:
---------------------------------------------------------------------------------
Three Months Ended
March 31,
(in millions) 2005 2004
---------------------------------------------------------------------------------
Other income
Nonregulated energy and delivery services income $ 6 $ 6
DIG Issue C20 amortization (See Note 9) 1 2
Investment gains 2 2
AFUDC equity 3 2
Other 7 5
---------------------------------------------------------------------------------
Total other income $ 19 $ 17
---------------------------------------------------------------------------------
Other expense
Nonregulated energy and delivery services expenses $ 5 $ 4
Donations 4 7
Contingent value obligations unrealized loss - 7
Loss from equity investments 3 2
Write-off of non-trade receivables - 7
Other 5 12
---------------------------------------------------------------------------------
Total other expense $ 17 $ 39
---------------------------------------------------------------------------------
Other, net $ 2 $ (22)
---------------------------------------------------------------------------------
Nonregulated energy and delivery services include power protection services
and mass-market programs (surge protection, appliance services and area
light sales) and delivery, transmission and substation work for other
utilities.
13. ENVIRONMENTAL MATTERS
The Company is subject to federal, state and local regulations addressing
hazardous and solid waste management, air and water quality and other
environmental matters. See Note 22 of the Company's 2004 Annual Report on
Form 10-K for a more detailed, historical discussion of these federal,
state, and local regulations.
HAZARDOUS AND SOLID WASTE MANAGEMENT
The provisions of the Comprehensive Environmental Response, Compensation
and Liability Act of 1980, as amended (CERCLA), authorize the EPA to
require the cleanup of hazardous waste sites. This statute imposes
retroactive joint and several liabilities. Some states, including North and
South Carolina and Florida, have similar types of legislation. The Company
and its subsidiaries are periodically notified by regulators, including the
EPA and various state agencies, of their involvement or potential
involvement in sites that may require investigation and/or remediation.
There are presently several sites with respect to which the Company has
been notified by the EPA, the State of North Carolina or the State of
Florida of its potential liability, as described below in greater detail.
The Company also is currently in the process of assessing potential costs
and exposures at other sites. For all sites, as the assessments are
developed and analyzed, the Company will accrue costs for the sites to the
extent the costs are probable and can be reasonably estimated. A discussion
of sites by legal entity follows.
Various organic materials associated with the production of manufactured
gas, generally referred to as coal tar, are regulated under federal and
state laws. PEC and PEF are each potentially responsible parties (PRPs) at
several manufactured gas plant (MGP) sites.
21
PEC, PEF and Progress Fuels Corporation have filed claims with the
Company's general liability insurance carriers to recover costs arising
from 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.
PEC
There are nine former MGP sites and a number of other sites associated with
PEC that have required or are anticipated to require investigation and/or
remediation.
During the fourth quarter of 2004, the EPA advised PEC that it had been
identified as a PRP at the Ward Transformer site located in Raleigh, North
Carolina. The EPA offered PEC and 34 other PRPs the opportunity to
negotiate cleanup of the site and reimbursement of less than $2 million to
the EPA for EPA's past expenditures in addressing conditions at the site.
Although a loss is considered probable, an agreement among PRPs has not
been reached; consequently, it is not possible at this time to reasonably
estimate the total amount of PEC's obligation for remediation of the Ward
Transformer site.
As of March 31, 2005 and December 31, 2004, PEC's accruals for probable and
estimable costs related to various environmental sites, which are included
in other liabilities and deferred credits and are expected to be paid out
over many years, were:
---------------------------------------------------------------------------------------
(in millions) March 31, 2005 December 31, 2004
---------------------------------------------------------------------------------------
Insurance fund $ 5 $ 7
Transferred from North Carolina Natural Gas 2 2
Corporation at time of sale
---------------------------------------------------------------------------------------
Total accrual for environmental sites $ 7 $ 9
---------------------------------------------------------------------------------------
The insurance fund in the table above was established when PEC received
insurance proceeds to address costs associated with environmental
liabilities related to its involvement with some sites. All eligible
expenses related to these are charged against a specific fund containing
these proceeds. PEC made no additional accruals, spent approximately $2
million related to environmental remediation and received no insurance
proceeds for the three months ended March 31, 2005.
This accrual has been recorded on an undiscounted basis. PEC measures its
liability for these sites based on available evidence including its
experience in investigating and remediating environmentally impaired sites.
The process often involves assessing and developing cost-sharing
arrangements with other PRPs. PEC will accrue costs for the sites to the
extent its liability is probable and the costs can be reasonably estimated.
Because the extent of environmental impact, allocation among PRPs for all
sites, remediation alternatives (which could involve either minimal or
significant efforts), and concurrence of the regulatory authorities have
not yet reached the stage where a reasonable estimate of the remediation
costs can be made, PEC cannot determine the total costs that may be
incurred in connection with the remediation of all sites at this time. It
is anticipated that sufficient information will become available for
several sites during 2005 to allow a reasonable estimate of PEC's
obligation for those sites to be made.
On March 30, 2005, the North Carolina Division of Water Quality renewed a
PEC permit for the continued use of coal combustion products generated at
any of the Company's coal-fired plants located in the state. The Company
has reviewed the permit conditions, which could significantly restrict the
reuse of coal ash and result in higher ash management costs and plans to
adjudicate the permit conditions. The Company cannot predict the outcome of
this matter.
22
PEF
As of March 31, 2005 and December 31, 2004, PEF's accruals for probable and
estimable costs related to various environmental sites, which are included
in other liabilities and deferred credits and are expected to be paid out
over many years, were:
-------------------------------------------------------------------------------------------------
(in millions) March 31, 2005 December 31, 2004
-------------------------------------------------------------------------------------------------
Remediation of distribution and substation transformers $ 25 $ 27
MGP and other sites 18 18
-------------------------------------------------------------------------------------------------
Total accrual for environmental sites $ 43 $ 45
-------------------------------------------------------------------------------------------------
PEF has received approval from the FPSC for recovery of costs associated
with the remediation of distribution and substation transformers through
the Environmental Cost Recovery Clause (ECRC). Under agreements with the
Florida Department of Environmental Protection (FDEP), PEF is in the
process of examining distribution transformer sites and substation sites
for potential equipment integrity issues that could result in the need for
mineral oil impacted soil remediation. PEF has reviewed a number of
distribution transformer sites and all substation sites. PEF expects to
have completed its review of distribution transformer sites by the end of
2007. Should further sites be identified, PEF believes that any estimated
costs would also be recovered through the ECRC. For the three months ended
March 31, 2005, PEF made no additional accruals and spent approximately $2
million related to the remediation of transformers. PEF has recorded a
regulatory asset for the probable recovery of these costs through the ECRC.
The amounts for MGP and other sites, in the table above, relate to two
former MGP sites and other sites associated with PEF that have required or
are anticipated to require investigation and/or remediation. In 2004, PEF
received approximately $12 million in insurance claim settlement proceeds
and recorded a related accrual for associated environmental expenses, as
these insurance proceeds are restricted for use in addressing costs
associated with environmental liabilities. PEF made no additional accruals
or material expenditures and received no insurance proceeds, for the three
months ended March 31, 2005.
These accruals have been recorded on an undiscounted basis. PEF measures
its liability for these sites based on available evidence including its
experience in investigating and remediating environmentally impaired sites.
This process often includes assessing and developing cost-sharing
arrangements with other PRPs. Because the extent of environmental impact,
allocation among PRPs for all sites, remediation alternatives (which could
involve either minimal or significant efforts), and concurrence of the
regulatory authorities have not yet advanced to the stage where a
reasonable estimate of the remediation costs can be made, at this time PEF
is unable to provide an estimate of its obligation to remediate these sites
beyond what is currently accrued. As more activity occurs at these sites,
PEF will assess the need to adjust the accruals. It is anticipated that
sufficient information will become available in 2005 to make a reasonable
estimate of PEF's obligation for one of the MGP sites.
In Florida, a risk-based corrective action (RBCA, known as Global RBCA)
rule was developed by the FDEP and adopted at the February 2, 2005,
Environmental Review Commission hearing. Risk-based corrective action
generally means that the corrective action prescribed for contaminated
sites can correlate to the level of human health risk imposed by the
contamination at the property. The Global RBCA rule expands the use of the
risk-based corrective action to all contaminated sites in the state that
are not currently in one of the state's waste cleanup programs and has the
potential for making future cleanups in Florida more costly to complete.
The effective date of the Global RBCA rule was April 17, 2005. The Company
is in the process of assessing the impact of this rule.
Florida Progress Corporation
In 2001, FPC established an accrual to address indemnities and retained an
environmental liability associated with the sale of its Inland Marine
Transportation business. In 2003, the accrual was reduced to $4 million
based on a change in estimate. As of March 31, 2005 and December 31, 2004,
the remaining accrual balance was approximately $3 million. Expenditures
related to this liability were not material to the Company's financial
condition for the three months ended March 31, 2005. FPC measures its
liability for these exposures based on estimable and probable remediation
scenarios.
23
Certain historical sites are being addressed voluntarily by FPC. An
immaterial accrual has been established to address investigation expenses
related to these sites. At this time, the Company cannot determine the
total costs that may be incurred in connection with these sites.
Progress Rail
On March 24, 2005, the Company closed on the sale of its Progress Rail
subsidiary. In connection with the sale, the Company incurred indemnity
obligations related to certain pre-closing liabilities, including certain
environmental matters (see discussion under Guarantees in Note 14A).
AIR QUALITY
The Company is subject to various current and proposed federal, state, and
local environmental compliance laws and regulations, which may result in
increased planned capital expenditures and operating and maintenance costs.
Significant updates to these laws and regulations and related impacts to
the Company since December 31, 2004, are discussed below. Additionally,
Congress is considering legislation that would require reductions in air
emissions of NOx, SO2, carbon dioxide and mercury. Some of these proposals
establish nationwide caps and emission rates over an extended period of
time. This national multi-pollutant approach to air pollution control could
involve significant capital costs that could be material to the Company's
consolidated financial position or results of operations. Control equipment
that will be installed on North Carolina fossil generating facilities as
part of the North Carolina Clean Smokestacks Act (Smokestacks Act), enacted
in 2002 and discussed below, may address some of the issues outlined above.
However, the Company cannot predict the outcome of the matter.
The EPA is conducting an enforcement initiative related to a number of
coal-fired utility power plants in an effort to determine whether changes
at those facilities were subject to New Source Review requirements or New
Source Performance Standards under the Clean Air Act. The Company was asked
to provide information to the EPA as part of this initiative and cooperated
in supplying the requested information. The EPA initiated civil enforcement
actions against other unaffiliated utilities as part of this initiative.
Some of these actions resulted in settlement agreements calling for
expenditures by these unaffiliated utilities in excess of $1.0 billion.
These settlement agreements have generally called for expenditures to be
made over extended time periods, and some of the companies may seek
recovery of the related cost through rate adjustments or similar
mechanisms.
Total capital expenditures to meet the requirements of the final rule under
Section 110 of the Clean Air Act (NOx SIP Call) in North and South Carolina
could reach approximately $370 million. This amount also includes the cost
to install NOx controls under North Carolina's and South Carolina's
programs to comply with the federal 8-hour ozone standard. However, further
technical analysis and rulemaking may result in requirements for additional
controls at some units. To date, the Company has spent approximately $303
million related to these projected amounts. Increased operation and
maintenance costs relating to the NOx SIP Call are not expected to be
material to the Company's results of operations. Further controls are
anticipated as electricity demand increases. Parties unrelated to the
Company have undertaken efforts to have Georgia excluded from the rule and
its requirements. Georgia has not yet submitted a state implementation plan
to comply with the Section 110 NOx SIP Call. The Company cannot predict the
outcome of this matter for the impact to its nonregulated operations in
Georgia.
The Company projects that its capital costs to meet emission targets for
NOx and SO2 from coal-fired power plants under the Smokestacks Act, will
total approximately $895 million by the end of 2013. PEC has expended
approximately $141 million of these capital costs through March 31, 2005.
The law requires PEC to amortize 70% of the original cost estimate of $813
million, during a five-year rate freeze period. PEC recognized amortization
of $27 million for the three months ended March 31, 2005, and has
recognized $275 million in cumulative amortization through March 31, 2005.
The remaining amortization requirement will be recorded over the future
period ending December 31, 2007. The law permits PEC the flexibility to
vary the amortization schedule for recording the compliance costs from no
amortization expense up to $174 million per year. The NCUC will hold a
hearing prior to December 31, 2007, to determine cost recovery amounts for
2008 and future periods. O&M expense will significantly increase due to the
24
additional materials, personnel and general maintenance associated with the
equipment. O&M expenses are recoverable through base rates, rather than as
part of this program. The Company cannot predict the future regulatory
interpretation, implementation or impact of this law.
On March 10, 2005, the EPA issued the final Clean Air Interstate Rule
(CAIR). The EPA's rule requires 28 states and the District of Columbia,
including North Carolina, South Carolina, Georgia and Florida, to reduce
NOx and SO2 emissions in order to attain state NOx and SO2 emissions
levels. The Company is reviewing the final rule. Installation of additional
air quality controls is likely to be needed to meet the CAIR requirements.
The Company is in the process of determining compliance plans and the cost
to comply with the rule. The air quality controls already installed for
compliance with the NOx SIP Call and currently planned by the Company to
comply with the Smokestacks Act will reduce the costs required to meet the
CAIR requirements for the Company's North Carolina units.
On March 15, 2005, the EPA finalized two separate but related rules: the
Clean Air Mercury Rule (CAMR) that sets emissions limits to be met in two
phases and encourages a cap and trade approach to achieving those caps, and
a de-listing rule that eliminated any requirement to pursue a maximum
achievable control technology (MACT) approach for limiting mercury
emissions from coal-fired power plants. NOx and SO2 controls also are
effective in reducing mercury emissions, however, according to the EPA the
second phase cap reflects a level of mercury emissions reduction that
exceeds the level that would be achieved solely as a co-benefit of
controlling NOx and SO2 under CAIR. The Company is in the process of
determining compliance plans and the cost to comply with the CAMR.
Installation of additional air quality controls is likely to be needed to
meet the CAMR's requirements. The de-listing rule has been challenged by a
number of parties; the resolution of the challenges could impact the
Company's final compliance plans and costs.
In conjunction with the proposed mercury rule, the EPA proposed a MACT
standard to regulate nickel emissions from residual oil-fired units. The
EPA withdrew the proposed nickel rule in March 2005.
PEF is filing a petition through the ECRC program for recovery of costs for
development and implementation of an integrated strategy to comply with the
CAIR and CAMR. PEF is developing an integrated compliance strategy for the
CAIR and CAMR rules because NOx and SO2 controls also are effective in
reducing mercury emissions. PEF estimates the program costs for the
remainder of 2005 to be approximately $2 million for preliminary
engineering activities and strategy development work necessary to determine
the Company's integrated compliance strategy. PEF projects approximately
$62 million in program costs for 2006. These costs may increase or decrease
depending upon the results of the engineering and strategy development
work. Among other things, subsequent rule interpretations, equipment
availability, or the unexpected acceleration of the initial NOx or other
compliance dates could require acceleration of some projects and therefore
result in additional costs in 2005 and 2006. PEF expects to incur
significant additional capital and O&M costs to achieve compliance with the
CAIR and CAMR through 2015 and beyond. The timing and extent of the costs
for future projects will depend upon the final compliance strategy.
In March 2004, the North Carolina Attorney General filed a petition with
the EPA under Section 126 of the Clean Air Act, asking the federal
government to force coal-fired power plants in 13 other states, including
South Carolina, to reduce their NOx and SO2 emissions. The state of North
Carolina contends these out-of-state emissions interfere with North
Carolina's ability to meet national air quality standards for ozone and
particulate matter. The EPA has agreed to make a determination on the
petition by August 1, 2005. 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 affected facilities. Integration of these new wastewater
streams into the existing wastewater treatment processes may result in
permitting, construction and treatment requirements imposed on PEC and PEF
in the immediate and extended future.
Based on new cost information and changes to the estimated time frame of
expenditures, the Company has revised the estimated amounts and time period
for expenditures to meet Section 316(b) requirements of the Clean Water
Act. The Company currently estimates that from 2005 through 2010 the range
of expenditures will be approximately $80 million to $110 million. The
range includes $15 million to $25 million at PEC and $65 million to $85
million at PEF.
25
OTHER ENVIRONMENTAL MATTERS
The Kyoto Protocol was adopted in 1997 by the United Nations to address
global climate change by reducing emissions of carbon dioxide and other
greenhouse gases. The treaty went into effect on February 16, 2005. The
United States has not adopted the Kyoto Protocol, and the Bush
administration has stated it favors voluntary programs. A number of carbon
dioxide emissions control proposals have been advanced in Congress.
Reductions in carbon dioxide emissions to the levels specified by the Kyoto
Protocol and some legislative proposals could be materially adverse to the
Company's consolidated financial position or results of operations if
associated costs of control or limitation cannot be recovered from
customers. The Company favors the voluntary program approach recommended by
the Bush administration and continually evaluates options for the
reduction, avoidance and sequestration of greenhouse gases. However, the
Company cannot predict the outcome of this matter.
Progress Energy has announced its plan to issue a report on the Company's
activities associated with current and future environmental requirements.
The report will include a discussion of the environmental requirements that
the Company currently faces and expects to face in the future with respect
to its air emissions. The report is expected to be issued by March 31,
2006.
14. COMMITMENTS AND CONTINGENCIES
Contingencies and significant changes to the commitments discussed in Note
23 of the Company's 2004 Annual Report on Form 10-K are described below.
A. Guarantees
As a part of normal business, Progress Energy and certain wholly-owned
subsidiaries enter into various agreements providing future financial or
performance assurances to third parties, which are outside the scope of
FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness
of Others" (FIN No. 45). Such agreements include guarantees, standby
letters of credit and surety bonds. At March 31, 2005, the Company does not
believe conditions are likely for significant performance under these
guarantees. To the extent liabilities are incurred as a result of the
activities covered by the guarantees, such liabilities are included in the
accompanying Consolidated Balance Sheets.
At March 31, 2005, the Company had issued guarantees and indemnifications
of certain legal, tax and environmental matters to third parties in
connection with sales of businesses and for timely payment of obligations
in support of its non-wholly owned synthetic fuel operations. Related to
the sales of businesses, the notice period extends until 2012 for the
majority of matters provided for in the indemnification provisions. For
matters which the Company has received timely notice, the Company's
indemnity obligations may extend beyond the notice period. Certain
environmental indemnifications related to the sale of synthetic fuel
operations have no limitations as to time or maximum potential future
payments. Other guarantees and indemnifications have an estimated maximum
exposure of approximately $111 million. At March 31, 2005, the Company has
recorded liabilities related to guarantees and indemnifications to
third-parties of $22 million. Management does not believe conditions are
likely for significant performance under these agreements in excess of the
recorded liabilities.
B. Insurance
PEC and PEF are members of Nuclear Electric Insurance Limited (NEIL), which
provides primary and excess insurance coverage against property damage to
members' nuclear generating facilities. Under the primary program, each
company is insured for $500 million at each of its respective nuclear
plants. In addition to primary coverage, NEIL also provides
decontamination, premature decommissioning and excess property insurance
with limits of $1.75 billion on each plant.
26
C. Other Commitments
As discussed in Note 23B of the Progress Energy annual report on Form 10-K
for the year ended December 31, 2004, the Company has certain future
commitments related to four synthetic fuel facilities purchased that
provide for contingent payments (royalties). The Company has exercised its
right in the related agreements to escrow those payments if certain
conditions in the agreements were met. The Company previously accrued and
retained 2004 and 2003 royalty payments of approximately $42 million and
$48 million, respectively. In May 2005, these funds were placed into escrow
upon establishment of the necessary escrow accounts.
D. Other Contingencies
1. Pursuant to the Nuclear Waste Policy Act of 1982, the predecessors to
PEF and PEC entered into contracts with the U.S. Department of Energy (DOE)
under which the DOE agreed to begin taking spent nuclear fuel by no later
than January 31, 1998. All similarly situated utilities were required to
sign the same standard contract.
DOE failed to begin taking spent nuclear fuel by January 31, 1998. In
January 2004, PEC and PEF filed a complaint in the United States Court of
Federal Claims against the DOE, claiming that the DOE breached the Standard
Contract for Disposal of Spent Nuclear Fuel (SNF) by failing to accept SNF
from various Progress Energy facilities on or before January 31, 1998.
Damages due to DOE's breach will likely exceed $100 million. Approximately
60 cases involving the Government's actions in connection with spent
nuclear fuel are currently pending in the Court of Federal Claims.
DOE and the PEC/PEF parties have agreed to a stay of the lawsuit, including
discovery. The parties agreed to, and the trial court entered, a stay of
proceedings, in order to allow for possible efficiencies due to the
resolution of legal and factual issues in previously filed cases in which
similar claims are being pursued by other plaintiffs. These issues may
include, among others, so-called "rate issues," or the minimum mandatory
schedule for the acceptance of SNF and high level waste (HLW) by which the
Government was contractually obligated to accept contract holders' SNF
and/or HLW, and issues regarding recovery of damages under a partial breach
of contract theory that will be alleged to occur in the future. These
issues have been or are expected to be presented in the trials that are
currently scheduled to occur during 2005. Resolution of these issues in
other cases could facilitate agreements by the parties in the PEC/PEF
lawsuit, or at a minimum, inform the Court of decisions reached by other
courts if they remain contested and require resolution in this case. The
trial court has continued this stay until June 24, 2005.
On February 27, 2004, PEC requested to have its license for the Independent
Spent Fuel Storage Installation at the Robinson Plant extended by 20 years
with an exemption request for an additional 20-year extension. Its current
license is due to expire in August 2006. On March 30, 2005, the NRC issued
the 40-year license renewal.
With certain modifications and additional approval by the NRC, including
the installation of onsite dry storage facilities at Robinson and
Brunswick, PEC's spent nuclear fuel storage facilities will be sufficient
to provide storage space for spent fuel generated on PEC's system through
the expiration of the operating licenses for all of PEC's nuclear
generating units.
With certain modifications and additional approval by the NRC, including
the installation of onsite dry storage facilities at PEF's nuclear unit,
Crystal River Unit No. 3 (CR3), PEF's spent nuclear fuel storage facilities
will be sufficient to provide storage space for spent fuel generated on
PEF's system through the expiration of the operating license for CR3.
In July 2002, Congress passed an override resolution to Nevada's veto of
DOE's proposal to locate a permanent underground nuclear waste storage
facility at Yucca Mountain, Nevada. In January 2003, the State of Nevada,
Clark County, Nevada, and the City of Las Vegas petitioned the U.S. Court
of Appeals for the District of Columbia Circuit for review of the
Congressional override resolution. These same parties also challenged EPA's
radiation standards for Yucca Mountain. On July 9, 2004, the Court rejected
the challenge to the constitutionality of the resolution approving Yucca
Mountain, but ruled that the EPA was wrong to set a 10,000-year compliance
period in the radiation protection standard. EPA is currently reworking the
standard but has not stated when the work will be complete. DOE originally
planned to submit a license application to the NRC to construct the Yucca
27
Mountain facility by the end of 2004. However, in November 2004, DOE
announced it would not submit the license application until mid-2005 or
later. Also in November 2004, Congressional negotiators approved $577
million for fiscal year 2005 for the Yucca Mountain project, approximately
$300 million less than requested by DOE but approximately the same as
approved in 2004. The DOE has acknowledged that a working repository will
not be operational until sometime after 2010, but the DOE has not
identified a new target date. PEC cannot predict the outcome of this
matter.
2. In 2001, PEC entered into a contract to purchase coal from Dynegy
Marketing and Trade (DMT). After DMT experienced financial difficulties,
including credit ratings downgrades by certain credit reporting agencies,
PEC requested credit enhancements in accordance with the terms of the coal
purchase agreement in July 2002. When DMT did not offer credit
enhancements, as required by a provision in the contract, PEC terminated
the contract in July 2002.
PEC initiated a lawsuit seeking a declaratory judgment that the termination
was lawful. DMT counterclaimed, stating the termination was a breach of
contract and an unfair and deceptive trade practice. On March 23, 2004, the
United States District Court for the Eastern District of North Carolina
ruled that PEC was liable for breach of contract, but ruled against DMT on
its unfair and deceptive trade practices claim. On April 6, 2004, the Court
entered a judgment against PEC in the amount of approximately $10 million.
The Court did not rule on DMT's request under the contract for pending
legal costs.
On May 4, 2004, PEC authorized its outside counsel to file a notice of
appeal of the April 6, 2004, judgment, and on May 7, 2004, the notice of
appeal was filed with the United States Court of Appeals for the Fourth
Circuit. On June 8, 2004, DMT filed a motion to dismiss the appeal on the
ground that PEC's notice of appeal should have been filed on or before May
6, 2004. On June 16, 2004, PEC filed a motion with the trial court
requesting an extension of the deadline for the filing of the notice of
appeal. By order dated September 10, 2004, the trial court denied the
extension request. On September 15, 2004, PEC filed a notice of appeal of
the September 10, 2004 order, and by order dated September 29, 2004, the
appellate court consolidated the first and second appeals. DMT's motion to
dismiss the first appeal remains pending. Argument on the consolidated
appeal is scheduled for May 25, 2005.
In the first quarter of 2004, PEC recorded a liability for the judgment of
approximately $10 million and a regulatory asset for the probable recovery
through its fuel adjustment clause. The Company cannot predict the outcome
of this matter.
3. On February 1, 2002, PEC filed a complaint with the Surface
Transportation Board (STB) challenging the rates charged by Norfolk
Southern Railway Company (Norfolk Southern) for coal transportation to
certain generating plants. In a decision dated December 23, 2003, the STB
found that the rates were unreasonable, awarded reparations and prescribed
maximum rates. Both parties petitioned the STB for reconsideration of the
December 23, 2003 decision. On October 20, 2004, the STB reconsidered its
December 23, 2003 decision and concluded that the rates charged by Norfolk
Southern were not unreasonable. Because PEC paid the maximum rates
prescribed by the STB in its December 23, 2003 decision for several months
during 2004, which were less than the rates ultimately found to be
reasonable, the STB ordered PEC to pay to Norfolk Southern the difference
between the rate levels plus interest.
PEC subsequently filed a petition with the STB to phase in the new rates
over a period of time, and filed a notice of appeal with the U.S. Court of
Appeals for the D.C. Circuit. Pursuant to an order issued by the STB on
January 6, 2005, the phasing proceeding will proceed on a schedule that
appears likely to produce an STB decision before the end of 2005. On
January 12, 2005, the STB filed a Motion to Dismiss PEC's appeal on the
grounds that its October 20, 2004 order is not final until PEC's phasing
application has been decided. PEC responded to this motion on January 26,
2005. The court has not yet ruled on the motion.
As of March 31, 2005, PEC has accrued a liability of $42 million, of which
$23 million represents reparations previously remitted to PEC by Norfolk
Southern that are now subject to refund. Of the remaining $19 million, $17
million has been recorded as deferred fuel cost on the Consolidated Balance
Sheet, while the remaining $2 million attributable to wholesale customers
has been charged to fuel used in electric generation on the Consolidated
Statements of Income. PEC or Norfolk Southern, as the case may be, will
make the appropriate payment to the other to reconcile all charges,
including interest, once a final STB decision in the phasing proceeding is
served.
28
The Company cannot predict the outcome of this matter.
4. The Company, through its subsidiaries, is a majority owner in five
entities and a minority owner in one entity that owns facilities that
produce synthetic fuel as defined under the Internal Revenue Code (Code).
The production and sale of the synthetic fuel from these facilities qualify
for tax credits under Section 29 if certain requirements are satisfied,
including a requirement that the synthetic fuel differs significantly in
chemical composition from the coal used to produce such synthetic fuel and
that the fuel was produced from a facility that was placed in service
before July 1, 1998. The amount of Section 29 tax credits that the Company
is allowed to claim in any calendar year is limited by the amount of the
Company's regular federal income tax liability. Synthetic fuel tax credit
amounts allowed but not utilized are carried forward indefinitely as
deferred alternative minimum tax credits. All entities have received PLRs
from the IRS with respect to their synthetic fuel operations. However,
these PLRs do not address the placed-in-service date determination. The
PLRs do not limit the production on which synthetic fuel credits may be
claimed. Total Section 29 credits generated to date (including those
generated by FPC prior to its acquisition by the Company) are approximately
$1.5 billion, of which $719 million has been used to offset regular federal
income tax liability and $777 million are being carried forward as deferred
alternative minimum tax credits. Also, $27 million has not been recognized
due to the decrease in tax liability resulting from expenses incurred for
the 2004 hurricane damage and loss on sale of Progress Rail. The current
Section 29 tax credit program expires at the end of 2007.
The sale of Progress Rail in 2005 (see Note 3) resulted in a capital loss
for tax purposes. Capital losses that are not offset with capital gains
generated in 2005 will be carried back to reduce the regular federal income
tax liability in 2004. The estimated impact of the sale will result in
approximately $17 million in tax credits no longer being realized and
reflected as a deferred tax asset.
On November 2, 2004, PEF filed a petition with the FPSC to recover $252
million of storm costs plus interest from customers over a two-year period
(see Note 4). Based on the reasonable expectation at December 31, 2004,
that the FPSC will grant the requested recovery of the storm costs, the
Company's loss from the casualty was reduced. Therefore, the Company's 2004
tax liability was greater than originally anticipated, along with its
ability to record Section 29 tax credits from its synthetic fuel facilities
in 2004.
The Company believes its right to recover storm costs is well established;
however, the Company cannot predict the timing or outcome of this matter.
If the FPSC should deny PEF's petition for the recovery of storm costs in
2005, there could be a material impact on the amount of 2005 synthetic
fuels production and results of operations.
IRS PROCEEDINGS
In September 2002, all of Progress Energy's majority-owned synthetic fuel
entities were accepted into the IRS's Pre-Filing Agreement (PFA) program.
The PFA program allows taxpayers to voluntarily accelerate the IRS exam
process in order to seek resolution of specific issues.
In February 2004, subsidiaries of the Company finalized execution of the
Colona Closing Agreement with the IRS concerning their Colona synthetic
fuel facilities. The Colona Closing Agreement provided that the Colona
facilities were placed in service before July 1, 1998, which is one of the
qualification requirements for tax credits under Section 29. The Colona
Closing Agreement further provides that the fuel produced by the Colona
facilities in 2001 is a "qualified fuel" for purposes of the Section 29 tax
credits. This action concluded the PFA program with respect to Colona.
In July 2004, Progress Energy was notified that the IRS field auditors
anticipated taking an adverse position regarding the placed-in-service date
of the Company's four Earthco synthetic fuel facilities. Due to the IRS
auditors' position, the IRS decided to exercise its right to withdraw from
the PFA program with Progress Energy. With the IRS's withdrawal from the
PFA program, the review of Progress Energy's Earthco facilities is back on
the normal procedural audit path of the Company's tax returns.
29
On October 29, 2004, Progress Energy received the IRS field auditors'
preliminary report concluding that the Earthco facilities had not been
placed in service before July 1, 1998, and that the tax credits generated
by those facilities should be disallowed. The Company disagrees with the
field audit team's factual findings and believes that the Earthco
facilities were placed in service before July 1, 1998. The Company also
believes that the report applies an inappropriate legal standard concerning
what constitutes "placed in service." The Company intends to contest the
field auditors' findings and their proposed disallowance of the tax
credits.
Because of the disagreement between the Company and the field auditors as
to the proper legal standard to apply, the Company believes that it is
appropriate and helpful to have this issue reviewed by the National Office
of the IRS, just as the National Office reviewed the issues involving
chemical change. Therefore, the Company is asking the National Office to
clarify the legal standard and has initiated this process with the National
Office. The Company believes that the appeals process, including
proceedings before the National Office, could take up to two years to
complete; however, it cannot control the actual timing of resolution and
cannot predict the outcome of this matter.
Through March 31, 2005, the Company, on a consolidated basis, has used or
carried forward approximately $1.1 billion of tax credits generated by
Earthco facilities. If these credits were disallowed, the Company's
one-time exposure for cash tax payments would be $300 million (excluding
interest), and earnings and equity would be reduced by approximately $1.1
billion, excluding interest. Progress Energy's amended $1.13 billion credit
facility includes a covenant that limits the maximum debt-to-total capital
ratio to 68%. This ratio includes other forms of indebtedness such as
guarantees issued by PGN, letters of credit and capital leases. As of March
31, 2005, the Company's debt-to-total capital ratio was 61.1% based on the
credit agreement definition for this ratio. The impact on this ratio of
reversing approximately $1.1 billion of tax credits and paying $300 million
for taxes would be to increase the ratio to 65.2%.
The Company believes that it is complying with all the necessary
requirements to be allowed such credits under Section 29, and, although it
cannot provide certainty, it believes that it will prevail in these
matters. Accordingly, while the Company adjusted its synthetic fuel
production for 2004 in response to the effects of expenses incurred due to
the hurricane damage and its impact on 2004 tax liability, it has no
current plans to alter its synthetic fuel production schedule for future
years as a result of the IRS field auditors' report. However, should the
Company fail to prevail in these matters, there could be material liability
for previously used or carried forward Section 29 tax credits, with a
material adverse impact on earnings and cash flows.
As discussed in Note 8F of the Progress Energy annual report on Form 10-K
for the year ended December 31, 2004, the Company implemented changes in
its capitalization policies for its Energy Delivery business units in PEC
and PEF effective January 1, 2005. As a result of the changes in accounting
estimates for the outage and emergency work and indirect costs, a lesser
proportion of PEC's and PEF's costs will be capitalized on a prospective
basis. The Company has requested a method change from the IRS. If the IRS
does not grant the Company's request, the Company cannot predict how the
IRS would suggest that the method change be applied. However, the
application of the method change to past periods could be reflected in a
cumulative adjustment to taxable income in 2005, which likely would have a
material impact on income from synthetic fuel tax credits.
PROPOSED ACCOUNTING RULES FOR UNCERTAIN TAX POSITIONS
In July 2004, the FASB stated that it plans to issue an exposure draft of a
proposed interpretation of SFAS No. 109, "Accounting for Income Taxes,"
that would address the accounting for uncertain tax positions. The FASB has
indicated that the interpretation would require that uncertain tax benefits
be probable of being sustained in order to record such benefits in the
financial statements. The exposure draft is expected to be issued in the
second quarter of 2005. The Company cannot predict what actions the FASB
will take or how any such actions might ultimately affect the Company's
financial position or results of operations, but such changes could have a
material impact on the Company's evaluation and recognition of Section 29
tax credits.
30
PERMANENT SUBCOMMITTEE
In October 2003, the United States Senate Permanent Subcommittee on
Investigations began a general investigation concerning synthetic fuel tax
credits claimed under Section 29. The investigation is examining the
utilization of the credits, the nature of the technologies and fuels
created, the use of the synthetic fuel and other aspects of Section 29 and
is not specific to the Company's synthetic fuel operations. Progress Energy
is providing information in connection with this investigation. The Company
cannot predict the outcome of this matter.
IMPACT OF CRUDE OIL PRICES
Although the Internal Revenue Code Section 29 tax credit program is
expected to continue through 2007, recent unprecedented increases in the
price of oil could limit the amount of those credits or eliminate them
entirely for one or more of the years following 2004. This possibility is
due to a provision of Section 29 that provides that if the average wellhead
price per barrel for unregulated domestic crude oil for the year (the
Annual Average Price) exceeds a certain threshold price (the Threshold
Price), the amount of Section 29 tax credits are reduced for that year.
Also, if the Annual Average Price increases high enough (the Phase Out
Price), the Section 29 tax credits are eliminated for that year. For 2004,
the Threshold Price was $51.35 per barrel and the Phase Out Price was
$64.47 per barrel. The Threshold Price and the Phase Out Price are adjusted
annually for inflation.
If the Annual Average Price falls between the Threshold Price and the Phase
Out Price for a year, the amount by which Section 29 tax credits are
reduced will depend on where the Average Annual Price falls in that
continuum. For example, for 2004, if the Annual Average Price had been
$57.91 per barrel, there would have been a 50% reduction in the amount of
Section 29 tax credits for that year.
The Secretary of the Treasury calculates the Annual Average Price based on
the Domestic Crude Oil First Purchases Prices published by the Energy
Information Agency (EIA). Because the EIA publishes its information on a
three-month lag, the Secretary of the Treasury finalizes its calculations
three months after the year in question ends. Thus, the Annual Average
Price for calendar year 2004 was published on April 6, 2005, and the Annual
Average Price for 2004 did not reach the Threshold Price for 2004.
Consequently, the amount of the Company's 2004 Section 29 tax credits was
not adversely affected by oil prices.
The Company estimates that the 2005 Threshold Price will be approximately
$52 and the Phase Out price will be approximately $65, based on an
estimated 2005 inflation adjustment. The monthly Domestic Crude Oil First
Purchases price published by the EIA has recently been $5 to $6 lower than
the corresponding monthly New York Mercantile Exchange (NYMEX) settlement
price for light, sweet crude oil. Through April 30, 2005, the average NYMEX
settlement prices for light, sweet crude oil were $50.55. The Company
estimates that NYMEX settlement prices would have to average approximately
$63 for the remainder of 2005 for the Threshold Price to be reached.
The Company cannot predict with any certainty the Annual Average Price for
2005 or beyond. Therefore, it cannot predict whether the price of oil will
have a material effect on its synthetic fuel business after 2004. However,
if during 2005 through 2007, oil prices remain at historically high levels
or increase, the Company's synthetic fuel business may be adversely
affected for those years, and, depending on the magnitude of such increases
in oil prices, the adverse affect for those years could be material and
could have an impact on the Company's synthetic fuel results of operations
and production plans.
In response to the historically high oil prices to date in 2005, the
Company has adjusted its planned production schedule for its synthetic fuel
plants by shifting some of its production planned for April and May 2005 to
the second half of 2005. If oil prices rise and stay at levels high enough
to cause a phase out of tax credits, the Company may reduce planned
production or suspend production at some or all of its synthetic fuel
facilities.
31
SALE OF PARTNERSHIP INTEREST
In June 2004, the Company, through its subsidiary Progress Fuels, sold in
two transactions a combined 49.8% partnership interest in Colona Synfuel
Limited Partnership, LLLP, one of its synthetic fuel facilities.
Substantially all proceeds from the sales will be received over time, which
is typical of such sales in the industry. Gain from the sales will be
recognized on a cost recovery basis as the facility produces and sells
synthetic fuel and when there is persuasive evidence that the sales
proceeds have become fixed or determinable and collectability is reasonably
assured. Based on projected production and tax credit levels, the Company
anticipates receiving total gross proceeds of approximately $24 million in
2005, approximately $31 million in 2006, approximately $32 million in 2007
and approximately $8 million through the second quarter of 2008. Gain
recognition is dependent on the synthetic fuel production qualifying for
Section 29 tax credits and the value of such tax credits as discussed
above. Until the gain recognition criteria are met, gains from selling
interests in Colona will be deferred. It is possible that gains will be
deferred in the first, second and/or third quarters of each year until
there is persuasive evidence that no tax credit phase out will occur for
the applicable calendar year. This could result in shifting earnings from
earlier quarters to later quarters in a calendar year. In the event that
the synthetic fuel tax credits from the Colona facility are reduced,
including an increase in the price of oil that could limit or eliminate
synthetic fuel tax credits, the amount of proceeds realized from the sale
could be significantly impacted.
5. The Company and its subsidiaries are involved in various litigation
matters in the ordinary course of business, some of which involve
substantial amounts. Where appropriate, accruals and disclosures have been
made in accordance with SFAS No. 5, "Accounting for Contingencies," to
provide for such matters. In the opinion of management, the final
disposition of pending litigation would not have a material adverse effect
on the Company's consolidated results of operations or financial position.
32
CAROLINA POWER & LIGHT COMPANY
d/b/a PROGRESS ENERGY CAROLINAS, INC.
CONSOLIDATED INTERIM FINANCIAL STATEMENTS
March 31, 2005
UNAUDITED CONSOLIDATED STATEMENTS of INCOME
- --------------------------------------------------------------------------------------
(in millions)
Three months ended March 31, 2005 2004
- ----------------------------------------------------------------------------------- --
Operating revenues $ 935 $ 901
Operating expenses
Fuel used in electric generation 248 224
Purchased power 67 62
Operation and maintenance 224 209
Depreciation and amortization 129 127
Taxes other than on income 46 43
- ----------------------------------------------------------------------------------- --
Total operating expenses 714 665
- ----------------------------------------------------------------------------------- --
Operating income 221 236
- ----------------------------------------------------------------------------------- --
Other income (expense)
Interest income 2 1
Other, net 1 (12)
- ----------------------------------------------------------------------------------- --
Total other income (expense) 3 (11)
- ----------------------------------------------------------------------------------- --
Interest charges
Interest charges 52 49
Allowance for borrowed funds used during construction (1) (1)
- ----------------------------------------------------------------------------------- --
Total interest charges, net 51 48
- ----------------------------------------------------------------------------------- --
Income before income tax 173 177
Income tax expense 57 62
- ----------------------------------------------------------------------------------- --
Net income 116 115
Preferred stock dividend requirement 1 1
- ----------------------------------------------------------------------------------- --
Earnings for common stock $ 115 $ 114
- ----------------------------------------------------------------------------------- --
See Notes to Consolidated Interim Financial Statements.
33
CAROLINA POWER & LIGHT COMPANY
d/b/a PROGRESS ENERGY CAROLINAS, INC.
UNAUDITED CONSOLIDATED BALANCE SHEETS
- ------------------------------------------------------------------------------------------------------
(in millions) March 31, December 31,
2005 2004
- ------------------------------------------------------------------------------------------------------
ASSETS
Utility plant
Utility plant in service $ 13,567 $ 13,521
Accumulated depreciation (5,877) (5,806)
- ------------------------------------------------------------------------------------------------------
Utility plant in service, net 7,690 7,715
Held for future use 5 5
Construction work in progress 470 379
Nuclear fuel, net of amortization 178 186
- ------------------------------------------------------------------------------------------------------
Total utility plant, net 8,343 8,285
- ------------------------------------------------------------------------------------------------------
Current assets
Cash and cash equivalents 183 18
Short-term investments 135 82
Receivables 398 397
Receivables from affiliated companies 36 20
Inventory 395 390
Deferred fuel cost 163 140
Prepayments and other current assets 95 135
- ------------------------------------------------------------------------------------------------------
Total current assets 1,405 1,182
- ------------------------------------------------------------------------------------------------------
Deferred debits and other assets
Regulatory assets 464 473
Nuclear decommissioning trust funds 603 581
Miscellaneous other property and investments 184 158
Other assets and deferred debits 107 108
- ------------------------------------------------------------------------------------------------------
Total deferred debits and other assets 1,358 1,320
- ------------------------------------------------------------------------------------------------------
Total assets $ 11,106 $ 10,787
- ------------------------------------------------------------------------------------------------------
CAPITALIZATION AND LIABILITIES
- ------------------------------------------------------------------------------------------------------
Common stock equity
Common stock without par value, authorized 200 million shares,
160 million shares issued and outstanding $ 1,988 $ 1,975
Unearned ESOP common stock (65) (76)
Accumulated other comprehensive loss (112) (114)
Retained earnings 1,256 1,287
- ------------------------------------------------------------------------------------------------------
Total common stock equity 3,067 3,072
- ------------------------------------------------------------------------------------------------------
Preferred stock - not subject to mandatory redemption 59 59
Long-term debt, net 3,247 2,750
- ------------------------------------------------------------------------------------------------------
Total capitalization 6,373 5,881
- ------------------------------------------------------------------------------------------------------
Current liabilities
Current portion of long-term debt 300 300
Accounts payable 253 254
Payables to affiliated companies 60 83
Notes payable to affiliated companies 23 116
Short-term obligations 108 221
Customer deposits 46 45
Other current liabilities 227 256
- ------------------------------------------------------------------------------------------------------
Total current liabilities 1,017 1,275
- ------------------------------------------------------------------------------------------------------
Deferred credits and other liabilities
Noncurrent income tax liabilities 1,005 991
Accumulated deferred investment tax credits 139 140
Regulatory liabilities 1,104 1,052
Asset retirement obligations 937 924
Other liabilities and deferred credits 531 524
- ------------------------------------------------------------------------------------------------------
Total deferred credits and other liabilities 3,716 3,631
- ------------------------------------------------------------------------------------------------------
Commitments and contingencies (Note 12)
- ------------------------------------------------------------------------------------------------------
Total capitalization and liabilities $ 11,106 $ 10,787
- ------------------------------------------------------------------------------------------------------
See Notes to Consolidated Interim Financial Statements.
34
CAROLINA POWER & LIGHT COMPANY
d/b/a PROGRESS ENERGY CAROLINAS, INC.
UNAUDITED CONSOLIDATED STATEMENTS of CASH FLOWS
- ----------------------------------------------------------------------------------------------------------------
(in millions)
Three Months Ended March 31, 2005 2004
- -------------------------------------------------------------------------------------------------------------
Operating activities
Net income $ 116 $ 115
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 149 149
Deferred income taxes 30 22
Investment tax credit (2) (3)
Deferred fuel (credit) cost (17) 13
Other adjustments to net income 5 13
Cash provided (used) by changes in operating assets and liabilities:
Receivables (1) 27
Receivables from affiliated companies (16) 4
Inventory (5) 31
Prepayments and other current assets (12) 4
Accounts payable 27 (4)
Payables to affiliated companies (23) (84)
Other current liabilities (7) 13
Other 37 30
- -------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 281 330
- -------------------------------------------------------------------------------------------------------------
Investing activities
Gross property additions (142) (121)
Nuclear fuel additions (30) (39)
Net contributions to nuclear decommissioning trust (10) (10)
Purchases of short-term investments (763) (601)
Proceeds from sales of short-term investments 710 828
Other investing activities (23) 3
- -------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by investing activities (258) 60
- -------------------------------------------------------------------------------------------------------------
Financing activities
Issuance of long-term debt, net 495 -
Net decrease in short-term obligations (113) (4)
Net change in intercompany notes (93) (109)
Retirement of long-term debt - (150)
Dividends paid to parent (146) (125)
Dividends paid on preferred stock (1) (1)
- -------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 142 (389)
- -------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 165 1
Cash and cash equivalents at beginning of period 18 12
- -------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 183 $ 13
- -------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Interim Financial Statements.
35
CAROLINA POWER & LIGHT COMPANY
d/b/a PROGRESS ENERGY CAROLINAS, INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
A. Basis of Presentation
These financial statements have been prepared in accordance with accounting
principles generally accepted in the United States of America (GAAP) for
interim financial information and with the instructions to Form 10-Q and
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by GAAP for annual statements. Because the accompanying
consolidated interim financial statements do not include all of the
information and footnotes required by GAAP, they should be read in
conjunction with the audited financial statements for the period ended
December 31, 2004 and notes thereto included in Progress Energy Carolinas,
Inc.'s (PEC) Form 10-K for the year ended December 31, 2004.
PEC collects from customers certain excise taxes levied by the state or
local government upon the customer. PEC accounts for excise taxes on a
gross basis. For the three months ended March 31, 2005 and 2004, gross
receipts tax and other excise taxes of approximately $22 million and $21
million, respectively, are included in electric revenue and taxes other
than on income on the Consolidated Statements of Income.
The amounts included in the consolidated interim financial statements are
unaudited but, in the opinion of management, reflect all normal recurring
adjustments necessary to fairly present PEC's financial position and
results of operations for the interim periods. Due to seasonal weather
variations and the timing of outages of electric generating units,
especially nuclear-fueled units, the results of operations for interim
periods are not necessarily indicative of amounts expected for the entire
year or future periods.
In preparing financial statements that conform with GAAP, management must
make estimates and assumptions that affect the reported amounts of assets
and liabilities, disclosure of contingent assets and liabilities at the
date of the financial statements and amounts of revenues and expenses
reflected during the reporting period. Actual results could differ from
those estimates. Certain amounts for 2004 have been reclassified to conform
to the 2005 presentation.
B. Stock-Based Compensation
PEC measures compensation expense for stock options as the difference
between the market price of Progress Energy's common stock and the exercise
price of the option at the grant date. The exercise price at which options
are granted by Progress Energy equals the market price at the grant date,
and accordingly, no compensation expense has been recognized for stock
option grants. For purposes of the pro forma disclosures required by SFAS
No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure - an Amendment of FASB Statement No. 123" (SFAS No. 148), the
estimated fair value of PEC's stock options is amortized to expense over
the options' vesting period. The following table illustrates the effect on
net income and earnings per share if the fair value method had been applied
to all outstanding and unvested awards in each period:
----------------------------------------------------------------------------------------
(in millions) 2005 2004
----------------------------------------------------------------------------------------
Net Income, as reported $ 116 $ 115
Deduct: Total stock option expense determined under fair
value method for all awards, net of related tax effects 1 2
----------------------------------------------------------------------------------------
Pro forma net income $ 115 $ 113
----------------------------------------------------------------------------------------
PEC expects to begin expensing stock options on July 1, 2005 (See Note 2).
36
C. Consolidation of Variable Interest Entities
PEC consolidates all voting interest entities in which it owns a majority
voting interest and all variable interest entities for which it is the
primary beneficiary in accordance with FASB Interpretation No. 46R,
"Consolidation of Variable Interest Entities - An Interpretation of ARB No.
51" (FIN No. 46R). PEC is the primary beneficiary of and consolidates two
limited partnerships that qualify for federal affordable housing and
historic tax credits under Section 42 of the Internal Revenue Code (Code).
As of March 31, 2005, the total assets of the two entities were $37
million, the majority of which are collateral for the entities' obligations
and are included in other current assets and miscellaneous other property
and investments in the Consolidated Balance Sheets.
PEC has an interest in a limited partnership that invests in 17 low-income
housing partnerships that qualify for federal and state tax credits. PEC
also has interests in two power plants resulting from long-term power
purchase contracts. PEC has requested the necessary information to
determine if the 17 partnerships and the two power plant owners are
variable interest entities or to identify the primary beneficiaries; all
three entities declined to provide PEC with the necessary financial
information. Therefore, PEC has applied the information scope exception in
FIN No. 46R, paragraph 4(g) to the 17 partnerships and the two power
plants. PEC believes that if it is determined to be the primary beneficiary
of any of these entities, the effect of consolidating the entities would
result in increases to total assets, long-term debt and other liabilities,
but would have an insignificant or no impact on PEC's common stock equity,
net earnings or cash flows.
PEC also has interests in several other variable interest entities for
which PEC is not the primary beneficiary. These arrangements include
investments in approximately 22 limited partnerships, limited liability
corporations and venture capital funds and two building leases with
special-purpose entities. The aggregate maximum loss exposure at March 31,
2005, that PEC could be required to record in its income statement as a
result of these arrangements totals approximately $24 million. The
creditors of these variable interest entities do not have recourse to the
general credit of PEC in excess of the aggregate maximum loss exposure.
2. NEW ACCOUNTING STANDARDS
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123 (REVISED 2004),
"SHARE-BASED PAYMENT" (SFAS NO. 123R)
In December 2004, the Financial Accounting Standards Board (FASB) issued
SFAS No. 123R, which revises SFAS No. 123, "Accounting for Stock-Based
Compensation" and supersedes Accounting Principles Board (APB) Opinion No.
25, "Accounting for Stock Issued to Employees." The key requirement of SFAS
No. 123R is that the cost of share-based awards to employees will be
measured based on an award's fair value at the grant date, with such cost
to be amortized over the appropriate service period. Previously, entities
could elect to continue accounting for such awards at their grant date
intrinsic value under APB Opinion No. 25, and PEC made that election. The
intrinsic value method resulted in PEC recording no compensation expense
for stock options granted to employees (See Note 1B).
As written, SFAS No. 123R had an original effective date of July 1, 2005
for PEC. In April 2005, the SEC delayed the effective date for public
companies, which resulted in a required effective date of January 1, 2006
for PEC. The SEC delayed the effective date due to concerns that
implementation in mid-year could make compliance more difficult and make
comparisons of quarterly reports more difficult. PEC currently intends to
implement SFAS No. 123R on the original effective date of July 1, 2005. PEC
intends to implement the standard using the required modified prospective
method. Under that method and with a July 1, 2005 implementation, PEC will
record compensation expense under SFAS No. 123R for all awards it grants
after July 1, 2005, and it will record compensation expense (as previous
awards continue to vest) for the unvested portion of previously granted
awards that remain outstanding at July 1, 2005. In 2004, Progress Energy
made the decision to cease granting stock options and replaced that
compensation with alternative forms of compensation. Therefore, the amount
of stock option expense expected to be recorded in 2005 is below the amount
that would have been recorded if the stock option program had continued.
PEC expects to record approximately $1 million of pre-tax expense for stock
options in 2005.
37
FASB INTERPRETATION NO. 47, "ACCOUNTING FOR CONDITIONAL ASSET RETIREMENT
OBLIGATIONS"
On March 30, 2005, the FASB issued Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations," an interpretation of SFAS No.
143, "Accounting for Asset Retirement Obligations." The interpretation
clarifies that a legal obligation to perform an asset retirement activity
that is conditional on a future event is within the scope of SFAS No. 143.
Accordingly, an entity is required to recognize a liability for the fair
value of an asset retirement obligation that is conditional on a future
event if the liability's fair value can be reasonably estimated. The
interpretation also provides additional guidance for evaluating whether
sufficient information is available to make a reasonable estimate of the
fair value. The interpretation is effective for PEC no later than December
31, 2005. PEC has not yet determined the impact of the interpretation on
its financial position, results of operations or liquidity.
3. REGULATORY MATTERS
On April 27, 2005, PEC filed for an increase in the fuel rate charged to
its South Carolina customers with the Public Service Commission of South
Carolina (SCPSC). PEC is asking the SCPSC to approve a $97 million, or 21
percent, increase in rates. PEC requested the increase for underrecovered
fuel costs for the previous 15 months and to meet future expected fuel
costs. This request reflects increases in the prices of coal and natural
gas. If approved, the increase would take effect July 1, 2005. The Company
cannot predict the outcome of this matter.
4. COMPREHENSIVE INCOME
--------------------------------------------------------------------------
(in millions)
Three Months Ended March 31, 2005 2004
--------------------------------------------------------------------------
Net income $ 116 $ 115
Other comprehensive income:
Changes in net unrealized gains on cash flow hedges
(net of tax expense of $1) 2 -
Other - 1
--------------------------------------------------------------------------
Other comprehensive income $ 2 $ 1
--------------------------------------------------------------------------
Comprehensive income $ 118 $ 116
--------------------------------------------------------------------------
5. DEBT AND CREDIT FACILITIES AND FINANCING ACTIVITIES
Changes to PEC's debt and credit facilities since December 31, 2004,
discussed in Note 9 of PEC's 2004 Annual Report on Form 10-K, are described
below.
In January 2005, PEC used proceeds from the issuance of commercial paper to
pay off $90 million of revolving credit agreement (RCA) loans.
On March 22, 2005, PEC issued $300 million of First Mortgage Bonds, 5.15%
Series due 2015, and $200 million of First Mortgage Bonds, 5.70% Series due
2035. The net proceeds from the sale of the bonds were used to pay off $300
million of its 7.50% Senior Notes on April 1, 2005 and reduce the
outstanding balance of commercial paper.
On March 28, 2005, PEC entered into a new $450 million RCA with a
syndication of financial institutions. The RCA will be used to provide
liquidity support for PEC's issuances of commercial paper and other
short-term obligations. The RCA will expire on June 28, 2010. The new $450
million RCA replaced PEC's $285 million three-year RCA and $165 million
364-day RCA, which were each terminated effective March 28, 2005. Fees and
interest rates under the $450 million RCA are to be determined based upon
the credit rating of PEC's long-term unsecured senior non-credit enhanced
debt, currently rated as Baa1 by Moody's and BBB by S&P. The RCA includes a
defined maximum total debt to capital ratio of 65%. The RCA also contains
various cross-default and other acceleration provisions, including a
cross-default provision for defaults of indebtedness in excess of $35
million. The RCA does not include a material adverse change representation
for borrowings, which had been a provision in the terminated agreements.
38
6. BENEFIT PLANS
PEC has a noncontributory defined benefit retirement (pension) plan for
substantially all full-time employees. PEC also has supplementary defined
benefit pension plans that provide benefits to higher-level employees. In
addition to pension benefits, PEC provides contributory other
postretirement benefits (OPEB), including certain health care and life
insurance benefits, for retired employees who meet specified criteria. The
components of the net periodic benefit cost for the three months ended
March 31 are:
-----------------------------------------------------------------------------------
Other Postretirement
Pension Benefits Benefits
---------------- --------------------
(in millions) 2005 2004 2005 2004
-----------------------------------------------------------------------------------
Service cost $ 7 $ 6 $ 2 $ 2
Interest cost 13 13 4 4
Expected return on plan assets (16) (17) (1) (1)
Amortization, net 2 - - 1
-----------------------------------------------------------------------------------
Net periodic cost / (benefit) $ 6 $ 2 $ 5 $ 6
-----------------------------------------------------------------------------------
7. RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS
PEC is exposed to various risks related to changes in market conditions.
PEC's parent, Progress Energy, has a risk management committee that
includes senior executives from various business groups. The risk
management committee is responsible for administering risk management
policies and monitoring compliance with those policies by all subsidiaries.
Under its risk management policy, PEC may use a variety of instruments,
including swaps, options and forward contracts, to manage exposure to
fluctuations in commodity prices and interest rates. Such instruments
contain credit risk if the counterparty fails to perform under the
contract. PEC minimizes such risk by performing credit reviews using, among
other things, publicly available credit ratings of such counterparties.
Potential nonperformance by counterparties is not expected to have a
material effect on the consolidated financial position or consolidated
results of operations of PEC. See Note 13 to PEC's Annual Report on Form
10-K for the year ended December 31, 2004.
A. Commodity Derivatives
General
Most of PEC's commodity contracts are not derivatives pursuant to SFAS No.
133 or qualify as normal purchases or sales pursuant to SFAS No. 133.
Therefore, such contracts are not recorded at fair value.
In 2003, PEC recorded a $38 million pre-tax ($23 million after-tax) fair
value loss transition adjustment pursuant to the provisions of DIG Issue
C20, "Scope Exceptions: Interpretation of the Meaning of Not Clearly and
Closely Related in Paragraph 10(b) regarding Contracts with a Price
Adjustment Feature." The related liability is being amortized to earnings
over the term of the related contract (See Note 10). At March 31, 2005 and
December 31, 2004, the remaining liability was $25 million and $26 million,
respectively.
Economic Derivatives
Derivative products, primarily electricity and natural gas contracts, may
be entered into from time to time for economic hedging purposes. While
management believes the economic hedges mitigate exposures to fluctuations
in commodity prices, these instruments are not designated as hedges for
accounting purposes and are monitored consistent with trading positions.
PEC manages open positions with strict policies that limit its exposure to
market risk and require daily reporting to management of potential
financial exposures. Gains and losses from such contracts were not material
to results of operations during the three months ending March 31, 2005 and
2004 and PEC did not have material outstanding positions in such contracts
at March 31, 2005 and December 31, 2004.
39
B. Interest Rate Derivatives - Fair Value or Cash Flow Hedges
PEC uses cash flow hedging strategies to hedge variable interest rates on
long-term and short-term debt and to hedge interest rates with regard to
future fixed-rate debt issuances. PEC uses fair value hedging strategies to
manage its exposure to fixed interest rates on long-term debt. The notional
amounts of interest rate derivatives are not exchanged and do not represent
exposure to credit loss. In the event of default by the counterparty, the
risk in these transactions is the cost of replacing the agreements at
current market rates.
Cash Flow Hedges
Gains and losses from cash flow hedges are recorded in accumulated other
comprehensive income (OCI) and amounts reclassified to earnings are
included in net interest charges as the hedged transactions occur. Amounts
in OCI related to terminated hedges are reclassified to earnings as the
hedged interest payments occur. The ineffective portion of interest rate
cash flow hedges for the three months ending March 31, 2005 and 2004 was
not material to PEC's results of operations. As of March 31, 2005, PEC had
$5 million of after-tax deferred losses in OCI related to terminated
hedges, of which an immaterial amount is expected to be reclassified to
earnings within the next 12 months.
During the three months ending March 31, 2005, PEC terminated all of its
cash flow hedges which were open at December 31, 2004 and had no open
interest rate cash flow hedges at March 31, 2005. As of December 31, 2004,
PEC had $131 million notional of open interest rate cash flow hedges.
Fair Value Hedges
At March 31, 2005 and December 31, 2004, PEC had no open interest rate fair
value hedges.
8. SEVERANCE COSTS
On February 28, 2005, as part of a previously announced cost management
initiative, Progress Energy approved a workforce restructuring, which is
expected to be completed in September of 2005. In addition to the workforce
restructuring, the cost management initiative includes a voluntary enhanced
retirement program. In connection with the cost management initiative, PEC
currently expects to incur estimated pre-tax charges of approximately $75
million. In addition, PEC expects to incur certain incremental costs other
than severance and postretirement benefits for recruiting, training and
staff augmentation activities that cannot be quantified at this time.
PEC recorded $14 million of expense during the first quarter of 2005 for
the estimated severance benefits to be paid as a result of the approximate
number of positions to be eliminated under the restructuring. This amount
includes approximately $4 million of severance costs allocated from
Progress Energy Service Company. These amounts will be paid over time and
are subject to revision in future quarters based on the impact of the
voluntary enhanced retirement program. The severance expenses are primarily
included in operations and maintenance (O&M) expenses on the Consolidated
Statements of Income.
The activity in the severance liability is as follows:
---------------------------------------------------
(in millions)
---------------------------------------------------
Balance as of January 1, 2005 $ 2
Severance Costs Accrued 10
Payments -
---------------------------------------------------
Balance as of March 31, 2005 $ 12
---------------------------------------------------
PEC has estimated that an additional $65 million charge will be recognized
in the second quarter of 2005 and relates primarily to postretirement
benefits that will be paid over time to those eligible employees who
elected to participate in the voluntary enhanced retirement program. The
results from the employee elections indicate that 553 of PEC's employees
have elected to participate in the voluntary enhanced retirement program.
The cost management initiative charges could change significantly primarily
due to the demographics of the specific employees who elected enhanced
retirement and its impact on the postretirement benefit actuarial studies.
40
9. FINANCIAL INFORMATION BY BUSINESS SEGMENT
PEC's operations consist primarily of the PEC Electric segment which is
engaged in the generation, transmission, distribution and sale of electric
energy primarily in portions of North Carolina and South Carolina. These
electric operations are subject to the rules and regulations of the FERC,
the NCUC, the SCPSC and the NRC. PEC Electric also distributes and sells
electricity to other utilities, primarily on the east coast of the United
States.
The Other segment, 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.
The financial information for PEC segments for the three months ended March
31, 2005 and 2004 is as follows:
-----------------------------------------------------------------------------------------------
(in millions) 2005 2004
-----------------------------------------------------------------------------------------------
PEC PEC
Electric Other Total Electric Other Total
-----------------------------------------------------------------------------------------------
Total revenues $ 935 $ - $ 935 $ 901 $ - $ 901
Segment profit (loss) 116 (1) 115 116 (2) 114
-----------------------------------------------------------------------------------------------
10. OTHER INCOME AND OTHER EXPENSE
Other income and expense includes interest income and other income and
expense items as discussed below. The components of other, net as shown on
the accompanying Consolidated Statements of Income for the three months
ended March 31, 2005 and 2004, are as follows:
---------------------------------------------------------------------------
(in millions) 2005 2004
---------------------------------------------------------------------------
Other income
Nonregulated energy and delivery services income $ 2 $ 2
DIG Issue C20 amortization (See Note 7) 1 2
AFUDC equity - 1
Other 3 3
---------------------------------------------------------------------------
Total other income $ 6 $ 8
---------------------------------------------------------------------------
Other expense
Nonregulated energy and delivery services expenses $ 2 $ 2
Donations 2 4
Write-off of non-trade receivables - 7
Other 1 7
---------------------------------------------------------------------------
Total other expense $ 5 $ 20
---------------------------------------------------------------------------
Other, net $ 1 $ (12)
---------------------------------------------------------------------------
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.
11. ENVIRONMENTAL MATTERS
PEC is subject to federal, state and local regulations addressing hazardous
and solid waste management, air and water quality and other environmental
matters. See Note 17 of PEC's 2004 Annual Report on Form 10-K for a more
detailed, historical discussion of these federal, state, and local
regulations.
41
HAZARDOUS AND SOLID WASTE MANAGEMENT
The provisions of the Comprehensive Environmental Response, Compensation
and Liability Act of 1980, as amended (CERCLA), authorize the EPA to
require the cleanup of hazardous waste sites. This statute imposes
retroactive joint and several liabilities. Some states, including North and
South Carolina, have similar types of legislation. PEC is periodically
notified by regulators, including the EPA and various state agencies, of
their involvement or potential involvement in sites that may require
investigation and/or remediation. There are presently several sites with
respect to which PEC has been notified by the EPA and the State of North
Carolina of its potential liability, as described below in greater detail.
PEC is also currently in the process of assessing potential costs and
exposures at other sites. For all sites, as assessments are developed and
analyzed, PEC will accrue costs for the sites to the extent the costs are
probable and can be reasonably estimated.
Various organic materials associated with the production of manufactured
gas, generally referred to as coal tar, are regulated under federal and
state laws. The principal regulatory agency that is responsible for a
specific former manufactured gas plant (MGP) site depends largely upon the
state in which the site is located. There are several MGP sites to which
PEC has some connection. In this regard, PEC and other potentially
responsible parties (PRPs) are participating in, investigating and, if
necessary, remediating former MGP sites with several regulatory agencies,
including, but not limited to, the U.S. Environmental Protection Agency
(EPA) and the North Carolina Department of Environment and Natural
Resources, Division of Waste Management (DWM).
PEC has filed claims with its general liability insurance carriers to
recover costs arising from actual or potential environmental liabilities.
All claims have been settled other than with insolvent carriers. These
settlements have not had a material effect on the consolidated financial
position or results of operations.
There are nine former MGP sites and a number of other sites associated with
PEC that have required or are anticipated to require investigation and/or
remediation.
During the fourth quarter of 2004, the EPA advised PEC that it had been
identified as a PRP at the Ward Transformer site located in Raleigh, North
Carolina. The EPA offered PEC and 34 other PRPs the opportunity to
negotiate cleanup of the site and reimbursement of less than $2 million to
the EPA for EPA's past expenditures in addressing conditions at the site.
Although a loss is considered probable, an agreement among PRPs has not
been reached; consequently, it is not possible at this time to reasonably
estimate the total amount of PEC's obligation for remediation of the Ward
Transformer site.
As of March 31, 2005 and December 31, 2004, PEC's accruals for probable and
estimable costs related to various environmental sites, which are included
in other liabilities and deferred credits and are expected to be paid out
over many years, were:
---------------------------------------------------------------------------------------
(in millions) March 31, 2005 December 31, 2004
---------------------------------------------------------------------------------------
Insurance fund $ 5 $ 7
Transferred from North Carolina Natural Gas
Corporation at time of sale 2 2
---------------------------------------------------------------------------------------
Total accrual for environmental sites $ 7 $ 9
---------------------------------------------------------------------------------------
The insurance fund in the table above was established when PEC received
insurance proceeds to address costs associated with environmental
liabilities related to its involvement with some sites. All eligible
expenses related to these are charged against a specific fund containing
these proceeds. PEC made no additional accruals, spent approximately $2
million related to environmental remediation and received no insurance
proceeds, for the three months ended March 31, 2005.
This accrual has been recorded on an undiscounted basis. PEC measures its
liability for these sites based on available evidence including its
experience in investigating and remediating environmentally impaired sites.
The process often involves assessing and developing cost-sharing
arrangements with other PRPs. PEC will accrue costs for the sites to the
extent its liability is probable and the costs can be reasonably estimated.
Because the extent of environmental impact, allocation among PRPs for all
sites, remediation alternatives (which could involve either minimal or
significant efforts), and concurrence of the regulatory authorities have
42
not yet reached the stage where a reasonable estimate of the remediation
costs can be made, PEC cannot determine the total costs that may be
incurred in connection with the remediation of all sites at this time. It
is anticipated that sufficient information will become available for
several sites during 2005 to allow a reasonable estimate of PEC's
obligation for those sites to be made.
On March 30, 2005, the North Carolina Division of Water Quality renewed a
PEC permit for the continued use of coal combustion products generated at
any of the Company's coal-fired plants located in the state. PEC has
reviewed the permit conditions, which could significantly restrict the
reuse of coal ash and result in higher ash management costs, and plans to
adjudicate the permit conditions. The Company cannot predict the outcome of
this matter.
AIR QUALITY
PEC is subject to various current and proposed federal, state, and local
environmental compliance laws and regulations, which may result in
increased planned capital expenditures and operating and maintenance costs.
Significant updates to these laws and regulations and related impacts to
PEC since December 31, 2004, are discussed below. Additionally, Congress is
considering legislation that would require reductions in air emissions of
NOx, SO2, carbon dioxide and mercury. Some of these proposals establish
nationwide caps and emission rates over an extended period of time. This
national multi-pollutant approach to air pollution control could involve
significant capital costs that could be material to PEC's consolidated
financial position or results of operations. Control equipment that will be
installed on North Carolina fossil generating facilities as part of the
North Carolina Clean Smokestacks Act (Smokestacks Act), enacted in 2002 and
discussed below, may address some of the issues outlined above. However,
PEC cannot predict the outcome of the matter.
The EPA is conducting an enforcement initiative related to a number of
coal-fired utility power plants in an effort to determine whether changes
at those facilities were subject to New Source Review requirements or New
Source Performance Standards under the Clean Air Act. The Company was asked
to provide information to the EPA as part of this initiative and cooperated
in supplying the requested information. The EPA initiated civil enforcement
actions against other unaffiliated utilities as part of this initiative.
Some of these actions resulted in settlement agreements calling for
expenditures by these unaffiliated utilities in excess of $1.0 billion.
These settlement agreements have generally called for expenditures to be
made over extended time periods, and some of the companies may seek
recovery of the related cost through rate adjustments or similar
mechanisms.
Total capital expenditures to meet the requirements of the NOx SIP Call
Rule in North and South Carolina could reach approximately $370 million.
This amount also includes the cost to install NOx controls under North
Carolina's and South Carolina's programs to comply with the federal 8-hour
ozone standard. However, further technical analysis and rulemaking may
result in requirements for additional controls at some units. PEC has spent
approximately $303 million to date related to these projected amounts.
Increased operation and maintenance costs relating to the NOx SIP Call are
not expected to be material to PEC's results of operations. Further
controls are anticipated as electricity demand increases.
PEC projects that its capital costs to meet emission targets for NOx and
SO2 from coal-fired power plants under the Smokestacks Act, will total
approximately $895 million by the end of 2013. PEC has expended
approximately $141 million of these capital costs through March 31, 2005.
The law requires PEC to amortize 70% of the original cost estimate of $813
million, during a five-year rate freeze period. PEC recognized amortization
of $27 million for the three months ended March 31, 2005, and has
recognized $275 million in cumulative amortization through March 31, 2005.
The remaining amortization requirement will be recorded over the future
period ending December 31, 2007. The law permits PEC the flexibility to
vary the amortization schedule for recording the compliance costs from no
amortization expense up to $174 million per year. The NCUC will hold a
hearing prior to December 31, 2007, to determine cost recovery amounts for
2008 and future periods. O&M expense will increase due to the additional
materials, personnel and general maintenance associated with the equipment.
O&M expenses are recoverable through base rates, rather than as part of
this program. PEC cannot predict the future regulatory interpretation,
implementation or impact of this law.
43
On March 10, 2005, the EPA issued the final Clean Air Interstate Rule
(CAIR). The EPA's rule requires 28 states and the District of Columbia,
including North Carolina, South Carolina, Georgia and Florida, to reduce
NOx and SO2 emissions in order to attain state NOx and SO2 emissions
levels. The Company is reviewing the final rule. Installation of additional
air quality controls is likely to be needed to meet the CAIR requirements.
The Company is in the process of determining compliance plans and the cost
to comply with the rule. The air quality controls already installed for
compliance with the NOx SIP Call and currently planned by the Company to
comply with the Smokestacks Act will reduce the costs required to meet the
CAIR requirements for the Company's North Carolina units.
On March 15, 2005, the EPA finalized two separate but related rules: the
Clean Air Mercury Rule (CAMR) that sets emissions limits to be met in two
phases and encourages a cap and trade approach to achieving those caps, and
a de-listing rule that eliminated any requirement to pursue a maximum
achievable control technology (MACT) approach for limiting mercury
emissions from coal-fired power plants. NOx and SO2 controls also are
effective in reducing mercury emissions; however, according to the EPA the
second phase cap reflects a level of mercury emissions reduction that
exceeds the level that would be achieved solely as a co-benefit of
controlling NOx and SO2 under CAIR. The Company is in the process of
determining compliance plans and the cost to comply with the CAMR.
Installation of additional air quality controls is likely to be needed to
meet the CAMR's requirements. The de-listing rule has been challenged by a
number of parties; the resolution of the challenges could impact the
Company's final compliance plans and costs.
In conjunction with the proposed mercury rule, the EPA proposed a MACT
standard to regulate nickel emissions from residual oil-fired units. The
EPA withdrew the proposed nickel rule in March 2005.
In March 2004, the North Carolina Attorney General filed a petition with
the EPA under Section 126 of the Clean Air Act, asking the federal
government to force coal-fired power plants in 13 other states, including
South Carolina, to reduce their NOx and SO2 emissions. The state of North
Carolina contends these out-of-state emissions interfere with North
Carolina's ability to meet national air quality standards for ozone and
particulate matter. The EPA has agreed to make a determination on the
petition by August 1, 2005. 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 affected facilities. Integration of these new wastewater
streams into the existing wastewater treatment processes may result in
permitting, construction and treatment requirements imposed on PEC in the
immediate and extended future.
Based on new cost information and changes to the estimated time frame of
expenditures, PEC has revised the estimated amounts and time period for
expenditures to meet Section 316(b) requirements of the Clean Water Act.
PEC currently estimates that from 2005 through 2010 the range of
expenditures will be approximately $15 million to $25 million.
OTHER ENVIRONMENTAL MATTERS
The Kyoto Protocol was adopted in 1997 by the United Nations to address
global climate change by reducing emissions of carbon dioxide and other
greenhouse gases. The treaty went into effect on February 16, 2005. The
United States has not adopted the Kyoto Protocol, and the Bush
administration has stated it favors voluntary programs. A number of carbon
dioxide emissions control proposals have been advanced in Congress.
Reductions in carbon dioxide emissions to the levels specified by the Kyoto
Protocol and some legislative proposals could be materially adverse to
PEC's consolidated financial position or results of operations if
associated costs of control or limitation cannot be recovered from
customers. PEC favors the voluntary program approach recommended by the
Bush administration and continually evaluates options for the reduction,
avoidance and sequestration of greenhouse gases. However, PEC cannot
predict the outcome of this matter.
Progress Energy has announced its plan to issue a report on the Company's
activities associated with current and future environmental requirements.
The report will include a discussion of the environmental requirements that
PEC currently faces and expects to face in the future with respect to its
air emissions. The report is expected to be issued by March 31, 2006.
12. COMMITMENTS AND CONTINGENCIES
Contingencies existing as of the date of these statements are described
below. No significant changes have occurred since December 31, 2004, with
respect to the commitments discussed in Note 18 of PEC's 2004 Annual Report
on Form 10-K.
44
A. Guarantees
As a part of normal business, PEC enters into various agreements providing
future financial or performance assurances to third parties, which are
outside the scope of Financial Accounting Standards Board (FASB)
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others"
(FIN No. 45). Such agreements include guarantees, standby letters of credit
and surety bonds. At March 31, 2005, PEC does not believe conditions are
likely for significant performance under these guarantees. To the extent
liabilities are incurred as a result of the activities covered by the
guarantees, such liabilities are included in the accompanying Consolidated
Balance Sheets. At March 31, 2005, PEC had no guarantees issued on behalf
of unconsolidated subsidiaries or other third parties.
B. Insurance
PEC is a member of Nuclear Electric Insurance Limited (NEIL), which
provides primary and excess insurance coverage against property damage to
members' nuclear generating facilities. Under the primary program, PEC is
insured for $500 million at each of its nuclear plants. In addition to
primary coverage, NEIL also provides decontamination, premature
decommissioning and excess property insurance with limits of $1.75 billion
on each plant.
C. Other Contingencies
1. Pursuant to the Nuclear Waste Policy Act of 1982, the predecessors to
PEC entered into contracts with the U.S. Department of Energy (DOE) under
which the DOE agreed to begin taking spent nuclear fuel by no later than
January 31, 1998. All similarly situated utilities were required to sign
the same standard contract.
DOE failed to begin taking spent nuclear fuel by January 31, 1998. In
January 2004, PEC filed a complaint in the United States Court of Federal
Claims against the DOE, claiming that the DOE breached the Standard
Contract for Disposal of Spent Nuclear Fuel (SNF) by failing to accept SNF
from various PEC facilities on or before January 31, 1998. Damages due to
DOE's breach will likely exceed $100 million. Approximately 60 cases
involving the Government's actions in connection with spent nuclear fuel
are currently pending in the Court of Federal Claims.
DOE and the PEC parties have agreed to a stay of the lawsuit, including
discovery. The parties agreed to, and the trial court entered, a stay of
proceedings, in order to allow for possible efficiencies due to the
resolution of legal and factual issues in previously filed cases in which
similar claims are being pursued by other plaintiffs. These issues may
include, among others, so-called "rate issues," or the minimum mandatory
schedule for the acceptance of SNF and high level waste (HLW) by which the
Government was contractually obligated to accept contract holders' SNF
and/or HLW, and issues regarding recovery of damages under a partial breach
of contract theory that will be alleged to occur in the future. These
issues have been or are expected to be presented in the trials that are
currently scheduled to occur during 2005. Resolution of these issues in
other cases could facilitate agreements by the parties in the PEC lawsuit,
or at a minimum, inform the Court of decisions reached by other courts if
they remain contested and require resolution in this case. The trial court
has continued this stay until June 24, 2005.
On February 27, 2004, PEC requested to have its license for the Independent
Spent Fuel Storage Installation at the Robinson Plant extended by 20 years
with an exemption request for an additional 20-year extension. Its current
license is due to expire in August 2006. On March 30, 2005, the NRC issued
the 40-year license renewal.
With certain modifications and additional approval by the NRC, including
the installation of onsite dry storage facilities at Robinson and
Brunswick, PEC's spent nuclear fuel storage facilities will be sufficient
to provide storage space for spent fuel generated on PEC's system through
the expiration of the operating licenses for all of PEC's nuclear
generating units.
45
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. In January 2003, the State of Nevada,
Clark County, Nevada, and the City of Las Vegas petitioned the U.S. Court
of Appeals for the District of Columbia Circuit for review of the
Congressional override resolution. These same parties also challenged EPA's
radiation standards for Yucca Mountain. On July 9, 2004, the Court rejected
the challenge to the constitutionality of the resolution approving Yucca
Mountain, but ruled that the EPA was wrong to set a 10,000-year compliance
period in the radiation protection standard. EPA is currently reworking the
standard but has not stated when the work will be complete. DOE originally
planned to submit a license application to the NRC to construct the Yucca
Mountain facility by the end of 2004. However, in November 2004, DOE
announced it would not submit the license application until mid-2005 or
later. Also in November 2004, Congressional negotiators approved $577
million for fiscal year 2005 for the Yucca Mountain project, approximately
$300 million less than requested by DOE but approximately the same as
approved in 2004. The DOE has acknowledged that a working repository will
not be operational until sometime after 2010, but the DOE has not
identified a new target date. PEC cannot predict the outcome of this
matter.
2. In 2001, PEC entered into a contract to purchase coal from Dynegy
Marketing and Trade (DMT). After DMT experienced financial difficulties,
including credit ratings downgrades by certain credit reporting agencies,
PEC requested credit enhancements in accordance with the terms of the coal
purchase agreement in July 2002. When DMT did not offer credit
enhancements, as required by a provision in the contract, PEC terminated
the contract in July 2002.
PEC initiated a lawsuit seeking a declaratory judgment that the termination
was lawful. DMT counterclaimed, stating the termination was a breach of
contract and an unfair and deceptive trade practice. On March 23, 2004, the
United States District Court for the Eastern District of North Carolina
ruled that PEC was liable for breach of contract, but ruled against DMT on
its unfair and deceptive trade practices claim. On April 6, 2004, the Court
entered a judgment against PEC in the amount of approximately $10 million.
The Court did not rule on DMT's request under the contract for pending
legal costs.
On May 4, 2004, PEC authorized its outside counsel to file a notice of
appeal of the April 6, 2004, judgment and on May 7, 2004, the notice of
appeal was filed with the United States Court of Appeals for the Fourth
Circuit. On June 8, 2004, DMT filed a motion to dismiss the appeal on the
ground that PEC's notice of appeal should have been filed on or before May
6, 2004. On June 16, 2004, PEC filed a motion with the trial court
requesting an extension of the deadline for the filing of the notice of
appeal. By order dated September 10, 2004, the trial court denied the
extension request. On September 15, 2004, PEC filed a notice of appeal of
the September 10, 2004 order and by order dated September 29, 2004, the
appellate court consolidated the first and second appeals. DMT's motion to
dismiss the first appeal remains pending. Argument on the consolidated
appeal is scheduled for May 25, 2005.
PEC recorded a liability for the judgment of approximately $10 million and
a regulatory asset for the probable recovery through its fuel adjustment
clause in the first quarter of 2004. PEC cannot predict the outcome of this
matter.
3. On February 1, 2002, PEC filed a complaint with the Surface
Transportation Board (STB) challenging the rates charged by Norfolk
Southern Railway Company (Norfolk Southern) for coal transportation to
certain generating plants. In a decision dated December 23, 2003, the STB
found that the rates were unreasonable, awarded reparations and prescribed
maximum rates. Both parties petitioned the STB for reconsideration of the
December 23, 2003 decision. On October 20, 2004, the STB reconsidered its
December 23, 2003 decision and concluded that the rates charged by Norfolk
Southern were not unreasonable. Because PEC paid the maximum rates
prescribed by the STB in its December 23, 2003 decision for several months
during 2004, which were less than the rates ultimately found to be
reasonable, the STB ordered PEC to pay to Norfolk Southern the difference
between the rate levels plus interest.
46
PEC subsequently filed a petition with the STB to phase in the new rates
over a period of time, and filed a notice of appeal with the U.S. Court of
Appeals for the D.C. Circuit. Pursuant to an order issued by the STB on
January 6, 2005, the phasing proceeding will proceed on a schedule that
appears likely to produce an STB decision before the end of 2005. On
January 12, 2005, the STB filed a Motion to Dismiss PEC's appeal on the
grounds that its October 20, 2004 order is not final until PEC's phasing
application has been decided. PEC responded to this motion on January 26,
2005. The court has not yet ruled on the motion.
As of March 31, 2005, PEC has accrued a liability of $42 million, of which
$23 million represents reparations previously remitted to PEC by Norfolk
Southern that are now subject to refund. Of the remaining $19 million, $17
million has been recorded as deferred fuel cost on the Consolidated Balance
Sheet, while the remaining $2 million attributable to wholesale customers
has been charged to fuel used in electric generation on the Consolidated
Statements of Income. PEC or Norfolk Southern, as the case may be, will
make the appropriate payment to the other to reconcile all charges,
including interest, once a final STB decision in the phasing proceeding is
served.
PEC cannot predict the outcome of this matter.
4. PEC is involved in various litigation matters in the ordinary course of
business, some of which involve substantial amounts. Where appropriate,
accruals and disclosures have been made in accordance with SFAS No. 5,
"Accounting for Contingencies," to provide for such matters. In the opinion
of management, the final disposition of pending litigation would not have a
material adverse effect on PEC's consolidated results of operations or
financial position.
47
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following Management's Discussion and Analysis contains forward-looking
statements that involve estimates, projections, goals, forecasts, assumptions,
risks and uncertainties that could cause actual results or outcomes to differ
materially from those expressed in the forward-looking statements. Please review
"SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS" for a discussion of the factors
that may impact any such forward-looking statements made herein and the Risk
Factors sections of Progress Energy's and Progress Energy Carolina's (PEC)
annual report on Form 10-K for the year ended December 31, 2004.
Amounts reported in the interim Consolidated Statements of Income are not
necessarily indicative of amounts expected for the respective annual or future
periods due to the effects of seasonal temperature variations on energy
consumption and the timing of maintenance on electric generating units, among
other factors.
This discussion should be read in conjunction with the accompanying financial
statements found elsewhere in this report and in conjunction with the 2004 Form
10-K.
RESULTS OF OPERATIONS
The Company's reportable business segments and their primary operations include:
o Progress Energy Carolinas Electric (PEC Electric) - primarily engaged in
the generation, transmission, distribution and sale of electricity in
portions of North Carolina and South Carolina;
o Progress Energy Florida (PEF) - primarily engaged in the generation,
transmission, distribution and sale of electricity in portions of Florida;
o Competitive Commercial Operations (CCO) - engaged in nonregulated electric
generation operations and marketing activities primarily in Georgia, North
Carolina and Florida;
o Fuels - primarily engaged in natural gas production in Texas and Louisiana,
coal mining, coal terminal services and fuel transportation and delivery in
Kentucky, West Virginia and Virginia; and
o Synthetic Fuels - engaged in the production and sale of synthetic fuels and
the operation of synthetic fuel facilities for outside parties in Kentucky,
West Virginia and Virginia.
The Corporate and Other category includes other businesses engaged in other
nonregulated business areas, including telecommunications, primarily in the
eastern United States, and energy services operations and holding company
results, which do not meet the requirements for separate segment reporting
disclosure.
Prior to 2005, Rail Services was reported as a separate segment. In connection
with the divestiture of Progress Rail (see Note 3 of the Progress Energy
Consolidated Interim Financial Statements), the operations of Rail Services were
reclassified to discontinued operations in the first quarter of 2005 and
therefore are no longer a reportable segment. In addition, synthetic fuel
activities were reported in the Fuels segment prior to 2005 and now are
considered a reportable segment. These reportable segment changes reflect the
current reporting structure. For comparative purposes, the prior year results
have been restated to align with the current presentation.
In this section, earnings and the factors affecting earnings for the three
months ended March 31, 2005 as compared to the same period in 2004 are
discussed. The discussion begins with a summarized overview of the Company's
consolidated earnings, which is followed by a more detailed discussion and
analysis by business segment.
OVERVIEW
For the quarter ended March 31 2005, Progress Energy's net income was $93
million, or $0.38 per share, compared to $108 million, or $0.45 per share, for
the same period in 2004. The decrease in net income as compared to prior year
was due primarily to:
o Severance charges recorded throughout the Company related to the cost
management initiative.
o Unfavorable weather at both utilities.
o Increased O&M charges at PEF related to a workers compensation
adjustment.
o Decreased synthetic fuel earnings.
48
Partially offsetting these items were:
o Utility customer growth in the Carolinas and Florida.
o Favorable wholesale sales in both the Carolinas and Florida.
o Increased nonregulated generation earnings due primarily to reduced
interest expense.
o Reduced losses recorded on contingent value obligations.
o The impact of tax levelization.
Basic earnings per share decreased in 2005 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 2005 and 2004 also reduced basic
earnings per share by $0.01 in the first quarter of 2005.
The Company's segments contributed the following profits or losses for the three
months ended March 31, 2005 and 2004:
- ----------------------------------------------------------------------
(in millions) Three Months Ended March 31,
Business Segment 2005 2004
- ----------------------------------------------------------------------
PEC Electric $ 116 $ 116
PEF 43 49
Fuels 10 10
CCO (5) (8)
Synthetic Fuel (1) 36
- ----------------------------------------------------------------------
Total Segment Profit 163 203
- ----------------------------------------------------------------------
Corporate & Other (58) (104)
- ----------------------------------------------------------------------
Income from continuing operations 105 99
Discontinued operations, net of tax (12) 9
- ----------------------------------------------------------------------
Net income $ 93 $ 108
- ----------------------------------------------------------------------
COST MANAGEMENT INITIATIVE
On February 28, 2005, as part of a previously announced cost management
initiative, the Company approved a workforce restructuring which is expected to
be completed in September 2005 and result in a reduction of approximately 450
positions. The cost management initiative is designed to permanently reduce by
$75 million to $100 million the projected growth in the Company's annual
operation and maintenance (O&M) expenses by the end of 2007. In addition to the
workforce restructuring, the cost management initiative includes a voluntary
enhanced retirement program. In connection with this initiative, the Company
currently expects to incur estimated pre-tax charges of approximately $210
million. In addition, the Company expects to incur certain incremental costs
other than severance and postretirement benefits for recruiting, training and
staff augmentation activities that cannot be quantified at this time.
The Company recorded $31 million of expense during the first quarter of 2005 for
the estimated severance benefits to be paid as a result of the approximate
number of positions to be eliminated under the restructuring and due to the
implementation of an automated meter reading initiative at PEF. These amounts
will be paid over time and are subject to revision in future quarters based on
the impact of the voluntary enhanced retirement program. The severance expenses
are primarily included in O&M expense on the Consolidated Statements of Income.
The Company has estimated that an additional $180 million charge will be
recognized in the second quarter of 2005 and relates primarily to postretirement
benefits that will be paid over time to those eligible employees who elected to
participate in the voluntary enhanced retirement program. Approximately 3,500 of
the Company's 12,300 employees were eligible to participate in the voluntary
enhanced retirement program. The results from the employee elections indicate
that 1,447 of the Company's employees have elected to participate in the
voluntary enhanced retirement program. The cost management initiative charges
could change significantly primarily due to the demographics of the specific
employees who elected enhanced retirement and its impact on the postretirement
benefit actuarial studies.
49
PROGRESS ENERGY CAROLINAS ELECTRIC
PEC Electric contributed segment profits of $116 million for the three months
ended March 31, 2005 and 2004, respectively. Results for 2005 were favorably
impacted by increased revenues due to customer growth and usage. In addition,
results in 2004 included the write-off of non-trade receivables. These favorable
items were offset by unfavorable weather, higher O&M expenses due primarily to
severance accruals related to the announced cost management initiative.
Revenues
PEC Electric's revenues for the three months ended March 31, 2005 and 2004, and
the percentage change by customer class are as follows:
- ---------------------------------------------------------------------------
(in millions of $) Three Months Ended March 31,
Customer Class 2005 Change % Change 2004
- ---------------------------------------------------------------------------
Residential $ 374 $ 3 0.8 $ 371
Commercial 215 7 3.4 208
Industrial 149 2 1.4 147
Governmental 19 - - 19
- --------------------------------------------------- ----------
Total retail revenues 757 12 1.6 745
Wholesale 174 18 11.5 156
Unbilled (19) 4 - (23)
Miscellaneous 23 - - 23
- --------------------------------------------------- ----------
Total electric revenues $ 935 $ 34 3.8 $ 901
- --------------------------------------------------- ----------
Less:
Pass-through fuel revenues (271) (32) (13.4) (239)
- --------------------------------------------------- ----------
Revenues excluding fuel $ 664 $ 2 0.3 $ 662
- ---------------------------------------------------------------------------
PEC Electric's energy sales for the three months ended March 31, 2005 and 2004,
and the amount and percentage change by customer class are as follows:
- ---------------------------------------------------------------------------
(in millions of kWh) Three Months Ended March 31,
Customer Class 2005 Change % Change 2004
- ---------------------------------------------------------------------------
Residential 4,672 (69) (1.5) 4,741
Commercial 3,080 22 0.7 3,058
Industrial 2,931 (62) (2.1) 2,993
Governmental 327 (18) (5.2) 345
- --------------------------------------------------- ----------
Total retail energy sales 11,010 (127) (1.1) 11,137
Wholesale 3,938 147 3.9 3,791
Unbilled (303) 82 - (385)
- --------------------------------------------------- ----------
Total kWh sales 14,645 102 0.7 14,543
- ---------------------------------------------------------------------------
PEC Electric's revenues, excluding recoverable fuel revenues of $271 million and
$239 million for the three months ended March 31, 2005 and 2004, respectively,
increased $2 million. The increase in revenues is attributable to favorable
customer growth of $20 million and an increase in wholesale revenues of $1
million. Favorable growth was driven by an increase in customers of 27,000 as of
March 31, 2005 as compared to March 31, 2004. The increase in wholesale revenues
is due primarily to favorable prices on excess generation sales. Favorable
customer growth and wholesale revenues were offset partially by unfavorable
weather of $19 million with heating degree days 8% below prior year.
Expenses
Fuel and Purchased Power
Fuel and purchased power costs represent the costs of generation, which include
fuel purchases for generation, as well as energy purchased in the market to meet
customer load. Fuel and purchased power expenses are recovered primarily through
cost recovery clauses, and, as such changes in these expenses do not have a
material impact on earnings. The difference between fuel and purchased power
costs incurred and associated fuel revenues that are subject to recovery is
deferred for future collection from or refund to customers.
50
Fuel and purchased power expenses were $315 million for 2005, which represents a
$29 million increase compared to the same period in the prior year. Fuel used in
electric generation increased $24 million to $248 million compared to the prior
year. This increase is due to an increase in fuel used in generation of $53
million due primarily to higher fuel costs are being driven primarily by an
increase in coal prices. The increase in fuel used in generation is offset by a
reduction in deferred fuel expense as a result of the under-recovery of current
period fuel costs. Purchased power expense increased $5 million to $67 million
compared to prior year. The increase in purchased power during the quarter is
due to resource availability and increased fuel costs.
Operations and Maintenance (O&M)
O&M expenses were $224 million for the three months ended March 31, 2005, which
represents a $15 million increase compared to the same period in 2004. Severance
expense related to the cost management initiative increased O&M expenses by $13
million during 2005. In addition, outage costs were $7 million higher compared
to prior year due to a planned outage at a coal-fired plant in March 2005 and
O&M expenses also increased $6 million related to the change in Energy Delivery
capitalization practice. These unfavorable items were partially offset by lower
compensation and benefits of $6 million and a reduction in storm costs. Results
for 2004 included $6 million of costs associated with an ice storm that hit the
Carolinas service territory. See discussion of change in Energy Delivery
capitalization practice in Note 8F of the Progress Energy annual report on Form
10-K for the year ended December 31, 2004.
Depreciation and Amortization
Depreciation and amortization expense was $129 million for the three months
ended March 31, 2005, which represents a $2 million increase compared to the
same period in 2004. The increase is attributable to higher NC Clean Air
amortization of $11 million and higher depreciation for assets placed in
services of $2 million. These increases were partially offset by a reduction in
depreciation expense of $11 million related to the depreciation studies filed in
2004. Depreciation rates are the same for 2005 and 2004; however, the 2004 year
to date retroactive adjustment for the new rates adopted related to the expanded
lives of the nuclear units was made in November 2004.
Taxes Other than on Income
Taxes other than on income were $46 million for the three months ended March 31,
2005, which represents a $3 million increase compared to the same period in
2005. This increase is due to higher property taxes of $1 million due to higher
property appraisals and higher payroll taxes of $1 million related to severance
accruals recorded during 2005.
Other income, net
Other income, net has increased $12 million for the period ending March 31, 2005
as compared to the same period in the prior year. This increase is due primarily
to a write-off of $7 million of non-trade receivables in the prior year. In
addition, investment losses have decreased $2 million compared to prior year.
PROGRESS ENERGY FLORIDA
PEF contributed segment profits of $43 million and $49 million in the three
months ended March 31, 2005 and 2004, respectively. The decrease in profits for
the three months ended March 31, 2005 when compared to 2004 is primarily due to
the impact of milder weather, weaker industrial sales and higher O&M expenses,
partially offset by higher wholesale sales and increased customer growth.
51
PEF's electric revenues for the three months ended March 31, 2005 and 2004, and
the amount and percentage change by customer class are as follows:
- ---------------------------------------------------------------------------
(in millions of $) Three Months Ended March 31,
Customer Class 2005 Change % Change 2004
- ---------------------------------------------------------------------------
Residential $ 431 $ 29 7.2 $ 402
Commercial 201 20 11.0 181
Industrial 63 - - 63
Governmental 53 7 15.2 46
Retail revenue sharing (2) 2 - (4)
- --------------------------------------------------- ----------
Total retail revenues 746 58 8.4 688
Wholesale 73 6 9.0 67
Unbilled (5) 1 - (6)
Miscellaneous 34 (1) (2.9) 35
- --------------------------------------------------- ----------
Total electric revenues $ 848 $ 64 8.2 $ 784
Less:
- --------------------------------------------------- ----------
Pass-through revenues (501) (54) (12.1) (447)
- --------------------------------------------------- ----------
Revenues excluding pass-
through revenues $ 347 $ 10 3.0 $ 337
- ---------------------------------------------------------------------------
PEF's electric energy sales for the three months ended March 31, 2005 and 2004,
and the amount and percentage change by customer class are as follows:
- ----------------------------------------------------------------------------
(in millions of kWh) Three Months Ended March 31,
Customer Class 2005 Change % Change 2004
- ----------------------------------------------------------------------------
Residential 4,347 56 1.3 4,291
Commercial 2,571 80 3.2 2,491
Industrial 940 (83) (8.1) 1,023
Governmental 709 37 5.5 672
- ---------------------------------------------------- ----------
Total retail energy sales 8,567 90 1.1 8,477
Wholesale 1,338 15 1.1 1,323
Unbilled (103) 32 - (135)
- ---------------------------------------------------- ----------
Total kWh sales 9,802 137 1.4 9,665
- ----------------------------------------------------------------------------
Revenues
PEF's revenues, excluding recoverable fuel and other pass-through revenues of
$501 million and $447 million for the three months ended March 31, 2005 and
2004, respectively, increased $10 million. The increase in revenues is due to
favorable customer growth and increased wholesale revenues of $7 million each.
Favorable customer growth was driven by a 35,000 increase in average retail
customers compared to prior year. Wholesale revenue favorability is attributable
primarily to new contracts entered into since March 31, 2004. These increases
were partially offset by the impacts of milder weather and weaker industrial
sales of $3 million each.
Expenses
Fuel and Purchased Power
Fuel and purchased power costs represent the costs of generation, which include
fuel purchases for generation, as well as energy purchased in the market to meet
customer load. Fuel and purchased power expenses are recovered primarily through
cost recovery clauses, and, as such changes in these expenses do not have a
material impact on earnings. The difference between fuel and purchased power
costs incurred and associated fuel revenues that are subject to recovery is
deferred for future collection or refund to customers.
52
Fuel and purchased power expenses were $433 million for the three months ended
March 31, 2005, which represents a $43 million increase compared to prior year.
This increase is due to increases in fuel used in electric generation and
purchased power expenses of $33 million and $10 million, respectively. Higher
system requirements and increased fuel costs in the current year account for $41
million of the increase in fuel used in electric generation. This increase was
partially offset by a decrease in deferred fuel expense as recovery of fuel
expenses in the prior year (that were previously deferred) was greater than in
the current year. In December 2004, the FPSC approved PEF's request for a cost
recovery adjustment in its annual filing due to the rising cost of fuel. Fuel
recovery rates increased effective January 1, 2005. The increase in purchased
power expense was primarily due to higher prices of purchases in the current
year as a result of increased fuel costs.
Operations and Maintenance (O&M)
O&M expenses were $189 million for the three months ended March 31, 2005, which
represents an increase of $29 million, when compared to the $160 million
incurred during the three months ended March 31, 2004. Severance expense related
to the cost management initiative increased O&M costs by $14 million during
2005. In addition, PEF recorded a workers compensation benefit adjustment of $8
million during 2005 as a result of an annual actuarial study. O&M expense also
increased $8 million related to the change in Energy Delivery capitalization
practice. See discussion of change in Energy Delivery capitalization practice in
Note 8F of the Progress Energy annual report on Form 10-K for the year ended
December 31, 2004.
Taxes Other than on Income
Taxes other than on income were $67 million for the three months ended March 31,
2005, which represents an increase of $5 million compared to prior year. This
increase is due to increases in franchise and gross receipts taxes of $2 million
and $1 million, respectively, related to an increase in revenues and an increase
in property taxes of $1 million due to property additions.
DIVERSIFIED BUSINESSES
The Company's diversified businesses consist of the Fuels segment, the CCO
segment and the Synthetic Fuels segment. These businesses are explained in more
detail below.
FUELS
The Fuels' segment operations include natural gas production, coal extraction
and terminal operations. The following summarizes Fuels' segment profits for the
three months ended March 31, 2005 and 2004:
- --------------------------------------------------------
(in millions) 2005 2004
- --------------------------------------------------------
Gas production $ 12 $ 13
Coal fuel and other operations (2) (3)
- --------------------------------------------------------
Segment Profits $ 10 $ 10
- --------------------------------------------------------
Natural Gas Operations
Natural gas operations generated profits of $12 million and $13 million for the
three months ended March 31, 2005 and 2004, respectively. The decrease in gas
earnings compared to prior year is attributable to reduced production as a
result of the sale of gas assets in 2004 offset partially by higher natural gas
prices. In December 2004, the Company sold certain gas-producing properties and
related assets owned by Winchester Production Company, Ltd., a subsidiary of
Progress Fuels (North Texas gas operations). The following summarizes the gas
production, revenues and gross margins for the three months ended March 31, 2005
and 2004 by production facility:
53
- ------------------------------------------------------------------------
2005 2004
- ------------------------------------------------------------------------
Production in Bcf equivalent
East Texas/LA gas operations 5.4 4.0
North Texas gas operations - 2.7
- ------------------------------------------------------------------------
Total Production 5.4 6.7
- ------------------------------------------------------------------------
Revenues in millions
East Texas/LA gas operations $ 33 $ 22
North Texas gas operations - 13
- ------------------------------------------------------------------------
Total Revenues $ 33 $ 35
- ------------------------------------------------------------------------
Gross Margin
in millions of $ $ 28 $ 27
As a % of revenues 85% 77%
- ------------------------------------------------------------------------
Coal Fuel and Other Operations
Coal fuel and other operations generated segment losses of $2 million for the
three months ended March 31, 2005 compared to losses of $3 million for the three
months ended March 31, 2004. The decrease in losses of $1 million is due
primarily to increased revenues as a result of higher coal prices. This
favorability was partially offset by higher coal mining costs (due to rising
prices of fuel and steel), a workers compensation accrual adjustment booked
during 2005 and reduced rates related to the waterborne coal transportation
settlement in 2004. In addition, results were unfavorably impacted by severance
expense of $1 million pre-tax recorded in 2005 related to the cost management
initiative.
COMPETITIVE COMMERCIAL OPERATIONS
CCO's operations generated segment losses of $5 million for the three months
ended March 31, 2005 compared to losses of $8 in the prior year. The decrease in
losses compared to prior year is due primarily to a reduction in depreciation
and amortization expense and interest expense. Depreciation and amortization
expenses decreased $4 million pre-tax ($2 million after-tax) as a result of the
expiration of certain acquired contracts that were subject to amortization.
Interest expense decreased $3 million pre-tax ($2 million after-tax) due to the
termination of the Genco financing arrangement in December 2004. In addition,
results were favorably impacted by a mark to market gain in the current quarter
compared to a loss in the prior year. This favorability was offset partially by
lower contract margins as a result of the expiration of certain tolling
agreements.
- -----------------------------------------------------
(in millions) 2005 2004
- -----------------------------------------------------
Total revenues $ 65 $ 33
Gross margin
In millions of $ $ 21 $ 23
As a % of revenues 32% 70%
Segment losses $ (5) $ (8)
- -----------------------------------------------------
The Company has contracts for its planned production capacity, which includes
callable resources from the cooperatives, of approximately 77% for 2005,
approximately 81% for 2006 and approximately 75% for 2007. The Company continues
to seek opportunities to optimize its nonregulated generation portfolio.
SYNTHETIC FUEL
The synthetic fuel operations generated segment losses of $1 million for the
three months ended March 31, 2005 compared to segment profits of $36 million for
the three months ended March 31, 2004. The production and sale of synthetic fuel
generate operating losses, but qualify for tax credits under Section 29 of the
Code, which typically more than offset the effect of such losses. See Note 14 to
the Progress Energy Consolidated Interim Financial Statements.
54
The operations resulted in the following for the three months ended March 31,
2005 and 2004:
- ------------------------------------------------------------------
(in millions) 2005 2004
- ------------------------------------------------------------------
Tons sold 2.0 2.9
- ------------------------------------------------------------------
Operating losses, excluding tax credits $ (38) $ (42)
Tax credits generated, net 37 78
- ------------------------------------------------------------------
Segment (losses) profits $ (1) $ 36
- ------------------------------------------------------------------
Synthetic fuels' earnings were negatively impacted by lower sales, forfeiture of
tax credits as a result of the sale of Progress Rail and decreased margins. The
decrease in sales quarter over quarter is primarily attributable to an internal
change in the quarterly production schedule in 2005 compared to 2004. The sale
of Progress Rail resulted in a capital loss for tax purposes, therefore $17
million of previously recorded tax credits were forfeited during the quarter.
See Note 14 to the Progress Energy Consolidated Interim Financial Statements for
further discussion.
In response to the historically high oil prices to date in 2005, the Company has
adjusted its planned production schedule for its synthetic fuel plant by
shifting some of its production planned for April and May 2005 to the second
half of 2005. If oil prices rise and stay at levels high enough to cause a phase
out of tax credits, the Company may reduce planned production or suspend
production at some or all of its synthetic fuel facilities.
CORPORATE & OTHER
Corporate & Other consists of the operations of Progress Energy Holding Company
(the holding company), Progress Energy Service Company and other consolidating
and non-operating entities. Corporate & Other also includes other nonregulated
business areas including the telecommunications operations of Progress
Telecommunications Corp. (PTC) and the operations of Strategic Resource
Solutions (SRS). PTC LLC operations provide broadband capacity services, dark
fiber and wireless services in Florida and the eastern United States. SRS was
engaged in providing energy services to industrial, commercial and institutional
customers to help manage energy costs primarily in the southeastern United
States. During 2004, SRS sold its subsidiary, Progress Energy Solutions (PES).
With the disposition of PES, the Company exited this business area.
Other nonregulated business areas
Other nonregulated businesses contributed segment losses of $1 million for the
three months ended March 31, 2005 compared to segment losses of $3 million for
the three months ended March 31, 2004. PTC earnings were essentially breakeven
for the quarter ended March 31, 2005, compared with segment loss $1 million for
the same period last year. PTC's results for 2004 were negatively impacted by
integration costs associated with its combination with EPIK in December 2003.
The remaining favorability is attributable to a reduction in investment losses
recognized by the nonutility subsidiaries of PEC.
Corporate Services
Corporate Services (Corporate) 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 2005 2004
- --------------------------------------------------------------------
Other interest expense $ (71) $ (73)
Contingent value obligations - (7)
Tax levelization (3) (39)
Tax reallocation (9) (9)
Other income taxes 29 30
Other (3) (3)
- --------------------------------------------------------------------
Segment profit (loss) $ (57) $ (101)
- --------------------------------------------------------------------
55
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, 2005 and 2004, the
CVOs had fair market values of approximately $13 million and $30 million,
respectively. Progress Energy recorded an unrealized gain of $0.5 million and an
unrealized loss of $7 million for the three months ended March 31, 2005 and
2004, respectively, to record the changes in fair value of the CVOs, which had
average unit prices of $0.13 and $0.31 at March 31, 2005 and 2004, 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 $3 million and $39 million for the three months
ended March 31, 2005 and 2004, respectively, in order to maintain an effective
tax rate consistent with the estimated annual rate. The tax credits associated
with the Company's synthetic fuel operations primarily drive the required
levelization amount. Fluctuations in estimated annual earnings and tax credits
can also cause large swings in the effective tax rate for interim periods.
Therefore, this adjustment will vary each quarter, but will have no effect on
net income for the year.
DISCONTINUED OPERATIONS
On March 24, 2005, the Company completed the sale of Progress Rail to One Equity
Partners LLC a private equity firm unit of J.P. Morgan Chase & Company. Gross
cash proceeds from the sale are estimated to be $433 million, consisting of $405
million base proceeds plus an estimated working capital adjustment. Proceeds
from the sale were used to reduce debt. The accompanying consolidated interim
financial statements have been restated for all periods presented for the
discontinued operations of Progress Rail. See Notes 3 and 14A to the Progress
Energy Consolidated Interim Financial Statements for additional discussion.
Rail discontinued operations resulted in losses of $12 million for the three
months ended March 31, 2005 compared to profits of $9 million for the three
months ended March 31, 2004. Earnings for 2005 include an estimated after-tax
loss on the sale of $17 million. The Company anticipates adjustments to the loss
on the divestiture during the second quarter of 2005 related to employee benefit
settlements and the finalization of working capital adjustments and other
operating estimates. The remaining unfavorability in earnings compared to prior
year is attributable primarily to increased transaction costs associated with
the sale.
LIQUIDITY AND CAPITAL RESOURCES
Progress Energy, Inc.
Progress Energy is a registered holding company and, as such, has no operations
of its own. The Company's primary cash needs at the holding company level are
its common stock dividend and interest expense and principal payments on its
$4.3 billion of senior unsecured debt. The ability to meet these needs is
dependent on its access to the capital markets, the earnings and cash flows of
its two electric utilities and nonregulated subsidiaries, and the ability of
those subsidiaries to pay dividends or repay funds to Progress Energy.
Cash Flows from Operations
Net cash provided by operating activities decreased $88 million for the three
months ended March 31, 2005, 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 net income, an under-recovery of fuel costs in 2005 of
$44 million when compared with 2004, and approximately $62 million in storm
restoration expenditures at PEF.
Investing Activities
Net cash used in investing activities increased by $142 million primarily due to
net purchases of short-term investments in 2005 compared to net proceeds from
short-term investments in 2004. Excluding this activity, cash used in investing
activities decreased $232 million. The decrease is due primarily to $405 million
in proceeds from the sale of Progress Rail in March 2005. See Note 3 to the
Progress Energy Consolidated Interim Financial Statements. This was partially
offset by additional capital expenditures for utility additions and nuclear
fuel.
56
Financing Activities
Net cash provided by financing activities was $153 million for the three months
ended March 31, 2005, compared to net cash used in financing activities of $346
million for the three months ended March 31, 2004, or a net increase of $499
million. The change in cash provided from financing activities was due primarily
to the March 1, 2004 maturity of $500 million 6.55% senior unsecured notes.
These notes were paid with cash and commercial paper capacity which was created
from the sale of assets during 2003.
In January 2005, the Company used proceeds from the issuance of commercial paper
to pay off $260 million of revolving credit agreement (RCA) loans, which
included $90 million at PEC and $170 million at PEF.
On January 31, 2005, Progress Energy, Inc. entered into a new $600 million RCA,
which expires December 30, 2005. This facility was added to provide additional
liquidity during 2005 due in part to the uncertainty of the timing of storm
restoration cost recovery from the hurricanes in Florida during 2004. The RCA
includes a defined maximum total debt to total capital ratio of 68% and a
minimum interest coverage ratio of 2.5 to 1. The RCA also contains various
cross-default and other acceleration provisions. On February 4, 2005, $300
million was drawn under the new facility to reduce commercial paper and pay off
the remaining amount of loans outstanding under other RCA facilities, which
consisted of $160 million at Progress Energy and $55 million at PEF. As
discussed below, the maximum size of this RCA was reduced to $300 million on
March 22, 2005.
On March 22, 2005, PEC issued $300 million of First Mortgage Bonds, 5.15% Series
due 2015, and $200 million of First Mortgage Bonds, 5.70% Series due 2035. The
net proceeds from the sale of the bonds were used to pay off $300 million of its
7.50% Senior Notes on April 1, 2005 and reduce the outstanding balance of
commercial paper. Pursuant to the terms of the Progress Energy $600 million RCA,
commitments were reduced to $300 million, effective March 22, 2005.
In March 2005, Progress Energy, Inc.'s five-year credit facility was amended to
increase the maximum total debt to total capital ratio from 65% to 68% due to
the potential impacts of proposed accounting rules for uncertain tax positions.
See Note 2 to the Progress Energy Consolidated Interim Financial Statements.
On March 28, 2005, PEF entered into a new $450 million RCA with a syndication of
financial institutions. The RCA will be used to provide liquidity support for
PEF's issuances of commercial paper and other short-term obligations. The RCA
will expire on March 28, 2010. The new $450 million RCA replaced PEF's $200
million three-year RCA and $200 million 364-day RCA, which were each terminated
effective March 28, 2005. Fees and interest rates under the $450 million RCA are
to be determined based upon the credit rating of PEF's long-term unsecured
senior non-credit enhanced debt, currently rated as A3 by Moody's Investor
Services (Moody's) and BBB by Standard and Poor's (S&P). The RCA includes a
defined maximum total debt to capital ratio of 65%. The RCA also contains
various cross-default and other acceleration provisions, including a
cross-default provision for defaults of indebtedness in excess of $35 million.
The RCA does not include a material adverse change representation for borrowings
or a financial covenant for interest coverage, which had been provisions in the
terminated agreements.
On March 28, 2005, PEC entered into a new $450 million RCA with a syndication of
financial institutions. The RCA will be used to provide liquidity support for
PEC's issuances of commercial paper and other short-term obligations. The RCA
will expire on June 28, 2010. The new $450 million RCA replaced PEC's $285
million three-year RCA and $165 million 364-day RCA, which were each terminated
effective March 28, 2005. Fees and interest rates under the $450 million RCA are
to be determined based upon the credit rating of PEC's long-term unsecured
senior non-credit enhanced debt, currently rated as Baa1 by Moody's and BBB by
S&P. The RCA includes a defined maximum total debt to capital ratio of 65%. The
RCA also contains various cross-default and other acceleration provisions,
including a cross-default provision for defaults of indebtedness in excess of
$35 million. The RCA does not include a material adverse change representation
for borrowings, which had been a provision in the terminated agreements.
For the three months ended March 31, 2005, the Company issued approximately 1.4
million shares representing approximately $60 million in proceeds from its
Investor Plus Stock Purchase Plan and its employee benefit and stock option
plans, net of purchases of restricted shares. The Company expects to realize
approximately $125 million of cash from the sale of stock through these plans
during 2005.
57
Future Liquidity and Capital Resources
As of March 31, 2005, there were no material changes in the Company's "Capital
Expenditures," "Other Cash Needs," "Credit Facilities," or "Credit Rating
Matters" as compared to those discussed under in Item 7 of the Form 10-K, other
than "Environmental Matters" and as described below and under "Financing
Activities."
As of March 31, 2005, the current portion of long-term debt was $1.1 billion,
which the Company expects to fund from issuances of new long-term debt,
commercial paper borrowings and/or issuance of new equity securities.
The amount and timing of future sales of company securities will depend on
market conditions, operating cash flow, asset sales and the specific needs of
the Company. The Company may from time to time sell securities beyond the amount
needed to meet capital requirements in order to allow for the early redemption
of long-term debt, the redemption of preferred stock, the reduction of
short-term debt or for other general corporate purposes.
On April 29, 2005, PEF made its initial filing with the FPSC seeking annual base
revenue increase of $206 million. See Note 4 to the Progress Energy Consolidated
Interim Financial Statements. Hearings for this proceeding are expected to occur
during the third quarter of 2005. A final ruling from the FPSC is expected in
December 2005 with new rates in effect January 2006.
PEF's petition for recovery of $252 million of storm costs is scheduled for
final order July 5, 2005. PEF has filed for a two-year recovery of storm costs.
On May 4, 2005, a bill was approved by the Florida Legislature that would
authorize the FPSC to consider allowing the state's investor-owned utilities to
issue bonds that are secured by surcharges on utility customer bills. These
bonds would be issued for recovery of storm damage costs and potentially to
restore depleted storm reserves. The amount of funds established for recovery is
subject to the review and approval of the FPSC. The bill will now be sent to
Governor Bush for his consideration. The Governor has indicated that he supports
the bill. The Company cannot predict the outcome of this matter.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
The Company's off-balance sheet arrangements and contractual obligations are
described below.
Guarantees
As a part of normal business, Progress Energy and certain wholly owned
subsidiaries enter into various agreements providing future financial or
performance assurances to third parties that are outside the scope of Financial
Accounting Standards Board (FASB) Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" (FIN No. 45). These agreements are entered into
primarily to support or enhance the creditworthiness otherwise attributed to
Progress Energy and subsidiaries on a stand-alone basis, thereby facilitating
the extension of sufficient credit to accomplish the subsidiaries' intended
commercial purposes. The Company's guarantees include performance obligations
under power supply agreements, tolling agreements, transmission agreements, gas
agreements, fuel procurement agreements and trading operations. The Company's
guarantees also include standby letters of credit, surety bonds and guarantees
in support of nuclear decommissioning. At March 31, 2005, the Company had issued
$1.3 billion of guarantees for future financial or performance assurance. The
Company does not believe conditions are likely for significant performance under
the guarantees of performance issued by or on behalf of affiliates.
The majority of contracts supported by the guarantees contain provisions that
trigger guarantee obligations based on downgrade events to below investment
grade (below BBB- or Baa3), ratings triggers, monthly netting of exposure and/or
payments and offset provisions in the event of a default. As of March 31, 2005,
no guarantee obligations had been triggered. If the guarantee obligations were
triggered, the maximum amount of liquidity requirements to support ongoing
operations within a 90-day period, associated with guarantees for the Company's
nonregulated portfolio and power supply agreements was $457 million. The Company
would meet this obligation with cash or letters of credit.
58
At March 31, 2005, the Company had issued guarantees and indemnifications of
certain legal, tax and environmental matters to third parties in connection with
sales of businesses and for timely payment of obligations in support of its
non-wholly owned synthetic fuel operations. Related to the sales of businesses,
the notice period extends until 2012 for the majority of matters provided for in
the indemnification provisions. For matters which the Company has received
timely notice, the Company's indemnity obligations may extend beyond the notice
period. Certain environmental indemnifications related to the sale of synthetic
fuel operations have no limitations as to time or maximum potential future
payments. Other guarantees and indemnifications have an estimated maximum
exposure of approximately $111 million. At March 31, 2005, the Company has
recorded liabilities related to guarantees and indemnifications to third-parties
of $22 million. Management does not believe conditions are likely for
significant performance under these agreements in excess of the recorded
liabilities.
Market Risk and Derivatives
Under its risk management policy, the Company may use a variety of instruments,
including swaps, options and forward contracts, to manage exposure to
fluctuations in commodity prices and interest rates. See Note 9 to the Progress
Energy Consolidated Interim Financial Statements and Item 3, "Quantitative and
Qualitative Disclosures About Market Risk," for a discussion of market risk and
derivatives.
Contractual Obligations
As of March 31, 2005, the Company's contractual cash obligations and other
commercial commitments have not changed materially from what was reported in the
2004 Annual Report on Form 10-K.
OTHER MATTERS
Synthetic Fuels Tax Credits
The Company has substantial operations associated with the production of
coal-based synthetic fuels. The production and sale of these products qualifies
for federal income tax credits so long as certain requirements are satisfied.
These operations are subject to numerous risks.
Although the Company believes that it operates its synthetic fuel facilities in
compliance with applicable legal requirements for claiming the credits, its four
Earthco facilities are under audit by the IRS. IRS field auditors have taken an
adverse position with respect to the Company's compliance with one of these
legal requirements, and if the Company fails to prevail with respect to this
position, it could incur significant liability and/or lose the ability to claim
the benefit of tax credits carried forward or generated in the future.
Similarly, the Financial Accounting Standards Board may issue new accounting
rules that would require that uncertain tax benefits (such as those associated
with the Earthco plants) be probable of being sustained in order to be recorded
on the financial statements; if adopted, this provision could have an adverse
financial impact on the Company.
The Company's ability to utilize tax credits is dependent on having sufficient
tax liability. Any conditions that negatively impact the Company's tax
liability, such as weather, could also diminish the Company's ability to utilize
credits, including those previously generated, and the synthetic fuel is
generally not economical to produce absent the credits. Finally, the tax credits
associated with synthetic fuels may be phased out if market prices for crude oil
exceed certain prices.
The Company's synthetic fuel operations and related risks are described in more
detail in Note 14 to the Progress Energy Consolidated Interim Financial
Statements and in the Risk Factors section of Progress Energy's Annual Report on
Form 10-K for the year ended December 31, 2004, which was filed with the SEC on
March 16, 2005.
59
PEF Rate Case Filing
On April 29, 2005, PEF submitted minimum filing requirements, based on a 2006
projected test year, to initiate a base rate proceeding regarding its future
base rates. In its filing, PEF has requested a $206 million annual increase in
base rates effective January 1, 2006. PEF's request for an increase in base
rates reflects an increase in operational costs with (i) the addition of Hines 2
generation facility into base rates rather than the Fuel Clause as was permitted
under the terms of existing Stipulation and Settlement Agreement (the
Agreement), (ii) completion of the Hines 3 generation facility, (iii) the need
to replenish PEF's depleted storm reserve by adjusting the annual accrual in
light of recent history on a going-forward basis, (iv) the expected
infrastructure investment necessary to meet high customer expectations, coupled
with the demands placed on PEF's strong customer growth, (v) significant
additional costs including increased depreciation and fossil dismantlement
expenses and (vi) general inflationary pressures.
Hearings on the base rate proceeding are expected during the third quarter of
2005 and a final decision is expected by the end of 2005. The Company cannot
predict the outcome of this matter.
PEF Storm Cost Filing
Hearings on PEF's petition for recovery of $252 million of storm costs filed
with the FPSC were held from March 30, 2005 to April 1, 2005. The FPSC is
scheduled to vote on the Company's petition on June 14, 2005, with an order
expected on July 5, 2005. The Company cannot predict the outcome of this matter.
On May 4, 2005, a bill was approved by the Florida Legislature that would
authorize the FPSC to consider allowing the state's investor-owned utilities to
issue bonds that are secured by surcharges on utility customer bills. These
bonds would be issued for recovery of storm damage costs and potentially to
restore depleted storm reserves. The amount of funds established for recovery is
subject to the review and approval of the FPSC. The bill will now be sent to
Governor Bush for his consideration. The Governor has indicated that he supports
the bill. The Company cannot predict the outcome of this matter.
Franchise Litigation
Three cities, with a total of approximately 18,000 customers, have litigation
pending against PEF in various circuit courts in Florida. As previously
reported, 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, as long as PEF continues to occupy the cities' rights-of-way to
provide electric service, notwithstanding the expiration of the franchise
ordinances under which PEF had agreed to collect such fees. The circuit courts
in those cases have entered orders requiring arbitration to establish the
purchase price of PEF's electric distribution system within five cities. Two
appellate courts have upheld those circuit court decisions and authorized the
cities to determine the value of PEF's electric distribution system within the
cities through arbitration.
Arbitration in one of the cases (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 (the City) at approximately $32 million, not including separation and
reintegration and construction work in progress, which could add several million
dollars to the award. The panel also awarded PEF approximately $11 million in
stranded costs, which, according to the award, decrease over time. In September
2003, Winter Park voters passed a referendum that would authorize the City to
issue bonds of up to approximately $50 million to acquire PEF's electric
distribution system. While the City has not yet definitively decided whether it
will acquire the system, on April 26, 2004, the City Commission voted to proceed
with the acquisition. The City sought and received wholesale power supply bids
and on June 24, 2004, executed a wholesale power supply contract with PEF with a
five-year term from the date service begins and a renewal option. On May 12,
2004, the City solicited bids to operate and maintain the distribution system
and awarded a contract in January 2005. The City has indicated that its goal is
to begin electric operations in June 2005. On February 10, 2005, PEF filed a
petition with the Florida Public Service Commission (FPSC) to relieve the
Company of its statutory obligation to serve customers in Winter Park on June 1,
2005, or at such time when the City is able to provide retail service. On April
19, 2005, the FPSC voted to approve PEF's petition. At this time, whether and
when there will be further proceedings regarding the City of Winter Park cannot
be determined.
60
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 $2 million in stranded costs.
The Town has not yet decided whether it will attempt to acquire the system;
however, on January 18, 2005, it issued a request for proposals for wholesale
power supply and to operate and maintain the distribution system. In March 2005,
PEF submitted a bid to supply wholesale power to the Town. The Town received
several other proposals for wholesale power and distribution services. In
February 2005, the Town Commission also voted to put the issue of whether to
acquire the distribution system to a voter referendum on or before October 2,
2005. At this time, whether and when there will be further proceedings regarding
the Town of Belleair cannot be determined.
Arbitration in the remaining city's litigation (the 1,500-customer City of
Edgewood) has not yet been scheduled. On February 17, 2005, the parties filed a
joint motion to stay the litigation for a 90-day period during which the parties
will discuss potential settlement. In April, the City Council voted to proceed
with arbitration. At this time, whether and when there will be further
proceedings regarding the City of Edgewood cannot be determined.
A fourth city (the 7,000-customer City of Maitland) is contemplating
municipalization and has indicated its intent to proceed with arbitration to
determine the value of PEF's electric distribution system within the City.
Maitland's franchise expires in August 2005. At this time, whether and when
there will be further proceedings regarding the City of Maitland cannot be
determined.
As part of the above litigation, two appellate courts reached opposite
conclusions regarding whether PEF must continue to collect from its customers
and remit to the cities "franchise fees" under the expired franchise ordinances.
PEF filed an appeal with the Florida Supreme Court to resolve the conflict
between the two appellate courts. On October 28, 2004, the Court issued a
decision holding that PEF must collect from its customers and remit to the
cities franchise fees during the interim period when the city exercises its
purchase option or executes a new franchise. The Court's decision should not
have a material impact on the Company.
Environmental Matters
The Company is subject to federal, state and local regulations addressing air
and water quality, hazardous and solid waste management and other environmental
matters. These environmental matters are discussed in detail in Note 13. This
discussion identifies specific environmental issues, the status of the issues,
accruals associated with issue resolutions and the associated exposures to the
Company. The Company accrues costs to the extent they are probable and can be
reasonably estimated. It is reasonably possible that additional losses, which
could be material, may be incurred in the future.
Progress Energy Carolinas, Inc.
The information required by this item is incorporated herein by reference to the
following portions of Progress Energy's Management's Discussion and Analysis of
Financial Condition and Results of Operations, insofar as they relate to PEC:
RESULTS OF OPERATIONS; LIQUIDITY AND CAPITAL RESOURCES and OTHER MATTERS.
RESULTS OF OPERATIONS
The results of operations for the PEC Electric segment are identical between PEC
and Progress Energy. The results of operations for PEC's nonutility subsidiaries
for the three months ended March 31, 2005 and 2004 are not material to PEC's
consolidated financial statements.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities decreased $49 million for the three months
ended March 31, 2005, when compared to the corresponding period in the prior
year. The decrease was caused primarily by the impact of an under-recovery of
fuel costs in 2005 and increase in working capital requirements.
Cash used in investing activities increased $318 million for the three months
ended March 31, 2005, when compared to the corresponding period in the prior
year primarily due to net purchases of short-term investments in 2005 compared
to net proceeds from short-term investments in 2004.
61
The current portion of long-term debt includes $300 million of 7.50% Senior
Notes which matured on April 1, 2005.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
PEC's off-balance sheet arrangements and contractual obligations are described
below.
Market Risk and Derivatives
Under its risk management policy, PEC may use a variety of instruments,
including swaps, options and forward contracts, to manage exposure to
fluctuations in commodity prices and interest rates. See Note 7 to PEC's
Consolidated Interim Financial Statements and Item 3, "Quantitative and
Qualitative Disclosures About Market Risk," for a discussion of market risk and
derivatives.
Contractual Obligations
As of March 31, 2005, PEC's contractual cash obligations and other commercial
commitments have not changed materially from what was reported in the 2004
Annual Report on Form 10-K.
62
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Progress Energy, Inc.
Other than described below, the various risks that the Company is exposed to has
not materially changed since December 31, 2004.
Progress Energy and its subsidiaries are exposed to various risks related to
changes in market conditions. Market risk represents the potential loss arising
from adverse changes in market rates and prices. The Company has a risk
management committee that includes senior executives from various business
groups. The risk management committee is responsible for administering risk
management policies and monitoring compliance with those policies by all
subsidiaries. Under its risk policy, the Company may use a variety of
instruments, including swaps, options and forward contracts, to manage exposure
to fluctuations in commodity prices and interest rates. Such instruments contain
credit risk 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.
Certain market risks are inherent in the Company's financial instruments, which
arise from transactions entered into in the normal course of business. The
Company's primary exposures are changes in interest rates with respect to its
long-term debt and commercial paper, fluctuations in the return on marketable
securities with respect to its nuclear decommissioning trust funds, changes in
the market value of CVOs, and changes in energy related commodity prices.
Interest Rate Risk
Progress Energy uses a number of models and methods to determine interest rate
risk exposure and fair value of derivative positions. For reporting purposes,
fair values and exposures are determined as of the end of the reporting period
using the Bloomberg Financial Markets system.
The exposure to changes in interest rates from the Company's fixed rate and
variable rate long-term debt at March 31, 2005 has changed from December 31,
2004. The total fixed rate long-term debt at March 31, 2005 was $9.36 billion,
with an average interest rate of 6.50% and fair market value of $9.88 billion.
The total variable rate long-term debt at March 31, 2005, was $0.86 billion,
with an average interest rate of 2.12% and fair market value of $0.86 billion.
The Company maintains a portion of its outstanding debt with floating interest
rates. As of March 31, 2005 approximately 13.8% of consolidated debt was in
floating rate mode compared to 16.1% at the end of 2004.
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 accordance with FAS
133 interest rate derivatives that qualify as hedges are broken into one of two
categories, cash flow hedges or fair value hedges. Cash flow hedges are used to
reduce exposure to changes in cash flow due to fluctuating interest rates. Fair
value hedges are used to reduce exposure to changes in fair value due to
interest rate changes.
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.
63
Fair Value Hedges:
As of March 31, 2005, Progress Energy had $150 million of fixed rate debt
swapped to floating rate debt by executing receive fixed interest rate swap
agreements. Under terms of these swap agreements, Progress Energy will receive a
fixed rate and pay a floating rate based on 3-month LIBOR.
- ------------------------------------------------------------------------------------------------------------------
Fair Value Hedges (dollars in millions)
Notional
Progress Energy, Inc. Amount Receive Pay(b) Fair Value Exposure (c)
- ------------------------------------------------------------------------------------------------------------------
Risk hedged as of March 31, 2005:
- ------------------------------------------------------------------------------------------------------------------
5.85% Notes due 10/30/2008 $ 100 4.10% 3-month LIBOR $ - $ (1)
7.10% Notes due 3/1/2011 $ 50 4.65% 3-month LIBOR $ - $ (1)
- ------------------------------------------------------------------------------------------------------------------
Total $ 150 4.28%(a) 3-month LIBOR $ - $ (2)
- ------------------------------------------------------------------------------------------------------------------
Risk hedged as of December 31, 2004:
- ------------------------------------------------------------------------------------------------------------------
5.85% Notes due 10/30/2008 $ 100 4.10% 3-month LIBOR $ 1 $ (1)
7.10% Notes due 3/1/2011 $ 50 4.65% 3-month LIBOR $ 2 $ (1)
- ------------------------------------------------------------------------------------------------------------------
Total $ 150 4.28%(a) 3-month LIBOR $ 3 $ (2)
- ------------------------------------------------------------------------------------------------------------------
(a)Weighted average rate
(b) 3-month LIBOR rate was 3.12% at March 31, 2005 and 2.56% at December 31,
2004.
(c) Exposure indicates change in value due to 25 basis point unfavorable shift
in interest rates.
Cash Flow Hedges:
As of March 31, 2005 Progress Energy had $75 million of pay-fixed forward
starting swaps in place to hedge cash flow risk due to future financing
transactions and $200 million of pay-fixed swaps to hedged cash flow for
commercial paper interest. Under terms of these swap agreements, Progress Energy
will pay a fixed rate and receive a floating rate based on either 1-month or
3-month LIBOR.
- ------------------------------------------------------------------------------------------------------------------
Cash Flow Hedges (dollars in millions)
Notional
Progress Energy, Inc. Amount Pay Receive(b) Fair Value Exposure(c)
- ------------------------------------------------------------------------------------------------------------------
Risk hedged as of March 31, 2005:
Commercial Paper interest risk through
2005 $ 200 3.07% 1-month LIBOR $ 1 $ -
Anticipated 10-year debt issue(d) $ 75 4.92% 3-month LIBOR $ 1 $ (1)
- ------------------------------------------------------------------------------------------------------------------
Total $ 275 4.91%(a) 3-month LIBOR $ 2 $ (1)
- ------------------------------------------------------------------------------------------------------------------
Risk hedged as of December 31, 2004:
Commercial Paper interest risk from 2005
through 2008 $ 200 3.07% 1-month LIBOR $ - $ -
Progress Energy Carolinas
- ------------------------------------------------------------------------------------------------------------------
Risk hedged as of March 31, 2005: None
Risk hedged as of December 31, 2004:
- ------------------------------------------------------------------------------------------------------------------
Anticipated 10-year debt issue $ 110 4.85% 3-month LIBOR $ (1) $ (2)
Rail car lease payment $ 21 5.17% 3-month LIBOR $ (1) $ -
- ------------------------------------------------------------------------------------------------------------------
Total $ 131 4.90%(a) 3-month LIBOR $ (2) $ (2)
- ------------------------------------------------------------------------------------------------------------------
(a)Weighted average rate
(b)3-month LIBOR rate was 3.12% at March 31, 2005 and 2.56% at December 31,
2004. 1-month LIBOR rate was 2.87% at March 31, 2005 and 2.40% at December 31,
2004.
(c)Exposure indicates change in value due to 25 basis point unfavorable shift in
interest rates.
(d)Anticipated 10-year debt issue hedges mature on March 1, 2016 and require
mandatory cash settlement on March 1, 2006.
64
Marketable Securities Price Risk
The Company's exposure to return on marketable securities for the nuclear
decommissioning trust funds has not changed materially since December 31, 2004.
CVO Market Value Risk
The Company's exposure to market value risk with respect to the CVOs has not
changed materially since December 31, 2004.
Commodity Price Risk
The Company is exposed to the effects of market fluctuations in the price of
natural gas, coal, fuel oil, electricity and other energy-related products
marketed and purchased as a result of its ownership of energy-related assets.
The Company's exposure to these fluctuations is significantly limited by the
cost-based regulation of PEC and PEF. Each state commission allows electric
utilities to recover certain of these costs through various cost recovery
clauses to the extent the respective commission determines that such costs are
prudent. Therefore, while there may be a delay in the timing between when these
costs are incurred and when these costs are recovered from the ratepayers,
changes from year to year have no material impact on operating results. In
addition, many of the Company's long-term power sales contracts shift
substantially all fuel responsibility to the purchaser. The Company also has oil
price risk exposure related to synfuel tax credits. See discussion in Note 14 to
the Progress Energy Consolidated Interim Financial Statements.
Derivative products, primarily electricity and natural gas contracts, may be
entered into from time to time for economic hedging purposes. While management
believes the economic hedges mitigate exposures to fluctuations in commodity
prices, these instruments are not designated as hedges for accounting purposes
and are monitored consistent with trading positions. The Company manages open
positions with strict policies that limit its exposure to market risk and
require daily reporting to management of potential financial exposures. The
Company recorded a $2 million pre-tax gain and a $12 million pre-tax loss on
such contracts for the three months ended March 31, 2005 and 2004, respectively.
The Company did not have material outstanding positions in such contracts at
March 31, 2005 or December 31, 2004.
PEF has derivative instruments related to its exposure to price fluctuations on
fuel oil purchases. At March 31, 2005, the fair values of these instruments were
a $34 million short-term derivative asset position included in other current
assets and a $23 million long-term derivative asset position included in other
assets and deferred debits. At December 31, 2004, the fair values of these
instruments were a $2 million long-term derivative asset position included in
other assets and deferred debits and a $5 million short-term derivative
liability position included in other current liabilities. These instruments
receive regulatory accounting treatment. Unrealized gains and losses are
recorded in regulatory liabilities and regulatory assets, respectively.
The Company uses natural gas hedging instruments to manage a portion of the
market risk associated with fluctuations in the future purchase and sales prices
of the Company's natural gas. The fair values of commodity cash flow hedges at
March 31, 2005 and December 31, 2004 were as follows:
- --------------------------------------------------------
(in millions) March 31, December 31,
2005 2004
- --------------------------------------------------------
Fair value of assets $ 19 $ -
Fair value of liabilities (26) (15)
- --------------------------------------------------------
Fair value, net $ (7) $ (15)
- --------------------------------------------------------
The Company performs sensitivity analyses to estimate its exposure to the market
risk of its commodity positions. The Company's exposure to commodity price risk
has not changed materially since December 31, 2004. A hypothetical 10% increase
or decrease in quoted market prices in the near term on the Company's derivative
commodity instruments would not have had a material effect on the Company's
consolidated financial position, results of operations or cash flows as of March
31, 2005.
Refer to Note 9 for additional information with regard to the Company's
commodity contracts and use of derivative financial instruments.
65
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 these
risks has not materially changed since December 31, 2004.
The information required by this item is incorporated herein by reference to the
Quantitative and Qualitative Disclosures About Market Risk discussed above
insofar as it relates to PEC.
66
Item 4: Controls and Procedures
Progress Energy, Inc.
Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, Progress
Energy carried out an evaluation, with the participation of its management,
including Progress Energy's Chairman and Chief Executive Officer and Chief
Financial Officer, of the effectiveness of Progress Energy's disclosure controls
and procedures (as defined under Rule 13a-15(e) under the Securities Exchange
Act of 1934) as of the end of the period covered by this report. Based upon that
evaluation, Progress Energy's Chief Executive Officer and Chief Financial
Officer concluded that its disclosure controls and procedures are effective to
ensure that information required to be disclosed by Progress Energy in the
reports that it files or submits under the Exchange Act, is recorded, processed,
summarized and reported, within the time periods specified in the SEC's rules
and forms, and that such information is accumulated and communicated to Progress
Energy's management, including the Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding required
disclosure.
There has been no change in Progress Energy's internal control over financial
reporting during the quarter ended March 31, 2005, 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 the Securities Exchange Act of 1934, PEC carried out an evaluation,
with the participation of its management, including PEC's Chairman and Chief
Executive Officer and Chief Financial Officer, of the effectiveness of PEC's
disclosure controls and procedures (as defined under the Securities Exchange Act
of 1934) as of the end of the period covered by this report. Based upon that
evaluation, PEC's Chief Executive Officer and Chief Financial Officer concluded
that its disclosure controls and procedures are effective to ensure that
information required to be disclosed by PEC in the reports that it files or
submits under the Exchange Act, is recorded, processed, summarized and reported,
within the time periods specified in the SEC's rules and forms, and that such
information is accumulated and communicated to PEC's management, including the
Chief Executive Officer and Chief Financial Officer, as appropriate, to allow
timely decisions regarding required disclosure.
There has been no change in PEC's internal control over financial reporting
during the quarter ended March 31, 2005, that has materially affected, or is
reasonably likely to materially affect, its internal control over financial
reporting.
67
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Legal aspects of certain matters are set forth in Part I, Item 1. See Note 14 to
the Progress Energy, Inc. Consolidated Interim Financial Statements and Note 10
to the PEC Consolidated Interim Financial Statements.
Item 2. Unregistered Sale of Equity Securities and Use of Proceeds
a. RESTRICTED STOCK AWARDS:
(a) Securities Delivered. On January 1, 2005, March 7, 2005, March 15, 2005 and
March 21, 2005, 13,000, 2,200, 101,500 and 3,500 restricted shares,
respectively, 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.
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.
c. ISSUER PURCHASES OF EQUITY SECURITIES FOR FIRST QUARTER OF 2005
- ------------------------------------------------------------------------------------------------------------------
Period (a) (b) (c) (d)
Total Number of Shares Maximum Number (or
Total Number of Average Price (or Units) Purchased as Approximate Dollar Value)
Shares Paid Per Part of Publicly of Shares (or Units) that
(or Units) Share Announced Plans or May Yet Be Purchased Under
Purchased(1) (or Unit) Programs(1) the Plans or Programs(1)
- ------------------------------------------------------------------------------------------------------------------
January 1 - January 31 13,000 $45.11 N/A N/A
- ------------------------------------------------------------------------------------------------------------------
February 1- February 28 0 N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------
March 1 - March 31 107,200 $42.26 N/A N/A
- ------------------------------------------------------------------------------------------------------------------
Total: 120,200(2) $42.57 N/A N/A
- ------------------------------------------------------------------------------------------------------------------
(1) As of March 31, 2005, Progress Energy does not have any publicly announced
plans or programs to purchase shares of its common stock.
(2) Shares of common stock were purchased in open-market transactions in
connection with restricted stock awards that were granted to certain key
employees pursuant to the terms of the Progress Energy 2002 Equity
Incentive Plan, which was approved by Progress Energy's Shareholders on May
8, 2002.
68
Item 6. Exhibits
(a) Exhibits
Exhibit Progress Progress Energy
Number Description Energy, Inc. Carolinas, Inc.
------ ----------- ------------ ---------------
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
69
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, 2005 (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.
Controller and Chief Accounting Officer
70