10-Q 1 pei_10q-.txt PGN/CPL 3RD QTR 10-Q 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 September 30, 2002 ------------------ OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . ------ ------ Commission Exact name of registrants as specified in their charters, state of I.R.S. Employer File Number incorporation, address of principal executive offices, and telephone number Identification Number 1-15929 Progress Energy, Inc. 56-2155481 410 South Wilmington Street Raleigh, North Carolina 27601-1748 Telephone: (919) 546-6111 State of Incorporation: North Carolina 1-3382 Carolina Power & Light Company 56-0165465 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 registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X . No . This combined Form 10-Q is filed separately by two registrants: Progress Energy, Inc. (Progress Energy) and Carolina Power & Light Company (CP&L). 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. APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. As of October 31, 2002, each registrant had the following shares of common stock outstanding Registrant Description Shares ---------- ----------- ------ Progress Energy, Inc. Common Stock (Without Par Value) 222,152,799 Carolina Power & Light Company Common Stock (Without Par Value) 159,608,055 (all of which were held by Progress Energy, Inc.)
1 PROGRESS ENERGY, INC. AND CAROLINA POWER & LIGHT COMPANY FORM 10-Q - For the Quarter Ended September 30, 2002 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 Supplemental Data Schedule Notes to Consolidated Interim Financial Statements Carolina Power & Light Company ------------------------------ Consolidated Statements of Income Consolidated Balance Sheets Consolidated Statements of Cash Flows Notes to Consolidated Interim Financial Statements Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk Item 4. Controls and Procedures PART II. OTHER INFORMATION Item 1. Legal Proceedings Item 2. Changes in Securities and Use of Proceeds Item 6. Exhibits and Reports on Form 8-K Signatures Certifications 2 GLOSSARY OF TERMS The following abbreviations or acronyms used in the text of this combined Form 10-Q are defined below: TERM DEFINITION Code Internal Revenue Service Code CP&L Carolina Power & Light Company CR3 Florida Power's nuclear generating plant, Crystal River Unit No. 3 CVO Contingent value obligation DEP Florida Department of Environment and Protection DOE United States Department of Energy Dt Dekatherm DWM North Carolina Department of Environment and Natural Resources, Division of Waste Management EasternNC Eastern North Carolina Natural Gas Company, formerly referred to as ENCNG EITF 98-10 Accounting for Contracts Involved in Energy Trading and Risk Management Activities EPA United States Environmental Protection Agency FASB Financial Accounting Standards Board FERC Federal Energy Regulatory Commission Florida Power Florida Power Corporation FPC Florida Progress Corporation FPSC Florida Public Service Commission Generally accepted Accounting principles generally accepted in the United States of America accounting principles IBEW International Brotherhood of Electrical Workers IRS Internal Revenue Service KWh Kilowatt-hour MGP Manufactured Gas Plant MW Megawatt NCNG North Carolina Natural Gas Corporation NCUC North Carolina Utilities Commission 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 PCH Progress Capital Holdings, Inc. PLR Private Letter Ruling Progress Energy Progress Energy, Inc. Progress Fuels Progress Fuels Corporation, formerly referred to as Electric Fuels Corporation Progress Rail Progress Rail Services Corporation Progress Telecom Progress Telecommunications Corporation Progress Ventures Business segment of Progress Energy primarily made up of non-regulated energy generation, coal and synthetic fuel operations and energy marketing and trading, formerly referred to as Energy Ventures Progress Ventures, Inc. Legal entity holding certain non-regulated operations and part of Progress Ventures business segment PUHCA Public Utility Holding Company Act of 1935, as amended RTO Regional Transmission Organization SCPSC Public Service Commission of South Carolina SEC United States Securities and Exchange Commission Service Company Progress Energy Service Co., LLC SFAS No. 133 Statements of Financial Accounting Standards No. 133, Accounting for Derivative and Hedging Activities SFAS No. 142 Statements of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets SFAS No. 143 Statements of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations SFAS No. 144 Statements of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets 3 SFAS No. 145 Statements of Financial Accounting Standards No. 145, Rescission of FASB Statement Nos. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections SFAS No. 146 Statements of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities SRS Strategic Resource Solutions Corp. the Company Progress Energy, Inc. and subsidiaries 4
SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS This combined report contains forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The matters discussed throughout this combined Form 10-Q that are not historical facts are forward-looking and, accordingly, involve estimates, projections, goals, forecasts, assumptions, risks and uncertainties that could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements. In addition, forward-looking statements are discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" including, but not limited to, statements under the sub-heading "Other Matters" concerning synthetic fuel tax credits and regulatory developments. Any forward-looking statement speaks only as of the date on which such statement is made, and neither Progress Energy (the Company) nor CP&L undertakes any obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made. Examples of factors that you should consider with respect to any forward-looking statements made throughout this document include, but are not limited to, the following: the impact of fluid and complex government laws and regulations, including those relating to the environment; the impact of recent events in the energy markets that have increased the level of public and regulatory scrutiny in the energy industry and in the capital markets; deregulation or restructuring in the electric industry that may result in increased competition and unrecovered (stranded) costs; the uncertainty regarding the timing, creation and structure of regional transmission organizations; weather conditions that directly influence the demand for electricity and natural gas; recurring seasonal fluctuations in demand for electricity and natural gas; fluctuations in the price of energy commodities and purchased power; economic fluctuations and the corresponding impact on the Company's and CP&L's 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 and CP&L from a terrorist attack; the inherent risks associated with the operation of nuclear facilities, including environmental, health, regulatory and financial risks; the ability to successfully access capital markets on favorable terms; the impact that increases in leverage may have on the Company and CP&L; the ability of the Company and CP&L to maintain their current credit ratings; the impact of derivative contracts used in the normal course of business by the Company and CP&L; the Company's continued ability to use Section 29 tax credits related to its coal and synthetic fuels businesses; the continued depressed state of the telecommunications industry and the Company's ability to realize future returns from Progress Telecom and Caronet, Inc.; the Company's ability to successfully integrate newly acquired businesses, including Westchester Gas Company, into its operations as quickly or as profitably as expected; the Company's ability to successfully complete the sale of North Carolina Natural Gas and apply the proceeds therefrom to reduce outstanding indebtedness; the Company's ability to manage the risks involved with the construction and operation of its non-regulated plants, including construction delays, 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 and trading operations; the extent to which the Company is able to reduce its capital expenditures through the utilization of the natural gas expansion fund established by the North Carolina Utilities Commission; and unanticipated changes in operating expenses and capital expenditures. Many of these risks similarly impact the Company's subsidiaries. These and other risk factors are detailed from time to time in the Progress Energy and CP&L SEC reports. You should closely read these SEC reports, including, particularly, Progress Energy's current report on Form 8-K filed with the SEC on August 9, 2002. 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 CP&L. 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 CP&L. 5 PART I. FINANCIAL INFORMATION Item 1. Financial Statements Progress Energy, Inc. CONSOLIDATED INTERIM FINANCIAL STATEMENTS September 30, 2002 CONSOLIDATED STATEMENTS OF INCOME Three Months Ended Nine Months Ended (Unaudited) September 30, September 30, (In thousands except per share amounts) 2002 2001 2002 2001 ----------------------------------------------------------------------------------------------------------------------------- Operating Revenues Electric $ 1,908,817 $ 1,879,934 $ 5,007,321 $ 5,077,928 Natural gas 60,568 51,671 211,171 258,820 Diversified businesses 383,141 398,942 1,060,613 1,217,532 ----------------------------------------------------------------------------------------------------------------------------- Total Operating Revenues 2,352,526 2,330,547 6,279,105 6,554,280 ----------------------------------------------------------------------------------------------------------------------------- Operating Expenses Fuel used in electric generation 459,293 446,309 1,205,731 1,194,453 Purchased power 269,108 268,794 675,066 698,218 Gas purchased for resale 47,505 36,282 150,277 203,060 Other operation and maintenance 324,880 290,651 1,011,096 890,148 Depreciation and amortization 211,088 268,475 642,979 849,395 Taxes other than on income 106,144 105,125 297,775 298,716 Diversified businesses 737,243 461,393 1,536,229 1,372,840 ----------------------------------------------------------------------------------------------------------------------------- Total Operating Expenses 2,155,261 1,877,029 5,519,153 5,506,830 ----------------------------------------------------------------------------------------------------------------------------- Operating Income 197,265 453,518 759,952 1,047,450 ----------------------------------------------------------------------------------------------------------------------------- Other Income (Expense) Interest income 3,002 5,549 11,317 24,997 Other, net (13,394) 16,671 (8,505) 7,214 ----------------------------------------------------------------------------------------------------------------------------- Total Other Income (Expense) (10,392) 22,220 2,812 32,211 ----------------------------------------------------------------------------------------------------------------------------- Interest Charges Net interest charges 149,431 170,044 498,475 530,259 Allowance for borrowed funds used during construction (3,721) (4,206) (11,064) (9,559) ----------------------------------------------------------------------------------------------------------------------------- Total Interest Charges 145,710 165,838 487,411 520,700 ----------------------------------------------------------------------------------------------------------------------------- Income before Income Taxes 41,163 309,900 275,353 558,961 Income Tax Benefit (110,771) (56,543) (129,728) (73,187) ----------------------------------------------------------------------------------------------------------------------------- Net Income $ 151,934 $ 366,443 $ 405,081 $ 632,148 ----------------------------------------------------------------------------------------------------------------------------- Average Common Shares Outstanding 216,079 205,866 214,700 201,925 Basic Earnings per Common Share $ 0.71 $ 1.78 $ 1.89 $ 3.13 Diluted Earnings per Common Share $ 0.70 $ 1.77 $ 1.88 $ 3.12 Dividends Declared per Common Share $ 0.545 $ 0.530 $ 1.635 $ 1.590 ----------------------------------------------------------------------------------------------------------------------------- See Notes to Progress Energy, Inc. Consolidated Interim Financial Statements. 6 Progress Energy, Inc CONSOLIDATED BALANCE SHEETS (Unaudited) (In thousands except share data) September 30, December 31, Assets 2002 2001 --------------------------------------------------------------------------------------------------------------- Utility Plant Electric utility plant in service $ 19,764,622 $ 19,176,021 Gas utility plant in service 540,693 491,903 Accumulated depreciation (10,522,018) (10,096,412) --------------------------------------------------------------------------------------------------------------- Utility plant in service, net 9,783,297 9,571,512 Held for future use 15,027 15,380 Construction work in progress 806,922 1,065,154 Nuclear fuel, net of amortization 215,493 262,869 --------------------------------------------------------------------------------------------------------------- Total Utility Plant, Net 10,820,739 10,914,915 --------------------------------------------------------------------------------------------------------------- Current Assets Cash and cash equivalents 58,940 54,419 Accounts receivable 794,659 723,807 Unbilled accounts receivable 231,393 199,593 Taxes receivable - 32,325 Inventory 918,297 893,971 Deferred fuel cost 183,942 146,652 Prepayments 62,740 49,056 Other current assets 190,358 224,409 --------------------------------------------------------------------------------------------------------------- Total Current Assets 2,440,329 2,324,232 --------------------------------------------------------------------------------------------------------------- Deferred Debits and Other Assets Regulatory assets 403,168 448,631 Nuclear decommissioning trust funds 790,858 822,821 Diversified business property, net 1,768,477 1,073,046 Miscellaneous other property and investments 515,613 464,589 Goodwill, net 3,785,073 3,690,210 Prepaid pension costs 503,357 489,600 Restricted cash 73,821 - Other assets and deferred debits 479,321 513,099 --------------------------------------------------------------------------------------------------------------- Total Deferred Debits and Other Assets 8,319,688 7,501,996 --------------------------------------------------------------------------------------------------------------- Total Assets $ 21,580,756 $ 20,741,143 --------------------------------------------------------------------------------------------------------------- Capitalization and Liabilities --------------------------------------------------------------------------------------------------------------- Capitalization Common stock (without par value, 500,000,000 shares authorized, 221,933,138 and 218,725,352 shares issued and outstanding, respectively) $ 4,278,913 $ 4,107,493 Unearned ESOP common stock (101,560) (114,385) Accumulated other comprehensive loss (39,102) (32,180) Retained earnings 2,094,639 2,042,605 --------------------------------------------------------------------------------------------------------------- Total common stock equity 6,232,890 6,003,533 Preferred stock of subsidiaries-not subject to mandatory redemption 92,831 92,831 Long-term debt, net 9,735,025 8,618,960 --------------------------------------------------------------------------------------------------------------- Total Capitalization 16,060,746 14,715,324 --------------------------------------------------------------------------------------------------------------- Current Liabilities Current portion of long-term debt 375,202 688,052 Accounts payable 657,572 725,977 Taxes accrued 123,645 - Interest accrued 153,903 212,387 Dividends declared 120,001 117,857 Short-term obligations 1,060,267 942,314 Customer deposits 159,920 154,343 Other current liabilities 391,470 419,398 --------------------------------------------------------------------------------------------------------------- Total Current Liabilities 3,041,980 3,260,328 --------------------------------------------------------------------------------------------------------------- Deferred Credits and Other Liabilities Accumulated deferred income taxes 1,157,446 1,434,506 Accumulated deferred investment tax credits 211,446 226,382 Regulatory liabilities 292,544 287,239 Other liabilities and deferred credits 816,594 817,364 --------------------------------------------------------------------------------------------------------------- Total Deferred Credits and Other Liabilities 2,478,030 2,765,491 --------------------------------------------------------------------------------------------------------------- Commitments and Contingencies (Note 13) --------------------------------------------------------------------------------------------------------------- Total Capitalization and Liabilities $ 21,580,756 $ 20,741,143 --------------------------------------------------------------------------------------------------------------- See Notes to Progress Energy, Inc. Consolidated Interim Financial Statements. 7 Progress Energy, Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS Nine Months Ended (Unaudited) September 30, (In thousands) 2002 2001 ---------------------------------------------------------------------------------------------------------- Operating Activities Net income $ 405,081 $ 632,148 Adjustments to reconcile net income to net cash provided by Operating activities Impairment of long-lived assets and investments 329,997 - Depreciation and amortization 801,157 997,680 Deferred income taxes (312,020) (78,987) Investment tax credit (14,930) (18,479) Deferred fuel cost (credit) (37,290) 25,616 Net increase in accounts receivable (96,005) (48,536) Net increase in inventories (29,069) (252,505) Net increase in prepaids and other current assets (23,169) (1,815) Net increase (decrease) in accounts payable 13,605 (60,828) Net increase in other current liabilities 99,521 65,630 Other 69,457 (24,281) ---------------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 1,206,335 1,235,643 ---------------------------------------------------------------------------------------------------------- Investing Activities Gross property additions (738,559) (884,837) Diversified business property additions and acquisitions (764,553) (194,661) Proceeds from sale of assets 670 5,532 Nuclear fuel additions (56,102) (113,099) Net contributions to nuclear decommissioning trust (13,367) (40,540) Fuel acquisition, net of cash acquired (17,355) - Net cash flow of company-owned life insurance program (4,086) (5,137) Investments in non-utility activities (5,068) 3,390 Net increase in restricted cash (73,821) - Other 388 - ---------------------------------------------------------------------------------------------------------- Net Cash Used in Investing Activities (1,671,853) (1,229,352) ---------------------------------------------------------------------------------------------------------- Financing Activities Proceeds from issuance of long-term debt 1,787,711 3,772,376 Net increase (decrease) in short-term indebtedness 117,953 (3,632,802) Net decrease in cash provided by checks drawn in excess of bank (37,471) (78,816) balances Retirement of long-term debt (1,049,918) (186,295) Issuance of common stock - 488,290 Dividends paid on common stock (350,903) (318,910) Other 2,667 (47,567) ---------------------------------------------------------------------------------------------------------- Net Cash Provided by (Used in) Financing Activities 470,039 (3,724) ---------------------------------------------------------------------------------------------------------- Net Increase in Cash and Cash Equivalents 4,521 2,567 Cash and Cash Equivalents at Beginning of the Period 54,419 101,296 ---------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents at End of the Period $ 58,940 $ 103,863 ---------------------------------------------------------------------------------------------------------- Supplemental Disclosures of Cash Flow Information Cash paid during the period - interest $ 540,512 $ 507,284 income taxes $ 104,863 $ 31,664 See Note 2 for non-cash investing and financing activity. ---------------------------------------------------------------------------------------------------------- See Notes to Progress Energy, Inc. Consolidated Interim Financial Statements. 8 Progress Energy, Inc. SUPPLEMENTAL DATA SCHEDULE Three Months Ended Nine Months Ended September 30, September 30, (Unaudited) 2002 2001 2002 2001 ----------------------------------------------------------------------------------------------------------------------------- Operating Revenues (in thousands) Electric Retail $ 1,602,600 $ 1,591,713 $ 4,176,454 $ 4,214,165 Wholesale 251,797 254,054 659,316 729,608 Unbilled 2,542 (7,493) 28,769 (54,272) Miscellaneous revenue 51,878 41,660 142,782 188,427 ----------------------------------------------------------------------------------------------------------------------------- Total Electric 1,908,817 1,879,934 5,007,321 5,077,928 Natural gas 60,568 51,671 211,171 258,820 Diversified businesses 383,141 398,942 1,060,613 1,217,532 ----------------------------------------------------------------------------------------------------------------------------- Total Operating Revenues $ 2,352,526 $ 2,330,547 $ 6,279,105 $ 6,554,280 ----------------------------------------------------------------------------------------------------------------------------- Energy Sales - Utility Electric (millions of kWh) Retail Residential 9,988 9,385 25,810 25,310 Commercial 6,881 6,597 18,012 17,553 Industrial 4,552 4,473 12,776 13,068 Other retail 1,185 1,164 3,183 3,135 ----------------------------------------------------------------------------------------------------------------------------- Total retail 22,606 21,619 59,781 59,066 Unbilled (3) (350) 716 (893) Wholesale 5,550 5,087 14,331 13,946 ----------------------------------------------------------------------------------------------------------------------------- Total Electric 28,153 26,356 74,828 72,119 ----------------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------------------------- Natural Gas Delivered (thousands of dt) 19,965 13,080 52,463 39,022 ----------------------------------------------------------------------------------------------------------------------------- Energy Supply - Utility (millions of kWh) Generated - Steam 14,529 13,451 37,628 37,242 Nuclear 7,720 7,553 22,640 21,503 Hydro 51 83 297 200 Combustion turbines 3,121 2,461 6,868 5,270 Purchased 4,142 3,945 10,991 11,330 ----------------------------------------------------------------------------------------------------------------------------- Total Energy Supply - (Company Share) (a) 29,563 27,493 78,424 75,545 ----------------------------------------------------------------------------------------------------------------------------- Detail of Income Taxes (in thousands) Income tax expense (credit) - current $ 163,024 $ (4,197) $ 197,212 $ 24,279 deferred (269,087) (47,082) (312,020) (78,987) investment tax credit (4,708) (5,264) (14,920) (18,479) ----------------------------------------------------------------------------------------------------------------------------- Total Income Tax Benefit $ (110,771) $ (56,543) $ (129,728) $ (73,187) ----------------------------------------------------------------------------------------------------------------------------- (a) Excludes co-owner's share of the energy supplied from the five generating facilities that are jointly owned.
9 Progress Energy, Inc. NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS 1. ORGANIZATION AND BASIS OF PRESENTATION Organization. Progress Energy, Inc. (the Company) is a registered holding company under the Public Utility Holding Company Act (PUHCA) of 1935, as amended. Both the Company and its subsidiaries are subject to the regulatory provisions of PUHCA. Through its wholly owned subsidiaries, Carolina Power & Light Company (CP&L), Florida Power Corporation (Florida Power) and North Carolina Natural Gas Corporation (NCNG), the Company is primarily engaged in the generation, transmission, distribution and sale of electricity in portions of North Carolina, South Carolina and Florida and the transport, distribution and sale of natural gas in portions of North Carolina. Through the Progress Ventures business unit, the Company is involved in non-regulated energy generation; coal, gas and synthetic fuel operations; and energy marketing and trading. Through other business units, the Company engages in other non-regulated business areas, including energy management and related services, rail services and telecommunications. Progress Energy's legal structure is not currently aligned with the functional management and financial reporting of the Progress Ventures business segment. Whether, and when, the legal and functional structures will converge depends upon legislative and regulatory action, which cannot currently be anticipated. Basis of Presentation. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (generally accepted accounting principles) 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 generally accepted accounting principles for complete financial statements. Because the accompanying consolidated interim financial statements do not include all of the information and footnotes required by generally accepted accounting principles, they should be read in conjunction with the audited financial statements for the period ended December 31, 2001 and notes thereto included in Progress Energy's Form 10-K for the year ended December 31, 2001. The amounts included in the consolidated interim financial statements are unaudited but, in the opinion of management, reflect all 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. Effective with the quarter ended September 30, 2002, the Company will no longer reclassify commercial paper as long-term debt. Certain amounts for 2001 have been reclassified to conform to the 2002 presentation. In preparing financial statements that conform with generally accepted accounting principles, 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. 2. ACQUISITIONS Generation Acquisition. On February 15, 2002, Progress Ventures, Inc. acquired 100% of two electric generating projects located in Georgia from LG&E Energy Corp., a subsidiary of Powergen plc. The two projects consist of 1) Walton County Power, LLC in Monroe, Georgia, a 460 megawatt natural gas-fired plant placed in service in June 2001 and 2) Washington County Power, LLC in Washington County, Georgia, a planned 600 megawatt natural gas-fired plant expected to be operational by June 2003. The Walton and Washington projects have been included in the consolidated financial statements since the acquisition date. The acquisition furthers Progress Ventures' expansion into non-regulated energy operations and positions it as a growing provider of energy in the Southeast. The aggregate cash purchase price of approximately $348 million included approximately $1.7 million of direct transaction costs. The purchase price was primarily allocated to fixed assets based on the preliminary fair values of the assets acquired. The transaction also included tolling and power sale agreements with LG&E Energy Marketing, Inc. for each project through December 31, 2004. The excess of the purchase price over the preliminary fair value of the net identifiable assets and liabilities acquired has been recorded as goodwill. Based on this preliminary allocation, goodwill of approximately $64.1 million has been recorded. The preliminary purchase price allocation is subject to adjustment for changes in the preliminary assumptions and analyses used, pending additional information including final asset valuations. 10 In addition, Progress Ventures, Inc. entered into a project management and completion agreement whereby LG&E has agreed to manage the completion of the Washington site construction for Progress Ventures. The estimated costs to complete the Washington project at the time of acquisition were approximately $167.6 million. The pro forma results of operations would not be materially different than the reported results of operations for the three and nine months ended September 30, 2002, or for the comparable periods in the prior year. Fuel Acquisition. On April 26, 2002, Progress Fuels Corporation, a subsidiary of Progress Energy, acquired 100% of Westchester Gas Company. The acquisition included approximately 215 producing natural gas wells, 52 miles of intrastate gas pipeline and 170 miles of gas-gathering systems located within a 25-miles radius of Jonesville, Texas, on the Texas-Louisiana border. The aggregate purchase price of approximately $153 million consisted of cash consideration of approximately $22 million and the issuance of 2.5 million shares of Progress Energy common stock valued at approximately $129 million. The purchase price included approximately $1.7 million of direct transaction costs. The purchase price was primarily allocated to fixed assets based on the preliminary fair values of the assets acquired. The excess of the purchase price over the preliminary fair value of the net identifiable assets and liabilities acquired has been recorded as goodwill. Based on this preliminary allocation, goodwill of approximately $33 million has been recorded. The preliminary purchase price allocation is subject to adjustment for changes in the preliminary assumptions and analyses used, pending additional information including final asset valuations and allocations to gas properties. The acquisition has been accounted for using the purchase method of accounting and, accordingly, the results of operations for Westchester have been included in Progress Energy's consolidated financial statements since the date of acquisition. The pro forma results of operations would not be materially different than the reported results of operations for the three and nine months ended September 30, 2002, or for the comparable periods in the prior year. 3. IMPAIRMENT OF LONG-LIVED ASSETS, INVESTMENTS AND OTHER ONE-TIME CHARGES Due to the decline of the telecommunications industry and continued operating losses, the Company initiated a valuation study to assess the recoverability of Progress Telecom's and Caronet's long-lived assets. Based on this assessment, the Company recorded asset impairments and other one-time charges totaling $330.4 million on a pre-tax basis in the third quarter of 2002 ($208.5 million after-tax). The asset write-downs and other one-time charges are included in diversified businesses expenses on the Consolidated Statements of Income. The results of Progress Telecom and Caronet are included in the Other segment (See Note 5). This write-down constitutes a significant reduction in the book value of these long-lived assets. The long-lived asset write-downs of $305.0 million on a pre-tax basis include an impairment of property, plant and equipment, construction work in process and intangible assets. The impairment charge represents the difference between the fair value and carrying amount of these long-lived assets. The fair value of these assets was determined using a valuation study heavily weighted on the discounted cash flow methodology and using market approaches as supporting information. The other one-time charges of $25.4 million on a pre-tax basis primarily relate to inventory adjustments. Effective June 28, 2000, Caronet entered into an agreement with Bain Capital where it contributed the net assets used in its application service provider business to a newly formed company, for a 35% ownership interest (15% voting interest), named Interpath Communications, Inc. (Interpath). In May 2002, Interpath merged with Usinternetworking, Inc. Pursuant to the terms of the merger agreement and additional funds being contributed by Bain Capital, CP&L now owns approximately 19% of the company (7% voting interest). As a result of the merger, the Company reviewed the Interpath investment for impairment and wrote off the remaining amount of its cost-basis investment in Interpath, recording a pre-tax impairment of $25.0 million in the third quarter of 2002 ($16.3 million after-tax). The investment write-down is included in other, net on the Consolidated Statements of Income. 4. FLORIDA POWER RATE CASE SETTLEMENT On March 27, 2002, the parties in Florida Power's rate case entered into a Stipulation and Settlement Agreement (the Agreement) related to retail rate matters. The Agreement was approved by the Florida Public Service Commission (FPSC) on April 23, 2002. The Agreement is generally effective from May 1, 2002 through December 31, 2005; provided, however, that if 11 Florida Power's base rate earnings fall below a 10% return on equity, Florida Power may petition the FPSC to amend its base rates. The Agreement provides that Florida Power will reduce its retail revenues from the sale of electricity by an annual amount of $125 million. The Agreement also provides that Florida Power will operate under a Revenue Sharing Incentive Plan (the Plan) through 2005, and thereafter until terminated by the FPSC, that establishes annual revenue caps and sharing thresholds. The Plan provides that retail base rate revenues between the sharing thresholds and the retail base rate revenue caps will be divided into two shares - a 1/3 share to be received by Florida Power's shareholders, and a 2/3 share to be refunded to Florida Power's retail customers; provided, however, that for the year 2002 only, the refund to customers will be limited to 67.1% of the 2/3 customer share. The retail base rate revenue sharing threshold amounts for 2002 will be $1,296 million and will increase $37 million each year thereafter. The Plan also provides that all retail base rate revenues above the retail base rate revenue caps established for each year will be refunded to retail customers on an annual basis. For 2002, the refund to customers will be limited to 67.1% of the retail base rate revenues that exceed the 2002 cap. The retail base revenue caps for 2002 will be $1,356 million and will increase $37 million each year thereafter. Any amounts above the retail base revenue caps will be refunded 100 percent to customers. The Agreement also provides that beginning with the in-service date of Florida Power's Hines Unit 2 and continuing through December 31, 2005, Florida Power will be allowed to recover through the fuel cost recovery clause a return on average investment and depreciation expense for Hines Unit 2, to the extent such costs do not exceed the Unit's cumulative fuel savings over the recovery period. Hines Unit 2 is a 516 MW combined-cycle unit under construction and currently scheduled for completion in late 2003. Additionally, the Agreement provides that Florida Power will effect a mid-course correction of its fuel cost recovery clause to reduce the fuel factor by $50 million for the remainder of 2002. The fuel cost recovery clause will operate as it normally does, including, but not limited to any additional mid-course adjustments that may become necessary, and the calculation of true-ups to actual fuel clause expenses. Florida Power will suspend accruals on its reserves for nuclear decommissioning and fossil dismantlement through December 31, 2005. Additionally, for each calendar year during the term of the Agreement, Florida Power will record a $62.5 million depreciation expense reduction, and may, at its option, record up to an equal annual amount as an offsetting accelerated depreciation expense. In addition, Florida Power is authorized, at its discretion, to accelerate the amortization of certain regulatory assets over the term of the Agreement. There was no accelerated depreciation or amortization expense recorded for the three and nine months ended September 30, 2002. Under the terms of the Agreement, Florida Power agreed to continue the implementation of its four-year Commitment to Excellence Reliability Plan and expects to achieve a 20% improvement in its annual System Average Interruption Duration Index by no later than 2004. If this improvement level is not achieved for calendar years 2004 or 2005, Florida Power will provide a refund of $3 million for each year the level is not achieved to 10% of its total retail customers served by its worst performing distribution feeder lines. The Agreement also provides that Florida Power will refund to customers $35 million of revenues Florida Power collected during the interim period since March 13, 2001. This one-time retroactive revenue refund was recorded in the first quarter of 2002 and will be returned to retail customers over an eight-month period ending December 31, 2002. Any additional refunds under the Agreement will be recorded as they become probable. No additional refunds have been accrued at September 30, 2002. 5. FINANCIAL INFORMATION BY BUSINESS SEGMENT The Company currently provides services through the following business segments: CP&L Electric, Florida Power Electric, Progress Ventures, Rail Services and Other. The prior period has been restated to reflect the current reportable segments. The CP&L Electric and Florida Power Electric segments are engaged in the generation, transmission, distribution, and sale of electric energy in portions of North Carolina, South Carolina and Florida. Electric operations are subject to the rules and regulations of FERC, the NCUC, the SCPSC and the FPSC. The Progress Ventures segment is primarily engaged in non-regulated energy generation and coal, gas and synthetic fuel operations. Management reviews the operations of the Progress Ventures segment after the allocation of 12 energy marketing and trading activities which Progress Ventures performs on behalf of the regulated utilities, CP&L and Florida Power. The marketing activity refers to soliciting and managing wholesale power supply contracts and to selling excess generation as available, all within the regulated framework. Contracts within this activity are subject to review under SFAS No. 133. The trading activity refers to trading as defined in EITF 98-10. This trading activity has primarily consisted of entering into standardized electric forward contracts. In addition, the trading activity has also included purchasing power for immediate resale. This trading has been conducted on behalf of CP&L and Florida Power, but is outside the regulated framework (i.e., is a non-regulated activity). Progress Ventures also enters into non-regulated trading transactions for its non-regulated plant and fuel businesses. The Rail Services segment operations include railcar repair, rail parts reconditioning and sales, railcar leasing and sales, and scrap metal recycling. These activities include maintenance and reconditioning of salvageable scrap components of railcars, locomotive repair, right-of-way maintenance and operating manufacturing facilities for new rail cars. The Other segment is primarily made up of regulated natural gas, other diversified businesses and holding company operations, which includes the transportation, distribution and sale of natural gas in portions of North Carolina, telecommunication services, miscellaneous non-regulated activities and elimination entries. For reportable segments presented in the accompanying table, segment income includes intersegment revenues accounted for at prices representative of unaffiliated party transactions. Intersegment revenues that are not eliminated represent natural gas sales to the CP&L Electric and the Florida Power Electric segments. Florida Power Progress Rail Services Segment (in thousands) CP&L Electric Electric Ventures (b) (c) Other (d) Totals ------------------------------------------------------------------------------------------------------------------------------ Three Months Ended 9/30/02 Revenues Unaffiliated $1,045,180 $863,637 $168,777 $194,611 $70,902 $2,343,107 Intersegment - - 135,029 1,282 (126,892) 9,419 ---------------------------------------------------------------------------------------- Total Revenues $1,045,180 $863,637 $303,806 $195,893 $(55,990) $2,352,526 Net Income (Loss) $179,308 $123,774 $72,976 $733 $(224,857) $151,934 Segment Income (Loss) After $167,974 $120,513 $87,571 $733 $(224,857) $151,934 Allocation (a) Total Segment Assets $8,785,416 $5,079,719 $2,381,706 $579,947 $4,753,968 $21,580,756 ============================================================================================================================== Florida Power Progress Segment CP&L Electric Electric Ventures Rail Services Other Totals ------------------------------------------------------------------------------------------------------------------------------ Three Months Ended 9/30/01 Revenues Unaffiliated $973,803 $906,131 $144,511 $219,554 $77,926 $2,321,925 Intersegment - - 88,014 478 (79,870) 8,622 ---------------------------------------------------------------------------------------- Total Revenues $973,803 $906,131 $232,525 $220,032 $(1,944) $2,330,547 Net Income (Loss) $168,456 $114,079 $61,660 $(2,165) $24,413 $366,443 Segment Income (Loss) After $156,725 $107,397 $80,073 $(2,165) $24,413 $366,443 Allocation (a) Total Segment Assets $9,101,248 $5,044,029 $1,005,962 $828,384 $4,693,366 $20,672,989 ============================================================================================================================== 13 CP&L Electric Florida Power Progress Rail Services Other (d) Segment Electric Ventures (b) (c) Totals --------------------------------------------------------------------------------------------------------------------------- Nine Months Ended 9/30/02 Revenues Unaffiliated $2,691,320 $2,316,001 $419,702 $574,514 $258,413 $6,259,950 Intersegment - - 394,848 2,632 (378,325) 19,155 ------------------------------------------------------------------------------------- Total Revenues $2,691,320 $2,316,001 $814,550 $577,146 $(119,912) $6,279,105 Net Income (Loss) $396,530 $258,271 $165,928 $2,979 $(418,627) $405,081 Segment Income (Loss) After $355,251 $248,741 $216,737 $2,979 $(418,627) $405,081 Allocation (a) Total Segment Assets $8,785,416 $5,079,719 $2,381,706 $579,947 $4,753,968 $21,580,756 =========================================================================================================================== Florida Power Progress Segment CP&L Electric Electric Ventures Rail Services Other Totals --------------------------------------------------------------------------------------------------------------------------- Nine Months Ended 9/30/01 Revenues Unaffiliated $2,577,664 $2,500,265 $395,767 $739,863 $327,211 $6,540,770 Intersegment - - 280,410 1,102 (268,002) 13,510 ------------------------------------------------------------------------------------- Total Revenues $2,577,664 $2,500,265 $676,177 $740,965 $59,209 $6,554,280 Net Income (Loss) $373,949 $269,996 $161,026 $(9,698) $(163,125) $632,148 Segment Income Loss) After $334,593 $251,601 $218,777 $(9,698) $(163,125) $632,148 Allocation (a) Total Segment Assets $9,101,248 $5,044,029 $1,005,962 $828,384 $4,693,366 $20,672,989 =========================================================================================================================== (a) After allocation of energy trading and marketing net income managed by Progress Ventures on behalf of the electric utilities. (b) Progress Ventures total segment assets at September 30, 2002, increased from the prior year due to the addition of non-regulated generating assets including Effingham, DeSoto, Walton and Washington, the transfer of the Rowan plant from CP&L in the first quarter of 2002 and the acquisition of Westchester Gas Company (See Note 2). The Effingham and Washington units are still under construction. (c) Rail Services total segment assets at September 30, 2002, decreased from the prior year due to the final purchase price allocation being recorded in the fourth quarter of 2001. (d) All goodwill is included in the Other Segment herein (See Note 7).
6. IMPACT OF NEW ACCOUNTING STANDARDS During the second quarter of 2001, the Financial Accounting Standards Board (FASB) issued interpretations of Statements of Financial Accounting Standards No. 133, "Accounting for Derivative and Hedging Activities," (SFAS No. 133) indicating that options in general cannot qualify for the normal purchases and sales exception, but provided an exception that allows certain electricity contracts, including certain capacity-energy contracts, to be excluded from the mark-to-market requirements of SFAS No. 133. The interpretations were effective July 1, 2001. Those interpretations did not require the Company to mark-to-market any of its electricity capacity-energy contracts currently outstanding. In December 2001, the FASB revised the criteria related to the exception for certain electricity contracts, with the revision to be effective April 1, 2002. The revised interpretation did not result in any significant changes to the Company's assessment of mark-to-market requirements for its current contracts. If an electricity or fuel supply contract in its regulated businesses is subject to mark-to-market accounting, there generally would be no income statement effect of the mark-to-market because such contracts are generally reflected in fuel adjustment clauses so that the contract's mark-to-market gain or loss would be recorded as a regulatory asset or liability. Any mark-to-market gains or losses in its non-regulated businesses would affect income unless those contracts qualify for hedge accounting treatment. The application of the new rules is still evolving, and further guidance from the FASB is expected, which could additionally impact the Company's financial statements. See Note 7 for more information on SFAS No. 142, "Goodwill and Other Intangible Assets." The FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," in July 2001. This statement provides accounting and disclosure requirements for retirement obligations associated with long-lived assets and is effective January 1, 2003. This statement requires that the present value of retirement costs for which the Company has a legal obligation be recorded as liabilities with an equivalent amount added to the asset cost and depreciated over an appropriate period. The liability is then accreted over time by applying an interest method of allocation to the beginning liability. The Company is in the process of identifying retirement obligations. Areas that are being reviewed include electric transmission and distribution, gas production and distribution, nuclear decommissioning, all generating facilities, coal mines, synthetic fuel facilities, terminals and telecommunication assets. The Company is also in the process of quantifying the obligations that have been identified under the measurement rules described in the standard. For regulated companies, there is not expected to be any impact on earnings. For non-regulated companies, the Company currently cannot predict the earnings impact. 14 Effective January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 provides guidance for the accounting and reporting of impairment or disposal of long-lived assets. The statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." It also supersedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" related to the disposal of a segment of a business. Adoption of this statement did not have a material effect on the Company's financial statements. In April 2002, the FASB issued SFAS No. 145 "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections" This standard will require gains and losses from extinguishment of debt to be classified as extraordinary items only if they meet the criteria of unusual and infrequent in Opinion 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." Any gain or loss on extinguishment will be recorded in the most appropriate line item to which it relates within net income before extraordinary items. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002; however, certain sections are effective for transactions occurring after May 15, 2002. The Company does not have any transactions that are affected by this statement as of September 30, 2002. For regulated companies, any expenses or call premiums associated with the reacquisition of debt obligations are amortized over the remaining life of the original debt using the straight-line method consistent with ratemaking treatment. In June 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal Activities." This statement supercedes Emerging Issues Task Force (EITF) Issue No. 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)". SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability is recognized at the date an entity commits to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. The provisions of SFAS No. 146 will be effective for any exit and disposal activities covered under the scope of this standard and initiated after December 31, 2002. 7. GOODWILL AND OTHER INTANGIBLE ASSETS Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets." This statement clarifies the criteria for recording of other intangible assets separately from goodwill. Effective January 1, 2002, goodwill is no longer subject to amortization over its estimated useful life. Instead, goodwill is subject to at least an annual assessment for impairment by applying a two-step fair-value based test. This assessment could result in periodic impairment charges. The Company has completed the first step of the initial transitional goodwill impairment test, which indicated that the Company's goodwill was not impaired as of January 1, 2002. In addition, the Company performed the annual goodwill impairment test for the CP&L Electric and Florida Power Electric segments as of April 1, 2002, and for the Other segment as of July 1, 2002. The changes in the carrying amount of goodwill for the nine months ended September 30, 2002, by reportable segment, are as follows: Florida CP&L Power Progress (in thousands) Electric Electric Ventures Other Total -------- -------- -------- ----- ----- Balance as of January 1, 2002 $1,921,802 $1,733,448 $ - $34,960 $3,690,210 Acquisitions - - 96,583 - 96,583 Divestitures - - - (1,720) (1,720) ----------------------------------------------------------------------------- Balance as of September 30, 2002 $1,921,802 $1,733,448 $96,583 $33,240 $3,785,073
The acquired goodwill relates to the acquisition of Westchester Gas Company in April 2002 and the acquisition of generating assets from LG&E Energy Corp in February 2002 (See Note 2). As required by SFAS No. 142, the results for the prior year periods have not been restated. A reconciliation of net income as if SFAS No. 142 had been adopted is presented below for the three and nine months ended September 30, 2001, and the years ending December 31, 2001, 2000 and 1999. 15 Three Months Ended Nine Months Ended Year Ended Year Ended Year Ended (in thousands, except per share data) September 30, 2001 September 30, 2001 2001 2000 1999 ------------------ ------------------ ---- ---- ---- Reported net income $ 366,443 $ 632,148 $ 541,610 $ 478,361 $ 379,288 Add back: Goodwill amortization 24,927 75,576 96,828 14,100 3,968 Adjusted net income $ 391,370 $ 707,724 $ 638,438 $ 492,461 $ 383,256 Basic earnings per common share: Reported net income $ 1.78 $ 3.13 $ 2.65 $ 3.04 $ 2.56 Adjusted net income $ 1.90 $ 3.50 $ 3.12 $ 3.13 $ 2.58 Diluted earnings per common share: Reported net income $ 1.77 $ 3.12 $ 2.64 $ 3.03 $ 2.55 Adjusted net income $ 1.89 $ 3.49 $ 3.11 $ 3.12 $ 2.58
The gross carrying amount and accumulated amortization of the Company's intangible assets as of September 30, 2002 and December 31, 2001 are as follows: September 30, 2002 December 31, 2001 ------------------------------------------- ------------------------------------------ (in thousands) Gross Carrying Accumulated Gross Carrying Accumulated Amount Amortization Amount Amortization -------------------------------- --------------------- --------------------- --------------------- -------------------- Synthetic fuel intangibles (a) $ 140,469 $ (39,450) $ 140,469 $ (22,237) Power sale agreements (b) 34,074 (3,912) - - Customer contracts (c) 11,500 (6,200) 17,300 (5,600) Other 21,546 (626) 18,771 (338) -------------------------------- --------------------- --------------------- --------------------- -------------------- Total $ 207,589 $ (50,188) $ 176,540 $ (28,175)
(a) Represents intangibles for synthetic fuel technology. These intangibles are being amortized on a straight-line basis over the period ending with the expiration of tax credits under Section 29 of the Internal Revenue Code on December 31, 2007. (b) Relates to the power sale agreements recorded as part of the acquisition of generating assets from LG&E Energy Corp. (See Note 2), which are amortized on a straight-line basis beginning with the in-service date of these plants through December 31, 2004. (c) Decrease at September 30, 2002 relates to the write-down of Progress Telecom assets (See Note 3). Total net intangible assets of $157.4 million and $148.4 million at September 30, 2002, and December 31, 2001, respectively, are included in other assets and deferred debits in the accompanying balance sheets. Amortization expense recorded on intangible assets for the three and nine months ended September 30, 2002 was $8.3 million and $24.5 million, respectively. The estimated amortization expense on intangible assets for the next five years is as follows: (in thousands) 2002 $32,822 2003 33,817 2004 36,542 2005 20,333 2006 19,864 8. COMPREHENSIVE INCOME Comprehensive income for the three and nine months ended September 30, 2002, was $141.8 million and $398.2 million, respectively. Comprehensive income for the three and nine months ended September 30, 2001, was $363.0 million and $594.5 million, respectively. Items of other comprehensive income for the three-month and nine-month periods consisted primarily of changes in the fair value of derivatives used to hedge cash flows related to interest on long-term debt, the cumulative effect of implementing SFAS No. 133 as of January 1, 2001 and reclassification of amounts into income. 9. FINANCING ACTIVITIES On February 6, 2002, CP&L issued $48.5 million principal amount of First Mortgage Bonds, Pollution Control Series W, Wake County Pollution Control Revenue Refunding Bonds, 5.375% Series 2002 Due February 1, 2017. On March 16 1, 2002, CP&L redeemed $48.5 million principal amount of Pollution Control Revenue Bonds, Wake County (Carolina Power & Light Company Project) Adjustable Rate Option Bond 1983 Series Due April 1, 2019, at 101.5% of the principal amount of such bonds. In February 2002, $50 million of Progress Capital Holdings, Inc. (PCH) medium-term notes, 5.78% Series, matured. Progress Energy funded this maturity through the issuance of commercial paper. In March 2002, a Progress Ventures, Inc. subsidiary, Progress Genco Ventures, LLC, obtained a $440 million bank facility that was to be used exclusively for expansion of its non-regulated generation portfolio. Borrowings under this facility are secured by the assets in the generation portfolio. In March 2002, June 2002 and September 2002, Progress Genco Ventures, LLC made draws under this facility of $120 million, $67 million and $25 million, respectively. In September 2002, Progress Genco Ventures, LLC terminated $130 million of the bank facility, reducing it from $440 million to $310 million. Borrowings under the facility are restricted for the operations, construction, repayments and other related charges of the credit facility for development projects, including DeSoto County Generating Company, LLC, Effingham County Power, LLC, MPC Generating Company, LLC and Rowan County Power, LLC. Cash held and restricted to operations was $13.0 million at September 30, 2002, and is included in other current assets. Cash held and restricted for long-term purposes was $73.8 million at September 30, 2002 and is included in deferred debits and other assets. On April 17, 2002, Progress Energy issued $350 million of senior unsecured notes due 2007 with a coupon of 6.05% and $450 million of senior unsecured notes due 2012 with a coupon of 6.85%. Proceeds from this issuance were used to pay down commercial paper. On June 27, 2002, CP&L announced the redemption of $500 million of CP&L Extendible Notes due October 28, 2009, at 100% of the principal amount of such notes. These notes were redeemed on July 29, 2002 and CP&L funded the redemptions through the issuance of commercial paper. On July 30, 2002, CP&L issued $500 million of senior unsecured notes due 2012 with a coupon of 6.5%. Proceeds from this issuance were used to pay down commercial paper. On July 1, 2002, $30 million of Florida Power medium-term notes, 6.54% Series, matured. Florida Power funded this maturity through the issuance of commercial paper. On July 11, 2002, Florida Power announced the redemption of $108.55 million principal amount of Citrus County Pollution Control Refunding Revenue Bonds, Series 1992 A Due January 1, 2027, $90 million principal amount of Citrus County Pollution Control Refunding Revenue Bonds, Series 1992 B Due February 1, 2022 and $10.115 million principal amount of Pasco County Pollution Control Refunding Revenue Bonds, Series 1992A Due February 1, 2022, at 102% of the principal amount of such bonds and $32.2 million principal amount of Pinellas County Pollution Control Refunding Revenue Bonds, Series 1991 Due December 1, 2014 at 101% of the principal amount of such bonds. These redemptions were finalized on August 12, 2002. On July 16, 2002, Florida Power issued $108.55 million principal amount of Citrus County Pollution Control Revenue Refunding Bonds, Series 2002A Due January 1, 2027, $100.115 million principal amount of Citrus County Pollution Control Revenue Refunding Bonds, Series 2002B Due January 1, 2022 and $32.2 million principal amount of Citrus County Pollution Control Revenue Refunding Bonds, Series 2002C Due January 1, 2018. Proceeds from this issuance were used to redeem Florida Power's pollution control revenue refunding bonds above. On August 5, 2002, CP&L announced the redemption of $150 million of First Mortgage bonds, 8.20% Series, due July 1, 2022 at 103.55% of the principal amount of such bonds. CP&L redeemed these notes on September 4, 2002 through the issuance of commercial paper. Progress Energy's 364-day revolving credit facility expired on November 12, 2002. In connection with the renewal, the facility was reduced in size from $550 million to approximately $430 million. In addition, the permitted debt to capital ratio was lowered from 70% to 68% effective June 30, 2003; Progress Energy's debt to capital ratio as of September 30, 2002, was 65.3%. Finally, a minimum EBITDA to interest expense ratio of 2.5x to 1 was imposed; for the twelve months ended September 30, 2002, Progress Energy's ratio of EBITDA to interest expense was 3.28x to 1. On November 13, 2002, Progress Energy issued 14.7 million shares of common stock at $40.90 per share for net proceeds of $600.0 million. Proceeds from the issuance will be used to retire commercial paper. 17 10. RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS Progress Energy uses interest rate derivative instruments to adjust the fixed and variable rate debt components of its debt portfolio. During March, April and May 2002, Progress Energy converted $1.0 billion of fixed rate debt into variable rate debt by executing interest rate derivative agreements with a total notional amount of $1.0 billion with a group of five banks. Under the terms of the agreements, which were scheduled to mature in 2006 and 2007 and coincide with the maturity dates of the related debt issuances, Progress Energy received a fixed rate and paid a floating rate based on three-month LIBOR. These instruments were designated as fair value hedges for accounting purposes. In June 2002, Progress Energy terminated these agreements. The terminations resulted in a $21.2 million deferred hedging gain reflected in long-term debt, which will be amortized and recorded as a reduction to interest expense over the life of the related debt issuances. Progress Genco Ventures, LLC is required to hedge 75 percent of the amounts outstanding under its bank facility through September 2005 and 50 percent thereafter pursuant to the terms of the agreement for expansion of its non-regulated generation portfolio. In May 2002, Progress Genco Ventures, LLC entered into hedges that included a series of zero cost collars that have been designated as cash flow hedges for accounting purposes. The fair value of these instruments was a $10.9 million liability position at September 30, 2002. In April, May and June 2002, CP&L entered into a series of treasury rate locks to hedge its exposure to interest rates with regard to a future issuance of fixed-rate debt. These agreements had a computational period of ten years. These instruments were designated as cash flow hedges for accounting purposes. The agreements, with a total notional amount of $350 million, were terminated simultaneously with the pricing of the $500 million CP&L senior unsecured notes in July 2002. CP&L realized a $22.5 million hedging loss, which will be amortized and recorded as an increase to interest expense over the life of the notes. In August 2002, Progress Energy converted $800 million of fixed rate debt into variable rate debt by executing interest rate derivative agreements with four counterparties with a total notional amount of $800 million. Under the terms of the agreements, which were scheduled to expire in 2006 and coincide with the maturity date of the related debt issuance, Progress Energy received a fixed rate of 3.38% and paid a floating rate based on three-month LIBOR. These instruments were designated as fair value hedges for accounting purposes. The fair value of these instruments was a $14.2 million asset position at September 30, 2002. In November 2002, Progress Energy terminated these agreements. The terminations resulted in a $14.0 million deferred hedging gain reflected in long-term debt, which will be amortized and recorded as a reduction to interest expense over the life of the related debt issuance. Progress Ventures periodically enters into derivative instruments to hedge its exposure to price fluctuations on natural gas sales. During 2002, Progress Ventures has executed cash flow hedges on approximately 17.3 Bcf of natural gas sales for the fourth quarter of 2002 and entire year 2003. These instruments did not have a material impact on the Company's consolidated financial position or results of operations. The notional amount of the above contracts is not exchanged and does 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. 11. EARNINGS PER COMMON SHARE Restricted stock awards and contingently issuable shares had a dilutive effect on earnings per share for the three and nine months ended September 30, 2002 and 2001. At September 30, 2002, there were options outstanding to purchase 2.5 million shares of common stock with a weighted average exercise price of $43.81. A reconciliation of the weighted average number of common shares outstanding for basic and dilutive earnings per share purposes is as follows (in thousands): Three Months Ended, Nine Months Ended, September 30, September 30, September 30, September 30, -------------- -------------- -------------- ------------- 2002 2001 2002 2001 ---- ---- ---- ---- Weighted Average Common Shares - Basic 216,079 205,866 214,700 201,925 Restricted Stock Awards 746 673 709 658 Stock Options 59 - 173 - --------- --------- --------- --------- Weighted Average Shares - Fully Dilutive 216,884 206,539 215,582 202,583
18 Employee Stock Ownership Plan shares that have not been committed to be released to participants' accounts are not considered outstanding for the determination of earnings per common share. Those shares totaled 4,616,400 and 5,223,387 at September 30, 2002 and September 30, 2001, respectively. 12. FPC-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF A SUBSIDIARY HOLDING SOLELY FPC GUARANTEED NOTES In April 1999, FPC Capital I (the Trust), an indirect wholly-owned subsidiary of FPC, issued 12 million shares of $25 par cumulative FPC-obligated mandatorily redeemable preferred securities (Preferred Securities) due 2039, with an aggregate liquidation value of $300 million and an annual distribution rate of 7.10%. Currently, all 12 million shares of the Preferred Securities that were issued are outstanding. Concurrent with the issuance of the Preferred Securities, the Trust issued to Florida Progress Funding Corporation (Funding Corp.) all of the common securities of the Trust (371,135 shares) for $9.3 million. Funding Corp. is a direct wholly owned subsidiary of FPC. The existence of the Trust is for the sole purpose of issuing the Preferred Securities and the common securities and using the proceeds thereof to purchase from Funding Corp. its 7.10% Junior Subordinated Deferrable Interest Notes (subordinated notes) due 2039, for a principal amount of $309.3 million. The subordinated notes and the Notes Guarantee (as discussed below) are the sole assets of the Trust. Funding Corp.'s proceeds from the sale of the subordinated notes were advanced to Progress Capital and used for general corporate purposes including the repayment of a portion of certain outstanding short-term bank loans and commercial paper. FPC has fully and unconditionally guaranteed the obligations of Funding Corp. under the subordinated notes (the Notes Guarantee). In addition, FPC has guaranteed the payment of all distributions required to be made by the Trust, but only to the extent that the Trust has funds available for such distributions (Preferred Securities Guarantee). The Preferred Securities Guarantee, considered together with the Notes Guarantee, constitutes a full and unconditional guarantee by FPC of the Trust's obligations under the Preferred Securities. The subordinated notes may be redeemed at the option of Funding Corp. beginning in 2004 at par value plus accrued interest through the redemption date. The proceeds of any redemption of the subordinated notes will be used by the Trust to redeem proportional amounts of the Preferred Securities and common securities in accordance with their terms. Upon liquidation or dissolution of Funding Corp., holders of the Preferred Securities would be entitled to the liquidation preference of $25 per share plus all accrued and unpaid dividends thereon to the date of payment. These Preferred Securities are classified as long-term debt on the Company's consolidated balance sheets. 13. COMMITMENTS AND CONTINGENCIES Contingencies and significant changes to the commitments discussed in Note 20 of the financial statements included in the Company's 2001 Annual Report on Form 10-K are described below. Commitments Guarantees During the first nine months of 2002, Progress Energy issued approximately $363 million of guarantees on behalf of Progress Ventures and its subsidiaries for obligations under power purchase agreements, tolling agreements, construction agreements and trading operations. Approximately $184 million of these commitments relate to certain guarantee agreements issued to support obligations related to Progress Ventures' expansion of its non-regulated generation portfolio. These guarantees ensure performance under generation construction and operating agreements. The remaining $179 million of these new commitments are guarantees issued to support Progress Ventures' energy trading and marketing functions. The majority of the trading and marketing contracts supported by the guarantees contain language regarding downgrade events, ratings triggers, monthly netting of exposure and/or payments and offset provisions in the event of a default. Based upon the amount of trading positions outstanding at October 31, 2002, if Progress Energy's ratings were to decline below investment grade, the Company would have to deposit cash or provide letters of credit or other cash collateral for approximately $17 million for the benefit of the Company's counterparties. 19 Contingencies 1) IRS Audit One of Progress Energy's synthetic fuel entities, Colona Synfuel Limited Partnership, L.L.L.P., is being audited by the Internal Revenue Service (IRS). The audit of Colona was not unexpected. The Company is audited regularly in the normal course of business as are most similarly situated companies. The Company (including Florida Progress prior to its acquisition by the Company) has been allocated approximately $241 million in tax credits to date for this synthetic fuel entity. As provided for in contractual arrangements pertaining to Progress Energy's purchase of Colona, the Company has begun escrowing quarterly royalty payments owed to an unaffiliated entity until final resolution of the audit. In September 2002, all of Progress Energy's majority-owned synthetic fuel entities were accepted into the IRS's Pre-Filing Agreement (PFA) program. The PFA program allows taxpayers to voluntarily accelerate the IRS exam process in order to seek resolution of specific issues. Either the Company or the IRS can withdraw from the program at any time, and issues not resolved through the program may proceed to the next level of the IRS exam process. While the ultimate outcome is uncertain, the Company believes that participation in the PFA program will likely shorten the tax exam process. In management's opinion, Progress Energy is complying with all the necessary requirements to be allowed such credits and believes it is likely, although it cannot provide certainty, that it will prevail if challenged by the IRS on any credits taken. 2) Franchise Taxes CP&L, like other electric power companies in North Carolina, pays a franchise tax levied by the State pursuant to North Carolina General Statutes ss. 105-116, a state-level annual franchise tax (State Franchise Tax). Part of the revenue generated by the State Franchise Tax is required by North Carolina General Statutes ss. 105-116.1(b) to be distributed to North Carolina cities in which CP&L maintains facilities. CP&L has paid and continues to pay the State Franchise Tax to the state when such taxes are due. However, pursuant to an Executive Order issued on February 5, 2002, by the Governor of North Carolina, the Secretary of Revenue withheld distributions of State Franchise Tax revenues to cities for two quarters of fiscal year 2001-2002 in an effort to balance the state's budget. In response to the state's failure to distribute the State Franchise Tax proceeds, certain cities in which CP&L maintains facilities adopted municipal franchise tax ordinances purporting to impose on CP&L a local franchise tax. The local taxes are intended to be collected for as long as the state withholds distribution of the State Franchise Tax proceeds from the cities. The first local tax payments were due August 15, 2002. On August 2, 2002, CP&L filed a lawsuit against the cities seeking to enjoin the enforcement of the local taxes and to have the local ordinances struck down because the ordinances are beyond the cities' statutory authority and violate provisions of the North Carolina and United States Constitutions. On September 14, 2002, the Governor of North Carolina signed into law a provision that prevents cities and counties from levying local franchise taxes on electric utilities. The new law is also intended to prevent a recurrence of the withholding of utility franchise tax payments by the state. This new legislation makes it likely that the lawsuit CP&L filed in August against certain cities that were seeking to enforce local franchise tax ordinances will become moot. 3) Claims and Uncertainties a) The Company is subject to federal, state and local regulations addressing air and water quality, hazardous and solid waste management and other environmental matters. Various organic materials associated with the production of manufactured gas, generally referred to as coal tar, are regulated under federal and state laws. The lead or sole regulatory agency that is responsible for a particular former coal tar site depends largely upon the state in which the site is located. There are several manufactured gas plant (MGP) sites to which both electric utilities and the gas utility have some 20 connection. In this regard, both electric utilities and the gas utility, with other potentially responsible parties, are participating in investigating and, if necessary, remediating former coal tar sites with several regulatory agencies, including, but not limited to, the U.S. Environmental Protection Agency (EPA), the Florida Department of Environmental Protection (FDEP) and the North Carolina Department of Environment and Natural Resources, Division of Waste Management (DWM). In addition, both electric utilities, the gas utility and Progress Ventures are periodically notified by regulators such as the EPA and various state agencies of their involvement or potential involvement in sites, other than MGP sites, that may require investigation and/or remediation. A discussion of these sites by legal entity follows. CP&L. There are 12 former MGP sites and 14 other active waste sites associated with CP&L that have required or are anticipated to require investigation and/or remediation costs. As of September 30, 2002, CP&L has not recorded any accruals for investigation and/or remediation costs for these sites. CP&L received insurance proceeds to address costs associated with CP&L waste sites. All eligible expenses related to these waste costs are charged against a centralized fund containing these proceeds. As of September 30, 2002, approximately $8.3 million remains in this centralized fund. As costs associated with CP&L's share of investigation and remediation of these sites become known, the fund is assessed to determine if additional accruals will be required. CP&L does not believe that it can provide an estimate of the reasonably possible total remediation costs beyond what remains in the centralized fund. This is due to the fact that the sites are at different stages: investigation has not begun at 15 sites, investigation has begun but remediation cannot be estimated at 7 sites and 4 sites have begun remediation. CP&L measures its liability for these sites based on available evidence including its experience in investigation and remediation of contaminated sites, which also involves assessing and developing cost-sharing arrangements with other potentially responsible parties. Once the centralized fund is depleted, CP&L will accrue costs for the sites to the extent its liability is probable and the costs can be reasonably estimated. Therefore, CP&L cannot currently determine the total costs that may be incurred in connection with the remediation of all sites. According to current information, these future costs at the CP&L sites are not expected to be material to the Company's financial condition or results of operations. A rollforward of the balance in this fund is not provided due to the immateriality of this activity in the periods presented. Florida Power. There are two former MGP sites and 10 other active waste sites or categories of sites associated with Florida Power that have required or are anticipated to require investigation and/or remediation costs. As of September 30, 2002, Florida Power has accrued approximately $11.1 million for probable and reasonably estimable costs at these sites. Florida Power believes that the maximum liability it can currently estimate on these sites is $17.0 million. Florida Power has filed for recovery of approximately $4.0 million of these costs. As more activity occurs at these sites, Florida Power will assess the need to adjust the accruals. These accruals have been recorded on an undiscounted basis. Florida Power measures its liability for these sites based on available evidence including its experience in investigation and/or remediation of contaminated sites, which includes assessing and developing cost-sharing arrangements with other potentially responsible parties. A rollforward of the balance in this accrual is not provided due to the immateriality of this activity in the periods presented. NCNG. There are 5 former MGP sites associated with NCNG that have or are estimated to have investigation or remediation costs associated with them. As of September 30, 2002, NCNG has accrued approximately $2.7 million for probable and reasonably estimable remediation costs at these sites. These accruals have been recorded on an undiscounted basis. NCNG measures its liability for these sites based on available evidence including its experience in investigation and remediation of contaminated sites, which also involves assessing and developing cost-sharing arrangements with other potentially responsible parties. NCNG will accrue costs for the sites to the extent its liability is probable and the costs can be reasonably estimated. NCNG does not believe it can provide an estimate of the reasonably possible total remediation costs beyond the accrual because three of the five sites associated with NCNG have not begun investigation activities. Therefore, NCNG cannot currently determine the total costs that may be incurred in connection with the investigation and/or remediation of all sites. According to current information, these future costs at the NCNG sites are not expected to be material to the Company's financial condition or results of operations. A rollforward of the balance in this accrual is not provided due to the immateriality of this activity for the periods presented. NCNG has received insurance proceeds associated with pollution liability settlements. In addition, NCNG is receiving approximately $5,000 per month in its rates to fund expenses associated with its share of costs to investigate, and if necessary, remediate these sites. On October 16, 2002, the Company announced plans to sell NCNG to Piedmont Natural Gas Company, Inc. See Note 14 for more information. 21 As part of the sale of the Inland Marine Transportation segment to AEP Resources in 2001, Florida Progress established an accrual to address liabilities which may result from known and unknown environmental liabilities but primarily to address contamination in soil and potentially groundwater at one site. The balance in this accrual is $9.9 million at September 30, 2002. Florida Progress estimates that its maximum contractual liability to AEP Resources associated with Inland Marine Transportation segment is $60 million. These accruals have been determined on an undiscounted basis. Florida Progress measures its liability for this site based on estimable and probable remediation scenarios. A rollforward of the balance in this accrual is not provided due to the immateriality of this activity for the periods presented. The Company believes that it is reasonably possible that additional costs, which cannot be currently estimated, may be incurred related to the environmental indemnification provision beyond the amounts accrued. The Company cannot predict the outcome of this matter. The Company is also currently in the process of assessing potential costs and exposures at other sites it has been notified of. 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. There has been and may be further proposed federal legislation requiring reductions in air emissions for nitrogen oxides, sulfur dioxide, carbon dioxide and mercury setting forth national caps and emission levels over an extended period of time. This national multi-pollutant approach would have significant costs which could be material to the Company's consolidated financial position or results of operations. Some companies may seek recovery of the related cost through rate adjustments or similar mechanisms. Control equipment that will be installed on North Carolina fossil generating facilities as part of the North Carolina legislation discussed below may address some of the issues outlined above. The Company cannot predict the outcome of this matter. The EPA has been conducting an enforcement initiative related to a number of coal-fired utility power plants in an effort to determine whether modifications at those facilities were subject to New Source Review requirements or New Source Performance Standards under the Clean Air Act. Both CP&L and Florida Power were asked to provide information to the EPA as part of this initiative and cooperated in providing the requested information. The EPA has initiated civil enforcement actions against other unaffiliated utilities as part of this initiative, some of which have resulted in settlement agreements calling for expenditures, ranging from $1.0 billion to $1.4 billion. A utility that was not subject to a civil enforcement action settled its New Source Review issues with the EPA for $300 million. These settlement agreements have generally called for expenditures to be made over extended time periods, and some of the companies may seek recovery of the related cost through rate adjustments or similar mechanisms. The Company cannot predict the outcome of this matter. In 1998, the EPA published a final rule addressing the issue of regional transport of ozone. This rule is commonly known as the NOx SIP Call. The EPA's rule requires 23 jurisdictions, including North Carolina, South Carolina and Georgia, but not Florida, to further reduce nitrogen oxide emissions in order to attain a pre-set state NOx emission level by May 31, 2004. CP&L is evaluating necessary measures to comply with the rule and estimates its related capital expenditures to meet these measures in North and South Carolina could be approximately $370 million, which has not been adjusted for inflation. 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. The Company cannot predict the outcome of this matter. In July 1997, the EPA issued final regulations establishing a new eight-hour ozone standard. In October 1999, the District of Columbia Circuit Court of Appeals ruled against the EPA with regard to the federal eight-hour ozone standard. The U.S. Supreme Court has upheld, in part, the District of Columbia Circuit Court of Appeals decision. Designation of areas that do not attain the standard is proceeding, and further litigation and rulemaking on this and other aspects of the standard are anticipated. North Carolina adopted the federal eight-hour ozone standard and is proceeding with the implementation process. North Carolina has promulgated final regulations, which will require CP&L to install nitrogen oxide controls under the State's eight-hour standard. The cost of those controls are included in the cost estimate of $370 million set forth above; however, further technical analysis and rulemaking may result in a requirement for additional controls at some units. The Company cannot predict the outcome of this matter. 22 The EPA published a final rule approving petitions under Section 126 of the Clean Air Act. This rule as originally promulgated required certain sources to make reductions in nitrogen oxide emissions by May 1, 2003. The final rule also includes a set of regulations that affect nitrogen oxide emissions from sources included in the petitions. The North Carolina fossil-fueled electric generating plants are included in these petitions. Acceptable state plans under the NOx SIP Call can be approved in lieu of the final rules the EPA approved as part of the 126 petitions. CP&L, other utilities, trade organizations and other states participated in litigation challenging the EPA's action. On May 15, 2001, the District of Columbia Circuit Court of Appeals ruled in favor of the EPA which will require North Carolina to make reductions in nitrogen oxide emissions by May 1, 2003. However, the Court in its May 15th decision rejected the EPA's methodology for estimating the future growth factors the EPA used in calculating the emissions limits for utilities. In August 2001, the Court granted a request by CP&L and other utilities to delay the implementation of the 126 Rule for electric generating units pending resolution by the EPA of the growth factor issue. The Court's order tolls the three-year compliance period (originally set to end on May 1, 2003) for electric generating units as of May 15, 2001. On April 30, 2002, the EPA published a final rule harmonizing the dates for the Section 126 Rule and the NOx SIP Call. In addition, the EPA determined in this rule that the future growth factor estimation methodology was appropriate. The new compliance date for all affected sources is now May 31, 2004, rather than May 1, 2003. The Company cannot predict the outcome of this matter. On June 20, 2002, legislation was enacted in North Carolina requiring the state's electric utilities to further reduce the emissions of nitrogen oxide and sulfur dioxide from coal-fired power plants. These levels exceed requirements of Title IV of the Clean Air Act pertaining to control of acid rain as well as the requirements discussed above with regard to the NOx SIP Call, 8-hour ozone standard and Section 126 petitions. Progress Energy expects its capital costs to meet these emission targets will be approximately $813 million. CP&L currently has approximately 5,100 MW of coal-fired generation in North Carolina that is affected by this legislation. The legislation requires the emissions reductions to be completed in phases by 2013, and applies to each utilities' total system rather than setting requirements for individual power plants. The legislation also freezes the utilities' base rates for five years unless there are extraordinary events beyond the control of the utility or unless the utility persistently earns a return substantially in excess of the rate of return established and found reasonable by the NCUC in the utility's last general rate case. Further, the legislation allows the utilities to recover from their retail customers the projected capital costs during the first seven years of the 10-year compliance period beginning on January 1, 2003. The utilities must recover at least 70% of their projected capital costs during the five-year rate freeze period. Pursuant to the new law, CP&L entered into an agreement with the state of North Carolina to transfer to the state all future emissions allowances it generates from over-complying with the new federal emission limits when these units are completed. The new law also requires the state to undertake a study of mercury and carbon dioxide emissions in North Carolina. Progress Energy cannot predict the future regulatory interpretation, implementation or impact of this new law. CP&L, Florida Power, Progress Ventures and NCNG have filed claims with the Company's general liability insurance carriers to recover costs arising out of actual or potential environmental liabilities. Some claims have been settled and others are still pending. While management 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. b) The Company and its subsidiaries are involved in various litigation matters in the ordinary course of business, some of which involve substantial amounts. Where appropriate, accruals have been made in accordance with SFAS No. 5, "Accounting for Contingencies," to provide for such matters. In the opinion of management, the final disposition of pending litigation would not have a material adverse effect on the Company's consolidated results of operations or financial position. 14. SUBSEQUENT EVENT On October 16, 2002, the Company announced the Board of Directors' approval to sell NCNG, and the Company's ownership interest in EasternNC, to Piedmont Natural Gas Company, Inc., for approximately $425 million in gross cash proceeds. The sale is expected to close in mid-2003 and must be approved by North Carolina and federal regulatory agencies. The Company expects to report NCNG as a discontinued operation in the fourth quarter of 23 2002. The carrying amounts for the assets and liabilities of the discontinued operations disposal group included in the Consolidated Balance Sheets, are as follows: September 30, December 31, (in thousands) 2002 2001 ---------------------------------------------- ------------- ------------ Total Utility plant, net $ 393,889 $ 393,149 Total Current Assets 58,952 118,378 Total Deferred Debits and Other Assets 42,474 42,419 Total Capitalization 389,715 387,981 Total Current Liabilities 66,813 129,027 Total Deferred Credits and Other Liabilities 38,787 36,938 24 CAROLINA POWER & LIGHT COMPANY CONSOLIDATED INTERIM FINANCIAL STATEMENTS September 30, 2002 CONSOLIDATED STATEMENTS OF INCOME Three Months Ended Nine Months Ended (Unaudited) September 30, September 30, (In thousands) 2002 2001 2002 2001 --------------------------------------------------------------------------------------------------------------------- Operating Revenues Electric $ 1,045,180 $ 973,803 $ 2,691,320 $ 2,577,664 Diversified businesses 4,304 3,088 11,127 9,208 --------------------------------------------------------------------------------------------------------------------- Total Operating Revenues 1,049,484 976,891 2,702,447 2,586,872 --------------------------------------------------------------------------------------------------------------------- Operating Expenses Fuel used in electric generation 222,273 186,546 569,295 497,687 Purchased power 123,365 113,837 287,593 291,038 Other operation and maintenance 181,007 167,153 564,011 515,241 Depreciation and amortization 130,530 143,720 405,375 421,513 Taxes other than on income 43,502 40,872 118,345 115,130 Diversified businesses 108,756 2,286 114,571 7,756 --------------------------------------------------------------------------------------------------------------------- Total Operating Expenses 809,433 654,414 2,059,190 1,848,365 --------------------------------------------------------------------------------------------------------------------- Operating Income 240,051 322,477 643,257 738,507 --------------------------------------------------------------------------------------------------------------------- Other Income (Expense) Interest income 330 2,660 5,198 13,686 Other, net (30,562) 4,610 (28,881) 16,530 --------------------------------------------------------------------------------------------------------------------- Total Other Income (Expense) (30,232) 7,270 (23,683) 30,216 --------------------------------------------------------------------------------------------------------------------- Interest Charges Net interest charges 49,390 63,010 167,289 193,189 Allowance for borrowed funds used during construction 276 (3,777) (5,597) (8,125) --------------------------------------------------------------------------------------------------------------------- Total Interest Charges 49,666 59,233 161,692 185,064 --------------------------------------------------------------------------------------------------------------------- Income before Income Taxes 160,153 270,514 457,882 583,659 Income Taxes 66,014 102,640 147,471 210,033 --------------------------------------------------------------------------------------------------------------------- Net Income 94,139 167,874 310,411 373,626 Preferred Stock Dividend Requirements (741) (741) (2,223) (2,223) --------------------------------------------------------------------------------------------------------------------- Earnings for Common Stock $ 93,398 $ 167,133 $ 308,188 $ 371,403 --------------------------------------------------------------------------------------------------------------------- See notes to Carolina Power & Light Company Interim Financial Statements. 25 Carolina Power & Light Company CONSOLIDATED BALANCE SHEETS (Unaudited) (In thousands) September 30, December31, Assets 2002 2001 ----------------------------------------------------------------------------------------------------------------- Utility Plant Electric utility plant in service $ 12,390,340 $ 12,024,291 Accumulated depreciation (6,272,139) (5,952,206) ----------------------------------------------------------------------------------------------------------------- Utility plant in service, net 6,118,201 6,072,085 Held for future use 7,105 7,105 Construction work in progress 463,408 711,129 Nuclear fuel, net of amortization 169,806 200,332 ----------------------------------------------------------------------------------------------------------------- Total Utility Plant, Net 6,758,520 6,990,651 ----------------------------------------------------------------------------------------------------------------- Current Assets Cash and cash equivalents 13,911 21,250 Accounts receivable 331,214 302,781 Unbilled accounts receivable 145,047 136,514 Receivables from affiliated companies 75,314 26,182 Notes receivable from affiliated companies 67,722 998 Taxes receivable - 17,543 Inventory 351,520 372,725 Deferred fuel cost 154,101 131,505 Prepayments 21,170 11,863 Other current assets 68,956 66,193 ----------------------------------------------------------------------------------------------------------------- Total Current Assets 1,228,955 1,087,554 ----------------------------------------------------------------------------------------------------------------- Deferred Debits and Other Assets Regulatory assets 260,651 277,550 Nuclear decommissioning trust funds 413,620 416,721 Diversified business property, net 8,437 111,802 Miscellaneous other property and investments 238,647 239,034 Other assets and deferred debits 97,253 135,373 ----------------------------------------------------------------------------------------------------------------- Total Deferred Debits and Other Assets 1,018,608 1,180,480 ----------------------------------------------------------------------------------------------------------------- Total Assets $ 9,006,083 $ 9,258,685 ----------------------------------------------------------------------------------------------------------------- Capitalization and Liabilities ----------------------------------------------------------------------------------------------------------------- Capitalization Common stock $ 1,926,999 $ 1,904,246 Unearned ESOP common stock (101,560) (114,385) Retained earnings 1,320,829 1,312,641 Accumulated other comprehensive loss (9,574) (7,046) ----------------------------------------------------------------------------------------------------------------- Total common stock equity 3,136,694 3,095,456 Preferred stock - not subject to mandatory redemption 59,334 59,334 Long-term debt, net 3,047,857 2,698,318 ----------------------------------------------------------------------------------------------------------------- Total Capitalization 6,243,885 5,853,108 ----------------------------------------------------------------------------------------------------------------- Current Liabilities Current portion of long-term debt 100,000 600,000 Accounts payable 230,292 300,829 Payables to affiliated companies 120,998 106,114 Notes payable affiliated companies - 47,913 Taxes accrued 91,265 - Interest accrued 48,584 61,124 Short-term obligations 252,285 260,535 Other current liabilities 165,016 208,645 ----------------------------------------------------------------------------------------------------------------- Total Current Liabilities 1,008,440 1,585,160 ----------------------------------------------------------------------------------------------------------------- Deferred Credits and Other Liabilities Accumulated deferred income taxes 1,238,114 1,316,823 Accumulated deferred investment tax credits 161,017 170,302 Regulatory liabilities 7,774 7,494 Other liabilities and deferred credits 346,853 325,798 ----------------------------------------------------------------------------------------------------------------- Total Deferred Credits and Other Liabilities 1,753,758 1,820,417 ----------------------------------------------------------------------------------------------------------------- Commitments and Contingencies (Note 8) ----------------------------------------------------------------------------------------------------------------- Total Capitalization and Liabilities $ 9,006,083 $ 9,258,685 ----------------------------------------------------------------------------------------------------------------- See Notes to Carolina Power & Light Company Consolidated Interim Financial Statements. 26 Carolina Power & Light Company CONSOLIDATED STATEMENTS OF CASH FLOWS Nine Months Ended (Unaudited) September 30, (In thousands) 2002 2001 ------------------------------------------------------------------------------------------------------------------- Operating Activities Net income $ 310,411 $ 373,626 Adjustments to reconcile net income to net cash provided by operating activities Impairment of long-lived assets and investments 126,262 - Depreciation and amortization 489,581 494,996 Deferred income taxes (73,640) (93,073) Investment tax credit (9,285) (12,518) Deferred fuel cost (credit) (22,596) (12,217) Net decrease in accounts receivable 159,263 84,570 Net (increase) decrease in inventories 11,893 (95,209) Net (increase) decrease in prepaids and other current assets (9,173) 2,607 Net decrease in accounts payable (4,547) (198,543) Net increase in other current liabilities 89,205 137,804 Other 52,874 45,704 ------------------------------------------------------------------------------------------------------------------ Net Cash Provided by Operating Activities 1,120,248 727,747 ------------------------------------------------------------------------------------------------------------------ Investing Activities Gross property additions (405,179) (615,554) Diversified business property additions (10,840) (5,311) Nuclear fuel additions (55,982) (70,316) Contributions to nuclear decommissioning trust (25,573) (25,564) Net cash flow of company-owned life insurance program (9,998) (5,137) Investments in non-utility activities (10,701) (18,827) ------------------------------------------------------------------------------------------------------------------ Net Cash Used in Investing Activities (518,273) (740,709) ------------------------------------------------------------------------------------------------------------------ Financing Activities Proceeds from issuance of long-term debt 543,967 296,124 Net decrease in short-term obligations (8,250) (181,860) Net decrease in intercompany notes (114,638) (6,543) Retirement of long-term debt (705,681) (217) Payment for termination of hedge (22,489) - Equity contribution from parent - 115,000 Dividends paid to parent (300,000) (197,664) Dividends paid on preferred stock (2,223) (2,223) ------------------------------------------------------------------------------------------------------------------ Net Cash Provided by Financing Activities (609,314) 22,617 ------------------------------------------------------------------------------------------------------------------ Net Increase (Decrease) in Cash and Cash Equivalents (7,339) 9,655 Cash and Cash Equivalents at Beginning of the Period 21,250 30,070 ------------------------------------------------------------------------------------------------------------------ Cash and Cash Equivalents at End of the Period $ 13,911 $ 39,725 ------------------------------------------------------------------------------------------------------------------ Supplemental Disclosures of Cash Flow Information Cash paid during the period - interest $ 169,092 $ 178,463 income taxes $ 181,444 $ 118,206 See Note 2 for non-cash investing activity. ------------------------------------------------------------------------------------------------------------------ See Notes to Carolina Power & Light Company Consolidated Interim Financial Statements.
27 Carolina Power & Light Company NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS 1. ORGANIZATION AND BASIS OF PRESENTATION Organization. Carolina Power & Light Company (CP&L) is a public service corporation primarily engaged in the generation, transmission, distribution and sale of electricity in portions of North Carolina and South Carolina. CP&L is a wholly owned subsidiary of Progress Energy, Inc. (the Company or Progress Energy). The Company is a registered holding company under the Public Utility Holding Company Act (PUHCA) of 1935, as amended. Both the Company and its subsidiaries are subject to the regulatory provisions of PUHCA. Basis of Presentation. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (generally accepted accounting principles) 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 generally accepted accounting principles for complete financial statements. Because the accompanying consolidated interim financial statements do not include all of the information and footnotes required by generally accepted accounting principles, they should be read in conjunction with the audited financial statements for the period ended December 31, 2001 and notes thereto included in CP&L's Form 10-K for the year ended December 31, 2001. The amounts included in the consolidated interim financial statements are unaudited but, in the opinion of management, reflect all adjustments necessary to fairly present CP&L'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. Effective with the quarter ended September 30, 2002, CP&L will no longer reclassify commercial paper as long-term debt. Certain amounts for 2001 have been reclassified to conform to the 2002 presentation, with no effect on previously reported net income or common stock equity. In preparing financial statements that conform with generally accepted accounting principles, 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. 2. FINANCIAL INFORMATION BY BUSINESS SEGMENT CP&L's operations consist primarily of the CP&L Electric segment with no other material segments. The financial information by business segment for CP&L Electric for the three and nine months ended September 30, 2002 and 2001 is as follows: (In thousands) Three Months Ended Nine Months Ended September 30, September 30, September 30, September 30, 2002 2001 2002 2001 ------------------------------------------------------------------------------------------------------------ Revenues $1,045,180 $973,803 $2,691,320 $2,577,664 Segment Income $179,308 $168,456 $396,530 $373,949 Total Segment Assets (a) $8,785,416 $9,101,248 $8,785,416 $9,101,248 ============================================================================================================ (a) CP&L Electric's total segment assets at September 30, 2002, decreased from the prior year due to the transfer of the Rowan plant to Progress Ventures in February 2002 in the amount of approximately $245 million.
The primary differences between the CP&L Electric and CP&L consolidated financial information relate to other non-electric operations and elimination entries. For the three and nine months ended September 30, 2002, the primary difference relates to asset impairments and other one-time charges recorded in the third quarter related to its Caronet, Inc. (Caronet) subsidiary and its investment in Interpath (See Note 3). 28 3. IMPAIRMENT OF LONG-LIVED ASSETS, INVESTMENTS AND ONE-TIME CHARGES Due to the decline of the telecommunications industry and continued operating losses, CP&L initiated a valuation study to assess the recoverability of Caronet's long-lived assets. Based on this assessment, CP&L recorded asset impairments and other one-time charges totaling $108.3 on a pre-tax basis in the third quarter of 2002 ($71.1 million after-tax). The asset write-downs and other one-time charges are included in diversified business expenses on the Consolidated Statements of Income. This write-down constitutes a significant reduction in the book value of these long-lived assets. The long-lived asset write-downs of $101.3 million on a pre-tax basis include an impairment of property, plant and equipment and construction work in process. The impairment charge represents the difference between the fair value and carrying amount of these long-lived assets. The fair value of these assets was determined using a valuation study heavily weighted on the discounted cash flow methodology and using market approaches as supporting information. The other one-time charges of $7.0 million on a pre-tax basis primarily relate to inventory adjustments. Effective June 28, 2000, Caronet entered into an agreement with Bain Capital where it contributed the net assets used in its application service provider business to a newly formed company, for a 35% ownership interest (15% voting interest) named Interpath Communications, Inc. (Interpath). In May 2002, Interpath merged with Usinternetworking, Inc. Pursuant to the terms of the merger agreement and additional funds being contributed by Bain Capital, CP&L now owns approximately 19% of the company (7% voting interest). As a result of the merger, CP&L reviewed the Interpath investment for impairment and wrote off the remaining amount of its cost-basis investment in Interpath, recording a pre-tax impairment of $25.0 million in the third quarter of 2002 ($16.3 million after-tax). The investment write-down is included in other, net on the Consolidated Statements of Income. 4. IMPACT OF NEW ACCOUNTING STANDARDS During the second quarter of 2001, the Financial Accounting Standards Board (FASB) issued interpretations of Statement of Financial Accounting Standards No. 133, "Accounting for Derivative and Hedging Activities," (SFAS No. 133) indicating that options in general cannot qualify for the normal purchases and sales exception, but provided an exception that allows certain electricity contracts, including certain capacity-energy contracts, to be excluded from the mark-to-market requirements of SFAS No. 133. The interpretations were effective July 1, 2001. Those interpretations did not require CP&L to mark-to-market any of its electricity capacity-energy contracts currently outstanding. In December 2001, the FASB revised the criteria related to the exception for certain electricity contracts, with the revision to be effective April 1, 2002. The revised interpretation did not result in any significant changes to CP&L's assessment of mark-to-market requirements for its current contracts. If an electricity or fuel supply contract in its regulated businesses is subject to mark-to-market accounting, there generally would be no income statement effect of the mark-to-market because such contracts are generally reflected in fuel adjustment clauses so that the contract's mark-to-market gain or loss would be recorded as a regulatory asset or liability. Any mark-to-market gains or losses in its non-regulated businesses would affect income unless those contracts qualify for hedge accounting treatment. The application of the new rules is still evolving, and further guidance from the FASB is expected, which could additionally impact CP&L's financial statements. The FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," in July 2001. This statement provides accounting and disclosure requirements for retirement obligations associated with long-lived assets and is effective January 1, 2003. This statement requires that the present value of retirement costs for which CP&L has a legal obligation be recorded as liabilities with an equivalent amount added to the asset cost and depreciated over an appropriate period. The liability is then accreted over time by applying an interest method of allocation to the beginning liability. CP&L is in the process of identifying retirement obligations. Areas that are being reviewed include electric transmission and distribution, nuclear decommissioning, all generating facilities and telecommunication assets. CP&L is also in the process of quantifying the obligations that have been identified under the measurement rules described in the standard. For CP&L's regulated operations, there is not expected to be any impact on earnings. CP&L currently cannot predict the earnings impact, if any, on its non-regulated companies. Effective January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 provides guidance for the accounting and reporting of impairment or disposal of 29 long-lived assets. The statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." It also supersedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" related to the disposal of a segment of a business. Adoption of this statement did not have a material effect on the Company's financial statements. In April 2002, the FASB issued SFAS No. 145 "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections" This standard will require gains and losses from extinguishment of debt to be classified as extraordinary items only if they meet the criteria of unusual and infrequent in Opinion 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." Any gain or loss on extinguishment will be recorded in the most appropriate line item to which it relates within net income before extraordinary items. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002; however, certain sections are effective for transactions occurring after May 15, 2002. CP&L does not have any transactions that are affected by this statement as of September 30, 2002. For CP&L, any expenses or call premiums associated with the reacquisition of debt obligations are amortized over the remaining life of the original debt using the straight-line method consistent with ratemaking treatment. In June 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal Activities." This statement supercedes Emerging Issues Task Force (EITF) Issue No. 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)". SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability is recognized at the date an entity commits to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. The provisions of SFAS No. 146 will be effective for any exit and disposal activities covered under the scope of this standard and initiated after December 31, 2002. 5. COMPREHENSIVE INCOME Comprehensive income for the three and nine months ended September 30, 2002 was $89.7 million and $307.9 million, respectively. Comprehensive income for the three and nine months ended September 30, 2001 was $164.1 million and $365.2 million, respectively. Items of other comprehensive income for the three-month and nine-month periods consisted primarily of changes in fair value of derivatives used to hedge cash flows related to interest on long-term debt, the cumulative effect of adopting SFAS No. 133 as of January 1, 2001 and reclassification of amounts into income. 6. FINANCING ACTIVITIES On February 6, 2002, CP&L issued $48.5 million principal amount of First Mortgage Bonds, Pollution Control Series W, Wake County Pollution Control Revenue Refunding Bonds, 5.375% Series 2002 Due February 1, 2017. On March 1, 2002, CP&L redeemed $48.5 million principal amount of Pollution Control Revenue Bonds, Wake County (Carolina Power & Light Company Project) Adjustable Rate Option Bond 1983 Series Due April 1, 2019, at 101.5% of the principal amount of such bonds. On June 27, 2002, CP&L announced the redemption of $500 million of CP&L Extendible Notes due October 28, 2009, at 100% of the principal amount of such notes. These notes were redeemed on July 29, 2002 and CP&L funded the redemptions through the issuance of commercial paper. On July 30, 2002, CP&L issued $500 million of senior unsecured notes due 2012 with a coupon of 6.5%. Proceeds from this issuance were used to pay down commercial paper. On August 5, 2002, CP&L announced the redemption of $150 million of First Mortgage bonds, 8.20% Series, due July 1, 2022 at 103.55% of the principal amount of such bonds. CP&L redeemed these notes on September 4, 2002 through the issuance of commercial paper. 7. RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS In April, May and June 2002, CP&L entered into a series of treasury rate locks to hedge its exposure to interest rates with regard to a future issuance of fixed-rate debt. These agreements had a computational period of 30 ten years. These instruments were designated as cash flow hedges for accounting purposes. The agreements, with a total notional amount of $350 million, were terminated simultaneously with the pricing of the $500 million CP&L senior unsecured notes in July 2002. CP&L realized a $22.5 million hedging loss, which will be amortized and recorded as an increase to interest expense over the life of the notes. The notional amount of the above contracts is not exchanged and does 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. 8. COMMITMENTS AND CONTINGENCIES Contingencies existing as of the date of these statements are described below. No significant changes have occurred since December 31, 2001, with respect to the commitments discussed in Note 15 of the financial statements included in CP&L's 2001 Annual Report on Form 10-K. Contingencies 1) Franchise Taxes CP&L, like other electric power companies in North Carolina, pays a franchise tax levied by the State pursuant to North Carolina General Statutes ss. 105-116, a state-level annual franchise tax (State Franchise Tax). Part of the revenue generated by the State Franchise Tax is required by North Carolina General Statutes ss. 105-116.1(b) to be distributed to North Carolina cities in which CP&L maintains facilities. CP&L has paid and continues to pay the State Franchise Tax to the state when such taxes are due. However, pursuant to an Executive Order issued on February 5, 2002, by the Governor of North Carolina, the Secretary of Revenue withheld distributions of State Franchise Tax revenues to cities for two quarters of fiscal year 2001-2002 in an effort to balance the state's budget. In response to the state's failure to distribute the State Franchise Tax proceeds, certain cities in which CP&L maintains facilities adopted municipal franchise tax ordinances purporting to impose on CP&L a local franchise tax. The local taxes are intended to be collected for as long as the state withholds distribution of the State Franchise Tax proceeds from the cities. The first local tax payments were due August 15, 2002. On August 2, 2002, CP&L filed a lawsuit against the cities seeking to enjoin the enforcement of the local taxes and to have the local ordinances struck down because the ordinances are beyond the cities' statutory authority and violate provisions of the North Carolina and United States Constitutions. On September 14, 2002, the Governor of North Carolina signed into law a provision that prevents cities and counties from levying local franchise taxes on electric utilities. The new law is also intended to prevent a recurrence of the withholding of utility franchise tax payments by the state. This new legislation makes it likely that the lawsuit CP&L filed in August against certain cities that were seeking to enforce local franchise tax ordinances will become moot. 2) Claims and Uncertainties a) CP&L is subject to federal, state and local regulations addressing air and water quality, hazardous and solid waste management and other environmental matters. Various organic materials associated with the production of manufactured gas, generally referred to as coal tar, are regulated under federal and state laws. The lead or sole regulatory agency that is responsible for a particular former coal tar site depends largely upon the state in which the site is located. There are several manufactured gas plant (MGP) sites to which CP&L has some connection. In this regard, CP&L, with other potentially responsible parties, are participating in investigating and, if necessary, remediating former coal tar sites with several regulatory agencies, including, but not limited to, the U.S. Environmental Protection Agency (EPA) and the North Carolina Department of Environment and Natural Resources, Division of Waste Management (DWM). In addition, CP&L is periodically notified by regulators such as the EPA and various state agencies of their involvement or potential involvement in sites, other than MGP sites, that may require investigation and/or remediation. 31 There are 12 former MGP sites and 14 other active waste sites associated with CP&L that have required or are anticipated to require investigation and/or remediation costs. As of September 30, 2002, CP&L has not recorded any accruals for investigation and/or remediation costs for these sites. CP&L received insurance proceeds to address costs associated with CP&L waste sites. All eligible expenses related to these waste costs are charged against a centralized fund containing these proceeds. As of September 30, 2002, approximately $8.3 million remains in this centralized fund. As costs associated with CP&L's share of investigation and remediation of these sites become known, the fund is assessed to determine if additional accruals will be required. CP&L does not believe that it can provide an estimate of the reasonably possible total remediation costs beyond what remains in the centralized fund. This is due to the fact that the sites are at different stages: investigation has not begun at 15 sites, investigation has begun but remediation cannot be estimated at 7 sites and 4 sites have begun remediation. CP&L measures its liability for these sites based on available evidence including its experience in investigation and remediation of contaminated sites, which also involves assessing and developing cost-sharing arrangements with other potentially responsible parties. Once the centralized fund is depleted, CP&L will accrue costs for the sites to the extent its liability is probable and the costs can be reasonably estimated. Therefore, CP&L cannot currently determine the total costs that may be incurred in connection with the remediation of all sites. According to current information, these future costs at the CP&L sites are not expected to be material to its financial condition or results of operations. A rollforward of the balance in this fund is not provided due to the immateriality of this activity in the periods presented. CP&L is also currently in the process of assessing potential costs and exposures at other sites of which it has been notified. As the assessments are developed and analyzed, CP&L will accrue costs for the sites to the extent the costs are probable and can be reasonably estimated. There has been and may be further proposed federal legislation requiring reductions in air emissions for nitrogen oxides, sulfur dioxide, carbon dioxide and mercury setting forth national caps and emission levels over an extended period of time. This national multi-pollutant approach would have significant costs which could be material to CP&L's consolidated financial position or results of operations. Some companies may seek recovery of the related cost through rate adjustments or similar mechanisms. Control equipment that will be installed on North Carolina fossil generating facilities as part of the North Carolina legislation discussed below may address some of the issues outlined above. CP&L cannot predict the outcome of this matter. The EPA has been conducting an enforcement initiative related to a number of coal-fired utility power plants in an effort to determine whether modifications at those facilities were subject to New Source Review requirements or New Source Performance Standards under the Clean Air Act. CP&L has been asked to provide information to the EPA as part of this initiative and cooperated in providing the requested information. The EPA has initiated enforcement actions against other unaffiliated utilities as part of this initiative, some of which have resulted in settlement agreements calling for expenditures ranging from $1.0 billion to $1.4 billion. A utility that was not subject to a civil enforcement action settled its New Source Review issues with the EPA for $300 million. These settlement agreements have generally called for expenditures to be made over extended time periods, and some of the utilities may seek recovery of the related cost through rate adjustments. CP&L cannot predict the outcome of this matter. In 1998, the EPA published a final rule addressing the issue of regional transport of ozone. This rule is commonly known as the NOx SIP Call. The EPA's rule requires 23 jurisdictions, including North Carolina and South Carolina, to further reduce nitrogen oxide emissions in order to attain a pre-set state NOx emission level by May 31, 2004. CP&L is evaluating necessary measures to comply with the rule and estimates its related capital expenditures could be approximately $370 million, which has not been adjusted for inflation. Increased operation and maintenance costs relating to the NOx SIP Call are not expected to be material to CP&L's results of operations. Further controls are anticipated as electricity demand increases. CP&L cannot predict the outcome of this matter. In July 1997, the EPA issued final regulations establishing a new eight-hour ozone standard. In October 1999, the District of Columbia Circuit Court of Appeals ruled against the EPA with regard to the federal eight-hour ozone standard. The U.S. Supreme Court has upheld, in part, the District of Columbia Circuit Court of Appeals decision. Designation of areas that do not attain the standard is proceeding, and further litigation and rulemaking on this and other aspects of the standard are anticipated. North Carolina adopted the federal eight-hour ozone standard and is proceeding with the implementation process. North Carolina has 32 promulgated final regulations, which will require CP&L to install nitrogen oxide controls under the State's eight-hour standard. The cost of those controls are included in the cost estimate of $370 million set forth above; however, further technical analysis and rulemaking may result in a requirement for additional controls at some units. CP&L cannot predict the outcome of this matter. The EPA published a final rule approving petitions under Section 126 of the Clean Air Act. This rule as originally promulgated required certain sources to make reductions in nitrogen oxide emissions by 2003. The final rule also includes a set of regulations that affect nitrogen oxide emissions from sources included in the petitions. The North Carolina fossil-fueled electric generating plants are included in these petitions. Acceptable state plans under the NOx SIP Call can be approved in lieu of the final rules the EPA approved as part of the 126 petitions. CP&L, other utilities, trade organizations and other states participated in litigation challenging the EPA's action. On May 15, 2001, the District of Columbia Circuit Court of Appeals ruled in favor of the EPA which will require North Carolina to make reductions in nitrogen oxide emissions by May 1, 2003. However, the Court in its May 15th decision rejected the EPA's methodology for estimating the future growth factors the EPA used in calculating the emissions limits for utilities. In August 2001, the court granted a request by CP&L and other utilities to delay the implementation of the 126 Rule for electric generating units pending resolution by the EPA of the growth factor issue. The court's order tolls the three-year compliance period (originally set to end on May 1, 2003) for electric generating units as of May 15, 2001. On April 30, 2002, the EPA published a final rule harmonizing the dates for the Section 126 Rule and the NOx SIP Call. In addition, the EPA determined in this rule that the future growth factor estimation methodology was appropriate. The new compliance date for all affected sources is now May 31, 2004, rather than May 1, 2003. CP&L cannot predict the outcome of this matter. On June 20, 2002, legislation was enacted in North Carolina requiring the state's electric utilities to further reduce the emissions of nitrogen oxide and sulfur dioxide from coal-fired power plants. These levels exceed requirements of Title IV of the Clean Air Act pertaining to control of acid rain as well as the requirements discussed above with regard to the NOx SIP Call, 8-hour ozone standard and Section 126 petitions. CP&L expects its capital costs to meet these emission targets will be approximately $813 million. CP&L currently has approximately 5,100 MW of coal-fired generation in North Carolina that is affected by this legislation. The legislation requires the emissions reductions to be completed in phases by 2013, and applies to each utilities' total system rather than setting requirements for individual power plants. The legislation also freezes the utilities' base rates for five years unless there are extraordinary events beyond the control of the utility or unless the utility persistently earns a return substantially in excess of the rate of return established and found reasonable by the NCUC in the utility's last general rate case. Further, the legislation allows the utilities to recover from their retail customers the projected capital costs during the first seven years of the 10-year compliance period beginning on January 1, 2003. The utilities must recover at least 70% of their projected capital costs during the five-year rate freeze period. Pursuant to the new law, CP&L entered into an agreement with the state of North Carolina to transfer to the state all future emissions allowances it generates from over-complying with the new federal emission limits when these units are completed. The new law also requires the state to undertake a study of mercury and carbon dioxide emissions in North Carolina. CP&L cannot predict the future regulatory interpretation, implementation or impact of this new law. CP&L has filed claims with its general liability insurance carriers to recover costs arising out of actual or potential environmental liabilities. Some claims have settled and others are still pending. While management 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. b) CP&L is involved in various litigation matters in the ordinary course of business, some of which involve substantial amounts. Where appropriate, accruals have been made in accordance with SFAS No. 5, "Accounting for Contingencies," to provide for such matters. In the opinion of management, the final disposition of pending litigation would not have a material adverse effect on CP&L's consolidated results of operations or financial position. 33 Item 2. Management's Discussion and Analysis of Financial Condition and ------ --------------------------------------------------------------- Results of Operations --------------------- RESULTS OF OPERATIONS For the three and nine months ended September 30, 2002, as compared to the corresponding periods in the prior year Progress Energy, Inc. Operating Results Progress Energy's consolidated earnings for the three and nine months ended September 30, 2002, were $151.9 million ($0.71 basic earnings per common share) and $405.1 million ($1.89 per share), respectively, compared to earnings of $366.4 million ($1.78 per share) and $632.1 million ($3.13 per share) for the same periods ended September 30, 2001. Current year earnings for the three and nine months ended September 30, 2002 were negatively impacted by the recognition of an impairment of the long-lived assets in the telecommunications business, decreases in revenues as part of Florida Power's retail rate settlement and increases in operations and maintenance expenses related to increased benefit costs and decreased pension credits. In addition, the common stock issuance in August 2001 (12.5 million shares) and purchase of Westchester Gas Company in April 2002 (2.5 million shares) resulted in dilution. Offsetting these negative factors were customer growth and improved weather which increased retail and wholesale sales, decreases in depreciation expense for the CP&L Electric and Florida Power Electric segments, decreases in interest charges resulting from lower average interest rates and additional capitalized interest as well as the elimination of goodwill amortization. Management tracks, monitors, and evaluates financial results based on reported earnings and ongoing earnings basis. The following reconciles reported earnings to ongoing earnings. ---------------------------------------------------------------------------------------------------------------- Three Months Ended Nine Months Ended September 30, September 30, ---------------------------------------------------------------------------------------------------------------- ($ millions, except per share figures) 2002 2001 2002 2001 ---- ---- ---- ---- Reported Earnings $151.9 $366.4 $405.1 $632.1 Intra-period tax allocation adjustment (39.0) (72.8) 40.5 (27.4) Contingent Value Obligations (CVO) mark to market (9.4) (16.8) (22.2) (7.9) Florida Retroactive Retail Rate Refund - - 21.0 - Progress Telecom/Caronet Asset Impairment and One-time Charges 224.8 - 224.8 - ---------------------------------------------------------------------------------------------------------------- Ongoing Earnings $328.3 $276.8 $669.2 $596.8 ====== ====== ====== ====== Ongoing Earnings Per Share $1.53 $1.34 $3.12 $2.96 ===== ===== ===== ===== ----------------------------------------------------------------------------------------------------------------
Each of the adjustments to reported earnings and the key business drivers are discussed in more detail in the business segment reviews that follow. CP&L Electric CP&L Electric contributed net income for the three and nine months ended September 30, 2002 of $179.3 million and $396.5 million, respectively, compared to net income of $168.5 million and $373.9 million, respectively, for the same periods in the prior year. Included in these amounts are energy marketing and trading activities, which are managed by Progress Ventures on behalf of CP&L, that had net income for the three and nine months ended September 30, 2002 of $11.3 million and $41.3 million, respectively, compared to net income of $11.7 million and $39.4 million, respectively, for the same periods in the prior year. Factors contributing to CP&L Electric's results include favorable electric revenue and margins driven by favorable weather compared to 2001 ($20.5 million and $22.7 million margin gain for the three and nine months ended September 30, 2002, respectively); a decrease in accelerated depreciation expense related to the nuclear plants ($16.8 million and $35.1 million decrease for the three and nine months ended September 30, 2002, respectively); and a decrease in interest expense resulting from lower debt and an average interest rate reduction (interest decreased by $13.6 million and $25.9 million for the three and nine months ended September 30, 2002, respectively). Additionally, CP&L Electric's results for the nine months ended September 30, 2002 were favorably impacted by a $25.7 million tax benefit reallocation from the holding company to CP&L. See Other Businesses section below for additional information on the tax benefit reallocation. 34 CP&L's electric revenues for the three and nine months ended September 30, 2002 and 2001 and the percentage change by customer class are as follows (in millions): ------------------------------------------------------------------------------------------------------------------ Three Months Ended September 30, Nine Months Ended September 30, -------------------------------------------------------------------------------- Customer Class 2002 % Change 2001 2002 % Change 2001 ------------------------------------------------------------------------------------------------------------------ Residential $384.6 12.6% $341.7 $952.4 4.5% $911.6 Commercial 244.6 8.0 226.5 630.7 5.4 598.5 Industrial 183.0 0.3 182.4 488.9 (1.8) 497.9 Governmental 23.5 4.0 22.6 58.9 3.7 56.8 ---------------------------------------------- ------------------------ ----------------- Total Retail Revenues 835.7 8.1 773.2 2,130.9 3.2 2,064.8 Wholesale 193.9 6.6 181.9 493.2 (0.9) 497.6 Unbilled (5.8) 28.0 (0.2) 8.5 - (42.3) Miscellaneous 21.4 13.2 18.9 58.7 1.9 57.6 ---------------------------------------------- ------------------------ ----------------- Total Electric Revenues $1,045.2 7.3% $973.8 $2,691.3 4.4% $2,577.7 ------------------------------------------------------------------------------------------------------------------ CP&L electric energy sales for the three and nine months ended September 30, 2002 and 2001 and the percentage change by customer class are as follows (in thousands of mWh): ------------------------------------------------------------------------------------------------------------------ Three Months Ended September 30, Nine Months Ended June 30, -------------------------------------------------------------------------------- Customer Class 2002 % Change 2001 2002 % Change 2001 ------------------------------------------------------------------------------------------------------------------ Residential 4,485 11.7% 4,015 11,732 2.3% 11,469 Commercial 3,675 7.0 3,433 9,493 3.3 9,186 Industrial 3,569 0.8 3,540 9,917 (2.2) 10,145 Governmental 425 2.7 414 1,087 (0.4) 1,093 ---------------------------------------------- ------------------------ ----------------- Total Retail Energy Sales 12,154 6.6 11,402 32,229 1.1 31,893 Wholesale 4,530 20.3 3,766 11,356 10.5 10,280 Unbilled (218) 29.0 (169) 27 - (771) ---------------------------------------------- ------------------------ ----------------- Total mWh sales 16,466 9.8% 14,999 43,612 5.3% 41,402 ------------------------------------------------------------------------------------------------------------------
Sales of energy to retail and wholesale customers increased for the three and nine months ended September 30, 2002, when compared to the same period in the prior year primarily due to the impacts of favorable weather in the current year and customer growth. In addition, an increase in the fuel factor for electric retail rates caused retail revenues to increase over the prior year. For the nine months ended, this was partially offset by a decrease in sales in the industrial customer class, primarily due to a decline in the industrial customer base (largely textiles customers) and the continued overall softness in the industrial markets driven by the weak economic environment. Wholesale energy sales growth rates for the three and nine months ended September 30, 2002 exceeded wholesale energy revenue growth rates as sales to other utilities were negatively impacted by a depressed market in 2002 and higher market prices in 2001. CP&L Electric's fuel expense increased $35.7 million for the three months ended September 30, 2002, when compared to $186.5 million in 2001, primarily due to an increase in volume and a change in generation mix, which was partially offset by a decrease in price. Purchased power expense increased $9.5 million for the three months ended September 30, 2002, when compared to $113.8 million in 2001, due to increases in volume and price. CP&L Electric's fuel expense increased $71.6 million for the nine months ended September 30, 2002, when compared to $497.7 million in 2001, primarily due to an increase in volume and a change in generation mix, which was partially offset by a decrease in price. Purchased power expense decreased $3.4 million for the nine months ended September 30, 2002, when compared to $291.0 million in 2001, primarily due to decreases in volume attributable to favorable market conditions and prices that existed in the first quarter of 2001. Fuel expenses are recovered primarily through cost recovery clauses and, as such, have no material impact on operating results. CP&L Electric's operations and maintenance expense increased by $13.9 million and $48.8 million for the three and nine months ended September 30, 2002, respectively, when compared to operations and maintenance expense of $167.2 million and $515.2 million, respectively, for the same periods in the prior year. The increase for the three and nine months ended September 30, 2002 was primarily due to increased salary and benefit costs ($6.3 million and $15.0 million for the three and nine months ended September 30, 35 2002); increased insurance costs combined with a lower NEIL refund ($2.0 million and $4.2 million for the three and nine months ended September 30, 2002); costs incurred to prepare for a nuclear outage ($4.5 million for the three and nine months ended September 30, 2002); costs related to a boiler overhaul ($9.4 million for the nine months ended September 30, 2002) and increased support charges from the Service Company as a result of higher vacancy rates in the prior year. Depreciation expense decreased $13.2 million and $16.1 million for the three and nine months ended September 30, 2002, when compared to depreciation expense of $143.7 million and $421.5 million, respectively, for the same periods in the prior year. CP&L's accelerated cost recovery program for nuclear generating assets allows flexibility in recording accelerated depreciation expense. The decrease for these periods relates to CP&L Electric's election to depreciate the nuclear assets at the lower end of the allowable range as set by the state utility commissions. See OTHER MATTERS below for additional information on CP&L's accelerated cost recovery program. For the three and nine months ended September 30, 2002, CP&L recorded accelerated depreciation expense of $13.2 million and $54.9 million, respectively. For the three and nine months ended September 30, 2001, CP&L recorded accelerated depreciation expense of $30.0 million and $90.0 million, respectively. These reductions are partially offset by increased depreciation costs resulting from the first phase of the Richmond units being placed into service in May 2001. Florida Power Electric Florida Power Electric contributed net income for the three and nine months ended September 30, 2002 of $123.8 million and $258.3 million, respectively, compared to net income of $114.1 million and $270.0 million, respectively for the same periods in the prior year. Included in these amounts are energy marketing and trading activities, which are managed by Progress Ventures on behalf of Florida Power, that had net income for the three and nine months ended September 30, 2002 of $3.3 million and $9.5 million, respectively, compared to net income of $6.7 million and $18.4 million, respectively, for the same periods in the prior year. Additionally, Florida Power Electric's results for the three and nine months ended September 30, 2002 were favorably impacted by a $13.4 million tax benefit reallocation from the holding company to Florida Power Electric. See Other Businesses section below for additional information on the tax benefit reallocation. Florida Power Electric's earnings for the three and nine months ended September 30, 2002, were negatively affected by the outcome of the Florida Power rate case settlement, which included a one-time retroactive revenue refund of $35.0 million, $21.0 million after tax, recorded in the first quarter of 2002 and a decrease in retail rates, which was partially offset by reductions in depreciation in accordance with the settlement. See Note 3 to the Progress Energy, Inc. Consolidated Interim Financial Statements for additional information on the settlement. In addition, Florida Power Electric results for the three months and nine months ended were negatively affected by increases in operations and maintenance expense as described more fully below. Florida Power's electric revenues for the three and nine months ended September 30, 2002 and 2001 and the percentage change by customer class are as follows (in millions): --------------------------------------------------------------------------------------------------------------- Three Months Ended September 30, Nine Months Ended September 30, ---------------------------------------------------------------------------- Customer Class 2002 % Change 2001 2002 % Change 2001 --------------------------------------------------------------------------------------------------------------- Residential $469.8 (5.7)% $498.2 $1,244.7 (3.0)% $1,283.2 Commercial 199.5 (8.0) 216.9 549.7 (3.3) 568.2 Industrial 52.6 (4.0) 54.8 157.7 (5.8) 167.5 Governmental 45.1 (7.2) 48.6 128.5 (1.6) 130.6 Retroactive Retail Revenue Refund - - - (35.0) - - ---------------------------------------------- ------------------------ ------------ Total Retail Revenues 767.0 (6.3) 818.5 2,045.6 (4.8) 2,149.5 Wholesale 57.8 (19.9) 72.2 166.1 (28.4) 232.0 Unbilled 8.4 - (7.3) 20.2 - (12.1) Miscellaneous 30.4 33.9 22.7 84.1 (35.8) 130.9 ---------------------------------------------- ------------------------ ------------ Total Electric Revenues $863.6 (4.7)% $906.1 $2,316.0 (7.4)% $2,500.3 --------------------------------------------------------------------------------------------------------------- 36 Florida Power's electric energy sales for the three and nine months ended September 30, 2002 and 2001, and the percentage change by customer class are as follows (in thousands of mWh): --------------------------------------------------------------------------------------------------------------- Three Months Ended September 30, Nine Months Ended September 30, ---------------------------------------------------------------------------- 2002 % Change 2001 2002 % Change 2001 --------------------------------------------------------------------------------------------------------------- Residential 5,503 2.5% 5,370 14,078 1.7% 13,841 Commercial 3,207 1.4 3,164 8,519 1.8 8,367 Industrial 983 5.3 934 2,859 (2.2) 2,923 Governmental 759 1.2 750 2,095 2.6 2,042 ---------------------------------------------- ------------------------ ------------ Total Retail Energy Sales 10,452 2.3 10,218 27,551 1.4 27,173 Wholesale 1,020 (22.7) 1,320 2,975 (18.8) 3,666 Unbilled 214 - (181) 689 - (122) ---------------------------------------------- ------------------------ ------------ Total mWh sales 11,686 2.9% 11,357 31,215 1.6% 30,717 ---------------------------------------------------------------------------------------------------------------
As a result of the settlement of the Florida Power rate case, effective May 1, 2002, Florida Power reduced its rates by 9.25%. The effect of this reduction was to reduce revenue by $30.9 million for the third quarter of 2002 and $51.4 million for the nine months ended September 30, 2002, when compared to the same periods in the prior year. Partially offsetting the decrease in rates and the one-time refund from the settlement detailed above were the impacts of favorable weather and customer growth. In addition, revenues for the first nine months of 2002 decreased when compared to the same period in the prior year due to the recognition of $63 million of deferred revenue in the first quarter of 2001, which is included in miscellaneous revenues in the table above. In 2001, the deferred revenues were offset by accelerated amortization of the Tiger Bay regulatory asset, discussed below, and therefore, had no net earnings impact. Wholesale electric revenues and sales decreased from the prior year due to the expiration of specific contracts. Fuel used in generation and purchased power decreased $32.0 million and $80.0 million for the three and nine months ended September 30, 2002, respectively, when compared to $414.7 million and $1,103.9 million, respectively, for the same periods in the prior year, primarily due to lower oil and gas prices and purchased power costs, partially offset by an increase in coal prices and volume from higher system requirements. In addition, the decrease for the three months ended September 30, 2002, was due to the lowered recovery of fuel expense as a result of the mid-course correction of Florida Power's fuel cost recovery clause as part of the settlement. Fuel and purchased power expenses are recovered primarily through cost recovery clauses and, as such, have no material impact on operating results. Operations and maintenance expense increased by $19.2 million and $69.9 million for the three and nine months ended September 30, 2002, respectively, when compared to operations and maintenance expense of $119.9 million and $350.6 million, respectively, for the same periods in the prior year. These amounts have increased due to a decreased pension credit in the current year ($6.5 million and $22.8 million lower for the three and nine months ended September 30, 2002); increased other employee benefit costs, primarily driven by medical costs (approximately $6.1 million and $15.6 million for the three and nine months ended September 30, 2002); increased spending related to Florida Power's Commitment to Excellence Program which is aimed at improving system reliability and customer satisfaction ($2.9 million and $8.5 million for the three and nine months ended September 30, 2002); and increased support charges from the Service Company as a result of higher vacancy rates in the prior year. Depreciation and amortization expense decreased by $21.7 million and $123.8 million for the three and nine months ended September 30, 2002, respectively, when compared to expense of $95.1 million and $341.8 million, respectively, for the same periods in the prior year. The Florida Power rate case settlement provides for ongoing reductions in depreciation, nuclear decommissioning and fossil dismantlement costs that reduced the amount of depreciation recorded by $19.5 million and $58.9 million for the three and nine months ended September 30, 2002, respectively. In addition, the first half of 2001 depreciation and amortization includes $63 million of accelerated amortization on the Tiger Bay regulatory asset associated with deferred revenue from 2000. Progress Ventures The Progress Ventures segment operations include natural gas exploration and production; coal fuel extraction, manufacturing and delivery, which includes synthetic fuels production; non-regulated generation; and energy marketing and trading activities on behalf of the utility operating 37 companies as well as for its non-regulated plants. Progress Ventures contributed segment income, including allocation of energy marketing and trading on behalf of the utilities, of $87.6 million and $216.7 million for the three and nine months ended September 30, 2002, respectively, compared to net income of $80.1 million and $218.8 million, respectively, for the same periods in the prior year. For the three months ended September 30, 2002, the majority of the increase relates to the addition of non-regulated plants in the current year. For the nine months ended September 30, 2002, the majority of the decrease relates to minor reductions in the net income related to energy marketing and trading, and in both the coal and gas fuel extraction, manufacturing and delivery operations, partially offset by the additions of non-regulated plants during the year. Progress Ventures' energy marketing and trading activities, including activities on behalf of CP&L and Florida Power, generated net income of $13.1 million and $49.1 million for the three and nine months ended September 30, 2002, respectively, compared to net income of $18.4 million and $57.8 million, respectively, for the same periods in the prior year. See Note 5 to the Progress Energy, Inc. Consolidated Interim Financial Statements for additional information on trading and marketing activities. Earnings for the three and nine months ended September 30, 2002, have decreased primarily due to the expiration of specific contracts and the impact of lower natural gas prices on the pricing of certain contracts. Progress Ventures' non-regulated generation operations generated net income of $16.5 million and $23.3 million for the three and nine months ended September 30, 2002, respectively, when compared to net income of $2.3 million and $3.4 million, respectively, for the same periods in the prior year. This increase is due to the completion of construction of additional non-regulated plants, transfer of generation assets from CP&L and the acquisitions of non-regulated plants in the current year. See Note 2 to the Progress Energy, Inc. Consolidated Interim Financial Statements for additional information on this acquisition. Progress Ventures, Inc.'s subsidiary, MPC Generating, LLC, currently has two tolling agreements for output on one of its non-regulated plants with Dynegy, Inc. through June 2008. These contracts are not subject to mark to market accounting under SFAS No. 133. If Dynegy, Inc., was to default on this contract and Progress Ventures was required to replace the contract on this non-regulated plant, this could negatively impact Progress Ventures' cash flows. Progress Energy does not expect these developments to have a material impact on the Company's consolidated results of operations, financial position or cash flows. Progress Ventures' natural gas exploration and production operations include the operations of Mesa Hydrocarbons, Inc. (Mesa), which owns natural gas reserves and operates wells in Colorado and sells natural gas. These operations also include the activities of the recently acquired Westchester Gas Company. See Note 2 to the Progress Energy, Inc. Consolidated Interim Financial Statements for additional information on this acquisition. These operations generated net income of $2.5 million and $3.7 million for the three and nine months ended September 30, 2002, respectively, when compared to net income of $0.7 million and $5.1 million, respectively, for the same periods in the prior year. Due to the acquisition of Westchester Gas Company in April 2002, the results of these operations are not comparative. However, the current year results have been negatively affected by the decreases in sales price of gas over the prior year. Progress Ventures periodically enters into derivative instruments to hedge its exposure to price fluctuations on natural gas sales. During 2002, Progress Ventures has entered into cash flow hedges for approximately 81 percent and 56 percent, respectively, of Mesa and Westchester's total projected natural gas sales for the fourth quarter of 2002 and the entire year 2003. See Note 10 to the Progress Energy consolidated interim financial statements for more information on these instruments. Progress Ventures' coal fuel extraction, manufacturing and delivery operations generated net income of $55.1 million and $139.9 million for the three and nine months ended September 30, 2002, when compared to net income of $57.3 million and $147.9 million, respectively, for the same periods in the prior year. The Progress Ventures segment sold 3.0 million and 9.4 million tons of synthetic fuel for the three and nine months ended September 30, 2002, respectively, compared to 4.0 million and 10.4 million tons, respectively, for the same periods in the prior year. The sales resulted in tax credits of $78.7 million and $253.8 million being recorded for the three and nine months ended September 30, 2002, respectively, compared to tax credits of $102.9 million and $271.8 million, respectively, for the same periods in the prior year. The synthetic fuel production and related tax credits are lower in 2002 than in 2001 because the production schedule in 2002 has been evenly distributed based on anticipated full-year production whereas in 2001 excess production in the first nine months of the year mandated lower fourth quarter production. The production and sale of the synthetic fuel from these facilities qualifies for tax credits under Section 29 of the Code. See "Synthetic Fuels" under OTHER MATTERS below for additional discussion of these tax credits. Results for the three and nine months ended September 30, 2002 were also favorably impacted from $10.2 million of interest being capitalized in accordance with SFAS No. 34. 38 Rail Services Rail Services' operations represent the activities of Progress Rail Services Corporation (Progress Rail) and include railcar repair, rail parts reconditioning and sales, scrap metal recycling and other rail related services. In the second quarter of 2001, Rail Services was reclassified from net assets held for sale and the cumulative Rail Services' operations since the acquisition date of November 30, 2000, were included in Progress Energy's consolidated results of operations. Progress Energy recorded an after-tax charge of $10.1 million in the second quarter of 2001 reflecting the reallocation of the purchase price and the reversal of the effect of net assets held for sale accounting. In the third quarter of 2001 and 2002, Rail Services was accounted for as an ongoing operation. As a result of the classification to net assets held for sale in November 2000 and the reversal of that designation in 2001, Rail Services year to date 2001 activity includes activity from December 2000. Rail Services contributed earnings for the three and nine months ended September 30, 2002 of $0.7 million and $3.0 million, respectively, compared to losses of $2.2 million and $9.7 million for the comparable periods in 2001. Rail Service's year to year results were impacted by a weak business environment, which resulted in $24.1 million decreased revenues for the quarter and a decrease of $93.5 million for the nine months ended September 30, 2002 when compared to 2001. In addition, Rail Services' transition from acting as a scrap reseller in 2001 to acting as a scrap resale agent in 2002 and asset sales in 2001 contributed to the revenue decrease. Corresponding decreases in operating costs and the impact of targeted cost cutting measures offset the revenue reductions. Other Businesses The Other segment primarily includes the operations of North Carolina Natural Gas Corporation (NCNG), Strategic Resource Solutions Corp. (SRS), Progress Telecommunications Corporation (Progress Telecom) and Caronet, Inc. (Caronet). This segment also includes other non-regulated operations of CP&L and FPC as well as holding company results. The Other segment generated a net loss of $224.9 million and $418.6 million for the three and nine months ended September 30, 2002, respectively, compared to net income of $24.4 million and a net loss of $163.1 million, respectively, for the same periods in the prior year. The decrease in earnings for the three and nine months ended September 30, 2002, when compared to the same periods in the prior year, was primarily due to the recognition of long-lived asset impairments and one time charges in the telecommunications businesses (total impairment and one-time charges of $355.4 million offset by $130.6 million tax benefit for a $224.8 million after-tax impact), partially offset by the elimination of goodwill amortization in 2002. Other segment earnings for the three and nine months ended September 30, 2002 were also positively impacted from $11.8 million of interest being capitalized in accordance with SFAS No. 34. In accordance with SFAS No. 142, effective January 1, 2002, Progress Energy no longer amortizes goodwill. For the three and nine months ended September 30, 2001, the Company amortized goodwill of $24.9 million and $75.6 million, respectively. At September 30, 2002, the Company had approximately $3.8 billion of unamortized goodwill. See Note 7 to the Progress Energy, Inc. Consolidated Interim Financial Statements for additional information on SFAS No. 142. NCNG recorded a net loss of $5.3 million and net income of $1.7 million for the three and nine months ended September 30, 2002, respectively, compared to net losses of $3.2 million and $1.0 million, respectively, for the same periods in the prior year. NCNG's margin on gas sales decreased by $2.3 million and increased by $5.2 million for the three and nine months ended September 30, 2002, respectively, when compared to margin on sales of $15.4 million and $55.8 million for the same periods in the prior year. The third quarter margin decrease resulted primarily from a retroactive rate reduction for one customer. The year-to-date margin increase resulted primarily from an increase in industrial volumes related to a decline in gas prices. NCNG's operations and maintenance expense decreased $0.2 million for the three months and increased $3.7 million for the nine months ended September 30, 2002, respectively. The increase for the nine months ended September 30, 2002 was primarily due to increased staffing and increased operations and maintenance expense associated with an increase in its fleet. In February 2002, NCNG filed a general rate case with the North Carolina Utilities Commission (NCUC) requesting an annual rate increase of $47.6 million. On May 3, 2002, NCNG withdrew the application, based upon the NCUC Public Staff's and other parties' interpretation of the order approving the merger of CP&L and NCNG that such a case was not permitted until 2003. On May 16, 2002, NCNG filed a request to increase its margin rates and rebalance its rates with the NCUC, requesting an annual rate increase of 39 $4.1 million to recover costs associated with specific system improvements. On September 23, 2002, the NCUC issued its order approving the $4.1 million rate increase. The rate increase was effective October 1, 2002. On October 16, 2002, the Company announced plans to sell NCNG, and the Company's ownership interest in EasternNC, to Piedmont Natural Gas Company, Inc. for approximately $425 million in gross cash proceeds. See Note 14 to the Progress Energy, Inc. Consolidated Interim Financial Statements for further discussion on the planned sale. Generally accepted accounting principles require 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 decreased by $39.0 million for the three months and increased $40.5 million for the nine months ended September 30, 2002, respectively, in order to maintain an effective tax rate consistent with the estimated annual rate. Income tax expense was decreased by $72.6 million and $27.2 million for the three and nine months ended September 30, 2001, respectively. The tax credits associated with Progress Energy's synthetic fuel operations lower the overall effective tax rate. 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. Progress Energy is subject to regulation under the Public Utility Holding Company Act (PUHCA) of 1935, as amended, of the SEC. According to a recent SEC order, Progress Energy's tax benefit not related to acquisition interest expense is to be allocated to profitable subsidiaries. Therefore, the tax benefit that was previously held in the holding company, included in the Other segment, was allocated on a preliminary basis to the profitable subsidiaries effective with the second quarter of 2002. The allocation has no impact on consolidated tax expense or earnings. However, in the nine months ended September 30, 2002, the allocation increased the holding company's tax expense $40.6 million with offsetting decreases in other segments. Progress Energy issued 98.6 million CVOs in connection with the Florida Progress 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. These CVOs are recorded at fair value based on published prices and unrealized gains and losses from changes in fair value are recognized in earnings. At September 30, 2002, the CVOs had a fair market value of approximately $19.7 million. Progress Energy recorded a gain of $9.4 million and $22.2 million for the three and nine months ended September 30, 2002, respectively, compared to a gain of $16.8 million and $7.9 million, respectively, for the same periods in the prior year to record the changes in fair value of CVOs. Progress Telecom, including Caronet's operations, had net losses of $225.3 million and $234.6 million for the three and nine months ended September 30, 2002, respectively. This compares to net losses of $2.4 million and $4.6 million for the same periods in 2001. The decrease in earnings in 2002, when compared to 2001, is primarily due to long-lived asset impairments and other one-time after tax charges of $208.5 million that resulted from a valuation study of the unit's long-lived assets. See Note 3 to the Progress Energy, Inc. Consolidated Interim Financial Statements for further discussion of these charges. This write-down constitutes a significant reduction in the book value of these assets and the ongoing operations are expected to have a negligible impact on Progress Energy's net income. Effective June 28, 2000, Caronet entered into an agreement with Bain Capital where it contributed the net assets used in its application service provider business to a newly formed company, for a 35% ownership interest (15% voting interest), named Interpath Communications, Inc. (Interpath). In May 2002, Interpath merged with USinternetworking, Inc. Pursuant to the terms of the merger agreement and additional funds being contributed by Bain Capital, CP&L now owns approximately 19% of the company (7% voting interest). As a result of the merger, the Company reviewed the Interpath investment for impairment and wrote off the remaining amount of its cost-basis investment in Interpath, recording a pre-tax impairment of $25.0 million in the third quarter of 2002 ($16.3 million after-tax). Excluding the asset impairments and one-time charges, Progress Telecom's (including Caronet's operations) third quarter 2002 loss of $0.5 million compares to the prior year's comparable period loss of $2.4 million. The reduced loss resulted primarily from lower depreciation charges as a consequence of the asset writedown. A loss for the nine months ended September 30, 2002 (excluding the one-time charges) of $9.7 million compares to a loss of $4.6 million for the comparable period in 2001. The depreciation reduction related to the asset writedown was more than offset by depreciation on additional fiber optics that were placed into service in the first half of the year. 40 LIQUIDITY AND CAPITAL RESOURCES Progress Energy, Inc. Statement of Cash Flows and Financing Activities Cash provided by operating activities decreased $29.3 million for the nine months ended September 30, 2002, when compared to the corresponding period in the prior year. The decrease in cash from operating activities for the 2002 period is due to a decrease in operating income from the impact of the Florida Power rate case settlement. In addition, changes in the balances of certain current assets and liabilities due to operational fluctuations decreased cash provided by operating activities. Net cash used in investing activities increased $442.5 million for the nine months ended September 30, 2002, when compared to the corresponding period in the prior year. The increase in cash used in investing activities is primarily due to an expansion of Progress Ventures' generation and fuel portfolio (see Note 2 to the Progress Energy, Inc. Consolidated Interim Financial Statements). During the first nine months of 2002, $738.6 million was spent on its utility subsidiaries' construction program and $764.6 million was spent in diversified business property additions. The acquisition of Westchester Gas Company resulted in a net cash outflow of $17.4 million. Net cash provided by financing activities increased $473.8 million for the nine months ended September 30, 2002, when compared to the corresponding period in the prior year. The increase in cash provided by financing activities is primarily due to an increase in short-term obligations as well as an increase in long-term debt, the details of which are described below. On February 6, 2002, CP&L issued $48.5 million principal amount of First Mortgage Bonds, Pollution Control Series W, Wake County Pollution Control Revenue Refunding Bonds, 5.375% Series 2002 Due February 1, 2017. On March 1, 2002, CP&L redeemed $48.5 million principal amount of Pollution Control Revenue Bonds, Wake County (Carolina Power & Light Company Project) Adjustable Rate Option Bond 1983 Series Due April 1, 2019, at 101.5% of the principal amount of such bonds. In February 2002, $50 million of Progress Capital Holdings, Inc. (PCH) medium-term notes, 5.78% Series, matured. Progress Energy funded this maturity through the issuance of commercial paper. In March 2002, a Progress Ventures, Inc. subsidiary, Progress Genco Ventures, LLC, obtained a $440 million bank facility that was to be used exclusively for expansion of its non-regulated generation portfolio. Borrowings under this facility are secured by the assets in the generation portfolio. In March, June and September 2002, Progress Genco Ventures, LLC made draws under this facility of $120 million, $67 million and $25 million, respectively. In September 2002, Progress Genco Ventures, LLC terminated $130 million of the bank facility, reducing it from $440 million to $310 million. Progress Genco Ventures, LLC is required to hedge 75 percent of the amounts outstanding under its bank facility through September 2005 and 50 percent thereafter pursuant to the terms of the agreement for expansion of its non-regulated generation portfolio. In May 2002, Progress Genco Ventures, LLC entered into hedges that included a series of zero cost collars that have been designated as cash flow hedges for accounting purposes. The fair value of these instruments was a $10.9 million liability position at September 30, 2002. Progress Energy uses interest rate derivative instruments to adjust the fixed and variable rate debt components of its debt portfolio. During March, April and May 2002, Progress Energy converted $1.0 billion of fixed rate debt into variable rate debt by executing interest rate derivative agreements with a total notional amount of $1.0 billion with a group of five banks. Under the terms of the agreements, which were scheduled to mature in 2006 and 2007 and coincide with the maturity dates of the related debt issuances, Progress Energy received a fixed rate and paid a floating rate based on three-month LIBOR. These instruments were designated as fair value hedges for accounting purposes. In June 2002, Progress Energy terminated these agreements. The terminations resulted in a $21.2 million deferred hedging gain reflected in long-term debt, which will be amortized and recorded as a reduction to interest expense over the life of the related debt issuances. On March 28, 2002, Standard & Poor's affirmed Progress Energy's corporate credit rating of BBB+ and the ratings of Florida Power and CP&L but revised the outlook for all three entities to negative from stable. S&P stated that its change in outlook reflects the increased business risk at Progress Ventures and lower-than-projected credit protection measures. S&P stated 41 that Progress Energy's plan to divest of non-core assets and use the proceeds to pay down acquisition-related debt is moving slower than S&P had expected. On September 4, 2002, S&P reaffirmed Progress Energy's credit ratings and maintained the negative outlook. On April 10, 2002, Moody's Investors Services revised its outlook to negative from stable on Progress Energy's senior unsecured debt rating of Baa1. Moody's maintained a stable outlook for both Florida Power and CP&L. Moody's stated that its change in outlook to negative was in response to the increased level of debt incurred by the company, primarily to finance the expansion of its Progress Ventures unregulated generation portfolio. On October 18, 2002, Moody's announced that it had placed Progress Energy's senior unsecured debt rating (Baa1) on review for possible downgrade. As its basis for review, Moody's cited primarily Progress Energy's recent writedown of the value of its long-lived telecommunications assets and the related delay in its deleveraging plan. Moody's further indicated that it did not expect its review to result in more than a one notch downgrade of Progress Energy's senior unsecured debt rating. Moody's confirmed its ratings of Progress Energy's commercial paper (P-2) and the ratings of its two operating utilities, CP&L (senior secured--A-3, commercial paper--P-2, stable outlook) and Florida Power (senior secured--A-1, commercial paper--P-1, stable outlook). The change in outlook by the rating agencies has not materially affected Progress Energy's access to liquidity nor the cost of its short-term borrowings. On April 17, 2002, Progress Energy issued $350 million of senior unsecured notes due 2007 with a coupon of 6.05% and $450 million of senior unsecured notes due 2012 with a coupon of 6.85%. Proceeds from this issuance were used to pay down commercial paper. In April, May and June 2002, CP&L entered into a series of treasury rate locks to hedge its exposure to interest rates with regard to a future issuance of fixed-rate debt. These agreements had a computational period of ten years. These instruments were designated as cash flow hedges for accounting purposes. The agreements, with a total notional amount of $350 million, were terminated simultaneously with the pricing of the $500 million CP&L senior unsecured notes in July 2002. CP&L realized a $22.5 million hedging loss, which will be amortized and recorded as an increase to interest expense over the life of the notes. On June 20, 2002, legislation was enacted in North Carolina requiring the state's electric utilities to reduce the emissions of nitrogen oxide and sulfur dioxide from coal-fired power plants. CP&L expects its capital costs to meet these emission targets will be approximately $813 million. See Note 13 to the Progress Energy, Inc. Consolidated Interim Financial Statements and OTHER MATTERS below for more information on this legislation. On June 27, 2002, CP&L announced the redemption of $500 million of CP&L Extendible Notes due October 28, 2009, at 100% of the principal amount of such notes. These notes were redeemed on July 29, 2002 and CP&L funded the redemptions through the issuance of commercial paper. On July 30, 2002, CP&L issued $500 million of senior unsecured notes due 2012 with a coupon of 6.5%. Proceeds from this issuance were used to pay down commercial paper. On July 1, 2002, $30 million of Florida Power medium-term notes, 6.54% Series, matured. Florida Power funded this maturity through the issuance of commercial paper. On July 11, 2002, Florida Power announced the redemption of $108.55 million principal amount of Citrus County Pollution Control Refunding Revenue Bonds, Series 1992 A Due January 1, 2027, $90 million principal amount of Citrus County Pollution Control Refunding Revenue Bonds, Series 1992 B Due February 1, 2022 and $10.115 million principal amount of Pasco County Pollution Control Refunding Revenue Bonds, Series 1992A Due February 1, 2022, at 102% of the principal amount of such bonds and $32.2 million principal amount of Pinellas County Pollution Control Refunding Revenue Bonds, Series 1991 Due December 1, 2014 at 101% of the principal amount of such bonds. These redemptions were finalized on August 12, 2002. On July 16, 2002, Florida Power issued $108.55 million principal amount of Citrus County Pollution Control Revenue Refunding Bonds, Series 2002A Due January 1, 2027, $100.115 million principal amount of Citrus County Pollution Control Revenue Refunding Bonds, Series 2002B Due January 1, 2022 and $32.2 million principal amount of Citrus County Pollution Control Revenue Refunding Bonds, Series 2002C Due January 1, 2018. Proceeds from this issuance were used to redeem Florida Power's pollution control revenue refunding bonds above. 42 On August 5, 2002, CP&L announced the redemption of $150 million of First Mortgage bonds, 8.20% Series, due July 1, 2022 at 103.55% of the principal amount of such bonds. CP&L redeemed these notes on September 4, 2002 through the issuance of commercial paper. In August 2002, Progress Energy converted $800 million of fixed rate debt into variable rate debt by executing interest rate derivative agreements with four counterparties with a total notional amount of $800 million. Under the terms of the agreements, which were scheduled to expire in 2006 and coincide with the maturity date of the related debt issuance, Progress Energy received a fixed rate of 3.38% and paid a floating rate based on three-month LIBOR. These instruments were designated as fair value hedges for accounting purposes. In November 2002, Progress Energy terminated these agreements. The terminations resulted in a $14.0 million deferred hedging gain reflected in long-term debt, which will be amortized and recorded as a reduction to interest expense over the life of the related debt issuance. Progress Energy's 364-day revolving credit facility expired on November 12, 2002. In connection with the renewal, the facility was reduced in size from $550 million to approximately $430 million. In addition, the permitted debt to capital ratio was lowered from 70% to 68% effective June 30, 2003; Progress Energy's debt to capital ratio as of September 30, 2002, was 65.3%. Finally, a minimum EBITDA to interest expense ratio of 2.5x to 1 was imposed; for the twelve months ended September 30, 2002, Progress Energy's ratio of EBITDA to interest expense was 3.28x to 1. On November 13, 2002, Progress Energy issued 14.7 million shares of common stock at $40.90 per share for net proceeds of $600.0 million. Proceeds from the issuance will be used to retire commercial paper. Future Commitments As of September 30, 2002, Progress Energy's contractual cash obligations have not changed materially from what was reported in the 2001 Annual Report on Form 10-K. The only changes in Progress Energy's contractual cash obligations involve the additional long-term debt issuances made through the third quarter of 2002 that are detailed above, and the finalization of Progress Ventures' purchase obligations related to generation and fuel acquisitions, as detailed in Note 2 to the Progress Energy, Inc. Consolidated Interim Financial Statements. As of September 30, 2002, Progress Energy's other commercial commitments have changed from what was reported in the 2001 Annual Report on Form 10-K. During the first nine months of 2002, Progress Energy issued approximately $363 million of guarantees on behalf of Progress Ventures for obligations under power purchase agreements, tolling agreements, construction agreements and trading operations. Approximately $184 million of these commitments relate to certain guarantee agreements issued to support obligations related to Progress Ventures' expansion of its non-regulated generation portfolio. These guarantees ensure performance under generation construction and operating agreements. The remaining $179 million of these new commitments are guarantees issued to support Progress Ventures' energy trading and marketing functions. The majority of the trading and marketing contracts supported by the guarantees contain language regarding downgrade events, ratings triggers, netting of exposure and/or payments and offset provisions in the event of a default. Based upon the amount of trading positions outstanding at October 31, 2002, if Progress Energy's ratings were to decline below investment grade, the Company would have to deposit cash or provide letters of credit or other cash collateral for approximately $17 million for the benefit of the Company's counterparties. OTHER MATTERS Florida Power Rate Case Settlement On March 27, 2002, the parties in Florida Power's rate case entered into a Stipulation and Settlement Agreement (the Agreement) related to retail rate matters. The Agreement was approved by the FPSC on April 23, 2002. The Agreement is generally effective from May 1, 2002 through December 31, 2005; provided, however, that if Florida Power's base rate earnings fall below a 10% return on equity, Florida Power may petition the FPSC to amend its base rates. See Note 4 to the Progress Energy, Inc. Consolidated Interim Financial Statements for additional information on the Agreement. 43 North Carolina Clean Air Legislation On June 20, 2002, legislation was enacted in North Carolina requiring the state's electric utilities to reduce the emissions of nitrogen oxide and sulfur dioxide from coal-fired power plants. Progress Energy expects its capital costs to meet these emission targets will be approximately $813 million. CP&L currently has approximately 5,100 MW of coal-fired generation in North Carolina that is affected by this legislation. The legislation requires the emissions reductions to be completed in phases by 2013, and applies to each utilities' total system rather than setting requirements for individual power plants. The legislation also freezes the utilities' base rates for five years unless there are extraordinary events beyond the control of the utility or unless the utility persistently earns a return substantially in excess of the rate of return established and found reasonable by the NCUC in the utility's last general rate case. Further, the legislation allows the utilities to recover from their retail customers the projected capital costs during the first seven years of the 10-year compliance period beginning on January 1, 2003. The utilities must recover at least 70% of their projected capital costs during the five-year rate freeze period. Pursuant to the new law, CP&L entered into an agreement with the state of North Carolina to transfer to the state all future emissions allowances it generates from over-complying with the new federal emission limits when these units are completed. The new law also requires the state to undertake a study of mercury and carbon dioxide emissions in North Carolina. Progress Energy cannot predict the future regulatory interpretation, implementation or impact of this new law. On June 14, 2002, the NCUC approved modification of CP&L's ongoing accelerated cost recovery of its nuclear generating assets. Effective January 1, 2003, the NCUC will no longer require a minimum annual depreciation. The aggregate minimum and maximum amounts of accelerated depreciation, $415 million and $585 million respectively, are unchanged from the original NCUC order. The date by which the minimum amount must be depreciated was extended from December 31, 2004 to December 31, 2009. On October 29, 2002, the SCPSC approved a similar modification. The order is effective as of November 1, 2002, and the aggregate minimum and maximum of $115 million and $165 million established for accelerated cost recovery by the SCPSC is unaffected by the order. As of September 30, 2002, CP&L has recorded cumulative accelerated depreciation expense of approximately $405 million. Franchise Taxes CP&L, like other electric power companies in North Carolina, pays a franchise tax levied by the State pursuant to North Carolina General Statutes ss. 105-116, a state-level annual franchise tax (State Franchise Tax). Part of the revenue generated by the State Franchise Tax is required by North Carolina General Statutes ss. 105-116.1(b) to be distributed to North Carolina cities in which CP&L maintains facilities. CP&L has paid and continues to pay the State Franchise Tax to the state when such taxes are due. However, pursuant to an Executive Order issued on February 5, 2002, by the Governor of North Carolina, the Secretary of Revenue withheld distributions of State Franchise Tax revenues to cities for two quarters of fiscal year 2001-2002 in an effort to balance the state's budget. In response to the state's failure to distribute the State Franchise Tax proceeds, certain cities in which CP&L maintains facilities adopted municipal franchise tax ordinances purporting to impose on CP&L a local franchise tax. The local taxes are intended to be collected for as long as the state withholds distribution of the State Franchise Tax proceeds from the cities. The first local tax payments were due August 15, 2002. On August 2, 2002, CP&L filed a lawsuit against the cities seeking to enjoin the enforcement of the local taxes and to have the local ordinances struck down because the ordinances are beyond the cities' statutory authority and violate provisions of the North Carolina and United States Constitutions. On September 14, 2002, the Governor of North Carolina signed into law a provision that prevents cities and counties from levying local franchise taxes on electric utilities. The new law is also intended to prevent a recurrence of the withholding of utility franchise tax payments by the state. This new legislation makes it likely that the lawsuit CP&L filed in August against certain cities that were seeking to enforce local franchise tax ordinances will become moot. Generation Acquisition During February 2002, Progress Ventures, Inc. completed the acquisition of two electric generating projects located in Georgia from LG&E Energy Corp., a subsidiary of Powergen plc. The two projects consist of 1) the Walton project in Monroe, Georgia, a 460 megawatt natural gas-fired plant placed in service in June 2001 and 2) the Washington project in Washington County, Georgia, a planned 600 megawatt natural gas-fired plant expected to be operational by June 2003. The transaction included tolling and power sale agreements with LG&E Energy Marketing, Inc. for both projects through 44 December 31, 2004. The aggregate cash purchase price of approximately $348 million included approximately $1.7 million of direct transaction costs. See Note 2 to the Progress Energy, Inc. Consolidated Interim Financial Statements for additional information on this acquisition. Fuel Acquisition On April 26, 2002, Progress Energy finalized the acquisition of Westchester Gas Company, which includes approximately 215 producing natural gas wells, 52 miles of intrastate gas pipeline and 170 miles of gas-gathering systems. The aggregate purchase price of approximately $153 million consisted of cash consideration of approximately $22 million and the issuance of 2.5 million shares of Progress Energy common stock valued at approximately $129 million. The purchase price included approximately $1.7 million of direct transaction costs. The properties are located within a 25-mile radius of Jonesville, Texas, on the Texas-Louisiana border. This transaction added 140 billion cubic feet (Bcf) of gas reserves to Progress Ventures' growing energy portfolio. See Note 2 to the Progress Energy, Inc. Consolidated Interim Financial Statements for additional information on this acquisition. Synthetic Fuels Tax Credits Progress Energy, through the Progress Ventures business unit, produces synthetic fuel from coal. The production and sale of the synthetic fuel qualifies for tax credits under Section 29 of the Internal Revenue Code (Section 29) if certain requirements are satisfied, including a requirement that the synthetic fuel differs significantly in chemical composition from the coal used to produce such synthetic fuel. All of Progress Energy's synthetic fuel facilities have received favorable private letter rulings from the Internal Revenue Service (IRS) with respect to their operations. These tax credits are subject to review by the IRS, and if Progress Energy failed to prevail through the administrative or legal process, there could be a significant tax liability owed for previously taken Section 29 credits, with a significant impact on earnings and cash flows. Tax credits for the nine months ended September 30, 2002 and 2001, were $253.8 million and $271.8 million, respectively, offset by operating losses, net of tax, of $121.9 million and $128.1 million, respectively, for the same periods. One synthetic fuel entity, Colona Synfuel Limited Partnership, L.L.L.P., from which the Company (and Florida Progress prior to its acquisition by the Company) has been allocated approximately $241 million in tax credits to date, is being audited by the IRS. The audit of Colona was not unexpected. The Company is audited regularly in the normal course of business as are most similarly situated companies. Total Section 29 credits generated to date (including Florida Progress prior to its acquisition by the Company) are approximately $963 million. In September 2002, all of Progress Energy's majority-owned synthetic fuel entities were accepted into the Internal Revenue Service's (IRS) Pre-Filing Agreement (PFA) program. The PFA program allows taxpayers to voluntarily accelerate the IRS exam process in order to seek resolution of specific issues. Either the Company or the IRS can withdraw from the program at any time, and issues not resolved through the program may proceed to the next level of the IRS exam process. While the ultimate outcome is uncertain, the Company believes that participation in the PFA program will likely shorten the tax exam process. In management's opinion, Progress Energy is complying with the private letter rulings and all the necessary requirements to be allowed such credits under Section 29 and believes it is likely, although it cannot provide certainty, that it will prevail if challenged by the IRS on any credits taken. The current Section 29 tax credit program expires in 2007. Nuclear Matters Spent Fuel Storage On December 21, 2000, CP&L received permission from the NRC to increase its storage capacity for spent fuel rods in Wake County, North Carolina. The NRC's decision came two years after CP&L asked for permission to open two unused storage pools at the Shearon Harris Nuclear Plant (Harris Plant). The approval means CP&L can complete cooling systems and install storage racks in its third and fourth storage pools at the Harris Plant. Orange County, North Carolina appealed the NRC license amendment to expand spent fuel storage capacity at the Harris Plant. On May 31, 2001, Orange County filed a petition for review in the U.S. Court of Appeals for the District of Columbia, and on June 1, 2001, filed a request for stay and expedition of the case with the court. 45 On June 29, 2001, the U.S. Court of Appeals denied Orange County's motion for a stay and rejected the request for an expedited schedule for the appeal. The parties filed briefs, and the court heard oral arguments on September 5, 2002. The court issued its ruling on September 19, 2002, denying Orange County's petitions for review of NRC orders, finding no error in the NRC's determinations. Pressurized Water Reactors On March 18, 2002 the Nuclear Regulatory Commission (NRC) sent a bulletin to companies that hold licenses for pressurized water reactors (PWRs) requiring information on the structural integrity of the reactor vessel head and a basis for concluding that the vessel head will continue to perform its function as a coolant pressure boundary. The Company filed responses as required. Inspections of the vessel heads at the Company's PWR plants have been performed during previous outages. In October 2001 at the Crystal River plant (CR3), one nozzle was found to have a crack and was repaired; however, no degradation of the reactor vessel head was identified. Current plans are to replace the vessel head at CR3 during its next regularly scheduled refueling outage in 2003. At the Robinson plant, an inspection was completed in April 2001 and no penetration nozzle cracking was identified and there was no degradation of the reactor vessel head. At the Harris plant, sufficient inspections were completed during the last refueling outage in the fourth quarter of 2001 to conclude there is no degradation of the reactor vessel head. The Company's Brunswick plant has a different design and is not affected by the issue. On August 9, 2002, the NRC issued an additional Bulletin dealing with head leakage due to cracks near the control rod nozzles. The NRC has asked licensees to commit to high inspection standards to ensure the more susceptible plants have no cracks. The Robinson plant is in this category and had a refueling outage in October 2002. The Company completed a series of examinations in October 2002 of the entire reactor pressure vessel head and found no indications of control rod drive mechanism cracking and no corrosion of the head itself. During the outage, a boric acid leakage walkdown of the reactor coolant pressure boundary was completed and no corrosion was found. For CR3, the Company has responded to the NRC that previous inspections are sufficient until the reactor head is replaced in the fall of 2003. For the Harris plant, the Company does not plan further inspections until its next regularly scheduled outage in Spring 2003. Security On February 25, 2002, the NRC issued orders formalizing many of the security enhancements made at the Company's nuclear plants since September 2001. These orders include additional restrictions on access, increased security presence and closer coordination with the Company's partners in intelligence, military, law enforcement and emergency response at the federal, state and local levels. These interim security measures were required to be completed at each nuclear site by August 31, 2002. The Company completed the requirements by the deadline and expects the NRC to perform an inspection for compliance in the near future. As the NRC, other governmental entities, and the industry continue to consider security issues, it is possible that more extensive security plans could be required. Standard Market Design On July 31, 2002, the Federal Energy Regulatory Commission (FERC) issued its Notice of Proposed Rulemaking in Docket No. RM01-12-000, Remedying Undue Discrimination through Open Access Transmission Service and Standard Electricity Market Design (SMD NOPR). The proposed rules set forth in the SMD NOPR would require, among other things, that 1) all transmission owning utilities transfer control of their transmission facilities to an independent third party; 2) transmission service to bundled retail customers be provided under the FERC-regulated transmission tariff, rather than state-mandated terms and conditions; 3) new terms and conditions for transmission service be adopted nationwide, including new provisions for pricing transmission in the event of transmission congestion; 4) new energy markets be established for the buying and selling of electric energy; and 5) load serving entities be required to meet minimum criteria for generating reserves. If adopted as proposed, the rules set forth in the SMD NOPR would materially alter the manner in which transmission and generation services are provided and paid for. Progress Energy is reviewing the SMD NOPR and expects to file comments thereto, portions of which are due on November 15, 2002 and January 10, 2003. FERC also has indicated that it expects to issue final rules during the third quarter of 2003. The Company cannot predict the outcome of this rulemaking or the possible outcome of any further proceedings, including appeals, related to this matter. 46 Regional Transmission Organizations On June 18, 2002, the GridSouth RTO sponsors (CP&L, Duke Energy and South Carolina Electric and Gas) announced that they will delay filing applications with their state commissions and will suspend the GridSouth implementation project. Postponing the filings will allow GridSouth time to review the effects of state and federal regulatory initiatives that are ongoing and continuing through the end of 2002. GridSouth will determine the appropriate time to file new applications with the state commissions based on the results of these regulatory developments. The GridFlorida applicants filed a revised RTO proposal with the FPSC on March 20, 2002 incorporating certain changes required by the FPSC's December 2001 order. The FPSC then conducted a series of workshops and meetings to allow parties an opportunity to comment on the applicants' March 20 compliance filing. As a result of these comments, the GridFlorida applicants filed modifications to certain aspects of the compliance filing on June 21, 2002. On September 3, 2002, the FPSC issued an order addressing the compliance of the applicants' modified filing with the FPSC's December 2001 order through final agency action, requiring additional revisions to the applicants' modified filing through proposed agency action, and scheduling an expedited hearing for late October 2002 to consider the applicants' revised market design proposal and other proposed agency action revisions protested by the parties. On October 3, 2002, the Office of Public Counsel filed a Notice of Appeal to the Florida Supreme Court regarding the FPSC's September 3rd order. At a public meeting on October 15, 2002, the FPSC voted to hold further proceedings in the GridFlorida docket in abeyance pending the outcome of the Office of Public Counsel's appeal. The actual structure of GridSouth, GridFlorida or any alternative combined transmission structure, as well as the date it may become operational, depends upon the resolution of all regulatory approvals and technical issues. Given the regulatory uncertainty of the ultimate timing, structure and operations of GridSouth, GridFlorida or an alternate combined transmission structure, the Company cannot predict whether their creation will have any material adverse effect on its future consolidated results of operations, cash flows or financial condition. Franchise Litigation Six cities, with a total of approximately 49,000 customers, have sued Florida Power in various circuit courts in Florida. The lawsuits principally seek 1) a declaratory judgment that the cities have the right to purchase Florida Power'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 Florida Power to continue to collect from Florida Power's customers and remit to the cities, franchise fees during the pending litigation, and as long as Florida Power continues to occupy the cities' rights-of-way to provide electric service, notwithstanding the expiration of the franchise ordinances under which Florida Power had agreed to collect such fees. Three circuit courts have entered orders requiring arbitration to establish the purchase price of Florida Power's electric distribution facilities within three cities. Two appellate courts have upheld those circuit court decisions and authorized cities to determine the value of Florida Power's facilities within the cities through arbitration. To date, no city has attempted to actually exercise the right to purchase any portion of Florida Power's electric distribution system. An arbitration in one of the cases was held in August 2002 and an award was issued in October 2002 setting the value of Florida Power's distribution system within one city at approximately $22 million. At this time, whether and when there will be further proceedings following this award cannot be determined. Additional arbitrations have been scheduled to occur in the fourth quarter of 2002 and second quarter of 2003. Progress Energy cannot predict the outcome of these matters. Union Contract Approximately 2,100 employees at Florida Power are represented by the International Brotherhood of Electrical Workers (IBEW). The current union contract was ratified in December 1999 and expires on December 1, 2002. Florida Power is currently in negotiations with the IBEW, but the Company cannot predict the outcome or impact of this matter. Carolina Power & Light Company 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 47 relate to CP&L: RESULTS OF OPERATIONS; LIQUIDITY AND CAPITAL RESOURCES and OTHER MATTERS. RESULTS OF OPERATIONS The results of operations for the CP&L Electric segment are identical between CP&L and Progress Energy. For the three and nine months ended September 30, 2002, the operations for CP&L's non-utility subsidiaries primarily relate to asset impairments and one-time charges recorded in the third quarter of 2002 related to its Caronet, Inc. subsidiary and its investment in Interpath (See Note 3 to the CP&L Consolidated Interim Financial Statements). The results of operations for CP&L's non-utility subsidiaries for the three and nine months ended September 30, 2001 are not material to CP&L's consolidated financial statements. LIQUIDITY AND CAPITAL RESOURCES During the first nine months of 2002, $405.2 million was spent on CP&L's construction program and $10.8 million was spent on diversified business property additions. As of September 30, 2002, CP&L's liquidity, contractual cash obligations and other commercial commitments have not changed materially from what was reported in the 2001 Annual Report on Form 10-K. Item 3. Quantitative and Qualitative Disclosures About Market Risk ------ ---------------------------------------------------------- Progress Energy, Inc. Market risk represents the potential loss arising from adverse changes in market rates and prices. Certain market risks are inherent in the Company's financial instruments, which arise from transactions entered into in the normal course of business. The Company's primary exposures are changes in interest rates with respect to its long-term debt and commercial paper, and fluctuations in the return on marketable securities with respect to its nuclear decommissioning trust funds. The Company manages its market risk in accordance with its established risk management policies, which may include entering into various derivative transactions. The Company's exposure to return on marketable securities for the decommissioning trust funds has not changed materially since December 31, 2001. The Company's exposure to market value risk with respect to the CVOs has also not changed materially since December 31, 2001. In March 2002, a Progress Ventures, Inc. subsidiary, Progress Genco Ventures, LLC, obtained a $440 million bank facility that was to be used exclusively for expansion of its non-regulated generation portfolio. In March, June and September 2002, Progress Genco Ventures, LLC made draws under this facility of $120 million, $67 million and $25 million, respectively. In September 2002, Progress Genco Ventures, LLC terminated $130 million of the bank facility, reducing it from $440 million to $310 million. Progress Genco Ventures, LLC is required to hedge 75 percent of the amounts outstanding under its bank facility through September 2005 and 50% thereafter pursuant to the terms of the agreement for expansion of its non-regulated generation portfolio. In May 2002, Progress Genco Ventures, LLC entered into hedges that included a series of zero cost collars that have been designated as cash flow hedges for accounting purposes. The fair value of these instruments was a $10.9 million liability position at September 30, 2002. During March, April and May 2002, Progress Energy converted $1.0 billion of fixed rate debt into variable rate debt by executing interest rate derivative agreements with a total notional amount of $1.0 billion with a group of five banks. Under the terms of the agreements, which were scheduled to mature in 2006 and 2007 and coincide with the maturity dates of the related debt issuances, Progress Energy received a fixed rate and paid a floating rate based on three-month LIBOR. These instruments were designated as fair value hedges for accounting purposes. In June 2002, Progress Energy terminated these agreements. As a result of the agreements, at June 30, 2002, Progress Energy had a $21.2 million deferred hedging gain reflected in long-term debt, which will be amortized and recorded as a reduction to interest expense over the life of the related debt issuances. On April 17, 2002, Progress Energy issued $350 million of senior unsecured notes due 2007 with a coupon of 6.05% and $450 million of senior unsecured notes due 2012 with a coupon of 6.85%. Proceeds from this issuance were used to pay down commercial paper. 48 In April, May and June 2002, CP&L entered into a series of treasury rate locks to hedge its exposure to interest rates with regard to a future issuance of fixed-rate debt. These agreements had a computational period of ten years. These instruments were designated as cash flow hedges for accounting purposes. The agreements, with a total notional amount of $350 million, were terminated simultaneously with the pricing of the $500 million CP&L senior unsecured notes in July 2002 described below. CP&L realized a $22.5 million hedging loss, which will be amortized and recorded as an increase to interest expense over the life of the notes. On June 27, 2002, CP&L announced the redemption of $500 million of CP&L Extendible Notes due October 28, 2009, at 100% of the principal amount of such notes. These notes were redeemed on July 29, 2002 and CP&L funded the redemptions through the issuance of commercial paper. On July 30, 2002, CP&L issued $500 million of senior unsecured notes due 2012 with a coupon of 6.5%. Proceeds from this issuance were used to pay down commercial paper. On August 5, 2002, CP&L announced the redemption of $150 million of First Mortgage bonds, 8.20% Series, due July 1, 2022 at 103.55% of the principal amount of such bonds. CP&L redeemed these notes on September 4, 2002 through the issuance of commercial paper. In August 2002, Progress Energy converted $800 million of fixed rate debt into variable rate debt by executing interest rate derivative agreements with four counterparties with a total notional amount of $800 million. Under the terms of the agreements, which were scheduled to expire in 2006 and coincide with the maturity date of the related debt issuance, Progress Energy received a fixed rate of 3.38% and paid a floating rate based on three-month LIBOR. These instruments were designated as fair value hedges for accounting purposes. The fair value of these instruments was a $14.2 million asset position at September 30, 2002. In November 2002, Progress Energy terminated these agreements. The terminations resulted in a $14.0 million deferred hedging gain reflected in long-term debt, which will be amortized and recorded as a reduction to interest expense over the life of the related debt issuance. Progress Ventures periodically enters into derivative instruments to hedge its exposure to price fluctuations on natural gas sales. During 2002, Progress Ventures has executed cash flow hedges on approximately 17.3 Bcf of natural gas sales for the fourth quarter of 2002 and entire year 2003. These instruments did not have a material impact on the Company's consolidated financial position or results of operations. As a result of these issuances and redemptions, the exposure to changes in interest rates from the Company's fixed rate and variable rate long-term debt at September 30, 2002, has changed from December 31, 2001. The total fixed rate long-term debt at September 30, 2002, was $8.9 billion, with an average interest rate of 6.85% and fair market value of $9.9 billion. The total variable rate long-term debt at September 30, 2002, was $1.1 billion, with an average interest rate of 1.78% and fair market value of $1.1 billion. The exposure to changes in interest rates from FPC mandatorily redeemable securities of trust at September 30, 2002, was not materially different than at December 31, 2001. Effective with the quarter ended September 30, 2002, the Company will no longer reclassify commercial paper as long-term debt. At December 31, 2001, the Company had reclassified $865 million of commercial paper to long-term debt. At September 30, 2002, the exposure to changes in interest rates from the Company's commercial paper facilities was not materially different than at December 31, 2001. Carolina Power & Light Company CP&L has certain market risks inherent in its financial instruments, which arise from transactions entered into in the normal course of business. CP&L's primary exposures are changes in interest rates with respect to long-term debt and commercial paper reclassified as long-term debt, and fluctuations in the return on marketable securities with respect to its nuclear decommissioning trust funds. CP&L's exposure to return on marketable securities for the decommission trust funds has not changed materially since December 31, 2001. On June 27, 2002, CP&L announced the redemption of $500 million of CP&L Extendible Notes due October 28, 2009, at 100% of the principal amount of such notes. These notes were redeemed on July 29, 2002 and CP&L funded the redemptions through the issuance of commercial paper. On July 30, 2002, CP&L issued $500 million of senior unsecured notes due 2012 with a coupon of 6.5%. Proceeds from this issuance were used to pay down commercial paper. 49 In April, May and June 2002, CP&L entered into a series of treasury rate locks to hedge its exposure to interest rates with regard to a future issuance of fixed-rate debt. These agreements had a computational period of ten years. These instruments were designated as cash flow hedges for accounting purposes. The agreements, with a total notional amount of $350 million, were terminated simultaneously with the pricing of the $500 million CP&L senior unsecured notes in July 2002. CP&L realized a $22.5 million hedging loss, which will be amortized and recorded as an increase to interest expense over the life of the notes. On August 5, 2002, CP&L announced the redemption of $150 million of First Mortgage bonds, 8.20% Series, due July 1, 2022 at 103.55% of the principal amount of such bonds. CP&L redeemed these notes on September 4, 2002 through the issuance of commercial paper. The exposure to changes in interest rates from CP&L's fixed rate long-term debt and variable rate long-term debt at September 30, 2002, was not materially different than at December 31, 2001. Effective with the quarter ended September 30, 2002, CP&L will no longer reclassify commercial paper as long-term debt. At December 31, 2001, CP&L had reclassified $261 million of commercial paper to long-term debt. At September 30, 2002, the exposure to changes in interest rates from CP&L's commercial paper facilities was not materially different than at December 31, 2001. Item 4. Controls and Procedures ------- ----------------------- Progress Energy, Inc. Within the 90 days prior to the filing date of this report, Progress Energy carried out an evaluation, under the supervision and with the participation of its management, including Progress Energy's chief executive officer and chief financial officer, of the effectiveness of the design and operation of Progress Energy's disclosure controls and procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934. Based upon that evaluation, Progress Energy's chief executive officer and chief financial officer concluded that its disclosure controls and procedures are effective in timely alerting them to material information relating to Progress Energy (including its consolidated subsidiaries) required to be included in its periodic SEC filings. Since the date of the evaluation, there have been no significant changes in Progress Energy's internal controls or in other factors that could significantly affect these controls. Carolina Power & Light Company Within the 90 days prior to the filing date of this report, CP&L carried out an evaluation, under the supervision and with the participation of its management, including CP&L's chief executive officer and chief financial officer, of the effectiveness of the design and operation of CP&L's disclosure controls and procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934. Based upon that evaluation, CP&L's chief executive officer and chief financial officer concluded that its disclosure controls and procedures are effective in timely alerting them to material information relating to CP&L (including its consolidated subsidiaries) required to be included in its periodic SEC filings. Since the date of the evaluation, there have been no significant changes in CP&L's internal controls or in other factors that could significantly affect these controls. PART II. OTHER INFORMATION Item 1. Legal Proceedings ------- ----------------- Legal aspects of certain matters are set forth in Part I, Item 1. See Note 12 to the Progress Energy, Inc. Consolidated Interim Financial Statements and Note 8 to the CP&L Consolidated Interim Financial Statements. Strategic Resource Solutions Corp. (SRS) was charged in a criminal complaint filed on October 9, 2002 by the San Francisco District Attorney's 50 office. Working with the San Francisco District Attorney's office, SRS has pled guilty to two charges, taking responsibility for the misconduct of one of its former employees. This proceeding occurred on October 15, 2002. SRS has agreed to pay a fine of $500,000. Although SRS did not receive any funds, because of the involvement of a former employee, SRS has accepted corporate criminal responsibility and agreed to pay an additional $500,000 as restitution. SRS will also be placed on probation and continue cooperating with the District Attorney's investigation and prosecution of other defendants. Item 2. Changes in Securities and Use of Proceeds ------- ----------------------------------------- RESTRICTED STOCK AWARDS: (a) Securities Delivered. On September 9, 2002 and October 1, 2002, 3,600 and 180,000 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. Section 9 of the Plan provides for the granting of Restricted Stock by the Organization and Compensation Committee of the Company's Board of Directors, (the Committee) to key employees of the Company, including its Affiliates or any successor, and to outside directors of the Company. The Common Shares delivered pursuant to the Plan were acquired in market transactions directly for the accounts of the recipients and do not represent newly issued shares of the Company. (b) Underwriters and Other Purchasers. No underwriters were used in connection with the delivery of Common Shares described above. The Common Shares were delivered to certain key employees of the Company. The Plan defines "key employee" as an officer or other employee of the Company who is selected for participation in the Plan. (c) Consideration. The Common Shares were delivered to provide an incentive to the employee recipients to exert their utmost efforts on the Company's behalf and thus enhance the Company's performance while aligning the employee's interest with those of the Company's shareholders. (d) Exemption from Registration Claimed. The Common Shares described in this Item were delivered on the basis of an exemption from registration under Section 4(2) of the Securities Act of 1933. Receipt of the Common Shares required no investment decision on the part of the recipients. All award decisions were made by the Committee, which consists entirely of non-employee directors. Item 6. Exhibits and Reports on Form 8-K ------- -------------------------------- (a) Exhibits Exhibit Description Progress CP&L Number ----------- Energy, Inc. ---- ------ ------------ 10(i) Amendment and Restatement dated July 26, 2002 to Progress X Energy Inc.'s $450,000,000 3-Year Revolving Credit Agreement dated November 13, 2001, as amended February 13, 2002. 10(ii) Assumption Agreement from Barclays Bank PLC dated December X 17, 2001 for an additional commitment of $50 million, increasing the amount of the Progress Energy, Inc. 364-Day Revolving Credit Agreement, dated November 13, 2001, to $550 million. 10(iii) Carolina Power & Light Company $272,500,000 364-Day X Revolving Credit Agreement dated as of July 31, 2002. 10(iv) Carolina Power & Light Company $272,500,000 3-Year X Revolving Credit Agreement dated as of July 31, 2002. 10(v) Assumption Agreement from the Bank of New York dated August X 5, 2002 for a total commitment of $25 million, increasing the amount of the CP&L 364-Day and 3-Year Revolving Credit Agreements dated as of July 31, 2002, to $285,000,000 each. 51 10(vi) Progress Energy, Inc. 2002 Equity Incentive Plan (Amended X X and Restated Effective July 10, 2002) 10(vii) 2002 Performance Share Sub-Plan (effective July 9, 2002), X X Exhibit A to the Progress Energy, Inc. 2002 Equity Incentive Plan
(b) Reports on Form 8-K filed during or with respect to the quarter: Progress Energy, Inc. Financial Item Statements Reported Included Date of Event Date Filed 5 No August 9, 2002 August 9, 2002 9 No August 13, 2002 August 13, 2002 9 No August 29, 2002 August 29, 2002 5 Yes October 16, 2002 November 6, 2002 5 No November 7, 2002 November 7, 2002 5 No November 6, 2002 November 13, 2002 Carolina Power & Light Company Financial Item Statements Reported Included Date of Event Date Filed 9 No August 13, 2002 August 13, 2002
52 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: November 14, 2002 (Registrants) By: /s/ Peter M. Scott III Executive Vice President and Chief Financial Officer By: /s/ Robert H. Bazemore, Jr. Vice President and Controller Chief Accounting Officer 53 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, William Cavanaugh III, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Progress Energy, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 /s/ William Cavanaugh III ------------------------- William Cavanaugh III Chairman and Chief Executive Officer 54 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Peter M. Scott III, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Progress Energy, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 /s/ Peter M. Scott III ---------------------- Peter M. Scott III Executive Vice President and Chief Financial Officer 55 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, William Cavanaugh III, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Carolina Power & Light Company; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 /s/ William Cavanaugh III ------------------------- William Cavanaugh III Chairman and Chief Executive Officer 56 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Peter M. Scott III, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Carolina Power & Light Company; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 /s/ Peter M. Scott III ---------------------- Peter M. Scott III Executive Vice President and Chief Financial Officer 57