Entergy 10-K 2006
Documents found in this filing:
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the registrants are a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ____ No Ö
Indicate by check mark if the registrants are not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ____ No Ö
Indicate by check mark whether the registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. Yes __Ö __ No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrants' knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Securities Exchange Act of 1934.
Indicate by check mark whether any of the registrants are a shell company (as defined in Rule 12b-2 of the Act.) Yes ____ No Ö
The aggregate market value of Entergy Corporation Common Stock, $0.01 Par Value, held by non-affiliates as of the end of the second quarter of 2005, was $15.9 billion based on the reported last sale price of $75.55 per share for such stock on the New York Stock Exchange on June 30, 2005. Entergy Corporation is the sole holder of the common stock of Entergy Arkansas, Inc., Entergy Gulf States, Inc., Entergy Louisiana Holdings, Inc., Entergy Mississippi, Inc., Entergy New Orleans, Inc., and System Energy Resources, Inc. Entergy Louisiana Holdings, Inc. is the sole holder of the common membership interests in Entergy Louisiana, LLC.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement of Entergy Corporation to be filed in connection with its Annual Meeting of Stockholders, to be held May 12, 2006, are incorporated by reference into Parts I and III hereof.
TABLE OF CONTENTS
This combined Form 10-K is separately filed by Entergy Corporation, Entergy Arkansas, Inc., Entergy Gulf States, Inc., Entergy Louisiana Holdings, Inc., Entergy Louisiana, LLC, Entergy Mississippi, Inc., Entergy New Orleans, Inc., and System Energy Resources, Inc. Information contained herein relating to any individual company is filed by such company on its own behalf. Each company makes representations only as to itself and makes no other representations whatsoever as to any other company. References to Entergy Louisiana are intended to apply both to Entergy Louisiana Holdings on a consolidated basis and to Entergy Louisiana, LLC.
The report should be read in its entirety as it pertains to each respective registrant. No one section of the report deals with all aspects of the subject matter. Separate Item 6, 7, and 8 sections are provided for each registrant, except for the Notes to the financial statements. The Entergy Corporation Notes to the financial statements are separately presented, but the Notes to the financial statements for the other registrants are combined. These two sets of Notes are marked by headers. All other Items are combined for the registrants.
In this filing and from time to time, Entergy makes statements concerning its expectations, beliefs, plans, objectives, goals, strategies, and future events or performance. Such statements are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Although Entergy believes that these forward-looking statements and the underlying assumptions are reasonable, it cannot provide assurance that they will prove correct. Except to the extent required by the federal securities laws, Entergy undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
Forward-looking statements involve a number of risks and uncertainties, and there are factors that could cause actual results to differ materially from those expressed or implied in the statements. Some of those factors (in addition to others described elsewhere in this report and in subsequent securities filings) include:
FORWARD-LOOKING INFORMATION (Concluded)
Certain abbreviations or acronyms used in the text and notes are defined below:
Entergy Corporation is an integrated energy company engaged primarily in electric power production and retail electric distribution operations. Entergy owns and operates power plants with approximately 30,000 MW of electric generating capacity, and it is the second-largest nuclear power generator in the United States. Entergy delivers electricity to 2.6 million utility customers in Arkansas, Louisiana, Mississippi, and Texas. Entergy generated annual revenues of $10.1 billion in 2005 and had approximately 14,100 employees as of December 31, 2005.
Entergy operates primarily through two business segments: U.S. Utility and Non-Utility Nuclear.
In addition to its two primary, reportable, operating segments, Entergy also operates the Energy Commodity Services segment and the Competitive Retail Services business. Energy Commodity Services includes (i) Entergy-Koch, LP and (ii) Entergy's non-nuclear wholesale power marketing business. Entergy Koch is a non-operating entity, which prior to the fourth quarter of 2004, owned and operated an energy marketing/trading and gas transportation/storage business. The Competitive Retail Services business markets and sells electricity, thermal energy, and related services in competitive markets, primarily in the ERCOT region in Texas. Entergy has decided to divest the retail electric portion of the Competitive Retail Services business operating in the ERCOT region of Texas, and now reports this portion of the business as a discontinued operation. Entergy reports Energy Commodity Services and Competitive Retail Services as part of All Other in its segment disclosures.
The following shows the principal subsidiaries and affiliates within Entergy's business segments. Companies that file reports and other information with the SEC under the Securities Exchange Act of 1934 are identified in bold-faced type.
Entergy aspires to achieve industry-leading total shareholder returns by leveraging the scale and expertise inherent in its core nuclear and utility operations. Entergy's scope includes electricity generation, transmission and distribution as well as natural gas transportation and distribution. Entergy focuses on operational excellence with an emphasis on safety, reliability, customer service, sustainability, cost efficiency, and risk management. Entergy also focuses on portfolio management to make periodic buy, build, hold, or sell decisions based upon its analytically-derived points of view which are continuously updated as market conditions evolve.
Availability of SEC filings and other information on Entergy's website
Entergy's annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments are available without charge on its website, http://www.shareholder.com/entergy/edgar.cfm, as soon as reasonably practicable after they are filed electronically with the SEC. Entergy is providing the address to its Internet site solely for the information of investors. Entergy does not intend the address to be an active link or to otherwise incorporate the contents of the website into this report.
Part I, Item 1 is continued on page 111.
ENTERGY CORPORATION AND SUBSIDIARIES
REPORT OF MANAGEMENT
Management of Entergy Corporation and its subsidiaries has prepared and is responsible for the financial statements and related financial information included in this document. To meet this responsibility, management establishes and maintains a system of internal control designed to provide reasonable assurance regarding the preparation and fair presentation of financial statements in accordance with generally accepted accounting principles. This system includes communication through written policies and procedures, an employee Code of Entegrity, and an organizational structure that provides for appropriate division of responsibility and the training of personnel. This system is also tested by a comprehensive internal audit program.
Entergy management assesses the effectiveness of its internal control over financial reporting on an annual basis. In making this assessment, management uses the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Management acknowledges, however, that all internal control systems, no matter how well designed, have inherent limitations and can provide only reasonable assurance with respect to financial statement preparation and presentation.
As a supplement to management's assessment, Entergy's independent auditors conduct an objective assessment of the degree to which management meets its responsibility for fairness of financial reporting and issue an attestation report on the adequacy of management's assessment. They evaluate Entergy's internal control over financial reporting and perform such tests and other procedures as they deem necessary to reach and express an opinion on the fairness of the financial statements.
In addition, the Audit Committee of the Board of Directors, composed solely of independent Directors, meets with the independent auditors, internal auditors, management, and internal accountants periodically to discuss internal controls, and auditing and financial reporting matters. The Audit Committee appoints the independent auditors annually, seeks shareholder ratification of the appointment, and reviews with the independent auditors the scope and results of the audit effort. The Committee also meets periodically with the independent auditors and the chief internal auditor without management present, providing free access to the Committee.
Based on management's assessment of internal controls using the COSO criteria, management believes that Entergy maintained effective internal control over financial reporting as of December 31, 2005. Management further believes that this assessment, combined with the policies and procedures noted above provide reasonable assurance that Entergy's financial statements are fairly and accurately presented in accordance with generally accepted accounting principles.
ENTERGY CORPORATION AND SUBSIDIARIES
MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS
Entergy operates primarily through two business segments: U.S. Utility and Non-Utility Nuclear.
In addition to its two primary, reportable, operating segments, Entergy also operates the Energy Commodity Services segment and the Competitive Retail Services business. Energy Commodity Services includes Entergy-Koch, LP and Entergy's non-nuclear wholesale assets business. Entergy-Koch, LP engaged in two major businesses: energy commodity marketing and trading through Entergy-Koch Trading, and gas transportation and storage through Gulf South Pipeline. Entergy-Koch sold both of these businesses in the fourth quarter of 2004, and Entergy-Koch is no longer an operating entity. The non-nuclear wholesale assets business sells to wholesale customers the electric power produced by power plants that it owns while it focuses on improving performance and exploring sales or restructuring opportunities for its power plants. Such opportunities are evaluated consistent with Entergy's market-based point-of-view. The Competitive Retail Services business markets and sells electricity, thermal energy, and related services in competitive markets, primarily in the ERCOT region in Texas. Entergy has decided to divest the retail electric portion of the Competitive Retail Services business operating in the ERCOT region of Texas, and now reports this portion of the business as a discontinued operation. Entergy reports Energy Commodity Services and Competitive Retail Services as part of All Other in its segment disclosures.
Following are the percentages of Entergy's consolidated revenues and net income generated by its operating segments and the percentage of total assets held by them:
In August and September 2005, Hurricanes Katrina and Rita caused catastrophic damage to large portions of the U.S. Utility's service territory in Louisiana, Mississippi, and Texas, including the effect of extensive flooding that resulted from levee breaks in and around the greater New Orleans area. The storms and flooding resulted in widespread power outages, significant damage to electric distribution, transmission, and generation and gas infrastructure, and the loss of sales and customers due to mandatory evacuations and the destruction of homes and businesses. Total restoration costs for the repair and/or replacement of the U.S. Utility's electric and gas facilities damaged by Hurricanes Katrina and Rita and business continuity costs are estimated to be $1.5 billion, including $835.2 million in construction expenditures and $664.8 million recorded as regulatory assets. The cost estimates do not include other potential incremental losses, such as the inability to recover fixed costs scheduled for recovery through base rates, which base rate revenue was not recovered due to a loss of anticipated sales. For instance, at Entergy New Orleans, the domestic utility company that continues to have significant lost revenue caused by Hurricane Katrina, Entergy estimates that lost net revenue due to Hurricane Katrina will total approximately $320 million through 2007. In addition, Entergy estimates that the hurricanes caused $32 million of uncollectible U.S. Utility customer receivables.
The estimated storm restoration costs also do not include the longer-term accelerated replacement of the gas distribution system in New Orleans that Entergy New Orleans expects will be necessary due to the massive salt water intrusion into the system caused by the flooding in New Orleans. The salt water intrusion is expected to shorten the life of the gas distribution system, making it necessary to replace that system over time. Entergy New Orleans currently expects the cost of the gas system replacement to be $355 million, with the project beginning in 2008 and extending for many years thereafter.
Entergy has recorded accruals for the portion of the estimated $1.5 billion of storm restoration costs not yet paid. In accordance with its accounting policies, and based on historic treatment of such costs in the U.S. Utility's service territories and communications with local regulators, Entergy recorded assets because management believes that recovery of these prudently incurred costs through some form of regulatory mechanism is probable. In December 2005, Entergy Gulf States' Louisiana jurisdiction, Entergy Louisiana, and Entergy Mississippi filed with their respective retail regulators for recovery of storm restoration costs. The filings are discussed in Note 2 to the consolidated financial statements. Because Entergy has not gone through the regulatory process regarding these storm costs, however, there is an element of risk, and Entergy is unable to predict with certainty the degree of success it may have in its recovery initiatives, the amount of restoration costs and incremental losses it may ultimately recover, or the timing of such recovery.
The temporary power outages associated with the hurricanes in the affected service territory caused Entergy Louisiana's and Entergy New Orleans' sales volume and receivable collections to be lower than normal beginning in September 2005. Revenues are expected to continue to be affected for a period of time that cannot be estimated as a result of customers at Entergy New Orleans and Entergy Louisiana that are unable to accept electric and gas service and as a result of changes in load patterns that could occur, including the effect of residential customers who can accept electric and gas service not permanently returning to their homes. Restoration for many of the customers who are unable to accept service will follow major repairs or reconstruction of customer facilities, and will be contingent on validation by local authorities of habitability and electrical safety of customers' structures. Entergy estimates that lost non-fuel revenues in 2006 caused by the hurricanes will be approximately $123 million for Entergy New Orleans and $39 million for Entergy Louisiana. Entergy's estimate of the revenue impact is subject to change, however, because of a range of uncertainties, in particular the timing of when individual customers will recommence taking service.
Entergy is pursuing a broad range of initiatives to recover storm restoration and business continuity costs and incremental losses. Initiatives include obtaining reimbursement of certain costs covered by insurance, obtaining assistance through federal legislation for damage caused by Hurricanes Katrina and Rita, and, as noted above, pursuing recovery through existing or new rate mechanisms regulated by the FERC and local regulatory bodies.
Entergy's non-nuclear property insurance program provides coverage up to $400 million on an Entergy system-wide basis, subject to a $20 million per occurrence self-insured retention, for all risks coverage for direct physical loss or damage, including boiler and machinery breakdown. Covered property generally includes power plants, substations, facilities, inventories, and gas distribution-related properties. Excluded property generally includes above-ground transmission and distribution lines, poles, and towers. The primary property program (excess of the deductible) is placed through Oil Insurance Limited ($250 million layer) with the excess program ($150 million layer) placed on a quota share basis through Underwriters at Lloyds (50%) and Hartford Steam Boiler Inspection and Insurance Company (50%). Coverage is in place for Entergy Corporation, Entergy Arkansas, Entergy Gulf States, Entergy Louisiana, Entergy Mississippi, and Entergy New Orleans. There is an aggregation limit of $1 billion for all parties insured by OIL for any one occurrence, and Entergy has been notified by OIL that it expects claims for Hurricane Katrina to materially exceed this limit. Entergy is currently evaluating the amount of the covered losses for each of the affected domestic utility companies, working with insurance adjusters, and preparing proofs of loss for Hurricanes Katrina and Rita. Entergy currently estimates that its net insurance recoveries for the losses caused by the hurricanes, including the effect of the OIL aggregation limit being exceeded, will be approximately $382 million.
In December 2005, the U.S. Congress passed and the President signed the Katrina Relief Bill, a hurricane aid package that includes $11.5 billion in Community Development Block Grants (for the states affected by Hurricanes Katrina, Rita, and Wilma) that allows state and local leaders to fund individual recovery priorities. The bill includes language that permits funding for infrastructure restoration. It is uncertain how much funding, if any, will be designated for utility reconstruction, and the timing of such decisions is also uncertain. Entergy is currently preparing applications to seek Community Development Block Grant funding.
Entergy New Orleans Bankruptcy
Because of the effects of Hurricane Katrina, on September 23, 2005, Entergy New Orleans filed a voluntary petition in the United States Bankruptcy Court for the Eastern District of Louisiana seeking reorganization relief under the provisions of Chapter 11 of the United States Bankruptcy Code (Case No. 05-17697). Entergy Corporation owns 100 percent of the common stock of Entergy New Orleans, has continued to supply general and administrative services, and has provided debtor-in-possession financing to Entergy New Orleans. Uncertainties surrounding the nature, timing, and specifics of the bankruptcy proceedings, however, have caused Entergy to deconsolidate Entergy New Orleans and reflect Entergy New Orleans' financial results under the equity method of accounting retroactive to January 1, 2005. Because Entergy owns all of the common stock of Entergy New Orleans, this change did not affect the amount of net income Entergy records resulting from Entergy New Orleans' operations for any current or prior period, but did result in Entergy New Orleans' net income for 2005 being presented as "Equity in earnings (loss) of unconsolidated equity affiliates" rather than its results being included in each individual income statement line item, as is the case for periods prior to 2005. Entergy reviewed the carrying value of its equity investment in Entergy New Orleans ($149.9 million as of December 31, 2005) to determine if an impairment had occurred as a result of the storm, the flood, the power outages, restoration costs, and changes in customer load. Entergy determined that as of December 31, 2005, no impairment had occurred because, as discussed above, management believes that recovery is probable. In addition to Entergy's equity investment in Entergy New Orleans, as of December 31, 2005 Entergy New Orleans owed Entergy and its subsidiaries a total of approximately $47 million in prepetition accounts payable. Entergy will continue to assess the carrying value of its investment in Entergy New Orleans as developments occur in Entergy New Orleans' recovery efforts.
Entergy continues to work with the federal, state, and local authorities to resolve the bankruptcy in a manner that allows Entergy New Orleans' customers to be served by a financially viable entity as required by law. Key factors that will influence the timing and outcome of the Entergy New Orleans bankruptcy include:
The exclusivity period for filing a final plan of reorganization by Entergy New Orleans is currently scheduled to end on April 21, 2006, with solicitation of acceptances of the plan scheduled to be complete by June 20, 2006. If a party to the bankruptcy proceeding, including Entergy New Orleans, requests it, the bankruptcy court has the authority to extend these deadlines. In addition, the bankruptcy judge has set a date of April 19, 2006 by which creditors with prepetition claims against Entergy New Orleans must, with certain exceptions, file their proofs of claim in the bankruptcy case.
The deconsolidation of Entergy New Orleans is retroactive to January 1, 2005, and its 2005 results of operations are presented as a component of "Equity in earnings (loss) of unconsolidated equity affiliates." Transactions in 2005 between Entergy New Orleans and other Entergy subsidiaries are not eliminated in consolidation as they were in periods prior to 2005. The variance explanations for 2005 compared to 2004 in "Results of Operations" below reflect the 2004 results of operations of Entergy New Orleans as if it were deconsolidated in 2004, consistent with the 2005 presentation as "Equity in earnings (loss) of unconsolidated equity affiliates." The variance explanations for 2004 compared to 2003 are based on as reported amounts. Entergy's as reported consolidated results for 2004 and the amounts included in those consolidated results for Entergy New Orleans, which exclude inter-company items, are set forth in the table below.
Results of Operations
Earnings applicable to common stock for the years ended December 31, 2005, 2004, and 2003 by operating segment are as follows:
Following is a discussion of Entergy's income before taxes according to the business segments listed above. Earnings for 2005 were negatively affected by $44.8 million net-of-tax of discontinued operations due to the planned sale of the retail electric portion of Entergy's Competitive Retail Services business operating in the ERCOT region of Texas. This amount includes a net charge of $25.8 million, net-of-tax, related to the impairment reserve for the remaining net book value of the Competitive Retail Services business' information technology systems.
Earnings for 2004 include a $97 million tax benefit that resulted from the sale of preferred stock and less than 1% of the common stock in a subsidiary in the non-nuclear wholesale assets business; and a $36 million net-of-tax impairment charge in the non-nuclear wholesale assets business, both of which are discussed below.
Earnings for 2003 include the $137.1 million net-of-tax cumulative effect of changes in accounting principle that increased earnings in the first quarter of 2003, almost entirely resulting from the implementation of SFAS 143. Earnings were negatively affected in the fourth quarter of 2003 by voluntary severance program expenses of $122.8 million net-of-tax. As part of an initiative to achieve productivity improvements with a goal of reducing costs, primarily in the Non-Utility Nuclear and U.S. Utility businesses, in the second half of 2003 Entergy offered a voluntary severance program to employees in various departments. Approximately 1,100 employees, including 650 employees in nuclear operations from the Non-Utility Nuclear and U.S. Utility businesses, accepted the offers.
Refer to "SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON OF ENTERGY CORPORATION AND SUBSIDIARIES" which accompanies Entergy Corporation's consolidated financial statements in this report for further information with respect to operating statistics.
The increase in earnings for the U.S. Utility from $643 million in 2004 to $660 million in 2005 was primarily due to higher net revenue and lower depreciation and amortization expenses, partially offset by lower other income, including equity in earnings of unconsolidated equity affiliates related to Entergy New Orleans, and higher taxes other than income taxes.
The increase in earnings for the U.S. Utility from $469 million in 2003 to $643 million in 2004 was primarily due to the following:
Net revenue, which is Entergy's measure of gross margin, consists of operating revenues net of: 1) fuel, fuel-related expenses and gas purchased for resale, 2) purchased power expenses, and 3) other regulatory credits. Following is an analysis of the change in net revenue comparing 2005 to 2004.
The price applied to unbilled sales variance resulted primarily from an increase in the fuel cost component included in the price applied to unbilled sales. The increase in the fuel cost component is attributable to an increase in the market prices of natural gas and purchased power. See "Critical Accounting Estimates - Unbilled Revenue" and Note 1 to the consolidated financial statements for further discussion of the accounting for unbilled revenues.
The rate refund provisions variance is due primarily to accruals recorded in 2004 for potential rate action at Entergy Gulf States and Entergy Louisiana.
The volume/weather variance includes the effect of more favorable weather in 2005 compared to 2004 substantially offset by a decrease in weather-adjusted usage due to the effects of Hurricanes Katrina and Rita and a decrease in usage during the unbilled sales period. See "Critical Accounting Estimates - Unbilled Revenue" and Note 1 to the consolidated financial statements for further discussion of the accounting for unbilled revenues.
The 2004 deferrals variance is due to the deferrals related to Entergy's voluntary severance program, in accordance with a stipulation with the LPSC staff. The deferrals are being amortized over a four-year period effective January 2004.
Gross operating revenues, fuel and purchased power expenses, and other regulatory credits
Gross operating revenues include an increase in fuel cost recovery revenues of $586.3 million resulting from increases in the market prices of purchased power and natural gas. As such, this revenue increase is offset by increased fuel and purchased power expenses. The price applied to unbilled sales and the rate refund provisions variances, discussed above, and an increase in gross wholesale revenue also contributed to the increase in gross operating revenues. Gross wholesale revenues increased $84.2 million primarily due to an increase in the average price of energy available for resale.
Other regulatory charges (credits) have no material effect on net income due to recovery and/or refund of such expenses. Other regulatory credits decreased primarily due to the following:
The decrease is partially offset by $24.8 million of higher deferrals of capacity charges that are not currently recovered through base rates but are expected to be recovered in the future. See Note 2 to the consolidated financial statements for a discussion of the formula rate plan filings that will be effective in 2006 for the 2005 test year for Entergy Louisiana and the Louisiana jurisdiction of Entergy Gulf States.
2004 Compared to 2003
Net revenue, which is Entergy's measure of gross margin, consists of operating revenues net of: 1) fuel, fuel-related expenses and gas purchased for resale, 2) purchased power expenses, and 3) other regulatory credits. Following is an analysis of the change in net revenue comparing 2004 to 2003.
The volume/weather variance resulted primarily from increased usage, partially offset by the effect of milder weather on sales during 2004 compared to 2003. Billed usage increased a total of 2,261 GWh in the industrial and commercial sectors.
The summer capacity charges variance was due to the amortization in 2003 at Entergy Gulf States and Entergy Louisiana of deferred capacity charges for the summer of 2001. Entergy Gulf States' amortization began in June 2002 and ended in May 2003. Entergy Louisiana's amortization began in August 2002 and ended in July 2003.
Base rates increased net revenue due to a base rate increase at Entergy New Orleans that became effective in June 2003.
The deferred fuel cost revisions variance resulted primarily from a revision in 2003 to an unbilled sales pricing estimate to more closely align the fuel component of that pricing with expected recoverable fuel costs at Entergy Louisiana. Deferred fuel cost revisions also decreased net revenue due to a revision in 2004 to the estimate of fuel costs filed for recovery at Entergy Arkansas in the March 2004 energy cost recovery rider.
The price applied to unbilled sales variance resulted from a decrease in fuel price in 2004 caused primarily by the effect of nuclear plant outages in 2003 on average fuel costs. See "Critical Accounting Estimates - Unbilled Revenue" and Note 1 to the consolidated financial statements for further discussion of the accounting for unbilled revenues.
Gross operating revenues, fuel and purchased power expenses, and other regulatory credits
Gross operating revenues include an increase in fuel cost recovery revenues of $475 million and $18 million in electric and gas sales, respectively, primarily due to higher fuel rates in 2004 resulting from increases in the market prices of purchased power and natural gas. As such, this revenue increase is offset by increased fuel and purchased power expenses.
Other regulatory charges (credits) have no material effect on net income due to recovery and/or refund of such expenses. Other regulatory credits increased primarily due to the following:
Other Income Statement Variances
2005 Compared to 2004
Other operation and maintenance expenses increased slightly from $1.467 billion in 2004 to $1.471 billion in 2005. The variance includes the following:
Taxes other than income taxes increased from $300.7 million in 2004 to $321.9 million in 2005 primarily due to higher employment taxes and higher assessed values for ad valorem tax purposes in 2005.
Depreciation and amortization expenses decreased from $794.1 million in 2004 to $783.8 million in 2005 primarily due to a change in the depreciation rate for Waterford 3 as approved by the LPSC effective April 2005.
Other income decreased from $134 million in 2004 to $111.2 million in 2005 primarily due to:
The decrease was partially offset by an increase of $35.3 million in interest and dividend income due to both the proceeds from the radwaste settlement, which is discussed further in "Significant Factors and Known Trends - Central States Compact Claim," and increased interest on temporary cash investments.
2004 Compared to 2003
Other operation and maintenance expenses decreased from $1.613 billion in 2003 to $1.569 billion in 2004 primarily due to voluntary severance program accruals of $99.8 million in 2003 partially offset by an increase of $30.5 million as a result of higher customer service support costs in 2004 and an increase of approximately $33 million as a result of higher benefits costs in 2004. See "Critical Accounting Estimates - Pension and Other Retirement Benefits" and Note 10 to the consolidated financial statements for further discussion of benefit costs.
Depreciation and amortization expenses increased from $797.6 million in 2003 to $823.7 million in 2004 primarily due to higher depreciation of Grand Gulf due to a higher scheduled sale-leaseback principal payment in addition to an increase in plant in service.
Other income (deductions) changed from ($36.0 million) in 2003 to $108.9 million in 2004 primarily due to the following:
Interest on long-term debt decreased from $433.5 million in 2003 to $390.7 million in 2004 primarily due to the net retirement and refinancing of long-term debt in 2003 and the first six months of 2004. See Note 5 to the consolidated financial statements for details on long-term debt.
Following are key performance measures for Non-Utility Nuclear:
2005 Compared to 2004
The increase in earnings for Non-Utility Nuclear from $245 million in 2004 to $282.6 million in 2005 was primarily due to the following:
The increase in earnings was partially offset by the following:
2004 Compared to 2003
The decrease in earnings for Non-Utility Nuclear from $300.8 million in 2003 to $245 million in 2004 was primarily due to the $154.5 million net-of-tax cumulative effect of a change in accounting principle that increased earnings in the first quarter of 2003 upon implementation of SFAS 143. See "Critical Accounting Estimates - Nuclear Decommissioning Costs" below for discussion of the implementation of SFAS 143. Earnings before the cumulative effect of accounting change increased by $98.7 million primarily due to the following:
Partially offsetting this increase were the following:
PARENT COMPANY & OTHER BUSINESS SEGMENTS
Sales of Entergy-Koch Businesses
In the fourth quarter of 2004, Entergy-Koch sold its energy trading and pipeline businesses to third parties. Entergy-Koch will continue in existence pending final receipt of the purchase price. In 2004, Entergy received $862 million of the sales proceeds in the form of a cash distribution by Entergy-Koch. Entergy ultimately expects to receive total net cash distributions exceeding $1 billion. Entergy expects to record an approximate $60 million net-of-tax gain when the remainder of the proceeds are received in 2006.
Entergy Corporation has guaranteed up to 50% of Entergy-Koch's indemnification obligations to the purchasers. However, Entergy does not expect any material claims under these indemnification obligations.
Results of Operations
2005 Compared to 2004
The decrease in earnings for Parent Company & Other Business Segments from $21.1 million in earnings to a $44.1 million loss was primarily due to the following:
These decreases were partially offset by the following:
2004 Compared to 2003
The decrease in earnings for Parent Company & Other Business Segments from $157.1 million to $21.1 million was primarily due to:
Partially offsetting the decrease in earnings was the following:
The effective income tax rates for 2005, 2004, and 2003 were 36.7%, 28.2%, and 37.9%, respectively. See Note 3 to the consolidated financial statements for a reconciliation of the federal statutory rate of 35.0% to the effective income tax rates. The lower effective income tax rate in 2004 is primarily due to the tax benefits resulting from the Entergy Asset Management stock sale discussed above.
Liquidity and Capital Resources
This section discusses Entergy's capital structure, capital spending plans and other uses of capital, sources of capital, and the cash flow activity presented in the cash flow statement.
Liquidity Effects of Hurricane Katrina and Hurricane Rita
As discussed above, Hurricanes Katrina and Rita impacted Entergy's service territory. In addition to the direct costs caused by the storms, Hurricanes Katrina and Rita have had other impacts that have affected the U.S. Utility's liquidity position. The Entergy New Orleans bankruptcy caused fuel and power suppliers to increase their scrutiny of the remaining domestic utility companies with the concern that one of them could suffer similar impacts, particularly after Hurricane Rita. As a result, some suppliers began requiring accelerated payments and decreased credit lines. In addition, the hurricanes damaged certain gas supply lines, thereby decreasing the number of potential suppliers. The hurricanes also exacerbated a market run-up in natural gas and power prices, thereby increasing the U.S. Utility's ongoing costs, which consumed available credit lines more quickly and in some instances required the posting of additional collateral. The U.S. Utility managed through these events thus far, adequately supplied the Entergy System with fuel and power, and as a result of steps taken by it regarding its storm costs expects to have adequate liquidity and credit to continue supplying the Entergy System with fuel and power. The Non-Utility Nuclear business also has had to post increased collateral (principally in the form of Entergy Corporation guarantees) due to rising fuel and power prices, and it has had adequate liquidity to meet that demand.
After the hurricanes, Entergy implemented a new financing plan that sourced $2.5 billion through a combination of debt and equity units intended to provide adequate liquidity and capital resources to Entergy and its subsidiaries while storm restoration cost recovery is pursued. In addition, the plan is intended to provide adequate liquidity and capital resources to support Non-Utility Nuclear and the Competitive Retail Services business. The plan, which Entergy accomplished primarily in the fourth quarter 2005, included 1) increasing Entergy's credit revolver capacity by establishing a new $1.5 billion Entergy Corporation facility; 2) issuing $0.5 billion of equity units; 3) issuing approximately $0.5 billion of new debt at various utility operating companies; and 4) providing capital in the amount of $300 million from Entergy Corporation to Entergy Gulf States.
Debtor-in-Possession Credit Agreement
On September 26, 2005, Entergy New Orleans, as borrower, and Entergy Corporation, as lender, entered into the Debtor-in-Possession (DIP) credit agreement, a debtor-in-possession credit facility to provide funding to Entergy New Orleans during its business restoration efforts. On December 9, 2005, the bankruptcy court issued its final order approving the DIP Credit Agreement. The indenture trustee of Entergy New Orleans' first mortgage bonds appealed the final order, and that appeal is pending. Subsequent to the indenture trustee filing its notice of appeal, Entergy New Orleans, Entergy Corporation, and the indenture trustee filed with the bankruptcy court a motion to approve a settlement among the parties. The settlement would result in the dismissal of the indenture trustee's appeal. The settlement is set for hearing in the bankruptcy court on March 22, 2006.
The credit facility provides for up to $200 million in loans. These funds were requested to enable Entergy New Orleans to meet its liquidity needs, including employee wages and benefits and payments under power purchase and gas supply agreements, and to continue its efforts to repair and restore the facilities needed to serve its electric and gas customers. The facility enables Entergy New Orleans to request funding from Entergy Corporation, but the decision to lend money is at the sole discretion of Entergy Corporation. As of December 31, 2005, Entergy New Orleans had $90 million of outstanding borrowings under the DIP credit agreement. Management currently expects the bankruptcy court-authorized funding level to be sufficient to fund Entergy New Orleans' expected level of operations through 2006.
Borrowings under the DIP credit agreement are due in full, and the agreement will terminate, at the earliest of (i) August 23, 2006, or such later date as Entergy Corporation shall agree to in its sole discretion, (ii) the acceleration of the loans and the termination of the DIP credit agreement in accordance with its terms, (iii) the date of the closing of a sale of all or substantially all of Entergy New Orleans' assets pursuant to section 363 of the United States Bankruptcy Code or a confirmed plan of reorganization, or (iv) the effective date of a plan of reorganization in Entergy New Orleans' bankruptcy case.
As security for Entergy Corporation as the lender, the terms of the December 9, 2005 bankruptcy court order provide that all borrowings by Entergy New Orleans under the DIP Credit Agreement are: (i) entitled to superpriority administrative claim status pursuant to section 364(c)(1) of the Bankruptcy Code; (ii) secured by a perfected first priority lien on all property of Entergy New Orleans pursuant to sections 364(c)(2) and 364(d) of the Bankruptcy Code, except on any property of Entergy New Orleans subject to valid, perfected, and non-avoidable liens of the lender on Entergy New Orleans' $15 million credit facility; and (iii) secured by a perfected junior lien pursuant to section 364(c)(3) of the Bankruptcy Code on all property of Entergy New Orleans subject to valid, perfected, and non-avoidable liens in favor of the lender on Entergy New Orleans' $15 million credit facility that existed as of the date Entergy New Orleans filed its bankruptcy petition.
The interest rate on borrowings under the DIP credit agreement will be the average interest rate of borrowings outstanding under Entergy Corporation's $2 billion revolving credit facility, which was approximately 4.7% per annum at December 31, 2005.
Entergy's capitalization is balanced between equity and debt, as shown in the following table. The increase in the debt to capital percentage from 2004 to 2005 is the result of increased debt outstanding due to additional borrowings on Entergy Corporation's $2 billion revolving credit facility, additional debt issuances, including Entergy Corporation's equity units issuance, along with a decrease in shareholders' equity, primarily due to repurchases of common stock.
Net debt consists of debt less cash and cash equivalents. Debt consists of notes payable, capital lease obligations, preferred stock with sinking fund, and long-term debt, including the currently maturing portion. Capital consists of debt, shareholders' equity, and preferred stock without sinking fund. Net capital consists of capital less cash and cash equivalents. Entergy uses the net debt to net capital ratio in analyzing its financial condition and believes it provides useful information to its investors and creditors in evaluating Entergy's financial condition.
Long-term debt, including the currently maturing portion, makes up substantially all of Entergy's total debt outstanding. Following are Entergy's long-term debt principal maturities as of December 31, 2005 by operating segment. The figures below include principal payments on the Entergy Louisiana and System Energy sale-leaseback transactions, which are included in long-term debt on the balance sheet.
Note 5 to the consolidated financial statements provides more detail concerning long-term debt.
In May 2005, Entergy Corporation terminated its two separate, revolving credit facilities, a $500 million five-year credit facility and a $965 million three-year credit facility. At that time, Entergy Corporation entered into a $2 billion five-year revolving credit facility, which expires in May 2010. As of December 31, 2005, $785 million in borrowings were outstanding on this facility.
In December 2005, Entergy Corporation entered into a $1.5 billion three-year revolving credit facility, which expires in December 2008. As of December 31, 2005, no borrowings were outstanding on this facility.
Entergy also has the ability to issue letters of credit against the total borrowing capacity of both the three-year and the five-year credit facilities, and $239.5 million of letters of credit had been issued against the five-year facility at December 31, 2005.
Following is a summary of the borrowings outstanding and capacity available under these facilities as of December 31, 2005.
Entergy Corporation's credit facilities require it to maintain a consolidated debt ratio of 65% or less of its total capitalization. If Entergy fails to meet this debt ratio, or if Entergy or the domestic utility companies (other than Entergy New Orleans) default on other indebtedness or are in bankruptcy or insolvency proceedings, an acceleration of the credit facilities' maturity dates may occur.
Capital lease obligations, including nuclear fuel leases, are a minimal part of Entergy's overall capital structure, and are discussed further in Note 9 to the consolidated financial statements. Following are Entergy's payment obligations under those leases:
Notes payable includes borrowings outstanding on credit facilities with original maturities of less than one year. Entergy Arkansas, Entergy Louisiana, and Entergy Mississippi each have 364-day credit facilities available as follows:
Operating Lease Obligations and Guarantees of Unconsolidated Obligations
Entergy has a minimal amount of operating lease obligations and guarantees in support of unconsolidated obligations. Entergy's guarantees in support of unconsolidated obligations are not likely to have a material effect on Entergy's financial condition or results of operations. Following are Entergy's payment obligations as of December 31, 2005 on non-cancelable operating leases with a term over one year:
The operating leases are discussed more thoroughly in Note 9 to the consolidated financial statements.
Summary of Contractual Obligations of Consolidated Entities
In addition to these contractual obligations, Entergy expects to contribute $349 million to its pension plans and $60 million to other postretirement plans in 2006. $109 million of the pension plan contribution was made in January 2006. $107 million of this contribution was originally planned for 2005; however, it was delayed as a result of the Katrina Emergency Tax Relief Act.
Capital Funds Agreement
Pursuant to an agreement with certain creditors, Entergy Corporation has agreed to supply System Energy with sufficient capital to:
Capital Expenditure Plans and Other Uses of Capital
Following are the amounts of Entergy's planned construction and other capital investments by operating segment for 2006 through 2008, excluding Entergy New Orleans:
In addition to the planned spending in the table above, the U.S. Utility, excluding Entergy New Orleans, also expects to pay for $310 million of capital investments in 2006 related to Hurricane Katrina and Rita restoration work that have been accrued as of December 31, 2005.Entergy New Orleans' planned capital expenditures for the years 2006-2008 total $93 million, and Entergy New Orleans expects to pay for $46 million of capital investments in 2006 related to Hurricane Katrina and Rita restoration work that have been accrued as of December 31, 2005.
Maintenance Capital refers to amounts Entergy plans to spend on routine capital projects that are necessary to support reliability of its service, equipment, or systems and to support normal customer growth.
Capital Commitments refers to non-routine capital investments for which Entergy is either contractually obligated, has Board approval, or is otherwise required to make pursuant to a regulatory agreement or existing rule or law. Amounts reflected in this category include the following:
From time to time, Entergy considers other capital investments as potentially being necessary or desirable in the future, including additional nuclear plant power uprates, generation supply assets, various transmission upgrades, environmental compliance expenditures, or investments in new businesses or assets. Because no contractual obligation, commitment, or Boardapproval exists to pursue these investments, they are not included in Entergy's planned construction and capital investments. These potential investments are also subject to evaluation and approval in accordance with Entergy's policies before amounts may be spent. In addition, Entergy's capital spending plans do not include spending for transmission upgrades requested by merchant generators, other than projects currently underway.
Estimated capital expenditures are subject to periodic review and modification and may vary based on the ongoing effects of business restructuring, regulatory constraints, environmental regulations, business opportunities, market volatility, economic trends, and the ability to access capital.
Dividends and Stock Repurchases
Declarations of dividends on Entergy's common stock are made at the discretion of the Board. Among other things, the Board evaluates the level of Entergy's common stock dividends based upon Entergy's earnings, financial strength, and future investment opportunities. At its January 2006 meeting, the Board declared a dividend of $0.54 per share. In 2005, Entergy paid approximately $453.5 million in cash dividends on its common stock.
In accordance with Entergy's stock-based compensation plan, Entergy periodically grants stock options to its employees, which may be exercised to obtain shares of Entergy's common stock. According to the plan, these shares can be newly issued shares, treasury stock, or shares purchased on the open market. Entergy's management has been authorized by the Board to repurchase on the open market shares up to an amount sufficient to fund the exercise of grants under the plans. In addition to this authority, the Board approved a program under which Entergy was authorized to repurchase up to $1.5 billion of its common stock through 2006. The amount of repurchases under the program may vary as a result of material changes in business results or capital spending, or as a result of material new investment opportunities. As a result of Hurricanes Katrina and Rita, the $1.5 billion share repurchase program was suspended, and the Board has extended authorization for completion of the plan through 2008. Entergy has $400 million of authority remaining under the $1.5 billion plan. In 2005, Entergy repurchased 12,280,500 shares of common stock under both programs for a total purchase price of $878.2 million.
Sources of Capital
Entergy's sources to meet its capital requirements and to fund potential investments include:
The majority of Entergy's internally generated funds come from the U.S. Utility. Circumstances such as weather patterns, price fluctuations, and unanticipated expenses, including unscheduled plant outages and storms, could affect the level of internally generated funds in the future. In the following section, Entergy's cash flow activity for the previous three years is discussed.
Provisions within the Articles of Incorporation or pertinent indentures and various other agreements relating to the long-term debt and preferred stock of certain of Entergy Corporation's subsidiaries restrict the payment of cash dividends or other distributions on their common and preferred stock. As of December 31, 2005, Entergy Arkansas and Entergy Mississippi had restricted retained earnings unavailable for distribution to Entergy Corporation of $396.4 million and $68.5 million, respectively. All debt and common and preferred stock issuances by the domestic utility companies and System Energy require prior regulatory approval and their preferred stock and debt issuances are also subject to issuance tests set forth in corporate charters, bond indentures, and other agreements. The domestic utility companies and System Energy have sufficient capacity under these tests to meet foreseeable capital needs.
After the repeal of PUHCA 1935, effective February 8, 2006, the FERC, under the Federal Power Act, and not the SEC, has jurisdiction over authorizing securities issuances by the domestic utility companies and System Energy (except securities with maturities longer than one year issued by (a) Entergy Arkansas which are subject to the jurisdiction of the APSC and (b) Entergy New Orleans which are currently subject to the jurisdiction of the bankruptcy court). Under PUHCA 2005 and the Federal Power Act, no approvals are necessary for Entergy Corporation to issue securities. Under a savings provision in PUHCA 2005, each of the domestic utility companies and System Energy may rely on the financing authority in its existing PUHCA 1935 SEC order or orders through December 31, 2007 or until the SEC authority is superceded by FERC authorization. The FERC has issued an order ("FERC Short-Term Order") approving the short-term borrowing limits of the domestic utility companies (except Entergy New Orleans) and System Energy through March 31, 2008. Entergy New Orleans may rely on existing SEC PUHCA 1935 orders for its short-term financing authority, subject to bankruptcy court approval. In addition to borrowings from commercial banks, the FERC Short-Term Order authorized the domestic utility companies (except Entergy New Orleans which is authorized by an SEC PUHCA 1935 order) and System Energy to continue as participants in the Entergy System money pool through February 8, 2007. Entergy Gulf States and Entergy Louisiana, LLC have obtained long-term financing authorization from the FERC. The money pool is an inter-company borrowing arrangement designed to reduce Entergy's subsidiaries' dependence on external short-term borrowings. Borrowings from the money pool and external short-term borrowings combined may not exceed authorized limits. As of December 31, 2005, Entergy's subsidiaries' aggregate money pool and external short-term borrowings authorized limit was $2.0 billion, the aggregate outstanding borrowing from the money pool was $379.7 million, and Entergy's subsidiaries' outstanding short-term borrowing from external sources was $40 million. To the extent that the domestic utility companies and System Energy wish to rely on SEC financing orders under PUHCA 1935 there are capitalization and investment grade ratings conditions that must be satisfied in connection with security issuances, other than money pool borrowings. See Note 4 to the consolidated financial statements for further discussion of Entergy's short-term borrowing limits.
Cash Flow Activity
As shown in Entergy's Statements of Cash Flows, cash flows for the years ended December 31, 2005, 2004, and 2003 were as follows:
Operating Cash Flow Activity
2005 Compared to 2004
Entergy's cash flow provided by operating activities decreased in 2005 primarily due to the following:
2004 Compared to 2003
Entergy's cash flow provided by operating activities increased in 2004 primarily due to the following:
In 2003, the domestic utility companies and System Energy filed, with the IRS, notification of a change in tax accounting method for their respective calculations of cost of goods sold. The adjustment implemented a simplified method of allocation of overhead to the production of electricity, which is provided under the IRS capitalization regulations. The cumulative adjustment placing these companies on the new methodology resulted in a $2.8 billion deduction on Entergy's 2003 income tax return. There was no tax cash benefit from the method change in 2003. In addition, on a consolidated basis, no cash tax benefit was realized in 2004 or 2005. The Internal Revenue Service has issued new proposed regulations effective in 2005 that may preclude a significant portion of the benefit of this tax accounting method change. In 2005, the domestic utility companies and System Energy filed a notice with the IRS of a new tax accounting method for their respective calculations of cost of goods sold. This new method is also subject to IRS scrutiny.
In 2005, Non-Utility Nuclear changed its method of accounting for income tax purposes related to its wholesale electric power contracts. The adjustment placing these companies on the new mark-to-market methodology is expected to result in a $3.8 billion deduction on Entergy's 2005 income tax return. The election did not reduce book income tax expense. This deduction is expected to reverse over the next four years. The timing of the reversal of this deduction depends on several variables, including the price of power. On a consolidated basis, it is estimated that there was a $7 million cash tax benefit from the method change in 2005.
In August of 2005, the Energy Policy Act of 2005 was enacted. This Act contains provisions that enable the full accumulation of nuclear decommissioning funds on a tax deductible basis, shortens the depreciation recovery period for certain transmission capital expenditures, provides a production credit for electricity generated by new nuclear plants, and expands the net operating loss carry-back period to five years for 2003, 2004, and 2005 losses to the extent of 20% of transmission capital expenditures incurred in 2005, 2006, and 2007.
In December of 2005, the Gulf Opportunity Zone Act of 2005 was enacted. The Act contains provisions that allow a public utility incurring a net operating loss as a result of Hurricane Katrina to carry back the casualty loss portion of the net operating loss ten years to offset previously taxed income. The Act also allows a five-year carry back of the portion of the net operating loss attributable to Hurricane Katrina repairs expense and first year depreciation deductions, including 50% bonus depreciation, on Hurricane Katrina capital expenditures.
Entergy expects the above provisions to generate 2006 income tax refunds of approximately $300 million, including Entergy New Orleans.
2005 Compared to 2004
Net cash used in investing activities increased in 2005 primarily due to the following activity:
Offsetting these factors was the following:
2004 Compared to 2003
Net cash used in investing activities decreased in 2004 primarily due to the following:
2005 Compared to 2004
Financing activities provided $496 million of cash in 2005 compared to using $1,672 million of cash in 2004 primarily due to the following activity:
2004 Compared to 2003
Net cash used in financing activities increased in 2004 primarily due to the following:
Offsetting the factors that caused an increase in cash used in financing activities in 2004 were the following:
Significant Factors and Known Trends
Following are discussions of significant factors and known trends affecting Entergy's business, including rate regulation and fuel-cost recovery, federal regulation, market and credit risks, and nuclear matters.
State and Local Rate Regulation and Fuel-Cost Recovery
The rates that the domestic utility companies and System Energy charge for their services are an important item influencing Entergy's financial position, results of operations, and liquidity. These companies are closely regulated and the rates charged to their customers are determined in regulatory proceedings, except for a portion of Entergy Gulf States' operations. Governmental agencies, including the APSC, the City Council, the LPSC, the MPSC, the PUCT, and the FERC, are primarily responsible for approval of the rates charged to customers. The status of material retail rate proceedings is summarized below and described in more detail in Note 2 to the consolidated financial statements.
In addition to the regulatory scrutiny connected with base rate proceedings, the domestic utility companies' fuel and purchased power costs recovered from customers are subject to regulatory scrutiny. The domestic utility companies' significant fuel and purchased power cost proceedings are described in Note 2 to the consolidated financial statements.
The FERC regulates wholesale rates (including Entergy intrasystem sales pursuant to the System Agreement) and interstate transmission of electricity, as well as rates for System Energy's sales of capacity and energy from Grand Gulf to Entergy Arkansas, Entergy Louisiana, Entergy Mississippi, and Entergy New Orleans pursuant to the Unit Power Sales Agreement.
System Agreement Proceedings
The domestic utility companies historically have engaged in the coordinated planning, construction, and operation of generating and bulk transmission facilities under the terms of the System Agreement, which is a rate schedule that has been approved by the FERC. The LPSC pursued litigation involving the System Agreement at the FERC. The proceeding includes challenges to the allocation of costs as defined by the System Agreement and raises questions of imprudence by the domestic utility companies in their execution of the System Agreement.
In June 2005, the FERC issued a decision in the System Agreement litigation, and essentially affirmed its decision in a December 2005 order on rehearing. The FERC decision concluded, among other things, that:
The FERC's decision would reallocate total production costs of the domestic utility companies whose relative total production costs expressed as a percentage of Entergy System average production costs are outside an upper or lower bandwidth. This would be accomplished by payments from domestic utility companies whose production costs are more than 11% below Entergy System average production costs to domestic utility companies whose production costs are more than 11% above Entergy System average production costs.
An assessment of the potential effects of the FERC's decision requires assumptions regarding the future total production cost of each domestic utility company, which assumptions include the mix of solid fuel and gas-fired generation available to each company and the costs of natural gas and purchased power. Entergy Louisiana, Entergy Gulf States, and Entergy Mississippi are more dependent upon gas-fired generation sources than Entergy Arkansas or Entergy New Orleans. Of these, Entergy Arkansas is the least dependent upon gas-fired generation sources. Therefore, increases in natural gas prices likely will increase the amount by which Entergy Arkansas' total production costs are below the average total production costs of the domestic utility companies.
Considerable uncertainty exists regarding future gas prices. Annual average Henry Hub gas prices (daily midpoint prices sourced from Platts Gas Daily) have varied significantly over recent years, ranging from $2.007/mmBtu to $8.529/mmBtu for the 1996-2005 period, and averaging $4.098/mmBtu during the ten-year period 1996-2005 and $5.434/mmBtu during the five-year period 2001-2005. Recent market conditions have resulted in gas prices that averaged $8.529/mmBtu for the twelve months ended December 2005. During the twelve-month period January 1, 2005 to December 31, 2005 forward gas contracts for each of the next four years based on daily NYMEX close averaged $8.74/mmBtu (2006), $7.95/mmBtu (2007), $7.32/mmBtu (2008), and $6.83/mmBtu (2009). If, after pending appeals, the FERC's decision becomes final and if gas prices occur similar to the NYMEX average closing prices given, the following potential annual total production cost reallocations among the domestic utility companies could result:
If natural gas prices deviate by $1/mmBtu up or down from the NYMEX average closing prices given above, it is expected that Entergy Arkansas' annual payments will change in the same direction by approximately $70 to $80 million.
The LPSC, APSC, MPSC, and the AEEC have appealed the FERC decision to the Court of Appeals for the D.C. Circuit. Entergy has intervened in the LPSC appeal and intends to intervene in the other appeals. The City of New Orleans has also intervened in the LPSC appeal.
Entergy will be required to file with the FERC a compliance filing to implement the provisions of the FERC's decision. Management believes that any changes in the allocation of production costs resulting from the FERC's decision and related retail proceedings should result in similar rate changes for retail customers. The timing of recovery of these costs in rates could be the subject of additional proceedings before Entergy's retail regulators. Although the outcome and timing of the FERC and other proceedings cannot be predicted at this time, Entergy does not believe that the ultimate resolution of these proceedings will have a material effect on its financial condition or results of operations.
Citing its concerns that the benefits of its continued participation in the current form of the System Agreement have been seriously eroded, in December 2005, Entergy Arkansas submitted its notice that it will terminate its participation in the current System Agreement effective 96 months from December 19, 2005 or such earlier date as authorized by the FERC. Entergy Arkansas indicated, however, that a properly structured replacement agreement could be a viable alternative. In response to an ALJ Initial Decision in the System Agreement proceeding in 2004, the APSC had previously commenced an investigation into whether Entergy Arkansas' continued participation in the System Agreement is in the best interest of its customers, and had also commenced investigations concerning Entergy Louisiana's Vidalia purchased power contract and Entergy Louisiana's then pending acquisition of the Perryville power plant.
Independent Coordinator of Transmission
In 2000, the FERC issued an order encouraging utilities to voluntarily place their transmission facilities under the control of independent RTOs (regional transmission organizations) by December 15, 2001. Delays in implementing the FERC order have occurred due to a variety of reasons, including the fact that utility companies, other stakeholders, and federal and state regulators continue to work to resolve various issues related to the establishment of such RTOs.
In April 2004, Entergy filed a proposal with the FERC to commit voluntarily to retain an independent entity (Independent Coordinator of Transmission or ICT) to oversee the granting of transmission or interconnection service on Entergy's transmission system, to implement a transmission pricing structure that ensures that Entergy's retail native load customers are required to pay for only those upgrades necessary to reliably serve their needs, and to have the ICT serve as the security coordinator for the Entergy region. The proposal was structured to not transfer control of Entergy's transmission system to the ICT, but rather to vest with the ICT broad oversight authority over transmission planning and operations.
After additional filings and subsequent declaratory orders issued by the FERC, on May 27, 2005, the domestic utility companies filed an enhanced ICT proposal with the FERC. Entergy believes that the filing is consistent with the FERC guidance received in the FERC's declaratory orders on the ICT. Among other things, the enhanced ICT filing states that the ICT will (1) grant or deny transmission service on the domestic utility companies' transmission system; (2) administer the domestic utility companies' OASIS node for purposes of processing and evaluating transmission service requests and ensuring compliance with the domestic utility companies' obligation to post transmission-related information; (3) develop a base plan for the domestic utility companies' transmission system that will result in the ICT making the determination on whether costs of transmission upgrades should be rolled into the domestic utility companies' transmission rates or directly assigned to the customer requesting or causing an upgrade to be constructed; (4) serve as the reliability coordinator for the Entergy transmission system; and (5) oversee the operation of the weekly procurement process. The enhanced ICT proposal clarifies the rights that customers receive when they fund a supplemental upgrade and also contains a detailed methodology describing the process by which the ICT will evaluate interconnection-related investments already made on the Entergy System for purposes of determining the future allocation of the uncredited portion of these investments.
On June 3, 2005, a group of generators filed with the FERC a request that the FERC schedule a technical conference on the enhanced ICT proposal in order for Entergy to provide additional information on the enhanced ICT proposal. In response, a stakeholder meeting was held in New Orleans on June 30, 2005. Interventions, protests, and comments were filed by interested parties on August 5, 2005. Entergy filed a response to the various pleadings on August 22, 2005. Entergy anticipates receiving a FERC order on the May 27, 2005 filing during the second quarter 2006.
As discussed below in "Available Flowgate Capacity Proceedings," on October 31, 2005, the domestic utility companies notified parties to the ICT proceeding of the potential loss of historical data related to Entergy's calculation of available transfer capability for its transmission system.
In March 2004, the APSC initiated a proceeding to review Entergy's proposal and compare the benefits of such a proposal to the alternative of Entergy joining the Southwest Power Pool RTO. The APSC sought comments from all interested parties on this issue. Various parties, including the APSC General Staff, filed comments opposing the ICT proposal. A public hearing has not been scheduled by the APSC at this time, although Entergy Arkansas has responded to various APSC data requests. In May 2004, Entergy Mississippi filed a petition for review with the MPSC requesting MPSC support for the ICT proposal. A hearing in that proceeding was held in August 2004. Entergy New Orleans appeared before the Utility Committee of the City Council in June 2005 to provide information on the ICT proposal. Entergy Louisiana and Entergy Gulf States have filed an application with the LPSC requesting that the LPSC find that the ICT proposal is a prudent and appropriate course of action. A hearing in the LPSC proceeding on the ICT proposal was held in October 2005, and Entergy Louisiana and Entergy Gulf States await the ALJ's initial decision.
Market-based Rate Authority
On May 5, 2005, the FERC instituted a proceeding under Section 206 of the FPA to investigate whether Entergy satisfies the FERC's transmission market power and affiliate abuse/reciprocal dealing standards for the granting of market-based rate authority, and established a refund effective date pursuant to the provisions of Section 206, for purposes of the additional issues set for hearing. However, the FERC decided to hold that investigation in abeyance pending the outcomes of the ICT proceeding and Entergy's affiliate purchased power agreements proceeding. On June 6, 2005, Entergy sought rehearing of the May 5 Order and that request for rehearing is pending.
On July 22, 2005, Entergy notified the FERC that it was withdrawing its request for market-based rate authority for sales within its control area. Instead, the domestic utility companies and their affiliates will transact at cost-based rates for wholesale sales within the Entergy control area. On November 1, 2005, Entergy submitted proposed cost-based rates for both the domestic utility companies and Entergy's non-regulated entities that sell at wholesale within the Entergy control area. Separately, the FERC accepted for filing Entergy Gulf States' proposed cost-based rates for wholesale sales to three separate municipalities. Additionally, Entergy reserves its right to request market-based rate authority for sales within its control area in the future. The relinquishment of market-based rates for sales within the Entergy control area is not expected to have a material effect on the financial results of Entergy.
Available Flowgate Capacity Proceeding
On December 17, 2004, the FERC issued an order initiating a hearing and investigation concerning the justness and reasonableness of the Available Flowgate Capacity (AFC) methodology, the methodology used to evaluate short-term transmission service requests under the domestic utility companies' open access transmission tariff, and establishing a refund effective date. In its order, the FERC indicated that although it "appreciates that Entergy is attempting to explore ways to improve transmission access on its system," it believed that an investigation was warranted to gather more evidence in light of the concerns raised by certain transmission customers and certain issues raised in a FERC audit report finding errors and problems with the predecessor methodology used by Entergy for evaluating short-term transmission requests, the Generator Operating Limits methodology. The FERC order indicates that the investigation will include an examination of (i) Entergy's implementation of the AFC program, (ii) whether Entergy's implementation has complied with prior FERC orders and open access transmission tariff provisions addressing the AFC program, and (iii) whether Entergy's provision of access to short-term transmission on its transmission system was just, reasonable, and not unduly discriminatory.
On March 22, 2005, the FERC issued an order that holds the AFC hearing in abeyance pending action on Entergy's ICT filing. The order holding the hearing in abeyance further indicated that it would cancel the hearing when the ICT begins to perform its functions. On April 8, 2005, several intervenors filed Emergency Motions for Interim Relief and Expedited Commission Action requesting that, during the interim period before the implementation of the ICT, the FERC (1) institute an audit process to examine and modify Entergy's current AFC process; and (2) require the Southwest Power Pool (SPP) to become involved in the AFC stakeholder process and order certain modifications to Entergy's stakeholder process. The audit process being proposed by the intervenors would not involve an independent auditor, but instead would be an investigation performed by a representative from the intervenors, Entergy, and possibly SPP. On April 25, 2005, Entergy filed its response to the emergency motion urging the FERC to reject the intervenors' request for the "audit" because the type of investigation proposed by the intervenors would be neither independent nor fair and would only distract from the implementation of the ICT. Instead, Entergy has proposed that the ICT conduct an independent review of the AFC process and procedures as part of its transition to assuming the identified ICT responsibilities, including the calculation of the AFCs. Entergy subsequently retained SPP to conduct an audit of the AFC processes and procedures. The SPP released its audit report on the AFC processes in which the SPP, among other things, identified an issue concerning limited instances in which transmission service was granted when there was insufficient AFC available. In light of this, the SPP has recommended that the AFC process be further automated to ensure the correct processing of every transmission service request. Entergy has advised the FERC Staff of this issue.
On April 21, 2005, the intervenors filed a separate request for rehearing arguing that the FERC must allow the AFC hearing to proceed in parallel with the establishment of the ICT.
On October 31, 2005, the domestic utility companies notified participants in the ICT proceeding that certain historic data related to the hourly AFC models may have been inadvertently lost due to errors in the implementation of a data archiving process. The data at issue is certain hourly AFC data for the nine-month period April 27, 2004 through January 31, 2005. Although Entergy is continuing to pursue all avenues for recovery and retrieval of the historic hourly data, it is difficult to predict whether and to what extent these efforts will ultimately be successful. Since discovering the potential loss of data, the domestic utility companies have taken steps to ensure that these errors cannot recur and to ensure that the current AFC hourly data, including the hourly data from February 1, 2005 forward, is adequately protected and retained. Entergy self-reported the event to the FERC's Office of Market Oversight and Investigations and is providing information to the investigation staff concerning this event. Additionally, Entergy will request that the ICT review the current process for retaining AFC-related data as part of its independent review discussed above.
The domestic utility companies (except Entergy New Orleans) are currently defendants to several complaints and rehearing requests before the FERC in which independent generation entities (GenCos) are seeking a refund of monies that the GenCos had previously paid to the Entergy companies for facilities necessary to connect their generation facilities to Entergy's transmission system. The FERC has issued orders in response to three complaints and in certain other dockets ordering Entergy to refund approximately $123 million in expenses and tax obligations previously paid by the GenCos, including $42 million for Entergy Arkansas, $28 million for Entergy Gulf States, $24 million for Entergy Louisiana, and $29 million for Entergy Mississippi. The refunds will be in the form of transmission credits that will be utilized over time as the GenCos take transmission service from Entergy. There are other complaints that have been filed with FERC in an approximate amount of $43 million, including $27 million for Entergy Arkansas, $8 million for Entergy Gulf States, and $8 million for Entergy Louisiana, in which the FERC has not taken action.
To the extent the Entergy companies are ordered to provide such refunds, these costs will qualify for inclusion in the Entergy companies' rates. The recovery of these costs is not automatic, however, especially at the retail level, where the majority of the cost recovery would occur. Entergy intends to pursue all regulatory and legal avenues available to it in order to have these orders reversed and have the affected interconnection agreements reinstated as agreed to originally by the generators.
Energy Policy Act of 2005
The Energy Policy Act of 2005 became law in August 2005. The legislation contains electricity provisions that, among other things:
The Energy Policy Act requires several rulemakings by the FERC and other government agencies in order to implement its provisions and the FERC in its rule-makings has indicated it plans, by February 8, 2007, for further review of, and possible changes to, its implementation of PUHCA 2005 and the repeal of PUHCA 1935. Therefore, it will be a period of time before a full assessment of its effects on Entergy and the energy industry can be completed.
Market and Credit Risks
Market risk is the risk of changes in the value of commodity and financial instruments, or in future operating results or cash flows, in response to changing market conditions. Entergy is exposed to the following significant market risks:
Entergy is also exposed to credit risk. Credit risk is the risk of loss from nonperformance by suppliers, customers, or financial counterparties to a contract or agreement. Credit risk also includes potential demand on liquidity due to collateral requirements within supply or sales agreements. Where it is a significant consideration, counterparty credit risk is addressed in the discussions that follow.
Commodity Price Risk
The sale of electricity from the power generation plants owned by Entergy's Non-Utility Nuclear business and Energy Commodity Services, unless otherwise contracted, is subject to the fluctuation of market power prices. Entergy's Non-Utility Nuclear business has entered into PPAs and other contracts to sell the power produced by its power plants at prices established in the PPAs. Entergy continues to pursue opportunities to extend the existing PPAs and to enter into new PPAs with other parties. Following is a summary of the amount of the Non-Utility Nuclear business' output that is currently sold forward under physical or financial contracts:
The Vermont Yankee acquisition included a 10-year PPA under which the former owners will buy the power produced by the plant, which is through the expiration in 2012 of the current operating license for the plant. The PPA includes an adjustment clause under which the prices specified in the PPA will be adjusted downward monthly, beginning in November 2005, if power market prices drop below PPA prices.
A sale of power on a unit contingent basis coupled with an availability guarantee provides for the payment to the power purchaser of contract damages, if incurred, in the event the seller fails to deliver power as a result of the failure of the specified generation unit to generate power at or above a specified availability threshold. All of Entergy's outstanding availability guarantees provide for dollar limits on Entergy's maximum liability under such guarantees.
Non-Utility Nuclear's purchase of the Fitzpatrick and Indian Point 3 plants from NYPA included value sharing agreements with NYPA. Under the value sharing agreements, to the extent that the average annual price of the energy sales from each of the two plants exceeds specified strike prices, the Non-Utility Nuclear business will pay 50% of the amount exceeding the strike prices to NYPA. These payments, if required, will be recorded as adjustments to the purchase price of the plants. The annual energy sales subject to the value sharing agreements are limited to the lesser of actual generation or generation assuming an 85% capacity factor based on the plants' capacities at the time of the purchase. The value sharing agreements are effective through 2014. The strike prices for Fitzpatrick range from $37.51/MWh in 2005 increasing by approximately 3.5% each year to $51.30/MWh in 2014, and the strike prices for Indian Point 3 range from $42.26/MWh in 2005 increasing by approximately 3.5% each year to $57.77/MWh in 2014.
Some of the agreements to sell the power produced by Entergy's Non-Utility Nuclear power plants and the wholesale supply agreements entered into by Entergy's Competitive Retail business contain provisions that require an Entergy subsidiary to provide collateral to secure its obligations under the agreements. The Entergy subsidiary may be required to provide collateral based upon the difference between the current market and contracted power prices in the regions where the Non-Utility Nuclear and Competitive Retail businesses sell power. The primary form of the collateral to satisfy these requirements would be an Entergy Corporation guaranty. Cash and letters of credit are also acceptable forms of collateral. At December 31, 2005, based on power prices at that time, Entergy had in place as collateral $1,630 million of Entergy Corporation guarantees for wholesale transactions, $237 million of which support letters of credit. The assurance requirement associated with Non-Utility Nuclear is estimated to increase by an amount up to $400 million if gas prices increase $1 per MMBtu in both the short- and long-term markets. In the event of a decrease in Entergy Corporation's credit rating to below investment grade, Entergy may be required to replace Entergy Corporation guarantees with cash or letters of credit under some of the agreements.
In addition to selling the power produced by its plants, the Non-Utility Nuclear business sells installed capacity to load-serving distribution companies in order for those companies to meet requirements placed on them by the ISO in their area. Following is a summary of the amount of the Non-Utility Nuclear business' installed capacity that is currently sold forward, and the blended amount of the Non-Utility Nuclear business' planned generation output and installed capacity that is currently sold forward:
As of December 31, 2005, approximately 96% of Non-Utility Nuclear's counterparty exposure from energy and capacity contracts is with counterparties with investment grade credit ratings.
Following is a summary of the amount of Energy Commodity Services' output and installed capacity that is currently sold forward under physical or financial contracts at fixed prices:
Entergy continually monitors industry trends in order to determine whether asset impairments or other losses could result from a decline in value, or cancellation, of merchant power projects, and records provisions for impairments and losses accordingly. As discussed in "Results of Operations" above, in 2004 Entergy determined that the value of the Warren Power plant owned by the non-nuclear wholesale assets business was impaired, and recorded the appropriate provision for the loss.
Foreign Currency Exchange Rate Risk
Entergy Gulf States, System Fuels, and Entergy's Non-Utility Nuclear business enter into foreign currency forward contracts to hedge the Euro-denominated payments due under certain purchase contracts. The notional amounts of the foreign currency forward contracts are 16.7 million Euro and the forward currency rates range from .96370 to 1.32540. The maturities of these forward contracts depend on the purchase contract payment dates and range in time from January 2006 to January 2007. The mark-to-market valuation of the forward contracts at December 31, 2005 was a net asset of $3.5 million. The counterparty banks obligated on these agreements are rated by Standard & Poor's Rating Services at AA on their senior debt obligations as of December 31, 2005.
Interest Rate and Equity Price Risk - Decommissioning Trust Funds
Entergy's nuclear decommissioning trust funds are exposed to fluctuations in equity prices and interest rates. The NRC requires Entergy to maintain trusts to fund the costs of decommissioning ANO 1, ANO 2, River Bend, Waterford 3, Grand Gulf, Pilgrim, Indian Point 1 and 2, and Vermont Yankee (NYPA currently retains the decommissioning trusts and liabilities for Indian Point 3 and FitzPatrick). The funds are invested primarily in equity securities; fixed-rate, fixed-income securities; and cash and cash equivalents. Management believes that exposure of the various funds to market fluctuations will not affect Entergy's financial results of operations as it relates to the ANO 1 and 2, River Bend, Grand Gulf, and Waterford 3 trust funds because of the application of regulatory accounting principles. The Pilgrim, Indian Point 1 and 2, and Vermont Yankee trust funds collectively hold approximately $952 million of fixed-rate, fixed-income securities as of December 31, 2005. These securities have an average coupon rate of approximately 5.2%, an average duration of approximately 5.6 years, and an average maturity of approximately 9.2 years. The Pilgrim, Indian Point 1 and 2, and Vermont Yankee trust funds also collectively hold equity securities worth approximately $519 million as of December 31, 2005. These securities are generally held in funds that are designed to approximate or somewhat exceed the return of the Standard & Poor's 500 Index, and a relatively small percentage of the securities are held in a fund intended to replicate the return of the Wilshire 4500 Index. The decommissioning trust funds are discussed more thoroughly in Notes 1, 8, and 15 to the consolidated financial statements.
Central States Compact Claim
The Low-Level Radioactive Waste Policy Act of 1980 holds each state responsible for disposal of low-level radioactive waste originating in that state, but allows states to participate in regional compacts to fulfill their responsibilities jointly. Arkansas and Louisiana participate in the Central Interstate Low-Level Radioactive Waste Compact (Central States Compact or Compact). Commencing in early 1988, Entergy Arkansas, Entergy Gulf States, and Entergy Louisiana made a series of contributions to the Central States Compact to fund the Central States Compact's development of a low-level radioactive waste disposal facility to be located in Boyd County, Nebraska. In December 1998, Nebraska, the host state for the proposed Central States Compact disposal facility, denied the compact's license application for the proposed disposal facility. Several parties, including the commission that governs the compact (the Compact Commission), filed a lawsuit against Nebraska seeking damages resulting from Nebraska's denial of the proposed facility's license. After a trial, the U.S. District Court concluded that Nebraska violated its good faith obligations regarding the proposed waste disposal facility and rendered a judgment against Nebraska in the amount of $151 million. In August 2004, Nebraska agreed to pay the Compact $141 million in settlement of the judgment. In July 2005, the Compact Commission decided to distribute a substantial portion of the proceeds from the settlement to the nuclear power generators that had contributed funding for the Boyd County facility, including Entergy Arkansas, Entergy Gulf States, and Entergy Louisiana. On August 1, 2005, Nebraska paid $145 million, including interest, to the Compact, and the Compact distributed from the settlement proceeds $23.6 million to Entergy Arkansas, $19.9 million to Entergy Gulf States, and $19.4 million to Entergy Louisiana. The proceeds caused an increase in pre-tax earnings of $28.7 million.
Critical Accounting Estimates
The preparation of Entergy's financial statements in conformity with generally accepted accounting principles requires management to apply appropriate accounting policies and to make estimates and judgments that can have a significant effect on reported financial position, results of operations, and cash flows. Management has identified the following accounting policies and estimates as critical because they are based on assumptions and measurements that involve a high degree of uncertainty, and the potential for future changes in the assumptions and measurements that could produce estimates that would have a material effect on the presentation of Entergy's financial position or results of operations.
Nuclear Decommissioning Costs
Entergy owns a significant number of nuclear generation facilities in both its U.S. Utility and Non-Utility Nuclear business units. Regulations require Entergy to decommission its nuclear power plants after each facility is taken out of service, and money is collected and deposited in trust funds during the facilities' operating lives in order to provide for this obligation. Entergy conducts periodic decommissioning cost studies (typically updated every three to five years) to estimate the costs that will be incurred to decommission the facilities. The following key assumptions have a significant effect on these estimates:
Entergy implemented SFAS 143, "Accounting for Asset Retirement Obligations," effective January 1, 2003. Nuclear decommissioning costs comprise substantially all of Entergy's asset retirement obligations. The following revisions were made to Entergy's estimated decommissioning cost liabilities in 2004 and 2005.
In the first quarter of 2004, Entergy Arkansas recorded a revision to its estimated decommissioning cost liability in accordance with a new decommissioning cost study for ANO 1 and 2 as a result of revised decommissioning costs and changes in assumptions regarding the timing of when the decommissioning of the plants will begin. The revised estimate resulted in a $107.7 million reduction in its decommissioning liability, along with a $19.5 million reduction in utility plant and an $88.2 million reduction in the related regulatory asset.
In the third quarter of 2004, Entergy Gulf States recorded a revision to its estimated decommissioning cost liability in accordance with a new decommissioning cost study for River Bend that reflected an expected life extension for the plant. The revised estimate resulted in a $116.8 million reduction in decommissioning liability, along with a $31.3 million reduction in utility plant, a $40.1 million reduction in the related regulatory asset, and a regulatory liability of $17.7 million. For the portion of River Bend not subject to cost-based ratemaking, the revised estimate resulted in the elimination of the asset retirement cost that had been recorded at the time of adoption of SFAS 143 with the remainder recorded as miscellaneous income of $27.7 million ($17 million net-of-tax).
In the third quarter of 2004, Entergy's Non-Utility Nuclear business recorded a reduction of $20.3 million in its decommissioning cost liability to reflect changes in assumptions regarding the timing of when the decommissioning of a plant will begin. Entergy considered the assumptions as part of recent studies evaluating the economic effect of the plant in its region. The revised estimate resulted in miscellaneous income of $20.3 million ($11.9 million net-of-tax).
In the first quarter of 2005, Entergy's Non-Utility Nuclear business recorded a reduction of $26.0 million in its decommissioning cost liability in conjunction with a new decommissioning cost study as a result of revised decommissioning costs and changes in assumptions regarding the timing of the decommissioning of a plant. The revised estimate resulted in miscellaneous income of $26.0 million ($15.8 million net-of-tax), reflecting the excess of the reduction in the liability over the amount of undepreciated assets.
In the second quarter of 2005, Entergy Louisiana recorded a revision to its estimated decommissioning cost liability in accordance with a new decommissioning cost study for Waterford 3 that reflected an expected life extension for the plant. The revised estimate resulted in a $153.6 million reduction in its decommissioning liability, along with a $49.2 million reduction in utility plant and a $104.4 million reduction in the related regulatory asset.
In the third quarter of 2005, Entergy Arkansas recorded a revision to its estimated decommissioning cost liability for ANO 2 in accordance with the receipt of approval by the NRC of Entergy Arkansas' application for a life extension for the unit. The revised estimate resulted in an $87.2 million reduction in its decommissioning liability, along with a corresponding reduction in the related regulatory asset.
In the third quarter of 2005, System Energy recorded a revision to its estimated decommissioning cost liability in accordance with a new decommissioning cost study for Grand Gulf. The revised estimate resulted in a $41.4 million reduction in the decommissioning cost liability for Grand Gulf, along with a $39.7 million reduction in utility plant and a $1.7 million reduction in the related regulatory asset.
As discussed in Note 1 to the consolidated financial statements, Entergy records an estimate of the revenues earned for energy delivered since the latest customer billing. Each month the estimated unbilled revenue amounts are recorded as revenue and a receivable, and the prior month's estimate is reversed. The difference between the estimate of the unbilled receivable at the beginning of the period and the end of the period is the amount of unbilled revenue recognized during the period. The estimate recorded is primarily based upon an estimate of customer usage during the unbilled period and the billed price to customers in that month, including fuel price. Therefore, revenue recognized may be affected by the estimated price and usage at the beginning and end of each period and fuel price fluctuations, in addition to changes in certain components of the calculation including changes to estimates such as line loss, which affects the estimate of unbilled customer usage, and assumptions regarding price such as the fuel cost recovery mechanism.
Impairment of Long-lived Assets
Entergy has significant investments in long-lived assets in all of its segments, and Entergy evaluates these assets against the market economics and under the accounting rules for impairment whenever there are indications that impairments may exist. This evaluation involves a significant degree of estimation and uncertainty, and these estimates are particularly important in Entergy's U.S. Utility and Energy Commodity Services segments. In the U.S. Utility segment, portions of River Bend and Grand Gulf are not included in rate base, which could reduce the revenue that would otherwise be recovered for the applicable portions of those units' generation. In the Energy Commodity Services segment, Entergy's investments in merchant generation assets are subject to impairment if adverse market conditions arise.
In order to determine if Entergy should recognize an impairment of a long-lived asset that is to be held and used, accounting standards require that the sum of the expected undiscounted future cash flows from the asset be compared to the asset's carrying value. If the expected undiscounted future cash flows exceed the carrying value, no impairment is recorded; if such cash flows are less than the carrying value, Entergy is required to record an impairment charge to write the asset down to its fair value. If an asset is held for sale, an impairment is required to be recognized if the fair value (less costs to sell) of the asset is less than its carrying value.
These estimates are based on a number of key assumptions, including:
In the fourth quarter of 2005, Entergy recorded a charge of $39.8 million ($25.8 million net-of-tax) as a result of the impairment of the Competitive Retail Services business' information technology systems. Entergy has decided to divest the retail electric portion of the Competitive Retail Services business operating in the ERCOT region of Texas and, in connection with that decision, management evaluated the carrying amount of the Competitive Retail Services business' information technology systems and determined that an impairment provision should be recorded.
In the fourth quarter of 2004, Entergy recorded a charge of approximately $55 million ($36 million net-of-tax) as a result of an impairment of the value of the Warren Power plant. Entergy concluded that the value of the plant, which is owned in the non-nuclear wholesale assets business, was impaired. Entergy reached this conclusion based on valuation studies prepared in connection with the Entergy Asset Management stock sale discussed above in "Results of Operations."
Qualified Pension and Other Postretirement Benefits
Entergy sponsors qualified, defined benefit pension plans which cover substantially all employees. Additionally, Entergy currently provides postretirement health care and life insurance benefits for substantially all employees who reach retirement age while still working for Entergy. Entergy's reported costs of providing these benefits, as described in Note 10 to the consolidated financial statements, are impacted by numerous factors including the provisions of the plans, changing employee demographics, and various actuarial calculations, assumptions, and accounting mechanisms. Because of the complexity of these calculations, the long-term nature of these obligations, and the importance of the assumptions utilized, Entergy's estimate of these costs is a critical accounting estimate for the U.S. Utility and Non-Utility Nuclear segments.
Key actuarial assumptions utilized in determining these costs include:
Entergy reviews these assumptions on an annual basis and adjusts them as necessary. The falling interest rate environment and worse-than-expected performance of the financial equity markets over the past several years have impacted Entergy's funding and reported costs for these benefits. In addition, these trends have caused Entergy to make a number of adjustments to its assumptions.
In selecting an assumed discount rate to calculate benefit obligations, Entergy reviews market yields on high-quality corporate debt and matches these rates with Entergy's projected stream of benefit payments. Based on recent market trends, Entergy reduced its discount rate used to calculate benefit obligations from 6.25% in 2003 to 6.00% in 2004 and to 5.90% in 2005. Entergy reviews actual recent cost trends and projected future trends in establishing health care cost trend rates. Based on this review, Entergy increased its health care cost trend rate assumption used in calculating the December 31, 2005 accumulated postretirement benefit obligation to a 12% increase in health care costs in 2006 gradually decreasing each successive year, until it reaches a 4.5% annual increase in health care costs in 2012 and beyond.
In determining its expected long-term rate of return on plan assets, Entergy reviews past long-term performance, asset allocations, and long-term inflation assumptions. Entergy targets an asset allocation for its pension plan assets of roughly 65% equity securities, 31% fixed-income securities and 4% other investments. The target allocation for Entergy's other postretirement benefit assets is 51% equity securities and 49% fixed-income securities. Based on recent market trends, Entergy reduced its expected long-term rate of return on plan assets used to calculate benefit obligations from 8.75% for 2003 to 8.5% in 2004 and 2005. The assumed rate of increase in future compensation levels used to calculate benefit obligations was 3.25% in 2003, 2004, and 2005.
The following chart reflects the sensitivity of qualified pension cost to changes in certain actuarial assumptions (dollars in thousands):
The following chart reflects the sensitivity of postretirement benefit cost to changes in certain actuarial assumptions (in thousands):
Each fluctuation above assumes that the other components of the calculation are held constant.
In accordance with SFAS No. 87, "Employers' Accounting for Pensions," Entergy utilizes a number of accounting mechanisms that reduce the volatility of reported pension costs. Differences between actuarial assumptions and actual plan results are deferred and are amortized into cost only when the accumulated differences exceed 10% of the greater of the projected benefit obligation or the market-related value of plan assets. If necessary, the excess is amortized over the average remaining service period of active employees.
Additionally, Entergy accounts for the effect of asset performance on pension expense over a twenty-quarter phase-in period through a "market-related" value of assets calculation. Since the market-related value of assets recognizes investment gains or losses over a twenty-quarter period, the future value of assets will be impacted as previously deferred gains or losses are recognized. As a result, the losses that the pension plan assets experienced in 2002 may have an adverse impact on pension cost in future years depending on whether the actuarial losses at each measurement date exceed the 10% corridor in accordance with SFAS 87.
Costs and Funding
In 2005, Entergy's total qualified pension cost was $118.3 million. Entergy anticipates 2006 qualified pension cost to increase to $131.6 million due to a decrease in the discount rate (from 6.00% to 5.90%), actual return on plan assets less than 8.5%, and a plan amendment at Non-Utility Nuclear. Pension funding was $131.8 million for 2005, and under current law, is projected to be $349 million in 2006. This projection may change pending passage of pension reform legislation. In January 2006, $109 million was funded. $107 million of this contribution was originally planned for 2005; however, it was delayed as a result of the Katrina Emergency Tax Relief Act. The rise in pension funding requirements is due to declining interest rates and the phased-in effect of asset underperformance from 2000 to 2002, offset by the Pension Funding Equity Act relief passed in April 2004.
Entergy's qualified pension accumulated benefit obligation at December 31, 2005, 2004, and 2003 exceeded plan assets. As a result, Entergy was required to recognize an additional minimum pension liability as prescribed by SFAS 87. At December 31, 2005, Entergy increased its qualified pension plans' additional minimum pension liability to $406 million ($382 million net of related pension assets) from $244 million ($218 million net of related pension assets) at December 31, 2004. Other comprehensive income increased to $15 million at December 31, 2005 from $6.6 million at December 31, 2004, after reductions for the unrecognized prior service cost, amounts recoverable in rates, and taxes. Net income for 2005, 2004, and 2003 was not affected.
Total postretirement health care and life insurance benefit costs for Entergy in 2005 were $83.7 million, including $24.3 million in savings due to the estimated effect of future Medicare Part D subsidies. Entergy expects 2006 postretirement health care and life insurance benefit costs to approximate $94.1 million, including a projected $27.8 million in savings due to the estimated effect of future Medicare Part D subsidies. The increase in postretirement health care and life insurance benefit costs is due to the decrease in the discount rate (from 6.00% to 5.90%) and an increase in the health care cost trend rate used to calculate benefit obligations.
As a company with multi-state domestic utility operations and a history of international investments, Entergy is subject to a number of federal, state, and international laws and regulations and other factors and conditions in the areas in which it operates, which potentially subject it to environmental, litigation, and other risks. Entergy periodically evaluates its exposure for such risks and records a reserve for those matters which are considered probable and estimable in accordance with generally accepted accounting principles.
Entergy must comply with environmental laws and regulations applicable to the handling and disposal of hazardous waste. Under these various laws and regulations, Entergy could incur substantial costs to restore properties consistent with the various standards. Entergy conducts studies to determine the extent of any required remediation and has recorded reserves based upon its evaluation of the likelihood of loss and expected dollar amount for each issue. Additional sites could be identified which require environmental remediation for which Entergy could be liable. The amounts of environmental reserves recorded can be significantly affected by the following external events or conditions:
Entergy has been named as defendant in a number of lawsuits involving employment, ratepayer, and injuries and damages issues, among other matters. Entergy periodically reviews the cases in which it has been named as defendant and assesses the likelihood of loss in each case as probable, reasonably estimable, or remote and records reserves for cases which have a probable likelihood of loss and can be estimated. Notes 2 and 8 to the consolidated financial statements include more detail on ratepayer and other lawsuits and management's assessment of the adequacy of reserves recorded for these matters. Given the environment in which Entergy operates, and the unpredictable nature of many of the cases in which Entergy is named as a defendant, however, the ultimate outcome of the litigation Entergy is exposed to has the potential to materially affect the results of operations of Entergy, or its operating company subsidiaries.
Sales Warranty and Tax Reserves
Entergy's operations, including acquisitions and divestitures, require Entergy to evaluate risks such as the potential tax effects of a transaction, or warranties made in connection with such a transaction. Entergy believes that it has adequately assessed and provided for these types of risks, where applicable. Any reserves recorded for these types of issues, however, could be significantly affected by events such as claims made by third parties under warranties, additional transactions contemplated by Entergy, or completion of reviews of the tax treatment of certain transactions or issues by taxing authorities. Tax reserves not expected to reverse within the next year are reflected as non-current taxes accrued in the financial statements. Entergy does not expect a material adverse effect on earnings from these matters.
New Accounting Pronouncements
In December 2005, Entergy implemented FASB Interpretation 47, "Accounting for Conditional Asset Retirement Obligations - an interpretation of FASB Statement No. 143", (FIN 47), effective as of that date, which required the recognition of additional asset retirement obligations other than nuclear decommissioning which are conditional in nature. The obligations recognized upon implementation represent Entergy's obligation to remove and dispose of asbestos at many of its non-nuclear generating units if and when those units are retired from commercial service and dismantled. For the U.S. Utility business, the implementation of FIN 47 for the rate-regulated business of the domestic utility companies was recorded as regulatory assets, with no resulting effect on Entergy's net income. Entergy recorded these regulatory assets because existing rate mechanisms in each jurisdiction allow for the recovery in rates of the ultimate costs of asbestos removal, either through cost of service or in rate base, from current and future customers. As a result of this treatment, FIN 47 is expected to be earnings neutral to the rate-regulated business of the domestic utility companies. Upon implementation of FIN 47 in December 2005, assets increased by $28.8 million and liabilities increased by $30.3 million for the U.S. Utility segment as a result of recording the asset retirement obligations at their fair values of $30.3 million as determined under FIN 47, increasing utility plant by $2.7 million, increasing accumulated depreciation by $1.8 million, and recording the related regulatory assets of $27.9 million. The implementation of FIN 47 for the portion of Entergy Gulf States not subject to cost-based ratemaking decreased earnings by $0.9 million net-of-tax.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
We have audited the accompanying consolidated balance sheets of Entergy Corporation and Subsidiaries (the "Corporation") as of December 31, 2005 and 2004, and the related consolidated statements of income; of retained earnings, comprehensive income, and paid-in capital; and of cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of Entergy-Koch, LP, the Corporation's investment in which is accounted for by the use of the equity method. The Corporation's equity in earnings of unconsolidated equity affiliates for the year ended December 31, 2003 includes $180,110,000 for Entergy Koch, LP, which earnings were audited by other auditors whose report (which as to 2003 included an explanatory paragraph concerning a change in accounting for inventory held for trading purposes and energy trading contracts not qualifying as derivatives) has been furnished to us, and our opinion for the year ended December 31, 2003, insofar as it relates to the amount audited by other auditors included for such company, is based solely on the report of such other auditors.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, such consolidated financial statements present fairly, in all material respects, the financial position of Entergy Corporation and Subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 8 to the consolidated financial statements, in 2003 Entergy Corporation adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 143, Accounting for Asset Retirement Obligations.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Corporation's internal control over financial reporting as of December 31, 2005, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 9, 2006 expressed an unqualified opinion on management's assessment of the effectiveness of the Corporation's internal control over financial reporting and an unqualified opinion on the effectiveness of the Corporation's internal control over financial reporting.
DELOITTE & TOUCHE LLP
New Orleans, Louisiana