Great Plains Energy 10-Q 2005
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005
o TRANSITION REPORT PURSUANT SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicated by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
As of October 31, 2005, the number of shares outstanding of (i) Great Plains Energys common stock was 74,694,629 and (ii) Kansas City Power & Light Companys common stock was one, which was held by Great Plains Energy Incorporated.
Great Plains Energy Incorporated and Kansas City Power & Light Company separately file this combined Quarterly Report on Form 10-Q. Information contained herein relating to an individual registrant and its subsidiaries is filed by such registrant on its own behalf. Each registrant makes representations only as to information relating to itself and its subsidiaries.
This report should be read in its entirety. No one section of the report deals with all aspects of the subject matter. It should be read in conjunction with the consolidated financial statements and related notes and with the managements discussion and analysis included in the companies 2004 Form 10-K.
Kansas City Power & Light Company is not required to file reports with the Securities and Exchange Commission (SEC) under Sections 13(a), 13(c), 14 or 15(d) of the Securities Exchange Act of 1934, as amended (the Exchange Act); however, Kansas City Power & Light Company has continued to file such reports, including this Quarterly Report on Form 10-Q, with the SEC voluntarily and will continue to do so. In addition, Kansas City Power & Light Company may determine to register its common stock under Section 12(g) of the Exchange Act and upon the effectiveness of the registration it will be required to file such reports.
CAUTIONARY STATEMENTS REGARDING CERTAIN FORWARD-LOOKING INFORMATION
Statements made in this report that are not based on historical facts are forward-looking, may involve risks and uncertainties, and are intended to be as of the date when made. In connection with the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, the registrants are providing a number of important factors that could cause actual results to differ materially from the provided forward-looking information. These important factors include:
This list of factors is not all-inclusive because it is not possible to predict all factors.
GLOSSARY OF TERMS
The following is a glossary of frequently used abbreviations or acronyms that are found throughout this report.
GREAT PLAINS ENERGY INCORPORATED
KANSAS CITY POWER & LIGHT COMPANY
Notes to Consolidated Financial Statements
The notes to consolidated financial statements that follow are a combined presentation for Great Plains Energy Incorporated and Kansas City Power & Light Company, both registrants under this filing. The terms Great Plains Energy, Company, KCP&L and consolidated KCP&L are used throughout this report. Great Plains Energy and the Company refer to Great Plains Energy Incorporated and its consolidated subsidiaries, unless otherwise indicated. KCP&L refers to Kansas City Power & Light Company, and consolidated KCP&L refers to KCP&L and its consolidated subsidiaries.
Great Plains Energy, a Missouri corporation incorporated in 2001, is a public utility holding company registered with and subject to the regulation of the Securities and Exchange Commission (SEC) under the Public Utility Holding Company Act of 1935, as amended (35 Act). Great Plains Energy does not own or operate any significant assets other than the stock of its subsidiaries.
Great Plains Energy has four direct subsidiaries with operations or active subsidiaries:
The operations of Great Plains Energy and its subsidiaries are divided into two reportable segments, KCP&L and Strategic Energy. Great Plains Energys legal structure differs from the functional management and financial reporting of its reportable segments. Other activities not considered a reportable segment include the operations of HSS, Services, all KLT Inc. operations other than Strategic Energy, and holding company operations.
Cash and Cash Equivalents
Cash equivalents consist of highly liquid investments with original maturities of three months or less. For Great Plains Energy, this includes Strategic Energys cash held in trust of $27.7 million and $21.0 million at September 30, 2005, and December 31, 2004, respectively.
Strategic Energy has entered into collateral arrangements with selected electricity power suppliers that require selected customers to remit payment to lockboxes that are held in trust and managed by a Trustee. As part of the trust administration, the Trustee remits payment to the supplier of electricity purchased by Strategic Energy. On a monthly basis, any remittances into the lockboxes in excess of disbursements to the supplier are remitted back to Strategic Energy.
Strategic Energy has entered into Master Power Purchase and Sale Agreements with its power suppliers. Certain of these agreements contain provisions whereby, to the extent Strategic Energy has a net exposure to the purchased power supplier, collateral requirements are to be maintained. Collateral posted in the form of cash to Strategic Energy is restricted by agreement, but would become unrestricted in the event of a default by the purchased power supplier. Strategic Energys restricted cash collateral was $17.5 million and $7.7 million at September 30, 2005, and December 31, 2004.
There was no significant dilutive effect on Great Plains Energys EPS from other securities for the three months ended and year to date September 30, 2005 and 2004. To determine basic EPS, preferred stock dividend requirements are deducted from income from continuing operations and net income before dividing by average number of common shares outstanding. The earnings (loss) per share impact of discontinued operations, net of income taxes, is determined by dividing discontinued operations, net of income taxes, by the average number of common shares outstanding. Diluted EPS, calculated using the treasury stock method, assumes the issuance of common shares applicable to stock options, performance shares and FELINE PRIDESSM.
The following table reconciles Great Plains Energys basic and diluted EPS from continuing operations.
As of September 30, 2005 and 2004, there were no significant anti-dilutive shares applicable to stock options or performance shares. As of September 30, 2005 and 2004, 6.5 million FELINE PRIDES had no dilutive effect because the number of common shares to be issued in accordance with the settlement rate, assuming applicable market value equal to the average price during the period, would be equal to the number of shares Great Plains Energy could re-purchase in the market at the average price during the period.
In November 2005, the Board of Directors declared a quarterly dividend of $0.415 per share on Great Plains Energys common stock. The common dividend is payable December 20, 2005, to shareholders of record as of November 29, 2005. The Board of Directors also declared regular dividends on Great Plains Energys preferred stock, payable March 1, 2006, to shareholders of record as of February 7, 2006.
Significant Non-Cash Items
As of September 30, 2005, KCP&L had sold SO2 emission allowances totaling $57.3 million of which $26.3 million was recorded in receivables. During the first quarter of 2005, HSS completed the sale of Worry Free. As part of the transaction, HSS received cash of $0.3 million and notes receivable totaling $5.2 million, net of a $3.0 million allowance. The notes receivable had no effect on Great Plains Energys and consolidated KCP&Ls cash flows with the exception of $0.3 million receipt of payments on the notes during 2005.
The Companys receivables are detailed in the following table.
Consolidated KCP&Ls other receivables at September 30, 2005, consisted primarily of receivables for the sale of SO2 emission allowances, receivables from partners in jointly owned electric utility plants and wholesale sales receivables. At December 31, 2004, the balance consisted primarily of receivables from partners in jointly owned electric utility plants, wholesale sales receivables and accounts receivable held by Worry Free. Great Plains Energys other receivables at September 30, 2005, and December 31, 2004, consisted primarily of accounts receivable held by Strategic Energy, including unbilled receivables of $112.0 million and $103.0 million, respectively.
During the third quarter of 2005, KCP&L entered into a new three-year revolving agreement to sell all of its retail electric accounts receivable to Kansas City Power & Light Receivables Company (Receivables Company), which in turn sold an undivided percentage ownership interest in the accounts receivable to Victory Receivables Corporation, an independent outside investor. In accordance with Statement of Financial Accounting Standards (SFAS) No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, the agreements qualify as a sale under which the creditors of Receivables Company are entitled to be satisfied out of the assets of Receivables Company prior to any value being returned to KCP&L or its creditors. Accounts receivable sold by KCP&L to Receivables Company under this revolving agreement totaled $124.5 million at September 30, 2005. Accounts receivable sold by Receivables Company to the outside investor under this revolving agreement totaled $70 million at September 30, 2005. The proceeds of this sale were forwarded to KCP&L as consideration for its sale. The new agreement allows for a maximum outstanding principal amount sold to the outside investor of $100 million during the period June 1 through October 31, and $70 million during the period November 1 through May 31 of each year.
Under the agreement, KCP&L sells its receivables at a fixed price based upon the expected cost of funds and charge-offs. These costs comprise KCP&Ls loss on the sale of accounts receivable. KCP&L services the receivables and receives an annual servicing fee of 2.5% of the outstanding principal amount of the receivables sold to Receivables Company. KCP&L does not recognize a servicing asset or liability since management determined the collection agent fee earned by KCP&L approximates market value.
Information regarding KCP&Ls sale of accounts receivable to Receivables Company under the new agreement is reflected in the following table.
KCP&L had a revolving agreement, which expired in January 2005, to sell all of its right, title and interest in the majority of its customer accounts receivable to Receivables Company, which in turn sold most of the receivables to independent outside investors. The expired agreement was structured as a true sale under which the creditors of Receivables Company were entitled to be satisfied out of the assets of Receivables Company prior to any value being returned to KCP&L or its creditors. Accounts receivable sold under the expired revolving agreement totaled $84.9 million at December 31, 2004. As a result of the sale to the outside investors, Receivables Company received up to $70 million in cash, which was forwarded to KCP&L as consideration for its sale. At December 31, 2004, Receivables Company had received $65.0 million in cash.
Information regarding KCP&Ls sale of accounts receivable to Receivables Company under the expired agreement is reflected in the following table.
In May 2004, Great Plains Energy, through IEC, completed its purchase of an additional 11.45% indirect interest in Strategic Energy bringing Great Plains Energys indirect ownership interest in Strategic Energy to just under 100%. The acquired share of intangible assets and related liabilities are detailed in the following table.
Amortization expense for the acquired share of intangible assets and related liabilities is detailed in the following tables.
In February 2004, the Board of Directors approved the sale of the KLT Gas natural gas properties (KLT Gas portfolio) and discontinuation of the gas business. Since the approval, the KLT Gas portfolio has been reported as discontinued operations in accordance with SFAS No. 144 Accounting for the Impairment or Disposal of Long-lived Assets. During 2004, KLT Gas completed sales of substantially all of the KLT Gas portfolio. At September 30, 2005, and December 31, 2004, KLT Gas had $1.3 million and $0.7 million of current assets and $0.1 million and $2.1 million of current liabilities recorded in assets and liabilities from discontinued operations, respectively. During the second quarter of 2005, a legal reserve related to these discontinued operations was recorded. During the third quarter of 2005, KLT Gas reached an agreement to settle the arbitration for less than the amount reserved. See Note 14 for more information. The following table summarizes the discontinued operations.
The following table summarizes the cash flows from the discontinued operations.
Great Plains Energy and consolidated KCP&Ls long-term debt is detailed in the following table.
During the third quarter of 2005, KCP&L redeemed its secured 1994 series EIRR bonds totaling $35.9 million by issuing secured EIRR Bonds Series 2005 also totaling $35.9 million; $14.0 million at a fixed rate of 4.05% until maturity at March 1, 2015, and $21.9 million at a fixed rate of 4.65% until maturity at September 1, 2035. KCP&L also redeemed its unsecured Series C EIRR bonds totaling $50.0 million by issuing unsecured EIRR Bonds Series 2005 also totaling $50.0 million at a fixed rate of 4.65% until maturity at September 1, 2035. The previous interest rate periods on these two series, with interest rates of 2.25% and 2.38%, respectively, expired on August 31, 2005. Both of the redeemed series were classified as current liabilities at December 31, 2004. Both of the new EIRR Bonds Series 2005 are covered by municipal bond insurance policies issued by XL Capital Assurance Inc. (XLCA). The insurance agreements between KCP&L and XLCA provide for reimbursement by KCP&L for any amounts that XLCA pays under the municipal bond insurance policies. The insurance policies are in effect for the term of the bonds. The insurance agreements contain a covenant that the indebtedness to total capitalization ratio of KCP&L and its consolidated subsidiaries will not be greater than 0.68 to 1.00. At September 30, 2005, KCP&L was in compliance with this covenant. KCP&L is also restricted from issuing additional bonds under its General Mortgage Indenture if, after giving effect to such additional bonds, the proportion of secured debt to total indebtedness would be more than 75%, or more than 50% if the long term rating for such bonds by Standard & Poors or Moodys Investors Service would be at or below A- or A3, respectively. The insurance agreement covering the unsecured
EIRR Bond Series 2005 also requires KCP&L to provide XLCA with $50.0 million of general mortgage bonds as collateral for KCP&Ls obligations under the insurance agreement in the event KCP&L issues general mortgage bonds (other than refundings of outstanding general mortgage bonds) resulting in the aggregate amount of outstanding general mortgage bonds exceeding 10% of total capitalization. In the event of a default under the insurance agreements, XLCA may take any available legal or equitable action against KCP&L, including seeking specific performance of the covenants.
KCP&L exercised its early termination option in the Combustion Turbine Synthetic Lease and purchased the leased property during the second quarter of 2005.
Amortization of Debt Expense
Great Plains Energys and consolidated KCP&Ls amortization of debt expense is detailed in the following table.
Short-Term Borrowings And Short-Term Bank Lines of Credit
Great Plains Energy has a $550 million revolving credit facility with a group of banks that expires in December 2009. A default by Great Plains Energy or any of its significant subsidiaries of other indebtedness totaling more than $25.0 million is a default under the facility. Under the terms of this agreement, Great Plains Energy is required to maintain a consolidated indebtedness to consolidated capitalization ratio, as defined in the agreement, not greater than 0.65 to 1.00 at all times. At September 30, 2005, the Company was in compliance with this covenant. At September 30, 2005, Great Plains Energy had no outstanding borrowings and had issued letters of credit totaling $22.2 million under the credit facility as credit support for Strategic Energy. At December 31, 2004, Great Plains Energy had $20.0 million of outstanding borrowings with an interest rate of 3.04% and had issued letters of credit totaling $8.0 million under the credit facility as credit support for Strategic Energy.
KCP&L has a $250 million revolving credit facility with a group of banks that expires in December 2009, to provide support for its issuance of commercial paper and other general purposes. A default by KCP&L on other indebtedness totaling more than $25.0 million is a default under the facility. Under the terms of the agreement, KCP&L is required to maintain a consolidated indebtedness to consolidated capitalization ratio, as defined in the agreement, not greater than 0.65 to 1.00 at all times. At September 30, 2005, KCP&L was in compliance with this covenant. At September 30, 2005, KCP&L had $13.6 million of commercial paper outstanding and no cash borrowings under the facility. The weighted-average interest rate of the commercial paper was 3.95%. At December 31, 2004, KCP&L had no cash borrowings or commercial paper outstanding.
Strategic Energy has a $125 million revolving credit facility with a group of banks that expires in June 2007. Great Plains Energy has guaranteed $25.0 million of this facility. A default by Strategic Energy of other indebtedness, as defined in the facility, totaling more than $7.5 million is a default under the facility. Under the terms of this agreement, Strategic Energy is required to maintain a minimum net worth of $62.5 million, a maximum funded indebtedness to EBITDA ratio of 2.25 to 1.00, a minimum fixed charge coverage ratio of at least 1.05 to 1.00 and a minimum debt service coverage ratio of at least 4.00 to 1.00, as those terms are defined in the agreement. In the event of a breach of one or
more of these four covenants, so long as no other default has occurred, Great Plains Energy may cure the breach through a cash infusion, a guarantee increase or a combination of the two. At September 30, 2005, Strategic Energy was in compliance with these covenants. At September 30, 2005, $80.3 million in letters of credit had been issued and there were no cash borrowings under the agreement. At December 31, 2004, $69.2 million in letters of credit had been issued and there were no cash borrowings under the agreement.
Pension Plans and Other Employee Benefits
The Company maintains defined benefit pension plans for substantially all employees, including officers, of KCP&L, Services and Wolf Creek Nuclear Operating Corporation (WCNOC). Pension benefits under these plans reflect the employees compensation, years of service and age at retirement.
In addition to providing pension benefits, the Company provides certain postretirement health care and life insurance benefits for substantially all retired employees of KCP&L, Services and WCNOC. The cost of postretirement benefits charged to KCP&L are accrued during an employee's years of service and recovered through rates.
During the third quarter of 2005, KCP&L received approvals from the State of Missouri Public Service Commission (MPSC) and The State Corporation Commission of the State of Kansas (KCC) on its previously filed agreements regarding its comprehensive energy plan. The agreements establish KCP&Ls annual pension costs before amounts capitalized at $22 million through the creation of a regulatory asset or liability for future recovery from or refund to customers, as appropriate. In accordance with the agreements, KCP&L reduced pension expense retroactive to January 1, 2005, for the difference between pension expense under SFAS No. 87, Employers Accounting for Pensions and the amount allowed for ratemaking. This resulted in a $10.8 million net reduction in pension expense and the establishment of a corresponding regulatory asset and liability. See Note 13 for additional information regarding KCP&Ls regulatory matters.
The following tables provide the components of net periodic benefit costs prior to the effects of capitalization and sharing with joint-owners of power plants.
The Companys Long-Term Incentive Plan is an equity compensation plan approved by its shareholders. The Long-Term Incentive Plan permits the grant of restricted stock, stock options, limited stock appreciation rights and performance shares to officers and other employees of the Company and its subsidiaries. In accordance with the provisions of SFAS No. 123, Accounting for Stock-Based Compensation, compensation expense and accrued dividends related to equity compensation are recognized over the stated vesting period. Forfeitures of equity compensation are recognized when incurred and previously recorded compensation expense related to the forfeited shares is reversed. The maximum number of shares of Great Plains Energy common stock that can be issued under the plan is 3.0 million. At September 30, 2005, 2.0 million shares remained available for future issuance.
The payment of performance shares is contingent upon achievement of specific performance goals over a stated period of time as approved by the Compensation and Development Committee of the Companys Board of Directors. The number of performance shares ultimately paid can vary from the number of shares initially granted depending on Company performance over stated vesting periods. Performance shares have a value equal to the fair market value of the shares on the grant date with accruing dividends. Year to date September 30, 2005, performance shares granted totaled 182,130; 17,024 of these shares were forfeited. Additionally, year to date September 30, 2005, 5,690 of the 19,313 granted performance shares outstanding at December 31, 2004, were forfeited. Performance shares granted and outstanding totaled 178,729 at September 30, 2005. For the three months ended and year to date September 30, 2005, the Company recognized compensation expense of $0.5 million and $1.2 million, respectively, for performance shares and reversed an insignificant amount of previously recognized compensation expense related to forfeited shares. There was no compensation expense for performance shares for the same periods of 2004.
Restricted stock cannot be sold or otherwise transferred by the recipient prior to vesting and has a value equal to the fair market value of the shares on the grant date. Restricted stock granted year to date September 30, 2005, totaled 76,375 shares; 6,214 of these shares were forfeited. Restricted stock shares issued in 2005 vest on a graded schedule over a stated period of time with accruing reinvested dividends. For the three months ended and year to date September 30, 2005, the Company recognized compensation expense of $0.4 million and $1.1 million, respectively, for restricted stock and reversed an insignificant amount of previously recognized compensation expense related to forfeited shares. For the same periods in 2004, the Company recognized compensation expense of $0.2 million and $0.4 million, respectively.
Cash-Based Long-Term Incentives
In 2005, Strategic Energy initiated long-term incentives designed to reward officers and key members of management with Great Plains Energy restricted stock (issued under the Long-Term Incentive Plan) and a cash performance payment for achieving specific performance goals over stated periods of time, commencing January 1, 2005. The restricted stock compensation expense is discussed in the preceding paragraph. For the three months ended and year to date September 30, 2005, compensation expense of $0.2 million and $1.0 million, respectively, was recognized for the cash-based incentives.
Components of income taxes are detailed in the following tables.
Effective Income Tax Rates
The effective income tax rates reflected in the financial statements and the reasons for their differences from the statutory federal rates are detailed in the following tables.
For the three months ended and year to date September 30, 2005, Great Plains Energys income taxes were reduced by $16.4 million and $17.6 million, respectively, and consolidated KCP&Ls income taxes were reduced by $15.1 million and $15.9 million, respectively, due to the favorable impact of sustained audited positions on the companies composite tax rates. Great Plains Energys income tax expense was also reduced by $5.7 million due to events during the three months ended September 30, 2005, that strengthened the probability of sustaining tax deductions taken on previously filed tax returns.
SFAS No. 109, Accounting for Income Taxes requires the companies to adjust deferred tax balances to reflect tax rates that are anticipated to be in effect when the differences reverse. The largest component of the companies decreases in income tax expense related to the sustained audited positions resulted from adjusting KCP&Ls deferred tax balance to its lower composite tax rate. The impact of the composite tax rate reductions on KCP&Ls deferred tax balances resulted in an $11.7 million tax benefit for both the Company and consolidated KCP&L.
Deferred Income Taxes
The tax effects of major temporary differences resulting in deferred income tax assets and liabilities in the consolidated balance sheets are in the following table.
The increase in Great Plains Energys current and noncurrent deferred income tax liabilities at September 30, 2005, compared to December 31, 2004, related to derivative instruments is due to increases in the fair value of Strategic Energys energy related derivative instruments as a result of increase in forward market prices for power. The increase in Great Plains Energys and consolidated KCP&Ls noncurrent deferred income tax asset at September 30, 2005, compared to December 31, 2004, related to SO2 emission allowance sales is due to regulatory treatment under the comprehensive energy plan approved by the MPSC and KCC. In the third quarter of 2005, KCP&L sold SO2 emission allowances under the approved plan for a total of $56.6 million.
Pursuant to a service agreement approved by the SEC under the 35 Act, consolidated KCP&L receives various support and administrative services from Services. These services are billed to consolidated KCP&L at cost, based on payroll and other expenses, incurred by Services for the benefit of consolidated KCP&L. These costs totaled $7.0 million and $37.9 million for the three months ended and year to date September 30, 2005, respectively, and $15.3 million and $46.3 million for the same periods in 2004. These costs consisted primarily of employee compensation, benefits and fees associated with various professional services. At September 30, 2005, and December 31, 2004,
consolidated KCP&L had a net intercompany payable to Services of $0.9 million and $9.2 million, respectively. On August 1, 2005, approximately 80% of Services employees were transferred to KCP&L to better align resources with the operating business.
Nuclear Liability and Insurance
The owners of Wolf Creek, a nuclear generating station, (Owners) maintain nuclear insurance for Wolf Creek in four areas: liability, worker radiation, property and accidental outage. These policies contain certain industry standard exclusions, including, but not limited to, ordinary wear and tear, and war. Both the nuclear liability and property insurance programs subscribed to by members of the nuclear power generating industry include industry aggregate limits for non-certified acts of terrorism and related losses, as defined by the Terrorism Risk Insurance Act, including replacement power costs. An industry aggregate limit of $0.3 billion exists for liability claims, regardless of the number of non-certified acts affecting Wolf Creek or any other nuclear energy liability policy or the number of policies in place. An industry aggregate limit of $3.2 billion plus any reinsurance recoverable by Nuclear Electric Insurance Limited (NEIL), the Owners insurance provider, exists for property claims, including accidental outage power costs for acts of terrorism affecting Wolf Creek or any other nuclear energy facility property policy within twelve months from the date of the first act. These limits are the maximum amount to be paid to members who sustain losses or damages from these types of terrorist acts. For certified acts of terrorism, the individual policy limits apply. In addition, industry-wide retrospective assessment programs (discussed below) can apply once these insurance programs have been exhausted.
Pursuant to the Price-Anderson Act, which was reauthorized through December 31, 2025, by the Energy Policy Act of 2005, the Owners are required to insure against public liability claims resulting from nuclear incidents to the full limit of public liability, which is currently $10.8 billion. This limit of liability consists of the maximum available commercial insurance of $0.3 billion, and the remaining $10.5 billion is provided through an industry-wide retrospective assessment program mandated by law, known as the Secondary Financial Protection (SFP) program. Under the SFP program, the Owners can be assessed up to $100.6 million ($47.3 million, KCP&Ls 47% share) per incident at any commercial reactor in the country, payable at no more than $15 million ($7.1 million, KCP&Ls 47% share) per incident per year effective with the Energy Policy Act of 2005. This assessment is subject to an inflation adjustment based on the Consumer Price Index and applicable premium taxes. This assessment is in addition to worker radiation claims insurance. In addition, the U.S. Congress could impose additional revenue-raising measures to pay claims.
Property, Decontamination, Premature Decommissioning and Extra Expense Insurance
The Owners carry decontamination liability, premature decommissioning liability and property damage insurance for Wolf Creek totaling approximately $2.8 billion ($1.3 billion, KCP&L's 47% share). NEIL provides this insurance.
In the event of an accident, insurance proceeds must first be used for reactor stabilization and site decontamination in accordance with a plan mandated by the Nuclear Regulatory Commission (NRC). KCP&Ls share of any remaining proceeds can be used for further decontamination, property damage restoration and premature decommissioning costs. Premature decommissioning coverage applies only if an accident at Wolf Creek exceeds $500 million in property damage and decontamination expenses, and only after trust funds have been exhausted.
Accidental Nuclear Outage Insurance
The Owners also carry additional insurance from NEIL to cover costs of replacement power and other extra expenses incurred in the event of a prolonged outage resulting from accidental property damage at Wolf Creek.
Under all NEIL policies, the Owners are subject to retrospective assessments if NEIL losses, for each policy year, exceed the accumulated funds available to the insurer under that policy. The estimated maximum amount of retrospective assessments under the current policies could total about $26.5 million ($12.4 million, KCP&Ls 47% share) per policy year.
In the event of a catastrophic loss at Wolf Creek, the insurance coverage may not be adequate to cover property damage and extra expenses incurred. Uninsured losses, to the extent not recovered through rates, would be assumed by KCP&L and the other owners and could have a material adverse effect on KCP&Ls financial condition, results of operations and cash flows.
The Low-Level Radioactive Waste Policy Amendments Act of 1985 mandated that the various states, individually or through interstate compacts, develop alternative low-level radioactive waste disposal facilities. The states of Kansas, Nebraska, Arkansas, Louisiana and Oklahoma formed the Central Interstate Low-Level Radioactive Waste Compact (Compact) and selected a site in northern Nebraska to locate a disposal facility. WCNOC and the owners of the other five nuclear units in the Compact provided most of the pre-construction financing for this project.
On December 18, 1998, the application for a license to construct this project was denied. After the license denial, WCNOC, the Compact Commission (Commission) and others filed a lawsuit in federal court contending Nebraska officials acted in bad faith while handling the license application. In September 2002, the U.S. District Court Judge presiding over the lawsuit issued his decision in the case finding that the State of Nebraska acted in bad faith in processing the license application for a low-level radioactive waste disposal site in Nebraska and rendered a judgment on behalf of the Commission in the amount of $151.4 million against the state. After the U.S. Court of Appeals affirmed the decision, Nebraska and the Commission settled the case by Nebraska agreeing to pay the Commission a one-time amount of $145.8 million. At the request of the Commission, WCNOC along with other members of the Compact, filed with the Commission their claims for refund. On August 1, 2005, WCNOC received a return of its investment of $19.6 million ($9.2 million, KCP&Ls 47% share), including pre-judgment interest and attorneys fees. The Commission continues to explore alternative long-term waste disposal capability and has retained a portion of the settlement, above the amounts returned, until it determines what role it will take in the development of alternative disposal capability. The maximum additional amount WCNOC might receive from the Commission-retained portion of the settlement is $2.5 million ($1.2 million, KCP&Ls 47% share). The Commission has stated that it plans to make a decision on the amount, if any, by January 2006. At September 30, 2005, KCP&Ls balance sheet no longer reflects an investment in the Compact. KCP&L's net investment in the Compact was $7.4 million at December 31, 2004.
Wolf Creek continues to dispose of its low-level radioactive waste at the reopened disposal facility at Barnwell, South Carolina. South Carolina intends to gradually decrease the amount of waste it allows from outside its compact until around 2008 when it intends to no longer accept waste from generators outside its compact. Wolf Creek remains able to dispose of some of its radioactive waste at a facility in Utah. Although management is unable to predict when a permanent disposal facility for Wolf Creek low-level radioactive waste might become available, this issue is not expected to affect continued operation of Wolf Creek.
The Company is subject to regulation by federal, state and local authorities with regard to air and other environmental matters primarily through KCP&Ls operations. The generation, transmission and distribution of electricity produces and requires disposal of certain hazardous products that are subject to these laws and regulations. In addition to imposing continuing compliance obligations, these laws and regulations authorize the imposition of substantial penalties for noncompliance, including fines, injunctive relief and other sanctions. Failure to comply with these laws and regulations could have a material adverse effect on consolidated KCP&L and Great Plains Energy.
KCP&L operates in an environmentally responsible manner and seeks to use current technology to avoid and treat contamination. KCP&L regularly conducts environmental audits designed to ensure compliance with governmental regulations and to detect contamination. At September 30, 2005 and December 31, 2004, KCP&L had $0.3 million accrued for environmental remediation expenses. The accrual covers water monitoring at one site. The amounts accrued were established on an undiscounted basis and KCP&L does not currently have an estimated time frame over which the accrued amounts may be paid out.
Environmental-related legislation is continuously introduced in Congress. Such legislation typically includes various compliance dates and compliance limits. Such legislation could have the potential for a significant financial impact on KCP&L, including the installation of new pollution control equipment to achieve compliance. However, KCP&L would seek recovery of capital costs and expenses for such compliance through rates. KCP&L will continue to monitor proposed legislation.
The following table contains estimates of expenditures to comply with environmental laws and regulations described below. The allocation between states is based on location of the facilities and has no bearing as to recovery in jurisdictional rates.
Expenditure estimates provided in the table above include, but are not limited to, the accelerated environmental upgrade expenditures contemplated in the MPSC and KCC agreements discussed in Note 13. KCP&Ls expectation is that any such expenditures will be recovered through rates.
Clean Air Interstate Rule
In the May 12, 2005, Federal Register, the Environmental Protection Agency (EPA) published the Clean Air Interstate Rule (CAIR), which requires reductions in SO2 and NOx emissions in 28 states including Missouri. This final regulation was effective July 11, 2005.
The reduction in both SO2 and NOx emissions will be accomplished through establishment of permanent statewide caps for NOx effective January 1, 2009, and SO2 effective January 1, 2010. More restrictive caps will be effective on January 1, 2015. KCP&Ls coal-fired plants located in Missouri are subject to CAIR, while its coal-fired plants in Kansas are not.
KCP&L expects to meet the emissions reductions required by CAIR at its Missouri plants through a combination of pollution control capital projects and the purchase of emission allowances in the open market as needed. The final rule establishes a market-based cap-and-trade program. Missouri will establish an emission allowance allocation mechanism through a State Implementation Plan (SIP) that is expected to be issued by December 2006. Facilities will demonstrate compliance with CAIR by holding sufficient allowances for each ton of SO2 and NOx emitted in any given year with SO2 emission allowances transferable among all regulated facilities nationwide and NOx emission allowances transferable among all regulated facilities within the 28 CAIR states. KCP&L will also be allowed to utilize unused SO2 emission allowances that it has banked from previous years of the Acid Rain Program to meet the more stringent CAIR requirements. KCP&L is currently allocated approximately 50,000 SO2 emission allowances per year and emits approximately 50,000 tons of SO2 per year. KCP&L had accumulated over 190,000 allocated SO2 emission allowances. KCP&L is permitted to sell excess SO2 emission allowances up to $120.0 million or 176,000 allowances in accordance with KCP&Ls comprehensive energy plan as approved by the MPSC and KCC. During the third quarter of 2005, KCP&L sold 64,500 SO2 emission allowances for $56.6 million. See Note 13 for more information.
Analysis of the final rule indicates that selective catalytic reduction technology for NOx control and scrubbers for SO2 control will likely be required for some of KCP&Ls Missouri plants. The timing of the installation of such control equipment is currently being developed. KCP&L continues to refine the preliminary cost estimates detailed in the table above and explore alternatives. The ultimate cost of these regulations could be significantly different from the amounts estimated. As discussed below, certain of the control technology for SO2 and NOx will also aid in the control of mercury.
Best Available Retrofit Technology Rule
In the July 6, 2005, Federal Register, the EPA published regulations on best available retrofit technology (BART) that amended its July 1999 regional haze regulations regarding emission controls for industrial facilities emitting air pollutants that reduce visibility. The BART regulations apply to specific eligible facilities and were effective September 6, 2005. KCP&L coal-fired plants on the BART eligible list include La Cygne Nos. 1 and 2 in Kansas and Iatan No. 1 and Montrose No. 3 in Missouri. The CAIR suggests that states in CAIR that meet the CAIR requirement may also meet BART requirements for individual sources. Missouri is considering this proposal as part of the CAIR SIP, but no final decision has been reached. Kansas is not a CAIR state and therefore BART will likely impact La Cygne Nos. 1 and 2. The BART rule directs state air quality agencies to identify whether emissions from sources subject to BART are below limits set by the state, or whether retrofit measures are needed to reduce emissions. States must submit a BART implementation plan in 2007 with required emission controls. If emission controls to comply with BART are required at La Cygne Nos. 1 and 2, additional capital expenditures will be required. KCP&L continues to refine its preliminary cost estimates detailed in the table above and explore alternatives. The ultimate cost of these regulations could be significantly different from the amounts estimated.
In July 2000, the National Research Council published its findings of a study under the Clean Air Act, which stated that power plants that burn fossil fuels, particularly coal, generate the greatest amount of mercury emissions from man-made sources. In the March 29, 2005, Federal Register, the EPA reversed its December 2000 finding that it was appropriate and necessary to regulate fossil fuel-fired power plants under section 112 of the Clean Air Act, concluding that the earlier finding lacked foundation and that recent information demonstrates that it is not appropriate or necessary to regulate fossil fuel-fired power plants under section 112. The EPA therefore removed coal- and oil-fired power plants from the section 112(c) list. Under section 112 of the Clean Air Act, the EPA would have been required to issue Maximum Available Control Technology standards for affected facilities and would have been prohibited from using cap and trade provisions for achieving compliance.
In the May 12, 2005, Federal Register, the EPA published the Clean Air Mercury Rule (CAMR), which regulates mercury emissions from coal-fired power plants located in 48 states, including Kansas and Missouri, under the New Source Performance Standards of the Clean Air Act. This final regulation was effective July 18, 2005.
The rule establishes a market-based cap-and-trade program that will reduce nationwide utility emissions of mercury in two phases. The first phase cap is effective January 1, 2010, and establishes a permanent nationwide cap of 38 tons of mercury for coal-fired power plants. The first phase cap is anticipated to be met by KCP&L taking advantage of mercury reductions achieved through capital expenditures to comply with CAIR and BART. The second phase is effective January 1, 2018, and establishes a permanent nationwide cap of 15 tons of mercury for coal-fired power plants. When fully implemented, the rule will reduce utility emissions of mercury by nearly 70% from current emissions of 48 tons per year.
Facilities will demonstrate compliance with the standard by holding allowances for each ounce of mercury emitted in any given year and allowances will be readily transferable among all regulated facilities nationwide. Under the cap-and-trade program, KCP&L will be able to purchase mercury allowances or elect to install pollution control equipment to achieve compliance. While it is expected that mercury allowances will be available in sufficient quantities for purchase in the 2010-2018 timeframe, the significant reduction in the nationwide cap in 2018 may hamper KCP&Ls ability to obtain reasonably priced allowances beyond 2018. KCP&L expects capital expenditures will be required to install additional pollution control equipment to meet the second phase cap. During the ensuing years, KCP&L will closely monitor advances in technology for removal of mercury from Powder River Basin coal and expects to make decisions regarding second phase removal based on then available technology to meet the January 1, 2018 compliance date. The ultimate cost of this rule could be significantly different from the amounts estimated in the table above. KCP&L is a participant in the Department of Energy (DOE) project at the Sunflower Electric Holcomb plant to investigate control technology options for mercury removal from coal-fired plants burning sub-bituminous coal.
On October 21, 2005, the EPA agreed to reconsider certain aspects of the rule and to invite additional comments on certain aspects of the rule. However, in its reconsideration notice, which was published in the October 28, 2005, Federal Register, the EPA reiterated its position that the methodology used for the risk analysis is performed to justify the CAMR is sound and scientifically justified. Comments are due by December 19, 2005. The EPAs actions to delist mercury under section 112 of the Clean Air Act and issue CAMR remain controversial and subject to challenge.
At a December 1997 meeting in Kyoto, Japan, delegates from 167 nations, including the U.S., agreed to a treaty (Kyoto Protocol) that would require a 7% reduction in U.S. CO2 emissions below 1990 levels, a nearly 30% cut from current levels. On March 28, 2001, the Bush administration announced it will not negotiate implementation of the Kyoto Protocol and it will not send the Kyoto Protocol to the U.S. Senate for ratification.
On February 14, 2002, President Bush unveiled his Clear Skies Initiative, which included a climate change policy. The climate change policy is a voluntary program that relies heavily on incentives to encourage industry to voluntarily limit emissions. The strategy includes tax credits, energy conservation programs, funding for research into new technologies, and a plan to encourage companies to track and report their emissions so that companies could gain credits for use in any future emissions trading program. The greenhouse strategy links growth in emissions of greenhouse gases to economic output. The administration's strategy is intended to reduce the greenhouse gas intensity of the U.S. economy by 18% over the next 10 years. Greenhouse gas intensity measures the ratio of greenhouse gas emissions to economic output as measured by Gross Domestic Product (GDP). Under
this plan, as the economy grows, greenhouse gases also would continue to grow, although at a slower rate than they would have without these policies in place. When viewed per unit of economic output, the rate of emissions would drop. The plan projects that the U.S. would lower its rate of greenhouse gas emissions from an estimated 183 metric tons per $1 million of GDP in 2002 to 151 metric tons per $1 million of GDP by 2012.
On December 19, 2002, KCP&L joined the Power Partners through Edison Electric Institute (EEI). Power Partners is a voluntary program with the DOE under which utilities commit to undertake measures to reduce, avoid or sequester CO2 emissions. On January 17, 2003, the EEI sent a letter to numerous Administration officials, in which the EEI committed to work with the government over the next decade to reduce the power sectors CO2 emissions per kWh generated (carbon intensity) by the equivalent of 3% to 5% of the current level. On December 13, 2004, Power Partners entered into a cooperative umbrella memorandum of understanding (MOU) with the DOE. This MOU contains supply and demand-side actions as well as offset projects that will be undertaken to reduce the power sectors CO2 emissions per kWh generated over the next decade consistent with the EEI commitment of 3% to 5%.
Air Particulate Matter and Ozone
In July 1997, the EPA revised ozone and particulate matter air quality standards creating a new eight-hour ozone standard and establishing a new standard for particulate matter less than 2.5 microns (PM-2.5) in diameter. On December 17, 2004, the EPA designated the Kansas City area as attainment with respect to the PM-2.5 NAAQS. In the May 3, 2005, Federal Register, the EPA published a final rule that designated Jackson, Platte, Clay and Cass counties in Missouri and Johnson, Linn, Miami and Wyandotte counties in Kansas as attainment with respect to the eight-hour ozone National Ambient Air Quality Standards (NAAQS) effective June 2, 2005.
Water Use Regulations
On February 16, 2004, the EPA finalized the Phase II rule implementing Section 316(b) of the Clean Water Act establishing standards for cooling water intake structures at existing facilities effective September 7, 2004. This final regulation is applicable to certain existing power producing facilities that employ cooling water intake structures that withdraw 50 million gallons or more per day and use 25% or more of that water for cooling purposes. KCP&L is required to complete a Section 316(b) comprehensive demonstration study on each of its generating facilities intake structures by the end of 2007, the studies are expected to cost a total of $1.2 million to $2.0 million. Depending on the outcome of the comprehensive demonstration studies, facilities may be required to implement technological, operational or restoration measures to achieve compliance. Compliance with the final rule is expected to be achieved between 2011 and 2014. Until the Section 316(b) comprehensive demonstration studies are completed, the impact of this final rule cannot be quantified.
Energy Policy Act of 2005
On August 8, 2005, President Bush signed into law the Energy Policy Act of 2005. The Energy Policy Act of 2005 repeals, effective February 8, 2006, the 35 Act, which places certain limitations and approval requirements on registered public utility holding company systems with respect to matters such as acquisitions, business combinations and activities, securities and affiliate transactions, and provides certain utility customer protection authority to the Federal Energy Regulatory Commission (FERC) and the states. Among other things, the Energy Policy Act of 2005 also revises the Public Utility Regulatory Policy Act (PURPA) to eliminate mandatory power purchase obligations; requires FERC to provide transmission investment incentives; accelerates depreciation on transmission lines and pollution control equipment; provides for the extension of production tax credits for wind energy generation; requires large municipals and cooperatives to provide open transmission access; requires a study of competition in wholesale and retail electricity markets; and authorizes the creation of an Electric Reliability Organization to establish and enforce mandatory reliability standards subject to
FERC oversight. Management has not yet fully determined its impact on Great Plains Energy and consolidated KCP&L.
Pennsylvania Gross Receipts Tax Contingency
In January 2005, Strategic Energy was advised by the Pennsylvania Department of Revenue of a potential tax deficiency relating to state gross receipts tax on Strategic Energys Provider of Last Resort (POLR) revenues from 2000 to 2002. During the first quarter of 2005, Strategic Energy reached a final settlement with the State of Pennsylvania for all three years with no deficiency related to the POLR revenues.
Income Tax Contingencies
Management evaluates and records contingent tax liabilities based on the probability of ultimately sustaining the tax deductions or income positions. Management assesses the probabilities of successfully defending the tax deductions or income positions based upon statutory, judicial or administrative authority.
At September 30, 2005, and December 31, 2004, the Company had $5.7 million and $13.4 million, respectively, of liabilities for contingencies related to tax deductions or income positions taken on the Companys tax returns. Consolidated KCP&L had liabilities of $1.7 million and $3.7 million at September 30, 2005, and December 31, 2004, respectively. Management believes the tax deductions or income positions are properly treated on such tax returns, but has recorded reserves based upon its assessment of the probabilities that certain deductions or income positions may not be sustained when the returns are audited. The tax returns containing these tax deductions or income positions are currently under audit or will likely be audited. The timing of the resolution of these audits is uncertain. If the positions are ultimately sustained, the Company will reverse these tax provisions to income. If the positions are not ultimately sustained, the Company may be required to make cash payments plus interest and/or utilize the Companys federal and state credit carryforwards. In the third quarter of 2005, the Company reversed $8.1 million of previously recorded contingent tax liabilities primarily due to sustained audited tax positions and the occurrence of events that strengthen the probability of successfully defending deductions taken on its tax returns. During the third quarter of 2005, consolidated KCP&L reversed $1.6 million of contingent tax liabilities.
Executing On Strategic Intent
KCP&L has continued to make progress in implementing its comprehensive energy plan during 2005. In the third quarter of 2005, KCP&L received approvals from the MPSC and KCC on its previously filed agreements regarding its comprehensive energy plan. The agreements were reached between KCP&L, the Commission staffs and certain key parties in the respective jurisdictions. The Sierra Club and Concerned Citizens of Platte County have appealed the MPSC order, and the Sierra Club has appealed the KCC order. These appeals are expected to be decided in 2006. Although subject to these appeals, the MPSC and KCC orders remain in effect pending the applicable courts decision.
The following are brief descriptions of the major provisions of the approved agreements.
The agreements provide regulatory clarity on certain items. However, normal regulatory risk will continue to exist as the commissions establish rates in the rate cases, including, but not limited to, the actual amount of costs to be recovered through rates, the return on equity, the capital structure utilized and expenses to be recovered. KCP&L projects that, if the cost of the plan is included in rate base, the rate increases to support the five year plan and increasing operating expenses would average approximately 3-4% annually, over the same time period.
The comprehensive energy plan is currently expected to be funded through a mix of sources as detailed in the following table.
Actual funding sources may differ from this estimated mix and may be affected by various factors, including, but not limited to, the results of the rate proceedings and market conditions.
Regulatory Assets and Liabilities
KCP&L is subject to the provisions of SFAS No. 71, Accounting for the Effects of Certain Types of Regulation. Accordingly, KCP&L has recorded assets and liabilities on its balance sheet resulting from the effects of the ratemaking process, which would not be recorded under GAAP for non-regulated entities. Regulatory assets represent costs incurred that have been deferred because future recovery in customer rates is probable. Regulatory liabilities generally represent probable future reductions in revenue or refunds to customers. KCP&Ls continued ability to meet the criteria for application of SFAS No. 71 may be affected in the future by competitive forces and restructuring in the electric industry. In the event that SFAS No. 71 no longer applied to all, or a separable portion, of KCP&Ls operations, the related regulatory assets and liabilities would be written off unless an appropriate regulatory recovery mechanism is provided. Additionally, these factors could result in an impairment of utility plant assets if the cost of the assets could not be expected to be recovered in customer rates. Whether an asset has been impaired is determined pursuant to the requirements of SFAS No. 144.
Except as noted below, regulatory assets for which costs have been incurred have been included (or are expected to be included, for costs incurred subsequent to the most recent rate case) in KCP&Ls rate base, thereby providing a return on invested costs when included in rate base. Certain regulatory assets do not result from cash expenditures and therefore do not represent investments included in rate base or have offsetting liabilities that reduce rate base. The pension accounting method difference (which may be either a regulatory asset or liability) and certain insignificant items in Regulatory Assets Other are not included in rate base.
Southwest Power Pool Regional Transmission Organization
Under FERC Order 2000, KCP&L, as an investor-owned utility, is strongly encouraged to join a FERC approved Regional Transmission Organization (RTO). RTOs combine transmission operations of utility businesses into regional organizations that schedule transmission services and monitor the energy market to ensure regional transmission reliability and non-discriminatory access. The Southwest Power Pool (SPP), of which KCP&L is a member, obtained approval from FERC as an RTO in a January 24, 2005, order. KCP&L intends on participating in the SPP RTO and during the third quarter of 2005, KCP&L filed applications with the MPSC and KCC seeking authorization to participate in the SPP RTO.
During 2005, a cost/benefit analysis was completed under the direction of the SPP Regional State Committee (composed of state commissioners from the states where the SPP RTO operates). The analysis indicates that implementation of an energy imbalance market within the SPP region would provide net benefits of approximately $373 million over a 10-year period to the transmission-owning members of the SPP RTO; however, there was no significant documented impact for KCP&L over the 10-year period. During June 2005, SPP filed its plans for the energy imbalance market with FERC. These plans include a May 1, 2006, start date for the energy imbalance market. During the third quarter of 2005, FERC issued an order rejecting this filing. In its order, FERC stated that significant modification or elaboration is needed before FERC can make its determination. SPP plans to make a revised filing in early 2006.
FERC Market Power Inquiry
KCP&L is authorized by FERC to sell wholesale power at market-based rates. As a condition of that authority, KCP&L must submit to FERC an updated market power analysis every three years. KCP&L submitted its most recent update in 2004. In December 2004, FERC issued an order finding that KCP&L potentially has generation market power in its own control area and the control area of the Kansas City, Kansas Board of Public Utilities (KCBPU). With respect to those control areas, FERC instructed KCP&L (i) to submit a delivered price test (DPT) analysis demonstrating that KCP&L does not possess generation market power; (ii) propose generation market power mitigation measures; or (iii) accept FERCs default cost-based rates for wholesale power sales or propose alternate cost-based rates (with cost support for such rates).
In February 2005, KCP&L submitted a DPT analysis demonstrating that, if KCP&Ls native load obligations are considered, KCP&L does not possess market power in its control area or the control area of KCBPU. On October 20, 2005, the FERC ruled that KCP&L had successfully rebutted the presumption of market power and terminated the proceeding.
Seams Elimination Charge Adjustment
Seams Elimination Charge Adjustment (SECA) is a transitional pricing mechanism authorized by FERC and intended to compensate transmission owners for the revenue lost as a result of FERCs elimination of regional through and out rates between PJM Interconnection (PJM) and the Midwest Independent Transmission System Operator, Inc. (MISO) during a 16-month transition period from December 1, 2004 through March 31, 2006. Each relevant PJM and MISO zone and the load-serving entities within that zone are allocated a portion of the SECA based on transmission services provided to that zone during 2002 and 2003. There are several unresolved matters and legal challenges to the SECA that are pending before FERC on rehearing. Management is unable to predict the outcome of legal and regulatory challenges to the SECA mechanism.
In the second quarter of 2005, PJM and MISO began invoicing Strategic Energy for these charges, based on allocations in compliance filings made by transmission owners and accepted by FERC, subject to refund and adjustment. Strategic Energy recorded purchased power expenses totaling $3.3 million and $10.5 million for the three months ended and year to date for these charges covering billings for the transition period through September 30, 2005. The compliance filings allocate approximately $1 million of charges per month, through March 2006. In the third quarter of 2005, Strategic Energy began to bill a portion of its SECA costs to its retail customers.
Management believes that a number of issues exist related to the SECA allocations. FERC established a schedule for resolution of certain SECA issues, including the issue of shifting SECA allocations to the shipper. The shipper in Strategic Energys situation is the wholesale supplier, which, through a contract with Strategic Energy, delivered power to various zones in which Strategic Energy was supplying retail customers. In most instances, the shipper was the purchaser of through and out transmission service and therefore included the cost of the through and out rate in its energy price. Management believes, but cannot assure, that Strategic Energy should not ultimately be responsible for the current level of SECA charges.
On August 25, 2005, WCNOC filed a lawsuit against Framatome ANP, Inc., and Framatome ANP Richland, Inc. (Framatome) in the District Court of Coffey County, Kansas. The suit alleges various claims against Framatome related to the design, licensing and installation of a digital control system. The suit seeks recovery of approximately $16 million in damages from Framatome.
On March 23, 2004, Robert C. Haberstroh filed suit for breach of employment contract and violation of the Pennsylvania Wage Payment Collection Act against Strategic Energy Partners, Ltd. (Partners), SE Holdings, L.L.C. (SE Holdings) and Strategic Energy in the Court of Common Pleas of Allegheny County, Pennsylvania. Mr. Haberstroh claims that he acquired an equity interest in Partners under the terms of his employment agreement and that through a series of transactions, Mr. Haberstrohs equity interest became an equity interest in SE Holdings. In 2001, Mr. Haberstrohs employment was terminated and SE Holdings redeemed his equity interest. Mr. Haberstroh is seeking the loss of his non-equity compensation (including salary, bonus and benefits) and equity compensation and associated distributions (his equity interest in SE Holdings).
Strategic Energy has filed a counterclaim against Mr. Haberstroh for breach of contract. SE Holdings, and its direct and indirect owners, have agreed to indemnify Strategic Energy and IEC against any judgment or settlement of Mr. Haberstrohs claim that relates to his alleged equity interest in SE Holdings, up to approximately $8 million plus any dividends or interest received in relation to his alleged interest.
On July 28, 2004, KLT Gas received a Notice and Demand for Arbitration Pursuant to Joint Operating Agreement from SWEPI LP doing business as Shell Western E&P and formerly known as Shell Western E&P Inc. (Shell). Prior to the October 2004 sale (with a July 1, 2004, effective date) of KLT Gas working interests in certain oil and gas leases in Duval County, Texas to Shell, KLT Gas had a 50% working interest in the leases. Shell held the other 50% working interest and was the operator of the properties under a joint operating agreement, as amended. Through arbitration, Shell sought recovery from KLT Gas of 50% of the fees, costs and settlements incurred in three lawsuits and Texas Railroad Commission proceedings, which Shell asserted totaled approximately $5.9 million for KLT Gas share, including interest. During the third quarter of 2005, the parties reached a confidential agreement to settle the matter for an amount less than was reserved in the second quarter of 2005 resulting in an $1.8 million after-tax gain reported as discontinued operations during the third quarter related to the reserve reversal.
Hawthorn No. 5 Subrogation Litigation
KCP&L filed suit on April 3, 2001, in Jackson County, Missouri Circuit Court against multiple defendants who are alleged to have responsibility for the 1999 Hawthorn No. 5 boiler explosion. KCP&L and National Union Fire Insurance Company of Pittsburgh, Pennsylvania (National Union) have entered into a subrogation allocation agreement under which recoveries in this suit are generally allocated 55% to National Union and 45% to KCP&L. Certain defendants have been dismissed from the suit and various defendants have settled with KCP&L. Trial of this case with the one remaining defendant resulted in a March 2004 jury verdict finding KCP&Ls damages as a result of the explosion were $452 million. After deduction of amounts received from pre-trial settlements with other defendants and an amount for KCP&Ls comparative fault (as determined by the jury), the verdict would have resulted in an award against the defendant of approximately $97.6 million (of which KCP&L would have received $33 million pursuant to the subrogation allocation agreement after payment of attorneys fees). In response to post-trial pleadings filed by the defendant, in May 2004 the trial judge reduced the award against the defendant to $0.2 million. Both KCP&L and the defendant have appealed this case to the Court of Appeals for the Western District of Missouri. Oral arguments are expected in the first quarter of 2006.
On December 31, 2001, a subsidiary of KLT Telecom Inc. (KLT Telecom), DTI Holdings, Inc. (Holdings) and its subsidiaries Digital Teleport Inc. (Digital Teleport) and Digital Teleport of Virginia, Inc., filed separate voluntary petitions in the Bankruptcy Court for the Eastern District of Missouri for reorganization under Chapter 11 of the U.S. Bankruptcy Code. DTI Holdings and its two subsidiaries
are collectively called DTI. In 2003, the Bankruptcy Court confirmed the plan of reorganization for these three companies.
KLT Telecom originally acquired a 47% interest in DTI in 1997. On February 8, 2001, KLT Telecom acquired control of DTI by purchasing shares from another Holdings shareholder, Richard D. Weinstein (Weinstein), increasing its ownership to 83.6%. In connection with this purchase, KLT Telecom granted Weinstein a put option. The put option provided for the sale by Weinstein of his remaining shares in Holdings to KLT Telecom during a period beginning September 1, 2003, and ending August 31, 2005. The put option provides for an aggregate exercise price for these remaining shares equal to their fair market value with an aggregate floor amount of $15 million. The floor amount of the put option was fully reserved during 2001. On September 2, 2003, Weinstein delivered to KLT Telecom notice of the exercise of his put option. KLT Telecom declined to pay Weinstein any amount under the put option because, among other things, the stock of Holdings had been cancelled and extinguished pursuant to the joint Chapter 11 plan confirmed by the Bankruptcy Court. Weinstein has sued KLT Telecom for allegedly breaching the put option and seeks damages of at least $15 million plus statutory interest. In April 2005, summary judgment in the Weinstein litigation was granted in favor of KLT Telecom, and Weinstein has appealed this judgment to the Missouri Court of Appeals for the Eastern District. The $15 million reserve has not been reversed pending the outcome of the appeal process, which management expects will conclude in the first quarter of 2006.
In March 2005, the Financial Accounting Standards Board (FASB) issued FASB Interpretation (FIN) No. 47, Accounting for Conditional Asset Retirement Obligations. FIN No. 47 clarifies that the term conditional asset retirement obligation, as used in FASB Statement No. 143, Accounting for Asset Retirement Obligation, refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. Great Plains Energy and consolidated KCP&L are required to adopt the provisions of FIN No. 47 by December 31, 2005, although earlier adoption is permitted. Management is currently evaluating the impact of FIN No. 47, and has not yet determined the impact on Great Plains Energy and consolidated KCP&Ls consolidated financial statements. KCP&L is a regulated utility subject to the provisions of SFAS No. 71 and management believes it is probable that any differences between expenses under SFAS No. 143, including FIN No. 47, and expenses recovered currently in rates will be recoverable in future rates.
Great Plains Energy
Great Plains Energy has two reportable segments based on its method of internal reporting, which generally segregates the reportable segments based on products and services, management responsibility and regulation. The two reportable business segments are KCP&L, an integrated, regulated electric utility and Strategic Energy, a competitive electricity supplier. Other includes the operations of HSS, Services, all KLT Inc. operations other than Strategic Energy, unallocated corporate charges, consolidating entries and intercompany eliminations. Intercompany eliminations include insignificant amounts of intercompany financing related activities. The summary of significant accounting policies applies to all of the reportable segments. For segment reporting, each segments income taxes include the effects of allocating holding company tax benefits. Segment performance is evaluated based on net income.
The following tables reflect summarized financial information concerning Great Plains Energys reportable segments.