Attached files
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| 8-K - 3RD QTR 2011 CVO REPORT - PROGRESS ENERGY INC | cvo_q3.htm |
Quarterly Report to Holders of Contingent Value Obligations
For the Quarter Ended September 30, 2011
November 15, 2011
To Holders of Contingent Value Obligations:
Overview
There are currently 98.6 million Contingent Value Obligations (CVOs) issued and outstanding. CVOs were issued as a result of the Progress Energy, Inc. (Progress Energy or the Company) and Florida Progress Corporation share exchange, which occurred on November 30, 2000. For every Florida Progress Corporation share owned at that time, one CVO was issued.
Each CVO represents the right of the holder to receive contingent payments, based on the net after-tax cash flow generated by the synthetic fuels plants previously owned by Solid Energy LLC, Ceredo Synfuel LLC, Solid Fuel LLC and Sandy River LLC (the Earthco plants). Qualifying synthetic fuels plants entitled their owners to federal income tax credits based on the barrel of oil equivalent of the synthetic fuels produced and sold by these plants. In the aggregate, holders of CVOs are entitled to payments equal to 50 percent of any net after-tax cash flow generated by the Earthco plants in excess of $80 million per year for each of the years 2001 through 2007. The synthetic fuels tax credit program expired on December 31, 2007, and all operations ceased.
As disclosed in previous reports, some of the tax credits generated by the Earthco plants in the years 2001 through 2007 were not realized or included in net after-tax cash flows for those years and are available to be realized in the future. CVO holders may be entitled to receive payments related to those carry forward tax credits, in addition to payments related to net after-tax cash flows. If any of these carry forward tax credits are realized, CVO holders will receive payments equal to 50 percent of the following amount: realized carry forward tax credits minus any amount by which net after-tax cash flow for the year in which they were generated was less than $80 million.
Upon the disposition of any interest in the Earthco plants to a third party prior to the year 2008, CVO holders may be entitled to share in the cash proceeds received by the Company from the third party. The CVO holders’ share of such disposition proceeds is based upon the CVO holders’ share of net after-tax cash flows generated in the years prior to the disposition.
All payments are first deposited with the CVO trustee (Trustee) in accordance with the legal documents governing the CVOs (the CVO Agreement). Net after-tax cash flow and carry forward credit payments will not generally be made to CVO holders until audit matters are resolved for the years of the tax returns in which the tax credits giving rise to the payments are realized. The Company cannot predict when the tax credits previously generated will be realized or when the audit matters for the tax return years in which tax credits are realized will be resolved. Based on past tax audit experience, the Company’s tax audits could take many years to resolve. Disposition proceeds payments will not generally be made to CVO holders until the termination of all indemnity obligations under the purchase and sale agreement related to the disposition.
For purposes of calculating CVO payments, net after-tax cash flows include the taxable income or loss for the Earthco plants adjusted for depreciation and other noncash items plus income tax benefits, and minus income tax incurred. The total amount of net after-tax cash flow for any year will depend upon the final determination of the income tax benefits realized and the income taxes incurred after completion of the income tax audits. Thus, the estimated after-tax cash flow generated by the Earthco plants could increase or decrease due to changes in income taxes for the year.
This is only an overview of the terms of the CVOs. The CVO Agreement contains significant additional information, including information concerning the realization of tax credits carried forward and payments of disposition proceeds.
Summary of Net After-Tax Cash Flows, Carry Forward Tax Credits and Deposits
The net after-tax cash flow and tax credits carried forward for the years 2001 through 2007 and the deposits with the Trustee were as follows:
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(in millions)
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Operation Year
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Net after-tax
cash flow(a)
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Tax credits carried
forward past 2007
and realized after 2007
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Remaining tax credits
generated but not
included in net after-
tax cash flow and not
yet realized
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Deposits with
Trustee
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2001
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$ | 2.6 | $ | - | $ | 112.9 | $ | - | ||||||||
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2002
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4.3 | - | 93.5 | - | ||||||||||||
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2003
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79.6 | - | 90.1 | - | ||||||||||||
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2004
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84.6 | - | 42.0 | 4.7 | (b) | |||||||||||
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2005
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(50.0 | ) | - | 87.3 | - | |||||||||||
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2006
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64.0 | - | - | - | ||||||||||||
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2007
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(90.0 | ) | - | - | - | |||||||||||
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Disposition of Ceredo Synfuel LLC
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N/A | N/A | N/A | 6.3 | (c) | |||||||||||
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(a)
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The amounts of net after-tax cash flows for the years 2001 through 2003 are final due to resolution of the Company’s tax audits for those years. The net after-tax cash flows for the years 2004 and after remain estimates, subject to revision based on final resolution of the Company’s tax audits for the years 2004 and after.
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(b)
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Deposited December 14, 2007, including interest. This deposit amount will be reduced by $2.4 million due to a decrease in the Company’s taxable income for the 2004 Operation Year subsequent to the original deposit date.
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(c)
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Deposited June 11, 2008, including interest.
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Realization of Carry Forward Tax Credits
For the Tax Year 2011, the Company estimates that it will not realize any tax credits generated in the Operation Years 2001 through 2007. The amount of realized tax credits is an estimate and is dependent on, among other things, the Company’s taxable income for the entire year. The actual amount of tax credits realized for the Tax Year 2011 may ultimately vary substantially from this amount.
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Allocable Expenses
In accordance with the CVO Agreement, the Company will be reimbursed for its “allocable expenses,” which include (1) certain fees and expenses related to the maintenance of the trust, (2) costs related to the administration of the CVOs and (3) the CVO holders’ share of the Company’s tax administration, audit or controversy expense related to the Earthco plants. The payments made to CVO holders will be reduced by the amount of these expenses. The Company is currently determining the amount of expense that should be allocated to the CVO holders. These expenses will be reported as soon as practicable.
Material Developments as of November 15, 2011
Claim of Holder of CVOs
On June 10, 2011, Davidson Kempner Partners, M.H. Davidson & Co., Davidson Kempner Institutional Partners, L.P., and Davidson Kempner International, Ltd. (jointly, Davidson Kempner) filed a lawsuit against the Company in the Supreme Court of the State of New York, County of New York. Davidson Kempner is a holder of CVOs and alleged that the Company improperly deducted escrow deposits in Operation Year 2005 in determining net after-tax cash flow under the CVO Agreement and that by taking this position, the Company breached their obligation under the CVO Agreement to exercise good faith and fair dealing. The plaintiffs alleged that this breach caused injury to the holders of CVOs in the approximate amount of $42 million. The plaintiffs requested declaratory judgment to require that the Company deduct the escrowed payments in Operation Year 2006.
On August 2, 2011, the parties filed a Stipulation of Discontinuance without Prejudice to dismiss the state lawsuit so that certain of the plaintiffs could file a federal lawsuit against the Company. On August 9, 2011, M.H. Davidson & Co. and Davidson Kempner International, Ltd. filed a lawsuit against the Company in the United States District Court for the Southern District of New York with the same allegations and seeking the same relief as the prior state lawsuit. On October 3, 2011, we entered a settlement agreement and release with Davidson Kempner under which the parties mutually released all claims related to the CVOs and the Company purchased all of Davidson Kempner’s CVOs at a negotiated purchase price of $0.75 per CVO. The parties to the federal lawsuit filed a Stipulation of Discontinuance with Prejudice dismissing the lawsuit on October 12, 2011.
Tender Offer for CVOs
The Company commenced a tender offer for any and all of its outstanding CVOs pursuant to the terms and conditions described in Progress Energy’s Offer to Purchase, dated November 7, 2011 and accompanying letter of transmittal. Under the terms of the tender offer, the purchase price will be $0.75 for each CVO tendered and accepted in the tender offer, without interest and subject to applicable withholding.
The tender offer is scheduled to expire at midnight, Eastern Time, February 15, 2012, unless extended, amended or earlier terminated by the Company in its sole discretion. However, the Company may accept CVOs for purchase from holders who validly tender CVOs by 5 p.m., Eastern Time, December 15, 2011, and have not withdrawn them.
The tender offer is not subject to the receipt of any minimum amount of CVOs, but is subject to the general conditions set forth in the Offer to Purchase. Holders of CVOs are urged to read the Offer to Purchase and the accompanying letter of transmittal carefully before making any decision with respect to the tender offer.
The Company has engaged Phoenix Advisory Partners as information agent. Questions regarding the tender offer may be directed to Phoenix Advisory Partners at (877) 478-5038 (toll free) or (212) 493-3910 (collect). The depositary for the tender offer is American Stock Transfer, LLC.
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Merger Agreement
On January 8, 2011, Duke Energy and Progress Energy entered into an Agreement and Plan of Merger (Merger Agreement). Pursuant to the Merger Agreement, Progress Energy will be acquired by Duke Energy in a stock-for-stock transaction (the Merger) and continue as a wholly owned subsidiary of Duke Energy. Consummation of the Merger is subject to customary conditions, including, among other things, approval of the shareholders of each company, expiration or termination of the applicable Hart-Scott-Rodino Act waiting period, and receipt of approvals, to the extent required, from state and federal regulatory agencies. Certain substantial changes in ownership of Progress Energy, including the Merger, can impact the timing of the utilization of tax credit carry forwards. The Company cannot predict the outcome of this matter.
Disposition of Ceredo Synfuel LLC
In March 2007, the Company sold its 100 percent partnership interest in Ceredo Synfuel LLC (Ceredo), which was one of the Earthco plants, to a third-party buyer. In addition, the Company entered into an agreement to operate Ceredo on behalf of the buyer. At closing, the Company received cash proceeds of $10 million and a nonrecourse note receivable of $54 million. Payments on the note were received as Ceredo produced and sold qualified coal-based solid synthetic fuels during 2007. The Company received payments on the note related to 2007 production of $49 million in 2007 and $5 million in 2008. A purchase price adjustment pursuant to the terms of the purchase and sale agreement and other adjustments to proceeds not related to the sale of the partnership interest in Ceredo resulted in total cash proceeds of $44 million. Pursuant to the terms of the purchase and sale agreement, the Company will indemnify the buyer against certain losses, including, but not limited to, losses arising from the disallowance of synthetic fuels tax credits. Based upon the cash proceeds received by the Company, the CVO holders’ share of disposition proceeds of approximately $6 million, excluding interest, was deposited with the Trustee in the second quarter of 2008. Disposition proceeds payments will not generally be made to CVO holders until the termination of all indemnity obligations under the purchase and sale agreement related to the disposition.
Tax Credits
Legislation enacted in 2005 redesignated the Section 29 tax credit as a general business credit under Section 45K of the Code (Section 45K) effective January 1, 2006. The previous amount of Section 29 tax credits that the Company was allowed to claim in any calendar year through December 31, 2005, was limited by the amount of its regular federal income tax liability. Section 29 tax credit amounts allowed but not utilized are carried forward indefinitely as deferred alternative minimum tax credits. The redesignation of Section 29 tax credits generated after January 1, 2006, as Section 45K general business credits removed the regular federal income tax liability limit on synthetic fuels production and subjects the tax credits to a one-year carry back and 20-year carry forward period. In accordance with IRS ordering rules, general business credits are utilized prior to deferred alternative minimum tax credits.
Carry Back of Tax Credits
At the time that the CVOs were issued, the synthetic fuels tax credits were designated as Section 29 tax credits and, as such, unused synthetic fuels tax credits could only be carried forward as deferred alternative minimum tax credits for use in future years. The redesignation of Section 29 tax credits as Section 45K general business credits subjects the tax credits generated on or after January 1, 2006, to a one-year carry back period prior to a 20-year carry forward period. This unanticipated change in the nature of the tax credits may result in the Company’s synthetic fuels tax credits being utilized and realized in a manner that is different from the utilization and realization expected at the time that the CVOs were issued.
For example, Section 45K tax credits generated in 2007 would first be realized in 2007. Any unused Section 45K tax credits generated in 2007 would then be carried back one year and realized in 2006. If any Section 45K tax credits generated in 2007 remain unused, they will then be carried forward for up to 20 years until fully realized. Under the carry forward rules applicable at the time that the CVOs were issued, tax credits generated in 2007 would first be used in 2007 and any unused tax credits would be carried forward as deferred alternative minimum tax credits to be used in future years.
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Given that when the CVOs were issued, unused Section 29 tax credits could only be carried forward, not back, the CVO Agreement does not address how a carry back of unused Section 45K tax credits should be handled. Thus, there is no provision in the CVO Agreement that provides for the 2006 net after-tax cash flow to be increased by unused Section 45K tax credits generated in 2007, carried back one year and realized in 2006. Similarly, there is no provision in the CVO Agreement that allows for the 2007 net after-tax cash flow to be increased by unused Section 45K tax credits generated in 2007, which are carried back one year and realized in 2006.
Although the CVO Agreement did not contemplate carry backs of the synthetic fuels tax credits, it does provide that tax credits realized during an Operation Year (i.e., the years 2001 through 2007) would be applied to the net after-tax cash flow of the year in which they are realized, regardless of the year in which they are generated. Accordingly, the Company believes that Section 45K tax credits generated in one Operation Year and carried back and realized in a previous Operation Year should be included in the net after-tax cash flow of the Operation Year in which they are realized.
Supplemental Information
Where can I find a current market value of the CVOs?
CVOs are traded on the Over The Counter “pink sheets.” To obtain a value, contact your broker or visit pinksheets.com. Type “PREX” in the “get quote” section and click “go,” to obtain the latest quote.
How can I purchase or sell CVOs?
You will need to contact a broker to purchase or sell CVOs.
What is the tax basis in the CVOs?
For federal income tax reporting purposes, the Company will treat 54.5 cents as the fair market value of each CVO issued on November 30, 2000, the effective date of the share exchange. That amount is the average of the reported high and low trading prices of the CVOs on the NASDAQ Over The Counter Market on November 30, 2000. If you received your CVOs in the share exchange, your tax basis for your CVOs is 54.5 cents. If you acquired your CVOs after the share exchange, please consult your tax advisor for your tax basis.
Who is the Securities Registrar and Transfer Agent for the CVOs?
American Stock Transfer & Trust Company
6201 15th Avenue
Brooklyn, NY 11219
Call toll-free: 1.877.711.4092
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